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

Good afternoon. Last presentation of the day. Glad to have here with us Maurizio from EXL, EXL's CFO. My name is Puneet Jain. I'm from JPMorgan's Payment Processing and IT Services team. we have Maurizio and John, who heads Investor Relations from the company. So the format of this presentation is going to be fireside chat. I'll start with a few questions, and then we'll open the floor for questions from audience. So Maurizio, Glad you could join us. Welcome.

So let's start with like a high level, like so for investors who may be new to the story, could you talk about like the company's positioning, what's EXL's value proposition? And how do you differentiate from your peers?

Sure. And thank you, Puneet, for having us today. It's always great to come to the JPMorgan conference and get in front of investors like this. So for people that are new to our story, when you look at EXL, we are about a $1.6-plus billion company in revenue. And when you bifurcate those two pieces, we have our Digital Operations & Solutions business, which is about 55% of our revenue and then 45% of our revenue is Data Analytics. And we've been in both sectors for many years now. And when you think about kind of our value proposition, what makes us unique versus our competitors or our competitor sets and peers. When you look at our Digital Operations business, which grew 17% organically in the third quarter. What makes us really drive that business? There's a number of factors that are unique to us and that we're able to bundle together. Clients are looking for a few things. One, they're looking for companies like EXL to transform their processes. Think of an insurance company with a significant claims process and they give that process to us to manage. We take that process, we digitize that process. We put AI transformation. It's our own solutions and also our AI process that we build also for the clients, so it's proprietary solutions and also additional solutions that we build for the client that help them transform that business. And that's really difficult for our clients to do on their own. They have to recruit staff to be able to do that. They have to also manage that process internally, and they find that very difficult to do. So they look to us to really transform that process. They look to us to also reduce their total cost of ownership. So we, obviously -- on an annual basis, we will give them efficiencies. We will guarantee percentage efficiencies within that process. That means we've reduced the number of people, and we make that process that much more efficient. Coupled with that and what makes us extremely unique in the market is we'll bring in Data Analytics to embed that into that process. More and more we go to market, not only with our digital capabilities within Digital Operations, but we also embed Data Analytics. You got to -- you need to remember Data Analytics is 45% of our business. We've been -- with the acquisition of Inductis back in 2006, we've been in data analytics for many years now. And now we're able to inject data analytics to drive those insights out of that process for management to make better decisions. And when a management group really sees that value all of a sudden a really -- it's really eye-opening to them. So not only do we digitize that process but we also embed the capabilities in Data Analytics to really bring out the insights for the client so they get a much more efficient process, but they also get that incremental information insights for them to make better decisions. And that makes us that much more valuable to that client and really brings out the value to our clients and really helps us really not only grow that process or [ add ] revenue, but also embed ourselves even more within that client base and it gives the client that much more confidence to really bring EXL into more processes within their operations.

In fact, I'll say like the EXLS was the only company that demonstrated the defensiveness of BPO model. You're probably one of the very, very few companies that trace their guidance -- annual guidance in 3Q. So what would you attribute that to? Would it be like the value proposition you talked about digitization as well as infusing AI? Or was like the guidance was more conservative or had some level of buffer to begin with?

I think what's driving our growth in this macro environment, our guidance this year is overall for the company is to grow revenues 15% to 16% organically. What's driving that is our capabilities. It's our digital capabilities, our ability to manage data and it's our ability to bring out insights through analytics. And when you couple that all together and then with the GenAI capabilities that we're building internally to train our group and really start to go into the market with those capabilities. That's what's really driving our revenue right now. And that gives us the opportunity to get into segments and really sell ourselves to build out within those segments.

So let's focus on your analytics practice, like you've hit absolute home run, been following EXL since Inductis acquisition and analytics has always been one piece, which is highly differentiated and has driven high growth rates for you. But it is underperforming operations management or Digital Operations management right now mostly because of current macro environment, which you attribute to marketing analytics. So talk to us like how large marketing analytics is? And how is like the rest of analytics business doing?

Yes. So when you carve out our analytics business and you look at the different pieces and you look at our direct marketing piece, and that is the piece that has declined on a year-over-year basis and has brought down our growth rate within analytics. If you look at just how large our direct marketing business is, it's less than 20% of overall analytics. So less than 20% of our total analytics revenue. If you look at our total analytics revenue and you carve out the direct marketing piece, overall analytics in the third quarter grew in the mid-teens. So still a very healthy growth rate for overall analytics. The direct marketing piece has been affected by our insurance clients reducing their spend because of the macro environment, them not being able to drive price overall, and they've had to look to reduce cost or reduce their marketing activities. So overall, when you look at analytics and you look at our banking sector piece, you look at our Payment Integrity business, you look at data management, like all of that combined is growing very healthy mid-teens combined. And then that's the one piece that's bringing down the overall growth rate partially.

And is that like the marketing analytics piece -- has that stabilized at all on a sequential basis. I understand on year-on-year basis it might take like a few more quarters for that to happen, but on a sequential growth basis, is it -- have you hit the bottom on marketing analytics?

It's difficult to say in any pieces of our business when something is declining, if we've actually hit the bottom, to be quite honest. It has come down pretty significantly between 2022 to 2023. I would say in 2022, it was extremely high because the market environment was very positive. And insurance companies were very active in marketing for new customers. Have we hit the bottom in direct marketing? I think we're getting closer to the bottom. We may have hit the bottom. That's not -- but it's very hard to call the bottom. We do have some Healthcare analytics revenue that we will be generating in the fourth quarter to stabilize that area. And so I think -- just overall, I think if we haven't hit the bottom, we're getting closer to the bottom.

And then let's talk about the other part of the business, 55% of revenue, Digital Operations management. If you had told me anytime in the last 10, 12 years, that business will outperform analytics, I would say, no. That's [indiscernible], but here we are. So what's driving this upside? That business grew 17%, I believe, in the last quarter, which is higher than what you would expect as a normalized growth for Digital Operations. So what's driving this upside?

Yes. So that's a very good point. And when you -- when back in November of 2022, we had our Investor Day. And we said at Investor Day that Digital Operating & Solutions would grow 8% to 10% over the next 2 years. That's not the case this year. And so what has really happened to really drive that revenue? I think you're seeing a number of our capabilities come together to really help drive larger, more strategic deals with our clients, particularly in insurance. And so what are we doing there? We are winning deals on the basis of that digital transformation piece that I talked about, being -- us being able to digitally transform our clients' processes in a tough macro environment. So you got to think of a client that sees their revenue growth slowing. That's when they start to think about how do I reduce my cost? And I reduce my cost by how? I give the operation to someone like EXL. They will digitize that operation. They will guarantee a certain level of efficiency on an annual basis, and that reduces my total overall cost of ownership and they'll embed data analytics into that process to help me even further make better decisions going forward on certain areas that are tied to that process. And so what you've seen is us winning much larger deals in -- over the last 12 to 18 months, and that's not starting to get reflected in our revenue. The one thing you have to keep in mind in Digital Operations, and we've done well in terms of growth far more than what we had said we would do. But a lot of these large deals that we have won, we are implementing right now. In the year of implementation, you have far less revenue that -- on an annualized basis that you realize that in years 2, 3, 4 and 5. So we are right now, if you look at our headcount growth, our headcount growth in Digital Operations has gone up fairly significantly because we're implementing these larger deals, and you start to realize the full revenue in years 2, 3, 4 and 5 and so that is what you end up seeing -- what you'll end up seeing in Digital Operations. And that's what gives us the confidence when we look at revenue for 2024 for the overall company to basically say multiple times that we do believe next year is a double-digit revenue growth year.

But can the Digital Operations growth hold or stay well above 8% to 10% level, not just next year, for next 2 or 3 years?

There is significant momentum within Digital Operations. I think as we build out our digital capabilities and as we embed more data analytics into that digital operation selling process and into that process, I think that will enable us to continue that double-digit growth.

So let's talk about GenAI, like we often hear concerns from investors as like the potential adverse impact of GenAI in Digital Ops. So how do you see GenAI? Like -- and how do you see like your role, EXL's role evolve in this emerging landscape?

Yes. So we have been doing a lot of work on GenAI. We have been working on GenAI previous to when -- previous to the spring when GenAI became very front center in terms of -- in the news. We are working with our clients, with each one of them, to essentially identify where within their operations or their processes can -- would GenAI further enhance or give them a significant benefit. And so we talked about in our call -- in our earnings call that we are having over 200 conversations with clients. So that means we're having significant amount of conversations around GenAI. We have a significant amount of POCs already in place, well over than -- well, more than a couple of dozen POCs already in place generating revenue. Clients are looking to us to implement GenAI. We're identifying those areas within our segments, whether it's banking, whether it's insurance. We developed that GenAI large language model with our client, and we start out with a POC. And that's been our process. But the one thing to keep in mind when we consider GenAI is every one of these conversations involves data management. How is your data set up? How -- is it structured correctly? Is it siloed? Are we -- do we have to pull data from many different locations? And that's where our data management piece is also further accelerating because of GenAI. We already had a significant growth in our data management area, particularly with the acquisition of Clairvoyant. You look at where Clairvoyant was in December 2021 when we bought it, you look at where it is today. They have far exceeded their targets over the last 2 years. Now you're seeing that group get heavily involved in GenAI. And not only do we have -- we talked about having 1,500 GenAI experts in [ CoE ] at EXL, and we're heavily training each -- getting to that level. But now you also have not only GenAI experts within Analytics, but you have the data management group linked right in with those GenAI folks. And that's critical for us now going forward. So for us, getting deeper with our clients, embedding GenAI and identifying those areas that we can do that and then pulling in our data management area is a home run for us at the end of the day.

So no, I agree, Clairvoyant acquisition, like the timing of that couldn't have been better, like just before the [ hype ], you acquired the asset, which is going to become very hard. So how large is data management practice within EXLS now?

So that's an area that we don't quantify our data management area, but it's...

All of that sits in analytics.

All that sits in analytics, and it's 1 of the 4 big pieces that sits in analytics.

And so for -- in operations management, so are you the one like who's going to provide like the POCs that you mentioned, offer GenAI-based solutions like the -- train the AI models for your clients and then manage them like you did with RPA.

That is our role. Yes, that's correct. So our digital group is the group that not only builds the GenAI solutions whether it's a smart agent solution or it's a data extraction solution. They are the ones that will build those large language models, and they work within our Digital Operations business to implement those with the rest of our operations group.

And how would that potential contract like when like, let's say, a client -- an insurance client implements GenAI-based solution on a large scale, how would that contract in terms of structure, like the way you build the client as well as in terms of the margins, headcount type of people you deploy look compared to what it is right now?

I think that -- so that process is still a little bit of a ways out, I think in what we're implementing in GenAI is a lot of solutions on a POC level, right? And when you look at kind of the large deals we have in place, we're just getting into areas of GenAI enhancements, right? So I think that is more of a 2024 item. And I think there's still a little bit of -- we still need to make decisions on pricing, on deal structure for GenAI to be embedded into these very large deals. But a lot of these large deals were we negotiated and contracted before GenAI became significant in the news back in the spring of this year. I think that is starting to evolve, but I think that's a 2024 item. I don't think the market is there yet overall.

Yes. And coming out of last recession in 2008, 2009, there was so many employee rebadging deals like the clients were looking to outsource or sell their BPO operations. And in this environment, if you think like with interest rates this high, can we see like a return of that trend like the clients would look to outsource their BPO operations? And if that happens, will you be willing to rebadge client employees to win those businesses?

We, for the most part, have shied away from rebadged opportunities. They -- rebadge opportunity would have to have a very large strategic value and have to get us up the value curve to do a rebadge deal. I think when we look at a large operation, we -- first off, we lead with digital, right? We want to digitize that process. We, overall, as a company, want to get up the value chain in terms of embedding more data analytics, digital technology into processes. In a rebadging deal, we would have to see a significant opportunity on all 3 of those to be able to do that. And we just haven't seen that in the market versus doing a rebadge deal just for a people arbitrage type deal and that's why we pretty much have shied away from doing those type of deals. We'd like taking on operations, hiring the employees, embedding the digital and really driving the efficiency for the client through owning that process and really getting the value out of that process through digital.

How does like the pipeline like you talked about like the stuff that you've already won, the deals that you've already won, they should drive incremental growth in year 2, year 3. But how does like the pipeline of new work -- potential work that might generate revenue over the next few years? How does that look like? And how is like the movement of deals within the pipeline right now?

So our pipeline, if you go back over the last 3 years, has grown exponentially. And that is really what's really driven the growth within EXL. If you look at the growth in both sides of our business, whether it's Digital Operations or Analytics, we have grown that pipeline significantly. And so how have we done that? It's really selling our capabilities at the end of the day. And what you see today is a very healthy pipeline in both sides of our business. And that gives us confidence in growing revenue 12 months out from now at the end of the day. The stuff that we've already won that we're implementing gives us confidence for the most part in growth in 2024. The deals that we win today, especially the larger deals really help us with late 2024 and going into 2025. But when you look at the overall growth of the pipeline, we did a lot to really grow that pipeline between 2020 and 2022. And we continue to see very nice growth in that pipeline and the quality of that pipeline in the higher value areas is getting that much better even there. And that's what's critical to us because we do believe that higher value pipeline, larger deals drives more value, higher price because you should get paid for that value.

Got it. Let's quickly talk about margins, and then I'll open the floor for questions. So you reported like I think, 20% plus operating margin levels in the last few quarters. And even for Q4, [ based on our ] model, I think we are at 19% plus level. So -- and all of these numbers, like whether it's high teens, 19% plus or 20% are much higher than your historical level of operating margins. So is this like the new normal for your margins? Or could there be some investments or some headwinds that we should consider as we think about margins for the next few years?

So we've done very well on margins over the last 3, 4 years. We hovered around 14%, 15% adjusted margins back in 2019 and 2020. We went through a period in which we became very efficient with our workforce, and that really drove margins to 18.3% in 2022. And this year, we're going to do about 100 basis points higher on margins to right around 19.3%, 19.4% for the year. In the fourth quarter, you're going to see lower margins just because we have a number of onetime investments that we want to make that got pushed off from Q2 to Q3 into Q4. But you annualize that, and you're going to be at 19.3%, 19.4% for the year. For us, we need to drive margins. Now we've done very well in driving margin. We drove margins to 100 basis points this year more than what we thought we would do at the beginning of the year because I was guiding to 10 to 20 basis points at the beginning of the year. I do believe now going into 2024, we do have a number of investments that we will need to make, particularly in GenAI to really further drive our top line growth. But at least starting out the year at 19.4% as a baseline or 19.3%, where we end up in 2023 is a good starting point and this becomes kind of our new standard for margins. Meaning, we don't anticipate going backwards. At a minimum, we maintain our margins going into 2024.

So talk to us like we hear from a lot of your peers that continued in the -- pricing pressure in the industry. So talk to us like if there is elevated level of pricing headwinds next year, what are the levers in the model that can help you offset and protect margins?

So if there is further pricing pressure, on our cost. And when I talk about cost on our people, right? People is 70% of our cost at the end of the day, right? And we saw that in 2022. And we saw that coming out of 2021. And so what did we do? We standardized our pricing in Analytics. We raised our price card twice in 2022 in Analytics. We also increased our [ COLA ] and our rate increases on our Digital Operations going back to clients in 2022 because the -- when we signed those contracts, the [ COLAS ] were based on historical inflation and that was not what was happening. So we were able to increase our price to offset our increase in cost. And that's how we still increased our margins during that period, right? So if we do anticipate an increase in price in terms of our costs, we -- then that would be the impetus for us to go back to clients and at least cover that increase to at least maintain margins going forward. And it's really to cover our people costs in those areas in which we have high demand for talent. And where is that? That's in technology, it's in digital, and it's in a few other pockets of our employee base.

Any questions from audience?

If you look inside just the existing client base and you're not going to ever penetrate a client at 100%. There's just some data sets and some processing capabilities will never transfer over to you. What is the legitimate market opportunity just sitting inside your existing clients right now?

They're still -- within our existing clients, there's still a lot of opportunity for us, if you look at across the base, take for example, a bank, right? in a global bank that we do a lot of business with. And most of our banking business is with the global banks. For the most part, we have a significant business, but it's in 1 or 2 areas, right? When you look at the structure of the bank, they're structured in 15 or 20 different organizations. So for us to land and expand is still significant within our client base. If you look at just insurance, in insurance, I think the number is somewhere between 25% and 30% of what can be outsourced has been outsourced. So even in our biggest sector, we believe there's still a lot of opportunity even within our client base. In insurance, it's interesting in that in many cases, we get a client on board, but with a much smaller process, and that usually leads to us getting a much larger process from that client. And I think just looking at the overall client base, whether it's insurance, whether it's banking, there's still a lot of opportunity for us and for the industry overall. I would -- it's not just us, I think the industry, I think there's a more willingness to outsource now than there has been in the past. And it gets back to kind of what I started with. why? It's because clients have trouble with transformation. They want to lower cost, and they have trouble getting insights out of their operations to make decisions.

So not to sneeze at $1.6 billion, but at the same time, you have a fair degree of complexity across multiple verticals already at this stage. Quite a number of different processing capabilities, some are in regulatory, non-regulatory, customer experience, internal processing capabilities, who knows what. Do you ever think about any aspects of opportunities in business simplification? -- business simplification for cost for driving more margin advantage.

So it's -- so for us to simplify ourselves a bit more in -- from multiple different areas, I think you will see that going forward as we build greater scale in each one of these areas, right? We built domain expertise in some particular areas. I think as we -- like if you look at insurance, right? If you look that's our biggest segment. We've gotten pretty -- we're building much more simplified systematic processes within insurance because it's our most mature process there. And I think that will lead to more simplification, more harmonized systematic processes and also be able to drive more margin and value, especially if we drive digital into that process. If we continue to put in our homegrown solutions and we harmonize that between all of our clients and become much more systematic, then that -- then you simplify the overall business, which I think we are doing more and more in insurance because we have scale, and that helps drive margin and efficiency going forward.

All right. We will stop here. Appreciate it.

Thank you very much.