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EXLS > SEC Filings for EXLS > Form 10-Q on 5-Nov-2012All Recent SEC Filings

Show all filings for EXLSERVICE HOLDINGS, INC.

Form 10-Q for EXLSERVICE HOLDINGS, INC.


5-Nov-2012

Quarterly Report


ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

You should read the following discussion in connection with our unaudited consolidated financial statements and the related notes included elsewhere in this Quarterly Report on Form 10-Q and our audited consolidated financial statements and the related notes included in our Annual Report on Form 10-K for the fiscal year ended December 31, 2011. Some of the statements in the following discussion are forward looking statements. See "Forward Looking Statements." Dollar amounts within Item 2 are presented as actual dollar amounts.

Forward Looking Statements

This Quarterly Report on Form 10-Q contains forward looking statements. You should not place undue reliance on these statements because they are subject to numerous uncertainties and factors relating to our operations and business environment, all of which are difficult to predict and many of which are beyond our control. Forward looking statements include information concerning our possible or assumed future results of operations, including descriptions of our business strategy. These statements often include words such as "may," "will," "should," "believe," "expect," "anticipate," "intend," "plan," "estimate" or similar expressions. These statements are based on assumptions that we have made in light of our experience in the industry as well as our perceptions of historical trends, current conditions, expected future developments and other factors we believe are appropriate under the circumstances. As you read and consider this Quarterly Report on Form 10-Q, you should understand that these statements are not guarantees of performance or results. They involve known and unknown risks, uncertainties and assumptions. Although we believe that these forward looking statements are based on reasonable assumptions, you should be aware that many factors could affect our actual financial results or results of operations and could cause actual results to differ materially from those in the forward looking statements. These factors include but are not limited to:

our dependence on a limited number of clients in a limited number of industries;

worldwide political, economic or business conditions;

negative public reaction in the United States or elsewhere to offshore outsourcing;

fluctuations in exchange rates between the currencies in which we receive our revenues and the currencies in which we incur our costs;

fluctuations in our earnings;

our ability to attract and retain clients;

our ability to successfully consummate or integrate acquisitions;

restrictions on immigration;

our ability to hire and retain enough sufficiently trained employees to support our operations;

our ability to grow our business or effectively manage growth and international operations;

increasing competition in our industry;

telecommunications or technology disruptions;

regulatory, legislative and judicial developments, including changes to or the withdrawal of governmental fiscal incentives;

technological innovation;

political or economic instability in the locations in which we operate;

unauthorized disclosure of sensitive or confidential client and customer data; and

adverse outcome of our disputes with the Indian tax authorities.

These and other factors are more fully discussed elsewhere in this Quarterly Report on Form 10-Q. These and other risks could cause actual results to differ materially from those implied by forward looking statements in this Quarterly Report on Form 10-Q.


You should keep in mind that any forward looking statement made by us in this Quarterly Report on Form 10-Q, or elsewhere, speaks only as of the date on which we make it. New risks and uncertainties come up from time to time, and it is impossible for us to predict those events or how they may affect us. We have no obligation to update any forward looking statements in this Quarterly Report on Form 10-Q after the date of this Quarterly Report on Form 10-Q, except as required by federal securities laws.

Overview

We are a leading provider of outsourcing and transformation services and focus on providing our clients with a positive business impact and enhancing their long term financial value. We customize our services to improve the economics of business performance and transform organizations to be leaner and more flexible. Our outsourcing services provide front-, middle- and back-office processing services for our primarily U.S.-based and U.K.-based clients. Outsourcing services involve the transfer to us of select business operations of a client, such as claims processing, finance and accounting and customer service, after which we administer and manage the operations for our client on an ongoing basis. We also offer a number of transformation services that include decision analytics, finance transformation and operations and process excellence services. These transformation services help our clients improve their operating environments through cost reduction, enhanced efficiency and productivity initiatives, and improve the risk and control environments within our clients' operations whether or not they are outsourced to us. We serve primarily the needs of Global 1000 companies in the insurance, healthcare, utilities, banking and financial services, transportation and logistics and travel sectors.

On October 1, 2011, we acquired Trumbull Services, LLC ("Trumbull"), a market leader in subrogation services for property and casualty insurance companies, from the Hartford Financial Services Group, Inc. (the "Trumbull Acquisition"). With the Trumbull Acquisition, we have strengthened our leadership position in the insurance industry with a highly skilled and experienced employee base and access to an advanced software platform, and have become a leading provider of complex insurance subrogation outsourcing services.

We market our services to our existing and prospective clients through our sales and client management teams, which are aligned by industry verticals and cross-industry domains such as finance and accounting. Our sales and client management teams operate from the U.S. and Europe and are supported by our business development team, which operates from the U.S. and India. We operate fifteen operations centers in India, including an operations center in Pune, India which began operations in June 2012 and is eligible for certain tax incentives as a result of being located in a special economic zone. We also operate five operations centers in the U.S., two operations centers in the Philippines, two operations centers in Bulgaria and one operations center in each of Romania, Malaysia and the Czech Republic.

We generate revenues principally from contracts to provide outsourcing and transformation services. For the three and nine months ended September 30, 2012, we had total revenues of $112.6 million and $325.3 million, respectively, compared to total revenues of $100.0 million and $258.0 million in the three and nine months ended September 30, 2011, respectively, an increase of $12.6 million and $67.3 million, respectively, or 12.6% and 26.1%, respectively.

Revenues from outsourcing services increased from $83.2 million and $208.8 million for the three and nine months ended September 30, 2011, respectively, to $92.0 million and $270.6 million for the three and nine months ended September 30, 2012, respectively. The increase in revenues from outsourcing services of $8.8 million for the three months ended September 30, 2012, was driven primarily by revenues of $2.1 million from the acquisition of Trumbull and net volume increases from existing and new clients aggregating to $11.5 million. The increase in revenues from outsourcing services of $61.8 million for the nine months ended September 30, 2012, was driven primarily by revenues of $45.9 million from the acquisitions of Business Process Outsourcing, Inc. ("OPI") and Trumbull and net volume increases from existing and new clients aggregating to $27.8 million. These increases were offset partially by a net decrease in revenues of $4.8 million and $11.9 million, primarily due to the depreciation of each of the Indian rupee, U.K. pound sterling and Czech koruna against the U.S. dollar during the three and nine months ended September 30, 2012 compared to the three and nine months ended September 30, 2011.


Revenues from transformation services increased from $16.8 million and $49.2 million for the three and nine months ended September 30, 2011, respectively to $20.7 million and $54.6 million for the three and nine months ended September 30, 2012, respectively. The increase was primarily due to a combination of increased revenues in recurring or annuity decision analytics services and an increase in project-based engagements both in our decision analytics and operations and process excellence practices during the three and nine months ended September 30, 2012 compared to the three and nine months ended September 30, 2011. Revenues from new clients for transformation services were $0.2 million and $5.2 million during the three and nine months ended September 30, 2012, respectively, and $0.1 million and $0.4 million during the three and nine months ended September 30, 2011, respectively.

We anticipate that our revenues will grow as we expand our service offerings and client base, both organically and through acquisitions. We provide our clients with a range of outsourcing services principally in the insurance, healthcare, utilities, banking and financial services, transportation and logistics and travel sectors, as well as cross-industry outsourcing services, such as finance and accounting services. Our clients transfer the management and execution of their processes or business functions to us. As part of this transfer, we hire and train employees to work at our operations centers on the relevant outsourcing services, implement a process migration to these operations centers and then provide services either to the client or directly to the client's customers. Each client contract has different terms based on the scope, deliverables and complexity of the engagement. The outsourcing services we provide to any of our clients (particularly under our general framework agreements), and the revenues and income that we derive from those services, may decline or vary as the type and quantity of services we provide under those contracts change over time, including as a result of a shift in the mix of products and services we provide.

For outsourcing services, we enter into long-term agreements with our clients with typical initial terms ranging from three to eight years. These contracts also usually contain provisions permitting termination of the contract after a short notice period. Although these agreements provide us with a relatively predictable revenue base for a substantial portion of our business, the long selling cycle for our outsourcing services and the budget and approval processes of prospective clients make it difficult to predict the timing of new client acquisitions. Revenues under new client contracts also vary depending on when we complete the selling cycle and the implementation phase. Since our client contracts can be terminated after a short notice period, and because we operate in a competitive commercial environment, during the ordinary course of our business one or more of our clients may terminate their respective contracts with us, thereby leading to fluctuations in our revenues.

Our transformation services can be significantly affected by variations in business cycles. In addition, our transformation services consist primarily of specific projects with contract terms generally not exceeding one to three years and may not produce ongoing or recurring business for us once the project is completed. These contracts also usually contain provisions permitting termination of the contract after a short notice period. The short-term nature and specificity of these projects could lead to further material fluctuations and uncertainties in the revenues generated from these businesses. We have experienced a significant increase in demand for our annuity-based transformation services, which are engagements that are contracted for one- to three-year terms.

We serve clients mainly in the U.S. and the U.K., with these two regions generating approximately 71.9% and 20.5%, respectively, of our total revenues for the three months ended September 30, 2012 and approximately 71.5% and 21.0%, respectively, of our total revenues for the three months ended September 30, 2011. For the nine months ended September 30, 2012, these two regions generated approximately 72.1% and 20.3%, respectively, of our total revenues and approximately 71.7% and 22.9%, respectively, of our total revenues for the nine months ended September 30, 2011.

In the three months ended September 30, 2012 and 2011, our total revenues from our three largest clients were $29.1 million and $29.2 million, respectively, accounting for 25.8% and 29.2% of our total revenues, respectively, during these periods. In the nine months ended September 30, 2012 and 2011, our total revenues from our three largest clients were $85.3 million and $86.7 million, respectively, accounting for 26.2% and 33.6% of our total revenues, respectively, during these periods. Although we are increasing and diversifying our customer base, we expect in the near future that a significant portion of our revenues will continue to be contributed by a limited number of large clients.


Pursuant to a services agreement, we provide services to The Travelers Companies ("Travelers"). These services to Travelers represented $11.2 million, or 9.9%, and $33.3 million, or 10.2%, respectively of our total revenues for the three and nine months ended September 30, 2012 and $10.7 million, or 10.7%, and $31.0 million, or 12.0%, respectively of our total revenues for the three and nine months ended September 30, 2011. Travelers may terminate the services agreement, or any work assignment or work order thereunder, each of which expires in December 2013, without cause upon 60 days' prior notice.

We derived revenues from five new clients for our services in each of the three months ended September 30, 2012 and 2011 and twenty five and thirteen new clients for our services in the nine months ended September 30, 2012 and 2011, respectively.

Revenues also include amounts representing reimbursable expenses that are billed to and reimbursed by our clients and typically include telecommunication and travel-related costs. The amount of reimbursable expenses that we incur, and any resulting revenues, can vary significantly from period to period depending on each client's situation and on the type of services provided. For the three months ended September 30, 2012 and 2011, 4.6% and 4.3%, respectively, of our revenues represent reimbursement of such expenses. For the nine months ended September 30, 2012 and 2011, 4.5% and 4.3%, respectively of our revenues represent reimbursement of such expenses.

To the extent our client contracts do not contain provisions to the contrary, we bear the risk of inflation and fluctuations in currency exchange rates with respect to our contracts. We hedge a substantial portion of our Indian rupee/U.S. dollar, Philippine peso/U.S. dollar and U.K. pound sterling/U.S. dollar exposure.

We have observed a shift in industry pricing models toward transaction-based pricing and other pricing models. We believe this trend will continue and we have begun to use transaction-based and other pricing models with some of our current clients and are seeking to move certain other clients from a billing rate model to a transaction-based or other pricing model. Such models place the focus on operating efficiency in order to maintain our operating margins. In addition, we have also observed that prospective larger clients are entering into multi-vendor relationships with regard to their outsourcing needs. We believe that the trend toward multi-vendor relationships will continue. A multi-vendor relationship allows a client to seek more favorable pricing and other contract terms from each vendor, which can result in significantly reduced operating margins from the provision of services to such client for each vendor. To the extent our large clients expand their use of multi-vendor relationships and are able to extract more favorable contract terms from other vendors, our operating margins and revenues may be reduced with regard to such clients if we are required to modify the terms of our relationships with such clients.


Critical Accounting Policies and Estimates

For a description of our critical accounting policies and estimates, refer to our Annual Report on Form 10-K for the year ended December 31, 2011.

Results of Operations

The following table summarizes our results of operations:



                                             Three months ended September 30,                 Nine months ended September 30,
                                              2012                      2011                  2012                      2011
                                                       (in millions)                                   (in millions)
Revenues(1)                              $         112.6           $         100.0       $         325.3           $         258.0
Cost of revenues (exclusive of
depreciation and amortization)(2)                   68.6                      61.7                 201.4                     158.0

Gross profit                                        44.0                      38.3                 123.9                     100.0

Operating expenses:
General and administrative
expenses(3)                                         13.8                      13.3                  41.0                      36.1
Selling and marketing expenses(3)                    7.0                       6.9                  22.5                      18.9
Depreciation and amortization
expenses(4)                                          6.3                       6.4                  18.7                      16.4

Total operating expenses                            27.1                      26.6                  82.2                      71.4

Income from operations                              16.9                      11.7                  41.7                      28.6
Other income/(expense):
Foreign exchange (loss)/gain                        (1.4 )                     0.5                  (2.3 )                     3.9
Interest and other income                            0.5                       0.3                   1.3                       1.3

Income before income taxes                          16.0                      12.5                  40.7                      33.8
Income tax provision                                 4.3                       4.1                  11.0                       8.6

Net income                               $          11.7           $           8.4       $          29.7           $          25.2

(1) Revenues include reimbursable expenses of $5.2 million and $4.3 million for the three months ended September 30, 2012 and 2011, respectively, and $14.6 million and $11.0 million for the nine months ended September 30, 2012 and 2011, respectively.

(2) Cost of revenues includes $0.3 million each during the three months ended September 30, 2012 and 2011, and $1.6 million and $1.3 million for the nine months ended September 30, 2012 and 2011, respectively, of non-cash amortization of stock compensation expense relating to the issuance of equity awards to employees directly involved in providing services to our clients as described in Note 13 to our unaudited consolidated financial statements contained herein.

(3) General and administrative expenses and selling and marketing expenses include $1.5 million and $1.8 million for the three months ended September 30, 2012 and 2011, respectively, and $5.8 million and $6.0 million during the nine months ended September 30, 2012 and 2011, respectively, of non-cash amortization of stock compensation expense relating to the issuance of equity awards to our non-operations staff as described in Note 13 to our unaudited consolidated financial statements contained herein.

(4) Depreciation and amortization includes $1.3 million and $1.4 million for the three months ended September 30, 2012 and 2011, respectively, and $4.1 million and $2.9 million for the nine months ended September 30, 2012 and 2011, respectively, of amortization of intangibles as described in Note 5 to our unaudited consolidated financial statements contained herein.


Three Months Ended September 30, 2012 Compared to Three Months Ended September 30, 2011

Revenues. Revenues increased 12.6% from $100.0 million for the three months ended September 30, 2011 to $112.6 million for the three months ended September 30, 2012. Revenues from outsourcing services increased from $83.2 million during the three months ended September 30, 2011 to $92.0 million during the three months ended September 30, 2012. The increase in revenues from outsourcing services of $8.8 million was primarily driven by revenues of $2.1 million from the acquisition of Trumbull and net volume increases from existing and new clients aggregating to $11.5 million. These increases were partially offset by a net decrease in revenues of $4.8 million, primarily due to the depreciation of each of the Indian rupee, U.K. pound sterling and Czech koruna against the U.S. dollar during the three months ended September 30, 2012 compared to the three months ended September 30, 2011.

Revenues from transformation services increased from $16.8 million for the three months ended September 30, 2011 to $20.7 million for the three months ended September 30, 2012. The increase was primarily due to a combination of increased revenues in recurring or annuity decision analytics services and an increase in project-based engagements both in our decision analytics and operations and process excellence practices during the three months ended September 30, 2012 compared to the three months ended September 30, 2011. Revenues from new clients for transformation services were $0.2 million and $0.1 million during the three months ended September 30, 2012 and 2011, respectively.

Cost of Revenues. Cost of revenues increased 11.2% from $61.7 million for the three months ended September 30, 2011 to $68.6 million for the three months ended September 30, 2012. The increase in cost of revenues was primarily due to an increase in employee-related costs of $9.6 million as a result of an increase in the number of our personnel directly involved in providing services to our clients, including $0.9 million of employee-related costs related to the acquisition of Trumbull. We also experienced an increase in reimbursable expenses of $0.8 million (resulting in an increase in revenues) and an increase in facilities, technology and other operating expenses of $4.2 million (primarily due to our acquisition of Trumbull and the opening of our new operations centers to support business growth). These increases were partially offset by a decrease of $7.8 million due to the net effect of depreciation of the Indian rupee, Bulgarian leva and Czech koruna and appreciation of the Philippine peso against the U.S. dollar during the three months ended September 30, 2012 compared to the three months ended September 30, 2011. Cost of revenues as a percentage of revenues decreased marginally from 61.7% for the three months ended September 30, 2011 to 60.9% for the three months ended September 30, 2012.

Gross Profit. Gross profit increased 14.9% from $38.3 million for the three months ended September 30, 2011 to $44.0 million for the three months ended September 30, 2012. The increase in gross profit was primarily due to an increase in revenues of $12.6 million, offset by an increase in cost of revenues of $6.9 million. Gross profit as a percentage of revenues increased marginally from 38.3% for the three months ended September 30, 2011 to 39.1% for the three months ended September 30, 2012, primarily due to the depreciation of the Indian rupee against the U.S. dollar, partially offset by the impact of the Trumbull acquisition in 2011.

Selling, General and Administrative Expenses. Selling, general and administrative ("SG&A") expenses increased 3.1% from $20.2 million for the three months ended September 30, 2011 to $20.8 million for the three months ended September 30, 2012. The increase in SG&A expenses was primarily due to an increase in employee-related costs of $1.2 million, including $0.4 million of employee-related costs related to the acquisition of Trumbull, and an increase in other SG&A costs of $0.8 million during the three months ended September 30, 2012 compared to the three months ended September 30, 2011. These increases were partially offset by a decrease of $1.3 million due to the net effect of depreciation of the Indian rupee and Czech koruna and appreciation of the Philippine peso against the U.S. dollar during the three months ended September 30, 2012 compared to the three months ended September 30, 2011. As a percentage of revenues, SG&A expenses decreased from 20.2% for the three months ended September 30, 2011 to 18.5% for the three months ended September 30, 2012.

Depreciation and Amortization. Depreciation and amortization decreased 1.7% from $6.4 million for the three months ended September 30, 2011 to $6.3 million for the three months ended September 30, 2012. For the three months ended September 30, 2012 depreciation increased by $0.7 million as compared to three months ended September 30, 2011, primarily due to the opening of our new operations centers and the acquisition of Trumbull, partially offset by a decrease in amortization of acquisition-related intangibles of $0.1 million. As we add more operations centers, we expect that our depreciation expense will increase to reflect the additional investment in equipment and other capital expenditures related to opening and maintaining operations centers necessary to meet our service requirements. This increase was offset by a decrease of $0.7 million due to the net effect of depreciation of the Indian rupee, and Czech koruna and appreciation of the Philippine peso against the U.S. dollar during the three months ended September 30, 2012 compared to the three months ended September 30, 2011. As a percentage of revenues, depreciation and amortization decreased from 6.4% for the three months ended September 30, 2011 to 5.6% for the three months ended September 30, 2012.


Income from Operations. Income from operations increased 44.7% from $11.7 million for the three months ended September 30, 2011 to $16.9 million for the three months ended September 30, 2012. As a percentage of revenues, income from operations increased from 11.7% for the three months ended September 30, 2011 to 15.0% for the three months ended September 30, 2012. The increase in income from operations as a percentage of revenues was primarily due to operating leverage resulting in lower SG&A expenses as a percentage of revenues during the three months ended September 30, 2012.

Other Income/(Expense). Other income is comprised of foreign exchange gains and losses, interest income and expense and other items. Other income decreased from $0.9 million for the three months ended September 30, 2011 to ($0.8 million) for the three months ended September 30, 2012. This decrease was primarily a result of a net foreign exchange loss of $1.3 million during the three months ended September 30, 2012 compared to a net foreign exchange gain of $0.5 million during the three months ended September 30, 2011, primarily attributable to the . . .

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