Exlservice Holdings Inc (EXLS) 2007 Q1 法說會逐字稿

Good day, ladies and gentlemen, and welcome to EXL's First Quarter 2007 Earnings Conference Call. My name is Cammie, and it will be my pleasure to be your coordinator today.

(OPERATOR INSTRUCTIONS)

As a reminder, this conference is being recorded for replay purposes. I would now like to turn the presentation over to the head of investor relations, Mr. Jarrod Yahes. Please proceed, sir.

Thank you, operator, and thanks, everyone, for joining us today on EXL's first quarter 2007 earnings announcement. Joining us from India are Vikram Talwar, our Vice Chairman and Chief Executive Officer, Rohit Kapoor, our President, and Matt Appel, EXL's CFO.

We hope you've had an opportunity to review the news release we issued a short time ago, as well as the PowerPoint presentation that's available for review on EXL's website on the investor relations section.

Let me quickly outline the agenda for today's call. Vikram will first begin with an overview of the demand environment for new business and macro factors impacting EXL. Rohit will talk about the operational performance of the company, and Matt will take you through the financial details, as well as provide an outlook for the year 2007 and close the presentation before we take questions.

Some of the matters we'll discuss in this call are forward-looking, and you should keep in mind that these forward-looking statements are subject to known and unknown risks and uncertainties that could cause actual results to differ materially from those expressed or implied by such statements.

Such risks and uncertainties include, but are not limited to, general economic conditions and those factors set forth in today's press release, discussed in the company's periodic reports and other documents filed with the Securities and Exchange Commission from time to time. EXL assumes no obligations to update the information presented on this conference call.

During our call today, we may reference certain non-GAAP financial measures that we believe provide useful information for investors, and you can find reconciliations of those measures to GAAP on the press release. So now let me turn the call over to Vikram Talwar, EXL's CEO and Vice Chairman. Vikram?

Thank you, Jared, and good morning to everyone. We are very pleased to say that the first quarter of 2007 was a very solid quarter for EXL and that we exceeded our financial goals for the quarter. In addition, our investments in building the leadership team within the organization are starting to pay off as we take advantage of robust demand for our services.

In the first quarter of 2007, we delivered revenues of $39.9 million, which was above our expectations and exceeded our profit guidance by a significant margin. Our performance was driven by continued rapid revenue growth in BPO and advisory services. The BPO business grew 11% sequentially and 67% year-over-year. The advisory business also had a very strong quarter, with record quarterly revenues that successfully mitigated the seasonality that this business line has historically experienced in the first quarter.

We added additional leadership during the quarter that is focused on bringing several new CFO-focused service lines to the market, performance measurement, activity-based management, financial and management reporting and enterprise risk management. We believe, that there are strong synergies between these services and the outsourcing and back office transaction processing activities that are at the very core of what we do.

While the research and analytics business line experienced a slow quarter, we are encouraged by the traction achieved in attracting business that is contracted and long-term in nature, versus traditional project-based work. This shift will enable this business to grow and scale along with the BPO business. For example, we recently won mandates from three insurance companies to provide analytical services.

These assignments are large in scale, and are more contracted and recurring in nature, which is particularly encouraging. From a sales and marketing perspective, our pipeline of business from new clients is very attractive. We are seeing continued strong demand in insurance, in mortgage, as well as in additional verticals.

Within the insurance space, prospective customers are exhibiting strong interest in research and analytic services. The analytics business will be an area of continued investment and focus for EXL. We believe the growth opportunity is significant for the skill sets that EXL brings to complex domain-focused analytics assignments.

In the mortgage segment, EXL continues to see strong demand from both existing and new clients. The cost pressures on this industry continue to intensify, which makes offshoring and outsourcing an attractive strategic imperative.

In sum, we believe that the demand environment remains attractive. We also believe that our strategy of providing a competitive edge to our clients by transforming and outsourcing their business processes is winning in the marketplace, and we should have some existing, significant client wins to report to you next quarter as our pipeline matures.

Now let me pass you over to Rohit, to comment on our operational performance for the quarter.

Thanks, Vikram, and good morning, everyone. I'm going to be providing you with an overview of our operational performance. On the people front, we added approximately 800 new professionals to our business during the quarter. EXL has now reached 9,000 employees, and we continue to focus on scaling the organization in a manner that is sustainable and built for long-term growth.

Our attrition rate has inched up during the quarter to 44% from 42% last quarter. This is an area of management focus and we are working on several initiatives to control attrition. However, we believe that the current level of attrition does not impede our ability to deliver operational excellence to our clients and grow our business.

The strong utilization of our physical infrastructure continued during the first quarter, which resulted in a benefit to our gross margins. Our new center in Noida of 1,200 seats became operational in the second quarter, and will enable us to fulfill expected demand from our clients.

We are also contemplating for a new recruiting and training center in Noida that will be available later this year. In addition, we are finalizing a long-term, real estate plan that reflects expansion into a third city in India to complement our operational delivery centers in Noida and Pune.

From a client perspective, we continue to see opportunities for growth across most major client relationships. Looking forward, we are anticipating that during the next two quarters, we will accelerate our relationship with a large U.S. life insurance company as the current migration is progressing according to plan. Our service delivery metrics and process performance continue to be very strong, thereby resulting in high levels of client satisfaction. This is proving to be a strong differentiator for EXL in the marketplace, as we compete for new customers.

Now, let me pass it over to Matt, who will provide more detail on our financial performance and guidance.

Thanks, Rohit, and good morning, everyone. Let me first take you through the income statement and provide some detail behind the numbers for the quarter. Revenues for the first quarter ended March 31, 2007, increased to $39.9 million, up 85% from $21.6 million in the quarter ended March 31, 2006. As compared to the fourth quarter of 2006, revenue for the first quarter of 2007 increased by $0.6 million or 2%, reflecting increases of $3.3 million in BPO and $0.2 million in advisory, offset by a decline in research and analytics of $2.9 million.

Within EXL's business line segments, in terms of revenue, BPO accounted for $32.7 million, or 82% of total revenue in the first quarter. Research and analytics contributed $4.2 million, or approximately 11% of total revenue, and advisory services contributed $2.9 million, or approximately 7% of total revenues.

To provide some qualitative commentary on our revenue performance of the three business lines during the quarter, BPO benefited from growth in processes performed for current clients, resulting in incremental revenues. Research and analytics revenue decline was attributable to significantly lower revenue from their largest customer, who cut discretionary spending in the first quarter. This is not indicative of the overall demand environment for these services.

And advisory service has benefited from business growth to existing, as well as new, clients, successfully mitigating a historical downturn in the first quarter. Gross margin for the quarter ended March 31, 2007, was 38.6%, compared to 35.3% in the quarter ended March 31, 2006. The increase in margin is attributable to business growth and the continued high utilization of our existing physical infrastructure in the BPO business, offset by lower margins in research and analytics due to lower business volume.

In comparison to the quarter ended December 31, 2006, gross margins decreased slightly from 42.9% and this was due primarily to the performance of research and analytics during the first quarter of 2007. Adjusted operating margin for the quarter, excluding the impact of stock compensation expense and amortization of intangibles, was 15.9% for the quarter ended March 31, 2007, compared to 7.5% in the quarter ended March 31, 2006, which was almost 400 basis points above our guidance.

Going forward, as emphasized over the last several quarters, we expect that our SG&A expenses will increase significantly as we add staff and leadership in sales and marketing and client relationship management, as well as industry domain and functional experts in insurance, banking and finance and accounting. In terms of exchange rate impacts during the quarter, let me first give you some background on how exchange rates affect our company.

First, we currently incur approximately 60% of our costs in rupees, the remainder in dollars, and from a revenue perspective, we bill slightly more than 50% in UK pounds, and the rest in U.S. dollars. From a currency fluctuation standpoint, the rupee appreciated about 0.5% against the dollar in the first quarter of 2007, compared to the fourth quarter of 2006, while the UK pound appreciated about 1% against the dollar, using the same periods for comparison.

Therefore, on a net basis, we benefited by approximately $100,000 for the quarter, before the impact of our hedging program, from which we benefited by an additional $570,000 in the quarter. Now, please note that these amounts relate only to the currency impact in the first quarter. The appreciation of the rupee in the second quarter, almost 6% to date, has been quite significant.

And as a rule of thumb, the way to think about our currency exposure is that for each 1% in the value of the rupee compared to the dollar, we are impacted negatively by approximately 40 basis points of operating margin. And this is of course before any benefit we would receive related to the appreciation of the UK pound. And, finally, on average, we hedge the majority of our exposure to the rupee and the pound six to 18 months forward.

From a balance sheet perspective, I would like to comment on receivables and cash at the end of the first quarter. Receivables increased by approximately $8 million during the quarter, due primarily to the timing of payments from our two largest customers. These amounts were paid during the first half of April. In addition, we pay our annual bonuses during the first quarter.

These two items, plus the significant investments made in fixed assets during the quarter, resulted in a net reduction of approximately $11 million in cash. I would like to conclude by reiterating our guidance for the full year of 2007. We are maintaining our previous guidance for revenues at between $160 million and $170 million, and adjusted operating margin before stock compensation expense and amortization of intangibles at 12% of revenues.

However, for the second quarter, we expect that operating margin will be negatively impacted by currency movements and the continued softness in our research and analytics business line.

We would now like to open the floor for your questions.

(OPERATOR INSTRUCTIONS)

And your first question, gentleman, comes from the line of Ashwin Shirvaikar with Citigroup. Please proceed.

Hi, thank you, and congratulations on the quarter, everybody.

Thanks.

Sure. The question is with regards to the go-forward margin profile since you're holding the line that you previously stated. I just want to understand there is obviously the currency impact in research analytics, but what's the impact of it seemed like you added a lot of people in the quarter and in the new center and new clients. Could you sort of go through it piece by piece and talk through the impact?

Sure, Ashwin. This is Matt. The three biggest impacts on the margin and therefore the reason for the guidance that we've reiterated today, as you've mentioned, is foreign currency exposure, and the significant appreciation in the rupee that everyone is familiar with and the softness in the R&A business. One other point is that we pay our annual increment starting in the second quarter, and they're rather significant, and so when you accumulate all of these items, they really do have quite a significant impact on the margin.

It's not clear where the rupee is going to go form this point, and so we're being cautious in that regard. As far as fixed assets. I would also mention that our new center six, which went into service this quarter, we'll start obviously taking that through the income statement this quarter. That will also cause a slight drag on our margins.

So all in, if you look at it on a year-over-year basis, would you expect margins on a GAAP basis to still be up?

Not at this juncture, no. In particular, because of the first two items that I mentioned, currency and the softness in R&A. R&A had a very strong third and fourth quarters, as you know, and so those two items taken together, no, I wouldn't expect them to be up from our previous points.

And the currency impact, it is completely offset, at least for the second quarter because of your hedge on the net line.

Sure. Well, the hedge, of course, is below the line. But in this quarter, the rupee has appreciated more than the pound, and so our natural hedge from our pound billings will not -- at the moment, at least, doesn't look like it will help us as much.

Okay, and how long will it take the longer relationships in research analytics to sort of make a meaningful revenue contribution?

Ashwin, this is Rohit. Let me take that. The new client wins that we have had in research and analytics, our initiative engagements are small pilots that we are running for them. Our expectation is that this will fully ramp up in 12 to 18 months.

12 to 18 months.

Right.

Are these sort of meaningful clients, sort of like an American Express sort of client?

American Express is the largest client relationship for the research and analytics business, so I don't think -- it took close to about five years to establish that level of a client relationship. These client relationships are very significant. Some of them are new client relationships and some of them are cross-sells into existing client relationships, and we believe that we can build up significant revenue streams on the analytics and the research side of our business form these clients.

Okay, thank you.

Your next question comes from the line of Julio Quinteros with Goldman Sachs. Please proceed.

Hi, real quickly, can you just give us the operating cash, CapEx and free cash flow for expectations for the full year?

Yes, our CapEx expectations for the year are between 11 and 15 million.

And free cash flow?

Looking at free cash flow?

Yes.

Just bear with us a minute.

Yes, Julio, we typically don't give cash flow guidance and we're going to maintain position here. Sorry for the delay in communicating that to you. But we were able to --

Okay, and can you just give us then -- I'm sorry, there might be a delay because I'm calling in from Asia right now. On the BPO versus the research and analytic wins, can you just break up the number --? I'm sorry, I might have missed, the total number of wins that you guys announced for the quarter, how many of those were actual BPO wins versus R&A wins?

Julio, I'll take that question. This is Rohit. In total we had 14 new global wins in the first quarter, ten of which were in the research and analytics business and four were in the risk advisory services business line. We did not have any new win in the first quarter for the BPO business.

In addition to this, there have been additional cross-sells that have taken place for both of the business lines across our existing clients, and we have closed on a couple of new client relationships in the second quarter for the BPO line of business.

Okay, and then, real quickly, the last question, on the client that was expected to ramp up in the first quarter, division that client ramp as expected, or was that pushed out into the second quarter? It was a large insurance client win.

Yes, Julio, as we've commented, we have undertaken the transition and migration for that client relationship, and that is proceeding according to plan. We would expect the revenue to kick in in significant amounts in Q2 and in Q3.

Q2 and in Q3, okay, great, thank you.

Your next question comes from the line of Cynthia Houlton with RBC Capital markets, please proceed.

Hi. You mentioned in your prepared comments about rising attrition levels and that there are things you're trying to put in place to focus on that. Can you kind of describe more specifically, kind of looking at where the attrition is coming from, and maybe you can highlight kind of specifically where you're seeing rising attrition and then kind of within what business segment are you seeing higher attrition? And then also what are the things you can do to offset that?

Hi, this is Vik, here. Let me take that. There has been a marginal blip upwards over the quarters in the attrition rate. These things do happen in this industry. It isn't a science, as you can well imagine. It's just at the end of the day personal reasons. It is all kinds of other aspects, including the highly competitive marketplace that we function in. We've taken some pretty aggressive steps for controlling attrition.

We have recently appointed one of our very senior operations vice presidents to head a new position called BPO HR, which is going to be focused entirely on the BPO side of the is and handle directly all of the attrition issues particularly in that area. So that's a very important milestone in our efforts to hold the attrition line.

We've also instituted additional management development program, further training programs at the supervisory levels. As you know, probably one of the most important reasons that people do attrite is in the area of having highly trained supervisors, and that's an area we're focusing on as we go forward. And, also, we believe that the attrition trends will sort of fluctuate over a period of time.

So you will see some quarters where they sort of come down a bit, some quarters where they go up a bit. However, we believe that we have adequate measures in place to ensure high-quality service to our clients, which have not been impacted at all by the slight blip that we have shown this quarter.

Okay, and then just a follow-up question on the assumptions that we should kind of think about going forward on your guidance and kind of the segment. Could you kind of give a little bit more color on how we think about the different segments going forward?

As we indicated, we expect the research and analytics business to remain soft for some time, as we mentioned several times here. We expect that BPO will continue it very strong performance and continue to grow marginally, as well the rest of our business. And so I think we have a pretty high level of confidence in the revenue guidance we've given you based on the net of all those factors.

Great. Thank you.

(OPERATOR INSTRUCTIONS)

Your next question comes the line of Bhuvnesh Singh with Credit Suisse. Please proceed.

Hey, guys. Good morning, and congratulations on your great results. I have a question on your revenue guidance. At this time, we did not increase our revenue guidance, despite better performance in 1Q and also despite the acquisition of UK pound against U.S. dollar helping us. Can you just give a reason for this [thing]. Is it just that the revenue shift which happened from the next couple of quarters -- 1Q that you did a better performance, or why exactly is the revenue guidance [didn't]?

Bhuvnesh, this is Rohit Kapoor. I'll take that question. The reason why we are not changing our revenue guidance is while we have outperformed in the first quarter, the research and analytics business line continues to remain soft and is below expectations in terms of its performance.

What we believe is happening with research and analytics business line, however, is that we are being able to cross-sell. We are being able to win new accounts out there and we are winning business, which is of a much more long-term and much more sustainable and defensible business than we are winning in that particular line of business.

So the quality of business out there is improving. However, it will take some time before this whole thing plays out. And that's the reason why we haven't changed the guidance for the overall revenue.

Rohit, can you also clarify that despite the benefits of currency appreciation, the pound appreciation to U.S. dollars, what have you built in that respect?

So the pound appreciation benefits us in terms of the overall revenue, but there are some contracts that we have that are denominated in sterling pound, which are on a cost-plus basis, and therefore these are -- the revenues are calculated at the exchange rate at the end of each month.

And therefore the variation and the impact on revenue is, again, not very significant for these cost-plus -- as far as cost-plus contracts.

Okay, I think I'll just take this currency thing offline to do that. I need to understand the [cost] thing better, but thanks a lot, and good quarter.

Thank you.

Your next question comes from the line of David Grossman with Thomas Weisel Partners. Please go ahead.

Thank you. Maybe if we could just go back to the analytics business for a moment. Is your sense that your revenue base with this particular client is based -- in other words, has it bottomed and stable, or do you think that sequentially and further out in '07 that that business could continue to be a headwind on a sequential basis?

David, this is Rohit. As you know, in the fourth quarter of 2006, we had a bunching up of projects in the R&A business, which came from a number of different clients, but including the largest client relationship that we have in this business line.

In the first quarter of 2007, our clients will typically evaluate what kind of budgets they have available and they will evaluate how their businesses are performing and then decide how they should spend their discretionary dollars or undertaking some of the project-based work, and that's what we think has happened in the first quarter of this year.

Going forward, into the second quarter and third quarter and fourth quarter, we are unsure at this point of time as to how this will play out, and therefore we don't know what volume of business we can expect from this particular client relationship. However, the encouraging trends really are our ability to compete in the marketplace and win business in research and analytics against our primary competitors.

We've added ten new client relationships in the first quarter in the research and analytics business line. We've added several client relationships where we have cross-sold business and sold the research and analytics business services. And therefore some of those trends are very encouraging and positive.

Okay, and perhaps you could -- you made a comment about the pipeline, and I think you were talking company wide and the prospects for some large new customer additions in the second and third quarter. Could you just perhaps elaborate on that and what you're seeing on the pipeline, the nature of the business and the size of the transactions?

Sure, the pipeline remains strong. We would have expected for a few large clients to have signed up with us in the first quarter. That did not happen. However, we have signed up some clients in the second quarter for the BPO line of business, and we feel that the pipeline is healthy. There is a strong demand from our clients for the services that we provide.

And there is also an increasing differentiation that has been created in the marketplace regarding EXL's operational delivery capability, which seems to be standing out, and our performance metrics scores are extremely good and the client satisfaction scores are extremely positive.

Can you help us? You said you added two large BPO customers in the second quarter. How does that impact the ramp, if you will, of the new facility in Noida and utilization of that facility versus perhaps your plan at the beginning of the year?

Our plans were really to be able to utilize that new capacity by the end of this year. We think with the client wins have had, we will be on track, and as we stated earlier, we are building out additional infrastructure this year itself, which is going to be both for training and recruitment, as well as new infrastructure, which would be created in a third city that we would anticipate would be operational by end of this year or the first quarter of next year?

And how large of a facility are you planning?

Typically we would look at a facility size which is a minimum of 500 agent workstations, expandable up to 1,000 agent workstations.

And just getting back to your commentary on margin, you've laid out pretty clearly what the headwinds and the tailwinds will be on a sequential basis, but could you perhaps be a little more specific on the investments that you're making in terms of salespeople and business domain specials in terms of where you are today, in terms of heads and where you want to be by the end of the year, so we can get a better idea of kind of the magnitude, if you will, of what you're doing?

Sure. Our sales and marketing expenditure last year was about 4% of revenues. In the first quarter, it's gone up to about 5% of revenues. We expect to take this number up to somewhere between 6% to 8% of revenues by the end of this year.

In terms of the sales team that we are adding on, we are adding on business development professionals. We are adding on account management and client relationship professionals and particularly as we sign up new client relationships, we will have dedicated account relationship managers for any new client relationship that we sign up.

We have also decided to invest in domain experts, both within the insurance industry vertical, as well as within the mortgage industry vertical. And these are going to be individuals who've got significant years of experience within the chosen verticals that can help us with some of our existing client relationships, as well as with some new client relationships. So there's a fair amount of investment that we are making in this particular area.

Is the 6% to 8% just by the fourth quarter or for the year?

I think we'll get to that number by the end of the year.

I see. And, again, I think Matt made a comment about GAAP margins on a year-over-year basis and I guess two questions. One is when you said you would not expect it to be up, does that mean you would expect it to be flattish, or do you expect it to be down? And then secondly, and I think he was referring to the second quarter, can you maybe perhaps kind of give us some insights ex-stock comp, as well, and amortization operating margin?

The margins as compared to the fourth quarter of last year, I believe that was the first part of your question. The difference in performance year-over-year is attributable entirely to the performance of research and analytics.

From a margin standpoint, going forward, our expectation is that margins will drop from the first quarter, which is why we've maintained our guidance, notwithstanding the margin performance of the first quarter, for the reasons that have already been articulated.

So there's nothing to add to that I think, other than what we've already said about exchange and softness in our business, the increments that are coming online, our new center coming online, et cetera.

So you would expect the pro forma margin to follow the same pattern, then, as the GAAP margin?

Yes, absolutely. They have the same relationship, yes.

Okay, and just one last question here is if I understood you right, you said that you had about a $100,000 positive impact from currency on the operating income line, and another $0.5 million in other income going the same direction. Did I understand that correctly?

You did. That's correct.

Okay, and can you just explain why the hedge went the same way as the benefit during the quarter?

Based on our budgeted rates and our outlooks dating back to last year.

David, the sterling pound appreciated against the U.S. dollar, and that's what gave the positive benefit.

I got it. Okay, so the hedge was on the rupee?

Right.

I got it, okay. Very good, thank you.

(OPERATOR INSTRUCTIONS)

Your next question comes from the line of Mitali Ghosh with Merrill Lynch. Please proceed.

Hi, good morning, everyone. I wanted to understand a bit more on the margin surprise that we had this quarter, and if I look at the general and administrative expenses, they are flattish, in fact, maybe slightly down on a quarter-on-quarter basis. So I'm just trying to understand what are the reasons that the margin outperformed your expectation and what we should think on general and administrative costs going ahead?

General and administrative costs, including selling, you should expect those to increase for the reasons that Rohit articulated in terms of the investments that we're making, as well as the additional facilities coming online.

In terms of margins on an overall basis, there's also the expectation that at the gross margin line we'll see some degradation for the reasons that we've already talked about. And so, there's nothing additional that hasn't already been articulated this morning.

Sure. My first part of the question really referred to why the margins outperformed this quarter. Maybe if you can just elaborate a bit more on that, compared to your expectations?

Sure. On a net basis, it's due to the fact that we continue to use our infrastructure and drive it to a very high degree as we continued to bring capacity online. We're better using our physical infrastructure. Our sales and marketing expenses have grown slightly but have not accelerated quite yet to the extent that we've predicted, and that's pretty much it.

Right, so essentially your revenue growth being slightly higher, but it's helped you in beating your utilization.

Certainly, and on the revenue growth as well, certainly. I thought you were asking just about expense impact.

Sure, and just two quick questions on what should one expect for tax rate the year? And secondly, what are the kind of compensation heights that you're looking at this quarter?

Sure. Our tax guidance remains the same at 15% to 20%. The effective tax rate for the quarter has come in at 17%, which is approximately in line with the past and we think that will hold true for the rest of the year.

So the income earned, it's U.S. based as opposed to exempt from the India side, is holding in proportion, so 17% is where we came in on the first quarter, and that's right in the middle of our guidance of 15% to 20%. The increments were in the range of about 10%, effective April 1st, so approximately 10%.

Okay, thanks a lot and all the best.

And at this time, there seems to be no more questions in queue. On behalf of EXL, I would like to thank you for attending today's conference. This concludes the presentation. You may now disconnect and have a great day.