Firstsource Solutions Limited analyst Q&A

Thank you very much. We will now begin the question-and-answer session. The first question is from the line of Manik Taneja from Axis Capital. Please go ahead.

I just wanted to pick your thoughts on a couple of things. Some of your peers as well as you have spoken about softer volumes compared to the initial client volume estimates that customers typically tend to provide through the course of calendar year 2023. Are you still seeing that play out or there is some amount of stability on that front? That's question number one. The second question that I have is that some of your peers have spoken about insourcing that they have seen in a couple of instances. Are you seeing any signs or discussions around this front at any of your clients? The third question was a clarification question. We have seen several leadership reinforcements over recent months, where are we in that journey now? Would be great to get your thoughts on that.

Thank you, Manik, for the question. Let me try and address the questions one after the other. The first question that you had was in terms of what we are seeing in the macroeconomic environment itself, client spend, volume so on and so forth. Let me just start by saying we still see the macro duality in some sense still playing out. What I mean by that is on one hand, while clients remain cautious in the uncertain macro environment , we also find that they are actively moving on programs where they see opportunities for meaningful cost optimization not just by leveraging outsourcing and offshoring but by reimagining the process itself and bringing in elements of technology including AI and automation. We have seized that opportunity and continue to engage with both our existing clients as well as exploring new logos with solutions that create value for them. So, that duality in my mind is likely to continue either which way. The second question that you had was related to the insourcing side. Actually , let me just take a step back and share with you how I see this trend in a larger context. The narrative for insourcing or global capability construct s in the last 12 months has moved from pure cost arbitrage to co-location and co -innovation. And here, there is a little bit of a paradox on one hand. Between 200 to 250 new centers are being established every year across various GCC hubs. Out of these about 55 to 65 % are de novo. That is the enterprise is setting up their own centers, but the rest are provider assisted. And the newer provider supported global capability centers even in an in sourced environment our focus around collaboration, around cutting-edge tech and proxies, b ut what we're also seeing is a growing numbe r of clients who are exploring divestitures of their offshore capital. In fact a number of such cases today is almost 5x of normal years and even more than what we saw post the global financial crisis. Part of this has to do with the impact of higher interest rates on working capital and thereby expensive debt servicing which is pushing companies with global capital footprints to consolidate and divest to free capital itself. The other part has to do with the advent of AI and the uncertainty arou nd its impact making companies rethink their entire strategy of deploying large pools of res ources on their roads. As Firstsource what we are trying to do is to position ourselves to take a dvantage of both these trends. We've created a comprehensive playbook when clients want to in source that has components of design, build and operate in partnerships with real estate firms, global talent agencies, and legal and regulatory advisors. This makes it easier for us and clients to get off the ground quickly and reap the benefits of colocation and co-innovation. We've also set up a team to focus on divestitures, especially in sectors we operate in and the geographies we operate in or on our radar itself. So, we think a combination of both of those allows us to take advantage of either the insourcing flat setting up for global capability centers or on the other hand it allows us to take advantage of what might play out in terms of captive divestitures itself. The third question that you had was related to the leadership and the off design and so on and so forth. We've rolled out the new o rg. structure effective from first of Jan. Portfolio alignments as I discussed in my initial commentary at the market and capability unit levels have happened. We're now firmly in execution mode. Having said that look there are still areas where we continue to explore the right talent. W e'll keep making interventions as and when we see a requirement itself.

If I can pick your thoughts on one more question. You spoke about both an interest and push from our end to since rely we drive more offshore delivery across som e parts of our vertical service offerings. What is driving that because historically the kind of work that we used to do in certain segments say for example on the provider side those used to be typically on shore delivery because of compliance or because of regulatory r easons. So, is there something else that we are trying to sell now on both healthcare as well as possibly on the collection side?

Let's talk a little bit about the healthcare segment itself. So, on the provider side I do expect that the buildup of enrollment will be gradual over the next 9 to 12 months, but on the provider side what we have focused on is on broad basing our portfolio. We are quite excited right now by the offshore revenue cycle management market where we believe that the current wave of tech led disruption is providing an opportunity for us to take share away from traditional revenue cycle management players who have largely built a people-based business. Similarly, on the payer side our strategy to focus on strategic accounts is playing well. We had good wins in this space in the third quarter and we see a very healthy pipeline as well. Therefore, we expect good growth momentum in the healthcare verticals in the coming quarters.

Thank you. The next question is from the line of Jalaj from Svan Investments. Please go ahead.

I wanted to pick your brains around the conversations around the highest deal wins. Could you talk a little about quantification of the numbers or the order book, how it does look like?

We do not get into specifics around the numbers yet in terms of the deal wins or t he size of the pipeline itself, but what I want to talk a little bit about is the pickup in our deal wins that you see whether it's in terms of the fact that our deal wins in the third quarter were the highest in the last three years or the fact that we exited third quarter with the highest ever pipeline in the history of the company. It's simply the result of the rigors that we've brought in our engagement with all our clients. What we are doing differently now is to participate more proactively in both the cost optimization and the process transformation agendas of our clients. We're actively hunting for sole source opportunities, both in our existing portfolio of clients as well as the new set of logos. And we are finding clients responding favorably to our efforts which is therefore then translating into the strength of our deal wins and pipeline. What you also will see is in terms of profile these deals are across the board. In example, in Q2 we had a large deal in the EdTech sector which was essentially a new logo. In Q3, we got a deal from our large financial services plan which was one of our existing customers in space. This kind of stuff in some sense is reflective of how we are going to market and the fruits of the rigors that we're deploying in the process how that's yielding results for us.

And one last question maybe so you touched upon the top quartile growth, so what sort of peers are we comparing the growth rates to?

So, that's a good question. I think what I would do is when we come back in at the end of Q4, I will be providing more detailed commentary in terms of what the top quartile revenue growth will be as well as talk a little bit about what those numbers would look like in terms of either the revenue side or in terms of margin itself because a lot of this is not just about the current quarter or the near term, but it's also about how we are building a business for the medium to long term itself so that we can continuously outperform itself.

And one last question if I may. So, when do you expect the BFS vertical to pick up per say seeing the basically the discussions with the clients we are having right now and any sort of improvement in terms of operating leverage and since we are spending a lot in the terms of technology and seeing the growth in top line, so when do we expect it would reflect?

So, let me talk a little bi t about the financial services v ertical and then talk a little bit about the margin side. If you look at the growth that we're seeing today in our financial services portfolio , we won a large deal for instance with an existing client in the UK whic h is in the financial services s pace and that in some sense reflects resilience in what we're seeing in the portfolio itself. What we are also seeing as a secular scheme which we think bode well for us is where clients are increasingly looking for service providers who offer an integrated capability across front office and back office so that they are truly end -to-end from a domain standpoint. This actually plays well for us because we are one of maybe a handful of providers who have that end -to-end capability; most players end up over investing on one area or the other. If you look at the mortgage space in particular the trajectory for 2024 suggests, based on all the commentary that I'm sure you read as much as I do t hat there is likely to be an easing of mortgage rates which should increase the refinance demand. What we are however doing though and this is this is more important than anything else, we are deeply engaged with our clients to help them build a search readiness playbook with the right mix of people and digital / AI intervention and as we have been broad basing our service portfolio we are not just talking to the mono liners in the mortgage space, but we are talking to mid-tier regional banks as well as broad basing our portfolio beyond origination to servicing and HELOC and other segments of the real estate sector. We are also seeing growth in our Fintech space and our collections business is a great hook there to land in the Fintech spaces as well as especially if you take a lot of the BNPL players in the segment. A lot of them are dealing with the large collections portfolio and our world -class leading capability in collections certainl y is helping in that regard. So, there are a number of things that we feel good about in the context of our current capabilities and how they’re geared up for the financial services space itself. Now the question that you had related to margins and what we end up seeing. One of the things that I talked about right upfront in th e context of our commentary is we are investing in building a deal funnel as well as refreshing our sales engine. Our intent is to fund these investments mainly through internal cost opt imization and efficiency gains a nd while we may see minor impact on our reported margins in a specific quarter itself, we remain confident of a structural improvement in our margins over the medium term. The fact of the matter is, I mean, if you just take two data points into account, we had the largest set of deal wins last quarter and we also exited the quarter with the highest pipeline ever in the history of the company. Just put those two things in perspective. It means that when these deals land and we hire people, there is a cost of growth that's going to come about and that's going to be playing out in a quarter itself. Now while we try to optimize for that through internal cost optimization and other efficiency initiatives that we are constantly working on , it could still result in a blip on quarter-to-quarter basis. Our intent is to make sure that we're building a resilient and durable business with margin improvement over the medium term. So, that's probably the way to think about it.

Two questions here, Ritesh. First is you've indicated kind of increased offshoring trend in certain segments of businesses like Healthcare and Collections. So, do you see this as a risk to revenue just like we saw 300 bps to 400 bps headwind to revenue in FY24 because of higher offshoring from our top client in CMT vertical?

No, I do not see this as a risk. What we are seeing is two sets of things. On the one hand, we are seeing a propensity to move offshore and near shore in some of our clients potentially being an opportunity where we can take additional volumes from them. We're also seeing the amenability on their part to look at that part of the business from an offshore standpoint benefit us. As we broadened our portfolio on the provider side as an example and we started playing in the mid-to-back end of the revenue cy cle side a lot of that work gets done offshore. So , naturally there's a tendency to move to work offshore as opposed to ot herwise. We feel good about it i f anything else between the locations that we have today in the mix, our ability to service whether it's our healthcare clients or our collections clients, our location makes across onshore, near shore and offshore positions us really well a nd actually in a way having locations in country in the US and UK in our minds it's going to be a net positive over the long run medium to long term.

But from a more near -term perspective getting into next year, do you see this more as a headwind? I'm talking more from a near term perspective.

No, we don't see it as a headwind.

And secondly while you've narrowed your guidance band for FY24, the ask rate CQGR still is very wide from 2% to 6% to get to the top end and the low end of the guidance range. So, at this point in time just wanted to check your comfort on whether you are more comfortable being at the lower end or at the mid end given the fact that you don't expect the usual seasonality in the collections business that plays out every year to happen this year?

Look I will only say this we do not specifically provide guidance on any specific quarter. So, I'm not going to comment on the math that you just provided. But having said that let me just reiterate the following: we had a good set of deal wins in the last two quarters that are in various stages of ramp up as we speak. You can also see this in the net headcount addition numbers as well as the facilities build out that we're doing. We feel good a bout where we will end up at the end of the quarter and for the full fiscal itself on the back of that. So, our purpose of narrowing the band was to give you more color as we approach the end of the quarter itself as you start looking at where we might end up for the full fiscal itself.

And just one more question, I think you indicated that we did see some decline in our mortgage business and this has come after 2 -3 quarters of stability that we had seen in the previous 2-3 quarters. So, could you just highlight what exactly happened because if I recall well, you had indicated that if kind of reached the bottom in mortgage revenue. I mean most of your clients have reached that the bare minimum of mortgage revenue that they can be at. So, from that perspective would we not be expecting a gradual ramp up each quarter?

Look, I am not too perturbed about what you might see as a marginal drop quarter-on-quarter in the business itself in the mortgage business as you are aware that business is down in the high single digits for us as a percentage of revenue, number one. Number two, we feel very comfortable with the deal wins that we've had in this space and the ramps that are happening as we speak. We also continue to have an active pipeline in the mortgage side and our leadership position in this space augers well for what's coming down the pie. So, if nothing else actually we are playing on offense out there. We have created a search readiness playbook which we think boards well for as and when the Fed chooses to relax interest rates as well. So, overall, I wouldn't read anything into what you might have seen as a minor aberration one quarter to the next.

Any quantification around how much does mortgage contribute to overall revenue now?

We're not getting into specifics of numbers, but what you can see is that it's not material enough that it should matter to the portfolio and that's the bigger point that I want to highlight out here is I think again as in our endeavor to build a business which is resilient and durable, we want to make sure that we take some of the macro discontinuities away from the way we're growing the business itself. That's the reason why we're continuing to broad base our portfolio. That's the reason why we feel that how we are putting the foundational blocks in place sets us up well for top quartile industry growth.

Thank you. The next question is from the line of Nikhil Choudhary from Nuvama. Please go ahead.

My first question is on deal wins, so just want to understand which segment and which geography is driving this growth. And second thing is regarding growth in being 30% for first half and when headcount growth being 16%, is it fair to assume that between ACV and TCV. ACV growth is more or less similar to head count while TCV is growing much more faster?

So, let me respond to the first part of the question which is where have we seen the deal wins itself. T he deal wins are broad ba sed across industry sectors. So, we've seen that across industry verticals and across geographies. So, if you look at growth that we are experien cing both in the US and Europe a nd in the European markets , we see the deal wins playing out . Similarly, we also see the deal wins playing out across financial services, healthcare , communications media tech as well as our diversified portfolio itself. I don't want to specifically comment on the TCV, ACV math because deals have different timelines. They're not necessarily drawn out in the manner that you might have been drawing a conclusion out there. What I think you should take a way is the fact that we've had t wo consecutive quarters of meaningful headcount addition and that in some sense is a reflection of the strength of that executable order book itself. So, the very fact that we are adding headcount supported by the fact that the deal wins continue to go up and last quarter was the highest deal wins that we've had as well as the pipeline that is there. I think these are all I would think as lead indicators in terms of how it's likely to play out from a revenue standpoint as well.

On similar line basically our deal wins tend to be very strong, but in a scenario where mortgage volumes comes back, that will be more discretionary and still not captured in this deal wins?

So, it's a good question. I'm going to give you two different perspectives. A lot of the independent mortgage companies that might be there, the mono liners who only specialize in mortgage, a lot of them may still be looking for a capacity in terms of how they ramp itself. As and when the origination volumes do come back, I would expect that it won't be discretionary, but they're looking to potentially build out the business for what's likely to play out. I mean, sometimes these things are in a cycle. The next cycle that ends up playing out where interest rates are coming down creates a market move towards maintainin g a certain threshold of people to support that volume itself. What I do expect is, the way we are preparing ourselves and what is resonating with our customer base is the fact that we can provide a combination of a people plus technology solution a nonlinear capability to help them ramp up to what might come down the pipe. Let me give you an example of that. T ake underwriting, which is one of the k ey areas in the mortgage value chain itself, the ability to have a digital underwriter a s an example. Leveraging AI along with the human in the loop is going to be a differentiated capability for organizations to ramp up as volumes come back and I think these are the kinds of opportunities that we feel very good about.

Thank you. The next question is from the line of Dipesh from Emkay Global. Please go ahead.

Couple of questions. First , in collection business , you indicated we are not expecting usual seasonality in Q4. So, can you help us understand what is changing in the business or why it is not happening usual seasonality, but you indica ted obviously growth to happen, but n ot the optics seasonally which we usually see. Second question is about top client, top client did well th is quarter despite off sources. So, just want to understand what led to it and whether it is because Q3 is generally higher volume quarter for that client whether it is usual seasonality or something more to it? Third question is about the E BIT margin, now it is down 60 b ps and we alluded to some of the reasons like salary high promotion, ramp up, b ut obviously there is an offsetting factor of significant offshore shift. So, considering all these factors put together it seems revenue is growing broadly in line with the way you expected, margins seem to be lagging. So, if you can provide some sense around how one should look at? And one question on other income side last quarter we indicated that non -controlling interest related and cont ingent reversal largely behind, b ut again this quarter we are seeing some movement. So, whether this is the last quarter, or do you expect it to continue?

So, let me start by talking a little bit about the collections for business itself. First and foremost, we continue to see significant traction in our collections business across first party collections, third party collections and legal collections. It's a world class capability. We continue to add significant clients as well as consolidate our position with several of the top banks that we are the n umber one collections provider for. We've added several new clients in this space particularly in the Fintech side as well. When I talked about the fact that the seasonality in Q4 may not be as much as what we typically see, we still expect the strength of what we've seen on the headcount a s well as the deal wins itself should bode well in terms of what reported growth should look like in general. Related to the top client, we don't typically talk about a specific client itself and what played out there, but what I do want to say is that we continue to actively engage with all our l arge clients, and we are continuing to seek and gain new business from them. So, I think you're going to see that as a secular theme just by virtue of the engagement that we are seeing with them itself. I'm going to give a headline message on the EBIT and then I want to call Dinesh to comment on the EBIT and the other income side. One of the things to bear in mind is that we are investing in building our deal funnel as well as refreshing our sales engine. We are continuing to fund some of these investments mainly through internal cost optimization and efficiency gains and therefore while on one hand we may see minor impact one quarter to the next on a reported margins, we do believe in the medium term this business is set up for a structural improvement in margins itself. So, on one hand, you may see cost of growth playing out in a particular quarter, but I w ouldn't read much into that. So, I actually think from that perspective we're still very much on track for the guidance that we provided last quarter as well as what we reiterated at the beginning of my commentary for the current quarter of where we will end up on the EBIT margin side. So, we will still be in that 11 % to 11.5% range that we had talked about as well. Dinesh, y ou want to add anything further to that.

No, I think you're right. I think most of the efficiencies are also part of the overall operating margin which we are showing, and I think the cost of increments are higher; it's almost 120 to 130 basis on account of increments and promotions in Q3 and once you offset with some of the efficiencies, the net is 60 bps. And Dipesh on other income, you're aware that last year we had two of the acquisitions where the contingent consideration did not got paid and that were part of the other income. So, you can see INR60 crore was the other income in the Q3 last year which in Q3 of the current year is a much smaller number of around 13 crores and is more on account of one of the transaction in the mortgage businesses. And going forward we don't see any major other income coming in the coming quarters. There will be a last trench in March 31st, but the number will be very small.

Thank you. The next question is from the line of Rahul Jain from Dolat Capital. Please go ahead.

Let me just break this down into different areas where w e are seeing the demand. So, we do believe that BFSI will continue to grow and be a meaningful part of our portfolio itself. The work we do on our customer experience side today across a bunch of banks and Fintechs and so on and so forth is certainly something that is differentiated, and we believe that that allows us to keep expanding and taking a share in that space itself. Our collections capability is world class and also differentiated because there's nobody else in the market who has that end-to-end capability across first party collections, third party collections and legal collections powered by a digital collections platform that we bring to bear from an IP perspective. Third, if you look at the specific processing c apabilities that we have built a long different asset and liability lines in the financial services space whether it's mortgage, consumer loans, the deposit side of the house specific capabilities around KYC, AML, financial crimes, fraud, etc. We believe that all of these areas continue to grow at a rapid clip itself. Our ability to bring all of these capabilities under one roof to customers creates the opportunity for us to build a story in all the markets in which we operate. Therefore I feel that we have a full arsenal of capability, we have a lot of the clients base that is there and our opportunity , if I go back to the one first source framework that I talked about , is how do we continue to just cross sell and upsell into these accounts itself and that that to me is the piece that we are working hard on and we're seeing some good green shoots of the same.

Thank you very much. We'll take that as a last question. I would now like to hand the conference back to Mr. Ritesh Idnani for closing comments.

Thank you all firstly for joining the call and for your questions. I just want to close out with a few final point s. I'm satisfied with our progress on the strategy refresh under the OneFirstsource framework. We're seeing a very strong interest among clients for our revamped go to market strategy and we're engaging actively with them especially to structure large transformational programs. As you can see this is re flected in our deal wins in Q3 which were the highest in the last 3 years even as we closed the quarter with the highest ever pipeline in the history of the company. We're also executing well and our headcount add ition in Q3 was the highest in t he last 12 quarters. This has boosted our confidence in the medium -term growth outlook and as such we are bringing forward some of our planned investments. We intend to fund these investments primarily through internal cost optimization and efficiency gains and while this may have a minor impact on margins in any specific quarter, we remained confident of a structural improvement in our margins over the medium term. That's all from our side. We look forward to interacting again with you in the next quarterly call. Thank you.

Thank you very much. On behalf of Firstsource Solutions Limited that concludes the conference. Thank you for joining us ladies and gentlemen. You may now disconnect your lines.