ExlService Holdings, Inc. (NASDAQ:EXLS) Q3 2023 Earnings Call Transcript

ExlService Holdings, Inc. (NASDAQ:EXLS) Q3 2023 Earnings Call Transcript October 29, 2023

Operator: Good day, everyone, and thank you for standing by. Welcome to the Third Quarter 2023 ExlService Holdings, Inc. Earnings Conference Call. At this time, all participants are in a listen-only mode. After the speakers’ presentation, there will be a question-and-answer session. [Operator Instructions] Please be advised that today’s conference is being recorded. I would like to now hand over the conference to your first speaker today, John Kristoff, Vice President of Investor Relations. John?

John Kristoff: Thanks, Maria. Hello, and thank you for joining EXL’s Third Quarter 2023 Financial Results Conference Call. On the call with me today are Rohit Kapoor, Vice Chairman and Chief Executive Officer, and Maurizio Nicolelli, Chief Financial Officer. We hope you’ve had an opportunity to review the third quarter earnings release we issued this morning. We have also posted an earnings release slide deck and investor fact sheet in the Investor Relations section of our website. As a reminder, some of the matters we’ll discuss this morning 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 SEC from time to time. EXL assumes no obligation to update the information presented on this conference call today. During our call, 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, slide deck and investor fact sheet. With that, I’ll turn the call over to Rohit.

Rohit Kapoor: Thanks, John. Good morning, everyone. Welcome to EXL’s Third Quarter 2023 Earnings Call. I’m pleased to be with you this morning reporting another strong quarter. We continued our growth momentum in the third quarter, with total revenue of $411 million, representing year-over-year growth of 14% on a reported basis and 13% in constant currency. We grew adjusted diluted EPS 21% to $0.37 per share. Our data-led strategy and balanced portfolio of businesses, bolstered by our differentiated digital and AI capabilities position us well to consistently deliver superior growth in an unpredictable environment. We delivered Analytics revenue of $183 million for the quarter, up 10% year-over-year and a sequential increase from the second quarter.

As anticipated, we experienced weaker demand and lower volumes in marketing analytics. Notwithstanding this headwind, we were able to achieve double-digit growth in our Analytics business. This growth was driven by strength in our payments integrity and data management service lines. In our Digital Operations & Solutions business, we generated third quarter revenue of $228 million, growing 17% year-over-year and 2% sequentially. This represents the 10th consecutive quarter of double-digit growth, which demonstrates the value clients place on our data-led integrated solutions. Each of our three segments within Digital Operations & Solutions delivered double-digit year-over-year growth during the quarter, with particularly robust performance in Insurance.

The slowdown in the macroeconomic growth environment is driving our clients to increase their focus on cost efficiency and improve productivity. As they make this pivot towards a lower cost operating structure, they are also looking to transform their operations. With EXL’s technological capabilities of data, digital and AI, combined with our domain expertise, we are able to create significant impact for our clients in an accelerated manner and with much greater certainty than they can achieve on their own. This has led to a material increase in demand for integrated digital operations which plays to our strengths across both our Data Analytics and Digital Operations & Solutions businesses. Our success pursuing large integrated deals is evident in our sales pipeline.

For the past six quarters, we have averaged 20%-plus year-over-year pipeline growth. And both our win rates and average deal sizes have increased. Over the past 12 months, we have won several deals over $50 million in total contract value, including a few deals over $100 million of total contract value. This validates the value clients see in our end-to-end solutions and gives us confidence in our ability to generate sustained double-digit growth going forward. Let me share an example of a recent win that illustrates the size, scope and level of integration to unlock value for our clients. One of the top insurance companies in the United States chose EXL as their partner to operate and transform their claims operation as part of a large multiyear deal.

We are the first point of contact for all claims, and responsible for moving the claim through the process. In addition to providing a multi-shore delivery model, we are transforming the operation through extensive use of analytics, digital and AI. For example, we are implementing an automated digital quality assistant that provides real-time monitoring and dashboard reporting of all KPIs. Our solution also includes an AI-based coaching module, which provides guidance to individual advisers. We are also implementing EXL’s smart data signals, which enables 100% real-time claim file review in a fully automated manner. This significantly improves claims outcomes by preventing leakage, improving customer sentiment and ensuring regulatory compliance.

This is just one high-level example of how we are combining all of our capabilities in analytics, data management, AI and domain expertise to maximize value for our clients. We continue to receive growing interest from our clients regarding use cases and data structure required to support generative AI. This bolsters our confidence that generative AI provides tangible growth opportunities for both our Data Analytics and Digital Operations & Solutions businesses moving forward. We are currently in more than 200 conversations with clients regarding generative AI use cases, and we have dozens of specific projects active in the sales pipeline. What is particularly encouraging is the diversity of use cases, which are leading us into new areas where we previously did not play.

For example, many of our clients struggle with software core management and modernizing legacy codes to contemporary code languages to upscale their analytics infrastructure. This process often entails meticulous code management, translation and testing. We recently developed a new GenAI-based solution for code conversion, leveraging our domain expertise. Our solution automates the transformation of legacy code to contemporary languages and features a robust debugging capability to ensure accuracy and efficiency. This significantly speeds this translation, while reducing the potential for errors. We are currently working with a leading global bank on a proof of concept to migrate close to 1 million lines of legacy SaaS code to Python. It will typically take many months to accomplish this.

But with our solution, it can be accomplished in a few weeks, allowing our clients to focus on retiring their technical debt. This is an example of how generative AI is helping us penetrate new buying centers as we now have several more customers interested in this solution. As planned, we have increased our investments in generative AI in the third quarter and will accelerate these investments further in the fourth quarter. This includes developing solutions, training and hiring specialists, and further strengthening our generative AI center of excellence where we currently have active GenAI engagements across all our key industry verticals. We believe these investments will position us well to capitalize on the strong pipeline of GenAI opportunities.

We also recently announced plans to invest in a new international operations headquarters in Dublin, Ireland. As part of the new center, we plan to hire up to 200 AI, data engineering and other specialized technology positions over the next three years. This builds upon our existing staff of more than 8,000 data scientists globally who are developing AI, cloud enablement and data integration technologies. As part of our investment, we will also establish new centers of excellence across our operations to develop best practices, improve efficiencies and reduce costs. This new center will also serve as a hub for intellectual property development and future geographic market expansion. Looking ahead, we are raising our 2023 revenue and EPS guidance given our strong third quarter performance and current visibility for the remainder of the year.

Maurizio will walk you through the details in a few moments. As we look forward to 2024, we are encouraged by the sustained growth in our revenue and EPS, the momentum in our growing sales pipeline and the underlying strength and resiliency of our business. We are well positioned with our current generative AI offerings and we continue to invest further in advancing our capabilities. This gives us confidence in our ability to sustain double-digit growth. And with that, I’ll turn the call over to Maurizio.

Maurizio Nicolelli: Thank you, Rohit, and thank you, everyone, for joining us this morning. I will provide insights into our financial performance for the third quarter and the first nine months of 2023, followed by our revised outlook. We delivered a strong third quarter with revenue of $411 million, up 13.7% year-over-year on a reported basis. On a constant currency basis, we grew revenue 13.2% year-over-year and 1.5% sequentially. Adjusted EPS was $0.37, an increase of 21.3% year-over-year. All revenue growth percentages mentioned hereafter are on a constant currency basis. Revenue from our digital operations solutions businesses as defined by three reportable segments, excluding Analytics, was $227.9 million, which represents year-over-year growth of 16.4%.

Sequentially, we grew revenue 2.3%. In the Insurance segment, we generated revenue of $136.4 million, an increase of 17.6% year-over-year and 6.3% sequentially. This growth was driven by the expansion of existing clients and new client relationships. The Insurance vertical, consisting of both our Digital Operations & solutions and Analytics businesses, grew 14.4% year-over-year with revenue of $170.8 million. In the Emerging segment, we grew revenue 14.7% year-over-year. This growth was driven by the expansion of existing client relationships and new client wins. Sequentially, revenue declined 2.8% to $65.3 million. The sequential revenue decline was driven by the bankruptcy of a client, Yellow Corporation. Excluding the impact of the bankruptcy, we expect revenue would have grown sequentially.

The Emerging vertical consists of both our Digital Operations & Solutions and Analytics businesses grew 4% year-over-year with revenue of $147.9 million. The Healthcare segment reported revenue of $26.2 million, representing growth of 14.8% year-over-year and a decrease of 3.6% sequentially. The year-over-year growth was driven by expansion in existing client relationships. The Healthcare vertical consisting of our Digital Operations & Solutions and Analytics businesses grew 28.6% year-over-year, with revenue of $92.3 million. In the Analytics segment, we generated revenue of $183.1 million, up 9.4% year-over-year and up slightly sequentially. Our decision analytics services, payment integrity and data management businesses continue to grow year-on-year, partially offset by the decline in marketing analytics as our clients in insurance and banking continue to reduce their marketing spend.

SG&A expenses as a percentage of revenue were up 180 basis points year-over-year to 20.2%, driven by investments in front-end sales, marketing, digital and AI capabilities. Our adjusted operating margin for the quarter was 20%, up 150 basis points year-over-year driven by higher volumes and revenue. Our effective tax rate for the quarter was 23.4%, down 60 basis points year-over-year, driven by higher profits in lower tax jurisdictions. Our adjusted EPS for the quarter was $0.37, a 21.3% increase year-over-year on a reported basis. Turning to our nine-month performance. Our revenue for the period was $1.217 billion, up 17.6% year-over-year on a constant currency basis. This growth was driven by both our Digital Operations & Solutions and Analytics businesses.

Adjusted operating margin for the period was 19.8%, up 140 basis points year-over-year. Nine-month adjusted EPS was $1.09, up 21.8% year-over-year on a reported basis. Our balance sheet remains strong. Our cash, including short and long-term investments as of September 30, was $275 million and our revolver debt was $210 million, for a net cash position of $65 million. We generated cash flow from operations of $132 million in the first nine months compared to $101 million for the same period in 2022. This improvement was driven by the expansion in our adjusted operating margin. During the first nine months, we spent $41 million on capital expenditures and repurchased $93.5 million of our shares at an average cost of $31 per share. Now, moving on to our outlook for 2023.

Based on our strong performance for the first nine months of the year and our current visibility across all verticals, we are raising our outlook for the year. We now anticipate revenue to be in the range of $1.62 billion to $1.628 billion, representing year-over-year growth of 15% on a reported basis, and 15% to 16% on a constant currency basis. This represents an increase of $9 million at the midpoint despite a foreign exchange headwind of $2 million from previous guidance. We expect a foreign exchange gain of approximately $1 million, net interest expense to be approximately $1 million and our full year effective tax rate to be in the range of 23% to 24%. Based on this, we anticipate our adjusted EPS to be in the range of $1.40 to $1.42, representing year-over-year growth of 16% to 18%, which is an increase from our prior adjusted EPS guidance of 15% to 17% growth.

We expect capital expenditures to be in the range of $50 million to $55 million. In summary, our data-led strategy is sound and is resonating with our clients. Our differentiated business model remains resilient due to our substantial recurring revenue and a well-balanced portfolio across our Data Analytics and Digital Operations & Solutions businesses. Our strong pipeline and high percentage of annuity revenue provide us with confidence in our ability to continue to deliver double-digit growth going forward. This, coupled with our expanding capabilities in data management and ongoing investments in generative AI, puts us in a strong position as we look to 2024. With that, Rohit and I would be happy to take your questions.

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Q&A Session

Operator: Thank you. [Operator Instructions] Our first question comes from the line of Bryan Bergin from TD Cowen. Bryan, go ahead.

Bryan Bergin: Hi, guys. Good morning. Thank you. I guess I’ll start here with the outlook. Can you just break down how you’re expecting Digital Ops and Analytics to grow in 4Q? And then just understanding it’s early here and the backdrop is quite uncertain, but we appreciate your commentary on sustaining double-digit growth. Can you just share some qualitative commentary on how you’re thinking about what’s going to remain consistent in ’24 versus ’23? What may not reoccur and maybe what might be incremental?

Rohit Kapoor: Sure, Bryan. So firstly, in terms of our guidance for the year and the implied guidance for the fourth quarter, we have increased our guidance as we mentioned by $9 million at the midpoint. This is despite a $2 million headwind on the currency side. And despite the fact that we have had one of our clients undergo bankruptcy and the volume has fallen off. We expect, after taking all of these things into consideration, that our fourth quarter would be flattish compared to our third quarter, and that’s across both of our business lines, and that’s how we would anticipate it might play out. Going forward, in terms of our double-digit growth, what we are seeing is we are seeing a very strong demand in the pipeline. We’ve seen our win rates increase.

We’ve seen the size of the deals increase. And therefore, we have confidence in terms of being able to sustain double-digit growth. What we are not sure of at this point of time is how would marketing analytics perform, and that’s something which, as we have shared with you previously, we’re looking to diversify our industry verticals within marketing analytics and focusing on areas of strength, particularly around data management, payment integrity and analytical services. Our expectation is that when we think about both of our business lines on Digital Operations & Solutions and on Data Analytics, both these business lines should be able to provide us with great growth opportunities. We would expect the Data Analytics business on a secular basis to give us double-digit growth as such.

And at this point of time, given the deals that we have already won, we think we’ve got — we are in a very good position as far as digital operations is concerned as well. So frankly, the portfolio seems to be performing well and it’s very well balanced, and we’re very pleased with the way in which things are at this point of time despite a pretty difficult macroeconomic environment.

Bryan Bergin: Okay. Appreciate that color. And then just on the margin here, as we kind of back into the implied 4Q adjusted operating margin, I think it would imply 18% or below. Is this just the timing of expenses you mentioned in kind of talent, GenAI solution development or any other top items to consider?

Maurizio Nicolelli: Yeah, Bryan, it’s — you’ve hit it a little bit on the head there, it’s a bit of timing. If you look at our AOPM for the first three quarters, we’ve had AOPM hovering right around 19.8%. So much higher than what we talked about in our guidance at the beginning of the year. And we talked about low to mid-18% range. So we performed very well on profitability in the first three quarters. We do have a number of investments that we want to make in Q4 in front-end sales, in marketing and also in our digital area, particularly in GenAI, which we were looking to do in Q3, that — some of that got postponed to Q4. And so that’s reflective in that high 17% to low 18% range of AOPM in the fourth quarter. And that doesn’t change our outlook going into 2024, it’s more of a timing for Q4. And that’s still — even with those percentage and that AOPM in Q4, you’re still at a 19% plus for the year given the performance of the first three quarters.