Syntel (SYNT) Q1 2011 Earnings Call April 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 Manish Hemrajani - Oppenheimer & Co. Inc. Jeffrey Rossetti Bryan Keane - Crédit Suisse AG Bhavan Suri - William Blair & Company L.L.C. Vincent Colicchio - Noble Financial Group, Inc. Joseph Vafi - Jefferies & Company, Inc. Puneet Jain - JP Morgan Chase & Co Mayank Tandon - Signal Hill Brian Kinstlinger - Sidoti & Company, LLC Presentation Operator
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I'll now turn the call over to Bharat -- to Syntel's Chairman, Bharat Desai. Bharat?Bharat Desai Thank you, David. Good morning, everybody, and thank you for joining us today. On our last earnings call in February, we discussed our expectations for flat sequential revenue in the first quarter of 2011 based on our clients' budget cycle. That, coupled with ongoing investments in our business, resulted in lower margins during the first quarter. These investments are critical to meeting client demand and enabling Syntel to maximize the market opportunity over the longer term. Top line acceleration as 2011 progresses should provide us with margin expansion opportunities. From a market perspective, overall demand for IT services remained stable and healthy. We continue to hear from our clients that they value Syntel's unique combination of size, capability and culture. Syntel's investment and industry-focused solutions have positioned us well to grow at a rate above the industry and 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 first quarter revenues came in at $145.4 million, increasing less than 1% sequentially but representing a 25% increase year-over-year. As anticipated, clients deferred project commitments pending improved visibility and finalization of their 2011 budgets. With this seasonal impact largely behind us, we expect contract signing and client spending to pick up, which will drive sequential revenue improvement in second quarter. First quarter revenue impacts, both positive and negative, were mostly client specific. KPO revenues were increased by $2.3 million as a result of a new project transition with a large client. While this created a spike in revenues, it also came with high expense levels, which dragged KPO and overall company gross margins. We expect these transition revenues and associated costs will reduce in the second quarter.
Syntel also saw healthy growth in our health care vertical, which grew 11% sequentially and helped drive the quarter improvement in our EBIT revenues.Offsetting this favorability were sequential spending reductions from a few large clients, which were anticipated. Gross margin in the first quarter reduced by 340 basis points as compared to the fourth quarter of 2010, coming in at 35%. While revenues during the quarter were flat, our costs of delivery increased approximately 6%. The main drivers for this increase were lower average utilization, the impact of wage increases and onetime transition costs associated with the large project mentioned earlier. During the first quarter, Syntel continued to hire in support of our 2011 growth plans and to effectively manage our delivery pyramid going forward. While utilization offshore improved by the end of the quarter, the average utilization rate during Q1 was below Q4 levels. As discussed on last quarter's call, we expect that this utilization rate will improve as 2011 progresses. First quarter costs also increased as a result of on-site compensation adjustments, which were effective January 1, 2011. The increases, which were in the low- to mid-single-digit range resulted in approximately 100 basis points of gross margin pressure. The company's SG&A levels were largely unchanged during the first quarter. Increases in SG&A will begin during the second quarter as we begin moving into our new SEZ-leased facility in Mumbai and a second building in our new state-of-the-art Chennai campus. Combined, we'll be adding approximately 6,000 finished seats by the end of the third quarter. These infrastructure costs, coupled with the impact of offshore compensation adjustments and visa processing fees, will result in significant Q2 cost increases. We expect, however, that revenue growth during the quarter will drive utilization and productivity improvements and result in operating margin expansion versus Q1 levels.
Overall, the demand environment remains stable and healthy. As Bharat mentioned, client budget cycles are largely complete and on average appear to be slightly above 2010 levels.For Syntel, there continues to be a significant opportunity for us to accelerate growth within our key strategic relationships. The new business pipeline is healthy, and clients are looking to Syntel to help them not only reduce cost and improve efficiency but also drive part leadership and competitive differentiation. This includes ROI-based projects, regulatory- and compliance-related changes, transformation initiatives and new technology plans. Read the rest of this transcript for free on seekingalpha.com