Exlservice Holdings Q3 2007 Earnings Call Transcript

Nov.13.07 | About: ExlService Holdings, (EXLS)

Exlservice Holdings, Inc. (NASDAQ:EXLS)

Q3 2007 Earnings Call

November 13, 2007 8:30 am ET

Executives

Jarrod Yahes - Head of Investor Relations and CorporateDevelopment

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

Operator

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

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

Jarrod Yahes

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

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

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

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

As a reminder, some of the matters we’ll discuss in thiscall are forward-looking and you should keep in mind that these forward-lookingstatements are subject to known and unknown risks and uncertainties that couldcause actual results to differ materially from those expressed or implied bycertain statements.

Such risks and uncertainties include, but are not limitedto, general economic conditions and those factors set forth in today's pressrelease, discussed in the company's periodic reports and other documents filedwith the Securities and Exchange Commission from time-to-time.

EXL assumes no obligation to update the informationpresented on this conference call. During our call today, we may referencecertain non-GAAP financial measures, which we believe provide usefulinformation for investors and you can find reconciliation’s of those measuresto GAAP on the press release itself.

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

Vikram Talwar

Thank you, Jarrod, and good morning to everyone. We are verypleased to report that the third quarter 2007 performance was above ourexpectations and the business continues to demonstrate strong growth trends andoperational performance.

We delivered revenues of $46.6 million in the third quarter,which represents growth of 8.4% from proceeding quarter. The continuation ofour 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 asexpected the research and analytics business line turn the quarter this yearwith growth of 23% on a sequential basis to $5.3 million.

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

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

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

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

As a reminder insurance represents just under half of EXL'srevenues 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 accountingclient. And what we believe there will be a key long-term relationship for EXL.

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

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

While historically the telecom sector has aggressivelyoutsourced customer service. Going forward, we expect there to be a significantopportunities to provide back-office and analytics functions that are mainlyin-house at the major telecom companies and we believe we are well positionedto capitalize on this opportunity.

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

As a result, we have been successful in introducing annualprice increases and currency protection in our recent contracts that are tiedto significant changes in cost factors. This changes protect both parties, ourmargins are attractively hedged while our customers can expect benefits of along-term stable relationship. We believe that this is a healthy partnershiprespective for clients and offshore providers.

While, we are pleased with our current growth and themomentum we have created in the market. We continue to focus aggressivelybuilding the front-end of our organization both in terms of strategic accountmanagement and sales and marketing.

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

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

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

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

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

But there has been no public statement by Aviva on itsdefinitive decision. Due to strict confidentiality requirements between theparties, we are unable to provide any further details or comments on anyspeculation as to what options Aviva may or may not be considering at thistime.

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

With respect to mortgage industry as you know this industrycontinues to experience significant due rates in an unprecedented marketenvironment. EXL has two clients in the mortgage industry that compriseapproximately 7% of our revenues. IndyMac Bank is the largest at approximately5% of our total revenues. We have a great relationship with IndyMac and believethat 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 IndyMacbusiness and outlook, we suggest you speak directly with them as they arenaturally the best source for such information.

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

Rohit Kapoor

Thank you, Vikram. I am going to highlight four criticalareas of business performance for the quarter. These include our strongoperational delivery across all three-business lines, progress in our researchand analytics business, our efforts in talent management and the implementationof our strategy on international expansion.

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

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

The results of our most recent semiannual customersatisfaction survey reflects a significant step up in our scores and providesus with the confidence that we can continue to grow our business at a rapidpace.

Our BPO business continues to scale very well and the riskadvisory business has now expanded into Europe and has minimal seasonality. Aswe discussed last quarter, the second quarter was considered to be the lowpoint for our research and analytics business and we expected to gainsignificant traction in the second half of 2007.

I’m pleased to report that the third quarter was quitestrong 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 combinationof increased business from existing accounts, winning new accounts andsuccessfully cross-selling to existing EXL accounts. This has resulted in asignificant diversification of customer concentration in this business.

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

Also, we have made key structural and management changes tofacilitate growth of the R&A business and refined our focus on selectofferings. Our efforts to provide integrated transformational and outsourcingservices will be key to delivering enhanced value to our clients and to createdifferentiated competitive positioning.

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

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

While we view this 5% reduction in attrition over twoquarters as a strong positive trend, we continue to focus our efforts on thelonger-term development of talent within the organization. This will beachieved through a more proactive talent management initiative, continuedinvestment in leadership and functional skills training and the implementationof rigorous HR practices.

This quarter we made key management additions to ourcooperate HR team and our compensation and benefits growth. We believe it willbe critical to continue to groom talent within the organization and to attractnew talent to scale up the organization.

During the third quarter, we have also posted significantprogress in terms of execution of our international expansion strategy. We areplease to report that during the third quarter we added a key member to the EXLteam to lead our efforts to strategically manage global infrastructure andhandle special projects.

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

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

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

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

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

Matt Appel

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

As compared with the second quarter of 2007, revenue for thethird 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 millionor 82% of total revenue in the second quarter. Analytics contribute $5.3million or approximately 11% of total revenue and advisory contributed $3.4million or approximately 7% of total revenue.

From a qualitative standpoint, BPO continues to benefit fromboth the growth and work perform for existing customers as well as work for newcustomers. Research and Analytics experience an expected strong quarter ascompared to the second quarter of 2007 with the conversion of additional newclient and crossover revenues.

Gross margin for the quarter ended September 30, 2007 was36.0% compared to 39.7% in the quarter ended September 30, 2006. In the secondquarter of 2007, our gross margin was 33.1%. The improvement experienced in thethird quarter of 290 basis points is primarily attributable to improvedperformance and staff utilization in the research and analytics business aswell 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 appreciationon our gross margin; therefore, compared to the second quarter of 2007, there’sbeen no net change in the impact of currency on our gross margin.

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

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

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

The increase in adjusted operating margin of 300 basispoints sequentially is primarily attributable to the improved performance instaff utilization in a research and analytics business as well as growth in ourBPO business that I mentioned previously.

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

As we discussed previously, we have an active hedgingprogram in which we hedge our rupee and U.K. pound exposure approximately 15 to18 months in for the future. While we realize gains of $2.3 million from thisprogram in the third quarter, our expectation is that due to the continuingweakness of the U.S. dollar our realized gains in the fourth quarter wouldapproximate $2.5 million of currency rates remain at current levels.

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

As we have pointed out in the past, our business is verycomplex from both the services and geographical standpoint and as a result, weexpect that our effective tax rate will experience fluctuation fromquarter-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 ninemonths ended September 30, 2007.

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

Before opening the floor for your questions, I’d like toconcluded by providing guidance for the full year of 2007. Based on the strongrevenue performances we’ve experiences so far this year and our increasinglevel 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 aremaintaining our adjusted operating margin guidance before stock compensationexpenses and amortization of intangibles at 12% of revenues for the full year.

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

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

Question-and-Answer Session

Operator

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

David Grossman - Thomas Weisel Partners

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

Can you give us a sense for the size of those contracts andthe 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 wementioned in the earlier transcript was basically, these are also going to bestrategic clients and we expect these to overtime generate approximately $5million as the definition that we have for strategic clients.

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

David Grossman - Thomas Weisel Partners

I’m sorry Vikram, what did you say the revenue level was fora 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 thecontract that you assumed in the fourth quarter, are you going to assume. Canyou help us better understand just how near-term the telecom opportunity is, interms of, what you’re seeing within the telecom vertical that would adjustperhaps the potential for that vertical to accelerate year over the next 12 to24 months?

Rohit Kapoor

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

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

It’s also a client that gives us an entry into the telecomvertical, which is a very large and substantial vertical and can be a greatopportunity set for us to participate particularly for doing finance andaccounting 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 newcontracts, you talked about foreign currency protection that you're getting insome of your new contracts. Can you help us understand the mechanics, of howthat’s working? And what kind of protection it offers to EXL?

Matt Appel

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

So, the pricing remains fixed as long as the currencyremains within that particular exchange rate band and outside of that exchangerate band, the pricing is adjusted either upwards or downwards in order toreflect 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 onyour guidance for the year. Is that dynamic or is that level for this year, orshould we think about that being a level that we should be modeling for 2008 aswell?

Matt Appel

Well, David. Thanks for the question. No, we’re notproviding any tax guidance, in fact any financial guidance for 2008. I’m happythough to speak to the change that we’ve experienced here in the third quarterand what we expect for the fourth quarter.

And to the extent that we experienced more U.S. based incomeas we do, for example, in our research and advisory business, and analyticsbusiness has performed as it had in the third quarter. We will experiencesignificantly 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 inthe third quarter; we’re taking some actions here that are too preliminary todiscuss. But for now, I feel that the current level of taxation is about whatyou might expect for the fourth quarter, which is why we gave guidance in the15% to 20% range for the full year.

David Grossman - Thomas Weisel Partners

Okay. And just one other question, really is related tocapacity, utilization and margins. It looks like the BPO margins wererelatively flat sequentially, and it would assume that you should have gottensome benefit from slightly better utilization in the new facilities.

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

Vikram Talwar

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

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

David Grossman - Thomas Weisel Partners

So, I guess, how should we think about that? Becausesequentially I think you’ve said that the currency did not necessarily impactthe gross margins. So as I look sequentially, what were the, kind of, costs ifyou will that increased sequentially, that offset the leverage that youtypically 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 ofour business for Q4 remain relatively the same, at this level of revenue so atapproximately the 36% rate.

And that’s where we settled into in the current currencyenvironment. I think that’s a good measure as this business has got larger itsapproaching $38 million worth of revenue in the third quarter. I think it’sreally 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 yourguidance?

Vikram Talwar

We’re assuming the current rate, which is approximately 39.2somewhere 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 Shirvaikarof 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 isit fair to say that your appropriate expectations are included in yourguidance.

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

Vikram Talwar

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

Ashwin Shirvaikar - Citigroup

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

Matt Appel

Hi Ashwin, this is Matt and I’ll take that. We’re really notgiving any guidance or setting any expectations for 2008. But I’ll say aboutthe 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 releaseour fourth quarter earnings in late February or early March.

Ashwin Shirvaikar - Citigroup

Okay. I just want to point out you are providing someguidance for ’08. But I think your hedging gains will roll-off but notproviding the offset to that.

Rohit Kapoor

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

And we would certainly expect that that would happen andthere are certainly other areas where we get leverage, which includes the priceincreases with our customers. It includes the operating leverage and a betterutilization of our infrastructure. So some of the currency hedge gains, whichwill be reducing or some of those we will be able to offset with some of thesemeasures.

Ashwin Shirvaikar - Citigroup

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

Rohit Kapoor

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

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

Ashwin Shirvaikar - Citigroup

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

Amit Shashank

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

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

And what you see our margins that are pretty steadily at 36to 37 gross margins, and that’s representative what that businesses level ofthat 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 ofJefferies & Company.

Joseph Vafi - Jefferies & Company

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

Is this something that you believe or that you’re seeingstart to emerge across the industry or is there’s something that more specificright 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 haveseen this actually being adopted by the Tier 1 players on a much more broadbase basis and also we are seeing customers agreeing to providing annual priceincreases in the contracts as well as agreeing to the foreign exchangeprotections.

So there’s a much better acceptance of that from theclients, 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 customerhere is being driven by just still very strong demand or maybe more by justdeeper partnerships and sharing risks and benefits and doing more forcustomers.

Rohit Kapoor

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

Its also being driven by the fact that the benefit that ourclients 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 betterthan 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 Philippinebuild out, how should we be looking at that relative to how much the build outright now is baked into your cost structure versus what might be additionalincremental cost over the next few quarters?

Rohit Kapoor

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

It does involve a significant capital outlay, as well ascash outlay in terms of security deposits and rent advance payments, and wewill 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 yourplanning on generating revenue out of that facility in 2008 is earlier in 2008or later in 2008?

Rohit Kapoor

Yes, we would expect to start operations from that facilityand, 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 CynthiaHoulton of RBC Capital Markets.

Cynthia Houlton - RBC Capital Markets

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

Matt Appel

The seat count is currently at about 7,500 it’s actually7,450 at the end of the third quarter.

Cynthia Houlton - RBC Capital Markets

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

Matt Appel

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

Cynthia Houlton - RBC Capital Markets

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

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

Rohit Kapoor

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

So we are currently engaged in active dialog with thisclient 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 onthe 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 possibilityin your current contract with them meaning the voice services that dial us anopportunity to be strategic or some more again those some of these otheropportunities 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 youtalked about roughly 800 fees (ph) that’s kind of the first opportunity? Isthis something that overtime, as your idea to can it expand in Philippines orare you thinking more, you need to have other geographies based on customerrequirements like Eastern Europe or South America et cetera?

Rohit Kapoor

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

And high priority for us right now is Eastern Europe. And weare currently carrying out diligence activities in Eastern Europe and alsolooking at different, an inorganic ways of being able to establish our presencethere.

Cynthia Houlton - RBC Capital Markets

Thank you.

Operator

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

Julio Quinteros - Goldman Sachs

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

Rohit Kapoor

Certainly Julio this is Matt. So the cash provided orgenerated 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 youwould like that is $11.1 million from operations. Our free cash flow in thethird quarter was $7.8 million and $4 million on year-to-date basis.

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

Julio Quinteros - Goldman Sachs

Okay, great. And just wanted to go back to the nature of thework, it sounded like, facing everything you said that you guys are willing tostart 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’veseen in the past where, there is some type of transaction associated with voiceor is it more the kind of the commodity type work where its inbound outboundkind of work?

Rohit Kapoor

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

It also involves activity which involves financial activitypertaining to the customer accounts; and therefore, it’s not just a low-endcommoditized 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 knowwhat 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 youguys, just can you give us some general color on traditional trend of revenueper head.

Vikram Talwar

Just give us a second. You know we generally don’t publishthat 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 theproductivity on a per head basis and maybe you guys have any sense on, whetherthings are actually going up, going down or they’re flat? What’s thedirectional 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 goingforward should we expect that to remain flat or should we expect someimprovements on the pricing side to drive improvements on the productivity ofthe revenue?

Vikram Talwar

You should expect some improvements in the future inlinewith 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 onBPO business because it carries 82% of our revenue, but as the other parts ofour business, we average in R&A, Research and Analytics continues to pickup 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 commentaryabout the investment bank in F&A; what are there verticals are you guysalready doing F&A working today?

Rohit Kapoor

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

Now, the nature of our finance and accounting work is alittle bit different in the sense that we also have the added capability ofdoing finance and accounting work in our risk advisory group. And thattypically, we are doing high end reconciliation work, as well as internal auditwork, 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 ofthe end of year, and then possibly just some color into 2008. As we think aboutthe 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 yourcurrent 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 guysassuming that there is any push outs or cancellations or delays in terms ofbudgets just getting all that sort of volatility that we’re seeing kind of atthe back up right now?

Rohit Kapoor

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

Also some of the new customer relationships that we havesigned up are giving us fairly good visibility in terms of the volume ofbusiness that we can expect from them going into 2008. So I would say thatdespite the uncertainty and the volatility in the marketplace we are actuallyseeing 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 theyear comes from a existing clients, and we don’t see anything slowing downthere.

Julio Quinteros - Goldman Sachs

Yeah, and I appreciate that part of it, I guess, all I’mtrying to get my arms around is even though their existing clients as they gothrough their own budgeting in a sort of cycles in a kind of at the end of yearhere, are you guys seeing any sort of conversations or having conversations aswhether they’re coming back to you and saying anything along the lines of wewant a whole things off or we’re pushing our plans for the ramp-ups. So thatthere would be a sequential impact as we kind of being to look at the firsthalf 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 infact we are in discussions on possible ramps. The one exception possibly couldbe on the mortgage industry where you could possibly see some slowdown for allthese 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 theline of Mitali Ghosh of Merrill Lynch.

Mitali Ghosh - Merrill Lynch

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

Matt Appel

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

Mitali Ghosh - Merrill Lynch

Yeah. That’s right.

Matt Appel

So. Okay. So, we always leave ourselves a little headroomfor investment and for the unexpected, but we pride ourselves in all this overachieving. And so, we don’t expect any decline, we know that we’re at 12.9% ona year-to-date basis and never knowing what the currency climate might be aswell. 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, Ithink, Rohit mentioned about the investments been made in selling andmarketing. I was just wondering, if you could, give us a sense of firstly, whatyou’re sales and marketing team is now; because I know you are in the processof expanding that.

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

Vikram Talwar

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

Mitali Ghosh - Merrill Lynch

Hi.

Vikram Talwar

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

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

Mitali Ghosh - Merrill Lynch

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

Matt Appel

The corresponding number of the 54 that I gave you. Is thatthe 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 marketinginvestment 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 thatyou'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 youthink, could be a sustainable number going forward?

Rohit Kapoor

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

Mitali Ghosh - Merrill Lynch

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

Matt Appel

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

Mitali Ghosh - Merrill Lynch

So, that Matt you're…

Matt Appel

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

Mitali Ghosh - Merrill Lynch

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

Rohit Kapoor

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

Mitali Ghosh - Merrill Lynch

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

Matt Appel

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

It’s quite honorous, but that’s the situation we're facedwith 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 ofmetrics that I was looking for if there was anything you could share on theshift utilization, how that is trended up?

Matt Appel

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

Mitali Ghosh - Merrill Lynch

Okay. Thanks a lot.

Matt Appel

Okay.

Operator

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

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 biggestclient is still Aviva or did Centrica pass Aviva this quarter.

Matt Appel

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

Dave Koning - Robert W. Baird

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

Vikram Talwar

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

So you should think in terms of the drag is same as wereported 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 JulioQuinteros 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, Iunderstand how that’s not a decline in quarter-over-quarter margins.

Matt Appel

I think, she characterizes it very well and she said we’llbe 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 currencysituation. 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 12for the full year, I mean just it doesn’t make, to me it just seems like, youmight always give a number that shows the current rate run as opposed tosimilar things we’re going to be more conservative. We’re trying to be moreconservative given the kind of offset that you guys have been able to deliverall 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 nowlike to turn the call back over to management for closing remarks.

Vikram Talwar

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

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

Operator

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

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