ExlService Holdings, Inc. (NASDAQ:EXLS) Q3 2022 Earnings Conference Call October 27, 2022 10:00 AM ET
Company Participants
Steve Barlow – Vice President of Investor Relations
Rohit Kapoor – Vice Chairman & Chief Executive Officer
Maurizio Nicolelli – Executive Vice President & Chief Financial Officer
Conference Call Participants
Bryan Bergin – Cowen & Company
Puneet Jain – JPMorgan
Moshe Katri – Wedbush Securities
Kate Kronstein – William Blair
Vincent Colicchio – Barrington Research
Robby Bamberger – Robert W. Baird
Operator
Good day and thank you for standing by. Welcome to the ExlService Holdings Conference Call. [Operator Instructions] Please be advised that today’s conference is being recorded.
I would now like to hand the conference over to your speaker, Steven Barlow, Vice President, Investor Relations. Please go ahead.
Steve Barlow
Thank you, Kurt. Good morning, everyone. Thank you for joining EXL’s Third Quarter 2022 Financial Results Conference Call. I’m Steven Barlow. 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 Q3 2022 earnings release we issued this morning. We have 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 call. During the 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
Thank you, Steven. Good morning, everyone. Welcome to our Q3 2022 earnings call. I hope all of you are doing well.
Following our strong performance in the first half of 2022, I am pleased to report another great quarter in Q3. Our third quarter revenue was $361.4 million, up 4.2% from Q2 and up 24.5% year-over-year. For the quarter, adjusted EPS was $1.54 per share which is up 18.5% year-over-year. Our Analytics business continues to drive revenue growth, generating $166.3 million in revenue for the quarter, up 3.1% sequentially and 38% year-over-year. For the first nine months of 2022, our Analytics business grew 42.6% year-over-year. Analytics now accounts for 46% of our total revenue. Our Digital Operations and Solutions business also had strong growth, growing at 14.8% in the third quarter to $195.1 million on a reported basis. For the first nine months of 2022, Digital Operations and Solutions revenue increased 13.8% year-on-year which is faster than our expectations. The third quarter growth in our Digital Operations and Solutions business was due to strong double-digit revenue growth in our insurance business which grew 18.6% year-over-year and our Emerging Business which generated year-over-year growth of 25.9%.
In the current macroeconomic environment, our clients are facing heightened volatility and uncertainty and they are looking to streamline operations, reduce costs and improve end customer experience. In this environment, our business model has become even more relevant and strategically important for our clients. We have all the tools necessary to drive this transformation. By harnessing data, we are helping our clients make better business decisions, embed intelligence in the workflow and streamline operations. We are doing this with tremendous speed to create an immediate impact, both in terms of cost containment and improved customer experience.
I would like to share a few examples of recent client engagements that help to illustrate how we are rapidly scaling solutions to help our clients reduce costs and improve customer engagement. We recently developed a powerful solution with a major U.K.-based utility that completely transformed their customer service engagement.
By analyzing unstructured customer interaction data, we were able to immediately identify disconnects between the back office and the front office that were driving operational inefficiencies and creating a poor user experience. Our data-led approach to finding and closing those gaps resulted in reducing the number of manual handoffs and eliminated error-prone processes that were causing the problems. We also introduced a conversational AI solution that helped cut customer service processing times and created a more seamless and engaging user experience. In another example, we have been collaborating with a large U.S.-based multiline insurance carrier to expand its life insurance distribution network. By capturing a wide range of traditional and nontraditional data sets, we’ve been able to create a true 360-degree view of the customer journey. This detailed customer view is then used to optimize cross-sell and upsell opportunities, matching the right agent with the right customer at the right time. The end result is a more targeted, efficient sales channel that can offer more personalized policies to customers.
We have also launched a new risk decisioning engagement with a major multinational bank. This is a new key logo for us which leverages our robust risk modeling capabilities and our deep operational expertise in the banking industry. The goal of this initiative is to develop an advanced credit risk strategy that supports smarter decisions for unsecured lending products. Here, again, we are deploying our data-led strategy to streamline operations on the credit decisioning side while improving customer experience in the form of real-time lending approvals. This combination has become incredibly valuable in the current market environment.
Now, I would like to talk about our talent and employee engagement. We continue to expand our talent base to stay ahead of growing demand, particularly in the areas of analytics and digital. Year-to-date, we have added 5,700 employees to our workforce. That’s more than we added in the entire year of 2021. Much of that talent acquisition has been focused on complex and in-demand capabilities such as data engineering, data science, AI and cloud.
In light of our data-led business strategy, we acquired talent that excels at the intersection of data and domain. We have also been successful in building a strong internal talent base through a well-planned strategy of digitally driven learning and development. Employee engagement with our on-demand learning platforms is very high. Approximately 71% of our employee population has regular engagement with our learning platform. About 2,800 employees have earned new certifications on the learning platform in the third quarter alone. We continue to invest heavily in creating the resources our employees need to thrive and grow at EXL and as professionals.
Our company-wide employee attrition rate has now stabilized to our pre-pandemic levels. Our employee retention rate in Analytics has consistently been encouraging in a high-demand talent market environment. We, therefore, believe EXL continues to remain an attractive destination for quality talent. Our pipeline of opportunities is strong with numerous large deals with strategic clients in Analytics and Digital Operations and Solutions. We have also added 40 new logos year-to-date across all business lines. Going forward, I remain optimistic about our continued growth prospects.
Before I turn the call over to Maurizio, I wanted to remind you that we are hosting an in-person Investor and Analyst Day on the morning of November 16 at 320 Park Avenue. We look forward to sharing our updated strategic vision for growth with you.
With that, I’ll hand over the call to Maurizio.
Maurizio Nicolelli
Thank you, Rohit and thanks, everyone, for joining us this morning. I will provide insights into our financial performance for the third quarter and the first nine months of 2022, followed by our revised outlook for 2022. We had a solid third quarter with revenue of $361.4 million, up 24.5% year-over-year on a reported basis. On a constant currency basis, revenue was up 26.4% and 4.8% sequentially. Adjusted EPS was $1.54, up 18.5%. 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 $195.1 million, up 17.2% year-over-year. Sequentially from the second quarter, revenue was up 6.1%. Insurance generated revenue of $116.2 million, up 20.3% year-over-year, driven by expansion in existing client relationships in life and annuities, property and casualty and new client wins in 2021 and 2022. The insurance vertical, consisting of both our Digital Operations and Solutions and Analytics businesses, grew 16.6% year-over-year. Emerging reported revenue of $56.1 million, up 31.1% year-over-year. This growth was driven by higher volumes in travel and transportation and new client wins in 2021 and 2022. The Emerging vertical, consisting of both our Digital Operations and Solutions and Analytics businesses, grew 38.3% year-over-year.
Healthcare reported revenue of $22.8 million, down 16.4% year-over-year, driven by lower volumes in our clinical services business. The healthcare vertical, consisting of our Digital Operations and Solutions and Analytics businesses, grew 9.3% year-over-year. Analytics generated revenue of $166.3 million, up 29% year-over-year on a constant currency basis. Clairvoyant contributed $12.5 million of revenue in the third quarter. Including Clairvoyant, Analytics grew 39.4% year-over-year. Growth in the third quarter was driven by new client wins in 2021 and 2022 and increased volumes in banking and financial services and payment integrity. Sequentially from the second quarter of 2022, Analytics grew 3.5%, demonstrating strong demand across our Analytics services.
Our SG&A expenses decreased by 150 basis points year-over-year to 18.4% driven primarily by operating leverage. Our adjusted operating margin for the quarter was 18.5%, down 90 basis points year-over-year, driven by investments in the ramp-up of new client wins and higher operating expenses as we return to the office. Our effective tax rate for the quarter was 24%, up 70 basis points year-over-year. This increase was due to higher taxes in certain jurisdictions driven by a change in profit mix, offset by higher tax credits. Our adjusted EPS for the quarter was $1.54, up 18.5% year-over-year on a reported basis.
Turning to our nine-month performance now. Our revenue for the period was $1.04 billion, up 26.8% year-over-year on a constant currency basis and up 22.7% on an organic constant currency basis. The growth was driven by Analytics, Emerging and Insurance. In line with our expectations, adjusted operating margin for the first nine months was 18.4%, down 80 basis points year-over-year, driven by investments needed for the ramp-up of new client wins, digital capabilities and higher operating expenses as we return to the office. Adjusted EPS for the period was $4.46, up 23.2% year-over-year on a reported basis.
Our balance sheet remains strong. Our cash and including short- and long-term investments on September 30 was $294 million and our revolver debt was $270 million for a net cash position of $24 million. In the first nine months of the year, we generated cash flow from operations of $101 million compared to $114 million in the same period last year due to higher variable compensation and higher cash taxes. During the first nine months, we spent $32 million on capital expenditures and repurchased $69 million of our shares at an average cost of $136.
Based on the strong performance in the first nine months of the year and our current outlook for the fourth quarter, we are increasing our guidance for 2022. Our revised 2022 guidance is as follows: Revenue is expected to be in the range of $1.39 billion to $1.4 billion. This represents year-over-year growth of 24% to 25% on a reported basis and 21% to 22% on an organic constant currency basis. This is an increase of $35 million at the midpoint which includes a foreign exchange headwind of $6 million from the previous guidance of $1.35 billion to $1.37 billion. We expect a foreign exchange gain between $5 million and $6 million, net interest expense between $1 million and $2 million and our effective tax rate to be in the range of 23% to 25%.
Based on the above, we expect our adjusted EPS to be in the range of $5.85 to $5.95, up 21% to 23%. We expect capital expenditures to be in the range of $37 million to $42 million. As interest rates continue to rise, we will allocate free cash flows to both buyback and repayment of debt.
As Rohit mentioned, we believe the demand for our services in our verticals of Analytics and Digital Operations and Solutions will become even more relevant and strategic in the current environment. Inflation pressures remain a concern. However, we believe we have the tools to manage costs without sacrificing our culture, our commitments to our customers and stockholders.
Rohit and I will now be happy to take your questions.
Question-and-Answer Session
Operator
[Operator Instructions] Our first question comes from Bryan Bergin from Cowen.
Bryan Bergin
I wanted to start on demand. Any updated color you can give there just around client decision-making? Any material changes really in tone versus 90 days ago? Has the composition of the pipeline changed too with high macro certainty? And if you can just within all this touch on your non-U.S. client conversations, that would be helpful, too.
Rohit Kapoor
Sure, Bryan. So the demand environment for our services continues to remain strong. It is strong for our Digital Operations and Solutions business as well as it’s strong for our Data Analytics business. We see that demand being strong across a cross-section of clients across industry verticals that we operate in. The pipeline for us is actually very robust and very healthy. We do see larger deals in the pipeline. While there have been some deals where decision-making has been pushed off, we’re also seeing deals where decision-making is actually being accelerated and clients are making their plans for 2023 and want to get ahead of that. This is probably the most well-advertised recession-free environment that we’ve ever seen. And therefore, it feels like everybody has planned for it in adequate measure.
Non-U.S. pipeline and non-U.S. client activity continues to be — also remain very healthy. We’re seeing good traction in terms of our clients and prospects in U.K. in Australia and New Zealand and the APAC region and really can’t point to any areas where there might be concerns. We were looking very closely at the marketing analytics spend. And that’s one area that we were very cautious about. And we have been pleasantly surprised that the depth of that change is actually not that strong at present. So we continue to remain watchful. We continue to kind of monitor the situation as we go along very, very closely. But so far, we haven’t really seen anything that causes us concern.
Bryan Bergin
Okay, that’s good to hear. Shifting to margin then, can you give us the latest thoughts on adjusted operating margin potential as you move through 4Q and potentially longer term? And just on the OpEx side, understanding you may not return to the same expense base that you were at pre-pandemic but as you think about a new normal in expenses going forward in a more hybrid world, where do you stand roughly today relative to that future expense base as it relates to return to office and travel and facility expenses? Just trying to understand how much more headwinds you may have to work against going forward.
Maurizio Nicolelli
Sure, Bryan. This is Maurizio. So when we started out the year, we talked about our adjusted operating margin being in the low 18% range for the calendar year. And that’s where we have ended up. We’ve been — we ended Q3 with an 18.5% adjusted operating margin. For year-to-date, it’s 18.4%. So we’re right in line, slightly above where we talked about our baseline for 2022 would be. And that’s also incorporated in our guidance for the rest of the year. Going forward, we continue to bring employees back to the office. We do have just globally, about 1/3 of our employees back to the office. But we do talk about a hybrid model being 1/3 of our employees being working from home, 1/3 being hybrid and 1/3 working from home. And so essentially a breakout of 1/3 between the three buckets.
We still have incremental expense from a good portion of our employees coming back to the office. But we do see as a baseline, that low 18% range as our margin for 2022 and a good starting point for 2023.
Operator
[Operator Instructions] We have our next question available now. Please welcome Puneet Jain from JPMorgan.
Puneet Jain
Great quarter and it was good to see large deals in the pipeline, some of which could be moving at a faster pace. Are there any common areas or client needs, where you are seeing acceleration in decision-making in the current environment?
Rohit Kapoor
Thanks, Puneet. So we are seeing larger deals in the pipeline. We are seeing more integrated deals in the pipeline as well. And by integrated, I mean deals that involve a lot more of digital, automation and analytics being — simultaneously being embedded into our Digital Operations and Solutions business. The area where we are seeing more strength in terms of the pipeline and the demand is certainly around our Insurance business which — there’s a lot of legacy work out there that needs to be modernized. There is a lot of change in the business model that needs to happen with the insurance carriers and they seem to be moving on that pathway pretty rapidly. And so we’re seeing good traction in that space.
We’re also seeing good traction in our Emerging Business vertical which is across traditional industries like utilities, travel, transportation and logistics. And again, the use of automation, the use of digital to improve customer experience and to reduce costs, that’s where we’re seeing most of the activity. So frankly — and you’re seeing this in our Digital Operations and Solutions segment growth rate which has gone up much higher than what our expectations were at the beginning of the year. And we think that that’s a strong, stable trend that is likely to continue.
Puneet Jain
Got it. Got it. And then your Q4 guidance on – implied Q4 guidance suggests sequential decline in revenue. Is that related to macro weakness that could have impact on analytics and marketing analytics side of the business? Or is there any specific client, maybe healthcare and operations management where you expect some sort of sequential decline?
Maurizio Nicolelli
Puneet, when you look at our guidance for the rest of the year in Q4, at the higher end of the range, it’s fairly flat with Q3. And so that — what’s in our guidance is a little bit of just uncertainty in the market for the rest of the year. When we come out with guidance, we have to look at just our own internal pipeline but also look at just the overall uncertainty in the market. The midpoint of the guidance still puts you right around 20% organic growth rate on a year-over-year basis. The higher end puts you at a little bit higher than that. So there’s a level of conservatism in our guidance just because of the uncertainty just in this overall market that we operate in today.
Operator
Our next question comes from Moshe Katri with Wedbush Securities.
Moshe Katri
Let me add my congrats on very strong numbers. So just big picture kind of question. From your perspective, can you talk a bit about how you feel about the business in terms of the resiliency of the business model, especially as we’re approaching a slowdown? And maybe you can compare that to the ‘07, ‘08 time frame, talk a bit about the end markets, the customers you talk to, the decision-makers, et cetera. What can – from your perspective, how do you feel versus where we were at during the last cycle in terms of the downturn?
Rohit Kapoor
Sure. Thanks, Moshe. Look, I think the way in which we have positioned our business which is entirely a data-led strategy, the ability to create value for our clients leveraging data actually works really well in a healthy economic environment and it works very well in a difficult economic environment as well. At this point of time, we are seeing our clients actually continue to make investments in analytics, continue to make investments in terms of leveraging data and continuing to make investments in terms of automation and streamlining their operations. And that’s exactly where we help our clients and that’s why we think we’ve become much, much more strategic partners to them. We do think that our business model is going to be resilient. It’s very different as compared to the ’07, ’08 time frame, where there was a dramatic impact for the financial services industry. And we are just not seeing that at this point of time right now. There — certainly, there are pockets where the demand has gone down. So for example, mortgage certainly has gone down quite significantly. Investment banking fees have certainly gone down quite significantly. But those are not the areas where EXL plays and we don’t have much exposure to those areas.
So frankly, we feel very good about our portfolio. We feel very good about the business model and the framework that we have of a data-led value creation framework that allows us to actually go through the cycle, I think, in a pretty streamlined manner.
Moshe Katri
All right. And just as a follow-up, some of your peers clearly seem to be kind of getting ready for that slowdown. I guess they’re kind of maybe pausing some offers that they’ve had for new recruits, et cetera. What’s EXL’s kind of strategy here in terms of getting ready for that pause or maybe a slowdown?
Rohit Kapoor
I think the approach that we have is we don’t want to miss out on the demand environment. And right now, frankly, we still have a challenge in terms of the supply side. So we’ve got everything kicking into high gear on the supply side. But at the same time, we are extremely disciplined and watchful for any sign of a slowdown that might take place. And so we are well prepared to be able to act on it. The good thing about our business model is that almost 70% to 75% of our cost structure is a variable cost structure. So our ability to manage that at short notice and with short cycles is actually very good. So we think we can manage that quite well. But at this point of time, we are still continuing to add talent to be able to meet the demand requirements of our clients.
Operator
Our next speaker is Maggie Nolan with William Blair.
Kate Kronstein
Hi, everyone. This is Kate Kronstein on for Maggie Nolan. Congrats on a great quarter. My first question is how much of the growth in digital operations is more of a function of the current macro and changing spending preferences? And kind of a follow-up on that, how sustainable do you see this level of growth moving forward?
Rohit Kapoor
Yes. Kate, for us, the growth that we’ve seen so far in our Digital Operations and Solutions business is largely on account of growth that we get from our existing clients, so our existing clients expanding the amount of work that they do with us and the new clients that we signed up in 2021 and the early part of 2022. So it doesn’t really factor in the new economic environment so much into it because, as you know, in Digital Operations and Solutions, the lead time for us to win a client and onboard a new client is fairly lengthy and it takes us 6 to 12 months to be able to implement and execute that. Some of the conversations that we are having now, those are the ones where we are saying they are larger deals. And these deals are focused on the dual mandate of cost containment and improving end customer experience. And I think some of that will play up over the next couple of quarters.
Kate Kronstein
Okay, great. That’s helpful. And then just one more question. On the Healthcare segment, what do you expect are the growth drivers of the Healthcare segment moving forward? And what gives you confidence that it will return to sequential growth within the segment?
Rohit Kapoor
Sure. So on the Healthcare, the way in which we think about that business which represents about 20% of our overall revenues, is an integrated business which has health care analytics. It’s got clinical services and it’s got our payment integrity business out there. And when we take a look at our integrated healthcare business, that’s actually still growing very nicely at about 9.3% this year. We have had a client that was transitioning which we’ve mentioned previously. So some of that will always take place in — and that can happen in any industry vertical. It’s not just limited to healthcare. And we’ve seen that happen to other industry verticals as well.
What we feel good about is the healthcare opportunity for us is very large. The use of data, automation and technology in healthcare is still lagging behind banking and financial services and, in fact, even lags behind other industry verticals. So frankly, the opportunity set out here is tremendous. And therefore, we are continuing to invest in this area and we think there’s a tremendous amount of value that we can create for our clients, leveraging data in healthcare. And we hope to be able to position ourselves for that growth and that value addition.
Operator
We’re setting up our next question and this person is Vincent Colicchio from Barrington Research.
Vincent Colicchio
I had a question on your top 3 and top 5, the client concentration declined sequentially. Is that due to your healthcare client, or is there something else going on there?
Rohit Kapoor
Right, Vincent. No, there’s nothing going on out there. I think our portfolio, as we grow, is certainly broadening out and expanding. We still have great relationships and great opportunity to continue to grow our top 5 clients. And we — it’s just a matter of timing and it’s just a matter of when that kicks in but nothing unusual going on out there right now.
Vincent Colicchio
And is there any new developments with your new economy clients currently versus 90 days ago?
Rohit Kapoor
For us, Vincent, the new economy clients still represents a very small fraction of our overall portfolio. So again, we are not heavily exposed out there. And also the work that we do with our clients out there is largely around finance and accounting and some of the shared services work which is very stable and hasn’t really seen any change as such. So nothing that causes us concern with that part of the business.
Operator
Vincent was cut off there. I don’t know if he lost connection or not. [Operator Instructions] Our next question currently is Robby Bamberger. And Robby is with Robert Baird.
Robert Bamberger
It looked like Clairvoyant was $12.5 million this quarter and had been running at $10 million to $11 million before. Can you maybe talk about how this acquisition is performing to your expectation? And it seems like it’s outperformed given your initial run rate. And then any other M&A that you’re looking at now?
Maurizio Nicolelli
Sure, Rob. So Clairvoyant, the acquisition has gone very well as planned from what we had talked about early in the calendar year. If you look at the integration of Clairvoyant, we’ve done a very good job on the operations side in terms of integrating it with the rest of our analytics group. But also, even more importantly, we have done very well in cross-selling their capabilities which was really important to us strategically when we made the acquisition. We talked about revenue from Clairvoyant adding between $40 million and $45 million to our overall revenue for 2022 and that’s coming in very nicely. Obviously, for the first three quarters, it came in at $34 million. With Q4, it should be well in the middle to the higher end of that range.
So we feel very good about the integration, the cross-sell of Clairvoyant with the rest of our analytics sales team and then also the performance in terms of revenue and also adding just immaterially but overall to the bottom line.
Robert Bamberger
Yes, that makes sense. And then in terms of the U.K., it looked like a nice sequential year-over-year growth there. Anything causing that acceleration there? And are you expecting that to continue?
Rohit Kapoor
Sure, Robby. We won some strategic clients in the U.K. and we continue to see good traction in our portfolio out there. Some of those clients that we’ve won as well as the expansion with some of our clients in the Utilities business is giving us nice growth in our Emerging segment. And we think the pipeline there is healthy. The dialogue that we have with our clients there is quite good. And so we’d expect that trend to continue.
Operator
[Operator Instructions] Thank you for your participation in today’s conference. This does conclude the program and you may now disconnect.
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