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Executives

Jonathan James - Vice President, Global Marketing and Investor Relations

Bharat Desai - Chairman, Chief Executive Officer, Co-founder

Keshav Murugesh - President and Chief Operating Officer

Arvind Godbole - Chief Financial Officer and Chief Information Security Officer

David Mackey - Vice President of Finance

Analysts

Joseph Foresi - Janney Montgomery Scott

Bryan Keane - Credit Suisse

Brian Kinstlinger - Sidoti

Joseph Vafi - Jefferies & Co.

Edward Caso - Wachovia Capital Markets

David Cohen – JPMorgan

Vincent Colicchio - Noble Financial Group

Syntel, Inc. (SYNT) Q4 2007 Earnings Call February 22, 2008 11:00 AM ET

Operator

Welcome to Syntel’s fourth quarter and full year 2007 conference call. (Operator Instructions) I will now turn the call over to Jonathan James, Syntel’s Vice President of Global Marketing and Investor Relations

Jonathan James

Syntel’s fourth quarter earnings release crossed Business Wire at 8:30 a.m. today. It’s also available on our website at syntelinc.com.

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

I’d now like to turn the call over to Bharat Desai, Syntel Chairman and CEO.

Bharat Desai

I’d like to spend a few minutes reviewing our 2007 highlights and discussing the factors impacting 2008. I will then turn the call over to Syntel’s President and Chief Operating Officer, Keshav Murugesh; and Syntel’s Chief Financial Officer, Arvind Godbole.

For Syntel, 2007 was a year marked with several key milestones. Revenue increased 25% over 2006 and EPS grew by 23%. Q4 represented our 15th consecutive quarter of revenue growth, a notable achievement considering 100% has been generated organically. Our knowledge process outsourcing offering, formerly known as BPO, continues to lead the way and gain market traction growing more than 150% year-over-year.

Throughout the year Syntel was recognized by a host of industry organizations and media, which included rankings in the Healthcare Informatics 100 list, the VARBusiness500 list, Software Magazine’s Top 500 solution providers, the Global Services 100, the Black Book of Outsourcing’s Top 50 Global Outsourcers, and the “Number 1 Super Stock Designation” in Michigan by Crain’s Detroit Business.

We also earned great research coverage from Aberdeen, Forrester and were prominently featured in Gartner’s Annual Magic Quadrant Report. This attention and recognition from industry analysts and the community plays an important part in keeping Syntel’s brand front and center among customers and prospects. These analysts’ reports largely focus on Syntel’s positioning as a responsive mid-tier alternative to Tier 1 providers.

Looking ahead into 2008 the major issue on everyone’s mind these days appears to be the state of the economy. So, over the last several months I’ve met several CxO-level executives at both clients and prospects. While there is concern about the state of the economy, what appears to be clear is that customers may reallocate their discretionary projects and are clearly interested in cost reduction initiatives.

Also while timing may vary, we believe that more and more customers are going to go this route and the economic pressures are going to force customers to look at cost structures and make strategic decisions about both IT and operations outsourcing.

We believe that the macro economic trends are very strong towards globalization of services. In our view this is an irreversible mega trend. In fact, from a historical perspective a challenging economy has served to accelerate offshore adoption, as was the case with both Y2K and 9/11.Even if IT budgets are flat or reduced in 2008 the allocation of those budgets towards global sourcing we believe will accelerate.

I will now turn the call over to Keshav Murugesh, Syntel’s President and Chief Operating Officer, and after that to Arvind Godbole, Syntel’s Chief Financial Officer to provide details on our operational and financial performance.

Keshav Murugesh

Overall, Syntel is pleased with the momentum in our business in both Q4 and the full year 2007. As Bharat mentioned, the acceleration in both our revenue and EPS was positive, particularly in light of headwinds created by currency, wages, and ongoing investments. Additionally, many of our key operational metrics also showed progress throughout the course of the year.

On the hiring front, Syntel added over 1,000 employees during the fourth quarter to finish the year at 11,709 worldwide. For the year, we have added more than 3,300 employees, which represented a 40% increase versus year-end 2006. In support of this hiring, Syntel spent over $32 million in CapEx during the year and added more than 4,000 finished seats in India.

Looking ahead, Syntel currently plans to add between 2,800 and 3,500 employees during 2008 in support of our revenue guidance. We will be aggressively building out Phase II of our Pune campus and Phase I of our Chennai campus for 2008 requirements and beyond.

At present, we plan to add close to 6,000 seats in India, investing approximately $50 to $60 million of CapEx during the year. Syntel gained traction during 2007 with several of our service offerings including custom KPO, demand management, product lifecycle management and global testing.

KPO again was a key revenue driver for Syntel, exiting the year at 19% of revenue and posting 155% year-over-year growth. During the fourth quarter, we added two new KPO clients, including for the first time an existing top 20 IT client. For the full year, Syntel doubled the number of active KPO clients, ending 2007 with 10 relationships. The customized, high value nature of these solutions was evidenced by the 52% gross margins achieved during the year.

As everyone is aware, many companies are being forced to address strategic business decisions in a challenging economic climate. We believe that regardless of the outcome of these decisions, Syntel is extremely well positioned in both the short and long-term to take advantage of the trend towards globalization of services. Our confidence is demonstrated by Syntel’s 2008 investment levels as well as our accelerated revenue and EPS guidance.

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

Arvind Godbole

I also have Dave Mackey, Syntel’s Vice President of Finance, joining me on the call. After my comments we will open the call to questions. We would like to apologize for the delay in this earnings announcement.

As we communicated earlier, our auditors requested additional time to complete their audit very late in the process, and as a result we had to delay this call. The issue that caused this delay related to our global tax reserve positions for previous years. In consultation with our auditors, we have increased our tax reserves by $5 million and adjusted retained earnings accordingly.

I would now like to turn our attention back to the key financial metrics for the fourth quarter and full year 2007.

Revenue for the fourth quarter was $94 million, up 28.6% from $73.1 million in the prior year and 7% sequentially. For the full year revenue increased 25% versus 2006 to $337.7 million, compared to $270.2 million for the prior-year period. By segment, Application Outsourcing accounted for 66%, KPO was 19%, eBusiness represented 10% and TeamSourcing was 5% for the quarter.

On a vertical basis, Q4 growth was largely driven by increases in financial services and insurance. For the quarter, financial services contributed 51% with insurance 20%, healthcare 13%, automotive 7%, and others was 9%.

From a customer concentration level, Syntel’s top three clients represented 46% of the revenue, while the top five ended the quarter at 59%, and top 10’s came in at 75%. Fixed price business represented 35% of revenue for the quarter and 38% overall for 2007.

Gross margin in the fourth quarter was 39.4% compared to 38.8% in the year ago period and 39.8% in Q3. By business segment, gross margin for Applications Outsourcing was 34.8%, KPO was 54.5%, eBusiness was 39.8%, and TeamSourcing 43.4%.

For the full year, Syntel’s gross margins came in at 39.2% versus 37.8% in 2006. During the year, we were able to absorb a 9% move in the rupee, and investments in people, as well as new services while expanding our margins.

The company’s selling, general and administrative expenses were 22.9% in the fourth quarter of 2007 compared to 19.3% in the prior year period and 20.9% in the third quarter of 2007. SG&A increased $3.1 million during the fourth quarter as a result of ongoing investments in infrastructure and sequential increases in other operating expenses. The full year increase in SG&A represents our ongoing investments in world-class infrastructure and sales, marketing, and branding initiatives.

Syntel’s operating income was 16.6% in the fourth quarter, compared to 19.6% in the prior period and 19% last quarter.

Net income for the fourth quarter was $15.9 million or $0.39 per diluted share, compared to $13.3 million or $0.32 per share in the prior year, and $18.3 million or $0.44 per share in the previous quarter. For the full year, the net income was $62.9 million or $1.52 per share, compared to $50.9 million or $1.24 per share in the prior year.

Other period-end metrics from the fourth quarter are as follows: the total headcount was 11,709, which represents a 40% increase over the end of 2006. Billable headcount defined as capacity was 1,709 on-site and 9,260 offshore for a total of 10,969.

Utilization levels were 93% on-site and 66% offshore with a global utilization at 70%. We ended this year with 3,602 people assigned to KPO. Delivery mix at the end of the year was 21% on-site and 79% offshore, largely driven by growth in KPO. Attrition during the quarter was 14.5% annualized.

Syntel launched 103 new projects during the quarter and added four new customers. The addition of two new Hunting Licenses take the total number of preferred partnerships to 88.

Relative to the balance sheet, Syntel ended the year with more than $116 million in cash and short-term investments. CapEx for the quarter was $9.9 million, and for a full year total of $32.4 million. DSO levels in the fourth quarter decreased to 57 days from 73 in the third quarter.

Based on the current visibility, we are pleased to provide initial guidance for 2008. We currently expect revenue in the range of $405 million to $420 million, and EPS between $1.60 to $1.70.

We’d now like to open the call for a Q&A session.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from the line of Joseph Foresi - Janney Montgomery Scott.

Joseph Foresi - Janney Montgomery Scott

Going back to the economic environment, is there anything you are seeing by either service offering or segment that you can point to that, a budget slowdown or has there been any hesitation, and how do you see this affecting your KPO business?

Bharat Desai

In many, many conversations with clients and prospects, clearly and specially in the financial services vertical, I would say they are all trying to figure out how do they fundamentally change their cost structure, and yet deliver the level of service that their clients continue to expect.

So, interestingly we think that our pipeline of prospects has actually never looked better for our KPO business, because they are all and I think it’s a combination of economic environment, I think it’s also largely due to a very unique set of highly custom capabilities we’ve built that are very definably, given what’s happening in the market.

So, in any outsourcing sale there tends to be a longer lifecycle and largely it’s the organization making a decision and then managing all the change that they have to manage within their organization, to drive towards a new way of their business. But we see these are real prospects that are keen on moving.

So, I would say that with the economic environment, the impetus for them to move faster towards KPO is stronger. The other thing I have seen is many times in many, many conversations customers would have applications outsourcing that maybe third or fourth in their list of priorities. I think it’s rapidly going to number one, so, both of those play to our strengths.

Joseph Foresi - Janney Montgomery Scott

On the hiring guidance side, it seems like the seat build out is ahead of what the hiring guidance that you gave, is that an initial hiring guidance and if so could that potential increase as you add more seats in the back half of the year?

Keshav Murugesh

Yes, currently we said we are expecting to hire between 2,800 and 3,500 employees. The guidance actually is consistent with our current revenue guidance and will be adjusted as the year progresses and as revenue projections change. So, you are right. Our current projection in terms of headcount is based on our current revenue projection, and we will revisit that as we fix our revenue guidance across the rest of the year in case we need to make changes.

Joseph Foresi - Janney Montgomery Scott

Could you provide some clarity, I know you added, I think two strategic clients. Maybe you can just talk about the pipeline on the short-term versus the long-term. Are they in the KPO area, is that a longer cycle, and how should we think about those clients in the short-term versus the long-term?

David Mackey

Joe when you look at the pipeline today, I think we see opportunities for both short-term and long-term. What we are seeing relative to the KPO specifically is where the relationship has been developed and is in some form of acceleration, the short-term pipeline looks extremely healthy.

For the new opportunities in some of the large scale introductory relationships that Bharat was talking about, clearly clients are more actively engaging us on a basis here. But I think the one thing we have to watch going forward is the timing in terms of how those things ramp.

Because clearly when you look at the Applications Outsourcing space today, it has been market validated and some of these newer services by definition will have longer sales cycle, even though the economic impetus is there. So, we expect the KPO sales cycle to continue to be a little bit longer especially for services that are not market validated as of yet with the exception of the clients we have today.

Joseph Foresi - Janney Montgomery Scott

Can you give us some color on what you expect from the other income line and the tax rate next year?

Arvind Godbole

Next year we are expecting the tax rate to be around 18%.

Keshav Murugesh

And Joe based on the significant investment program that we have across 2008, we actually believe that at this stage the other income levels will be slightly lower than what we are used to seeing currently. So, that’s baked into our guidance as well.

David Mackey

I think, the other thing that’s important to note is that when you look at the other income line, one of the components that is showing up there today is the gain on hedging and relative to our guidance for next year, we have obviously not assumed any gain in that line. Our guidance is based on a rupee to dollar exchange rate of 39.7 for 2008.

Operator

Your next question comes from the line of Bryan Keane - Credit Suisse.

Bryan Keane - Credit Suisse

On the headcount, the 40% was slightly below your goal, I think it was 42%. I just want to know if there was any color on that. And then if you just look at the overall headcount growth in ‘07 it grew 40%, in ’06, 37%. And now the growth rate is going to be a little bit lower. I was just hoping you can explain the relationship, headcount to revenue. I know you described it a little bit, but it is different from where we have been before.

David Mackey

First of all when you look at the 40% growth for this year, one of the things that sticks out is when you look at our year-end utilization levels offshore, we’re sitting at 66%. So clearly we’re in a pretty comfortable level in terms of the number of people that we have onboard today and our ability to drive growth going forward.

I think the one thing that’s different as we look into 2008 and Joe’s question touched a little bit on this is the fact that as we stand here today the hiring guidance that we provided is linked to the revenue guidance. So, the acceleration that we’ve reported at this point in terms of the headcount is linked to the revenue, which at $405 to $420 million is a 20% to 25% growth versus 2007.

So, the reason you see some softness, at least an optical softness in the hiring guidance for the upcoming year is more around the fact that there is an optical softness to the revenue guidance as well, so it’s not going to take an accelerated number of heads to drive similar to less growth in the upcoming year.

I think the other thing that’s important to note is as the mix of services and the growth rate in those services changes throughout the year, the number of heads required to drive incremental dollars should also be decreasing. That’s a factor in terms of just the number of types of services that we’re providing and also the improvements in both pricing and productivity that we expect in 2008.

Bryan Keane - Credit Suisse

And along those lines then the KPO business which continues to grow, maybe the headcount was higher there and now that you are hitting scale, a lot large numbers, that growth rate comes down a little bit as we go forward?

David Mackey

And I think that’s correct and I think it’s consistent with what you’ve seen in the past three years. In 2005 we had a 225% growth rate in our KPO business. In 2006, that dropped to 200%.

This year if you look at the revenue growth, and again it is all surrounding the law of large numbers, our KPO business grew 155%. So obviously given that it is now 19% of total revenue and a much bigger portion of our business, it’s going to be more and more difficult to maintain the growth rates in that business segment.

Bryan Keane - Credit Suisse

SG&A came in quite a bit higher than I expected, and that lowered the overall operating margin. Can you talk a little bit about SG&A going forward and then what we should expect for operating margin in ‘08? Is it flat, slightly down, slightly up margins?

Arvind Godbole

As compared to the previous quarter, the G&A increased by $3 million, but almost half of that relates to non-recurring expenses, in the nature of several marketing initiatives that we have taken, sales meetings and some client specific investments.

The balance increase relates to an increase in the operating expenses such as compensation as we grow the headcount, and the CapEx related cost. However, going forward we expect it to be around, between 20% and 21%.

Keshav Murugesh

And Bryan, to your other question, obviously we are investing significantly in our business, and therefore we will continue to do all the right things in terms of the SG&A line, in terms of branding, marketing, new offerings, whatever else we need to do. And at this stage, we are focused on delivering a similar operating income as we have delivered during this year.

Bharat Desai

Yes, I think the market opportunity looks great. Syntel’s positioning has never been better, so we will continue to invest in expanding our footprint and taking advantage of the opportunities that the market presents to us.

Bryan Keane - Credit Suisse

I know the tax rate looks like it’s 18% or so, for next year. Any thoughts on 2009 tax rate and how the changes to STPI, Software Technology Parks of India, will affect you there.

Arvind Godbole

The tax holiday for some of our units will be available only up to March 2009, because it is going to sunset as of now. Hence there will be an upward bias for the coming years including 2009. But, we are going to set off partially by the benefits, which are available under the new scheme that is the SEZ, special economic zone.

So, we’ll have some margin there but, as of now we are seeing the tax rate for the 2009 to around 19% and it may go up slightly as we go to 2010 and ‘11. However, as per the recent news that we are hearing in this budget, which is a couple of days from now that is next Friday, they might extend the tax holiday by one more year. But as of now, we are not sure, but that’s what the news.

Operator

Your next question comes from the line of Brian Kinstlinger - Sidoti.

Brian Kinstlinger - Sidoti

The Apps Outsourcing has a gross margin of 24.8% was that correct?

David Mackey

No. The gross margin in the Applications Outsourcing, Brian, was 34.8 in the fourth quarter.

Brian Kinstlinger - Sidoti

When you take a look at your top line growth, I’m trying to figure out the underlying strengths of your business which are KPO, and Apps Outsourcing, maybe give us a sense of the growth rate there versus the rest of the business that you are expecting?

David Mackey

I think we touched on a little bit before when we talked about the law of large numbers relative to the KPO. Clearly we don’t expect the KPO business in 2008 to have the same type of growth rate and trajectory that we experienced in 2007. So, when you look at the growth rate in that business, we expect that to obviously slow down because of the law of large numbers.

However, one of the areas we are very, very focused on is accelerating the growth in our Applications Outsourcing business and accelerating the growth in overall IT. So, we believe that the combination of the two will allow us to drive healthy growth in 2008.

Brian Kinstlinger - Sidoti

And when you say accelerated revenue growth in the guidance, at the high end it’s in line with what you did this year. Can you just reconcile that, are you referring to past guidance or what are you referring to?

David Mackey

I think when you look at how we are walking into this year in terms of the revenue guidance and the visibility to those numbers this clearly represents an acceleration for Syntel. Last year when we walked into the year for the first time, we gave guidance that was 60% visibility to a 15% growth rate on the low-end.

Walking into 2008, we are giving the same visibility, which is 60% to a 20% growth rate on the low-end. So, clearly relative to prior years this represents an acceleration for us in terms of our visibility and our visibility to the low-end of guidance.

Brian Kinstlinger - Sidoti

I want to focus on KPO a little bit. You’ve doubled your clients there. There is pretty big customer concentration at the highest client there. Is that concentration decreasing or increasing and give us a sense where you are with some of your other clients, just stages of projects. Are they still in initial phases, or are they beginning to ramp up to the next level?

Keshav Murugesh

Actually as far as the concentration is concerned, we continue to focus actually, we’re still in sell mode and with some of the large clients that we have there. We’ve at this stage begun to scratch the surface we believe, and we’ve been able to move in a significant number, amount of work to our KPO centers.

But we’re continuously focusing on increasing the kind of work that we’re doing, and taking the quality of work to a different level. So, we’re actually now moving up the value chain, introducing new offerings, and therefore at this stage we believe that each of those accounts continue to be under-penetrated.

So, we’re really focusing on growing those relationships significantly. At the same time, some of the other clients, at least one or two of them that were much smaller earlier are now beginning to ramp up much faster, and we feel very confident with the way the move is taking place there.

David Mackey

Brian, while we do have a concentration issue within the KPO segment, we have seen, as Keshav mentioned, some very, very healthy acceleration from the other nine clients in this area. And if you look at the growth rates for 2007 versus 2006, while our largest client actually grew about 160% year-over-year, the contribution from other KPO clients grew 140%. So, there is some good acceleration from the next tier of clients.

Keshav Murugesh

I think what is most exciting for us is the fact that our cross-selling efforts are beginning to bear fruit just now. We did announce earlier that we have actually cross-sold BPO into one of our top 20 IT clients as well. And I think what’s happening in terms of the overall business trends that Bharat spoke about earlier, we are actually seeing lot more interest for our KPO services now from our top 20 list of clients as well, which is very exciting for us.

Brian Kinstlinger - Sidoti

Among your your hiring guidance, how much of that is BPO versus the rest of the business?

David Mackey

Probably a similar mix, Brian, to what we saw this year, about two-thirds of it will be KPO.

Brian Kinstlinger - Sidoti

You provide your revenue by industry, and as I look at the healthcare unit, which was I think you said 13% of revenue, it’s been $12 million plus for about six quarters. What’s the dynamic there that’s making that growth so much slower than everything else in your business?

David Mackey

I think one of the biggest reasons that we don’t see the type of acceleration that we see in healthcare that we see in some of the others is we do have a large number of project-based initiatives in the healthcare area. So, to the extent that it is one of our segments that is somewhat development based, we have that revenue replacement issue.

Brian Kinstlinger - Sidoti

Was there anything one-time in SG&A or non-recurring, as you would classify in the fourth quarter?

Keshav Murugesh

Yes, actually, as Arvind spoke a little earlier, of the $3 million increase that we saw during this quarter, he actually said that about $1.5 million was more corporate-related expenses and marketing-related expenses that are unlikely to recur. So, in terms of your model, you shouldn’t take that in.

Brian Kinstlinger - Sidoti

Why are they unlikely to recur, the marketing and sales expenses?

David Mackey

I think, Brian, from a quarter-over-quarter standpoint, if you look at some of the charges that took place in the SG&A in the fourth quarter, things like specific marketing and branding initiatives relating to events, those are charges that will not be happening in the first quarter.

Things like taking a reserve for allowance for doubtful accounts that is not something we anticipate to take in the next quarter. So they’re truly are some one-time items, and while they are operational, and while they’re important to our business, we don’t expect them to be part of our systemic cost structure moving forward.

Brian Kinstlinger - Sidoti

Related to the other income line, can you quantify how much this year you had on hedging and for the quarter?

Arvind Godbole

We’ve been following a hedging strategy and we’ve been hedging our revenues for the quarters as and when we feel appropriate. We also consult various bankers. We have specialized consultants who are advising us and we follow it on a day-to-day basis. And that is why even that is also factored in our planning for the next year, so we are I think we are adequately protected.

Brian Kinstlinger - Sidoti

What was the actual gain on hedging down there for the year and the quarter, because we saw the fourth quarter spike so much in terms of other income?

David Mackey

$0.4 for the quarter and $0.6 for the year, Brian.

Brian Kinstlinger - Sidoti

And what was the other increase in other income for the quarter?

Arvind Godbole

Other income basically, we have booked some profits in several of our investments, and that is the reason why you are seeing a spike and that’s what we typically do in the year-end.

David Mackey

That was about $600,000 in the fourth quarter.

Operator

Your next question comes from the line of Joseph Vafi - Jefferies & Co.

Joseph Vafi - Jefferies & Co.

The Phase II of Pune and Chennai, are those are SEZs? Is that correct?

Keshav Murugesh

That is right.

Joseph Vafi - Jefferies & Co.

We haven’t heard much here on the Fringe Benefit Tax for Syntel, is that something we should be looking at all in ‘08 as part of GAAP earnings?

Arvind Godbole

Fringe Benefit Tax was introduced in the current year, but we do not have a significant impact because of that.

Joseph Vafi - Jefferies & Co.

If we could drill down into maybe some of the other lines of business. Obviously eBusiness was up a little bit here in Q4. Is there any particular outlook you might want to provide on eBusiness maybe for the first quarter and looking into 2009?

David Mackey

I think Joe when you look at our eBusiness segment it’s been relatively flat quarter-to-quarter and year-over-year. Again it is the nature of this business and the way we have defined it is that it’s short duration project work.

Obviously, this is one of the areas that we are watching in 2008 because this is one of the places you might see, as Bharat described, some discretionary types of spend. So, it is something that we don’t have the visibility too that we typically do on the maintenance and the pure Applications Outsourcing side.

Joseph Vafi - Jefferies & Co.

So, if you looked at that business as you look into the year any change in visibility on that particular line of business. I know its short project length, but just trying to get a feel for if we think that line of business can actually be up here in ‘09?

David Mackey

I think we certainly have the opportunity to, but given the current visibility I don’t know that we would have a comfort level in committing to that at this point.

Joseph Vafi - Jefferies & Co.

On the KPO business, if that hiring there is a little bit more of a just-in-time model I would imagine as compared to the IT businesses is that the right way to look at it?

David Mackey

Yes, much more so, yes.

Bharat Desai

But, there is still a lead-time from hire to deploy.

Joseph Vafi - Jefferies & Co.

If we look at the hiring goals this year versus last and I think some of the commentary earlier about maybe a little bit of it shifted. It sounds like perhaps we are going to be hiring more in ‘08 relative to ‘07 outside of KPO if we would say that the IT lines of business or maybe that KPO is going to grow a little bit more slowly. Would that be the right way to look at it?

David Mackey

I think it’s relatively consistent, Joe. I think about 60% of our hiring in 2007 was in the KPO segment and I think looking at two-thirds for next year is fairly consistent. So, I think the slowdown we’re going to see in terms of the growth rate in KPO is more on the law of large numbers than it is around the trajectory with our clients.

Joseph Vafi - Jefferies & Co.

On the pricing environment it sounds like you’re looking at some potential opportunities for some price increases. Is that fair to say that is on new and renewal business at this point?

David Mackey

Yes, consistent with what we’ve seen for the last few years, we expect to see price increases in the 3% to 5% range for both new and existing business.

Operator

Your next question comes from the line of Edward Caso - Wachovia Capital Markets.

Edward Caso - Wachovia Capital Markets

Can you talk a little bit about wages? You mentioned continuing good news on the pricing side, but do you share the belief with some of the Tier 1 players that you may actually have lower wage increases this year.

Keshav Murugesh

We’ve been hearing there has a been lot of noise on the wage side, but as far as we are concerned we continue to believe that the offshore wage inflation is going to be in the region of 14% to 15%, onsite is going to be more like 4% to 5% and we baked that into our guidance. If you actually saw what one of the large firms released yesterday in their report, I think that report is pretty consistent with our assumption.

Edward Caso - Wachovia Capital Markets

Could you also talk a little bit about lot of the Tier 1s are saying that they’re gaining share against the Tier 2 and if you actually worked the numbers you could see that that is happening through the last several quarters. Within your universe of clients, have you lost share to some other players or not?

Bharat Desai

Actually, what we’re seeing is I would say the opposite. I have to commend the Tier 1s for the growth rates that they have shown over the past few years and they’ve really executed very well. But we’re seeing clients who really are looking for responsive nimble capable organizations.

And at their current sizes, these organizations are no longer viewed as nimble by customers and the things that customers found attractive in them, they don’t see any more. And number three, some of them are looking for $50 and $100 million commitments before they take on customers.

So that’s a great spot for us. So, we are actually seeing exactly the opposite where good global brands say I can’t commit $50 million to this company, let’s see what we can do. So, hopefully it answers your question.

Operator

Your next question comes from the line of David Cohen – JPMorgan.

David Cohen – JPMorgan

I was wondering if you could talk a little bit about the KPO opportunities and the pipeline in terms of industry and then in terms as well, and some more detail about the kind of work you are actually looking at doing for the prospects?

Keshav Murugesh

Yes, our focus as far as the KPO business is concerned is more on the asset management, the credit card, merchant processing and the travel services side. And so definitely the banking and financial services part of the vertical and on the other side on the healthcare side, we have a new offering now launched which is more on the payer-provider area.

Currently in terms of revenue numbers, the big success area today is really the whole banking services, banking and financial services space and that is where we continue to build momentum, more around reconciliation, and the attribution of funds and those services. Where we are looking at we are actually helping clients in terms of moving some of their key processes, to our KPO locations in India thereby reducing their costs, but more importantly creating a very sticky service for ourselves.

So, currently in terms of the pipeline, we are continuing to focus very strongly on penetrating our existing client base, offering some of those services to a specific list of clients that we have carved out for ourselves and again cross-selling services across our existing IT client business that we have.

Bharat Desai

We’ve made a very conscious decision to stay out of commodity and low end and call center businesses. We are looking at those processes that we believe are high value to our clients’ businesses and most of them therefore take a very studied approach. Because in most cases it’s a very custom transition that these companies may or may not have considered before. But, that’s the space that we see as being very exciting in the banking and financial services areas, in the insurance area, and in the life sciences and healthcare area.

David Cohen – JPMorgan

And in terms of the skill set to support that business, how do you find the labor markets?

Bharat Desai

You have to grow it. The very fact that it’s a custom new area, you may find some skill sets but you have to invest very heavily in growing and developing that skill set.

David Cohen – JPMorgan

Are any of the hedging benefits within the operating income or is it all in the other income line?

Arvind Godbole

Hedging gain is in the other income.

David Cohen – JPMorgan

Do you get the hedge accounting treatment for the currency?

Arvind Godbole

Yes, what we do is basically bulk of our currency is sold as forward. So, we get a gain because we manage the hedging properly. So, we do the hedging only when the time is appropriate and because of our proper decisions, we could make some gains. But the objective is not to make a gain we are not going to speculate on the ForEx movement. We do not have any derivative positions.

David Cohen – JPMorgan

In terms of the SG&A, you talked quite a bit about, it was up and some of it was probably not going to continue. In the quarter, was the SG&A consistent with what you had expected? Were any of these one-time items somewhat of a surprise to you?

Arvind Godbole

No, not really. They were expected, and there are some events which we typically organize in the last quarter of the year, and some initiatives we have kicked off. So, they are not really going to recur in the coming quarters. And also bulk of the increase is also primarily due to the increase in the hiring and marketing expenses. And also we have commissioned lot of facilities. So, the effect of the full depreciation is coming up in the subsequent quarters as we go on adding facilities.

David Cohen – JPMorgan

Did you give the D&A in the quarter? And if not do you have it?

David Mackey

Yes, the D&A in the quarter, David, was 3.3 million.

Operator

Your next question comes from the line of Vincent Colicchio - Noble Financial Group.

Vincent Colicchio - Noble Financial Group

What is your overall exposure to commercial banks? On the IT side how does your pipeline look with commercial banks? Is it any different from other industry segments?

David Mackey

Overall, Vince our exposure on the commercial banking side is less than 2% of total. And in terms of the pipeline, I would say that it is certainly not skewed towards that any more than our normal business.

Vincent Colicchio - Noble Financial Group

Large contracts on the Application Outsourcing side, do you have any large contracts coming up for renewal in the near future?

David Mackey

I think what we have coming up, Vince, is the same types of issues that we have every year relative to expiration of Master Services Agreements and renegotiation of the pricing on those, and as we’ve talked about, those have all had a forward bias, but the contracts on specific pieces of work don’t always run in concert with the Master Services Agreement timing. So it is somewhat stagnant and stagnated that way, but we don’t expect to have any significant issues.

Vincent Colicchio - Noble Financial Group

How large is Testing Services now as a percentage of revenue?

David Mackey

We have not reported the Testing Service yet as a separate offering, Vince, although I can tell you that from a headcount standpoint today the Testing segment is over 1,200 people.

Operator

You have a follow-up question from the line of Brian Kinstlinger - Sidoti & Company.

Brian Kinstlinger - Sidoti

About a year ago, the company talked a little bit about Client Partners impacting the business and some of their top clients growing as a result of Client Partners that were installed with those clients. I am wondering for the year if you are able to hire any and if not, is it still a focus of the company and just give us some color on that?

Keshav Murugesh

I think the whole focus on Client Partners and ensuring that huge amount of client intimacy between ourselves and the client is a significant focus area. So, if you look at the concentration itself, you will notice that obviously the revenue from our top ten clients increased.

I think that’s because of I think all the good work that we have done in terms of the investments, in terms of our infrastructure, people, and our new offerings program and the fact that the Client Partner program really helped to create that connect or knowledge between the clients and ourselves.

But having said that in spite of the fact that the concentration has increased we continue to believe that a number of those clients are under-penetrated. So the focus really is to continue to focus, to look at new areas within each one of those clients and sell revenues, sell new offerings into each one of those other areas.

And the great part is, as Dave mentioned earlier, that our Tier 2 clients actually grew 17% during this year. So, the focus really is to continue to introduce new offerings, make sure that the Client Partners get more impactful with each one of those other clients in the top ten list and bring the same attention to the next list of ten clients, that’s the most exciting opportunity at Syntel.

Brian Kinstlinger - Sidoti

I was just going to ask specifically in the last two quarters, I have asked the question, I think you’ve had couple of cherry picking or finding those people. Have you been able to this quarter find those people just where are you in the hiring of that?

Bharat Desai

We actually think that this program is really pivotal and we are really investing heavily in that. And over the last couple of years, we have really significantly changed our entire leadership development program. So, we feel very confident that there are many, many young leaders in the company, who will grow into those positions.

And therefore, as a company we’re making significant investments in identifying these people early, and developing them through some very specific initiatives to be able to grow from Project Managers to Engagement Managers to Delivery Managers to Delivery Directors to Client Partners.

So, if we find some good ones outside of course we’ll hire them. But we believe that the majority of our new Client Partners will actually come from our Leadership Development Program, and this is something we as a leadership team track on a regular basis and this is a regular discussion even in Board Meetings.

Dave Mackey

And Brian, as Keshav mentioned, I think where you’re starting to see some of the results of that, clearly we have our Client Partners that have been with us for a while and they have been extremely successful in accelerating the revenues with our top ten clients which grew another 29% in 2007. And obviously their time is being extremely well utilized and completely consumed servicing those top ten accounts.

Where we have seen some success and Bharat alluded to this is as we bring people up through the formalized training programs and create junior Client Partners and move through a mentoring program. These folks are starting to be assigned to some of our smaller Tier 2 and Tier 3 accounts with the objective of accelerating net revenue and in fact as Keshav mentioned our Tier 2 accounts or accounts number 11 through 20 grew 17% in 2007.

So, that is a very healthy acceleration for some of those accounts and we’re obviously looking for those people to continue to grow and for those accounts to continue to grow.

Brian Kinstlinger - Sidoti

What was the timing for coming online with Pune Phase II and Chennai Phase I and what is the impact on your employed operating margin that you have discussed?

Keshav Murugesh

Pune Phase II will be on stream during the Q2 of this year, and Chennai Phase I at this stage we expect will be ready in Q4 2008.

Dave Mackey

And in terms of the impact on the margins, one of the things we do expect in 2008, Brian, is that while we have a little bit of leverage on the gross margin side, we also expect that our SG&A will be up a little bit this year. So bringing Pune Phase II online in Q2 will have a pretty significant impact on our overall D&A and our overall SG&A levels. But as Bharat and Keshav have both mentioned earlier, what we see is that basically the increase in gross margins will be offset by a slightly larger level on the SG&A side.

Brian Kinstlinger - Sidoti

Did you give cash flow from operations?

Dave Mackey

We did not give the number, but the cash from ops in the Q4 was $35.8 million.

Brian Kinstlinger - Sidoti

Apps Outsourcing margin was down 200 basis points. Every other line was up on the operating margin what was the cause for that and is that just the beginning of a new project?

Dave Mackey

I think it’s a couple of things, Brian. One of it is the currency appreciation which obviously affects that segment, also when you look at the utilization levels at the end of the year and you look at the headcount levels, one of the places where we’ve increased our readiness going into 2008 is in the IT side and specifically the Applications Outsourcing side offshore. So, we are running our utilization levels for that business slightly lower than we have historically.

Bharat Desai

Well, thank you everybody for joining us today. Both operationally and financially we are pleased with the overall company performance in 2007 and despite what looks like a challenging economic environment, we believe we are extremely well positioned in the marketplace, and our prospects for 2008 and beyond have never looked better.

Our team remains focused on accelerating our top line growth and delivering sustainable margins. We look forward to talking to you during the next quarter.

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Source: Syntel, Inc. Q4 2007 Earnings Call Transcript
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