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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
(Mark One)
[X] Quarterly report pursuant to Section 13 or 15(d) of the Securities Exchange
Act of 1934
For the quarterly period ended June 30, 2004 or
[ ] Transition report pursuant to Section 13 or 15(d) of the Securities Exchange
Act of 1934
For the transition period from ____________ to _____________
Commission file number 0-22903
SYNTEL, INC.
(Exact Name of Registrant as Specified in Its Charter)
Michigan 38-2312018
------------------------------ ------------------
(State or Other Jurisdiction of (IRS Employer
Incorporation or Organization) Identification No.)
525 E. Big Beaver Road, Suite 300, Troy, Michigan 48083
- ------------------------------------------------- ----------
(Address of Principal Executive Offices) (Zip Code)
(248) 619-2800
----------------------------------------------------
(Registrant's Telephone Number, Including Area Code)
Indicate by check mark whether the registrant: (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days.
Yes [X] No [ ]
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Exchange Act.)
Yes [X] No [ ]
Indicate the number of shares outstanding of each of the issuer's classes
of common stock, as of the latest practicable date.
Common Stock, no par value: 40,601,766 shares issued and outstanding as of July
30, 2004.
1
SYNTEL, INC.
INDEX
Page
----
Part I Financial Information
Item 1 Financial Statements
Condensed Consolidated Statements of Income 3
Condensed Consolidated Balance Sheets 4
Condensed Consolidated Statements of Cash Flows 5
Notes to the Condensed Consolidated Financial Statements 6
Item 2 Management's Discussion and Analysis of 14
Financial Condition and Results of Operations
Item 3 Quantitative and Qualitative Disclosures about Market Risk 19
Item 4 Controls and Procedures 21
Part II Other Information 23
Signatures 24
Certificate of Chief Executive officer 26
Certificate of Chief Financial officer 27
Certification of Chief Executive Officer and Chief Financial Officer 28
2
SYNTEL, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF INCOME
(IN THOUSANDS, EXCEPT SHARE DATA)
THREE MONTHS ENDED SIX MONTHS ENDED
JUNE 30, JUNE 30,
-------- --------
2004 2003 2004 2003
------- ------- ------- -------
Net Revenues $45,846 $43,915 $90,935 $87,993
Cost of revenues 26,234 24,156 52,319 49,236
---------------------------------------
GROSS PROFIT 19,612 19,759 38,616 38,757
Selling, general and administrative expenses 8,822 6,509 17,661 14,398
---------------------------------------
Income from operations 10,790 13,250 20,955 24,359
Other income, principally interest 357 845 1,353 1,460
---------------------------------------
Income before income taxes 11,147 14,095 22,308 25,819
Provision for income tax 1,742 3,821 3,581 7,168
---------------------------------------
Net income before loss from equity 9,405 10,274 18,727 18,651
investment
Loss from equity investment 0 22 0 47
---------------------------------------
Net income $ 9,405 $10,252 $18,727 $18,604
=======================================
Dividend per share $ 0.06 $ - $ 0.12 $ -
EARNINGS PER SHARE:
Basic $ 0.23 $ 0.26 $ 0.47 $ 0.47
Diluted $ 0.23 $ 0.25 $ 0.46 $ 0.46
WEIGHTED AVERAGE COMMON SHARES
OUTSTANDING:
Basic 40,259 39,470 40,190 39,358
Diluted 40,510 40,638 40,562 40,566
The accompanying notes are an integral part of the consolidated financial
statements.
3
SYNTEL, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS)
JUNE 30, DECEMBER 31,
2004 2003
-------- ---------
ASSETS
Current assets:
Cash and cash equivalents $100,183 $110,699
Short term investments, principally marketable securities 49,187 26,137
Accounts receivable, net of allowances of $ 827 and $ 809 at June
30, 2004 and December 31, 2003, respectively 28,394 25,828
Revenue earned in excess of billings 6,597 6,601
Deferred income taxes and other current assets 5,560 5,617
---------------------
Total current assets 189,921 174,882
Property and equipment 27,921 25,617
Less accumulated depreciation 19,618 18,502
---------------------
Property and equipment, net 8,303 7,115
Goodwill 906 906
Deferred income taxes and other non current assets 3,463 3,178
---------------------
$202,593 $186,081
=====================
LIABILITIES
Current liabilities:
Accounts payable 2,265 1,662
Accrued payroll and related costs 12,270 11,851
Income taxes payable 7,887 6,507
Accrued liabilities 5,051 5,798
Deferred revenue 3,203 4,456
Dividends payable 2,436 2,401
---------------------
Total current liabilities 33,112 32,675
SHAREHOLDERS' EQUITY
Total Shareholders' Equity 169,481 153,406
---------------------
Total liabilities and shareholders' equity $202,593 $186,081
=====================
The accompanying notes are an integral part of the consolidated financial
statements.
4
SYNTEL, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
SIX MONTHS ENDED
JUNE 30,
--------
2004 2003
--------- --------
Cash flows from operating activities:
Net income $ 18,727 $ 18,604
Adjustments to reconcile net income to net cash provided by operating activities
Depreciation and amortization 1,471 1,134
Realized (gains) losses on sales of available-for-sale securities (612) (291)
Deferred income taxes (460) 935
Stock warrants 77 (25)
Compensation expenses related to restricted stock options 146 0
Loss on equity investments 0 47
Changes in assets and liabilities :
Accounts receivable and revenue earned in excess of billings, net (2,895) (3,510)
Other current assets (85) 914
Accrued payroll and other liabilities 3,280 3,503
Deferred revenue (1,472) (2,422)
----------------------
Net cash provided by operating activities 18,177 18,889
----------------------
Cash flows used in investing activities:
Property and equipment expenditures (2,728) (2,211)
Purchase of available-for-sale securities (36,112) (21,005)
Proceeds from sales of available-for-sale securities 13,095 3,678
----------------------
Net cash (used in) investing activities (25,745) (19,538)
----------------------
Cash flows (used in) provided by financing activities:
Net proceeds from issuance of stock 2,114 2,016
Common stock repurchases 0 (160)
Dividends paid (4,817) 0
----------------------
Net cash provided by (used in) financing activities (2,703) 1,856
----------------------
Effect of foreign currency exchange rate changes on cash (245) (460)
Net (decrease) increase in cash and cash equivalents (10,516) 747
Cash and cash equivalents, beginning of period $ 110,699 $ 134,976
----------------------
Cash and cash equivalents, end of period $ 100,183 $ 135,723
======================
Non cash investing and financing activities:
Cash dividend for second quarter of 2004 declared but unpaid as on June 30, 2004 $ 2,436 $ 0
Stock Warrants 77 (25)
----------------------
$ 2,513 $ (25)
======================
Cash paid for income taxes $ 3,624 $ 3,307
======================
The accompanying notes are an integral part of the consolidated financial
statements.
5
SYNTEL, INC. AND SUBSIDIARIES
NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
1. BASIS OF PRESENTATION:
The accompanying condensed consolidated financial statements of Syntel, Inc.
(the "Company") have been prepared by management, without audit, pursuant to the
rules and regulations of the Securities and Exchange Commission. Certain
information and footnote disclosures normally included in financial statements
prepared in accordance with generally accepted accounting principles have been
condensed or omitted pursuant to such rules and regulations. In the opinion of
management, the accompanying unaudited condensed consolidated financial
statements contain all adjustments, consisting of normal recurring adjustments,
necessary to present fairly the financial position of Syntel, Inc. and its
subsidiaries as of June 30, 2004, the results of their operations for the three
month and six month periods ended June 30, 2004 and June 30, 2003, and cash
flows for the six months ended June 30, 2004 and June 30, 2003. The year end
condensed balance sheet as of December 31, 2003 was derived from audited
financial statements but does not include all disclosures required by accounting
principles generally accepted in the United States. For further information,
refer to the consolidated financial statements and footnotes thereto included in
the Company's annual report on Form 10-K for the year ended December 31, 2003.
Operating results for the six months ended June 30, 2004 are not necessarily
indicative of the results that may be expected for the year ending December 31,
2004.
2. PRINCIPLES OF CONSOLIDATION AND ORGANIZATION
The consolidated financial statements include the accounts of Syntel, Inc.
("Syntel"), a Michigan corporation, and its wholly owned subsidiaries. All
significant inter-company balances and transactions have been eliminated.
The wholly owned subsidiaries of Syntel, Inc. are:
- Syntel Limited ("Syntel India"), an Indian limited liability company
formerly known as Syntel (India) Ltd.;
- Syntel Singapore PTE., Ltd. ("Syntel Singapore"), a Singapore
limited liability company;
- Syntel Europe, Ltd. ("Syntel U.K."), a United Kingdom limited
liability company;
- Syntel Canada Inc. ("Syntel Canada"), an Ontario limited liability
company;
- Syntel Deutschland GmbH ("Syntel Germany"), a German limited
liability company;
- Syntel Hong Kong Ltd. ("Syntel Hong Kong"), a Hong Kong limited
liability company;
- Syntel (Australia) Pty. Limited ("Syntel Australia"), an Australian
limited liability company;
- Syntel Delaware LLC ("Syntel Delaware"), a Delaware limited
liability company;
- SkillBay LLC ("SkillBay"), a Michigan limited liability company; and
- Syntel (Mauritius) Limited ("Syntel Mauritius"), a Mauritius limited
liability company.
The wholly owned subsidiary of Syntel Delaware LLC is:
- Syntel Solutions (Mauritius) Ltd. ("Syntel Solutions"), a Mauritius
limited liability company.
The wholly owned subsidiary of Syntel Solutions is:
- Syntel Sourcing Pvt. Ltd. ("Syntel Sourcing"), an Indian limited
liability company.
The wholly owned subsidiaries of Syntel Mauritius are:
- Syntel International Pvt. Ltd. ("Syntel International"), an Indian
limited liability company; and
- Syntel Global Pvt. Ltd. ("Syntel Global"), an Indian limited
liability company.
6
3. USE OF ESTIMATES
The preparation of financial statements in conformity with accounting principles
generally accepted in the United States requires management to make estimates
and assumptions that affect the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities at the date of the financial
statements and the reported amounts of revenues and expenses during the
reporting periods. Such estimates include, but are not limited to allowance for
doubtful accounts, impairment of goodwill, contingencies and litigation, the
recognition of revenues and profits based on the proportional performance method
and potential tax liabilities. Actual results could differ from those estimates
and assumptions used in the preparation of the accompanying financial
statements.
4. REVENUE RECOGNITION
The Company recognizes revenues from TeamSourcing services provided through time
and material contracts as the services are performed.
Revenue from fixed-price applications management, maintenance and support
engagements is recognized as earned which generally results in straight-line
revenue recognition as services are performed continuously over the term of the
engagement.
Revenue on fixed-price, applications development and integration projects in the
Company's application outsourcing and E-Business segments are measured using the
proportional performance method of accounting. Performance is generally measured
based upon the efforts incurred to date in relation to the total estimated
efforts to the completion of the contract. The Company monitors estimates of
total contract revenues and cost on a routine basis throughout the delivery
period. The cumulative impact of any change in estimates of the contract
revenues or costs is reflected in the period in which the changes become known.
In the event that a loss is anticipated on a particular contract, provision is
made for the estimated loss. The Company issues invoices related to fixed price
contracts based on either the achievement of milestones during a project or
other contractual terms. Differences between the timing of billings and the
recognition of revenue based upon the proportional performance method of
accounting are recorded as revenue earned in excess of billings or deferred
revenue in the accompanying financial statements.
Revenues are reported net of sales incentives.
Reimbursements of out-of-pocket expenses are included in revenue in accordance
with Emerging Issues Task Force Consensus ("EITF') 01-14, "Income Statement
Characterization of Reimbursement received for `Out of Pocket' expenses
incurred".
5. CASH AND CASH EQUIVALENTS
For the purpose of reporting Cash and Cash Equivalents, the Company considers
all liquid investments purchased with maturity of three months or less to be
cash equivalents.
At June 30, 2004 and 2003, approximately $26.1 million and $62.8 million,
respectively, represent corporate bonds and treasury notes held by Bank One, for
which "AAA" rated letters of credit have been provided by the bank. The
remaining amounts of cash and cash equivalents are invested in money market
accounts with various banking and financial institutions.
6. STOCK WARRANTS SALES INCENTIVE
During 2002, the Company granted to a significant customer immediately
exercisable warrants entitling the customer to purchase 322,210 shares of
Company stock at an exercise price of $7.25 per share. The stated exercise price
was based upon the customer purchasing a specified minimum level of services
(the "Performance Milestone") from the Company over a specified period ended on
October 16, 2003. The customer earned the sales incentive as they met the
Performance Milestone within the specified period. The customer exercised the
warrant in February 2003 and received 209,739 shares in a cashless exercise.
In accordance with EITF 01-09, "Accounting for Consideration Given by a Vendor
to a Customer or a Reseller of the Vendor's Products", the Company recorded the
value of this sales incentive as a reduction of revenues, to the extent of
7
revenues earned up to October 16, 2003.
The measurement of this sales incentive, which previously was based on the
market value of the Company's stock at each period end, was finalized based on
sale of the shares in quarter ended September 30, 2003 by the customer at an
average sale price of $22.31. Accordingly, the final value of the sales
incentive was $4.7 million. Cumulatively, the Company had recorded $2.9 million
of the sales incentive as a reduction of revenue up to December 31, 2002. The
remaining sales incentive of $1.8 million was recorded during 2003, $(0.02)
million of which was recorded during the six months ended June 30, 2003.
The Company has also granted the same customer certain additional performance
warrants at significantly higher performance milestones. The Company has
estimated that such higher performance milestones will not be met. Accordingly,
the Company has not accounted for these performance warrants. If and when the
Company estimates that such higher performance milestones will be met, the sales
incentive associated with the performance warrants will be recorded as a
reduction of revenue.
7. COMPREHENSIVE INCOME
Total Comprehensive Income for the three and six months period ended June 30,
2004 and 2003 was as follows:
THREE MONTHS ENDED SIX MONTHS ENDED
JUNE 30, JUNE 30,
-------- --------
2004 2003 2004 2003
------- -------- -------- --------
(in thousands) (in thousands)
Net income $ 9,405 $ 10,252 $ 18,727 $ 18,604
Other comprehensive income
- Unrealized Gain (loss) 198 (70) (47) (56)
- Foreign currency translation adjustments (2,815) 755 (1,291) 817
-----------------------------------------------------
Total comprehensive income $ 6,788 $ 10,937 $ 17,389 $ 19,365
=====================================================
8. EARNINGS PER SHARE
Basic and diluted earnings per share are computed in accordance with Statement
of Financial Accounting Standards ("SFAS") No, 128 "Earnings per share".
Basic earnings per share are calculated by dividing net income by the weighted
average number of shares outstanding during the applicable period.
The Company has stock awards outstanding, which are considered to be potentially
dilutive to the basic earnings per share. Diluted earnings per share is
calculated using the treasury stock method for the dilutive effect of options
which have been granted pursuant to the stock option plan, by dividing the net
income by the weighted average number of shares outstanding during the period
adjusted for these potentially dilutive options, except when the results would
be anti-dilutive. The potential tax benefits on exercise of stock options is
considered as additional proceeds while computing dilutive earnings per share
using the treasury stock method.
The following table summarizes the movement in the Capital Structure from March
31, 2004:
NO. OF SHARES
( in thousands)
Balance as on March 31, 2004 40,245
ADD:
Shares issued on exercise of stock options /purchase plan 28
------
Balance as on June 30, 2004 40,273
======
8
The following table sets forth the computation of earnings per share.
THREE MONTHS ENDED JUNE 30,
---------------------------
2004 2003
---- ----
Weighted Weighted
Average Earnings per Average Earnings per
Shares Share Shares Share
------ ----- ------ -----
(in thousands, except per share earnings)
Basic earnings per share 40,259 $ 0.23 39,470 $ 0.26
Potential dilutive effect of stock awards outstanding 251 - 1,168 (0.01)
------------------------------------------
DILUTED EARNINGS PER SHARE 40,510 $ 0.23 40,638 $ 0.25
==========================================
SIX MONTHS ENDED JUNE 30,
-------------------------
2004 2003
---- ----
Weighted Weighted
Average Earnings per Average Earnings per
Shares Share Shares Share
------ ----- ------ -----
(in thousands, except per share earnings)
Basic earnings per share 40,190 $ 0.47 39,358 $ 0.47
Potential dilutive effect of stock awards outstanding 372 (0.01) 1,208 (0.01)
------------------------------------------
DILUTED EARNINGS PER SHARE 40,562 $ 0.46 40,566 $ 0.46
==========================================
9. SEGMENT REPORTING
The Company is organized geographically and by business segment. For management
purpose, the Company is primarily organized on a worldwide basis into four
business segments:
- Applications Outsourcing
- e-Business
- TeamSourcing
- Others
These segments are the basis on which the Company reports its primary segment
information to management. The Others segment includes business process
outsourcing. No balance sheet/identifiable assets data is presented since the
Company does not segregate its assets by segment. Financial data for each
segment for the three and six months period ended June 30, 2004 and 2003 is as
follows:
9
THREE MONTHS ENDED SIX MONTHS ENDED
JUNE 30, JUNE 30,
2004 2003 2004 2003
---- ---- ---- ----
(in thousands) (in thousands)
REVENUES:
Applications Outsourcing $34,338 $32,907 $68,192 $65,874
e-Business 8,010 8,608 16,511 17,074
TeamSourcing 3,065 2,400 5,494 5,045
Others 433 - 738 -
----------------------------------------------
$45,846 $43,915 $90,935 $87,993
----------------------------------------------
GROSS PROFIT:
Applications Outsourcing $15,174 $15,583 $29,707 $30,593
e-Business 3,017 3,922 6,489 7,607
TeamSourcing 1,212 254 2,081 557
Others 209 - 339 -
----------------------------------------------
19,612 19,759 38,616 38,757
Selling, general and administrative expenses 8,822 6,509 17,661 14,398
----------------------------------------------
Income from operations $10,790 $13,250 $20,955 $24,359
----------------------------------------------
During the three months ended June 30, 2004, revenues from American Express
Corp. were $7.2 million, which is approximately 15.7% of total consolidated
revenues, as compared to $6.7 million during the three months ended June 30,
2003, contributing approximately 15.2% of total consolidated revenues.
During the six months ended June 30, 2004 and 2003, American Express Corp.
contributed revenues in excess of 10% of total consolidated revenues. Revenue
from this customer was $14.0 million during the six months ended June 30, 2004,
contributing approximately 15.4% of total consolidated revenues, as compared to
$13.2 million during the six months ended June 30, 2003, contributing
approximately 15.0% of total consolidated revenues.
10. GEOGRAPHIC INFORMATION
Customers of the Company are primarily located in the United States. Net
revenues and net income (loss) were attributed to each geographic location as
follows:
THREE MONTHS ENDED SIX MONTHS ENDED
JUNE 30, JUNE 30,
-------- --------
2004 2003 2004 2003
---- ---- ---- ----
(in thousands) (in thousands)
NET REVENUES
North America, primarily United States $ 41,085 $ 39,986 $ 80,996 $ 80,382
India 20,922 17,132 40,705 32,368
UK 3,494 3,761 7,394 7,304
Far East, primarily Singapore 393 162 764 299
Germany 609 24 1,814 29
Inter-company revenue elimination (primarily India) (20,657) (17,150) (40,738) (32,389)
--------------------------------------------------
TOTAL REVENUE $ 45,846 $ 43,915 $ 90,935 $ 87,993
--------------------------------------------------
NET INCOME/(LOSS)
North America, primarily United States 3,336 2,011 $ 4,983 $ 3,408
India 5,577 8,092 12,337 14,894
UK 470 297 1,065 629
Far East, primarily Singapore 52 (42) 76 (93)
Germany (30) (84) 266 (187)
--------------------------------------------------
INCOME/(LOSS) AFTER INCOME TAXES $ 9,405 $ 10,274 $ 18,727 $ 18,651
--------------------------------------------------
10
11. INCOME TAXES
The following table accounts for the differences between the federal statutory
tax rate of 35% and the Company's overall effective tax rate:
THREE MONTHS ENDED SIX MONTHS ENDED
JUNE 30, JUNE 30,
-------- --------
2004 2003 2004 2003
---- ---- ---- ----
(in thousands) (in thousands)
Income before income taxes $ 11,147 $ 14,095 $ 22,308 $ 25,819
---------------------------------------------------
Statutory provision 35.0% 35.0% 35.0% 35.0%
State taxes, net of federal benefit 1.5% 1.2% 1.1% 1.1%
Tax-free investment income (0.6%) (0.6%) (0.5%) (0.7%)
Foreign effective tax rates different from US
statutory rate (15.9%) (14.9%) (17.3%) (14.3%)
Tax reserves 0.0% 6.4% 0.0% 6.7%
Research & Development Tax Credits (4.4%) 0.0% (2.2%) 0.0%
---------------------------------------------------
EFFECTIVE INCOME TAX RATE 15.6% 27.1% 16.1% 27.8%
---------------------------------------------------
The Company records provisions for income taxes based on enacted tax laws and
rates in the various taxing jurisdictions in which it operates. In determining
the tax provisions, the Company also provides for tax contingencies based on the
Company's assessment of future regulatory reviews of filed tax returns. Such
reserves, which are recorded in income taxes payable, are based on management's
estimates and accordingly are subject to revision based on additional
information.
During the three and six months ended June 30, 2004, the effective income tax
rate was 15.6% and 16.1%, respectively. The tax rate continues to be positively
impacted by the combined effects of offshore transition and reduced onsite
profitability. In addition, during the three months ended June 30, 2004, the
provision for income tax was reduced by research and development tax credits
claimed. The tax credits relate to increased qualified expenditures for software
development. The Company recently completed a review of such qualified
expenditures and filed refund claims for the tax years ended December 31, 1999,
2000, 2001 and 2002. The appropriate tax benefit for these years has been
recorded currently in conjunction with the completion of the review. This tax
credit had a positive impact of $0.5 million on taxes and a $0.01 impact on
earnings per share.
Syntel India has not provided for disputed Indian income tax liabilities
aggregating $2.1 million for the financial years 1995-96 to 2000-01. Syntel
India has obtained an opinion from one independent legal counsel (former Chief
Justice of the Supreme Court of India) for the financial year 1998-99 and two
opinions from another independent legal counsel (also a former Chief Justice of
the Supreme Court of India) for the financial years 1999-2000 and 2000-01, which
support Syntel India's stand in this matter. During the second quarter of 2004,
Syntel India also obtained opinions from the said legal counsel for the periods
1995-96 to 1997-98 and periods beginning with financial year 2001-02 to date
which also support Syntel India's stand in this matter.
Syntel India filed an appeal with Commissioner of Income Tax (Appeals) for the
financial year 1998-99 and received a favorable decision. However the Income Tax
Department has appealed this favourable decision with the Income Tax Appellate
Tribunal. A similar appeal filed by Syntel India with Commissioner of Income Tax
(Appeals) for the financial year 1999-2000 was however dismissed in March 2004.
Syntel India has appealed this decision with the Income Tax Appellate Tribunal.
Syntel India has since also filed appeals against the demands raised in March
2004 by the Income Tax Officer for similar matters relating to the financial
years 1995-96, 1996-97, 1997-98 and 2000-01.
11
12. STOCK BASED COMPENSATION
As permitted by SFAS No. 123, the Company has elected to measure stock based
compensation cost using the intrinsic value method, in accordance with
Accounting Principles Board ("APB") Opinion No. 25, "Accounting for Stock Issued
to Employees" and has adopted the disclosure requirements of SFAS No. 148,
"Accounting for Stock-Based Compensation - Transition and Disclosure, an
amendment of FASB Statement No. 123". Had the fair value of each stock option
granted been determined consistent with the methodology of FASB Statement No.
123, "Accounting for Stock Based Compensation", the pro forma impact on the
Company's net income and earnings per share is as follows:
THREE MONTHS ENDED SIX MONTHS ENDED
JUNE 30, JUNE 30,
-------- --------
2004 2003 2004 2003
---- ---- ---- ----
(in thousands) (in thousands)
NET INCOME
Net income, as reported $ 9,405 $ 10,252 $ 18,727 $ 18,604
Stock based compensation expenses recognized in
statement of income, net of tax 121 0 121 0
Stock based compensation expenses determined under
the fair value method, net of tax (128) (93) (1,062) (1,261)
--------------------------------------------
PRO FORMA NET INCOME $ 9,398 $ 10,159 $ 17,786 $ 17,343
--------------------------------------------
EARNINGS PER SHARE, PRO FORMA
Basic earnings per share $ 0.23 $ 0.26 $ 0.44 $ 0.44
Diluted earnings per share $ 0.23 $ 0.25 $ 0.44 $ 0.43
EARNINGS PER SHARE AS REPORTED
Basic earnings per share $ 0.23 $ 0.26 $ 0.47 $ 0.47
Diluted earnings per share $ 0.23 $ 0.25 $ 0.46 $ 0.46
WEIGHTED AVERAGE SHARES OUTSTANDING
Basic 40,259 39,470 40,190 39,358
Diluted 40,510 40,638 40,562 40,566
Estimated fair value of option granted $ 5.50 $ 5.84 $ 5.50 $ 5.84
Under SFAS No. 123, the fair value of each option grant is estimated on the date
of grant using the Black-Scholes option-pricing model with the following
assumptions for grants:
AS ON JUNE 30,
--------------
2004 2003
---- ----
Assumptions
Risk free interest rate 3.77% 2.48%
Expected life 5.00 5.00
Expected volatility 73.79% 77.37%
Expected dividend yield 1.45% 0.00
RESTRICTED STOCK:
On different dates during the three months ended June 30, 2004 the Company
issued 319,300 shares of incentive restricted stock to its non-employee
directors and some employees as well as to some employees of its subsidiaries.
The stocks were granted to employees for their future services as a retention
tool at a zero exercise price, with the restrictions on transferability lapsing
with regard to 10%, 20%, 30%, and 40% of the shares issued on or after the
first, second, third and fourth anniversary of the grant dates, respectively.
Based upon the market value on the grant dates, the Company recorded $5.8
million of unearned compensation during the three months ended June 30, 2004,
included as a separate component of shareholders equity to be expensed over the
four
12
year's service period on a straight line basis. During the three months ended
June 30, 2004, the Company expensed $0.1 million as compensation cost on account
of these stock grants.
The recipients are also eligible for dividends declared on their restricted
stock. The dividends paid on shares of unvested restricted stock are charged to
compensation cost. During the three months ended June 30, 2004, the Company
recorded $0.02 million as compensation cost for dividends paid on shares of
unvested restricted stock.
13
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
SYNTEL INC. AND SUBSIDIARIES
RESULTS OF OPERATIONS
REVENUES. The Company's revenues consist of fees derived from its Applications
Outsourcing, e-Business, TeamSourcing and Others business segments, where the
Others segment includes primarily Business Process Outsourcing. Net revenues in
the three months ended June 30, 2004 increased to $45.8 million from $43.9 in
the three months ended June 30, 2003, representing an 4.4% increase. Our
revenues have increased primarily consequent to our increased workforce.
Information technology offshoring is a growing trend with increasing numbers of
Global Corporations aggressively outsourcing their crucial applications
development or business processes to vendors with an offshore presence. Syntel
has benefited from this trend. Worldwide billable headcount, including personnel
employed by Syntel India, Syntel Singapore, Syntel U.K., and Syntel Germany as
of June 30, 2004 increased 17.0% to 2,748 employees as compared to 2,349
employees as of June 30, 2003. However, the growth in revenues was not
commensurate with the growth in the billable headcount. This is primarily
because a significant growth in the billable headcount was in India, where our
recoveries per off-shore billable resource are generally lower as compared to an
on-site based resource. As of June 30, 2004, the Company had approximately 54.6%
of its billable workforce in India as compared to 48.5% as of June 30, 2003. The
Company also decreased its dependence on its larger customers. The top five
customers accounted for 39.8% of the total revenues in the three months ended
June 30, 2004, down from 42.2% of the total revenues in the three months ended
June 30, 2003. Moreover, the top 10 customers accounted for 62.2% of the
revenues in the three months ended June 30, 2004 as compared to 66.1% in the
three months ended June 30, 2003.
APPLICATIONS OUTSOURCING REVENUES. Applications Outsourcing revenues increased
to $34.3 million for the three months ended June 30, 2004, or 74.9% of total
revenues, from $32.9 million, or 74.9% of revenues for the three months ended
June 30, 2003. The $1.4 million increase was attributable primarily to revenues
from new engagements contributing $12.0 million largely offset by $10.6 million
in lost revenues as a result of project completion and net reduction in revenues
from existing projects. The revenues for the six months ended June 30, 2004
increased to $68.2 million, or 75.0% of total revenues, from $65.8 million or
74.9% of total revenues for the six months ended June 30, 2003. The $2.4 million
increase for six months ended June 30, 2004 was attributable principally to
revenues from new engagements, contributing approximately $21.5 million, largely
offset by $19.1 million in lost revenues as a result of projects completion and
net reduction in revenues from existing projects.
APPLICATIONS OUTSOURCING COST OF REVENUES. Cost of revenues consists of costs
directly associated with billable consultants in the US and offshore, including
salaries, payroll taxes, benefits, relocation costs, immigration costs, finders
fees, trainee compensation and travel. Applications Outsourcing costs of
revenues increased to 55.8% of total Applications Outsourcing revenues for the
three months ended June 30, 2004, from 52.6% for the three months ended June 30,
2003. Cost of revenues for the six months ended June 30, 2004 increased to 56.4%
of total Applications Outsourcing revenues, from 53.6% for the six months ended
June 30, 2003. Both the 3.2% and 2.8% increase in cost of revenues, as a percent
of revenues for the three and six months ended June 30, 2004, respectively, were
attributable primarily to the aggressive offshore hiring which impacted costs,
but did not necessarily add to revenues as a significant number of these hires
were still in training.
e-BUSINESS REVENUES. e-Business revenues decreased to $8.0 million for the three
months ended June 30, 2004, or 17.5% of total revenues, from $8.6 million, or
19.6% of revenues for the three months ended June 30, 2003. The $0.6 million
decrease was attributable primarily due to lost revenues as a result of project
completion contributing $3.0 million largely offset by revenues from new
engagements and net increase in revenues from existing projects contributing
$2.4 million. The revenues for the six months ended June 30, 2004 decreased to
$16.5 million, or 18.2% of total revenues, from $17.1 million or 19.4% of total
revenues for the six months ended June 30, 2003. The $0.6 million decrease for
six months ended June 30, 2004 was attributable principally to lost revenues as
a result of projects completion contributing approximately $5.0 million, largely
offset by approximately $4.4 million in revenue from new engagements and net
increase in revenues from existing projects.
14
e-BUSINESS COST OF REVENUES. e-Business cost of revenues consists of costs
directly associated with billable consultants in the US and offshore, including
salaries, payroll taxes, benefits, relocation costs, immigration costs, finders
fees, trainee compensation, and travel. e-Business cost of revenues increased to
62.3% of total e-Business revenues for the three months ended June 30, 2004,
from 54.4% for the three months ended June 30, 2003. Cost of revenues for the
six months ended June 30, 2004 increased to 60.7% of total e-Business revenues,
from 55.4% for the six months ended June 30, 2003. Both the 7.9% and 5.3%
increase in cost of revenues, as a percent of revenues for the three and the six
months ended June 30, 2004, respectively, were attributable primarily to the
aggressive hiring which impacted costs, but did not necessarily add to revenues
as a significant number of these hires were still in training.
TEAMSOURCING REVENUES. TeamSourcing revenues increased to $3.1 million for the
three months ended June 30, 2004, or 6.7% of total revenues, from $2.4 million,
or 5.5% of total revenues for the three months ended June 30, 2003. The $0.7
million increase was primarily due to revenues from new engagements and ramping
up of revenue from the Skillbay web portal which helps clients of Syntel with
their supplemental staffing requirements. The revenues for the six months ended
June 30, 2004 increased to $5.5 million, or 6.0% of total revenues, from $5.0
million or 5.7% of total revenues for the six months ended June 30, 2003. The
$0.5 million increase for six months ended June 30, 2004 was attributable
principally to revenues from new engagements, contributing approximately $2.6
million, largely offset by $2.1 million in lost revenues as a result of projects
completion and net reduction in revenues from existing projects.
TEAMSOURCING COST OF REVENUES. TeamSourcing cost of revenues consists of costs
directly associated with billable consultants in the US, including salaries,
payroll taxes, benefits, relocation costs, immigration costs, finders fees,
trainee compensation, and travel. TeamSourcing cost of revenues decreased to
60.5% of TeamSourcing revenues for the three months ended June 30, 2004, from
89.4% for the three months ended June 30, 2003. Cost of revenues for the six
months ended June 30, 2004 decreased to 62.1% of total TeamSourcing revenues,
from 89.0% for the six months ended June 30, 2003. Both the 28.9% and 26.9%
decrease in cost of revenues, as a percent of total TeamSourcing revenues was
attributable primarily to the higher margin TeamSourcing placements and net
revenues from Skillbay web portal placements in the three and six months ended
June 30, 2004.
OTHERS REVENUES. The Others segment started contributing revenues during the
first quarter of 2004. Revenues from this segment were $0.4 million or 0.9% of
total revenues for the three months ended June 30, 2004 and $0.7 million or 0.8%
of total revenues for the six months ended June 30, 2004.
OTHERS COST OF REVENUES. The Others segment cost of revenues consists of costs
directly associated with billable consultants, including salaries, payroll
taxes, benefits, finders fees, trainee compensation, and travel. The Others
segment cost of revenues was 51.7% of the segment's revenues for the three
months ended June 30, 2004 and 54.1% of the segment's revenues for the six
months ended June 30, 2004.
SELLING, GENERAL, AND ADMINISTRATIVE EXPENSES. Selling, general, and
administrative expenses consist primarily of salaries, payroll taxes and
benefits for sales, solutions, finance, administrative, and corporate staff;
travel; telecommunications; business promotions; and marketing and various
facility costs for the Company's global development centers and other offices.
Selling, general, and administrative costs for the three months ended June 30,
2004 were $8.8 million or 19.2% of total revenues, compared to $6.5 million or
14.8% of total revenues for the three months ended June 30, 2003.
Selling, general, and administrative costs for the three months ended June 30,
2003 include a reversal of $0.8 million attributable to the successful recovery
of receivables previously provided for as allowance for doubtful accounts, a
$0.5 million decrease in the estimated reserves for litigation and legal fees
due to settlements and other changes in estimates of underlying legal costs
during the second quarter.
After considering the impact of the above-mentioned items, the selling, general,
and administrative expenses were 19.2% and 18.2% of total revenues, for the
three months ended June 30, 2004 and 2003, respectively. The 1.0 percentage
point increase in selling, general, and administrative expenses as a percentage
of revenue is primarily due to increases in costs related to depreciation of
$0.3 million, telecommunications of $0.4 million, professional fees of $0.1
million and others of $0.2 million which resulted in an approximately 1.8
percentage point increase, partially offset by increases in revenue in the three
month ended June 30, 2004 as against the three months ended June 30, 2003, which
resulted in an approximately 0.8 percentage point decrease.
Selling, general, and administrative costs for the six months ended June 30,
2004 were $17.7 million or 19.4% of total
15
revenues, compared to $14.4 million or 16.4% of total revenues for the six
months ended June 30, 2003.
Selling, general, and administrative costs for the six months ended June 30,
2003 include a reversal of $0.8 million attributable to the successful recovery
of receivables previously provided for as allowance for doubtful accounts, a
$1.0 million decrease in the estimated reserves for litigation and legal fees
due to settlements and other changes in estimates of underlying legal costs
during the six months and a downward revision of the 2002 estimate of bonus
compensation of $0.8 million.
After considering the impact of the above-mentioned items, the selling, general,
and administrative expenses are at 19.4% and 19.3% of total revenues, for the
six months ended June 30, 2004 and 2003, respectively. The 0.1 percentage point
increase in selling, general, and administrative expenses as a percentage of
revenue is primarily due to net increases in costs related to depreciation,
telecommunications and professional fees, which resulted in an approximately 0.7
percentage point increase, largely offset by increases in revenue during the six
months ended June 30, 2004 as against the six months ended June 30, 2003, which
resulted in an approximately 0.6 percentage point decrease.
INCOME TAXES
During the three and six months ended June 30, 2004, the effective income tax
rate was 15.6% and 16.1%, respectively. The tax rate continues to be positively
impacted by the combined effects of offshore transition and reduced onsite
profitability. In addition, during the three months ended June 30, 2004, the
provision for income tax was reduced by research and development tax credits
claimed. The tax credits relate to increased qualified expenditures for software
development. The Company recently completed a review of such qualified
expenditures and filed refund claims for the tax years ended December 31, 1999,
2000, 2001 and 2002. The appropriate tax benefit for these years has been
recorded currently in conjunction with the completion of the review. This tax
credit had a positive impact of $0.5 million on taxes and a $0.01 impact on
earning per share.
LIQUIDITY AND CAPITAL RESOURCES
The Company generally has financed its working capital needs through operations.
The Company's cash and cash equivalents consist primarily of certificates of
deposit, corporate bonds and treasury notes. A part of such amounts are held by
Bank One for which a AAA rated letter of credit has been provided. The remaining
amounts are held by various banking institutions including other US-based and
India-based banks.
Net cash generated by operating activities was $18.2 million for the six months
ended June 30, 2004, compared to $18.9 million for the six months ended June 30,
2003. The number of days sales outstanding in accounts receivable was
approximately 69 days and 59 days as of June 30, 2004 and June 30, 2003,
respectively. The increase in the number of days sales outstanding in accounts
receivable was due to relatively higher billing as against the collection during
the six months ended June 30, 2004.
Net cash used in investing activities was $25.7 million for the six months ended
June 30, 2004, consisting principally of $36.1 million for the purchase of
available-for-sale securities and $2.7 million for capital expenditures,
consisting principally of capital work in progress including capital advances
towards construction of a Global Development Center at Pune, India, PCs and
communications equipment, partially offset by the sale of available-for-sale
securities of $13.1 million. Net cash used in investing activities was $19.5
million for the six months ended June 30, 2003, consisting principally of $21.0
million for the purchase of available-for-sale securities and $2.2 million for
capital expenditures, consisting principally of PCs and communications equipment
partially offset by the sale of available-for-sale securities of $3.7 million.
Net cash used in financing activities was $2.7 million for the six months ended
June 30, 2004, consisting principally of $4.8 million in dividends paid out,
partially offset by $2.1 million of proceeds from issuance of shares under stock
option and stock purchase plans. Net cash provided by financing activities was
$1.8 million for the six months ended June 30, 2003, consisting principally of
$2.0 million of proceeds from the exercise of stock options, offset by common
stock repurchases of $0.2 million.
The Company has a line of credit with Bank One, which provides for borrowings of
up to $20.0 million. The line of credit has been renewed and now expires on
August 31, 2004. The line of credit contains covenants restricting the Company
from, among other things, incurring additional debt, issuing guarantees and
creating liens on the Company's property, without the prior consent of the bank.
The line of credit also requires the Company to maintain certain tangible net
worth levels and
16
leverage ratios. The line of credit has a sub-limit of $5.0 million for letters
of credit, which bear a fee of 1% per annum of the face value of each standby
letter of credit issued. Borrowings under the line of credit bear interest, at
the option of the Company, either at (i) a formula approximating the Eurodollar
rate plus the applicable margin of 1.25%, or (ii) the bank's prime rate plus
1.25%. No borrowings were outstanding at June 30, 2004 and 2003.
The Company believes that the combination of present cash balances and future
operating cash flows will be sufficient to meet the Company's anticipated cash
requirements for at least the next 12 months.
CRITICAL ACCOUNTING POLICIES
We believe the following critical accounting policy, among others, affect our
more significant judgments and estimates used in the preparation of our
consolidated financial statements. The Company has discussed the critical
accounting policies and estimates with the Audit Committee of the Board of
Directors.
REVENUE RECOGNITION. Revenue recognition is the most significant accounting
policy for the Company. The Company recognizes revenue from time and material
contracts as services are performed. During the quarters ended June 30, 2004 and
2003, revenues from time and material contracts constituted 47.2% and 47.6%,
respectively of total revenues. Revenue from fixed-price, application
management, maintenance and support engagements is recognized as earned, which
generally results in straight-line revenue recognition as services are performed
continuously over the term of the engagement. During the quarter ended June 30,
2004 and 2003, revenues from fixed price application management and support
engagements constituted 32.7% and 26.1%, respectively.
Revenue on fixed price development projects is measured using the proportional
performance method of accounting. Performance is generally measured based upon
the efforts incurred to date in relation to the total estimated efforts to the
completion of the contract. The Company monitors estimates of total contract
revenues and cost on a routine basis throughout the delivery period. The
cumulative impact of any change in estimates of the contract revenues or costs
is reflected in the period in which the changes become known. In the event that
a loss is anticipated on a particular contract, provision is made for the
estimated loss. The Company issues invoices related to fixed price contracts
based on either the achievement of milestones during a project or other
contractual terms. Differences between the timing of billings and the
recognition of revenue based upon the proportional performance method of
accounting are recorded as revenue earned in excess of billings or deferred
revenue in the accompanying financial statements. During the quarter ended June
30, 2004 and 2003, revenues from fixed price development contracts constituted
20.1% and 26.4%, respectively.
SIGNIFICANT ACCOUNTING ESTIMATES
The preparation of the consolidated financial statements in conformity with
generally accepted accounting principles requires management to make estimates
and judgments that affect the reported amounts of assets and liabilities and the
disclosure of contingent assets and liabilities at the date of the consolidated
financial statements, and the reported amounts of revenues and expenses for the
reporting period. By their nature, these estimates and judgments are subject to
an inherent degree of uncertainty. The Company bases its estimates and judgments
on historical experience and on various other assumptions that are believed to
be reasonable under the circumstances. Actual results could differ from those
estimates.
REVENUE RECOGNITION. The use of the proportional performance method of
accounting requires that we make estimates about our future efforts and costs
relative to our fixed price contracts. While the Company has procedures in place
to monitor the estimates throughout the performance period, such estimates are
subject to change as each contract progresses. The cumulative impact of any such
changes is reflected in the period in which the changes become known.
ALLOWANCE FOR DOUBTFUL ACCOUNTS. The Company records an allowance for doubtful
accounts based on a specific review of aged receivables. The provision for the
allowance for doubtful accounts is recorded in selling, general and
administrative expenses. These estimates are based on our assessment of the
probable collections from specific customer accounts, the aging of the accounts
receivable, analysis of credit data, bad debt write-offs, and other known
factors.
INCOME TAXES -- ESTIMATES OF EFFECTIVE TAX RATES AND RESERVES FOR TAX
CONTINGENCIES. When preparing financial statements, the Company records
provisions for income taxes based on tax laws and regulations in each of the
various jurisdictions where it conducts business.
In determining the tax provisions, the Company also provides reserves for tax
contingencies based on the Company's
17
assessment of future regulatory reviews of filed tax returns. Such reserves are
recorded in income taxes payable and are based on management's estimates and
accordingly are subject to revision based on additional information.
During the three and six months ended June 30, 2004, the effective income tax
rate was 15.6% and 16.1%, respectively. The tax rate continues to be positively
impacted by the combined effects of offshore transition and reduced onsite
profitability. In addition, during the three months ended June 30, 2004, the
provision for income tax was reduced by research and development tax credits
claimed. The tax credits relate to increased qualified expenditures for software
development. The Company recently completed a review of such qualified
expenditures and filed refund claims for the tax years ended December 31, 1999,
2000, 2001 and 2002. The appropriate tax benefit for these years has been
recorded currently in conjunction with the completion of the review. This tax
credit had a positive impact of $0.5 million on taxes and a $0.01 impact on
earnings per share.
Syntel India has not provided for disputed Indian income tax liabilities
aggregating $2.1 million for the financial years 1995-96 to 2000-01. Syntel
India has obtained an opinion from one independent legal counsel (former Chief
Justice of the Supreme Court of India) for the financial year 1998-99 and two
opinions from another independent legal counsel (also a former Chief Justice of
the Supreme Court of India) for the financial years 1999-2000 and 2000-01, which
support Syntel India's stand in this matter. During the second quarter of 2004,
Syntel India also obtained opinions from the said legal counsel for the periods
1995-96 to 1997-98 and periods beginning with financial year 2001-02 to date
which also support Syntel India's stand in this matter.
Syntel India had filed an appeal with Commissioner of Income Tax (Appeals) for
the financial year 1998-99 and received a favorable decision. However the Income
Tax Department has appealed this favourable decision with the Income Tax
Appellate Tribunal. A similar appeal filed by Syntel India with Commissioner of
Income Tax (Appeals) for the financial year 1999-2000 was however dismissed in
March 2004. Syntel India has appealed this decision with the Income Tax
Appellate Tribunal. Syntel India has since also filed appeals against the
demands raised in March 2004 by the Income Tax Officer for similar matters
relating to the financial years 1995-96, 1996-97, 1997-98 and 2000-01.
ACCRUALS FOR LEGAL EXPENSES AND EXPOSURES. The Company estimates the costs
associated with known legal exposures and their related legal expenses and
accrues for either the probable liability, if that amount can be reasonably
estimated, or otherwise the lower end of an estimated range of potential
liability.
FORWARD LOOKING STATEMENTS / RISK FACTORS
Certain information and statements contained in Management's Discussion and
Analysis of Financial Condition and Results of Operations and other sections of
this report, including the allowance for doubtful accounts, contingencies and
litigation, potential tax liabilities, interest rate or foreign currency risks,
and projections regarding our liquidity and capital resources, could be
construed as forward looking statements within the meaning of Section 27A of the
Securities Act of 1933, and amended, and Section 21E of the Securities Exchange
Act of 1934, as amended. In addition, the Company or persons acting on its
behalf may, from time to time, publish other forward looking statements. Such
forward looking statements are based on management's estimates, assumptions and
projections and are subject to risks and uncertainties that could cause actual
results to differ materially from those discussed in the forward looking
statements. Some of the factors that could cause future results to materially
differ from the recent results or those projected in the forward looking
statements include the following, which factors are more fully discussed in the
Company's most recently filed Annual Report on Form 10-K and other SEC filings,
in each case under the section entitled "Risk Factors":
- Recruitment and retention of IT professionals;
- Government regulation of immigration;
- Variability of quarterly operating results;
- Customer concentration;
- Risk of termination of Syntel by customers;
- Changes in customer needs;
- Exposure to regulatory and general economic conditions in India;
- Intense competition;
- Ability to manage growth;
- Fixed-price engagements;
- Potential liability to customers;
- Dependence on principal;
18
- Risks related to possible acquisitions; and
- Limited intellectual property protection.
Also, potential anti-outsourcing legislation could adversely affect our
business. In the past few months, the issue of outsourcing of services abroad by
American companies has become a topic of political discussion in the United
States. Measures aimed at limiting or restricting outsourcing by U.S. companies
are under discussion in Congress and several state legislatures. While no
substantive anti-outsourcing legislation has been introduced to date, given the
intensifying debate over this issue, the introduction of such legislation is
possible. If introduced, such legislation may consist of measures concerning
restrictions on outsourcing by government agencies and on government contracts
with firms that outsource services directly or indirectly or measures designed
to introduce deterrents on U.S. companies outsourcing work to foreign companies.
In the event that any such measures become law, the Company's business,
financial condition, and results of operations could be adversely affected and
its ability to service its customers could be impaired.
In addition, statements containing words such as "could", "expects", "may",
"anticipates", "believes", "estimates", "plans", and similar expressions, are
forward-looking statements. The Company does not intend to update the forward
looking statements or risk factors to reflect future events or circumstances.
Some of the factors that could cause future results to materially differ from
the recent results or those projected in the forward-looking statements include,
but are not limited to, significant increases or decreases in demand for the
Company's services, increased competition, lower prices and margins, changes in
customer's technology spending, failure to successfully develop and market new
products and services, competitor introductions of superior services, continued
industry consolidation, instability and currency fluctuations in India and other
international markets, results of litigation, failure to retain and recruit key
employees, adverse economic conditions, acts of war or global terrorism and
unexpected natural disasters.
RECENT ACCOUNTING PRONOUNCEMENTS
None.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.
We are exposed to the impact of interest rate changes and foreign currency
fluctuations.
INTEREST RATE RISK
We consider investments purchased with an original or remaining maturity of less
than three months at date of purchase to be cash equivalents. The following
table summarizes our cash and cash equivalents and investments in marketable
securities (in thousands):
JUNE 30, DECEMBER 31,
2004 2003
---- ----
ASSETS
Cash and cash equivalents $ 100,183 $ 110,699
Investments, marketable securities 49,187 26,137
----------------------
TOTAL $ 149,370 $ 136,836
----------------------
Our exposure to market rate risk for changes in interest rates relates primarily
to our investment portfolio. We do not use derivative financial instruments in
our investment portfolio. Our investments are in high-quality Indian Mutual
Funds and, by policy, limit the amount of credit exposure to any one issuer. At
any time, changes in interest rates could have an impact on interest earnings
for our investment portfolio. We protect and preserve our invested funds by
limiting default, market and reinvestment risk. Investments in interest earning
instruments carry a degree of interest rate risk. Floating rate securities may
produce less income than expected if there is a decline in interest rates. Due
in part to these factors, our future investment income may fall short of
expectations, or we may suffer a loss in principal if we are forced to sell
securities, which have declined in market value due to changes in interest rates
as stated above.
19
FOREIGN CURRENCY RISK
Our sales are primarily sourced in the United States and our subsidiary in the
United Kingdom and are mostly denominated in U.S. dollars or UK pounds
respectively. Our foreign subsidiaries incur most of their expenses in the local
currency. Accordingly, all foreign subsidiaries use the local currency as their
functional currency. Our business is subject to risks typical of an
international business, including, but not limited to differing economic
conditions, changes in political climate, differing tax structures, other
regulations and restrictions, and foreign exchange rate volatility. Accordingly,
our future results could be materially adversely impacted by changes in these or
other factors. The risk is partially mitigated as the Company has sufficient
resources in the respective local currencies to meet immediate requirements. We
are also exposed to foreign exchange rate fluctuations as the financial results
of foreign subsidiaries are translated into U.S. dollars in consolidation. As
exchange rates vary, these results, when translated, may vary from expectations.
During the three months ended June 30, 2004, the Indian rupee has depreciated by
0.9% as compared to the three months ended March 31, 2004. The impact of this
rupee depreciation favourably impacted our gross margin by 14 basis points,
operating income by 19 basis points and net income by 18 basis points, each as a
percentage of revenue. The Indian rupee denominated cost of revenues and
selling, general and administrative cost was 27.7% and 24.0%, respectively,
which did not have a material impact.
Although the Company cannot predict future movement in interest rates or
fluctuations in foreign currency rates, the Company does not currently
anticipate that interest rate risk or foreign currency risk will have a material
impact.
20
ITEM 4. CONTROLS AND PROCEDURES
EVALUATION OF DISCLOSURE CONTROLS AND PROCEDURES. Based on their evaluation of
the Company's disclosure controls and procedures as of June 30, 2004 as well as
based on mirror certifications from senior Management, the Company's Chairman,
President and Chief Executive Officer and Chief Financial Officer have concluded
that, as of the end of the period covered by this report, the Company's
disclosure controls and procedures are designed to ensure that information
required to be disclosed by the Company in the reports that it files or submits
under the Securities Exchange Act of 1934 (the Exchange Act) is recorded,
processed, summarized and reported within the time periods specified in the
Securities and Exchange Commission's rules and forms and are operating in an
effective manner. There have been no changes in the Company's internal controls
or in other factors which could materially affect internal controls subsequent
to the date the Company carried out its evaluation. During the three months
ended June 30, 2004, there were no changes in the Company's internal controls
over financial reporting which materially affected, or would have been
reasonably likely to have materially affected, the Company's internal controls
over financial reporting.
DISCLOSURE CONTROLS AND INTERNAL CONTROLS. Disclosure Controls are procedures
designed to ensure that information required to be disclosed in our reports
filed under the Exchange Act, such as this Report, is recorded, processed,
summarized and reported within the time periods specified in the U.S. Securities
and Exchange Commission's (the SEC) rules and forms. Disclosure Controls are
also designed to ensure that such information is accumulated and communicated to
our management, including the CEO and CFO, as appropriate to allow timely
decisions regarding required disclosure. Internal Controls are procedures
designed to provide reasonable assurance that (1) our transactions are properly
authorized; (2) our assets are safeguarded against unauthorized or improper use;
and (3) our transactions are properly recorded and reported, all to permit the
preparation of our financial statements in conformity with generally accepted
accounting principles.
LIMITATIONS ON THE EFFECTIVENESS OF CONTROLS. The company's management,
including the CEO and CFO, does not expect that our Disclosure Controls or our
Internal Controls will prevent all error and all fraud. A control system, no
matter how well designed and operated, can provide only reasonable, not
absolute, assurance that the control system's objectives will be met. Because of
the inherent limitations in all control systems, no evaluation of controls can
provide absolute assurance that all control issues and instances of fraud, if
any, within the company have been detected. The design of any system of controls
is based in part upon certain assumptions about the likelihood of future events,
and there can be no assurance that any design will succeed in achieving its
stated goals under all potential future conditions. Over time, controls may
become inadequate because of changes in conditions or deterioration in the
degree of compliance with its policies or procedures.
SCOPE OF THE CONTROLS EVALUATION. In the course of the Controls Evaluation, we
sought to identify data errors, control problems or acts of fraud and confirm
that appropriate corrective actions, including process improvements, were being
undertaken. Our Internal Controls are also evaluated on an ongoing basis by our
Internal Audit Department and by other personnel in our organization. The
overall goals of these various evaluation activities are to monitor our
Disclosure Controls and our Internal Controls, and to modify them as necessary;
our intent is to maintain the Disclosure Controls and the Internal Controls as
dynamic systems that change as conditions warrant.
Among other matters, we sought in our evaluation to determine whether there were
any "significant deficiencies" or "material weaknesses" in the company's
Internal Controls, and whether the company had identified any acts of fraud
involving personnel with a significant role in the company's Internal Controls.
This information was important both for the Controls Evaluation generally, and
because the Rule 13a-14 Certifications of the CEO and CFO require that the CEO
and CFO disclose that information to our Board's Audit Committee and our
independent auditors. We also sought to deal with other controls matters in the
Controls Evaluation, and in each case if a problem was identified, we considered
what revision, improvement and/or correction to make in accordance with our
ongoing procedures.
From the date of the Controls Evaluation to the date of this Report, there have
been no significant changes in Internal Controls or in other factors that could
significantly affect Internal Controls.
CONCLUSIONS. Based upon the Controls Evaluation, our CEO and CFO have concluded
that our Disclosure Controls are effective to ensure that material information
relating to Syntel and its consolidated subsidiaries is made known to
management, including the CEO and CFO, particularly during the period when our
periodic reports are being prepared, and that our Internal Controls are
effective to provide reasonable assurance that our financial statements are
fairly presented in conformity with generally accepted accounting principles.
21
OUTLOOK. During the year 2003, the Company created a management task force to
fulfill compliance with the requirements of Section 404 of the Sarbanes Oxley
Act. The Company is in an advanced stage of preparedness and has also appointed
an external agency to assist the Company. The Company has also moved ahead with
BS 7799 and SAS 70 related initiatives during 2004. The Company has appointed
external agencies to assist with these exercises as well. Key members of the
Company's management team are involved in all these exercises.
22
PART II
OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS.
While the Company is a party to ordinary routine litigation incidental to its
business, the Company is not a party to any material pending legal proceedings.
ITEM 2. CHANGES IN SECURITIES, USE OF PROCEEDS AND ISSUER PURCHASES OF EQUITY
SECURITIES.
None.
ITEM 3. DEFAULTS UPON SENIOR SECURITIES.
None.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
The Company held an Annual Meeting of Shareholders on Thursday, June 3, 2004. At
the meeting, George R. Mrkonic, Jr. and Vasant Raval were elected directors of
the Company to serve three years term until the annual meeting of shareholders
in 2007. The vote of the shareholders with regard to the election of Mr. Mrkonic
as a director was 37,870,066 shares FOR and 2,203,448 shares WITHHELD. The vote
of the shareholders with regard to the election of Mr. Raval as a director was
39,711,562 shares FOR and 361,952 shares WITHHELD. The following persons
continued to serve their terms of office as directors of the Company after the
meeting: Paritosh K. Choksi, Bharat Desai, Neerja Sethi, and Douglas E. Van
Houweling.
ITEM 5. OTHER INFORMATION.
None.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K.
(a) Exhibits
Exhibit No. Description
31.1 Rule 13a-14(a)/15d-14(a) Certification of Chief Executive Officer
31.2 Rule 13a-14(a)/15d-14(a) Certification of Chief Financial Officer
32 Section 1350 Certification of Chief Executive Officer and Chief Financial Officer
(b) Reports on Form 8-K
During the quarter for which this report is filed, the Company filed three
Reports on Form 8-K. The first Report on Form 8-K was dated April 23, 2004. In
that Report on Form 8-K, the Company reported under Item 12 that it issued a
press release containing its results of operations and financial condition for
the first quarter ended March 31, 2004 and included the text of that press
release as an exhibit under Item 7. The second Report on Form 8-K was also dated
April 23, 2004. In that Report on Form 8-K, the Company reported under Item 9 a
clarification to information provided in that day's earnings call. The third
Report on Form 8-K was dated June 10, 2004. In that Report on Form 8-K, the
Company reported under Item 4 the declination to stand for reappointment of the
Company's certifying accountant and filed as an exhibit under Item 7 a letter
from that former certifying accountant.
23
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
SYNTEL, INC.
Date August 5, 2004 /s/ Bharat Desai
----------------------------------------
Bharat Desai, Chairman, President and
Chief Executive Officer
Date August 5, 2004 /s/ Keshav Murugesh
----------------------------------------
Keshav Murugesh, Chief Financial Officer
24
EXHIBIT INDEX
EXHIBIT NO. DESCRIPTION
31.1 Rule 13a-14(a)/15d-14(a) Certification of Chief Executive Officer
31.2 Rule 13a-14(a)/15d-14(a) Certification of Chief Financial Officer
32 Section 1350 Certification of Chief Executive Officer and Chief Financial
Officer
25