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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 September 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
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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: 40,549,188 shares issued and outstanding as of
October 25, 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 20
Item 4 Controls and Procedures 21
Part II Other Information 23
Signatures 24
Certificate of Chief Executive Officer 26
Certificate of Chief Operating Officer and Chief Financial Officer 27
Certification of Chief Executive Officer and
Chief Operating Officer and Chief Financial Officer 28
2
SYNTEL, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF INCOME
(IN THOUSANDS, EXCEPT PER SHARE DATA)
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
------------- -------------
2004 2003 2004 2003
--------- --------- ---------- -----------
Net revenues $ 46,602 $ 44,105 $ 137,537 $ 132,098
Cost of revenues 27,014 25,738 79,333 74,974
--------- --------- ---------- -----------
GROSS PROFIT 19,588 18,367 58,204 57,124
Selling, general and administrative expenses 8,850 5,371 26,511 19,769
--------- --------- ---------- -----------
Income from operations 10,738 12,996 31,693 37,355
Other income, principally interest 753 632 2,106 2,092
--------- --------- ---------- -----------
Income before income taxes 11,491 13,628 33,799 39,447
Provision for/(benefit from) income taxes (402) 2,884 3,179 10,052
--------- --------- ---------- -----------
Income before income/(loss) from equity
investment 11,893 10,744 30,620 29,395
Income/(loss) from equity investment 0 13 0 (34)
--------- --------- ---------- -----------
Net income $ 11,893 $ 10,757 $ 30,620 $ 29,361
========= ========= ========= ===========
Dividend per share $ 0.06 $ 1.31 $ 0.18 $ 1.31
EARNINGS PER SHARE:
Basic $ 0.30 $ 0.27 $ 0.76 $ 0.74
Diluted $ 0.29 $ 0.26 $ 0.76 $ 0.72
WEIGHTED AVERAGE COMMON SHARES OUTSTANDING:
Basic 40,236 39,718 40,205 39,478
Diluted 40,335 40,975 40,486 40,634
The accompanying notes are an integral part of the consolidated financial
statements.
3
SYNTEL, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS)
SEPTEMBER 30, DECEMBER 31,
2004 2003
------------- ------------
ASSETS
Current assets:
Cash and cash equivalents $ 106,292 $ 102,854
Short term investments 50,069 33,982
Accounts receivable, net of allowances of $799 and $809 at
September 30, 2004 and December 31, 2003, respectively 28,787 25,197
Revenue earned in excess of billings 5,139 6,324
Deferred income taxes and other current assets 6,012 5,642
--------- ---------
Total current assets 196,299 173,999
Property and equipment 33,142 25,617
Less accumulated depreciation 20,090 18,502
--------- ---------
Property and equipment, net 13,052 7,115
Goodwill 906 906
Deferred income taxes and other non current assets 2,341 3,178
--------- ---------
$ 212,598 $ 185,198
========= =========
LIABILITIES
Current liabilities:
Accounts payable $ 1,831 $ 1,056
Accrued payroll and related costs 13,089 11,851
Income taxes payable 5,926 6,507
Accrued liabilities 5,897 5,798
Deferred revenue 4,910 4,179
Dividends payable 2,433 2,401
--------- ---------
Total current liabilities 34,086 31,792
SHAREHOLDERS' EQUITY
Total shareholders' equity 178,512 153,406
--------- ---------
Total liabilities and shareholders' equity $ 212,598 $ 185,198
========= =========
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)
NINE MONTHS ENDED SEPT 30,
2004 2003
--------- ---------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income $ 30,620 $ 29,361
Adjustments to reconcile net income to net cash provided by operating
activities
Depreciation and amortization 2,197 1,913
Bad debts written off (3) 0
Realized gains on sales of short term investments (996) (414)
Deferred income taxes 1,612 981
Stock warrants sales incentive 77 1,621
Compensation expenses related to restricted stock options 524 0
Loss on equity investments 0 34
Changes in assets and liabilities:
Accounts receivable and revenue earned in excess of billings, net (2,844) (4,860)
Other current assets (1,184) 442
Accrued payroll and other liabilities 2,785 4,418
Deferred revenue 503 (3,161)
--------- ---------
Net cash provided by operating activities 33,291 30,335
--------- ---------
CASH FLOWS FROM INVESTING ACTIVITIES:
Property and equipment expenditures (8,213) (3,012)
Equity and other investments 0 223
Purchase of short term investments (43,890) (22,439)
Proceeds from sales of short term investments 28,173 7,002
--------- ---------
Net cash used in investing activities (23,930) (18,226)
--------- ---------
CASH FLOWS FROM FINANCING ACTIVITIES:
Net proceeds from issuance of stock 2,933 5,812
Common stock repurchases (1,479) (160)
Dividends paid (7,252) (49,865)
--------- ---------
Net cash used in financing activities (5,798) (44,213)
--------- ---------
Effect of foreign currency exchange rate changes on cash (125) (619)
--------- ---------
Net increase/(decrease) in cash and cash equivalents 3,438 (32,723)
Cash and cash equivalents, beginning of period 102,854 124,995
--------- ---------
Cash and cash equivalents, end of period $ 106,292 $ 92,272
========= =========
Non cash investing and financing activities:
Cash dividend declared but unpaid $ 2,433 $ 2,397
Stock warrants 77 0
Cash paid for income taxes 4,520 2,402
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 un-audited
condensed consolidated financial statements contain all adjustments,
consisting of normal recurring adjustments, necessary to present fairly the
consolidated financial position of Syntel, Inc. and its subsidiaries as of
September 30, 2004, the results of their consolidated operations for the
three month and nine month periods ended September 30, 2004 and September
30, 2003, and cash flows for the nine months ended September 30, 2004 and
September 30, 2003. The year-end condensed consolidated 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 nine months ended September 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:
o Syntel Limited ("Syntel India"), an Indian limited liability
company formerly known as Syntel (India) Ltd.;
o Syntel Singapore PTE., Ltd. ("Syntel Singapore"), a Singapore
limited liability company;
o Syntel Europe, Ltd. ("Syntel U.K."), a United Kingdom limited
liability company;
o Syntel Canada Inc. ("Syntel Canada"), an Ontario limited
liability company;
o Syntel Deutschland GmbH ("Syntel Germany"), a German limited
liability company;
o Syntel Hong Kong Ltd. ("Syntel Hong Kong"), a Hong Kong limited
liability company;
o Syntel (Australia) Pty. Limited ("Syntel Australia"), an
Australian limited liability company;
o Syntel Delaware LLC ("Syntel Delaware"), a Delaware limited
liability company;
o SkillBay LLC ("SkillBay"), a Michigan limited liability
company; and
o Syntel (Mauritius) Limited ("Syntel Mauritius"), a Mauritius
limited liability company.
The wholly owned subsidiary of Syntel Delaware LLC is:
o Syntel Solutions (Mauritius) Ltd. ("Syntel Solutions"), a
Mauritius limited liability company.
The wholly owned subsidiary of Syntel Solutions is:
o Syntel Sourcing Pvt. Ltd. ("Syntel Sourcing"), an Indian
limited liability company.
The wholly owned subsidiaries of Syntel Mauritius are:
o Syntel International Pvt. Ltd. ("Syntel International"), an
Indian limited liability company; and
o 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 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 September 30, 2004 and 2003, approximately $24.5 million and $23.9
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, $1.6 million of which was recorded during the nine months ended
September 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 nine months period ended
September 30, 2004 and 2003 was as follows:
THREE MONTHS ENDED NINE MONTHS ENDED
------------------ -----------------
SEPTEMBER 30, SEPTEMBER 30,
------------- -------------
2004 2003 2004 2003
-------- -------- -------- --------
(In thousands) (In thousands)
Net income $ 11,893 $ 10,757 $ 30,620 $ 29,361
Other comprehensive income
- Unrealized Gain (loss) 9 291 (38) 235
- Foreign currency translation
adjustments (201) 626 (1,492) 1,443
-------- -------- -------- --------
Total comprehensive income $ 11,701 $ 11,674 $ 29,090 $ 31,039
======== ======== ======== ========
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
June 30, 2004:
PARTICULARS NO. OF SHARES
(IN THOUSANDS)
--------------
Balance as on June 30, 2004 40,273
ADD:
Shares issued on exercise of stock options /purchase plan 67
LESS:
Common Stock repurchased (100)
-------
Balance as on September 30, 2004 40,240
========
8
The following table sets forth the computation of earnings per share.
THREE MONTHS ENDED SEPTEMBER 30,
2004 2003
---- ----
Weighted Weighted
Average Earnings Average Earnings
Shares per Share Shares per Share
------ --------- ------ ---------
(In thousands, except per share earnings)
Basic earnings per share 40,236 $ 0.30 39,718 $ 0.27
Potential dilutive effect of stock awards
outstanding 99 (0.01) 1,257 (0.01)
------ ------ ------ ------
DILUTED EARNINGS PER SHARE 40,335 $ 0.29 40,975 $ 0.26
====== ====== ====== ======
NINE MONTHS ENDED SEPTEMBER 30,
2004 2003
---- ----
Weighted Weighted
Average Earnings Average Earnings
Shares per Share Shares per Share
------ --------- ------ ---------
(In thousands, except per share earnings)
Basic earnings per share 40,205 $ 0.76 39,478 $ 0.74
Potential dilutive effect of stock awards
outstanding 281 - 1,156 (0.02)
------ ------ ------ ------
DILUTED EARNINGS PER SHARE 40,486 $ 0.76 40,634 $ 0.72
====== ====== ====== ======
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:
o Applications Outsourcing
o e-Business
o TeamSourcing
o 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 nine months period ended September 30,
2004 and 2003 is as follows:
9
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
2004 2003 2004 2003
---- ---- ---- ----
(In thousands) (In thousands)
REVENUES:
Applications Outsourcing $ 36,706 $ 34,561 $ 104,898 $ 100,435
e-Business 6,143 7,491 22,654 24,565
TeamSourcing 3,308 2,053 8,802 7,098
Others 445 - 1,183 -
-------- -------- --------- ---------
46,602 44,105 137,537 132,098
GROSS PROFIT:
Applications Outsourcing 16,013 15,640 45,720 46,233
e-Business 2,309 2,501 8,798 10,108
TeamSourcing 1,085 226 3,166 783
Others 181 - 520 -
-------- -------- --------- ---------
19,588 18,367 58,204 57,124
Selling, general and administrative expenses 8,850 5,371 26,511 19,769
Income from operations 10,738 12,996 31,693 37,355
During the three months ended September 30, 2004, revenues from American
Express Corp. were $7.9 million, which is approximately 17.0% of total
consolidated revenues, as compared to $6.9 million during the three months
ended September 30, 2003, contributing approximately 15.8% of total
consolidated revenues.
During the nine months ended September 30, 2004 and 2003, American Express
Corp. contributed revenues in excess of 10% of total consolidated revenues.
Revenue from this customer was $21.9 million during the nine months ended
September 30, 2004, contributing approximately 15.9% of total consolidated
revenues, as compared to $20.1 million during the nine months ended
September 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 NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
2004 2003 2004 2003
---- ---- ---- ----
(In thousands) (In thousands)
NET REVENUES
North America, primarily United States $ 42,090 $ 40,421 $ 123,086 $ 120,803
India 24,050 18,866 64,755 51,234
UK 3,081 3,328 10,475 10,632
Far East, primarily Singapore 410 253 1,174 552
Germany 569 163 2,383 192
Inter-company revenue elimination (primarily India) (23,598) (18,926) (64,336) (51,315)
-------- -------- --------- ---------
TOTAL REVENUE 46,602 44,105 137,537 132,098
-------- -------- --------- ---------
NET INCOME/(LOSS)
North America, primarily United States 3,625 2,076 8,608 5,437
India 7,861 8,627 20,198 23,521
UK 371 111 1,436 740
Far East, primarily Singapore 108 (31) 184 (124)
Germany (72) (26) 194 (213)
-------- -------- --------- ---------
NET INCOME/(LOSS) 11,893 10,757 30,620 29,361
-------- -------- --------- ---------
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 NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
2004 2003 2004 2003
---- ---- ---- ----
(In thousands) (In thousands)
Income before income taxes $11,491 $13,628 $33,799 $39,447
------- ------- ------- -------
Statutory provision 35.0% 35.0% 35.0% 35.0%
State taxes, net of federal benefit 0.9% 1.3% 1.0% 1.2%
Tax-free investment income (0.4%) (0.6%) (0.5%) (0.7%)
Foreign effective tax rates different from US
statutory rate (23.8%) (18.9%) (19.5%) (15.9%)
Tax reserves (15.2%) 4.4% (5.2%) 5.9%
Research & development tax credits 0.0% 0.0% (1.4%) 0.0%
------- ------- ------- -------
EFFECTIVE INCOME TAX RATE (3.5%) 21.2% 9.4% 25.5%
------- ------- ------- -------
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.
The provision no longer required for any particular tax year, is credited to
the current period's income tax expenses. During the three months ended
September 30, 2004, the Company has reversed $1.7 million of such tax
provision related to the year 2000 and credited it to the current period's
income tax expenses. During the three and nine months ended September 30,
2004, the effective income tax rate was (3.5%) and 9.4%, respectively.
During the three and nine months ended September 30, 2003, the effective
income tax rate was 21.2% and 25.5%, respectively. The effective income tax
rate during three and nine months ended September 30, 2004, without
adjusting the above-mentioned reversal and the tax credit of $0.5 million in
Syntel India, was 16.2% and 16.1%, respectively. The tax rate continues to
be positively impacted by the combined effects of offshore transition and
reduced onsite profitability.
Syntel India has not provided for disputed Indian income tax liabilities
aggregating $2.01 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 received
orders for appeals filed with Commissioner of Income Tax (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 and received a favorable decision for 1995-96 and for the other
three years the contention of Syntel India is partially upheld. Syntel India
is in the process of filing the appeal with the Income tax Appellate
Tribunal for the amounts not allowed by the Commissioner of Income Tax
(Appeals).
Further, Syntel India has received demand for interest amounting to $0.018
million for late payment of demand pertaining to the financial year 2000-01
against which Syntel India has filed an appeal with Commissioner of Income
Tax (Appeals). Similar demand for interest amounting to $0.012 million for
the demand pertaining to the financial year 1999-00 was received against
which Syntel India is in the process of filing appeal with Commissioner of
Income Tax (Appeals).
11
TAX CREDIT
During the three months ended September 30, 2004 Syntel India has accounted
for a credit of approximately $0.5 Million in respect of US branch profit
taxes related to prior periods up to June 30, 2004 and also reclassified in
the balance sheet $1.0 million from provision for income taxes to deferred
tax liability.
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 NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
2004 2003 2004 2003
---- ---- ---- ----
(IN THOUSANDS) (IN THOUSANDS)
NET INCOME
Net income, as reported $11,893 $10,757 $30,620 $29,361
Stock based compensation expenses recognized in
statement of income, net of tax 304 0 425 0
Stock based compensation expenses determined under the
fair value method, net of tax (290) 60 (1,352) (1,201)
------- ------- ------- -------
PRO FORMA NET INCOME $11,907 $10,817 $29,693 $28,160
======= ======= ======= =======
EARNINGS PER SHARE, PRO FORMA
Basic earnings per share $ 0.30 $ 0.27 $ 0.74 $ 0.71
Diluted earnings per share $ 0.30 $ 0.26 $ 0.73 $ 0.69
EARNINGS PER SHARE AS REPORTED
Basic earnings per share $ 0.30 $ 0.27 $ 0.76 $ 0.74
Diluted earnings per share $ 0.29 $ 0.26 $ 0.76 $ 0.72
WEIGHTED AVERAGE SHARES OUTSTANDING
Basic 40,236 39,718 40,205 39,478
Diluted 40,335 40,975 40,486 40,634
Estimated fair value of option granted $ 5.42 $ 5.52 $ 5.42 $ 5.52
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 SEPTEMBER 30,
2004 2003
---- ----
Assumptions
Risk free interest rate 3.48% 3.14%
Expected life 5.00 5.00
Expected volatility 72.76% 76.91%
Expected dividend yield 1.45% 1.05%
12
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 year's service period on a straight line basis. During the
three months ended September 30, 2004, the Company expensed $0.36 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 September 30, 2004, the
Company recorded $0.02 million as compensation cost for dividends paid on
shares of unvested restricted stock.
13. RECLASSIFICATION
Certain prior period amounts have been reclassified to conform with the
current period presentation.
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 September 30, 2004
increased to $46.6 million from $44.1 in the three months ended September
30, 2003, representing an 5.7% 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
September 30, 2004 increased 13.7% to 2,939 employees as compared to 2,584
employees as of September 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 September 30, 2004, the Company
had approximately 57.2% of its billable workforce in India as compared to
51.4% as of September 30, 2003. The Company also decreased its dependence on
its larger customers. The top five customers accounted for 41.7% of the
total revenues in the three months ended September 30, 2004, down from 43.1%
of the total revenues in the three months ended September 30, 2003.
Moreover, the top 10 customers accounted for 61.9% of the revenues in the
three months ended September 30, 2004 as compared to 66.9% in the three
months ended September 30, 2003.
APPLICATIONS OUTSOURCING REVENUES. Applications Outsourcing revenues
increased to $36.7 million for the three months ended September 30, 2004, or
78.8% of total revenues, from $34.6 million, or 78.4% of revenues for the
three months ended September 30, 2003. The $2.1 million increase was
attributable primarily to revenues from new engagements contributing $16.9
million largely offset by $14.8 million in lost revenues as a result of
project completion and net reduction in revenues from existing projects. The
revenues for the nine months ended September 30, 2004 increased to $104.9
million, or 76.3% of total revenues, from $100.4 million or 76.0% of total
revenues for the nine months ended September 30, 2003. The $4.5 million
increase for nine months ended September 30, 2004 was attributable
principally to revenues from new engagements, contributing approximately
$35.8 million, largely offset by $31.3 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, finder's fees, trainee compensation and travel. Applications
Outsourcing costs of revenues increased to 56.4% of total Applications
Outsourcing revenues for the three months ended September 30, 2004, from
54.7% for the three months ended September 30, 2003. Cost of revenues for
the nine months ended September 30, 2004 increased to 56.4% of total
Applications Outsourcing revenues, from 54.0% for the nine months ended
September 30, 2003. Both the 1.7% and 2.4% increase in cost of revenues, as
a percent of revenues for the three and nine months ended September 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 $6.1 million for the
three months ended September 30, 2004, or 13.2% of total revenues, from $7.5
million, or 17.0% of revenues for the three months ended September 30, 2003.
The $1.4 million decrease was attributable primarily due to lost revenues as
a result of project completion and net reduction in revenue from existing
projects contributing $4.8 million offset by revenues from new engagements
contributing $1.8 million and sales incentive granted to a significant
customer impacting revenue $1.6 million for the three months ended September
30, 2003. The revenues for the nine months ended September 30, 2004
decreased to $22.7 million, or 16.5% of total revenues, from $24.6 million
or 18.6% of total revenues for the nine months ended September 30, 2003. The
$1.9 million decrease for nine months ended September 30, 2004 was
attributable principally to lost revenues as a result of projects completion
contributing approximately $8.2 million, largely offset by approximately
$4.7 million in revenue from new engagements and net increase in revenues
from existing projects and $1.6 million sales incentive granted to a
significant customer for the three months ended September 30, 2003.
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 decreased to 62.4% of total e-Business revenues for the three
months ended September 30, 2004, from 66.6% for the three months ended
September 30, 2003. Cost of revenues for the nine months ended September 30,
2004 increased to 61.2% of total e-Business revenues, from 58.9% for the
nine months ended September 30, 2003. The 4.2% decrease in cost of revenues
as a percent of revenues for the three months ended September 30, 2004 is
principally attributable to the increase in the offshore component of the
services and the 2.3% increase in cost of revenues, as a percent of revenues
for the nine months ended September 30, 2004, was 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 $3.3 million for
the three months ended September 30, 2004, or 7.1% of total revenues, from
$2.1 million, or 4.7% of total revenues for the three months ended September
30, 2003. The $1.2 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 nine months ended September 30, 2004 increased to $8.8
million, or 6.4% of total revenues, from $7.1 million or 5.4% of total
revenues for the nine months ended September 30, 2003. The $1.7 million
increase for nine months ended September 30, 2004 was attributable
principally to revenues from new engagements and ramping up of revenue from
the Skillbay web portal, contributing approximately $3.4 million, largely
offset by $1.7 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 67.2% of TeamSourcing revenues for the three months
ended September 30, 2004, from 89.0% for the three months ended September
30, 2003. Cost of revenues for the nine months ended September 30, 2004
decreased to 64.0% of total TeamSourcing revenues, from 89.0% for the nine
months ended September 30, 2003. Both the 21.8% and 25.0% 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 nine months ended September
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 1% of
total revenues for the three months ended September 30, 2004 and $1.2
million or 0.9% of total revenues for the nine months ended September 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 59.3% of the segment's revenues for the
three months ended September 30, 2004 and 56.0% of the segment's revenues
for the nine months ended September 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 September 30, 2004 were $8.9 million or 19.0% of total revenues,
compared to $5.4 million or 12.2% of total revenues for the three months
ended September 30, 2003.
Selling, general, and administrative costs for the three months ended
September 30, 2003 include a reversal of $0.7 million bad debt expense,
primarily on account of successful recovery of receivables previously
provided for as allowance for doubtful accounts, $1.7 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 third
quarter and $0.3 million reduction in office related expenses due to
settlement of vendor disputes and other miscellaneous reversals.
After considering the impact of the above-mentioned items, the selling,
general, and administrative expenses were 19.0% and 18.3% of total revenues,
for the three months ended September 30, 2004 and 2003, respectively. The
0.7 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 $0.1 million, marketing expenses of $0.3 million,
office expenses of $0.3 million and others
15
of $0.1 million which resulted in an approximately 1.8 percentage point
increase, partially offset by increases in revenue in the three month ended
September 30, 2004 as against the three months ended September 30, 2003,
which resulted in an approximately 1.1 percentage point decrease.
Selling, general, and administrative costs for the nine months ended
September 30, 2004 were $26.5 million or 19.3% of total revenues, compared
to $19.8 million or 15.0% of total revenues for the nine months ended
September 30, 2003.
Selling, general, and administrative costs for the nine months ended
September 30, 2003 included a reversal of $1.5 million primarily on account
of successful recovery of receivables previously provided for as allowance
for doubtful accounts or written off, a $2.7 million revision of the
estimated reserves for litigation and legal fees due to settlements and
other changes in estimates of underlying legal costs, $0.5 million reduction
in office related expenses due to settlement of vendor disputes and other
miscellaneous reversals, and a downward revision of the 2002 estimates of
bonus compensation of $0.8 million
After considering the impact of the above-mentioned items, the selling,
general, and administrative expenses are at 19.3% and 19.1% of total
revenues, for the nine months ended September 30, 2004 and 2003,
respectively. The 0.2 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 marketing
expenses, which resulted in an approximately 0.9 percentage point increase,
largely offset by increases in revenue during the nine months ended
September 30, 2004 as against the nine months ended September 30, 2003,
which resulted in an approximately 0.7 percentage point decrease.
INCOME TAXES
The Company provides for tax contingencies based on management's estimates
and accordingly are subject to revision based on additional information. The
provision no longer required for any particular tax year, is credited to the
current period's income tax expenses. During the three months ended
September 30, 2004, the Company has reversed $1.7 million of such tax
provision related to the year 2000 and credited it to the current period's
income tax expenses.
During the three and nine months ended September 30, 2004, the effective
income tax rate was (3.5%) and 9.4%, respectively. During the three and nine
months ended September 30, 2003, the effective income tax rate was 21.2% and
25.5%, respectively. The effective income tax rate during three and nine
months ended September 30, 2004, without adjusting the above-mentioned
reversal and the tax credit of $0.5 million in Syntel India, was 16.2% and
16.1%, respectively. The tax rate continues to be positively impacted by the
combined effects of offshore transition and reduced onsite profitability.
During the three months ended September 30, 2004 Syntel India has accounted
for a credit of approximately $0.5 Million in respect of US branch profit
taxes related to prior periods up to June 30, 2004 and also reclassified in
the balance sheet $1.0 million from provision for income taxes to deferred
tax liability.
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 $33.3 million for the nine
months ended September 30, 2004, compared to $30.3 million for the nine
months ended September 30, 2003. The number of days sales outstanding in net
accounts receivable was approximately 66 days and 62 days as of September
30, 2004 and September 30, 2003, respectively. The increase in the number of
day's sales outstanding in net accounts receivable was due to relatively
higher billing as against the collection during the nine months ended
September 30, 2004.
Net cash used in investing activities was $23.9 million for the nine months
ended September 30, 2004, consisting principally of $43.9 million for the
purchase of short term investments and $8.2 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 short term investments of $28.2 million. Net cash used in investing
activities was $18.2 million for the nine months ended September 30, 2003,
consisting principally of $22.4 million
16
for the purchase of short term investments and $3.0 million for capital
expenditures, consisting principally of PCs and communications equipment
partially offset by the sale of short term investments of $7.0 million.
Net cash used in financing activities was $5.8 million for the nine months
ended September 30, 2004, consisting principally of $7.3 million in
dividends paid out and $1.5 million in common stock repurchases, partially
offset by $2.9 million of proceeds from issuance of shares under employee
stock option plan and employee stock purchase plan. Net cash used in
financing activities was $44.2 million for the nine months ended September
30, 2003, consisting principally of $49.9 million in dividends paid out and
$0.2 million in common stock repurchases, partially offset by $5.8 million
of proceeds from issuance of shares under employee stock option plan and
employee stock purchase plan.
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, 2005. 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 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 September 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 three months ended
September 30, 2004 and 2003, revenues from time and material contracts
constituted 45.6% and 48.2%, 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 three months ended September 30, 2004 and 2003,
revenues from fixed price application management and support engagements
constituted 35.7% and 27.6%, 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 three months ended September 30, 2004 and 2003,
revenues from fixed price development contracts constituted 18.7% and 24.2%,
respectively.
SIGNIFICANT ACCOUNTING ESTIMATES
The preparation of the consolidated financial statements, in conformity with
generally accepted accounting principles in the United States of America,
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.
17
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 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.
The provision no longer required for any particular tax year, is credited to
the current period's income tax expenses. During the three months ended
September 30, 2004, the Company has reversed $1.7 million of such tax
provision related to the year 2000 and credited it to the current period's
income tax expenses. During the three and nine months ended September 30,
2004, the effective income tax rate was (3.5%) and 9.4%, respectively.
During the three and nine months ended September 30, 2003, the effective
income tax rate was 21.2% and 25.5%, respectively. The effective income tax
rate during three and nine months ended September 30, 2004, without
adjusting the above-mentioned reversal and the tax credit of $0.5 million in
Syntel India, was 16.2% and 16.1%, respectively. The tax rate continues to
be positively impacted by the combined effects of offshore transition and
reduced onsite profitability.
Syntel India has not provided for disputed Indian income tax liabilities
aggregating $2.01 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 received
orders for appeals filed with Commissioner of Income Tax (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 and received a favorable decision for 1995-96 and for the other
three years the contention of Syntel India is partially upheld. Syntel India
is in the process of filing the appeal with the Income tax Appellate
Tribunal for the amounts not allowed by the Commissioner of Income Tax
(Appeals).
Further, Syntel India has received demand for interest amounting to $0.018
million for late payment of demand pertaining to the financial year 2000-01
against which Syntel India has filed an appeal with Commissioner of Income
Tax (Appeals). Similar demand for interest amounting to $0.012 million for
the demand pertaining to the financial year 1999-00 is received against
which Syntel India is in the process of filing appeal with Commissioner of
Income Tax (Appeals).
TAX CREDIT
During the three months ended September 30, 2004 Syntel India has accounted
for a credit of approximately $0.5 Million in respect of US branch profit
taxes related to prior periods up to June 30, 2004 and also reclassified in
the balance sheet $1.0 million from provision for income taxes to deferred
tax liability.
18
UNDISTRIBUTED EARNINGS OF FOREIGN SUBSIDIARIES
The Company considers the undistributed earnings of foreign subsidiaries to
be indefinitely reinvested, and therefore no provision for U. S. federal and
state income tax or applicable withholding tax has been provided thereon.
The undistributed earnings of the foreign subsidiaries, to the extent
repatriable, are subject to compliance of the respective local laws. The
unrecognized taxes on the undistributed repatriable earnings are
approximately $41.1 million at September 30, 2004.
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, as 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":
o Recruitment and retention of IT professionals;
o Government regulation of immigration;
o Variability of quarterly operating results;
o Customer concentration;
o Risk of termination of Syntel by customers;
o Changes in customer needs;
o Exposure to regulatory and general economic conditions in India;
o Intense competition;
o Ability to manage growth;
o Fixed-price engagements;
o Potential liability to customers;
o Dependence on principal;
o Risks related to possible acquisitions;
o Limited intellectual property protection; and
o Potential anti-outsourcing legislation
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.
19
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 short term
investments (in thousands):
SEPTEMBER 30, DECEMBER 31,
ASSETS 2004 2003
-------- --------
Cash and cash equivalents $106,292 $102,854
Short term investments 50,069 33,982
-------- --------
TOTAL $156,361 $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.
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 September 30, 2004, the Indian rupee has
depreciated by 2.4% as compared to the three months ended June 30, 2004. The
impact of this rupee depreciation favourably impacted our gross margin by 38
basis points, operating income by 50 basis points and net income by 48 basis
points, each as a percentage of revenue. The Indian rupee denominated cost
of revenues and selling, general and administrative cost was 28.1% and
27.5%, 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 September 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 September
30, 2004, there were no changes in the Company's internal controls over
financial reporting which materially affected, or are reasonably likely to
materially affect, 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 and is
ready to approach concerned agencies for certifications. 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. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS.
COMPANY PURCHASES OF EQUITY SECURITIES
Period (a) Total Number of (b) Average Price Paid (c) Total Number of (d) Maximum Number (or
Shares (or Units) per Share (or Unit) Shares (or Units) Approximate Dollar
Purchased * Purchased as Part of Value) of Shares (or
Publicly Announced Units) that May Yet Be
Plans or Programs Purchased Under the
Plans or Programs
July 1, 2004 to July 31, -0- Not Applicable -0- Not Applicable
2004
August 1, 2004 to 90,000 $14.59 -0- Not Applicable
August 31, 2004
September 1, 2004 to 10,000 $16.45 -0- Not Applicable
September 30, 2004
Total 100,000 $14.77 -0- Not Applicable
* All shares were purchased in open-market transactions.
ITEM 3. DEFAULTS UPON SENIOR SECURITIES.
None.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
None.
ITEM 5. OTHER INFORMATION.
None.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K.
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 Operating Officer
and Chief Financial Officer
32 Section 1350 Certification of Chief Executive Officer and Chief
Operating Officer and Chief Financial Officer
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 November 1, 2004 /s/ Bharat Desai
-----------------------------------------------
Bharat Desai, Chairman, President and
Chief Executive Officer
Date November 1, 2004 /s/ Keshav Murugesh
-----------------------------------------------
Keshav Murugesh, Chief Operating Officer and
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 Operating Officer
and Chief Financial Officer
32 Section 1350 Certification of Chief Executive Officer and Chief
Operating Officer and Chief Financial Officer
25