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Syntel Inc. (NASDAQ:SYNT)

Q1 2008 Earnings Call

April 24, 2008 10:00 am ET

Executives

Jonathan James - Chief Marketing Officer

Bharat Desai - Chairman & CEO

Keshav Murugesh - President and COO

Arvind Godbole - CFO

Dave Mackey - VP Finance

Vincent Colicchio - Noble Financial Group

Analysts

Joseph Foresi - Janney Montgomery Scott

Ed Caso - Wachovia

Brian Kinstlinger - Sidoti

Tim Fox - Deutsche Bank

Joseph Vafi - Jefferies & Co

Bryan Keane - Credit Suisse

David Cohen - JPMorgan

Operator

Welcome to the Syntel's first quarter 2008 Conference 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 April 24, 2008.

I will now turn the call over to Jonathan James, Syntel's Chief Marketing Officer. Sir, you may begin.

Jonathan James

Thank you and good morning, everyone. Syntel's first quarter earnings release crossed Business Wire at 8:31 this morning. It's also available on our website at www.Syntelinc.com

Before we begin today's call, I would like to remind you that some of the comments made today 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 will now turn the call over to Bharat Desai, Syntel's Chairman and CEO. Bharat?

Bharat Desai

Thank you, Jonathan. Good morning, everybody, and thank you for joining us today. I'd like to begin with some comments regarding our Q1 performance and also address some of the macro level trends in our industry. I'll then turn the call over to Syntel's President and Chief Operating Officer, Keshav Murugesh, and Syntel's Chief Financial Officer, Arvind Godbole.

Overall, we're pleased with the Company's performance during the first quarter, and believe that Syntel remains well-positioned despite the overall economic environment. While there is universal concern about the state of the U.S. economy, the magnitude of the business impact and how organizations react to these challenges is largely client specific.

The pressures on many clients to justify spending levels, it's not surprising that the driver for our growth during the quarter was cost reduction based initiatives. This was evidenced by double-digit growth for both our Knowledge Process Outsourcing and Applications Management Service offerings. In the current environment it should come as no surprise that this growth in these services was driven largely by clients in our financial services and insurance segments.

While timing of decision making may vary, economic and operational pressures, will force companies to look at their cost structures and prioritize their initiatives. Regardless, we firmly believe that the macroeconomic trend towards the globalization of services will not change. In our view, this is an irreversible mega trend. In short, we believe our market positioning has never been better given our core offerings, our strong capability, our mid-tier status, and our Blue Chip customer base.

I would now like to turn the call over to Keshav Murugesh, Syntel's, President and Chief Operating Officer, and then from him to, Arvind Godbole, Syntel's Chief Financial Officer, to provide details on our operational and financial performance. Keshav?

Keshav Murugesh

Thanks, Bharat. Good morning, everyone and welcome.

Overall, Syntel is pleased with the momentum we generated in the first quarter. Q1 marked the 16th consecutive quarter of revenue growth for Syntel, posting 5% sequential improvement and over 30% growth, compared to the first quarter of 2007. So on a services perspective, revenue acceleration was driven by demand for our three key segments, KPO, Applications Outsourcing, and e-Business. These three segments sequentially grew 15%, 7%, and 4% respectively.

Our Team Sourcing revenues during the quarter dropped in excess of 50%, as we successfully converted several staffing projects to Syntel managed Applications Outsourcing engagements. Our legacy staffing business now represents only 3% of revenue.

During the first quarter, there were several positive metrics related to client acquisition and acceleration. Syntel's client additions during the first quarter were the highest in over four years, with 11 new customers generating revenue. On the Knowledge Processing Outsourcing front, we added two new clients, including our first healthcare KPO customer and our second successful cross-sell from IPO.

Additionally, Syntel signed one new hunting license, and activated three existing relationships. We were also pleased with the fact that our customer concentration levels reduced by approximately 2% at the top three, five, and 10 levels. On the hiring front, Syntel added almost 400 employees during the first quarter. For the full year, we continue to expect net hires in the range of 2,800 to 3,500 in support of our current revenue guidance of $407 to $420 million.

Recently, there has been increased industry attention on the subject of easing supply side dynamics in India. We believe that if sustainable this development on the talent front has the potential to allow for increased flexibility in hiring and downward pressure on wages.

From a construction perspective, we will continue to aggressively build out our campus infrastructure in India ahead of demand. Phase II of our Pune campus will open in the second quarter of 2008, and Phase I of our new Chennai campus is scheduled to open in the fourth quarter. Combined, these two phases will add approximately 6,000 seats of capacity for 2008 and beyond.

Syntel expects to spend between $50 and $60 million of CapEx in support of these efforts and other infrastructure upgrades. As we move through 2008, our business objectives remain clear. We are committed to accelerating our top line growth, maintaining our operating margins, and investing in people, new service offerings, and world class infrastructure.

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

Thank you, Keshav and good morning. I also have Dave Mackey, Syntel's Vice President of Finance, joining me on the call. After my comments, we'll open the call to questions.

Revenue for the first quarter was $98.5 million, up 31% from $75.4 million in the prior year period and 5% sequentially. By segment, Applications Outsourcing accounted for 67%, KPO was 20%, e-Business represented 10%, and Team Sourcing was 3% for the quarter.

On a vertical basis, financial services contributed 53%, with insurance 20%, healthcare 12%, automotive 7%, and other was 8%. From a customer concentration level, Syntel's top three clients represented 44% of revenue, while the top five ended the quarter at 56%, and the top 10 came in at 73%. Fixed price business represented 39% of revenue for the quarter.

Gross margin in the first quarter was 40.3% compared to 39.1% in the year ago period, and 39.4% in Q4 of '07. By business segment, gross margin for Application Outsourcing was 33.8%, KPO was 61%, e-Business was 44.5%, and Team Sourcing 28.5%.

The company's selling, general, and administrative expenses were 20.8% in the first quarter of 2008, compared to 17.2% in the prior year period and 22.9% in the fourth quarter of 2007. Syntel's operating income was 19.4% in the first quarter, compared to 22% in the prior year period and 16.6% last quarter.

Our first quarter tax rate was favorably impacted by $3 million reversal of tax reserves as per FIN-48. This added $0.07 per share to the quarterly earnings. Net income for the first quarter was $20.4 million, or $0.49 per diluted share, compared to $15.4 million, or $0.37 per share in the prior year period, and $15.9 million, or $0.39 per share, in the prior quarter.

Other period-end metrics from the first quarter are as follows: total headcount was 12,093, which represents the 3% sequential increase and over 39% over Q1 of 2007. Billable headcount was 1,752 on-site and 9,538 offshore, for a total of 11,290.

Utilization levels were 92% on-site and 66% offshore with a global utilization at 70%. We ended the quarter with 4,028 people assigned to KPO. Delivery mix at the end of the quarter was 20% on-site and 80% offshore. Attrition during the quarter was 14.3% annualized. Syntel added 11 new customers, the additional one new "Hunting License", which takes the total number of preferred partnerships to 89, and activated pre-licenses taking the total to 60.

Relative to the balance sheet, Syntel ended the quarter with $109 million in cash and short-term investments. CapEx for the quarter was $8 million and DSO levels increased to 66 days from 57 in the fourth quarter. Based on results from the quarter, we are pleased to update our guidance for 2008. We currently expect revenue in the range of $407 million to $420 million, and EPS between $1.69 to $1.78.

We would now like to open the call for a Q&A session. Operator.

Question-and-Answer Session

Operator

(Operator Instructions) Our first question comes from the line of Joseph Foresi.

Joseph Foresi - Janney Montgomery Scott

Hi, guys. I wonder if you could first talk about, it looks like your Other Income came in a little bit lighter than expected and the tax rate was lower. Are those two related, was there perhaps a hedge that went against you in the quarter?

Arvind Godbole

As mentioned during the earnings call for last quarter, the Other Income was higher than last quarter basically because we booked some profit in some of our investments. And that is the reason there was a spike. The current quarter was also impacted due to the depreciation of the rupee during the quarter. We have forward sales booked at X rate, and such sale has to be mark-to-market at the quarter end, resulting in income or loss based on the rupee movement during that quarter. And previous quarter we had some gains, and this quarter we have a loss.

Joseph Foresi - Janney Montgomery Scott

Okay. And that in turn brought your tax rate down or?

Arvind Godbole

No, tax rate primarily was down because we had a reversal during this quarter, and this is in line with the FIN-48, as you know, as per FIN-48 we are required to reassess the tax positions every quarter. And we had certain tax provisions for which we had created reserves and we received certain appeals in our favor.

And that brought on the tax rate, because $3 million reversal has given us $0.07, as we mentioned in the release. And we'll continue to make it further, so tax contingencies based on our estimates. The provisions which are not required for particular year are credited to the income tax expense.

Joseph Foresi - Janney Montgomery Scott

No, I guess I understand. I guess what I'm wondering is what is your tax rate excluding the tax reversal? Was it around 14%?

Arvind Godbole

For the quarter it would have been 13.5%.

Joseph Foresi - Janney Montgomery Scott

Okay. And that seems like it's down from what it historically has been at. Can you just give me some color as to why it's decreased?

Arvind Godbole

Primarily because that is a function of the tax planning exercise that we have, and going forward, we expect that it will be 16 to 18% for the balance of the year, and as our units go out of the tax holiday.

Joseph Foresi - Janney Montgomery Scott

Okay. And then, just in reference to the demand environment, we've heard some of the larger vendors talk about, we've seen pretty much in line numbers in the March quarter, and than we've seen than guide lower in June. Have you seen demand decrease more over the last month or two or has there been any change in that? And if there has been one, how should we look at the model at this point?

Bharat Desai

Let me try and address that, Joe. We feel very good about the demand environment today. Remember, over two-thirds of our revenue comes from "keep the lights on" type operations both application maintenance, as well as KPO. And these are typically operational line items for companies.

So as companies have faced a challenging economic environment, they are starting to look much more seriously at putting these initiatives of applications outsourcing or knowledge process outsourcing, or BPO, really front and center. So we feel that we have perhaps the best dialogue and best active set of prospects and feel good about where we are.

Joseph Foresi - Janney Montgomery Scott

Okay. So I guess using those comments, why you just move the bottom line of the revenue guidance up, why not the top line?

Bharat Desai

Great question. I think if you look out, I think there are two important things to remember. The impact of the economy varies from company-to-company, and how each company responds varies. What we've found is that while these initiatives have become a high priority, these are large complex organizations, who have to manage change, and for a number of them these are new initiatives. So we feel great about where we are. But out of our control and out of our hands is the timing and sizing.

Keshav Murugesh

But Joe, just to give you some comfort. We are also very enthused with the fact that, we have almost 76% visibility to the lower end of the guidance at this stage. And as Bharat did mention that, 32% of our business is essentially non-recurring in nature, development of soft augmentation kind of work. So at this stage, this is just a range of numbers that we are providing. You are aware that just two months ago we gave you a range. We've already upped that range at this stage. And we'll see how things pan out as the year progresses and we'll keep you updated.

Joseph Foresi - Janney Montgomery Scott

Okay. And then, just lastly here, it looks like some of your competitors have talked about maybe a softening in the labor supply, and I know, you guys talked about it in the opening. And they've also had sort of lighter pricing numbers. I wonder if you guys could talk about maybe what you're seeing on the labor front, what your plans are for wage increases, and what pricing is expected to be like? Thank you.

Keshav Murugesh

Sure, I'll address that. Like I said earlier, at this stage we continue to expect to hire approximately 2,800 to 3,500 people during 2008. So no change from what we gave out the last quarter. And it is possible based on what we are hearing and possibly what's likely to happen in the future that, we could have include utilization possible due to the easing in the supply side, and the improvement in the hiring flexibility.

Having said that, at this stage, we again believe that the majority of the hiring will be back ended loaded. And as far as the wage inflation goes, we've already been past Q1, which is the traditional quarter for the on-site rate inflation. We believe that we saw wage inflation in the range of about 4% on-site. And we continue to believe that the wage inflation offshore for us will be 14 to 15%.

Having said that, we did mention even the last time, we do a fixed and a variable kind of compensation, we have that kind of a compensation philosophy. And so, based on how we perform on the revenue front, we'll actually see and exact wage inflation. But at this stage, we believe it will be 14 to 15%, based on the guidance that we have given. And we feel quite comfortable that that's where it will be.

Joseph Foresi - Janney Montgomery Scott

And on the pricing front? Thanks.

Dave Mackey

Yes, I'll take that, Joe. I think as Keshav mentioned one of the benefits of having a significant component of your comp linked to performance is that it does provide a natural hedge, if you will, against pressure, if there is such on the top side. So the variable component of this compensation is linked to not only revenue acceleration for the company individual performance, but also margin.

So, for example, if wages in India do not increase at the same rate that people think, if it does create a level of pressure on pricing, which we have not seen as yet, what we would be able to do is pull back on some of those wage increases to account for lower pricing and therefore manage our margins accordingly. So we believe there is enough flexibility based on the model, but as of right now, we are not seeing pressure to reduce the price increases that we had planned for 2008.

Joseph Foresi - Janney Montgomery Scott

Thank you.

Operator

Your next question comes from the line of Ed Caso.

Ed Caso - Wachovia

Hi. Ed Caso, Wachovia. I think I may have one question that Joe hasn't touched on. Cash flow, can you talk about what your expectation is for the year and sort of why the DSOs ticked up?

Dave Mackey

Yes, I'll take that, Ed. Clearly, relative to the DSOs, this is a very, very normal pattern for Syntel. We do tend to because of the billing cycles recoup a lot of cash in the fourth quarter and drive down our DSOs accordingly. In fact, our DSOs the last three years have been at 57, 56, and 52 days at the end of the year.

We typically run our business between 60 and 65 days. That's kind of normal. Q1, obviously, a little bit on the high side, but again, from a historical pattern standpoint, nothing out of the ordinary for Syntel. Relative to the cash flow, obviously, the spike in the DSOs had a negative impact on first quarter cash flow.

But as we look forward, we think based on the increase on the expense line for the D&A and the offsets that we're going to see relative to the dividends that we pay, and the CapEx that we're planning between $50 and $60 million for the year, that at these kind of levels you should be able to see net cash for Syntel in the year somewhere between in the $10 million range anyway.

Ed Caso - Wachovia

Okay. Thank you. And last question, we're starting to hear about vendor's offshore providers sort of giving back or absorbing transition costs to win outsourcing related work. Are you starting to see that? Is that starting to become part of your model?

Dave Mackey

I don't think Ed, that's an abnormal behavior from clients in the past two or three years. I mean, clearly, what's incumbent, a vendor is to make sure that clients, both in the short-term and the long-term, achieve the cost reduction objectives that they're trying. So one of the things that we've always done when we initiate new types of engagement, especially on the application maintenance front is to go ahead and absorb that cost.

It's something that's very important to our clients and it's something that we're able to manage over the course of a three to five-year engagement, which is typically the term for some of these longer term types of projects.

Ed Caso - Wachovia

On a relative basis, have you had to give up more upfront than historically?

Dave Mackey

No. I think it's all about clients achieving their cost reduction objectives. And clearly, there's a balancing act for us as well. But, no, I have not seen a significant change in that.

Ed Caso - Wachovia

Thank you.

Operator

Your next question comes from the line of Brian Kinstlinger.

Brian Kinstlinger - Sidoti

Hi. Good morning.

Bharat Desai

Morning, Brian.

Brian Kinstlinger - Sidoti

The first question I had was on applications outsourcing. You've finally accelerated that year-over-year growth to be in line with the market it looks like as of this quarter. And I'm curious if that was sustainable that couple of clients doing that, and if so, does your current guidance suggest you'll be able to maintain that level for the year?

Dave Mackey

I'll take that, Brian. I think when you look at the acceleration in the applications outsourcing line clearly we're pleased with some of the progress that we've made in that area. I will provide one bit of caution. As Keshav, mentioned in his comments, we did have a major team sourcing engagement that was converted to an applications outsourcing engagement.

So from an overall revenue acceleration there was a bit of a bucket switch that occurred within Q1 and that did prop up the applications outsourcing revenue. Now, that being said, we did move that to a Syntel-managed type of a project, which is obviously our long-term objective, so that's good. But I do believe it served to inflate a little bit the Q1 applications outsourcing growth rate.

That being said, as both Keshav and Bharat, have mentioned, when you look at the pipeline and you look at the opportunities that are out there in front of us, clearly, the cost reduction based initiatives, and specifically applications maintenance and KPO, will be the drivers for growth. And with maintenance becoming a much larger percentage of our overall business, we're getting more and more comfortable in our ability to accelerate that business.

Brian Kinstlinger - Sidoti

That said though, that will remain in apps outsourcing, so for the year, that will create an opportunity, do you see growth rates up for the remainder of the year, correct?

Dave Mackey

Absolutely, but in terms of the sequential quarter-to-quarter growth rate it did create a bit of an anomaly.

Brian Kinstlinger - Sidoti

Great. And in BPO, I'm curious how minus your top customer there how the other clients continue to track, are they continuing to grow faster, and is anyone else becoming a major portion of that line item?

Dave Mackey

Yes. Actually, we had very, very good acceleration in almost all of our KPO clients again. And I will tell you that our other clients, with the exception of our largest client in that area, actually grew faster once again. So we continue to push down our reliance on that single largest customer and continue to grow and expand not only the number of KPO relationships that we have, but also the depth and the acceleration of those relationships.

Brian Kinstlinger - Sidoti

Now and follow-up to the KPO business, two things, first of all, you've almost seen no competition you've said on this call so far in where you've been. So I'm wondering (a) if that's changed, and then (b) your gross margin there was reached some of those earlier levels from almost six quarters ago.

And I'm curious what was the dynamics there and if we should expect it to pull back, I think you said 61% unless I got that wrong or it should remain up here?

Keshav Murugesh

Yes. We're very pleased with the performance of that segment again this quarter. And as Dave mentioned, obviously our focus is to continue to grow revenue from each one of those customers. So that being a new segment, they are obviously seeing different customers take the revenue up at different points in time. So we expect to see very strong revenue performance over the next few quarters from that segment.

Having said that, during this quarter, I think both the productivity and the utilization levels on the segment were significantly higher. And to some extent that has skewed the margin upward a bit. But you should expect to see gross margins for the segment in the 50% levels.

Brian Kinstlinger - Sidoti

And I'll get to competition in a second. But when you talk about salary increases is that IT or is that all inclusive, and how do BPO salaries increase generally?

Keshav Murugesh

When we talk about wage inflation it will be both IT and BPO. And on both sides of the business, like I did mention earlier, we do have a fixed component and a variable components, which is tied in strongly to the performance of the segment, as well as the company on the whole. So when we're talking about wage inflation of 14% or 15%, we expect to see that across the board.

Brian Kinstlinger - Sidoti

Okay. And in terms of the competition, you mentioned generally you are competing against the "do it in-house" kind of theory. And I'm wondering if that's begun to change at all or so far have you really still faced limited competition?

Dave Mackey

I think because of the nature of the type of the work that we're doing in this area, Brian, it's still largely a case where we're fighting companies that think that they may want to do this in-house. I believe it's definitely hard for a lot of the larger companies to see the long-term benefit of a model that they believe isn't terrible scalable.

So in terms of new competitors entering this area and moving into a customized BPO, KPO type of environment, we haven't seen a material change in the last few quarters.

Brian Kinstlinger - Sidoti

Okay. Two more questions. First of all, last quarter you mentioned about working junior guys into the junior partner since it's been so difficult hiring. And when I take a look at your customer concentration has come down drastically, 2% on each line to 3% which suggests other people are growing faster.

Give us a sense of how much of that is just new clients ramping up quickly versus how much maybe impact of the partners, and just sort of how that process is going for you guys?

Keshav Murugesh

Sure. I'll take that. That's a great observation. And the reality is, again, we're really delighted to see the concentration levels come down this quarter. And I think it's because of very focused activity around really driving or giving the same attention that our top 10 customers got to our next level, next 10 or next 20 customers, which is actually creating this impact. And also really winning in the marketplace in terms of bringing in new clients, and then ramping them quickly.

So I think a lot of focus at Syntel has been around the new offerings program, taking that to our existing client base, using it to see new customers. And also, expanding the Client Partner program in such a way that not only are we bringing in Junior Client Partners profiles but also growing what we call our Engagement Manager profile through very specific, very focused kind of training programs, and getting more and more people who understand the systems model very well in front of our clients. And I think that's what is really working well for us.

Bharat Desai

Brian, if I may, excellent, excellent comments, Keshav. If I may, I'd just like to amplify those comments and maybe just somewhat correct an impression you have. It is not because we're not able to find engagement managers outside that we're not bringing them on. Our access to talent for Syntel has never been better.

Our brand and capability is having an impact where we're being able to attract talent, but it's a very conscious decision we've made that we want to grow our leaders within the company. It's the strongest message we can send our employees and our customers. And this was not something we took lightly. We've thought about this a lot.

We looked at the market and looked at the companies that were the most successful in their businesses. We looked at companies like, Goldman Sachs and McKinsey that stand out as icons in their industries, and G.E. and said if there are companies we want to emulate, these are the ones. So it's a very conscious investment we've made that is now starting to bear fruit and will be the foundation for our future I believe.

Brian Kinstlinger - Sidoti

Great. Last question is related to your cash position. Could you give us a sense of how much of your cash is in India versus how much is in the U.S. and the subsequent returns you're getting on each?

Dave Mackey

Brian, we've never reported where the cash balances are located. But obviously, when you look at the overall tax rate, the majority of our cash generation is in India and that's where the majority of our investments will be. Obviously, the returns we get on our money and cash based out of India is going to be higher than it is here in the U.S.

We have no exposure to auction rate securities. We are extremely conservative in terms of how we have our cash invested here in the U.S. It's in highly liquid, very low yield types of instruments. And that's about all I can tell you on the cash front.

Brian Kinstlinger - Sidoti

Can you give us a sense for what kind of returns people expect in India? I mean, I've heard numbers as high as 8% from some companies. So I'm just trying to get a sense of the cash in India, what you think you can earn on that even without knowing how much is there?

Dave Mackey

Again, I think historically we are even conservative in terms of how we invest our money over in India. And if you look at an expectation of interest earned on cash for the year, to expect something in the 4% to 5% range would not be outrageous.

Brian Kinstlinger - Sidoti

Great. Thank you, guys.

Operator

Your next question comes from the line of Tim Fox.

Tim Fox - Deutsche Bank

Thank you. Good morning. My first question was around the strong client addition this quarter, and I think you mentioned you had two in the KPO segment. Just wondering if you could comment on some of the other client additions in terms of vertical or segment?

Keshav Murugesh

I'll take that. Obviously, like we said earlier, we have been focusing very strongly on the new offering program as well as the offering programs across some of our key verticals, and really on increasing the growth rates on our IP business. And that includes a number of things like focusing on new geographies. Europe is one location where we've made some good moves. We are making some moves in India.

Our focus on new offerings including, PLM, vesting, demand management, platform play, all of this is now resonating well we believe in the marketplace. And we continue to focus on pushing for cost reduction opportunities on maintenance side. So all of this really has helped us with this increase in these new clients, and I would say that the growth in the clients has been across verticals, but I think the main beneficiaries for us would have been around the banking, financial services, insurance, and the manufacturing verticals.

Tim Fox - Deutsche Bank

Okay, great. And my follow-up question was in the bucket of revenue that's non-recurring in nature, specifically like software development. Have you seen any change at all in the environment on decision making on software development projects, any push back at all on the timing around those projects at this point?

Dave Mackey

I think Tim, when you look at where clients' focus is today, especially in the large users of these services, which are financial services and insurance, there's clearly been a refocusing onto cost reduction based initiatives as opposed to discretionary project work. Now, that being said, there are certain development initiatives that are not perceived as discretionary because they have a short-term return and an immediate benefit back to the business.

So clearly, those types of initiatives are not being put on the back burner. But what we are seeing as expected was really a reallocation of spend with the offshore providers, with the focus on cost reduction based initiatives, and at best case a delay in terms of discretionary spending.

Tim Fox - Deutsche Bank

Okay, great. And just lastly, more of a housecleaning, just to be clear the revised guidance range on EPS, does that include the $0.07 benefit from the first quarter tax paid?

Keshav Murugesh

Yes, it does.

Tim Fox - Deutsche Bank

It does. Okay, thank you.

Operator

Your next question comes from the line of Joseph Vafi.

Joseph Vafi - Jefferies & Co

Hi, guys. Good morning and congratulations for taking growth to 30%. I don't think we've ever seen that before, so congratulations on that.

Keshav Murugesh

Thank you.

Dave Mackey

Thanks, Joe.

Bharat Desai

Thanks for recognizing that.

Joseph Vafi - Jefferies & Co

A lot of my questions have obviously been answered. But I know we talked a little bit about your large BPO customer. I was wondering if you could provide some color for us on your largest 10% customer in the IT bucket, and what you see the outlook for that customer being here in 2008.

Dave Mackey

Sure, Joe. Obviously, as we touched on with the KPO customer, I think the acceleration in the relationship in that area remains extremely strong. They continue to look at us for not only incremental transaction work, but also new processes for us to manage. And that business is on a nice trajectory.

Relative to our largest IP client, clearly the growth in the business and the health of the relationship remain extremely strong. It's a company whose business has been impacted by a difficult overall economy. But I do believe it's also a client as a very, very mature user of global services, takes advantage of these types of opportunities to accelerate cost reduction based initiatives, and actually looks at this as a way to, if not only maintain, but also leapfrog their competitors in terms of realigning their structure.

So I do believe that there are discretionary projects that, as I mentioned before, will get tabled, will not be accelerated at the same rate. But the benefit comes from the types of project work like maintenance.

Joseph Vafi - Jefferies & Co

Right.

Dave Mackey

And I think that's echoed in our largest customer.

Joseph Vafi - Jefferies & Co

Okay, that's helpful. And so, do you expect this client to actually, it's still a growth engine for 2008, then?

Dave Mackey

I would certainly expect this client to grow.

Joseph Vafi - Jefferies & Co

Okay. And so, it sounds like, then, you are seeing some more maintenance opportunities come down the pike from these guys.

Dave Mackey

Yes.

Joseph Vafi - Jefferies & Co

Okay. I know we talked, it was mentioned a little bit here and kind of maybe stepping back and looking at things a little more strategically, company is doing a little bit in Europe. We do hear a lot of noise out of larger players about the European opportunity. It's clearly an opportunity, but there are some high costs associated with Europe and some other things. And maybe get a little more color on kind of where Syntel's strategy is for Europe at this point in time?

Keshav Murugesh

Sure. And I'll take that just now. Again, as far as Europe is concerned, that is clearly an opportunity area for us. And one of the things that we have done during this quarter actually is to move a very senior Syntel hand into Europe now to really head our farming capability in that area.

And what we've really done is moved this person in to really follow our global accounts and grow the momentum with those accounts in that particular geography. We've provided this person with a number of new sales feet on the ground there. And simultaneously, we're also looking at bringing in a very senior hunter profile, that will help us with bringing in or introducing new clients that we will thereafter expand in terms of both IT and BPO.

And you aware that we already have a presence in the U. K. both in Reading, as well as in Brighton, we also opened an office in Stuttgart in Germany. And we are also looking at other opportunities of aligning very strategically with specific partners in other parts of Europe. So I would say there's nothing, we're taking all the right action for this stage. It will take a little time before we begin to see the results of the activity.

But we are pretty confident that over a period of time Europe is going to play a significant part of Syntel's overall growth plans.

Joseph Vafi - Jefferies & Co

Okay, that's helpful. And then, maybe just one more question. It sounds like there was a little bit better movement in the quarter on getting some Hunting Licenses to start generating revenue. Is there anything to kind of point to there that is worth commenting on in terms of trends in there or better execution, or how should we be looking at that?

Dave Mackey

I don't think so, Joe. I think we continue to focus on adding new Hunting Licenses. We continue to focus on accelerating those initiatives. Obviously, we are very pleased with the fact that three new Hunting Licenses actually generated revenue in the first quarter. But how and when a client starts its initiative I think is, as Bharat touched on earlier, beyond our control. And that number does tend to fluctuate quarter to quarter.

If we can continue to have that kind of progress and activate those number of licenses for the next couple of quarters, then I would tell you it's a trend. But as of right now, it's something we're happy with, but we'll wait and see to see if that's something that's sustainable.

Keshav Murugesh

Having said that, I will just add one bit of color there, and that's we are pleased to see the kind of conversations we are now having with a number of clients or potential clients who are used to using the so called tier-one as their provider. So we are actually seeing them probably get a lot more comfortable with having the right size kind of partner also as part of the group. So a lot more of conversation on that side, and again, that's a positive sign vis-à-vis.

Bharat Desai

Yes. I would say, it really was a conscious focus on our part, Joe, to have the same kind of attention in our customer's number 11 through 30 as we've given in customer's number one through 10. And it was predicated on having the engagement manager program start to take hold. So I think you're seeing some initial results of that.

Joseph Vafi - Jefferies & Co

Okay, that's very helpful. Congratulations, again guys. Thanks.

Keshav Murugesh

Thank you.

Dave Mackey

Thanks, Joe.

Operator

Your next question comes from the line of Bryan Keane.

Bryan Keane - Credit Suisse

Yes. Hi. I joined the call a little bit late, so I apologize if some of this has been covered. But just, back on the economy, you talked about possible delays in discretionary, have you guys seen any project cancellations at all?

Keshav Murugesh

No, we haven't at all.

Bryan Keane - Credit Suisse

Okay. And what verticals, when you talk about the economy, some areas of strain, some areas of weakness where I guess where's the weakness been in, which vertical, my guess would be in the financial services area, but if you can give me color on that it would be great?

Dave Mackey

Sure, Bryan. I think, again, relative to discretionary spending the financial services has been weak in that area. But the cost reduction based initiatives in that area have been pretty strong for us. And as a matter of fact, if you look at our revenue in the first quarter, our financial services as a percent of total actually went up again. So we were at 53% for Q1 versus a number of 51% in the fourth quarter.

That being said, there is some weakness at least for a company like Syntel more around the services side than the specific verticals. So, for example, if you look at our large customers in our retail vertical, the majority of what we were doing for them was on the development front.

And as a result, our retail business has probably been a little bit more impacted than somebody who had very large maintenance portfolios in that vertical. So I think it's less about specific vertical health or softness and more about the types of services and the stickiness of those services that you're selling into those verticals.

Bryan Keane - Credit Suisse

Okay, great. And then just finally, I wanted to be clear. Obviously, the tier ones you're talking about a significant slowdown in June. It doesn't sound like to me that you're expecting kind of the same impact that some of those other players are talking about. Is that correct?

Keshav Murugesh

Actually, based on our guidance, again, we are kind of happy with the fact that we have 76% visibility to the low end of the guidance. At this point in time, our focus is completely on execution and, like Bharat and Dave mentioned earlier, we're actually quite enthused with the number of visits we are seeing, with the number of RSPs that we are dealing with. And generally, the kind of conversations we are having with a number of players who either are already our customers or today who are using the tier-one. So overall, at this stage, it will be business as usual for us.

Bryan Keane - Credit Suisse

Okay, great. Thanks a lot, and congratulations.

Dave Mackey

Thank you.

Operator

Your next question comes from the line of David Cohen.

David Cohen - JPMorgan

Hi. Thank you. Would you talk a little bit about the sales cycle for the clients that you signed in this quarter?

Dave Mackey

Sure, I can give you a little bit of color on that, David. When you look at the 11 new customers that we brought in, I would tell you that probably a third of them are customers that we have engaged for the first time within the last six months. A third of them are clients that we've been speaking to or having conversations with over the past year. And some of them actually go back almost a year and a half.

So no clear cut pattern in terms of quick hit versus long-term sales cycle, I do think there's an interesting dynamic that's taking place out there again more around the types of services that clients are procuring. And what you tend to find is that if a client is coming to you for a development initiative in this environment, clearly it has an ROI justification and it has a relatively short-term payback for that company.

Those tend to be quicker hit, smaller sales cycle types of initiatives versus things like KPO and maintenance where the sales cycles tend to be a little bit longer because there is typically significant behavior change involved in implementing those types of models.

So again, I think a little bit more around the types of services, but no clear cut pattern or nothing definitive in terms of vertical approach or the clients that we've added in this quarter that I think will give you kind of some insight into anything.

Keshav Murugesh

And if I may add to that, those are great comments, Dave, but if I may add to that. What is interesting again was with most of those customers it was a lot of the new offerings program that actually got sold them first, which is again an exciting trend for us we believe.

Dave Mackey

That's a good point.

Bharat Desai

I agree. And if I may just give you just some overall color, the kinds of relationships we seek and the kind of client base that we target, it is realistic to expect a 12 to 18-month sales cycle from initial call to first dollar of revenue.

David Cohen - JPMorgan

Okay, thanks. And earlier you talked a little bit about absorbing implementation costs. Could you talk a little bit about the mechanics around that? So is it that you're doing work upfront that you're not billing for, or are there actually in some cases payments to the client for transitions? Would you just walk through that a little bit in more detail?

Dave Mackey

Typically how those models work David, is if you're transitioning work from a client to a vendor, like Syntel, the client doesn't want to have a transition bubble in terms of what they pay during that period of transition. So what we typically do in terms of the billings is smooth out over the life of the entire project the billings, such that the client doesn't have an impact in the year of transition.

David Cohen - JPMorgan

So it's more the timing of the payments rather than absorbing costs?

Dave Mackey

Not only the timing of the payments, but also the timing of the revenue recognition.

David Cohen - JPMorgan

Sure. Okay.

Dave Mackey

Because during a transition period, we're effectively not earning the same level of revenue that we are when we're actually managing the applications and delivering on service levels.

David Cohen - JPMorgan

And is there any way to think about what the transition typically costs to the client in terms of their own spend?

Dave Mackey

I think that's something that's really client specific, David. Some clients are very aggressive in transition and are very mature in terms of how they work with their vendors to enact that. Obviously, if I'm going to do an offshore initiative and transition a first piece of maintenance from a new client to Syntel, I would expect that transition to be longer in nature and require more involvement from the client in terms of subject matter experts and their number of people involved in that transition.

So it does tend to get easier over time. With my large clients where I'm doing multiple maintenance applications, that transition time can be shortened in most cases. And the reliance on the client for subject matter expertise is also lessened.

David Cohen - JPMorgan

Okay. And then in terms of the revenue guidance, what portion of that do you expect to come from new clients and what from existing clients?

Dave Mackey

I think, as always, when you look at our revenue guidance we typically expect over 95% of our revenues to come from customers that have done business with us in the past. And I don't expect that to change in 2008.

David Cohen - JPMorgan

Great. And the last question, one of the things that we've been hearing is about companies looking to consolidate or reduce the number of vendors suppliers they work with. Do you have any thoughts on (1) are you seeing that, and then (2) how Syntel expects to fare as that process unfolds?

Bharat Desai

Let me take that. This is Bharat. Actually, what we've seen is most target companies that we have, which is Global 2000 companies, typically will want to deal with three to five companies. And they're increasingly looking to find capable mid-tier companies. And the exciting part is many, many of the conversations we're having with large global brands are already in a tier-one or a global integration company relationship, and are actively engaged with Syntel to see how we can bring value to them.

So when large global companies look to finding a partner, they are looking for a company that's capable, but that's also nimble and responsive. And we find ourselves really well positioned from that standpoint. So we're not seeing the reduction in base that you're talking about.

Dave Mackey

And I think to add to what.

Bharat Desai

It's perhaps more rationalization of pace.

Dave Mackey

I think to add to what Bharat said, David, one of the things that we're actively selling and clients are actively buying from us today is increased flexibility and is that mid-tier status. If you are going to see consolidation of vendors, what you're going to see are consolidation of vendors who look, act, and behave the same way, because they really don't provide a differentiated approach for the customer.

That being said, where there are large portfolios that have already been outsourced, the ability to consolidate vendors is still extremely difficult in this space. The concept of vendor-to-vendor transition is still extremely rare, because in order to make it effective for a client to want to do this, some vendor would have to undercut price and absorb the cost of vendor-to-vendor transition. And that still remains very, very rare in this space.

Bharat Desai

And keep in mind, the client's view is that actually increases their risk and reduces their flexibility.

David Cohen - JPMorgan

Great, thank you.

Operator

At this time, we have time for one final question. And that comes from the line of Vincent Colicchio.

Vincent Colicchio - Noble Financial Group

Last quarter, you guys were excited about the asset management side of your KPO business in terms of pipeline. Has there been any change there, is that still robust?

Dave Mackey

Looking good.

Vincent Colicchio - Noble Financial Group

That was an easy one.

Dave Mackey

Yes.

Vincent Colicchio - Noble Financial Group

Okay. I guess the last one. Nice quarter, guys.

Dave Mackey

Thank you so much.

Bharat Desai

Well, since that was the last caller, I will make my closing remarks. Thank you, again, for joining us today.

And both operationally and financially, we are pleased with the overall Company performance for the quarter. Despite the challenging economic environment, we believe we are extremely well positioned in the marketplace and our prospects for 2008 and beyond have never looked better. The entire Syntel leadership team remains committed to delivering enhanced value to all our key stakeholders that means employees, investors, and clients.

And we look forward to talking to you next quarter. Goodbye and thank you.

Operator

This concludes Syntel's first quarter earnings call. A replay of today's call will be available beginning at noon by dialing 1-800-642-1687 and pressing the pass code, which is 41975527. The replay will be available through midnight on May 1, 2008. Thank you.

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