Exlservice Holdings Inc (EXLS) 2009 Q4 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the fourth quarter 2009 EXL Service earnings conference call. My name is Jasmine and I will be our operator for today. At this time all participants are in listen only mode. Later we will conduct a question and answer session. (Operator Instructions) As a reminder, this conference is being recorded for replay purposes. I would now like to turn the conference over to your host for today, Ms. Jean Liang, Head of Investor Relations. Please proceed.

Good morning, everyone, and thanks for joining our fourth quarter 2009 earnings announcement. Joining us today in New York are Rohit Kapoor, our President and CEO, and Vishal Chhibbar, our CFO. We hope you had an opportunity to review the press release we issued last night along with the updated, investor-friendly fact sheets that are available for review in the investor relation section on the EXL website. On the agenda for today's call, Rohit will provide a business update for the year, discuss some of EXLs investment priorities, and provide guidance for 2010. Vishal will then take you through the financial details of the fourth quarter, the year, provide additional color on our guidance 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 uncertainty that can cause actual results to differ materially from those expressed or implied by such statements. Such risks and uncertainty 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 obligations 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 these measures to GAAP can be found on the press release. Now, I'd like to turn the call over to Rohit.

Thanks, Jean. Good morning, everyone. Thank you for joining today's call. I'm going to start the call by recapping some of EXLs key accomplishments over the past year. At the end of 2008, EXL was in a transition period. We had experienced client attrition as a result of the economic turmoil and the sale of the Aviva BOT business. As a result, we expected declines in revenue and profitability for 2009. But as the year progressed, we remained focused on acquiring new clients and growing existing strategic relationships while executing on our strategy of becoming the partner of choice in our selected verticals.

I want to highlight four key successes in 2009 that are indicative of EXLs strong execution during the adverse economic environment. First, we brought on board seven new outsourcing client relationships in the last 18 months. More importantly, we grew these relationships aggressively over the course of the year while maintaining operational excellence and customer satisfaction. Our continued ability to win new clients at a fast pace is demonstrative of our strong positioning in the marketplace and our ability to compete with even the larger and more established players.

Second, we renewed our two largest client contracts which were a leading utility provider and leading US insurance company at commercial (inaudible) that were consistent with the rest of our client portfolio. Next, we expanded our global delivery footprint it include both central and eastern Europe and enhanced our experience in managing international operations. Our investment in the Philippines turned profitable on the back of significant volume expansion.

Finally, we demonstrated our ability to source deals, exercise prudence in pursuing deals and create shareholder value. We executed on two strategic acquisitions. One was in July with Schneider in the Czech Republic and another with American Express in India which we announced in November and just recently closed. The investment we made in our corporate development team this year further demonstrates our commitment to inorganic growth opportunities going forward.

As a result of these accomplishment, our head count increased to over 10,700 people globally at the end of the 2009 which is the highest in our history. Operationally, we migrated 120 processes in 2009, which represents a 30% increase to the total number of processes we manage. Our ability to migrate these many processes shows the progress we have made in terms of our migration skills, as well as an increase in our processing capabilities. We exited 2009 with higher volumes, a more diversified client base and an even stronger balance sheet than we did a year ago. This clearly demonstrates the soundness of our business model and the resilience in our execution capabilities.

This was all reflected in our financial results over the course of the year. In 2009, EXL experienced sequential revenue growth and margin expansion. We were able to grow our revenues year on year despite the client-specific head winds we faced. We also continued to make the critical growth-oriented investments to prepare ourselves for an economic rebound and the year ahead. Despite the transition of Aviva, outsourcing revenues increased each quarter in 2009 but particularly in the back half of the year as we ramped up with our new clients. In this period, we ramped up multiple clients in Paulo and still were able to increase our customer satisfactions course. This goes to show that our leadership in insurance and utilities is substantiated through our execution and the proof is in our financial results.

We experienced sequential growth of 11.5% in the fourth quarter in our outsourcing business even excluding the one time Aviva payment. Our deep domain knowledge continues to position us well in light of our clients' demands. While we have traditionally been more successful in selling our transformational capabilities to our outsourcing clients, in the fourth quarter, we successful sold outsourcing work to one of our transformation clients. We were engaged by one of our banking clients to work with them in the area of fraud investigation, a very specialized back office function. We began small in this engagement but have demonstrated our knowledge and capabilities and now expect that this engagement to grow five-fold in the next few quarters. This is encouraging because it shows our ability to deliver a more cohesive transformation and outsourcing solution to our clients and further differentiate our capabilities in the marketplace.

Similar to our experience in outsourcing this past year, in transformation services, we also experienced sequential quarterly growth throughout 2009 and our team did a great job of remaining client-focused in a challenging discretionary spending environment. Although utilization was very low in the first part of the year, our decision to maintain our bench proved critical as client activity returned in the last two quarters and gross margins grew closer to our targeted gross margins for the transformation business. We saw an increase in client activity for our transformation business in the fourth quarter as our clients chose to fully utilize their annual budgets at the end of the year. This budget flush helped us to achieve record revenues of $12.4 million for the quarter in transformation. We believe that our clients will revert back to the disciplined spending of first quarter of 2010 as they manage their new budgets. Our transformation services revenues will reflect that although the activity will not be nearly as constrained as it was in the first half of 2009.

In our transformation services business, we continue to innovate and develop industry specific product offerings to deliver tangible value to our clients. For example, we recently launched the formalization and launch of our four transformation offerings that are unique in the marketplace in terms of their ability to bring effectiveness and efficiency to our clients. These solutions include the automated E-track reconciliation, sustainable claims cost reduction, integrated marketing and risk analytics, and a next generation analytics center of excellence. We believe the launch of these four new transformation service offerings will continue to drive growth in our annuity-based transformation services business. The annuity-based business made up 35% of our transformation revenues in the forth quarter versus 18% at the beginning of the year. We anticipate that it will continue to grow in 2010 in excess of the growth rate of the more project-based elements of our transformation services.

As our organization gross and expands, we continue to make some leadership changes that will allow us to become better aligned with our strategic objectives. Developing networks and alliances will further strengthen and enhance our service offerings and extend our penetration in our focussed vertical area. To that end, we announce that Rembert de Villa, in addition to his role as head of transformation, will lead partnerships and alliances to spearhead this effort. We also hired a new vice-president for decision analytics as well as a new vice-president of operations and process excellence in the fourth quarter as we continue to see client demand stabilize.

From an M&A perspective, as valuation expectations came down in 2009, we executed on opportunities to grow our business inorganically and announced two deals. In July we acquired the back office operations of Schneider logistics in the Czech republic which further deepened our transportation and logistics capability, and expanded our geographical footprint into central Europe. In November, we announced a second acquisition, the global business travel services back office operations for American Express in Gurgaon. We have also closed the American Express transaction ahead of schedule and expect that to immediately start contributing to revenues. We also believe that there is a great opportunity to gain some revenue synergies from this deal and are developing our detailed go-to-market strategy for the travel vertical. Specifically there are numerous opportunities with American Express partners including hotels, airlines and rental car companies where we can jointly deliver value.

We continue to seek good opportunities in the marketplace for bolt on acquisition that provide EXL additional processing and technology capabilities that enhance our suite of service offerings and expect to execute on additional acquisitions in 2010. Strategically, we would like to gain an on-shore delivery platform, assets which would deepen our insurance capability and technology to enable greater end to end processing.

Looking forward to 2010, we have confidence in our client demand and, therefore, EXL will make significant investments to real estate and our infrastructure as we balance plans for growth and profitability. We will leverage our existing global distribution platform and grow our physical infrastructure. As we recently announced, we will be expanding to Jaipur, a tier two city in India, to open a new SEZ center there. This expansion provided an opportunity to lower our operating costs and tap into a qualified talent pool. We expect that the new center will be operational in the second quarter of this year and hold approximately 500 seats.

We also will invest in a new SEZ facility in Noida that will help us achieve our growth rate goals in 2010 and beyond. This facility will be a large scale campus and eventually hold approximately 2,200 seats. However, we will be building out in two phases. We expect the first phase to roll out in the third quarter this year with 800 seats; the remaining 1400 seats will be rolled out in 2011. This new campus will leverage the strong management tea that we already have in Noida. The investments we are making now into these SEZ facilities will help bring down our tax rate over time. Additionally, we will look for further geographic expansion and are actively pursuing opportunities on shore in the US that will further increase our end to end processing capabilities.

Another area of strategic importance for us in 2010 is to leverage technology a lot more. We will continue to develop tools internally and will increasingly seek to leverage technology for greater business process optimization and make investments in this area. We will actively seek work flow solutions and tool sets along with industry-specific platforms that can increase business process efficiency and effectiveness. Also, we are actively seeking out acquisitions where a specific IP or technology can reinforce our strength in our selected verticals and drive greater scale.

In 2010, we remain focused on investing in our domain expertise and becoming a category killer in our selected verticals. A key element of this strategy is developing our future leaders. In 2009, we invested over 37,500 hours of training for our management team, created an insurance training academy and refined the career development path for our front line employees. Attrition for 2009 was 23.1%, the lowest in EXL's history. We believe that this was a result of both the broader economic climate as well as our investment in our people. However, we anticipate that as the broader economic environment improves, attrition should also increase and we plan to remain focused on creating the opportunities and training to keep our top talent.

We expect that the vast majority of our growth in 2010 will come from our existing clients' accounts. However, I would like to provide you with some color with regard to our sales pipeline and customer sentiments. We continue to see a healthy level of activity in insurance, banking and financial services, and transportation and logistics opportunities. We are currently involved in the final stages of three client opportunities in these verticals. Depending on the ultimate scope and size, any one of these opportunities could have an impact on our performance at the end of 2010 and positively impact our growth going into 2011. However, given the high unemployment rates in both the US and the UK, decision cycles continue to be long and there is increased sensitivity to offshoring programs. This is consistent with our observation around smaller deal sizes. We see opportunity in that our customers are looking beyond labor arbitrage and more focused on productivity gains and transformational outsourcing. They are also more sensitive to large upfront investments in outsourcing than they have been in the past.

Before I hand the call over to Vishal, I want to highlight this past year demonstrates EXL's ability to execute in extraordinary times. Despite the head winds we had coming into 2009, we were able to replace and grow our revenues, make investments in our delivery infrastructure, employee training and development, strategic acquisitions and still were able to expand our margins and deliver strong cash flows. I want to thank the EXL team for their hard work and dedication this past year. During the economic turmoil, the EXL team pulled together and focused on the day-to-day needs of our clients. I'm very proud of the team and our accomplishment in the last year and believe that we are well-positioned in 2010 to continue capturing growth in what continues to be a dynamic and high growth market for our services. Now, let me pass it over to Vishal who will provide details on our financial performance of the year and our 2010 guidance.

Thanks, Rohit and good morning, everyone. EXL's financial results demonstrate our ability to successfully navigate and execute in uncertain environments. Our 2009 revenues of $191 million present a 5.1% growth over last year. We exceeded the top end of our revenue guidance of $180 million due to the continued sequential growth in outsourcing services, a sharp increase in revenues from transformation services in the fourth quarter and a one-time payment from a client of approximately $5.1 million. Excluding the one-time time client payment, we would still is are exceeded the top end of our guidance by $5.9 million, and grown revenues over 2008 by 2.3%. Furthermore, we were able to grow our revenues year-over-year despite a negative GBP foreign exchange impact in 2009.

Outsourcing service revenues were $152.6 million this year compared to $138.8 million in 2008. The revenues increased approximately 10% year-over-year as revenues grew sequentially each quarter in 2009, and particularly rapidly in the second half. Transformation revenues were $38.4 million compared to $42.9 million in 2008. This was a revenue difference of 10.7% compared to 2008 due to lower client discretionary spending. Revenues adjusted for the one-time client payment in the fourth quarter were $54.4 million compared to the $48.2 million in the third quarter, representing a sequential growth of 12.8% and a year-over-year growth of 24.4%. Based on current exchange rates for the UK pounds, normalized fourth quarter revenue excluding the one-time client payment and that client's revenue contribution and the sharp increase in transformation services, the waterfall run rate would have been $50 million.

Fourth quarter outsourcing services revenues excluding the one time client payment increased by 11.5% to $42 million compared to the $37.7 million in the previous quarter due to continued ramp of client win and growth from existing clients. Year-over-year, outsourcing services growth was 26.6%. Transformation services revenues increased sharply in the fourth quarter to $12.4 million. This was a record quarter for transformation services representing 17.7% sequential growth over the third quarter and a year-over-year growth of 17.6%.

In 2009, approximately 64% of revenues were denominated in US dollars, 34% in UK pounds and the remaining 2% in other global currency. By comparison, in 2008, approximately 57% of revenues were denominated in US dollars and 43% in UK pounds. This shift in our revenue mix should shield us from the pressure GBP has been under as of late.

Gross margin in 2009, excluding the one time client payment was 41.2% compared to 38.1% in the prior year. Our growth margins increased approximately 300 basis points, of that, 200 basis points of the margin improvement were executable to higher productivity in outsourcing services. These productivity gains were partially off set by a lower utilization in transformation services during the first half of the year. Gross margin for the fourth quarter of 2009 excluding the impact of one-time client payment was 44.1% compared to 41.6% in the fourth quarter of 2008. Outsourcing growth margin for 2009 excluding the impact of one-time client payment was 43.5% compared to 38.6% in the prior year. Transformation gross margins for 2009 was 31.4% compared to 36.6% in the previous year primarily due to the lower revenues in the first half of 2009.

Additionally I would also like to highlight that we protect our margins with a disciplined pricing approach. Our pricing practice includes annual price increases to protect against inflation and we also work with our clients to mitigate foreign exchange rates in our contracts. EXL has now over 55% of our revenues where clients agree to dynamic pricing to share effects with us or the client commits to annual volumes which allow us to hedge our exposure with a high degree of (inaudible). In 2009, we increased investment by 23% in our sales and marketing margin to 7.3% of revenues because it's a strategic priority and will ensure long term sustainable growth. We expect to maintain our sales and marketing spent at around 7% of revenue.

From 2005 to 2009, EXL spent on sales and marketing went from $1.7 million to $13.9 million. This is an eight-fold increase to our expenditure and an ongoing investment in our future growth. General administrative expenses for 2009 were slightly lower at 16.7% of revenue compared to 17.1% of 2008. General and administrative expenses increased to $9.7 million in fourth quarter when compared with the previous quarter mainly due to the fees related to a recent acquisition and impact of foreign exchange. EBITDA for 2009 which excludes the impact of stock compensation expense, amortization of intangibles and [depositions] was $42.9 million compared to $32.1 million in 2008, an increase of 33.6%.

Full year stock based compensation expense for 2009 was $7.1 million. For 2010, we expect a stock based compensation expense to be approximately $9 million. Full year 2009 operating margin was 12.8% compared to 8.6% in 2008. Full year adjusted operating margin which excludes the impact of stock based compensation expense and amortization of intangibles grew to 14.3% from 11.8% in 2008 after normalizing for the one-time client payment. This increase of 250 basis points over the previous year was primarily driven by higher growth margins which was partially offset by higher sales and marketing expense.

Adjusted operating margin for the fourth quarter excluding one time client payment was 16.3% compared to 14.4% in the fourth quarter of the prior year. In 2009, the average rate for rupee was INR48.4 to the dollar compared to INR43.9 in 2008. The average UK pound rate moved from GBP1.84 in 2008 to GBP1.57 in 2009. The appreciation of US dollar against the Indian rupee and the UK pound has had a net positive impact of approximately 120 basis points on our operating model during the course of the year. For the full year 2009, foreign exchange losses amounted to $5.9 million compared to a loss of $9.3 million in 2008. Losses this year were related to forward currency hedges that we had taken 12 to 18 months prior to the date of maturity when the Indian rupee traded between INR39 to INR45 to the dollar and UK pound between GBP2 and GBP1.45. Every 1% appreciation of the Indian rupee against the US dollar has a negative impact of 50 to 60 basis points through our adjusted operating margin which is partially offset by FX gain on our cash flow hedges.

For the full years 2009, other income which consists primarily of interest income totaled to over $1 million compared to $3.4 million in 2008 mainly due to declining yields in marketplace for our cash balance. Short term yields are well below 25 basis points and we expect interest income to be stable or lightly lower in 2010 based on lower expected cash balance from M&A activity and an expected low interest rate environment.

EXL's 2009 tax expense of $3.7 million or 19% of pretax income was higher than expected mainly due to higher profitability in the United States and the one-time client payment of $5.1 million. This one time payment was fully taxable and did not qualify for any tax benefits. For 2010, we expect the effective tax rate to be in the mid 20s as a tax benefit of some of our Indian operations tented under the (inaudible) is set to expire. Additionally, our recent acquisition of American Express business back office will be fully taxable as it has completed a 10 year [tax holiday] under the [GTSC] team. 2009 net income from continuing operations increased 41.8% to $15.8 million versus $11.1 million last year. This is largely due to an increase in operating profits by an $8.7 million lower foreign exchange losses by $3.3 million and a one-time client payment which was partially offset by lower (inaudible) and higher taxes. Diluted earnings per share from continuing operations for the year ended 2009 was a $0.54 as compared to $0.38 in 2008 which represents a growth of approximately 42%. Excluding the one-time client payment, diluted earnings per share from continued operations for the year was $0.43.

Cash flow from operations in 2009 was $35.7 million, an increase of approximately 18% as compared to the [$30.3 million] in 2008. We reduced DSO's to 58 days at the end of 2009 from 69 days at the end of the prior year and had strong cash flow generation from the business which resulted in an ending cash balance of $132.2 million. Please note that the cash balance does not reflect a payment due for recent AmEx acquisition and the payment for the year end (inaudible) compensation which will be paid in the first quarter of 2010. Capital expenditure for 2009 was $11.5 million, a significant portion of it was related to do opening new delivery center in [Tumay], India and Cluj, Romania, and the refurbishment of our existing infrastructure.

Capital expenditures in 2010 will be in the range of $20 million to $25 million as EXL expands into the tax advantage Special Economic Zone delivery centers, we expect to build approximately 1,300 seats in Noida and Jaipur, India, to support the ongoing growth and expansion. For 2010, we are providing revenue guidance of $225 million to $230 million and an adjusting operating profit margin guidance of 12% to 14%. This guidance represents a growth of 21% to 24% over 2009 revenues, excluding the one-time payment. Our guidance includes a contribution from American Express of $16.7 million and this implies an organic growth rate of 12% to 15% for 2010. The guidance also assumes growth from new and existing outsourcing plans where we have higher visibility. We also see general stabilizing in the economy and believe this will allow for normal business volumes in transformation business. We have not factored in any significant revenue from new plans as our sales cycles are long.

The adjusted operating margin guidance is based on exchange rate INR46 to the dollar and a GBP USD rate of 1.5 compared with the 2009 average rate of approximately INR48.3 to the dollar and a GBP rate of 1.57. This appreciation of rupee against the dollar has a negative impact to the adjusting operating margin of between 2.5% to 3%. We expect to offset this impact by higher transformation growth margin, contracted pricing adjustments in our outsourcing business and lower general and administrative expenses as a percent of revenue. We expect to see operating leverage in our model year-over-year as we grow. The American Express business travel transaction is expected to be margin neutral and accretive on a nonGAAP basis. Based on the current exchange rate of INR46, we expect over $2 million in foreign exchange gains for 2010.

To recap, the numbers for 2010, the expected revenues of between $225 million to $230 million, adjusted operating margin of 12% to 14%, we expect stock based compensation of approximately $9 million, the effective tax rate to be in the mid-20s and CapEx to be between $20 million to $25 million. Now I would like to open the call for any questions that you may have. Thank you.

(Operator Instructions) Your next questions comes the line of David Grossman with Thomas Weisel.

Thanks and congratulations on the fourth quarter results. Just going back to the revenue line in the fourth quarter, it sounds like you're at $54 million and change when you back out the Aviva payment. Was there any Aviva revenue in the quarter aside from that payment that will not reoccur going forward?

Hi, David. This is Rohit. Yes, David, we did have revenue in the fourth quarter from Aviva which we recognize and that will be tailing off. The revenue from Aviva in the fourth quarter is approximately $1.8 million dollars.

Okay. Then the actual seasonality that you're talking about in transformation was closer to $2 million rather than $4 million?

That's correct.

It sounds like you've had great momentum in that business both in the third and fourth quarter, so it sounds like you expect to see a sequential decline in the March quarter. How much that have is seasonality and how much of that was just a lot of stuff happening in the fourth quarter that won't recur going forward once you make all the adjustments we just talked about?

David, as far as our revenues are concerned, let me just provide a conceptual background as to how we think about our revenues. We think about our revenues as having a core solid foundation of outsourcing and annuity-based revenues which is steady, stable and sticky. On top of that we have some transformation project-based revenue which can be volatile and quarter on quarter that number can move up and down fairly significantly. As such, we would expect the transformation business to continue to move up on an annual basis and grow year on year but on a quarter on quarter basis, there will be volatility associated with that business particularly as customers exercise their discretionary spending from budgets that they allocate for doing such work.

The second part of the volatility comes from foreign exchange and as the FX rates move up or down, particularly sterling pound against US dollar and in 2009, that is something that impacted our revenues and can impact our revenues on a go-forward basis as well.

The last piece is associated with the setup costs, the transition and the migration and technology costs, associated with new clients on new processes being ramped up for existing clients where they can be a sudden spurt in activity and revenue recognition associated with this particular on-boarding of new customers that might take place. And it's really these three layers on the transformation project volatility, the one time setup transition and technology cost associated with the transitional for existing clients or new clients, and the FX rates which will have an impact on our revenues.

Okay. Thank you. I think I follow that logic. An aside on the currency, what is your expectation for foreign exchange gains and losses in 2010?

In 2010, hi, this is Vishal. In 2010 we expect a gain of about $2 million at the exchange rate of 46 (inaudible) rupee.

Okay. Got it. And then just back, Rohit on the pipe line, I think you talked about three, I assume those are strategic size deals in the pipeline. I think we were, if I I'm remembering right, there were two at the end of last quarter, can you give us a sense for what you're seeing in terms of obviously you have added one. The sales cycle, is it still relatively long? Is it shortening at all? And is it realistic to expect that if you close one of these, any of the deals that close in the March quarter could legitimately contribute to revenue by the fourth quarter of 2010?

Yes, David. We've got three strategic outsourcing clients in the final stages of evaluation in our pipeline. And all three clients are actually in the insurance industry vertical, so we feel very good and confident about winning our fair share of business from this pipeline. If these deals were to close in the next couple of months, we could expect to see some revenue kick in in the fourth quarter of 2010. And certainly it will add to our growth rate and momentum in 2011.

From a pipeline color perspective, we are now beginning to see more demand come in from prospects in banking and financial services, as well as demand coming from clients within the transportation and logistics industry verticals. And we also see demand coming in from continental Europe prospects. These are areas where we think there is growth opportunity for us, and even though these are early stage indications that we are seeing in terms of our pipeline, we think as we get engaged with some these prospects, we will be able to bring them to a final decision over the next 12 months or so, and that is very encouraging for us.

The size of the customer deal that we are seeing is somewhat smaller as compared to what we saw in the past, and I think that's driven by the fact that the clients are looking to engage in specific identified opportunities and get started on outsourcing relationship and then build up their long-term outsourcing programs, so these are just the initial early phases of the outsourcing that they're talking to us about.

Okay. And then one thing that struck me in your commentary was about the potential for adding capacity on site. Could you help us better understand, at least strategically what underlies that comment and what the scale of something we would expect to you do and the form it would take?

Sure. Our intention to acquire capability on shore in the US is driven by three fundamental underlying factors.

One is we would like to be able to offer our clients end to end capability and particularly the work thats done in the US associated with the mail room, the imaging, scanning and indexing of paper-based documents and converting that into electronic formats so this can be processed in an offshore location, the ability to manage that is one driver of for our rationale for wanting to have an offshore facility.

The second is, as we get engaged with clients doing more complex work with them, there is a fair amount of licensing and regulatory requirements that we as a company need to meet. In order to satisfy these licensing and regulatory requirements, we need to have subject matter experts who are certified and trained on these regulations and compliance standards and these individuals necessarily need to be based on shore in the US.

The third factor is that some of our clients would like us to transition the work across in phases, and they'd like us to be able to demonstrate our capability on shore before taking the work off shore, and therefore, we would be able to have a holding ability to be able to perform work for our clients on shore for a a short period of time before taking that overseas. So based on these fundamental factors, we thing we should strategically acquire an onshore capability. The size of the onshore capability would be fairly small and we would think about acquiring this capability in a low-cost location so that we can offer services to our customers on a competitive basis.

Okay. Thank you for that. And then just finally, on the amortization, what are you factoring in, I think you gave us the stock comp number of about $9 million. What should we factor in for amortization in 2010?

Hi, David. The amortization for the AmEx though we have not yet finalized (inaudible) accounting, we expect that that would be in the range of $1 million to $1.5 million in additional amortization.

Your next question comes from John Maietta with Needham and Company.

I was wondering if you could talk about the level of interest you're seeing from potential first-time outsource clients.

Sure, John. I think if you take a look at at our pipeline, there are a number of prospects in our pipeline which are first time buyers and users of outsourcing services. Many of them have used transformation services on shore but they haven't used the global delivery model for in engaging transformation services. So I would say almost three-fourths of our pipeline is made up of first time buyers which are looking at testing the global delivery model for both the transformation services and outsourcing services.

Okay. And along those lines, maybe you could comment about the level of interest you're seeing with regard to integrated services. I know it's early days along that evolution but to the extent you can provide some color, that would be helpful.

Sure. I think EXL started the practice of integrating transformation and outsourcing services way back in 2006 and for the last four years, we've been offering our customers an integrated package of servicing combining our outsourcing capability and the skills we have if transformation to provide additional value to them. I think this strategy of ours really seems to be resonating well with our customers who are looking well beyond the labor cost arbitrage today as the market becomes much more vell established and more players start to adopt outsourcing and transformation. So we're seeing that many more customers are talking to us about an integrated model and today in fact many of the (inaudible) that we are seeing request information for specific capabilities that we can point to where we can demonstrate our integrated approach.

Ladies and gentlemen, due to question volumes, please limit your questions to one question and one follow-up. Your next question comes from the line of Bryan Keane with Credit Suisse. Please proceed.

This is Alvin Goshee for Bryan. Just a quick question on your margin guidance. You gave a lot of puts and takes in terms some outsourcing pricing contracts coming up, utilization in transformation, can you just guide us through what's in that number, the high end and low end?

Hi. On our adjusted operating margin, we expect the margin on the high end to be around 14% and the low end to be 12%.

Right. But just in terms what have gets you there, how much will be that be attributed to the pricing and outsourcing, the increased utilization transformation, and then kind of pull back to the investments you guys are making?

Okay. So in terms of if you look at our back from fourth quarter run rate, the FX has an impact of 17 bip, and the impact of investments we are making on account of the SEZ and the CapEx has an impact of about 120 to 170 basis points offset by some of the pricing impacts which is around 50 to 60 basis points.

Your next question comes from the line of Ashwin Shirvaikar with Citi. Please proceed.

My first question is you talked about the tax rate, not just for this year but going forward a little bit but if you could focus on what the tax strategy as you become more global, thinking more about US growth were you fully taxed and eastern Europe and Philippines as well as India, if you can comment on that?

Yes, Ashwin, this is Vishal. The taxes were higher in 2009, particularly in the fourth quarter, because of the one-time payment from Aviva which was not eligible for any tax benefit and drove our taxes higher. Further in fourth quarter, there were some (inaudible) taxes on account of finalizing a full year audit and annual tax return, but if you look at our full year annual taxes for 2009 excluding this one-time Aviva payment, taxes would have been 13.4%. Now as I said earlier in my call, we expect the 2010 taxes to be in the mid-20s and the reason for higher taxes in 2010 is two-fold. Our AmEx deal has got no tax benefits and is fully taxable at 35%. Secondly, certain of our units in India coming off the tax holiday in 2010, which will also attract a higher tax rate of 35%. Whether we win the impact we are trying to mitigate in terms of our EPR for going forward is dependent on our SEZ expansion and because the SEZ that expansion is more happening at the back end it would not have a major impact in 2010 to mitigate or reduce the tax rate. But as we are able to grow our business in the (inaudible) in India, all other geographies like Tumay or eastern Europe where the tax rates are lower, we should be able to bring down the tax rate in the coming years beyond 2010.

You actually expect 2011 tax rate to go down from 2010?

Yes.

Okay. One question if I can on working capital trends, as you sort of return to growth here, what should we expect from working capital and just broadly speaking sort of a flow-through from net income to cash, how should we see that trending?

Ashwin, this year as you know we generated net of investment about $35 million, and that was assuming CapEx of about $11.5 million. In 2010, we expect to generate between $35 million to $40 million from cash flow from operations but it will be offset by higher CapEx investments and that will impact our cash flow going down from operations which will add to our cash amount to the extent of about maybe in the range of $20 million in 2010.

Your next question comes from the line of Joseph Foresi with Janney, Montgomery Scott.

My first question is how much do you expect Schneider Logistics acquisition to add to revenue in 2010 and if we back that out, what would the organic growth look like?

Hi. In 2009, the Schneider acquisition was already there in our numbers for about seven months, and in 2010, the incremental impact is only approximately about $2 million. So if you take that out I think it has a marginal impact on our growth rates.

So how much was it over the seven months?

$2.5 million.

And then just if -- this is more of a broader question, maybe you could talk about heading into 2010, what your expectations are, what lead to you the low end of guidance, maybe the high end of guidance, maybe to even exceed guidance, what would have to take place and maybe each scenario?

Sure. Joe, the guidance that we have provided is basically a well-balanced middle of the fair way guidance which we think the company should be able to execute on. I think there are several factors that will cause us to over-perform or underperform to this level. Number one is going to be how our transformation business plays out and if there is continued strength in the transformation business and that continues to perform well, that can have an impact to our 2010 numbers either positively or negatively. Number two is from a risk perspective, if there is anything that happens to our clients' portfolio or any of our clients get impacted, from a financial standpoint, that can have material impact to our business.

The outsourcing business for us is relatively steady and stable. The acquisition of any one of the three strategic outsourcing clients that I mentioned could positively impact our business towards the latter half of the year particularly in fourth quarter of 2010. From a margin perspective, we've guided to an adjusted operating margin of 12% to 14% and I just wanted to explain first the strategy of the company and then talk about the possible upsides and downsides to our adjusted operating margin for 2010.

First, as a broad strategic theme, we think that we can expand our adjusted operating margins by 300 to 500 basis points over the next three to five years. And we do think that we can take our adjusted operating margins into the high teens over the next three to five years. However, we as a company have consciously decided to make sure that we continue to make investments in areas that are strategically important for us so that we can deliver sustained and stable growth in our business for the next five years. We will continue to make investments in infrastructure, in people development, in technology, in building capabilities and in further strengthening our front end. And we will sequentially take up our adjusted operating margin in a gradual and incremental fashion and reinvest any excess margin that we are able to make in terms of enhancing the strength of our fundamental platform and our business model.

For 2010, there are a number of factors that can impact our adjusted operating margins positively or negatively. Number one is the transformation business, if that continues to perform as strongly as it has and it continues to grow rapidly, that can drop down significant amount of margin to our bottom line very, very meaningfully and conversely if that business was to be impacted, it can also take away from a margin. Number two foreign exchange rates will have an impact on our adjusted operating margin. While we have hedged out our revenue and our cost of doing business for the next 12 months or so, the adjusted operating margin does not include the FX gain and particularly the $2 million of FX gain that we anticipate in 2010 is below the adjusted operating margin line. So foreign exchange can have a significant impact to our operating margins even though that will get offset by either an increase or a decrease to our FX gains that we anticipate for the year.

Further, there are some expansions that we are taking which are going to be onshore expansions or international expansions that we are looking at and as we look to build out the infrastructure and have and seed these businesses with strong management teams, they can have a drag on our operating margins and have an impact on our adjusted operating margins. The last piece is as we continue to move forward and look at M&A aggressively and look at growing our business inorganically in addition to our strong organic growth rate, the cost of looking at some of these acquisitions can also have a a material impact on our adjusted operating margins. So those would be some of the factors that can have either a positive or a negative impact to our revenue and to our margins.

The next question comes from the line of Ed Caso with Wells Fargo Securities. Please proceed.

Good morning. You mentioned a possible nervousness among your top clients if something happened, is there some reason you might be nervous?

Ed, my comment was really we have a customer portfolio and we actually think the customer portfolio is a very well positioned customer portfolio because a majority of our business comes in from industry verticals which are very stable. We have almost half of our business coming in from clients in the insurance industry vertical. We also have approximately 25% to 30% of our business coming from clients within the utilities industry vertical and these are traditionally very stable industry verticals where we don't expect much of a customer impact. However, there are other clients that we have which could get impacted by a downturn in the economy and there is always a possibility that if some of our clients get acquired by another player and the acquiring entity has a different strategic rationale for how they think about outsourcing, it can materially impact our revenue stream, and that is a risk that I would see. We really don't see any fundamental risk with any of our clients in our stable industry portfolios.

Last quarter you mentioned two clients that were potentially close and in this quarter you mentioned three. Does the three, do they include the two you mentioned last quarter or is the mix different?

The three that we have here are actually new clients which are part of our pipeline. And they are in our pipeline. Of the two we had mentioned earlier, we had closed on one of them and one dropped off.

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

Great, thanks, guys. Just wanted to follow your revenue guidance. First of all, in terms of the 2010 guidance that you guys provided, have you assumed any sort of seasonality in terms of budget flush in the fourth quarter of 2010? And then secondly if you can comment on the relative growth rates for outsourcing versus transformation in terms of what's making your guidance, that would be great.

Sure, Vincent. In terms of our guidance for 2010, we have not factored in any budget flush associated with the transformation business in fourth quarter. We have seen certain years where that budget flush is applicable and we are able to realize a higher revenue in that quarter, but we've also seen a couple of years where clients have chosen to hold back spending in the fourth quarter and it depends on what the economic outlook is. At this point in time it's very difficult for us to predict which way our clients will be thinking about their business and budgets particularly for the fourth quarter on transformation associated projects. One much mitigant for us is to move more and more of our work towards annuity based volume volume within the transformation line. And as I said in my prepared remarks, that percentage has increased to 35% and we will continue to expand that contribution for the transformation business. In terms of the growth rate of both the outsourcing and transformation business, we will look at a healthy mix of contribution between outsourcing and transformation with outsourcing representing about 80% of our business and transformation being 20% of our business. On a long-term basis, we would expect that both these businesses will grow at approximately the same pace and therefore contribute to our business approximately the amount they contribute today.

And just secondly, on margins just wanted to go back to your remark in terms of the long-term margin potential, the 300 to 500 basis points that you're targeting for the next three to five years, I just wanted to be clear whether that the margin potential that's available from the model or are you implying that you still have the ability to achieve that including all the investments that you are targeting whether it's people, M&A, et cetera. Thanks.

Sure. I think on the adjusted operating margin, the expansion of our margin will really come from enhanced size and scale and the operating leverage that we will gain as a consequence of that. If you take a look at our gross margins which are roughly in the neighborhood of about 40%, that is pretty much in line of that of much larger players and also in line with some of the IT service companies. However, our SG&A line is much more significant number as a percentage of revenue. We think that over the next three to five years, we should be able to take up our adjusted operating margin to somewhere in the high teens and that is going to be after making the investments that we need to make which we will make over the next three to five years.

Your next question comes from the line of Sachin Jain with Jefferies & Company.

This is Sachin Jain. Nice set of fourth quarter numbers, guys. My first question is assuming that the demand environment gets strong in the coming quarters, do you expect attrition rates to reach the levels we saw in 2006, 2007? Or do you think there has been a structural shift in the offshore landscape and attrition rates could move around a bit but would not reach the levels we saw a few years back?

Thanks, Sachin. Our expectation is that the attrition rate came down very significantly in the early part of 2009 and they can go up somewhat in 2010 and beyond, particularly if demand picks up and particularly if the economies in India, the Philippines begin to grow much more rapidly. The attrition rate we think is a sustainable attrition rate we think would typically be in the mid-20s, high 20s, with 30% type of range. The other factor which will be a consideration for our business is that we do expect salary increments to be a little bit higher as compared to the previous year and we would factor in wage increases somewhere in the mid single digits to the high single digits that would take place this year and beyond. Over and above that for EXL, as our brand gets much more recognized, as EXL becomes a much larger player and becomes an employer of choice, and as our investment in people development strategies gets much more well know and accepted, we would think about our attrition rate stabilizing and therefore being an offset to the growth that might take place in the industry or in the country in which we operate in.

Okay. And then this increase in the annuity mix should clearly help developing the transformation business but what kind of head room do you have in increasing this annuity mix lets say over the next two to three years? How high can it go longer term?

Our long-term as operations for the annuity-based business is to have somewhere between half and two-thirds of our business coming in from annuity based streams within transformation. A second shift for us is really for us to combine transformation offerings along with outsourcing and offer that to a customer under a single pricing package. And, therefore, that is also going to help us in terms of increasing the annuity based volume of the transformation business.

Your next question comes from the line of Tim Weis with Baird.

Just wanted to get a quick update on Romania. I think you guys were supposed to be building a center that was supposed to be operational in first quarter, and then what your expectations are for growth in the Philippines in 2010?

Sure. The Romanian site for us has been built out and we would expect to commence operations in Romania by the end of the first quarter. As we announced earlier, we have already signed up a significant strategic client for doing work for our Romanian operations and we will be servicing this client in continental Europe through our operations in Kluge in Romania, and we would expect that to begin by the ends of the first quarter.

And then just what your growth expectations are for the Philippines?

The Philippines today has approximately 800 employees on our payroll. It is a business that is growing quite rapidly. We would expect the Philippine operation to be continue to be embraced by more clients both from our existing client portfolio and our new client portfolio, and the business that we are doing in the Philippines is again business that we are taking on on a very disciplined basis. We are making sure that the kind of businesses that we take on in the Philippines is high quality business which is much more sticky and stable and we are staying away from telemarketing and telesales and technical help desk which we view as much more commodityized business. So we will grow our business in the Philippines in a disciplined manner and we would expect a faster growth rate to take place for our business in the Philippines.

Your next question comes from the line of Jon Maietta from Needham and Company.

Rohit, you had talked about in your prepared remarks driving further process automation and I was wondering if you could talk about to what extent workflow tools may be things that you would develop internally versus little tuck-in acquisition?

So, Jon, we certainly intend to leverage technology a lot more in our business and our approach on using technology is to be able to create either point applications or tools that can enhance the efficiency and effectiveness of our customer operations rather than to getting into developing enterprise wide platforms for our customers business. Typically some of these tools will get developed internally and one such example is the E-track reconciliation tool that we created by virtue of our knowledge of the finance and accounting business as well as our specific industry experience in insurance that led us to develop and create this tool internally. We also look at acquisitions where the point applications and tools can sit on top of the platform and can provide for greater efficiency and effectiveness for our customers. So we are going to use both the strategies of internal development as well as acquisitions, but it's difficult for me to give you a sense of how much will come from which part of our strategy.

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

Well, I just want to thank everybody for joining us on this call. I know that for this earnings call, we have taken the opportunity to address the performance of the fourth quarter and provide guidance for 2010 and we look forward to the performance of the company in 2010 and providing you all with a constant update on our business. We thank you for your participation and look forward to seeing you on our next call.

Ladies and gentlemen, that concludes today's conference. Thank you for your participation. You may now disconnect. Have a great day.