ITEM 1. BUSINESS
Forward-looking and Cautionary Statements
This Annual Report on Form 10-K (“Annual Report”) contains statements that are not historical facts and that constitute “forward-looking statements” within the meaning of such term under the Private Securities Litigation Reform Act of 1995, Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934. These forward-looking statements include statements regarding the business outlook, the demand for the products and services, and all other statements in this Annual Report other than recitation of historical facts. Words such as “expect”, “potential”, “believes”, “anticipates”, “plans”, “intends” and similar expressions are intended to identify such forward-looking statements. Forward-looking statements in this Annual Report include, without limitation, forecasts of market growth, future revenues, future expectations concerning growth of business, cost competitiveness, and other matters that involve known and unknown risks, uncertainties and other factors that may cause results, levels of activity, performance or achievements to differ materially from results expressed or implied by this Annual Report. Such risk factors include, among others: whether certain market segments grow as anticipated; the competitive environment in the information technology services industry; and whether the companies can successfully provide services/products and the degree to which these gain market acceptance. These and other risks in the sections entitled are discussed in Item 1A
ITEM 1A. RISK FACTORS
We operate in a rapidly changing economic and technological environment that presents numerous risks, many of which are driven by factors that we cannot control or predict. The following discussion, as well as the discussion in the “Critical Accounting Policies and Estimates” section of the Management’s Discussion and Analysis of Financial Condition and Results of Operations contained herein, highlights some of these risks. The risks described below are not the only risks we may face. Additional risks and uncertainties not currently known to us or that we currently deem to be immaterial may adversely affect our business, financial condition, results of operations and/or cash flows.
Uncertain global economic conditions may continue to adversely affect demand for our services.
Our revenue and gross margin depend significantly on general economic conditions and the demand for IT services in the markets in which we operate. Economic weakness and constrained IT spending has resulted, and may result in the future, in decreased revenue, gross margin, earnings and growth rates. A material portion of our revenues and profitability is derived from our clients in North America and Europe. Weakening in these markets as a result of high government deficits, credit downgrades or otherwise, could have a material adverse affect on our results of operations. Ongoing economic volatility and uncertainty affects our business in a number of other ways, including making it more difficult to accurately forecast client demand beyond the short term and effectively build our revenue and resource plans. Economic downturns also may lead to restructuring actions and associated expenses. Uncertainty about future economic conditions makes it difficult for us to forecast operating results and to make decisions about future investments. Delays or reductions in IT spending could have a material adverse effect on demand for our products and services, and consequently the results of operations, financial condition, cash flows and stock price.
Our global operations expose us to numerous and sometimes conflicting legal and regulatory requirements, and violation of these regulations could harm our business.
We are subject to numerous, and sometimes conflicting, legal regimes on matters as diverse as anticorruption, import/export controls, content requirements, trade restrictions, tariffs, taxation, sanctions, immigration, internal and disclosure control obligations, securities regulation, anti-competition, data privacy and labor relations. Compliance with diverse legal requirements is costly, time-consuming and requires significant resources. Violations of one or more of these regulations in the conduct of our business could result in significant fines, criminal sanctions against us or our officers, prohibitions on doing business and damage to our reputation.
Violations of these regulations in connection with the performance of our obligations to our clients also could result in liability for significant monetary damages, fines and/or criminal prosecution, unfavorable publicity and other reputational damage, restrictions on our ability to process information and allegations by our clients that we have not performed our contractual obligations. Due to the varying degrees of development of the legal systems of the countries in which we operate, local laws might be insufficient to protect our rights. In particular, in many parts of the world, including countries in which we operate and/or seek to expand, practices in the local business community might not conform to international business standards and could violate anticorruption laws, or regulations, including the U.S. Dodd-Frank Act, the U.S. Foreign Corrupt Practices Act and the U.K. Bribery Act 2010. Violations of these laws or regulations by us, our employees or any of our subcontractors, agents, alliance or joint venture partners and other third parties with which we associate could subject us to criminal or civil enforcement actions (whether or not we participated or knew about the actions leading to the violations), including fines or penalties, disgorgement of profits and suspension or disqualification from work, including U.S. federal contracting, any of which could materially adversely affect our business, including our results of operations and our reputation.
Changes in laws and regulations could also mandate significant and costly changes to the way we implement our services and solutions or could impose additional taxes on our services and solutions. For example, because outsourcing and systems integration represent a significant portion of our business, changes in
laws and regulations to limit using off-shore resources in connection with our government work, which have been proposed from time to time by various U.S. states, could adversely affect our results of operations. Such changes may result in contracts being terminated, or work being transferred onshore, resulting in greater costs to us and could have a negative impact on our ability to obtain future work from government clients. We currently do not have significant contracts with U.S. federal or state government entities.
International immigration and work permit laws may adversely affect our ability to deploy our workforce and provide services in accordance with our global delivery model.
We have international operations in twenty seven countries and recruit professionals on a global basis and, therefore, must comply with the immigration and work permit/visa laws and regulations of the countries in which we operate or plan to operate. As of January 31, 2012, 4,695 IT professionals, representing approximately 17.5% of our worldwide workforce are providing services under work permits/visas. Historically, we have done much of our recruiting outside of the countries where the client work is located. Accordingly, any perception among our IT professionals, whether or not well founded, that our ability to assist them in obtaining temporary work visas and permanent residency status has been diminished, could lead to significant employee attrition. Our inability to obtain sufficient work permits/visas on a timely basis due to the impact of these regulations, including any changes to immigration and work permit/visa regulations in particular jurisdictions, could have a material adverse effect on our business in effectively utilizing our global delivery model, therefore impacting our results of operations, financial condition and cash flows.
Changes in our level of taxes, and audits, investigations and tax proceedings, could have a material adverse effect on our results of operations and financial condition.
We are subject to income taxes in numerous jurisdictions. We calculate and provide for income taxes in each tax jurisdiction in which we operate. Tax accounting often involves complex matters and judgment is required in determining our worldwide provision for income taxes and other tax liabilities. We are subject to ongoing tax audits in various jurisdictions. Tax authorities may disagree with our intercompany charges, cross-jurisdictional transfer pricing or other matters and assess additional taxes. We regularly assess the likely outcomes of these audits in order to determine the appropriateness of our tax provision. However, there can be no assurance that we will accurately predict the outcomes of these audits, and the amounts ultimately paid upon resolution of audits could be materially different from the amounts previously included in our income tax expense and therefore could have a material impact on our tax provision, net income and cash flows.
In addition, our effective tax rate in the future could be adversely affected by changes to our operating structure, changes in the mix of earnings in countries with differing statutory tax rates, changes in the valuation of deferred tax assets and liabilities, changes in tax laws and the discovery of new information in the course of our tax return preparation process. In particular, the carrying value of deferred tax assets is dependent on our ability to generate future taxable income. In addition, President Obama’s administration has announced proposals for other U.S. tax legislation that, if adopted, could adversely affect our tax rate. There are also other tax proposals that have been introduced, that are being considered, or that have been enacted by the United States Congress or the legislative bodies in foreign jurisdictions that could affect our tax rate, the carrying value of deferred tax assets, or our other tax liabilities.
Our net income could decrease if the Government of India reduces or withdraws tax benefits and other incentives it currently provides to us, or otherwise increases our effective tax rate.
Presently, we benefit from the tax holidays given by the Government of India for the export of IT services from specially designated software technology parks (“STPs”) and special economic zones (“SEZs”) in India. As a result of these incentives, which include a 10 year tax holiday from Indian corporate income taxes for the operation of most of our Indian facilities, our operations have been subject to relatively low tax liabilities. The tax benefits available for all our STP facilities expired on March 31, 2011. Consequently, our effective Indian tax rate has increased significantly.
Development centers operating in SEZs are entitled to certain income tax incentives of 100% of the export profits for a period of five years, 50% of such profits for the next five years and 50% of the profits for a further period of five years subject to satisfaction of certain capital investments requirements. Our profitability would be adversely affected if we are not able to continue to benefit from these tax incentives. Further, provisions of the Indian Income Tax Act 1961 are amended on an annual basis by enactment of the Finance Act. In addition, we may also be subject to changes in taxation resulting from the actions of applicable income tax authorities in India or from Indian tax laws that may be enacted in the future. For example, we may incur increased tax liability as a result of a determination by applicable income tax authorities that the transfer price applied to transactions involving our subsidiaries and the Company was not appropriate.
Increases in our effective tax rate due to expired tax benefits, changes in applicable tax laws or the actions of applicable income tax or other regulatory authorities could materially reduce our profitability.
Our business could be adversely affected if we do not anticipate and respond to technology advances in our industry and our clients’ industries.
The IT and offshore outsourcing services industries are characterized by rapid technological change, evolving industry standards, changing client preferences and new product introductions. Our success will depend in part on our ability to develop IT solutions that keep pace with industry developments. We may not be successful in addressing these developments on a timely basis or at all, if these developments are addressed, we will be successful in the marketplace. In addition, products or technologies developed by others may not render our services noncompetitive or obsolete. Our failure to address these developments could have a material adverse effect on our business, results of operations, financial condition and cash flows.
A significant number of organizations are attempting to migrate business applications to advanced technologies. As a result, our ability to remain competitive will be dependent on several factors, including our ability to develop, train and hire employees with skills in advanced technologies, breadth and depth of process and technology expertise, service quality, knowledge of industry, marketing and sales capabilities. Our failure to hire, train and retain employees with such skills could have a material adverse impact on our business. Our ability to remain competitive will also be dependent on our ability to design and implement, in a timely and cost-effective manner, effective transition strategies for clients moving to advanced architectures. Our failure to design and implement such transition strategies in a timely and cost-effective manner could have a material adverse effect on our business, results of operations, financial condition and cash flows.
Our business could be materially adversely affected if we do not or are unable to protect our intellectual property or if our services are found to infringe or misappropriate on the intellectual property of others.
Our success depends in part upon certain methodologies and tools we use in designing, developing and implementing applications systems in providing our services. We rely upon a combination of nondisclosure and other contractual arrangements and intellectual property laws to protect confidential information and intellectual property rights of ours and our third parties from whom we license intellectual property. We enter into confidentiality agreements with our employees and limit distribution of proprietary information. The steps we take in this regard may not be adequate to deter misappropriation of proprietary information and we may not be able to detect unauthorized use of, protect or enforce our intellectual property rights. At the same time, our competitors may independently develop similar technology or duplicate our products or services. Any significant misappropriation, infringement or devaluation of such rights could have a material adverse effect upon our business, results of operations, financial condition and cash flows.
Litigation may be required to enforce our intellectual property rights or to determine the validity and scope of the proprietary rights of others. Any such litigation could be time consuming and costly. Although we believe that our services do not infringe or misappropriate on the intellectual property rights of others and that we have all rights necessary to utilize the intellectual property employed in our business, defense against these claims,
even if not meritorious, could be expensive and divert our attention and resources from operating our company. A successful claim of intellectual property infringement against us could require us to pay a substantial damage award, develop non-infringing technology, obtain a license or cease selling the products or services that contain the infringing technology. Such events could have a material adverse effect on our business, financial condition, results of operations and cash flows.
Our clients’ proprietary rights may be misappropriated by our employees or subcontractors in violation of applicable confidentiality agreements.
We require our employees and subcontractors to enter into non-disclosure arrangements to limit access to and distribution of our clients’ intellectual property and other confidential information as well as our own. We can give no assurance that the steps taken by us in this regard will be adequate to enforce our clients’ intellectual property rights. If our clients’ proprietary rights are misappropriated by our employees or our subcontractors or their employees, in violation of any applicable confidentiality agreements or otherwise, our clients may consider us liable for that act and seek damages and compensation from us.
System security risks and cyber-attacks could disrupt our information technology services provided to customers, and any such disruption could reduce our expected revenue, increase our expenses, damage our reputation and adversely affect our stock price.
Experienced computer programmers and hackers may be able to penetrate our network security and misappropriate or compromise our confidential information or that of third parties, create system disruptions or cause shutdowns. Computer programmers and hackers also may be able to develop and deploy viruses, worms, and other malicious software programs that attack our products or otherwise exploit any security vulnerabilities of our products. In addition, sophisticated hardware and operating system software and applications that we produce or procure from third parties may contain defects in design or manufacture, including “bugs” and other problems that could unexpectedly interfere with the operation of the system.
We manage and store various proprietary information and sensitive or confidential data relating to our business. In addition we routinely process, store and transmit large amounts of data for our clients, including sensitive and personally identifiable information. Breaches of our security measures or the accidental loss, inadvertent disclosure or unapproved dissemination of proprietary information or sensitive or confidential data about us or our clients, including the potential loss or disclosure of such information or data as a result of fraud, trickery or other forms of deception, could expose us, our customers or the individuals affected to a risk of loss or misuse of this information, result in litigation and potential liability for us, damage our brand and reputation or otherwise harm our business. The cost and operational consequences of implementing further data protection measures could be significant. We may not be successful in implementing new systems and transitioning data, which could cause business disruptions and be more expensive, time consuming, disruptive and resource-intensive. Such events could have a material adverse effect on our business, financial condition, results of operations and cash flows.
Industry consolidation may cause us to lose key relationships and intensify competition.
Acquisitions or other consolidating transactions within our industry could harm us in a number of ways, including the loss of customers, if competitors consolidate with our current or potential customers, our current competitors become stronger or new competitors emerge from consolidations. Any of these events could put us at a competitive disadvantage, which could cause us to lose customers, revenue and market share. If one of current clients merges or consolidates with a company that relies on another provider for its consulting, systems integration and technology, or outsourcing services, we may lose work from that client or lose the opportunity to gain additional work. The increased market power of larger companies could also increase pricing and competitive pressures on us. Any of these possible results of industry, consolidation could force us to expend greater resources to meet new or additional competitive threats, which could also adversely affect our results of operations, financial condition and cash flows.
Our international operations subject us to increased exposure to foreign currency fluctuations.
We have international operations in twenty seven countries and as we expand our international operations, more of our customers may pay us in foreign currencies. Transactions in currencies other than U.S. Dollars (“USD”) subject us to fluctuations in currency exchange rates. Accordingly, changes in exchange rates between the USD and other currencies could have a material adverse effect on our revenues and net income, which may in turn have a negative impact on our business, results of operations, financial condition and cash flows. The exchange rate between the USD and other currencies has changed substantially in recent years and may fluctuate in the future. We expect that a majority of our revenues will continue to be generated in USD for the foreseeable future and that a significant portion of our expenses, including personnel costs, as well as capital and operating expenditures, will continue to be denominated in other currencies such as Indian Rupees, Canadian Dollars (“CAD”), Mexican Pesos, Australian Dollars, British Pounds (“GBP”), Euros, and Japanese Yen. Hedging strategies, such as forward contracts and options related to transaction exposures that we have implemented or may implement to mitigate this risk may not reduce or completely offset our exposure to foreign exchange fluctuations. Consequently, our results of operations may be adversely affected if other currencies appreciate against the USD and an effective foreign exchange hedging program is not in place.
We are subject to counterparty default risks.
We have numerous arrangements with financial institutions that include cash and investment deposits, foreign currency option contracts, and forward contracts. As a result, we are subject to the risk that the counterparty to one or more of these arrangements will default, either voluntarily or involuntarily, on its performance under the terms of the arrangement. In times of market distress, a counterparty may default rapidly and without notice to us, and we may be unable to take action to cover our exposure, either because we lack the contractual ability or because market conditions make it difficult to take effective action. If one of our counterparties becomes insolvent or files for bankruptcy, our ability eventually to recover any losses suffered as a result of that counterparty’s default may be limited by the liquidity of the counterparty or the applicable legal regime governing the bankruptcy proceeding. In the event of such default, we could incur significant losses, which could harm our business, results of operations, and financial condition.
Our revenues are concentrated in a limited number of clients in a limited number of industries which are primarily located in the United States and Europe and our revenues may be reduced if these clients significantly decrease their IT spending.
Our revenues are highly dependent on clients primarily located in North America, as well as clients concentrated in certain industries. Economic slowdowns, changes in U.S. law and other restrictions or factors that affect the economic health of these industries may affect our business. In the year ended December 31, 2011, approximately 80.7% of our revenue was derived from customers located in the United States and Canada. We have in the past derived, and may in the future derive, a significant portion of our revenue from a relatively limited number of clients. Our five largest clients represented approximately 39.8%, 72% and 70% of revenues for the years ended December 31, 2011, 2010 and 2009, respectively. Consequently, if our top clients reduce or postpone their IT spending significantly, this may lower the demand for our services and negatively affect our revenues and profitability. Further, any significant decrease in the growth of the financial services or other industry segments on which we focus may reduce the demand for our services and negatively affect our revenues, profitability and cash flows.
Our preferred vendor contracts may result in lower pricing for our services.
We are party to several “preferred vendor” contracts and we are seeking additional similar contracts in order to obtain new or additional business from large or medium-sized clients. Clients enter into these contracts to reduce the number of vendors and obtain better pricing in return for a potential increase in the volume of business to the preferred vendor. While these contracts are expected to generate higher volumes, they generally result in lower margins. Although we attempt to lower costs to maintain margins, we may not be able to sustain
margins on such contracts. In addition, the failure to be designated a preferred vendor, or the loss of such status, may preclude us from providing services to existing or potential clients, except as a subcontractor, which could have a material adverse effect on our business, results of operations, financial condition and cash flows.
Continued pricing pressures may reduce our revenues.
We market our service offerings to large and medium-sized organizations. Generally, the pricing for the projects depends on the type of contract:
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Time and Material Contracts - Contract payments are based on the number of consultant hours worked on the project.
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Annual Maintenance Contracts - Contracts with no stated deliverables and having a designated workforce, the pricing is based on fixed periodic payments.
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Fixed Price Contracts - Contracts based upon deliverables and/or achieving of project milestones, pricing is based on a fixed price.
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Some process outsourcing contracts provide pricing per transaction.
Customers typically have the right to cancel contracts with minimal notice. Contracts with deliverables or project milestones may provide for certain payments if the deliverables or project milestones are not met within contract timelines.
The intense competition and the changes in the general economic and business conditions can put pressure on us to change our prices. If our competitors offer deep discounts on certain services or provide services that the marketplace considers more valuable, we may need to lower prices or offer other favorable terms in order to compete successfully. Any such changes may reduce margins and could adversely affect results of operations, financial condition and cash flows.
Any broad-based change to our prices and pricing policies could cause revenues to decline or be delayed as our sales force implements and our customers adjust to the new pricing policies. Some of our competitors may bundle software products and services for promotional purposes or as a long-term pricing strategy or provide guarantees of prices and product implementations. These practices could, over time, significantly constrain the prices that we can charge for certain services. If we do not adapt our pricing models to reflect changes in customer use of our services or changes in customer demand, our revenues and cash flows could decrease.
Early or unanticipated termination of client projects may result in a decrease in profitability if we have a higher number of unassigned IT professionals.
Most of our projects are terminable by the client without payment of a termination fee. An unanticipated termination of a major project could result in the loss of substantial anticipated revenues and could require us to maintain or terminate a significant number of unassigned IT professionals, resulting in a higher number of unassigned IT professionals and/or significant termination expenses. The loss of any significant client or project could have a material adverse effect on our business, results of operations, financial condition and cash flows.
Our client contracts, including those with our two largest customers, typically can be terminated without cause and with little or no notice or penalty, which could negatively impact our revenues and profitability.
Our clients typically retain us through non-exclusive master service agreements (“MSA”). Most of our client project contracts, including those that are on a fixed-price and fixed-price service level agreement (“SLA”) basis can be terminated with or without cause, with zero to ninety days notice and without termination-related penalties. Our MSAs typically do not include any commitment by our clients to give us a specific volume of business or future work. Additionally, certain of our MSAs do not require the client to make payments for any
services or work reasonably deemed unacceptable to the client. Our business is dependent on the decisions and actions of our clients, many of which are outside our control, which might result in the termination of a project or the loss of a client and we could face liabilities as a result of such termination. Our clients may demand price reductions, change their outsourcing strategy by limiting the number of suppliers they use, moving more work in-house or to our competitors or replacing their existing software with packaged software supported by licensors. Any of these decisions or actions could adversely affect our revenues and profitability.
We may face difficulties in providing services within our industry and technology practices, offering new and existing service lines and managing increasingly large and complex projects, which could lead to clients discontinuing their work with us.
We have been expanding the nature and scope of our engagements by extending the breadth of our practices and the services we offer. The success of our new practices and service offerings is dependent, in part, upon demand for such services by our existing and new clients and our ability to meet this demand in a cost-competitive and effective manner. We cannot be certain that we will be able to attract existing and new clients for such new services or effectively meet our clients’ needs.
We intend for the increased breadth of our practices and service offerings to result in larger and more complex projects for our clients. To achieve this result, we need to establish closer relationships with our clients and develop a thorough understanding of their operations. Our ability to establish such relationships will depend on the proficiency of our management personnel, software professionals and, if necessary subcontractors, as well as other competitive factors such as our performance and delivery capability. Larger and more complex projects may involve multiple engagements or stages, and there is a risk that a client may choose not to retain us for additional stages or may cancel or delay additional planned engagements. Such cancellations or delays make it difficult to plan for project resource requirements, and failure to plan appropriately may have an adverse impact on our business, results of operations and financial condition.
An inability to recruit and retain IT professionals will adversely affect our ability to deliver our services.
Our industry relies on large numbers of skilled IT employees, and our success depends upon our ability to attract, develop, motivate and retain a sufficient number of skilled IT professionals and project managers who possess the technical skills and experience necessary to deliver our services. Qualified IT professionals are in demand worldwide and are likely to remain a limited resource for the foreseeable future. Our failure to attract or retain qualified IT professionals in sufficient numbers may have a material adverse effect on our business, results of operations, financial condition and cash flows.
Wage increases in India and other countries where our competitive advantage is related to lower wage costs may adversely affect our cost structure.
We have a significant offshore presence in India where a majority of our technical professionals are located. In the past, the Indian economy has experienced many of the problems confronting the economies of developing countries, including high inflation and varying gross domestic product growth. Salaries and other related benefits constitute a major portion of our total operating costs. Most of our employees are based in India where our wage costs have historically been significantly lower than wage costs in the United States and Europe for comparably skilled professionals, and this has been one of our competitive advantages.
However, wage increases in India or other countries where we have our operations may prevent us from sustaining this competitive advantage. We may need to increase the levels of our employee compensation more rapidly than in the past to retain talent. Unless we are able to continue to increase the efficiency and productivity of our employees, wage increases in the long term may reduce our profit margins which would adversely affect our results of operations, financial condition and cash flows.
Clients may seek to reduce their dependence on India for outsourced IT services or take advantage of the services provided in countries with labor costs similar to or lower than India.
Clients which presently outsource a significant proportion of their IT services requirements to vendors in India may, for various reasons, including to diversify geographic risk, seek to reduce their dependence on one country. We expect that future competition will increasingly include firms with operations in other countries, especially those countries with labor costs similar to or lower than India, such as China, the Philippines and countries in Eastern Europe. Since wage costs in our industry in India are increasing, our ability to compete effectively will become increasingly dependent on our reputation, the quality of our services and our expertise in specific industries.
Our quarterly operating results are subject to significant variations.
Our revenues and operating results are subject to significant variations from quarter to quarter depending on a number of factors, including the timing and number of client projects commenced and completed during the quarter, the number of working days in a quarter, employee hiring, attrition and utilization rates and the mix of time-and-material projects versus fixed-price deliverable projects and maintenance projects during the quarter. Additionally, periodically our cost increases due to both the hiring of new employees and strategic investments in infrastructure in anticipation of future opportunities for revenue growth. We recognize revenues on time-and-material projects as the services are performed. Revenues related to fixed-price contracts that provide for complex information technology application development services are recognized as the services are performed using the percentage of completion method with input (cost to cost) method while contracts that do not provide for complex information technology development services are recognized as the services are performed using proportional performance basis with input (efforts expended) method. Contracts with no stated deliverables, with a designated workforce assigned, recognize revenues on a straight-line basis over the life of the contract. Although fixed-price deliverable projects have not contributed significantly to revenues and profitability to date, operating results may be adversely affected in the future by cost overruns on fixed-price deliverable projects. Because a high percentage of our expenses are relatively fixed, variations in revenues may cause significant variations in our operating results.
We may be required to record a significant charge to earnings if our goodwill or amortizable intangible assets become impaired.
We are required under U.S. generally accepted accounting principles (US GAAP) to review our amortizable intangible assets for impairment when events or changes in circumstances indicate the carrying value may not be recoverable. Goodwill is required to be tested for impairment at least annually. Factors that may be considered a change in circumstances indicating that the carrying value of our amortizable intangible assets may not be recoverable include a decline in stock price and market capitalization, slower growth rates in our industry or other materially adverse events. We may be required to record a significant charge to earnings in our financial statements during the period in which any impairment of our goodwill or amortizable intangible assets is determined.
This may adversely impact our results of operations. As of December 31, 2011, our goodwill and amortizable intangible assets were $671.8 million, which represented 39.2% of total consolidated assets. We refer the reader to Footnote 12 (in Item 8 of this Annual Report on Form 10-K) of our Notes to Consolidated Financial Statements for the results of our annual impairment evaluation.
If our infrastructure investments do not coincide with increased growth in our business, our profitability may be adversely affected.
Our business model includes developing and operating global development centers in order to support our Global Delivery Model. We have global development centers located in Australia, Mexico, Canada, the U.S. and India. We are in the process of expanding our global development center in Bangalore, Mumbai, Pune and Hyderabad, all located in India. We are developing these facilities in expectation of increased growth in our
business. If our business does not grow as expected, we may not be able to benefit from our investment in this and other facilities, thereby incurring fixed cost, which will likely reduce our profitability.
Founders have significant influence over the Company.
Sunil Wadhwani and Ashok Trivedi, co-chairmen and the co-founders of iGATE, beneficially own approximately 43.3% of our outstanding common stock as of January 31, 2012, and therefore have significant influence in respect of matters requiring shareholder approval.
The loss of the services of key members of our Senior Leadership Team would have an adverse impact on our business.
Our success is highly dependent on the efforts and abilities of our Chief Executive Officer, Phaneesh Murthy and our senior management team. These personnel possess business and technical capabilities that are difficult to replace. Although each executive has entered into an employment agreement containing non-competition, non-disclosure and non-solicitation covenants, these contracts do not guarantee that they will continue their employment with us or that such covenants will be enforceable. If we lose the service of any of the key executives, we may not be able to effectively manage our current operations and meet our ongoing and future business challenges and this may have a material adverse effect on our business, results of operations, financial condition and cash flows.
Any disruption in the supply of power, IT infrastructure and telecommunications lines to our facilities could disrupt our business process or subject us to additional costs.
Any disruption in basic infrastructure, including the supply of power, could negatively impact our ability to provide timely or adequate services to our clients. We rely on a number of telecommunications service and other infrastructure providers to maintain communications between our various facilities and clients in India, the United States and elsewhere. Telecommunications networks are subject to failures and periods of service disruption which can adversely affect our ability to maintain active voice and data communications among our facilities and with our clients. Such disruptions may cause harm to our clients’ business. We do not maintain business interruption insurance and may not be covered for any claims or damages if the supply of power, IT infrastructure or telecommunications lines is disrupted. This could disrupt our business process or subject us to additional costs, materially adversely affecting our business, results of operations, financial condition and cash flows.
We may not be successful at identifying, acquiring or integrating other businesses.
We completed the acquisition of Patni on May 12, 2011. We expect to continue pursuing strategic and targeted acquisitions, intended to enhance or add to our offerings of services and solutions, or enable us to expand in certain geographic and other markets. Depending on the opportunities available, we may increase the amount of investment in such acquisitions. We may not successfully identify suitable acquisition candidates. We also might not succeed in completing targeted transactions or achieve desired results of operations. Furthermore, we face risks in successfully integrating any businesses we might acquire. Ongoing business may be disrupted and our management’s attention may be diverted by acquisition, transition or integration activities. In addition, we might need to dedicate additional management and other resources, and our organizational structure could make it difficult for us to efficiently integrate acquired businesses into our ongoing operations and assimilate and retain employees of those businesses into our culture and operations. We may have difficulties as a result of entering into new markets where we have limited or no direct prior experience or where competitors may have stronger market positions. We might fail to realize the expected benefits or strategic objectives of any acquisition we undertake. We might not achieve our expected return on investment, or may lose money. We may be adversely impacted by liabilities that we assume from an acquired company, including from terminated employees, current or former clients, or other third parties, and may fail to identify or assess the magnitude of certain liabilities, shortcomings or other circumstances prior to acquiring a company, which could result in unexpected litigation or regulatory exposure, unfavorable accounting treatment, unexpected increases in taxes or other adverse effects on our business. If we are unable to complete the
number and kind of acquisitions for which we plan, or if we are inefficient or unsuccessful at integrating any acquired businesses into our operations, we may not be able to achieve our planned rates of growth or improve our market share, profitability or competitive position in specific markets or services.
The shares of Series B Preferred Stock are senior obligations, rank prior to our common stock with respect to dividends, distributions and payments upon liquidation and have other terms, such as a put right and a mandatory conversion date, that could negatively impact the value of shares of our common stock.
We have issued $330 million of Series B Preferred Stock to Viscaria Limited. The rights of the holders of our Series B Preferred Stock with respect to dividends, distributions and payments upon liquidation rank senior to similar obligations to our common stock holders. Upon our liquidation or upon certain changes of control, the holders of our Series B Preferred Stock are entitled to receive, prior and in preference to any distribution to the holders of any other class of our equity securities, an amount equal to the greater of the outstanding principal plus all accrued and unpaid dividends on such Series B Preferred Stock (which cumulative dividends accrue at the rate of 8% per annum and compound quarterly) and the amount such holders would have received if such Series B Preferred Stock had been converted into common stock.
The terms of the Series B Preferred Stock provide rights to their holders that could negatively impact our Company. Subject to receiving necessary shareholder approvals, if any, under the rules of the NASDAQ, shares of our Series B Preferred Stock may be converted at any time at the option of the holder at an initial conversion price of $20.30 per share (which conversion price is subject to adjustment upon the occurrence of certain events). The Series B Preferred Stock have a put right that provides the holder the right to require us to purchase its shares of Series B Preferred Stock (for an amount equal to the outstanding principal plus accrued and unpaid dividends thereon) at the date that is six years after the latest applicable issuance date thereof (subject to extension in limited circumstances). This put right could expose us to a liquidity risk if we do not have sufficient cash resources at hand or are not able to find financing on sufficiently attractive terms to comply with our obligations to repurchase the Series B Preferred Stock upon exercise of such put.
Further, so long as Viscaria Limited and certain other holders affiliated with Viscaria Limited own in the aggregate at least one half of Viscaria Limited’s initial equity investment in iGATE, no dividends on our common stock (or any other equity securities junior in right to the Series B Preferred Stock) may be paid without the consent of a majority of such holders. To the extent any dividend, distributions or other payments are made on our common stock, the holders of the Series B Preferred Stock shall have the right to participate on an as converted basis in any such dividends, distributions or other payments. The existence of such a senior security could have an adverse effect on the value of our common stock.
Viscaria Limited, an affiliate of Apax Partners LLP and Apax Partners, L.P. is a significant shareholder in our Company and may have conflicts of interest with us or you in the future.
In connection with the Patni Acquisition, we entered into the Viscaria Purchase Agreement, with Viscaria Limited, a company backed by funds advised by Apax Partners LLP and Apax Partners, L.P., pursuant to which we (a) have sold to Viscaria Limited 330,000 shares of Series B Preferred Stock. As a result of this ownership, Viscaria Limited, among other things, has elected one of the directors to our Board of Directors and can increase it to two directors in the event that the size of our Board of Directors increases to 10 or more, and to veto certain actions, including rejecting proposed mergers or sales of all or substantially all of our assets. In addition, as of December 31, 2011, issued and outstanding Series B Preferred Stock would represent approximately 23.4% of the current voting power at a meeting of our stockholders.
The interests of Viscaria Limited and its affiliates may differ from our other stockholders in material respects. For example, Viscaria Limited may have an interest in pursuing acquisitions, divestitures, financings (including financings that are secured and senior to the notes) or other transactions that, in their judgment, could enhance their equity investments, even though such transactions might involve risks to you. Viscaria Limited or its affiliates or
advisors are in the business of making or advising on investments in companies, and may from time to time in the future, acquire interests in, or provide advice to, businesses that directly or indirectly compete with certain portions of our business or are suppliers or customers of ours. They may also pursue acquisition opportunities that may be complementary to our business and, as a result, those acquisition opportunities may not be available to us. You should consider that the interests of these holders may differ from yours in material respects.
Our ability to generate cash depends on many factors beyond our control, and we may not be able to generate the cash required to service our debt.
Our ability to make payments on and refinance our indebtedness, and to fund our operations will depend on our ability to generate cash in the future. Our historical financial results have been, and our future financial results are expected to be, subject to substantial fluctuations, and will depend upon general economic conditions and financial, competitive, legislative, regulatory and other factors that are beyond our control. If we are unable to meet our debt service obligations or fund our other liquidity needs, we may need to refinance all or a portion of our debt, before maturity, seek additional equity capital, reduce or delay scheduled expansions and capital expenditures or sell material assets or operations. We cannot assure you that we will be able to pay our debt or refinance it on commercially reasonable terms, or at all, or to fund our liquidity needs.
If for any reason we are unable to meet our debt service obligations, we would be in default under the terms of the agreements governing our outstanding debt. If such a default were to occur, the lenders under each of the Revolving Credit Facility and the Packing Credit Facility could elect to declare all amounts outstanding under the Revolving Credit Facility and the Packing Credit Facility, as applicable, immediately due and payable, and such lenders would not be obligated to continue to advance funds under the Revolving Credit Facility and the Packing Credit Facility, as applicable. If the amounts outstanding are accelerated, we cannot assure you that our assets will be sufficient to repay in full the money owed to the banks or to our debt holders.
The Indenture, the Revolving Credit Facility and the Packing Credit Facility contain various covenants limiting the discretion of our management in operating our business and could prevent us from capitalizing on business opportunities and taking some corporate actions.
The Indenture, the Revolving Credit Facility and the Packing Credit Facility impose significant operating and financial restrictions on us. These restrictions limit or restrict, among other things, our ability and the ability of our restricted subsidiaries to:
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incur additional indebtedness;
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make restricted payments (including paying dividends on, redeeming, repurchasing or retiring our capital stock);
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make investments;
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create liens;
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sell assets;
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enter into agreements restricting our subsidiaries’ ability to pay dividends, make loans or transfer assets to us;
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engage in transactions with affiliates; and
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consolidate, merge or sell all or substantially all of our assets.
A breach of any of the covenants contained in the Revolving Credit Facility and the Packing Credit Facility including our inability to comply with the financial covenants could result in an event of default there under, which would allow the lenders under the Revolving Credit Facility and the Packing Credit Facility, as applicable, to declare all borrowings outstanding to be due and payable, which would in turn trigger an event of default under the
Indenture and, potentially, our other indebtedness. At maturity or in the event of an acceleration of payment obligations, we would likely be unable to pay our outstanding indebtedness with our cash and cash equivalents then on hand. We would, therefore, be required to seek alternative sources of funding, which may not be available on commercially reasonable terms, terms as favorable as our current agreements or at all, or face bankruptcy. If we are unable to refinance our indebtedness or find alternative means of financing our operations, we may be required to curtail our operations or take other actions that are inconsistent with our current business practices or strategy.
Our earnings may be adversely affected if our subsidiary, Patni receives an adverse determination resulting from a pending tax review of its domestic or foreign operations.
We face challenges from domestic and foreign tax authorities regarding the amount of current taxes due. These challenges include questions regarding the amount of deductions, transfer pricing and the allocation of income among various tax jurisdictions. To the extent we are able to prevail in matters for which accruals have been established or are required to pay amounts in excess of such accruals, our effective tax rates in a given financial statement period may be materially affected. Additionally, we operate in several countries and our failure to comply with the local tax regime may result in additional taxes, penalties and enforcement actions. To the extent we do not comply with tax-related regulations, our profitability will be adversely affected.
If we do not effectively manage our anticipated expansion growth by continuing to implement systems enhancements and other improvements, our ability to deliver quality services may be adversely affected.
We had experienced significant growth in our operations in the last five years, except in 2009, where our revenues had dropped due to the economic downturn. The situation has improved now as compared to 2009, due in part to our acquisition of Patni, with sequential quarter on quarter revenue growth. The global economy is showing signs of recovery, however, there is no guarantee that the current growth will continue. This uncertainty places significant demands on our management, and our operational and financial infrastructure. If we do not effectively manage our growth, the quality of our services may suffer thereby negatively affecting our brand and operating results. Our anticipated expansion and growth in international markets heightens these risks as a result of the particular challenges of supporting a rapidly growing business in an environment of multiple languages, cultures, customs, legal systems, alternative dispute systems, regulatory systems and commercial infrastructures. To effectively manage this growth, we will need to continue to improve our operational, financial and management controls and our reporting systems and procedures. These systems enhancements and improvements will require significant capital expenditures and management resources. Failure to implement these improvements could impact our ability to manage our growth, financial condition, results of operations and cash flow.
The markets in which we operate are subject to the risk of earthquakes, floods, tsunamis and other natural and manmade disasters.
Some of the regions that we operate in are prone to earthquakes, floods, tsunamis and other natural and manmade disasters. In the event that any of our business centers are affected by any such disasters, we may sustain damage to our operations and properties, suffer significant financial losses and be unable to complete our client engagements in a timely manner, if at all. Further, in the event of a natural disaster, we may also incur costs in redeploying personnel and property. For instance, on account of the natural calamities in Japan in March 2011, and the resulting fallout of nuclear radiation from damaged nuclear power plants, we were required to temporarily relocate some of the employees from our offices in Japan to India. In addition, if there is a major earthquake, flood or other natural disaster in any of the locations in which our significant customers are located, we face the risk that our customers may incur losses, or sustained business interruption, which may materially impair their ability to continue their purchase of products or services from us. A major earthquake, flood or other natural disaster in the markets in which we operate could have a material adverse effect on our business, financial condition, results of operations and cash flows.
If our Company or its subsidiaries fail to maintain and enhance the brands and the competitive advantages they afford us, demand for our services may be adversely affected.
The brand identity that we have developed has contributed to the success of our business. Maintaining and enhancing the Company brands is critical to expanding our customer base and other strategic partners. We believe that the importance of brand recognition will increase due to the relatively low barriers to entry in the IT and IT-enabled services market. Maintaining and enhancing our brand will depend largely on our ability to be a technology pioneer and continue to provide high-quality services, which we may not do successfully. If we fail to maintain and enhance the Company brands, or if we incur excessive expenses in this effort, our business, results of operations, financial condition and cash flows will be materially and adversely affected.
ITEM 1B.
ITEM 1B. UNRESOLVED STAFF COMMENTS
None
ITEM 2.
ITEM 2. PROPERTIES
Information regarding the principal properties owned and leased by the Company and its subsidiaries as of December 31, 2011 is set forth below:
We currently have capacity for approximately 25,000 professionals at these facilities. As of December 31, 2011, we had used approximately 80% of our existing office space in our operations.
In addition to the properties listed above, the Company and its subsidiaries lease sales offices in many IT services markets in the United States and throughout the world. These locations allow the Company to respond quickly to the needs of our clients and to recruit qualified IT professionals in these markets.
ITEM 3.
ITEM 3. LEGAL PROCEEDINGS
In the ordinary course of our business, we are involved in a number of lawsuits and administrative proceedings. While uncertainties are inherent in the final outcome of these matters, Company management believes, after consultation with legal counsel, that the disposition of these proceedings should not have a material adverse effect on our financial position, results of operations or cash flows.
ITEM 4.
ITEM 4. REMOVED AND RESERVED
PART II
ITEM 5.
ITEM 5. MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES
Our common stock is traded on the NASDAQ National Market under the ticker symbol “IGTE”. The following table sets forth, for the periods indicated, the range of high and low closing sale prices for iGATE’s common stock as reported on the NASDAQ National Market.
On January 31, 2012, we had 289 registered holders of record of our common stock. We currently have no program regarding the repurchase of our common stock.
Dividends
On January 20, 2010, the Board of Directors declared an annual cash dividend for the year ended December 31, 2009 of $0.11 per share payable to the shareholders of record as on February 26, 2010, which was paid on March 15, 2010.
On October 12, 2010, the Board of Directors authorized a cash dividend of $0.15 per share of common stock, as a dividend as a result of the Company’s performance for the year 2010. Although, the net income in the fiscal year 2010 increased by 81.1% as compared to the fiscal year 2009, on January 19, 2011, the Board of Directors decided to retain the 2010 profits for funding the Patni Acquisition and hence, no further dividend was declared.
Further, so long as Viscaria Limited remains a shareholder of iGATE Series B Stock, the issuance of future dividends will require the consent of a majority of the majority investor holders. The terms of the senior notes also contain restrictions on the ability to declare dividends; while the Board of Directors has the ability to declare dividends, subject to these restrictions, it is likely that cash from operations will be used for working capital and to service debt over the next few years.
ITEM 6.
ITEM 6. SELECTED FINANCIAL DATA
(1) On May 12, 2011, the Company acquired Patni and the selected financial information for the year 2011 includes Patni results for the period from May 16, 2011 through December 31, 2011.
(2) In 2007, we incurred $0.8 million related to the restructuring of our Shared Services segment.
(3) In 2007, we incurred $2.0 million in total charges related to goodwill impairment in our subsidiary iGATE Global.
(4) In 2007, we recorded an impairment charge of $0.6 million on our investment in Concours, which was offset by a gain of $0.4 million from an escrow account related to a prior sale of a business.
(5) On September 4, 2008, the Board of Directors authorized management to utilize a tax-free separation for the divestiture of iPS and declared a stock dividend consisting of 1 share of Mastech for each 15 shares of iGATE. On September 30, 2008, we completed the spin-off of Mastech. On July 31, 2008, we completed the sale of iCRI. In December 2007 we sold jobcurry Systems Private Ltd.
(6) Working capital represents current assets less current liabilities.
ITEM 7.
ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The following discussion and analysis should be read in conjunction with our Consolidated Financial Statements and related Notes included elsewhere in this Annual Report on Form 10-K. This discussion and analysis also contains forward-looking statements and should also be read in conjunction with the disclosures and information contained in “Disclosure Regarding Forward-Looking Statements” and “Risk Factors” in this Annual Report on Form 10-K.
We use the terms “iGATE,” “we,” the “Company,” “our” and “us” in this report to refer to iGATE Corporation and its subsidiaries. All references to years, unless otherwise noted, refer to our fiscal year, which ends as of December 31. For example, a reference to “fiscal 2011” means the 12-month period that ended as of December 31, 2011. All references to quarters, unless otherwise noted, refer to the quarters of our fiscal year.
We use the term “in local currency” so that certain financial results may be viewed without the impact of foreign currency exchange rate fluctuations, thereby facilitating period-to-period comparisons of business performance. Financial results “in local currency” are calculated by restating current period activity into U.S. dollars using the comparable prior year period’s foreign currency exchange rates. This approach is used for all results where the functional currency is not the U.S. dollar.
Overview
iGATE Corporation (“iGATE” or “the Company”) is a leading provider of IT and IT-enabled operations offshore outsourcing solutions services to large and medium-size organizations. iGATE provides end-to-end business solutions that leverage technology, thus enabling its clients to enhance business performance.
On May 12, 2011, we completed the acquisition of a majority stake in Patni Computer Systems Limited (the “Patni Acquisition”). Patni is a company incorporated in India under the Indian Companies Act, 1956. Patni is engaged in IT consulting, software development and BPO. It provides multiple service offerings to its clients across various industries including banking and insurance; manufacturing, retail and distribution; life sciences; product engineering; and communications, media and entertainment and utilities. Patni’s various service offerings include application development and maintenance, enterprise software and systems integration services, business and technology consulting, product engineering services, infrastructure management services, customer interaction services and BPO, quality assurance and engineering services. The Patni Acquisition was valued at $1.2 billion.
Industry Background
The rise of global service providers has enabled companies to reduce costs and improve productivity. This growth has been driven by numerous factors, including the broad adoption of global communications, increased competition from globalization, and the organization and availability of highly-trained offshore workforces. While many of the initial global providers focused on IT services, numerous other players have arisen to offer business services as well, including BPO.
IT and business services are typically managed as separate offerings by service providers. The two offerings have very different workflows and infrastructure requirements. Additionally, whereas IT services require highly trained professionals, many offshore business services, such as BPO, generally require only graduates with foreign language skills. As a result, many large service providers, who offer both IT and business services, manage them through separate internal organizations. Many clients have also separated these functions. Unfortunately, this separation often results in competing interests between IT and business operations.
As global services has become mainstream, many clients are now seeking tighter integration of their IT and business processes to maintain differentiation and cost effectiveness. Additionally, as most BPO services depend upon client technology and infrastructure, many BPO clients are seeking to outsource their IT services as well. We believe that this demand will require global service providers to offer converged IT and business solutions. We believe that those providers who are experts in their clients’ IT and businesses processes and who can best deliver converged services using a combination of onsite and offshore professionals will most benefit from these industry trends.
Economic Trends and Outlook
According to Gartner Inc., an IT research and advisory company, the IT Services industry worldwide IT spending is forecasted to total $874.0 billion in 2012, a 3.1 % increase from 2011 revenue of nearly $848 billion.
If the global economic recovery continues, modest growth in IT spending is expected. However, the potential for event-driven disruptions such as the recent earthquake and tsunami in Japan, or general global economic slowdowns would likely have an adverse impact on IT spending. The IT industry is aggressively pursuing innovations that it expects to stimulate demand beyond such modest growth. Besides organic growth, IT service providers are also aggressively pursuing mergers and acquisitions to stimulate growth. We believe that our business model is diversified, both geographically and operationally - we serve both IT and IT-enabled solutions. We believe our strategy of a global delivery model and the Patni Acquisition positions us well to provide a greater breadth of services in catering to market needs and opportunities.
Recent events impacting future operations
Proposed acquisition of balance stake of Patni and delisting from the Stock exchanges
If the delisting is successful and all the shares of Common Stock are tendered, iGATE’s beneficial ownership in Patni is expected to increase from approximately 81.2% to 100%. Upon the delisting being successful, public trading of the Patni shares of Common Stock on the BSE and the NSE and ADSs on the NYSE will cease. The promoters also will seek to cause the Common Stock of Patni to be deregistered under the Exchange Act. As the sole shareholder of Patni, iGATE will receive the benefit of the right to participate in any and all future increases in Patni’s value and will bear the complete risk of any and all losses incurred in the operation of Patni and any decreases in Patni’s value.
Upon completion of the delisting, Patni’s public shareholders who tender their shares of Common Stock will not bear the risks of potential decreases in the value of their holdings in Patni based on any downturns in Patni’s future performance. Under the delisting, Patni’s public shareholders will receive a single cash price for their shares of Common Stock (including those represented by ADSs which are converted into Common Stock).
Financing arrangement
On March 8, 2012 (the “Closing Date”), Pan-Asia iGATE Solutions (“Pan-Asia”) entered into a credit agreement (the “Credit Facility”) for a secured term loan facility with the lenders named therein and DBS Bank Ltd., Singapore, as administrative agent (the “Administrative Agent”).
The Credit Facility has a commitment amount of $215.0 million and matures on May 8, 2014. The Credit Facility contains customary representations and warranties, events of default and affirmative and negative covenants, and does not contain any financial covenants. The borrowing under the Credit Facility carries an annual interest rate of LIBOR plus applicable margin varying from 2.8% to 3.2% for terms extending from 0 to 27 months. The facility is secured through a pledge of iGATE Technologies’ equity interests in Pan-Asia representing an indirect interest in Patni of up to 65%. The Company, along with several of its wholly owned subsidiaries, has entered into a Guaranty (the “Guaranty”) with the Administrative Agent, under which the Company has guaranteed all of the obligations of Pan-Asia under the Credit Facility.
After the Closing Date, the Credit Facility will be available to finance Pan-Asia’s purchase of the remaining publicly traded equity shares of Patni.
Critical Accounting Policies and Estimates
The following explains our most critical accounting policies and estimates. See Note 1 to our Consolidated Financial Statements set forth on pages 65 to 74 of this Form 10-K for a complete description of our significant accounting policies.
Revenue Recognition
Revenue is recognized when there is persuasive evidence of a contractual arrangement with customers, services have been rendered, the fee is fixed or determinable and collectability is reasonably assured. The Company has concluded that it has persuasive evidence of an arrangement when it enters into an agreement with its clients with terms and conditions which describe the services and the related payments are legally enforceable. When the terms of the agreement specify service level parameters that must be met, the Company monitors such service level parameters and determines if there are any service credits or penalties which need to be accounted for. Revenue is recognized net of any service credits that are due to a client and net of applicable taxes and includes reimbursements of out-of- pocket expenses, with the corresponding cost for out-of- pocket expenses included in cost of revenue.
IT services are provided either on a fixed-price, fixed time frame or on a time and material basis. Revenue with respect to time-and-material contracts is recognized as the related services are performed. Time-and-material contracts typically bill at an agreed upon hourly or daily rate. The Company’s fixed price contracts include application maintenance and support services, on which revenue is recognized ratably over the term of maintenance. Revenues related to fixed-price contracts that provide for highly complex information technology application development services are recognized as the services are performed using the percentage of completion method with input (cost to cost) method while contracts that do not provide for highly complex information technology development services are recognized as the services are performed using proportional performance basis with input (efforts expended) method. The Company considers the input method the best available measure of progress on these contracts as there is a direct relationship between input and productivity. Costs are recorded as incurred over the contract period. Provisions for estimated losses, if any, on uncompleted contracts are recorded in the period in which such losses become probable based on the current contract estimates.
Significant judgment is required to estimate the time and cost to complete the project. Our project delivery personnel continually review the labor hours incurred and the estimated total labor hours, which may result in revisions to the amount of revenue recognized for the contract. Changes in estimates are accounted for in the period
of change. Any estimation process, including that used in preparing contract accounting models, involves inherent risk. We reduce the inherent risk relating to revenue and cost estimates through approval and monitoring processes. Risks relating to service delivery, usage, productivity and other factors are considered in the estimation process.
Goodwill
Goodwill represents the cost of the acquired businesses in excess of the fair value of identifiable tangible and intangible net assets purchased. We review goodwill for impairment annually and whenever events or changes in circumstances indicate its carrying value may not be recoverable in accordance with ASC 350, Intangible Assets including Goodwill and Amortization.
The provisions of ASC 350 requires that recoverability of goodwill be evaluated using a two-step process. Under the first step, the estimated fair value of the reporting unit in which the goodwill resides is compared with its carrying value of the assets and liabilities (including goodwill). If the fair value of the reporting unit exceeds its carrying value, step two does not need to be performed. If the fair value of the reporting unit is less than its carrying value, an indication of goodwill impairment exists for the reporting unit and the step two of the impairment test (measurement) is performed. Under step two, an impairment loss is recognized for any excess of the carrying amount of the reporting unit’s goodwill over the implied fair value of that goodwill. The implied fair value of goodwill is determined by allocating the fair value of the reporting unit in a manner similar to a purchase price allocation, in a business combination. The residual fair value after this allocation is the implied fair value of the reporting unit goodwill.
The fair values used in this evaluation are estimated based upon the market capitalization adjusted for a control premium and discounted future cash flow analysis. The discounted future cash flow analysis is based upon a number of estimates and assumptions including operating results and business plans. The Company has applied a control premium of 20%, which was arrived at based on historical acquisition trends of listed companies in India. The Company performs its annual impairment review of goodwill on November 30, and when a triggering event occurs between annual impairment tests. Based on the results of its annual impairment tests, the Company determined that no impairment of goodwill existed as of December 31, 2011, and 2010.
Intangible Assets
As of December 31, 2011, the definite lived intangible assets were predominantly comprised of customer relationships and intellectual property rights arising from the Patni Acquisition. The acquired company is often party to certain customer contracts and relationships that are of material value to an acquirer. Customer contracts and relationships refer to forecast revenues from existing customers from whom there is a readily identifiable income stream as at the valuation date, as a result of established business relationships with them. We have estimated the fair value of customer contracts and relationships based on the Excess Earnings Method under the Income Approach.
The excess earnings method is predicated on the basis that the value of an intangible asset is the present value of the earnings it generates, net of a reasonable return on other assets also contributing to that stream of earnings. The main steps under this method are:
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Forecast sales to which the acquired intangibles contribute and estimate the cash flows earned from these sales. To arrive at the projected revenues from the existing customers, we have considered the revenues of the last 5 years from all the existing customers as at the valuation date and applied an annual average churn rate of 3% (rounded) to these revenues.
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Deduct the tax charge on these cash flows - we estimated the effective tax rate on a go forward basis to be 30%
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Deduct contributory asset charges - in order to assess the excess earnings attributable to customer contracts and relationships, we have deducted contributory asset charges for the use of other assets. The
contributory charges for the economic returns are computed based on the assets utilized by the intangible asset. The notional contributory charges are based on the presumption that the contributory assets were leased from a third party in an arms-length transaction. All such contributory charges are computed based on the fair value of the relevant contributory asset. The applied contributory asset charges take into account the return of the asset (wear and tear) and the return on asset (interest on invested capital).
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We considered the risk of the above intangible in relation to the risk of other intangibles and in relation to the risk of the overall business. Based on this analysis, we utilized a discount rate of 18.00%. We used this to discount the excess earnings to obtain the value of the intangible.
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We have assumed an economic life of 15 years considering the uncertainty of continuity of customer relationships beyond this period and also that the present value factor beyond such period is not material.
The estimated useful life of customer relationship and intellectual property rights is 15 years and 0.5 year to 6 years, respectively. Customer relationships and intellectual property rights are amortized over their respective individual estimated useful lives in proportion to the economic benefits consumed in each period (i.e. based on ratio of the undiscounted cashflows for a period to the total estimated undiscounted cashflows). The estimated useful life of an identifiable intangible asset is based on a number of factors including the effects of obsolescence, demand, competition and other economic factors (such as the stability of the industry, and known technological advances) and the level of maintenance expenditures required to obtain the expected future cash flows from the asset.
Income taxes
Determining the consolidated provision for income tax expense, income tax liabilities and deferred tax assets and liabilities involves judgment. As a global company, we calculate and provide for income taxes in each of the tax jurisdictions in which we operate. This involves estimating current tax exposures in each jurisdiction as well as making judgments regarding the recoverability of deferred tax assets. Tax exposures can involve complex issues and may require an extended period to resolve. In assessing the realizability of deferred tax assets, we consider whether it is more likely than not that some portion or all of the deferred tax assets will not be realized and adjust the valuation allowances accordingly. Factors considered in making this determination include the period of expiration of the tax asset, planned use of the tax asset, tax planning strategies and historical and projected taxable income as well as tax liabilities for the tax jurisdiction in which the tax asset is located. Valuation allowances will be subject to change in each future reporting period as a result of changes in one or more of these factors. Changes in the geographic mix or estimated level of annual income before taxes can affect the overall effective tax rate.
We apply an estimated annual effective tax rate to our quarterly operating results to determine the interim provision for income tax expense. In accordance with FASB guidance on uncertainty in income taxes, a change in judgment that impacts the measurement of a tax position taken in a prior year is recognized as a discrete item in the interim period in which the change occurs. In the event there is a significant unusual or infrequent item recognized in our quarterly operating results, the tax attributable to that item is recorded in the interim period in which it occurs.
Derivative instruments and hedging activities
The Company enters into foreign currency forward and option contracts (“derivative contracts”) to mitigate and manage the risk of changes in foreign exchange rates on inter-company and end customer accounts receivables and forecasted sales and inter-company transactions. The Company hedges anticipated sales transactions that are subject to foreign exchange exposure with derivative contracts that are designated effective and that qualify as cash flow hedges under ASC Topic 815, “Derivatives and Hedging”.
As part of hedge strategy, the Company also enters into derivative contracts which are replaced with successive new contracts up to the period in which the forecasted transaction is expected to occur i.e. (roll-over
hedges). In case of rollover hedges, the hedge effectiveness is assessed based on changes in fair value to the extent of changes in spot prices and recorded in accumulated other comprehensive income (loss) until the hedged transactions occur and at that time is recognized in the consolidated statements of income. Accordingly, the changes in the fair value of the contract related to the changes in the difference between the spot price and the forward price (i.e. forward premium/discount) are excluded from assessment of hedge effectiveness and is recognized in consolidated statements of income and are included in foreign exchange gain (loss).
In respect of derivative contracts which hedge the foreign currency risk associated with the both anticipated sales transaction and the collection thereof (dual purpose hedges), the hedge effectiveness is assessed based on overall changes in fair value with the effective portion of gains or losses included in accumulated other comprehensive income (loss). The effective portion of gain or loss attributable to forecasted sales are reclassified from accumulated other comprehensive income (loss) and recognized in consolidated statements of income when the sales transaction occurs. Post the date of sales transaction, the Company reclassifies an amount from accumulated other comprehensive income (loss) to earnings to offset foreign currency translation gain (loss) recorded for the respective receivable during the period. In addition, the Company determines the amount of cost to be ascribed to each period of the hedging relationship based on the functional currency interest rate implicit in the hedging relationship and recognizes this cost by reclassifying it from accumulated other comprehensive income (loss) to consolidated statements of income for recognized receivables based on the pro rata method.
Changes in the fair value of cash flow hedges deemed ineffective are recognized in the consolidated statement of income and are included in foreign exchange gain (loss). The Company also uses derivatives contracts not designated as hedging instruments under ASC No. 815 to hedge intercompany and end customer accounts receivables and other monetary assets denominated in currencies other than the functional currency. Changes in the fair value of these derivatives are recognized in the consolidated statements of income and are included in foreign exchange gain (loss).
Stock-based compensation
FASB ASC Topic 718-10-25, “Accounting for Stock - Based Compensation”, requires all share-based payments, including grants of stock options, restricted stock units and employee stock purchase rights, to be recognized in our financial statements based on their respective grant date fair values. Under this standard, the fair value of each employee stock option and employee stock purchase right is estimated on the date of grant using an option pricing model that meets certain requirements.
We currently use the Black-Scholes option pricing model to estimate the fair value of our share-based payments. The determination of the fair value of share-based payment awards utilizing the Black-Scholes model is affected by our stock price and a number of assumptions, including expected volatility, expected life, risk-free interest rate and expected dividends. We estimate the expected volatility of our stock options at grant date based on the historical traded prices of our stock as the expected volatility assumption required in the Black-Scholes model. The expected life of the stock options is based on historical and other data including life of the option and vesting period.
The risk-free interest rate assumption is the implied yield currently available on zero-coupon government issues with a remaining term equal to the expected term. The dividend yield assumption is based on our history and expectation of dividend payouts.
We evaluate the assumptions used to value stock-based awards on a periodic basis. If factors change and we employ different assumptions, stock-based compensation expense may differ significantly from what we have recorded in the past. If there are any modifications or cancellations of the underlying unvested securities, we may be required to accelerate, increase or cancel any remaining unearned stock-based compensation expense. To the extent that we grant additional equity securities to employees or we assume unvested securities in connection with any acquisitions, our stock-based compensation expense will be increased by the additional unearned compensation resulting from those additional grants or acquisitions.
Use of Estimates in the Preparation of Financial Statements
The preparation of financial statements in accordance with U.S. GAAP requires management to make estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes. Significant items subject to such estimates and assumptions include the useful lives of property and equipment, carrying amount of property and equipment, intangibles and goodwill, valuation allowance for receivables and deferred tax assets, valuation of derivative instruments, valuation of share-based compensation, assets and obligations related to employee benefits, income tax uncertainties and other contingencies and commitments. Management believes that the estimates used in the preparation of the consolidated financial statements are prudent and reasonable. Although these estimates are based upon management’s best knowledge of current events and actions, actual results could differ from these estimates.
Presentation of Supplemental Non-GAAP Financial Measures
In this management’s discussion and analysis, we use supplemental non-GAAP financial measures as defined by the Securities and Exchange Commission. These non-GAAP measures are not in accordance with, or an alternative for measures prepared in accordance with, U.S. GAAP and may be different from non-GAAP measures used by other companies. In addition, these non-GAAP measures are not based on any comprehensive set of accounting rules or principles. Reconciliations of these non-GAAP measures to their comparable GAAP measures are included in the financial tables set forth on pages 49 and 50 of this Form 10-K.
Results of Operations from Continuing Operations for the Year Ended December 31, 2011 as Compared to the Year Ended December 31, 2010 (Dollars in thousands):
* Patni results are for the period from May 16, 2011 through December 31, 2011
** Cost of revenues is exclusive of depreciation and amortization
Revenues
Consolidated revenues for the year ended December 31, 2011 were $779.6 million as compared to $280.6 million for the year ended December 31, 2010. The significant increase in the revenues was mainly due to the Patni Acquisition. The Patni segment accounted for $479.4 million, inclusive of intercompany revenues of $6.0 million or 61.5% of consolidated revenues.
The iGATE segment accounted for $307.5 million, inclusive of intercompany revenues of $1.3 million (39.4% of consolidated revenues) for the year ended December 31, 2011, an increase of $26.9 million, or 9.6%, as compared to $280.6 million for the year ended December 31, 2010. The revenue increase for the periods presented is directly attributable to a combination of increased business with our recurring customers and new customer wins offset by unfavorable movement in currency markets. There was an increase in average billable headcount from 7,398 for the year ended December 31, 2010 to 7,678 for the year ended December 31, 2011. Revenues increased mainly due to the increased volume by 10.2% which was partly offset by unfavorable movement in currency markets by 0.6% for the year ended December 31, 2011 as compared to the year ended December 31, 2010. Our top five customers accounted for 73.7% and 72.2% of the revenue for the year ended December 31, 2011 and 2010, respectively.
Gross margin
Consolidated gross margin was $296.1 million or 38.0% of consolidated revenues for the year ended December 31, 2011, as compared to $112.7 million or 40.2% of consolidated revenues for the year ended December 31, 2010. The decrease in gross margin percentage is due to salary increments in 2011 which was partially offset by improved utilization contributing to the increase in gross margin in absolute terms.
The increase in gross margin in absolute terms was mainly due to the Patni Acquisition. The Patni segment accounted for $176.6 million (59.6% of consolidated gross margin) or 36.8% of the segment revenues. The iGATE segment gross margin was $119.6 million (40.4% of consolidated gross margin) or 38.9% of the segment revenues for the year ended December 31, 2011, as compared to $112.7 million or 40.2% of the segment revenues for the year ended December 31, 2010.
Selling, general and administrative expenses
Selling, general and administrative expenses (“SG&A”) include all costs that are not directly associated with revenue-generating activities. SG&A expenses include employee costs, corporate costs and facilities costs. Employee costs include selling, marketing and administrative salaries and related employee benefits, travel, recruiting and training costs. Corporate costs include costs such as acquisition and delisting costs, legal, accounting and outside consulting fees. Facilities costs primarily include rent and communications costs.
Consolidated SG&A costs for the year ended December 31, 2011 were $151.5 million or 19.4% of consolidated revenues, as compared to $50.7 million or 18.1% of consolidated revenues for the year ended December 31, 2010. The significant increase in SG&A costs was mainly due to non-recurring costs associated with the Patni Acquisition. The Patni segment accounted for $95.2 million (inclusive of intercompany costs of $0.4 million) or 62.8% of consolidated SG&A costs.
The iGATE segment accounted for $56.7 million (37.4% of consolidated SG&A costs) or 18.4% of the segment revenues, as compared to $50.7 million or 18.1% of segment revenues for the year ended December 31, 2010. The net employee cost increased by $13.3 million for the year ended December 31, 2011, as compared to the year ended December 31, 2010, mainly due to an increase in salaries, bonus and benefits of $11.8 million, travel expense and related costs of $2.0 million which was partly offset by a decrease in recruitment expense of $0.5 million. The net corporate cost increased by $11.2 million for the year ended December 31, 2011 mainly due to expenses associated with the Patni Acquisition of $7.2 million, expenses relating to delisting of $0.7 million and $3.3 million increase in outside professional services, marketing, accounting, bad debts and
administrative charges. The net facilities costs increased by $1.9 million for the year ended December 31, 2011, mainly due to an increase in rental, office and building maintenance and communication related expenses. We have recorded $20.4 million as cost reimbursement from Patni towards the sales and administrative support provided for the current period.
Depreciation and amortization costs
Consolidated depreciation and amortization costs for the year ended December 31, 2011 were $38.7 million or 5.0% of consolidated revenues, as compared to $9.0 million or 3.2% of consolidated revenues for the year ended December 31, 2010. The significant increase in depreciation and amortization costs is mainly due to the Patni Acquisition. The Patni segment accounted for $28.9 million or 74.7% of consolidated depreciation and amortization costs.
The iGATE segment accounted for $9.8 million or 3.2% of the segment revenues for the year ended December 31, 2011, as compared to $9.0 million or 3.2% of segment revenues for the year ended December 31, 2010.
Operating income
Consolidated operating income was $105.9 million or 13.6% of consolidated revenues for the year ended December 31, 2011 and $53.0 million or 18.9% of consolidated revenues for the year ended December 31, 2010. The increase in absolute terms is mainly due to the Patni Acquisition. The Patni segment accounted for $52.4 million or 10.9% of the segment revenues.
The iGATE segment accounted for $53.1 million or 17.3% of the segment revenues for the year ended December 31, 2011 as compared to $53.0 million or 18.9% of segment revenues for the year ended December 31, 2010.
Interest expense
We issued 9% senior notes on April 29, 2011 and recorded interest expense of $46.6 million for the year ended December 31, 2011. We also amortized the debt issuance costs of $3.7 million for the year ended December 31, 2011. The interest expense recorded on our $57.0 million line of credit at weighted average interest rate of 1.07% amounted to $0.7 million for the year ended December 31, 2011.
Foreign exchange gain/(loss), net
Foreign exchange gain was $13.1 million for the year ended December 31, 2011 as compared to loss of $0.4 million for the year ended December 31, 2010.
The favorable foreign currency movement related to foreign currency derivative contracts entered into in connection with the Patni Acquisition which resulted in a net realized gain of $15.0 million on settled contracts for the year ended December 31, 2011.
The Company also recognized unfavorable foreign currency movement resulting in a realized loss of $1.0 million on settlement of cash flow hedges for the year ended December 31, 2011 as compared to a loss of $0.1 million for the year ended December 31, 2010.
We also recognized a foreign currency gain of $5.3 million on remeasurement of escrow account balance for the year ended December 31, 2011 and $4.5 million of foreign currency loss related to our intercompany debt in India and remeasurement of current assets denominated in foreign currency as compared to a loss of $0.2 million for the year ended December 31, 2010.
We have also recorded a foreign currency gain of $1.4 million on the derivative contract taken against the packing credit facility borrowed under our line of credit for the year ended December 31, 2011.
The Patni segment accounted for $3.2 million foreign exchange loss.
Other income, net
Our investment income for the year ended December 31, 2011 totaled $14.7 million as compared to $3.2 million for the year ended December 31, 2010. The significant increase in investment income is mainly due to the Patni Acquisition. The Patni segment accounted for $12.5 million of the investment income.
The iGATE segment investment income for the year ended December 31, 2011 totaled $2.2 million as compared to $3.2 million for the year ended December 31, 2010. In the 2011 second quarter, we liquidated the investments to fund the Patni Acquisition, which reduced investment income in the current year as compared to the year ended December 31, 2010.
We recognized gain on sale of fixed assets of $1.4 million and gain on sale of investment in affiliate of $0.6 million during the year ended December 31, 2010.
Income taxes
Our effective tax rate was 28.7% (including Patni) and 10.3% for the years ended December 31, 2011 and 2010, respectively. The effective tax rate increased mainly due to the expiration of the STPI tax holiday on our foreign earnings in March 2011 which was partly offset by a deferred tax benefit of $ 3.9 million recorded on the carry forward of losses relating to the earlier years and $ 2.6 million on account of foreign tax credit. Based on the Company’s application, the IRS ruled on January 12, 2012 that the Company’s acquisition of Patni falls within the meaning of section 338-(d)- (3) of the Internal Revenue Code and election can be made to be a qualified stock purchase (“QSP”) under Section 338-(g). This election entailed us to calculate the U.S. income tax basis earnings and profits and foreign (non-U.S.) tax pools for Patni. Based on such calculations, we have recorded a tax provision of $6.9 million on our U.S. subsidiary iGATE Technologies share of India subsidiary, Patni’s undistributed earnings for the post-acquisition period from May 16, 2011 through December 31, 2011. This calculation will be re-visited by us on a quarterly basis every year.
The effective tax rate of the iGATE segment and the Patni segment was 39.4% and 25.2%, respectively, during the year ended December 31, 2011.
Non controlling interest
We recorded $8.6 million share of profits of non controlling interest in Patni representing 18.2% share of net income of $47.3 million of Patni.
Preferred dividend
On February 1, 2011, pursuant to the securities purchase agreement with Viscaria Limited dated January 10, 2011, we issued 210,000 shares of Series B Preferred Stock for a consideration of $210 million and an additional 120,000 shares was issued on May 9, 2011 for a consideration of $120 million. We have accrued for cumulative dividends of $22.1 million at a rate of 8.00% per annum, compounded quarterly, for the year ended December 31, 2011.
Results of Operations from Operations for the Year Ended December 31, 2010 as Compared to the Year Ended December 31, 2009 (Dollars in thousands):
* As the comparable period absolute number is negative, the % change from comparable period is not computed.
** As we believe that the effective tax rate is a better comparable measure, the % change from comparable period is not computed.
Revenues
Revenues for the year ended December 31, 2010 increased by 45.3%, as compared to the year ended December 31, 2009. Our revenue increase for the periods presented is directly attributable to a combination of increased business with our recurring customers, favorable movement in currency markets and new customer wins. There was an increase in average billable headcount from 6,055 for the year ended December 31, 2009 to 7,398 for the year ended December 31, 2010. Revenues increased due to a 32.3% increase in volume, a 8.7% increase in average blended realization rate and a 4.3% favorable movement in currency markets for the year ended December 31, 2010 as compared to the year ended December 31, 2009. Our top five customers accounted for 72.2% and 70.2% of the revenue for the years ended December 31, 2010 and 2009, respectively.
Gross margin
The gross margin as a percentage of sales was 40.2% for the year ended December 31, 2010, as compared to 39.1% for the year ended December 31, 2009. Increase in gross margin percentage was primarily on account of improved utilization and strengthening of the US dollar against other currencies. The utilization rate increased to 86.5% for the year ended December 31, 2010 as compared to 85.4% for the year ended December 31, 2009. The gross margin increased due to the favorable movement of the US Dollar against other currencies by 0.9% of revenues.
Selling, general and administrative expenses
Selling, general and administrative expenses (“S,G&A”) include all costs that are not directly associated with revenue-generating activities. S,G&A expenses include employee costs, corporate costs and facilities costs.
Employee costs include selling, marketing and administrative salaries and related employee benefits, travel, recruiting and training costs. Corporate costs include costs such as legal, accounting and outside consulting fees. Facilities costs primarily include rent and communications costs.
S,G&A costs for the year ended December 31, 2010 were 18.1% of revenues, as compared to 18.3% of revenues for the year ended December 31, 2009. Our net employee cost increased by $8.1 million for the year ended December 31, 2010, as compared to the year ended December 31, 2009, mainly due to an increase in salaries, bonus and benefits of $6.0 million, recruitment expense of $0.8 million, and travel expense and related costs of $1.3 million. Our net corporate cost increased by $5.7 million for the year ended December 31, 2010 due to expenses associated with the Patni Acquisition of $3.7 million, increase in marketing, outside professional services, legal costs, accounting, and administrative charges which was partly offset by decrease in the provision for doubtful debts. Our net facilities costs increased by $1.4 million for the year ended December 31, 2010, mainly due to increase in rental, maintenance and communication related expenses. The increase in S,G&A costs includes unfavorable impact of the movement of the US dollar against other currencies amounting to $2.1 million.
Depreciation and amortization costs
Depreciation and amortization costs for the year ended December 31, 2010 were 3.2% of revenues, as compared to 3.9% of revenues for the year ended December 31, 2009. Depreciation and amortization costs as a percentage of revenue decreased by 0.7%, due to the increased revenue for the year ended December 31, 2010 as compared to the year ended December 31, 2009. Depreciation costs in absolute terms for the year ended December 31, 2010 increased by $1.6 million as compared to the year ended December 31, 2009 due to the capitalization of the phase IV campus located in Bangalore and leasehold improvements on SEZ units in Chennai and Hyderabad. The additional investment in the furniture and fixtures, computers and office equipments for the new facilities added during 2010 also contributed to the increase in the depreciation costs. Amortization costs decreased by $0.2 million, due to an identifiable intangible asset that was fully amortized during the year ended December 31, 2009.
Operating income
Operating income was 18.9% of revenue for the year ended December 31, 2010 and 16.8% of revenue for the year ended December 31, 2009. This increase was primarily due to the increased revenue and increased operational efficiency.
Other income (expense), net
Other income (expense), net is primarily comprised of investment income which for the year ended December 31, 2010 totaled $3.2 million as compared to $3.4 million for the year ended December 31, 2009. In 2010, our investments were primarily in a dividend yielding money market mutual fund. The Net Asset Value of the units tends to decrease on payment of the dividends leading to a loss on redemption of the units which has been compensated for by the dividend income. In 2009, the investments were primarily in a high yield interest bearing fixed income securities.
Other income (expense), net also includes the unfavorable foreign currency movements resulting in the realized loss on our hedges amounting to $0.1 million for the year ended December 31, 2010 as compared to realized loss of $7.6 million for the year ended December 31, 2009. There was an unfavorable foreign currency loss related to our intercompany debt in India and the remeasurement of the current assets denominated in the foreign currency, amounting to $0.2 million for the year ended December 31, 2010 as compared to the favorable foreign currency gain of $0.1 million for the year ended December 31, 2009.
We recognized gain on sale of fixed assets of $1.4 million during the year ended December 31, 2010.
Income taxes
Our effective tax rate was 10.3% and 2.0% for the years ended December 31, 2010 and 2009, respectively. The tax expense and the effective tax rate increased mainly due to change in the mix of earnings between our US and international operations, resulting in higher earnings in US. iGATE Global is eligible to claim a tax holiday on the majority of its operating income through March 31, 2011. The tax holiday has resulted in a benefit of $17.1 million and $9.8 million for the years ended December 31, 2010 and 2009, respectively.
Use of non-GAAP Financial Measures:
Effective from the fourth quarter of fiscal 2010, we decided to use non-GAAP net income data and non-GAAP basic and diluted earnings per share. These non-GAAP measures are not in accordance with, or an alternative for measures prepared in accordance with, U.S GAAP and may be different from non-GAAP measures used by other companies. In addition, these non-GAAP measures are not based on any comprehensive set of accounting rules or principles. Reconciliations of these non-GAAP measures to their comparable GAAP measures are included in the attached financial tables.
We believe that non-GAAP measures have limitations in that they do not reflect all of the amounts associated with iGATE’s results of operations as determined in accordance with GAAP and that these measures should only be used to evaluate iGATE’s results of operations in conjunction with the corresponding GAAP measures. These non GAAP measures should be considered supplemental in nature and should not be considered in isolation or be construed as being more important than comparable GAAP measures.
We believe that providing Adjusted EBITDA and non-GAAP net income and non-GAAP basic and diluted earnings per share in addition to the related GAAP measures provides investors with greater transparency to the information used by our management in our financial and operational decision-making. These non-GAAP measures are also used by management in connection with iGATE’s performance compensation programs.
The non-GAAP financial measures contained herein exclude the following items:
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Amortization of intangible assets: Intangible assets comprise value of our customer relationships from the recent Patni acquisition and the previous delisting of iGATE’s Indian subsidiary. We incur charges relating to the amortization of these intangibles. These charges are included in our GAAP presentation of earnings from operations, operating margin, net income and diluted earnings per share. We exclude these charges for purposes of calculating these non-GAAP measures.
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Stock-based compensation: Although stock-based compensation is an important aspect of the compensation of our employees and executives, determining the fair value of the stock-based instruments involves a high degree of judgment and estimation and the expense recorded may not reflect the actual value realized upon the future exercise or termination of the related stock-based awards. Furthermore, unlike cash compensation, the value of stock-based compensation is determined using a complex formula that incorporates factors, such as market volatility, that are beyond our control. Management believes it is useful to exclude stock-based compensation in order to better understand the long-term performance of our core business.
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Acquisition expenses: We incurred costs related to its acquisitions, which are inconsistent in amount and frequency and are significantly impacted by the timing and nature of iGATE’s acquisitions. We believe that eliminating these expenses for purposes of calculating these non-GAAP measures facilitates a more meaningful evaluation of our current operating performance and comparisons to its past operating performance.
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Forex gain: The Company entered into forward foreign exchange contracts to mitigate the risk of changes in foreign exchange rates on payments related to the acquisition of Patni. We also recognized favorable foreign currency gain on re-measurement of escrow account balance maintained for facilitating payments related to Patni acquisition. We believe that eliminating the non-capitalized items
for purposes of calculating these non-GAAP measures facilitates a more meaningful evaluation of our current performance and comparisons to its past performance.
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Severance Cost: As a result of the acquisition of Patni, we incurred severance costs in connection with the termination of the services of some of Patni’s employees. We believe that eliminating these expenses for purposes of calculating these non-GAAP measures facilitates a more meaningful evaluation of our current operating performance and comparisons to its past operating performance.
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Delisting expenses: iGATE is voluntarily delisting the equity shares of its majority owned subsidiary, Patni from the National Stock Exchange of India Limited and the Bombay Stock Exchange Limited and the American Depository Shares from the New York Stock Exchange. Delisting is an infrequent activity and expenses incurred in connection therein are inconsistent in amount and are significantly impacted by the timing and nature of the delisting. We believe that eliminating these expenses for purposes of calculating these non-GAAP measures facilitates a more meaningful evaluation of our current operating performance and comparisons to its past operating performance.
From time to time in the future, there may be other items that we may exclude in presenting our financial results.
The table below presents a reconciliation of our non-GAAP financial measures to the most comparable GAAP measures for each of the past three years (in thousands, except for per share data):
* Includes assumed conversion of 17.3 million shares of Series B Preferred Stock as of January 1, 2011.
** Includes Patni balances since May 16, 2011
Non-GAAP Disclosure of Adjusted EBITDA
Effective from the second quarter of fiscal 2011, we decided to present Adjusted EBITDA as a supplemental measure of our performance. We define Adjusted EBITDA as net income attributable to iGATE Corporation plus (i) depreciation and amortization, (ii) interest expense, (iii) income tax expense, minus (iv) other income, net plus
(v) foreign exchange (gain)/loss, (v) stock-based compensation (vi) acquisition expenses (vii) severance expenses and (viii) delisting (going private) expenses. We eliminated the impact of the above as we do not consider them as indicative of our ongoing operating performance. These adjustments are itemized below. You are encouraged to evaluate these adjustments and the reasons we consider them appropriate for supplemental analysis. In evaluating Adjusted EBITDA, you should be aware that in the future we may incur expenses that are the same as or similar to some of the adjustments in this presentation. Our presentation of Adjusted EBITDA should not be construed as an inference that our future results will be unaffected by unusual or non-recurring items.
We present Adjusted EBITDA because we believe it assists investors and analysts in comparing our performance across reporting periods on a consistent basis by excluding items that we do not believe are indicative of our core operating performance. In addition, we use Adjusted EBITDA: (i) as a factor in evaluating management’s performance when determining incentive compensation, (ii) to evaluate the effectiveness of our business strategies and (iii) because our credit agreement and our indenture use measures similar to Adjusted EBITDA to measure our compliance with certain covenants.
Adjusted EBITDA has limitations as an analytical tool. Some of these limitations are:
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Adjusted EBITDA does not reflect our cash expenditures, or future requirements, for capital expenditures or contractual commitments;
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Adjusted EBITDA does not reflect changes in, or cash requirements for, our working capital needs;
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Adjusted EBITDA does not reflect the significant interest expense, or the cash requirements necessary to service interest or principal payments, on our debts; although depreciation and amortization are non-cash charges, the assets being depreciated and amortized will often have to be replaced in the future, and adjusted EBITDA does not reflect any cash requirements for such replacements; non-cash compensation is and will remain a key element of our overall long-term incentive compensation package, although we exclude it as an expense when evaluating our ongoing operating performance for a particular period; Adjusted EBITDA does not reflect the impact of certain cash charges resulting from matters we consider not to be indicative of our ongoing operations; and other companies in our industry may calculate Adjusted EBITDA differently than we do, limiting its usefulness as a comparative measure.
Because of these limitations, Adjusted EBITDA should not be considered in isolation or as a substitute for performance measures calculated in accordance with GAAP. We compensate for these limitations by relying primarily on our GAAP results and using Adjusted EBITDA only supplementally.
* Includes Patni Balances since May 16, 2011
The company presents the non-GAAP financial measure Adjusted EBITDA because, management uses this measure to monitor and evaluate the performance of the business and believes the presentation of this measure will enhance the investors’ ability to analyze trends in the business and evaluate our underlying performance relative to other companies in the industry.
Liquidity and Capital Resources
Cash from Operations
Our largest source of operating cash flows is cash collections from our customers for different information technology services we render under various Statements of Work (SOWs). Our primary uses of cash from operating activities are for personnel related expenditures, leased facilities and taxes.
Net cash provided by operating activities increased in fiscal 2011 and 2010 primarily due to higher net income adjusted for depreciation, amortization of intangible assets and stock-based compensation in each of these periods. These increases in fiscal 2011 and 2010 were partially offset by certain unfavorable changes in working capital, primarily increases in accounts receivable and unbilled revenues resulting from increases in revenues during the fourth quarters of 2011 and 2010, respectively, in comparison to the prior years. Our working capital may be impacted by some of the aforementioned factors in future periods, certain amounts and timing of which are variable.
Investing Activities
Cash used in investing activities for the year ended December 31, 2011 was $1.2 billion, $11.6 million and $41.7 million for the year ended December 31, 2011, 2010 and 2009, respectively.
On May 12, 2011, we completed the Patni Acquisition for net cash consideration of $1.2 billion.
During the year ended December 31, 2010, we sold one of our office buildings located in Bangalore, India and some of our furniture and office equipments at office located in Hyderabad, India for a consideration of $3.0 million. The capital expenditure incurred was $21.4 million, $16.8 million and $13.2 million for the years ended December 31, 2011, 2010 and 2009, respectively. Significant portions of capital expenditures in all the three years presented were due to expansion of our campus located in offshore centers in India.
Our investment portfolio and other investments increased by $10.1 million for the year ended December 31, 2011 as compared to a decrease of $1.1 million for the year ended December 31, 2010 and an increase of $28.3 million for the years ended December 31, 2009. The decrease in investments during 2010 was due to the Patni Acquisition plans.
Financing Activities
Cash provided by financing activities was $1.1 billion for the year ended December 31, 2011 as compared to the usage of $13.3 million and $4.3 million for the years ended December 31, 2010 and 2009, respectively.
Dividends paid amounted to $14.5 million and $6.0 million for the years ended December 31, 2010 and 2009, respectively. No dividends were paid during the current period, as the Board of Directors decided to retain the 2010 profits for funding the Patni Acquisition. The net proceeds from exercise of employee stock options was $0.7 million, $2.1 million and $2.0 million for the years ended December 31, 2011, 2010 and 2009, respectively.
On February 1, 2011, we issued Series B Preferred Stock amounting to $210 million and an additional $120 million on May 9, 2011. Proceeds from such issuance, net of related costs of $3.4 million, amounted to $326.6 million. Proceeds from the sale of the Series B Preferred Stock were used to finance the Patni Acquisition.
On February 21, 2011, we entered into an arrangement with Standard Chartered Bank for an unsecured revolving working credit facility of $70 million, renewable on an annual basis. As of December 31, 2011, we had borrowed $52.0 million under this line of credit at an effective interest rate of 1.07%.
On April 29, 2011, we issued $770 million ($737 million, net of commitment, placement and other financing and professional fees) aggregate principal amount of 9.0% Senior Notes due 2016 (“Notes”) in a private placement for financing a portion of the Patni Acquisition. The Notes require semi-annual interest payments on May 1 and November 1. Proceeds from the issue were used to finance the Patni Acquisition. We paid interest of $35.0 million on November 1, 2011.
On May 10, 2011, we entered into an arrangement with DBS Bank Ltd., Singapore, as administrative agent for the Lenders and DBS Bank Ltd., Bangalore Branch, as lead arranger, for Revolving Credit Commitments, an unsecured revolving working credit facility of $50 million, maturing on May 16, 2016. As of December 31, 2011, we had borrowed $5.0 million under this line of credit at an effective interest rate of 3.2%.
Our cash, cash equivalents and short-term investments were $430.0 million, $139.8 million and $96.8 million as of December 31, 2011, 2010 and 2009, respectively. We believe that cash generated from operations along with the unutilized line of credit arrangements will be adequate to meet our reasonable foreseeable operating liquidity requirements.
Contractual Obligations
The following table summarizes our contractual obligations as of December 31, 2011:
Our primary future cash requirements will be to fund working capital, debt service, capital expenditures, and benefit obligations. In addition to our working capital requirements, we expect our primary cash requirements for 2012 to be as follows:
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Debt service - We expect to make payments of approximately $69.3 million during 2012 for interest associated with senior notes. We do not foresee the need to repatriate earnings of foreign subsidiaries in order to make our scheduled debt payments.
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Capital expenditures - We expect to spend approximately $60.3 million for new and existing facility expansion, new hardware and software during 2012. We will fund the entire capital expenditures through a combination of available cash reserves and short term investments and expect to fund the costs of future expansion through our net cash flows provided by operations and ADS net proceeds at Patni.
We and our subsidiaries may from time to time seek to retire or purchase our outstanding debt (including publicly issued debt) through cash purchases and/or exchanges, in open market purchases, privately negotiated transactions, by tender offer or otherwise. Such repurchases or exchanges, if any, will depend on prevailing market conditions, liquidity requirements, contractual restrictions and other factors. The amounts involved may be material.
Future Sources of Liquidity
We expect our primary source of cash to be positive net cash flows provided by operating activities. Further, we continue to focus on cost reductions and have initiated steps during 2011 to reduce overheads and provide cash savings. The Company currently has two revolving credit facilities providing for borrowings of up to an aggregate of $120 million subject to certain contractual limitations. At December 31, 2011, we had borrowed $57 million under the revolving credit facilities. Both revolving credit facilities include other conditions that, if not complied with, could restrict our availability to borrow.
For more information on the revolving credit facilities and the restrictions on borrowing there under, please refer to Note 4 Line of Credit and Note 5, Senior Notes to our audited consolidated financial statements included elsewhere in this Form 10-K.
In order to meet our cash needs we may, from time to time, repatriate the earnings of our foreign subsidiaries, borrow under our credit facilities or issue long term or short-term debt or equity, if the market and our credit facilities and the indentures governing our notes permit us to do so. We regularly evaluate market conditions, our liquidity profile, and various financing alternatives for opportunities to enhance our capital structure. If market conditions are favorable, we may refinance our existing debt or issue additional securities.
On November 29, 2010, iGATE filed with the SEC the second amendment to a registration statement on Form S-3 (as it may be amended from time to time, the “registration statement”) relating to a proposed follow-on public offering of 10 million shares of its common stock, 6 million shares offered by its selling shareholders and $100 million of debt securities. This document shall not constitute an offer to sell or the solicitation of any offer to buy nor shall there be any sale of those securities in any State in which such offer, solicitation or sale would be unlawful prior to registration or qualification under the securities laws of any such State. Further, there is no way to predict whether or not we will be successful in completing the offering as contemplated and if it is successful, we cannot be certain if, or how much of, the net proceeds will be used for the purposes identified above. If we do not generate sufficient cash from operations, face unanticipated cash needs such as the need to fund significant strategic acquisitions or do not otherwise have sufficient cash and cash equivalents, we may need to incur additional debt or issue additional equity.
Based on past performance and current expectations, we believe that our existing cash and cash equivalents and short-term investments of $430 million as of December 31, 2011, and future cash provided by operating activities will be sufficient to meet our future cash requirements described above. Our ability to meet these requirements will depend on our ability to generate cash in the future, which is subject to general economic, financial, competitive, legislative, regulatory and other factors that are beyond our control.
Debt Service Obligations
As a result of the acquisition of Patni, our level of indebtedness increased. As of December, 31, 2011, principal payments due under our indebtedness were $827 million, excluding capital lease obligations of $1 million. Our interest expense for the year 2011 was $50.6 million, and includes $11.6 million of accrued interest expense.
Our leverage requires that a substantial portion of our cash flows from operations be dedicated to the payment of principal and interest on our indebtedness. We continually monitor our exposure to the risk of increased interest rates as portions of our borrowings under our credit facilities are at variable rates of interest.
The Company has made all scheduled payments timely under the indenture governing its senior notes, and the revolving facilities.
Off-Balance Sheet Arrangements
We do not have any off-balance sheet arrangements.
Seasonality
Our operations are generally not affected by seasonal fluctuations. However, our consultants’ billable hours are affected by national holidays and vacation policies, which vary by country.
Inflation
We do not believe that inflation had a significant impact on our results of operations for the periods presented. On an ongoing basis, we attempt to minimize any effects of inflation on our operating results by controlling operating costs and whenever possible, seeking to insure that billing rates reflect increases in costs due to inflation.
For all significant foreign operations, the functional currency is the local currency. Assets and liabilities of these operations are translated at the exchange rate in effect at each period end. Statement of Income accounts are translated at the average exchange rate prevailing during the year. Translation adjustments arising from the use of differing exchange rates from period to period are included as a component of other comprehensive income (loss). Realized gains and losses from foreign currency transactions are included in other income, net for the periods presented.
Recently Issued Accounting Standards
For information with respect to recent accounting pronouncements and the impact of these pronouncements on our consolidated financial statements, see Note 1.21 of Notes to Consolidated Financial Statements included elsewhere in this Annual Report
ITEM 7A.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Market Risk Factors
We are exposed to market risks from adverse changes in foreign exchange rates, interest rates, especially the Indian Rupee (“Rupee”). We do not engage in speculative or leveraged transactions, nor do we hold or issue financial instruments for trading purposes.
Foreign Exchange Rate Sensitivity
Our cash flow and earnings are subject to fluctuations due to exchange rate variation between the Rupee and USD, CAD, JPY, EUROs and GBP. This foreign currency risk exists based upon the nature of the subsidiary operations namely iGATE Global and Patni. For example, the majority of the revenue that the Company derives from Patni’s operations originates from services provided to two customers in the United States and Canada. This results in an inherent foreign currency risk between USD, CAD and Rupee exchange rates.
We attempt to limit our exposure to changing Rupee rates mainly through financial market transactions. These transactions may include entering into forward or option contracts to hedge existing exposures. The instruments are used to reduce risk by essentially creating offsetting currency exposures. The following table presents information related to foreign currency contracts held by the Company (in thousands):
Interest Rate Sensitivity
The Company is exposed to changes in interest rates primarily as a result of long-term and short-term debt. The nature and amount of the Company’s long-term and short-term debt can be expected to vary as a result of future business requirements, market conditions and other factors.
Effect of Hypothetical 10% Fluctuation In Market Prices
Our primary net foreign currency exposure is the Indian Rupee. The fair value of foreign exchange contracts are subject to changes in foreign currency exchange rates.
As of December 31, 2011, the potential gain or loss in the fair value of the Company’s outstanding foreign currency contracts assuming hypothetical 10%, 5%, 2% and 1% fluctuations in currency rates would be approximately (in millions):
However, it should be noted that any change in the fair value of the contracts, real or hypothetical, would be significantly offset by an inverse change in the value of the underlying hedged items. In relation to currency contracts, this hypothetical calculation assumes that each exchange rate would change in the same direction relative to the USD.
ITEM 8.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The Financial Statements and Supplementary Data required by this item are filed as part of this Form 10-K. See Index to Consolidated Financial Statements on page 58 of this Form 10-K.
MANAGEMENT’S RESPONSIBILITY FOR FINANCIAL REPORTING
The accompanying Consolidated Financial Statements of iGATE Corporation and subsidiaries have been prepared by management, which is responsible for their integrity and objectivity. The statements have been prepared in conformity with accounting principles generally accepted in the United States of America and necessarily include amounts based on management’s best estimates and judgments.
The Company’s Consolidated Financial Statements for the year ended December 31, 2011 have been audited by Ernst & Young, an Independent Registered Public Accounting Firm, whose report thereon appears on page 59 of this Form 10-K.
The Board of Directors pursues its responsibility for the Company’s financial reporting and accounting practices through its Audit Committee, all of the members of which are independent directors. The Audit Committee’s duties include recommending to the Board of Directors the Independent Registered Public Accounting Firm to audit the Company’s financial statements, reviewing the scope and results of the independent accountants’ activities and reporting the results of the committee’s activities to the Board of Directors. The Independent Registered Public Accounting Firm has met with the Audit Committee in the presence of management representatives to discuss the results of their audit work. The Independent Registered Public Accounting Firm has direct access to the Audit Committee.
Phaneesh Murthy
President, Chief Executive Officer and Director
Sujit Sircar
Chief Financial Officer
iGATE CORPORATION
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
Report of Independent Registered Public Accounting Firm
Board of Directors and Shareholders of iGATE Corporation
We have audited the accompanying consolidated balance sheets of iGATE Corporation as of December 31, 2011 and 2010 and the related consolidated statements of income, equity and comprehensive income (loss), and cash flows for each of the three years in the period ended December 31, 2011. These consolidated financial statements are the responsibility of iGATE’s management. Our responsibility is to express an opinion on these financial statements based on our audits.
We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of iGATE Corporation at December 31, 2011 and 2010 and the consolidated results of its operations and its cash flows for each of the three years in the period ended December 31, 2011, in conformity with U.S. generally accepted accounting principles.
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), iGATE Corporation’s internal control over financial reporting as of December 31, 2011, based on criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission and our report dated March 14, 2012 expressed an unqualified opinion thereon.
/s/ Ernst & Young
Gurgaon, India
March 14, 2012
iGATE CORPORATION
CONSOLIDATED BALANCE SHEETS
(dollars in thousands, except per share data)
See accompanying notes
iGATE CORPORATION
CONSOLIDATED STATEMENTS OF INCOME
(dollars and shares in thousands, except per share data)
See accompanying notes
iGATE CORPORATION
CONSOLIDATED STATEMENTS OF EQUITY AND COMPREHENSIVE INCOME (LOSS)
iGATE CORPORATION
CONSOLIDATED STATEMENTS OF EQUITY AND COMPREHENSIVE INCOME (LOSS) - Continued
See accompanying notes
iGATE CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS
See accompanying notes
iGATE CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2011
1. Company Overview and Summary of Significant Accounting Policies
1.1 Company Overview
iGATE Corporation (“iGATE” or the “Company”) is one of the leading providers of Information Technology (“IT”) and IT-enabled operations offshore outsourcing solutions services to large and medium-size organizations. iGATE provides end-to-end business solutions that leverage technology thus enabling its clients to enhance business performance.
On May 12, 2011, the Company through two of its wholly-owned subsidiaries, Pan-Asia iGATE Solutions (“Pan Asia”), and iGATE Global Solutions Limited (“iGATE Global”) (together with Pan Asia, the “Purchasers”) completed the acquisition of a majority stake in Patni Computer Systems Limited (the “Patni Acquisition”). Patni Computer Systems Limited (“Patni”) is a company incorporated in India under the Indian Companies Act, 1956. Patni is engaged in IT consulting, software development and business process outsourcing (“BPO”).
1.2 Basis of Preparation of Financial Statements and Principles of Consolidation
The accompanying financial data has been prepared by us in accordance with U.S. generally accepted accounting principles (“GAAP”).
The accompanying financial statements have been prepared on a consolidated basis and reflect the financial statements of iGATE and all of its subsidiaries that are more than 50% owned or controlled. When the Company does not have a controlling interest in an entity, but exerts a significant influence on the entity, the Company applies the equity method of accounting and are initially recorded at cost. All inter-company transactions and balances are eliminated in consolidation.
1.3 Use of estimates
The preparation of financial statements in accordance with GAAP requires management to make estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes. Significant items subject to such estimates and assumptions include the useful lives of property and equipment, carrying amount of property and equipment, intangibles and goodwill, valuation allowance for receivables and deferred tax assets, valuation of derivative instruments, valuation of share-based compensation, assets and obligations related to employee benefits, income tax uncertainties and other contingencies and commitments. Management believes that the estimates used in the preparation of the consolidated financial statements are prudent and reasonable. Although these estimates are based upon management’s best knowledge of current events and actions, actual results could differ from these estimates. Appropriate changes in estimates are made as management become aware of changes in circumstances surrounding the estimates. Changes in estimates are reflected in the financial statements in the period in which changes are made and, if material, their effects are disclosed in the notes to the consolidated financial statements.
1.4 Revenue Recognition
The Company derives its revenues primarily from IT services and to a lesser extent from BPO services. Revenue is recognized when there is persuasive evidence of a contractual arrangement with customers, services have been rendered, the fee is fixed or determinable and collectability is reasonably assured. The Company has concluded that it has persuasive evidence of an arrangement when it enters into an agreement with its clients with terms and conditions which describe the services and the related payments are legally enforceable.When the
iGATE CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2011
terms of the agreement specify service level parameters that must be met, the Company monitors such service level parameters and determines if there are any service credits or penalties which need to be accounted for. Revenue is recognized net of any service credits that are due to a client and net of applicable taxes and includes reimbursements of out-of-pocket expenses, with the corresponding cost for out-of-pocket expenses included in cost of revenue.
IT services are provided either on a fixed price, fixed time frame or on a time and material basis. Revenue with respect to time-and-material contracts is recognized as the related services are performed. Time-and-material contracts typically bill at an agreed upon hourly or daily rate. The Company’s fixed price contracts include application maintenance and support services, on which revenue is recognized ratably over the term of maintenance. Revenue related to fixed-price contracts that provide for highly complex information technology application development services are recognized as the services are performed using the percentage of completion method with input (cost to cost) method while contracts that do not provide for highly complex information technology development services are recognized as the services are performed using proportional performance basis with input (efforts expended) method. The Company considers the input method to be the best available measure of progress on these contracts as there is a direct relationship between input and productivity. Costs are recorded as incurred over the contract period. Provisions for estimated losses, if any, on uncompleted contracts are recorded in the period in which such losses become probable based on the current contract estimates.
Revenues from BPO services are derived from both time-based and transaction-priced contracts. Revenue from these contracts are recognized on rendering of the services as per the terms of the contract.
Unbilled revenue represents revenue recognized in excess of amounts billed. These amounts are billed after the milestones specified in the agreement are achieved. Billing done during the reporting period in excess of revenue recognized or billing done in advance is recorded as deferred revenue until the revenue recognition criteria is met.
Direct and incremental contract origination and set up costs incurred in connection with support/maintenance service arrangements are charged to expense as incurred. These costs are deferred only in situations where there is a contractual arrangement establishing a customer relationship for a specified period. The costs to be deferred are limited to the extent of future contractual revenues. Further, revenue attributable to set up activities is deferred and recognized systematically over the periods that the related fees are earned, as services performed during such period do not result in the culmination of a separate earnings process.
The Company grants volume discounts to certain customers, which are computed based on a pre-determined percentage of the total revenues from those customers during a specified period, as per the terms of the contract. These discounts are earned only after the customer has provided a specified cumulative level of revenues in the specified period. The Company reports revenues net of discounts offered to customers. The Company estimates the total number of customers that will ultimately earn these discounts, based on which a portion of the revenue on the related transactions is allocated to the services that will be delivered in the future.
Warranty costs on sale of services are accrued based on management’s estimates and historical data at the time related revenues are recorded.
1.5 Cash and cash equivalents
The Company classifies all highly liquid investments, including fixed term deposits, with original maturity at the date of purchase of three months or less and that are readily convertible to known amounts of cash to be cash equivalents.
iGATE CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2011
1.6 Investments
Management determines the appropriate classification of investment securities at the time of purchase and re-evaluates such designation at each balance sheet date. As of December 31, 2011 and 2010, investment securities were classified as available-for-sale (short-term investments). The investment securities classified as available-for-sale consists of units of liquid and fixed maturity mutual funds and other investments. Other investment primarily consists of certificate of deposit with banks, which are carried at fair value and non convertible debentures. The investments that are expected to be realized in cash within one year, but do not otherwise qualify as cash equivalents, are classified as short-term investments. The investments that are not expected to be realized in cash within one year are classified as other investments and disclosed as part of “Deposits and other assets” in balance sheet.
The Company accounts for its investments in accordance with Financial Accounting Standards Board (“FASB”) ASC Topic 320, “Accounting for Certain Investments in Debt and Equity Securities”. These investments are considered available for sale and are recorded at fair value, with the unrealized gains or losses, net of tax, reported as a component of accumulated other comprehensive income in the consolidated statement of equity and comprehensive income (loss). The unrealized gain or loss is the difference between the Company’s original cost for an investment and the investment’s fair value at each reporting period. The fair values represent either the quoted market prices for the investments at balance sheet date where available or Net Asset Value (“NAV”) as stated by the issuers of these mutual fund units in the published statements. NAVs represent the price at which the issuer will issue further units in the mutual fund and the price at which the issuer will redeem such units from the investors. Accordingly, such NAV are analogous to fair market value with respect to these investments as transactions of these mutual funds are carried out at such prices between investors and the issuers of these units of mutual funds. Fair value of investments in certificate of deposits, classified as available for sale, is determined using observable market inputs.
Realized gains and losses, and decline in value judged to be other than temporary on available-for-sale securities are included in the consolidated statements of income. The cost of securities sold or disposed is determined on average cost basis.
1.7 Accounts Receivable
The Company extends credit to clients based upon management’s assessment of their creditworthiness. Accounts receivable are recorded at the invoiced amount and do not bear interest.
1.8 Allowance for Uncollectible Accounts
Accounts receivable are reviewed periodically to determine the probability of loss. The allowance for uncollectible accounts or doubtful debts is determined using the combination of the specific identification method for balances deemed uncollectible, as well as judgments made by the Company based upon historical and expected collection experience.
1.9 Property and equipment
Property and equipment are stated at cost. The Company provides for depreciation using the straight-line method over the estimated useful lives. Upon disposal, assets and related accumulated depreciation are removed from the Company’s accounts and the resulting gains and losses are reflected in other income, net in the Consolidated Statements of Income. Improvement and betterments that extend the useful life of an asset are capitalized and depreciated over the remaining useful life of the related asset.
iGATE CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2011
Leased capital assets are recorded at the lower of the fair value of the leased property or the present value of the minimum lease payments during the lease term and depreciated over their useful life or the lease term whichever is shorter. The depreciation on the same is disclosed as part of the accumulated depreciation on property and equipment.
The estimated useful lives of assets are as follows:
Building
25 - 40 years
Computer equipment
1.5 -3 years
Furniture and fixtures
5 years
Vehicles
5 years
Leasehold improvements
Shorter of the life of the improvement or lease term ranging from 3 to 10 years
Leased capital assets
Shorter of the life of the leased asset or lease term
Advances paid towards the acquisition of property and equipment and the cost of property and equipment not put to use before the balance sheet date are disclosed under the caption capital work-in-progress in Note 11.
Property and equipment are reviewed for impairment if indicators of impairment arise. There were no impairment charges related to property and equipment recognized during the years ended December 31, 2011, 2010 and 2009.
Software that has been purchased is included in property and equipment and is amortized using the straight-line method over two to five years.
1.10 Accounting for leases
The Company leases its delivery centers and office facilities under operating lease agreements that are renewable on a periodic basis at the option of the lessor and the lessee. The lease agreements contain rent free periods and rent escalation clauses. Lease payments under operating leases are recognized as an expense on a straight-line basis over the lease term.
The Company procures certain networking components, office equipments and vehicles under financing lease arrangement. The lease classification and accounting of the finance lease is accounted for in accordance with FASB ASC Topic 840 “Accounting for Leases”. The lower of the fair value of the leased property or the present value of the minimum lease payment is capitalized as an asset with a corresponding liability and depreciated on a straight-line basis over the lease term or the estimated useful life of the asset whichever is shorter.
1.11 Goodwill and intangible assets
The Company accounts for its business combinations under the acquisition method of accounting. Intangible assets acquired in a business combination are recognized and reported separately from goodwill. Goodwill represents the cost of the acquired businesses in excess of the fair value of identifiable tangible and intangible net assets purchased. We review goodwill for impairment annually and whenever events or changes in circumstances such decline in operating results, business plans and future cash flows indicate its carrying value may not be recoverable.
The provisions of ASC 350 requires that recoverability of goodwill be evaluated using a two-step process. Under the first step, the estimated fair value of the reporting unit in which the goodwill resides is compared with
iGATE CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2011
its carrying value of the assets and liabilities (including goodwill). If the fair value of the reporting unit exceeds its carrying value, step two does not need to be performed. If the fair value of the reporting unit is less than its carrying value, an indication of goodwill impairment exists for the reporting unit and the step two of the impairment test (measurement) is performed. Under step two, an impairment loss is recognized for any excess of the carrying amount of the reporting unit’s goodwill over the implied fair value of that goodwill. The implied fair value of goodwill is determined by allocating the fair value of the reporting unit in a manner similar to a purchase price allocation, in a business combination. The residual fair value after this allocation is the implied fair value of the reporting unit goodwill.
The fair values used in this evaluation are estimated based upon the market capitalization adjusted for a control premium and discounted future cash flow analysis. The discounted future cash flow analysis is based upon a number of estimates and assumptions including operating results and business plans. The Company has applied a control premium of 20% which was arrived at based on historical acquisition trends of listed companies in India. The Company performs its annual impairment review of goodwill on November 30, and when a triggering event occurs between annual impairment tests. Based on the results of its annual impairment tests, the Company determined that no impairment of goodwill existed as of December 31, 2011, and 2010.
Intangible assets are initially valued at fair market value using generally accepted valuation methods appropriate for the type of intangible asset. Intangible assets with definite lives are amortized over the estimated useful lives and are reviewed for impairment, if indicators of impairment arise such as termination of contracts with customers, restructuring actions or plans or downward revisions to forecasts. The evaluation of impairment is based upon a comparison of the carrying amount of the intangible asset to the estimated future undiscounted net cash flows expected to be generated by the asset. If estimated future undiscounted cash flows are less than the carrying amount of the asset, the asset is considered impaired. The impairment expense is determined by comparing the estimated fair value of the intangible asset to its carrying value, with any shortfall from fair value recognized as an expense in the current period. The estimated fair value is computed based on the forecasted future revenue and cash flows from the customer contracts.
As of December 31, 2011, the definite lived intangible assets predominantly comprise customer relationships arising from the Patni Acquisition and balance relates to intellectual property rights. The estimated useful life of customer relationships and intellectual property rights is 15 years and 0.5 year to 6 years, respectively. Customer relationships and intellectual property rights are amortized over their respective individual estimated useful lives in proportion to the economic benefits consumed in each period (i.e. based on ratio of the undiscounted cashflows for a period to the total estimated undiscounted cashflows). The estimated useful life of an identifiable intangible asset is based on a number of factors including the effects of obsolescence, demand, competition and other economic factors (such as the stability of the industry, and known technological advances) and the level of maintenance expenditures required to obtain the expected future cash flows from the asset.
1.12 Foreign currency
The consolidated financial statements are reported in U.S. Dollars, which is the Company’s functional currency. The functional currency for foreign subsidiaries is their respective local currency. The translation of the functional currencies of the respective subsidiaries into U.S. Dollars is performed for balance sheet accounts using the exchange rates in effect as of the balance sheet date and for revenues and expense accounts using an average exchange rate prevailing during the respective period. The gains or losses resulting from such translation are reported under accumulated other comprehensive income (loss) as a separate component of equity.
Monetary assets and liabilities of each subsidiary denominated in currencies other than the subsidiary’s functional currency are translated into the respective functional currency at the rates of exchange prevailing at the balance sheet date and gains or losses are recorded in the income statement.
iGATE CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2011
1.13 Earnings per share
The Company computes earnings per share in accordance with FASB ASC Topic 260 “Earnings per Share” and FASB ASC Topic 260-10-45 “Determining Whether Instruments Granted in Share-Based Payment Transactions Are Participating Securities”. Basic earnings per share for different classes of stock (common stock, unvested restricted stock and Series B Preferred Stock) is calculated by dividing net income available to each class by the weighted average number of shares outstanding for each class. Diluted earnings per share is computed using the weighted average number of common stock, unvested restricted stock plus the potentially dilutive effect of common stock and Series B Preferred Stock equivalents.
1.14 Income taxes
Income taxes are accounted for using the liability method as described in FASB ASC Topic 740-10, “Accounting for Income Taxes”. Deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities, and their respective tax bases. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect of changes in tax rates on deferred tax assets and liabilities is recognized as income or expense in the period that includes the enactment date. The measurement of deferred tax assets is reduced, if necessary, by a valuation allowance for any tax benefits of which future realization is not more likely than not. Changes in valuation allowance from period to period are reflected in the income statement of the period of change. Tax benefits of deductions earned on exercise of employee stock options in excess of compensation charged to earnings are credited to additional paid in capital. Deferred taxes are not provided on the undistributed earnings of non-U.S. subsidiaries as it is expected that the earnings of the foreign subsidiaries will be indefinitely reinvested.
FASB ASC Topic 740, “Accounting for Income Taxes”, on the accounting for uncertainty in income taxes recognized in an enterprise’s financial statements, prescribes a recognition threshold of more-likely-than-not to be sustained upon examination. Recognized income tax positions are measured at the largest amount that has a greater than 50% likelihood of being realized. Changes in recognition or measurement are reflected in the period in which one change in judgment occurs.
1.15 Derivative instruments and hedging activities
The Company enters into foreign currency forward and option contracts (“derivative contracts”) to mitigate and manage the risk of changes in foreign exchange rates on inter-company and end customer accounts receivables and forecasted sales and inter-company transactions. The Company hedges anticipated sales transactions that are subject to foreign exchange exposure with derivative contracts that are designated effective and that qualify as cash flow hedges under ASC Topic 815, “Derivatives and Hedging” (ASC No. 815).
As part of hedge strategy, the Company also enters into derivative contracts which are replaced with successive new contracts up to the period in which the forecasted transaction is expected to occur i.e. (roll-over hedges). In case of rollover hedges, the hedge effectiveness is assessed based on changes in fair value to the extent of changes in spot prices and recorded in accumulated other comprehensive income (loss) until the hedged transactions occur and at that time is recognized in the consolidated statements of income. Accordingly, the changes in the fair value of the contract related to the changes in the difference between the spot price and the forward price (i.e. forward premium/discount) are excluded from assessment of hedge effectiveness and is recognized in consolidated statements of income and are included in foreign exchange gain (loss).
In respect of derivative contracts which hedge the foreign currency risk associated with the both anticipated sales transaction and the collection thereof (dual purpose hedges), the hedge effectiveness is assessed based on
iGATE CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2011
overall changes in fair value with the effective portion of gains or losses included in accumulated other comprehensive income (loss). The effective portion of gain or loss attributable to forecasted sales are reclassified from accumulated other comprehensive income (loss) and recognized in consolidated statements of income when the sales transaction occurs. Post the date of sales transaction, the Company reclassifies an amount from accumulated other comprehensive income (loss) to earnings to offset foreign currency translation gain (loss) recorded for the respective receivable during the period. In addition, the Company determines the amount of cost to be ascribed to each period of the hedging relationship based on the functional currency interest rate implicit in the hedging relationship and recognizes this cost by reclassifying it from accumulated other comprehensive income (loss) to consolidated statements of income for recognized receivables based on the pro rata method.
Changes in the fair value of cash flow hedges deemed ineffective are recognized in the consolidated statement of income and are included in foreign exchange gain (loss). The Company also uses derivatives contracts not designated as hedging instruments under ASC No. 815 to hedge intercompany and end customer accounts receivables and other monetary assets denominated in currencies other than the functional currency. Changes in the fair value of these derivatives are recognized in the consolidated statements of income and are included in foreign exchange gain (loss).
In respect of derivatives designated as hedges, the Company formally documents all relationships between hedging instruments and hedged items, as well as its risk management objective and strategy for undertaking various hedge transactions. The Company evaluates hedge effectiveness at the time a contract is entered into as well as on an ongoing basis. If during this time, a contract is deemed ineffective, the change in the fair value is recorded in the consolidated statements of income and is included in foreign exchange gain (loss). In situations in which hedge accounting is discontinued and the derivative remains outstanding, the net derivative gain or loss continue to be reported in accumulated other comprehensive income unless it is probable that the forecasted transaction will not occur by the end of the originally specified time period (as documented at the inception of the hedging relationship) or within an additional two-month period of time thereafter.
1.16 Stock based compensation
FASB ASC Topic 718-10-25 “Accounting for Stock-Based Compensation” requires compensation costs related to share-based transactions, including employee share options, to be recognized in the financial statements based on its fair value. The Company recognizes compensation expense for stock options net of estimated forfeitures which are estimated at the time of grant and revised, if necessary, in subsequent periods if actual forfeitures differ from those estimates. Stock-based compensation recognized in the Consolidated Statement of Income is based on awards ultimately expected to vest.
The Company has elected to use the Black-Scholes-Merton pricing model to determine the fair value of share-based awards on the date of grant which is recorded as an expense on a straight-line basis over the vesting term.
1.17 Employee benefits
Defined Contribution Plans
Eligible employees of the Company in India receive benefits from the Provident Fund, administered by the Government of India, which is a defined contribution plan. Both the employees and the Company make monthly contributions to the Provident Fund equal to a specified percentage of the eligible employees’ salary.
Eligible United States employees of the Company may elect to participate in an employee retirement savings plan maintained pursuant to Section 401(k) of the United States Internal Revenue Code of 1986, as
iGATE CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2011
amended, (the “401(k) Plan”). The 401(k) Plan allows for employees to defer a portion of their annual earnings on a pre-tax basis through voluntary contributions to the 401(k) Plan. The Company may make discretionary matching contributions under the 401(k) Plan, but the Company is not currently making any such matching contributions.
The Company has no further funding obligation under defined contribution plans beyond the contributions elected or required to be made under these plans. Contributions are charged to income in the year in which they are incurred and are included in the Consolidated Statements of Income.
Defined Benefit Plans
Employees in India are entitled to benefits under the Gratuity Act, a defined benefit retirement plan covering eligible employees. The plan provides for a lump-sum payment to eligible employees at retirement, death, and incapacitation or on termination of employment, of an amount based on the respective employee’s salary and tenure of employment. In India, iGATE Global contributes to funds administered and managed by the ICICI Prudential Life Insurance Company Limited and Reliance Life Insurance Company Limited (the “Fund Administrators”) to fund the gratuity liability of its Indian subsidiaries. Under this scheme, the obligation to pay gratuity remains with the Company, although the Fund Administrator administers the scheme.
Patni contributes annually to a gratuity fund administered by Patni through a trust set up for that purpose. All assets of the Patni plan are owned by the trust and comprises of investment in government securities, government securities based mutual funds and other securities.
Current services costs for defined benefit plans are accrued in the period to which they relate. The liability in respect of defined benefit plans is calculated annually by a qualified actuary using the projected unit credit method. The Company recognizes the net funded position of its plans as an asset or liability in the consolidated balance sheets. In measuring the defined benefit obligations, the Company uses discount rates based on yields of high quality fixed income instruments (i.e. yields on high quality corporate bonds) prevailing as at the balance sheet date for the corresponding tenure of the obligations.
1.18 Fair value of financial instruments and concentration of credit risk
The carrying amounts reported in the balance sheets for cash and cash equivalents, short-term investments, accounts and unbilled receivables, other current assets, line of credit, accounts payable, accrued expenses and other current liabilities is at fair value due to the short-term maturity of these items and the variable interest rate on its line of credit borrowings.
Financial instruments that potentially subject the Company to concentrations of credit risk consist principally of cash and cash equivalents, short-term investments, accounts and unbilled receivables and derivative instruments. By their nature, all such instruments involve risks including credit risks of non-performance by counterparties. A substantial portion of the Company’s cash and cash equivalents are invested with nationally recognized banks located in the United States, Canada, Europe and India. A portion of the funds are also invested in mutual funds, time deposits and non convertible debentures with nationally recognized banks in India. Accounts and unbilled receivables are unsecured and are derived from revenue earned from customers in industries based primarily in the United States, Canada and Europe. The Company monitors the credit worthiness of its customers to whom it grants credit terms in the normal course of its business and of counterparties when it enters into foreign exchange contracts. Management believes there is no significant risk of loss in the event of non-performance of the counterparties to these financial instruments, other than the amounts already provided for in the consolidated financial statements.
iGATE CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2011
1.19 Commitments and contingencies
Liabilities for loss contingencies arising from claims, tax assessments, litigation, fines and penalties and other sources are recorded when it is probable that a liability has been incurred and the amount of the assessment and/or remediation can be reasonably estimated. Legal costs incurred in connection with the same are expensed as incurred.
1.20 Advertising cost
Advertising costs incurred during the year have been expensed. The total amount of advertising costs expensed was $1.3 million, $0 and $0 for the years ended December 31, 2011, 2010 and 2009, respectively.
1.21 Recently issued accounting pronouncements
In May 2011, the FASB issued Accounting Standard Update (“ASU”) No. 2011-04-Fair Value Measurement, which amends the fair value measurement guidance and includes some enhanced disclosure requirements. The most significant change in disclosures is an expansion of the information required for Level 3 measurements based on unobservable inputs. The ASU is effective for fiscal years beginning after December 15, 2011. The Company will adopt this ASU in the first quarter of 2012 and is currently evaluating its impact on the financial statements and disclosures.
In June 2011, the FASB issued ASU No. 2011-05-Comprehensive Income, which eliminates the current option to report other comprehensive income and its components in the statement of stockholders’ equity. Instead, an entity will be required to present items of net income and other comprehensive income in one continuous statement or in two separate, but consecutive, statements. The ASU was effective for fiscal years beginning after December 15, 2011. In December 2011, the FASB also issued an amendment to defer the presentation on the face of the financial statements the effects of reclassifications out of accumulated other comprehensive income on the components of net income and other comprehensive income for annual and interim financial statements. The implementation of the aforementioned amendment is not expected to have a material impact on our consolidated financial position and results of operations.
In September 2011, the FASB issued ASU No. 2011-08 Intangibles-Goodwill and Others, which is intended to reduce the cost and complexity of the annual goodwill impairment test by providing entities an option to perform a “qualitative” assessment to determine whether further impairment testing is necessary. The ASU is effective for annual and interim goodwill impairment tests performed for fiscal years beginning after December 15, 2011. Early adoption is permitted. An entity can choose to early adopt if its annual test date is before the issuance of the final standard, provided that the entity has not yet performed its 2011 annual impairment test or issued its financial statements. An entity has the option to first assess qualitative factors to determine whether it is necessary to perform the current two-step test. If an entity believes, as a result of its qualitative assessment, that it is more-likely-than-not that the fair value of a reporting unit is less than its carrying amount, the quantitative impairment test is required. Otherwise, no further testing is required. The Company is currently evaluating whether or not to take the option available in the ASU.
In December 2011, the FASB issued an ASU No. 2011-11-Disclosure about Offsetting Assets and Liabilities, which requires entities to disclose both gross information and net information about both instruments and transactions eligible for offset in the statement of financial position and instruments and transactions subject to an agreement similar to a master netting arrangement. The scope would include derivatives, sale and repurchase agreements and reverse sale and repurchase agreements, and securities borrowing and securities lending arrangements. The objective of this disclosure is to facilitate comparison between those entities that
iGATE CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2011
prepare their financial statements on the basis of U.S. GAAP and those entities that prepare their financial statements on the basis of IFRS. In addition, the standard requires disclosure of collateral received and posted in connection with master netting agreements or similar arrangements. The ASU is effective for annual and interim period for fiscal years beginning on or after January 1, 2013.The company is currently evaluating this ASU.
2. Business combination
On May 12, 2011, the Company completed the acquisition of a majority stake in Patni. Patni provides multiple service offerings to its clients across various industries including banking and insurance; manufacturing, retail and distribution; life sciences; product engineering; and communications, media and entertainment and utilities. The various service offerings include application development and maintenance, enterprise software and systems integration services, business and technology consulting, product engineering services, infrastructure management services, customer interaction services and BPO, quality assurance and engineering services. The Company believes that its strategy of a global delivery model and the Patni Acquisition positions it well to provide a greater breadth of services in catering to market needs and opportunities.
The Patni Acquisition involved acquiring 60,091,202 shares or 45.0% of the outstanding share capital from the promoters of Patni (44.4% of the outstanding share capital on a fully diluted basis) and 22,913,948 shares (inclusive of the American Depositary Shares representing 20,161,867 shares) or 17.1% of the outstanding share capital of Patni from General Atlantic Mauritius Limited (16.9% of the outstanding share capital on a fully diluted basis). In accordance with the requirements of the Securities and Exchange Board of India (Substantial Acquisition of Shares and Takeover) Regulations, 1997, as amended, and a tender offer pursuant to the U.S. Securities Exchange Act of 1934, as amended, and the rules and regulations of the U.S. Securities and Exchange Commission, the Purchasers also acquired an additional 27,085,565 shares or 20.3% of the outstanding shares of the Company (20% of the outstanding share capital on a fully diluted basis) through a mandatory open public offer (“MTO”) to the other shareholders of Patni. The Patni Acquisition was valued at approximately $1.24 billion.
The acquisition has been accounted for under the acquisition method of accounting in accordance with Accounting Standards Codification No. 805, “Business Combination”. The total purchase price has been allocated to Patni’s net tangible and intangible assets based on their estimated fair values at the date of acquisition. Since the actual results from May 12, 2011 through May 15, 2011 were not material, for convenience the Company utilized May 15, 2011 as the acquisition date. The purchase price in excess of amounts allocated to net tangible and intangible assets has been recorded as goodwill. The Company does not expect the goodwill recognized to be deductible for income tax purposes. The results of operations of Patni for the period from May 15, 2011 through December 31, 2011 have been included in the Company’s consolidated results for the year ended December 31, 2011. Non controlling interest represents the estimated fair value of the shares (as of the acquisition date) of Patni held by the general public and the fair value of share-based payments that is attributable to pre-combination service as of the date of acquisition amounting to $211.9 million.
iGATE CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2011
The following table summarizes the allocation of the assets acquired and liabilities assumed (dollars in thousands):
Patni’s revenues and net income included in the Company’s Statement of Operations for the year ended December 31, 2011 is $479.4 million and $47.3 million, respectively.
The following supplemental pro forma results of operations of the Company for the year ended December 31, 2011 and 2010 assume that the Patni Acquisition occurred at the beginning of the comparable period. The pro forma amounts include certain adjustments, including interest expense, depreciation and amortization expense, income taxes, and dividends on the Series B Preferred Stock, and adjustments for recurring cost savings related to termination of the services of certain employees and vacating certain redundant facilities identified by the management in a formal plan at the date of acquisition (in thousands).
3. Series B Preferred Stock
On January 10, 2011, the Company entered into a securities purchase agreement with an entity to raise equity financing to pay a portion of the cash consideration for the Patni Acquisition. Under the securities purchase agreement, the Company agreed to sell, in a private placement, up to 480,000 shares of newly designated 8.00% Series B Convertible Participating Preferred Stock, no par value per share (the “Series B
iGATE CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2011
Preferred Stock”), for an aggregate purchase price of up to $480 million. On February 1, 2011 and May 9, 2011, the Company issued 210,000 shares and 120,000 shares, respectively, of the Series B Preferred Stock for a consideration of $330 million.
Significant economic terms of the Series B Preferred Stock include:
•
accrues cumulative dividends at a rate of 8.00% per annum, which dividends, if not paid, are added to the liquidation preference of the Series B Preferred Stock and compounded quarterly;
•
is entitled to participate in dividends and other distributions payable on the Company’s common stock on an as-converted basis;
•
provides for a holder option to convert the outstanding principal plus accrued and unpaid dividends into the Company’s common stock at any time and from time to time at an initial conversion price of $20.30 per share (which conversion price is subject to adjustment in certain circumstances);
•
is subject to a Company option to convert the Series B Preferred Stock into common stock of the Company after 18 months from the applicable closing date if, among other things, the volume weighted average price of the Company’s common stock exceeds 205% of the then applicable conversion price for a specified period of time;
•
is redeemable for cash at an amount equal to the outstanding principal plus accrued and unpaid dividends upon the exercise of the holder’s put right at six years from the last occurring closing date;
•
provides that, if the Series B Preferred Stock is not sooner converted, such preferred stock is subject to a mandatory conversion into shares of the Company’s common stock on the date that is six years from the applicable closing date (subject to extension in limited circumstances) unless the holder exercises the put right described in the immediately preceding bullet point; and
•
provides the holder the right to receive, prior to any payment in respect of any junior equity securities, the greater of the outstanding principal plus accrued and unpaid dividends and the as-converted value upon liquidation of the Company or upon certain changes of control.
The Company incurred issuance costs amounting to $3.4 million which have been netted against the proceeds received from the issuance of Series B Preferred Stock. The Series B Preferred Stock is being accreted over a period of six years. The amount accreted during the year ended December 31, 2011 totaled $0.3 million.
The Company is accruing for cumulative dividends at a rate of 8.00% per annum, compounded quarterly. The amount of such dividend accrued during the year ended December 31, 2011 totaled $22.1 million.
4. Line of credit
On February 21, 2011, iGATE Global entered into an arrangement with a bank for availing an unsecured packing credit facility of $70 million at an annual interest rate of LIBOR plus 195 basis points, renewable on an annual basis. Effective August 2011, the interest rate is LIBOR plus 60 basis points. As of December 31, 2011, the Company had borrowed $52 million under this line of credit at a weighted average interest rate of 1.08%.
On May 10, 2011, the Company entered into a unsecured credit agreement with another bank, as administrative agent for the Lenders and the bank, for Revolving Credit Commitments in an aggregate principal U.S. Dollar Equivalent of $50 million, maturing on May 10, 2016. The proceeds are to be used for working capital and other general corporate purposes. The facility carries an interest rate of LIBOR plus 280 basis points. As of December 31, 2011, the Company had borrowed $5.0 million under this line of credit at an interest rate of 3.2%.
iGATE CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2011
As of December 31, 2011, Patni has a line of credit facility of $11.5 million with a bank for requirements such as pre and post shipment loan, export bill discounting, overdrafts, working capital demand loans, financial and performance guarantees, etc. This facility bear interest as negotiated with the bank from time to time. The facility is secured by Patni’s accounts receivables and amounts outstanding are payable on demand to the banks on noncompliance of terms and conditions mentioned in the respective facility letter. As of December 31, 2011, Patni has availed performance guarantee facility of $0.8 million and $ 3.8 million as of December 31, 2011 and 2010, respectively.
5. Senior Notes
On April 29, 2011, the Company sold, $770 million of 9.0% senior notes due May 1, 2016 (the “Notes”) through a private placement exempt from the registration requirements of the Securities Act, pursuant to an Indenture (the “Indenture”) by and among the Company, iGATE Technologies Inc., and the Trustee, as supplemented by the Supplemental Indenture dated as of May 12, 2011, by and among the Company, iGATE Technologies, Inc., iGATE Holding Corporation, iGATE Inc. and the Trustee. The interest is payable semi-annually in cash in arrears on May 1 and November 1 of each year, beginning on November 1, 2011. The Notes are senior unsecured obligations of the Company, guaranteed by the Company’s domestic subsidiaries, as identified in Note 24.
The terms of the Indenture governing the Notes, among other things, limits the ability of the Company and its restricted subsidiaries to (i) incur additional indebtedness or issue certain preferred stock; (ii) pay dividends on, or make distributions in respect of, their capital stock or repurchase their capital stock; (iii) make certain investments or other restricted payments; (iv) sell certain assets; (v) create liens or use assets as security in other transactions; (vi) merge, consolidate or transfer or dispose of substantially all of their assets; and (vii) engage in certain transactions with affiliates. These covenants are subject to a number of important limitations and exceptions that are described in the Indenture. The Indenture also contains certain financial covenants relating to Consolidated Priority Debt Leverage Ratio and a Fixed Charge Coverage Ratio that the Company is required to comply with, when any of the above events occur. As of December 31, 2011, no such events have occurred.
At any time prior to May 1, 2014, the Company may redeem the Notes in whole or in part, at its option, at a redemption price equal to 109% of the principal amount of such Notes and accrued and unpaid interest, if any, to the redemption date. At any time and from time to time on or after May 1, 2014, the Company may redeem the Notes, in whole or in part, at a redemption price equal to the percentage of principal amount set forth below plus accrued and unpaid interest to the redemption date:
Upon the occurrence of a change of control triggering event specified in the Indenture, the Company must offer to purchase the Notes at a redemption price equal to 101% of the principal amount thereof, plus accrued and unpaid interest, if any, to the date of purchase.
Simultaneously with the private placement, the Company entered into a registration rights agreement with the initial purchasers of the Notes (the “Registration Rights Agreement”). Under the Registration Rights Agreement, the Company was required to use its reasonable best efforts to cause a registration statement for substantially identical notes, which will be issued in exchange for the Notes, to be filed with the Securities and Exchange Commission (“SEC”) and to complete the exchange offer within 240 days after the issue date of the Notes.
iGATE CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2011
On Dec 13, 2011, the Company issued a prospectus made pursuant to the Registration Rights Agreement which granted the initial purchasers and any subsequent holders of the Notes certain exchange and registration rights. This exchange offer was intended to satisfy those exchange and registration rights with respect to the Notes. The Exchange Offer was completed and as of February, 14, 2012, all the Notes were tendered by the Note holders.
The Company incurred debt issuance costs amounting to $33.5 million, of which $3.7 million was amortized as of December 31, 2011. Of the balance of $29.8 million, $5.8 million is included in prepaid expenses and other current assets and $24.0 million is included in deposits and other assets. These costs are being amortized to interest expense over a period of five years using the effective interest method. Interest expense (including amortized debt issuance costs) on the Notes for the year ended December 31, 2011 was $50.3 million.
6. Cash and cash equivalents
Cash and cash equivalents comprises the following (in thousands):
As of December 31, 2011 and 2010, there were no restrictions on cash.
7. Investments
Short term investments comprise of the following (in thousands):
iGATE CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2011
Other investments, included in deposits and other assets, comprise of the following (in thousands):
Contractual maturities of short-term and other investments in available for sale securities as of December 31, 2011 was as follows (dollars in thousands):
Dividends from available for sale securities, gross realized gains and losses on sale of available for sale securities are as follows (dollars in thousands):
The changes in the net unrealized gain on marketable securities carrying value for the years ended December 31, 2011 and 2010 are as follows (in thousands):
iGATE CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2011
8. Accounts receivable
The following table provides details of the allowance for doubtful accounts as recorded by the Company (in thousands):
9. Derivative instruments and hedging activities
The following table presents information related to foreign currency contracts:
OUTSTANDING HEDGE TRANSACTIONS QUALIFYING FOR HEDGE ACCOUNTING AS OF DECEMBER 31, 2011 (in thousands)
iGATE CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2011
The forward contracts as of December 31, 2011 will all mature by March 31, 2013. As each contract matures, USDs, CADs, GBPs and EUROs are sold at each contracted strike price and equivalent Indian Rupees received. The outstanding contracts meet the qualifying criteria to receive hedge accounting and have been deemed to be effective. The option contracts as of December 31, 2011 will all mature by May 31, 2013. As each contract matures, the Company will sell USDs and CADs at each contracted strike price depending upon prevailing Rupee exchange rates. The outstanding contracts meet the qualifying criteria to receive hedge accounting and have been deemed to be effective. As a result, the Company has recorded gross accumulated other comprehensive loss of $18.9 million and gross accumulated other comprehensive gain of $0.8 million as of December 31, 2011 and 2010, respectively.
The unamortized premium on options amounted to $0 and $0.02 million and is disclosed as part of derivative asset as of December 31, 2011 and 2010, respectively, in the Consolidated Balance Sheet.
The estimated net amount of existing gains that is expected to be reclassified from accumulated other comprehensive income into earnings within the next twelve months is $8.4 million December 31, 2011.
OUTSTANDING HEDGE TRANSACTIONS NOT QUALIFYING FOR HEDGE ACCOUNTING AS OF DECEMBER 31, 2011 (in thousands)
iGATE CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2011
The effect of derivative instruments on the Consolidated Statements of Income for the year ended December 31, 2011 (in thousands):
The effect of Derivative Instruments on the Consolidated Statements of Income for the year ended December 31, 2010 (in thousands):
The effect of derivative instruments on the Consolidated Statements of Income for the year ended December 31, 2009 (in thousands):
Information on the location and amounts of derivative fair values in the Consolidated Balance Sheets (in thousands):
iGATE CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2011
Derivatives not designated as hedging instrument (dollars in thousands):
In January 2011, the Company entered into forward foreign exchange contracts to mitigate the risk of changes in foreign exchange rates on payments related to the Patni Acquisition. These contracts did not satisfy the criteria for hedge accounting. For the year ended December 31, 2011, the Company recorded a realized gain of $15.0 million on maturity of these forward contracts in May 2011.
In Septemeber 2011, the Company entered into a derivative contract to hedge a portion of its US$ packing credit facility (refer note 4). The Company did not designate this derivative contract as a hedge and accordingly the unrealized mark to market gain amounting to $1.4 million has been recorded in the consolidated statements of income.
Patni entered into foreign currency exchange contracts to hedge the fluctuations in foreign exchange rates for recognized balance sheet items such as inter-company and end customer receivables, and were not originally designated as hedges. Realized losses and changes in the fair value of these derivatives totaling to ($17.3) million is recorded in foreign exchange (gains) losses, net in the consolidated statements of income.
10. Prepaid expenses and other current assets
Prepaid expenses and other current assets consist of the following (in thousands):
iGATE CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2011
11. Property and equipment, net
Property and equipment consist of the following (in thousands):
Depreciation expense on property and equipment amounted to $30.9 million, $8.2 million and $6.7 million during the years ended December 31, 2011, 2010 and 2009, respectively. Leased assets amounted to $1.1 million and $1.3 million as of December 31, 2011 and 2010, respectively and accumulated depreciation on such assets amounted to $0.5 million and $0.5 million as of December 31, 2011 and 2010, respectively.
12. Goodwill and intangible assets
The changes in the carrying value of goodwill for the years ended December 31, 2011 and 2010 (in thousands):
The changes in the carrying value of intangible assets for the years ended December 31, 2011 and 2010 (in thousands):
iGATE CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2011
As of December 31, 2011, intangible assets comprise of the following (in thousands):
Customer relationships and intellectual property rights are amortized over a weighted average period of 7.6 years and 2.9 years, respectively.
Amortization expense related to identifiable intangible assets was $7.8 million, $0.8 million and $0.9 million for the years ended December 31, 2011, 2010 and 2009, respectively. Future estimated annual amortization is as follows (in thousands):
13. Leases
The Company leases vehicles, certain networking components and office equipments under capital leases which are secured by a lien of the underlying asset. Future minimum rental payments as of December 31, 2011 (in thousands):
iGATE CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2011
The Company conducts its operations using facilities under non-cancellable operating lease agreements that expire at various dates. Future minimum lease payments under these agreements are as follows (in thousands):
Rent expense under cancellable and non-cancellable operating leases were $9.6 million, $4.5 million and $4.3 million for the years ended December 31, 2011, 2010 and 2009, respectively.
14. Other accrued liabilities
Other accrued liabilities consist of the following (in thousands):
15. Accumulated other comprehensive income (loss)
The components of accumulated other comprehensive income (loss) was as follows (in thousands):
16. Employee benefit plan
Defined Contribution Plan
The Company’s contribution to the Provident Fund for the years ended December 31, 2011, 2010 and 2009 was $6.3 million, $2.4 million, and $1.9 million, respectively.
iGATE CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2011
Defined Benefit Plan
iGATE Global and Patni provide for gratuity, a defined benefit retirement plan covering eligible employees in India. Liabilities with regard to the plan are determined by actuarial valuation. The following table sets forth the net periodic cost recognized in respect of such plans (in thousands):
Change in benefit obligation (in thousands):
Change in fair value of plan assets (in thousands):
Funded status (in thousands):
iGATE CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2011
The weighted average assumptions used in accounting for the Gratuity Plan for the years ended December 31, 2011, 2010 and 2009 are presented below:
iGATE Global
Patni
The Company evaluates these assumptions annually based on its long-term plans of growth and prevalent industry standards. The estimates of future salary increases, considered in the actuarial valuation, take account of historical compensation increases, inflation rate, seniority, promotions and other relevant factors such as supply and demand factors in the employment market. The discount rate is based on the corporate bond rates in India. The expected rate of return on the plan assets has been determined considering the plan asset allocation, historical rates of return earned on such plan assets and current market trends. Plan assets are primarily invested in long-term fixed income securities and to a lesser extent in money market funds.
Unrecognized actuarial loss is amortized over the average remaining service period of the employees expected to receive benefits under the plan.
The following benefit payments reflect expected future service, as appropriate, which are expected to be paid during the years shown (in thousands):
iGATE CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2011
Plan assets - Fund allocation: iGATEGlobal
Plan assets - Fund allocation: Patni
Investment strategy - The objective is to ensure that the defined benefit plan assets will be sufficient to fund the defined benefit obligations in the long-term and to meet the current defined benefit obligations while simultaneously managing the risk.
Risk Management - The Company mitigates the return risk or interest rate risk by allocating the plan assets in various fixed income securities which has low or moderate risk. The plan assets are managed through professionally qualified investment managers. The fund allocation and the performance of the fund is reviewed on a monthly basis and rebalancing is done, if warranted. The actual allocation of funds may differ from the target allocation depending on the current requirements of the cash flows.
Fair value - ASC 820 “Fair value measurements”, establishes a three-tier value hierarchy, which prioritizes the inputs used in the valuation methodologies in measuring fair value:
Level 1 - Observable inputs that reflect quoted prices (unadjusted) for identical assets or liabilities in active markets.
Level 2 - Includes other inputs that are directly or indirectly observable in the marketplace.
Level 3 - Unobservable inputs which are supported by little or no market activity.
In accordance with ASC 820, the Company measures plan asset investments at fair value and is classified within Level 1 or 2. This is because the investments are in debt instruments involving fixed income securities and money market instruments that are principally valued using quoted market prices.
Accumulated benefit obligation was $6.4 million and $0.6 million, respectively, at December 31, 2011 and 2010. The contribution likely to be made during 2012 is $2.5 million.
iGATE CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2011
Director pension benefits
Two former founder directors of Patni India are entitled to receive pension benefits upon retirement or on termination from employment at the rate of 50% of their last drawn monthly salary. The pension is payable from the time the eligible individual reaches the age of 65 years and is payable to the respective individual or the surviving spouse. In 2011, Patni settled the pension liability of one of the founder directors by purchasing a non-participating annuity contract. The funding discharges Patni of all future pension obligations to this individual.
For the other founder director, the payment of pension will start when he reaches the age of 65. The Company has invested in a plan with Life insurance Corporation of India which will mature at the time this founder director will reach age of 65. Since the Company is obligated to fund the shortfall, if any, between annuity payable and the value of plan asset, the pension liability is actuarially valued at each balance sheet date.
With regard to Patni’s founder directors pension plans, the following table sets forth the plan’s funded status and amounts recognized in the it’s consolidated balance sheet (in thousands).
iGATE CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2011
Key weighted average assumptions used to determine benefit obligation for Patni’s founder directors pension plan were as follows:
The Plan asset is invested with Life Insurance Corporation of India which in turn has invested the funds in Government Security funds and are classified as Level 2.
Net periodic pension cost included the following components (in thousands):
Key weighted average assumptions used to determine net periodic pension cost for the the former founder directors plan were as follows:
The expected benefit payments for next ten years are as follows (in thousands):
A former founder and executive director with Patni USA is entitled to receive pension benefits upon retirement or on termination from employment at the rate of 50% of his last drawn monthly salary. The pension is payable from the time the eligible individual reaches the age of 71 years and is payable to the respective individual or the surviving spouse. In 2011, the Company settled the pension liability by funding a non participating annuity contract. The funding discharges the Company of all future pension obligations to this individual.
iGATE CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2011
With regard to the former founder and executive director’s pension plan, the following table sets forth the plan’s funded status and amounts recognized in the Company’s consolidated balance sheet (in thousands).
As of December 31, 2011, the pretax amounts in accumulated other comprehensive loss, not yet recognized as a component of net periodic pension costs consists of actuarial loss of zero. The estimated actuarial loss that will be amortized from other comprehensive loss in net periodic pension cost in fiscal 2012 is zero.
17. Stock Based Compensation
Stock-based compensation cost in cost of revenues for the years ended December 31, 2011, 2010 and 2009 was $2.3 million, $1.7 million and $2.1 million, respectively. Stock-based compensation cost included within selling, general and administrative expenses for the years ended December 31, 2011, 2010 and 2009 was $8.4 million, $5.0 million and $3.1 million, respectively. The Company has recognized a related tax (expense) benefit associated with its share-based compensation arrangements for the years ended December 31, 2011, 2010 and 2009 of $630, $341 and $(78), respectively.
iGATE Corporation Stock Incentive Plans
During 2000, the Company adopted the Second Amended and Restated Stock Incentive Plan (the “1996 Plan”). The 1996 Plan provided that up to 14.7 million shares of the Company’s common stock shall be allocated for issuance to directors, executive management and key personnel. This plan expired by its terms on November 3, 2006 and no options have been granted under the 1996 Plan since this date.
On May 25, 2006, the 2006 iGATE Corporation Stock Incentive Plan (the “2006 Plan” and together with the 1996 Plan, the “iGATE Plans”) were approved by the Company’s shareholders. The 2006 Plan replaced the expired 1996 Plan. Revisions were made primarily to address changes in applicable law since 2000. The 2006 Plan provides that up to 14.7 million shares of the Company’s common stock shall be allocated for issuance to officers, employees, directors and consultants of the Company and its subsidiaries. At December 31, 2011, there were 7.1 million shares of common stock available for issuance under the 2006 Plan.
iGATE CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2011
A summary of the stock option and restricted stock activity is presented below:
iGATE CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2011
During 2011, 2010 and 2009, options covering a total of 0.2 million, 0.7 million and 0.9 million shares, respectively, of Common Stock were granted under the iGATE Plans. Options generally expire ten years from the date of the original grant or earlier if an option holder ceases to be employed by or associated with the Company for any reason.
During 2011, 2010 and 2009, the Company granted 2.0 million, 0.3 million and 0.2 million shares of restricted stock, respectively. Restricted stock grants generally vest over a four year period. Upon vesting, these shares have voting rights.
On March 30, 2010, the Compensation Committee (“Committee”) approved a grant of 0.1 million restricted stock to the Chief Executive Officer covering the performance period from January 1, 2010 through December 31, 2012. For this grant, the Committee approved a performance/payout scale that provides for payouts ranging from 0% to 200% of achievement of target 3-year EPS growth. The stock based compensation expense recorded relating to this grant amounted to $0.2 million and $0.5 million for the year ended December 31, 2011 and 2010, respectively.
On May 12, 2011 and June 15, 2011, the Compensation Committee awarded grants of 1.5 million performance based restricted award grants to certain Executive Committee Members and other employees . These awards will vest only if the Company attains specified twelve-month trailing adjusted EBITDA goals at any fiscal quarter, beginning with the quarter ending December 31, 2011, within the five year period of January 1, 2011 through December 31, 2015. If the Company achieves its maximum twelve-month trailing adjusted EBITDA goal at any eligible fiscal quarter end within this performance period, two times the target number of shares will vest. The stock based compensation expense recorded relating to this grant amounted to $2.2 million for the year ended December 31, 2011.
The total intrinsic value of options exercised during 2011, 2010 and 2009 was $2.0 million, $8.2 million and $4.7 million, respectively. The fair value of stock options vested during 2011, 2010 and 2009 was $6.5 million, $6.7 million and $5.2 million, respectively. The income tax (expense) benefit classified as a financing cash inflow for 2011, 2010 and 2009 was $0, $0.3 million and $(0.1 million), respectively.
iGATE CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2011
As of December 31, 2011, approximately $36.3 million of unrecognized compensation cost is expected to be recognized for the unvested shares. This expense is expected to be recognized over a weighted-average period of 2.7 years as of December 31, 2011.
iGATE Stock Options Outstanding as of December 31, 2011:
1996 Plan
2006 Plan
iGATE Global Stock Option Plans
iGATE Global maintains two employee stock option plans herein referred to as “Plan 1” and “Plan 2” and collectively the “iGATE Global Plans”. The iGATE Global Plans are administered by a committee appointed by the Board of Directors of iGATE Global. Plan 1 provides for the issuance of a maximum of 3 million shares of iGATE Global common stock and Plan 2 provides for the issuance of a maximum of 4.5 million shares of iGATE Global common stock. Options to purchase iGATE Global common stock are typically granted at the prevailing market values for each of the iGATE Global Plans. The Company does not expect to make future grants from the iGATE Global Plans.
iGATE CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2011
Options granted under the iGATE Global Plans generally vest over a four year period and expire ten years from the date of grant or earlier if an option holder ceases to be employed with iGATE Global, its holding company or any of its subsidiary companies.
There are no options outstanding under Plan 2.
iGATE Global also maintains an employee restricted stock unit plan herein referred to as (“RSU Plan”). The RSU Plan is administered by a committee appointed by the Board of Directors of iGATE Global. The RSU Plan is a separate plan providing for the issuance of a maximum of 3.0 million shares of iGATE Global common stock. These restricted stock units are granted at a $0.09 strike price. Restricted stock unit grants for the RSU Plan generally vest over a four year period and expire ten years from the date of grant or earlier if a holder ceases to be employed by or associated with iGATE Global for any reason. The Company does not expect to make future grants from the RSU Plan.
The fair value of grants under the RSU plan was estimated using the prevailing market value of iGATE Global common stock at the date of grant. The fair value is then amortized on a straight-line basis over the requisite service periods of the awards, which is generally the vesting period. A forfeiture rate is also applied to the estimated compensation cost of the granted restricted stock units. Forfeitures are estimated based on voluntary termination behavior, as well as an analysis of actual option forfeitures.
iGATE CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2011
As of December 31, 2011, no additional compensation cost is expected to be recognized under the iGATE Global Plans.
The fair value of each option grant under the iGATE Plans and the iGATE Global Plans was estimated using the Black-Scholes option pricing model. The fair value is then amortized on a straight-line basis over the requisite service periods of the awards, which is generally the vesting period. Use of a valuation model requires management to make certain assumptions with respect to selected model inputs. Expected volatility was calculated based on the historical volatility of either iGATE or iGATE Global common stock and volatility derived from exchange traded shares. The average expected life was based on the contractual term of the option and expected employee exercise and post-vesting employment termination behavior. The risk-free interest rate was based on U.S. Treasury zero-coupon issues with a remaining term equal to the expected life assumed at the date of grant. The risk-free rate for each of the iGATE Global Plans was based on an equivalent Indian risk-free rate. Forfeitures are estimated based on voluntary termination behavior, as well as an analysis of actual option forfeitures.
Patni Stock Option Plans
On June 30 2003, Patni established the Patni ESOP 2003 plan (the “2003 ESOP Plan”). Under the 2003 ESOP Plan, Patni is authorized to issue up to 11,142,085 equity shares to eligible employees. Employees covered by the 2003 ESOP Plan are granted an option, which may be based on service or performance criteria, to purchase shares of Patni subject to the requirements of vesting. The options vest in a graded manner from one year to four years and expire at the end of five years from the date of vesting. The compensation committee constituted by the Board of Directors of Patni administers the 2003 ESOP Plan. The 2003 ESOP Plan has been amended to enable Patni to issue up to 2,000,000 ADR linked options (wherein one ADR linked option is equal to two equity shares of Patni) to its employees.
In June 2009, the shareholders authorized Patni to issue upto an additional 8,000,000 equity shares to eligible employees under the 2003 ESOP Plan (hereinafter referred to as the “ESOP Plan”).
The fair value of outstanding options at the date of the Patni Acquisition amounted to $18.2 million using the Black-Scholes-Merton option pricing model. The fair value of vested options and fair value of unvested options attributable to the pre-combination service period aggregating $13.9 million was included as part of non-controlling interest and recorded as a component of purchase consideration. The fair value of unvested options attributable to post-combination service period amounting to $4.3 million will be recorded as stock-based compensation cost on a straight line basis over the remaining vesting/service period.
The weighted average grant date fair value of options granted during the year ended December 31, 2011 was $6.00 for equity linked options and $12.99 for ADR linked options, respectively.
iGATE CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2011
Stock options activity under the ESOP Plan is as follows:
During the period from May 16, 2011 through December 31, 2011, 0.02 million restricted shares were granted which generally vest over a 4 year period.
The total intrinsic value of options exercised for the period May 16, 2011 through December 31, 2011 was $5.8 million. The fair value of stock options vested for the period May 16, 2011 through December 31, 2011 was $11.4 million.
As of December 31, 2011, approximately $0.6 million of unrecognized compensation cost is expected to be recognized for the unvested shares. This expense is expected to be recognized over a weighted-average period of 2 years as of December 31, 2011.
The weighted-average assumptions used in the Black-Scholes option pricing model are as follows:
iGATE CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2011
18. Earnings per share
Earnings per share for the common stock, unvested restricted stock and the Series B Preferred Stock under the two class method are presented below (dollars and shares in thousands, except per share data):
iGATE CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2011
The number of outstanding options to purchase common shares for which the option exercise prices exceeded the average market price of the common shares aggregated 0.5 million, 0.6 million and 0.5 million shares for the years ended December 31, 2011, 2010 and 2009, respectively. These options were excluded from the computation of diluted earnings per share under the treasury stock method. The number of shares of outstanding Series B Preferred Stock for which the earnings per share exceeded the earnings per share of common stock aggregated to 17.3 million shares as of December 31, 2011. These shares were excluded from the computation of diluted earnings per share for the year ended December 31, 2011 as they were anti-dilutive.
19. Other income, net
Components of other income, net are as follows (in thousands):
20. Income taxes
The components of income (loss) from continuing operations before income taxes, as shown in the accompanying consolidated statements of income, consists of the following (in thousands):
The provision (benefit) for income taxes from continuing operations consists of the following (in thousands):
iGATE CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2011
The reconciliation of income taxes computed using the statutory U.S. income tax rate and the provision for income taxes from continuing operations is as follows (in thousands):
Under the Indian Income-tax Act, 1961, the Company’s Indian subsidiaries are eligible to claim a tax holiday for 10 consecutive assessment years on profits derived from the export of software services from divisions registered under the Software Technology Parks at Bangalore, Chennai and Noida. The tax holiday expired on 31st March 2011. For the years ended December 31, 2011, 2010 and 2009, the tax holiday resulted in income tax benefits of $3.2 million, $13.0 million and $8.1 million respectively, when calculated at the statutory US rate. Non-operating income, such as interest income and capital gains income along with operating income to the extent of expiry of tax holiday is not included in the tax holiday, and has been considered as part of our income tax provision.
Under the Indian Income-tax Act, 1961, iGATE Global and Patni are eligible to claim income tax holiday of 100% for the initial five consecutive assessment years followed by 50% for the subsequent ten consecutive assessment years on the profits derived from the export of software services from the divisions registered under the SEZ. For the years ended December 31, 2011 and 2010, the tax holiday benefits were $7.4 million (including $2.4 million for Patni) and $4.1 million respectively, when calculated at the statutory US rate.
The basic earnings per share effect of the tax holiday is $0.14, $0.30 and $0.18 respectively, for the years ended December 31, 2011, 2010 and 2009. The diluted earnings per share effect of the tax holiday is $0.19, $0.30 and $0.17 respectively, for the years ended December 31, 2011, 2010 and 2009.
During 2011, an amount of $3.9 million has been recognized as a deferred tax asset on certain tax losses in view of the favorable decision from Karnataka High Court.
The US branch of the Company’s Indian subsidiary has approximately $8.8 million of net operating losses (NOL) available to offset future federal and state taxable income. These losses are due to expire between the years of 2024 and 2031.
The Company conducts its business globally, and, as a result, the Company and some of its subsidiaries file income tax returns in India, the US., and various foreign jurisdictions. The tax years ended March 31, 2009 to March 31, 2011 remain open to examination by the Indian tax authorities. The Company is no longer subject to U.S. federal tax examinations by tax authorities for years before 2007 with regard to the Company’s US branch and with regard to the Company’s US entities.
iGATE CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2011
The components of the deferred tax assets and liabilities were as follows (in thousands):
The Company has not provided for U.S. deferred income taxes or foreign withholding tax on basis differences in its non-U.S. subsidiaries, other than Patni of $50.8 million, that result primarily from undistributed earnings the Company intends to reinvest indefinitely. Determination of the deferred income tax liability on these basis differences is not practicable because such liability, if any, is dependent on circumstances existing if and when remittance occurs.
The Company has established a partial valuation allowance against its deferred tax assets, due to uncertainty regarding their future realization. In assessing the realizability of its deferred tax assets, management considers the projected future taxable income and tax planning strategies. As a result, the Company has created a valuation
iGATE CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2011
allowance for deferred tax assets at entities or units that have been unprofitable and where it believes that such assets may not be utilized in the near term.
The change in the total valuation allowance for deferred tax assets as of December 31, 2011, 2010 and 2009 is as follows (in thousands):
Additions during the year includes amount added on account of Patni acquisition amounting to $13.6 million (an amount of $1 million is the movement in the valuation allowance for Patni).
ASC 740-10-Reserves:
As of December 31, 2011, an amount of $ 30.2 million is the ASC 740-10-Reserve with respect to our Patni subsidiary. A reconciliation of the beginning and ending amount of unrecognized tax benefits is as follows (in thousands):
The Company recognizes interest related to uncertain tax positions within the interest expense line in the consolidated statements of income. The US branch of Patni’s subsidiary has $0.5 million as accrued interest related to uncertain tax positions for the year ended December 31, 2011. At December 31, 2011, the total amount of accrued interest in the consolidated balance sheet amounted to 1.3 million. There are no penalties as of December 31, 2011. During the current year, an amount of $7.6 million is reversed by the US branch of Patni’s subsidiary on account of expiry of the statute of limitations relating to year ended March 2008.
As of December 31, 2011, the Company had $25.3 million of net unrecognized tax benefits arising out of the tax positions which would affect the effective tax rate, if recognized. The company’s unrecognized tax benefit largely includes the provision made in the US for onsite activity, which would be contingent to IRS audit review. The nature of the events that would cause the change to the reserves will be mainly due to the ‘expiry of the statute of limitation in US. Although, it would be difficult to anticipate the final outcome on timing of resolution of any particular uncertain tax position, the Company believes that the total amount of unrecognized tax benefits will be decreased by $7.2 million during the next 12 months due to expiry of statute of limitation.
iGATE CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2011
Election of Patni Acquisition as a Qualified Stock Purchase
The Company’s acquisition of Patni qualified as a qualified stock purchase or QSP. iGATE calculated the U.S. income tax basis earnings and profits and foreign (non-US) tax pools for Patni. Based on such calculations, we have provided US$ 6.9 million of current tax on our U.S. subsidiary, iGATE Technologies Inc (iTI)’s share of Indian subsidiary, Patni’s undistributed earnings for the post-acquisition period May 16, 2011 through December 31, 2011. This calculation will be re-visited on a quarterly basis.
21. Share capital
On May 5, 2011, the Company’s shareholders approved an amendment to increase the number of authorized shares of Common Stock issuable under the articles of incorporation from 100,000,000 to 700,000,000.
22. Segment information
Following the Patni Acquisition, the Company’s Chief Executive Officer, who is the chief operating decision maker, determined that the business will be operated and managed through the following segments: (a) iGATE Corporation and its subsidiaries other than Patni and (b) Patni. The consolidated financial results include the Patni results with effect from May 16, 2011. As a result, no comparative information is provided for the Patni segment for the years ended December 31, 2010 and 2009.
The following table presents selected financial information for the Company’s reporting segments for the years ended December 31, 2011, 2010 and 2009 respectively (in thousands):
The Patni segment accounted for $473.4 million of revenues (net of intercompany revenues of $6.0 million) for the period from May 16, 2011 through December 31, 2011. The iGATE segment accounted for $306.2 million of revenues (net of intercompany revenues of $1.3 million) for the year ended December 31, 2011.
iGATE CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2011
Total assets by segment were as follows (in thousands):
Revenues based on the location of the customer and fixed assets by geographic area consisted of the following (in thousands):
The following is a concentration of revenues greater than 10% for the periods shown:
The Company accounts for multiple contracts (statement of works) with RBC and GE as separate arrangements, since each of these arrangements are negotiated separately. The receivables from these customers comprised 25% and 45% of net billed and unbilled receivables as of December 31, 2011 and 2010, respectively.
iGATE CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2011
23. Related party transactions
The Company has advanced employees $1.8 million and $1.5 million as of December 31, 2011 and 2010, respectively. These advances are primarily given for initial conveyance and living expenses while on travel.
As of December 31, 2011, Sunil Wadhwani directly owned 10,621,551 common shares of the Company and indirectly owned 1,880,124 common shares of the Company through two family trusts and one family foundation.
As of December 31, 2011, Ashok Trivedi directly owned 10,714,082 common shares of the Company and indirectly owned 1,787,593 common shares of the Company through one family trust.
Messrs. Wadhwani and Trivedi have leased out to iGATE Global four apartments owned jointly and individually by them in Chennai, India, which were used as guesthouses by iGATE Global. The total rent paid was $1,700 ($850 each is paid to Mr. Wadhwani and Mr. Trivedi) for the year ended December 2010. This lease was terminated in April 2010.
Sunil Wadhwani and Ashok Trivedi also own a significant interest in Mastech Holdings, Inc. The transactions with Mastech Holdings Inc. are as follows (in thousands):
The balances receivable from related parties are summarized as follows (in thousands):
24. Guarantor Subsidiaries - Supplemental condensed consolidating financial information
In connection with the consummation of the Patni Acquisition, the Company issued Notes which are the senior unsecured obligations of the Company. The Notes are guaranteed by the Company’s wholly owned domestic subsidiaries iGATE Technologies Inc., iGATE Inc. and iGATE Holding Corporation (collectively, the “Guarantors”). The Company has not included separate financial statements of the Guarantors because they are wholly-owned by the Company, the guarantees issued are full and unconditional, and the guarantees are joint and several.
iGATE CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2011
Condensed consolidating financial information for the Company and the Guarantors are as follows (in thousands):
CONDENSED CONSOLIDATED BALANCE SHEETS
AS OF DECEMBER 31, 2011
iGATE CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2011
CONDENSED CONSOLIDATED BALANCE SHEETS
AS OF DECEMBER 31, 2010
iGATE CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2011
CONDENSED CONSOLIDATED STATEMENTS OF INCOME
FOR THE YEAR ENDED DECEMBER 31, 2011
CONDENSED CONSOLIDATED STATEMENTS OF INCOME
FOR THE YEAR ENDED DECEMBER 31, 2010
iGATE CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2011
CONDENSED CONSOLIDATED STATEMENTS OF INCOME
FOR THE YEAR ENDED DECEMBER 31, 2009
iGATE CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2011
CONDENSED CONSOLIDATED STATEMENT OF CASH FLOWS
FOR THE YEAR ENDED DECEMBER 31, 2011
iGATE CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2011
CONDENSED CONSOLIDATED STATEMENT OF CASH FLOWS
FOR THE YEAR ENDED DECEMBER 31, 2010
iGATE CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2011
CONDENSED CONSOLIDATED STATEMENT OF CASH FLOWS
FOR THE YEAR ENDED DECEMBER 31, 2009
iGATE CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2011
25. Commitments and contingencies
Capital commitments
As of December 31, 2011, the Company has open purchase orders totaling $3.2 million to purchase property and equipment.
Bank guarantees
As of December 31, 2011, guarantees and letter of credit provided by banks on behalf of iGATE Global to customs authorities and vendors for capital procurements aggregated to $1.9 million. These guarantees and letters of credit have a remaining expiry term of approximately one to three years.
Other commitments
The Company has entered into a service agreement with a customer that provides a customer the option, exercisable at any time by providing 60 days’ notice to the Company to acquire an equity stake of up to 7% of the outstanding voting shares at fair market value. The fair market value is the volume weighted average trading price of the Company’s shares on the NASDAQ National Market for five consecutive trading days immediately before the date on which the customer delivers its notice under the option. The option does not restrict the customer in any way from buying the Company shares in the open market. The service agreement also requires the Company to register the shares upon exercise of option by the customer and there are no events or circumstances that would require the Company to transfer consideration under the agreement.
Contingencies
Income taxes - iGATE Global
At December 31, 2011, iGATE Global has an open tax demand of $2.2 million for assessment years 2004-05, 2007-08 and 2008-09. In all the above assessment orders, demand is raised mainly on account of disallowance of certain 10A benefits. Although the Company has paid an amount of $1.9 million in relation to these demands, which are pending at various levels of appeals, management considers these disallowances as not tenable against the Company, and therefore no provision for tax contingencies has been established related to unpaid amounts.
Income taxes - Patni
Patni has received Income Tax Demand orders, amounting to $ 101.68 million for the assessment years 2002-03, 2003-04, 2004-05, 2005-06, 2006-07 and 2007-08. The assessment orders demand is raised mainly on account of disallowance of certain 10A benefits and transfer pricing adjustment on account of interest on delayed recoveries from associated enterprises and BPO operation. Although the Company has paid an amount of $5.75 million related to these demands,which are pending at various levels of appeals, management considers these disallowances as not tenable against the Company, and therefore no provision for tax contingencies has been established related to unpaid amounts.
In December 2011, Income Tax department has issued a draft assessment order for assessment year 2008-09 disallowing the tax benefits under section 10A of the Indian Income Tax Act as per the earlier assessments, as well as making a transfer pricing adjustment for delayed recoveries from the associated enterprises. The Company has filed the objections against the draft order before the Dispute Resolution Panel (“DRP”) newly set up under the Income Tax Act. Management considers these disallowances as not tenable against the Company, and therefore no provision for tax contingencies has been established.
iGATE CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2011
The Company is involved in lawsuits and claims which arise in ordinary course of business. Management believes that the ultimate outcome of these matters will not have a material adverse impact on its financial position, results of operations and cash flows.
26. Fair Value Measurements
FASB ASC Topic 820“Fair Value Measurements” establishes a three-tier value hierarchy, which prioritizes the inputs used in the valuation methodologies in measuring fair value:
Level 1 - Observable inputs that reflect quoted prices (unadjusted) for identical assets or liabilities in active markets.
Level 2 - Includes other inputs that are directly or indirectly observable in the marketplace.
Level 3 - Unobservable inputs which are supported by little or no market activity.
The fair value hierarchy also requires an entity to maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value.
In accordance with ASC 820, assets and liabilities are to be measured based on the following valuation techniques:
Market approach - Prices and other relevant information generated by market transactions involving identical or comparable assets or liabilities.
Income approach - Converting the future amounts based on the market expectations to its present value using the discounting methodology.
Cost approach - Replacement cost method.
iGATE CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2011
Assets and liabilities measured at fair value are summarized below (in thousands):
iGATE CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2011
Investments
The Company’s investments consist primarily of investment in debt linked mutual funds and certificates of deposit with banks. Fair value of debt linked mutual funds are based on prices as stated by the issuers of mutual funds and are classified as Level 1 or 2 after considering whether the fair value is readily determinable. Fair value of investments in certificate of deposits, classified as available for sale, is determined using observable market inputs and are classified as Level 2.
Assets and liabilities not measured at fair value
The fair value of Company’s current assets and current liabilities approximate their carrying value because of their short-term maturity. Such financial instruments are classified as current and are expected to be liquidated within the next twelve months. The fair value of capital lease obligations has been estimated by discounting cash flows based on current rate available to the Company for similar types of borrowing arrangements. The fair value and carrying value of capital lease obligations is set out below (in thousands):
27. Quarterly Financial Information (Unaudited)
The following table sets forth certain unaudited financial information for each of the quarters indicated below and, in the opinion of management, contains all adjustments, consisting only of normal recurring adjustments, if necessary, for a fair presentation thereof. Earnings per share amounts for each quarter are required to be computed independently, and therefore may not equal the amount computed for the entire year.
iGATE CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2011
28. Subsequent Events
Proposed acquisition of remaining stake of Patni and delisting from the Stock Exchanges
On November 16, 2011, Pan-Asia and iGATE Global (collectively the “Promoters”), subsidiaries of the Company announced that they were initiating the process of voluntarily delisting the equity shares of Patni from the Indian Stock Exchanges and the ADSs from the New York Stock Exchange. The delisting offer (the “Delisting Offer”) involves a price discovery mechanism, which is known in India as the “Reverse Book Building Process.” The offer price (the “Offer Price”) (i.e., the price at which the shares of the Public Shareholders are to be purchased pursuant to the Delisting Offer) is determined after establishment of a statutorily prescribed “floor price,” which is determined in accordance with Delisting Regulations. The floor price for the Delisting Offer is Rs. 356.74. In accordance with the Indian Delisting Regulations, the Promoters made the Public Announcement on March 14, 2012 relating to an offer to purchase the remaining publicly traded equity shares of Patni. The Public Announcement gives details of the Delisting Offer and the period during which it would be open. The entire process including payment of consideration to the shareholders who have validly tendered shares would take up to 30 to 60 days while the actual delisting from the exchanges would take up to 60 to 90 days, from the date of the public announcement. As of March 9, 2012, Patni stock closed at Rs. 475.45, Rs. 475.50 and $19.20 on the NSE, BSE and NYSE respectively.
Financing arrangement
On March 8, 2012 (the “Closing Date”), Pan-Asia entered into a credit agreement (the “Credit Facility”) for a secured term loan facility with the lenders named therein and DBS Bank Ltd., Singapore, as administrative agent (the “Administrative Agent”).
The Credit Facility has a commitment amount of $215.0 million and matures on May 8, 2014. The Credit Facility contains customary representations and warranties, events of default and affirmative and negative covenants, and does not contain any financial covenants. The borrowing under the Credit Facility carries an annual interest rate of LIBOR plus applicable margin varying from 2.8% to 3.2% for terms extending from 0 to 27 months. The facility is secured through a pledge of iGATE Technologies’ equity interests in Pan-Asia representing an indirect interest in Patni of up to 65%. The Company, along with several of its wholly owned subsidiaries, has entered into a Guaranty (the “Guaranty”) with the Administrative Agent, under which the Company has guaranteed all of the obligations of Pan-Asia under the Credit Facility.
After the Closing Date, the Credit Facility will be available to finance Pan-Asia’s purchase of the remaining publicly traded equity shares of Patni.
Other
In January 2012, service tax authorities in India have issued a notice to Patni asking it to make additional payment of service tax amounting to approximately $1 million plus interest for delayed payment. The Company is in the process of responding to this notice and based on its assessment believes that these demands are not tenable against the Company, and therefore no provision for this tax contingency has been established.
The Company has evaluated subsequent events though the date of filing the financial statements and no events, other than what has been disclosed above, has occurred from the balance sheet date through that date that would impact the Consolidated Financial Statements.
ITEM 9.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
Not Applicable.
ITEM 9A.
ITEM 9A. CONTROLS AND PROCEDURES
Disclosure Controls and Procedures
The Company maintains disclosure controls and procedures that are designed to ensure that information required to be disclosed in the reports that the Company files or submits under the Securities Exchange Act of 1934 is recorded, processed, summarized, and reported within the time periods specified in the SEC’s rules and forms, and that such information is accumulated and communicated to the Company’s management, including its Chief Executive Officer and Chief Financial Officer, as appropriate, to allow timely decisions regarding required disclosure.
As of the end of the period covered by this report, the Company carried out an evaluation, under the supervision and with the participation of Company management, including the Chief Executive Officer and the Chief Financial Officer, of the effectiveness of the design and operation of the Company’s disclosure controls and procedures pursuant to the Securities Exchange Act of 1934 (“Exchange Act”) Rules 13a-15(b) and 15d-15(b). Based upon, and as of the date of this evaluation, the Chief Executive Officer and the Chief Financial Officer concluded that the Company’s disclosure controls and procedures were effective. The results of management’s assessment were reviewed with the Company’s Audit Committee.
The certification required by Section 302 of the Sarbanes-Oxley Act of 2002 are filed as exhibits 31.01 and 31.02, respectively, to this Annual Report on Form 10-K.
Management’s Report on Internal Control over Financial Reporting
Management of the Company is responsible for establishing and maintaining adequate internal control over financial reporting. The Company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. Internal control over financial reporting includes maintaining records that in reasonable detail accurately and fairly reflect our transactions; providing reasonable assurance that transactions are recorded as necessary for preparation of our financial statements; providing reasonable assurance that receipts and expenditures of company assets are made in accordance with management authorization; and providing reasonable assurance that unauthorized acquisition, use, or disposition of company assets that could have a material effect on our financial statements would be prevented or detected on a timely basis. Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become ineffective because of changes in conditions or that the degree of compliance with established policies or procedures may deteriorate.
The Company’s management, including the Company’s Chief Executive Officer and Chief Financial Officer, conducted an evaluation of the effectiveness of the Company’s internal control over financial reporting as of December 31, 2011. In making its assessment of internal control over financial reporting, management used the criteria described in the Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission.
Based upon this assessment, management has concluded and hereby reports that the Company’s internal control over financial reporting was effective as of December 31, 2011. There were no changes in our internal control over financial reporting during the quarter ended December 31, 2011 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.
The Company’s independent registered public accounting firm, Ernst & Young, has issued its report on the effectiveness of the Company’s internal control over financial reporting.
Report of Independent Registered Public Accounting Firm
The Board of Directors and Shareholders of iGATE Corporation
We have audited iGATE Corporation’s internal control over financial reporting as of December 31, 2011, based on criteria established in Internal Control - Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (the COSO criteria). iGATE Corporation’s management is responsible for maintaining effective internal control over financial reporting, and for its assessment of the effectiveness of internal control over financial reporting included in the accompanying Management Report on Internal Control Over Financial Reporting. Our responsibility is to express an opinion on the company’s internal control over financial reporting based on our audit.
We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, testing and evaluating the design and operating effectiveness of internal control based on the assessed risk, and performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion.
A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
In our opinion, iGATE Corporation maintained, in all material respects, effective internal control over financial reporting as of December 31, 2011, based on the COSO criteria.
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the 2011 consolidated financial statements of iGATE Corporation and our report dated March 14, 2012 expressed an unqualified opinion thereon.
/s/ Ernst & Young
Gurgaon, India
March 14, 2012
ITEM 9B.
ITEM 9B. OTHER INFORMATION
None
PART III
ITEM 10.
ITEM 10. DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE
Information required by this Item, not set forth below, is incorporated herein by reference from the Company’s definitive proxy statement relating to the 2012 Annual Meeting of Shareholders scheduled to be held on April 13, 2012, which will be filed with the SEC within 120 days after the close of the Company’s fiscal year ended December 31, 2011 (the “Proxy Statement”).
ITEM 11.
ITEM 11. EXECUTIVE COMPENSATION
The information required by this Item is incorporated by reference to the Proxy Statement.
ITEM 12.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS
The information required by this Item is incorporated by reference to the Proxy Statement.
ITEM 13.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE
The information required by this Item is incorporated by reference to the Proxy Statement.
ITEM 14.
ITEM 14. PRINCIPAL ACCOUNTING FEES AND SERVICES
The information required by this Item is incorporated by reference to the Company’s Proxy Statement.
PART IV
ITEM 15.
ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES
(a) l. Financial Statements
The following Consolidated Financial Statements of the registrant and its subsidiaries are included on pages 60 to 64 and the report of Independent Registered Public Accounting Firm is included on page 59 in this Form 10-K.
Report of Independent Registered Public Accounting Firm.
Consolidated Balance Sheets - December 31, 2011 and 2010.
Consolidated Statements of Income - Years ended December 31, 2011, 2010 and 2009.
Consolidated Statements of Shareholders’ Equity and Comprehensive Income (Loss) - Years ended December 31, 2011, 2010 and 2009.
Consolidated Statements of Cash Flows - Years ended December 31, 2011, 2010 and 2009.
Notes to Consolidated Financial Statements
All other schedules are omitted because they are not required, are not applicable, or the required information is shown in the Consolidated Financial Statements or notes thereto.
2. Exhibits
Exhibits required by Item 601 of Regulation S-K are listed in the Exhibit Index, which is incorporated herein by reference.
* Management compensatory plan or arrangement
(1) These interactive data files shall be deemed furnished and not filed for purposes of Section 11 and 12 of the Securities Act of 1933, as amended, and Section 18 of the Securities Exchange Act of 1934, as amended, and not otherwise subject to liability under those sections.
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized, on this 14th day of March, 2012.
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated