Firstsource Solutions Limited (FSL) Earnings Call Transcript & Summary

Ladies and gentlemen, good day and welcome to the Firstsource Solutions Limited Q2 FY '21 Earnings Conference Call. [Operator Instructions] Please note that this conference is being recorded. I now hand the conference over to Mr. Ankur Maheshwari from Firstsource Solutions Limited. Thank you, and over to you, sir.

Thank you, Aniba. Welcome, everyone, and thank you for joining us for the quarter ended September 30, 2020, earnings call for Firstsource. To take us through the results and to answer your queries, we have with us today, Vipul Khanna, our MD and CEO; and Dinesh Jain, our CFO. We will be starting this call with a brief presentation, providing an overview of the company's performance, followed by Q&A session. Do note that the results, fact sheet and the presentation have been e-mailed to you and will be also available on our website, www.firstsource.com. Before we begin the call, please note that some of the matters we will discuss on this call, including our business outlook, are forward-looking and as such, are subject to known and unknown risks. These uncertainties and the risks are included, but not limited to what we have mentioned in our prospectus filed with SEBI and subsequent annual reports that are available on our website. With that said, I will pass on the call over to Vipul Khanna to begin the proceedings. Over to you.

Thank you, Ankur. Ankur, can you hear me okay?

I can, yes.

All right. Good morning, and good evening, everyone. Thank you for joining us today. I hope that you and your family are safe and sound and getting in the festivities more as Diwali approaches. I'm excited to share the update on our performance. We had a good quarter. Revenue grew at 13.1% year-on-year in constant currency. And the EPS for this quarter came in at INR 1.50 per share compared to INR 0.97 per share last year for the same period. We are experiencing a solid recovery in the business from last quarter, following an uptick in the economic activity. The demand environment, particularly in BFS and in Comms Media & Tech is getting stronger, resulting in the buildup of a robust pipeline. While Healthcare was steady at least with the last quarter, this business remains under pressure, given the impact from the COVID on hospitalization. In Q2 for the fiscal year '21, we secured 15 new clients, 11 of those were in BFS, including a pharma co and fintech and 4 were in Healthcare. Last quarter, when I had spoken to you, we have articulated the 3 key elements of our growth focus: one, that we focus on core processes for the industries we serve, Banking and Financial Services, Healthcare, Comms Media & Tech and the diverse industries [ to encompass ] the emerging verticals. The second element was modernizing our offering and underpinning them with our digital first, digital now approach. Accordingly, we have retooled our offerings as Digitally Empowered Contact Centers, or DECC, smart back office and platforms automation and analytics. And the third element was building out a scalable and entire organization with the right leadership, skills and...

Mr. Khanna. Sorry to interrupt Mr. Khanna, this is the operator. May I request, just hold the microphone closer to you when you're speaking. Probably it's moving, and that's why we -- your audio kind of fluctuates, sir.

Is this better?

Maybe you can continue speaking. I'll let you know if it's good.

Okay. All right. So we are investing behind these 3 elements to build out a sustained and consistently growing business. During this quarter, we rebranded our Healthcare business to Health Plans and Healthcare Services to better reflect the scope of the broader Healthcare segment we serve. Healthcare Services, including telehealth, importation of monitoring and medical devices are a rapidly growing segment and a focus area for us. We continue to build our platform's road map and drive their adoption in the market. I'm encouraged by the pipeline for our platform-based services and the increasing share of transformative and digital conversations with clients and prospects. Building the digital muscle in the organization is a key focus for me. During this quarter, we launched the first of its kind citizenship development program in partnership with UiPath for our employee base to create their personal bots. Now in my experience, automation is fundamentally a ground-up movement and the broader scale base accelerates the digitalization of our solutions. We also signed a strategic partnership with Unifor, a global leader in conversation in AI to add more horsepower to our DECC solution for more personalized and engaging customer experience. We are pleased that this quarter's results are a validation that this growth focus is beginning to pay off. Let me spend a few minutes reviewing our key industry performance. Our Banking and Financial Services segment grew 55.9% year-on-year and 45.8% in constant currency on the back of strong growth in our U.S. BFS segment. Let me take a minute to talk about the 2 components of Mortgage. There is origination and there is servicing. Within origination, there are pretty much 2 types of transactions. That is, one is the refinance of an existing mortgage because interest rates are lower and you refinance the loan, however remaining the same -- borrower remaining the same, lender may or may not be the same. So that's kind of refinance of an existing markets. And then there is mortgage for a new purchase, whether I buy an existing property or I buy a new house, but I'm doing that transaction and then financing that. So that's like a purchase mortgage. We saw good demand from both these segments, refinance as well as purchase mortgages. In fact, for the last several months, we've seen a good surge in purchase mortgages. September, for example, saw a 21% surge in existing home sales versus September a year ago and a 32% increase in new home sales versus a year ago. Now as you'll appreciate, the new purchase mortgages are less sensitive to interest rate movements relative to refinancing. And the expectations as we talk to industry experts and to the Mortgage Bankers Association and others, the new purchase mortgage growth is expected to continue well into the medium term, which we believe provides a reasonable hedge against the eventual tapering off of the current higher refinance margins. On the servicing side, mortgage defaults are increasing given the economic hardships many people are facing. By the end of September, the margin delinquency rate in residential properties had increased to 8.2%. This is an increase of almost 4 percentage points versus both June of this year and versus September a year ago. We expect growing demand for export capacity and digital solutions as the mortgage industry prepares for higher default. Our clients are increasingly trusting us to have compassionate conversations with borrowers, helping them exit mortgage payment forbearance [ or temporary halts ] into longer-term solutions. Selection, which is the second part of our BFS business, and particularly our digital collections is witnessing strong traction amongst both existing and new clients. As with mortgage default servicing, high unemployment and under requirement levels in this current financial environment is driving higher loan credit losses and provisions across all lending categories. The collections business, as you know, is counter cyclical, and we expect a good demand scenario for the medium term. More importantly, we appreciate the privilege of helping individuals get their financial affairs in order gracefully while maintaining the health of the financial sector. Our U.K. BFS business operated at solid volume. After last month's scramble to keep operations running, the U.K. financial institutions are now preparing to tackle the new normal more structurally. The 2 primary themes we are hearing from our clients are a lower and more sustainable cost base and an increased digital access to consumers. I expect an uptick in the buying activity in the U.K. financial services sector in the next few quarters. Switching to Healthcare. Healthcare declined 4.3% year-on-year and 9.8% in constant currency. The industry continues to experience volume challenges. Industrial procedures are still not close to pre-COVID levels, impacting both hospital visits and health plan claim volume. As for investor reports, August was the sixth consecutive month in which patient volumes were below 2019 levels and below budget for hospitals, and we believe September was no different. The second factor we are seeing now for a few months is that the cycle time to convert Medicaid payments to revenue is being impacted by slower billing from the hospitals as they deal with capacity constraints in multiple priorities on their leadership capacity and processing capacity. We anticipated a recovery in this segment from Q2. However, given the increase in COVID-19 cases we are witnessing, this could get delayed until later this fiscal year. On a positive note, engagement to our digital screening and collection tool is seeing increasing traction. Hospitals are witnessing a shifting payer mix as there has been an uptick in self-taken customers and Medicaid patients. And a decrease in commercial reimbursement as employment levels -- unemployment levels have had. To counter this, hospitals are turning to remote customer engagement such as telehealth, financial counseling and online portals for price estimates and payment plans. We made good pipeline progress for this service, and we continue to develop adjacent areas of growth in the revenue cycle management value chain. On the flip side, fewer medical procedures have resulted in fewer claims and more cash with the health plans of the health insurance companies. Consequently, we are seeing an increased appetite for disruptive and long-range impact solutions from this sector. Our Health Plans and Healthcare Services business is scaling well. We added 2 new clients and increased our engagement scope with a number of existing clients despite volume compression in a few clients from lower payer volumes. The sales pipeline build is very solid, and our digital intake solution Sympraxis is faring strongly in competitive situations. Telehealth has witnessed significant acceleration in adoption by consumers. And this has been aided by regulatory action to normalize remote care charges in EMS' fee schedule to incentivize providers and health plans to do more of telehealth. And as you are aware, it's kind of once in a generation change in telehealth adoption that we've seen in the U.S. in the last 6 months. As I mentioned earlier, we added a new client in this segment and scaled that relationship with an existing remote care provider. Communications Media &Tech, CMT, that grew 3.7% year-on-year and we grew 5.9% in constant currency. This segment is witnessing solid volume recovery and grew sequentially by 27.8% in constant currency. We have also started moving some of the processes to a work-from-home model, which we couldn't do earlier in the year from client constraints. As I had mentioned in the last call, when the U.K. -- when the pandemic started in the U.K., our biggest client had prioritized service to few customer segments only. As they have gradually normalized service and sales operations, volume recovery product has been strong, both on and offshore. Overall trajectory for CMT is encouraging, pipeline build is decent, and we should be at nearly pre-COVID levels by Q3 or start of Q4. Let me take a quick sense and do a final view on the outlook for FY 2021 -- fiscal year 2021. While market uncertainty and volume volatility continues to remain high, considering our trajectory and secured business, we are revising the guidance upwards. Our full year 2021 revenue is expected to grow between 9% to 12% in constant currency and our operating margin is expected to be in the range of 11% to 11.5%. With that, let me turn the call over to Dinesh to cover the financial details for this quarter. Dinesh?

Thank you, Vipul. Let me quickly take you through the financial highlights for the Q2 FY 2021. Revenue came in at INR 1,187.7 crore and in dollar terms, $159.8 million. This implies a year-on-year growth of 13.1% in constant currency and 20.6% in rupee terms. On the margin front, operating margin or earnings before interest and tax came in at INR 135.8 crore or 11.4% of the revenue. Profit after tax came in at INR 105.3 crore or 8.9% of the revenue. This is the first time we achieved the INR 100 crore pack. It's an immensely proud feeling for all of us. This has been my dream to achieve this target ever since I joined the company at inception in 2002. Our cash flow from operation and free cash flow generation has been quite strong. We generated INR 235 crore cash from operations and our free cash flow, after adjusting for CapEx came in at INR 209 crore or in dollar terms, $28.3 million. Our DSO declined sequentially from 63 days to 54 days, including unbilled. Our team and we have ensured that we bill on time and also do a follow-up to ensure that the collections are done on the right time. And this is, I think, cash generation is a pure reflection of the -- we're able to bill on time and collect on time. On the same way, I think this has resulted into a higher cash balance. As of September 30, we have INR 215.9 crore cash after repaying of almost INR 150.6 crore of working capital borrowing. And also, as you are aware of, we have utilized around INR 10 crore on a stock purchase for a swap trust. Net debt stand at INR 391 crore versus the INR 553 crore in Q1 or $53 million versus the $73 million in Q1. Tax rate for Q2 was around 16.1%, but I think we're keeping the expected range for the year between 13% to 15% for the tax. Hedging side, as you're all aware of, being I think you always see the pound hedges for us for 2 to 3 years. And as of today, we are carrying around GBP 59.5 million of hedges for next 3 years with the rates ranging between INR 102 to INR 119 per pound. On a dollar term, the hedges are up for $57 million with a rate around INR 76.4 position. Overall, I'm very pleased with our strong collective effort to deliver this performance despite multiple challenges everyone which we are facing in the last 6 few months. With this, we can open the call for question.

[Operator Instructions] Our first question is from the line of Manik Taneja from JM Financial.

Congratulations to the team for the execution. Just wanted to understand the trend that you've seen in terms of increased offshore delivery in the current quarter, how should we be reading that? That's my question #1. The second question is a bookkeeping question in terms of trying to understand what was the contribution of the Mortgage business in the current quarter.

Is my audio clear now?

Yes, Vipul. Very much.

Okay. All right. So Manik, from an offshore sustainability, as I mentioned in the last quarter call, where we are today, we are building services without necessarily keeping a focus one site or the other and onwards is off site. We are in the process of building the right capabilities, taking the right opportunities and we're doing that. It just happens that even mortgage demand has been strong. And that's something which we have been working very hard over the last several quarters to make sure we had the right training, the right economy and capacity, both on and offshore to deliver to that demand as it comes through. So because that demand has come through, offshore delivery has kind of increased from last quarter given that development. But structurally, we are driving numbers to the other at this stage, right? That's the answer, on or off. As I look to the future, for instance, as we see more demand for servicing for mortgage, a chunk of that will be offshore -- onshore. And then you'll see some components that come offshore as well. So we should see this ratio moving about a little here and there, a bit on and off depending on the business portfolio. Your second question was how much is the mortgage growth?

Yes, that's correct.

Yes. So obviously, mortgage was a majority of the growth that we saw in BFS, both in origination as well as servicing. And collection business had decent increase given Q2 or so, then it's kind of stuck in the middle. It starts to build up towards Q4. So despite COVID, we were in the part of the year, et cetera, I think they kind of grew reasonably up. Europe was marginally up sequentially, but largely flat, which is a good thing given where the volume has been for the U.K. BFS segments.

Okay. And sir, are you not calling out the absolute numbers? Because last quarter, the mortgage business was used to be about $35.5 million, $36 million in revenue.

Happy to share. So I think this quarter, we were closer to more like $45 million, $46 million, something like that. Maybe $44 million to $46 million, that's the range of mortgage.

Our next question is from the line of Mohit Jain from Anand Rathi.

First one, you mentioned about this offshore versus onsite thing. But if you look at last 4, 5 quarters are offshore has gone up quite considerably. But at the same time, margins are more or less at the same level, including your guidance. So where is this incremental margin benefit going into in the form of investments? And second was related, why even if you increase mortgage, the rate at which it is growing in your outlook remains okay? Why the margin guidance is more or less similar where [indiscernible]?

Sure. So look, I think the growth has been fairly strong in the quarter. Take mortgage as an example, like it has grown pretty strongly this quarter. The demand environment for talent is also hot, right? Talent for mortgage across the industry is in short supply. So there has been an uptick in the cost of talent for mortgage, one. And two, given the majority of the operations are still work-from-home, the supply chain of getting somebody on board, getting the equipment to them and their training happening, everything happening, the time to bill has somewhat increased given this distributed situation. [indiscernible]

I'm sorry, Mr. Khanna, we are not able to hear you clearly.

You're not audible.

There is some echo from somewhere. How about now?

It's fine.

Much better, sir.

So Mohit, as I was saying, there is cost of talent, which has picked up a little bit. There is a time to bill, which has picked up a bit longer a little bit. And the fact that we continue to invest for growth. We see demand. We are continuing to invest both in operating capacity as well as leadership and account management capacity to make sure that we harvest the growth opportunities out there. So that's kind of -- that's taken some point of from the Mortgage margins. But other businesses have performed well on margins. Overall, I think we improved margins quarter-on-quarter about 40 basis points. And we think given the strong demand environment for the next 2 quarters, at this point, our expectation is we'll kind of stay in the range of 11% to 11.5% for the full year.

So this investment for growth, does this also mean some pricing discounts, et cetera? Or this is more into new capabilities that [indiscernible]?

No, more -- absolutely the latter. There are no discounts. But as I said, in some cases, there is some mismatch in terms of the cost of talent versus price recovery, and we are trying to kind of get that calibrated. There will be some timing lag in terms of signed contracts. But that's the normal execution and calibration that we need to do. There is the operating cost for growth. And then there is the new business build cost of growth that we've been talking over the past few quarters in terms of the focus in leadership and the new sales and account management capacity, not just in BFS, but across businesses that we have.

And your thoughts of 2 to 5 clients, also? Like top 1, do you see some normalization? In 2 to 5, is that primarily mortgage clients? Or do you think some recovery in some other accounts as well from a top client perspective?

It's a good mix of CMT, BFS and Healthcare clients in the top 5. Clearly, the Mortgage component there has been driving. We saw good recovery, as you would see from the top clients. We saw good recovery given the volumes came back to top clients. So that and Mortgage helped. Other BFS customers have held steady, but we see a decent pipeline as we go into the next few quarters, that we should see a broad-based BFS growth more than -- somewhat more than what we've seen -- or in addition to what we've seen in Mortgage. That's the right way to phrase it.

Then last one for Dinesh, sir. Sir, this other expenses piece was a little on the higher side. Is there a onetime expense or something, which is not going to happen from next quarter onwards? And connected to that, industry has moved up significantly because of work-from-home. Is there a way our company can also sort of benefit from this initiative in terms of your cost reduction progress?

So there is no one-off in any of the line item, whether it's revenue or expenses, everything is normal. And I think along with the -- when you take the growth component, the operating cost is always going to come higher because – I think especially Vipul already talked about the mortgage side of things. So that also -- some of the cost component is part there. As far as the work-from-home, I think that as of today... [Technical Difficulty]

Thank you for your patience. Mr. Jain, the line is connected now.

Yes. So I think it got disconnected. So what I was saying, there are no one-off in any of the line item, whether revenue or expenses. As far as the expenses, they are higher in terms of the percentage maybe and on value term also, on account of being as we already talked about in mortgages and other businesses here, you have work-from-home, you need to have an extra cost covenant. It's not that you're going to save it. The saving is only on the facility side, which you already have, the center. But I think going forward, if we're able to have some capacities, which will not go back to the offices, the likely chance that margin profile which we are showing has been built in there. So I see as of today that, I think, margin profile guidance is what we have indicated. And as far as there is no one-off in any of the dynamics.

Mohit, if I may add to this.

Sure.

Mohit, just to add to the point about work-from-home margins lift. I think there are some obviously cost line items where you see the lift but keep in mind, our relative portfolio been on and off. Onshore operations, right, have been kind of continuing the decent mix of work-from-home and at site. And regardless of sort of the location, the onshore, the weightage of labor cost or human cost is higher relative to infrastructure versus, say, offshore, right? So some of the advantage that you see from offshore, work-from-home, that does not have much pass-through in the onshore operations because the cost mix between talent and others is different there relative to offshore.

Okay. So you mean the benefit will flow to players who are more offshore-driven than site-driven?

It's a relative thing, yes. I mean we get advantages of being onshore and showing better growth and better [ equipment to your ] clients. But yes, that's one of the corollaries of that.

Our next question is from the line of Dipesh Mehta from Emkay Global.

Congrats on the strong execution and strong performance. A couple of questions. First, just to understand your thought process on the guidance. Now we have revised guidance to 9% to 12%, and only 2 quarters left. So why such a wide range when we are already 1 month in the third quarter? So I just want to get your thought process. What are the pros and cons or puts and takes you consider when you guided this wider range? First. Second question on the healthcare side. Healthcare even so -- so can you provide us the mix, what is the payer and provider mix now? And whether any incremental optimism on payer side? Because I think some of your peers indicated, payer is recovering really strongly. So if you can provide your perspective on this. I have a couple of other questions, but I think once you answer this, I can ask those questions.

Great. Thank you, Dipesh, for your time for us. So I think the first question on how we came to the range of 9% to 12%. So look, when we started in -- when we spoke to you in July or August, we had said 6% to 10% at the start of the second quarter. We are sort of 6 months into the year coming to the end of October. Looking at the deal pipeline, looking at the what we have signed business and the expected start date, our prudent guidance at this stage is 9% to 12%. The reason we have it a little bit broad is to keep in mind and kind of ground us to the fact that it’s still is a absolutely unique air, right, this FY 2021 for the industry and the world. The volatility in terms of demand recovery in healthcare is something that we are watching. The second element is we want to make sure that there are no supply side shocks as well, right? If there is a lock down or if there is a shelter-in-place order somewhere else as well. So we've keeping an eye for supply side constraints as well. So given sort of some of volatility still there in demand and the supply side environment, we think this is best to give a guidance of 9% to 12% of this range at this time of the year. Your second question on Healthcare. The payer/provider mix is kind of changing a tad, as you would expect. It is now 43%-57% between payer and provider, right? It's up a few points in the favor of payer so your sentiment is right. The payer business, as I mentioned, it’s seeing an uptick. Health plans are having the best financial period, given there are less claims coming on to them, medical costs are lower. And there is reason on there. We've seen sort of increasing appetite from health care executives to consider and take on transformation projects, which have multiyear impacts, not just looking for immediate term impact. And it's showing in our pipeline, it's showing in our conversion. And as I mentioned, we had 2 new client wins in healthcare payer. We see a very healthy pipeline build with some high-quality conversations. And for a reasonable chunk of our existing portfolio, despite claim volumes being lower, we saw increased spend as we kind of went into other areas for them. So I'm sort of bullish about healthcare payer segment over the next several quarters, kind of playing out [ are acceptable ] and how we are executing with the added investments we've done to the leadership team and switching capacity there.

Understood. So one question on the mortgage side. Because of very strong growth, obviously, some of the operating parameters, I don't know whether utilization or [indiscernible] field sector, whichever, but which you never gave the operating efficiency, this kind of thing. Might have been because you planned for strong growth. So once stability retained, so what margin compression will be explained by those parameter? And how much would be because of our talent cost increases? If you can give some color because talent cost increase might sustain for some time, but this operating -- once you reach some capacity stability, then I think your margins should reflect it. So if you can provide some perspective how this margin is divided between these 2 aspects. And second question is about the effective tax rate. Now what one should expect your medium-term tax rate? This year, I think Dinesh indicated around 13% to 15%. But for next 2 years, if one try to get some sense, what would be that number? And the third is about capital allocation. Now we have very strong case in H1. If you can provide your thought process about capital return?

Yes. Dipesh, on the market, you mentioned talent cost. What was the other thing you said, the other component of the margin?

Because revenue growth is very strong, your utilization of resources might have implication. It might not be optimally utilized kind of thing because you, let's say, recruit 100 people in anticipation of growth and that recruitment engine would be aware of that kind of planning. And that's why your utilization would be lower from optimal level. So how you can explain this margin compression between these 2 aspects, talent cost increase and there's some of the margin lever not optimally utilizing mortgage?

Okay. I understand. So I think the second component, which is time to bill, hiring ahead of need because you can't really time it to perfection in terms of demand and supply. There is no training or kind of investing in talent, in some cases, with longer lead times for training because it's kind of, frankly, in the long term, kind of gets more profitable. We are working on all levers, right? Our academy that we established offshore as well as now onshore, that's starting to kick in. Obviously, that's an investment for us, but it kind of phase out in the medium term. So bulk of our operating source -- if I could use the term operating investment is going towards this asset. There is, I don't know, maybe my guess is about 1/4 of the margin impact we talked about would come from talent costs kind of picking up. Again, as I said, we think, over time, we will manage it. We'll calibrate with our clients, right, as we get into sort of some price calibrations with them. Not something which we are worried about. It's still a growth environment, it's healthy relationships. So I would say bulk of our sort of margin investment for the same mortgage is going towards funding and fueling the growth. Dinesh, you want to answer for the tax rate?

Yes. So I think tax rate is, I believe, I think next 2 to 3 years, it is not actually more than 18%. So I think it will range between 13% to 18%. And as you know, the onshore, as we have a lot more onshore, is automatically reflection of their effective tax rates of around 20%, 21%. So automatically, the effective tax is lower. We don't know what's going to happen into this U.S. election. There are a lot of talks happening around tax rate increase for corporates. If anything, if that change happens, then we need to revise the guidance. Otherwise, I don't see, as of today, any change in these range too. So max can be 18%.

And Dipesh, on your -- on your question of capital allocation, I think as you rightly noticed, we had good cash flow generation. We took the opportunity to kind of moderate down our debt -- working capital debt with that. We had a good dividend payout last year. They're still in the middle of the year as we come towards -- as we progress more in the year, we'll take a look at it on the capital allocation side. But for now, I think we continue to generate work at debt and look for both opportunities for organic and inorganic investments.

We'll take our next question from the line of [indiscernible] from Rare Enterprises.

So on your margin front, in your media business, Communication Media, I see that this quarter has a big jump in EBIT margin. So could you explain what is the reason for this? And also how sustainable this is? And what has moved this margin? That's the first question.

Okay. It's a fair observation. I think a part of the CMT, if you recall, is we had a lower volume in Q1 because of the demand situation and most of our clients prioritizing to serve only the very vulnerable society customer base. We obviously pared down some of our variable expenses. We couldn't do it all, we didn't want to do it all. And then there was obviously the fixed cost base. As volumes have come back, there has been an element of catch-up on revenue. And I think that's kind of showing in higher margins. Last quarter was kind of suboptimal because of the reasons that I mentioned. So there is a little bit of a catch-up and there's a little bit of a normalization. From a sustainability standpoint, I think we've kind of -- so that business is – change in EBIT range, it can fluctuate between sort of 10% to 13-odd-percent. This month, this quarter was a little bit higher because there was little bit of catch-up. So I think we'll start to see normalization to our historical levels as we compete with COVID levels in the next 2 quarters.

Okay. So you said the sustainable range is between 10% to 13%, that percentage. Okay. And one more thing, I couldn't hear you properly in the beginning of the call. So I just wanted to understand if you said way. You said that in the situation right now, new purchase mortgages are increasing, at the same time delinquency rates are increasing, right? Is that the correct statement you've made? And so how do you see -- I mean, this is -- how do you see the situation like this will ever be ending? And what are the different scenarios, possible scenarios you see? And how does this impact FSL? And how are you preparing to deal with such a situation?

Sure. No, it is somewhat of a unique situation. Normally, you see one or the other. Now we're seeing sort of both.

Sorry, I can't hear you. Is it my line or I'm not sure.

Well, we can hear Mr. Khanna. I think it is possible you're not able to hear us clearly.

Okay. I can hear you clearly. You guys can hear me, Ankur and…

Yes, we can. Yes. It's better now.

Yes. Yes. Go ahead.

So I think your observation is right that the situation, the macro situation we've seen in the housing market, especially in the U.S., is that there is demand is picking up for purchase mortgages. And obviously, there is a refi mortgage volumes are high because interest rates are record low. But at the same time, delinquencies are rising. So I think it reflects the fact that a chunk of the population is not impacted, right? And a chunk of the population is impacted. This is how the pandemic has impacted different sections of the society. And but there’s demand coming for second homes or people moving from big cities to suburban houses or people not wanting to live in rentals and want to own their own property now or there is more liquidity and they want to put it in property or all 4 of those factors are kind of driving new housing demand up, right? And we've seen this very strong trend coming through and builders have announced new projects and stuff like that. And this is expected to continue over the next -- sort of over the medium term. Delinquencies for now, as you know, in the U.S. environment, there is a very structured process. If people start to kind of miss mortgage payments, there is a very structured [ payment of ] if they get abeyance or temporary sort of calls, and then it moves to more structured solutions, more permanent solutions of either redoing the mortgage payment or worst case, like repo and so. So I think what we've seen thus far is that delinquencies are rising. As I mentioned, they've grown about 4% year-on-year or even quarter-on-quarter. At this stage, it's still the early days of abeyance, right? But as this continues, it results go to the next step, go to fall into the next step. And the industry will need capacity for that. So I think we are preparing for that. We have won some business. We're building solutions. We are adding up on our capacity for that as well because that wave will come in the next -- either it comes next quarter or quarter after that, no one sort of knows. But we're preparing for that. As demand comes, we want to make sure we participate in that, more than our fair share on that.

Our next question is from the line of Rahul Jain from Dolat Capital.

Yes. Congratulation for great execution and actually in the hitting the INR 1 billion quarterly profit milestone. My question is a bit similar to the previous [ parts again ]. With next signal, how constructively we think beyond 1 or 2 quarters? That is part A. Secondly, how we plan to mitigate the challenges on the health care side, given the situation in the provider elements of it? And will the superlative traction in payers should be good enough to drive us to the level of growth we are looking into this?

Thank you for the kind words. Sorry, I missed the first question. You said -- can you repeat your first question. Second part was about the health care. How do we think about health care.

Yes. Yes. So I think you partly answered in the previous question as well. But I mean how you -- how this mix signal essentially land up in terms of how we deliver in the BFS space, same element, given that demand has new home sales as well as improved [ delivery ] on free cash flow. So how do you think beyond a couple of quarters? Of course, the current book and client position may give us confidence for now. But what is the real thing beyond this couple of quarters when this next signal may normalize to some degree?

Okay. Understood. Okay. So let me try to answer and if I don't, please follow-on. So look, mortgage, as I said, between origination, obviously there is somewhat of a hedge between existing mortgage and purchase mortgage originations. Interest rate movements, our sense is the low interest rate regime that we are in today, unless unemployment comes back to where it was pre-COVID, sort of the 4% to 5% levels, interest rates will continue to be low because there is that much lack in economy and try to absorb it. So to that extent, anywhere from 3 to 6 quarters is where I see the interest rates continuing the way they are in the U.S. That's one factor to consider. Again, as I mentioned, the purchase mortgage demand will continue for longer, even if the refinance starts to taper off once interest rates kind of stabilize or start to move in the other direction. By what’s spoken to clients and to industry experts, the sense is that about 60% of the existing mortgages in the U.S. are still in the money, which means that there is still incentive for 60% of the mortgage holders to go in for a refinance and still save money. So there is that much work still needs to be done on the refi side. Whether that's done in 3 quarters or 6 quarters, I guess, we will see how that kind of plays out or even longer. The second factor I want to say is that between our origination and mortgage, it's about a 2/3-1/3 mix at this point in time that we've seen over the last 2 quarters. And we are very conscious that we don't go too high on one or the other and that we keep sharply focused on building our servicing portfolio, both regular servicing as well as default serving. And I think that provides a natural hedge to sort of the origination side of the house as well. So I think it's a portfolio, and our job is to manage -- make sure that we manage the portfolio given the changes to the macro environment. But I think I feel reasonably sort of comfortable that we have 2 or 3 sort of iron in the mortgage fire that has been changed, we'll be able to kind of balance in with the other. On health care, this thing has obviously extended on, right? People are still not going to hospitals for elective treatment unless it's a real emergency. And that's just kind of showing up on hospital finances and the volumes that come through. Part of this thing to think about is that some of the volumes are lost, right? Some of these procedures is not going to happen, right? If you used to go or somebody used to go for a quarterly, let's say, diagnostic for cancer or something, they missed 2, they missed 2. But if you have to go for a knee surgery or a new replacement, if not now, you will go after 3 months or 6 months. So some of the volumes is not lost forever, it will come back. And I feel reasonably in good shape that our eligibility services, which is a big chunk of our provider business. We are amongst the market leaders. We continue to kind of hold strong relationship with our clients. And as volumes pick up, there is nothing structurally missing in this business, it will come back. And we're pushing hard on the self-pay, which is the other component of our provider business. As volumes or payment responsibility shifts to individuals, the self-pay business will kind of pick up, and we've been pushing hard on our digital tool, their engagement to come on strong. So I think it's a macro situation we are facing. It could last through sort of Q3, maybe start of Q4 as well, but it should normalize, and we are looking for additional packets of growth in providers to go further in the same value chain.

Right. And if I may ask one more. You've seen a good jump in new clients that you said for the last quarters. So if you could share more insight from the elements in terms of the size of the scalability potential, any other flavor you could give on this?

Yes. So as I mentioned, this quarter, we had 15, of which 9 were Banking and Financial Services. Mortgage obviously was a big chunk of that and there, the obviously the traction is part, right? The demand is there, you’ll see a sign then you kind of get going on that. And to that extent, the revenues that we kind of declared for Q2 had a good mix of growth from existing clients as well as sort of revenue starting to come through from Q1 and Q2 wins as well. On health care, we've seen on the payer side, good traction in terms of immediate convertibility, right, sign a deal and sort of get on with the revenue. On the provider side, while there have been -- the buildup to revenue is kind of taking longer than what we've seen historically. So a little bit of a mixed bag of the availability. But I'm kind of beginning to see that the deal sizes in our pipeline in BFS and in Healthcare, especially payer, are starting to pick up from what we have seen historically.

And our next question is from the line of Sarvesh Gupta from Maximal Capital.

Congratulations for a good set of number. Most of my questions related to the quarterly performance has been answered. One question which I had, by the way, was if I look at your relatively medium-term trajectory, we have been -- sort of been able to move more towards the offshore from -- in the last 2 years from 20-odd-percent to 27%. And at least, if not for the top 5 clients, we have been able to reduce our concentration in the top client. So if one has to look at the next 3 years, what is the aspiration in terms of reaching a particular level of margins? Do we have a number that we want to reach to? And of course, I was thinking that the offshore/onshore mix will be the main driver of that. So do you have a number around that metric as well?

Yes. So look, as I've been kind of saying, I think the onshore/offshore mix, at this stage, is a function of the kind of business and the kind of capability we are building. We aren't necessarily kind of driving towards a specific target. It is a valid lever, of course, offshore gives you sort of the lever on margins. But at this stage, we are at the -- the focus is to build the right relationship and the right services, which continue to kind of give us a differentiated position and momentum for the market. From a margin standpoint, we've guided for 11% to 11.5% versus 10.8% that we had in FY '20. And also, given we are in the early days of building our business in newer segments like more digitals, our push -- renewed push into the health care payer, et cetera, we expect that the operating margins to be in the same range in the short to medium term. Over time, with scale, we will see some advantages from operating leverage start to come through into the margins. We haven't kind of sat down and model for the long-term to see where we expect long-term margins to be. So I couldn't answer more specifically, except thematically, we do want to continue to invest. And I do expect that some scale, we should start to see some benefit from operating revenue to come through into our margins.

Okay. The reason I was asking you is, of course, if you compare our return on capital employed to many of our peers, it is possibly in the much lower side, and one of the reasons I see is lower margins as such. So I was trying to figure out if there is a plan in the next 3 years to sort of scale it up to a more respectable number?

Yes. So again, just your comment on the ROCE, yes, important to point out that a big part of where our ROCE is because of the goodwill on the balance sheet, right? And this has been flat for a long time from historical acquisitions. And that kind of weighs -- has its weight on the way ROCE comes out to be. Incremental ROCE is more relevant metric. I think we've given some numbers, Ankur can share more details with you, right? So one-on-one. But I think our focus is growth, our focus is contemporary offerings. So that's why the push towards digital. And digital in general should be higher margin, but there is the path and there is a ramp to kind of get to a meaningful scale on digital as well. How those factors, puts and takes play out on the margin, that's something we can talk more in the subsequent quarters.

Understood. And with regard to...

Mr. Gupta, may I request you to return to the queue, please, as there are other participants.

Sure. Just one more question, if I can?

Okay.

Yes. So with regard to our U.K. business, now given the rise -- recent rise in the COVID cases, are we seeing any new headwinds over there, especially from the client side in the month of October? Because I think the lockdowns and the COVID situation has sort of increased exponentially in the recent times.

It has, for sure, are we seeing the impact, right, on The Street and stuff like that. Now from a demand standpoint, we haven't seen any impact yet. From a supply side standpoint, we had the opportunity now for the last several months to build up pretty strong work in office as well as work from home and some of our clients who were sensitive early on to work-from-home or not like work-from-home, we've seen movement on that, right, including our biggest clients. We have some capacity, reasonable capacity now for our work-from-home. So to that extent, we feel good that if there's another strong or multiple weeks sort of lock down, we can continue operations between our on and off -- on and off, as in work-from-home and work-from-office options. Demand, thus far, we haven't seen any impact.

Even on the deal win side?

Deal win side obviously was low as the year started by, right? Through summer as people came back from summer holidays, we saw more conversations, I think it was building up. I hope the momentum continues into the end of the year, and it doesn't impact. But we did see more conversation in the last 2 months than we saw in the first few months.

Our next question is from the line of Sachin Kasera from Svan Investments.

Congrats for a good set of numbers. Most of the questions have been answered. Just one question on acquisitions. So now it's more than a year since you have been here. So any thoughts that you have been able to crystallize one -- in terms what is the size of acquisition you are looking? What are the areas and capabilities you are looking? And secondly, have you started to see some attracted deals on the table?

So look, as I mentioned early on, to me acquisition is a very viable and a valued part of growing a business. And we want to do it systematically, right? In the last several quarters, we've built up our -- strengthened our relationships and our reach into the market. We're building up our pipeline of interesting sort of targets and companies. We do want to prioritize at this stage acquisitions in the areas of provider, even collections given sort of what the demand environment will be. Those are our top priorities at this stage. Nothing specific to report, but we continue to work hard on building visibility and pipeline to add new capabilities, right, that's the primary focus. In the adjacent area of growth, if we need capabilities, we kind of try to kind of do it through the inorganic route. But I don't have anything specific to report at this stage.

But in terms of the valuation expectations or even with [indiscernible] that you're looking at, now you’re looking at deals because of the way market has shaped up better than what it was 6 months or a year back? Or it’s still remains very, very specific to deals?

I think it's specific to deals given we are looking for specific capabilities rather than sort of scale or revenue only. And obviously, we want to be judicious, even in those areas that we pay a reasonable amount, not under, not over, we pay fair value and bring those capabilities in the kingdom. So that's how I kind of tend to think about acquisitions.

Our next question is from the line of [ Himesh Satra from Sequent Investments ].

So my question is, we have seen that there has been a considerable reduction in the net debt, but finance costs hasn't come down to that extent. So can I know the reason?

Finance cost did come out quarter-on-quarter. And also that you have to remember that cash collection normally happens at period end. So probably we'll see more in the coming quarter. But finance costs have dropped in a real term also because the rates are cheaper now.

There are no further questions from the participants, I now hand the conference back to the management for closing comments.

Great. Well, first of all, thank you, everyone, for bearing. It looks like we had bad line quality. So thank you for straining hard and listening to us. If you have further questions, reach out, Ankur is there. If I need to, I'll help you out, given the line quality. But thank you for great questions. Thank you for your interest. We look forward to keeping our heads down and executing and come back to you and speak to you in the next quarter. Thank you.

Thank you very much. Ladies and gentlemen, on behalf of Firstsource Solutions Limited, that concludes this conference. Thank you for joining us, and you may now disconnect your lines.