ExlService Holdings, Inc. (EXLS) Earnings Call Transcript & Summary

All right. Good afternoon. My name is Puneet Jain. I am a payment processing and IT services analyst at JPMorgan. Glad to have here with us Maurizio, ExlService's EVP and CFO; and Steve Barlow, who is Head of Investor Relations at the company. Welcome both of you. So the format of this presentation, I'm going to ask questions. [Operator Instructions]

So Maurizio, let's start with a broad question, like for the benefit of investors who may not be as close to Exl's story. Can you talk about the company's positioning and why you win in IT BPO services market?

Sure. So when you think about Exl, and let's just take a little bit of a step back, back in -- the company started back in the late '90s and really grew its operations business between 2000 and 2010. And we think of that as kind of the decade of operations management. We bought a company called Inductis, our first entry into analytics, back in 2006, right? And so we started to build our analytics business, right? And so we have -- we grew out of being in the BPO space, the business process operations space, right? And that's where we started the company, right? We started to grow analytics through the 2000, 2010 decade. And we call that kind of the decade of analytics. So where have we gotten to ourselves today. If you look at our results in the third quarter of this year, 42% of our revenue in Q3 was from analytics. What you're seeing is a company that's pivoting from where it started. And everyone still kind of characterizes us as a BPO company. And I have to remind everyone that we've gone through a rebranding kind of exercise. Our growth is not -- the significant growth is in analytics. It's going to be in digital. That's where Exl is really growing into. Recently, we -- in the last 3 months, we rebranded ourselves. And you have to look at the definition of Exl. Previously and today, the definition of Exl was we're an operations management company with analytics. The new definition of Exl, which is more where we are today and going forward, we're a global analytics and digital solutions company. We're leading with analytics. Analytics, when I talked about it at the Investor Day in November 2020, I said revenue would grow 10% plus. Analytics would grow 13% to 15%. And our operations management fees will grow 6% to 8%. So we were already telling everyone, we're leading with analytics. If you come in to where we are today, look at the third quarter, analytics is growing well into 20% range for 2021. And operations management is close to 10%, right? So we have good growth all around, but the leading part of our business is really analytics. If you just fast forward 3 years from now or 4 years from now, where will the company really be in terms of its revenue mix? You're going to find that more than 50% of our revenue is going to be analytics and digital. And I say digital, digital proprietary products, not digital embedded in operations management deals, right? So there's a big pivot that's happening within our company because what you're seeing by through this pivot is you're seeing revenue acceleration, but you're also seeing the opportunity to drive margin also. And look at where our margins have gone from where they were probably 24 months ago. It's a significant margin. Now there's benefit there from working from home. But if you just look at our revenue growth, Q3 of this year versus our headcount growth, revenue is growing over 20%, our headcount growth was only 8.5%. So you're seeing us become more efficient and also getting the benefit now for kind of the work from home environment. So that's kind of the -- that's the positioning of our company really going forward and what's really going to drive us. And when you look at where we are in the market, particularly in analytics, we have over 6,000 analytics professionals now. We hired 500 analytics people just in the third quarter alone this year to drive future growth. Those are people that are just getting trained up right now. that will be available for our growth going into 2022. So we're funding that growth through headcount and positioning ourselves going forward. And that's the value-add that we bring, particularly in analytics that not only have we been doing this for a while. We have scale. And there's not only so many companies that have scale that are positioned in the market that can really accelerate as quickly as we can because we have that scale in the market. Hopefully, that's helpful for investors.

No, it is. It is. And I have to say, like when we talk to IT buyers, the clients, we often hear Exl associated as analytics more than a BPO or operations management now. And so it's definitely resonating. So let me ask about analytics. What are the some of the ways you help your clients make sense of all that data? There is explosion of data everywhere for enterprises. And analytics is something that they need. So how do you help the mix and of all that data? And is all of your analytics like -- or is your analytics spec, is it still primarily hiring data scientists like analytics professionals you talked about? Or do you use tools and solutions or you offer some of those solutions to clients to analyze data to do predictive modeling and all that?

Yes. So there's many different avenues of revenue generation within analytics within our business. And I'll give you a few examples, right? One example could be in health care. 2 years ago, 2, 3 years ago, we bought a company called [indiscernible]. It's a payment integrity business, right? And so what do we do there? Payers make payments. And sometimes they double or triple pacing. We've run that payment through our algorithms and find that they made a mistake and they get that savings, and we get a percentage of that savings as revenue back to us. That's an area that we have driven very good growth because with claims being paid and the dollar number is going up, the opportunity for us continues to be significant. And that market a number of players in that market is actually shrink. So that's an area of analytics that we've done very well in. We also run analytics for marketing campaigns for insurance companies that's grown very well over the last 12 months, right? And that's something that we've been doing for a number of years now, very tight connections to our insurance clients. And then you get back to kind of the legacy kind of analytics business that we started back in 2006. And in that business, we're running a lot of analytical services on data, right? We're doing a lot of modeling work where clients will set up data lakes of structured and unstructured data and we help them make use of that or make sense of it through our predictive models and also our algorithms that we run on that -- on those data lakes. And we're really kind of just in the beginning phase of being able to do that. A lot of what we do now or we're moving into, I would say, is kind of doing also helping clients get their analytics and data to the cloud. And so we've been working with a lot of our clients to help them make that migration. We're already working with them on their data lakes, which sit on their local installations or infrastructure. Now they're looking to move that into the cloud. We were agnostic where they want they can put it to our cloud. We put it to their cloud. We want to help them make that migration, and then we want to be the backbone that helps them analyze it. And we have the leverage, or we have scale to be able to do that for them.

Got you. And talk about like the competitive landscape in this new type of analytics services like where you help cloud migration or where you help implement a tool. Like would you compete with like in that area? And how should we think about medium-term and long-term growth for Exl in analytics services?

Very good question. And when you think about the competition like within analytics, it's much more broad, right? When you think of the traditional BPO area, you're centered around 3 to 5 companies, right? But for us in analytics, it's much more broad. You have the smaller niche players that focus on one particular type of service or area right? And that's what they've kind of modeled their company on, be able to do this specific kind of service for their clients. So we'll encounter that at times. But what we're seeing more and more is we're starting to compete with some of the larger players that are in the industry. An example -- a clear example would be Accenture, right? That's one large company that's in our -- that's in the analytics space that we'll compete with now. But that's also a kind of a sign of the scale that we have now really going forward in that we are at scale. So we're finding ourselves competing with much bigger players and being successful at it really going forward. And when you think about kind of the growth now going forward, within analytics, we said back in Investor Day, we would grow analytics between 13% and 15% over the next 2 years, right? And this year, we're growing in the low 20% range, on a year-over-year basis, just on an annualized basis. Going forward, we still envision sticking probably to that growth rate. It would be hard to say right now, that's not achievable, right? And so we're still looking at that type of growth rate. At least for 2022, we're going to update kind of our projection for the next 3 to 4 years beyond that, hopefully, in February at the beginning of the year. But when you think about it today, that is our gross vector. Right now, it's growing 20% plus. And it's going to -- and it's the area that 2 things. One, the market for that is very -- has a strong demand right now for analytics services, and we're taking advantage of that. And really going forward, it's just really our leverage that we'll be able to really take advantage of.

Got you. And if we look at the other side of the business, operations management, how has the demand environment for operations management shifted as a result of the pandemic? Like the last recession we had in 2008, 2009, a lot of clients outsource their in-house operations. They adopted more outsourcing. They even sold some of their own captive centers. There were a lot of employee rebadging deals. So as a result of this pandemic, are you seeing like a change in mix towards outsourcing versus in-house in terms of clients' preference? Is it moving in any direction at all?

Yes. So in our operations management area, what we're seeing is really 3 things, and it's kind of centered around what you just talked about is clients are reevaluating. And so what are they reevaluating right now because of the pandemic? One is the pandemic hit, and we were very successful in terms of standing up our clients' operations in India, especially when the second wave hit India, we did very well. We got affected by it, but we did very well. We supplied 100% of our clients' needs, and they did not lose a beat because of that. I think -- but a lot of companies were captives, struggled in that process. So what are they looking for really going forward? They're looking for diversity. In the back of their mind, they're thinking, we manage too much of our -- we have too much risk in us managing our own operations. if we diversify ourselves, we reduce that risk. And we diversify with a company that is always strong that can operate through a crisis. So that's one reason clients are reevaluating whether they should have their own captive or if they should offload it or at least offload a piece of it, right? The second piece is clients want to become more efficient. And some of our clients struggle to digitize their processes, and that's where we are very helpful, especially in the segments that we are very successful in like in insurance and health care. And when insurance companies review their processes, a big area that they want to do is they want to become more digital and advanced than having a manual process. We go to them and we offer them to take over their operation but also give them efficiencies every year. And that basically means we're embedding digital and reducing the number of people needed to run that operation overall and make them more efficient also. And then the last thing, at the end of the day, there's also a cost aspect to it. We're able to drive costs lower and become more efficient with that process. And that's still, for many clients, one of the reasons why they're reevaluating whether they want to outsource their operation to a company like ours. Operations management for us is growing right around 10% right now on an annual basis. What we're seeing here is 2 things. One is we're seeing our pipeline double over the last 12 months. Our pipeline has gone up significantly over the last 12 months. And the reason for that -- one of the reasons for that is we're just seeing larger deals coming through our pipeline. Clients are more comfortable with us. They're looking to reevaluate, and that's helping us drive growth in 2021 but also driving growth into 2022 because once you've signed one of these deals, -- It's a longer-term deal of 3 to 5 years. So it becomes a bit of an annuity really going forward that you can build off of.

One trend that was very hard prepandemic and should still be hard is automation of services, especially in operations management. Talk to us how EXLS fits in the overall value chain and how economics of a contract changes when you automate a business process for your client.

Sure, sure. So when we contract with a client to take over their operation, we embed efficiencies. An example would be we'll embed 4% efficiencies every year for the 5-year contract. It essentially means you're making that 20% more efficient over the 5-year deal, right? And so how are we doing that? We're essentially embedding digital, right? And then we embed that digital benefit into the overall contract. So we're getting paid on that benefit of the digital contract through the overall contract fee and the client essentially what the client should be seen is a lower cost over a period of time from what they were paying, right? And they should see efficiency receives really going forward in that if the process can be done more digital, more automated with less people really going forward.

So automation essentially replaces other ways of cutting cost. In the past, you would have done it by learning curve and whatnot. But now you're using automation as a tool to provide that efficiency gains to customers.

Right. So it's a higher margin piece for us within these contracts, and the client sees the benefit and cost also from what they were, what their original cost was.

And how would you like the work you do in operations management can be automated given the tools that are there in the markets. I understand with like it's an evolving field. AI is picking up, increasingly a lot more work can be automated, something -- but based on what you -- what's your best estimate? Like if there is like a way to do that, like how much of work can potentially be automated in operations management?

I think it depends on the process to a large extent. I think it's -- I [indiscernible] give you a great answer, but it's a little bit process dependent, right? Inevitably, you want to embed process efficiencies into every process. And there's no reason why you can't, right? I don't think I've seen any -- every deal that we do now in operations management has some form of digital transformation. And so -- and I think when you look at it, the scale is pretty varied between some contracts, there's not a lot, some contracts, there's far more than what the normal is, right? But I think when we go through our contracts, anything between 2% and 5% a year in terms of efficiencies is not abnormal.

Right, right. And let's talk about near-term trends. Like how much of the business is still operating below where it would be if there was no pandemic? Like how much of business is still yet to recover completely from the pandemic?

I think when you look at kind of the most recent quarter we just closed, given our growth rate overall, I think every area of our business has come back. I would just say the one area that has not is our small travel business within our emerging segment. That is the area that grew in Q3, but it's nowhere near where it was pre-pandemic, right? And so I think that is the area that still has the potential to grow back over the next hopefully, 12, 18 months.

And how is your order book changing in terms of size, you mentioned like it's doubled compared to last year. But also in terms of scope of the contracts, like are you seeing like clients willing to do larger-sized deals compared to what they would have done in the past? And how should we think about medium-term growth for operations management as a result?

Yes. We have seen the pipeline grow significantly. What we're seeing is larger deals come our way that we are bidding on. And those are very attractive to us because really accelerate our growth within Operations Management. And that has helped our growth this year also. The one thing that you have seen that you have not seen in the past is our emerging unit is doing very well this year. It had a great third quarter where it grew well into the double digits during the quarter. And that's a result of expansions of existing clients, but also new deals coming on board and that are significant, that are moving the needle. And so we are seeing an acceleration in the pipeline. You're seeing the larger deals come through, and that should help our growth rate really going forward. We talked about 6% to 8% growth rate for operation management for the next 2 years at Investor Day. I think in previous to Investor Day, the general growth rate was 5% to 7%. I would say 6% to 8% is still very doable for us really going forward. But having said that, we're doing very well with growth rate right around 10% right now.

Switching gears a little bit, talk about delivery model, like you've talked about a hub-and-spoke model for delivery. More employees continuing to work from home on a permanent basis than any time before -- before the pandemic, any time before the pandemic. So talk about like how many employees like are back in to office versus still working from home? And where do you expect that normalized to over the next few years.

Yes. It's an area that gets a lot of talk within our company because it's so important on how we set this up really going forward. And we do think a permanent change has come through the whole work buyer, particularly in our area. We have still over 90% of our employees working from home. We're still in a work from home environment. And so we talk about internally, potentially starting to go back to the office in January. That is still a soft target. No different than many other companies. Many other companies still have that as a soft target. I think we're still -- it's still a little bit of a wait and see in how this is going to pan out. But that's kind of our soft target right now. Now having said that, we talk about internally having up to 50% of our employees working in the office, probably 20% of our employees working in a flex model, meaning they come in 1 to 3 days a week, and then the remaining 30% working from home where they come in maybe 1 or 2 days a month. And that's -- and so we've gone out to our 6 largest clients. And that is kind of the percentages that clients are comfortable with, our six largest. So we went to them to say, okay, what do you think? How do you envision this? This is how we first manage our workforce in this new environment. This -- we're thinking about this type of setup going forward. And that's what really came back from those 6 largest clients. And so there -- from there, we need to, at some point, start to effectuate that. So in this new environment, you're basically looking at probably about 50% of your people being in the office, which changes the dynamics. We do have to retrofit our offices for social distancing. We'll have to expand the amount of space that people have from where they are today, right? So that's going to take up additional office space. But there is going to be the opportunity for some office space rationalization over the next 2 to 3 years once we start to go back. And we realize when you're in the office that we have this open space in this location that we're not using, right? So that's an opportunity to de-lease that space, right? And start to rationalize given the new structure.

Yes. That makes sense. But what would that model imply for supply like -- or access to supply because like if people can work from home, they can be anywhere in the world. I mean not in the world, but anywhere in the country wherever your operations are, right? So would that allow you to hire from a larger labor pool and what does that mean for the wage inflation, attrition, some of the metrics that have generally trended higher in operations management space, especially the attrition metric. Can we expect like slight reduction in some of those metrics as you adopt that model, new delivery model?

It's it will give us the opportunity to expand our talent pool. And so that is a clear kind of potential benefit. We are investing in technology to better protect everyone's computers and access for people working from home so that clients feel more secure with their data. And we're doing that for everybody, whether you're working from -- you predict the work from the office or work from home. That way, if a pandemic got a bit ever hit again and everyone had to go back to working from home, there's no issue, right? And so we could easily operate. I think for us going forward, and I'll give analytics as an example, it opens up the pool to potentially more candidates in analytics because you can go and recruit somewhat that lives in a city that's not in your area, right? So it's not in India in Gorgon, where we have a big operation, it could be 2, 3 hours away. But that person could be -- if you set that person up well, with an office in a system, they can be very productive. [indiscernible], we're expanding our -- the reach of talent really going forward. And so that should really help us on some of those metrics that you're thinking about because it expands our talent pool, and it helps us really broaden ourselves and be able to supply even more services to our clients.

And could that model also help you evolve your contracts from being an input-based model like FTE contracts to more output-based contracts, whether it's transaction pricing, whether it's outcome-based, because that will help you delink that revenue from headcount equation?

It will, it will. And we have already been making that pivot -- So a lot of our contracts are transaction-based, particularly like in digital, that's how we're modeling it. We have a lot of contracts now that are outcome-based based on the client gets the benefit, we get the benefit also proportionately. And then in our traditional FTE kind of pricing, we've changed our pricing model. Historically, within -- particularly in analytics, if a job required 10 people, we would average cost those 10 people, draw a margin on top of that, and that will be the price that we [indiscernible] the client. Now we've done it the other way around, whereby we have a price for that role per hour for that person. And if we need the discount for the client, we'll discount, but then you're evaluating -- you have a set price and you're evaluated on a discount process. So we've moved our pricing to more of a Big 4 consulting type model, particularly for analytics and consulting, our consulting business. And I think that will really help us really going forward to drive price and drive value, right? Because then you're -- if we have wage inflation, you can optimize your price by having a client sharing in that inflation. But then also, you're driving price, you're driving the value of that service.

It's very interesting. So it seems like FTE is also becoming more an output based, like more price driven and no, it's interesting. And then finally, on the same delivery model, your margins are running higher, much higher than historical averages, partly because a lot more people are working from home, there are facility expense savings and whatnot, some of which will continue in the new delivery model as well. How should we think about margins too? Like why wouldn't some of those cost savings be passed on to clients because of competition or whatever? Could that result in margins normalizing from where they are right now to a more normal mid-teens, high teens levels?

Yes. Our margins have gone up significantly. And I would say there's 2 drivers to margins right now. One is we become much more efficient. Look at our headcount growth over the last 12 months versus revenue growth. we are driving efficiencies. You can make the case that we probably -- we were overstaffed pre-pandemic that we could have been more efficient. That's driving a big enhancement to margins. There is the margin benefit from the work from home environment, but we also have cost there, technology costs, in particular, that we're spending on to really better enhance computer equipment for the people working from home. So as much as there is a savings, there's also a cost there. But then also our margin enhancements just from us being efficient as we're going forward. So as much as there's a benefit, there's also a cost to this working from home environment. And we're going to be -- when we go back to being in the office, you're not going back 100%, but you are still going back 50% potentially with everybody. And then you're still going to have another piece of that workforce coming in every once in a while. So it's a gray area, I would say, between that and also the technology cost. We are already -- we'll be spending in that area. But we've become more efficient. That's what's really offsetting it at the end of the day.

All right. Thanks a lot out of time. I wanted to ask about M&A and capital returns, but we'll get cut off here. So appreciate your time, Maurizio. Thanks a lot.

Thank you, Puneet. Thank you so much.

Okay. Bye.

Bye.