Earnings Call Transcript - EXLS Q1 2021

Operator, Operator

Good day, and thank you for standing by. Welcome to the Q1 2021 ExlService Holdings, Inc. Earnings Call. I would now like to hand the conference over to your speaker today, Mr. Steven Barlow. Please go ahead.

Steven Barlow, Vice President of Investor Relations

Thank you, Amanda. Good morning, everyone. Thank you for joining EXL's first quarter 2021 financial results conference call. I'm Steve Barlow, EXL's Vice President of Investor Relations. With me today in our offices in New York 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 Q1 2021 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 those measures to GAAP can be found in the press release as well as the investor fact sheet. I'll now turn the call over to Rohit Kapoor, EXL's Chief Executive Officer. Rohit?

Rohit Kapoor, Chief Executive Officer

Thank you, Steve. Good morning, everyone. Welcome to our Q1 2021 earnings call. I hope all of you and your families are safe and healthy. I'm pleased to report a strong start to 2021. EXL generated first quarter revenues of $261.4 million, which represents a 4.7% sequential increase and a 5.5% year-over-year increase, both on a constant currency basis. Our strong performance was led by our Analytics business, which secured new wins across multiple industry verticals. Further, we successfully expanded within our existing strategic clients by penetrating new buying centers and offering new solutions. Adjusted EPS for the quarter grew by 46% year-over-year to $1.18, driven by lower operating expenses. Our Analytics business had an outstanding quarter, crossing $100 million in quarterly revenue for the very first time. We reported $102.3 million in revenue, representing a 4.1% sequential growth and a 10% year-over-year growth. The primary driver of this growth was our data-led marketing solution, which experienced strong demand this quarter as our clients resumed their customer acquisition and growth initiatives. We are also seeing accelerated adoption of our data and analytics services, which is driving growth in our strategic clients across banking, health care, and insurance. Our Operations Management business reported revenues of $159.1 million in the first quarter, up 5.1% quarter-over-quarter, driven by the ramp-up of large deal wins in Healthcare, Life and Annuities Insurance, and Banking. As we focus on growth in 2021, we recognize that we are working through a period of continued impact from the COVID-19 pandemic. Specifically, there is a new surge of infections in India, the Philippines, and Colombia. The situation in India is particularly concerning due to the substantial increase in the number of cases, combined with an overwhelmed health care infrastructure. Our delivery locations in Noida, Gurgaon, Pune, and Bangalore are amongst the most affected regions in India. Even though almost everyone is working from home, we have team members and their families who are directly impacted by the virus. The top priority for us in this environment is the health and safety of our employees. We are taking proactive measures. And today, almost all of our employees are working from home in India. We are also helping our employees by investing in and facilitating easier access to medical care through partnerships and support groups. Our clients have been very supportive and flexible, demonstrating a true spirit of partnership in these trying times. We are keeping our clients apprised of the situation and are collaborating with them to ensure steady operational resiliency. To date, we've had minimal disruption to our service delivery and are actively engaged in managing the situation as it evolves. Our primary client markets are bouncing back as vaccination rates continue to climb throughout the United States, the UK, and Europe. Increasingly, we see a trend towards clients making bigger, bolder investments in building out data, analytics, and digital capabilities. Our clients are laser-focused on delivering superior customer experiences, improving speed, and building and scaling future-ready operating models. As a result, our data-led value creation framework is resonating very well in the market, and we continue to see momentum across two vectors: one, enabling better business decisions by leveraging deep data and analytics capabilities; and two, delivering superior customer outcomes by applying cloud-enabled AI solutions. The increased demand for data and analytics is moving in lockstep with the large-scale transition of customer interaction to digital channels. Our clients are investing in highly personalized, direct-to-consumer marketing to enable more effective customer acquisition and retention. This results in a larger addressable market for our data-led marketing solutions and proprietary marketing analytics algorithms. The second vector where we are gaining market traction is the adoption of EXL's AI-powered solutions in the cloud. Our clients are pursuing speed as their primary goal, which in turn drives enhanced customer experience, superior business outcomes, and improved efficiency. However, current business processes are constrained by legacy technologies and heavy dependence on manual intervention. In order to become data-driven and effectively harness the power of AI, our clients would have had to redesign enterprise-wide platforms and processes, which is expensive, time-consuming, and has a low success rate. In contrast, EXL's AI solutions are deployed upstream on the cloud and are easily configurable. This generates clean data flows that intermediates downstream legacy processes and technology. The cloud ecosystem allows us to swiftly deploy machine learning and AI-driven interventions along with automation to enable what we call the AI operating system. Our ability to transition clients to an AI operating system creates powerful business impact. The understanding of current state business processes, combined with AI-powered cloud solutions, minimizes execution risk and accelerates speed of transition. An example of this work in action is an engagement we entered into with one of the largest independent title insurance businesses to modernize their title search process. The company's legacy title search process was time-consuming, entirely manual, and distributed across several vendors. Using EXL's AI operating system, the firm was able to seamlessly migrate to an entirely cloud-based automated search process that improved both the speed and accuracy of the title search and will enable our clients to capture market share much faster than the competition. This engagement positions EXL as the cloud-enabled AI transformation partner of choice. In addition to delivering for our clients, our mission to find a better way means we are committed to doing our part as a global citizen to build a better future by operating in a responsible and sustainable manner. At EXL, we have taken several actions to enhance our sustainability programs over the past year. In the fall of 2020, we published our first annual sustainability report, which was developed in accordance with the Global Reporting Initiative Standards and aligned to the United Nations Sustainability Development Goals. We recently signed up to become a participant of the United Nations Global Compact. More recently, we expanded our sustainability disclosures in our proxy statement and have provided metrics and long-term goals relating to our environmental commitments and workforce diversity. Among such goals, we intend to raise the representation of women, particularly in leadership positions at EXL from 18% to 25% by 2025. Lastly, as you know, after 19 years of service, Pavan Bagai has decided to retire from EXL on October 1, 2021. Pavan has been an architect of EXL as well as a mentor and confidant of many within the company, including myself. He has been a great partner for me in building the organization into what it is today. Pavan's career with EXL mirrors the company's own growth. His leadership established the foundation of our Operations Management business; his guidance helped develop the Analytics business, and it is his insight that has enabled our shift to digital. Pavan has been instrumental in navigating the company through every challenge it has faced. Pavan will leave an indelible mark on the organization and for each of us. Over the next several months, Pavan's responsibilities will be transitioned to other members of the leadership team at EXL. We are fortunate to have the next cohort of leaders who are now ready to pick up the mantle. All of us at EXL will miss him, and we wish him all the very best. With that, I will turn over the call to Maurizio.

Maurizio Nicolelli, Chief Financial Officer

Thank you, Rohit, and thanks, everyone, for joining us this morning. I will provide insights into our financial performance for the first quarter of 2021, followed by our updated outlook for 2021. As Rohit mentioned, our quarter was better than expected with revenue of $261.4 million, up 6.3% year-over-year, and adjusted earnings per share was $1.18. All revenue growth numbers mentioned hereafter are on a constant currency basis. Revenue from our Operations Management business, as defined by three reportable segments, excluding Analytics, was $159.1 million, up 2.8% year-over-year. Sequentially from the fourth quarter, revenue was up 5.1%. Insurance generated revenue of $91.2 million, up 7.6% year-over-year, driven by expansion in existing client relationships. Compared to the fourth quarter of 2020, revenue was up 2.1%. Healthcare reported revenue of $30.3 million, up 12% year-over-year, driven by higher volumes in our Clinical Services business and new wins of 2020. Sequentially, Healthcare grew 25%. Emerging reported revenue of $37.7 million, down 12.5% year-over-year, due to the reduction in travel and transportation volumes. However, we are seeing good traction in this business now, and we won several new logos in the first quarter of 2021. Analytics had revenue of $102.3 million, up 10% year-over-year. This growth was driven by higher volumes across all industry verticals with expansion in existing client relationships and new wins in 2020 as clients embrace data-led solutions. Compared to the fourth quarter of 2020, revenue was up 4.1%. Our SG&A expenses increased by 100 basis points year-over-year to 18.7% of revenue, driven by investments in front-end sales and marketing. Our adjusted operating margin for the quarter was 20.2%, up 540 basis points year-over-year, driven by improved operating margins due to cost optimization measures and lower infrastructure expenses. Our GAAP tax rate for the quarter was 21.9%. Excluding the impact of discrete items, our normalized effective tax rate for the quarter was 24.2%. Our adjusted EPS for the quarter was $1.18, up 45.7% year-over-year. EXL's balance sheet continues to remain strong with a focus on liquidity and cash flow generation from operations. Our cash and short-term investments at March 31 was $376 million, and our debt was $239 million for a net cash position of $137 million. We generated cash flow from operations in Q1 of $15.2 million compared to a negative cash outflow of $13.6 million in Q1 of 2020. Our DSOs at March 31 was 54 days. During the quarter, we spent $12.7 million on capital expenditures, as we continue to invest in the business for long-term growth. We repurchased 313,000 shares at a cost of $27 million. Now, moving on to our guidance for 2021. The economic environment in the U.S. and U.K. is improving, while COVID-19 is surging in our delivery geographies, such as India and the Philippines. We will continue to assess the situation and respond to changing circumstances with the primary focus being the health and safety of our staff. We feel confident that we can manage our delivery commitments. In addition, we know our business model is resilient and agile, as demonstrated by our improving sequential quarter-over-quarter performance since the trough in the second quarter of 2020. We are increasing our revenue guidance for 2021 to be in the range of $1.04 billion to $1.07 billion, up $10 million at the top end of the range. The increase in our revenue guidance is driven by our strong first quarter exit momentum and better visibility in our business despite an FX headwind of approximately $1 million. This represents a year-over-year growth rate of 9% to 12% on a reported basis and 8% to 11% on a constant currency basis. This guidance also aligns to the medium-term revenue targets we disclosed in our Investor Day in November. We expect Analytics to grow over 15% and Operations Management to grow in the range of 6% to 8%. We expect a foreign exchange gain between $2.5 million and $3.5 million, net interest expense of $3 million to $4 million, and our effective tax rate to be in the range of 23.5% to 24.5%. In terms of capital allocation, we will continue to invest in analytics, digital solutions, and technology. We expect capital expenditures to be in the range of $35 million to $40 million. We anticipate buying back our shares at a pace slightly higher than what we did in 2020. Based on the above, we expect our adjusted earnings per share to be in the range of $4 to $4.30, up 13% to 22%, driven by our higher revenue expectation, along with increased business efficiencies. As the year unfolds, we expect our margins to decline in subsequent quarters. We plan to increase our investments in digital, data, and analytics to accelerate growth in 2022 and beyond. As we discussed last quarter, we expect to incur increased costs due to the reinstatement of salary increments and higher technology costs related to the hybrid operating model. In addition, during the latter part of the second half of the year, we anticipate increased operating expenses on facilities, transportation, and travel depending on a return to a more normalized operating environment. In conclusion, we had a good start to 2021, despite the challenges created by the pandemic. We have demonstrated a flexible and resilient business model, which enables us to create new data-led and digital solutions to meet our clients' transformation agendas. Now Rohit and I would be happy to take your questions.

Rohit Kapoor, Chief Executive Officer

Amanda, could you queue up the questions, please?

Operator, Operator

Your first question comes from Bryan Bergin with Cowen.

Bryan Bergin, Analyst

I wanted to ask just on the India surge impact and the risk around that. Does the risk impact certain businesses more than others? Can you dig in a bit more there on the potential service disruption magnitude and how we should be thinking about that? I know you mentioned minimal service disruption so far, but what are you thinking forward here?

Rohit Kapoor, Chief Executive Officer

For us, the India geography represents about 45% of our revenue delivery capabilities. It really represents all industry verticals across the board, perhaps a little less so in health care, which is much more skewed towards the Philippines and Colombia. At this current point in time, like we mentioned on the call, nearly 100% of the work that's being done is being accomplished by our employees working from home. We really do not have anybody coming into the office, and it depends on how the surge of the virus and the infections continues and for how long it lasts in India. The situation on the ground is not very good right now because the medical infrastructure is unable to cope with the demand for healthcare right now in the country. That creates a problem not only for our employees but also for their families, and that's generating the challenges and the issues. The impact is going to be across all businesses; it is not really tied to any one business.

Bryan Bergin, Analyst

A follow-up here on margins. So specifically, Ops Management gross margin looks to be at record levels. Can you unpack the drivers there in the quarter? Is it the mix of work, anything that's one-time? Can you give us a sense of what is lasting within that outperformance?

Maurizio Nicolelli, Chief Financial Officer

A few things are happening within that margin. One is, we did have some additional revenue during the quarter that flowed through to the bottom line, which really helped the Ops Management margin. Additionally, we are seeing a good amount of efficiencies in our Ops Management. So we've been able to operate our business and keep headcount more efficient than over the last 12 months, and you're starting to see some of that reflected within our Ops Management margin. Lastly, we are benefiting from some cost reductions due to the environment we're in. That is also contributing to the Ops Management margin. Going forward, the lasting impact should be mainly from that cost efficiency as we aim to be leaner.

Operator, Operator

Your next question comes from Maggie Nolan with William Blair.

Maggie Nolan, Analyst

I'm curious about what specific considerations are given in the guidance, considering the developments in India and the Philippines, particularly around those margins you were just discussing with Bryan?

Rohit Kapoor, Chief Executive Officer

As of right now, our business has not been impacted at all. Like we said, there's been minimal disruption to our ability to fulfill the demand of our clients, and we are seeing strong demand and a robust pipeline of activity right now. Our assumption in our guidance assumes that we will have minimal disruption going forward. However, that's something we need to monitor as the situation evolves. We don't really know how this will unfold in India and the Philippines. In the Philippines, the rate of infection seems to have stabilized, which creates a better hope. However, in India, the rate of infection has significantly increased, which does create its own challenges. It really depends on how long this continues and what the impact on our employee population will be. Our number one priority is to ensure our employees can stay healthy and safe, and we will provide them with the best medical care and attention we can.

Maggie Nolan, Analyst

To dig into that further, are you referring to disruption from a logistical delivery standpoint or are there additional considerations in terms of productivity? My second question concerns your AI solutions. Can you clarify the proprietary components in relation to your partner ecosystem, and how are the AI solutions incorporated into your pricing structure within contracts?

Rohit Kapoor, Chief Executive Officer

The disruption is primarily due to the impact of the infections on our employees or their immediate families. As you know, in India, many of our employees live in extended family environments and must care for their family as well. We have adequate planning and a buffer in terms of a bench of resources, allowing us to flexibly manage this across our employee population. However, it depends on how this progresses and how long it lasts. Regarding AI solutions, we are developing both proprietary solutions and embedding some partner solutions into our proprietary capabilities rapidly over the last 12 to 15 months. What is proprietary is our understanding of the domain of our customers' business and the technology application within those processes. We have track records, data, and performance scorecards associated with the intervention of these proprietary capabilities. Our clients are engaging with us more actively regarding the adoption of AI solutions in the cloud, and we see tremendous opportunity here.

Operator, Operator

Your next question comes from Puneet Jain with JPMorgan.

Puneet Jain, Analyst

Following up on Maggie's question in Analytics. As you offer more solutions, will the revenue model differ from what it has been in the past? Will it move more towards a SaaS-based model for some of those offerings, or still remain FTE-based?

Rohit Kapoor, Chief Executive Officer

Overall, we expect that as we introduce more proprietary and partner interventions, we will shift towards outcome-based pricing models and transaction-based pricing models. We have seen a noticeable shift in Q1 towards transaction-based and outcome-based pricing models, both in Operations Management, where we’ve deployed digital technologies, as well as in Analytics, where some of our current work is driven by outcome-based pricing models. The data-driven marketing initiatives that we had, which had a strong component in the first quarter of 2021, were primarily driven on an outcome basis. Therefore, we anticipate more outcome- and transaction-based pricing in Analytics.

Puneet Jain, Analyst

What was the incremental license fee revenue that drove margin upside in the Healthcare vertical this quarter?

Rohit Kapoor, Chief Executive Officer

We haven't shared anything specific on the Healthcare vertical from a licensing perspective. Our Healthcare business in Operations Management grew nicely over the previous quarter and year-over-year due to several new clients we signed up in 2020, which we onboarded through the year, resulting in visible revenue in the first quarter. But all that is based off the Operations Management work that we do for our clients there.

Operator, Operator

Your next question comes from Vincent Colicchio with Barrington Research.

Vincent Colicchio, Analyst

I'm curious if a meaningful portion of your employees in India have COVID or have COVID in their families as of yet?

Rohit Kapoor, Chief Executive Officer

We track the number of employees that have been impacted by COVID, but we don't share that publicly. What I will share is that the percentage of our employees directly affected by COVID is in the low single digits. However, when considering family impacts, that number significantly increases. Therefore, we ensure our employees can take care of themselves and their families, supporting them during this time.

Vincent Colicchio, Analyst

What needs to happen to hit the high end of your revenue outlook for the year?

Rohit Kapoor, Chief Executive Officer

One positive factor is that the demand environment is very strong. Our pipeline is very robust. We would need to effectively convert that pipeline into actual revenue. Additionally, we should avoid significant disruptions affecting our delivery capacity to meet the robust demand we see from clients. We are experiencing notable strength in data and analytics as well as in our industry verticals, meaning the demand side appears to be broad-based. The challenge might arise from fulfillment and our ability to convert demand into revenue.

Operator, Operator

Your next question comes from David Grossman with Stifel.

David Grossman, Analyst

Could you review the commentary about the margin trend during the year? I wonder what you have visibility on today in terms of higher expenses as the year progresses and what component of that margin guidance is more variable depending on the pace of reopening and other elements associated with returning to normal?

Maurizio Nicolelli, Chief Financial Officer

Let me dig a little deeper into our AOP and margins for the rest of the year. We had a very good Q1 in terms of margins, just over 20%. This was driven largely by the revenue increase, which fell to the bottom line alongside certain cost efficiencies from our current work-from-home environment. Going forward, we have several areas where we plan to invest, including digital, data, and analytics. We will also be investing in technology to support a hybrid operating model. The return to office projections in the second half of the year presents further uncertainties. While we anticipated a more substantial return in Q3, it may be delayed to later in the year for various locations, especially India and the Philippines. Consequently, our thinking regarding margins reflects these considerations along with a bit of conservatism given the uncertainties in the market due to the COVID surges in India and the Philippines.

David Grossman, Analyst

Can you size some of those items, such as the margins and investments, to understand their impact on the year? How significant are they?

Maurizio Nicolelli, Chief Financial Officer

If you look at the additional investments and technology spending along with the return to office expenses, they should be fairly equal in terms of total impact. None of the three will significantly outweigh the others. I would space them evenly throughout the remainder of the year.

David Grossman, Analyst

Did you provide any specifics on the first quarter regarding the OP business? Were there any one-time revenue contributions that drove margins?

Maurizio Nicolelli, Chief Financial Officer

There have certainly been some one-time items. However, the primary driver remains the return of volumes on the Ops Management side, especially in insurance and healthcare. That's immensely significant.

David Grossman, Analyst

Regarding how client conversations have evolved, I understand there was a quick shift last year. How are conversations now about your commitment to a hybrid work-from-home model, and are there any impacts on contracting and pricing?

Rohit Kapoor, Chief Executive Officer

Conversations with clients are transparent and collaborative. Clients have been very flexible with us in terms of how we conduct our work, and they trust us with more responsibility. Hybrid constructs mean that when we return to the office, social distancing will necessitate more office space and thus increase the infrastructure cost per employee. The costs of working from home are lower, but when combined, the overall cost structure remains fairly neutral. Our clients understand this, and they appreciate our attempts to establish a structure that allows employees to work from home but still facilitate essential in-office meetings to foster alignment of business objectives, cultural coherence, and innovation.

David Grossman, Analyst

So your current reading is that it will be neutral to margins moving forward?

Rohit Kapoor, Chief Executive Officer

Yes, it's neutral to both pricing and margins.

David Grossman, Analyst

Regarding the robust pipeline you've discussed, could you give us a sense of activity in 2021 compared to 2020 and 2019?

Rohit Kapoor, Chief Executive Officer

The pipeline is significantly stronger than previous periods, indicating strong double-digit growth. We're seeing acceleration in our decision-making velocity, which is shortening the sales cycle. This positive momentum indicates that our clients are rapidly adopting digital channels for customer interactions, necessitating our swift support.

David Grossman, Analyst

Is any increase in the pipeline or velocity of decision-making attributed to an urgent catch-up from 2020, or is it primarily driven by long-term changes?

Rohit Kapoor, Chief Executive Officer

There may be a slight catch-up, but largely, the shift to digital channels for customer interaction is driving accelerated decision-making. Clients recognize the urgency of adapting to this change to remain competitive.

Operator, Operator

Your next question comes from Ashwin Shirvaikar with Citi.

Ashwin Shirvaikar, Analyst

I have a headcount question. It's obviously down sequentially and year-over-year against the backdrop of improving demand and acceleration you've mentioned. How much of this decline is due to productivity gains from automation versus specific verticals that are still not recovering, like travel? Secondly, what is your approach to hiring lower-level delivery employees in India and the Philippines given the current environment?

Maurizio Nicolelli, Chief Financial Officer

On headcount, there's a decline in Q1 versus Q4, but we see productivity gains year-over-year. In Analytics, we've been hiring to align with revenue growth, investing in critical roles that are in high demand. In Operations Management, we've achieved cost efficiencies over the last 12 months, resulting in a decrease in headcount, while our business in that area expands. This trend is consistent across all three of our Operations Management segments.

Rohit Kapoor, Chief Executive Officer

To address your hiring question, we're conducting remote hiring effectively, allowing us to onboard talent smoothly. However, we need to monitor hiring closely due to the recent surge in pandemic conditions in India.

Ashwin Shirvaikar, Analyst

Regarding margins, I noticed some good detail on factors influencing them. Why didn't you provide an updated margin outlook for the year? Should we assume that margins are ticking up by about 50 to 100 basis points higher than where you started the year?

Maurizio Nicolelli, Chief Financial Officer

The increase in our adjusted EPS implies that higher margins are coming for the year. While we aim to elevate margins, we recognize the importance of balancing this with market uncertainties in our delivery centers. Thus, while we increase margins, we do so cautiously, reflected in our adjusted EPS growth.

Operator, Operator

Your next question comes from Robbie Ememberg with Baird.

Unidentified Analyst, Analyst

It has been a couple of years since you last engaged in M&A. Given $4 per share in net cash, when do you expect to be ready to pursue a deal again, and which segments are most interesting to you?

Maurizio Nicolelli, Chief Financial Officer

We are actively seeking M&A opportunities in the market. Our pipeline is significant, although valuations are currently high, which presents a challenge. We are exploring targets across our business sectors, focusing on digital capabilities, additional analytics, and solutions within Insurance and Healthcare. However, we must ensure that the targets align strategically and are at the right valuation to drive return on invested capital. Given our capital position and consistent quarterly cash flow generation, acquisitions are inevitable, but the exact timing remains unclear.

Unidentified Analyst, Analyst

One last question on EPS guidance. Q1 was $1.18, and the rest of the quarter appears to average around $1 per quarter. Is there conservatism in that outlook, and can you provide details on the EPS growth cadence throughout the year?

Maurizio Nicolelli, Chief Financial Officer

We assess EPS growth based on year-over-year comparisons and consider where we will invest to drive growth in 2022 and 2023. The guidance reflects solid growth, coupled with additional investments later in the year. We're aware of the pandemic's impact on India and the Philippines and the uncertain return to office situations in different geographies, and this perspective informs our EPS guidance.

Operator, Operator

Thank you for joining. That does conclude today's call. You may now disconnect.