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EXLS > SEC Filings for EXLS > Form 10-Q on 3-May-2013All Recent SEC Filings

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Form 10-Q for EXLSERVICE HOLDINGS, INC.


3-May-2013

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, 2012. Some of the statements in the following discussion are forward looking statements. See "Forward Looking Statements" below. 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 U.S. or elsewhere to offshore outsourcing;

• fluctuations in our earnings;

• our ability to attract and retain clients;

• our ability to successfully consummate or integrate strategic 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 geographies 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.


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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 for our clients, who are primarily global companies. Outsourcing services involve the transfer to us of select business operations of a client, such as claims processing, policy administration and finance and accounting, 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 provide additional insight into their future financial and operational results, improve their operating environments through cost reduction, enhanced efficiency and productivity initiatives, and enhance 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, travel, transportation and logistics sectors.

On October 12, 2012, we acquired Landacorp, Inc. ("Landacorp"), a leading provider of healthcare solutions and technology (the "Landacorp Acquisition"). Landacorp has more than 50 million lives under management on its software platforms and has developed services and technology solutions that share vital clinical data with payers, providers, plan participants and accountable care organizations.

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. We operate fifteen operations centers in India, six operations centers in the U.S., two operations centers each in the Philippines and 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 months ended March 31, 2013, we had total revenues of $116.0 million compared to total revenues of $104.6 million in the three months ended March 31, 2012, an increase of $11.4 million or 10.9%.

Revenues from outsourcing services increased from $89.7 million for the three months ended March 31, 2012, to $97.6 million for the three months ended March 31, 2013. The increase in revenues from outsourcing services of $7.8 million for the three months ended March 31, 2013, was driven primarily by revenues of $4.3 million from the Landacorp Acquisition in 2012 and net volume increases from existing and new clients aggregating to $5.9 million. These increases were offset partially by a net decrease in revenues of $2.4 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 March 31, 2013 compared to the three months ended March 31, 2012.

Revenues from transformation services increased from $14.9 million for the three months ended March 31, 2012 to $18.4 million for the three ended March 31, 2013. The increase was primarily due to a combination of increased revenues in recurring or annuity-based decision analytics services and an increase in project-based engagements both in our decision analytics and finance transformation services. Revenues from new clients for transformation services were $0.3 million and $0.5 million during the three months ended March 31, 2013 and 2012, respectively.


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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, travel, transportation and logistics 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.

Through the Landacorp Acquisition on October 12, 2012, we added a leading care management software platform for healthcare payers. As a result of our Trumbull Acquisition, on October 1, 2011, we acquired the capability to provide subrogation services as well as access to a software platform called SubroSource™ for providing subrogation services to property and casualty insurers. In connection with our acquisition of Professional Data Management Again ("PDMA") in April 2010, we acquired an insurance policy administration platform called LifePRO to administer life insurance, health insurance annuities and credit life and disability insurance policies for insurance and healthcare clients. As we increase our service capabilities utilizing platform- and other software-based services, revenues from such services will continue to grow in proportion to our total revenues. Revenues from annual maintenance and support contracts for our software platforms provide us with a relatively predictable revenue base and are generally recognized ratably over the terms of the contracts. New license sales and implementation projects have a long selling cycle and it is difficult to predict the timing of signing of such new contracts which may lead to fluctuations in our short term 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 71.7% and 20.8%, respectively, of our total revenues for the three months ended March 31, 2013 and approximately 72.6% and 20.0%, respectively, of our total revenues for the three months ended March 31, 2012.

In the three months ended March 31, 2013 and 2012, our total revenues from our top ten clients accounted for 59.7% and 60.3% of our total revenues, respectively. None of our clients accounted for more than 10% of our total revenues during the three months ended March 31, 2013 compared to one client during the three months ended March 31, 2012. 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.

We derived revenues from seven and eleven new clients for our services in the three months ended March 31, 2013 and 2012, 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 depending on each client's situation and on the type of services provided. For the three months ended March 31, 2013 and 2012, 3.8% and 4.0%, respectively, of our revenues represent reimbursement of such expenses.


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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 foreign currency 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.


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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, 2012.

Results of Operations

The following table summarizes our results of operations:



                                                           Three months ended March 31,
                                                            2013                 2012
                                                                   (in million)
Revenues(1)                                             $       116.0        $       104.6
Cost of revenues (exclusive of depreciation and
amortization)(2)                                                 72.9                 66.7

Gross profit                                                     43.1                 37.9

Operating expenses:
General and administrative expenses(3)                           15.0                 13.3
Selling and marketing expenses(3)                                 9.8                  7.8
Depreciation and amortization expenses(4)                         6.5                  6.4

Total operating expenses                                         31.3                 27.5

Income from operations                                           11.8                 10.4
Other income/(expense):
Foreign exchange (loss)/gain                                      -                    1.1
Interest and other income                                         1.0                  0.4

Income before income taxes                                       12.8                 11.9
Income tax provision                                              3.0                  3.0

Net income                                              $         9.8        $         8.9

(1) Revenues include reimbursable expenses of $4.4 million and $4.1 million for the three months ended March 31, 2013 and 2012, respectively.

(2) Cost of revenues includes $0.9 million and $0.7 million during the three months ended March 31, 2013 and 2012, 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 $2.8 million and $2.1 million for the three months ended March 31, 2013 and 2012, 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 $1.6 million and $1.4 million for the three months ended March 31, 2013 and 2012, respectively, of amortization of intangibles as described in Note 5 to our unaudited consolidated financial statements contained herein.


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Three Months Ended March 31, 2013 Compared to Three Months Ended March 31, 2012

Revenues. Revenues increased 10.9%, from $104.6 million for the three months ended March 31, 2012 to $116.0 million for the three months ended March 31, 2013. Revenues from outsourcing services increased from $89.7 million during the three months ended March 31, 2012 to $97.6 million during the three months ended March 31, 2013. The increase in revenues from outsourcing services of $7.8 million was primarily driven by revenues of $4.3 million from the Landacorp Acquisition and net volume increases from existing and new clients aggregating to $5.9 million. These increases were partially offset by a net decrease in revenues of $2.4 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 March 31, 2013 compared to the three months ended March 31, 2012.

Revenues from transformation services increased from $14.9 million for the three months ended March 31, 2012 to $18.4 million for the three months ended March 31, 2013. 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 finance transformation services. Revenues from new clients for transformation services were $0.3 million and $0.5 million during the three months ended March 31, 2013 and 2012, respectively.

Cost of Revenues. Cost of revenues increased 9.4%, from $66.7 million for the three months ended March 31, 2012 to $72.9 million for the three months ended March 31, 2013. The increase in cost of revenues was primarily due to an increase in employee-related costs of $8.9 million as a result of an increase in the number of our personnel directly involved in providing services to our clients, including $1.8 million of employee-related costs related to the Landacorp Acquisition. We also experienced an increase in reimbursable expenses of $0.2 million (resulting in an increase in revenues) and an increase in facilities, technology and other operating expenses of $0.6 million (primarily due to the Landacorp Acquisition and new operations centers to support business growth). These increases were partially offset by a decrease of $3.5 million due to the net effect of depreciation of the Indian rupee and the Czech koruna and appreciation of the Philippine peso against the U.S. dollar during the three months ended March 31, 2013 compared to the three months ended March 31, 2012. Cost of revenues as a percentage of revenues decreased marginally from 63.7% for the three months ended March 31, 2012 to 62.9% for the three months ended March 31, 2013.

Gross Profit. Gross profit increased 13.6%, from $37.9 million for the three months ended March 31, 2012 to $43.1 million for the three months ended March 31, 2013. The increase in gross profit was primarily due to an increase in revenues of $11.4 million, offset by an increase in cost of revenues of $6.2 million. Gross profit as a percentage of revenues increased marginally from 36.3% for the three months ended March 31, 2012 to 37.1% for the three months ended March 31, 2013, primarily due to the Landacorp Acquisition in October 2012, and depreciation of the Indian rupee against the U.S. dollar during the three months ended March 31, 2013 compared to the three months ended March 31, 2012.

Selling, General and Administrative Expenses. Selling, general and administrative ("SG&A") expenses increased 17.3%, from $21.1 million for the three months ended March 31, 2012 to $24.8 million for the three months ended March 31, 2013. The increase in SG&A expenses was primarily due to an increase in employee-related costs of $3.6 million, including $1.6 million of employee-related costs related to the Landacorp Acquisition and our continued investment in sales and client management personnel. We also experienced an increase in other SG&A expenses of $0.6 million, primarily due to increased professional fees, facilities and technology costs incurred at our new operating centers, costs associated with the Landacorp Acquisition as well as increases in other marketing expenses. These increases were partially offset by a decrease of $0.6 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 March 31, 2013 compared to the three months ended March 31, 2012. As a percentage of revenues, SG&A expenses increased from 20.2% for the three months ended March 31, 2012 to 21.4% for the three months ended March 31, 2013, primarily as a result of the Landacorp Acquisition.

Depreciation and Amortization. Depreciation and amortization increased 2.4% from $6.4 million for the three months ended March 31, 2012 to $6.5 million for the three months ended March 31, 2013. The increase is primarily due to an increase in amortization of acquisition-related intangibles of $0.2 million and depreciation related to our new operations centers of $0.2 million offset by a decrease of $0.3 million due to the net effect of depreciation of the Indian rupee and the Czech koruna and appreciation of the Philippines peso against the U.S. dollar during the three months ended March 31, 2013 compared to the three months ended March 31, 2012. As a percentage of revenues, depreciation and amortization expenses decreased from 6.1% for the three months ended March 31, 2012 to 5.6% for the three months ended March 31, 2013.


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Income from Operations. Income from operations increased 12.9%, from $10.4 million for the three months ended March 31, 2012 to $11.8 million for the three months ended March 31, 2013. As a percentage of revenues, income from operations increased marginally from 10.0% for the three months ended March 31, 2012 to 10.2% for the three months ended March 31, 2013. The increase in income from operations as a percentage of revenues was primarily due to higher margins from the Landacorp Acquisition during the three months ended March 31, 2013.

Other Income/(Expense). Other income/(expense) is comprised of foreign exchange gains and losses, interest income, interest expense and other items. Other income/(expense) decreased from $1.5 million for the three months ended March 31, 2012 to $1.0 million for the three months ended March 31, 2013, due to insignificant net foreign exchange loss during the three months ended March 31, 2013 compared to net foreign exchange gain of $1.1 million during the three months ended March 31, 2012 attributable to movement of the U.S. dollar against the Indian rupee, offset by increase of $0.6 million in net interest income and other income. The average exchange rate of the Indian rupee against the U.S. dollar increased from 49.78 during the three months ended March 31, 2012 to 53.95 during the three months ended March 31, 2013.

Provision for Income Taxes. Provision for income taxes was $3.0 million in each of the three months ended March 31, 2012 and March 31, 2013, respectively. The effective rate of taxes decreased from 25.3% during the three months ended March 31, 2012 to 23.5% during the three months ended March 31, 2013. Refer to Note 12 to the unaudited consolidated financial statements for further details.

Net Income. Net income increased 9.5%, from $8.9 million for the three months ended March 31, 2012 to $9.8 million for the three months ended March 31, 2013, primarily due to an increase in operating income of $1.4 million, offset by a decrease in other income of $0.5 million. As a percentage of revenues, net income decreased from 8.5% for the three months ended March 31, 2012 to 8.4% for the three months ended March 31, 2013.

Liquidity and Capital Resources

As of March 31, 2013, we had $108.6 million in cash and cash equivalents and short-term investments (including $58.4 million held by our foreign subsidiaries). We do not intend to repatriate our overseas funds since our future growth depends upon the continued infrastructure and technology investments, geographical expansions and acquisitions outside of the U.S. Therefore, we need to continuously and permanently reinvest the earnings generated outside of the U.S. If we were to repatriate our overseas funds, we would need to accrue and pay applicable taxes.

Cash flows provided by operating activities increased from $4.4 million in the three months ended March 31, 2012 to $6.6 million in the three months ended March 31, 2013. Generally, factors that affect our earnings-including pricing, volume of services, costs and productivity-affect our cash flows provided by operations in a similar manner. However, while management of working capital, including timing of collections and payments, affects operating results only indirectly, the impact on the working capital and cash flows provided by operating activities can be significant. The increase in cash flows provided by operations for the three months ended March 31, 2013 was predominantly due to an increase in net income adjusted for non-cash items by $1.4 million along with a decrease in working capital of $0.9 million. The increase in net income adjusted for non-cash items is primarily due to an increase in net income of $0.8 million, stock based compensation expense of $0.9 million and depreciation and amortization expense of $0.2 million, offset by decrease in unrealized foreign exchange gain of $0.8 million.

Changes in operating assets and liabilities are primarily due to an increase in . . .

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