Exlservice Holdings Q3 2007 Earnings Call Transcript

Exlservice Holdings, Inc. (EXLS)

Q3 2007 Earnings Call

November 13, 2007 8:30 am ET

Executives

Jarrod Yahes - Head of Investor Relations and Corporate Development

Vikram Talwar - Vice Chairman and Chief Executive Officer

Rohit Kapoor - President and Chief Operating Officer

Matt Appel - Chief Financial Officer

Amit Shashank - General Counsel

Analysts

David Grossman - Thomas Weisel Partners

Ashwin Shirvaikar - Citigroup

Joseph Vafi - Jefferies & Company

Cynthia Houlton - RBC Capital Markets

Julio Quinteros - Goldman Sachs

Mitali Ghosh - Merrill Lynch

Dave Koning - Robert W. Baird

Presentation

Operator

Good day, ladies and gentlemen, and welcome to the Third Quarter 2007 ExlService Earnings Conference Call. My name is Grecian (ph) and I’ll be your coordinator for today. At this time, all participants are in listen-only mode. We will be facilitating a question-and-answer session towards the end of today’s conference (Operator Instructions).

I would now like to turn the presentation over to your host for today’s conference Mr. Jarrod Yahes, Head of Investor Relations and Corporate Development. Please proceed sir.

Jarrod Yahes

Thank you, operator, and thanks everyone for joining us today on EXL’s third quarter 2007 earnings announcement. Joining us today are Vikram Talwar, our Vice Chairman and Chief Executive Officer, Rohit Kapoor, our President and Chief Operating Officer, and Matt Appel, EXL’s Chief Financial Officer.

We hope you’ve had an opportunity to review the news release we issued this morning, as well as the power point presentation that is available for a view on EXL’s website in the investor relation section.

Let me quickly outline the agenda for today’s call. Vikram will first begin with an overview of the third quarter including specifics on some of our new client wins and the investments we’ve made recently in the front end of our business.

Rohit is then going to talk about some of the operational highlights we’ve had during the quarter, including a discussion of our success and workforce management and our international expansion. And Matt will then take you through the financial details and provide the revised outlook for the year 2007, and then close the presentation before we go on to take questions.

As a reminder, some of the matters we’ll discuss in this call are forward-looking and you should 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 certain statements.

Such risks and uncertainties include, but are not limited to, general economic conditions and 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 and you can find reconciliation’s of those measures to GAAP on the press release itself.

So now, let me turn the call over to Vikram, Vice Chairman and CEO of EXL. Vikram.

Vikram Talwar

Thank you, Jarrod, and good morning to everyone. We are very pleased to report that the third quarter 2007 performance was above our expectations and the business continues to demonstrate strong growth trends and operational performance.

We delivered revenues of $46.6 million in the third quarter, which represents growth of 8.4% from proceeding quarter. The continuation of our rapid revenue growth was driven by very strong performance in BPO.

The BPO business grew 46% year-over-year and 7.5% sequentially. The advisory business line also posted strong results and as expected the research and analytics business line turn the quarter this year with growth of 23% on a sequential basis to $5.3 million.

This quarter, I will touch on two themes, that our sharp focus as we plan EXL’s growth into 2008 and beyond. New client acquisition and the investments we are making in our sales and marketing and strategic account management functions.

In terms of new BPO client wins, we continued our industry leadership in the insurance vertical. Last quarter, we discuss the strength of the insurance pipeline. This quarter we're pleased to report that we had added a new leading U.S. insurance company as a BPO client. And there are two other insurance companies that we expect to close shortly.

Our strategic focus on the insurance industry is continuing to pay-off. And today, we are the clear leader in property and casualty and life insurance BPO in both quality referent creditability of our client base diversity and complexity of our insurance processes and the breadth of capabilities we offered to the industry.

The EXL offers unique transformation capabilities to the insurance industry that facilitates their efforts to improve their processes whether they outsource or offshore them to EXL or leverage our transformation capabilities. Within the banking financial services and insurance sector, our focus continues to be insurance.

As a reminder insurance represents just under half of EXL's revenues and we now have over 15 insurance clients. During the third quarter, we also added a leading U.S. investment bank as a finance and accounting client. And what we believe there will be a key long-term relationship for EXL.

All of the above mentioned wins have the ability to become strategic clients of more than $5 million of annuity revenue over the course of the next several years. Further more as we widened our lead in the insurance and banking verticals, we continue to demonstrate success a new industry vertical penetration on the hills of our win in 2006 with British Gas and the recent finance in accounting signing with the Fortune 500 transportation and logistics provider that we announced last quarter.

We are pleased to announce that we have established a significant new client relationship in the telecom vertical. While at this stage, the work is primarily voice based. We believe we will see strong growth opportunities going forward to provide a suite of back-office and analytical services encompassing the full range of our service offerings overtime.

While historically the telecom sector has aggressively outsourced customer service. Going forward, we expect there to be a significant opportunities to provide back-office and analytics functions that are mainly in-house at the major telecom companies and we believe we are well positioned to capitalize on this opportunity.

It is worth mentioning a few words on the current pricing environment. EXL continues to be extremely disciplined when it comes to price. In today’s global economic environment, we believe there is a broad understanding that the cost of inputs are increasing in India and that this is a result of both wage inflation and the appreciation of the Indian rupee.

As a result, we have been successful in introducing annual price increases and currency protection in our recent contracts that are tied to significant changes in cost factors. This changes protect both parties, our margins are attractively hedged while our customers can expect benefits of a long-term stable relationship. We believe that this is a healthy partnership respective for clients and offshore providers.

While, we are pleased with our current growth and the momentum we have created in the market. We continue to focus aggressively building the front-end of our organization both in terms of strategic account management and sales and marketing.

Within our strategic account management function this quarter, we added Andrew Gibson a senior Subject Matter Expert in Insurance. Andy brings over 23 years of experience in the insurance field and was most recently the head of EXL’s North America Insurance practice. We welcome Andy to the team with expectation that he will make a significant contribution to our efforts to bring transformational outsourcing solutions that add value to our strategic clients.

On the sales and marketing front, we continue to execute well on our vision to enable the engine to move client acquisition. During the third quarter, we welcome Krishna Nacha to EXL as the Chief Sales and Marketing Officer. Krishna has a strong industry background and he is welcome addition to the team. As he execute in our plan to invest in sales and marketing, our spend has increased from approximately 4.5% of sales last year to 5.5% during the third quarter of 2007.

We intend to continue to invest as we scale our front-end to our vertical expansion into 2008. I would like to end with the few comments about our relationship with Aviva and our exposure in the mortgage industry. As you know, EXL has a strong relationship with Aviva since 2003. And today, we are the largest provider of BPO services to Aviva.

Investors are also aware that one of the two contracts EXL has with Aviva is a build-operate-transfer contract that provides Aviva the option to take that Pune operations back in house. This option was previously available to Aviva as of January 2008 with the six month notice period.

On September 10, EXL modified its agreement with Aviva to push back the exercise date for the duty to April 2008. And also to shorten the notice period, Aviva is required to give EXL to three months. There has been a great deal of speculation recently regarding Aviva’s plans and its future BPO strategy.

But there has been no public statement by Aviva on its definitive decision. Due to strict confidentiality requirements between the parties, we are unable to provide any further details or comments on any speculation as to what options Aviva may or may not be considering at this time.

Further more, we are also unable to provide an estimate as to when we may have additional information to provide. Please be assured that we will report on this subject as soon as it is appropriate to do so. In the mean time, we will have no further comment on this subject.

With respect to mortgage industry as you know this industry continues to experience significant due rates in an unprecedented market environment. EXL has two clients in the mortgage industry that comprise approximately 7% of our revenues. IndyMac Bank is the largest at approximately 5% of our total revenues. We have a great relationship with IndyMac and believe that they have a well-won business model that leverages off shoring.

We will continue our transparent reporting on this subject, when and if there is a material change. If you have any questions about IndyMac business and outlook, we suggest you speak directly with them as they are naturally the best source for such information.

Now, let me pass it over to Rohit, to comment on our operations for the quarter.

Rohit Kapoor

Thank you, Vikram. I am going to highlight four critical areas of business performance for the quarter. These include our strong operational delivery across all three-business lines, progress in our research and analytics business, our efforts in talent management and the implementation of our strategy on international expansion.

Historically, EXL has had a very strong operational delivery capability. This capability has been institutionalize within EXL based on the rigorous implementation of highly discipline and mature operating processes as well as the use of proprietary tools and methodologies.

During the third quarter, EXL continue to successfully execute and deliver superior levels of service quality across all three-business lines. With the addition of a new client operation in the telecom vertical we have now been able to seamlessly manage operations across three geographic locations in India, Noida, Pune and Gurgaon.

The results of our most recent semiannual customer satisfaction survey reflects a significant step up in our scores and provides us with the confidence that we can continue to grow our business at a rapid pace.

Our BPO business continues to scale very well and the risk advisory business has now expanded into Europe and has minimal seasonality. As we discussed last quarter, the second quarter was considered to be the low point for our research and analytics business and we expected to gain significant traction in the second half of 2007.

I’m pleased to report that the third quarter was quite strong for the research and analytics business, as at posted revenues up 23% sequentially, and had a corresponding return to more normalize margins.

The increased volumes are broad based and on a combination of increased business from existing accounts, winning new accounts and successfully cross-selling to existing EXL accounts. This has resulted in a significant diversification of customer concentration in this business.

We are also particularly encouraged by our ability to attract research and analytics business, that is contracted and longer term in nature, as compared to traditional project base work. While this shift will take some more time to fully play out, it will enable this business to grow and scale along with the BPO business over the longer term.

Also, we have made key structural and management changes to facilitate growth of the R&A business and refined our focus on select offerings. Our efforts to provide integrated transformational and outsourcing services will be key to delivering enhanced value to our clients and to create differentiated competitive positioning.

During the third quarter EXL continue to invest in building robust HR practices within the organization. Our investments in training, management development and career passing for our employees are starting bear fruit.

We are very pleased to report that our attrition has improved again this quarter for the second quarter in row to 39%, a 3% improvement from the second quarter and a 5% improvement from the first quarter.

While we view this 5% reduction in attrition over two quarters as a strong positive trend, we continue to focus our efforts on the longer-term development of talent within the organization. This will be achieved through a more proactive talent management initiative, continued investment in leadership and functional skills training and the implementation of rigorous HR practices.

This quarter we made key management additions to our cooperate HR team and our compensation and benefits growth. We believe it will be critical to continue to groom talent within the organization and to attract new talent to scale up the organization.

During the third quarter, we have also posted significant progress in terms of execution of our international expansion strategy. We are please to report that during the third quarter we added a key member to the EXL team to lead our efforts to strategically manage global infrastructure and handle special projects.

This individual will be charged with developing EXL’s organic infrastructure footprint in locations around the globe as we respond to changing needs of our clients. Last quarter we announced the commitment to be operational in the Philippines within three to six months.

We have advanced this initiative significantly as we have secured a facility that will house approximately 800 seats and will be operationally ready in the early part of the second quarter of 2008. We also continue to evaluate strategic options for expansion in Eastern Europe.

Lastly, we held our semi annual client-marketing event in Lahoya (ph) California this past month. And I just wanted to provide some feedback on that event. What we are hearing is that our clients continue to look for transformational solutions that improve that back office operations in a more strategic manner rather than lift and shift outsourcing strategies.

We are also hearing that they want to diversify their delivery operations outside of India. We will continue to focus on executing on all of these important opportunity sets as we position EXL for the future.

Now, let me pass it over to Matt, who will provide more detail on our financial performance and guidance.

Matt Appel

Thanks Rohit. EXL’s revenue for the third quarter ended September 30, 2007 increased to $46.6 million up 31% from $35.7 million in the quarter ended September 30, 2006 and once again exceeded our expectation for the quarter.

As compared with the second quarter of 2007, revenue for the third quarter of 2007 increased $3.6 million or 8.4% including increases of $2.7 million or 8% in BPO and $1.0 million or 23% in research and analytics.

Within EXL’s business lines, BPO accounted for $38.0 million or 82% of total revenue in the second quarter. Analytics contribute $5.3 million or approximately 11% of total revenue and advisory contributed $3.4 million or approximately 7% of total revenue.

From a qualitative standpoint, BPO continues to benefit from both the growth and work perform for existing customers as well as work for new customers. Research and Analytics experience an expected strong quarter as compared to the second quarter of 2007 with the conversion of additional new client and crossover revenues.

Gross margin for the quarter ended September 30, 2007 was 36.0% compared to 39.7% in the quarter ended September 30, 2006. In the second quarter of 2007, our gross margin was 33.1%. The improvement experienced in the third quarter of 290 basis points is primarily attributable to improved performance and staff utilization in the research and analytics business as well as growth in our BPO business.

From a currency perspective, the rupee appreciated only 1% during the third quarter compared to the unprecedented depreciation of 7% during the second quarter, while the U.K. pound appreciated approximately 2% during the third quarter.

With approximately 52% of our revenues denominated in U.K. pounds this natural head served to offset the impact of the rupee appreciation on our gross margin; therefore, compared to the second quarter of 2007, there’s been no net change in the impact of currency on our gross margin.

We yielded approximately $2.3 million of gains from our hedging program during the third quarter, which delivered substantial cash flow, but please keep in mind that these gains don’t help us from a gross margin perspective and are also not sustainable over the longer term.

Finally, I would like to point out the gross margin for our advisory business was 44.1% for the quarter ended September 30, 2007 compared to 29.8% in the previous quarter. Third quarter gross margin reflects the change in bonus allocation among our business lines as compared to the second quarter, that’s the reason for the difference.

Adjusted operating margin for the quarter excluding the impact of stock compensation expense and amortization of intangibles was 13.0% for the quarter ended September 30, 2007 compared to 15.7% for the quarter ended September 30, 2006 and 10.0% for the quarter ended June 30, 2007.

The increase in adjusted operating margin of 300 basis points sequentially is primarily attributable to the improved performance in staff utilization in a research and analytics business as well as growth in our BPO business that I mentioned previously.

During the third quarter, we experienced an anticipated increase in sales and marketing expense for approximately 80 basis points as a percentage of revenue as we executed on our investment strategy in both sales and marketing and strategic account management.

As we discussed previously, we have an active hedging program in which we hedge our rupee and U.K. pound exposure approximately 15 to 18 months in for the future. While we realize gains of $2.3 million from this program in the third quarter, our expectation is that due to the continuing weakness of the U.S. dollar our realized gains in the fourth quarter would approximate $2.5 million of currency rates remain at current levels.

Again, I would remind you that this level is not sustainable and our expectation is that gains from hedging program in 2008 will be significantly lower than 2007 levels.

As we have pointed out in the past, our business is very complex from both the services and geographical standpoint and as a result, we expect that our effective tax rate will experience fluctuation from quarter-to-quarter.

Our effective tax rate for the third quarter of 2007 is 22% as compared to 5% in the second quarter of 2007 and stand at 15% for the nine months ended September 30, 2007.

The geographic distribution of our income in the third quarter, principally due to improved performance and research and analytics and the impact of exchange rate fluctuations on realized gains for our hedging program are the principal reasons for the rate change. We expect our effective tax rate for the full year 2007 to fall between 15 and 20%.

Before opening the floor for your questions, I’d like to concluded by providing guidance for the full year of 2007. Based on the strong revenue performances we’ve experiences so far this year and our increasing level of confidences in the business going forward.

We are increasing our revenue guidance’s to between $176 and $178 million from $168 to $172 million previously. In addition, we are maintaining our adjusted operating margin guidance before stock compensation expenses and amortization of intangibles at 12% of revenues for the full year.

Finally, with respect to diluted earnings per share guidance for the full year, we are revising this upward to between $0.76 and $0.80 per share from $0.74 to $0.78 per share previously. Please note that we’ll provide guidance’s on 2008, at the time of our fourth quarter 2007 earnings release in early 2008.

This time, we’d now like to open the floor to your questions.

Question-and-Answer Session

Operator

(Operator Instructions) And your first question comes from the line of David Grossman of Thomas Weisel Partners.

David Grossman - Thomas Weisel Partners

Thanks, and I guess, good afternoon to you all. Just quickly a couple of questions on some of the new business, you talked about the activity in the quarter as well as the prospectus I think, for two new insurance clients in the fourth quarter.

Can you give us a sense for the size of those contracts and the rate at which those contracts you expect ramp in terms of timing?

Vikram Talwar

Hi Dave, this is Vik here. The size of the contracts, as we mentioned in the earlier transcript was basically, these are also going to be strategic clients and we expect these to overtime generate approximately $5 million as the definition that we have for strategic clients.

In terms of timing, we anticipated that we should be closing the contracts in this quarter and hopefully see some ramp ups comings through in the first quarter of 2008.

David Grossman - Thomas Weisel Partners

I’m sorry Vikram, what did you say the revenue level was for a strategic client?

Vikram Talwar

Was $5 million.

David Grossman - Thomas Weisel Partners

On an annual basis?

Vikram Talwar

On an annual basis, overtime obviously. Right.

David Grossman - Thomas Weisel Partners

And you talked about the telecom opportunity and the contract that you assumed in the fourth quarter, are you going to assume. Can you help us better understand just how near-term the telecom opportunity is, in terms of, what you’re seeing within the telecom vertical that would adjust perhaps the potential for that vertical to accelerate year over the next 12 to 24 months?

Rohit Kapoor

Hi, David. This is Rohit. I’ll take that. The activity for the client in the telecom vertical actually began in the third quarter and it’s started off on 1 of September 2007. This year we will obviously not be earning revenue for the full year with these clients and we would expect that we would be able to realize our full year revenues in 2008, as well as to see some expanded business with this particular client relationship.

The opportunity set for us with this particular client is both on the voice side, as well as, on the back-office side; where there are a number of opportunities in finance and accounting and research and analytics related work, that we would hope to undertake for this particular relationship.

It’s also a client that gives us an entry into the telecom vertical, which is a very large and substantial vertical and can be a great opportunity set for us to participate particularly for doing finance and accounting and back-office work for the telecom vertical.

David Grossman - Thomas Weisel Partners

Okay. And if I can just again stay on the some of the new contracts, you talked about foreign currency protection that you're getting in some of your new contracts. Can you help us understand the mechanics, of how that’s working? And what kind of protection it offers to EXL?

Matt Appel

Sure. The way in which we are structuring our customer contracts with new clients is to give them a fixed price, as long as the currency remains within a band. And the range of band is something, which we negotiate with each customer, typically it ends up being a exchange based band of plus-minus 2% to plus-minus 5% at the widest end.

So, the pricing remains fixed as long as the currency remains within that particular exchange rate band and outside of that exchange rate band, the pricing is adjusted either upwards or downwards in order to reflect the change in the foreign exchange rates.

David Grossman - Thomas Weisel Partners

Okay. And then just a question on the tax rate. I know Matt; you talked about, obviously a pretty big uptick in the fourth quarter based on your guidance for the year. Is that dynamic or is that level for this year, or should we think about that being a level that we should be modeling for 2008 as well?

Matt Appel

Well, David. Thanks for the question. No, we’re not providing any tax guidance, in fact any financial guidance for 2008. I’m happy though to speak to the change that we’ve experienced here in the third quarter and what we expect for the fourth quarter.

And to the extent that we experienced more U.S. based income as we do, for example, in our research and advisory business, and analytics business has performed as it had in the third quarter. We will experience significantly higher tax rate and that’s what we had in the third quarter, quite a bit more U.S. income and hedge gains also are taxable to us in the U.S.

And so, both of those things came to bear on our tax rate in the third quarter; we’re taking some actions here that are too preliminary to discuss. But for now, I feel that the current level of taxation is about what you might expect for the fourth quarter, which is why we gave guidance in the 15% to 20% range for the full year.

David Grossman - Thomas Weisel Partners

Okay. And just one other question, really is related to capacity, utilization and margins. It looks like the BPO margins were relatively flat sequentially, and it would assume that you should have gotten some benefit from slightly better utilization in the new facilities.

So, I'm wondering if you could just help us understand better kind of the margin dynamic that you’re experiencing in the BPO business, sequentially, as well as whether the better capacity utilization should drive that up in the fourth quarter.

Vikram Talwar

Specifically better capacity utilization would drive higher margins, David, and you’re right that the margin sequentially remain unchanged but there are also factors that play in terms of gross margin in terms of the cost in India and so it’s not related just entirely to capacity utilization.

Cost related to for example to transportation and to other employee related costs and certain factors that are above the line and other elements of cost come through those, but we are committed to offsetting those kind of cost increases in productivity, which is why you see the margins kind of holding rather study given the constant exchange environment.

David Grossman - Thomas Weisel Partners

So, I guess, how should we think about that? Because sequentially I think you’ve said that the currency did not necessarily impact the gross margins. So as I look sequentially, what were the, kind of, costs if you will that increased sequentially, that offset the leverage that you typically see given the better capacity utilization in the September quarter.

Vikram Talwar

That really too detail to really drive into at this time, David. But, just, I would expect that margins, gross margins in that side of our business for Q4 remain relatively the same, at this level of revenue so at approximately the 36% rate.

And that’s where we settled into in the current currency environment. I think that’s a good measure as this business has got larger its approaching $38 million worth of revenue in the third quarter. I think it’s really hard to move the margin needle too significantly with any one item.

David Grossman - Thomas Weisel Partners

Okay, Thanks. Just last one last, I’m sorry.

Vikram Talwar

Go ahead.

David Grossman - Thomas Weisel Partners

Just one last question, it was really just on the rupee, what your guidance, what’s the rupee rate that you’re assuming in your guidance?

Vikram Talwar

We’re assuming the current rate, which is approximately 39.2 somewhere between 39.5 and 39, 39.2, 39.3.

David Grossman - Thomas Weisel Partners

Okay, very good. Thank you.

Operator

Your next question comes from the line of Ashwin Shirvaikar of Citigroup.

Ashwin Shirvaikar - Citigroup

Hi, thanks, and congratulations guys on a very nice quarter. I know you cannot necessarily comment externally on Aviva and IndyMac, but is it fair to say that your appropriate expectations are included in your guidance.

I mean, your comments were a little bit uncertain. I just wanted to make sure that that was in your guidance.

Vikram Talwar

It very much is Ashwin. Its for the guidance that we given for the full year. Yes, it is included.

Ashwin Shirvaikar - Citigroup

Okay. I wanted to understand about 2008 as the hedging gains roll off. What should we see for operating profit? Is that an offset there in terms of, what we should expect?

Matt Appel

Hi Ashwin, this is Matt and I’ll take that. We’re really not giving any guidance or setting any expectations for 2008. But I’ll say about the hedging gains is that they will begin to roll off rather significantly, even the first quarter of ‘08 and throughout ’08, as you would expect.

But, we’ll speak in more detail about 2008 when we release our fourth quarter earnings in late February or early March.

Ashwin Shirvaikar - Citigroup

Okay. I just want to point out you are providing some guidance for ’08. But I think your hedging gains will roll-off but not providing the offset to that.

Rohit Kapoor

Could you Ashwin. Ashwin this is Rohit. If I can just add to Matt’s comment, the areas where we will benefit positively is as our research and analytics business continues to grow and get back to normal levels of profitability and volume that’s actually provide us with additional margin growth in 2008.

And we would certainly expect that that would happen and there are certainly other areas where we get leverage, which includes the price increases with our customers. It includes the operating leverage and a better utilization of our infrastructure. So some of the currency hedge gains, which will be reducing or some of those we will be able to offset with some of these measures.

Ashwin Shirvaikar - Citigroup

Okay. Got it. I just wanted to also drill down into the research analytics, the new contract that you are signing there. You said that they were broad based in longer term. Could you provide some quantification around what you mean by longer term, this multi year contracts?

Rohit Kapoor

Yes. Certainly, we signed up for example in the research and analytics business a new customer, which is a three-year customer contract. We’ve also increased a brief scope of business under an existing long-term contract that we have with one of our insurance clients.

So we are definitely seeing more annuity based revenue and these contracts are extending up to three years with volumes that will allow us for annuity-based work across multiple years.

Ashwin Shirvaikar - Citigroup

Right. And my last question is that Amit, you talked little bit about the change in bonus allocation. But I did not quite understand the implications, could you go through that?

Amit Shashank

Sure, sure. On each quarter, we revaluate our bonus provision as you’re expecting. What would be the slightly allocation in that provision that took place between the second and the third quarter has a dramatic impact on our smallest line of business.

And so there was a -- about $200,000 adjustment that we realize, we needed to make to that provision in the third quarter and it has a rather dramatic impact on their margins. A way to think about that business though is not in terms of this bonus adjustment but rather to look at the second and the third quarter together.

And what you see our margins that are pretty steadily at 36 to 37 gross margins, and that’s representative what that businesses level of that business performance, just that be this adjustment have skewed Q2 and Q3. That’s what we’re trying to point out.

Ashwin Shirvaikar - Citigroup

Okay. Got it.

Amit Shashank

As you look, Okay.

Ashwin Shirvaikar - Citigroup

Okay. Thank you.

Operator

Your next question comes from the line of Joseph Vafi of Jefferies & Company.

Joseph Vafi - Jefferies & Company

Hi, gentlemen and good quarter here. I was wondering if you could drill down a little bit more on to some of the comments you made on contracts and taken into account affects here.

Is this something that you believe or that you’re seeing start to emerge across the industry or is there’s something that more specific right now that EXL based on what you know in the industry?

Rohit Kapoor

Yeah. Hi, Joe. This is Rohit, and I’ll take that. We have seen this actually being adopted by the Tier 1 players on a much more broad base basis and also we are seeing customers agreeing to providing annual price increases in the contracts as well as agreeing to the foreign exchange protections.

So there’s a much better acceptance of that from the clients, there is a much more broad based industry acceptance of this practice, and I think that’s a very encouraging sign for this industry and for EXL.

Joseph Vafi - Jefferies & Company

Okay. Do you believe that the acceptance by the customer here is being driven by just still very strong demand or maybe more by just deeper partnerships and sharing risks and benefits and doing more for customers.

Rohit Kapoor

I think, it’s a combination of both of those factors, as well as the fact that clients wants to deal with partners that are going to be profitable and are going to be there to server them the long-term, and therefore they are willing to share the risk with their partners.

Its also being driven by the fact that the benefit that our clients receive is somewhere between 40% to 50% of cost savings and, therefore, their ability to absorb the exchange rate movements of 5% to 10% is much better than the ability on our part to absorb that kind of an exchange rate movement.

Joseph Vafi - Jefferies & Company

Okay. That’s helpful. And then maybe one question on the Philippine build out, how should we be looking at that relative to how much the build out right now is baked into your cost structure versus what might be additional incremental cost over the next few quarters?

Rohit Kapoor

So the Philippine build out in 2007 principally has some start up and operational cost built into it and which we’ve already factored into our financial guidance and plan for 2007.

It does involve a significant capital outlay, as well as cash outlay in terms of security deposits and rent advance payments, and we will be providing more color on that when we give full year guidance of 2008.

Joseph Vafi - Jefferies & Company

Okay. And then, if you could just remind us again your planning on generating revenue out of that facility in 2008 is earlier in 2008 or later in 2008?

Rohit Kapoor

Yes, we would expect to start operations from that facility and, therefore, to earn revenues, they’re beginning in Q2 of 2008.

Joseph Vafi - Jefferies & Company

Okay. Very good. Thank you very much.

Rohit Kapoor

Sure.

Operator

And your next question comes from the line of Cynthia Houlton of RBC Capital Markets.

Cynthia Houlton - RBC Capital Markets

Hi, just a couple of questions. First do we skip seat count some of those metrics?

Matt Appel

The seat count is currently at about 7,500 it’s actually 7,450 at the end of the third quarter.

Cynthia Houlton - RBC Capital Markets

And any split in terms of how that segments out by the different groups?

Matt Appel

No, we don’t break the seat count down by a group. That’s overall productive seat count.

Cynthia Houlton - RBC Capital Markets

Okay. And then just a follow-up on this telecom win that you’re stating out with voice services, obviously, it’s seems like an interesting opportunity, because you, you talked about some of the other non-voice opportunities over time.

When you find these customers are something that was laid out as a part of the contract or is it that you initially signed this client to do voice services and overtime you see the opportunities you discuss this over services? Or is it just that you are going to do the build out the voice first and than you are going to build out the other. Could you just clarify that in terms of where your contract is with them currently?

Rohit Kapoor

Sure, Cynthia the contract currency states that it's only for voice services. However, you may be have being participating in some of their requirements for back office and for research and analytics and other services.

So we are currently engaged in active dialog with this client in terms of talking to them about providing other types of services, which are back office and transaction processing.

Cynthia Houlton - RBC Capital Markets

Okay, that that’s helpful. And than in terms of, is it so, are you willing to give more clarity whether it's wireless or any mortality on the nature of the clients?

Vikram Talwar

Its, this is Vik, its wireless.

Cynthia Houlton - RBC Capital Markets

Okay. And then…

Vikram Talwar

Primarily.

Cynthia Houlton - RBC Capital Markets

Okay. And then this is someone that you see as a possibility in your current contract with them meaning the voice services that dial us an opportunity to be strategic or some more again those some of these other opportunities added in with what your current contract is?

Vikram Talwar

I believe it's both.

Cynthia Houlton - RBC Capital Markets

Okay. And then just in terms of the Philippines, have you talked about roughly 800 fees (ph) that’s kind of the first opportunity? Is this something that overtime, as your idea to can it expand in Philippines or are you thinking more, you need to have other geographies based on customer requirements like Eastern Europe or South America et cetera?

Rohit Kapoor

So, Cynthia we will continue to expand in the Philippines as we see the demand and as we continue to service clients out there. But having said that, we are focused in terms of expanding into other geographic locations as well.

And high priority for us right now is Eastern Europe. And we are currently carrying out diligence activities in Eastern Europe and also looking at different, an inorganic ways of being able to establish our presence there.

Cynthia Houlton - RBC Capital Markets

Thank you.

Operator

(Operator Instructions) Your next question comes from the line of Julio Quinteros of Goldman Sachs.

Julio Quinteros - Goldman Sachs

Hey, guys. Real quickly, can I get the operating cash, CapEx and free cash flow for the quarter?

Rohit Kapoor

Certainly Julio this is Matt. So the cash provided or generated from operations was $10 million.

Julio Quinteros - Goldman Sachs

Is that a nine-month a year or three months a year?

Rohit Kapoor

No. That’s a three months a year, nine-months figure if you would like that is $11.1 million from operations. Our free cash flow in the third quarter was $7.8 million and $4 million on year-to-date basis.

We've spent approximately $7 million worth of CapEx year-to-date and would expect to spend somewhere in the neighborhood of say $11 million to $15 million in the full year. And our expenditures on that $7 million of CapEx are fairly evenly spread throughout the year. We spend approximately $2.2 million during the third quarter.

Julio Quinteros - Goldman Sachs

Okay, great. And just wanted to go back to the nature of the work, it sounded like, facing everything you said that you guys are willing to start off with a voice-based contract and then move to additional services. What is the nature of the voice, I mean is this the kind of stuff that we’ve seen in the past where, there is some type of transaction associated with voice or is it more the kind of the commodity type work where its inbound outbound kind of work?

Rohit Kapoor

Julio, this is Rohit. The kind of work that we are currently engaged in is customer service front and it’s typically what we will do with the customer in new logical and then expand into other products and services.

It also involves activity which involves financial activity pertaining to the customer accounts; and therefore, it’s not just a low-end commoditized piece of business.

Julio Quinteros - Goldman Sachs

Got it. Great. And then if we were to look at the, there is -- I think you guys gave us this seats -- productive seats, but I wanted know what the total numbers seats was?

Vikram Talwar

That was the total number of seats that we gave you, 7,450.

Julio Quinteros - Goldman Sachs

7,450, total number of seats.

Rohit Kapoor

7,450 were the total seats.

Vikram Talwar

Got it, Okay, and then Rohit…

Rohit Kapoor

No, I am waiting for your next question over here.

Julio Quinteros - Goldman Sachs

And then, if I look at the revenue per head figure for you guys, just can you give us some general color on traditional trend of revenue per head.

Vikram Talwar

Just give us a second. You know we generally don’t publish that anywhere Julio. So, we’ll have to sit here and calculate it.

Julio Quinteros - Goldman Sachs

No. But, what -- I’m just trying to understand the productivity on a per head basis and maybe you guys have any sense on, whether things are actually going up, going down or they’re flat? What’s the directional trend of revenue productivity?

Vikram Talwar

It’s flat. Generally flat, at this point Julio.

Julio Quinteros - Goldman Sachs

Okay. But with pricing, kind of working in your favor going forward should we expect that to remain flat or should we expect some improvements on the pricing side to drive improvements on the productivity of the revenue?

Vikram Talwar

You should expect some improvements in the future inline with the kind of pricing improvements should Rohit talked about.

Julio Quinteros - Goldman Sachs

Okay.

Vikram Talwar

You know of course, Julio its easy to concentrate just on BPO business because it carries 82% of our revenue, but as the other parts of our business, we average in R&A, Research and Analytics continues to pick up momentum. We’ll see them contributing to that revenue very significantly.

Julio Quinteros - Goldman Sachs

Got it, okay. And then just going back to the commentary about the investment bank in F&A; what are there verticals are you guys already doing F&A working today?

Rohit Kapoor

So, we think F&A work in the insurance industry vertical. We do a fair amount of F&A work in mortgage and banking and financial services. We also signed up a large client in the transportation industry vertical this year, where the work is principally in finance and accounting. We also have media client that was signed up, which is again finance and accounting work. And then our large customer in the utility industry we do some finance and accounting work there.

Now, the nature of our finance and accounting work is a little bit different in the sense that we also have the added capability of doing finance and accounting work in our risk advisory group. And that typically, we are doing high end reconciliation work, as well as internal audit work, which is different types of processes within finance and accounting.

Julio Quinteros - Goldman Sachs

Okay. Got it. And then just to sort of finish out on kind of the end of year, and then possibly just some color into 2008. As we think about the budgets cycles finishing out 2008, sorry for 2007 and then looking at 2008, what should we be thinking about, what the impact is of budgets cycles to your current book of business?

And as they begin to sort of ramped down for ’07 and into ’08 how quickly should we expect these things to come back online for you guys assuming that there is any push outs or cancellations or delays in terms of budgets just getting all that sort of volatility that we’re seeing kind of at the back up right now?

Rohit Kapoor

So, our sense is that for the clients that we have within the insurance industry vertical they are relatively stable, and they have being making their plans and budgeting for that offshoring strategies in 2008. And we are already seeing what kind of demand there is likely to be in 2008 from some of these existing clients within the insurance industry vertical.

Also some of the new customer relationships that we have signed up are giving us fairly good visibility in terms of the volume of business that we can expect from them going into 2008. So I would say that despite the uncertainty and the volatility in the marketplace we are actually seeing very good visibility in terms of the volume of business going into 2008.

Matt Appel

Also bear in mind the large portion of our revenue in the year comes from a existing clients, and we don’t see anything slowing down there.

Julio Quinteros - Goldman Sachs

Yeah, and I appreciate that part of it, I guess, all I’m trying to get my arms around is even though their existing clients as they go through their own budgeting in a sort of cycles in a kind of at the end of year here, are you guys seeing any sort of conversations or having conversations as whether they’re coming back to you and saying anything along the lines of we want a whole things off or we’re pushing our plans for the ramp-ups. So that there would be a sequential impact as we kind of being to look at the first half of 2008, that’s what I am trying to get my arms around?

Vikram Talwar

Broadly, that most of our clients we see none of that. If in fact we are in discussions on possible ramps. The one exception possibly could be on the mortgage industry where you could possibly see some slowdown for all these reasons.

Julio Quinteros - Goldman Sachs

Right.

Vikram Talwar

With the others, we don’t see anything at the moment.

Julio Quinteros - Goldman Sachs

Okay. Great. Thank you very much.

Operator

(Operator Instructions) Your next question comes from the line of Mitali Ghosh of Merrill Lynch.

Mitali Ghosh - Merrill Lynch

Hi, good evening. I just wanted to understand a bit on your fourth quarter assumption, if I understand that correctly are you looking for a slight margin decline next quarter and what are you really building into that?

Matt Appel

So, Mitali, this is Matt. You’re commenting on our adjusted operating margin guidance.

Mitali Ghosh - Merrill Lynch

Yeah. That’s right.

Matt Appel

So. Okay. So, we always leave ourselves a little headroom for investment and for the unexpected, but we pride ourselves in all this over achieving. And so, we don’t expect any decline, we know that we’re at 12.9% on a year-to-date basis and never knowing what the currency climate might be as well. But now, we’re not forecasting a decline in our margins.

Mitali Ghosh - Merrill Lynch

Okay. So, financial guidance…?

Matt Appel

And our guidance should not imply that to you. Okay.

Mitali Ghosh - Merrill Lynch

Right. So it’s just been conservative?

Matt Appel

That would be one way to characterizes it.

Mitali Ghosh - Merrill Lynch

Right. Okay. Second thing is just on; you mentioned about, I think, Rohit mentioned about the investments been made in selling and marketing. I was just wondering, if you could, give us a sense of firstly, what you’re sales and marketing team is now; because I know you are in the process of expanding that.

And secondly, is there a sort of level of investment that which you would be comfortable going forward. You know the percentage to sales?

Vikram Talwar

Okay. The sales and marketing team. This is Vik here, Mitali how are you? Sorry, about that.

Mitali Ghosh - Merrill Lynch

Hi.

Vikram Talwar

The sales and marketing team has a total of about 54 people now. And that includes the marketing team in India, the U.K., and what we have in the Inductis. And that has shown growth over the previous quarter and it will continue to add to that.

Bare in mind, it is not merely to sales and marketing team but our investment in the last quarter in what we call our strategic account management team that I had mentioned earlier, which is the addition particularly of subject matter experts like Andy and people that we now as I mentioned dedicate to the existing relationships to enhance value as well as work to mind additional business from these relationships and that is also an additional extend that we have that is classified under sales and marketing.

Mitali Ghosh - Merrill Lynch

Sure. And what would the number be that the corresponding number for what you just gave in the previous quarter. Just to make sure I have like-to-like?

Matt Appel

The corresponding number of the 54 that I gave you. Is that the question?

Mitali Ghosh - Merrill Lynch

Yes.

Matt Appel

Okay. I think the corresponding number was approximately 48.

Mitali Ghosh - Merrill Lynch

Okay. And then on the level of sales and marketing investment that you think, you could stabilize that?

Rohit Kapoor

What? I am sorry. Could you repeat that, please?

Mitali Ghosh - Merrill Lynch

Yeah. I was just wondering you have mentioned earlier that you've taken up your selling and marketing investments to roughly I think 5.5%, so…

Rohit Kapoor

That’s correct.

Mitali Ghosh - Merrill Lynch

So, just wondering whether you have a number where you think, could be a sustainable number going forward?

Rohit Kapoor

We should be really looking at, what we would be comfortable with would be around 7%. And we aim to get there. We've said that before I believe.

Mitali Ghosh - Merrill Lynch

Right, right. And, if I may just Matt, on the tax rate, just wanted to understand is there any fringe benefit tax element in the taxation that you have provided and anything that we should be baking in for this year or next year?

Matt Appel

No, the fringe benefit tax is not accounted for in income taxes. So, it's above the line and it's not in that 22% that we're reporting this quarter

Mitali Ghosh - Merrill Lynch

So, that Matt you're…

Matt Appel

Mitali, one second, of course we do accrue for friendly benefit tax and so it is included in our operating results, but it’s not in the effective tax rate.

Mitali Ghosh - Merrill Lynch

Right. Is that something that you would have provided only this quarter or I mean or has it been there…

Rohit Kapoor

No, no. We have been providing, this is the second quarter for which we've provided for the fringe benefit tax. So, since the inception of the new tax law as of April 1st or the second…

Mitali Ghosh - Merrill Lynch

Right, right. And though you will be recovering this from employees presumably it’s not something that our taking the credit for in the P&L. Is that the correct understanding?

Matt Appel

That’s correct Mitali, because we understand that accounting for this being enforced on the industry as that it’s expense with the time, the liability is recognized on investing and when it’s recovered the credit goes to capital, so there is no netting in the P&L.

It’s quite honorous, but that’s the situation we're faced with at this time, as I believe our competitors are as well.

Mitali Ghosh - Merrill Lynch

Right, right. And just finally, if I can just a couple of metrics that I was looking for if there was anything you could share on the shift utilization, how that is trended up?

Matt Appel

The shift utilization is currently at 1.36 and it's relatively unchanged from prior quarters. It varies minimally from quarter-to-quarter.

Mitali Ghosh - Merrill Lynch

Okay. Thanks a lot.

Matt Appel

Okay.

Operator

Your next question comes from a line of Dave Koning of Baird.

Dave Koning - Robert W. Baird

Yeah. Hey guys, nice quarter.

Vikram Talwar

Thank you.

Dave Koning - Robert W. Baird

Just two real quick ones. First of all, I guess the biggest client is still Aviva or did Centrica pass Aviva this quarter.

Matt Appel

Aviva is still a largest client comprises 26.5% of our revenue. Centrica is the second largest client of 25.7%.

Dave Koning - Robert W. Baird

Okay. And then, just secondly, finally, the currency benefits this quarter, the hedge benefit $2.2 million or so. Last quarter, you gave the amount of operating profit drag that was going against that and then the doubted between the two being kind of it the excess hedge benefit. I’m wondering if you can kind of disaggregate those two pieces again this quarter.

Vikram Talwar

Well, I really provided my inside quarter-over-quarter rather than on a cumulative basis. There is no impact to this quarter due to the appreciation of the pound, appreciated approximately 2% during the quarter and offset the rupee appreciation.

So you should think in terms of the drag is same as we reported the last quarter. There is no incremental drag this quarter.

Dave Koning - Robert W. Baird

Okay. Great. Thank you.

Operator

And your next question is a follow-up from the line of Julio Quinteros of Goldman Sachs.

Julio Quinteros - Goldman Sachs

Matt, I just wanted to clarify, I think there was Mitali, who ask you question about the full year guidance for margins here at 12.9% year-to-date, but the guidance is just 12% for the full year. I’m not sure, I understand how that’s not a decline in quarter-over-quarter margins.

Matt Appel

I think, she characterizes it very well and she said we’ll be in conservative. We don’t expect to have a decline in our margins. However, there is uncertainty in the market especially in the currency, the currency situation. And so that’s why we’ve held that guidance to 12% for the full year.

Julio Quinteros - Goldman Sachs

Okay.

Matt Appel

We always aim to over achieve and this would be one area.

Julio Quinteros - Goldman Sachs

Yeah. I know.

Matt Appel

I realize that but it just seems like to go from 12.9 to 12 for the full year, I mean just it doesn’t make, to me it just seems like, you might always give a number that shows the current rate run as opposed to similar things we’re going to be more conservative. We’re trying to be more conservative given the kind of offset that you guys have been able to deliver all year as it is.

Julio Quinteros - Goldman Sachs

Well, we understand. Thanks for you comments.

Operator

And we have no further questions at this time. I would now like to turn the call back over to management for closing remarks.

Vikram Talwar

Thank you very much. Ladies and gentlemen, thanks a lot for joining us today. As I mentioned at the very beginning, we are very pleased with our results and it is our expectations that you will be joining again at our next earnings call sometime in February.

Again, we thank you for your time, your questions and hope to see you in the near future. Thank you.

Operator

Thank you for your participation in today’s conference. This concludes the presentation, and you may now disconnect.

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