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

All right. Good afternoon, everyone. My name is Puneet Jain. I am payment processing and computer services analyst at JPMorgan. Glad to have here with us Maurizio Nicolelli, ExlService's EVP and CFO. Welcome. And we also have Steve and John from the Investor Relations team here in the room. Welcome all of you. The format of this presentation is going to be fireside chat. I'll start with a few questions, and then we'll -- I'll open the floor for questions from audience. So Maurizio, you've hosted your Investor Day yesterday where you shared your long-term vision as well as financial targets. So for benefit of investors who may not be as close to your story, can you recap good takeaways like from Investor's Day, like where your focus is as a company and recap the financial targets.

Sure. And thank you for having me today, Puneet, and welcome, everyone. So yesterday, we had Investor Day in our office here on Park Avenue. And the purpose of Investor Day was really to communicate our data-led approach in our business. We made the pivot to being a data-led company within analytics and digital operations solutions a few years ago, back in 2020. And it's been very successful. That pivot has been very successful for us. When you look back and you look at the growth rate on both parts of our business, and we highlighted that yesterday, it has been a meaningful change. If you look at digital operations, we were growing at a CAGR growth rate between 2016 and 2019 at around 6%. Between 2020 and 2022, it's at 12%. Data Analytics was at a CAGR of right around 15% during that same time period, 2016 to 2019, and now it's growing at a 28% CAGR -- annual CAGR rate. And so the pivot in our business being data-led has really pushed both areas of our business. And yesterday, when we went through kind of the insights within that business, we also updated our financial targets for -- or at least our medium-term targets going forward. When we look at revenue, and we talked a little bit about revenue for the company yesterday, this year, in 2022 we're growing 22% organically for the whole business. And that is with analytics growing over 30% and digital operations growing right around 16% for the year. When we look at our medium-term targets, we look at -- look, it's over a 2-year plus period, right? And so we have very good visibility into 1 year but not 2 years. And so our revenue -- our medium-term target for revenue going forward is between 11% and 13% overall for the company. Now when we had our Investor Day back in November of 2020, we were forecasting 10% plus for our medium-term targets. So what we have done is increase that. Now when we go into the next two years, we still see a lot of uncertainty in the marketplace. The environment has significantly changed over the last 12 months. We also -- there's also the risk of potentially a recession in the next 2 years. And so that tempers our medium-term outlook. When we look at margins, when we talked about margins back in November of 2020, we spoke of 16% to 17% adjusted operating margins for the business. We are going to -- our midpoint of our guidance for this year puts us at 18.3%. So we've done a lot of -- we've leveraged the company very well over the last 2 years. We've increased our margins by 240 basis points since 2020. Going forward, we still think we can continue to drive margin, but it's incremental margin. So our guidance for the medium term is 18% plus, which essentially puts us in the 18% bracket. We're going to end the year in the low 18% range. But keep in mind, you still have headwinds in margins. And when you think about headwinds and margins, you have to think about wage inflation, which we are seeing within our business. And where we see wage inflation within our business, we see it in analytics, we see it in technology, we see it in digital, in cloud. So that is a piece of our cost structure that is higher than what it has been. We also have a certain amount of return-to-office expenses coming up. And so that also tempers our margin guidance for the next 2 years. And then EPS growth, we continue to see EPS grow in double digits going forward for our medium-term targets. But just in summary, when you look at the medium-term targets that we had in November 2020 and where we are today, there's been an obvious increase in each one of those targets. And that's really reflective of the momentum in our business today.

That was very clear, like this data-led pivot that you talked about, like it was very evident like at the Analyst Day, and obviously, your analytics business is a huge beneficiary of that. So bring to life like for us, your analytics practice, give us example of type of work you do for your clients. And what does competitive landscape look like in analytics?

Sure. And so our analytics business, with its growth rate of 28% organic CAGR over the last 2 years, went from being 38% of our business to 46% of our business. So it is really becoming almost half our business now. We have 8,000 -- over 8,000 data scientists that support that business, and it's become really a big meaningful piece of our business now. One great example of our analytics business is one of the wins that we talked about back in the fall of 2021, where we brought in one of the big 3 automakers here in the U.S. They became a new client of ours. And what do we do for them? We help them collect the data straight from all the sensors that sit in the cars that you drive that they built, right? So we help them collect that data. We help them manage that data, house it. Some of it is unstructured. Some of it is structured data. We help them manage that data, put it into either their cloud or our cloud. And then we help them also run the models and get the insights out of that data for them to use that data. So we are running essentially an end-to-end process for that client. And that's significant. What we're seeing now in our analytics practice, historically, we would have more project-related work that would be somewhere between 6 to 18 months type work. Now we're getting into much larger engagements that are end-to-end. And there in that situation, we're also becoming an augmentation of their own staff. Essentially, we're becoming an extension of their analytics group. And knowing that now that we're getting into these much larger engagements, who are we competing with. We're competing with many of the large firms now and also small firms. It's a very wide variety of competitors within analytics. You'll have the big accounting firms that have their own analytics divisions. You'll have a lot of the competitors that we compete with in operations management that do some analytics work. You'll also have also -- you'll see competitors like Accenture and a few others that are some of the larger players. And then you also have a number of the niche analytics players in that marketplace that we will compete with for certain jobs. So it's a wide variety of competitors that we have within analytics, which is a little bit different than within our digital operations solutions business, where it's much more siloed to a couple of handful of competitors.

So if I think about the company, ExlService, like 5, 10 years ago, it used to be an operations management company that also used to provide analytics. Now analytics is half of the revenue. And this is like a, I'd say -- I wouldn't say very different, but different business than operations management. Type of people you hire, the services you provide, engagement models are different from operations management. So how do you excel in both services which are different -- somewhat different from each other? Like how do you provide like those services? How do you operate like internally, like what had to change or if there was any need for change in your internal process in the way you operate as a company to provide both services and also generate synergies between the 2 units?

Yes. So we -- so a few years back, back in 2019, going into 2020, we restructured ourselves to create an analytics-specific group. So we have 4 segments within our business. We have Insurance, Healthcare and what we call Emerging. Those 3 segments are really focused on our digital operations solutions business. And then we created a fourth segment, which is strictly Analytics, right? And so what we're able to do is really focus on analytics in that group. But keep in mind -- and within our culture, we call it the One EXL Culture. Culturally, we're all under one umbrella. And there's a lot of synergies to a certain extent, between the two. If you look at the top 50 clients that we have, 60% of those clients do both digital operations solutions and analytics business with us, right? So we are cross-selling between the 2. So that means the front-end folks that we have are working together in front of the client as 1 unified company. Now operationally, what we have will be separate just because it's a different type of work and also different type of employees that we're hiring between the two. But overall, it's still under one umbrella, one company culture and the front end is going to the client as one solution or at least as one front-end face.

Let's talk about current macro environment, like obviously a lot of uncertainty, and you talked about yesterday and mentioned today as well, that 11% to 13% guidance for the 2 years bakes in some level of macro uncertainty. What are the trends you are seeing like in your client accounts? Like are you seeing like any pause, any delays in new project awards? And talk to us like if there is like a macro recession next year, what does that mean for EXL, like how defensive your services could prove to be?

So we have been talking about a potential slowdown with investors over the last couple of conference calls. We have not really seen much of a change in our macro -- in our selling environment with our clients. We see the macro environment being uncertain. We read the headlines no different than everyone else here. Within our business, we have not seen any significant change. When we released the third quarter earnings, we increased our guidance for the rest of the year going into the fourth quarter because of a very good third quarter we had and our forecast for the fourth quarter being just as positive. So right now, the momentum in the business really has not changed based on the macro environment. We get confidence from that by looking at our pipeline. Our pipeline has grown significantly over the last 18 months and it's still very robust. So when we look at our pipeline, we look at the success we're having in our wins, that tells us that not much has really changed going into December and the beginning of 2023. Now having said that -- and that's why at Investor Day, I put up 2 slides. The first slide was the increase in our guidance of 22% for the year in terms of revenue growth and then the medium-term guidance because that risk is still sitting out there. Knowing that risk is still out there, we still believe that we can grow 11% to 13% revenue even if the uncertainty turns into a recession and we get affected by it. But what gives us the ability to continue to grow through an uncertain environment? In digital operations, we lead with data and using that data we digitize our clients' operations. So we'll take -- we'll win a deal to take over an operation for, say, an insurance company. And it's about -- say it's 200 people in that operation. We will embed digital to make it more efficient. And so why does the client come to us in this circumstance? They come to us for a few reasons. One is they want to delever themselves from them having to manage that operation in an environment like when COVID hit. They saw that we did not -- our operations did not get disrupted. So they're looking for risk management to delever themselves; two, they struggled to digitize their own operations, and they look to us. We have the domain expertise, and we have the digital capabilities to be able to do that for them as part of our agreement to run the process for them; and then lastly, it's cost. Cost is going to be a big factor in an uncertain environment where they have cost pressures. And so we can help them manage through that environment going forward. And so as much as an uncertain environment could be a headwind to us, it could also provide a little bit of a tailwind to us in digital operations. In analytics, a few things are happening there. One is the world is so centered now around making decisions around data and running analytics on the data and making decisions off that data, that we are benefiting from that significantly within our business. I think clients -- really that is becoming core to many of our clients. When we get into these larger engagements that's what they view as an extremely critical item for them to make decisions. So in data analytics, we're getting into much larger engagements with our clients, and that is becoming more core to them. And even when you look at the project work that we do in analytics, we put up a slide yesterday that said today, 81% of our revenue is annuity type based, meaning it's more than 1 year. 54% of our revenue is digital operations solutions and that contract -- that average contract is 4 to 5 years. So what you're seeing is an annuity base in our business that has -- that is fairly long. But the project type business that we have that's led just slightly less than 20% is the entry way with clients to enter into much longer engagements. So as much as that is project work that's less than 1 year, it's actually our entry way if we do a good job to get into much longer agreements with clients, and that's how we really view that project work.

So you mentioned like clients try to delever themselves like during the COVID times. And that happened in 2008, 2009, when a lot of clients like look to sell their in-house operations like they -- and many vendors did employee re-batching deals and all that. So maybe talk about like the insourcing versus outsourcing in this new macro environment like which will win? And also if you are seeing any trends of vendor consolidation, which happened back in 2008, 2009 as well?

I guess in terms of insourcing, outsourcing in terms of clients selling their operations, we will take a look at that, but that's not a big area for us to really build our business around. What we want to do is really win the operation and really run it for the client. And that's where we've been very successful at going forward.

But is there like increased demand for outsourcing because of all these macro headwinds that clients are facing, that instead of dealing it themselves, doing it themselves, maybe not sell it to the vendor but outsource it to someone else?

So in the areas that we have domain expertise, particularly Insurance, Healthcare and a few other segments, we're seeing that increased demand. But also what we're also seeing is larger deals coming our way. We've been talking about that over the last 3 to 4 quarters because that's what's really driving the pipeline. We're seeing slightly more in total number of deals, but the deals are becoming much larger, particularly in the area where we have domain expertise because I think clients are looking to do more in terms of outsourcing. And these larger deals are opportunities for us to really extend our growth of the overall company. And that's what's really driving digital operations solutions right now. In the third quarter, we grew 17% in digital operations solutions over the prior year. That's significant. It's never been that high at EXL. And that's at the top of the industry right now. So what we're seeing is the much bigger deals because clients are willing to outsource more. And for us, it means we're becoming more strategic to the client, and the discussions are going further up the chain in terms -- into the CXO level.

Given a lot of your clients could be going through their annual budgeting process right now, they're trying to decide next year's spending priorities and taking those decisions. Given like the long sales cycles in operations management, how much of your revenue -- next year's revenue will stem from projects that will start next year, which might be somewhat dependent on macro if there is like a severe recession versus the work that's already been decided or been awarded or is being very close -- or is close to being awarded now?

Yes. When you look at our revenue for 2023, when we close out 2022, we will have close to 90% visibility into next year. And so it gets back to what I talked about in terms of annuity, right? 81% of our revenue right now is annuity-based, more than 1 year. So that gives you clear visibility for that 81% going into 2023. So every year, we really started the year with some very good clear visibility going into the following year. And then we have the stub of revenue that we need to go win in the current year to hit our targets for revenue for the rest of the year.

Let's switch gears a little bit, talk about margins. So you guided for 18% plus margins over next 2 years. Wage inflation, like you mentioned wage inflation as one of the headwinds, are you seeing any ease in supply pressure, which would push -- which is higher -- much higher than normal levels?

I think we've seen a good amount of wage inflation over the past 12 months in those areas that I talked about. And I think we'll probably continue to see that going into 2023. Does that continue? I'm not sure we really know that just yet. We are planning for it to continue. We're not going to assume that it's going to come down. But we're still seeing that. For us, analytics is so core to our growth that we're going to ensure that we fund the right level of compensation for our employees within analytics. But we're also mitigating that through price, right? We have set up a standardized rate card within analytics, and we have been driving price off that rate card as we've increased price a few times now off that rate card to mitigate that wage inflation. So as much as there's wage inflation, we're also looking to mitigate that through price, right? And we have not seen much in terms of losses because we have increased price. It tells me that our services are very much valued. And clients, to a certain extent in that area, expect a certain level of price increase.

So is it fair to say that analytics gross margins, because you're getting increased to offset wage inflation, can stay at current levels and be in line with operations management over the next 2 years?

I think when you look at gross margins, our margins -- gross margins between analytics and digital operations solutions are going to be very comparable. When you go down the line below gross margin, what you're going to find is you're going to have far less overhead for analytics. And so why is that? 46% of the revenue -- of our revenue is driven by 8,000 employees. 54% of our revenue is driven by 35,000 employees, right? And so you're optimizing and you have a higher margin in analytics, which, in the long run, in the very long run, what that should do is create leverage for margins going forward. Meaning, you should be able to increase margins over time if a bigger portion of your revenue is in analytics.

Talk to us about the delivery model. Like before COVID, it was almost 100% work from offices. Last year or last couple of years, it's been 80%, 90% from home. Where are you right now in terms of where people are based at? And what do you see that model evolve to over long term?

So we've been working on our future operating model for at least 12 months now with clients, in that we want to make sure clients are comfortable with our future operating model. And that we don't want to develop that without the insights from clients and what they're comfortable with. Some clients want us in the office because of data security concerns. Some clients have their employees working from home, so they don't mind us working from home as long as we have the right controls in place. We think about it as a 1/3, 1/3, 1/3. I think -- our future operating model would tell you that about 1/3 of employees are going to work in the office, 1/3 are going to be hybrid coming in 2 to 3 days a week and the last 1/3 is going to be working from home. Currently, we have 68% of our employees globally either working from home or working in a hybrid environment. So overall, we are almost there to that future operating model.

And what does that mean for your margin profiles? Like you talked about return to offices as one of the headwinds. And not just margins, like what does that mean for your hiring and your retention of employees?

So our attrition rate at the end of the third quarter was 34% and it actually came down from 38% at the end of June. And so why did it come down? It actually spiked higher in June than where we have historically been. We've historically been in the low 30% range. It spiked higher because of the issues that us and many of our competitors were having in the Philippines. So now we have been able to get that situation under control. The government has become much more open to having people working from home or in a hybrid environment in the economic incentive zones. So that has become much better. It has alleviated a lot of the attrition that has happened prior to the third quarter. So we've come down to right around 34%. I think going forward in this new future operating model, we'll probably hover somewhere in the low 30% range for attrition. And just because there is a certain amount of high attrition in our digital operations solutions business, because we run operations not just during the day but also at night. And so that nightly shift creates a lot of attrition for us also. But overall, I think we'll get back down to the low 30% range. And I think we are fairly comfortable that is a good working percentage for us going forward. And it still is below a lot of our competitors in the space.

Are there any questions from the room?

So historically speaking, the BPO business has had some cyclicality of less than [indiscernible] on less cyclicality this time around. And I guess the answer is analytics. First of all, am my understanding that correctly? And then secondly, what is the lag in the business? These are pretty big projects that take a long time to negotiate and implement. If you did see a slowdown, would it just take a while because of the lag effect in the business model?

So what we've seen since COVID is decisions being made faster than what they were historically, which was really interesting. We never thought that, that would be the case, right? Because you're right, it used to take a long time to get to a decision with a client, particularly for our digital operations deal. In COVID that accentuated and that time became much shorter. And I think it's a few things. One is clients wanted to make decisions quicker, and it was also easier to get people -- connect with people because everyone was home, it was easier to get someone on a call, right? So I think that is going to help us. I think that's going to help us going forward. I think this time around, we have not seen any change. So it's the pipeline, again, that really drives our kind of mindset on what's happening within our client base. If that significantly change and we see deals that -- potential deals that are in our pipeline that all of a sudden get discarded or no longer in there because the client pulls it, that would tell us that something is happening within the market. So that's not the case. I think in analytics, we're seeing longer type engagements now as we're getting into much bigger engagements, whereby we're not just running analytics or developing models for our clients, we're actually helping them manage their data in a significant way. So that's much more time consuming and a much bigger deal there. And so I think those two will help us really mitigate through a potential uncertain -- or a potential recessionary environment. And so that's why we get comfortable with 11% to 13%, which is far lower, by the way, than where we are today. And we still have that momentum where we are today. We're just cautious when we give that medium-term guidance, if that explains it.

Any other questions?

So just on the analytics piece, you guys have done a great job. You're growing faster than your comps and everything. But if analytics is kind of like the secret sauce these days, why is nobody else doing it? What's preventing your competitors? It sounds like you guys have patents, intellectual property, you have people -- and you lose 1/3 of your people every year. So why isn't everybody else just hiring these analytics people and doing the same thing?

Well, our attrition analytics is lower than 1/3, right? So in analytics and digital, it's significantly lower than a 1/3, right? So that's critical, right? If you have higher value services, you can't lose 1/3 of your employees. That would be a problem. I think we have developed -- we have the capabilities. We've developed the capabilities over time. We started analytics in 2006 when we bought a company called Inductis in India. So we got into analytics probably much earlier than a lot of the competitors you're thinking of. So we built up those capabilities. But on top of that, we have built up the pipes into the graduate schools in India to really fund the supply needs for our growth. And that, I think, is a big deal. I think if you look at the 2,000 people that we hired in the third quarter, 500 were in analytics right out of the graduate schools in India, and they're getting trained right now to supply the business that we win in Q4 and Q1, right? So we're front-running our hiring. And we have that -- we have developed a very good pipe into the colleges to be able to get that supply. I don't know if all of our competitors have done that nor did they get into analytics as early as we have to develop that capabilities. Could they do that over time? Yes, I mean, absolutely. Well, we're starting to build also that reputation of being one of the biggest analytics houses globally now.

All right. Thanks a lot.

Thank you, Puneet. Thank you, everyone.