-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, Tr/YiOYRMLxyx2ZnxKCzMFttKet4tJDkEKjstehA67D5BURDB5uBtxj3H9DGydqJ jM4T9Q+iG7jhylS4aayMWg== 0000950124-04-003666.txt : 20040809 0000950124-04-003666.hdr.sgml : 20040809 20040809082736 ACCESSION NUMBER: 0000950124-04-003666 CONFORMED SUBMISSION TYPE: 10-Q PUBLIC DOCUMENT COUNT: 4 CONFORMED PERIOD OF REPORT: 20040630 FILED AS OF DATE: 20040809 FILER: COMPANY DATA: COMPANY CONFORMED NAME: SYNTEL INC CENTRAL INDEX KEY: 0001040426 STANDARD INDUSTRIAL CLASSIFICATION: SERVICES-COMPUTER PROGRAMMING SERVICES [7371] IRS NUMBER: 382312018 STATE OF INCORPORATION: MI FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-Q SEC ACT: 1934 Act SEC FILE NUMBER: 000-22903 FILM NUMBER: 04959486 BUSINESS ADDRESS: STREET 1: 525 EAST BIG BEAVER ROAD STREET 2: SUITE 300 CITY: TROY STATE: MI ZIP: 48083 BUSINESS PHONE: 2486193524 MAIL ADDRESS: STREET 1: 525 EAST BIG BEAVER ROAD STREET 2: SUITE 300 CITY: TROY STATE: MI ZIP: 48083 10-Q 1 k86669e10vq.txt QUARTERLY REPORT FOR PERIOD ENDED JUNE 30, 2004 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 EX-31.1 2 k86669exv31w1.txt 302 CERTIFICATION OF CHIEF EXECUTIVE OFFICER Exhibit 31.1 CERTIFICATIONS I, Bharat Desai, Chairman, President, and Chief Executive Officer of Syntel, Inc., certify that: 1. I have reviewed this quarterly report on Form 10-Q of Syntel, Inc.; 2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report; 3. Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report; 4. The registrant's other certifying officer(s) and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) for the registrant and have: a) Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared; b) Evaluated the effectiveness of the registrant's disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and c) Disclosed in this report any change in the registrant's internal control over financial reporting that occurred during the registrant's most recent fiscal quarter (the registrant's fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant's internal control over financial reporting; and 5. The registrant's other certifying officer(s) and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant's auditors and the audit committee of the registrant's board of directors (or persons performing the equivalent functions): a) All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant's ability to record, process, summarize and report financial information; and b) Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal control over financial reporting. Date August 5, 2004 /s/ Bharat Desai - ---------------------------------- Bharat Desai, Chairman, President, and Chief Executive Officer 26 EX-31.2 3 k86669exv31w2.txt 302 CERTIFICATION OF CHIEF FINANCIAL OFFICER Exhibit 31.2 CERTIFICATIONS I, Keshav Murugesh, Chief Financial Officer of Syntel, Inc., certify that: 1. I have reviewed this quarterly report on Form 10-Q of Syntel, Inc.; 2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report; 3. Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report; 4. The registrant's other certifying officer(s) and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) for the registrant and have: a) Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared; b) Evaluated the effectiveness of the registrant's disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and c) Disclosed in this report any change in the registrant's internal control over financial reporting that occurred during the registrant's most recent fiscal quarter (the registrant's fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant's internal control over financial reporting; and 5. The registrant's other certifying officer(s) and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant's auditors and the audit committee of the registrant's board of directors (or persons performing the equivalent functions): a) All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant's ability to record, process, summarize and report financial information; and b) Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal control over financial reporting. Date August 5, 2004 /s/ Keshav Murugesh - ---------------------------------------- Keshav Murugesh, Chief Financial Officer 27 EX-32 4 k86669exv32.txt 906 CERTIFICATION OF CHIEF EXECUTIVE OFFICER AND CHIEF FINANCIAL OFFICER Exhibit 32 CERTIFICATION PURSUANT TO 18 U.S.C. SECTION 1350, AS ADOPTED PURSUANT TO SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002 In connection with the Quarterly Report of Syntel, Inc. (the "Company") on Form 10-Q for the period ending June 30, 2004 as filed with the Securities and Exchange Commission on the date hereof (the "Report"), we, Bharat Desai, Chairman, President, and Chief Executive Officer of the Company and Keshav Murugesh, Chief Financial Officer of the Company, certify, pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, that: (1) The Report fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934; and (2) The information contained in the Report fairly presents, in all material respects, the financial condition and result of operations of the Company. /s/ Bharat Desai - ------------------------------------------------ Bharat Desai Syntel, Inc. Chairman, President, and Chief Executive Officer August 5, 2004 /s/ Keshav Murugesh - ------------------------------------------------ Keshav Murugesh Syntel, Inc. Chief Financial Officer August 5, 2004 28 -----END PRIVACY-ENHANCED MESSAGE-----