Exlservice Holdings Inc (EXLS) 2011 Q3 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the EXL third quarter 2011 earnings conference call. At this time, all participants are in a listen-only mode. Later we will conduct a question-and-answer session, and instructions will follow at that time. (Operator Instructions) As a reminder, this conference is being recorded.

I would now like to turn the call over to your host, Jarrod Yahes, Treasurer. Sir, you may begin.

Thanks, Operator. Greetings, and thanks to everyone for joining our third quarter 2011 earnings announcement. Joining us today from our corporate headquarters here in New York are Rohit Kapoor, our President and Chief Executive Officer, and Vishal Chhibbar, our Chief Financial Officer.

We hope you've had an opportunity to review the third quarter earnings press release we issued last evening after the market closed. We've also made available EXL's updated investor fact sheet on the Investor Relations section on our website.

On the agenda for today's call, Rohit will provide a business update for the quarter and talk about some of EXL's recent exciting client wins. Vishal will then take you through the financial details of the third quarter, as well as provide additional color on our updated guidance for 2011. We'll then take questions at that point.

We look forward to see many of you at our investor day later this morning at the New York Marriott on Lexington Avenue. Registration starts at 9.30, and we anticipate kicking things off at 10 a.m. We will also post the PowerPoint presentation for our investor day on EXL's website after the conclusion of this call, for those of you who will be dialing in.

Some of the matters we'll discuss in this call are forward-looking. Please keep in mind that those 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 SEC 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 disclosures, which we believe provide useful information for investors. Reconciliation of those measures to GAAP can be found on the press release.

Now I will turn the call over to Rohit. Rohit.

Thanks, Jarrod, and good morning. Thank you for joining today's call to discuss EXL's third quarter 2011 earnings. I will start by providing you with an update on our quarter, discuss some of our recent client wins, and provide you with an insight into EXL's strategic thinking.

For the third quarter, EXL delivered strong results in revenue growth and profitability. I am delighted to report that we achieved a significant milestone this quarter by crossing $100 million in revenues in a single quarter. Revenues grew by 48% on an annual basis, and 18% sequentially. Revenues in outsourcing had another record quarter and led our growth.

We experienced both organic growth in outsourcing, as well as had a significant contribution from two additional months of revenue from our OPI acquisition. In outsourcing, we saw particular strength in our Clinical Center of Excellence in the Philippines, as well as broad-based growth across several of our financial services and insurance clients in India. Our Finance and Accounting Center of Excellence, including our OPI acquisition, continues to grow month-on-month due to growth in both existing clients and new business. The integration of OPI is progressing well, and the business performance is exhibiting growth at or above our expectations as a combined part of EXL.

In transformation, revenues grew sequentially by 3.5% quarter-on-quarter. Both decision analytics and operations and process excellence continue to exhibit strong demand and are being managed in an integrated fashion to deliver impactful solutions for our clients.

Our risk and financial management business, or RFM, is being integrated with our Finance and Accounting Center of Excellence. RFM is increasingly servicing as the front-end financial transformation arm of EXL's Finance and Accounting Center of Excellence, providing strategic services to CFOs and their organizations.

In terms of our pipeline, we are seeing a larger number of smaller deals, a strong pipeline in finance and accounting and insurance, and an emerging pipeline in the banking and financial services verticals. The pace of client decision making seems about the same as it has been, with no noticeable pickup or slowdown due to the ongoing turmoil in Europe.

On the strategic client front, I am delighted to report that of the two strategic prospects we discussed last quarter, we have closed one of them in the insurance vertical. At the same time, we have added another strategic prospect to the pipeline in the insurance vertical. The strategic client win this quarter is particularly exciting. This win, with the leading insurance and retirement services provider, is indicative of the types of deals we want to pursue where we have the ability to make a significant positive business impact for our clients.

As part of the engagement, EXL has signed a 10-year contract, where we have assumed full end-to-end operational responsibility for the servicing of a closed block of variable annuity policies. We would be responsible for comprehensive service delivery relating to this closed block of business, as well as managing the transition to our LifePRO platform. We will leverage our state TPA licenses for our US onshore operations to deliver services to this client.

We are creating a delivery center in Richmond, Virginia, to service the policies and enhance our onshore insurance processing expertise. We plan on migrating the policies from a legacy system to EXL's LifePRO platform over time, providing significant operational and overhead efficiencies in the process.

Going forward, we anticipate building on this win by leveraging our ability to help insurance clients by variablizing their cost structures and reducing their dependence on legacy insurance systems. With our experience in providing end-to-end processing for insurance companies using both onshore and offshore resources, as well as the use of our proprietary LifePRO platform, EXL has a strong position to make inroads in the US market for outsourcing of closed blocks.

We believe the market for outsourcing closed blocks of life insurance, disability insurance, health insurance, and annuities is significant, and the existing installed base of LifePRO customers adds credibility to EXL as we look to capitalize on this market opportunity.

I am also excited about another growth opportunity for EXL in subrogation services for property and casualty insurers, with our recent addition of Trumbull Services. With this transaction, we have strengthened our leadership position in the insurance industry, and have added a highly skilled and experienced employee base and an advanced software platform.

In conjunction with this contract, EXL will continue to provide services to The Hartford consistent with its existing Trumbull relationship. The Hartford is one of EXL's strategic clients, and we are absolutely delighted to expand our relationship with them through this important transaction.

The new Trumbull business is indicative of the trust that clients place in us in terms of core operations, as they contemplate meaningful changes to their business operations. Trumbull also brings along a number of valuable relationships with other insurance companies that are new to EXL. We would expect to cross sell our insurance service offerings to this expanded client base and develop deeper relationships with these clients. Trumbull's service offerings is delivered off the well-known and highly regarded Subrosource platform, which clients can access through the cloud or via a platform BPO offering. This addition furthers our efforts to lead with client offerings that have the ability to generate a positive business impact for our clients through revenue enhancement, as well as cost reduction.

Our existing employee base and management team is growing. EXL's attrition rates came down to 30% this quarter, which represents the lowest level of attrition since the end of 2009. We will endeavor to keep the rates of attrition at manageable levels through ongoing investments in learning and development. EXL's strong growth and people management and learning and development practices will be instrumental to enhancing our employer of choice status in the years to come.

We have made some important new employee additions to bolster our Philippines management team, and will continue to hire senior and middle management talent to support the rapid growth in that location. We've also brought on Becky Dennis, a seasoned professional, as our Chief Marketing Officer, to assist us with strengthening our brand equity and enhancing our visibility with potential clients and the advisory community.

To support our growth, EXL is building critical new infrastructure both onshore and offshore. Onshore, we now have more than 500 professionals across delivery centers in Texas, Connecticut, Indiana, Virginia, and New Jersey, in addition to our corporate headquarters in New York. We anticipate growing our onshore operations next year, particularly for work in transformation services and insurance processing and analytics, work that requires specialist skills. Offshore, we are contemplating our second center in the Philippines, and making plans for a third center next year to support the rapid growth there.

Phase two of our Noida SEZ is approaching completion and will become operational by the end of this year.

We are also conducting a evolutionary restructuring of the client-facing functions of our business along industry vertical lines and centers of excellence. We believe this will further our ability to be closer to our clients in competition, enhance our domain expertise, and drive further innovation in IP and technology.

For some time now it has been a competitive requirement in our business to provide clients with incremental productivity benefits beyond labor cost arbitrage. We are increasingly seeing that clients are looking for a positive business impact that goes further than traditional benefits and touches many aspects of their business. These benefits might be in the form of revenue enhancement, sharper decision making, greater returns on technology assets, product innovation, and capability enhancement.

At the investor day, we will provide a lot more color around our strategy for generating those types of business impact and detail the pillars of that strategy. We look forward to seeing many of you in person at the Marriott East Side shortly.

I would now like to hand the call over to Vishal to discuss our financial results and guidance.

Thanks, Rohit. And thanks, everyone, for joining us today. EXL third quarter results reflect revenue growth from existing clients, as well as contribution of two additional months from our recent OPI acquisition. Revenues this quarter were $100 million, representing a year-over-year growth of 48%, of which approximately 15% is attributable to strong organic growth. Sequentially, revenues grew 17.6%. Adjusting for sequential growth for one-time planned revenues of $2.2 million we received in the prior quarter, revenues increased sequentially by 20.8%, driven by two additional months of OPI revenue, contributing 18%, and organic sequential growth of 4%, offset by a negative foreign exchange impact of approximately 1.3%.

In addition to growing our revenues, we have successfully diversified our client portfolio and reduced our revenue concentration. Top three and top 10 clients contributed approximately 29% and 61% of revenues in third quarter, compared to 40% and 75%, respectively, in the third quarter of 2010. Outsourcing services revenue for the third quarter were $83.2 million compared to $50.5 million for the third quarter last year, an increase of approximately 65%.

This has been the strongest quarter on term -- on record in terms of number of processes migrated by clients to our delivery facilities. EXL on-boarded 59 processes, of which 25 were in our newly formed Finance and Accounting Center of Excellence. The F&A Center of Excellence includes our F&A outsourcing and risk and financial management business.

Transformation services revenues this quarter were $16.9 million, sequentially up 3.4%. Demand for our decision analytics business continues to be strong, led by growth in offshore business. Onshore, we have been aggressively hiring resources in response to demand from clients for higher caliber decision analytics resources. Analytics is one of the key areas we will focus on to generate business impact for our clients.

Gross margins this quarter was 58.3%, down sequentially by 50 basis points, driven by lower gross margin from our OPI acquisition and one-time plant revenue we had seen in the second quarter, offset by one-time service tax refund and a stronger US dollar.

This quarter we were able to increase our operating leverage from G&A expenses by approximately 140 basis points sequentially, from 14.6%, down to 13.2% of revenues. As compared to the same period last year, G&A decreased by 230 basis points. This improved G&A leverage we have experienced over the past few years is attributable to the overall growth of our business and the scalable G&A infrastructure we have put in place to effectively manage our rapidly growing base of business across multiple geographies and business lines.

Sales and marketing expense this quarter was $6.9 million, or 6.9% of revenues, and an amount of -- and amount of spend was up 30% year-over-year. We continue to invest in our sales and marketing effort and believe it to be a key lever to drive our long-term organic growth of 15% to 20%.

Depreciation and amortization expense increased to 6.4% of revenues, compared to 6.2% in the same period last year and 6% in the prior quarter. The sequential increase is mainly attributable to the two additional months of intangibles as a result of our recent OPI acquisition.

Operating income margin for the third quarter was at 11.7%, compared to 10.3% for the third quarter of 2010, and 11.1% from the previous quarter.

Adjusted operating margin, which excludes the impact of stock compensation expense and amortization of intangibles for this quarter, was 15.2%, compared to 14.5% for the period same -- same period last year, driven mainly by lower SG&A expenses, offset by lower gross margins that I spoke about earlier.

Adjusted EBITDA for the quarter was $20.3 million, or 20.3% of revenues, an increase of 52.1% year-over-year, and a record quarterly adjusted EBITDA generation for EXL. Year-to-date EBITDA was $52.3 million, an increase of 44.3% over 2010. Year-to-date cash flow from operations was $40.5 million, compared to $23.7 million in 2010, an increase of approximately 70%. DSOs this quarter stood at 52 days, compared to 52 -- 50 days in the last quarter.

As you know, EXL completed an equity offering during the quarter. Three million shares of stock were sold by Oak Hill Capital, while one million new shares of stock were sold by the company. This quarter, we paid off [$30] million outstanding on our revolver, using strong cash flow we generated from our operations, as well as the $21.6 million of net proceeds from the equity offering.

The effective tax rate for this quarter was 33%. The significant increase compared to last year is per our expectation due to expiry of the tax holiday of some of our delivery centers in India, as well as non-deductible expenses relating to our acquisition. For the calendar year 2011, we believe our tax rate will be around 26% to 27%. We are setting up new tax advantage facilities and ramping up existing tax advantage facilities in India and Philippines, to be as tax efficient as possible going forward.

Net income this quarter was $8.4 million, compared to $7.8 million for the same period last year. Adjusted diluted earnings per share was $0.35, as compared to $0.32 for the same period last year, an increase of 9.2%.

Our FX gain for the quarter were $0.5 million, reflecting the recent strength in the US dollar. At the current exchange rates, we expect to incur an FX loss of approximately $1 million in the fourth quarter.

Based on our strong year-to-date results and visibility of our client ramps for the remainder of the year, we are updating our revenue guidance. Last quarter we updated our revenue guidance to $354 million to $358 million, to take into account the strong Q2 outperformance, the expected organic growth, and increased confidence in the growth of our recent acquisition.

After a strong third quarter and the visibility [into] client ramps, we expect revenues to be at the top end of our guidance range between $354 million to $358 million, representing an annual growth of approximately 42%.

This takes into account known seasonal softness in our transformation business that we expected in the fourth quarter due to fewer billable days in the month of December. It also takes into account approximately $3 million headwind of our -- [or to] our revenues as a result of change in existing foreign exchange rates, as compared to those prevailing at the time of our previous guidance update in our Q2 earnings. This headwind is due to the fact that in contracts representing approximately 40% of our revenues, EXL has currency collars that protect our margins for currency fluctuation where both revenues and costs come down in a strong dollar environment. Overall, our EPS is protected and has no impact.

We are updating our adjusted operating margin guidance for the calendar year 2011. While we have had a strong year-to-date profitability as a result of robust growth and higher-than-expected operational leverage, the profitability was positively impacted by a one-time claim -- client payment in Q2, and the service tax refund in Q3. As such, we expect the adjusted operating margin in the fourth quarter to be somewhat lower than the levels we witnessed in the two preceding quarters, despite the positive currency impact that we will receive at current exchange rates. We now expect the adjusted operating margin for the year to be between 14.5% to 15%, an increase from our earlier guidance of 13.5% to 14%.

Our third quarter and year-to-date performance has been robust due to the organic revenue growth and new and existing clients and across business lines growth, synergies from our prior acquisitions and solid expense management. We continue to leverage our strong momentum by making prudent investments and cementing our long-term growth aspirations.

We look forward to seeing many of you at our investor day later today, where our management team will be present to provide more details on our strategy.

I would now like to open the floor to any questions you may have. Thanks.

(Operator Instructions) Our first question comes from Dave Koning from Baird. Your line is open.

Yes. Hey, guys. Great job again.

Thanks, Dave.

Thanks.

Yes. And first of all, yes, congrats on the new strategic client that you won. I guess I'm wondering, you talked, I think last quarter or maybe the quarter before, about how typically you need a few strategic client wins to kind of keep the pipeline and the growth going to generate kind of your expected 15%, 20% or so growth in the out year. And I think you've signed two year-to-date. I'm just wondering on kind of the expectations. Do you think you can get that third one signed yet this year? And maybe regardless, maybe you're feeling good regardless about some of the other deals that are -- the smaller ones that are in the pipeline. But kind of just your confidence in the normal growth rate kind of as we head into next year, given the pipeline.

Hello, Dave. I think you're absolutely correct. We've signed two strategic deals in the first three quarters of this year. In addition to that, we've also had the addition of the Trumbull business, which is an expansion of our relationship with The Hartford. And with these strategic wins, we feel confident of being able to maintain the growth rate that we had guided to, which is a 15% to 20% organic growth rate year-on-year.

If we are able to get another client win by the end of this year, we would expect to come towards the top end of that range in terms of our revenue. But we feel quite comfortable in terms of where we are today with the strategic client wins and the combination of the Trumbull business that has been added on to EXL.

Great. Thanks. And then just one other question. You raised the margin guidance. And I think you called out something in Q3 that hit the operating margin, some sort of refund. Can you just give maybe the size of that and explain that a little more?

Yes. Hi, David. This is Vishal. There was a one-time service tax benefit we accrued for -- in Q3, which approximately impacts about 1.5% of our adjusted operating margin benefit, which will not reoccur in Q4. And that is the reason why we think that in Q4 our margins would be slightly lower than the Q3 margins.

Okay. So that might have been a little over a million, million, $1.5 million or so in operating income?

Yes.

Okay. And then just the last thing is just the switch now to FX losses. And I understand you're getting the benefit from the currency above the line and then you're getting the losses now below the line. Based on where we are today, kind of how should that look in 2012?

So if the FX remains where it is today, definitely it will have an impact on our revenues for approximately 10 -- $8 million to $12 million, depending on where the average rate for next year comes around. And also, it may give a benefit to our margins, and that will improve. But it will be offset by probably losses on our FX [gain] line.

Do you know the amount about of the losses where we stand today?

No, we have not [got] -- it will be roughly around what we have in the quarter, and it will be -- you can analyze that about $4 million to $5 million.

Okay. Great. Thanks. Great job.

Our next question comes from Tien-Tsin Huang from JP Morgan. Your line is open.

Thanks. Good morning. Yes, looks like a good quarter here. I want to ask about the strategic win on LifePRO. What's sort of the -- obviously, it's a pretty marquee win, it's something you've been talking about. So I'm curious about the migration, the roadmap and the migration to LifePro and if there's any risk. And I'm assuming here that the margin profile initially will be a little bit lower until you get the transition done. So I'm just trying to understand how that will play out here.

Sure, Tien-Tsin. For us, this win is obviously an exciting win because it combines our LifePRO platform along with our servicing capability. The transition to the LifePRO platform will actually take place over a period of two years. And, therefore, in the initial two years, there will be a fair amount of conversion costs that we will incur in supporting this transition from the existing platform to the new platform.

Secondly, a significant portion of the servicing of this particular contract is going to be done onshore, where the margins are somewhat lower than our corporate margins. However, we anticipate that over a period of time, with the transition to the LifePRO platform and our ability to manage a balanced servicing structure using both onshore and offshore resources, we would be able to generate our normal corporate profitability on this contract over the life of the contract.

That's good to know. And then the facility in Richmond, is there going to be -- how significant is that? Will there be any margin impact?

The facility in Richmond is not a very large facility. It's a facility which can accommodate close to about 150 or so resources. However, it gives us a strong foundational base to be able to tap into the talent pool in that particular geographic location. And it provides a second center for us to be able to deliver insurance operations from. The first one also being the one where we have insurance operations capability now in Hartford with the Trumbull addition that has taken place.

Understood. Understood. So I guess just on the Trumbull deal, was there any kind of capital outlay for that asset? I mean, it sounds like a normal way win, but it sounds like you're also re-badging some people there as well. Did you pay anything for that specifically, from a capital perspective?

So the upfront consideration for the Trumbull addition actually is minimal, and it is $250,000 of consideration. However, there are a number of elements in that transaction which provide for stability in the workforce and provide for longevity of the contract associated with the expansion of business there.

Really what it is is a testament to our -- the strength of our relationship with The Hartford as a client, and the confidence that The Hartford has in EXL being able to service them as a long-term strategic partner. It also obviously gives us additional clients, which are currently being serviced by the Trumbull business.

Good. So it's very, very low, very low number. Okay. It's good to know. Thanks, Rohit. Appreciate it.

Our next question comes from Joseph Foresi from Janney Montgomery. Your line is open.

Hi, Rohit. I wonder if you can talk a little bit about what you're hearing from clients regarding 2012, and then anything that you're seeing on the pricing environment.

Sure, Joe. I think this is actually a very, very active and an interesting time for us because most of our clients are going through their budgeting cycles and planning for 2012. As we engage with our clients, they're looking at ways in which they can reduce their costs, improve their revenues, and looking at ways in which they can actually leverage the capabilities that EXL has got to help them achieve their business objectives.

So the sense we get is despite the macroeconomic environment, clients are fairly focused in terms of doing things that they have traditionally done, and this long-term cycle of looking at offshoring and outsourcing continues to play out quite nicely. We are actually quite confident about how this will play out as we step into 2012, despite the challenges in Europe and some of the slowdown that's taken place globally.

Rohit, any comments on the pricing environment or any changes in the competitive environment?

The pricing environment continues to remain fairly stable. We haven't really seen any deterioration in the pricing environment. The one area where I think we are at a significant advantage is the fact that with the rupee depreciating quite significantly against the dollar, our ability to price better for new contracts has obviously gotten enhanced. And we are encouraging our new prospects to commit towards longer term contracts with minimum volume commitments so that we can provide them with a pricing and a contract structure that is going to be very attractive to them.

And then I guess the last question from me. I think as we look at 2012, correct me if I'm wrong, I think the firm -- or you guys have always said that you're looking for 15% to 20% organic growth, and then maybe 10% from acquisitions. I think if I look at the amount of acquisitions you did this year, it looks like if you consider those organic growth rates, maybe you're above that range for next year.

So maybe you could just frame for us what your targets are going into next year, and if you can just maybe take a look at the revenue and the margin side of things from a historical perspective.

Sure. I think for us, we remain on the glide path of trying to grow our business at 15% to 20% on an organic basis. The inorganic growth for us is difficult to predict because it depends upon when we do a particular transaction and whether it makes sense to do a transaction or not. In general, we would anticipate doing some tuck-in acquisitions that will contribute anywhere between 0% to 10% of additional growth. This year, we will end up at close to about 42% growth on a combined basis, which is higher than the long range trajectory that we had.

What I will say is, we're not shy about doing larger size acquisitions. And, in fact, our confidence from doing some acquisitions which have been very successful for us bolsters our ability to be able to do larger deals if necessary. And at the same time, if we do not see adequate market opportunities, we don't need to do any acquisitions just for the sake of doing acquisitions, and we will continue to focus on building up strong capability and delivering strong organic growth.

So as such, our goal and target of growing our business on a combined basis at 20% to 30%, remains pretty much intact, and we should be able to grow our bottom line at slightly better than that rate.

Thank you.

Our next question comes from Manish Hemrajani from Oppenheimer. Your line is open.

Good morning, guys. Great quarter.

Thanks.

Just a question on the macro. I wonder if you could walk us through any impact you are seeing on either deal sizes or decision making, and what assumptions have you baked into your guidance?

Sure, Manish. One of the things which I think has changed as a consequence of the macro environment is some of the global 1,000 companies are now starting out engagements at a smaller size and scale, testing the waters, developing confidence with their strategic partners, and then expanding over a period of time.

In the past, we would see some large size deals come through, and now we're seeing even larger customers actually start out with smaller size engagements. That actually plays to EXL's strength, because our ability to provide attention to the customer, to be able to develop this confidence with the client base and grow the business with these lines is much better than some of the larger players, which may not find us to be a attractive value proposition.

So as such, I think the demand environment remains fairly active for us and fairly broad-based. We continue to see strength in terms of a demand in the various verticals in which we service our clients, as well as in finance and accounting.

Okay. And then switching to OPI. Given that OPI contributed slightly above $22 million in the first full quarter, should we use that as kind of a run rate going forward or do you feel that you left something on the table this quarter and we could see above-average growth rates in the near term for OPI?

No, I think OPI is a business which we've acquired. At the time when we acquired the business in calendar year 2010, they had done close to about $75 million of revenue. In 2011, as we had guided, we expected the revenues to be somewhere in the neighborhood of about $85 million or so, which would imply a growth rate of about 15%. We think we would be able to sustain that growth rate for OPI.

And I think the big thing which we are really proud of is the fact that OPI for us was a significant acquisition. And despite undertaking a fairly significant acquisition, we've been able to maintain the overall growth rate of the combined company at the similar pace at which we are growing, which is 15% to 20%, and not drop a [beat there]. I think that's really a testament to our ability to integrate acquisitions and to be able to build them up as we scale our business going forward.

Got it. One question on the transformation business. 3Q generally tends to be a strong quarter for risk and financial management. But if you look at transformation business revenue, this quarter's actually down year-over-year. Can you give us some more color on why that was the case? And was there any revenue slippage in 3Q that we could expect to see in 4Q?

There are a couple of things that are playing out in the transformation line of business. Number one is we're moving more and more work from onshore to offshore. And as we move more work from onshore to offshore, particular in the risk and financial management business, the -- while the revenue is lower, the volume of business that we are actually doing is much higher and the margins that we make on the business are much better than the onshore work that we were previously doing.

Number two is the annuity base of contracts within transformation is actually increasing, and that's something which we like and, therefore, we are strategically pushing towards that direction. And we are much more focused in terms of having the right quality of business and the business being done from the right location so that it becomes a sustainable and a strong foundation for us.

You are right, the third quarter traditionally would be a strong quarter for us. But because of these two reasons, it's not as strong as what it's been traditionally in previous years.

Got it. Got it. One last one from me. On the strategic win on LifePRO, any kind of CapEx deployment for the Richmond facility?

No, the -- there is no significant CapEx that we will anticipate for the Richmond facility. It is something that we are taking on a lease, and there is no significant build out that we need to do out there. So there won't be any significant CapEx associated with that transaction.

Thank you. That's all I have.

Our next question comes from David Grossman from Stifel Nicolaus. Your line is open.

Hi. Thank you. Rohit, I wonder if I could just ask you a little bit about the fourth quarter guidance. If I use the parameters that you guys have outlined, including the million dollars of FX losses in the quarter, I get a sequentially down quarter in EPS of about a nickel and doing back of the envelope math. But it looks like about $0.03 of that would be a combination of dilution from the new primary shares as well as the one-time item in the September quarter.

But I guess number one is a $0.30 number about right for the December quarter? And then, number two, what would contribute that incremental dilution sequentially, if, in fact, that $0.03 is not the right number and a $0.30 number is right for the quarter?

Hi, David. So, David, I guess we can talk about the various elements of our guidance for the fourth quarter. But as you know, we don't typically guide towards an EPS number. We will have -- we do anticipate an FX loss of close to $1 million. There is a service tax refund which we got in the third quarter, which we don't anticipate getting in the fourth quarter. And, therefore, based on our annual guidance for adjusted operating margins, the annual -- the fourth quarter adjusted operating margin that we would anticipate would be somewhere between 14% and 15%.

Based on the revenues that we would anticipate in the fourth quarter and the fact that the tax rate actually has gone up in the third quarter and the fourth quarter, there may be a decline in the quarterly EPS numbers. But we are sharing with you our best guess in terms of how that might play out. And in terms of the performance of the business, that continues to be on track.

And I think given the changes that have taken place in the foreign exchange landscape, this is how it's impacting our business. We actually feel good that -- with the fact that the impact to our bottom line is negligible or insignificant on an overall basis, because on the one hand our margins improve and on the other hand we have an FX loss, which totally compensates each other.

Right. But I think your commentary is net net, FX should be a neutral in the fourth quarter as well, right?

Yes.

Okay. And maybe just a question about the tax rate for next year. Given the fact that you're ramping Noida, and I'm not really quite sure how some of the mix of business will impact the tax rate onsite versus offshore. But should we expect the tax rate to go down next year or do you think it will stay flattish around current levels in 2011?

Hi, David. This is Vishal. Our ETR, as I mentioned earlier, we expect for the year now to be around 26% to 27%. But you are right, as we expand into more tax efficient facilities like, as you said in Noida or the Philippines, where our business is ramping up, for next year, we expect that will marginally come down to the mid-20s tax rate.

Okay. Thanks for that, Vishal. And then I guess one more for you, Rohit. Looking at this new contract that you signed during the quarter, it sounds like this type of business is going to bring with it some contract specific margin compression at the front end. Can you help us better understand the margin profile of this type of contract? And at what point the compression, the margins, if you will, go from below corporate average to either at or above corporate average?

Sure, David. I think you're right, this will bring margin compression, particularly in the early part of the year. And in terms of margin, if you're looking at the adjusted operating margin for this particular contract, we would actually anticipate that the first two years or so the margin will be below our corporate average, and after the first two years, we should be able to bring the contract to levels which are similar to the corporate average.

The gross margin on the contract will actually be lower throughout the life of the contract, just because of the onshore cost structure that we have associated with this business. And that will stabilize as we balance out the cost structure between the use of onshore resources and offshore resources.

And is that typical that your other contracts that you would be below corporate average for a two-year period, and then at corporate average? Is that a typical evolution of a contract that does not have a platform in transition of resources, et cetera?

No. Our other contracts typically will be below corporate average for between six to 12 months, and we expect them all to get to our normal corporate average within a 12 month period. The only time where they're below corporate average is when you're doing the transition and the migration of the processes, and we're investing more upfront to stabilize these processes during the initial phases.

Right. So not to belabor this online, and we can talk about this afterwards. But just theoretically, shouldn't the opportunity then to be at a higher margin after that two-year period rather than at a corporate average, given that you're transitioning to your own platforms, et cetera?

Yes, you're absolutely right. I mean, if you take a look at the LifePRO platform and the software sales that we make on the LifePRO platform, the margin associated with that business is definitely higher than our corporate average. And as we get towards the latter part of the contract, we would have better than corporate average in terms of our margins at the operating level.

I see. Okay. Great. Thank you very much.

Our next question comes from Kunal Tayal from Bank of America. Your line is open.

Hi. Thanks. Rohit, just a question on the growth outlook for your top five clients. I know in the past you have mentioned that there is a lot of headroom to increase run rate with these clients. But just from a near to mid-term perspective, what should be our expectations here in terms of growth for the top five clients?

I think, Kunal, our top five clients are from different industries and different, I guess periods of the evolution of the relationship with us. As a group in general, we would continue to anticipate there to be fairly strong growth with these top five clients. However, the growth will be lumpy, because once we've completed the transition of some of the processes in a particular division or in a particular part of the business of these client relationships, it does take some time for us to transition over to other divisions and other areas of business of these clients.

As a group altogether, the top five clients will continue to grow for us, we think quite nicely because the penetration rates that we have with them currently is still minimum.

Sure. That's helpful. Secondly, regarding the increase in your operating margin guidance, Vishal, if you can split that into how much is from currency, one-time benefits and increased SG&A leverage that you saw or any other factors. And just a follow-up as to what would be the sensitivity of your operating margins due to [the] movement? Thanks.

Yes. Thanks, Kunal. The increase in our operating margin guidance is mostly driven by, if you look at it on a YTD basis, the FX rate has not moved much compared to where it is today. So the currency impact has been minimal for the first nine months. And most of the benefit which has flown in has been to our productivity on our SG&A line for -- on a YTD basis.

In terms of the currency movement, at current exchange rates for Q4, we expect that the currency would give us benefit of about 120 to 130 bps.

Sorry. This is for the entire next year, are you saying?

No, for the Q4. Next year --

Just for Q4.

-- we have not yet -- we're not yet giving out our guidance about the next year.

Right. Is there a sensitivity number we can work with, for example, a 1% depreciation in INR versus US [could impact] margins by about 40, 50 basis points?

Yes. So 1% movement in the rupee is about 40 to 50 basis points, 40 basis points impact to our margins.

Sure. Got it. Thank you.

Our next question comes from Ashwin Shirvaikar from Citi. Your line is open.

Thank you. Congratulations on the quarter, guys, and [all the] contracts. I wanted to follow up on some of these questions with regards to the nature of the contract that you signed and also the proposed increase in transformational work over time. As the onshore proportion increases, how do you expect sort of the proportion of BPO versus transformation to look like in, say a two to three year time frame? Is this a major shift in direction for you guys or just incremental?

Hi, Ashwin. I think the way we would categorize it is that for us the combination of transformation, as well as the use of platforms and the revenues that we get from platforms, will stay in the neighborhood of about 20% to 25% of our overall revenues, which is -- and the balance will be both onshore and offshore BPO.

We do think that a certain component of onshore BPO is necessary and strategic for the overall growth rate of our business, and we will continue to invest in building up that capability. However, as a percentage of our overall revenues, that will be a smaller piece as compared to our offshore BPO revenue.

Okay. And one more question on the penetration of clients, especially with insurance. As you increase that penetration and become more strategic for your clients or in your reach to become more strategic for your clients, do you foresee a need to sort of constantly grow the product focus on the -- in the portfolio with deals such as the one you did with Trumbull?

Yes, I think as we go deeper into an industry vertical, there will be a need for us to continuously expand our product offering and our service portfolio so that we can have a much broader and comprehensive strategic relationship with our clients in the vertical. Today, as you know, within the insurance industry vertical, we now have somewhere close to about 70 clients that we deal with in the insurance industry vertical. And while we can continue to build and grow our relationship with these clients, even with the existing portfolio, our intent would be to continue to adopt a leadership position -- leadership positioning out here, and also expand the product set in the service offering portfolio to these clients.

Great. That sounds all very good. I'll see you guys in an hour or so. Thanks.

Thank you.

Our next question comes from Jason Kupferberg from Jefferies. Your line is open.

Hi. This is Aman Singh for Jason Kupferberg. Actually I had a quick question regarding your earlier comment on clients starting out with more of a smaller deal before they gain confidence and move on to bigger deals. Is that having a larger number of smaller deals in the pipeline, does that impact the velocity of contract signings that you need to achieve to get to the annual organic growth target?

Aman, yes, I think we do need to sign up a larger number of deals. But it also depends upon the pace of acceleration of growth with -- of the relationship with these clients. And if that pace and the -- of growth is going to be fairly rapid, then it's pretty much like us signing a large strategic client up front, and the client transitioning the business over a period of time.

The big difference is clients are unwilling to make a commitment to a large block of business up front while they're quite comfortable getting to the same number over a period of time. And so I think the difference is really in terms of the commitment that the client makes up front versus over a period of time. And from our perspective, we are able to give them attention and manage the transition equally well, regardless of whether they'd like to give the commitment up front or they'd like to do it over a period of time.

Clearly, if they do not make the commitment up front, then the negotiation for pricing and the contractual terms actually work in our favor, because it's a smaller piece of business that they're giving out, and there's less competition and less pricing pressure to win that smaller piece of business.

Okay. All right. Thank you. But does that involve any extra -- I mean, winning large number of small deals versus bigger deals, is that extra -- how does that affect expenses, if you could highlight that a little bit.

For, in terms of our sales and marketing program, I think we've now got adequate bench strength across the industry verticals to reach out to adequate clients who support our organic growth rate. Our expense base to acquire these new logos, even though they start out much smaller, is not materially different if we had to put in all of our effort in trying to win a large deal. Typically a large deal will end up also taking a longer period of time. It ends up with a greater amount of marketing expense associated with a number of interactions and engagements with the customer. So on the whole, it doesn't really materially shift the economics of our customer acquisition.

All right. Thank you. And just one last question, actually, on the attrition side. I mean, the attrition rate has been good, especially this quarter. I mean, how comfortable do you feel in sustaining the growth trends in the -- or the positive trend in the attrition rate?

Well, I think the attrition rate is a combination of, A, what the company does to make itself an employer of choice and to make sure that the employee satisfaction and engagement scores are high. And, B, it's a factor of what's happening in the macroeconomic environment in our service delivery locations.

We are pleased with the change and the reduction in the attrition rate that has taken place this quarter. We do think that longer term we'd like to have our attrition rates be below 30%, and we would target to bring the attrition rates down to that level. I think as we grow in size and scale and as employees experience being part of EXL, the experience that they have within EXL is a great experience for them. We are seeing increase in the employee engagement scores, and we are seeing that our investment in learning and development programs actually play out very, very positively.

So we feel confident of being able to at least maintain these attrition rates, if not bring them down a little bit further.

All right. Thank you very much.

Our next question comes from Rick Eskelsen from Wells Fargo. Your line is open.

Thanks very much for taking my question. Just a quick question on the onsite growth that you're expecting. Do you expect to be doing that through M&A like with Trumbull or in the context of a large strategic client or are you guys really targeting doing that organically with some of your existing work?

Right, Rick. I think for us, it will largely be a combination of both. We are much more strategically focused in terms of looking at the right types of opportunities which give us specific domain capability and build out our presence in a particular industry vertical. And we'll be looking to do that both with the existing base that we've got with Trumbull and with LifePRO and the new client win that we've got, and building on that capability, as well as looking at inorganic growth with specific new clients or new businesses that we can acquire.

Okay. Thanks. And then just last question. Have you seen any issues with ramp ups on new deals that you've won, any delays from clients?

No, we haven't seen any real delays that have taken place. So, for example, the clients that we signed up in 2010, their ramp ups have been fairly normal and no real change out there that we've experienced in 2011.

Great. Thank you very much.

Our next question comes from Vincent Lin from Goldman Sachs. Your line is open.

Thanks for taking my questions. I just have a quick follow-up on the quarter. It looks like the financial services revenue is [banking and health] insurance together. It looks like on a vertical basis those revenues have posted a small decline quarter-over-quarter. I just want to make sure there's nothing specific there, and maybe just a normal kind of seasonality or the ebbs and flow of client activity. Thanks.

Hi, Vincent. I think in the third quarter what has significantly changed is that we have a full quarter impact of the OPI revenues that have kicked in. And by virtue of the OPI revenues kicking in, some of the industry vertical revenue percentages might have shifted. There's nothing that has happened in our business in terms of a change for that vertical.

Very good. That's very helpful. Thank you.

And I'm showing no further questions at this time. I would now like to turn the call back over to Rohit Kapoor for closing remarks.

Thanks, Operator. Thank you, everybody, for attending today's conference call. We look forward to seeing many of you at our annual investor day in an hour's time at the Marriot on the East Side, and providing you with a further detail of our corporate strategy and having you meet with our management team. Thank you so much.

Ladies and gentlemen, that does conclude today's conference. You may all disconnect, and have a wonderful day.