Form 10-Q
Table of Contents

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

 

 

FORM 10-Q

 

 

(Mark One)

x QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

FOR THE QUARTERLY PERIOD ENDED MARCH 31, 2011

OR

 

¨ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

FOR THE TRANSITION PERIOD              FROM TO             

COMMISSION FILE NUMBER 001-33089

 

 

EXLSERVICE HOLDINGS, INC.

(Exact name of registrant as specified in its charter)

 

 

 

DELAWARE   82-0572194

(State or other jurisdiction of

incorporation or organization)

 

(I.R.S. Employer

Identification No.)

280 PARK AVENUE, 38TH FLOOR,

NEW YORK, NEW YORK

  10017
(Address of principal executive offices)   (Zip code)

(212) 277-7100

(Registrant’s telephone number, including area code)

 

 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes  x    No  ¨

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    Yes    ¨    No  ¨

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):

 

Large accelerated filer   ¨    Accelerated filer   x
Non-accelerated filer   ¨  (Do not check if a smaller reporting company)    Smaller reporting company   ¨

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    Yes  ¨    No  x

As of April 29, 2011, there were 29,671,677 shares of the registrant’s common stock outstanding (excluding 262,098 shares held in treasury and 94,827 shares of restricted stock), par value $0.001 per share.

 

 

 


Table of Contents

TABLE OF CONTENTS

 

          PAGE  

ITEM

   PART I. FINANCIAL INFORMATION   

  1.

   FINANCIAL STATEMENTS   
  

Consolidated Balance Sheets (Unaudited) as of March 31, 2011 and December 31, 2010

     3   
  

Consolidated Statements of Income (Unaudited) for the Three Months Ended March 31, 2011  and 2010

     4   
  

Consolidated Statements of Cash Flows (Unaudited) for the Three months Ended March 31, 2011 and  2010

     5   
  

Notes to Consolidated Financial Statements (Unaudited)

     6   

  2.

   Management’s Discussion and Analysis of Financial Condition and Results of Operations      21   

  3.

   Quantitative and Qualitative Disclosures About Market Risk      30   

  4.

   Controls and Procedures      30   
   PART II. OTHER INFORMATION      31   

  1.

   Legal Proceedings      31   

1A.

   Risk Factors      31   

  2.

   Unregistered Sales of Equity Securities and Use of Proceeds      31   

  3.

   Defaults Upon Senior Securities      31   

  4.

   (Removed and Reserved)      31   

  5.

   Other Information      31   

  6.

   Exhibits      32   

Signatures

     33   

 

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Table of Contents

PART I. FINANCIAL INFORMATION

 

ITEM 1. FINANCIAL STATEMENTS

EXLSERVICE HOLDINGS, INC.

CONSOLIDATED BALANCE SHEETS

(In thousands, except share and per share amounts)

 

     March 31,
2011
    December 31,
2010
 
     (Unaudited)        

Assets

    

Current assets:

    

Cash and cash equivalents

   $ 112,543      $ 111,182   

Short-term investments

     3,168        3,084   

Restricted cash

     221        231   

Accounts receivable, net of allowance for doubtful accounts of $246 each at March 31, 2011 and December 31, 2010

     45,288        44,186   

Prepaid expenses

     3,447        3,317   

Deferred tax assets, net

     2,253        1,721   

Advance income-tax, net

     4,751        5,364   

Other current assets

     5,350        5,244   
                

Total current assets

     177,021        174,329   
                

Fixed assets, net of accumulated depreciation of $52,996 at March 31, 2011 and $48,723 at December 31, 2010

     37,530        34,733   

Restricted cash

     3,570        3,432   

Deferred tax assets, net

     15,353        14,333   

Intangible assets, net

     17,956        18,591   

Goodwill

     43,411        43,370   

Other assets

     16,650        16,895   
                

Total assets

   $ 311,491      $ 305,683   
                

Liabilities and Stockholders’ Equity

    

Current liabilities:

    

Accounts payable

   $ 5,752      $ 4,860   

Deferred revenue

     6,545        5,108   

Accrued employee cost

     13,913        23,947   

Accrued expenses and other current liabilities

     17,927        16,560   

Current portion of capital lease obligations

     222        231   
                

Total current liabilities

     44,359        50,706   
                

Capital lease obligations, less current portion

     389        389   

Non-current liabilities

     6,420        6,042   
                

Total liabilities

     51,168        57,137   
                

Commitments and contingencies

    

Preferred stock, $0.001 par value; 15,000,000 shares authorized, none issued

     —          —     

Stockholders’ equity:

    

Common stock, $0.001 par value; 100,000,000 shares authorized, 29,846,835 shares issued and 29,592,619 shares outstanding as of March 31, 2011 and 29,690,463 shares issued and 29,437,961 shares outstanding as of December 31, 2010

     30        30   

Additional paid-in capital

     139,015        136,173   

Retained earnings

     120,627        112,266   

Accumulated other comprehensive income

     1,734        1,126   
                

Total stockholders’ equity including shares held in treasury

     261,406        249,595   
                

Less: 254,216 shares as of March 31, 2011 and 252,502 shares as of December 31, 2010,
held in treasury, at cost

     (1,103     (1,069
                

ExlService Holdings, Inc. stockholders’ equity

     260,303        248,526   

Non-controlling interest

     20        20   
                

Total stockholders’ equity

     260,323        248,546   
                

Total liabilities and stockholders’ equity

   $ 311,491      $ 305,683   
                

See accompanying notes

 

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EXLSERVICE HOLDINGS, INC.

CONSOLIDATED STATEMENTS OF INCOME

(Unaudited)

(In thousands, except share and per share amounts)

 

     Three months ended March 31,  
     2011      2010  

Revenues

   $ 72,907       $ 54,489   

Cost of revenues (exclusive of depreciation and amortization)

     44,219         31,485   
                 

Gross profit

     28,688         23,004   
                 

Operating expenses:

     

General and administrative expenses

     10,471         9,305   

Selling and marketing expenses

     5,857         4,150   

Depreciation and amortization

     4,852         3,073   
                 

Total operating expenses

     21,180         16,528   
                 

Income from operations

     7,508         6,476   

Other income/(expense):

     

Foreign exchange gain

     1,648         606   

Interest and other income, net

     325         418   
                 

Income before income taxes

     9,481         7,500   

Income tax provision

     1,120         1,877   
                 

Net income

   $ 8,361       $ 5,623   
                 

Earnings per share:

     

Basic

   $ 0.28       $ 0.19   

Diluted

   $ 0.27       $ 0.19   

Weighted-average number of shares used in computing earnings per share:

     

Basic

     29,620,218         29,128,741   

Diluted

     30,911,066         30,157,956   

See accompanying notes

 

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EXLSERVICE HOLDINGS, INC.

CONSOLIDATED STATEMENTS OF CASH FLOW

(Unaudited)

(In thousands)

 

     Three months ended
March 31,
 
     2011     2010  

Cash flows from operating activities:

    

Net income

   $ 8,361      $ 5,623   

Adjustments to reconcile net income to net cash provided by operating activities:

    

Depreciation and amortization

     4,852        3,073   

Stock-based compensation expense

     2,248        1,828   

Unrealized foreign exchange loss

     297        599   

Deferred income taxes

     (1,553     (1,000

Non-controlling interest

     —          7   

Change in operating assets and liabilities (net of effect of acquisitions):

    

Restricted cash

     (118     (3,582

Accounts receivable

     (1,051     (317

Prepaid expenses and other current assets

     (544     926   

Accounts payable

     (1,059     (161

Deferred revenue

     1,436        (1,166

Accrued expenses and other liabilities

     (6,137     (4,391

Income taxes payable

     609        (1,472

Other assets

     411        (818
                

Net cash provided by/(used for) operating activities

     7,752        (851
                

Cash flows from investing activities:

    

Purchase of fixed assets

     (7,158     (5,385

Business acquisition (net of cash acquired)

     —          (29,122

Purchase of short-term investments

     (72     —     

Proceeds from redemption of short-term investments

     —          1,843   
                

Net cash used for investing activities

     (7,230     (32,664
                

Cash flows from financing activities:

    

Principal payments of capital lease obligations

     (51     (36

Payment on purchase of treasury stock

     (34     —     

Proceeds from exercise of stock options

     595        261   
                

Net cash provided by financing activities

     510        225   
                

Effect of exchange rate changes on cash and cash equivalents

     329        315   
                

Net increase/(decrease) in cash and cash equivalents

     1,361        (32,975

Cash and cash equivalents, beginning of period

     111,182        132,215   
                

Cash and cash equivalents, end of period

   $ 112,543      $ 99,240   
                

See accompanying notes

 

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EXLSERVICE HOLDINGS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

March 31, 2011

(Unaudited)

(In thousands, except share and per share amounts)

1. Organization and Basis of Presentation

Organization

ExlService Holdings, Inc. (“ExlService Holdings”) is organized as a corporation under the laws of the State of Delaware. ExlService Holdings, together with its subsidiaries (collectively, the “Company”), is a leading provider of outsourcing services and transformation services. The Company’s clients are located principally in the United States and the United Kingdom.

Basis of Presentation

The unaudited interim consolidated financial statements have been prepared in accordance with generally accepted accounting principles for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by generally accepted accounting principles for annual financial statements and therefore should be read in conjunction with the audited consolidated financial statements and footnotes thereto included in the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 2010.

The unaudited interim consolidated financial statements reflect all adjustments (of a normal and recurring nature) which management considers necessary for a fair presentation of such statements for these periods. The unaudited consolidated statements of income for the interim periods presented are not necessarily indicative of the results for the full year or for any subsequent period.

2. Summary of Significant Accounting Policies

Principles of Consolidation

The accompanying unaudited consolidated financial statements include the financial statements of ExlService Holdings and all of its subsidiaries. All intercompany balances and transactions have been eliminated in consolidation.

The non-controlling interest represents the minority partner’s interest in the operation of exl Service.com (India) Private Limited (“Exl India”) and the profits associated with the minority partner’s interest in those operations, in the unaudited consolidated balance sheet and unaudited consolidated statement of income, respectively. The non-controlling interest in the operations for the three months ended March 31, 2011 and 2010 was insignificant and is included under general and administrative expenses in the unaudited consolidated statements of income.

Use of Estimates

The preparation of the unaudited consolidated financial statements in conformity with U.S. generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the unaudited consolidated financial statements and the unaudited consolidated statements of income during the reporting period. Estimates are based upon management’s best assessment of the current business environment. Actual results could differ from those estimates. The significant estimates and assumptions that affect the financial statements include, but are not limited to, allowance for doubtful receivables, future obligations under employee benefit plans, deferred tax valuation allowances, income-tax uncertainties and other contingencies, valuation of derivative financial instruments,

 

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EXLSERVICE HOLDINGS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

March 31, 2011

(Unaudited)

(In thousands, except share and per share amounts)

 

stock-based compensation expense, depreciation and amortization periods, recoverability of long-term assets including goodwill and intangibles, and estimates to complete fixed price contracts.

Recent Accounting Pronouncements

In September 2009, the FASB issued Update No. 2009-13, “Multiple-Deliverable Revenue Arrangements—a consensus of the FASB Emerging Issues Task Force.” It updates the existing multiple-element revenue arrangements guidance currently included under ASC topic 605-25, which originated primarily from the guidance in EITF Issue No. 00-21, “Revenue Arrangements with Multiple Deliverables.” The revised guidance primarily provides two significant changes: (1) eliminates the need for objective and reliable evidence of the fair value for the undelivered element in order for a delivered item to be treated as a separate unit of accounting, and (2) eliminates the residual method to allocate the arrangement consideration. In addition, the guidance also expands the disclosure requirements for revenue recognition. ASU 2009-13 is effective for the first annual reporting period beginning on or after June 15, 2010, with early adoption permitted provided that the revised guidance is retroactively applied to the beginning of the year of adoption. The adoption of new guidance from January 1, 2011 did not have any impact on the Company’s unaudited consolidated financial statements as the number of multiple deliverable revenue arrangements is insignificant.

3. Earnings Per Share

Basic earnings per share is computed by dividing net income to common stockholders by the weighted average number of common shares outstanding during each period. Diluted earnings per share is computed using the weighted average number of common shares plus the potentially dilutive effect of common stock equivalents issued and outstanding at the reporting date, using the treasury stock method. Stock options, restricted stock and restricted stock units that are anti-dilutive are excluded from the computation of weighted average shares outstanding.

Cash or in-kind dividends declared with respect to unvested shares of restricted stock and restricted stock units are withheld by the Company and paid to the holder of such shares of restricted stock and restricted stock units, without interest, only if and when such shares of restricted stock and restricted stock units vest. Any unvested shares of restricted stock and restricted stock units are immediately forfeited without consideration upon the termination of holder’s employment with the Company or its affiliates. Accordingly, the Company’s unvested restricted stock and restricted stock units do not include non-forfeitable rights to dividends or dividend equivalents and are therefore not considered as participating securities for purposes of earnings per share calculations pursuant to the two-class method. However, the Company’s vested restricted stock units against which the underlying common stock has not been issued, contain non-forfeitable rights to dividends or dividend equivalents and are therefore after vesting considered as participating securities for the purposes of computing basic earnings per share pursuant to the two-class method. Application of this treatment had an insignificant effect on the computation of basic earnings per share.

The following table sets forth the computation of basic and diluted earnings per share:

 

     Three months ended March 31,  
     2011      2010  

Numerators:

     

Net income

   $ 8,361       $ 5,623   

Denominators:

     

Basic weighted average common shares outstanding

     29,620,218         29,128,741   

Dilutive effect of share based awards

     1,290,848         1,029,215   
                 

Diluted weighted average common shares outstanding

     30,911,066         30,157,956   
                 

Weighted average common shares considered anti-dilutive in computing diluted earnings per share

     611,069         1,328,643   

 

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EXLSERVICE HOLDINGS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

March 31, 2011

(Unaudited)

(In thousands, except share and per share amounts)

 

4. Segment Information

The Company is organized around its outsourcing services and transformation services segments. The Company’s recent acquisitions of the American Express Global Travel Service Center (“GTSC”) and Professional Data Management Again, Inc. (“PDMA”) are classified as part of the outsourcing services segment.

The chief operating decision maker generally reviews financial information at the consolidated statement of income level but does not review any information except for revenues and cost of revenues of the individual segments. Therefore, the Company does not allocate or evaluate depreciation, amortization, interest expense or income, capital expenditures and income taxes to its operating segments. Consequently, it is not practical to show assets, capital expenditures, depreciation or amortization by segment.

Revenues and cost of revenues for each of the three months ended March 31, 2011 and 2010 for outsourcing services and transformation services segments, respectively, are as follows:

 

     Three months ended March 31, 2011      Three months ended March 31, 2010  
     Outsourcing
Services
     Transformation
Services
     Total      Outsourcing
Services
     Transformation
Services
     Total  

Revenues

   $ 56,841       $ 16,066       $ 72,907       $ 41,590       $ 12,899       $ 54,489   

Cost of revenues (exclusive of depreciation and amortization)

     34,235         9,984         44,219         23,579         7,906         31,485   
                                                     

Gross profit

   $ 22,606       $ 6,082       $ 28,688       $ 18,011       $ 4,993       $ 23,004   
                                                     

Operating expenses

           21,180               16,528   

Other income / (expense)

           1,973               1,024   

Income tax provision

           1,120               1,877   
                             

Net income

         $ 8,361             $ 5,623   
                             

5. Business Combinations, Goodwill and Intangible Assets

On March 1, 2010, the Company acquired the GTSC operations of American Express located in Gurgaon, India, that provides the travel-related business process outsourcing services of American Express. The purchase price for the GTSC, which was paid in cash, was approximately $29,122. The Company paid a premium for the GTSC acquisition to provide services to the travel sector, deepen the Company’s relationship with a significant client and expand its capability set in analytics, exception processing and transaction processing.

On May 1, 2010, the Company acquired a 100% stake in PDMA, developer of the LifePRO® insurance policy administration platform used by approximately 40 insurance companies. The purchase price for PDMA, which was paid in cash, was approximately $14,061 (including cash acquired of $1,039), net of working capital adjustments. The Company paid a premium for the PDMA acquisition to expand its capability in providing a policy administration platform for its clients along a wide range of products.

 

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EXLSERVICE HOLDINGS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

March 31, 2011

(Unaudited)

(In thousands, except share and per share amounts)

 

Goodwill

The following table sets forth details of the Company’s goodwill balance as of March 31, 2011:

 

     Outsourcing
Services
    Transformation
Services
     Total  

Balance at January 1, 2010

   $ 2,834      $ 16,785       $ 19,619   

Goodwill arising from acquisitions

     28,557        —           28,557   

Purchase accounting adjustments (1)

     (5,303     —           (5,303

Currency translation adjustments

     497        —           497   
                         

Balance at December 31, 2010

     26,585        16,785         43,370   

Currency translation adjustments

     41        —           41   
                         

Balance at March 31, 2011

   $ 26,626      $ 16,785       $ 43,411   
                         

 

  (1) Represent adjustments related to the GTSC and PDMA acquisitions.

Intangible Assets

Information regarding the Company’s intangible assets is as follows:

 

     As of March 31, 2011  
     Gross
Carrying
Amount
     Accumulated
Amortization
    Net Carrying
Amount
 

Customer relationships

   $   16,595       $ (2,201   $ 14,394   

Leasehold benefits

     1,004         (334     670   

Developed technology

     2,100         (193     1,907   

Non-compete agreements

     200         (115     85   

Trade names and trademarks

     900         —          900   
                         
   $ 20,799       $ (2,843   $ 17,956   
                         
     As of December 31, 2010  
     Gross
Carrying
Amount
     Accumulated
Amortization
    Net Carrying
Amount
 

Customer relationships

   $ 16,595       $ (1,726   $ 14,869   

Leasehold benefits

     1,002         (257     745   

Developed technology

     2,100         (140     1,960   

Non-compete agreements

     200         (83     117   

Trade names and trademarks

     900         —          900   
                         
   $ 20,797       $ (2,206   $ 18,591   
                         

Amortization expense for the three months ended March 31, 2011 and 2010 was $636 and $181, respectively. The weighted average life of intangible assets was 9.7 years for customer relationships, 3.2 years for leasehold benefits, 10.0 years for developed technology and 1.7 years for non-compete agreements.

 

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EXLSERVICE HOLDINGS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

March 31, 2011

(Unaudited)

(In thousands, except share and per share amounts)

 

Estimated amortization of intangible assets during the year ending March 31,

  

2012

   $ 2,361   

2013

   $ 2,140   

2014

   $ 1,842   

2015

   $ 1,790   

2016

   $ 1,790   

6. Fair Value Measurements

The following table sets forth the Company’s assets and liabilities that were accounted for at fair value on a recurring basis as of March 31, 2011 and December 31, 2010. The table excludes short-term investments, accounts receivable, accounts payable and accrued expenses for which fair values approximate their carrying amounts.

Assets and Liabilities Measured at Fair Value

 

As of March 31, 2011

   Level 1      Level 2      Level 3      Total  

Assets

           

Money market and mutual funds

   $ 90,139       $ —         $ —         $ 90,139   

Derivative financial instruments

     —           4,001         —           4,001   
                                   

Total

   $ 90,139       $ 4,001       $ —         $ 94,140   
                                   

Liabilities

           

Derivative financial instruments

   $ —         $ 11       $ —         $ 11   
                                   

As of December 31, 2010

   Level 1      Level 2      Level 3      Total  

Assets

           

Money market and mutual funds

   $ 83,335       $ —         $ —         $ 83,335   

Derivative financial instruments

     —           4,214         —           4,214   
                                   

Total

   $ 83,335       $ 4,214       $ —         $ 87,549   
                                   

Liabilities

     —           —           —           —     

Derivative Financial Instrument: The Company’s derivative financial instruments consist of foreign currency forward exchange contracts. Fair values for derivative financial instruments are based on broker quotations and are classified as Level 2. See Note 7 for further details.

7. Derivatives and Hedge Accounting

The Company actively looks to mitigate the exposure of foreign currency market risk by entering into various hedging transactions, authorized under Company policies, with counterparties that are highly rated financial institutions. The Company’s primary exchange rate exposure is with U.K. pound sterling and the Indian rupee. The Company also has exposure in Philippine pesos, Czech koruna and other local currencies in which it operates. The Company uses derivative instruments for the purpose of mitigating the underlying exposure from foreign currency fluctuation risks associated with forecasted transactions denominated in certain foreign currencies and to minimize earnings and cash flow volatility associated with changes in foreign currency exchange rates, and not for speculative trading purposes. These derivative financial instruments are largely forward foreign exchange contracts that are

 

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EXLSERVICE HOLDINGS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

March 31, 2011

(Unaudited)

(In thousands, except share and per share amounts)

 

designated effective and that qualify as cash flow hedges under ASC topic 815, “Derivatives and Hedging” (“ASC No. 815”). The Company also uses derivatives consisting of foreign currency exchange contracts not designated as hedging instruments under ASC No. 815 to hedge intercompany balances and other monetary assets or liabilities denominated in currencies other than the functional currency.

The Company had outstanding foreign exchange contracts totaling $181,530, GBP 8,287 and EUR 372 as of March 31, 2011 and totaling $166,030, GBP 8,434 and EUR 785 as of December 31, 2010. The Company estimates that approximately $3,309 of net derivative gains included in accumulated other comprehensive income (“AOCI”) could be reclassified into earnings within the next twelve months based on exchange rates prevailing as of March 31, 2011. At March 31, 2011, the maximum outstanding term of derivative instruments that hedge forecasted transactions was thirty-three months.

The Company evaluates hedge effectiveness at the time a contract is entered into as well as on an ongoing basis. If during this time, a contract is deemed ineffective, the change in the fair value is recorded in the unaudited consolidated statements of income and is included in foreign exchange gain. For hedge relationships that are discontinued because the forecasted transaction is not expected to occur by the end of the originally specified period, any related derivative amounts recorded in equity are reclassified to earnings. No significant amounts of gains or losses were reclassified from AOCI into earnings as a result of forecasted transactions that failed to occur during the three months ended March 31, 2011 and 2010.

The following tables set forth the fair value of the foreign currency exchange contracts and their location on the unaudited consolidated financial statements:

Derivatives designated as hedging instruments:

 

     March 31,
2011
     December 31,
2010
 

Other current assets:

     

Foreign currency exchange contracts

   $ 3,309       $ 3,171   

Other assets

     

Foreign currency exchange contracts

   $ 636       $ 1,029   

Other non current liabilities:

     

Foreign currency exchange contracts

   $ 11       $ —     

Derivatives not designated as hedging instruments:

 

     March 31,
2011
     December 31,
2010
 

Other current assets:

     

Foreign currency exchange contracts

   $ 56       $ 14   

 

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EXLSERVICE HOLDINGS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

March 31, 2011

(Unaudited)

(In thousands, except share and per share amounts)

 

The following tables set forth the effect of foreign currency exchange contracts on the unaudited consolidated statements of income for the three months ended March 31, 2011 and 2010:

 

Derivatives in Cash Flow
Hedging Relationships

   Amount of Gain or
(Loss) Recognized in

AOCI on Derivative
(Effective Portion)
     Location of Gain or
(Loss) Reclassified from
AOCI into Income
(Effective Portion)
   Amount of Gain or
(Loss) Reclassified from

AOCI into Income
(Effective Portion)
     Location of
Gain/ (Loss)
Recognized in Income
on Derivative
(Ineffective Portion
and Amount Excluded
from Effectiveness
Testing)
   Amount of Gain/
(Loss) Recognized in
Income on Derivative
(Ineffective Portion and
Amount Excluded from
Effectiveness Testing)
 
         2011              2010                   2011              2010                   2011              2010      

Foreign exchange contracts

   $ 889       $ 2,955       Foreign
exchange gain
   $ 1,203       $ 589       Foreign
exchange gain
   $ —         $ —     

 

Derivatives not designated

as Hedging Instruments

   Location of Gain or (Loss)
Recognized in Income
on Derivatives
   Amount of Gain or  (Loss)
Recognized in Income
on Derivatives
 
          2011              2010      

Foreign exchange contracts

   Foreign exchange gain    $ 371       $ 975   

8. Comprehensive Income:

The following table sets forth the change in the components of comprehensive income for the three months ended March 31, 2011 and 2010:

 

     Three months ended March 31,  
         2011             2010      

Net income

   $ 8,361      $ 5,623   

Other comprehensive income:

    

Unrealized gain/(loss) on effective cash flow hedges, net of taxes

     (314     2,366   

Foreign currency translation adjustment

     902        2,513   

Retirement benefits, net of taxes

     20        14   
                

Total other comprehensive income

     608        4,893   
                

Total comprehensive income

   $ 8,969      $ 10,516   
                

9. Capital Structure

The Company has one class of common stock.

During the three months ended March 31, 2011, the Company acquired 1,714 shares of common stock from employees in connection with withholding tax payments related to the vesting of restricted stock for a total consideration of $34. The purchase price of $19.76 per share was the average of the high and low price of the Company’s shares of common stock on the Nasdaq Global Select Market on the trading day prior to the vesting date of the shares of restricted stock. These shares are held as treasury stock.

 

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EXLSERVICE HOLDINGS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

March 31, 2011

(Unaudited)

(In thousands, except share and per share amounts)

 

10. Employee Benefit Plans

The Company’s Gratuity Plans in India and Philippines provide a lump sum payment to vested employees on retirement or on termination of employment in an amount based on the respective employee’s salary and years of employment with the Company. Liabilities with regard to the Gratuity Plan are determined by actuarial valuation using the projected unit credit method. Current service costs for the Gratuity Plan are accrued in the year to which they relate. Actuarial gains or losses or prior service costs, if any, resulting from amendments to the plans are recognized and amortized over the remaining period of service of the employees.

Net gratuity cost includes the following components:

 

     Three months ended March 31,  
         2011              2010      

Service cost

   $ 171       $ 125   

Interest cost

     64         30   

Actuarial loss

     26         42   
                 

Net gratuity cost

   $ 261       $ 197   
                 

The Company maintains the Exl Service Inc. 401(k) Plan, the Inductis 401(k) Profit Sharing Plan and the PDMA 401(k) Profit Sharing Plan, (the “401(k) Plans”) under Section 401(k) of the Internal Revenue Code of 1986 covering all eligible employees, as defined. The Company may make discretionary contributions of up to a maximum of 3% of employee compensation within certain limits. The Company’s contribution to the 401(k) Plans amounted to $146 and $77 during the three month periods ended March 31, 2011 and March 31, 2010, respectively.

During the three month periods ended March 31, 2011 and 2010, the Company contributed the following amounts to various defined contribution plans on behalf of its employees in India, the Philippines, Romania and the Czech Republic:

 

Three months ended March 31, 2011

   $ 1,022   

Three months ended March 31, 2010

   $ 833   

11. Leases

The Company leases motor vehicles for some of its employees. Such leases are recorded as capital leases. Future minimum lease payments under these capital leases at March 31, 2011 are as follows:

 

Year ending March 31,

  

2012

   $ 265   

2013

     246   

2014

     141   

2015

     34   
        

Total minimum lease payments

     686   

Less: amount representing interest

     75   
        

Present value of minimum lease payments

     611   

Less: current portion

     222   
        

Long term capital lease obligation

   $ 389   
        

 

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EXLSERVICE HOLDINGS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

March 31, 2011

(Unaudited)

(In thousands, except share and per share amounts)

 

The Company conducts its operations using facilities leased under non-cancelable operating lease agreements that expire at various dates. Future minimum lease payments under non-cancelable operating lease agreements expiring after more than twelve months are as follows:

 

Year ending March 31,

  

2012

   $ 4,826   

2013

     3,717   

2014

     1,270   

2015

     528   

2016

     536   

2017 and thereafter

     1,662   
        
   $ 12,539   
        

The operating leases are subject to renewal periodically and have scheduled rent increases. The Company accounts for scheduled rent on a straight line basis over the lease period. Rent expense under both cancelable and non-cancelable operating leases was $2,812 and $1,848 for the three months ended March 31, 2011 and 2010, respectively. Deferred rent as of March 31, 2011 and December 31, 2010 was $3,638 and $3,324, respectively, and is included in “Accrued expenses and other current liabilities” in the unaudited consolidated balance sheet as of March 31, 2011 and the audited balance sheet as of December 31, 2010.

12. Income Taxes

The Company recorded income tax expense of $1,120 and $1,877 for the three months ended March 31, 2011 and 2010, respectively. The effective rate of taxes decreased significantly from 25.0% during the three months ended March 31, 2010 to 11.8% during the three months ended March 31, 2011, primarily due to the release of a valuation allowance on deferred tax assets of $1,961 related to the Company’s assessment that the deferred tax assets generated by certain of the Company’s operating units in India that were under a tax holiday period were more likely than not to be realized upon the expiration of the tax holiday period.

The fiscal year under the Indian Income Tax Act ends on March 31. Certain of the Company’s operations centers in India qualified for an exemption from corporate tax under Section 10A or 10B of the Indian Income Tax Act. This exemption was available for a period of ten consecutive years beginning with the financial year in which the operations center began to manufacture or produce eligible goods and services and expires on April 1, 2011. The tax holiday period for some of the Company’s operations centers in India had already expired on April 1, 2010 and for other operations centers it expired on April 1, 2011 as a result of the sunset of relevant tax exemption scheme. Therefore, any profits generated from the services provided from such operations centers will be fully taxable after that date. As a result of the expiration of the tax holiday period on April 1, 2011, the Company’s tax expense will significantly increase in and after 2011.

During 2010, we have established operations centers in Noida and Jaipur, India in special economic zones that are eligible for tax incentives for services provided from such locations until 2025 under the Special Economic Zones Act, 2005.

Deferred tax assets and liabilities are recognized for future tax consequences attributable to temporary differences between the financial statement carrying values of assets and liabilities and their respective tax bases and operating loss carry forwards. At March 31, 2011, the Company performed an analysis of the deferred tax asset valuation allowance for certain units of its Indian subsidiaries and net operating loss carry forward for its domestic entities. Based on this analysis, the Company released the valuation allowance on deferred tax assets pertaining to such units of the Company’s subsidiaries since it was determined that it was more likely than not that they would be realizable. The Company continues to carry a valuation allowance on the deferred tax assets on net operating loss carry forwards. The valuation allowance as of March 31, 2011 and December 31, 2010 was approximately $653 and $2,621, respectively.

 

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EXLSERVICE HOLDINGS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

March 31, 2011

(Unaudited)

(In thousands, except share and per share amounts)

 

During 2007, the Indian government passed tax legislation that, among other items, subjects Indian taxpayers to a Minimum Alternative Tax (“MAT”). As of March 31, 2011 and December 31, 2010, deferred income taxes related to the MAT were approximately $4,250 and $4,157, respectively.

The Company’s provision for income taxes also includes the impact of provisions established for uncertain income tax positions determined in accordance with ASC No. 740, “Income Taxes” (“ASC No. 740”) as well as the related net interest. Tax exposures can involve complex issues and may require an extended period to resolve. Although the Company believes that it has adequately reserved for its uncertain tax positions, no assurance can be given that the final tax outcome of these matters will not be different. The Company adjusts these reserves in light of changing facts and circumstances, such as the closing of a tax audit or the refinement of an estimate. To the extent that the final tax outcome of these matters differs from the amounts recorded, such differences will impact the provision for income taxes in the period in which such determination is made.

The following summarizes the activity related to the gross unrecognized tax benefits from January 1, 2011 through March 31, 2011:

 

Balance as of January 1, 2011

   $ 4,136   

Increases related to prior year tax positions

     —     

Decreases related to prior year tax positions

     —     

Increases related to current year tax positions

     314   

Decreases related to current year tax positions

     —     

Effect of exchange rate changes

     10   
        

Balance as of March 31, 2011

   $ 4,460   
        

The unrecognized tax benefits as of March 31, 2011 of $4,460, if recognized, would impact the effective tax rate.

The Company has not recognized any interest and penalties during the three months ended March 31, 2011. The unrecognized tax benefits may increase or decrease in the next 12 months depending on the Company’s tax positions.

13. Stock-Based Compensation

The following costs related to the Company’s stock-based compensation plan are included in the unaudited consolidated statements of income:

 

     Three months
ended March 31,
 
     2011      2010  

Cost of revenue

   $ 395       $ 389   

General and administrative expenses

     982         830   

Selling and marketing expenses

     871         609   
                 

Total

   $ 2,248       $ 1,828   
                 

 

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EXLSERVICE HOLDINGS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

March 31, 2011

(Unaudited)

(In thousands, except share and per share amounts)

 

The fair value of each stock option granted to employees is estimated on the date of grant using the Black-Scholes option-pricing model with the following weighted average assumptions:

 

     Three months ended March 31,  
             2011                     2010          

Dividend yield

     0     0

Expected life (years)

     5.76        5.33   

Risk free interest rate

     2.32     2.64

Volatility

     40     40

The estimated expected term of options granted has been based on historical experience since October 2006, which is representative of the expected term of the options. Volatility has been calculated based on the volatility of the Company’s common stock and the volatility of stocks of comparative companies. The risk-free interest rate that the Company uses in the option valuation model is based on U.S. treasury zero-coupon bonds with a remaining term similar to the expected term of the options.

The Company does not anticipate paying any cash dividends in the foreseeable future and therefore uses an expected dividend yield of zero in the option valuation model. The Company is required to estimate forfeitures at the time of grant and revise those estimates in subsequent periods if actual forfeitures differ from those estimates. The Company uses historical data to estimate pre-vesting option forfeitures and records stock-based compensation expense only for those awards that are expected to vest. All stock-based payment awards are amortized on a straight-line basis over the requisite service periods of the awards, which are generally the vesting periods.

Stock option activity under the Company’s stock plans is shown below:

 

     Number of
Options
    Weighted-
Average
Exercise
Price
     Aggregate
Intrinsic
Value
     Weighted-
Average
Remaining
Contractual
Life (years)
 

Outstanding at December 31, 2010

     3,075,617      $ 12.17       $ 28,810         7.25   

Granted

     308,367        20.00         

Exercised

     (52,431     11.35         

Forfeited

     (46,160     9.65         
                                  

Outstanding at March 31, 2011

     3,285,393      $ 12.95       $ 25,376         7.35   
                                  

Vested and exercisable at March 31, 2011

     1,573,560      $ 12.30       $ 13,135         6.39   
                

Available for grant at March 31, 2011

     2,867,744           
                

The unrecognized compensation cost for unvested options as of March 31, 2011 is $7,991, which is expected to be expensed over a weighted average period of 2.55 years. The weighted-average fair value of options granted during the three months ended March 31, 2011 and 2010 was $8.21 and $7.44, respectively. The total fair value of shares vested during the three months ended March 31, 2011 is $1,508.

 

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EXLSERVICE HOLDINGS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

March 31, 2011

(Unaudited)

(In thousands, except share and per share amounts)

 

Restricted Stock and Restricted Stock Units

Restricted stock and restricted stock unit activity under the Company’s stock plans is shown below:

 

     Restricted Stock      Restricted Stock Units  
     Number     Weighted-
Average
Intrinsic
Value
     Number     Weighted-
Average
Intrinsic
Value
 

Outstanding at December 31, 2010

     235,885      $ 18.88         624,815      $ 18.13   

Granted

     —          —           329,622        19.76   

Vested

     (37,687     23.67         (66,254     18.34   

Forfeited

     (18,181     19.43         (10,920     18.41   
                                 

Outstanding at March 31, 2011

     180,017      $ 17.82         877,263      $ 18.72   
                                 

As of March 31, 2011, unrecognized compensation cost of $16,794 is expected to be expensed over a weighted average period of 3.0 years.

14. Related Party Transactions

The Company provides services to Oak Hill Capital Partners, an affiliate of the Oak Hill Capital Partners, L.P., one of the Company’s significant stockholders. The Company recognized revenues of approximately $15 and $16 during the three months ended March 31, 2011 and 2010, respectively. At March 31, 2011 and December 31, 2010, the Company had an account receivable of $20 and $9, respectively, related to these services.

15. Geographical Information

 

     Three months ended
March 31,
 
     2011      2010  

Revenues

     

United States

   $ 52,418       $ 38,582   

United Kingdom

     18,441         14,317   

Rest of World

     2,048         1,590   
                 
   $ 72,907       $ 54,489   
                 
     March 31,
2011
     December 31,
2010
 

Fixed assets, net

     

India

   $ 33,622       $ 30,447   

United States

     1,062         1,143   

Philippines

     1,691         2,049   

Rest of World

     1,155         1,094   
                 
   $ 37,530       $ 34,733   
                 

 

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EXLSERVICE HOLDINGS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

March 31, 2011

(Unaudited)

(In thousands, except share and per share amounts)

 

16. Commitments and Contingencies

Fixed Asset Commitments

At March 31, 2011, the Company had committed to spend approximately $2,157 under agreements to purchase fixed assets. This amount is net of advances paid in respect of these purchases.

Other Commitments

The Company’s certain delivery centers in India have been established as 100% Export-Oriented units under the “Export Import Policy” (the “Policy”) or Software Technology Parks of India units (“STPI”) under the STPI guidelines issued by the Government of India that has provided the Company with certain incentives on imported and indigenous capital goods. Under the Policy, these units must achieve certain export ratios and realize revenues attributable to exports over a specified period. In the event that these units are unable to meet the requirements over the specified period, the Company may be required to refund these incentives along with penalties and fines. However, management believes that these units will continue to achieve the export levels within the required timeframe as they have consistently generated the required levels of export revenues.

ExlService Philippines, Inc. (“Exl Philippines”) is registered as an Ecozone IT Enterprise with the Philippines Economic Zone Authority. The registration has also provided the Company with certain incentives on the import of capital goods and requires Exl Philippines to meet certain export obligations.

Contingencies

U.S. and Indian transfer pricing regulations require that any international transaction involving associated enterprises be at an arm’s-length price. Transactions among the Company’s subsidiaries and the Company may be required to satisfy such requirements. Accordingly, the Company determines the pricing among its associated enterprises on the basis of detailed functional and economic analysis involving benchmarking against transactions among entities that are not under common control. The tax authorities have jurisdiction to review this arrangement and in the event that they determine that the transfer price applied was not appropriate, the Company may incur increased tax liability, including accrued interest and penalties. The Company is currently involved in disputes with the Indian tax authorities over the application of some of its transfer pricing policies. The Company has received the following assessment orders from the Indian tax authorities with respect to their audit of certain of the Company’s subsidiaries. The Indian tax authorities are examining income tax returns for other tax years.

 

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Table of Contents

EXLSERVICE HOLDINGS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

March 31, 2011

(Unaudited)

(In thousands, except share and per share amounts)

 

The details of the assessment orders as of March 31, 2011 are set forth below:

 

Entity

   Tax Year     

Issue

   Amount
Demanded
(Including
Interest)
    Amount
Deposited
(Including
additional
Interest)
     Bank
Guarantee
Issued
(Including
additional
Interest)
 
Exl India      2003-04       The assessment order alleges that the transfer price we applied to transactions between EXL India and EXL Inc. in the 2003-04 tax year was not appropriate and also disallows certain expenses claimed as tax deductible by EXL India.    $ 2,180      $ 2,180       $ —     
Exl India      2004-05       The assessment order alleges that the transfer price we applied to transactions between EXL India and EXL Inc. for the 2004-05 tax year was not appropriate and also disallows certain expenses claimed as tax deductible by EXL India.      2,113        2,113         —     
Exl India      2005-06       The assessment order alleges that the transfer price we applied to transactions between EXL India and EXL Inc. for the 2005-06 tax year was not appropriate and also disallows certain expenses claimed as tax deductible by EXL India.      3,983        3,983         —     
Exl India      2006-07       The assessment order alleges that the transfer price we applied to transactions between EXL India and EXL Inc. for the 2006-07 tax year was not appropriate and also disallows certain expenses claimed as tax deductible by EXL India.      4,056        1,719         —     
Exl Inc.      2003-04       The assessment order alleges that EXL Inc. has a permanent establishment in India.      3,288        1,570         2,454   
Exl Inc.      2004-05       The assessment order alleges that EXL Inc. has a permanent establishment in India.      105        45         59   
Exl Inc.      2005-06       The assessment order alleges that EXL Inc. has a permanent establishment in India.      780        404         458   
Exl Inc.      2006-07       The assessment order alleges that EXL Inc. has a permanent establishment in India.      1,339        —           —     
                               
         $ 17,844      $ 12,014       $ 2,971   
                               

Based on advice from its Indian tax advisors, the facts underlying its position and its experience with these types of assessments, the Company believes that the probability of loss is remote and accordingly has not accrued any amount with respect to these matters in its unaudited consolidated financial statements. The Company does not expect any impact from these assessments on its future income tax expense. The Company is subject to U.S. income taxes on the profits it recognizes in the United States. The Company has deposited the entire amount demanded by the Indian tax authorities with respect to the assessment orders received by Exl India and by Exl Inc. with the exception of the assessment orders relating to the 2006-07 tax year of Exl India and the 2006-07 tax year of Exl Inc. as disclosed above. There is a likelihood that the Company might receive similar orders for subsequent years until the above disputes are resolved.

Amounts paid as deposits in respect of the assessments described above aggregating to $12,014 and $11,898 as of March 31, 2011 and December 31, 2010, respectively, are included in “Other assets” and amounts deposited for bank guarantees aggregating to $2,971 and $2,963 as of March 31, 2011 and December 31, 2010, respectively, are included in “Restricted cash” in the Company’s unaudited consolidated balance sheet as of March 31, 2011 and the audited consolidated balance sheet as of December 31, 2010.

 

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EXLSERVICE HOLDINGS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

March 31, 2011

(Unaudited)

(In thousands, except share and per share amounts)

 

17. Subsequent Events

On April 30, 2011, ExlService Holdings and F&A BPO Merger Sub, Inc., a Delaware corporation and a wholly owned subsidiary of ExlService Holdings (“Merger Sub”), entered into a definitive Merger Agreement (the “Merger Agreement”) with Business Process Outsourcing, Inc., a Cayman Islands exempted company (“OPI”) and Shareholder Representative Services LLC, a Colorado limited liability company. OPI is a leading global provider of finance and accounting outsourcing services. Under the terms of the Merger Agreement and subject to the conditions set forth therein, Merger Sub will merge with and into OPI and OPI will survive and become a wholly owned subsidiary of ExlService Holdings. The aggregate consideration for all the outstanding capital stock of OPI will be $91,000 in cash, subject to adjustment based on working capital, OPI’s debt and certain transaction expenses.

 

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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, 2010. 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.

Overview

We are a leading provider of outsourcing and transformation services focused on providing a competitive edge to our clients. Our outsourcing services provide front-, middle- and back-office process outsourcing 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, risk and financial management 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. A significant portion of our business relates to processes that we believe are integral to our clients’ operations, and the close nature of our relationships with our clients assists us in developing strong strategic long-term relationships with them. We serve primarily the needs of Fortune Global 500 and Fortune 1000 companies in the insurance, utilities, banking and financial services, transportation and logistics and travel sectors.

We market our services directly through our sales and marketing and client management teams, which operate out of the United States and the United Kingdom. We currently operate twelve operations centers in India, one operations center in Romania, one operations center in Philippines, one operations center in Czech Republic and one operations center in the U.S. We are also in the process of expanding some of our operations centers in India.

On March 1, 2010, we acquired the Global Travel Service Center (“GTSC”) operations of American Express located in Gurgaon, India, that provides the travel-related business process outsourcing services of American Express. The purchase price of the transaction, which was paid in cash, was approximately $29.1 million. Through this transaction, we have started to provide services to the travel sector, deepened our relationship with a significant client and expanded our capability set in analytics, exception processing and transaction processing.

On May 1, 2010, we acquired a 100% stake in Professional Data Management Again, Inc. (“PDMA”), developer of the LifePRO® insurance policy administration platform used by approximately 40 insurance companies. The purchase price for PDMA, which was paid in cash, was approximately $14.1 million (including cash acquired of $1.0 million), net of working capital adjustments. The PDMA acquisition has provided us a policy administration platform for our insurance clients for a wide range of insurance products.

We generate revenues principally from contracts to provide outsourcing and transformation services. For the three months ended March 31, 2011, we had total revenues of $72.9 million compared to total revenues of $54.5 million in the three months ended March 31, 2010, an increase of $18.4 million or 33.8%. Revenues from outsourcing services were higher by $15.2 million in the three months ended March 31, 2011 compared to the three months ended March 31, 2010, primarily due to revenues from our acquisitions of PDMA and GTSC of $7.7 million, net volume increases from existing and new clients of approximately $7.2 million and an increase of approximately $0.3 million due to the appreciation of the Indian rupee, U.K. pound sterling and Czech koruna against the U.S. dollar in the three months ended March 31, 2011 compared to the three months ended March 31, 2010. Revenues from transformation services were higher by $3.2 million during the three months ended March 31, 2011 compared to the three months ended March 31, 2010, primarily due to a combination of increased revenues in recurring or annuity analytics services and an increase in project-based engagements both in our analytics consulting and risk management practices. We believe this reflects increased spending by our clients for analytics services, particularly in the areas of customer management, process improvement and risk management, as compared to the previous year.

 

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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, including transaction processing, customer services, debt management, finance and accounting services and collection 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 initial terms ranging from three to five years. 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.

Our transformation services include various services such as decision analytics services, which are intended to facilitate more effective data-based strategic and operating decisions by our clients, risk and financial management services and operations and process excellence services.

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 year 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 serve clients mainly in the United States and the United Kingdom, with these two regions generating approximately 71.9% and 25.3%, respectively, of our total revenues for the three months ended March 31, 2011 and approximately 70.8% and 26.3%, respectively, of our total revenues for the three months ended March 31, 2010.

We derive a significant portion of our revenues from a limited number of large clients. In the three months ended March 31, 2011 and 2010, our total revenues from our three largest clients were $27.8 million and $23.7 million, respectively, accounting for 38.2% and 43.5% of our total revenues, respectively, during these periods.

We provide services to The Travelers Companies (Travelers), which represented $10.1 million, or 13.8%, of our total revenues for the three months ended March 31, 2011 and $8.5 million, or 15.5% of our total revenues for the three months ended March 31, 2010, under a services agreement. 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 provide services to Centrica plc (Centrica), which represented $9.3 million, or 12.8%, of our total revenues for the three months ended March 31, 2011 and $9.5 million, or 17.5%, of our total revenues for the three months ended March 31, 2010, under an agreement that is scheduled to expire in April 2012. Centrica may terminate the agreement without cause upon three months prior notice and payment of a breakup fee.

We provide services to subsidiaries of American Express Company (American Express) under (i) a master services agreement for our outsourcing services, which agreement cannot be terminated by American Express without cause and which provides us with a minimum volume commitment over a period of eight years and (ii) a master agreement for our transformation services, which agreement may be terminated by American Express without cause upon five days prior written notice. Our aggregate revenues from outsourcing services and transformation services to American Express represented $8.5 million, or 11.6% of our total revenues for the three months ended March 31, 2011 and $3.9 million or 7.1% of our total revenues for the three months ended March 31, 2010.

 

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We derived revenues from three and four new clients for our services, in the three months ended March 31, 2011 and 2010, respectively. 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.

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 March 31, 2011 and 2010, 4.3% and 4.6%, 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, Philippines peso/U.S. dollar and U.K. pound sterling/U.S. dollar foreign currency exposure.

Our management has observed in recent periods 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 to the extent we are required to modify the terms of our relationship 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, 2010.

Results of Operations

The following table summarizes our results of operations:

 

     Three months ended March 31,  
             2011                      2010          
     (in million)  

Revenues(1)

   $ 72.9       $ 54.5   

Cost of revenues (exclusive of depreciation and amortization)(2)

     44.2         31.5   
                 

Gross profit

     28.7         23.0   
                 

Operating expenses:

     

General and administrative expenses(3)

     10.4         9.3   

Selling and marketing expenses(3)

     5.9         4.1   

Depreciation and amortization expenses(4)

     4.9         3.1   
                 

Total operating expenses

     21.2         16.5   
                 

Income from operations

     7.5         6.5   

Other income/(expense):

     

Foreign exchange gain

     1.7         0.6   

Interest and other income

     0.3         0.4   
                 

Income before income taxes

     9.5         7.5   

Income tax provision

     1.1         1.9   
                 

Net income

   $ 8.4       $ 5.6   
                 

 

(1) Revenues include reimbursable expenses of $3.1 million and $2.5 million for the three months ended March 31, 2011 and 2010, respectively.
(2) Cost of revenues includes $0.4 million and $0.4 million for the three months ended March 31, 2011 and 2010, respectively, as 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 $1.9 million and $1.4 million for the three months ended March 31, 2011 and 2010, respectively, as 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 $0.6 million and $0.2 million for the three months ended March 31, 2011 and 2010, 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, 2011 Compared to Three Months Ended March 31, 2010

Revenues. Revenues increased 33.8% from $54.5 million for the three months ended March 31, 2010 to $72.9 million for the three months ended March 31, 2011. Revenues from outsourcing services increased from $41.6 million during the three months ended March 31, 2010 to $56.8 million during the three months ended March 31, 2011. The increase in revenues from outsourcing services of $15.2 million was primarily driven by revenues of $7.7 million from acquisitions of GTSC and PDMA, net volume increases from existing and new clients aggregating to $7.2 million and revenues of $0.3 million due to the appreciation of the Indian rupee, U.K. pound sterling and Czech koruna against the U.S. dollar during the three months ended March 31, 2011 compared to the three months ended March 31, 2010.

Revenues from transformation services increased from $12.9 million for the three months ended March 31, 2010 to $16.1 million for the three months ended March 31, 2011. The increase was primarily due to a combination of increased revenues in recurring or annuity analytics services and an increase in project-based engagements both in our analytics consulting and risk management practices. Revenues from new clients for transformation services were $0.2 million and $0.1 million during the three months ended March 31, 2010 and 2011, respectively.

Cost of Revenues. Cost of revenues increased 40.4% from $31.5 million for the three months ended March 31, 2010 to $44.2 million for the three months ended March 31, 2011. 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 our headcount of personnel directly involved in providing services to our clients, including $3.8 million of employee-related costs related to our acquisitions, an increase in reimbursable expenses of $0.6 million (resulting in an increase in revenues), an increase in facilities, technology and other operating expenses by $3.0 million, primarily due to our new operating centers including our acquisitions and to support our revenue growth, and an aggregate increase of $0.6 million due to the appreciation of the Indian rupee, Philippine peso and Czech koruna against the U.S. dollar during the three months ended March 31, 2011 compared to the three months ended March 31, 2010. As a percentage of revenues, cost of revenues increased from 57.8% for the three months ended March 31, 2010 to 60.7% for the three months ended March 31, 2011.

Gross Profit. Gross profit increased 24.7% from $23.0 million for the three months ended March 31, 2010 to $28.7 million for the three months ended March 31, 2011. The increase in gross profit was primarily due to an increase in revenues of $18.4 million, offset by an increase in cost of revenues of $12.7 million. Gross profit as a percentage of revenues decreased from 42.2% for the three months ended March 31, 2010 to 39.3% for the three months ended March 31, 2011, primarily due to the increase in cost of revenues as a percentage of revenues as mentioned above.

SG&A Expenses. SG&A expenses increased 21.3% from $13.4 million for the three months ended March 31, 2010 to $16.3 million for the three months ended March 31, 2011. The increase in SG&A expenses was primarily due to an increase in employee-related costs of $2.0 million, including our continued investment in front-end sales and client management personnel, an increase in professional fees of $0.5 million, primarily related to our acquisition related costs and an increase in other SG&A costs of $0.3 million during the three months ended March 31, 2011 compared to the three months ended March 31, 2010. As a percentage of revenues, SG&A decreased from 24.7% for the three months ended March 31, 2010 to 22.4% for the three months ended March 31, 2011.

Depreciation and Amortization. Depreciation and amortization increased 57.9% from $3.1 million for the three months ended March 31, 2010 to $4.9 million for the three months ended March 31, 2011. The increase was primarily due to an increase in amortization of acquisition-related intangibles of $0.4 million, an increase in depreciation primarily related to our new operations centers including our acquisitions of $1.3 million and an increase of $0.1 million due to the appreciation of the Indian rupee against the U.S. dollar. As we add more operations centers, we expect that depreciation expense will increase to reflect the additional investment in equipment and operations centers necessary to meet our service requirements. As a percentage of revenues, depreciation and amortization increased from 5.6% for the three months ended March 31, 2010 to 6.7% for the three months ended March 31, 2011.

 

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Income from Operations. Income from operations increased 15.9% from $6.5 million for the three months ended March 31, 2010 to $7.5 million for the three months ended March 31, 2011. The increase in income from operations was primarily due to an increase in gross profit by $5.7 million, offset by an increase in operating expenses of $4.7 million as mentioned above. As a percentage of revenues, income from operations decreased from 11.9% for the three months ended March 31, 2010 to 10.3% for the three months ended March 31, 2011.

Other Income/(Expense). Other income/(expense) is comprised of foreign exchange gains and losses, interest income, interest expense and other items. Other income increased from $1.0 million for the three months ended March 31, 2010 to $2.0 million for the three months ended March 31, 2011, primarily as a result of net foreign exchange gain of $1.6 million during the three months ended March 31, 2011 compared to $0.6 million during the three months ended March 31, 2010, primarily attributable to the movement of the U.S. dollar against the Indian rupee and the U.K. pound sterling. The average exchange rate of the Indian rupee against the U.S. dollar was 45.26 during the three months ended March 31, 2011 compared to 45.72 during the three months ended March 31, 2010.

Provision for Income Taxes. Provision for income taxes decreased significantly from 25.0% during the three months ended March 31, 2010 to 11.8% during the three months ended March 31, 2011, primarily due to the release of a valuation allowance on deferred tax assets of $2.0 million. Refer to Note 12 to the unaudited consolidated financial statements for further details.

Net Income. Net income increased from $5.6 million for the three months ended March 31, 2010 to $8.4 million for the three months ended March 31, 2011, primarily due to an increase in operating income of $1.0 million, other income of $1.0 million and decrease in provision for income taxes of $0.8 million as mentioned above. As a percentage of revenues, net income increased from 10.3% for the three months ended March 31, 2010 to 11.5% for the three months ended March 31, 2011.

 

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Liquidity and Capital Resources

At March 31, 2011, we had $115.7 million in cash and cash equivalents and short-term investments.

Cash flows provided by operating activities increased from ($0.9) million in the three months ended March 31, 2010 to $7.8 million in the three months ended March 31, 2011. Cash flows from net income adjusted for non-cash items increased by $4.1 million during the three months ended March 31, 2011 compared to the three months ended March 31, 2010, primarily due to an increase in net income of $2.7 million and depreciation and amortization expense of $1.8 million.

Cash flows from changes in working capital increased by $4.5 million during the three months ended March 31, 2011 compared to the three months ended March 31, 2010, primarily due to the payment against a bank guarantee with respect to our income tax proceedings during the quarter ended March 31, 2010.

Cash flows used for investing activities decreased from $32.7 million in the three months ended March 31, 2010 to $7.2 million in the three months ended March 31, 2011. The decrease is primarily due to the payment of the purchase consideration of approximately $29.1 million for the acquisition of GTSC during the three months ended March 31, 2010.

Cash flows provided by financing activities were insignificant during the three months ended March 31, 2011 and 2010.

We expect to use cash from operating activities to maintain and expand our business. As we have focused on expanding our cash flow from operating activities, we continue to make capital investments, primarily related to new facilities and capital expenditures associated with leasehold improvements to build out our facilities and purchase of telecommunications equipment and computer hardware and software in connection with managing client operations. We incurred approximately $7.2 million of capital expenditures in the three months ended March 31, 2011. We expect to incur capital expenditures of approximately $15.0 million to $18.0 million in the remainder of 2011 primarily to meet the growth requirements of our clients, including additions to our existing facilities and expanding our new operations centers in Noida, India as well as to improve our internal technology. The timing and volume of such capital expenditures in the future will be affected by new client contracts we may enter into or the expansion of business under our existing client contracts.

In connection with the tax assessment orders issued against Exl India and Exl Inc. we may be required to deposit additional amounts with respect to the assessment orders received by us and for similar orders for subsequent years that may be received by us. Refer to Note 16 to our unaudited consolidated financial statements for further details.

We anticipate that we will continue to rely upon cash from operating activities to finance our acquisitions, capital expenditures and working capital needs. If we have significant growth through acquisitions, we may need to obtain additional financing.

 

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Off-Balance Sheet Arrangements

As of March 31, 2011 and December 31, 2010, we had no off-balance sheet arrangements or obligations.

Contractual Obligations

The following table sets forth our contractual obligations as of March 31, 2011:

 

     Payment Due by Period  
     Less than
1 year
     1-3
years
     4-5
years
     After
5 years
     Total  
     (in millions)  

Capital leases

   $ 0.3       $ 0.4       $ —         $ —         $ 0.7   

Operating leases

     4.9         5.5         1.1         1.1         12.6   

Purchase obligations

     2.2         —           —           —           2.2   

Other obligations(a)

     1.0         1.8         1.6         2.4         6.8   
                                            

Total contractual cash obligations(b)

   $ 8.4       $ 7.7       $ 2.7       $ 3.5       $ 22.3   
                                            

 

(a) Represents estimated payments under the Company’s Gratuity Plan.
(b) Excludes $4.5 million related to uncertain tax positions, since the extent of the amount and timing of payment is currently not reliably estimable or determinable.

Certain units of our Indian subsidiaries have been established as 100% Export-Oriented units under the Export Import Policy or Software Technology Parks of India units (“STPI”) under the STPI guidelines issued by the Government of India that has provided us with certain incentives on imported and indigenous capital goods on fulfillment of certain conditions. In the event that these units are unable to meet those conditions over the specified period, we may be required to refund those incentives along with penalties and fines. However, we believe that these units have in the past and will continue to satisfy those conditions.

Exl Philippines is registered as an Ecozone IT Enterprise with the Philippines Economic Zone Authority. The registration has provided the Company with certain incentives on the import of capital goods and requires Exl Philippines to meet certain export obligations.

Recent Accounting Pronouncements

In September 2009, the FASB issued Update No. 2009-13, “Multiple-Deliverable Revenue Arrangements—a consensus of the FASB Emerging Issues Task Force.” It updates the existing multiple-element revenue arrangements guidance currently included under ASC topic 605-25, which originated primarily from the guidance in EITF Issue No. 00-21, “Revenue Arrangements with Multiple Deliverables.” The revised guidance primarily provides two significant changes: (1) eliminates the need for objective and reliable evidence of the fair value for the undelivered element in order for a delivered item to be treated as a separate unit of accounting, and (2) eliminates the residual method to allocate the arrangement consideration. In addition, the guidance also expands the disclosure requirements for revenue recognition. ASU 2009-13 is effective for the first annual reporting period beginning on or after June 15, 2010, with early adoption permitted provided that the revised guidance is retroactively applied to the beginning of the year of adoption. The adoption of new guidance from January 1, 2011 did not have any impact on our unaudited consolidated financial statements as the number of multiple deliverable revenue arrangements is insignificant.

Forward Looking Statements

This Quarterly Report on Form 10-Q contains forward looking statements. You should not place undue reliance on those 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,”

 

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“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 our earnings;

 

   

our ability to attract and retain clients;

 

   

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;

 

   

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

 

   

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;

 

   

our ability to successfully consummate or integrate strategic acquisitions; 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 these 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.

 

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ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

During the three months ended March 31, 2011, there were no material changes in our market risk exposure. For a discussion of our market risk associated with exchange rate risk and interest rate risk, see Item 7A “Quantitative and Qualitative Disclosures about Market Risk” in our Annual Report on Form 10-K for the year ended December 31, 2010.

 

ITEM 4. CONTROLS AND PROCEDURES

Evaluation of Disclosure Controls and Procedures

The Company maintains disclosure controls and procedures that are designed to ensure that information required to be disclosed in the reports the Company files under the Securities Exchange Act of 1934 (the “Exchange Act”) is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms, and that such information is accumulated and communicated to the Company’s management, including its Chief Executive Officer (“CEO”) and Chief Financial Officer (“CFO”), to allow timely decisions regarding required financial disclosure. In connection with the preparation of this Quarterly Report on Form 10-Q, the Company’s management carried out an evaluation, under the supervision and with the participation of the CEO and CFO, of the effectiveness and operation of our disclosure controls and procedures as of March 31, 2011. Based upon that evaluation, the CEO and CFO have concluded that, as of March 31, 2011, our disclosure controls and procedures were effective.

Changes in Internal Control over Financial Reporting

During the three months ended March 31, 2011, there was no change in our internal control over financial reporting (as defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act) that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.

 

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PART II. OTHER INFORMATION

 

ITEM 1. LEGAL PROCEEDINGS

Refer to Note 16 to our unaudited consolidated financial statements contained herein for the information regarding our ongoing legal proceedings.

 

ITEM 1A. RISK FACTORS

We have disclosed under the heading “Risk Factors” in our Annual Report on Form 10-K for the year ended December 31, 2010 the risk factors which materially affect our business, financial condition or results of operations. You should carefully consider the “Risk Factors” set forth in our Annual Report on Form 10-K for the year ended December 31, 2010 and the other information set forth elsewhere in this Quarterly Report on Form 10-Q. You should be aware that these risk factors and other information may not describe every risk facing our Company. Additional risks and uncertainties not currently known to us also may materially adversely affect our business, financial condition and/or results of operations.

 

ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS

Unregistered Sales of Equity Securities

None.

Use of Proceeds

None.

Purchases of Equity Securities by the Issuer

On February 04, 2011, we acquired 1,714 shares of common stock from employees in connection with withholding tax payments related to the vesting of restricted stock for a total consideration of approximately $33,869. The purchase price of $17.96 per share was the average of the high and low price of the our shares of common stock on the Nasdaq Global Select Market on the trading day prior to the vesting date of the shares of restricted stock. These shares are held as treasury stock.

 

ITEM 3. DEFAULTS UPON SENIOR SECURITIES

None.

 

ITEM 4. (REMOVED AND RESERVED)

None.

 

ITEM 5. OTHER INFORMATION

None.

 

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ITEM 6. EXHIBITS

The following exhibits are being filed as part of this Quarterly Report on Form 10-Q:

 

31.1    Certification of the Chairman of ExlService Holdings, pursuant to Rule 13a-14 of the Exchange Act, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
31.2    Certification of the President and Chief Executive Officer of ExlService Holdings, pursuant to Rule 13a-14 of the Exchange Act, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
31.3    Certification of the Chief Financial Officer of ExlService Holdings, pursuant to Rule 13a-14 of the Exchange Act, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
32.1    Certification of the Chairman of ExlService Holdings, pursuant to Rule 13a-14(b) of the Exchange Act and 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
32.2    Certification of the President and Chief Executive Officer of ExlService Holdings, pursuant to Rule 13a-14(b) of the Exchange Act and 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
32.3    Certification of the Chief Financial Officer of ExlService Holdings, pursuant to Rule 13a-14(b) of the Exchange Act and 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

 

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SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned hereunto duly authorized.

 

    EXLSERVICE HOLDINGS, INC.

Date: May 10, 2011

  By:  

/s/  VISHAL CHHIBBAR

    Vishal Chhibbar
   

Chief Financial Officer

(Duly Authorized Signatory, Principal Financial and Accounting Officer)

 

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