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Executives

David Mackey – SVP, Finance

Bharat Desai – Chairman

Prashant Ranade – CEO & President

Arvind Godbole – CFO & Chief Information Security Officer

Analysts

Bryan Keane – Credit Suisse

Bhavan Suri – William Blair & Company

Joseph Foresi – Janney Montgomery Scott

Joseph Vafi – Jefferies & Co.

Reik Read – Robert W. Baird & Co.

Brian Kinstlinger – Sidoti & Company

Srinivas Anantha – Oppenheimer & Co.

David Cohen – JP Morgan

Justin Cable – Global Hunter Securities

Vincent Colicchio – Noble Financial

Chris Wicklund – Wells Fargo Securities

Syntel, Inc. (SYNT) Q4 2009 Earnings Call Transcript February 11, 2010 10:00 AM ET

Operator

Ladies and gentlemen, thank you for standing by and welcome to the Syntel fourth quarter and full-year 2009 earnings call. At this time, all participants are in a listen-only mode. Later we will conduct a question-and-answer session. (Operator instructions) As a reminder, this call is being recorded today; Thursday, February 11, 2010.

I would now like to turn the call over to David Mackey, Syntel's Senior Vice President of Finance.

David Mackey

Thank you and good morning everyone. Syntel's fourth quarter earnings release crossed GlobeNewswire at 8:30 am today. It’s also available on our Web site at www.syntelinc.com.

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

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

Bharat Desai

Thank you, David. Good morning everybody and thank you for joining us today. 2009 was a year full of both challenges and accomplishments for Syntel. The economic meltdown, which impacted growth opportunities during the first half of the year, was offset from a bottom line perspective by improved cost dynamic and an organizational focus on productivity and efficiency.

I firmly believe that Syntel’s strong financial and operational discipline allowed us to not only adapt to market challenges but come out of 2009 as a stronger company. In fact, Syntel was able to post record revenues, margins, earnings and cash in what was perhaps the most difficult business environment in the past 50 years. We were able to do so without sacrificing on the key investments necessary to drive our business forward.

As we turn our attention to 2010, the overall business climate appears to be improving. At the same time, we are facing a marketplace which is extremely dynamic in nature. High-value offshore-centric services, automation, the convergence of technology and operations and value-added partnerships will all be critical to success going forward.

As the macro trend towards globalization of services evolves, the market will continue to be ripe with opportunity. I believe that Syntel’s culture and 30-year history as a flexible, innovative and responsive company will serve us well. As a smaller, more nimble organization, we are extremely well positioned to be able to adapt quickly and service the rapidly-changing business requirements of our clients.

As many of you are aware, Syntel recently accounted that Keshav Murugesh had left the company. We again thank Keshav for all his contributions over the past eight years. Our new President and Chief Executive Officer, Prashant Ranade, has joined us on today’s call. Prashant brings a unique combination of skill to this role, given his leadership ability, experience at global organizations and three-year tenure on our Board of Directors. I am confident that Prashant will be able to step in and lead Syntel going forward.

At this time, I would like to introduce Prashant Ranade. Prashant?

Prashant Ranade

Thank you, Bharat. It is my pleasure to participate in today’s call, and I look forward to personally meeting with many of you in the future. Syntel’s culture of passion, talent, and innovation has been (inaudible) into the D&A of organization over the past 30 years. It is my job to help leverage these inherent skills to continue to create value for our clients, employees and shareholders.

From my perspective, the foundation for success at Syntel is already in place. The company is extremely well positioned in the marketplace with excellent people, deep domain expertise of blue-chip customer base and a customer-centric approach to solutions. With the macro-economic trend towards globalization of services as a backdrop, I am excited about the opportunity to lead Syntel into the new decade.

As Bharat mentioned in his opening remarks, Syntel’s fourth quarter revenue, margin, EPS, and cash levels was the highest in the company’s history. While an improving demand environment in Q4 was instrumental in helping drive top line, Syntel was also able to assist customers with approximately 6 million of short-term project requirements during the quarter. Overall, the top line acceleration was broad-based across both services and verticals.

Development, maintenance, KPO and TeamSourcing resources, all grew sequentially in fourth quarter. From a vertical perspective, financial services and healthcare were the key contributors. The rapid expansion of revenues during the quarter allowed Syntel to leverage fixed expenses and once again expand both gross and operating margins. This was despite the fact that company added over 1,000 employees, reduced offshore utilization by 2% and saved 3.6% depreciation in Indian rupee.

Overall, 2009 was a productive year for Syntel. While our revenue acceleration was muted by a difficult economic climate, we were able to focus our attention on productivity, efficiency and improving client relationships. These efforts, coupled with currency favorability and a healthy supply environment allowed for significant expansion in both margins and earnings per share. In 2009, Syntel also made progress on our key investment plans, including strategic hiring and the creation of new services and world-class infrastructure.

Turning our attention to the current year, we entered 2010 with a very different state of dynamics than a year ago. From a revenue perspective, we believe that IT budget this year will be relative flat with a slightly upward bias. That being said, we expect that offshore partners will account for a higher percentage of clients’ budget in 2010. Mainstream cost reduction initiatives will be the primary driver for growth. However, we would also expect that as clients continue to reduce baseline costs that some discretionary projects will be funded. While additional clarity, including 2010 budget finalization and ROI justification will be required before discretionary spending commitments are made, many of our clients realize that their technology environments and business processes have not kept pace with business changes.

While the prospects for revenue acceleration are improving, it is also clear that Syntel will face margin pressures in 2010. The current rupee/dollar exchange rate of 46 rupees represents a 5% depreciation versus 2009 and results in an operating margin headwind of 200 basis points. With overall demand environment improving and industry hiring re-accelerating, Syntel also anticipates margins to be impacted by salary increases during the year.

As in past, these increases will be a combination of fixed and variable compensation designated to align objectives and drive performance. Additionally, Syntel expects that offshore utilization levels will be reduced during the year as hiring increases in advance of demand. These factors combined with ongoing investments in our business result in reduced gross margin and operating margin expectations for the year.

Our guidance for 2010, which Arvind will detail a little later in the call, also takes into account a range of outcomes from negotiations regarding our KPO joint venture with one of our largest clients. As we have highlighted on prior calls and in our SEC filings, Syntel is currently in negotiations regarding the extension of and the terms and conditions under which the joint venture provides KPO services. While we continue to make progress with the discussions, no formal agreement has been reached at this time. As this joint venture represented 17% of Syntel’s revenue in 2009, changes to the terms and conditions of agreement could have a material impact on our business. The current contract runs through 2012 with the client option to purchase the joint venture beginning in April 2010.

Our guidance currently assumes a range of discounts which would impact both revenue and margins in 2010. However, guidance does not assume that the clients will exercise the option to purchase the joint venture nor does it assume that the contract will continue with the same pricing, terms and conditions and without economic impact to Syntel.

In summary, we are extremely pleased with our 2009 performance and look forward to the prospects that 2010 brings. Our blue-chip customer base remains largely underpenetrated and our deep pipeline is extremely healthy. (inaudible), we have been successful in working closely with our clients and adding the value and thought leadership they expect from a business partner. The blueprint for client expansion is in place and we are aggressively investing in the resources and services necessary to replicate these successes at other high-opportunity accounts.

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

Arvind Godbole

Thanks Prashant, and good morning. After my comments, we will open the call to questions. Once again Syntel posted record financial performance in several key areas during the fourth quarter of 2009.

Revenue for the fourth quarter was $117.8 million, up 7% from the $104.7 million posted in both the previous quarter and prior-year period. As previously mentioned, revenue performance benefitted from approximately $6 million of short-duration project work completed during the quarter; excluding this amount, Syntel was still able to post sequential gains in all of our reported segments led by both maintenance and development work in Applications Outsourcing.

For the fourth quarter, Applications Outsourcing accounted for 75% of the revenue, KPO was 17%, e-Business represented 5% and TeamSourcing was 3%.

From a vertical perspective, revenue expansion was driven by healthy growth in our financial services and healthcare verticals which grew 18% and 12% respectively versus the previous quarter. For the fourth quarter, financial services contributed 58%; with insurance at 17%; healthcare, 15%; automotive, 2%; and others was 8%.

Syntel’s customer concentration level remained relatively flat in the fourth quarter. Our top three clients represented 51% of revenue, top five contributed 62%, and top 10 came in at 77%.

Customer concentration was adversely impacted by the Q4 short-term development work. Excluding the discretionary projects, Syntel’s customer concentration would have been approximately 2% lower and come in below our third quarter levels. The fixed price component of our business represented 45% of revenue for the quarter.

With respect to Syntel’s margin performance, our gross margin expanded to 50.2% in the fourth quarter; this represented an increase versus 48.3% reported in the year-ago period and 49.3% in Q3. By business segment; gross margin for Applications Outsourcing was 45.1%; KPO was 72.9%; e-Business was 48.1%; and TeamSourcing, 56.8%. Sequentially, our gross margins were favorably impacted by increased revenue and improved productivity. This was partially offset by a slightly lower offshore utilization and a 3% appreciation in the Indian rupee versus US dollar.

Moving down the income statement; our selling, general and administrative expenses were 17.0% in the fourth quarter of 2009 compared to 19.4% in the prior-year period and 18.1% in the third quarter.

On a dollar basis, SG&A was up $1 million sequentially, largely as a result of exchange impacts. On a percentage basis, SG&A was significantly lower due to the rapid revenue growth and associated fixed costs coverage.

Net income for the fourth quarter was $35.8 million or $0.86 per dilute share compared to $26.7 million or $0.64 per share in the prior-year period, and $30.3 million or $0.73 per share in the previous quarter. The record earnings performance represented 18% growth sequentially and over 34% versus the fourth quarter of 2008.

From a balance sheet perspective, the fourth quarter of 2009 also produced solid results. Our total cash and short-term investments on December 31 were $200.1 million, an increase of $25.2 million from the third quarter. The DSO level decreased to 42 days from 52 days reported last quarter. Our capital spending in the fourth quarter increased to $10.6 million as the continued progress on the construction of our new campus at Chennai, India. Syntel ended the quarter with a total headcount of 12,567 of which 3,685 were appointed [ph] to KPO. Our billable headcount was 2,026 onsite and 9,673 offshore for a total of 11,699.

Operationally, our metrics remained extremely solid. Utilization levels at the end of the quarter were 92% onsite, 76% offshore, and 79% globally. Our delivery mix currently stands at 20% onsite and 80% offshore. Voluntary attrition during the quarter was 12.9%, up from 11.2% last quarter. Syntel added seven new customers in Q4 and two new hunting licenses to take the total number of preferred partnerships to 100.

From a full-year perspective, Syntel’s revenue grew 2% to $419 million, despite the difficult economic climate. Currency favorability, a healthy supply environment, and a companywide focus on productivity allowed us to expand gross margins to 48.7% and operating margins to 29.9% during the year. This represented year-over-year expansion of approximately 500 basis points and 600 basis points respectively. (inaudible) growth to $2.86 per share up 36% from $2.10 per share posted in the year 2008.

After capital expenditure of $25.5 million and dividends paid of $10 million, Syntel was still able to grow its cash balance of $67.7 million during the year.

Looking forward, I would now like to provide you with our initial guidance for 2010. Based on our current visibility levels and factors previously mentioned in Prashant’s prepared remarks, Syntel expects revenue to be in a range of $430 million to $460 million and EPS in the range of $2.15 to $2.45 for the full-year 2010. This is based on an exchange rate assumption of 46 rupees to the US dollar for the full year.

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

Question-and-Answer Session

Operator

(Operator instructions). Our first question comes from Bryan Keane from Credit Suisse. Your question please?

Bryan Keane – Credit Suisse

Hoping you guys could just update us on your conversations with your largest client; what are those conversations like and when do figure we might have a resolution there?

David Mackey

Sure. I will take that Bryan. I think as the company has said all along, we are in negotiations with the client regarding the terms and conditions of the joint venture. We continue to make progress on those discussions but at this point in time we have not come to a final resolution. We will certainly keep everyone posted and let you know via a formal document when we do sign that agreement. But in terms of the exact timing, it would be a little bit early for us to comment on that.

Bryan Keane – Credit Suisse

Okay. And just looking at the overall client base, I guess taking the largest client aside, what does pricing look like? And I guess this year would be that if you are negotiating price here you know when to have to negotiate price with all your other larger clients.

David Mackey

I don’t think that’s the case at all Bryan. We are in a unique situation in our KPO joint venture and looking to change those terms and conditions to allow both companies to achieve both our short-term and long-term business objectives. The overall market conditions for the remainder of our clients and the services that we provide them remain stable at this point in time. Certainly, we are going to have to revisit the pricing discussions as we move throughout the year depending on how the economic climate changes. But at this point in time, we do not anticipate pricing pressure from the balance of our customer base.

Bryan Keane – Credit Suisse

Any potential for price increases as we go forward here in 2010?

David Mackey

I think as always the case the price increases tend to lag the changes in the cost structures. So, obviously as we look into 2010, as Prashant and Bharat and Arvind have said, we are facing some pretty significant margin headwinds. I think the majority of our clients want to know that those cost changes are systemic before we can start discussing price increases.

Bryan Keane – Credit Suisse

Okay. Just last question from me; can you talk a little bit about wage inflation? What was it this year and what do you expect in the model going forward for 2010?

Bryan Mackey

The wage increases in 2009 were negligible. As we have said, we do expect to have to give wage increases in 2010. They will be a combination of both fixed and variable increases so that we can align the variable component with both individual performance and corporate performance. In terms of the specifics for the wages, we are not going to provide that at this time because we do believe it is competitive and sensitive information; however, we would expect that the onsite increases will be effective January 1 and the offshore increase will the effective April 1.

Bryan Keane – Credit Suisse

Okay, helpful. Thanks a lot.

David Mackey

Thanks, Bryan.

Operator

Thank you. Our next question comes from Bhavan Suri from William Blair & Company.

Bhavan Suri – William Blair & Company

Hi, guys nice quarter. Couple of just quick questions; if look at this quarter and I strip out the $6 million you grew 7% sequentially. I look at last quarter, you grew 5% sequentially. If I run those numbers through 2010, and I know you guys tend to guide a little conservatively compared to other folks, it just seems that the top line guidance is a little light. I mean if I take the sequential numbers even excluding the $6 million, I am quite a way ahead of those guidance.

David Mackey

I think when it comes to the top line guidance, Bhavan, as you said, the company has historically been quite conservative in our guidance. I can tell you that as we walk into 2010, the visibility to the low end of the guidance is consistent with how we’ve historically guided in the past. We currently have 62% visibility to that $430 million number, which is a slightly higher than where we have been in the past, 1% or 2%, depending on the year. I think the other thing to keep in mind is that we have been talking about with respect to the margin pressures that our JV contract negotiations could create, and also will create similar pressures for us on the top line growth. So that is one thing to keep in mind when you look at the guidance for the top line in 2010.

Bhavan Suri – William Blair & Company

With that mind, I guess it is just kind of how you guys guide which is the 10% above where you have got committed revenue to.

David Mackey

Yes. I think the other thing too, Bhavan, is we are walking into this year and we know for example that barring something unforeseen, the cost reduction based services will continue to be strong and continue to help drive our business forward. The real question comes to the discretionary project work and when and in what amounts those types of projects start to come online is still something that we don’t have a lot of visibility to. So that’s clearly something to watch, especially as we get through the first and second quarter and have better visibility to what those projects look like in the back half for the year.

Bhavan Suri – William Blair & Company

Sure. Turning to those discretionary projects, the $6 million worth in the past quarter, what was the nature of those engagements? They’re pretty much IT services, did you have add-on small BPO additions, because you grow the BPO revenue nicely sequentially too.

David Mackey

It was entirely in the IT services area, and obviously when you look at our customer concentration levels for the quarter it is pretty easy to deduce that it was driven by one of our larger client. So it was bolt-on work to some of the exiting services that we are providing, which again I think not only gave us a tremendous lift on the top line but also because it was relatively low cost work considering the number of the people who are already in place, that also was extremely high margin work for us as well.

Bhavan Suri – William Blair & Company

Good. Just one final quick one; when I look the KPO business, the headcount seems to have declined 3,900 or so down to 3,600, revenue seems to have ramped up, the gross margin didn’t change much. And I am trying to understand, did pricing go up in the KPO business at all?

David Mackey

This to me Bhavan was the classic case of addition by subtraction. As we have reported throughout 2009, we had a very large India-based client that was doing, I believe if you go back to the third quarter of 2008, about $4 million a quarter. So, effectively what we have been able to do as that client ramped down was bring on new clients and expand our existing relationship, and it has obviously been higher margin work. So while the revenues have remained relatively flat what we have done is removed a high-dollar low-margin client and replaced it with money from not only new clients but our existing clients at a much higher margin.

Bhavan Suri – William Blair & Company

Then how many KPO customers do you have now?

David Mackey

In the fourth quarter, we had eight that were active. As a matter of fact that India-based client in the fourth quarter generated zero revenue. So that stream that we have been talking about has been ramping down the past few quarters is now non-existence.

Bhavan Suri – William Blair & Company

Great, thanks.

Operator

Thank you. Our next question comes from Joseph Foresi from Janney Montgomery Scott. Your question please?

Joseph Foresi – Janney Montgomery Scott

My first question here is just on the top line guidance for 2010. What could you do with the top end of that guidance, and maybe you could just give us a scenario where you have reached the lower end. I am just trying to get a feel for what the factors would be?

David Mackey

I think as I mentioned, Joe, the one wild card that we were looking at is not only the amount of the discount that we provide to our JV partner when we do renegotiate that contract, but also the timing of those discussions. So clearly, if we go through 2010, and the longer we go through that year the more we would anticipate that the top line would have a benefit by not renegotiating. So that has the potential to create a wide range of scenarios in terms of the revenue performance. I think the low end is reflective of a situation where there is very little to no discretionary spending that comes through in 2010, and any significant early impact from the JV renegotiations. The high end represents a late and smaller renegotiation amount and the onset of some discretionary work in the back half of the year.

Joseph Foresi – Janney Montgomery Scott

Okay. I think you talked about margins a little bit, maybe some potential headwinds coming from hiring wages and then of course the large client. Maybe you could just talk about some – give some color on the order of magnitude that – obviously, we can see what is embedded in the guidance, but order of magnitude of the headwinds in heading into next year.

David Mackey

In Prashant’s prepared remarks, he specifically discussed the assumption for currency which is 46 for next year. We are looking at about a 5% appreciation in the Indian rupee. So on the operating margins as we have always said, a 1% move in the currency affects our cost about 40% – our margins, I should say, about 40%. So we are looking at 200 basis points of headwind from that amount specifically. Obviously, the JV creates a wide range of potential outcomes depending on where that comes in. So that’s part of the reason that you do see that wide range.

Bharat Desai

A quick correction, Dave, I think you meant 40 basis points.

Joseph Foresi – Janney Montgomery Scott

Yes, 40%.

Bharat Desai

That’s okay.

Joseph Foresi – Janney Montgomery Scott

Yes, 40% would have been different.

David Mackey

Lot of numbers. So, thank you, Bharat. That’s good. The wage impact, we have historically seen when wages have gone up, 5% onsite, 10% offshore, an impact of between 200 and 300 basis points. I don’t think we are looking at that magnitude this year. But again, we are going to have fixed and variable components and depending on how the company performs, those wage increments will kick in at different levels. So there is some volatility, I think that’s part of the reason we have such a wide range of numbers.

I can tell you that embedded in our guidance and in those EPS numbers, what we are probably looking at is an operating margin that’s going to vary somewhere between 23% and 25% and the reality is that – that’s reflective of those margin headwinds that we are looking at, but still makes the company extremely competitive from an overall margin standpoint. So despite the fact that we are facing these pressures, the reality is we had a phenomenal year in 2009. We will have a lot the favorability fall through to the bottom line and now some of these pressures that other people I think maybe in better positions to mitigate in terms of a year-over-year perspective are going to impact our performance in 2010. But by no means, means that the company is not going to be competitive from the services and from the performance financially to the overall industry.

Joseph Foresi – Janney Montgomery Scott

Any change in the top five or ten clients, any secondary catalyst here in accounts that are growing pretty rapidly?

David Mackey

I think there is certainly an opportunity to see a shakeup in our top five and top ten in the coming year. Obviously, a lot of that’s going to be predicated on how quickly some of these clients ramp up and move through some of the plans that we have discussed. But, yes, we do see the possibility for some of that this year.

Joseph Foresi – Janney Montgomery Scott

And then just one last quick one, I know that Keshav has left and maybe gone to a competitor. Was that – maybe you guys could just talk about any potential – has there been any changes in the staff that was associated with him while he was at the company and do you foresee there being any?

Prashant Ranade

Yes, I will comment on that. This is Prashant. On the day that Keshav submitted his resignation, our VP of HR submitted his resignation and after taking over as a CEO last week on Tuesday, I accepted his resignation and that has been the only change in the leadership team.

Joseph Foresi – Janney Montgomery Scott

Thank you.

David Mackey

Thanks, Joe.

Operator

Thank you. Our next question comes from Joseph Vafi from Jefferies & Co. Your question please?

Joseph Vafi – Jefferies & Co

Hi, guys, good morning. Perfect Q4. I thought maybe if we just look at the quarter for a second and those extra for projects, would we classify that as budget flush or it just happened to be some projects that the clients wanted to get done. Just trying figure out if this is a sign of pockets of strength in the business and getting to the backlog of projects or if there was kind of just a flash here?

David Mackey

It is kind of hard of differentiate the two, Joe. I think clearly there was some important work to the client that needed to get done. I think based on the company’s performance there was also an opportunity for them to get that done in the fourth quarter. So I think it was kind of the perfect storm, if you will. That being said, I don’t believe it’s indicative of an overall trend in discretionary spending or short-term project work. It is not an uncommon pattern for Syntel to see this fourth quarter uptick in terms of some of the projects with the couple of clients that we are talking about here. The thing that was exaggerated this quarter was the magnitude of that amount.

Joseph Vafi – Jefferies & Co

Okay that’s fair. And then secondly on guidance, and obviously you have the same overall methodology in place. But if you look at maybe where the upside would be coming from this year versus last year, it’s clearly a different year with different demand dynamic, customers that maybe a little bit different in terms of what they want to do this year. Would you kind of look at that –- where you are looking at guidance and excluding the big customer that we’re waiting for more news on, are we looking for more growth out of the top five and out of the top 10 this year towards the guidance number or how else might the guidance be a little bit different?

David Mackey

I really don’t see a huge change, Joe. I think the one thing that we do take some comfort in is obviously with the pullback in 2009 on discretionary spending. When you look at the portfolio of services that we have, clearly it is more skewed toward some of the longer term sticky services, specifically the maintenance and the KPO, which I think, at least provides comfort that that base is there grow from. In terms of the clients, as we have said all long, we do believe that our top 10 remain underpenetrated and obviously since those are our healthiest in our deepest relationships, they always offer the best potential for short-term revenue acceleration. That being said, I think we are doing the right things to grow tier 2 and tier 3 accounts within Syntel. There is a significant opportunity to take $5 million and $10 million relationships to becoming $10 million and $20 million relationships. And if things progress there, it would certainly be our expectation that some of our smaller clients have the ability to drive some of the revenue growth to a higher percentage and to grow at a higher cliff than the top three, top five, top 10. That being said, as we have seen the last three to five years, we have this question come every year and the reality is our top clients continue to grow at a healthy cliff. So back to the comment about our customer base being underpenetrated, we think there is still opportunity even with our largest clients.

Joseph Vafi – Jefferies & Co

Okay. That’s helpful. Then is there anything that we should – I don't really expect you to say much on the negotiations here – but I know there was an 8-K that was filed a little bit earlier in the month about waving their right for a couple months. Should we be looking at – is there a way to kind of bracket the time frame we should be looking at and trying to expect an agreement is likely in the next three months or it is likely in the next six months or how should we think about that?

David Mackey

I don’t think there is anything to – I am sorry. Go ahead Bharat.

Bharat Desai

Yes, I will take that. The relationship is extremely strong in the past. We’ve just completed five years of successful partnership. It’s created value for both organizations. The negotiations are quite complex since it’s a lengthy agreement. It’s difficult to predict when we will bring closure to the negotiations. What I will say is that two companies are made aligned on a long-term business objective and our contract does go through – our current contract does go through 2012.

David Mackey

I think to add a little bit of color to that, Joe and Bharat is right, the reality is the negotiations are extremely complex. I think in terms of the timing, the 8-K that was issued does not give any insight into anything being imminent. But what I do think the 8-K does is certainly provide some insight into the nature of the discussions and the tone of the discussion and the intent of the two parties to work out a long-term agreement. So directionally I think what it does point to is that the overall health of the relationship and the fact that we are largely on the same page in terms of what we want to accomplish long term.

Joseph Vafi – Jefferies & Co

Okay, that’s helpful. Thanks a lot. And congratulations Prashant on the new role.

Prashant Ranade

Thank you very much. I look forward to meeting you.

Operator

Thank you. Our next question comes from Reik Read from Robert W. Baird & Co.

Reik Read – Robert W. Baird & Co.

Could you guys maybe spend a little bit of time on banking and insurance and talk about how firm those budgets are at this point? Are those folks still largely interested in cost reductions or do you see more of these folks starting to go down the path of discretionary in picking that up?

Bharat Desai

I will take that. Right now, the conversations we are having with our banking customers, and that includes payment systems, capital markets and retail commercial banks, are largely in the area of cost reduction initiatives. Our conservations with our insurance clients, both P&C and life and annuity, are actually both in the areas of cost reduction as well as some investments for future client acquisition and competitive offerings by those companies.

David Mackey

I think the reality on the financial services side, Reik, is that when you look at what they are trying to accomplish in you, you look at budgets that are going to be relatively flat to potentially up a little bit – down a little in 2010, you’ve got clients that are looking to create self-funding mechanisms for discretionary spends. So the only way that’s going to get spent is that the cost reductions that Bharat was speaking about to kick in. And that’s why I think we are optimistic that as long as the business environment remains stable that we will see some discretionary spending in the back half of the year when those cost reductions have been achieved or those cost reduction programs are in place. But until the client has visibility to the fact that they are taking money out of the budget, it’s going to be difficult to see that kind of spending get funded.

Reik Read – Robert W. Baird & Co.

Okay. And then maybe back to the comments you guys where making before on this next set of customers, and Dave, I think you had stated that a couple of these $5 million guys could become $10 million or $20 million. Is that a function of client partners at this point? And can you maybe talk about how many you are adding and what impact can be over the course of the year.

David Mackey

Yes, I think as we’ve spoken on the last couple of quarters, the client partner program is extremely important and one of the key initiatives that the company intends to use to help drive revenue and drive value forward with our clients. And we’ve done a number of things over the last few quarters both in terms of trying to find the right skill set externally and also create additional capabilities from training and mentoring programs internally to be able to do that. We have added a couple of client partners here in the last couple of quarters. It is our expectation that we will continue to do that throughout 2010. And once we are able to marry up the right client partner with the right skill set with proper client, we do believe that it will be an accelerator to helping drive incremental revenues with these clients. That being said, when you are talking about customers that are $3 million, $5 million, even $7 million in size, the question becomes one of scale and whether you have a client partner that’s dedicated solely to a $5 million high-potential account or you’re having splitting time between two or three potential high-dollar account that are of similar size. So part of it is creating the additional capacity, part of it is marrying the right person with the right customer, and part of it is also understanding how we leverage these people, because obviously we are not going to be able to create 20 new client partners this year, and as a result we need to be somewhat selective in terms of how we view these accounts and how we allocate these scarce resources.

Reik Read – Robert W. Baird & Co.

Will the investment in client partners place some of the margin pressure that you are talking about or is that just a normal course investment at this point?

David Mackey

It’s clearly one of the areas of accelerated investment for the company, but in terms of the pressure it’s going to put, I think that in and of itself would be something that would be manageable. I think all of our key investment programs in and of themselves would be things that are manageable. So the real challenge to the margin pressures that we are looking at in 2010 are as they are going to stay, it’s the currency, it’s the wage issue, it’s the reduction in utilization, and it’s the re-negotiation of our contract.

Reik Read – Robert W. Baird & Co.

Okay, great. Thank you, guys.

David Mackey

Thanks, Reik.

Operator

Thank you. Our next question comes from Brian Kinstlinger from Sidoti & Company. Your question please?

Brian Kinstlinger – Sidoti & Company

Good morning. The first question I had was what was the exchange rate for the fourth quarter that you guys mentioned?

David Mackey

The exchange rate in the fourth quarter was 46.6.

Brian Kinstlinger – Sidoti & Company

So, at 46.6, if I excluded the $6 million of revenue and that didn’t change costs much because you said the people were in place, you still had about a 47.5% gross margin. So I guess, I am wondering – not looking year over year, I am looking sequentially, we are not that far off on what your guidance suggests for foreign exchange. So would it have a huge impact on the margins from the December quarter?

David Mackey

I think when you look at the implied gross margin and, as I said, we are looking at operating margins for next year that are going to be in the 23% to 25% range. If you look at what that implies from a gross margin standpoint, we are probably looking between 43% and 45% on a gross margin basis, and that’s for the full year. So part of it is not just the quarter-to-quarter impact, but obviously the year-over-year impact. The real driver for the gross margin is if you are going to look sequentially quarter-to-quarter, we’d be looking at the items such as the re-negotiation on the joint venture, the drop in utilization because we did ramp up significantly to meet some of that demand in Q4, and also the wage pressures as we move – on-site wage pressures in Q1 and offshore wage pressures in Q2.

Brian Kinstlinger – Sidoti & Company

Right, now I am clear. And just specifically talking about currency from the fourth quarter, isn't that all in there for the most part? Yes, you will have to have a whole bunch of other levers that don't go your way, but when we look at the fourth quarter with the currency at 46.6, there is not much of a change from the December quarter we saw compared to what you are assuming in for the next quarters, right?

David Mackey

That’s correct. It’s fairly modest. Yes, a little bit over 0.5%.

Brian Kinstlinger – Sidoti & Company

Okay. Can you update us a little bit on the BPO business development? A while back, pre-recession, there were discussions of some huge opportunities to cross sell what you are doing at State Street. Are you still able to do that? Are you precluded right now from selling those services given the re-negotiations you are in right now and State Street might feel competitive, just take us through that please.

Bharat Desai

Sure, I will do that Brian. This is Bharat. Our agreement with our JV partner does preclude us from working in those specific processes with some of the direct competitor in that space. We do have a number of prospects and some early pilot initiatives with a number of organizations in the B&FS and insurance and healthcare space. So the only thing with the KPO business is that the sales cycle does tend to be fairly long. So we feel great about the opportunity pipeline, what we find hard to predict at this time is when they’ll close and how fast they’ll move.

David Mackey

I think Brian, you are right in saying and that goes with what Bharat just said, part of the challenge in 2009 was – you look at for example the cross sell opportunity and leveraging some of our knowledge in credit markets and payment card systems, part of the challenge that we had is those initiatives in 2009 largely got put on the table. These things were on the back burner. They were not top of mind for clients. They had bigger challenges to deal with. Now we do believe that those conversations are being reenergized, they are moving forward, but as Bharat said, you are talking about a lot of services that are not mainstream cost reduction services. These are custom solutions. The sales cycle is extremely long and the expectation is that when we do finally engage with these clients it’s going to be for one or two small processes. It’s going to be for a select handful of their end clients and so they get a better understanding that things are working well. So not only is the sales cycle long for these services, but the ramp up tends to be quite slow as well.

Brian Kinstlinger – Sidoti & Company

Great. I have two more BPO-related questions; the first one is departure of Keshav, has that in any way lengthened the time that the negotiation might take? My guess is he was instrumental in that process along with obviously some other people there.

Bharat Desai

I’ll take that. No, I don’t think it’s going to affect the length of negotiation for the ultimate outcome. This has been managed by a team at Syntel, and most of the team is largely intact and has been involved in delivering service and providing support services to our client.

Brian Kinstlinger – Sidoti & Company

Okay. In regard to your largest IT client, there have been discussions over time about them starting up and they’ve done some pilot projects with you on the KPO side. Has that advanced at all or they sort of halted that process?

David Mackey

They are still moving extremely slow Brian.

Brian Kinstlinger – Sidoti & Company

Okay. Can you talk about your cash and your plans, and you said you’ve historically paid some special dividends; maybe you give us a sense for how much is in the US or what your plans are there?

Bharat Desai

Sure, Brian. I’ll take that. There really is no change in the company philosophy. Our clients lack the security of a healthy balance sheet. It provides Syntel an opportunity to be opportunistic about M&A even though most of our growth since 2000 has been organic. It can fund our growth of operations. The company does pay a dividend and if the board feels that we have excess cash and it can be returned to shareholders cash efficiently, the board does make that decision from time to time.

Brian Kinstlinger – Sidoti & Company

Are you able to disclose how much is in the US?

Bharat Desai

We don’t disclose that – provide that information.

David Mackey

No we don’t. We do not break down between the cash balances that are in the US and that are international.

Brian Kinstlinger – Sidoti & Company

Great. And one last question, which I don’t think anyone asked – I was shocked – can you give us any recruiting expectations for either the current quarter or for the year?

David Mackey

I will handle that Brian. Obviously we hired over 1,000 people in the fourth quarter, pretty good acceleration. We would expect again to be hiring here in the first quarter. We are not going to give specific hiring guidance for the year in terms of number of people, but a lot of the hiring that we did in the fourth quarter and some that we’ve done early here in the first has been lateral and more about existing demand and things that are current on our plate. We are going to have to start to expand the hiring from a trainee perspective as well, and as a result we would expect some drops in our utilization as we move through 2010.

Brian Kinstlinger – Sidoti & Company

Great. Thanks, guys.

David Mackey

Thanks, Brian.

Operator

Thank you. Our next question comes from Srinivas Anantha from Oppenheimer & Co. Your question please?

Srinivas Anantha – Oppenheimer & Co.

Thank you. Looking at your guidance for next, especially in the top line, maybe if you guys could quantify, how much of that top line growth is being driven by increased spending from your existing customers and new customer wins?

David Mackey

Sri, in any given year 95% plus of our revenue is going to come from clients that had done business with us in the previous year. So the expectation is clearly that the majority of our revenue acceleration in 2010 is going to come from customers that are already engaged with Syntel that are familiar with the company and its services. And it’s more about doing more with Syntel and deepening the relationship than it is with creating new ones. That being said, we do obviously continue to focus on adding new clients and starting to build those relationships. But a customer who joins us in 2010 really presents more of a 2011 opportunity than a current opportunity.

Srinivas Anantha – Oppenheimer & Co.

With respect to your negotiations with your JV partner, I know you guys said in the press release you have assumed a range of possibilities here. Is there any way to quantify such as, let’s say, if you were to give them a 15% pricing discount, what impact would it have on the top line and on the margins?

David Mackey

I think, we are not going to provide specifics Sri, but what I can tell you is that obviously this client is significant. Thus we do publicly disclose that the joint venture is between 17% and 18% of revenue depending on the quarter. If you look at our KPO segment, it’s pretty easy to deduce what percentage of our overall revenue and what percentage of our KPO revenue that represents. So if you want to look at potential discounts and apply to that portion of our business, it is pretty ease to see what the impact would be on both the top line and also understand that that’s going to fall directly through to the bottom line.

Srinivas Anantha – Oppenheimer & Co.

Got it. Given the variability of that particular contract, just to keep up with the growth rates for all two years, does 2010 require any higher CapEx requirements than what we have seen in the past or should we expect relatively stable CapEx?

Bharat Desai

Actually, the CapEx in 2010 will be higher than 2009. We will be building out or furnishing two GDCs at Chennai and we’re also building our phase III in Pune. So, Arvind can give the exact CapEx estimate, but it will be significantly higher than 2009.

Arvind Godbole

Sure. Current year, we have spent $25.5 million and next year we are expecting the spent between $40 million and $50 million predominantly on the two campuses. One of them will be (inaudible) in Q2 and Pune, there is two expansions.

Srinivas Anantha – Oppenheimer & Co.

Okay. Thanks.

Bharat Desai

And this is – just to clarify, this is exclusive of any additional land purchases we might make for future campuses.

Srinivas Anantha – Oppenheimer & Co.

Great. Thanks a lot.

Operator

Thank you. Our next question comes from David Cohen from JP Morgan. Your question please?

David Cohen – JP Morgan

Hi, thanks. Prashant, I was wondering if you could talk a little bit about your perspective on Syntel. I know you’ve been in the role for short time. But obviously you are familiar with the company and the business, and maybe just step back and give us some of your big picture thoughts, and then maybe your sort of top three priorities over the next three months or so?

Prashant Ranade

Yes, I will. Thank you. As you right said, being associated with Syntel as an independent director, I am familiar with our strategy I have been involved in reviewing the execution of the strategy as well as knowing our leadership team. What is – Syntel is very well positioned based on the foundation of consistent results, result-oriented leadership team, and our customer-for-life philosophy. So, with that, as I look ahead, you know, we have a strong pipeline. So, I am very confident and comfortable about 2010 and outlook is really to accelerate the execution of plans which we have in place. So, as far as three key initiatives, customer penetration, new service offerings that we have planned, rollout of the service offerings, and business excellence through people excellence.

David Cohen – J.P. Morgan

Okay. And then, Dave, I am sorry if I missed it, but what are you expecting for the tax rate for 2010?

Prashant Ranade

Within 17% or 18% [ph].

David Cohen – J.P. Morgan

Okay. Great, thanks very much.

David Mackey

Thanks David.

Operator

Thank you. Our next question comes from Justin Cable from Global Hunter Securities. Your question please?

Justin Cable – Global Hunter Securities

Just a couple of quick questions here. In terms of your rationale revenue guidance for 2010 and then possibly maybe for Q1, I mean, should we think about the guidance as being sort of modest sequential increases starting with Q1 through Q4, or more backend loaded or how should we think about it?

Bharat Desai

I think when you look at the quarters for 2010, Justin, you know, Q1, clearly the expectation is that, that revenue will be soft for a couple of reasons. One, Q1 revenue is historically soft for Syntel, the second obviously is that we have had this $6 million of short-term discretionary projects that are going to be not recurring in the first quarter. So, we would expect to see Q1 come in a little bit light. You know, we would expect all things being equal to see gradual acceleration across the year in terms of that growth, and if there is going to be significant upside of an opportunity, we would expect that to be back-half loaded and largely driven by an increase in discretionary project work.

Justin Cable – Global Hunter Securities

Got it. Okay, thanks. And then in terms of the assumption for the price discounts for the JV at the low end of the guidance range, does that assume that, that goes into effect right away or it’s an effect at the beginning of the year or starting sometime in Q2?

Bharat Desai

The lower end of the guidance would assume a deeper discount and an earlier signing period. So, you know –

Justin Cable – Global Hunter Securities

But in terms of earlier signing period, would it commence starting in Q2 or starting immediately?

Bharat Desai

I think, again, there is no way to quantify that, because there are two variables there. One being the percentage of the discount and one being the timing, but clearly, the low end of guidance represent at least based on our current visibility and our current judgment represents the conservative view of what that outcome could be.

Justin Cable – Global Hunter Securities

Right, okay. And then lastly just, what the assumptions made for other income for 2010? It just fluctuated over the quarters?

Bharat Desai

The assumption for 2010 on the other income that is going to be relatively flat with 2009.

Justin Cable – Global Hunter Securities

Thank you very much.

Operator

Thank you. Our next question comes from Vincent Colicchio from Noble Financial. Your question please?

Vincent Colicchio – Noble Financial

Dave, at the KPO business, what was the driver of growth, was it purely your top client?

David Mackey

Actually, it was fairly broad-based, Vince. We did have some acceleration with our top KPO client. We had, for example, one of our new medical pharmaceutical KPO clients that actually doubled the revenue from Q3 to Q4. So, we did see some healthy acceleration there. You know, I think it was fairly broad-based which is encouraging.

Vincent Colicchio – Noble Financial

Okay. Should we expect, you know, more of the same in the current quarter?

David Mackey

You know, again the wildcard being a potential renegotiation of this large JV relationship, but excluding that, I think we should expect to see, you know, the KPO business and the clients that we have in hand continue to move forward. As I mentioned a little bit earlier, the nice thing too about Q4 is that we have actually removed all of the revenue now from the roll-off of the India-based KPO client, so we don’t have that headwind impacting us anymore going forward.

Vincent Colicchio – Noble Financial

On the e-Business side, it tends to be a very lumpy business, it tends to be discretionary. Having said that, any help you can give us there for 2010?

David Mackey

I think similar to the overall commentary about discretionary spending, as you rightly said, one of the areas that’s going to be the most volatile and have the most variability and not only the revenues but also the margins associated with that segment, based on the fact that those projects tend to be very short duration, very high dollar types of work, you know, that being said, there is a component of maintenance in the e-Business segment, it’s the recurring piece. So, there is a kind of a stable book of business even within the e-Business segment, and we did see some acceleration here in Q4. So, we are optimistic that things tend to be at this point hopefully at their lowest levels. There is some potential downside, but there may be at this point more upside than downside to the e-Business segment.

Vincent Colicchio – Noble Financial

Okay, that’s it from me. Thanks.

David Mackey

Thanks Vince.

Operator

Thank you. Our next question comes from Ed Caso from Wells Fargo Securities. Your question please?

Chris Wicklund – Wells Fargo Securities

This is Chris Wicklund for Ed Caso. Maybe if you could talk a little bit about some of the service offerings that you are planning deeper investment in for 2010?

David Mackey

Sure. I mean, I think the approach as Prashant alluded to is that the company is looking for new ways to not only cross-sell services to our existing clients, but to make sure that we have got our breadth and depth of services to also attract new clients, and a number of them can be, you know, small niche services that may not have significant revenue opportunities in and of themselves but it’s more about having a right solution for a client to create a relationship or to expand a relationship. That being said from a horizontal standpoint, you know, some of the things that we are looking at, obviously infrastructure management, demand management, we have seen good traction and expect to continue to get good traction in our global testing service and migration services is one of the areas that we think have some good long-term potential. We have also rolled out a number of vertical-specific offerings and we will continue to do so a lot in the healthcare area, some work in the financial services around transaction analytics and fraud detection, point-of-sale testing for retail.

These are all kind of some niche solutions, and we are also looking at technology types of things and we have not only taken the approach on the technology side of creating centers of excellence and developing new solutions, but also partnering with software and solution providers to help them take their products and their solutions to market. So, you know, the strategy is clearly to kind of get our fingers in, in a number of different areas and use that to expand our footprint, and we would expect to continue to do that throughout 2010.

Chris Wicklund – Wells Fargo Securities

Okay, that’s helpful. Thank you. And then also utilization in the IT business at the end of the quarter, and maybe what you are targeting for the year, what your guidance assumes?

David Mackey

Yes. The utilization on the IT segment dropped from 72% at the end of the third quarter to 69% at the end of the fourth quarter. You know, it’s going to fluctuate based on how the demand ramps up and when we do our hiring. I think overall, our anticipation through 2010 is that the utilization levels on IT will be lower than that. As I mentioned a little bit earlier, we need to continue to do some hiring, we need to bring on some additional trainees to make sure that we are building out the delivery pyramid. And as we do that, I would expect that, that utilization will probably trend a little bit lower than we have run historically and even than we ran in the fourth quarter.

Chris Wicklund – Wells Fargo Securities

Okay, thank you.

Bharat Desai

Thanks Chris.

Operator

Thank you. There are no further questions in the queue at this time. I would like to turn the program back to management for any further remarks.

Bharat Desai

Thank you everybody for joining us today. With 2009 behind us, we look forward to the opportunities presented by improving demand environment. While our clients’ cost reduction and process improvement plan continue to progress, the requirements for technology upgrades and regulatory and compliance related initiatives are also gaining momentum. Syntel plans to leverage our deep domain expertise, flexible approach, and differentiated services to help our clients achieve their business objectives. We look forward to talking to you next quarter. Good bye and thank you.

Operator

This concludes fourth quarter earnings call. A replay of today’s call will be available until February 18th, 2010 by dialing 800-642-1687 and entering the pass code, which is 54740625. Thank you.

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Source: Syntel, Inc. Q4 2009 Earnings Call Transcript
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