Exlservice Holdings Inc (EXLS) 2009 Q2 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the EXL 2009 Earnings Conference Call. My name is Lisa and I will be your coordinator for today. At this time, all participants are in a listen-only mode. We will be facilitating a question and answer session towards the end of this conference. (Operator Instructions).

I would now like to turn the presentation over to your host for today's call, Miss Jean Liang, head of Investor Relations. Please, proceed.

Thanks Lisa. Good morning and thanks everyone for joining our second quarter 2009 earnings announcement. Joining us today from our offices in India are Rohit Kapoor, our President and Chief Executive Officer, and Vishal Chhibbar our CFO.

We hope you've had an opportunity to review the news release we issued this morning and the PowerPoint presentation that is available for review in the Investor Relations section on EXL's website.

I would like to call your attention to an investor friendly spreadsheet that we are now also including in the Investor Relations section on our website. The spreadsheet which will be updated quarterly contains historical financial information and some relevant operational statistics. We hope you will find the information helpful as we continue to enhance the transparency in our communications.

On the agenda for today's call, Rohit will discuss some of recent strategic developments at EXL and provide an update on the way we are managing our business. Vishal will then take you through the financial details of the second quarter and then close the presentation before we take questions.

Some of the matters we'll discuss in this call are forward-looking. Please 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, 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 for investors. Reconciliations of those measures to GAAP can be found on the press release.

Now I will turn the call over to Rohit.

Thanks Jean. Good morning to everyone in the US and good evening to those of you joining us in India. Thank you for joining today's call. I am pleased to announce that we are expanding our global delivery capabilities even further by setting up a new center in Romania in addition to the Czech Republic capability that we recently acquired. With our expansions into the countries in Central and Eastern Europe, and our Philippines and India facilities already operating at significant scale, EXL is executing on its strategic objective of increasing our global footprint to provide our clients with world-class global delivery capabilities. This reiterates our commitment to invest in our long-term growth despite the very difficult economic environment.

This quarter we continue to successfully capitalize on the major infrastructure investments in India and in the Philippines that we have already made. After only 15 months of operational delivery, I am pleased to report that our Philippine center has now achieved operating profitability. At the end of the second quarter, we had about 650 employees working out of our Manila center which is a critical mass of our operations there and provides a strong base from which to build and grow.

Our second center in Pune became operational at the end of May, and by the end of the second quarter we had grown to over 200 employees in the new center in Pune.

Our revenues for the second quarter grew sequentially over the first quarter to $42.4 million. This quarter, we made the requisite investments in our outsourcing business to support the continued sequential growth we anticipate in each quarter for the second half of the year. We are currently undertaking multiple process migrations and employ training programs for our new outsourcing clients, and expect to complete them over the second half of the year. This will drive continued sequential revenue growth in the second half of 2009. Additionally, we do not have any large contracts that will be up for renewal for the rest of the year.

Our transformation business appears to have stabilized in the last quarter, and we have seen an increase in activity and faster decision making by some of our clients. We are encouraged by the increase in dialog relative to the first half of the year, and are cautiously optimistic for the remainder of the year for this business.

We continue to work towards changing the business mix within our transformation business towards more annuity based and recurring revenue streams. This quarter we were able to expand existing relationships in offshore decision analytics and in offshore risk management services with three banking and two insurance clients.

I would like to highlight a couple of examples of our progress. After a competitive (inaudible) bake-off we were selected for a three year deal that provides a large insurance client with risk analytics capabilities for underwriting and pricing in both personal and commercial lines within the property and casualty insurance domain. For another large insurance, we are in a multiyear arrangement to provide analytics for claims management and catastrophe modeling. Currently the annuity based revenue stream is less than 25% of our transformation revenues. However, as this annuity based business grows, we will have greater revenue visibility and less volatility for our transformation business. We expect our annuity based decision analytics business to grow at well over 50% in the coming year.

More importantly, the increasing amount of transformation work that we do for our outsourcing clients confirms that there's a market demand for an integrated offering that can bring increased business benefits to our clients.

While the pricing environment stabilized this quarter, we continue to aggressively manage costs in areas such as payroll, infrastructure, transportation, and utilization to further optimize our cost structure. We remain focused on being operationally lean as we prepare our business for greater scale and profitability.

This quarter, we continued to invest in our front office, and increased our sales and marketing and strategic account management teams to 48 professionals who are actively involved in expanding the mindshare of EXL with our prospects, clients, and the advisory community. This is a 17% increase in our sales force compared to a year ago. We now have created a dedicated strategic deal team that works on creating customized solutions for large pursuits and significant opportunities.

From an operational perspective, we are pleased to register attrition of 22% this quarter, down significantly from 30.7% in the second quarter of last year, and flat relative to the 21% we reported last quarter. The slowdown in economic growth in India and the Philippines continues to create more favorable supply side dynamics in our business and that positively impacts on our ability to retain our talent.

Additionally, we have been investing in our people management methodologies, training and development programs, and creating opportunities for employee growth within the Company. For example, we have launched an internal insurance academy based on US and European insurance certification standards which will develop subject matter exports within the Company. This will further enhance and broaden our insurance domain knowledge and delivery capability.

We also continue to provide functional development learning programs such as lean advanced six sigma green belt and black belt, and SAS certifications. We have also created leadership development programs which identify and cultivate high potential performers. These investments not only help us retain talent, but they also further improve and differentiate our capabilities from competition.

This quarter we also took the opportunity to acquire key talent for the company including a new management team for our operations in the Czech Republic that is highly qualified and has a longstanding track record of successfully servicing clients in the US and in Europe. We also continue to invest in our business and in future growth by adding key leadership positions within transformation such as a new vice president for product development and in other strategic areas such as legal, profit, outsourcing, and in migrations.

Over the last few months, we have deliberated over EXL's long-term strategy and positioning in the marketplace. We have determined that EXL will continue its focus on establishing a leadership position in a few key industry verticals. We intend to continue to differentiate ourselves in our chosen domain to become a category killer in insurance, utilities, and banking and financial services. We will also focus on transportation and logistics as a new emerging vertical. EXL already had deep industry knowledge and capability in these verticals, and we will proactively invest in adding further talent, infrastructure, and client base in these domains.

What becoming a category killer means for us is that we are committed to making significant investments in domains and industry specific training and certification programs for our employees, creating the technology and tools that are relevant for each industry, developing best practices that allow us to further differentiate our capabilities, hiring subject matter experts in each domain, and creating partnerships for each of our verticals. Our commitment to these verticals will transmit to better client business benefits and accelerated progress towards becoming the benchmark service provider for these industries.

We believe that by being a category killer in select industries, we can develop the necessary size, scale, and profitability to continue to invest in our business while also maintaining a business strategy that allows us to focus and not be distracted from serving our clients with the best possible customer service and delivery satisfaction.

We continue to feel positive about our pipeline. With respect to the pipeline of outsourcing opportunities we discussed last quarter, we reported that we entered into exclusive contractual negotiations with two of these prospects. We announced one of those opportunities. Our win in the Czech Republic with a leading transportation and logistics company and hope to have a positive outcome to report for the other contract negotiations in the near future.

The last few quarters have yielded exciting new client wins for EXL. We believe that we have tremendous momentum in the marketplace in terms of winning vis-a-vis our key competition. I'm also very encouraged by the M&A opportunities that we are currently assessing. Our M&A pipeline continues to mature as we move further towards execution of potential transactions. As valuation expectations have to come to more reasonable levels, more opportunities have become available. With one of the cleanest balance sheets in our industry and a strong cash position, EXL is extremely well positioned to capitalize on these opportunities.

While we continue to take a very disciplined approach to M&A, we are actively engaged in several conversations with assets that will provide enhancements to our profit capabilities while bolster our industry vertical expertise and are hopeful that we will continue to make progress in this area. Additionally we feel very confident in our integration abilities as the integration efforts of our recent tuck-in acquisition have been progressing on schedule.

There are three (technical difficultly) I wanted to call out for investors that we are excited about at EXL. First, in conjunction with our ten year anniversary celebration, we felt the time was right to initiate a new brand and a new tag line, "Go Next. Now." The new brand captures our long tradition of relentlessly perusing excellence by recognizing and successfully addressing the issues that would impact our clients in the future. While our company has changed and grown dramatically over the last ten years, our values remained constant and have made us the ethical strong and resilient organization that we are today. The new brand embodies our values of accountability, innovation, excellence, urgency, integrity, and respect.

Second, we have initiated the concept of an insurance roundtable where we invited our numerous insurance clients to come together and exchange best practices. This annual event helps EXL to develop better products and services which with contribute to our practice and position us as the dominant business process outsourcing provider for the insurance industry.

Lastly, I'm pleased to announce that we will be hosting EXL's first annual Investor Day on Friday, November 6 on the same day as our third quarter earnings announcement. The event will be held in New York City at the NASDAQ market site in Times Square. We believe that providing the investor and analyst community deeper insight into the uniqueness of our business model, as well as greater understanding of our financial model will enhance the level of understanding our company. We will be providing more details shortly and look forward to seeing all of our current and prospective investors, as well as the research analysts that cover EXL there.

In summary, the strategic operational and financial direction in which EXL is heading is very exciting. Based on the financial results of this quarter, we believe that volumes have stabilized after bottoming out in quarter one. With the effective management of gross margins and profitability, stabilization in our transformation business, achieving significant scale in the Philippine center, and FX volatility diminishing, we expect our financial metrics to become even more attractive as volumes increase in the third and fourth quarter.

As such, EXL is very well positioned in the marketplace. Our business is growing profitably, and we retain the flexibility to take advantage of the market environment to acquisition opportunities that can further supplement our strong organic growth.

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

Thanks Rohit and good morning everyone. EXL's financial results for the second quarter of 2009 met our revenue and margin expectations despite the continued difficult economic climate. Revenue for the quarter ended 30 June 2009 was higher at $42.4 million compared to $41 million for the quarter ended March 31, 2009. The revenue same quarter last year was $47 million.

Approximately two-thirds of our revenue is denominated in US dollar, with the other one-third denominated in UK pound. We expect revenue growth to accelerate in the second half of 2009 inline with our stated guidance based on several our new client wins over the last few quarters.

Outsourcing services revenue for this quarter was higher at $34.5 million compared to $33.4 million for the previous quarter. For same period last year, revenue was $36.1 million. As Rohit mentioned, we are seeing signs of stability in our transformation business as revenues from transformation business services for this quarter increased to $7.9 million from $7.6 million last quarter, and though still lower than the $10.9 million in the second quarter of last year.

Gross margin for this quarter was 39.1% compared to 40.6% for the first quarter of this year, and 35.7% for the second quarter of 2008. The [150] (technical difficulty) gross margin decrease from the first quarter is driven by incremental costs pertaining to ramp-up associated with new clients, annual salary agreements that came into effect on April 1, and the increase in stock based compensation expense including FBT. Outsourcing gross margin for this quarter was 41.9% compared to 45.3% in the quarter ended March 31, 2009 mainly due to the aforementioned reasons.

Transformation services gross margin for this quarter was higher at 26.8% compared to the 19.7% last quarter due to higher utilization, but still lower relative to 36.1% in the second quarter of 2008. To the extent revenues (inaudible) in the back half of 2009, this will improve the gross margins in the transformation business.

General and administrative expenses were 18% of revenue for this quarter compared to 16.4% in the previous quarter. The 168 basis point increase was driven by salary increments and certain one-time expenses or costs related to our recent win in Czech Republic, provision for doubtful debt related to a small mortgage line, and an increase in stock compensation expense, and impact of FX. Our stock comp expenses this quarter increased by 100 BPS or approximately $400,000 over the last quarter driven by the new grant in [Feb of] this year, investing of grant from prior years, and we expect in second half the stock expense to be slightly lower than the Q2 expense.

As lease came up in second half there is adequate room to improve our operating leverage, but I would like you to keep in mind that as Rohit has mentioned, we are more active in the M&A front. And as for new accounting rules all expenses related to M&A will flow to our income statement irrespective of the fact whether we are successful in our closing and winning the deal, and these expenses are not included in our guidance.

We continue to be committed to our front end business, development functions, despite the market -- current market conditions. Sales and marketing expenses for this quarter was $3.3 million compared to $3.2 million for the quarter ended March 31, 2009, and $2.9 million for the second quarter 2008. Depreciation expenses this quarter were $2.8 million compared to $2.4 million for the quarter ended March 2009, an increase of 70 basis points due to onetime write-off of certain leasehold assets in an existing center which we will refurbish and the impact of our new center in Pune.

Adjusted operating margin which includes -- excludes the impact of stock compensation expense and amortization of intangibles for the second quarter of 2009 was 11.3% compared to 14.2% in the first quarter of 2009, and 9.7% in the second quarter of 2008. Normalized adjusted operating margin for the second quarter of 2009 would have been approximately 200 basis points higher excluding the impact of cost related to the Czech transaction, provision of doubtful debt, write-off of lease holder's assets, and the fringe benefit tax on the stock compensation expense.

Foreign exchange losses related to cash through hedging this quarter were $1.7 million compared to $1.3 million in the last quarter driven primarily by the strengthening of GBD against the INR. Based on the Q2 exchange rates, we expect foreign exchange loss for the second half of 2009 to be approximately $4 million.

As we continue with our geographical expansion, changing in our mix, business mix between outsourcing and transformation services, new acquisitions coupled with the mix of (inaudible) of our delivery centers across geographies, we expect our tax rate to go up in the future.

Net income for this quarter was $1.3 million compared to $3 million for the quarter ended March 31, 2009, and $2.6 million for the quarter ended June 30, 2008. Diluted earnings per share from continuing operations were $0.04 for the second quarter of 2009 compared to $0.10 for the first quarter of 2009, and $0.09 in the second quarter of 2008.

EXL continues to generate strong cash flows. Cash flow from operation for the second quarter of 2009 was $7.8 million. With a continuous focus on collections, the DSO reduced to 68 days this quarter, compared to 70 days in the previous quarter, and 83 days in Q2 '08. Capital expenditure for this quarter was $1.8 million compared to the $5 million we spent in the first quarter of 2009 as we completed our new center in Pune to accommodate the new client wins from the second half of 2008. On CapEx spent for second half, we expect to be lower than our original estimate.

Cash balance for this quarter was $114.3 million compared to the $106.6 million for the quarter ended March 31, 2009. EXL continues to have among the strongest balance sheet in our industry and we will continue to look at utilizing a cash balance to grow both organically and inorganically. As Rohit has mentioned, we are on track toward to meeting our 2009 revenue guidance of $170 million to $175 million and adjusted operating margins of 10% to 12%.

In closing, we believe that our continued focus on our clients, improving the efficiency of our operations, tightly controlling our discretionary spend, prudently investing in our front-end sales and marketing, and maintaining the [sense] of our balance sheet enables us to navigate the challenging environment, and positions the Company well for the future.

I would now like to open the discussion for any questions you may have. Thank you.

Thank you. (Operator Instructions). Our first question comes from David Grossman from Thomas Weisel, please proceed.

Thanks, good morning. I was wondering, it sounds like you're pretty much adhering to your previous guidance both in terms of revenue and margin. Can you help us understand better just what the visibility is now that we're halfway into the year, and you're in the process of ramping several of these contracts. Just how much visibility we have on that, and if there's some variability, what would the variability come from other than currency that could affect those numbers?

Sure David, this Rohit. The visibility that we have into the second half of the year is actually very high. As you know, our outsourcing business is very predictable and highly visible. We therefore are fairly confident of the ramps that are taking place with some of our existing clients and the volume of business that we would hope to accrue in the second half of the year.

The transformation business for us is far more volatile and is not that visible. The visibility in the transformation business is only between 60 to 90 days. As such, as we have only two quarters remaining for the rest of the year, I would say that the visibility for our revenue as well as our margin guidance is at a very highly confident level.

And in terms of the -- Rohit, you had gone through the pipeline. I think you had mentioned that of the two deals that were in process, you signed one obviously recently, and you've got one more that you hope to sign soon. How many other similar deals are in the pipeline currently aside from the one that's still pending?

Our pipeline actually is quite mature and robust. And we have several prospects who are part of our pipeline at various stages of negotiation. The two deals that we had mentioned and disclosed were deals where we had reached exclusive negotiations and where we thought the probability of the win rate was extremely high, and we had disclosed those two opportunities. For us, there are as I said, several other prospects which are there in the pipeline, and depending upon how these progress and as they get into the final stages, we will disclose that to the marketplace.

Okay, and then just in terms of currency, it sounds like you're expecting about $4 million in losses in the second half of the year based on current spot rates. And I know this is a hard thing to gauge, but if the spot rates -- if the rupee stays at 47/48 and the dollar kind of bounces around where it is versus the pound, would we expect -- could you give us an idea of kind of what would happen with that line item next year? Or is it just too far out to at least kind of put some brackets around where that number would go?

Hi David, this Vishal. I'll take that question. On the rupee, if the rupee stays the same and the pound move, then obviously -- if the pound appreciates that will give us a tail wind in the second half if the rupee remains where it is today. For the 2010 outlook, I think we really do not provide FX guidance on that, but we think that the FX volatility will diminish and we do expect some tail winds in our next year because of the hedging program has been fully implemented.

So net of hedging this year, is currency going to be a net negative to the bottom-line, or do you think it's going to be relatively neutral?

For 2010?

Yes. No, for 2009.

For 2009 I think it will be a negative.

I'm talking net of the margin benefit.

Right, this -- so David, essentially as you know for us whatever gain we get above the line gets washed out by the FX loss or gain below the line, and as such, we also have a policy of hedging out our rupee base for a 12 month period, so for the remainder of 2009, we are almost fully hedged as such. And therefore, currency movements should not really have a material impact on our bottom-line profitability.

Okay, and just one last question. Rohit, you said that you're opening up a new center in Romania. Is that a center that's going to be staffed to support specific clients at the outset, or is that something that you're building in anticipation of filling [them] on future demand?

Sure. The fact that we are setting up in Romania is a Greenfield operation. We signed a lease for a facility out there as well as hired staff in Romania already. For us continental Europe is becoming an increasingly important marketplace for prospects and for clients. As well as finance and accounting is becoming an extremely important service line. And therefore, we are committed to establishing a significant presence in Central and Eastern Europe.

Presently, the one client that we are in exclusive negotiations with, part of their operation would get serviced out of Romania if we were to win that contract and that contract was to conclude successfully, and therefore we would end up servicing the client out our Romanian facilities.

Okay, great. Thanks very much.

(Operator Instructions). And our next question comes from Jon Maietta from Needham & Company. Please proceed.

Okay, thanks very much. Rohit, with regard to the Schneider Logistics win, I was wondering if you could talk about potentially how that may ramp over time and when and what the opportunity is around that piece of business.

Sure Jon. We've acquired the Schneider facilities in the Czech Republic as well as deep capability in the Czech Republic as well. For us the business would accrue to our top line pretty much for all of Q3 as well as Q4, and we would expect to have revenues associated with the 200 plus headcount that we have in the Czech Republic facility.

We also believe that Schneider Logistics will be a significant strategic customer for EXL, and there are multiple additional opportunities that we are exploring with this customer for being able to service them out of India and the Philippines, in addition to the services that get provided out of the Czech Republic. So we actually think that there is a significant opportunity with this customer and we can scale up our business with this client quite significantly over a period of time.

Okay, and then with regard to the transformation services business, you talked about less than 25% of that business today is annuity based. Where would you like to see that business get, the annuity business, get to as a percentage of transformation revenues over the next two or three years, let's say?

We are actually targeting for annuity and recurring revenues within the transformation line of business to get to somewhere around 65% of total revenues over a three year period. And we think that by winning the right kind of clients and acquiring the right kind of [properties] with these clients, we'll be able to get there over the next three years.

Okay, great. Thanks very much.

And our next question comes from Brandon Dobell, from William Blair, please proceed.

Question about the transformation business. You mentioned let's call it a better pipeline, or better discussions with potential customers. What kind of either size of deal are you seeing out there, or complexity of deal, and are these with existing customers or new customers? I guess, just trying to get a feel for what the pipeline looks like from a content perspective.

Sure, the pipeline for the transformation business is actually strong both with existing clients as well as new clients. We are seeing existing clients ramp up as they derive greater amount of business benefits from the services that we provide to them, and we are seeing new clients adopt outsourcing of these types of activities on a much more larger, and on much more global scale.

The size of the contract that we are winning within transformation range from between $0.5 million, to $2 million to $3 million on an annuity basis. And therefore these are very meaningful client opportunities that we are seeing, and this will also give us a very strong foundation and a base for our transformation business.

And in your prepared remarks Rohit, you talked about the three kind of category killer verticals. In that discussion you mentioned setting up partnerships for each of those verticals. I wanted to I guess get some more information on what you mean by partnerships in each of those verticals and how you think those partnerships I guess, would either drive better margin or better returns on capital for you.

Sure. So for us the partnerships that we would seek to drive for the chosen industry verticals would primarily be around certain factors. Factor number one is there may be certain technology platforms that we can combine with our processing and servicing capability, and we'd like to be able to offer that to the customer as a unified package.

There would be other partnerships that we would be able to strike depending on the client base as well as the geographic spread of some of these relationships that might exist. Our viewpoint really is that if we are able to offer a much larger and broader spectrum of products and services to our clients, and if we can offer them a one-stop-shop we will be able to have a much more deeper and meaningful relationship with our customers, and over a period of time, we'd hope to be able to drive higher margins based on that relationship.

Do you think that initiative will require any step-up in investment or capital, or is it more just about the qualitative aspects of those partnerships?

I think initially most of these partnerships would be qualitative and would not really require any investment of capital. However, over a period of time if we find some of these partnerships to be successful, we'd be happy to invest capital in terms of making these much more deeper and stronger relationships.

Okay, great. Thanks a lot.

And our next question comes from Joseph Foresi from Janney Montgomery Scott. Please proceed.

Hi. Just a housekeeping question. I think you guys talked about revenue and I might have missed it. What was the contribution from currency on revenue this quarter? The movement in currency.

Hi Joe, this is Vishal here. The benefits of the pound appreciating was roughly about $1 million.

About $1 million. Okay. And then just kind of talking about general demand trends. I was wondering, as you're kind of looking forward, have you -- how would you characterize the demand right now for services? Is it stabilizing, has it picked up, and what are you seeing on the pricing front and volume fronts?

So, Joe, on the demand side, we're actually seeing an increased amount of activity from our existing clients, as well as increased activity from prospects. As we go into the third quarter, this is typically the budgeting cycle for most of our prospects and clients, and we would expect to see them actually plan for increased volume growth as we go into the budgeting cycle. And therefore, the third quarter is going to be a critical quarter for us in terms of some of the engagements that we have both with our existing clients as well as with new prospects.

So -- I mean, just using the sales cycle, and this is my last question, just using the sales cycle being 12 to 18 months, should we expect a pick-up towards the back half of the year heading into next year, or just how would we think about this from a timing perspective, and has that sales cycle increased or decreased at all?

Sure. So with the existing clients, the incremental volumes would pretty much be factored in for calendar year 2010, and for new clients and prospects, I think you should think about it in the second half of 2010.

Okay. Thank you very much.

Our next question comes from Vincent Colicchio from Noble Financial. Please proceed.

I'm sorry if I've missed this one, but do you have any large clients that are facing distress that should be a concern?

I'm sorry, I missed the question. Are there any large clients?

Under financial distress that could be a concern going forward?

Sure, so as you know, that we've got approximately 80 customers that we currently deal with, and our client concentration is provided in fact on our website. For us, it is extremely important to look at the portfolio diversification of our customer base, and in the current economic environment we are extremely vigilant in terms (technical difficulty) of taking a look at all of our customers and focusing particularly on some of our larger clientele and customer relationships.

As such, we believe that the portfolio is healthy. However; there are clients which do get impacted by the economic environment particularly in the US and in the European geographies.

Okay. But there's nothing in particular that should be a concern to us today?

We don't really talk about individual client names as such, and then therefore, most of this monitoring we do is really an internal process, and it's really spread across the entire portfolio of customers that we have, and it's not really singled out on any particular individual client.

Okay, thanks. Could you give us some help with the tax rate assumption for this year and next year?

Sure, Vince, this is Vishal here. For this year I think we would be inline with our expectations. But for next year, we are still evaluating the impact of the new budget on our taxes which is yet to be passed by the house of the law. However, we do expect the tax rate for next year to increase meaningfully as a result of some of our (inaudible) coming due, as well as change in our geographical distribution of our business on account of organic and inorganic growth.

Okay, thank you.

Our next question comes from Ashwin Shirvaikar from the Citigroup. Please proceed.

Hi Rohit, hi Vishal. My first question is on the transformation business. Would you expect similar margins in the annuity part of the transformation business as in the project based piece? Partly I'm asking because it seems very relevant in an environment where the annuity piece you said is growing 50%, but the project based piece is down significantly.

Sure Ashwin. We would expect the annuity based part of our transformation business to yield margins which are similar to our outsourcing business as this is pretty much annuity based and recurring in nature. The project based business that we have within transformation, the margins there depend strictly upon utilization. And during periods of low utilization our margins are low, as was evidenced in our first quarter and second quarter margins for the transformation business, and as that volume picks up, we would expect our margins to go up sequentially.

Are you already there with regards to margins being equivalent to the -- annuity margins being equivalent to the outsourcing piece, or is that a process that takes some time?

The annuity based business typically will have some startup costs associated with it much like the outsourcing business. But those annuity based contracts which have matured there we are at similar level of gross margins as the outsourcing business.

Got it, and you mentioned a 17% increase in the sales force year-over-year. What should we expect going forward in terms of with the sales force headcount and the absolute SG&A level?

Well, our approach is to continue to make investments in the front end, and we will typically like to target an investment level of somewhere between 7% to 8% of revenues focusing on our sales and marketing teams, our strategic account management teams, as well as the strategic solutioning team that we have created. So we will target maintaining our investments at those levels.

In absolute terms, SG&A? You'd maintain that, or does it go upward in recent -- in the near-term?

Our SG&A which includes the G&A expenses will only go up marginally as our volume scales up. And we would expect our G&A portion as a percentage of revenue to come down as our volumes scale up.

Got you. And my last question is, can you talk about your cash flow outlook for the full year? Can you sustain the DSOs at these levels?

From a cash flow perspective, I think the second quarter was an extremely healthy quarter for us. We do think that some of the capital expenditures that we will incur will slow down and that we will have much lower levels of capital expenditure for the full year than what we thought initially. And we also are seeing an improvement in our ability to collect to receivables, and to be able to bring down our DSOs quite significantly.

So I think there is a tremendous opportunity for the Company to continue to drive strong cash flow from operations. The key really will be in terms of some of the investments that we will make for our expansion in Central and Eastern Europe, as well as to some investments that we would make for doing some M&A activity, and those will require capital to be used for that.

Okay, great. Thank you.

And our next question comes from Vincent Lin from Goldman Sachs. Please proceed.

Great, thanks. Just wanted to drill deeper into the margin outlook for the second half. I think you mentioned that there's the potential for the transport -- transformation business to post improved margins in -- sequentially, assuming volume could improve a little bit. But I think your guidance for the overall margin, the second half, actually imply a downward trajectory versus the first half. So I'm just wondering if you can comment a little bit about the dynamics there, and maybe related to this, how much negative impact that we should be expecting from the investment in the new Romania center.

Sure Vincent. Well, so for us, we do see several levers for margin expansion and as you correctly pointed them out, the growth in our transformation business, the growth in our Philippine business, as well as higher volumes in our outsourcing business will certainly drive that. However, there are a number of other factors that act as a headwind to our margins, and those are really going to be the investments that we'll be making in Eastern and Central Europe, the investments that we will be making in terms of becoming a category killer in the industry verticals that we have chosen both in terms of the training and development input that we want provide to our staff and team, as well as some investments in technology that we want to make in order to be able to better leverage some of our capabilities in these domains. So it's really a combination of both of these factors.

I would like to point out two fundamental issues that impact our company today. Number one is as we increase the ramp-up of new client business, that will be a significant headwind to our margins and we've seen that in Q1 and Q2 of this year, and as we continue to ramp up in Q3 and Q4, that will continue to be a headwind for us, and that in our minds is a good headwind because we are building and growing our business.

The second factor is as we become more active in M&A, there is going to be greater amount of expense associated with diligence and professional fees related to these M&A activities. Which again, we need to absorb as part of our financial statement and through our P&L because the accounting rules have really changed. And both these activities we view them as positive, long-term impacts for the Company. However, they do act as a drag on our earnings in the current quarters.

Okay, and then just my last question. Looks like headcount growth decreased quarter-over-quarter for the first time excluding the Aviva divestiture, but despite that, you are expecting I think continued positive sequential revenue growth for the second half this year, and I think that all makes sense just given the client ramp-up schedules that you're expecting. So with that, should we expect positive headcount growth going forward?

Yes. I think there would be a positive growth in the employee headcount going forward. However, Vincent, as you are aware, we do not really focus in on the employee headcount as a measure of trying to drive revenue growth. As an example, our transformation business revenues can increase with no addition of headcount because we have significant amount of unutilized capacity within the transformation business and we would hope that we'd be able to drive an increased amount of revenue in Q3 and Q4 with the same volume base that we have on headcount.

The other factor is that we are constantly driving towards process improvement and process efficiencies, and therefore that again takes away from the headcount growth that we would normally have associated with our revenues.

And the last piece is that we are moving more and more towards transaction based pricing and outcome based pricing, and as we engage with our clients on transaction based and outcome based pricing formats, it is not necessary that our headcount growth will be positively correlated with our revenue growth.

Okay, that's helpful. Thanks.

And our next question comes from Tim Wojays from Robert W. Baird. Please proceed.

Good morning guys, nice quarter. Just a question on your geographical expansion and plans long-term. You've moved into Central and Eastern Europe, now this quarter with Romania and the Czech Republic. Are you guys satisfied with that near-term? Are you looking other geographies like Central and Latin America, or South America?

Sure. For us geographic expansion is a strategic initiative and a priority for us and we will constantly be looking at that. However, the way in which we would like to expand geographically is to do it a measured pace.

As you are aware, last year we decided to enter into the Philippines, this year we decided to enter into Central and Eastern Europe, and we will look at expanding into another geographic location perhaps over the next several quarters. It's not something which we will look at doing simultaneously because we think that building new capacity, integrating that new capacity and infrastructure, and having the capability developed is an extremely important aspect of our continued growth and diversification. And therefore we will do this in a measured format.

Great, that's great. And then also just on the client side, are you seeing more clients versus maybe 12 or 18 months ago looking for a global delivery platform versus maybe just an Indian based platform?

We are seeing clients -- particularly those that have got a global presence look at outsourcing at the enterprise level, and therefore they are looking at outsourcing across multiple locations, and having global delivery capability is becoming extremely important.

So our response on that is yes, I think clients will increasingly look at partners that they can rely upon to provide services to them across a global delivery network and EXL is again, developing its delivery capability in a pretty predetermined and consistent manner in order to be able to service these customers.

Okay, that's it for me. Thanks.

Our next question comes from Ed Caso from Wells Fargo Securities, please proceed.

This is Chris for Ed. Continuing on M&A, what size deals are you targeting currently?

Ed, for us there are a number of M&A opportunities that we are taking a look at, and some of the deals that we are taking a look at are relatively small size deals and however, there are some that are fairly substantial and big.

As you know, the cash that we have sitting on our balance sheet is close to about $114 million, and we really have the ability to be able to consummate a transaction which is going to be somewhere in the neighborhood of about $50 million to $75 million, and that will typically be the sweet spot for us in terms of taking a look at acquisitions.

It's very difficult to give a correct estimate in terms of the size of the deal that we actually might do because the opportunities that are we taking a look at are pretty diverse and vary in size quite significantly.

Okay, that's helpful. And then also if you could -- compare or contrast the client sentiment between Europe and the United States in the last few months, and how that may have differed from last time (technical difficulty).

For us, clearly the number of prospects and clients that we have in the US is a lot larger than what we have in UK and in Europe, and therefore the opportunity to drive additional revenue from clients within the US continues to remain a large portion of our business.

What we are seeing is an increased amount of activity in -- with clients in continental Europe and that's why we believe that our expansion into Central and Eastern Europe is going to be fundamental to be able to tap into that opportunity. Some of the clients in UK have moved across and therefore they're already maxed out in terms of the amount of work that they can potentially offshore to India or to the Philippines, and we think that there might be greater opportunity in continental Europe and in the US for us to tap into prospective targets.

Thank you.

Our next question comes from Tien-tsin Huang from JPMorgan. Please proceed.

Hi, thanks, can you elaborate on the provision for the mortgage customer? How large was that, and how critical was that customer?

I'll start. Tien-tsin, this Vishal here. The provision we made is for a very small mortgage client and it's around $170,000 for this quarter.

$170,000, so relatively small, good.

That client was not -- yes, the client was not meaningful in our world.

Good. Just wanted to make sure. And then just on Aviva, yesterday WNS I guess, announced an expanded contract or some changes to the contract. Does that have any implications to EXL in any way?

So thinking now, Aviva is the strategic customer of ours. We have an outsourcing contract with them which pretty much goes on all the way through 2012. The contract that we have with Aviva is -- got safeguards and penalties built in into that contract should there be change in direction, and therefore we have minimum volume commitment associated with that contract.

What Aviva might decide to do with that contract, we obviously cannot control, and we also cannot control what a competitor might decide to offer for trying to acquire that piece of business. An argue point remains that we will be disciplined and we will provide the best services that we possibly can to our clients, and we will be guided by the provisions of our contract which are very robust, and which protect our interest completely. And at the same time, if competition decides to act in an uneconomical fashion, or would like to try to buy revenue, that's their outlook and they can do as they choose.

Okay, that's good to know. Maybe if I can just sneak in one more. Centrica looks like it grew nicely in the quarter, anything unique there?

No. Our relationship with Centrica remains very, very healthy and stable. We are expanding with them in a number of different high value process areas which are providing them with a tremendous amount of business impact and uplift. We look forward to continuing to service them as our large customer and the relationship is at a very, very satisfactory level.

Great, thank you. Thanks for the detail.

Our next question comes from the Bryan Keane from Credit Suisse. Please proceed.

Yeah, hi. I missed some of the call, but I think one of you guy's comments was decision making has improved, and earlier in the week one of your peers was actually saying almost the opposite, that decisions are still elongated and slow. So just trying to reconcile, maybe you can help me understand the differences in perspectives.

Sure Bryan. What we are seeing is that for the transformation business, that is project based as well as high end, the decision making is actually accelerating and is being taken much quicker. And clients are also looking to spend the budgets that they have for the fiscal year and for the calendar year.

On the outsourcing part of our business, the decision making is pretty much the same as what it used to be, and the sale cycle is still 12 to 18 months that we are seeing out there, and therefore there's -- they'll be no change in terms of the decision making process for our clients in outsourcing.

Okay, that's helpful, and then the acceleration in revenue that you're expecting sequentially, I know you have the Schneider Logistics acquisition, what else is in there? What other large contracts are coming on that's going to build the revenue sequentially?

So there a number of clients that we signed up at the end of the third quarter and fourth quarter of last year that we've been transitioning and migrating across in Q1 and Q2 of this year, where we have employees that are -- and associates that are in process training in the second quarter of this year, and those employees will become fully billable in Q3 and Q4 for us. We will see an increase in our revenue associated with these new clients that we've signed up previously as we start to recognize revenue and as these employees become fully productive for our customers. The Schneider business will also add to our revenue in Q3 and Q4.

Okay, and the Q3/Q4, are we talking about two to four large contracts that are meaningful, or is there 10 to 12? I'm just trying to get a sense of how many contracts are ramping up in the third and fourth quarter periods.

There are basically four contracts that are ramping up in a meaningful manner.

Okay, and then just finally, the -- I know you're still in exclusive agree -- or talks with one client. Any idea on the timing of that? Is that any minute, or is that -- could that drag on for a little while?

Bryan, that could be a fairly imminent and we hope that it will take place in the next few weeks, and will be able to get implemented sometime towards the end of this year.

Okay. Thanks a lot.

And I will now turn the call back over to Rohit Kapoor for closing remarks. Please proceed.

Thank you. I really wanted to thank everybody for joining today's call. I think as we said earlier, this quarter was a good quarter for us where we were to able to grow our business over Q1, and it seems that we have bottomed out in Q1 of 2009, and we look forward to continuing to grow our business into Q3 and Q4 of this year, and meeting our revenue and earnings guidance for the rest of the year.

Thank you so much for attending, and we hope you can join us on November 6, and -- when we have our third quarter earnings call, as well as our Investor Day in New York. Thank you.

Thank you for participating in today's conference. This concludes the presentation. You may now disconnect. Have a great day.