ExlService Holdings, Inc. — Q3 2013 Form 10-Q
Reporting period: Quarter and nine months ended September 30, 2013. Unaudited; comparisons are with the corresponding 2012 periods. ExlService provides outsourcing and transformation services, principally to clients in the U.S. and U.K.
Financial performance
| Metric | Q3 2013 | Q3 2012 | 9M 2013 | 9M 2012 |
|---|---|---|---|---|
| Revenue | $122.3m | $112.6m | $354.3m | $325.3m |
| Gross profit / margin | $50.3m / 41.1% | $44.0m / 39.1% | $135.4m / 38.2% | $123.9m / 38.1% |
| Operating income / margin | $19.5m / 16.0% | $16.9m / 15.0% | $44.4m / 12.5% | $41.7m / 12.8% |
| Net income | $13.2m | $11.7m | $32.2m | $29.7m |
| Diluted EPS | $0.39 | $0.35 | $0.95 | $0.90 |
- Revenue rose 8.6% in Q3 and 8.9% year to date. Outsourcing services generated $99.7m in Q3 and $294.6m in 9M; transformation services generated $22.6m and $59.8m, respectively.
- Q3 gross margin and operating margin improved year over year; 9M operating margin declined as SG&A grew faster than revenue. Net margin was 10.8% in Q3 versus 10.4%; 9M net margin was 9.1% in both years.
- Cash from operations was $44.2m for 9M, versus $43.4m. Capital expenditures were $11.7m, giving approximate operating cash flow less capital expenditures of $32.5m. Cash and cash equivalents increased to $132.4m from $103.0m at year-end 2012.
- At September 30, cash and short-term investments totaled $138.5m, including $70.5m held by foreign subsidiaries. Current assets were $237.6m and current liabilities $67.1m. The company reported no borrowings on its credit facility; capital lease obligations totaled $2.7m. It had a $15m revolving facility available, subject to conditions.
- Total liabilities were $87.0m. The filing reports no off-balance-sheet arrangements. Contractual cash obligations totaled $38.7m, principally operating leases.
Changes and notable items
- Landacorp, acquired in October 2012, contributed $7.4m of Q3 and $16.0m of 9M outsourcing revenue. Revenue growth also reflected client volume gains, partly offset by foreign-exchange effects.
- Q3 SG&A rose 19.2% to $24.8m, including a $2.0m write-off of an acquired Landacorp receivable. Stock-based compensation was $9.5m for 9M, up from $7.3m; the filing includes an additional $0.9m expense from modified vesting conditions.
- Foreign-exchange losses were $2.5m in Q3 and $3.1m in 9M, compared with $1.3m and $2.4m, respectively, in 2012. Other comprehensive loss was $11.5m in Q3 and $30.6m in 9M, largely reflecting hedge and currency translation effects; comprehensive income was $1.7m and $1.6m, respectively.
- The effective tax rate fell to 24.2% for Q3 and 25.2% for 9M, from 27.0% in both 2012 periods. Management attributed the decline mainly to Philippine tax-holiday extensions, R&D credits and other deductions, partly offset by reduced Indian tax benefits.
Outlook, risks and contingencies
- On November 1, 2013, Travelers gave notice terminating its services agreement. Travelers represented 9.6% of Q3 revenue and 9.7% of 9M revenue. Management estimated a $14m–$28m reduction in 2014 revenue; it did not expect a material impact on 2013 revenue and expected to redeploy staff and infrastructure. The company may have to provide disentanglement services at its expense for up to 18 months; transition plans had not been discussed.
- Management expected $3m–$5m of additional capital expenditures in the remainder of 2013. It anticipated funding ordinary capital needs, working capital and smaller acquisitions from operating cash flow; significant acquisition-led growth could require additional financing.
- Key risks include client and industry concentration, the Travelers transition, foreign-exchange exposure, pricing and margin pressure, hiring and retention, international operations, data security, and changes to tax incentives. The top ten clients contributed 57.1% of Q3 and 58.8% of 9M revenue; no client exceeded 10% in 2013.
- Indian tax authorities disputed transfer-pricing and permanent-establishment positions, with $14.8m in aggregate assessments at September 30; $12.9m had been paid or secured by bank guarantees. Management considered ultimate liability remote and recorded no accrual. The filing notes further assessments remain possible.
- Management stated disclosure controls were effective and reported no material change in internal control over financial reporting.
Important facts for investors to verify
- Travelers’ final termination date, transition costs, actual 2014 revenue loss, and the pace of client replacement or redeployment.
- Whether revenue growth and margins persist after separating Landacorp contributions, currency effects and the acquired-receivable write-off.
- Cash generation and investment needs, including the location and repatriation constraints on foreign cash and the terms of the undrawn credit facility.
- Developments in Indian tax disputes, potential additional assessments, and the duration of Philippine and Indian tax incentives.
- Foreign-exchange exposures and hedge liabilities: derivative liabilities were $19.8m at September 30, and approximately $11.4m of net derivative losses in accumulated other comprehensive income were expected to be reclassified into earnings within 12 months.