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iGATE Corporation (NASDAQ:IGTE)

Q32012 Earnings Call

October 12, 2012 8:00 am ET

Executives

Araceli Roiz - Head of Investor Relations

Phaneesh Murthy - President and Chief Executive Officer

Sujit Sircar - Chief Financial Officer

Analysts

Glenn Greene - Oppenheimer Securities

Joe Foresi - Janney Montgomery Scott

Amit Singh - Jefferies & Company

Mayank Tandon - Needham & Company

Brian Kinstlinger - Sidoti & Company

Richard Eskelsen - Wells Fargo Securities

Pinku Pappan - Nomura Group

David Sagalov - Jefferies & Company

Operator

Greetings, and welcome to the iGATE's third quarter 2012 quarterly earnings conference call. At this time, all participants are in a listen-only mode. A brief question-and-answer session will follow the formal presentation. (Operator Instructions) As a reminder, this conference is being recorded.

It is now my pleasure to introduce your host, Araceli Roiz, Head of Investor Relations for iGATE Corporation. Thank you, Ms. Roiz. You may now begin.

Araceli Roiz

Thank you, Rob. Good morning and thank you for joining our call to discuss our third quarter 2012 financial results. With me today are Phaneesh Murthy, iGATE’s President and Chief Executive Officer; and Sujit Sircar, iGATE’s Chief Financial Officer.

A copy of today’s press release and supplemental financial information are posted on iGATE's Investor Relations website at www.igate.com. Today’s call is being recorded and a copy of the transcript will be available later today on our website.

Before we begin, I would like to remind everyone that some of the statements made during today's discussion maybe forward-looking in nature and may involve some risks and uncertainties. These risks and uncertainties may cause actual results to differ materially from those set forth within the statements. Additional information concerning these risks and uncertainties can be found in the company's recently issued press release also available on our corporate website as well as our latest 10-K. iGATE Corporation assumes no obligation to update any forward-looking statements.

I will now turn the floor over to Phaneesh.

Phaneesh Murthy

Thank you, Araceli and good morning and good afternoon to all of you. I think the quarter has been a very mixed quarter for us. Some very good news and some bad news. Overall, more positive than negative.

So let me start first with the highlights on the revenue side. The revenue has grown by 1.2% on a quarter-on-quarter, lower than we expected, lower than we hoped for. I think there are two or three reasons for this. We believe that decision making cycles are a little longer than what we had anticipated but more importantly, actually, contracting cycles are actually taking a lot longer than what we had anticipated, even if the decisions that are made.

The good news is that we got the go ahead on one of the large contracts that we were working on. The contract itself will probably be done over the next few weeks but we have got the go ahead and we will probably be starting work there at the beginning of the year. So again, revenues get pushed out at little because of the contracting cycles but that’s very, very positive news from our side. It is a very defining deal for iGATE.

The second good news is actually that we won fairly nice $119 million five-year deal from a large insurance company. This was on our radar. It was on our horizon. We were 50% of the work, another vendor was doing 50% of the work and the consolidation happened and we actually ended up getting all of the work.

So those two very, very positive. The third large deal, actually the second large deal that we were working on, it's progressing well. We haven’t yet got any clearance. We are hoping it will close in Q4 from our information. We are the only party that they are negotiating and engaging with. So we hope its all good news there. We will see what happens in the quarter. We are keeping our fingers crossed.

The margins have been very, very strong. We had an non-GAAP EPS of $0.46. The margins grew, gross margins back to close to 40%. EBITDA went back to about plus 25%. We opened nine new clients, five of which were Fortune 1,000 kind of clients, spread across multiple sectors, insurance, product engineering solutions, MIBL, the manufacturing, retail, one in BFS in Europe also.

So, overall, I think the pipeline continues to be quite strong. We have a number of very interesting opportunities in the pipeline. With the win of $200 million plus contract, iGATE is laying the foundation, we hope, for the future in some way that we hope that we will be able to compete in much larger deals over the future.

Couple of the other very important highlights of the quarter. One is that we welcome the addition of Naomi Seligman on our board. For those of you who know of Naomi, she is one of the most respected names in the CIO circuit. Works with a number of CIOs of very, very large corporations and is just a very, very, very special lady and it gives me great pleasure to welcome her on to the board of iGATE.

I had mentioned some time back that we are going to be rolling out our corporate brand campaign and we will be rolling that out late Q4, early Q1. We will probably be taking on a little more costs on the SG&A side of that but we think that given the fact that there seems to be some momentum of all these deals, we would like to try and get a little more visibility going.

As a first step of that corporate brand rollout, we are conducting the first of its kind iGATE CEO professional golf style tournament. So essentially, this is CEO golf tournament only which nobody else has done and it’s a professional style tournament with all the trappings that go with that. That event is being co-sponsored by Forbes and NYSE. So, again, hopefully we will get some good networking and other things going from there.

On the corporate restructuring, I am very pleased to report that things are going very well according to plan. We did the de-listing of the Patni shares from the NYSE. We will continue to do the balance sheet cleanup. I think we acquired Patni Americas from under Patni India and therefore cleaned up a sandwich structure which has helped us lowering the effective tax rate and also has helped us move almost 55% to 60% of our revenues into the U.S. directly. So, from a cash flow perspective, it becomes a very, very comfortable for the U.S. cash flow.

In this quarter, we have won a number of very nice awards including the Golden Peacock Innovation Management Award. We also are judged the leader in the 2012 Global Outsourcing 100 list. We won the world class award, the highest honor under the large service organizations category at the Global Performance Excellence Award. We were ranked number three in the leaders category for the Product and Engineering Practice by Zinnov Consulting in its Global R&D Service Providers’ Rating.

We did a clients' meet and I promised to give you some early read of what we are seeing from the clients. We did a clients' meet in September. We did one in the U.S. and we also did one in Europe. We did a little bit of a poll across our clients. We had roughly about 160 people, 170 people attending these meets in both the locations combined.

We feel roughly about 50% of our people are expecting revenue budgets to be relatively flat. We are seeing roughly about 20% of our customers expecting budget going up. 30% are expecting budgets to be a little down compared to 2012. Most of the current spending that we are seeing is in applications which are for customers seeking CRM kind of applications, mobility, social analytics, those kinds of work.

Although one of the challenges with those kinds of projects are that they are not the $10 million kind of projects. Each of them is $300,000, $400,000, $200,000 kind of projects because those are the size of the apps that typically we end up building.

So, overall, I would say that if I were to summarize the quarter back and I will come back for questions and answers a little later after Sujit gives you color on the numbers a little more, poor on the revenue growth front, very strong on the margin growth front. Two deals over $100 million confirmation attained. One we are hoping to continue to win in this quarter. Hopefully, we are keeping our fingers crossed on that front.

Naomi coming on the board, huge news, I think, from our perspective. The corporate restructuring is going extremely smoothly. Finally, our corporate brand campaign is going to be rolled out very shortly and we will be taking on a little more cost on the SG&A side for that.

I am going to turn it over to Sujit now to give you a little color on the financial numbers and then I will come back for Q&A.

Sujit Sircar

Thank you, Phaneesh. Good morning, everyone, and thank you for joining us on this call. I will take this opportunity to briefly discuss with you the key highlights of our financial performance for the third quarter ended September 30, 2012.

Our revenue for the quarter was $271.1 million compared to $268 million in the previous quarter, which represents an increase of 1.2%, which was mainly on account of an increase in volumes. This quarter our largest customer accounted for 12.7% of revenue, while our top 5 and top 10 customers accounted for 37.5% and 48.3% of the total revenue, respectively.

Our gross profit margin was 39.8% as compared to last quarter’s reported gross margin of 37.4%. This sequential improvement was a result of non-recurrence of visa related charges we took in Q2 as well as some improvement in the efficiency in delivery.

SG&A for the quarter was $43 million compared to $39.8 million last quarter. This excludes D&A and delisting cost of nearly $1.06 million related to our structural cleanup. SG&A cost were in line with what we projected and we continue to anticipate the current spend rate to normalize at this rate on a quarterly basis.

For the quarter, GAAP EBITDA was $63.8 million or 23.5% while non-GAAP EBITDA, which excludes stock-based compensation and delisting costs was $68.6 million or 25.3%. In the previous quarter, GAAP EBITDA was $59.4 million or 22.2% while non-GAAP EBITDA, which excludes stock-based compensation and costs relating to delisting, was $63.2 million or 23.6%.

Depreciation and amortization expense for the quarter was $10 million versus $11.4 million in the previous quarter with the decrease attributable to assets with one-year depreciation schedules that concluded in the third quarter. D&A will trend relatively in line for the next few quarters.

We continue to manage our ForEx conservatively and hedge roughly 60% to 80% of our receivables on a rolling 12-month basis. This quarter, due to rupee movement, our ForEx impact was a loss of $3.8 million against a loss of $17.3 million in the previous quarter.

This quarter, we booked cost at an average exchange rate of INR 54.9 while our average hedging contract rate was approximately INR 52. The difference in our average rupee denominates costs and our average transaction hedge rate was less than the last quarter and resulted in reduced negative impact for the quarter.

Tax amount for the quarter was $8.5 million or an effective tax rate of 23.1%, an improvement over the last quarter's effective tax rate of 26.9%. The improvement in tax rate was finally due to a reversal of certain tax liability from an expiring statute of limitation as well as a reversal of prior year tax provision. This reversal will now bring our effective tax rate from the calendar year down to around 26%, 27%. For the next year, we expect the tax rate to be in the range of 27% to 28%.

For the quarter, our non-GAAP net income, which adds back amortizations, stock-based

compensation, delisting costs and ForEx impact on delisting related assets and liabilities net of tax, was $35.6 million or $0.46 per diluted share, compared to $21.5 million or $0.28 per diluted share in the previous quarter.

Now moving onto the balance sheet for the quarter. CapEx was $4.4 million, while cash generated from operating activities was $36.5 million on account of the improved net income, reduce tax rate and ForEx benefit. As of September 30, 2012, cash and cash equivalents were $559.1 million, and our DSO stood at 77 days. We ended the quarter with a total head count of 27,543, which includes net new hires of 126, and our total active client count is 293.

With this, I will now turn the call back to Araceli.

Araceli Roiz

Thank you, gentlemen. Rob, you can now open the floor over for questions.

Question-and-Answer Session

Operator

Thank you. We will now be conducting a question-and-answer session. (Operator Instructions) One moment please, while we poll for questions. Our first question is from the line of Glenn Greene of Oppenheimer. Please proceed with your question.

Glenn Greene - Oppenheimer Securities

Thank you. I guess the few question, I just want to get a little more color on the big deal activity and congratulations on the couple of big wins. Maybe first, on the big deal win, could you just remind us the size of this and when you start to think you are going to a meaningful revenue ramp up? It sounded like it's really in 2013 and just the timeframe of the deal as well.

Phaneesh Murthy

I think two questions. So, the first one is that we will probably make an announcement very soon. The deal value will be between $250 million and $300 million. It is a 10-year deal and we anticipate revenues to start early to mid-Q1 based on the contracting process.

Also, I do want to caution one thing, as we bring some of these bigger deals on to the system, there will be a little bit of a dilatory impact on margins for a two, three quarters during the transition and other periods where we are doing a lot of investment in the technology to bring the operation cost down. These are all iTOPS deals, I think I had reminded you.

One the second big deal, we anticipate closure of that deal this year. If that does happen then we will start seeing revenues from Q2 potentially onwards.

Glenn Greene - Oppenheimer Securities

It sounds like you are more optimistic on that deal now and it sounded like you might have been through some months ago, if I heard you right, it sounds like they are only negotiating with you at this point. So you are kind of well along in the RFP process and it sounds like you may the vendor that’s been chosen. It's just sort of working through terms. Is that a reasonable characterization?

Phaneesh Murthy

Glenn, no, we know that they are engaging only with us. I think, however, this is not an organization we have done business with earlier, Glenn. So we don’t know all of the internal decision making cycles and the politics that go with such large deals. If this was an organization we had done business with, I would be lot more confident we were at the same stage.

Glenn Greene - Oppenheimer Securities

Okay, and then just for lastly, on the $109 million deal, I was a little bit confused because it sounded like they are already a client of yours and they have consulted other vendors and you won the other side of it. Is the $109 million all incremental? Or is roughly 50% of it incremental?

Phaneesh Murthy

It's about half incremental. It's $109 million over five years. We were doing about half of that work in a different model. We just changed the whole thing to an outcomes based model and we consolidated from another vendor who was doing the other half of the work.

Glenn Greene - Oppenheimer Securities

Okay, great, I will jump back in the queue. Thank you.

Operator

Thank you. Our next question is from the line of Joe Foresi of Janney Montgomery Scott. Please proceed with your question.

Joe Foresi - Janney Montgomery Scott

I thin you talked about there being extended lead times and slower renewals. Maybe you can give us a little more color of what particular vertical those are coming from and help us reconcile that versus your large deal signings.

Phaneesh Murthy

A lot of deals we are finding that there are delays in both the decision making and more importantly in contract signings. What we are seeing more and more is that contract terms typically are different from what we would see in contracts, even many months ago and certainly a couple of years ago.

It's just that negotiating back to the kinds of terms that you want and are willing to accept just takes a long time. So the master templates on some of these contracts is changing. The master templates that is coming out has terms which are not particularly comfortable for many service providers and certainly are not comfortable for us as a class service provider and therefore it does take a lot longer to negotiate back to where we want the contracts to be.

So these large deals, of course as you know, we have been working on for a very long period of time. So it's just taken a lot longer to reach these stages. Also if I look at even some of our other mid-sized deals, which we recently won another deal, all on the $10 million of dollar range and we were actually anticipating to win that in the June quarter and sign off on the June quarter and we signed off late in the September quarter. So these are some of the challenges that we are seeing just in terms of delays and contract signings.

Joe Foresi - Janney Montgomery Scott

So there is no real change in the demand environment. It is just taking longer to close the deals. Is that what you are saying?

Phaneesh Murthy

I think our pipeline is very strong. It continues to be quite comfortable. That’s not an issue. I think our pipeline is probably among the largest that it has ever been in our history. I would say that, yes, that the demand environment continues to be relatively stable. It is just that it is taking more time.

So I don’t know how you would characterize that because that uncertainty in the macro environment, I think, is causing the delays in the decision making. I do not believe it is a temporary thing because of the elections or anything like that. I think it is really more because of the macro uncertainty rather than a temporary thing because of the elections.

Joe Foresi - Janney Montgomery Scott

Okay, and just one last question from me. You talked about no breakaway quarters in your prior conversations with the street. Is that still the case? You are not expecting any breakaway quarters and can we see a flattish sort of down December and after talking to people about 2013, how does that ramp, the run rate look over the next couple of quarters?

Phaneesh Murthy

Actually one of the things which I didn’t mention on the bad news side was the fact that one of our clients which we had opened the center for outside the country. We had given them a very special pricing of almost at cost for the first three years. A relatively large client and after three years we found that we were not able, this was in the mortgage space, we found that because of the mortgage environment we had not been able to ramp up many customers on to that center.

Therefore we went back to the client and said that we should increase the price and there was also declining volumes because the client was also not doing all that great. We decided to part ways. So there will be hit in the revenues because of that, for example. However, it's good from the margin perspective because what will end up happening is that our cost structure will come down. That client was at margins which were almost zero margin.

So that’s all good and this is the reason why we are not probably seeing any quick breakaway quarters because we have this little bit of a bad news in addition to the good news which is on the larger deals.

Joe Foresi - Janney Montgomery Scott

Okay, any color on the size of that? Thank you.

Phaneesh Murthy

About $1.5 million a month, roughly about $4 million or $4.5 million a quarter.

Operator

Our next question is from the line of Jason Kupferberg with Jefferies & Company. Please proceed with your question.

Amit Singh - Jefferies & Company

Hi, this is Amit Singh for Jason Kupferberg. Just on line with the last question. As you are speaking with your clients regarding the budgets for next year, do you have any insight into their revenues for next year and where do you see the growth to be? Do you think it will be pretty much in line with this year or the environment as based on your pipeline and demand environments is like? Better or lower?

Phaneesh Murthy

You know, Amit, I must confess that while many people credit me with having had a more accurate estimate of the environment than all others, in reality I think we also misunderstood the decision making cycles and the slowness in the environment. So it’s a little difficult to answer that question fully.

I do believe, however, that if you just look at our size of the deals that we are winning et cetera, we do anticipate that next year will be a better year. Now, how much of a better year, it s really very difficult to call right now and that’s the struggle internally that we are going through and it’s a challenging situation. I must confess while we did read some of the elements of the market relatively well we didn’t read some of the elements of the market relatively well and I think all I can say right now is we continue to be focused on above average growth and our best in class earning growth.

I think that’s the best I can tell you right now and as we start getting more and more color, we will be able to provide it to you on this.

Amit Singh - Jefferies & Company

No, it makes sense and just quickly, I mean the mega deal that you won, you mentioned that it will start adding to the revenues by first quarter, but if I remember from last quarter, that thing you mentioned that each of those deals have the capacity to add around 3% to the top line. How long do you think the ramp up tier would be? Do you have any idea in that at this moment?

Phaneesh Murthy

I think it will take, most of these deals the way they are structured, it will probably take a couple of quarters from start to ramp up to that level and so that’s broadly what our current anticipation is.

Operator

Our next question is from the line of Mayank Tandon of Needham & Company. Please proceed with your question.

Mayank Tandon - Needham & Company

Well, thank you, good morning. Phaneesh, you talked a lot about the broad demand picture, can you give us a sense of maybe as you look at the verticals and horizontals what are some of the key customer priority items as you look out for the next 12 to 18 months.

Phaneesh Murthy

I am going to try and you have to please remember that my statements are colored with the fact that in a sense is what we offer is what we get and reads on. If you are carrying a hammer, most problems look like a nail to you. So the bigger deals that we are bidding for and any deals which we are talking which are in the $10 million range and above are all deals which are of the type where there is a messy set of operations brought about by multiple legacy environments through acquisitions or through whatever it is.

Messy legacy systems, we take over those operations, lower the process costs by converting it to a single streamlined system, a single streamlined process. Those typically transformative deals is what we are winning and we are getting a lot of and that’s what our iTOPS stuff is all about. So deals that we are winning are all iTOPS kind of deals.

The second thing that we are seeing on the discretionary spend, most of the discretionary spend we are seeing is really on customer stickiness apps and customer related apps, CRM apps and so on and so forth. So lot of mobility, social media, et cetera, all in trying to get a little better handle on the customer, on their customer.

The problem, like I said, with that spend is that typically, you spend $300,000, $400,000 on a mobility app. If we had written that kind of process on the mainframe, application on the mainframe, it would have probably taken $5 million. That’s just the nature of the changing world and that’s what it is.

So we are not seeing a whole lot of large initiatives from clients unless it is something that we are proactively going out assessing situations and coming up with a more creative solution for them. That’s really what we are doing. Otherwise we are not seeing any big stuff.

We are, of course, continuing to see the regular application maintenance and so on but on the AD side application development, on the SI side, the SAPs, the CRMs, et cetera, we are not seeing very large projects.

Mayank Tandon - Needham & Company

Great, that’s very helpful. Also, in terms of your growth rate, it's still running, one would say, a little bit below trend relative to a lot of your peers even those that are growing at the lower of the industry range. How much do you think it is macro versus just issues that you have address around the Patni sales force integration and other integration issues that might be coming up?

Phaneesh Murthy

I do believe that it’s a large combination of both here. We have our problems. There is just no denying that. We have added Sanjay Tugnait as the head of sales in the last quarter. I think he is doing a phenomenal job in reenergizing the sales force and bringing in some new players.

All indicating that we have our own problems. The fact that we are not winning the right number of customers that I would like to win, these are all indicators of the fact that we have our own problems. There is a little bit of macro environment trend definitely but overall, I would still say that this is probably 60%, 65% our internal issue, 35%, 40% macro environment issue here.

Mayank Tandon - Needham & Company

And you expect to obviously fix that. How long will it take to have all the pieces in place where you can actually get that sales engine in full throttle?

Phaneesh Murthy

I think it's an evolutionary thing. It's not a revolutionary thing in the sense that it is not going to be a one time fix and everything. I think we continue to make progress. We continue to bring new people into the system. So hopefully we will continue to add little more every time and start inching upwards.

But there is no doubt about the fact that our patience levels have run out and our pace of change will be dramatically faster right now than what we have been going at in the integration cycle over the last few quarters.

Mayank Tandon - Needham & Company

And finally, Phaneesh, can we get your comments around pricing? Are you seeing any pricing issues in the market? Or is pricing holding up well?

Phaneesh Murthy

I think we are relatively stable on pricing. Large deals, by their own nature, tend to be a little lower priced but on all our other deals, I think, we are quite comfortable on our pricing.

Operator

Our next question is from the line of Brian Kinstlinger of Sidoti & Company. Please proceed with your question.

Brian Kinstlinger - Sidoti & Company

Great, thanks. Phaneesh, you mentioned that the large contract will serve the increase from margin percentage. I am wondering in light of you touching your peak or getting close to your peak target margin coupled with the rupee strength, will that offset it to keep the margin percentage roughly flat from where it is right now?

Phaneesh Murthy

I think what our continued intention, Brian, is to expand further into or research and solution building a little more. So what's happening is that we want to reel the margins relatively at this level, give or take a little bit here and there but we like what we are seeing in our iTOPS offering.

We have a fairly interesting and what is looking like fairly compelling story with many of these banking and financial service and insurance customers which is really all about the fact that for so many years, they have been working on process maturity and its not gotten them anywhere and we have this hypothesis that process maturity is passé and now it is data maturity that we have to worry and how do you clean your data whether its your client data or whether its your reference data, whether the market data.

We have a whole set of IP which we have built tools, assessment framework, all of that stuff and its one of those deals and one of those iTOPS deals is around this. Then we have this whole thing around the TPA, around the insurance stuff. So I think we are emboldened enough that we want to continue to invest more and more in these areas. So I don’t anticipate to much more of a margin expansion here, Brian.

Brian Kinstlinger - Sidoti & Company

Yes, understood, and then quickly on the margin, one last question and then I will move on to some other questions. Could you give us a sense for how much of the second or third quarter gross margin was impacted by the visas and then FX as well and then maybe any other delta?

Sujit Sircar

Third quarter, if you recall, last quarter we had almost $5 million of extra cost on account of visa which is not there in this quarter. So the margin impact of 2% incremental is mainly on account of visa not being there now.

Brian Kinstlinger - Sidoti & Company

And did we see a margin on negative piece related to FX there as well?

Sujit Sircar

It's sensitive. If you see in every percentage of movement of ForEx, it gives a 20 to 25 basis point differentials in terms of the margin but since our hedge position is as such it balances it out. So any negative impact in terms of the margin in gross margin will be taken into other income. So I think in terms of EPS it's quite neutral that way.

Brian Kinstlinger - Sidoti & Company

Okay, and then Phaneesh, this is the second straight quarter we have talked about vendor consolidation. I think you talked about it last quarter as well on the call. Is this something you expect to see a lot more of? Are you already facing any competition right now for some of the other larger or even medium size contracts?

Phaneesh Murthy

Well, Brian, I don’t know how you call it but certainly if you look at these larger deals that we are seeing, it has an element of vendor consolidation except in this deal which we are expecting to win this quarter. We are not one of the vendors. There are two or three vendors who are actually doing those components of work except they are doing it in your mess for less kind of model and we are coming in and offering it as an integrated iTOPS story and how we will reduce the process cost and outcome cost and so on and so forth.

So, I think, to be honest, Brian, what's happening now, is that in almost everything, there are certain elements of anything that you are bidding for which is touched by some vendors or the other. So there is some transition or take away from some vendor or the other as you are winning and again on the corollary side, as you are losing, it's roughly the same.

So there is always a little bit of concern about the fact that if somebody else wins in a consolidation exercise, it is very lightly that some other vendor is actually losing right now because some portion of it are touched. Because many companies have a certain level of maturity in the amount that they have going on in-house versus external and in some of the more current deals, they are not looking at expanding that in-house versus external. So the "percentage" of off-shoring or whatever it is if you want to look at it is not going up very dramatically from the way I see it.

Now, on the other hand, if I start looking at a very positive trend for us, is that in our largest customer we had not been doing any operations work and now we have started doing operations work in that customer. Obviously they were doing all their operations work with somebody. We are starting to win deals in that.

So I don’t know how you call it. Whether it's vendor consolidation, I don’t think it's exactly vendor consolidation but I think it is the fact that larger pieces of our work seems to be moving work from some other vendors rather purely from customers which earlier used to be the case.

Brian Kinstlinger - Sidoti & Company

Got it. That makes a lot of sense. Last two questions and then I am through. They are completely separate. The first is a numbers question. The size of tax reversal you mentioned and then the second question is more of a balance sheet question. If you guys took a little more debt, obviously, I am curious if you are foreseeing the additional capital requirements and maybe your thoughts on free cash flow over the next year or so?

Sujit Sircar

First question was on the tax rate. Tax rate reversal was there close to $1.9 million. That’s bought us down primarily because of some of the provisions which is not required for the prior periods is the reversal. Going forward, we were guiding around 30% as a tax rate. I think, we will ending up the year with around 27% and next year our effective tax rate will be around 27% to 28%. That’s what we feel.

Secondly on the free cash flow. We have generated operating cash flow of $37 million this quarter. We continue to believe that we are in a situation to make around $120 million of free cash flow on a constant currency basis.

See, currency plays a big role in the whole thing. Last quarter, because of the appreciation in rupee, we have made $25 million incremental cash in our balance sheet. So we feel that $120 million on a constant currency rate is the free cash flow for going forward.

Operator

Thank you. Our next question is from the line of Richard Eskelsen of Wells Fargo. Please proceed with your question.

Richard Eskelsen - Wells Fargo Securities

Phaneesh, the first question, is just for you. You talked about wanting to have above average growth and I was wondering if you could give an expectation and for the what industry is going to grow this year and next year?

Phaneesh Murthy

My own sense is that next year, we look at 2013, it's really very difficult to predict this. I don’t have a number yet. In my 20 years of outsourcing experience it has become one of the most difficult things for us to estimate, actually. For me to estimate at least. Plus, as you percentage of business from the outcomes is starting to go up and all these iTOPS, it is becoming a little more difficult for us to even predict ourselves a little in terms of our revenues.

So I would say that I don’t know. If you remember, our goal, our mission statement, cost for us being number and earnings growth, I think, we will continue to focus extremely hard on that. We continue to focus on the deals that we know that because of our internal efficiency improvement mechanisms, we can make very profitable. But I really don’t have any current insight that I can share with you which is any credible or meaningful, to be honest.

Richard Eskelsen - Wells Fargo Securities

Thanks. I guess, the other two questions are just around your client meetings. The first one is, what was the sense for discretionary spending that you got from your clients at the two meetings for next year?

Phaneesh Murthy

I think what I had indicated was roughly about for discretionary spend. So 20% clearly are increasing their budgets and they intend to spend almost a lot of more of that money with customer facing systems and applications. Even the 50% who said that their budgets would be relatively flat are actually looking to increase their discretionary spend on customer facing apps a little more by reducing their other costs in infrastructure and apps support on the legacy environment. So we do believe that discretionary spend will probably go up a little in 2013.

Richard Eskelsen - Wells Fargo Securities

Thanks, and just the last question. Can you give a contrast or some color on what you heard differently between the European clients and the U.S. clients and what the pulse was over in Europe? Thanks.

Phaneesh Murthy

I think the environment and the mood was generally much more positive in the U.S. than in Europe. I think in Europe, certainly, we found a much larger degree of pessimism, a larger percentage of people, the numbers I gave are an average across the world. The numbers in Europe were a little more skewed towards flat and down versus up.

So clearly a much more negative environment in Europe and certainly other than this very large deal that we are working on, we really don’t have a whole lot to show in Europe.

Richard Eskelsen - Wells Fargo Securities

I guess, just following up on that quickly. Do you see your European clients wanting to accelerate the cost savings measures? Was that something that came up a lot? Were they a lot more open into looking for more innovative ways to save cost?

Phaneesh Murthy

I think the answer is yes, but I don’t think they know what are the implications of this, to be honest. I believe that the concern around the social systems in Europe is actually much larger than it has ever been. While I believe that there is a motivation to save cost I am not seeing the appetite to deal with the social costs of all of those things.

So net net, I am not yet confident that the full implications of some of the early attempts to try and save cost are there. At least, mainly, we have the mix of customers that we are not seeing that.

Operator

Thank you. Our next question is from the line of Pinku Pappan of Nomura Group. Please proceed with your question.

Pinku Pappan - Nomura Group

Phaneesh, just wanted to pick your brains on the client meet. You talked about 20% of your customers are willing their budgets. Do you see any trend at all in what industry groups these customers belong to? Is there any trend at all which industry groups are looking at flat budgets vis-à-vis increasing budgets or even down?

Phaneesh Murthy

Very clearly, I think the manufacturing retail distribution sector is the most optimistic overall. So if I look at as a percentage, they would be very high outliers in terms of optimism and increasing budgets.

Pinku Pappan - Nomura Group

Okay, and on the downside, it's probably BFS?

Phaneesh Murthy

BFS and probably even EIS, because the problem of the investment income having come down to zero for the insurance companies or investment income being very close to zero, I think, has put very significant pressure on them from their overall admin cost perspective.

Pinku Pappan - Nomura Group

Okay, and on the client with whom you have parted ways, is the impact going to come in the next quarter or has it already come?

Phaneesh Murthy

No, the impact on the client which we lost, we are parting with?

Pinku Pappan - Nomura Group

Yes.

Phaneesh Murthy

I think the impact will be from this quarter onwards over the next couple of quarters.

Pinku Pappan - Nomura Group

Okay, so it's going to ramp down slowly. Is it mid or two quarters? Is that what you are trying to say?

Phaneesh Murthy

That’s right.

Pinku Pappan - Nomura Group

Okay, and any thoughts about how you are going to treat the debt now that you have acquired Patni America? Your cash flow in the U.S. have increased. Any thoughts whether you are going to accelerate your debt repayment plans or something on that?

Phaneesh Murthy

On that side, we are doing very well. So our bond instrument that we had issued which were the 9% bonds were a non-call three. So we can call them back in April, May, 2014 and that’s the first time that we think that we will be able to restructure this. We believe two things will happen.

One is the amount of debt will come down and two, the cost of the debt will come down. So therefore we believe that the interest cost will actually come down quite significantly from the second half of 2014 for us.

Pinku Pappan - Nomura Group

Okay, but the line of credit that you have taken probably those can come down in the immediate future?

Phaneesh Murthy

Yes, but they are very cheap lines of credit to be honest. They will come down in the very short term future but they are fairly cheap. They are at what, 3%, 4%.

Sujit Sircar

3%.

Phaneesh Murthy

3%, yes. So to that extent.

Pinku Pappan - Nomura Group

Okay, and you talked about margins. You are looking to kind note it in. Does that hold for 2013 kind of keeping the 25% EBITDA margin intact for the whole year or do you think some investments would or all, maybe some of the transactions on the deals that you have taken. Are you looking at slightly lower than 25% for the next year?

Phaneesh Murthy

Our margin goals remain 40% and 25%. We think that there maybe two or three quarters of margin weakness because as we bring some of these larger deals onto the system and it does look like we will be bringing some of these larger deals almost together onto the system. So to that extent we will have some dilution impact on margin.

That’s on the gross margin. On the EBITDA side, we were inching our EBITDA beyond the 25% and therefore we were going to roll out our corporate brand and corporate visibility program and that will take another point or two out.

So I would say, maybe marginally it will come down for 2013 but our long term goal is still the 40%, 25%. So we are not deviating from a long term margin goal or margin anticipation at all.

Pinku Pappan - Nomura Group

Okay, and just one last quick one on the large deal that you won. What are the kind of service lines that you expect in the book to come in? Which service lines does this span, this large contract?

Phaneesh Murthy

This is an iTOPS deal. So basically it's taking over operations and the legacy environments. They are replacing it with a new system and running the operations on that new system for a 10-year period. So it’s tech plus process. That’s our model. Even if I look at the $109 million deal that we won, that’s also very, very similar. It's basically tech plus process. They are all iTOPS deals.

Operator

Thank you. We are during the end of our allotted time for question and answer session. There is time for one final question. This final question is from the line of Romeo Reyes of Jefferies & Company. Please proceed with your question.

David Sagalov - Jefferies & Company

This is Dave Sagalov for Romeo. I will keep it quite short. I am just wondering, can you tell us the balance of the term loan, the two incremental term loans that you have taken. The one due February '14 and the one due June '14. I know the one in June '14 is ramping up slowly as you continue to take out the Patni shares. I am just wondering where that stands today?

Sujit Sircar

Okay, one was 24 months, the first one which was $265 million and the other one was 18-months, that $70 million which we have taken.

David Sagalov - Jefferies & Company

I just interested to see how much is drawn today.

Sujit Sircar

$220 million and $2.3 million.

David Sagalov - Jefferies & Company

I think at the last quarter it was $226 million, roughly?

Sujit Sircar

Yes, because of the exchange rate, David.

David Sagalov - Jefferies & Company

I see, that makes sense. The other one is fully drawn at $70 million today?

Sujit Sircar

Yes. That’s done.

David Sagalov - Jefferies & Company

Great, and then $5 million still drawn on the revolver?

Sujit Sircar

$5 million, yes. That’s right.

David Sagalov - Jefferies & Company

Perfect, and then just one another quick question. Do you feel that the company has completed the client rationalization here? Or is there still room to grow on that front and margins continue to increase as a result of that as well? Kind of limiting in a lower margin contract.

Phaneesh Murthy

We are not doing any proactive work in client rationalization right now, David. We are not doing any proactive work. Even this contract, our idea is what would have been that we got the price increase that we wanted. We just didn’t want to do the work at these kinds of cost.

It was a new site. It was only center. It was the only client in that center. We had the option that we can close down that center. At that price, we didn’t want to do the work but would have liked to continue to do that work at a different price.

David Sagalov - Jefferies & Company

All right, I understand, great and then lastly. In the past you had given us company targets for top line and margins. Any update on those? It seems like you are well ahead of schedule on all the previous targets on the gross margin, EBITDA margin. Any updates internal target wise?

Araceli Roiz

We basically enacted a policy of no more guidance now. I think during the acquisition it was very complicated. So we started to give a little bit more color but moving forward we are going to back to our original policy.

Operator

Thank you. There are no further questions. I will now turn the floor back to Ms. Roiz for closing comments.

Araceli Roiz

Thank you, Rob. So, once again, I would like to thank all participants for joining our call. If you have any follow-up questions, please feel free to contact me. Moderator, go ahead and conclude the call.

Operator

Thank you. This concludes today’s teleconference. You may disconnect your lines at this time and thank you for your participation.

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