Exlservice Holdings Inc (EXLS) 2009 Q1 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the EXL First Quarter 2009 Earnings Conference Call. My name is [Oniqua] and I will be your Operator for today. At this time, all participants are in a listen-only mode. We will have a question and answer session towards the end of the conference. (Operator Instructions) As a reminder, today's call is being recorded for replay purposes. At this time, I would now like to turn the call over to Jarrod Yahes. Please, proceed.

Thank you, Operator. And thanks, everyone, for joining us today on EXL's First Quarter 2009 Earnings Announcement. Joining us in New York today are Rohit Kapoor, our President and Chief Executive Officer, and Matt Appel, our Chief Financial Officer. We hope you've had an opportunity to review the news release we issued this morning 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 to today's call. Rohit will first talk about the market environment, provide some comments on EXL's first quarter and an update on the way we're managing our business and speak about the pipeline of immediate opportunities that present themselves. Matt will take you through the financial details of the first quarter and provide an update on guidance for calendar year 2009 and then close the presentation before we take questions.

Some of the matters we will 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 obligation to update the information presented on this conference call.

During our call today, we may reference certain non-GAAP financial measures, which we believe provide useful information to investors and you can find reconciliations of those measures to GAAP on the press release.

I would also like to take the opportunity before handing the call over to Rohit to introduce EXL's investors and research analysts to Jean Liang, EXL's new head of Investor Relations. Jean comes to EXL with a background most recently in investment banking at Goldman Sachs and prior to that seven years of management consulting experience at Accenture. I look forward to introducing Jean to you in the weeks and months to come. On my part, I will be at EXL overseeing the treasury function and corporate development activities and Jean will be reporting into me for the Investor Relations function. It has been a pleasure working with you since the IPO of EXL in 2006 and I look forward to keeping in touch as I transition the Investor Relations role over to Jean.

So now, let me turn the call over to Rohit. Rohit?

Thanks, Jarrod. Good morning, everyone. And thank you for joining today's call. I am pleased to announce that EXL continues to navigate effectively in what continues to be a very difficult economic environment for our clients. As their revenues come under pressure, our clients are looking for ways to cut their own operating and administrative costs without sacrificing on customer satisfaction and quality of service. Outsourcing and transformation are two of the many levers clients are applying against their strategic cost reduction objectives and EXL continues to play an important role in improving the economics of our clients' business.

As such, we believe that this is a critical time for EXL to continue to invest in our capabilities, in our frontend, in our talent, and in building out our global physical infrastructure to respond to the growing needs of our clients.

From a delivery perspective, EXL continues to make strong progress in expanding our relationship with multiple strategic clients that we recently acquired in order to grow our business. Our overall revenue for the quarter was $40.9 million, slightly higher than the normalized fourth quarter 2008 base of $40.5 million that we discussed last quarter.

We are currently undertaking multiple process migrations and employee training programs for these clients and anticipate our new relationships to scale over the course of the year and accelerate further back towards the second half of 2009. As a result, we believe that the first quarter would represent a low revenue point for our outsourcing business. We would expect to expand and grow our outsourcing business on a sequential basis quarter on quarter for the remainder of the year based on contracted book of business that we have secured over the past several quarters.

Our outsourcing business continued to show growth with both existing clients and with some of the new clients that we recently acquired. With respect to existing clients, I am pleased to announce that last quarter we renewed our contract with Centrica. We also renewed and expanded our relationship with another top ten U.S. insurance carrier for a five year term. We expect each of these contracts to exceed $100 million in revenues over their respective terms. The signing of these two renewals is an indication that EXL continues to be able to sign larger and larger contracts as we develop deeper relationships with our strategic clients.

We believe that our ability to win small pieces of business with large clients and expand the scope and size of these relationships over time is a tremendous strength and it reflects the value that our clients place on our services over time.

These two client renewals are a clear indicator of that capability. It is also an indication that EXL is a provider with strong operational discipline and sound financial stability, attributes that clients are looking for in order to build long-term strategic partnerships.

In the face of cost pressures that our clients are facing, we continue to make prudent decisions with respect to pricing. We continue to work in partnership with our clients to bring down their cost of delivery where appropriate and thereby offer lower pricing without sacrificing our margins.

In addition, we have been proactive with clients by offering them pricing stability by hedging out foreign exchange risk based upon minimum committed volumes. We also have created the right alignment in our pricing structure by offering volume discounts that encourages our clients to direct more business to EXL.

Lastly, we continue to be proactive about moving towards transaction based pricing for select processes and clients. We strongly believe this can provide for an overall more efficient cost structure that can benefit both our clients and us if implemented appropriately.

As expected, we experienced a significant slow down this quarter in volumes on the project based part of our transformation business. In this environment, clients have cut back on discretionary spending of all types and our business was impacted as a result. We expect the transformation business to remain soft for the next few quarters; however, we are changing the business mix within our transformation business towards more annuity based and recurring revenue streams.

We are seeing recent success in winning new clients and expanding existing relationships in offshore decision analytics and in offshore risk management services. This work is predominantly annuity based and is contracted for in similar terms as our outsourcing business. Specifically, we have added marquee decision analytics clients in insurance and retail banking which further complements our expertise in credit card analytics.

In these areas, we have recently won expansions with existing clients that will result in ramps taking place over the course of 2009. While this revenue stream is still less than 25% of the entire transformation revenue stream, we expect it to grow at well over 50% for the coming year.

Going forward, this annuity based business will provide some additional cushion to the revenue volatility in the rest of the transformation business.

EXL continues to aggressively manage for efficiency and to a lean cost structure while investing for long-term growth. This is evident in our strong gross margins and adjusted operating margins. This quarter we delivered adjusted operating margins of 14.2%. That was well above our expectations as a result of tight cost management of discretionary and general and administrative expenses.

While we are keeping the lid on costs, we are also prudently expanding our investments in sales and marketing. We have grown our investment in sales and marketing over 30% year on year and now have 46 professionals engaged in sales and marketing and strategic account management expanding the mindshare of EXL within our prospects, clients, and within the advisory community.

From an operational perspective, we are pleased to register our lowest attrition to date of 21% compared to 34% last quarter. The slowdown in growth taking place in India and the Philippines has resulted in more favorable supply side dynamics in our business and that is having a beneficial impact on our ability to retain our talent. Additionally, our people management methodologies, training opportunities, and creating opportunities for employee growth within the Company has contributed to the lower levels of attrition we are witnessing.

EXL continues to expand its global footprint successfully. At the end of the first quarter we had 500 employees working out of our Philippines center which represents a strong critical mass for us to build and grow the operation there. We continue to invest in providing the right level of leadership for our Philippines operation so that we can scale up our business there. Furthermore, we continue to make strong progress towards the establishment of an Eastern European footprint and expect to have meaningful progress to report to you in our next communication to investors.

With respect to the pipeline of outsourcing opportunities we discussed last quarter, there were three opportunities that were in the process of decision making. While those opportunities have yet to be finalized, we would anticipate some favorable decisions shortly. There has been significant progress with two of these three strategic opportunities. We have now entered into exclusive contractual negotiations with two of these prospects and hope to have a positive outcome to report in the near future. These near-term decisions, which if decided favorably would be exciting outsourcing wins for EXL and we look forward to updating the market as and when they happen.

Lastly, there are three recent events I wanted to call out for investors that we are excited about at EXL. First, as you know, we have closed on our CFO search and have hired Vishal Chhibbar as our Chief Financial Officer. Vishal joins us from GE Capital Australia and will start with us on June 1, 2009. He will be here with me for EXL's second quarter earnings release. I'm excited to have Vishal join us. He has the right blend of leadership skills and deep financial knowledge and experience that we are seeking in our evaluation of candidates. We anticipate Vishal continuing to increase the sophistication of our financial processes in line with his prior experience at large global corporations. Some of the key areas in which we expect Vishal to add strategic value include optimization of our strategic growth investments, financial planning and forecasting, strategy cost management, and enhancement of our merger and acquisition integration capabilities. Vishal is a valuable addition to the senior management team at EXL and we expect him to be a tremendous asset to the organization.

I would also like to take this opportunity to thank Matt Appel for his role as CFO at EXL over the last two years. Matt has built a great finance team at EXL. We wish Matt all the very best in his future.

Secondly, this month marks the tenth year anniversary of EXL. We will be celebrating this milestone with a series of events at our various facilities around the world - in the U.S., in the U.K., in India, and in the Philippines. Both Vikram and I are extremely proud of the continued growth of the organization and would like to thank all of the hardworking professionals and management without whom building such a Company would've never been possible. We hope that the next ten years are even more rewarding than the last and look forward to continuing to build and grow the Company.

Lastly, and perhaps most importantly, we have just received the results of our annual client satisfaction survey for 2008. The survey measured EXL along the lines of overall customer satisfaction, service, delivery, quality, new process deployment capability, customer experience, and contribution to client business. In short, we are extremely pleased with the result as well as the trend. In fact, an overwhelming majority of our client responses indicated that they would place EXL in the top two boxes on a five point scale on overall client satisfaction. This is an increase of over 10% from 2007 which was a further increase from 2006 levels.

These results are indicative of EXL's relentless focus on process excellence and delivering to client expectations. This result is what gives us the confidence that we will continue to grow our business even in uncertain times. We are fortunate to partner with a great set of clients that see great value in our services.

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

Thanks, Rohit, and good morning to everyone. EXL's financial results for the first quarter of 2009 met our expectations in terms of revenues and exceeded our expectations in terms of margins. Revenues for the quarter ended March 31, 2009 were $40.9 million compared to $43.7 million in the fourth quarter of 2008 and $44.4 million for the same period last year.

In the first quarter of 2009, approximately two-thirds of our revenues were denominated in U.S. dollars with the remainder denominated in U.K. pounds. This is a meaningful shift from last year when pound denominated revenues represented slightly more than half of total revenues as it insulates us from the risk of FX fluctuations on our revenue base. Even with this shift, depreciation of the pound had a 2.4% negative impact on our revenue sequentially and a 12% negative impact year over year.

Outsourcing services revenues for the first quarter of 2009 were $33.4 million compared to $33.2 million in the fourth quarter of 2008 and $34.9 million in the first quarter of 2008. As expected, revenues from transformation services for the first quarter of 2009 decreased to $7.6 million compared to $10.5 million in the fourth quarter of 2008 and $9.5 million in the first quarter of 2008 mainly due to the sharp decline in spending of discretionary projects across multiple client relationships.

Gross margin for the first quarter of 2009 was 40.6% compared to 38.1% for the fourth quarter of 2008 and 35.6% for the first quarter of 2008 with outsourcing contributing gross margin of 45.3%. This exceptional margin performance in outsourcing which was 160 basis points higher than the fourth quarter of 2008 is due to our continued focus on efficiency, operating leverage, and the cost of delivery. We expect gross margin for outsourcing to decline in the short-term as we initiate operations at our new center in Pune and realize the impact of salary increments that were effective on April 1.

Transformation services gross margin was 19.7% for the first quarter of 2009, reflecting the decline in revenues in a business with largely fixed costs.

General and administrative expenses were 16.4% of revenue for the quarter ended March 31, 2009 compared to 15.8% in the fourth quarter of 2008 and 18.8% for the first quarter of 2008 as we continue to tightly control discretionary spending and benefit from the relatively weak rupee.

Sales and marketing expenses for the quarter ended March 31, 2009 were $3.2 million or 7.8% of revenue compared to $3.0 million or 6.8% of revenue for the fourth quarter of 2008 and $2.4 million or 5.3% for the first quarter of 2008, representing an increase of approximately 250 basis points over the previous year. We continue to believe that investing in our frontend is the right strategy to grow on a long-term basis.

Operating margin for the quarter ended March 31, 2009 was 10.4% compared to 12.4% for the quarter ended December 31, 2008 and 5.7% for the quarter ended March 31, 2008. Adjusted operating margin for the first quarter of 2009 which excludes the impact of stock compensation expense and amortization of intangibles was 14.2% compared to 14.4% in the quarter ended December 31, 2008 and 8.4% in the quarter ended March 31, 2008. Adjusted operating profit for the first quarter of 2009 was $5.8 million which represents an increase of approximately 56% from the first quarter of 2008.

Foreign exchange losses for the quarter ended March 31, 2009 were $1.3 million. As we discussed in our last call, we initiated a balance sheet hedging program during the fourth quarter of 2008. This program was fully functional for the first quarter of 2009 in mitigating currency swings impacting our foreign denominated assets and liabilities. Based on currently prevailing exchange rates, we expect the total foreign exchange loss for 2009 will be approximately $8 million. Note that this was also our expectation when we last spoke in March.

Interest income was $0.3 million for the first quarter of 2009 and this reflects the low interest rates currently being paid on U.S. based deposits. Our tax rate in the first quarter of 2009 was 8% and reflects the distribution of taxable income we currently expect for the full year 2009.

Net income for the quarter ended March 31, 2009 was $2.9 million as compared to $3.4 million for the quarter ended December 31, 2008 and $6.8 million for the quarter ended March 31, 2008. The change in net income comparing first quarter 2009 to first quarter 2008 is primarily due to the impact of FX swinging from a gain of $1.6 million in 2008 to a loss of $1.3 million in 2009. Diluted earnings per share from continuing operations were $0.10 for the first quarter of 2009 as compared to $0.12 for the quarter ended December 31, 2008 and $0.16 for the quarter ended March 31, 2008.

EXL's cash balance as of March 31, 2009 stood at $106.6 million which was down slightly from $112.2 million as of year end 2008. This decrease is due principally to the payment of our annual bonuses in the first quarter as well as the timing of capital expenditures. Capital expenditures for the first quarter were approximately $5 million as we commenced build out of our new operations center in Pune.

We expect the center to be operational before the end of the second quarter. I would also like to point out that global economic conditions have not impacted the collection of receivables as our DSOs stand at approximately 70 days which is unchanged from last quarter and an improvement of 14 days from the first quarter of 2008.

As far as our outlook for calendar year 2009 is concerned, we're maintaining the guidance articulated during our 2009 call for revenues between $170 million and $175 million and adjusted operating margin guidance between 10% and 12%. Please note that we do expect that adjusted operating margin will fall near the top of that range.

In closing, we believe we are responding appropriately to the challenging economic environment by focusing on improving the efficiency of our operations and maintaining the strength of our balance sheet. We continue to invest prudently for future growth while retaining maximum flexibility with respect to our cost structure.

I'd like to now open the floor for any questions you might have.

(Operator Instructions) Your first question comes from the line of Joseph Foresi with Janney Montgomery Scott. Please, proceed.

Hi, guys. I wonder if you could just start by sort of giving us maybe a better understanding of the puts and takes in the transformational business. Maybe you could talk a little bit about -- I know you had said in your prepared remarks about what you're seeing on the positive side. I think you talked about some stability and then what's causing the negative and generally how those contracts are structured.

Sure. Hi, Joe. This is Rohit. Let me address that. As you know, the transformation business for us includes four different skill sets that we have there. We have analytics, risk advisory services, we have six sigma based project process reengineering work, and we also have some advisory business as part of our transformation business mix.

The project based work that we do is the piece that is getting pushed back where clients have chosen to either delay their decisions on getting started on certain projects or they have deferred and decided not to go ahead with some of these projects. That's what's creating the impact.

This part of our businesses has always been a frontend business and has always been subject to volatility; however, what we are seeing right now is that there is an increased focus towards offshore transformation services and EXL is very well positioned to provide these services to our clients and we've actually won some recent engagements with new clients as well as expanded our relationship with existing clients whereby our analytical services business and our risk advisory services business out of India has increased quite significantly. And we expect that these wins and these expansions will actually create a very stable base for the transformation business.

Is there a difference between where you're seeing the new business and where you're seeing the drop-off maybe by service or geography?

No. There is no difference by geography. But the reaction is quite different by the type of service we provide. At the end of the day, our clients are increasing the use of analytical services because it helps them make better decisions in terms of gaining access to new customers, regaining customers, and improving their credit underwriting standards and pricing. They are also using more and more of our risk management services because in today's environment there is an increased focus on compliance and EXL is again very well positioned to help out our clients in terms of these types of situations.

Okay. And then just -- you mentioned some renewals, some pretty large contracts. I was wondering if you could talk about pricing and the size of those contracts. What is different in negotiations this time versus maybe last time, especially given what the economy's doing?

Sure. I think that's an extremely important question, Joe. And I think EXL has very successfully negotiated the renewal of these two large contracts which represent a significant portion of our business. And the terms on which we've negotiated the renewal of these contracts are actually very, very attractive. We've been able to actually create pricing stability for our clients and for ourselves. I think that's one fundamental shift that has taken place in terms of the renewal of these contracts this time around where we've negotiated long-term contracts. In the case of Centrica, we've renewed the contract for a three year period with an ability to extend it by another two years on the part of the client and therefore the full term of that contract is a five year term and with the large insurance carrier that we've renewed our contract, that's also a five year term contract. Given the volatility in the foreign exchange environment, given the volatility in some of the inflationary environment, we've chosen to be very, very careful in terms of structuring long-term contractual agreements that provide adequate protection both to EXL as well as to our clients in terms of structuring these contracts. And in terms of absolute pricing levels, these contracts have been renewed at pricing levels which are very attractive for EXL as well as to the client as such.

And then just lastly, any update on the use of cash, especially vis-a-vis any potential acquisitions out there? Thanks.

Sure. From an M&A standpoint, we've always said that we would acquire businesses where it makes a strategic fit and adds to the strategic capability of EXL. As such, we continue to be engaged in several conversations where we are looking at assets to be acquired that will provide a strategic capability addition to EXL. So far, we've not really consummated any transaction as such, but we are hopeful that we will be able to make progress in this direction and we do intend to use the cash on our balance sheet to further enhance our capabilities and our skill set and our geographic footprint.

Okay. Thank you.

Your next question comes from the line of Nathan Rozof with Citi. Please, proceed.

Hi. This is Nathan on for Ashwin Shirvaikar. I wanted to dig into the cost of service line in a little bit more detail since clearly that's where you guys demonstrated such strong performance this quarter. In particular, I was hoping if you could provide a little bit more color around the ramp of costs through the year as you, one, rollout the Pune facility. And I'm sorry. I missed the date when that will be operational. And then, as well, what the plans are in terms of timing for expanding into the eastern European facility as well.

Sure. In terms of the client wins that we've had, there are several that we are currently in the process of transitioning and ramping up our operations in India. And as you are familiar, as we ramp up on some of these new customer operations, there typically is an increased cost up front that we incur. We have been incurring that cost in the first quarter and we will continue to incur that cost in the second quarter as well. The full revenue impact on account of the ramp up of the new clients will only take place in the second half of 2009.

In terms of our facilities and our infrastructure, our Pune facility, the new facility that we've created out there will be operational by the end of this month and therefore the impact of that will be felt in the second quarter of 2009. As regards our international delivery locations, we are looking to expand into Eastern Europe and our assumption would be that we'd be able to expand into Eastern Europe over the next couple of quarters. So, over the next three to six months, we should have something built up there and we'll make the investment there.

I do want to be -- I do want to kind of remind everybody that the investment that we will make in Eastern Europe will be significantly lower than what we invested in the Philippines which was a large infrastructure and facility for us and the Eastern European infrastructure that we will create will probably be much smaller in size and scale.

Okay. Thank you. And then turning over the transformation side of the business a little bit, how should we think about the costs in that business on an absolute basis going forward through the year?

The transformation business for us has a cost structure which is largely made up of people costs. As you know, this is a high value business for us and the people costs constitute a majority of the cost structure. So, what we've been able to accomplish in the first quarter of 2009 is actually to rationalize our cost structure outside of people costs and we've started to hold steady as far as our people costs in this business is concerned but we continue to make an investment on the people front in our transformation business because we believe our transformation business is fundamentally very critical to the overall growth and the business strategy of the Company.

The transformation business provides us as a very significant front end in terms of engaging with clients early on. It also allows us the opportunity to add additional value to our customer relationships over and above and beyond our outsourcing relationships. So, fundamentally for us, the transformation business is absolutely critical. It is strategic and we will continue to invest in that business despite the volatility and despite the turndown in the volumes out there.

Thank you. And then one last nit before I turn the call back over. Can you provide any quantification of the impact of foreign exchange on the cost of service line in this quarter? Just complete in Q1?

Sure, Nate. This is Matt. So, FX, aside from the FX gain or loss line which is what you're asking, actually had a negative impact on our profitability for the first quarter. This is because of the swing. The swing in the pound was much more significant and more impactful on revenues even with our revenues only being approximately a third denominated in pounds. The change in the rupee from quarter to quarter was quite small. So, the impact was almost negligible, like 1%, 1.5%. I wouldn't think of FX having a large impact on gross or operating margins on a quarter over quarter basis.

Got it. Thanks, Matt. We're going to miss you on next quarter's call. All the best to you from us here at Citi. And Jarrod, congrats on your expanded responsibilities as well. Thanks, guys.

Thanks, Nate.

Your next question comes from the line of David Grossman with Thomas Weisel. Please, proceed.

Good morning. Thanks. I'm just trying to take everything in you've said about the progression of both revenue and margin throughout the year. Perhaps you could give us maybe a couple more comments or some insights into how we should think about how these different factors may impact both revenue growth and profitability as the year progresses. Because, obviously, you've got a pretty high water mark here for margins in the first quarter and assuming, I guess, currency remains flat, if you could perhaps, again, just give us a better idea of kind of how we should think about the progression throughout the year?

Sure, David. This is Rohit. First, in terms of revenues, we would expect our revenues to expand sequential; however, we think that most of the expansion on our revenue base would really take place in Q3 and Q4 of 2009.

In terms of our margins, there are three factors that would be contributing as a drag to our margins. Number one is our expansion into Pune and the additional infrastructure that we've created out there. Number two, we've just gone in with a salary increment and as you are aware, the annual salary increments for our Company take place on the first of April and therefore they will impact our business for the remaining nine months of this year. The third significant area is going to be our intended expansion into Eastern Europe which will create a drag on our earnings.

At the same time, we do expect to get a positive benefit by, number one, our volumes increasing on a quarterly basis, number two, us being able to rationalize the margins on our transformation business which currently is a drag on us, and number three, our Philippines operation getting into breakeven territory which we do expect that will be accomplished over the next couple of months. It's really balancing out a number of these positive factors and negative headwinds that we think we would come in at the top end of our range in terms of margin guidance.

So, in terms of maybe some of the -- just putting a couple of kind of ranges or numbers around some of these things, for example, can you give us a better idea of what the salary -- what the hike was this year? I guess in terms of the revenue growth sequentially, I don't know how many contracts are the value of the contracts that we should think about ramping to full rates in the second half of the year.

Sure. In terms of salary increments, this year we've gone ahead with salary increments in India which are in the low to mid single digits and this is roughly half of the increase that we would've gone in in the previous year. So, we have gone down with a much slower salary increment in India in line with the market environment out there.

In terms of the ramps of our customer revenues, right now we are in the process of migrating and transitioning some of these clients that we signed up in the previous quarters and therefore the revenue impact is going to be minimal in Q2; however, we would expect the revenue impact to be fairly significant that will allow us to get to our midpoint of our guidance range on the revenue side in Q3 and Q4 of this year.

So, should we think about the second quarter being kind of flattish to modestly up from the first quarter and the ramp in the second half of the year to hit the $170 million to $175 million?

Yes, David. We would think about second quarter being flattish as such.

I see. And in terms of the renewals that you announced during the quarter, when you look at the revenue on a year over year basis, should we think of, in 2009, those renewals as being incremental on a year over year basis? Would they be flattish or would they perhaps be down on year over year basis as you think about the run rates for those contracts?

So, David, as we've previously stated, our contract with Centrica is a stable, mature client relationship and we would expect that relationship to continue to be stable; however the relationship we have with the insurance carrier that we've just recently renewed, we think that there is significant opportunity for us to continue to grow and build that business and we would anticipate growth in that contract.

Okay. And just one last thing. On the $170 million to $175 million, how much visibility do you have on that based on kind of contracts won and in the backlog right now?

David, I think as you're aware, with our business there is a very high level of visibility and confidence in terms of the revenue on the outsourcing side. The area where we do not have adequate amount of visibility is the business on the transformation side. I think the visibility on the transformation business is also becoming better but right now we don't have full visibility into the transformation business as such.

Have you assumed much of a ramp in that business during the course of the year?

We are anticipating that the transformation business will ramp up in the second half of the year, yes.

I see. Great. Thank you very much.

Thank you.

Your next question comes from the line of Joseph Vafi with Jefferies & Company. Please, proceed.

Hi, gentlemen. Good morning. And, Matt, the best to you and congratulations, Jarrod, on the new gig as well. Maybe we could just kind of talk about pricing environment just a little bit, just number one. If you look at your base of business and maybe kind of look at the pricing concessions that potentially you've made so far to the base over the last few quarters, how far are we through that cycle now and do we really see any more revenue headwinds coming from potential further price concessions to customers that might not have yet been implemented?

Sure, Joe. This Rohit and I'll address that. In terms of pricing, there continues to be a client demand and pricing pressure that we see both from existing clients as well as from new clients particularly given the current economic environment. However for our business which really is a 10% to 12% operating margin business, we've chosen to be very, very disciplined in terms of our negotiations with our customers and we've chosen to work with them so that we can reduce that cost structure if possible and thereby give them a price reduction. We have not chosen to go and give a price reduction by cutting our margins because we don't think that long-term that's a sustainable business model that we can adhere to.

As such, I think we are fortunate that we have great customer relationships and, as is evident from the two large customer contracts that we've renewed, as well as several other major existing clients where we've reached agreement on the commercial terms, we think that the pricing impact on our business is going to be minimal as such. We remain disciplined and what we are trying to do is to offer pricing stability to our customers and work with them in a manner whereby our margins are not compromised and the customer in effect can get a better effective price. We also, I should point out to you that we also have a very effective and a very strong program of continuous process improvement and we are able to deliver to our customers significant improvements in the economics of their business just by virtue of optimizing their processes. And that is another very significant lever that we use in order to provide benefits to our customer relationships.

Okay. Fair enough. I know, Rohit, you said that you're expecting the Philippines to become breakeven to profitable in the next couple of months. Is that going to be based on volumes? Is there anything else we should be looking at there to focus on the profitability? And is there a headcount number perhaps that gets you to profitability there? And how good is the visibility to getting profitable in the Philippines?

Sure. The profitability in the Philippines is primarily going to be driven by the increase in volume of business out there. Currently as you can see the increase in headcount that has taken place in the Philippines is all being deployed towards training programs and towards ramps. And as these ramps materialize into contractual revenue, we will be able to get into breakeven and into the profitable territory. We think we are fairly confident in terms of the visibility of these ramps and we would expect that the breakeven is achieved fairly quickly over the next couple of months.

Alright. Thank you very much.

Your next question comes from the line of Ed Caso with Wachovia. Please proceed.

Hi. Good morning. This is Chris Wicklund for Ed Caso. It looks like your contribution from your non top ten clients came in from Q4. Can you comment on what drove that?

I'm sorry, Chris. I didn't hear all of your question. Do mind repeating it?

I'm sorry. It looks like the - can you hear me now?

Yes.

Great. It looks like the contribution from your non top ten clients came in for Q4. Can you comment on what drove that?

Non top ten came in. You mean higher or lower?

Came in a little lower.

No, that's -- yes. That's the case. So, nominally what's driving that is the amount of revenue we generated in the first quarter. There was a slight increase in the percentage of revenue attributable to the top ten clients. I think it's about 5% more than it was in the fourth quarter. This is not a shift in our business or anything that ought to be sustained but rather has more to do with the smaller clients in the transformation business who tend to be the non top ten clients. The larger clients are the longer-term, large outsourcing services clients.

Okay. Thanks. And then also it was commented earlier on expecting a better environment for the transformation business in the second half. Can you comment on what you are hearing from your clients that gives you confidence in achieving a better second half?

Sure. There are a couple of things which we are hearing from our clients that gives us confidence. Number one is we are increasing the volume of the annuity base and recurring revenue streams within the transformation business. And with those committed ramps and contracts in place, we would expect there to be an increase in that part of the business within transformation.

Number two is we are also talking to our clients who are telling us that while they had delayed some of the decisions on certain projects, those projects do need to be carried out because those are critical for the long-term success of these organizations and those projects do need to be delivered and to be completed and they do not have any in-house resources to be deployed on these projects. So, we would expect them to be engaged with us and we would expect us to be able to assist them with the completion of these projects and helping them with their decision making both in terms of customer acquisition, retention and underwriting and pricing.

Okay. Thank you. That's very helpful. And then lastly, I think you mentioned earlier that you're receiving a pretty low rate on your cash. I presume that's in the U.S. I know it's still early here, but have you had any discussions with regards to some of the proposals in Washington in regards to repatriation of cash?

Chris, the lion's share of our cash sits in U.S. Cash balances for example in India would actually earn a much higher return due to other risk factors. But, no, we're not having any discussion in Washington on that topic. We're very conservative in nature. We're reserving our nest egg in a very prudent way. It will be there when we want to deploy it for growth. So, with the fed funds rate being so low and general interest rates being low, the safe type investments that we tend to put our money in are also yielding lower returns than they did last year.

Great. Thank you.

Your next question comes from the line of David Koning with Robert W. Baird. Please, proceed.

Yes. Hi, guys. Just a couple quick ones. First of all, the FX losses below the line, you talked about I think $8 million for the year or so and you started off at $1.3 million in Q1. I would've actually thought that that would kind of trail off through the year as some of the comps change on the rupee. So, I guess I'm surprised that it's going to ramp back up. Maybe you can talk a little bit about that?

Sure. The $8 million number is based on the contracts that were in force at the time we gave our initial guidance. Those contracts are relatively unchanged for the duration of 2009 as we were fully hedged on them previously. Those contracts are entered into 18, 24, and in some cases -- in the case of the contract for 2009, 18 to 24 months before they mature. So, based on anticipated revenues, we're able to see based on prevailing FX rates what the likely outcome will be on those contracts for the remainder of the year which is why it may be a little lumpy. There's more hedging in the -- later in the year as our business grows.

Okay. That's helpful. So, if you know 18 to 24 months or you hedge 18 to 24 months early, how should we think about 2010? Just so we get our models kind of in line with how you're looking at how to hedge your losses next year.

Sure. So, I don't think we specifically disclosed -- that is 2010 data. I'm pretty sure you can calculate that from the information that we provide in our Q. But the thing to remember is that we're actually hedging more than 18 to 24 months now. We talked about this last quarter. In our K and in our call, we talked about the fact that we're now hedging minimum committed volumes on longer-term contracts. And so we had some hedges that were out 34 months as of the end of 2008. Having not placed any more of those type right now, our maturities look like they could go out as far as 31 months. So, it's -- the amount of hedges that we've placed for 2010, as you would expect at this point, are lower than what we have for 2009. But the rates are different. We don't give specific insight into cost line items for 2010 at this point in time.

Okay. I guess just the only other one is on the tax rate, very favorable tax rate to continue, but longer-term, some of your competitors, the tax rates -- I think Genpact this year is going to be 18% or something like that. Long-term, is that more the normalized rate? 20%? How should we think about it as some of the favorable tax regions and have to go through potentially higher rate adjustments?

Sure. Without commenting on how Genpact calculates their effective tax rate because if I'm expert in anything, it's not that. I do know from their business model that they are -- they do business in many countries. At the present time, we don't do business necessarily in all those countries. So, if you look at the EXL model and what we anticipate it will look like for 2009, our business is still very much conducted predominantly from India and in India we continue to enjoy a tax holiday on substantially all of our business conducted from the various locations there. And that tax holiday is enforced until the end of March 2010; so, for all of our calendar year 2009.

We also have a tax holiday in the Philippines as that business becomes more and more profitable. It's certainly profitable on a transfer pricing basis. So, there's a five year minimum tax holiday there as well that we talk about in our filings. So, the wild card in terms of our tax rate, if you will, is the amount of income in the United States jurisdiction and that has a lot to do with our transformation business because those services are delivered to a large extent on shore. That may be why our tax rate is lower than someone else's. But I think our outlook takes into effect what we'll earn in each jurisdiction and in each business line.

Great. Thank you.

Your next question comes from the line of Jon Maietta with Needham and Company. Please, proceed.

Hey. Thank you very much. Last quarter, Rohit, I think you had talked about seeing more competition from some of the larger offshore providers in the outsourcing business, in the BPO business. If you could help us think about the go to market strategy against those folks as they come into the market?

Sure. I think you're referring to some of the IT players which are getting into the BPO space.

Exactly.

Getting more active. Absolutely. And we see continued increase in interest on behalf of some of the IT players that are getting into the outsourcing space. They continue to be aggressive as well as they tend to use pricing as a lever to establish relationships on the outsourcing side. From our perspective, our go to market strategy and defense against that kind of competition is primarily driven in the verticals that we have a deep amount of capability in and domain knowledge and process experience as compared to some of the IT players which don't necessarily have that domain experience and expertise. Pricing at the end of the day for most of our customers is an important factor but it is not the only factor on the basis of which a decision is made. As such, we've been able to articulate our value proposition to our customers very effectively and be able to talk to them about our experience on managing ongoing operating processes and our operating process management discipline as well as our domain expertise as being key differentiators vis-a-vis some of the IT players.

Okay. And then, Matt, what was cash from operations in the quarter, please?

Cash from operations was a very slight negative. I think minus $1 million for the reasons that I talked about in my prepared remarks.

Thank you very much.

Your next question comes from the line of Tien-tsin Huang with JPMorgan. Please, proceed.

Hi. Thanks. Just a few quick questions if I could. First, the transformation business. Did you disclose your margin target for the year? And also did you give a utilization rate within transformation?

No. We do not provide specific guidance on either the margin or on the utilization on that business. We have shared what the actual gross margin for that business in the first quarter has been. That was 19.7%.

So, no directional guidance there you can share?

Directionally, as such, the transformation business we would expect to be at or above the outsourcing business in terms of gross margins. In a steady state environment, that's the level we would expect.

I heard about the renewals. I just want to clarify the top ten insurance company, you disclosed $100 million in TCV. How much of that is incremental or new scope versus just renewed business?

I think that's difficult to estimate. I think there certainly is growth built into that contract. The 2008 revenue from that client relationship is obviously significantly below the annualized number that we've provided. We do expect to continue to build and grow our relationship with that customer in 2009 and beyond.

Okay. So that will step up? Just two more then. The top client, from our calculations looked like it grew faster or actually stepped up sequentially. Is this sustainable or is this the result of maybe some burst of catch-up work with renewal? I'm just curious if there's anything unusual in that trend?

No. The largest customer relationship for us did grow in absolute revenue terms quarter on quarter. We believe the revenue from this client relationship will be fairly stable. This customer relationship is also obviously impacted by currency movements, particularly pound against dollar. But in terms of the volume of business we would expect this business to be stable.

Okay. So, stable from Q1 levels?

Right.

Then last one, maybe just for you, Rohit, just on protectionism? We get the question a lot. Are you seeing -- is that discussion kicking in with any of your client conversations? Is it becoming more of an issue?

Certainly the level of dialogue and the intensity of the dialogue has increased significantly. We have that dialogue with every single client now. But in terms of its impact on the ground on our business, particularly in outsourcing, we haven't seen any real visible impact on our outsourcing business as a consequence of this.

Great. Thank you. Nice work on the margins.

Thanks.

Your next question comes from the line of Vincent Colicchio with Noble Financial. Please, proceed.

Rohit, are there any large contracts coming up for renewal later this year we should know about?

No. There are no other large contracts that are up for renewal later on this year. We do have multiple, large, long-term contracts which are already in place. But there's nothing which is at risk of renewal right now.

Do we have any large clients that are under financial distress that should be of concern to us?

As you know, for us, most of our customer relationships -- 50% of our client base is in insurance. We think while the insurance vertical has been impacted, they're not in a distressed environment as some of the banks. Our volume of business with banks and financial institutions as such is significantly low and we don't think that will impact us much.

Okay. My other questions are answered. Nice job on the margins. Nice quarter, guys.

Thank you.

Your next question comes from the line of Vincent Lin with Goldman Sachs. Please, proceed.

Hi. Thanks. I wanted to focus on the sequential revenue ramp up that you discussed. Looks like your headcount growth was fairly flat, quarter over quarter. So, just wondering if you are planning to hire additional resources as you ramp up the client relationships that you talk about? Or is it going to be coming more from just increased shift utilization.

Sure. Vincent, this is Rohit. First of all, we do not measure our business on the basis of employee headcount. Therefore we do not think about growing our revenues by growing the employee headcount in our business. As such, while there may be a correlation, that's not the way in which we think about our business. The revenue ramp ups that will take place in our business will take place because of increasing the number of transactions that we undertake for our customers and the volume that we are going to be seeing coming forth from new clients. As such, we also, as I stated earlier, have continuous process improvement programs in place. And these continuous process improvement programs will eliminate cost and will eliminate headcount as such. Therefore, it's really a combination of new business from new clients combined with some of the cost optimization and process improvements that we incur and are able to execute upon which will result in the revenue stream going up for us.

Got it. Okay. And you mentioned that you're expecting a sequential improvement in terms of the transformation side in the second half of the year. I just wanted to make sure that -- are you referring to the rate of decline moderating or are you actual expecting an increase in terms of the absolute amount of revenues in the second half versus the current run rate.

We would actually expect an increase in the absolute revenues in the second half of the year versus the first half of the year.

Okay. And lastly, did you provide the amount of capital expenditures that you're expecting for '09?

Sure. That expectations is unchanged from our last discussion. That would be $15 million to $20 million of which we've spent $5 million in the first quarter.

Okay. Great. Thanks.

Thank you.

At this time, there are no additional questions. I would now like to turn the call back over to Rohit Kapoor for closing remarks.

Thank you, all, for attending this morning's conference call. As such, I just wanted to close by saying that EXL remains well positioned in this marketplace. We continue to win new customers and we continue to have a very high level of customer satisfaction amongst our clients. We do look forward to building and growing our business in this tough economic environment but I think we are well positioned and the key for us going forward is really going to be on execution. We look forward to you joining us at our second quarterly earnings call in the next quarter. Thank you.

Ladies and gentlemen, this concludes the presentation. You may now disconnect. Thank you and have a good day.