Earnings Call Transcript - EXLS Q2 2022

Operator, Operator

Ladies and gentlemen, thank you for being here, and welcome to the Second Quarter 2022 ExlService Holdings, Inc. Earnings Conference Call. All participants are currently in listen-only mode. Following the presentations from our speakers, we will open the floor for a question-and-answer session. It is now my pleasure to introduce Vice President of Investor Relations, Steven Barlow.

Steven Barlow, Vice President of Investor Relations

Thank you, Andrew. Good morning, everyone. Thanks for joining our second quarter conference call. I'm Steve Barlow, EXL's Vice President of Investor Relations. On the call today are Rohit Kapoor, our Vice Chairman and Chief Executive Officer; and Maurizio Nicolelli, our Chief Financial Officer. We hope you've had an opportunity to review our Q2 2022 earnings release we issued this morning. We've also updated our investor fact sheet in the Investor Relations section of EXL's website. As you know, some of the matters we'll discuss in this call are forward-looking. Please keep in mind that these forward-looking statements are subject to known and unknown risks and uncertainties that could cause actual results to differ materially from those expressed or implied by such statements. Such risks and uncertainties include, but are not limited to, general economic conditions, those factors set forth in today's press release, discussed in the Company's periodic reports and other documents filed with the Securities and Exchange Commission from time to time. EXL assumes no obligation to update the information presented on this conference call. During our call today, we may reference certain non-GAAP financial measures, which we believe provide useful information for investors. Reconciliation of these measures to GAAP can be found in our press release as well as on the investor fact sheet. I'll now turn the call over to Rohit Kapoor, EXL's Chief Executive Officer. Rohit?

Rohit Kapoor, CEO

Thank you, Steve. Good morning, everyone. Welcome to our Q2 2022 earnings call. I hope all of you are doing well. I'm pleased to report another great quarter following our strong performance in Q1. Our second quarter revenue was $346.8 million, up 5.3% from Q1 and up 26.1% year-over-year. For the quarter, adjusted EPS was $1.50 per share, up 31.6% year-over-year. Our growth was driven by our Analytics business, which generated $161.3 million in revenue for the quarter, up 8.2% sequentially and 44.8% year-over-year. Analytics now accounts for 47% of our total revenue. Our Digital Operations & Solutions business saw strong growth this quarter with revenue of $185.5 million, up 2.9% quarter-over-quarter and 13.3% year-over-year. This was led by double-digit revenue growth from our emerging business segment, which generated year-over-year growth of 32.4%. Our data-led approach is unique and resonates well in the marketplace. Our clients need to respond much faster with the most relevant service offerings to their end customers in this new world of increased volatility and higher expectations from the consumer. Our data-led approach allows for precision-based targeted responses, better business decisions, and improved operational processes in a systemic way. This has led to an accelerated growth of our overall business, and we are very pleased with the business results so far. I want to spend a few minutes today talking about the current macroeconomic environment and how we see it impacting our business. A combination of high inflation, talent scarcity, and global supply constraints has created significant uncertainty and volatility in the economic environment. With continued geopolitical risks, rising interest rates, and a low growth environment, these threats are likely to be persistent. However, in the current environment, it becomes more important than ever for businesses to invest in technology, automation, and data-led transformation to stay relevant for their customers. We expect that the demand for our services will likely remain strong while the composition of these services might undergo a change. Cost management is likely to become more important, along with managing delinquencies and prevention of fraud, which tends to rise in slow growth environments. EXL is very well positioned to help our clients navigate this turbulence and be a value-added strategic partner. Our data analytics and digital solutions help our clients drive workflow efficiencies, create hyper-personalized customer engagement, and mitigate their risk. Our capabilities are mission-critical for our clients and are a fundamental lever for them to address their most significant challenges. And finally, our geographic mix of business is well situated to deal with the global uncertainty and volatility. As we continue to create new data-led business solutions for our clients, we are proud to announce our recent joint venture with Oliver Wyman and Corridor Platforms. This new solution delivers a turnkey risk decisioning system in real-time for regional banks and credit unions. It is based on enterprise risk analytics, governance, and automation solutions that EXL, Corridor, and Oliver Wyman are currently delivering for some of the world's largest banks. This new solution brings all of those capabilities together as a hosted solution on the cloud. We call it risk decisioning as a service, and it is being offered on a usage-based pricing model, which aligns costs with demand on the platform. This variable cost structure is intended to make our proven institutional-grade risk and governance solutions accessible to smaller financial institutions. As more retail bank customers turn to digital lending alternatives such as point-of-sale financing and digital loans, this solution will play a key role in helping smaller financial institutions keep pace with changing trends in customer demand. In a similar vein, in order to further enhance our capabilities around being a data-led business, we have been investing in upstream data management capabilities. We are working on a number of high-profile global data transformation projects to help clients redesign their data management capabilities and drive their shift to the cloud. Our 2021 acquisition of Clairvoyant is helping drive our scale and success with these initiatives. In one example, with a U.K. general insurer, EXL leveraged its enterprise data management, analytics, machine learning, and AI capabilities to enhance their growth trajectory through our data and analytics-led transformation roadmap. We helped the client orchestrate a cloud-optimized analytics-ready enterprise data platform that unlocks significant business benefits across the insurance value chain. We enabled data science as a service capability for delivery of advanced analytics use cases like image analytics-based underwriting, machine learning-based fraud detection, and quote manipulation detection. With these types of data-led transformation projects, of course, comes a huge demand for highly skilled talent. To address the challenges of the current talent scarce market, we've redoubled our efforts over the past several quarters to position EXL as a destination for top talent. Our ability to provide work that matches the aspirations of highly capable people, our culture of constant improvement, our relentless investment in learning and our consistent growth are factors that help us attract the best people. We crossed a milestone of 40,000 total employees in June with close to 50% growth in analytics talent from the first half of 2021 to the first half of 2022. Also, more than 70% of our current hiring is for complex skills, which are aligned with our data-led and digital solutions delivery for our clients. In fact, this quarter, in a market with high demand for talent, our employee engagement increased to the highest level we've ever recorded. Our world-class talent, resilient business model, and robust pipeline make me confident in EXL's ongoing growth prospects. We will continue to closely monitor our client base and the broader macroeconomic environment for signs of headwinds. However, we remain confident that the strong demand for our services, combined with the critical role we play for our clients' businesses will position us well.

Maurizio Nicolelli, CFO

Thank you, Rohit, and thanks, everyone, for joining us this morning. I will provide insights into our financial performance for the second quarter and the first six months of 2022, followed by our revised outlook for 2022. We had a strong second quarter with revenue of $346.8 million, up 23.6% year-over-year and 6% sequentially on an organic constant currency basis. Adjusted EPS was $1.50. All revenue growth numbers mentioned hereafter are on an organic constant currency basis. Revenue from our digital operations and solutions businesses as defined by three reportable segments, excluding Analytics, was $185.5 million, up 15% year-over-year. Sequentially from the first quarter, revenue was up 3.7%. Insurance generated revenue of $108.6 million, up 15.9% year-over-year, driven by expansion in existing client relationships in life and annuities, property and casualty, and new client wins of 2021. The insurance vertical consisting of both our digital operations and solutions and Analytics businesses grew 16.1% year-over-year. Emerging reported revenue of $53.9 million, up 36.1% year-over-year. This growth was driven by new client wins of 2021 and expansion in existing client relationships. The emerging vertical consisting of both our digital operations and solutions and Analytics businesses grew 43.5% year-over-year. Health care reported revenue of $23.1 million, down 18.4% year-over-year, driven by lower volumes in the clinical services business, primarily due to a transitioning client. The health care vertical consisting of digital operations and solutions and Analytics businesses grew 10.8% year-over-year. Analytics had revenue of $161.3 million, up 36.1% year-over-year on an organic constant currency basis. Clairvoyant contributed $11 million of revenue. Including Clairvoyant, Analytics grew 44.8% on a reported basis. Similar to the first quarter, this growth was driven by increased volumes in banking and financial services, payment integrity, and direct marketing. Sequentially, from the first quarter of 2022, Analytics grew 8.7% on an organic constant currency basis, signifying continued demand across our analytics services. Our SG&A expenses decreased by 180 basis points year-over-year to 18.6%, driven by pandemic-related expenses in the prior year and operating leverage. Our adjusted operating margin for the quarter was 18.7%, up 80 basis points year-over-year due to lower SG&A expenses, partially offset by investments in ramping new client wins of 2021 and 2022 and higher facility and travel expenses as we return to the office. Sequentially, adjusted operating margin increased by 50 basis points, driven by operating leverage. Our effective tax rate for the quarter was 23.3%, down 100 basis points year-over-year. This decrease was driven mainly by lower taxes in certain foreign jurisdictions. We do not anticipate any change in our tax rate due to work-from-home requirements in the Philippines as we are in compliance with current government regulations. Our adjusted EPS for the quarter was $1.50, up 31.6% year-over-year on a reported basis. Turning to our six-month performance. Our revenue for the period was $676 million, up 27% year-over-year on a constant currency basis and up 23.1% on an organic constant currency basis. This growth is driven by Analytics, Emerging, and Insurance. Adjusted operating margin for the period was 18.4%, down 60 basis points year-over-year, driven by investments needed for a ramp-up of new client wins and investments in front-end sales, digital capabilities, and higher facility and travel expenses as we return to the office. Adjusted EPS for the period was $2.92, up 25.9% year-over-year on a reported basis. Our balance sheet remains strong. Our cash, including short- and long-term investments at June 30, was $288.5 million, and our revolver debt was $285 million for a net cash position of $3.5 million. In the first six months of the year, we generated cash flow from operations of $53 million compared to $53.9 million in the same period last year. During the first six months, we spent $25 million on capital expenditures, repaid $10 million of debt, and repurchased $57 million of our shares at an average cost of $133 per share. In our conversations with clients, we currently do not anticipate significant changes in their spending outlook, giving us confidence as we look ahead. At the same time, we are conscious that the macro environment with high inflation remains with us, but we believe our business model is resilient. Based on the strong performance in the first half of the year and our current outlook for our services across all our verticals, we are increasing our guidance for 2022. Second quarter revenue does include approximately 2% of one-time revenue that may not occur in subsequent quarters. Our revised 2022 guidance is as follows: Revenue is expected to be in the range of $1.35 billion to $1.37 billion. This represents a year-over-year growth of 20% to 22% on a reported basis and 17% to 19% on an organic constant currency basis. This is an increase of $35 million at the midpoint, including a foreign exchange headwind of $7 million from previous guidance of $1.315 billion to $1.335 billion. Our acquisition of Clairvoyant is going well, and we are reiterating our guidance of $40 million to $45 million in 2022. We expect a foreign exchange gain between $3 million and $4 million, net interest expense of approximately $2 million, and our effective tax rate to be in the range of 23% to 25%. Based on the above, we expect our adjusted diluted EPS to be in the range of $5.60 to $5.80, up 16% to 20% from the $4.83 we reported in 2021. In terms of capital allocation, we have a good pipeline of acquisition targets, which we are evaluating based on the capabilities they could contribute. In addition, we will continue to spend on internally developed solutions to enhance the value of our offerings. We expect capital expenditures to be in the range of $40 million to $45 million. We anticipate our buyback program will continue at the pace similar to 2021. Looking at the third quarter, we expect revenue in the third quarter to be comparable to the second quarter revenue and adjusted diluted EPS to be lower due to the higher return-to-office expenses as we gradually return to the office, higher travel expenses, and continued investments in digital capabilities. In conclusion, we had a successful second quarter. Our solutions and services in our data-led go-to-market framework are resonating well with our customers who are in need of digital transformation with state-of-the-art technology such as cloud, AI, machine learning, and Analytics. In addition, we have a strong focus on cost containment measures to ensure healthy margins and drive EPS growth for the remainder of the year. Now Rohit and I would be happy to take your questions.

Operator, Operator

Our first question comes from Bryan Bergin with Cowen.

Bryan Bergin, Analyst

I wanted to start by digging in a bit on the macro and client sentiment comments. So can you just confirm, Rohit, have you seen any disturbing change in client behavior or decision-making pace through the last, I guess, even into July? And can you segment that by what you made in digital ops versus like anything different to call out there? And also, just if things do slow down, how are you thinking about that Analytics growth risk just as it relates to some of the shorter cycle work you have?

Rohit Kapoor, CEO

Sure, Bryan. So we continue to see a very strong engagement with our clients and prospects across the board. And frankly, our pipeline is strong, and we are quite encouraged by the dialogue that's taking place. However, like I noted in my prepared remarks, there is a shift in the composition of the pipeline as well as the conversations that we are having with our customers. So one area where we are seeing our clients being more cautious is around marketing analytics, and that's something which we would expect them to readjust as they go forward into the second half of the year. But at the same time, we are also seeing increased strength in terms of cost management as well as managing delinquencies and getting prepared for a higher level of delinquencies and fraud. So we think on an overall basis, the strength continues to be strong and is balanced out while the composition of that demand seems to be shifting a little bit. The sales cycle for us continues to be about the same as we had previously and the progression of the pipeline continues to be at the same pace as what we've experienced previously. So overall, from a macroeconomic environment with our customer base, we think things continue to be heading along the same as what they were previously.

Bryan Bergin, Analyst

Okay. Okay. That's good to hear. And then just a follow-up on margins. You had a quarter here with strong op margin surprise. How are you thinking about kind of fiscal '22 op margin target for the year and in second half and then just longer-term potential just based on your pricing initiatives, wage levels and internal efficiency opportunities?

Maurizio Nicolelli, CFO

Sure, Bryan. When we consider our operating margin or adjusted operating margin, we achieved 18.7% this quarter, which exceeded our expectations. Looking ahead to the rest of the year, we anticipate ongoing return-to-office expenses in Q3 and Q4, resulting in higher costs during the latter half of the year. Therefore, we expect our margin guidance to remain consistent with the first half, falling within the low 18% range. This projection accounts for the additional costs associated with the return to office and some new investments planned for the second half. As we move into 2023, we aim to maintain comparable margins while also seeking to grow them slightly. Over the past few years, we have successfully increased our margins, and as we introduce more value-added services and adjustments to pricing, we expect to see incremental improvements as we progress into 2023 and beyond.

Operator, Operator

And our next question comes from the line of Puneet Jain with JPMorgan.

Puneet Jain, Analyst

Following up on Bryan's question on potential slowdown, macro slowdown and its impact on Analytics. How should we think about like the mix of Analytics business as it relates to marketing analytics versus risk management services that you provide? And can you also talk about the new JV and potential financial implications from that over the near term?

Rohit Kapoor, CEO

Certainly, Puneet. We believe that the ongoing macroeconomic slowdown is causing significant volatility and uncertainty in the market. In this situation, adopting a data-driven approach has become increasingly crucial for our clients. We are observing our clients' growing investments in automation, advanced analytics, cloud migration, and agility. As this fundamental shift progresses, demand for our services remains robust. Our data-driven approach is effective for both digital operations and data analytics, which is well-received, positioning us advantageously in this macroeconomic climate. Clients are recognizing the need for more analytics to navigate this volatile environment, leading them to invest further in these capabilities, where we excel as strong partners. Our joint venture and the introduction of our unique risk decisioning-as-a-service solution holds great appeal for midsized and smaller banks, financial institutions, and credit unions. We’ve initiated productive discussions in this area, and we look forward to seeing how this develops. This venture allows us to engage with key decision-makers in these financial institutions and expands our customer base beyond just larger banks. We see this diversification of our portfolio as a long-term strategic benefit.

Puneet Jain, Analyst

Got you. And then on the attrition rate, it seemed like it increased a little bit, assuming most of it is from the Philippines. Can you talk about supply issues and the supply trends you expect for the rest of the year in the U.S., India, and your other major locations?

Rohit Kapoor, CEO

Sure. The attrition rate has definitely increased, currently at 38%. It appears that this trend is affecting the entire industry. Our main goal is to hire the right talent, attract the best individuals, engage with them effectively, invest in their learning and development, create strong career pathways, and enable our employees to deliver their best work in line with their expectations. The majority of attrition is occurring at the lower levels. We are focused on meeting our customers' service level requirements and maintaining our operations despite the rising attrition rate. We believe we have shown the ability to manage this and are confident in doing so in the future. One positive aspect of the high attrition rate is that it signifies a strong demand for these skills. We have observed that critical areas such as analytics and digital have not experienced increased attrition, and we are successfully managing those areas. We believe we are in a stronger position compared to some of our peers, and we aim to continue this management. Retention remains our top priority, as it's essential to win the minds and hearts of our workforce. I also want to highlight the outstanding work the team has accomplished in the past two quarters. Considering our growth rate, the level of engagement, and the execution we've achieved, it's been impressive. We are very pleased with the team's performance.

Operator, Operator

And our next question comes from the line of Maggie Nolan with William Blair.

Maggie Nolan, Analyst

Nice quarter. You gave some data points around how your employee base of analytics-focused employees is growing nicely. So what does that look like in terms of the percentage of overall employees? And how has that been trending? And as that grows, should we expect it to have an impact on your revenue per employee over time?

Rohit Kapoor, CEO

Thanks, Maggie. So yes, the headcount in our analytics business has grown very nicely, and it's grown by 50% year-over-year. We have a very strong recruitment program from the premier colleges and institutions in the U.S. and in India, and we continue to build our brand in these institutions. The total headcount for the analytics business has certainly increased as a percentage of our total headcount. This is something that continues to drive up. Yes, the revenue per headcount will continue to move up as our employee base in analytics expands.

Maggie Nolan, Analyst

And then at the gross margin level, has there been much of an impact from the transition of the healthcare clients? And is that something you can continue to offset at the operating margin level in the back half of the year here? Or how should we be thinking about the dynamics at both gross and operating margin levels?

Maurizio Nicolelli, CFO

Maggie, sure. So let's talk a little bit about the gross margin. The gross margin this quarter came in at 36.2%. So it was affected to a certain extent by healthcare by our transitioning clients during the period. You saw the healthcare gross margin come down also. Going forward, we are projecting a higher gross margin in healthcare in Q3 and Q4, trying to return to recent levels from Q1 and Q4. It had an effect during the period on our gross margin. We had nice operating leverage on our SG&A line, which really was an offset and helped us drive to 18.7% in adjusted operating margin. But moving forward, the 36.2% gross margin was affected by healthcare, and also by increments that we paid earlier in the year, which contributed to the lower gross margin. We are forecasting a higher gross margin as we approach the second half of the year.

Operator, Operator

And our next question comes from the line of Ashwin Shirvaikar with Citi.

Ashwin Shirvaikar, Analyst

Guys, I guess my first question is with regards to the stronger growth profile in '22. How does that impact the medium-term outlook? There's only one other year remaining there. Do you think of it in terms of tougher comps, elevated exit growth rate? Or are you contemplating a different growth profile into next year because of an economic downturn or slowdown?

Rohit Kapoor, CEO

Sure, Ashwin. So in terms of the comps, for us, 2021 was a year when we saw the return back of the demand from the pandemic, and it became a high-growth year for us. Therefore, our growth rates in '22 are based off that higher growth number in '21. So frankly, we think that the comps are pretty much consistent, and they're going to continue in this direction. The lift that we are getting is from both our businesses on data analytics and our digital operations and solutions. Both these businesses have accelerated their growth rates. We think the fundamental reason why this has accelerated is because our data-led approach, which applies to both analytics and our digital operations and solutions, is resonating strongly with our clients. Our clients want to make improvements based on data, and whether it is making better business decisions or running better operations, both these require data to be understood. We think that this data-led approach is what's helping us. We do think the macroeconomic environment will be volatile and uncertain. But like we said, we think that the use of data in this environment becomes even more critical. We expect that to continue. Regarding our guidance into the medium term and '23, we will provide color on that when we provide our guidance for '23 at the end of the year. For now, our pipeline and demand environment remain strong.

Ashwin Shirvaikar, Analyst

Got it. Got it. And then on digital ops solutions, the gross margin, I know it tends to be down sequentially, I think, from Q1 to Q2, but on a year-over-year basis, it was down almost 400 basis points. Anything to call out that's driving that? I might have missed it; I was a little late, I'm sorry. Is there any impact, say, from attrition or productivity commitments? And how should we model that for the rest of the year and into next?

Maurizio Nicolelli, CFO

Yes. Ashwin, in terms of the gross margin in digital operations, it is affected by two things. One is the lower gross margin in healthcare that I discussed earlier, and the second is that we've invested a lot for new client ramp-ups. Given our growth rate within digital operations and solutions, we needed to invest more for new client ramp-ups, which is positive because it helps us drive revenue into the second half of the year. So as you look at that gross margin in the second half of the year, you should consider the Q4, Q1 percentages, which will more accurately reflect the second half of the year.

Operator, Operator

And our next question comes from the line of Vincent Colicchio with Barrington Research.

Vincent Colicchio, Analyst

Yes. So Rohit, I'm curious, do you have any new economy clients that are facing funding challenges, which could be an issue going forward?

Rohit Kapoor, CEO

Yes, Vincent. So for us, just so you know, in terms of our overall portfolio, we've got very little exposure to new economy clients, whether they be FinTech or Insurtechs or others. We certainly do business with a number of them. But as a percentage of our total revenue and total profit, it's still a very small number. To your specific question about whether we have exposure to any of these new-age companies that might be having concerns about their credit quality, we don't have any such customer in our portfolio currently with a challenged position. We are fortunate that our portfolio is pretty clean and doesn’t have much exposure to this part of the economy, which seems to be drifting down. We also don’t have any customers with associated credit risk.

Vincent Colicchio, Analyst

On your decisioning application you introduced for the banking sector, what is your vision there? Will we see more of these types of applications in the near future? Is there a pipeline you're working on?

Rohit Kapoor, CEO

Yes, absolutely. This is a very conscious, deliberate, and proactive approach we are taking, which is how can we offer a solution as a service to our customers? That's something we are trying to implement across our portfolio. We do believe that clients are looking for solutions where they pay on a usage basis and a consumption model. Clients want to access these solutions on the cloud and leverage the deep knowledge and capability of their partners in this area. This is something we will continue to pursue, whether it be about risk decisioning, data management, marketing analytics, fraud and risk management, or managing delinquencies. We will keep investing in areas where we can offer a usage-based or consumption-based service offering to our clients. We believe this approach will be very attractive to clients and beneficial for us.

Operator, Operator

Thank you. I'm showing no further questions. With that, we would like to thank you for participating in today's conference call. This does conclude the program, and you may now disconnect.