Syntel Inc. Q2 2008 Earnings Call Transcript

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 |  About: Syntel, Inc. (SYNT)
by: SA Transcripts

Syntel Inc. (NASDAQ:SYNT)

Q2 2008 Earnings Call

July 24, 2008 10:00 am ET

Executives

David Mackey - VP of Finance

Bharat Desai - Chairman and CEO

Keshav Murugesh - President and COO

Arvind Godbole - CFO

Analysts

Ed Caso - Wachovia Securities

Brian Kinstlinger - Sidoti & Company

Bryan Keane - Credit Suisse

Joseph Foresi - Janney Montgomery Scott

Joseph Vafi - Jefferies & Company

Tim Fox - Deutsche Bank Security

David Cohen - JPMorgan

Vincent Colicchio - Noble Financial Group

Operator

Ladies and gentlemen, thank you for standing by, and welcome to the Syntel's second quarter 2008 conference call. (Operator Instructions)

As a reminder, this call is being recorded today, Thursday July 24, 2008.

I will now turn the call over to David Mackey, Syntel's Vice President of Finance. Sir, you may begin.

David Mackey

Thank you, and good morning everyone. Syntel's second quarter earnings release crossed Business Wire at 8:38 am today. It's also available on our website at www.syntelinc.com

Before we begin, I would 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 will now turn the call over to Bharat Desai, Syntel's Chairman and CEO. Bharat?

Bharat Desai

Thank you, David. Good morning everybody, and thank you for joining us today. We are pleased with both the financial and operational progress made by Syntel during the second quarter despite a difficult economic climate. Credit issues, commodity prices and negative sentiment continue to dominate the headlines. As expected, these trends are directly impacting the behaviors of both new and existing clients for Syntel.

However, as we've stated in previous calls, the responses to these business challenges have been largely client specific. What we are seeing is that client behaviors appear to be magnified in this environment. Mature, aggressive users of offshore services continue to take advantage of the speed, quality and cost provided by globalization. Conversely, clients who are new to global sourcing or have historically struggled with organization change have been much slower in their decision making process.

In this economy, the focus for many clients is improving both the cost and efficiency of their operations, which has been playing to Syntel's strength. Applications maintenance and KPO services, which can reduce customer cost by up to 50%, now represent over two-thirds of our revenues. In addition to providing a long-term recurring revenue stream, these services also provide us with the proper positioning to win development and enhancement work on these systems and processes, when discretionary spending improves.

In short, we believe that our stable client base, strong cost reduction services, and nimble culture of innovation have Syntel extremely well positioned. Our depth of knowledge in key verticals and expanded services are resonating extremely well in the marketplace. As a result, Syntel's new business pipeline is now ripe with high quality, large scale opportunities with brand name companies. Overtime, the ramp of these clients will allow us to continue our growth and improve our revenue diversification.

I would now like to turn the call over to Keshav Murugesh, Syntel's President and Chief Operating Officer and then 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. As Bharat has mentioned, Syntel is pleased with the continued progress in our business during the second quarter. From a revenue standpoint, Q2 marked the 17 consecutive quarter of revenue growth for Syntel, and our first ever $100 million quarter.

Our top line grew 5% sequentially, and 29% versus the same quarter of 2007. Revenue contribution from a services perspective was broad based during this quarter. Our KPO segment maintained its trajectory, growing 6% sequentially and 89% versus the second quarter of last year. We are also encouraged by the progress in our IT services revenue, which grew 5% sequentially and 19% versus the second quarter of last year.

With respect to our vertical segments, Syntel experienced healthy top line improvement in all of our key verticals during this second quarter. Financial services, once again led all verticals posting over 6% sequential growth, and 53% versus the same quarter of last year. While, we do not believe this to be an indication of a change in the economic outlook for this sector, it does reinforce the fact that many spending decisions today are clients specific.

From an operational cost perspective, the second quarter saw continued positive momentum in several few areas, including the depreciation of the Indian rupee and the extension of the STPI tax holiday.

Most importantly, the supply side of our business in India continues to ease, as is evidenced by announcements of reduced wage pressure, stable attrition levels, and improved resourcing flexibility.

These factors should allow for improved utilization and productivity levels, and a much more just in time resourcing model. For Syntel in 2008 – this will result in fewer net additions required to achieve our revenue goals and improve margin upside. As a result, we now expect to add approximately 2500 net employees during the year in support of our increased revenue guidance for 2008, which is currently 412 to 422 million.

From a construction perspective, given the reduced hiring requirements, we will now be able to push finalization of some campus components into 2009. We now expect to add approximately 4000 finished seats in 2008, with physical space available for an additional 3500 seats heading into 2009. Phase II of our Pune campus is scheduled for completion this year, this quarter and Phase I of our new Chennai campus is tracking for initiation in the fourth quarter.

As a result of these plans, both SG&A and cash flow will be favorably impacted in 2008. We currently expect to spend between $35 and $45 million in CapEx during this year. In addition to these capital expenditures, we also plan to increase our investments during the second half of this year, targeting new service offerings and enhanced geographic visits.

One of the key focus areas for growth in 2008, and beyond is improved visibility and traction in Europe. To this end, we will be increasing the strength of both our senior leadership and sales footprint in key markets. We will also be investing in new relationships and strategic partnerships to help drive our growth.

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?

Arvind Godbole

Thanks 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 second quarter was $103.4 million, up 29% from $80.4 million in the prior year period, and 5% sequentially. By segment, application outsourcing accounted for 64%, KPO was 20%, e-business represented 13%, and team sourcing was 3% for the quarter. On a vertical basis, financial services contributed 54% with insurance 20%, healthcare 12%, automotive 6%, and other was 8%.

From a customer's concentration perspective, Syntel's top three clients represented 46% of the revenue, while the top five ended the quarter at 58% and top ten came in at 70%. Fixed price business was 38% of revenue for the quarter. Gross margin in the second quarter was 41.1% compared to 38.2% in the year ago period, and 40.3% in Q1.

By business segment gross margin for Application Outsourcing was 34.0%. KPO was 56.0%, e-Business was 53.9% and Team Sourcing 36.5%. Gross margins were favorably impacted by depreciation in the Indian rupee, improved utilization and better pricing. These improvements more than offset the cost associated with annual salary hikes in India this quarter.

The company's selling, general, and administrative expenses were 19.1% in the second quarter of 2008, compared to 20.1% in the prior year period and 20.8% in the first quarter. SG&A level, also benefitted from a favorable currency movement during the quarter, which reduced our operational rupee cost and resulted in a foreign exchange translation game.

As a result of improved gross margin and reduced SG&A levels, Syntel’s operating income improved to 22.1% in the second quarter. This favorably compared to 18.0% in the prior year period and 19.4% last quarter.

While the rupee depreciation favorably impacted our operating margins, Syntel conversely incurred losses on hedging positions, which were reflected in the income line of the P&L. During the second quarter the impact of hedging losses was $2.5 million.

Our second quarter tax-rate was 20.5%, which was impacted by a one time reversal of deferred tax asset taken against the original expiration of the STPI. The tax rate was also adversely impacted by the expiration of the tax holiday on certain lease facilities in India and geographic distribution of profits in the quarter.

Net income for the second quarter was $17.4 million or $0.42 per diluted share compared to $13.3 million or $0.32 per share in the prior year period and $20.4 million or $0.49 per share in the prior quarter.

Other period-end metrics from the second quarter are as follows, total headcount was 12,045, which is flat versus Q1 and represents a 30% increase versus Q2 '07. Billable headcount was 1,712 on-site and 9,542 offshore, for a total of 11,254.

Utilization levels were 94% on-site and 68% offshore with a global utilization at 72%. We ended the quarter with 4,205 people assigned to KPO. Delivery mix at the end of the quarter was 20% on-site, and 80% offshore. Attrition during the quarter was 14.5% annualized.

Syntel added 5 new customers and had now added 16 new clients year-to-date. We also added one new "Hunting License", which takes the total number of preferred partnerships to 90, and activated one license taking the total to 61.

Relative to the balance sheet, Syntel ended the quarter with $116 million in cash and short-term investments. CapEx for the quarter was $13.9 million and DSO levels reduced to 63 days from 66 in the first quarter.

Based on results from the quarter and current visibility, we are pleased to update our guidance for 2008. We currently expect revenue in the range of $412 million to $422 million and EPS between $1.74 to $1.82. This guidance is based on exchange rate of 43 Indian rupees to the dollar for the second half of 2008.

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

Question-and-Answer Session

Operator

(Operator Instructions). And your first question will to the line of Ed Caso from Wachovia Securities.

Ed Caso - Wachovia Securities.

Good morning, Ed Caso. I was hoping you could provide some impact from the currency on both the gross profit line and on the SG&A line, if you could do that in a basis points?

David Mackey

Sure, Ed. I think when you look at the depreciation quarter-over-quarter, on the exchange line, we had about a 5.8% movement sequentially, which affected our gross margins by about a 170 basis points. The impact on the operating margin line over the same period, which would include both the impact of the gross margin and the SG&A line would be about 250 basis points.

That is just a movement in the currency for the quarter. There were two other impacts that Arvind had touched on a little bit earlier. One, is a one-time adjustment to the SG&A line, which was the impact of the balance sheet revaluation. The other is the $2.5 million loss in hedging that flow through the other income line.

Ed Caso - Wachovia Securities.

Can you help us with the tax rate in the next several quarters, it's kind of an bouncing around here?

David Mackey

Ed, we expect the tax rate in the second half of this year to be about 19%, if you pull out the onetime adjustments in some of the non-operational items that impacted us in the first half of the year, you'll see that the effective tax rate was around this 19%. We don't expect that to change in the back half of the year.

Ed Caso - Wachovia Securities

And you also seen to have a really good e-Business quarter. Can you give a little color to that and how important was that to the your upside here in the quarter?

David Mackey

Obviously, given the spike in the e-Business revenue during the quarter, it was healthy for us, both in terms of the contribution to the revenue, as well as the contribution on the margin side. You know, one of the things that that segment does for us is, when we get that revenue line moving, it does allow us to cover some of our fixed cost, which are pretty high in that area.

So, you also saw a good movement in the gross margin for that segment as well. The one downside to revenue improvement in the e-Business segment as we've to find it is the fact that those revenues tend to be short-term in duration. So they are lumpy in nature.

Obviously it's been a challenge for us to sustain the revenue, and to sustain the growth in the segment. But, we are clearly encouraged by the fact that projects that do flow through this area, which are historically discretionary for Syntel, actually had a very good quarter.

Ed Caso - Wachovia Securities

Thank you. Congratulations.

David Mackey

Thanks Ed.

Operator

And your next question will go to the line of Brian Kinstlinger from Sidoti & Company.

Brian Kinstlinger - Sidoti & Company

Hi. Thanks for taking my question. The first question I have was related to the revised guidance. I mean you beat the top line by $0.04 and you raised your top end by $0.04, but I guess am curious with the rupee moving whether – would you get further benefits from the rupee in the third and fourth quarter, not to think that that might not be conservative or is it the European operation that’s offsetting the upside from the rupee that you're investing in?

Keshav Murugesh

Brian, that's a good question, and that’s something that obviously we'll keep monitoring over the next two quarters as well, but the guidance that we now have provided is essentially based on the current information and visibility we have to our business.

This is based on an exchange rate of 43 rupees to the dollar, and obviously we'll also take into consideration on the one or two other areas that I spoke about earlier, which is a fact that we will expect to see reduced hiring. We will expect to see slightly lower cost on our depreciation line, as we push some of the construction activities into the next year.

But more importantly, we are also continuing to invest significantly in all the areas, I did speak about. So one is investing strongly in our new offerings program, investing strongly in terms of bringing in the right leadership across the company, as well as investing strongly in our geographical expansion program, and based on what the rupee actually does against the dollar during the quarter, we will keep updating guidance, but at this stage, we feel very comfortable with this guidance.

Brian Kinstlinger - Sidoti & Company

How much will you be in the second half of the year, do you think will run the P&L for the hiring and the recruiting and whatever else you need to add for more focus on Europe? Can you give us a rough estimate.

David Mackey

We're not going to give a dollar figure related to that, Brian. I think the timing of when those people come on and make you sure that we find the right people to fill the roles is as critical obviously as making sure that we get that moving, so that can be a moving target.

But as Keshav mentioned clearly one of our focus areas going forward is to improve our revenue diversification and clearly, given the market opportunity in Europe, it is one of the areas that we feel comfortable investing in at this point in time.

Brian Kinstlinger - Sidoti & Company

And then, when I look at the utilization from the easing of supply, do you expect it to increase from the 68% offshore, and if so, where could this go? Long-term or short-term, whichever you prefer to answer from that perspective.

David Mackey

Sure. I mean, I think when you look at the balance of this year, we continue to believe that there is opportunity to improve the offshore utilization level. To get that number at or above 70% is probably not unreasonable.

Now, obviously that's predicated on the fact that the supply side economy that we're dealing with today continues, so the increased flexibility clearly is a systemic change to the business model and it's something that smart companies will be taking advantage of in this market.

Brian Kinstlinger - Sidoti & Company

Okay. And suppose the rupee stays at 43, what is your, for the rest of the year even though it's not necessarily exactly there, but suppose that happens, what'll your hedging loss be in the third and the fourth quarter, respectively?

Arvind Godbole

The current guidance is based on the current rate of 43 rupees. If it remains there for the balance two quarters, it will be neutral. We will not have any gain or loss.

Brian Kinstlinger - Sidoti & Company

There'll be no gains or loss based on where you hedged from --?

Arvind Godbole

Right, because that has been already mark-to-market as of now.

Brian Kinstlinger - Sidoti & Company

Okay. The next question then I have was the, could you just define what the size of that balance sheet one-timer was and exactly what it was again, I missed that, sorry. You said it was a one-time benefit in SG&A from the balance sheet item.

Arvind Godbole

I was referring to the STPI extension benefit.

Brian Kinstlinger - Sidoti & Company

And how big was it?

David Mackey

Yes, Brian, I think that the revaluation of the balance sheet that flowed through the SG&A line in the second quarter, the impact of during the quarter was about $2 million and that is going to be a non-recurring item, so we do expect in the third quarter to see, all things being equal, the SG&A line moving up $2 million sequentially.

Brian Kinstlinger - Sidoti & Company

And then what's the incremental from the build out of the new facility in Pune in the third quarter.

David Mackey

We're probably looking at about $1 million of increment from Pune in Q3.

Brian Kinstlinger - Sidoti & Company

So all in, you got $3 million increase from the second to the third quarter.

David Mackey

It would not be surprising, that's correct.

Brian Kinstlinger - Sidoti & Company

Okay. My last question is related to the KPO gross margin. It was the only one not to go up, but it's all offshore, so I would think depreciating rupee would help you. Can you explain why that margin didn't go up?

David Mackey

Sure, I think the one thing that really impacted the KPO segment is the same way we get the increased favorability from the currency move. In the quarter, we also had a much higher exposure to the salary hikes as a result of that.

I will also tell you that the salary hikes on the KPO segment were slightly higher than they were on the IT segment of our business.

Brian Kinstlinger - Sidoti & Company

Can you give us a percentage?

David Mackey

We're not going to give a split between the salary increments in IT and in KPO.

Brian Kinstlinger - Sidoti & Company

Great. Thanks very much for the answers.

David Mackey

Thank you.

Operator

(Operator Instructions) And your next question will go to the line of Bryan Keane from Credit Suisse.

Bryan Keane - Credit Suisse

Hi, good morning. I guess, I'm just trying to understand the headcount cut and what are the implications? Does that mean, for I guess going forward in '09 and beyond, won't that affect the revenue line?

Keshav Murugesh

No, Bryan. I think, first and foremost, I think what we are focused on really is on making the right investments to dramatically grow the revenue line, but having said that, I think what we're also doing is to take advantage of the systemic opportunities that we get in the marketplace to make sure that it's more of a just-in-time kind of hiring process one, as well as make sure that it's also linked in well to the delivery of our campus program.

So for this year, we are guiding towards 2,500 net hires, but while we're doing that, we are not at all stopping construction of our campuses. We actually continue to invest very strongly in the construction of our campuses.

All we're doing is pushing out a little bit of it into the first quarter of next year, but we're extremely well prepared to bring in new people and new leaders across 2009 and beyond.

David Mackey

I think, there's a couple other things that you need to keep in mind as well Bryan. As Keshav mentioned the systemic change in the structure is really one time in nature, so as you transition your operating utilization levels from the 60s into the 70s, you have a one-time reduction in the hiring requirements.

When you stabilize your utilization levels up into the 70s, then your hiring guidance should in theory marry with your growth and revenue.

The other dynamic that's taking place for us is obviously is our KPO becomes a bigger percentage of our total and bigger dollar amount on the whole, the growth rate in that segment is slowing.

And when you look at the hiring requirement required to sustain revenue growth, the IT revenue dollar per head is actually higher than it is on the KPO. So as a result, when that growth rate slows, it's going to take fewer heads going forward to generate higher revenues.

Bryan Keane - Credit Suisse

Okay, that's helpful. And then Application Outsourcing, the revenues there were flat sequentially, is that any reason to be concerned about that going forward?

David Mackey

I don't think so. It was something that we expected. We did have a large development project in the Applications Outsourcing area in the first quarter that ended. This was expected.

I think the other good news for us is that when you look at the spike that happened in the e-Business segment during the quarter, we do know that a portion of that revenue will be moving into maintenance mode and moving into the Applications Outsourcing segment in the third quarter.

Bryan Keane - Credit Suisse

Okay and then just finally, could you talk a little bit about the health of the top 10 clients. It came down a touch to 70% and maybe with that, some thoughts on the pricing in the environment would be great. Thanks.

David Mackey

Sure. I think overall we're pleased with the movement in our top 10 clients. Given the growth rate during the quarter, what you'll see is that the clients outside of our top 10 accelerated at a much faster rate and that's been one of the company's key objectives going forward here.

We realized that the more we rely on our top 2 or 3, or the more that we rely on our top 10 clients, the more exposed our business is going forward to some of the risks and uncertainties that a number of our competitors are seeing.

So clearly client diversification, geographic diversification, service diversification are all critical elements of our strategy going forward, and we're actually pleased with the dip in the reduction of our customer concentration at the top 10 levels.

Bryan Keane - Credit Suisse

I was just going to ask, any drastic change in the top 10 clients in terms of what their IT plans are?

David Mackey

I don't think we've seen a significant change, and maybe Bharat can add a little bit of color here, but I think what we're largely seeing is some stability.

Bharat Desai

Yes, I'd echo that.

Bryan Keane - Credit Suisse

Okay, stability in those clients. Okay and then just a final question, which is on pricing, how does that look in the environment?

David Mackey

Right, actually if you look at our implied pricing, the growth in the revenue for the quarter actually exceeded the growth in utilized headcount, so clearly what we saw is on an operational basis a higher revenue per head, which we're pretty pleased with.

I think there's two components to that. One is the fact that we do continue to inch up our pricing in the marketplace. I think the second is that we're improving productivity especially on our fixed fee engagements.

Bryan Keane - Credit Suisse

Okay. Congratulations on the quarter.

David Mackey

Thanks, Bryan.

Operator

And your next question will go to the line of Joseph Foresi from Janney Montgomery Scott.

Joseph Foresi - Janney Montgomery Scott

Hi gentleman. My first question is just on the revenue side of things. I think, given the demand backdrop that we're seeing from some of the other vendors, I was just curious as to what the thought process was to raise the top end of revenue guidance and maybe you can give us some color on what your visibility is on the numbers?

Keshav Murugesh

Right. Yes, actually, Joe at this stage, the visibility that we have for the low end of our guidance is about 85% and the thought process behind that increase in the guidance was specifically around the information and the visibility that we have today.

We feel comfortable with those numbers at this stage. There are still a lot of uncertainties out there in the marketplace. We want to make sure that we build all of that into this guidance. Right now, we're very comfortable with what is given out.

David Mackey

I think the other thing that's important is our business, I think, is somewhat different than some of our competitors in that, as was mentioned earlier, over two-third of our revenue currently come from long-term recurring cost production based revenue stream. Then, as a result, I think it gives us better visibility and also gives a better platform from which to grow our top line.

Joseph Foresi - Janney Montgomery Scott

And what do you expect for the growth trajectory in the KPO business, maybe to the back half of the year?

David Mackey

You know, I think, what you're going to see obviously relative to what you've seen in the past is slowing. We grew about 155% in 2007 versus 2006. What you see on a year-over-year comp basis here in the second quarter is that we've grown just under 90%.

So, we're clearly getting into situation of a law of large numbers. We have to expect that the growth rate on a year over year comparable basis will continue to slowdown. Our objective is to continue to try and maintain or slightly accelerate the sequential revenue growth.

Bharat Desai

And Joe, let me just add on here. David talk about the visibility that we have on KPO with our existing customer base and clearly, there is a lot of pain in the markets today in terms of some of the areas that we are in.

For example, the capital market space and some of the other areas, and therefore, some of these large customers are also taking a breather in terms of just planning for the future better, but while this is happening, we are actually focusing very strongly on selling deeper and deeper into each one of those organizations. So, that’s one positive element I would add there.

The other is the fact that even on our India-based KPO business, we've actually had a pretty successful run with our clients there and our effort in terms of seeding this opportunity with a number of other new clients in India as well is resonating well and so, whereas for the time being, I would expect to see a slower growth rate, I think the longer term is much more positive.

Joseph Foresi - Janney Montgomery Scott

Okay. And then, just on your hiring plans, I know you've altered them a little bit or reduced them. How does that affected the campus offers that you've already made for this year? Are they going to be pushed out at all?

Keshav Murugesh

No. Actually, it does not affect our campus offers at all. We've built that into this guidance.

David Mackey

And if you look at the hiring guidance Joe, and you look at the fact that our headcount was relatively flat in the second quarter, what we're talking about in the back half of the year is bringing on over 2000 people. So, the campus requirement that the back end loaded cycle is still something that we expect here.

Joseph Foresi - Janney Montgomery Scott

Okay. And one, just last quick one, I know one of your larger clients is a major credit card company here in the US, and they've had some difficult numbers on an earnings perspective.

I wonder if you could give us some perspective on how that client is tracking and if you any change in its growth and thanks.

Keshav Murugesh

Well, we don't really comment on any specific clients, but I can just tell it generally in terms of our credit card clients. In spite of the fact that some of them maybe having some slight difficulty currently with their numbers, it actually throws up a much bigger opportunity for Syntel.

Because their attention to Syntel is only increasing now, in terms of the offerings we provide to them, in terms of not just the IT exposure that they help to us, but now also to the KPO business that we can positively use to impact their business.

So, actually, we see it as an opportunity and we're actually having a number of visits from these clients. We're having a number of engaging conversations with them, and we feel very positive about it.

David Mackey

I think the other thing that's important to know specific to the credit card business, is that while most of the key credit card issuers and most of the key credit card companies are experiencing some level of difficulty, the one thing that has not changed and has actually continued to accelerate is the number of transactions or the transaction volumes in these businesses.

So, to the extent that the services that are being sold, our transaction base and whether that's ITO or KPO, we don't really see a material impact as a result of the reduction in their profits.

Keshav Murugesh

And if I may just add on one more thing, we're actually seeing more of a move with some of these clients towards an integrated IT/KPO approach, which actually is something that we've been talking about for a while.

We've actually have found it difficult with some of the large customers to actually get them to understand the structure, but now, with the pain that some of them maybe feeling, we're actually seeing faster movement towards that model, which is exactly the model that works for Syntel.

Joseph Foresi - Janney Montgomery Scott

Thank you and congratulations.

Keshav Murugesh

Thank you.

David Mackey

Thanks, Joe.

Operator

And your next question will go to the line of Joseph Vafi from Jefferies & Company.

Joseph Vafi - Jefferies & Company

Hi, gentleman. Good results here. Congrats on the $100 million quarter.

David Mackey

Thank you.

Joseph Vafi - Jefferies & Company

Maybe we're just going to start with Europe, and maybe a couple extra questions. Clearly, it's an opportunity across the sector to grow year off and maybe just a few more thoughts and why growing, and now you are actually are you investing ahead of demand there now or are you actually seeing demand to kind of get to European investment or an increase European investment profitable pretty soon here?

Bharat Desai

Let me try and address that Joe. I'd say, Europe has been lagging the US in terms of adapting the global services model. As these companies compete in the market for the same customer, they're now starting to see that they've lagged and that they need to catch up.

So, we think, this is a great time to be expanding our efforts in Europe, and that's certainly one of the drivers. The second is, it is clearly an area for increased growth and penetration. Having said that, we recognize that Europe is not one market, it is many different markets and that is what will bring some challenges that we will factor in our goal to market portfolio.

Keshav Murugesh

Right. And if I may add on, if I may add, that’s a great answer, but let me just add on. For us, Europe really is definitely the UK as well as the rest of Europe, so we will actually be having an appropriate kind of strategy, covering both those geographies within Europe.

We are seeing significant demand and very good traction from our existing global clients already in terms of their added footprint into Europe and therefore, wanting us to be involved in some of those opportunities. So that's one.

The second thing that we want to do as a company also is to introduce the same focus and attention that we gave to our US client, to our European clients as well and so this is not really a US de-listing strategy. This is a strategy where we want to expand our revenues from new geographies by bringing in the same attention that is regulating well in the US marketplace.

So, the approach here will be to bring in additional people, additional new service offerings, fine tune to that particular geography, introduce the integrated IT, KPO approach, and work on appropriate strategic relationships that will help us to leap to our revenues.

Joseph Vafi - Jefferies & Company

Okay, that's helpful. And then just a little bit more on the timing now, is this some, do you see this is a drag to profitability in the next couple of quarters, or is it kind of increased investments there? Kind of be neutral to earning.

David Mackey

I think they are neutral to earnings Joe. The guidance that we've given for this year includes the impact of those investments. So, one of the things that we're clearly doing is making sure that our business is operating healthy, and that we are creating the right types of behaviors that allow us to fund this types of investments as well.

Joseph Vafi - Jefferies & Company

Okay, that's helpful Dave. And then, maybe just kind of back on KPO in general. Can you update us on about how many customers you have in KPO now?

David Mackey

We still have 12 customers. We did not add a new customer this quarter.

Joseph Vafi - Jefferies & Company

Okay.

David Mackey

I think the one thing that we do take some positive momentum out of the KPO segment this quarter is the fact that the growth is really being driven by some of our smaller KPO clients, and we understand that going forward, that's really going to be what allows us to be successful in terms of accelerating this segment. So, pretty pleased with the fact that, that's taking place.

Joseph Vafi - Jefferies & Company

Okay. It did seem though that your top 3 did kind of concentrate up a little bit more sequentially and maybe, I mean, I know it's material the numbers and the like, but there may be any kind at least qualitative color on how far along your largest customer is now in terms of expanding in KPO and what the incremental opportunity is there moving forward?

David Mackey

Actually, the interesting thing is the expansion in the top 3 was not driven by the KPO client. So, we're pretty happy with where those relationships set. We believe there is still fairly significant opportunity with all three of our top 10 clients to continue to accelerate and even within our top 3 clients, we believe that growth opportunity continues to exist and we continue to post nice healthy, sequential, and year-over-year comps for all those clients.

Keshav Murugesh

And I may just add that although our focus really is on reducing the client exposure in our top 10, and really getting more and more performance from the next 20 or 30 clients, we still believe that those top 3 or 4 clients that you might be referring to, even on the KPO side, are still under-penetrated. So, there's still huge opportunity for upside even from here based on their plans, our plans, and what we're doing together.

Bharat Desai

And we continue to invest in the business to leverage the lessons and successes of our top 3 and 5 clients to the next 10 and top 20, and those actions and those specific processes are moving along nicely.

Joseph Vafi - Jefferies & Company

Okay, that's helpful. And then finally, just one more on the top customers here, it sounds like there was some movement outside of the largest client. Is that a pure IT client or is that a blended client at this point?

And then finally, would that your largest KPO client would, I guess you're still betting on some growth there, but maybe is it just, should we look at it as growing kind of at a company average right now rather than faster than average?

David Mackey

Joe, I wouldn't necessarily say that the client that you're talking about in terms of the big growth driver in the top 3 was purely an IT client today. One of the ways that we clearly hope to accelerate that growth rate is to introduce some of the KPO offerings to that client.

So, as we talk about it, while we continue to do more of the same with these clients, and we do understand that longer term for us to be successful, we need to add new services to be able to better penetrate those clients. With the specific KPO clients that we're discussing here, the opportunity continues. I don't believe that they will grow as necessarily lower than the client average. So, in terms of penetration levels, we don't believe we've kind of hit a large number situation.

Joseph Vafi - Jefferies & Company

All right, thanks a lot guys.

Operator

And your next question will go to the line of Tim Fox from Deutsche Bank Securities.

Tim Fox - Deutsche Bank Securities

Hi, thank you for taking my call. Just most of my questions have been answered. Just one higher level question around the supply side dynamics you're seeing, I guess the question is, do you consider what we're seeing secular shift that has legs?

I mean, this is, we are seeing captive businesses roll off, we're seeing the larger companies pull back a bit on their hiring, the Indian economy is cooling at the edges, and is this something that you think is sustainable and could be a long-term benefit to hiring and utilization rates in the long-term?

Bharat Desai

Let me take a stab at that and then Keshav can jump in. I'd say the one change you're seeing, where clients or captives are diversifying, is something we had fully expected and it really comes from a deeper understanding that this is a highly specialized business.

It's changing very fast, and companies that are in the financial services or life sciences businesses, recognized that their best and brightest should really be focused on their core business, and since this is such a specialized business, they come to the best of breed for that.

So, I think that's what driving that and I expect, it's really simply, I think, the industry maturing and their finding that by partnering with the best in breed company, they actually can deliver better, faster, cheaper, which every global 2000 company want vis-à-vis even there on captive investment. I'll defer to Keshav on thoughts on the Indian economy and supply side.

Keshav Murugesh

Right. I think those are excellent comments Bharat, and I will just add that there are one or two other factors that are playing here. I think the first is, we're actually seeing the potential employee-based also getting a little more discipline, as opposed to the earlier way of operated. So earlier, we probably saw the trends becoming more mercenary-like.

I think some of the uncertainties that our employees or potential employees from the campuses saw with delays in hiring by some of the large players, reduction on headcount with some of the captives.

Things like that have to some extent really got them focused more strongly on the stable players and therefore, I think, players that are seen as stable in the marketplace will see benefit from this trend.

The second thing is on the KPO side, with some of these noise taking place, we're also seeing employees to some extent now preferring to work with companies that provide them a broad range of experience working for different clients as opposed to just the captives where they're seen as working with just one client, and therefore getting connected very strongly to any uncertainty that one client has.

So these, I think, are two things that obviously are going to keep changing the supply side metrics, but having said that on the other side, we'll also have to wait and watch and see how FBI in some new sectors in India particularly the retail side could affect supplies from this industry.

But, for now and for the next few quarters, I believe that this industry is going to be favorably positioned and therefore, I believe that Syntel will continue to focus on productivity and focusing strongly on the organizational maturity and obviously, utilization levels.

Tim Fox - Deutsche Bank Securities

Thank you for those comments and just quickly on the KPO business. Obviously, it's growing quite nicely for you and you've diversified your skill base a bit there. Just wondering if you're looking at the depressed valuations across the landscape and considering picking up some incremental skills through M&A that something we might see late 2008 into '09.

Keshav Murugesh

Again, in that area, we will continue to be opportunistic. However, our main focus in our business plan is really predicated on organic growth.

Tim Fox - Deutsche Bank Securities

Wonderful, congratulations on the quarter. Thank you.

Keshav Murugesh

Thank you.

Operator

And your next question will go to the line of David Cohen.

David Cohen - JPMorgan

You talked about the [APS] business seeing a project roll off, that was expected. Any project over the next six months or so that you're expecting to roll off?

David Mackey

I think every quarter David, we expect on the e-business side to see project roll off. So, those tend to be high dollar values, short duration types of work, and it's been the key reason that it's been difficult for us to grow that segment.

It's really how we've defined it, it creates a bit of a treadmill effect. We do have visibility to some development projects o the applications outsourcing side. There's always work that's rolling off.

About 30% of our revenue portfolio today is development-based. So, by definition, those projects have fixed starts and fixed ends, but in terms of kind of materially impacting quarter-to-quarter sequential trend, I don't see an issue.

David Cohen - JPMorgan

The sequential growth in the E-business was stronger than it historically runs presumably from what you've been discussing. What was the type of work that was driving the second quarter?

David Mackey

Oddly enough David if you look at one of the larger project spike that we saw during the quarter, it was what we would historically consider to be a discretionary project, and it was with a banking client.

So, I guess, kind of flying in the states of what we're hearing and reinforcing both Bharat and Keshav's comments about spending decisions being client-specific. Part of our e-Business revenue growth in the quarter was driven by discretionary projects from a financial services client.

David Cohen – JPMorgan

Okay. And then the sequential growth in [APS], and perhaps I'd misunderstood but that was also a little slower than historically, and it sounds like you're expecting that to pick back up going forward. Did I understand that right?

David Mackey

That's correct. The project drag that we spoke about was really something that we had in the first quarter that did not continue into the second quarter in terms of the applications outsourcing segment.

So, we had a revenue replacement issue, if you will within that segment in the second quarter and as I mentioned, one of the positives coming out of the spike in the e-business during the second quarter, is that we expect that project to move into maintenance mode during the third quarter, which will have the effect of reducing the e-Business revenue in Q3, but correspondingly increasing the applications outsourcing revenue in Q3.

David Cohen - JPMorgan

Okay. And then, I think you mentioned that in KPO, obviously you talked for a while about the deceleration, because of large numbers. But I think, I heard you say that the target is to maintain or accelerate the sequential growth going forward in KPO.

I guess the sequential growth was significantly lower than it's been historically. Again, did I understand that right in terms of your outlook for how you're going to see the growth there.

David Mackey

Obviously, one of the issues with the KPO segment is that the sale cycle tends to be long and the project ramps are not necessarily as visible. Once we've penetrated into a client, once we've picked up responsibility for managing a process or a certain type of transaction for that client that visibility improves.

Obviously, what we have visibility today are the plans with our existing clients over the next couple of quarters that the real wildcard to acceleration within the KPO segment is the addition of new clients, and new processes, and that's something that we're actively working on and Keshav has talked a little bit earlier about in terms one of the key focus areas is bringing on the next two or three large scale KPO opportunities, whether it's with an existing IT client or whether it's a new green field opportunity.

David Cohen - JPMorgan

Okay. And then on pricing, with labor costs coming down and demands for not necessarily, the bulk of the kind services you provide, but broadly, what's the outlook over the next sort of 12 months in terms of pricing?

I mean, do you think that pricing is going to be sustainable at sort of a stable level or is it reasonable to think the pricing is going to come under pressure.

David Mackey

I think pricing will be stable for the foreseeable future. There are still a number of levers in this business to pull, and then I guess it depends on how you define pricing. Clearly, it will be increasingly difficult for us to increase unit rates with clients.

However, there's kind of a longer term lever that we have to pull, which is continuing to leverage our offshore delivery centers at a higher and higher ratio, which allows clients to realize a lower cost per unit in terms of service.

So, a couple of different dynamics taking place within a pricing discussion. However, we believe that going forward that our unit rates will be stable with our clients. Obviously, the prices downward pressure over time, if the labor supply issues and wage related issues in India continue for the foreseeable future.

David Cohen - JPMorgan

Okay. And then lastly, I think in the prepared remarks, you talked about the different kinds of clients or prospects and the ones that are more aggressive or sophisticated are accelerating their use of your services and others where you're seeing more delays. How do you think about the profile of your client base, both maybe sort of in terms of top 10 and then the rest in terms of how they fit those sort of two categories?

David Mackey

It's a great question David. I think clearly, when you look at the top 10 clients for Syntel having been the primary growth driver for the company over the past few years, they are by and large mature users of offshore services, who understand and have globalization strategies in place.

So, we don't believe that we are, right now, exposed to seeing significant stalls or pull back from those types of clients. Obviously, our tier 2 and tier 3 customers are a mixed bag.

So, we would expect that there would be some slowness and some softness in those clients that are relatively new to offshore, to those clients that are still doing small amounts of work with Syntel, but understand the globalization model and our mature users, we would be expect those revenues to accelerate.

Keshav Murugesh

Yes. I just add on by saying that from a trend perspective for the larger clients, the large mature players, obviously, they would use the uncertainty in the marketplace to really try and lock in longer term kind of contract at favorable rates.

But there, the approach from our side really is to move away from a labor arbitrage or a rate-based pricing system to more of value creation system. We also focus very strongly on having discussions on new areas.

So, for example, new areas, new offerings do not necessarily come in within the existing rate cards. So, our focus is, how do they keep penetrating that client with a new offering program? And finally, we're actually having a number of conversations with some of our large existing clients today on the KPO side of our business, which is another interesting dynamics. So, that’s as far as that bunch of clients is concerned.

The tier II kind of clients, I think I did mention even in the last call. They would use this opportunity really to aggressively move offshore, because they need to get that efficiency or that lower cost base and that's exciting for us, because we're actually continuing to see that kind of momentum.

We're continuing to see a number of visits, we're continuing to see significant number of discussions on many opportunities, and I think all of this, much of it will ultimately end up in boosting the revenue line. Timing is the only uncertainty here, because some clients move faster, some take a little longer in the decision cycle.

David Cohen - JPMorgan

Thank you.

Operator

And your final question will go to the line of Vincent Colicchio.

Vincent Colicchio - Noble Financial Group

Nice quarter guys. Question on the competitive environment, are you seeing some of the larger players get more interested in smaller deals than they have previously given competitive pressures?

David Mackey

I think that's one of the areas where we continue to be encouraged, Vince. Our sense is that the larger players are still aggressively pursuing larger projects and larger clients and given the sales effort involved, it makes a lot of sense.

So, I believe we'd be more concerned if we felt that some of the very large players out there where as interested in some smaller deals as we are.

Bharat Desai

And I think the client behavior is also reflective of that because companies that have in the past used these large companies for smaller deals haven't had that great in experience and so realized that it's really mid-tier companies like Syntel that really provide them the combination of capability and responsiveness that these guys are looking for. So, we're again, that's something we're very encouraged by.

Vincent Colicchio - Noble Financial Group

You added 16 new clients in the first half of the year. Has the ramp on those clients been inline with your expectations?

David Mackey

I think so Vince. Clearly, we expect in any given year that the majority of the revenue generated will come from clients that did business with us during the prior year. So, expectations for new client adds in terms of immediate revenue generation are always relatively low.

Keshav Murugesh

But, what is interesting there is the fact that number of those clients actually came in through our horizontal offering approach.

So, our ability now to cross sell and introduce the number of other offerings into those clients are significantly high, and that's where our focus is.

Vincent Colicchio - Noble Financial Group

Okay. The rest of my questions were answered. Thanks guys.

Keshav Murugesh

Thank you.

David Mackey

Thanks, Vince.

Operator

And there are no further questions at this time. You can make any concluding remark.

Bharat Desai

Thank you everybody for joining us today. Again, while we are pleased with our performance during the quarter, we remain focused on leveraging our current market positioning, to deepen our existing relationships, and to help attract new clients.

This will be accomplished by maintaining our investment programs designed to differentiate and grow the company and the continued successful execution of our business plans. We look forward to talking to you next quarter. Goodbye and thank you.

Operator

This concludes today's Syntel second quarter earnings call. A replay for today's call will be available beginning at noon, dialing 800-642-1687, and pressing the pass code, which is 54820161. The replay will begin through out midnight through July 31, 2008.

Thank you.

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