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Syntel (NASDAQ:SYNT)

Q2 2011 Earnings Call

July 21, 2011 10:00 am ET

Executives

Prashant Ranade - Chief Executive Officer, President and Director

Arvind Godbole - Chief Financial Officer, Principal Accounting Officer and Chief Information Security Officer

Bharat Desai - Co-Founder and Executive Chairman

David Mackey - Vice President of Finance

Analysts

Joseph Foresi - Janney Montgomery Scott LLC

Manish Hemrajani - Oppenheimer & Co. Inc.

David Koning - Robert W. Baird & Co. Incorporated

Vincent Colicchio - Noble Financial Group, Inc.

Rahul Bhangare

Edward Caso - Wells Fargo Securities, LLC

Joseph Vafi - Jefferies & Company, Inc.

Puneet Jain - JP Morgan

Mayank Tandon - Signal Hill

Brian Kinstlinger - Sidoti & Company, LLC

Operator

Ladies and gentlemen, thank you for standing by, and welcome to the Syntel Second Quarter 2011 Earnings Call. [Operator Instructions] As a reminder, this call is being recorded today, Thursday, July 21, 2011.

I will now turn the call over to David Mackey, Syntel's Senior Vice President of Finance. Sir, you may begin.

David Mackey

Thank you, and good morning, everyone. Syntel's second quarter earnings release crossed GlobeNewswire at 8:30 a.m. today. It's also available on our website at www.syntelinc.com.

On the call with us today, we have Bharat Desai, Syntel's Chairman; Prashant Ranade, Syntel's CEO and President; and Arvind Godbole, Syntel's Chief Financial Officer.

Before we begin, I'd like to remind you that some of the comments made on today's call and responses to questions may contain forward-looking statements. These statements are subject to the risks and uncertainties described in the company's earnings release and other filings with the SEC.

I'll now turn the call over to Syntel's Chairman, Bharat Desai. Bharat?

Bharat Desai

Thank you, David. Good morning, everybody, and thank you for joining us today. We are pleased with the progress made during the second quarter as solid revenue growth enabled Syntel to absorb costs associated with offshore wage increases, visa fees and infrastructure expansion. As a result, margins expanded versus first quarter levels. From a Syntel perspective, the demand environment for IT services continues to be stable and healthy. While our customers remain vigilant regarding global economic challenges, we've yet to see changes in spending patterns related to 2011 initiatives.

Projects designed to drive cost improvement and business efficiency remain top of mind, and clients have continued to spend on engagements with defined return on investment. In addition, we're beginning to see clients move forward with pilots and proof of concepts related to new technology-driven offerings including analytics, cloud computing and mobility.

The business opportunity for Syntel is robust, and the organization focus remains clear. We must continue to leverage our unique combination of size, capability and culture to help our clients compete in their respective industries. By doing this, we are firmly convinced that Syntel can grow our business at a rate faster than the industry and thereby gain share.

I would now like to turn the call over to Prashant Ranade, Syntel's Chief Executive Officer and President, to provide further details. Prashant?

Prashant Ranade

Thank you, Bharat, and welcome, everyone. Syntel's second quarter revenues came in at $157 million, increasing 8% sequentially and more than 20% year-over-year. The combination of 2011 budget finalization and a relatively stable economic environment provided clients with the comfort to move forward with project commitments.

Revenue growth in the quarter was broad-based across the company, with most key services, verticals and angiographies improving sequentially. Arvind, will provide further details on revenue performance in his prepared remarks.

Second quarter gross margin expanded by 120 basis points as compared to the first quarter levels, coming in at 36.2%. Revenue acceleration in the quarter drove improved utilization, which allowed us to more than offset higher costs associated with offshore wage increases, visa fees and rupee appreciation.

Offshore utilization for IT improved from 63% to 66% on a period-end basis and from 61% to 65% on average in Q2. We were able to achieve this while maintaining our focus on campus hiring, as Syntel's net headcount grew over 2% in second quarter.

The company's SG&A expenses increased $3.2 million during Q2, as we began moving into our new 4,000-seat facility in Mumbai. SG&A was also impacted by currency-related balance sheet translations and our annual offshore wage increases. While global economic uncertainty remains a concern, we are pleased that at this point in time, client spending patterns have not been impacted.

From a Syntel perspective, the overall demand environment and new business pipeline for our services continues to be stable and healthy. Mining of our top 30 accounts remains the #1 focus for the company, as we look to leverage our deep domain expertise and unique engagement model to expand our footprint. Clients are increasingly looking for their partners to provide business value far beyond level arbitrage, and we believe that Syntel is well positioned to provide this differentiated value.

In the second half of 2011, we'll continue to invest in creating long-term sustainable value for our clients, shareholders and employees. Key initiatives include the hiring of approximately 2,000 campus trainees, ongoing infrastructure expansion in Chennai and Pune and the creation of new domain and service capabilities. These investments will limit our margin expansion opportunities in 2011 but will position Syntel to drive growth at or above industry levels for 2011 and beyond.

I would now like to turn the call over to Arvind Godbole, Syntel's Chief Financial Officer, who will discuss Syntel's financial performance. Arvind?

Arvind Godbole

Thanks, Prashant, and good morning. After my comments, we'll open the call to questions.

Syntel's second quarter revenue came in at $157 million, up 20% from the year-ago period and 8% sequentially. For the second quarter, Applications Outsourcing accounted for 74% of revenue, KPO at 15%, e-Business represented 8% and TeamSourcing was 2%. From a vertical perspective, financial services contributed 59%, with healthcare at 17%, insurance 12%, automotive 3% and all other accounted for 9%.

Vertical growth was led by healthcare and financial services, which sequentially grew 10% and 9%, respectively. In fact, all vertical grew at, at least, 7%, with the exception of insurance, which continues to face business challenges.

Syntel's customer concentration levels reduced slightly during the quarter. Our top 3 clients represented 52% of revenue, top 5 contributed 63% and top 10 came in at 77%. The fixed-priced component of our business was at 38% of revenue for the quarter.

With respect to Syntel's margin performance, our gross margin was 36.2% in the second quarter. This represented a decrease versus 39.5% reported in the year-ago period but a sequential improvement versus the 35.0% in the first quarter of 2011.

As Prashant mentioned, improved utilization more than offset the quarterly impact of offshore wage increases, visa fees and currency. Our direct costs were adversely impacted by a 1.3% appreciation in the Indian rupee during the quarter, which reduced the gross margins by over 40 basis points.

By business segments, gross margin for Applications Outsourcing was 32%, KPO at 56.5%, e-Business was 34.5% and TeamSourcing 39.7%.

Going down the income statement, our selling, general and administrative expenses were 17.7% in the second quarter of 2011 compared to 14.6% in the year-ago period and 16.9% in the first quarter. On a dollar basis, SG&A was up $3.2 million sequentially. Facility expansion costs, offshore wage increases and currency-related impacts drove the majority of the quarter increase.

Rupee appreciation versus the U.S. dollar sequentially increased SG&A by $0.6 million including a $0.4 million impact from the balance sheet translation adjustment.

Other income during the quarter decreased $0.2 million, coming in at $5.9 million. The company recorded a $0.4 million gain on hedging, which was $0.6 million lower than the $1 million gain recorded in the first quarter. Additional interest income of $0.5 million helped offset the lower hedging gaps.

Our tax rate for the second quarter came in at 20.9% as compared to the 22.5% posted in Q1 of 2011. In the second quarter, the company recorded a $0.9 million tax reversal for reserve positions no longer required.

Net income for the second quarter was $27.6 million or $0.66 per diluted share compared to $28.3 million or $0.68 per diluted share in the year-ago period and $25 million or $0.60 cents per diluted share in the previous quarter.

The company's balance sheet at the end of the second quarter of 2011 remains extremely healthy. Our total cash and short-term investments on June 30 were $294.6 million, and DSO levels were at 56 days.

Capital spending in quarter 2 was $10.3 million, as we continued support [ph] for new buildings in Mumbai and Chennai and initial construction of Phase III in Pune.

Syntel entered the second quarter with a total headcount of 18,027, of which 5,048 were assigned to KPO. Our billable headcount was 2,762 on-site and 14,098 offshore for a total of 16,860. Net additions to global headcount were 470. Utilizing levels at the end of the quarter were 94% on-site, 73% offshore and 77% globally.

Our delivery mix currently stands at 20% on-site and 80% offshore. Voluntary accretion during the quarter was 16%, an increase versus 14.1% reported last quarter.

Syntel added 4 new customers in quarter 2 and one new Hunting License, which takes the total number of preferred partnerships to 207.

Looking forward, I would now like to provide you with the guidance for 2011. Based on our current visibility levels, Syntel expects the revenue to be in the range of $625 million to $640 million and EPS to be in the range of $2.75 to $2.90 for the full year 2011. The company currently has 91% visibility to the low end of the revenue range, and our guidance is based on an exchange rate assumption of INR 44.5 to the dollar.

We have assumed that our operating margins will be in the 20% to 21% range, and that our effective tax rate will be approximately 22%. CapEx for the full year is still expected to be in the range of $70 million to $80 million, including land purchases.

We will now open the call for a question-and-answer session. Operator?

Question-and-Answer Session

Operator

[Operator Instructions] Our first question comes from Joseph Vafi from Jefferies.com.

Joseph Vafi - Jefferies & Company, Inc.

I was wondering if we could just drill into that revenue line a little bit more. I mean, 8% sequential growth, pretty strong for you guys this quarter. What do we see in terms of the visibility to Q3 in terms of maybe some of that growth continuing into Q3 and basically were we seeing projects that just started that still were in ramp up phase and that 8% really doesn't comprise a full run rate on maybe some new 2011 projects?

Prashant Ranade

Thanks for your comment on growth rate. We are pleased with our Q2 growth rate. We have provided the guidance consistent with what we have done in the past. So based on 91% visibility, we have increased our lower-end guidance and higher-end was also increased to $640 million. The demand environment is stable. Customers are looking at short-term development projects, and we have been able to take advantage of that based on the investments we have made. So we expect the revenues to grow sequentially during next 2 quarters.

Joseph Vafi - Jefferies & Company, Inc.

Okay. Where there any big projects that maybe ended in the quarter that would maybe be a little bit of a headwind in terms of where the Q3 revenue may go or any other onetime things in the revenue we should be thinking about here for Q3?

David Mackey

No, I think Prashant's comments, Joe, are pretty accurate in terms of directionally where we're happy with the performance in the second quarter. We did have a little bit more growth in the development portfolio this quarter than the maintenance portfolio, which obviously creates a little bit of lumpiness. The other thing that we had this quarter in terms of a onetime impact is the transition revenues that we had with our large KPO clients from Q1 did continue into Q2. We had about $1.8 million of revenue in the second quarter related to that transition. We do expect that to ramp down considerably in Q3. It should provide a margin improvement for the KPO business but will create a little bit of a headwind for revenue growth in that segment in Q3. Other than that, there's really nothing in the business that's nonrecurring other than obviously the development projects do tend to be between 3 and 6 months in duration.

Joseph Vafi - Jefferies & Company, Inc.

Okay. And then maybe just one final question on margins. I know -- and Prashant was talking about continued investments and the like for the rest of 2011 for new service offerings, et cetera. Maybe some commentary here on where you think maybe margins may progress relative to utilization. You had a nice sequential increase here in gross margin despite all the Q2 items that you had to absorb. So I guess we would assume to see a little bit more margin recovery here for revenues continue to grow and we can keep utilization where it is or maybe a little bit higher at least on the gross margin line.

David Mackey

I think the expectation, Joe, is that the gross margin, despite the investments that Prashant has talked about and the operating margins, clearly given the full year guidance that we've provided at 20% to 21%, they need to improve in the second half of the year, and we do expect them to improve sequentially in Q3 and Q4. The investments, in terms of incremental from where we were last quarter, are really in the areas of additional hiring from the campuses and the infrastructure associated with that. That being said, we still believe there's a pretty good opportunity for us to continue to improve the utilization despite that aggressive hiring in Q3 and Q4. I think just relative to where we were last quarter, the expectation of the magnitude of that utilization increase has been somewhat tempered.

Operator

Our next question comes from Edward Caso from Wells Fargo Securities.

Edward Caso - Wells Fargo Securities, LLC

I was wondering if you could get us up-to-date on the status of the State Street KPO relationship?

Prashant Ranade

Also in our clients, State Street remained aligned on long-term goals. This relationship is over 8 years in place, and we have provided substantial value. And we are going to continue to have discussions related to the contract, which we know is expiring first quarter of next year. But at this time, there is no additional update. We'll keep you posted as we progress in those discussions.

Edward Caso - Wells Fargo Securities, LLC

In your commentary, you mentioned that the insurance sector remains troubled. We've heard that elsewhere. Could you sort of give us a little bit more flavor or color to that?

Prashant Ranade

Yes, Ed. Majority of our insurance business comes from PNC Group, and it is driven -- a higher percentage is driven by development projects. And as we know, over last 2 or 3 quarters, several of PNC insurers have taken a substantial hit, causing them to slow down on some of the development projects. Having said that, we are seeing stabilization in that. Obviously, none of us can predict next catastrophe. But based on that, we expect the development projects to be increasing, moving forward from this point. But clearly, it has been impacted by what PNC insurers have seen.

Edward Caso - Wells Fargo Securities, LLC

There's a possible legislation or proposed legislation in the U.S. to allow favorable repatriation of funds. Is this something that the company would consider?

Bharat Desai

Ed, this is Bharat. Yes, we're awaiting the development of that. And if that is passed, the board will look at our position and the legislation and its terms and make a decision at that time.

Operator

Our next question comes from Mayank Tandon from Needham & Company.

Mayank Tandon - Signal Hill

Bharat and Prashant and David, I wanted to ask you about the demand side again just to follow up on Joe's questions earlier. What does the pipeline look like and also the conversion cycle relative to say 3, 6 months ago?

Prashant Ranade

Clearly, we see demand stabilization and more interest in releasing the short-term ROI projects on the development side. So that's the reason we see potential to take advantage of that demand opportunity and, hence, our investments in trainees as well as infrastructure.

David Mackey

I would say, and just to add a little bit of color to Prashant's comments, at a macro level, Mayank, the pipeline remains extremely healthy. I feel comfortable in saying that the additions to the pipeline at this point in time still outstrip the items that are actually coming out of the pipeline and moving into production mode. So from an overall perspective, the pipeline is growing. We still have a lot of regulatory and compliance-related work that's queuing up that's going to need to get done over the next 18 to 24 months. There are a number of, not only short-term ROI-based projects, but also longer-term transformational projects that are in the pipeline. And the KPO pipeline continues to be robust but the timing, obviously, quite uncertain. So I think the pipeline, as a whole, remains extremely healthy for the company. And I think the conversion rate of that pipeline is something we're looking for to try and improve over time. But at this point, given the overall demand environment, I would say that the conversion rate out of the pipeline remains stable and consistent.

Mayank Tandon - Signal Hill

Great. That's very helpful. I also want to go back to the State Street issue. Just looking at some of the headlines coming out of State Street a couple of days ago, they talked about expanding the IT outsourcing projects with some large players. Is there an opportunity for Syntel to work outside the scope of the JV on the IT side specifically?

Prashant Ranade

Our business on the IT side is strong with State Street, and that is clearly driven by our long relationship on the KPO side of over 8 years.

Mayank Tandon - Signal Hill

Okay. So we should read into that, that you could incrementally benefit from some of this news coming out of State Street in terms of their propensity to increase their outsourcing on the IT side. Is that fair?

Prashant Ranade

Clearly, there is a potential for that, and we are positioned to take advantage of it project-by-project.

Mayank Tandon - Signal Hill

Got it. Just one final question. Going back to the issue around cost. Could you just quantify what the impact of the wage increases and visa costs were this quarter?

David Mackey

I don't think we're going to get into the specifics on the wages. We had talked about an offshore increase for the April 1 cycle that was in the low-double digit range. I think the wage increases came in consistent with our expectations. I can tell you from a nonrecurring perspective that we had a little bit over $1 million of visa costs in the second quarter, which we do not expect to be there in the third quarter.

Operator

Our next question comes from Brian Kinstlinger from Sidoti & Company.

Brian Kinstlinger - Sidoti & Company, LLC

The first question I had is a follow-up to that question, the visas, $1.5 million -- sorry, $1 million-plus of costs. You had the $400,000 of balance sheet costs as well, and then you got the $1 million, I think, of new costs coming on for facilities. With that said, it sounds like SG&A x foreign exchange would be down modestly, maybe flat. Is that sort of how you think about it or are there incremental costs that could drive that higher?

David Mackey

Are you talking into the third and fourth quarters, Brian?

Brian Kinstlinger - Sidoti & Company, LLC

Just the third versus June.

David Mackey

Sure. I mean, when you look at some of the comments that Prashant made, obviously, we are continuing to move into our new facilities and we do expect infrastructure expansion in the third quarter. There are some reversals, like you said, that should be nonrecurring into Q3. We also have our client events scheduled for the third quarter of 2011, which will take the SG&A levels up. So we do expect, sequentially, SG&A will increase in the third quarter versus the second, although there are some opportunities based on what you said in terms of reversals from the second quarter levels.

Brian Kinstlinger - Sidoti & Company, LLC

And so I understand, for the year, the increased costs from facilities after the September quarter, when is the next time that you would expect to see an incremental bump up from facility costs, bringing on new seats? Is that not until the middle of '12? Is that completed?

David Mackey

No, I think it's going to be a little bit more uniform, Brian. I think we're going to be bringing on those seats now in a more phased-in fashion throughout Q3 and Q4. So we do expect -- and as Prashant mentioned, we've got some accelerated hiring, which has tempered some of the EPS expectations for the year. Obviously, that's going to require and necessitate additional infrastructure and seat capacity to handle those people.

Brian Kinstlinger - Sidoti & Company, LLC

Now what should we read into that increase? I mean, our original thought was that you were slowing recruiting but now you're picking it back up. So what does that tell us about your thoughts and maybe about 2012? What are you already seeing or hearing about how spending is going to ramp over that early period, early there?

Prashant Ranade

As I said earlier, the demand environment is healthy. And because of our positioning and relationship with clients, we see an opportunity to take advantage of the demand. And that is what has driven our decision to bring in trainees. We are doing it at a uniform rate, and that will position us even better to take advantage of a demand environment as we see it today.

David Mackey

And then, I think it's twofold, Brian. One, as Prashant mentioned, it certainly will allow us to service our clients in 2012 as the demand continues to be healthy. I think the other thing that's critical is, as you know, in 2010, we had a snap back in demand and the hiring was somewhat skewed towards laterals. And one of the things we've really needed to do over time is to rebalance the overall service delivery pyramid in the company so that we can manage our costs of delivering service going forward. And this will allow us to not only to meet demand in 2012 but also better position ourselves to drive the right kinds of margins and the right kinds of delivery for our clients going forward.

Brian Kinstlinger - Sidoti & Company, LLC

Understood. And then on the utilization side, the IT, you gave the statistics for the average and for the year, thanks. And as we think about the high end of your guide for the end of the year, supposing you got there, where would that put you in utilization, given your hiring plans from the 66%, where would end? And where is the goal to take yourself as we look out a year? Is it mid-70s, is it low-70s?

David Mackey

I don't think we'll ever get to a mid-70s, Brian. I think that kind of a utilization rate really starts to redline on your ability to grow business. From our perspective, as we've always said, the utilization in this space for IT should be between 60% and 80%. And at 60%, you're either in a hyper-growth mode or you've done a poor job of demand forecasting. At 80%, given the fact that these numbers include trainees and the bench and buffer necessary to manage your business, you're redlining on your ability to grow your business at all. So in an ideal, normal, stable growth environment, I think a 70% offshore IT utilization rate is a good place to target. And that's the number we're going to try and move our business towards as we get towards the end of this year. We may not make it to 70% given the campus hiring that we're going to do and, obviously, some of that will be a function of where revenue ends up in Q3 and Q4, but, clearly, we do see the opportunity in 2012. And as a result, our target, as we go through the rest of this year, will be to get towards 70% as opposed to getting up and above that number.

Brian Kinstlinger - Sidoti & Company, LLC

Two last questions, one is a follow-up. Each one percentage of offshore, if nothing else change of utilization, changes the gross margin by about how much?

David Mackey

In the neighborhood of about 25 basis points.

Brian Kinstlinger - Sidoti & Company, LLC

And then the last question, unrelated, is on the KPO side. You've talked about trying to sell some of your larger customers, who are big IT customers, into the KPO. Has there been any progress and maybe take us through that cross-selling opportunity?

Prashant Ranade

Yes. If you look at current quarter, our non-joint venture business actually grew at a higher percentage rate and we are pleased with that. Now clearly, that is a smaller portion of the business. And our current customers, as well as some of the customers outside that segment, we certainly have an opportunity to create a larger KPO opportunity in our client base today, as well as there are few clients outside our current top 30 clients. But clearly, among top 30 clients, there is an opportunity to grow into their KPO segment. Having said that, our focus in KPO remains on a mission-critical custom processes as opposed to generic processes.

Operator

Our next question comes from Joseph Foresi from Janney Montgomery Scott.

Joseph Foresi - Janney Montgomery Scott LLC

I just wanted to first ask -- I mean, just looking at the guidance, you raised the revenue but the top end of the earnings didn't move much. I assume that that's based on directionally what you think about margins. I know there's been a lot of talk about that. I was wondering, given the range of the 20% to, I believe, 21% guidance that you've given, should we be looking at the top end of that range or the lower end of the range and maybe you could just talk a little bit about some of the moving factors below the line as well?

Prashant Ranade

Clearly, we have raised the lower end of the guidance. Your observation is correct. On a higher end, based on the additional revenues of $5 million, there was a potential for $1 million contributing to earnings. But because what we discussed earlier, the accelerated hiring and investment and our decision to invest in those areas to prepare ourselves to take advantage of the growth is really a main contributor to that.

Joseph Foresi - Janney Montgomery Scott LLC

And I assume the philosophy of the company that you're going to add headcount, you'd sacrifice, I guess, margin a little bit here for the future potential growth trajectory of the business.

Prashant Ranade

That is exactly what we are doing right now, as you pointed out and I discussed earlier, because we do see demand opportunities and positioning ourselves to take advantage of the demand remains our main goal.

David Mackey

I think the other thing that's important to remember here, Joe, is if we're going to get to a 20% to 21% operating margin for the full year, it's certainly necessitates that we have healthy sequential operating margin performance in the back half of the year. And the other thing to remember is we're making these investments, we're delivering that kind of margin, but you're looking at an exit margin rate that's going to be better than where you came into this year. So in terms of how we look at 2012, we think these are the absolute right decisions for us as a business to position ourselves to perform well next year.

Joseph Foresi - Janney Montgomery Scott LLC

Sure, that makes sense. So I guess, just -- if 2012 ends up looking better that what the current assumptions that you're making in your hiring, do you believe that utilization will make up for -- I mean, I guess what I'm getting at is, do we think 20% is probably, on the operating line, the true bottom? Do you think you'll be able to make that up with utilization some of the other factors if you do have -- if 2012 ends up looking better than what you're currently projecting?

David Mackey

If 2012 ends up looking better, I mean, to be honest with you, you may run into the exact opposite situation where if things continue to firm up and stabilize for next year and we need to look at accelerating the hiring in the back half of the year and then bringing on additional trainees, you could end up with a few more basis points of sacrifice in terms of utilization, and it would certainly keep us towards the lower end of that operating margin. So a lot of where we come within that 20% to 21% range is going to be predicated on what 2012 looks like.

Joseph Foresi - Janney Montgomery Scott LLC

Okay. And then just assessing your assumptions on the tax rate or other income, should we be thinking about any of those differently at this point?

Prashant Ranade

We expect the tax rate to be around 22% for the full year and other income around $22 million for the full year.

Joseph Foresi - Janney Montgomery Scott LLC

And then the last question for me. I think you've talked on prior calls just about the penetration rate of accounts 11 to 20. Maybe you could just give us an update on how that's progressing and just how you're mining revenue from those accounts and what maybe your expectations are going forward?

Prashant Ranade

In that range of customer segment, our growth rate was higher than overall growth rate, and the top 30 clients remain our biggest opportunity to grow our revenues because they have seen our differentiated offerings, we have performed for them. So that is the biggest opportunity for us to grow the business.

David Mackey

And just to give a little color to Prashant's comments, Joe, if you look at our business in the first half of this year versus the first half of last year, we're up about 23% year-over-year. Our top 10 clients are up 20% year-over-year. So if you look at clients 11 through 30, which is the focus area -- part of the focus area that Prashant is talking about, that business has actually grown faster and has grown to 25% during the same period.

Operator

Our next question comes from Rahul Bhangare from William Blair & Company.

Rahul Bhangare

I may have missed this on the call but were there any KPO wins in the quarter? And if so, maybe break them out by vertical?

David Mackey

We did have one new KPO client added in the quarter and it was in the financial services vertical.

Rahul Bhangare

Okay, great. Also, an update to the pricing environment?

Prashant Ranade

Pricing environment remains stable to slight upward bias based on what we have seen in our client base.

Rahul Bhangare

Have you been able to garner rate product price increases?

Prashant Ranade

There are clients where we have successfully done that, yes.

David Mackey

And some of that, Rahul, was the function of where you are in your client's cycles. I mean not every one of our contracts is negotiated on annual basis. So what we have seen is where we've had the opportunity to sit down with clients and reengage on pricing. Clearly, we've had an upward bias with those customers and directionally, pricing has been headed in the right way.

Rahul Bhangare

Okay. And also to the competitive environment, are you seeing Accenture or IBM more so these days?

David Mackey

I don't think we're going to make specific commentaries about specific customers or specific competitors. The environment remains, from our perspective, relatively stable. We tend to see the same types of providers. We are operating consistently in a multivendor environment. So whether it's the large systems integrators, whether it's the large offshore pure plays, whether it's niche or specialty providers, there's always going to be a mix of these names on every large engagement, and we are seeing that type of approach to multivendor environments continuing.

Rahul Bhangare

So relative to previous quarters, the same?

David Mackey

I don't see a fundamental change in client behavior in terms of how they're allocating their spend, no.

Operator

And our next question comes from Puneet Jain from JPMorgan.

Puneet Jain - JP Morgan

Obviously, you talked about how margins in any given year will depend on demand and your need for investments. But if we look at our full cycle or on a normalized basis, should we expect Syntel's margin at around 20% on normalized basis assuming FX does not move?

David Mackey

Assuming a constant foreign exchange, Puneet, our expectation has always been that operating margin is going to be a function of the overall demand environment. When demand for these services is extremely healthy, there are a number of pressures on the cost side, wages go up, currency appreciates in value, utilization levels have to be lower because you're ready to meet client demand. Conversely, when the demand softens in this environment, and we certainly saw that in 2009, the cost side of this business gets extremely healthy. So there are some natural trade-offs to an overall demand environment and the ability to ratchet up or ratchet down the operating margin. That being said, I think on a long-term basis, when we look at our business, there's nothing that we see that says this can't be a 20-20 business where we continue to grow the top line at 20% and the operating margins are in the range of 20%.

Puneet Jain - JP Morgan

Okay, that's helpful. And second, it appears that the top end of the revenue guidance requires around 5% sequential growth in the second half. And obviously, you talked about good pipeline, steady conversion rates and have high visibility on the upcoming quarters. So based on that and also on the macro headlines that we hear almost every day, so is top line is still achievable if macro slightly deteriorates from here on? Or do you need steady macro or maybe macro improvement in order to reach the top end of your guidance.

Prashant Ranade

Our range of our revenue is based on the demand environment as we see it today. Clearly, it is dynamic and that's the reason we provide range as opposed to a single number. And as David mentioned earlier, our revenues through Q2 -- our first half, I'm sorry, include transition revenues that we expect would ramp down.

Puneet Jain - JP Morgan

Right. So my question basically was -- so I understand there is a range but my question was what needs to happen to the demand environment in the second half in order for you to hit the top end of that range?

Prashant Ranade

I mean it is a question of timing of when the projects are released. So clearly, the pipeline is there. We are readying ourselves to take advantage of that. And if we see the environment, well, there is an opportunity to go beyond that. We want to make sure we are not caught shorthanded, and that is reason for accelerated investment.

Operator

Our next question comes from Manish Hemrajani from Oppenheimer.

Manish Hemrajani - Oppenheimer & Co. Inc.

A couple of questions from my end. Growth has been pretty strong in the first half of the year, but your full year guidance implies a slowdown in the growth rate going into the second half of the year. What's driving the conservative picture for the second half? Please elaborate on that.

David Mackey

I think, and as Prashant just mentioned, when you look at our revenue guidance for the year, it's visibility-based. We have 91% at this point in time committed to the low end of guidance, which is consistently where we've been in the July time frame the past 4 or 5 years. So a lot of this has to do with what we have in the bag and historically what we've been able to do in terms of layering revenue on top of that going forward. As Prashant mentioned, the overall macro environment is dynamic, that's the reason we provide a range. There are certainly scenarios where if things line up, we have the ability to meet or beat that high end of guidance. There are also scenarios where if things deteriorate or get more difficult, we could fall below the high-end of that guidance. So the reason we provide that range is to allow us to see how things materialize. Certainly, one of the wildcards that we have to watch is where client budgets come in towards the end of the year. That's historically been an opportunity to generate large amounts of revenue fairly quickly, but it's a function of how clients view their business and where their budgets have been year-to-date. So we think there are certainly some variability left, but we feel good about where we are in terms of revenue guidance at this point. And we plan on providing an update to this revenue guidance in October.

Manish Hemrajani - Oppenheimer & Co. Inc.

All right. On your margin guidance of 20% to 21% for the year, you're looking at significant margin expansion for the second half of the year. Any risk to that fixed margin picture if you meet your low end of revenue guidance?

David Mackey

I think, obviously, there's risk if we get aggressive in hiring. And for whatever reason, there's an unforeseen pullback on the top line, to some extent, we have to make sure that we're trying to manage that business and manage that risk reward trade-off between doing the right things to make sure we set ourselves up to be successful in 2012 and managing the P&L for this year. So there are scenarios where the 2, the top and the bottom, can be mismatched. But we do believe that there's enough flexibility in how we manage and then run our business to be able to phase in and phase out the resourcing and the infrastructure to be able to manage that going forward.

Manish Hemrajani - Oppenheimer & Co. Inc.

Okay, got it. And your utilization numbers, do you include the trainees as well or is that excluded?

David Mackey

The numbers include trainees.

Operator

Our next question comes from Vincent Colicchio from Noble Financial.

Vincent Colicchio - Noble Financial Group, Inc.

Just a couple of questions from me. I'm not sure who this one is for but on the KPO side, can you give us some color in terms of what that looks like today? How many clients do you have and if some of the smaller clients bubbled up into sizable clients in the second or third spot? And also related to that, what does the outlook look like in terms of the balance for the year? Will growth largely be coming from your top client?

Prashant Ranade

We haven't provided information about total number of clients. But we are pleased with the fact that in Q2, the growth rate of non-JV KPO business was higher than average growth rate. And clearly, there are opportunities in 3 areas. Those clients remain a growth opportunity. Then we have healthy pipeline based on the long-term relationships, which we have with our current top 30 clients. And we have made progress in terms of where we are today versus last quarter. Having said that, this is a mine shift in terms of outsourcing or doing KPO business, so the cycle times remain longer in this segment of our business.

Bharat Desai

And also we, as a strategy, have focused on custom mission-critical processes that take us close to a client's business. And that's always a long selling cycle and a strategy decision that the company has to make. But having said that, we think we're very well positioned in the long run in this segment.

Vincent Colicchio - Noble Financial Group, Inc.

And could you remind us about the main new areas that you're investing today, and also give us color in terms of interest level in such areas in the most recent quarter?

Bharat Desai

Right. I mentioned the fact that 3 areas, mobility, cloud computing and analytics, we ran several pilots of proofs of concepts. And each of those areas are areas that clients are intrigued with the new technology and the impact it can have on their business. In mobility, the 2 main areas are -- and we've done a number of pilots across each of the verticals. And the focus remains in 2 main areas: one, how can our clients be serving their clients on mobile platforms and are there new opportunities to do business with these clients; secondly, how can our clients conduct their business from mobile platforms in running their business. Cloud computing remains a very interesting opportunity for enterprise clients. Directionally, we see enterprise clients moving perhaps more into virtualization or private clouds, and there are some initial pilots and some one-off projects that they're doing in this area. And then analytics, again, remains a good opportunity in the long run, I think. Most of the work in business intelligence so far has been in data warehousing and reporting. So customers have tried to see, report against sort of information and trend. We think that there's a tremendous opportunity in the area of unstructured data and what that could mean to our clients' business, also, in forecasting and projecting what that data might mean in terms of future trends. So we think -- we're pleased with the interest we've seen across the board in these 3 areas. And these are the areas that we've made investments in because we see -- potentially, each of these could be game-changing areas in customers' businesses.

Vincent Colicchio - Noble Financial Group, Inc.

And one last question, on the e-Business side, which is probably related to the last question. Where do we see revenue going directionally in the second half of the year?

David Mackey

Okay. Obviously, it's always been a lumpy business for us, Vince. We're really pleased that it's been stable here in the first half of the year and stable at levels significantly above where we were last year. As Bharat mentioned and as you rightly deduce, a lot of the acceleration in growth that we've seen in the e-Business area has come from data warehousing, data mining types of initiatives. It's one of the areas in our e-Business segment that has performed extremely well. And certainly, the logical extension, as Bharat was talking about, is the ability to move beyond that into kind of the next phases, into the analytics and predictive types of technologies. But we do have good visibility to the e-Business side. I wouldn't tell you that it's 100% to a consistent revenue stream, but we feel good about the overall pipeline for e-Business. And we think we should be relatively stable in that segment through the back half of the year.

Operator

Our next question comes from Dave Koning from Robert W. Baird.

David Koning - Robert W. Baird & Co. Incorporated

Just a couple of quick ones. I think -- first on the other income, I think you said $22 million for the year. It started off the first half at $12 million, so that implies $10 million in the back half. What might it be that the back half, why would that be lower when I would imagine the cash balance...

Prashant Ranade

Right. Because the first 2 quarters had exchanged against which we are not factoring in the guidance. So this is based on the interest income and the regular line items.

David Koning - Robert W. Baird & Co. Incorporated

Got you. Okay, okay. That makes a lot of sense. And then, secondly, just high level, there's a lot of conversation about gross margins and very well explained. But I guess from a high level perspective, if we look at the last 5 years, gross margins have averaged just a bit over 40%. In most years, they've been kind of around there, a little above. Can we expect, given this year is, obviously, a little more of an investing year with some of the utilization, et cetera, that longer term, we do get back into that kind of around 40% range, not necessarily in any one year, but longer term that we kind of get back to that?

Prashant Ranade

I think we have given the range of gross margin, which is in the neighborhood of 38%. The gross margin is clearly a function of, as you pointed out, utilization, demand environment, and then there is a third element which is exchange rate. But we do believe, based on what we see, this 38% neighborhood margin is -- that is the right corridor for our business.

Operator

We have a follow-up question or comment from Brian Kinstlinger from Sidoti & Company.

Brian Kinstlinger - Sidoti & Company, LLC

Yes, I'm curious about the impact on the hiring into the SEZ locations and if you're going to deliver growth the second half of this year out of those locations and next year. How will the tax rate move year-over-year next year? Will it be down 100 basis points as you start to deliver on those tax-protected areas?

David Mackey

I think there are 2 factors to remember, Brian. One is when you look at the overall blended tax rate for 2011, you really are going to only see the impact for 3 quarters of the expiration of the old tax holidays. So from an overall tax rate perspective, 2012 may not be better than 2011 because you're going to have a full year of impact there. That being said, we do expect the majority of our growth to be in SEZ facilities going forward. We do expect to be able to drive that tax rate down on a year-over-year basis, all things being equal. 2012 will probably not represent that again because I said it's a full year versus 3 quarters. But we do expect between the growth and our ability to manage our business going forward that we should see the tax rate driven down over time.

Operator

There are no more questions at this time. This concludes Syntel's Second Quarter Earnings Call. A replay of today's call will be available until July 28, 2011, by dialing (800) 642-1687 and entering the pass code which is 8151036. Thank you.

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