Syntel Management Discusses Q3 2012 Results - Earnings Call Transcript

Oct.18.12 | About: Syntel, Inc. (SYNT)

Syntel (NASDAQ:SYNT)

Q3 2012 Earnings Call

October 18, 2012 10:00 am ET

Executives

Zaineb Bokhari - Head of Investor Relations

Bharat Desai - Co-Founder and Executive Chairman

Prashant Ranade - Chief Executive Officer, President and Director

Arvind S. Godbole - Chief Financial Officer, Chief Information Security Officer and principal Accounting Officer

Rakesh Khanna - Chief Operating Officer

Analysts

Joseph D. Foresi - Janney Montgomery Scott LLC, Research Division

Brian Kinstlinger - Sidoti & Company, LLC

Amit Singh - Jefferies & Company, Inc., Research Division

Richard Eskelsen - Wells Fargo Securities, LLC, Research Division

Puneet Jain - JP Morgan Chase & Co, Research Division

Vincent A. Colicchio - Noble Financial Group, Inc., Research Division

Nathan J. Novak - Robert W. Baird & Co. Incorporated, Research Division

Manish Hemrajani - Oppenheimer & Co. Inc., Research Division

Gregory W. Halter - LJR Great Lakes Review

Rahul Bhangare

Operator

Ladies and gentlemen, thank you for standing by, and welcome to the Syntel Third Quarter 2012 Earnings Call. [Operator Instructions] As a reminder, this conference call is being recorded today, Thursday, October 18, 2012. I will now turn the call over to Zaineb Bokhari, Syntel's Head of Investor Relations.

Zaineb Bokhari

Thank you, and good morning, everyone. Syntel's third 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; Arvind Godbole, Syntel's Chief Financial Officer; Rakesh Khanna, Syntel's Chief Operating Officer; and Nitin Rakesh, President for Americas Business Development.

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, Zaineb, and thank you, everybody, for joining the call today. We delivered solid growth at a healthy level of profitability this quarter despite ongoing headwinds from the uncertain macro economy.

Our market position is getting stronger. Our domain-led vertical offerings provide very targeted solutions to our customers' specific business demands. Our horizontal offerings enabled our customers to become more efficient and to free up resources to focus on innovating and creating value for their customers and shareholders. Our investments in new technologies are helping us expand our market reach and future prospects.

Many customers are looking to modernize their technology infrastructure and leverage these investments in the pursuit of new markets and to better serve fast-changing customer needs. We are increasingly engaged in client discussions about the transformative impact these technologies can have in their businesses and their market positioning.

As an example, the opportunity to harness and leverage the explosion of structured and unstructured data to run their businesses more smartly and to drive new revenue sources is increasingly viewed as a big competitive advantage by our clients. Our investment in these areas has positioned us very well to continue to remain a trusted partner of our customers and to help them win in the marketplace.

Even as decision cycle times remain somewhat slow, our pipeline of opportunities continues to get stronger. Our customers are facing rising regulatory and compliance demand, ongoing cost concerns and rising competitive pressures. We see opportunity ahead to help our customers navigate the challenges they face. We are confident that a deep understanding of our customers' businesses, coupled with our strong value proposition, will drive our future growth and help our customers achieve long-term success.

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 third quarter revenues were $186.4 million, rising 4% sequentially and 11% year-over-year. Our third quarter results reflect our continued focus on delivering differentiated offerings and our dedication to serving our customers. During the quarter, we saw growth across all verticals and continued to invest in our capabilities. As we look to our future prospects, we feel well positioned and on track to grow faster than the market overall.

Macroeconomic conditions remained a challenge in the third quarter and clients remained cautious. But we continue to see opportunity as well. As an example, we saw improving growth out of Europe and continue to invest in the region. Arvind will provide further details on our outlook and our third quarter revenue performance in his prepared remarks.

Third quarter gross margin widened by 424 basis points as compared to the second quarter, coming in at 45.5%, higher utilization and a sequential decline in visa-related expenses contributed to the improvement seen during the third quarter. The Indian rupee's appreciation had a modest negative impact on gross margin during the quarter. We added 132 employees during the quarter, growing headcount by 1% sequentially and 10% from the year-ago quarter. Offshore utilization of IT rose to 70% in Q3 from 66% in Q2 on a period end basis and to 67% from 65% on average. We remain focused on campus hiring and expect utilization levels to trend lower over the balance of the year as we bring on additional associates.

The company's SG&A expenses declined $7.6 million during Q3 as compared to a year ago, impacted by a one-time item recorded in the year-ago period. On a sequential basis, SG&A expenses rose by $10.1 million. The impact of currency-related balance sheet translations was the primary driver for the increase in SG&A during the quarter, while other expense levels were well managed. We do not view this quarter's operating margin as sustainable in view of the recent volatility in the rupee and our investment plans.

The uncertain macro economy remains a concern as 2012 nears its finish and cycle times remain extended. Despite this, we continue to see opportunity ahead as customers recognize that an investment in technology gives them business leverage. We think the outlook for our industry remains favorable, and our strong presence in key verticals will afford us tremendous future benefits and allow us to take advantage of emerging and ongoing trends.

As I noted earlier, we are investing in our business. This includes having capable leaders in place to help us achieve our long-term goals. To this end, last month, I'm pleased to announce appointment of Nitin Rakesh as our new President of American Business Development to lead our Americas sales and business development effort. He will be relocating his family from Mumbai and will be based out of our New York office. In addition, we are working to broaden our geographic footprint with the anticipated opening of a Syntel facility in the Philippines in the first half of 2013.

I want to conclude by thanking the employees of Syntel around the world for their continued dedication and hard work.

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 S. Godbole

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

Syntel's third quarter revenue came in at $186.4 million, up 11% from the prior-year period and 4% sequentially. For the third quarter, Applications Outsourcing accounted for 75% of the revenue, KPO was 15%, e-Business represented 8% and TeamSourcing was 2%.

From a vertical perspective, financial services contributed 55%; with health care at 17%; insurance, 14%; retail, 5%; automotive, 4%; and all other accounted for 5%. Vertical growth was led by retail and automotive, which grew about 14% and 6%, respectively, on a sequential basis. The financial services vertical grew by 4% sequentially. Syntel's customer concentration levels remain comparable to the previous quarter. Our top 3 clients represented 52% of revenue, top 5 contributed 64%, and top 10 came in at 78%. The fixed price component of our business was at 38% of revenue for the quarter.

With respect to Syntel's margin performance, our gross margin was 45.5% in the third quarter. This represented an increase versus 39.8% reported in the year-ago period and the 41.3% reported in the second quarter of 2012. Higher utilization and the absence of visa-related costs led to a sequential decline in the direct cost during the quarter. The Indian rupee appreciated by 0.96%, lowering gross margin by 46 basis points. By business segment, gross margin for Applications Outsourcing was 42.1%; KPO was at 63%; e-Business was 45.7%; and TeamSourcing, 44.2%.

Moving down the income statement, our selling, general and administrative expenses were 15.6% in the third quarter of 2012 compared to 21.9% in the prior-year period and 10.6% in the second quarter. On a dollar basis, SG&A was higher by $10.1 million sequentially. The impact on SG&A from the balance sheet calculation adjustment this quarter was $3.7 million loss as compared to a $5.3 million gain recorded in quarter 2 of 2012. The appreciation of the rupee increased SG&A by $0.2 million. Aside from these 3 factors, facilities-related expense and the cost associated with customer conference added to SG&A on a sequential basis.

Other income increased by $7.5 million from the prior quarter, coming in at approximately $10 million. The company recorded a $1.5 million gain on hedging versus a $4.4 million loss in the second quarter. Other income also included approximately $1 million profit from an asset sale this quarter. Our tax rate for the third quarter came in at 21.7% as compared to the 24.4% posted in Q2.

Net income for the third quarter was $51.5 million or $1.23 per diluted share compared to $26.2 million or $0.63 per diluted share in the prior-year period and $43.4 million or $1.04 per diluted share in the previous quarter. The company's balance sheet at the end of the third quarter of 2012 remains extremely healthy. Our total cash and short-term investments on September 30 were $422.1 million, and DSOs were at 52 days. Capital spending for the quarter was $11.3 million.

Syntel ended the third quarter with a total headcount of 20,192, of which 6,139 were assigned to KPO. Our billable headcount was 2,983 on-site and 15,863 offshore, for a total of 18,846. The net additions to the global headcount were 132. Utilization levels at the end of the quarter were 95% on-site, 76% offshore and 79% globally. Our delivery mix at quarter end was 19% on-site and 81% offshore. Voluntary attrition during the quarter was 15.3% versus the 17% reported last quarter. Syntel added 4 new customers in quarter 3 and 1 new Hunting License, which takes the total number of preferred partners to 112.

Looking forward, I would now like to provide you with guidance for our 2012. Based on our current visibility levels, Syntel expects revenue to be in the range of $730 million to $735 million and EPS to be in the range of $4.36 to $4.40 for the full year 2012. The company currently has a 99% visibility to the lower end of the revenue range, and our guidance is based on an exchange rate assumption of INR 52.7 to $1. We expect the operating margin will be in the 28% to 29% range, and that our effective tax rate will be in the low to mid-20s. CapEx for the year is expected to be in the range of $32 million to $35 million.

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 Foresi of Janney Montgomery.

Joseph D. Foresi - Janney Montgomery Scott LLC, Research Division

My first question is just on the revenue side, I think this is the second quarter that you brought down the top end of the guidance. Maybe you can just talk about what you expected or thought might happen in the beginning of the year and then maybe what is it coming through where -- given that you brought it down.

Zaineb Bokhari

So Joe, if you recall some of the comments that we made as the year progressed, we noted that in Q2 the macro environment did get incrementally a little bit worse. I would say that on a Q2 to Q3 basis, the environment was more stable. But as we progressed through the year, we do typically evaluate the revenue range and tighten it and that's something that we've done this go around as well.

Joseph D. Foresi - Janney Montgomery Scott LLC, Research Division

Okay. And then my second question. Maybe you could provide a little bit more color on what caused gross margin to come in so strong in this particular quarter. And how should we think about margins in general as we head in 2013?

Arvind S. Godbole

It was in the range of 42% to 43%. This quarter, we had a benefit because we did not have the visa costs, which we had for the previous quarter. And we also had some wage inflation -- some costs associated with the wage inflation in the higher risk regions and Italy in the second quarter. So primarily, that is the reason for reduction in the direct cost by $3.5 million. This is also partially offset by costs relating to additional hiring.

Joseph D. Foresi - Janney Montgomery Scott LLC, Research Division

Okay. And I know it's early, but -- and we've talked about the 2020 goalpost, any thoughts on what operating margin level with the currency sort of moving this direction 2013 could be at?

Prashant Ranade

The 2013 guidance, as you know, we'll provide in February 2013 when we provide revenue as well as margin and EPS guidance. But as I've said in my prepared remarks, this margin, operating margin at the current level is not sustainable. We are pleased with it. It is a combination of our operating performance vis-à-vis utilization and also benefit of exchange rate through the last quarter.

Joseph D. Foresi - Janney Montgomery Scott LLC, Research Division

Okay. And then just one last question from my side. You said you're opening a facility in the Philippines. Is that for work -- new work that you've contracted? And maybe you could just talk a little bit about what the prospects are for that facility.

Prashant Ranade

So the reason for a facility in the Philippines is if you look at, and as you know, all of our current facilities outside of North America and Europe are in India. And outside India, when we scanned the market, other locations from a supply standpoint, Philippines was the next best place we saw, and that's the reason we felt having a footprint there would be helpful and beneficial to our clients and that's the reason we'll open that facility in the first half of 2013.

Operator

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

Brian Kinstlinger - Sidoti & Company, LLC

The first call -- on previous calls, you guys have stated you'd hire aggressively, I think, even in a slower growth environment in the second half of the year, which is I think we all can agree we're seeing. However, you've only added 132 employees during the quarter, and this is the slowest I've ever since the first half of '09 for obvious reasons. So the 2 questions I have are, what's the reason? Is there a change in philosophy by management from what we've heard in the last 2 quarters? And then secondly, where do you expect utilization will go over the next few quarters?

Zaineb Bokhari

So Brian, I would say that our hiring plan is something that we're on track with. But if you look at the trend, certainly if you compare it to last year, we brought on about 1,200 individuals in that Q4. And so I would say with respect to this year, we do expect there to be more of a skewing towards Q4 as we did last year. And so based on that, we would expect the utilization to trend lower in Q4.

Brian Kinstlinger - Sidoti & Company, LLC

Right. I'm aware that you said that. But over the last few quarters, you said utilization would be dropping, and it hasn't. It's gone up every quarter. So that to me is a change of philosophy I'm talking about. As you guys mentioned, you were preparing for next year. You need to hire so you don't make the same mistake that you made in 2009. So why -- what's changed that hasn't allowed utilization to drop like you thought it would over the course of the year?

Prashant Ranade

I think first of all, Brian, our campus hiring plan is consistent with what we have done in previous years. If you look at 2011, even in that year, we saw Q4 we have invested the highest campus hire. So we'll do the same thing this quarter. So that remains consistent with the plan. I do acknowledge that in terms of timing, it is a function of where we have training facilities, where we need training and then we do have to build new hires certain office. But the philosophy remains intact, and we expect Q4 to have higher number of campus hires.

Brian Kinstlinger - Sidoti & Company, LLC

Okay. And then I'm curious, with the exchange rate moving the way it did, I'm curious why cost of goods sold, with the way revenue did, was actually down. I know you have the visa impact. Maybe you can quantify the visa impact, but I've never seen, again, cost of goods sold actually decline pretty much quarter -- especially as much as it did quarter-to-quarter.

Arvind S. Godbole

Yes, as I mentioned earlier, the direct cost have finally gone down because we had lower visa cost to the extent of $3.5 million. As I said, we have not had these costs...

Brian Kinstlinger - Sidoti & Company, LLC

$3.5 million?

Arvind S. Godbole

$3.5 million as compared to Q3 2011. And also, we typically have a bankable risk regions during the second quarter. And if the wage -- because of the wage increase to be able to make some changes for the retirement benefit, and that amount is around $1.1 million. This is not there this quarter. It is typically not there in the third quarter every year. So that goes in the direction of $12.6 million in the cost. It was partially offset by additional gearing and some other costs. And also, it will be partially -- will be up this season. As far as the year is concerned, again, as we have stated on the last quarter we reported, we reported a $5.3 million gain because of the calculation gain. Add [indiscernible] to that, we had a $3.1 million loss, so that will increase the cost estimate by $9 million for this quarter.

Brian Kinstlinger - Sidoti & Company, LLC

Okay. And I guess in tandem with the headcount question, I had revenue growth was 11% year-over-year and has slowed for several quarters. I think now it is below what you've talked about the market rate is unless you think the market rate has changed. Are you confident you can reaccelerate revenue growth? And if so, what gives you that confidence?

Prashant Ranade

Well, a couple of things. We remain committed to making sure that our growth rate is higher than the market rate. And as you rightly pointed out, the current growth rate put out by NASSCOM was back in February of this year. And since then, there have been several additional developments in markets, but they only put that forecast out once a year. So they will put it out again in 2013. But we are pleased with our overall growth rate. Because number one, our growth rate has been purely organic growth rate, and we have grown faster than majority of the companies in our space. And again, we remain committed and confident about growing higher than the market rate based on our domain-led offerings and our commitment to operations excellence.

Brian Kinstlinger - Sidoti & Company, LLC

Okay. And the last question I have is on the SG&A. You've got -- I'm curious of timing over the next few quarters of new seats and facilities, namely the Philippines and anything else you have in India and how that will affect SG&A. Do you have an expected maybe number you expect to add $1 million, $2 million in quarterly costs maybe some additions to help us out?

Prashant Ranade

As you know, we don't provide the specific cost associated with Philippines facility, but you are absolutely right. As the facility comes onscreen, it will have impact on SG&A.

Operator

Our next question comes from Jason Kupferberg of Jefferies.

Amit Singh - Jefferies & Company, Inc., Research Division

This is Amit Singh for Jason. Just coming back to the top line again, regarding the continued client decision-making delays. Could you provide a little more detail on the outsourcing segment, which I believe saw the slowest year-over-year growth since I think third quarter '09? Are you just seeing the decision-making delays or also experiencing some project cancellations there? And in addition to that, how is the performance of that business from your biggest customer? Is there any slowdown of spending over there?

Prashant Ranade

So first of all, as we have shared with you over the last few quarters, there's clearly a macroeconomic uncertainty, which has impacted the overall decision cycles. But I would characterize over the last 2 quarters the environment as being stable. And we are confident about growing higher than the market growth rate based on some of the new offerings that we have invested in and I would request Rakesh to comment on some of those.

Rakesh Khanna

Sure. What we see is the spend around grander business, we don't see changes. That remains very stable. The areas which are really the transformational spend where we see certain decision cycles getting longer, but this is getting offset by the spend on regulatory changes.

Amit Singh - Jefferies & Company, Inc., Research Division

Okay. And just quickly going back on the strong margins again. Even if we look on a year-to-year basis, let's say third quarter last year, then again there were no visa or wage-related costs, the gross margin still increased 5%, 6% year-over-year. Is this primarily just because of utilization? Or is there some FX factors there?

Prashant Ranade

Amit you are absolutely right. That has been, if you look at past few years, generally, our quarter 1 starts with the lower utilization and it progressively increases with majority of visa costs coming in, in Q2. So those are the main factors. And then we have utilization is the level we use depending on the combination of the demand environment, actual projects, and additional fluctuation you see is related to the exchange rate as Arvind explained in his prepared remarks.

Operator

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

Richard Eskelsen - Wells Fargo Securities, LLC, Research Division

It's actually Rick Eskelsen on for Ed. The first one is just on operating margin. You mentioned it not being sustainable. Was wondering if you could kind of parse out how much is due to the rupee moving against you here and how much is due to your continued investments?

Prashant Ranade

It is a combination of both, Ed. Partly about a little less than half is related to rupee movement. But as you know, from Q2 to Q3, rupee has actually appreciated. So majority of the benefit in Q3 comes from operating leverage, specifically utilization.

Richard Eskelsen - Wells Fargo Securities, LLC, Research Division

And then just also talking about your hiring outlook. Some of your competitors have talked more about focusing on improving their own utilization over adding to headcount. Are you finding it easier to find high-quality talent in the current environment?

Prashant Ranade

Actually, we have not found an issue hiring the right people. Obviously, it depends on the process that each organization has in terms of attracting, nurturing and retaining the associates. So we'll continue with those. But as we shared over the last 2 quarters, our focus remains on campus hiring over the last several quarters, and that's what we expect going into Q4.

Richard Eskelsen - Wells Fargo Securities, LLC, Research Division

Last one for me just on the revenue guidance. If I'm doing the math right, it looks like the low end implies about roughly equivalent sequential growth rate in the fourth quarter. In the past, I think it had been somewhat of a seasonally weaker quarter especially with the holidays and things like that. Can you just give a little more detail about what you're seeing there and what gives you that confidence?

Prashant Ranade

Yes, good observation, Ed. Historically till the last year, the Q4 was weaker or flat compared to Q3. But as we said in Q2, we do expect sequential growth from Q3 to Q4 combination of pipeline as well as the line projects that we knew about. So it was based on those 2 things that we made that comment in Q2.

Operator

Our your next question comes from Puneet Jain of JPMorgan.

Puneet Jain - JP Morgan Chase & Co, Research Division

Are you seeing any delays in your client base, specifically in the financial services clients? I know it might be too early, but what are your clients indicating for their spending plans of next years?

Zaineb Bokhari

Puneet, with respect to what we're seeing within the financial services, we think our customers continue to face some challenges due to the macro environment that they are spending on Myton types of projects. There is some hesitancy remaining on the discretionary spending side. Regulatory changes here and abroad in support of things like transparency and disclosure is supporting some of the spend we're seeing, as well as the explosion of data and the need to continue to integrate some of the deferred systems and leverage new technology. So that's basically what we've seen within B&FS .

Puneet Jain - JP Morgan Chase & Co, Research Division

And what are you hearing from your clients about their spending plans for next year? I know it might be too early, but any color will be great.

Zaineb Bokhari

Yes, I mean I would agree with you. It is rather early in the process. But we will come back to you when we issue our outlook for 2013 and share some color regarding what their -- how their budgets are finalizing.

Puneet Jain - JP Morgan Chase & Co, Research Division

Okay. And can you also give us an update on your investment plan, maybe talk about the areas you expect investments will ramp up in the fourth quarter and next year relative to what you did in 3Q?

Prashant Ranade

Okay. The investment will basically be in 3 areas, and we have been consistent investing in those 3 areas. First one is infrastructure, making sure we have world-class facilities. Second one is hiring. So campus hiring is something, as I said earlier, will be ramped up in Q4. And third area is our service offering, which are domain-led service offerings, and Rakesh can provide you a little more color on specific offerings.

Rakesh Khanna

Yes, Puneet, we continue to build intellectual property around our existing cloud social media. And domain-led accelerated around Dodd-Frank, Solvency II with the regulatory stuff going on out there.

Operator

Our next question comes from Vincent Colicchio of Noble.

Vincent A. Colicchio - Noble Financial Group, Inc., Research Division

Prashant, did your clients 6 through 20 grow in the quarter? And what are your thoughts about the upcoming quarters for that group of clients?

Prashant Ranade

So for Q3, our clients 6 through 20 as a percentage growth rate grew at a slightly lower rate than clients 1 through 5. But if you look at year-to-date 3 quarters, our client 6 through 20 actually grew at higher than, as a percentage, higher than clients 1 through 5 as well as our average growth rate. And we feel very good about our prospects with these clients 6 through 20 given that they are well-known brand names and are Fortune 500 blue-chip companies, as well as the fact that they are under-penetrated but we have existing relationships. So we'll remain focused on growing clients 6 through 20.

Vincent A. Colicchio - Noble Financial Group, Inc., Research Division

Okay. And then you had -- the competitive environment, did that change sequentially? In particular, were there any changes in pricing?

Prashant Ranade

So the pricing remained stable over the last couple of quarters. As far as competitive environment is concerned, we, as you know, faced same competitors. But our differentiated offering and focus on operational excellence resonates very well with our clients, and that's what has allowed us to achieve better-than-market growth rates.

Vincent A. Colicchio - Noble Financial Group, Inc., Research Division

And then in your prepared remarks, you mentioned that Europe is actually improving for you. I know it's a relatively small -- it's been a relatively small piece of business in the past. Is that -- do you have meaningful opportunities there in the near future? And how much business did you do there in the quarter?

Zaineb Bokhari

So Vince, I would say that macro conditions in Europe are still fairly challenging, and our exposure and our presence there, as you noted, is small. In the quarter, it was still below 7% as a percentage of overall revenue. But we are investing there certainly in terms of some of the front-end capabilities -- client-facing capabilities rather. And over the long term, it's an area that we see a fair amount of opportunity. And the growth potential is there because as you know, Europe has lagged the U.S. in terms of use of outsourcing. So the way I would characterize it is that in the meantime, as conditions start to stabilize, perhaps we are just readying ourselves for that eventual recovery.

Vincent A. Colicchio - Noble Financial Group, Inc., Research Division

All right. And last question, do you expect any type of budget flush in the fourth quarter? I know historically, you don't assume that in your expectations in terms of guidance. But maybe you can talk to the possibility of that.

Zaineb Bokhari

So you're absolutely right, Vince. We don't factor that into our outlook. Our outlook is visibility-based. So we did talk about Q4 seeing some sequential growth over Q3, but that was related to some of the delays that we have seen and called out in Q2 and that's contributing to the growth that we expect in Q4 over Q3.

Operator

Our next question comes from Nathan Novak of Baird.

Nathan J. Novak - Robert W. Baird & Co. Incorporated, Research Division

Quick housekeeping question first. Your INR 52.7 guidance, is that for the rest of the year or is that a full year average?

Arvind S. Godbole

That is for the full year average.

Nathan J. Novak - Robert W. Baird & Co. Incorporated, Research Division

Full year average?

Arvind S. Godbole

Yes.

Nathan J. Novak - Robert W. Baird & Co. Incorporated, Research Division

Okay. Got you. And it looks like you have about $10 per share in cash now. Can you talk a little bit about your interest in potentially putting that to work, whether that be a special dividend, maybe some tuck-in M&A activity?

Bharat Desai

Yes. So as I've mentioned in the past, our board regularly reviews our cash position to make decisions on the best use of that cash. Our team is continuing to evaluate opportunities for tuck-in M&A to extend our reach. And as the board feels appropriate, they will make decisions about the best deployment of that cash.

Nathan J. Novak - Robert W. Baird & Co. Incorporated, Research Division

All right. Got you. And last one for me. Can you just walk through margin EPS growth for next year? You mentioned that the current margins looks like they're not necessarily sustainable going forward. It looks like the rupee stays at about the same rate. This could become a headwind in Q2. Could you walk me through maybe a little bit of the margins that could help you potentially grow EPS next year in spite of those FX headwinds?

Prashant Ranade

So if you look at our historic performance, I would go back even 8 to 9 years, we have operated with above-average industry operating margin and with our what we call our 2020 vision of our market growth rate and 20% operating margin, this very wide range of exchange variation. So what we do is when there are headwinds related to exchange rate, we'll invest -- we'll use our utilization level and operate at the highest utilization to offset that to ensure we maintain the margin. And when we have opportunity like exchange rate tailwinds, we'll use that opportunity to invest in the business based on demand environment.

Nathan J. Novak - Robert W. Baird & Co. Incorporated, Research Division

Got you. Could you remind me again...

Arvind S. Godbole

I just want to make corrections. The INR 52.70, that is for the balance of the year, that is the quarter 4. It's not for the full year.

Nathan J. Novak - Robert W. Baird & Co. Incorporated, Research Division

Got you. Got you. That makes sense. On the utilization front, can you remind me what levels you're comfortable on, on the high side? Like, how high would you potentially go?

Arvind S. Godbole

So if we look at...

Zaineb Bokhari

So with respect to what we've shared in terms of ranges of utilization that we're comfortable with, we talk about IT offshoring, and we prefer to operate within a band of 60% to 80% and that's still applicable in this quarter on a period-end basis. I think we came in right in the middle of that range.

Operator

Our next question comes from Manish Hemrajani of Oppenheimer.

Manish Hemrajani - Oppenheimer & Co. Inc., Research Division

On the top line, you brought down your guidance now 2 quarters in a row, have you seen macro deteriorate significantly since the Q1? Or were you being too aggressive back then in your guidance to begin with? And what are you seeing out there now which could impact next year? And I'm probably being too optimist here by asking you this, but can you give us an early read into what you expect for next year?

Manish Hemrajani - Oppenheimer & Co. Inc., Research Division

First of all, we are not providing next year's guidance till February 2013. But as far as additional comments, Zaineb will provide you additional comments around the rest of your question.

Zaineb Bokhari

So Manish, if you recall, on our Q2 call was the first time that we noted that there was an incremental deterioration in terms of the overall macro economy, and we did see some cycle times extending at that point in time. I would say that on a Q2 to Q3 basis, the environment was stable. But what happens is as the year progresses, we do typically tighten the range, and the overall outlook is set based on the facility that we have.

Manish Hemrajani - Oppenheimer & Co. Inc., Research Division

Okay. And then what kind of work are you moving to the Philippines? That's obviously a very voice-heavy market?

Prashant Ranade

You are absolutely right. Currently, it's a voice-heavy market, but there are 2 areas that we see there. One is investment-friendly environment, and there are aspirations to grow IT side of the business. And we are also encouraged by the supply side of health care professionals. So those are the factors. So we are not, as you know, in voice-only business. Our focus is some KPO work and additional IT work.

Manish Hemrajani - Oppenheimer & Co. Inc., Research Division

Okay. Are you getting any tax off from the government there?

Prashant Ranade

They do offer certain benefits for investment in Philippines, not too dissimilar from most countries including India office.

Manish Hemrajani - Oppenheimer & Co. Inc., Research Division

Got it. And can you just break out what the visa cost on margins where in 3Q and what was it in 2Q?

Arvind S. Godbole

Quarter 2, we had $4.3 million of visa costs. As compared to that, in the quarter 3 we had $800,000. So a reduction of $3.5 million as compared to the quarter 2.

Manish Hemrajani - Oppenheimer & Co. Inc., Research Division

Got it. And did you say that your gross margin expectations for the next quarter were in the 42%, 43% range?

Arvind S. Godbole

Yes. 42% to 43%.

Zaineb Bokhari

And that's a full year outlook. As you know, we don't provide quarterly guidance. That's the full year outlook.

Operator

Our next question comes from Greg Halter of Great Lakes review.

Gregory W. Halter - LJR Great Lakes Review

Wondered if you could either provide the third quarter or year-to-date cash flow from operating activities figure?

Arvind S. Godbole

Yes, for the third quarter, the operating cash flow was $59.8 million. Investing, we had $12.8 million, and financing was negative $1.9 million and exchange rate impact was $3.5 million negative. So resulting in net cash flow of $67.2 million for the quarter.

Gregory W. Halter - LJR Great Lakes Review

All right. And I believe most of your cash is still overseas, I think, in India and correct me if I'm wrong on that. I think it was like 90% or so. And also, what kind of rate did you earn on your cash and investments in the quarter?

Arvind S. Godbole

Yes, for the third quarter on a consolidated basis, we recorded 7.7%.

Gregory W. Halter - LJR Great Lakes Review

7.3%?

Arvind S. Godbole

7.7%.

Gregory W. Halter - LJR Great Lakes Review

7.7%. Okay. And most of that cash, greater than 90% is in India, is that correct?

Arvind S. Godbole

Yes, the cash in India is around yes, it's around 90% or so. But out of that, I think it's held in U.S. dollars as well.

Prashant Ranade

Did you get that, Greg? Even though cash in India is 90%, some of that, we don't break that out, is held in U.S. dollars.

Operator

Our next question comes from Rahul Bhangare of William Blair.

Rahul Bhangare

Most of them have been answered so far. But just digging a little bit deeper on the regulatory spending side, can you break that out maybe between financial services and health care? I know ICD-10 has been pushed back to 2014, but are you seeing any types of acceleration in those deployments?

Prashant Ranade

So as you know, ICD-9 to 10 is something that is similar to Y2K with tremendous potential. So currently, it has been pushed out to October 2014. We have invested in those offerings. We have done some pilots and financial neutrality part for certain clients. But for the next 2 quarters, we expect the election impact to particularly help payers have that wait-and-see approach around that particular offering. But it will clarify itself depending on which side wins the presidential election, anywhere from 1 to 3 quarters because that initiative will definitely go ahead. And HHS decides what is the implementation date which is currently October 2014. And as far as -- I will point to Rakesh to comment on the regulatory offering around banking and financial services.

Rakesh Khanna

Yes, what we have seen in the banking area, like I mentioned earlier, more around the Basel III, the Dodd-Frank. Clearly, those are the regularity trends. And even on the health care, in addition to what Prashant mentioned along the Health Care Reform Act, and we also anticipate some growth coming in, in the medical loss ratio Accountable Care kind of stuff going forward. So we are building -- we continue to build capability in those areas.

Rahul Bhangare

Okay. Your -- can we talk about the demand trends specifically within your top 2 customers?

Prashant Ranade

So we are pleased with -- we don't comment about specific customer. And that's why I would refer to our performance over the last several quarters, and we are pleased with the growth we have seen with certainly top 2 clients but overall, the company growth rate as well. And we expect that with the offerings we have with our focus on execution we have, our opportunity to grow is there with all of our clients.

Rahul Bhangare

Okay. And I believe you said that there were 4 new customers in the quarter. How many of those were KPO customers, if any, and maybe talk about the pipeline as it relates to KPO?

Prashant Ranade

Yes. So 1 out of those 4 clients was a KPO customer, and we have good pipeline of KPO clients. As we have shared with you in the past, the cycle times for the KPO decision are longer, but we are comfortable and confident about our pipeline as well as the fact that we won 1 KPO client in the last quarter.

Operator

Our next question is a follow-up from Brian Kinstlinger of Sidoti & Company.

Brian Kinstlinger - Sidoti & Company, LLC

One last question, because I'm not quite sure I understand with revenue coming at the low end and you lowering revenue at the high end twice. I guess in the third quarter specifically, what happened on the cost side that allowed you to beat and raise guides and earnings by so much, especially concerning how the rupee went? I know what happened with the visa costs, you already knew that last quarter. So what particularly happened that you didn't realize was going to happen on the cost side?

Arvind S. Godbole

Well, during this quarter we had lower direct cost to the tune of $4.6 million. At the same time, we had SG&A increase of almost $9 million, which was primarily due to the exchange rate fluctuation. In quarter 2, we had a $5.3 million gain. Before that, we had $3.7 million loss. But we also have, as compared to previous quarter, we had a $4.4 million loss in the other income, which was a hidden loss. Against that, we had a $1.5 million gain. So -- and we also had a gain from [indiscernible] which is around $1 million. So these are the factors that are actually contributed to the increasing the EPS for this quarter. But if you see our full year guidance actually for next quarter, we are looking at a lower EPS as compared to this quarter.

Brian Kinstlinger - Sidoti & Company, LLC

Okay. But just to be clear because the -- yes, I understand that quarter-to-quarter, but you knew about a lot of that stuff outside of currency. And so $1 million certainly doesn't impact by $0.45 for the other income that you saw on the gain this quarter versus the loss last quarter, and you knew about the lower cost of goods sold. So again, I'm just trying to understand what occurred that you didn't think would occur?

Arvind S. Godbole

No, there are too many uncertainties when you give the guidance. We just go by the visibility that we have at that point in time with the foreign exchange rate, and we grew the guidance at a particular exchange rate and we'll do the hedging whether we feel appropriate. But it is still very difficult to [indiscernible] be for the balance of the quarter, and that is why we made the guidance based on the visibility at that point in time.

Prashant Ranade

And from the operating point standpoint, which is what we have control over, and we are comfortable about how we're seeing is the handling areas that we have control over. The utilization part was the main contributor to the EPS.

Brian Kinstlinger - Sidoti & Company, LLC

Got it. Okay. So that -- it was the hiring that's been a little bit slower than you thought?

Prashant Ranade

Exactly.

Operator

Our next question is a follow-up from Vincent Colicchio of Noble Financial.

Vincent A. Colicchio - Noble Financial Group, Inc., Research Division

Prashant, one of your peers has said that they've seen increased consolidation activity. Do you see increased pressure on that side? Is that an opportunity or a threat to your business?

Prashant Ranade

Actually, we look at that as an opportunity, Vince, because staying relevant to clients is what our focus is, what we are focused on. And having differentiated domain-led offerings have served us well. So we haven't seen impact because of consolidation. In fact, we have seen benefit coming from multi-sourcing trend, especially on some of the clients who had single source impact, which has actually helped us.

Vincent A. Colicchio - Noble Financial Group, Inc., Research Division

So that should continue to play out, I assume, in upcoming quarters?

Prashant Ranade

Yes.

Operator

I'm showing no further questions. This concludes Syntel's Third Quarter Earnings Call. A replay of today's call will be available until October 25, 2012, by dialing (855) 859-2056 and entering the passcode, which is 39646088. Thank you.

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