ExlService Holdings, Inc. (EXLS) Q2 2012 Earnings Report, Transcript and Summary

Good day, ladies and gentlemen, and welcome to the EXL Service Holdings, Inc. Second Quarter 2012 Earnings Conference Call. [Operator Instructions] As a reminder, today's call is being recorded. I would now like to turn the conference over to your host, Mr. Charlie Murphy, Head of Investor Relations. Sir, you may begin.

Thank you, Shannon. Greetings, and thanks to everyone for joining our Second Quarter 2012 Earnings Call. I'm Charlie Murphy, Head of Investor Relations. With us today in New York are Rohit Kapoor, our Vice Chairman and Chief Executive Officer; and Vishal Chhibbar, our Chief Financial Officer. We hope you have had an opportunity to review the second quarter earnings press release we issued this morning. We have also made available the updated investor fact sheet on the Investor Relations section of EXL's website. Some of the matters we'll discuss in this call are forward-looking. Please keep in mind that these forward-looking statements are subject to known and unknown risks and uncertainties that could cause actual results to differ materially from those expressed or implied by such statements. Such risks and uncertainties include, but are not limited to, general economic conditions, those factors set forth in today's press release, discussed in the company's periodic reports and other documents filed with the Securities and Exchange Commission from time to time. EXL assumes no obligations 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. Reconciliations of those measures to GAAP can be found on the press release. Now, I will turn the call over to Rohit.

Thank you, Charlie, and welcome, everyone, to our second quarter earnings conference call. The agenda for the call is as follows: First, I will discuss highlights from our second quarter, including a deeper look into our transformation business. Then, I will discuss significant achievements during the quarter, as well as provide comments on the demand environment. After that, I will turn it to Vishal for a more in-depth review of the second quarter financials and our 2012 annual guidance. And finally, we'll open it up to your questions. EXL reported strong second quarter results. On a reported basis, revenue rose 27% year-over-year and 3% sequentially. On a constant currency basis, revenue increased a strong 33% year-over-year and 6% sequentially. Our sequential constant currency top line growth was driven by a rapid acceleration in our transformation business, with particular strength from Decision Analytics. As we indicated in the previous quarter, we expected to see an uptick in our transformation business. Not only did we see this, but we saw a dramatic resurgence which drove record revenue and gross profit in transformation for the quarter. In addition, outsourcing had a solid quarter, driven by service expansions by large clients in our insurance, utilities and travel domains. A key theme for the quarter was the impressive acceleration in our transformation business to record revenues. As utilization in this business rose, our gross margin increased significantly during the quarter. This gives us confidence that transformation is a healthy, growth-oriented and profitable business and that our investments in this capability over the past several years have been prudent. We believe this new level of revenue and profit in transformation is not only sustainable, but also one that we can continue to grow strongly over time. A material and growing portion of our new business pipeline is emanating from prospects in transformation, particularly in Decision Analytics. Over the last few years, we have greatly improved our capabilities across transformation and are encouraged by the positive operational change and focused business insights we are able to generate for our clients here. For example, in Decision Analytics, we are performing complex claims operation analytics in Property & Casualty insurance, improving our clients' customer experience and increasing the accuracy of their performance measurement, leading to millions of dollars of cost savings annually, with a much better ability to forecast. In retail banking, we are helping clients generate tens of millions of incremental revenue dollars through marketing analytics, including predictive modeling and customer segmentation. Also in banking, we are utilizing our experience in risk analytics across the credit life cycle to help clients extend credit more efficiently and prevent billions of dollars in delinquency and fraud losses. In our Finance Transformation practice, we are strengthening global insurance firms' financial control across multiple countries around the world. And in our Operations & Process Excellence practice, we are partnering with global health care firms. And as their industry goes through rapid change, we are helping them think about new business models through Six Sigma and operations-based reengineering consulting. We won a new strategic account in the quarter in transformation. We initiated discussions for Decision Analytics services with this client during the first quarter. And during the second quarter, it became evident that the revenue opportunity would be far larger and across more of the client's operations than we had previously estimated. This is a multi-year series of engagements with a global bank to perform complex risk and operational analytics across 3 of the client's divisions. This is the first significant deal signed by transformation this year, and we believe that in the future, we can add more strategic client relationships in transformation. In addition, this relationship should represent an impressive case study to validate our expertise in this domain, where we now work with a strong portfolio of leading global banks. In the second quarter, EXL won 9 new clients, 6 in transformation and 3 in outsourcing. For the first half, EXL added 17 new clients, more than twice the year-ago total. We continue to see a trend towards smaller new client deals. We continued to advance the build-out of our global delivery capabilities in the second quarter. In May, we opened a new delivery center in a tax-advantaged SEZ in Pune, India, to provide complex transaction processing in our core domains of insurance and finance and accounting. The center is expected to eventually employ over 700 professionals in addition to the over 2,500 professionals at EXL's existing sites in Pune. Investing in our people remained a core priority in the second quarter. Domain expertise and an engaged workforce are keys to long-term client satisfaction and differentiation for EXL and not simply lower cost of ownership. On this front, we are delighted to have been named 1 of the top 10 learning and development organizations in India by the World HRD Congress this quarter. We continue to develop our Center for Talent in Noida, India, opened earlier this year. And we implemented high single-digit wage increases to our workforce in India in April. Turning to the demand environment. We see stable demand and are working aggressively on several RFPs, both large and small. BPO and analytics remain resilient, under-penetrated and continue to gain market acceptance. The global economic outlook has deteriorated further since our last call in May. This is likely to have both positive and negative effects on our business. On the positive side, companies will need to accelerate efforts to reduce operating costs, which can increase demand for our capabilities. On the negative side, some decision-making, particularly on large outsourcing contracts, could get pushed up. The competitive environment remains aggressive. We continue to see large services firms investing in the BPO business, leading to pricing pressure. This makes continuing to cultivate unique industry-focused solutions a critical mission for EXL. We are maintaining our focus on generating differentiated, profitable partnerships with our current and future clients. Our qualified strategic deal pipeline is currently at 3. It is fair to say that the decision cycle on these outsourcing deals are taking longer than strategic deals in our past experience. One of these deals has been in the pipeline for a year, and one of them has been in the pipeline fully 2 years. We continue to anticipate that all 3 deals will close this year and are working to add more to the pipeline. We believe that the concept of strategic clients in our pipeline is becoming less relevant than a few years ago, when we introduced this stuff. Over time, we have become larger and more diversified with lower client concentration. This makes any single deal less material to our growth than a few years ago. We are also seeing an evolution of our new business pipeline from a limited number of large deals to small deals, some of which can grow into much larger relationships over time. Many of these deals are currently in transformation services. We continue to look for acquisitions that complement our capabilities in our focus verticals and that add proprietary intellectual property that can enhance our client relationships. With over $100 million in cash and equivalents at the end of the quarter and no debt outstanding, we are in a good position to execute on opportunities here. As I look to the second half of 2012, I remain optimistic about EXL's outlook. We believe we are making the right investments for growth, executing on our key opportunities and creating a more valuable firm every day. And now, I will turn the call over to Vishal.

Thank you, Rohit, and good morning, everyone. In the second quarter, EXL reported strong revenues of $108 million, up 27% year-over-year and 3% sequentially. On a constant currency basis, revenues rose approximately 33% year-over-year and approximately 6% sequentially. Excluding a onetime payment of $2.2 million in the year-ago quarter, constant currency revenue growth was 37% year-over-year, and constant currency organic revenue growth was 17% year-over-year. Constant currency year-over-year revenue growth was driven both by acquisitions, in particular OPI, which anniversary-ed in May, and strong organic growth in both our outsourcing and transformation businesses. Driving sequential constant currency top line growth was an acceleration in our transformation business. For the first half of 2012, revenue grew 35% on a reported basis or 41% on a constant currency basis, excluding the onetime impact in the second quarter of 2011. In the second quarter, transformation services revenue accelerated to $19.1 million, up 17% year-over-year, or 29% on a reported basis, and up 18% year-over-year and 29% sequentially on a constant currency basis. This exceptional sequential growth was driven in particular by large -- 2 large new Decision Analytics deals from banking and insurance clients, as well as service expansion and process reengineering and finance transformation. These deals represent excellent evidence of our differentiated capabilities in our transformation practice and robust underlying demand for these services. Our outsourcing business also performed well in the quarter. Revenue grew 29% year-over-year and declined 1% sequentially on a reported basis, and 36% year-over-year and 2% sequentially on a constant currency basis. Excluding the onetime payment, outsourcing grew 41% year-over-year on a constant currency basis. Versus the year-ago quarter, constant currency revenue growth was driven both by acquisitions and strong increase on our health insurance and Property & Casualty insurance practices. Driving sequential constant currency revenue growth were service expansion with existing clients and our utilities, Property & Casualty insurance and travel verticals. We continued to advance our outsourcing practice to even more complex and innovative transaction processing, ensuring that we are delivering dynamic business impact to our partners. We look forward to a strong second half of our outsourcing business, driven in particular by insurance and utilities domains. Foreign currency movement had a negative effect on our revenues growth of 6% year-over-year and 3% sequentially. As highlighted before, an approximately 25% of revenues, we share foreign exchange risk with our clients, which in turn subjects these revenues to volatility in the Indian rupees to U.S. dollar exchange rate but has no material impact on our margins or bottom line. You will notice that the majority of the contracts where we have shared foreign currency risks are in outsourcing business. These are long-term contracts with some of our highest-quality client partnerships. Over the last 2 months, the rupee moved from INR 53 in May to about INR 56. Our hedging program performed well to protect earnings per share despite such volatility. In the second quarter, gross margins were up 10 basis points year-over-year and 260 basis points sequentially. On a year-over-year basis, foreign currency drove 440 basis points gross margin improvement, as approximately 60% of our costs are located in India. This improvement was nearly offset by a onetime client payment with no associated costs in the year-ago quarter, acquisitions and the BPO platform conversion costs. Typically in the second quarter, we see a drop in gross margin sequentially, driven by wage increase. But a pickup in transformation and foreign currency tailwind cost are results to break this trend this year. On a sequential basis, foreign currency drove approximately 260 basis points margin improvement. Transformation acceleration and higher efficiency in outsourcing drove approximately 130 basis points improvement, while annual increment detracted approximately 130 basis points. Our G&A margin was at 12.8%, down 170 basis points year-over-year and flat sequentially. Year-over-year improvement was driven by foreign exchange and operating leverage and lower G&A from acquisitions. We continue to believe that we can leverage our G&A costs over time as we grow and are focused on tightly managing expenses. Sales and marketing expenses were 7.1%, down 10 basis points year-over-year and 40 basis points sequentially. In the second quarter, we posted a net foreign exchange loss of $2.1 million. This line, as many of you know, is where our hedging program kicks in to protect our earnings per share from currency volatility. Since we saw a strong rupee depreciation during the quarter, our operating margins were up, offset by an increase in the cash flow for hedge losses, ensuring that there’s a -- EPS had a neutral impact. For 2012, we anticipate foreign exchange losses of approximately $3.5 million to $4.2 million. Our hedging program ensures that we are hedged on a pre-tax income basis, protecting earnings per share and increasing EPS volatility -- visibility. In the second quarter, our tax rate was up 28.6%, up 10 basis points year-over-year and 330 basis points quarter-over-quarter. This higher-than-expected tax rate was driven by a change in our geographical mix due to the higher profits from our U.S.-based portfolio. For 2012, we still expect a mid-20s tax rate, aided by bringing on new business in SEZ, in India and Philippines. DSO in the second quarter was 51 versus 50 in the year-ago quarter. We will continue to focus on collection and ensures stable DSO. For the first half of 2012, our capital expenditure were $13 million versus $9 million in the year-ago period, driven by facilities expansions. For 2012, we continue to expect approximately $25 million to $30 million in capital expenditures. Our balance sheet remains strong. And as of 30th June, we had over $100 million in cash and short-term investments, with no debt outstanding. Net income for the second quarter was $9.1 million, up 7% year-over-year and 2% sequentially. Diluted EPS for the second quarter was $0.27, flat year-over-year and sequentially, while adjusted and diluted EPS was $0.36, up 2% year-over-year and flat sequentially. The onetime client payment in the last year's quarter represented approximately $0.05 adjusted and diluted share. Excluding this, adjusted and diluted earnings per share were up 19% year-over-year. Turning to 2012 guidance. We are maintaining our adjusted earnings per share guidance of $1.5 to $1.55. Despite a volatile rupee, we are confident in our guidance given the strong momentum exhibited in our second quarter results, year-to-date new client wins, robust new business pipeline and focus on cost containment. Assuming a second half of 2012 exchange rate of INR 55 to U.S. dollars, we now project revenues of $438 million to $442 million, primarily due to the ongoing weakness in the rupee. Since we first provided 2012 guidance in March at an exchange rate of INR 49 to the dollar, the rupee has depreciated over 10%, creating a headwind of approximately $10 million in 2012. On a constant currency basis versus 2011, the midpoint of this guidance would be $453 million or 26% year-over-year growth, which is in line with our earlier guidance of 24% to 27%, excluding the onetime payment in 2011. On a constant currency basis, our business features a strong degree of visibility driven by higher recurring revenues in our BPO and analytics practices. We are encouraged by EXL's achievements in this quarter, in particular, the strong acceleration in our transformation practice, our steady growth in outsourcing and our cost discipline. And now, we would be happy to take your questions. Thank you.

[Operator Instructions] Our first question is from Ashwin Shirvaikar with Citi.

I guess my first question is -- the pickup in transformational work is great. How sustainable is it as you look at future quarters?

Thanks, Ashwin. I think the way in which we are viewing the transformation business is looking at the quality of the customer relationships and looking at the type of work that we are winning. As we mentioned on the call, the work that we are winning is primarily in Decision Analytics, and this is a new area that continues to grow very, very rapidly and provides a tremendous business impact for our clients. Our viewpoint is that most of the new transformation work that we are winning has a significant annuity nature to those contracts. And therefore, we believe that this revenue stream is going to be sustainable and something that we can build up on. We've seen the transformation business grow over the last several quarters and several years, and we continue to believe that this would be a recurring revenue stream that is long-term, sustainable and growth-oriented.

Okay. And I guess a follow-up question is that I think you mentioned that you see a gradual change in the opportunity set from a set of larger deals to many smaller ones that you have to sort of mine or farm over time. And I'm curious what implications that has for your cost structure or the way your sales force is currently structured. And then I did have a brief numbers question as well that's separate.

I guess the implication that the changed market environment has for us is that we would continue to invest heavily in sales and marketing to win new customer logos. And the revenue ramp-ups would take place over a period of time rather than it being a step function in terms of the revenue changes that are taking place. Therefore, in terms of our financials, you would not be able to directly attribute a new client win to step changes in our revenue. But rather, these changes will happen gradually and over a period of time. I think the good news about this is from a client perspective, it gives them an opportunity to get comfortable with us, to expand their business relationships with us, and develop these over a period of time. And from our perspective, it actually reduces the risk associated with a client transition because our ability to manage the smaller engagements is a lot better, where we can focus on each client and make sure that each transition is 100% successful.

Got it. The numbers question is why are you using INR 55 to the dollar as the conversion rate for the second half? Why not use something that's more conservative and, perhaps, more in line with some of the recent levels, the lows?

Yes, Ashwin, this is Vishal. I think when we were doing our analysis, 2, 3 days back, the rupee was more like INR 55, INR 55.20. And usually we take the current spot rate. It has moved in the last 1 or 2 days to more like INR 55, INR 56. So as we have clearly said, that every rupee movement has a revenue impact of $2 million to $2.5 million on an annual basis, this is the best we were looking at, at this point of time. And if the rupee changes, and it's been volatile in the last month, where it has gone down to INR 54, it's come back to, again, INR 55. It's very difficult to predict, and so we chose a INR 55 rate to give the guidance at.

Our next question is from Edward Caso with Wells Fargo Securities.

My question, given the power outage in India the last 2 days, wiping out half the country's electricity, what -- can you talk about what systems you have in place, both from a -- keeping the lights on for the computers as well as getting your people to and from? And whether your clients -- the level of concern your clients have expressed over this event?

Sure, Ed. I think this has been rather unfortunate that India has experienced this kind of a massive power outage across so many different states in the country for such an extended period of time. However, EXL's resiliency programs are very, very strong, and we've been able to demonstrate that over the last 2 days. We maintain our reliance on the power supply of both on the state electricity grids, as well as we have our own power generators, where we can generate adequate power to keep our operations ongoing for a number of days on a standalone basis. Over the last 2 days, we've experienced no operational impact to any of our client operations. We have been beefing up the fuel supplies that we have in each one of our centers to make sure that we are adequately protected for sustained periods of time of power outages, and we think we are more than adequately covered on that. From a transportation perspective, certainly, the metro in India, in Delhi, was impacted by the power outage. However, we were able to work around with our own transportation fleet and provide transportation to our own employees to get them to work on time and to get them to their homes very safely. And as such, we think that our -- the redundancies that we've built in and the business continuity planning programs that we've invested in have held us in very good stead during this time period. From a client perspective, we've been in constant communication with our clients, and we've advised them of the issue, as well as the possible impact associated with their operations. And our clients are quite comfortable with the measures that we've taken and how we've handled this crisis.

My other question revolves around the U.S. elections. Do you sense your clients are pausing in front of the election on maybe some of the larger transactions to avoid any negative publicity? And if that's the case, could there be some decision-making that happens in the November, December time frame?

I think the political rhetoric certainly has stepped up, and that's something which we certainly see our clients experiencing across the board. In terms of their decision-making cycles, we are unable to point to specific examples with clients where they may have pushed out decision-making. However, I'm sure this is something which plays up on the minds of our clients at the senior levels, at the management team and at the board level. Our viewpoint is that our clients are driven by making sure that they act responsibly for their shareholders and that they will take the right decisions to make sure that they generate economic value for their investors, for their clients and for their employees. And the political rhetoric will always be there, but we expect them to take the rational decision.

Our next question is from Tien-Tsin Huang with JPMorgan.

Great results on the transformation side. I'm curious, how do you define a strategic win deal size-wise in transformation? And how much more could we see from this -- from the strategic deal that you talked about here in terms of revenue?

Sure. So our definition of a strategic win is unchanged, and we typically define a strategic win as a client that would generate in excess of $5 million annually. And in the case of this client as well, we expect a similar level of revenue to be generated. I think the difference between a client which is strategic in transformation and in outsourcing is the ramp-up period timeline is quite different. In the case of a transformation client, the ramp-up is fairly quick, and we can hit the hurdle level of $5 million fairly quickly, whereas an outsourcing client would perhaps take a much longer time period to ramp up. In terms of the potential revenue from this client or from any strategic client, we fully expect the potential revenue from any strategic client to be much more meaningful than the initial $5 million. And these are client relationships where we can continue to build and grow and mine the account across multiple geographies, multiple product lines and multiple divisions.

That's a very -- that's a good answer, right. So just to be clear, so it sounds like this strategic deal in transformation, there's still -- you're not at the $5 million yet. There's still some room to grow here sequentially. And then my follow-up is just the 3 strategic outsourcing deals. I totally understand the timing you discussed there, but have you seen any scope or pricing change in your conversations with those 3 deals given the changes in the rupee, given the changes in the cycle and given your comments around competition?

Sure. The decision-making cycle with these 3 strategic prospects have certainly been extended. And as the rupee has depreciated over this time period, certainly the pricing has changed in order to be competitive with the market environment and with the current foreign exchange rates. However, in terms of the margin that these deals would afford or the size of these deals, that's pretty much remained constant.

Our next question is from Bhavan Suri with William Blair & Company.

It's Rahul Bhangare in for Bhavan. Could you give us an update on the competitive environment? Are you seeing any of the larger IT players starting to come in and compete for deals?

Yes. Rahul, as I mentioned in my prepared remarks, we continue to see large global services firms, as well as IT services companies continue to invest in developing the BPO market for themselves. And from a competitive standpoint, we do run into them now much more frequently than we did in the past. Our viewpoint continues to be that the main value that we can add to our customer relationship is to create business impact for our clients. And the best way to create business impact for our clients is to be exceptionally strong in domain expertise, to use and leverage analytics, to provide incremental value to our clients and to have strong skill sets for operational service delivery.

On average, would you say that the win rate has improved relative to last quarter or stayed stable?

Well, it's difficult to talk about the win rate for strategic clients because there hasn't been any decision-making that we've seen with our strategic prospects in the last quarter. But in terms of the number of new clients that we have won, certainly that base has accelerated this year over last year.

Okay. And if I could sneak in one more. The strategic transformation win in the quarter, how long was that in the pipeline?

It only came into the pipeline towards the end of the first quarter. And in the second quarter, we won that mandate. And in fact, the revenues for that particular client will be realized in the third quarter and the fourth quarter this year.

Our next question comes from Manish Hemrajani with Oppenheimer.

A question on outsourcing in general. For the past 2 years, you've typically seen an uptick in revenue from Q1 to Q2. This time around, we saw a slight decline in sequential revenue for outsourcing. Anything we should be reading into that? And then what's your confidence level now for the 3 strategic wins in outsourcing or deals in outsourcing versus where it was at the beginning of the quarter?

Sure. I think there has been a slight change in our business mix between last year and this year. And that change is the acquisition of OPI that we completed towards the end of the second quarter last year. As you are aware, the finance and accounting business that we do has a seasonality factor to it between Q1 and Q2. And there is an impact due to seasonality in that line of business, just by virtue of the nature of work that we undertake in finance and accounting. The second aspect is, obviously, the currency which had an impact between Q1 and Q2. And again, the OPI business that we bought was largely a business which had exchange rate risk being shared with clients. So that's been a significant change between last year and this year. In terms of the strategic prospects that we've got in the pipeline, we continue to remain confident about our success rate associated with these 3 strategic prospects. Please keep in mind that these 3 strategic prospects are qualified strategic prospects, which means that they are in their final stages of decision-making and there are no more than 2 or 3 competitors remaining at this stage, and we are qualified to be able to win with each one of these 3 strategic prospects. We'll see how that pans out over the next couple of quarters, but our expectation is that, that decision will get taken by the end of the year.

Got it. Now, health care seems to be one of the higher growth areas from a vertical perspective in BPOs. What is your current exposure to health care? And what plans do you have to boost your presence there?

Manish, I think you're absolutely right. The health care industry vertical is a vertical that is undergoing a lot of change, and clients in this industry vertical are faced with significant cost pressures. As such, we are seeing tremendous opportunity, both in transformation to reengineer and redesign the back-end operations of clients in health care, as well as a greater propensity to outsource work in health care. I think EXL is very well positioned in this vertical. And as we announced previously, we have won a significant client in health care previously, and we continue to build and grow on top of that portfolio, where we provide clinical services out of Manila for clients for the health care industry vertical. I think over the next few quarters, this vertical will remain a very active vertical, and we are positioning ourselves with increased added capability to take advantage of the changes in the marketplace here.

Our next question is from David Grossman with Stifel, Nicolaus.

Rohit, given the change in deal sizes that you've articulated and now with some change in mix, I guess, first, are you still comfortable with a 15% to 20% organic growth target? And if so, how should we think of the composition of that growth, broken down between growth in the installed base versus new bookings? And also in that same context, the discussion about the pipeline seems like the large-deal market really isn’t what's driving growth. And maybe you've got a more relevant pipeline figure you can give us to kind of benchmark the status of the pipeline versus the historical look at the strategic pipeline.

Sure, David. So I think in terms of the long-term growth rate of the industry, as well as the long-term growth rate of EXL, we remain confident about both of these from a long-term perspective, and we think the business models for providing outsourced services at lower cost and higher quality and greater business impact continues to remain intact. And that trend, as it plays out, EXL will be a participant in that trend. And we think we can grow at a pace which is going to be very attractive. In terms of where that growth rate will come from, we continue to believe that the growth rate from our existing installed base will drive a significant portion of that growth. In the past, as we've indicated, we think, of the 15% growth rate, close to about 12% to 13% comes from existing clients, and somewhere between 2% to 3% comes in from new clients. The -- because of the deal size becoming smaller, I think the new clients will take a longer period to ramp up. And therefore, if you take a look at the definition of a new client win and how that scales up over a period of time, I think some of those elements will change on a go-forward basis. You're absolutely right about the pipeline and the way in which you'd be able to look at how our revenues are progressing. We do need to give some deeper thoughts to how we will report out the metrics. And the relevance of strategic prospects is becoming much lower. And I think the relevance of the total value of the pipeline and the total growth opportunity from existing clients is becoming more and more relevant. So we will be looking at ways in which we can better describe the functioning of our business and the development of the pipeline to provide greater color to you. But right now, we don't have any established metrics on that to share as yet.

Okay, good. Just a follow-up here on the competitive environment. Can you give us a sense of whether you think it's more or less manageable than it has been historically? And then secondly, how should we think about its impact on, first of all, how you go to market, given that you've got some larger players that are getting more aggressive in the marketplace? And what impact, if any, it's having on your perspective on acquisitions?

Sure. So I think the competitive dynamics have changed. And in terms of our ability to succeed in this changed competitive environment, I think the factors that cause us to succeed have also changed. Three or 4 years ago, our competition used to be primarily against other pure-play business process outsourcing companies. But at that point of time, we were much smaller in size and scale. We had much less developed capabilities in our industry verticals. And it was a question of establishing our credentials for our clients and making sure that they thought of us as a credible service provider. Today, our competition is against much larger, well-established global and IT services companies. But at the same time, our capability set has improved dramatically, our size and scale has improved dramatically, and our bench trend of our employee talent has improved very significantly. In addition, the capabilities that we have in analytics are, today, providing greater business insight and much more business impact to our customers. So the basis of competition has shifted. I would say that our ability to compete in the changed business environment continues to remain strong, and we continue to succeed and win new clients and win strategic clients. And therefore, we are confident of being able to build and grow out our business.

So getting back to just how you have to evolve your model, though, I mean, is the focus going forward, given the change in the competitive landscape, going to be leading with analytics? And how important is scale going forward? And are there any other factors that may impact, again, your acquisition strategy? Or can you do most of this organically?

Sure. So I think our approach is going to be to provide an integrated solution to our clients, offering both outsourcing as well as analytics. We think we create the maximum value for our clients when we can provide the synergy between analytics and operations. In terms of the go-to-market strategy, in many cases, the decision cycle is much shorter when we lead with transformation services, and therefore, we will continue to use that as an entry strategy amongst our client base and then leverage our opportunities in outsourcing. From an M&A perspective, we continue to think that acquiring capability is very, very important for us to remain competitive in the marketplace. And therefore, we'll continue to focus in on M&A. And as our business is a business that throws out a fair amount of free cash flow, we think we have an ability to use that cash flow for acquiring capabilities that can enhance our competitive positioning in the marketplace. In the past, we've demonstrated a strong ability to identify, structure, negotiate and integrate acquisition candidates and assets. And that's the capability that we will continue to leverage on, on a go-forward basis.

Our next question is from Joseph Foresi with Janney Montgomery.

Rohit, based on your comments today, I was wondering, is the smaller stuff, the new client wins, enough to backfill the slowdown in the strategic deals? I know it's rather early in the process, but I wonder if you could give us your general thoughts on that when you look at the total growth rate.

Yes, Joe, as I -- we do think that if we have multiple smaller deals that are all growing simultaneously, they will be easily able to replace a large strategic deal value. And therefore, we think the growth with our existing clients, as well as the growth with the multiple new clients that we've signed up, allows us to grow our business at our targeted overall company growth rates and achieve our objectives.

Okay. And then on the outsourcing side, you talked about a slowdown. Are you currently seeing that slowdown in decision-making? Is it broad-based? And maybe you could just relate it to past slowdowns and sort of what your conversations are with the client around those.

In each of the cases that we have as qualified strategic prospects, they all seemed to be internal factors that are causing the delay in decision-making. I think these decisions on taking large pieces of outsourcing relationships and providing -- and giving that to a third-party provider, these are emotional decisions that do take a fair amount of time. They also are decisions that have a wide impact on the client organization. And therefore, the clients have to be fairly deliberate in their thinking and fairly committed in terms of taking that decision. Right now, we have seen a slowdown in that decision-making cycle. But it just seems to be attributable to internal factors associated with each one of these prospects.

Okay. And then the last one for me just real quickly. Are the customers' requirements for deals, have they changed at all? Are they expecting more technology, more solutions versus basic labor arbitrage? And maybe you could just talk about how EXL would be changing along with those requirements.

Yes. I think clients have certainly become more sophisticated, and they're certainly looking for much more value to be created in terms of the partnerships that they are striking up. I think what they're looking for is tangible business impact to their business and business insight that provides an opportunity for them to expand their revenues, for them to lower their cost structure, improve their customer experience and create total shareholder return and competitiveness for themselves. From our perspective, we think about it as using a number of levers to be able to deliver that. Number one is the main expertise; number two is analytics; number three is technology, tools and platforms that we've invested in; number four is our geographical spread, which is both onshore, offshore and multi-shore. And we think we've got all the necessary inputs to be able to deliver to our client's expectations.

Our next question is from Dave Koning with Baird.

I just had a few housekeeping items. I guess, first of all, what was the OPI contribution to the quarter, I guess, before it anniversary-ed? I don't know if you have that number, but just so we can kind of back into an organic growth number.

Yes. The 20% was contributed by the 2 acquisitions we've had in the last 1 year, which is OPI and a smaller deal off the Trumbull. And then organic growth rate, that's why it's around 17% on a constant currency basis.

Okay, okay. I got you. Secondly, transformation, obviously, a lot of questions about that. It was very strong in the quarter. Is that something that could -- I know it's a little bit lumpy. Could that decline sequentially just given how good it was in Q2?

Yes, David, I think the transformation business has a base layer of annuity business that will continue to remain stable and continue to build and grow. But it also has a second layer of project-based business, which is volatile. Typically, we do see the transformation business decline in the fourth quarter, and we do see the third quarter as being seasonally high. So there is going to be volatility associated with the transformation line of business, though we would continue to expect to see the growth and maturity of this business continue to develop.

Okay, great. And then finally, just backing into kind of -- well, looking at guidance and then backing into margins, it looks like you're kind of implying an adjusted margin maybe around 16.5% or so. I guess I'm wondering, is that right? And then from that level, I mean, could next year actually be up because you’ll have a full year benefit of the rupee next year?

So, Dave, on the adjusted operating margin, if you look at the first half, you've had an adjusted operating margin of about 16%. And in the second half, also we expected to be in mid-teens. And if the rupee remains at these levels, we would expect the adjusted operating margin will remain in the mid-teens, between 16% to 17%.

Our next question is from Jason Kupferberg with Jefferies & Company.

I just wanted to talk a little bit more about some of the macro commentary you gave on the overall environment. It sounds like maybe you felt it got a little worse in Q2 versus Q1. Can you just contrast the impact that you're seeing from the environment on the ramp of existing deals versus the sales cycles on the new deals that you're waiting to convert out of the pipeline? I think most of the commentary so far has been on the sales cycles for stuff in the pipeline. But I just wanted to clarify what's actually happening with the ramp on existing deals that you're turning from backlog into revenue, if you will. And then if you can maybe expand on that a little bit, I know it's too early to give specific guidance for next year, but just any preliminary qualitative thoughts on 2013 just based on the pace of year-to-date wins and whatever you're seeing in terms of pace of both sales cycles and ramps?

Jason, I think because of the change in the macroeconomic environment, I think there is a mixed impact with new clients and with prospects in the pipeline. However, with existing clients and the installed customer base, we have not seen any noticeable change associated with their ramp-up, as well as the execution of the backlog of orders that we had with existing clients. We have several large clients that continue to ramp up, and they continue to ramp up in Q2 and have plans to ramp up in subsequent quarters as well. As far as 2013 is concerned, we don't provide any guidance on that at present. As and when we are in a position to provide guidance on the year, we'd be happy to do so.

Okay. I mean, just where you sit now, would there be any reason to think that on a constant currency basis, you can't do your typical 15% to 20%? Or is it simply way too early to say?

I think it's too early to say. I will say, one comment which is, I think, really, really important, and that's to do with our business on a currency adjusted basis. So as you're all aware, almost 25% of our business is business where we share the exchange rate risk with our clients, and the revenue associated with this percentage of our business goes up or down as the currency goes up or down. However, the balance business is well protected, and where we take out hedges for long periods of time to be able to insulate ourselves from the FX risk. The key point is that if the Indian rupee remains at current levels or depreciates further for a sustained period of time and if that currency shift is going to be a permanent shift, then we will expect to see there being changes in terms of the pricing structure in order to remain competitive with the marketplace. And then that will have an impact in terms of the growth rate of the company from a revenue perspective, though from a margin perspective and from an EPS perspective, it will be neutral.

Okay. And then just a housekeeping item on the transformational business. I mean, where could you see that going as a percent of total revenues over the next few years assuming that the traction that you've been experiencing continues?

So the basic mix of our business is fundamentally 80% outsourcing and 20% transformation. And what we've seen over the last several years is that, that mix in general has remained constant. Please keep in mind that most of the acquisitions that we have done have actually been on the outsourcing side and get added on to the outsourcing segment revenue, whereas on transformation, it's largely been organic growth that's driven the revenues in the transformation business to remain at 20%. So we would continue to see a faster growth rate in transformation, and we would continue to see the portfolio mix stay somewhere between 80% for outsourcing and 20% for transformation.

Our next question is from Mayank Tandon with Needham.

Rohit, just a very quick question around pricing. I just want to be clear, are you seeing any pricing renegotiations on your current deals? Or is this really pricing pressure that you're seeing on situations you're competing on?

Well, we're certainly seeing pricing pressure associated with new business that we are competing on. And with the volatility and the exchange rates, I think the way in which competition uses that sometimes can be out-of-sync with where the exchange rates are or the types of contractual arrangements that providers want to have with their clients. We've been very, very disciplined in terms of the way in which we've approached this. And I think from our perspective, we think the right way of structuring a contract with our clients is one where we share the exchange rate risk with our clients and provide them with the upside if the currency depreciates and also that our clients take the downside if the currency appreciates. As far as the existing book of business is concerned, as I mentioned earlier, we take out FX hedges to protect ourselves for a long period of time. And typically, these are anywhere between 12 to 24 months. And therefore, any discussion that we'll have with our clients with our existing book and the existing portfolio will be to make price adjustments only if the currency movements are permanent, and these changes will take place from a future timeline perspective and not on an immediate basis.

Great. So just looking at the quarterly trends, can you give us a sense of, however you want to put it, the realized rate or the billing rate, how has that been trending for the last several quarters?

If you take a look at our billing rate, across the company, the billing rate has probably been increasing because the transformation business has been growing. We've also added on certain platform-based businesses and some nonlinear growth businesses to our portfolio. And therefore, on a combined basis, our billing rates have been increasing. If I was to break it out, just on the outsourcing side, the new clients that we are signing up right now, because of the currency devaluation that has taken place, there the billing rate is lower because of the devalued currency.

Our next question is from Vincent Colicchio with Noble Financial.

Most of my questions were answered. Just one last one here. Given the increased competitive -- given the increased competition, I'm just curious, are you -- have you changed at all the type of target company you go after in terms of size, maybe going down a little bit in size given the environment?

From an acquisition perspective?

No, in terms of new customer acquisition.

New customer acquisition?

Yes.

No, not really. For us, the primary target continues to remain the Global 1000 companies. And we think even though they might start out small with us, over a long period of time, we can have a significant business relationship with them. For certain product lines, we also think that some of the mid-market customers are the right customer base for us, and we continue to target them. The area that we are very sharply focused on is choosing clients in our domains and in the areas where we've got capabilities, as well as working with clients in the geographies where we can most effectively service them. So those are much more important to us than anything else.

I'm showing no further questions at this time. I would now like to turn the conference back over to management for closing remarks.

Well, I just want to conclude by saying that I think we had a terrific quarter, and we continue to remain confident about the future progress of the company. Thank you all for joining this call, and we look forward to seeing you at our next earnings call.

Ladies and gentlemen, this concludes today's conference. Thank you for participation, and have a wonderful day.