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, 2006 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 000-22903
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 a large accelerated
filer, an accelerated filer, or a non-accelerated filer. See definition of
"accelerated filer and large accelerated filer" in Rule 12b-2 of the Exchange
Act. (Check one):
Large Accelerated Filer [ ] Accelerated Filer [X] Non-Accelerated - Filer [ ]
Indicate by check mark whether the registrant is a shell company (as
defined in Rule 12b-2 of the Exchange Act.)
Yes [ ] No [X]
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: 41,084,720 shares issued and outstanding as
of October 31, 2006.
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 17
Financial Condition and Results of Operations
Item 3 Quantitative and Qualitative Disclosures about Market Risk 24
Item 4 Controls and Procedures 25
Part II Other Information 26
Signatures 27
Exhibit - Certificate of Chief Executive Officer 34
Exhibit - Certificate of Chief Financial Officer 35
Exhibit - Certification of Chief Executive Officer and Chief Financial Officer 36
2
SYNTEL, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF INCOME
(IN THOUSANDS, EXCEPT SHARE DATA)
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
------------------------- --------------------------
2006 2005 2006 2005
---------- ----------- ------------ ------------
Net Revenues $ 69,217 $ 58,501 $ 197,123 $ 163,910
Cost of revenues 42,635 35,298 123,267 97,756
---------- ----------- ------------ ------------
GROSS PROFIT 26,582 23,203 73,856 66,154
Selling, general and administrative expenses 13,056 10,533 35,299 32,397
---------- ----------- ------------ ------------
Income from operations 13,526 12,670 38,557 33,757
Other income, principally interest 1,298 810 3,525 2,654
---------- ----------- ------------ ------------
Income before provision for income taxes 14,824 13,480 42,082 36,411
Provision for income taxes 293 1,741 4,443 5,992
---------- ----------- ------------ ------------
NET INCOME $ 14,531 $ 11,739 $ 37,639 $ 30,419
========== =========== ============ ============
Dividend per share $ 1.31 $ 0.06 $ 1.43 $ 1.68
EARNINGS PER SHARE :
Basic $ 0.36 $ 0.29 $ 0.92 $ 0.75
Diluted $ 0.35 $ 0.29 $ 0.92 $ 0.75
WEIGHTED AVERAGE COMMON SHARES OUTSTANDING :
Basic 40,865 40,576 40,783 40,487
Diluted 41,123 40,669 41,038 40,588
The accompanying notes are an integral part of the condensed consolidated
financial statements.
3
SYNTEL, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS)
SEPTEMBER 30, DECEMBER 31,
2006 2005
------------- ------------
ASSETS
Current assets:
Cash and cash equivalents $ 37,212 $ 99,390
Short term investments 38,579 21,083
Accounts receivable, net of allowances for doubtful accounts of $ 2,578
and $ 2,575 at September 30, 2006 and December 31, 2005, respectively 40,491 27,907
Revenue earned in excess of billings 9,052 8,366
Deferred income taxes and other current assets 12,496 10,003
------------- ------------
Total current assets 137,830 166,749
Property and equipment 62,869 54,690
Less accumulated depreciation and amortization 29,223 25,504
------------- ------------
Property and equipment, net 33,646 29,186
Goodwill 906 906
Deferred income taxes and other non current assets 2,291 1,320
------------- ------------
TOTAL ASSETS $ 174,673 $ 198,161
============= ============
LIABILITIES AND SHAREHOLDERS' EQUITY
LIABILITIES
Current liabilities:
Accounts payable $ 5,088 $ 6,890
Accrued payroll and related costs 17,033 15,906
Income taxes payable 3,363 9,809
Accrued liabilities 7,720 7,446
Deferred revenue 4,121 3,356
Dividends payable 2,442 2,476
------------- ------------
Total current liabilities 39,767 45,883
SHAREHOLDERS' EQUITY
Total shareholders' equity 134,906 152,278
------------- ------------
TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY $ 174,673 $ 198,161
============= ============
The accompanying notes are an integral part of the condensed consolidated
financial statements.
4
SYNTEL, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
NINE MONTHS ENDED
SEPTEMBER 30,
2006 2005
---------- ----------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income $ 37,639 $ 30,419
Adjustments to reconcile net income to net cash provided by operating activities
Depreciation and amortization 4,302 3,407
Bad debt provisions / (credits) 0 500
Realized gains on sales of short term investments (284) (392)
Deferred income taxes 1,085 1,366
Compensation expense related to restricted stock 1,366 1,273
Share based compensation expense 528 0
Changes in assets and liabilities :
Accounts receivable and revenue earned in excess of billings, net (11,965) (10,003)
Other current assets (4,709) (3,609)
Accrued payroll and other liabilities (6,175) 6,423
Deferred revenues (1,087) (1,586)
---------- ----------
Net cash provided by operating activities 20,700 27,798
---------- ----------
CASH FLOWS FROM INVESTING ACTIVITIES:
Property and equipment expenditures (9,351) (11,049)
Purchase of short term investments :
Investments in mutual funds (39,993) (3,184)
Investments in term deposits with banks (56,953) (4,416)
Proceeds from sales of short term investments :
Proceeds from sales of mutual funds 42,893 16,557
Maturities of term deposits with banks 36,256 22,682
---------- ----------
Net cash (used in) / provided by investing activities (27,148) 20,590
---------- ----------
CASH FLOWS FROM FINANCING ACTIVITIES:
Net proceeds from issuance of common stock 1,604 2,527
Common stock repurchases - (676)
Dividends paid (58,632) (68,446)
---------- ----------
Net cash used in financing activities (57,028) (66,595)
---------- ----------
Effect of foreign currency exchange rate changes on cash 1,298 (343)
---------- ----------
Change in cash and cash equivalents (62,178) (18,550)
Cash and cash equivalents, beginning of period 99,390 109,142
---------- ----------
Cash and cash equivalents, end of period $ 37,212 $ 90,592
========== ==========
Non cash investing and financing activities:
Cash dividends declared but unpaid $ 2,442 $ 2,446
========== ==========
Cash paid for income taxes $ 10,417 $ 5,737
========== ==========
The accompanying notes are an integral part of the condensed 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" or "Syntel") 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 and
its subsidiaries as of September 30, 2006, the results of their operations for
the three month and nine month periods ended September 30, 2006 and 2005, and
cash flows for the nine months ended September 30, 2006 and 2005. The year end
condensed balance sheet as of December 31, 2005 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, 2005.
Operating results for the nine months ended September 30, 2006 are not
necessarily indicative of the results that may be expected for the year ending
December 31, 2006.
2. PRINCIPLES OF CONSOLIDATION AND ORGANIZATION
The consolidated financial statements include the accounts of Syntel, Inc.
("Syntel"), a Michigan corporation, its wholly owned subsidiaries, and a joint
venture. 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;
- Syntel (Mauritius) Limited ("Syntel Mauritius"), a Mauritius limited
liability company;
- Syntel Consulting Inc ("Syntel Consulting"), a Michigan corporation;
- Syntel Sterling BestShores (Mauritius) Limited ("SSBML"), a Mauritius
limited liability company; and
- Syntel Worldwide (Mauritius) Limited ("Syntel Worldwide"), a Mauritius
limited liability company.
The formerly wholly owned subsidiary of Syntel Delaware (as of December 31,
2004) that became a partially owned joint venture of Syntel Delaware LLC on
February 1, 2005 is:
- State Street Syntel Services (Mauritius) Ltd. ("SSSSML"), a Mauritius
limited liability company formerly known as Syntel Solutions (Mauritius)
Ltd.
The wholly owned subsidiary of SSSSML 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.
The wholly owned subsidiary of SSBML is:
- Syntel Sterling BestShores Solutions Private Limited" ("SSBSPL"), 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 long-lived assets and 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 consolidated balance sheets.
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 an original maturity of three months or
less to be cash equivalents.
At September 30, 2006 and December 31, 2005, approximately $6.6 million and
$60.8 million, respectively, represent corporate bonds and treasury notes held
by JP Morgan Chase Bank NA, 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
In 2000, the Company agreed to grant to a significant customer performance
warrants entitling the customer to purchase shares of Company stock. The
issuance of the performance warrants is dependent upon the customer meeting
performance milestones by purchasing specified minimum levels of services from
the Company over a specified period. The Company has estimated that such
performance milestones will not be met during the year. Accordingly, the Company
has not accounted for these performance warrants. If and when the Company
estimates that such performance milestones will be met, the sales incentive
associated with the performance warrants will be recorded as a reduction of
revenue.
7
7. COMPREHENSIVE INCOME
Total Comprehensive Income for the three and nine months ended September 30,
2006 and 2005 was as follows:
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
--------------------- ----------------------
2006 2005 2006 2005
---------- --------- --------- -----------
(in thousands) (in thousands)
Net income $ 14,531 $ 11,739 $ 37,639 $ 30,419
Other comprehensive income
- Unrealized gain (loss) 505 164 1,298 353
- Foreign currency
translation
adjustments 36 (439) (1,460) (1,098)
---------- --------- --------- -----------
Total comprehensive income $ 15,072 $ 11,464 $ 37,477 $ 29,674
========== ========= ========= ===========
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 options, 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 shares 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, 2006
NO. OF SHARES
PARTICULARS (IN THOUSANDS)
Balance as on June 30, 2006 40,839
ADD:
Shares issued on exercise of stock options and restricted stock 73
---------------
Balance as on September 30, 2006 40,912
===============
The following table sets forth the computation of earnings per share.
THREE MONTHS ENDED SEPTEMBER 30,
2006 2005
-------------------- -------------------
Weighted Weighted
Average Earnings Average Earnings
Shares per Shares Shares per Share
-------- ---------- -------- ---------
(in thousands, except per share earnings)
Basic earnings per share 40,865 $ 0.36 40,576 $ 0.29
Potential dilutive effect of stock options
outstanding 258 (0.01) 93 -
-------- ---------- -------- ---------
DILUTED EARNINGS PER SHARE 41,123 $ 0.35 40,669 $ 0.29
======== ========== ======== =========
8
NINE MONTHS ENDED SEPTEMBER 30,
2006 2005
-------------------- -------------------
Weighted Weighted
Average Earnings Average Earnings
Shares per Shares Shares per Share
-------- ---------- -------- ---------
(in thousands, except per share earnings)
Basic earnings per share 40,783 $ 0.92 40,487 $ 0.75
Potential dilutive effect of stock options
outstanding 255 - 101 -
-------- ---------- -------- ---------
DILUTED EARNINGS PER SHARE 41,038 $ 0.92 40,588 $ 0.75
======== ========== ======== =========
9. SEGMENT REPORTING
The Company is organized geographically and by business segment. For management
purposes, the Company is primarily organized on a worldwide basis into four
business segments:
- Applications Outsourcing ;
- e-Business ;
- TeamSourcing; and
- Business Process Outsourcing ("BPO")
These segments are the basis on which the Company reports its primary segment
information to management. Management allocates all corporate expenses among the
segments. 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 month and nine month periods ended September 30, 2006 and
2005 is as follows:
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
------------------ --------------------
2006 2005 2006 2005
-------- -------- --------- ---------
(in thousands) (in thousands)
REVENUES:
Applications Outsourcing $ 49,394 $ 43,872 $ 142,433 $ 124,725
e-Business 9,929 7,946 27,885 22,687
TeamSourcing 4,235 4,727 13,460 12,279
BPO 5,659 1,956 13,345 4,219
-------- -------- --------- ---------
69,217 58,501 197,123 163,910
-------- -------- --------- ---------
GROSS PROFIT:
Applications Outsourcing 18,286 18,443 53,592 52,224
e-Business 3,149 2,253 7,336 7,547
TeamSourcing 1,760 1,286 4,937 3,596
BPO 3,387 1,221 7,991 2,787
-------- -------- --------- ---------
26,582 23,203 73,856 66,154
Selling, general and administrative
expenses 13,056 10,533 35,299 32,397
-------- -------- --------- ---------
Income from operations $ 13,526 $ 12,670 $ 38,557 $ 33,757
======== ======== ========= =========
9
During the nine months ended September 30, 2006 and 2005, American Express Corp.
contributed revenues in excess of 10% of total consolidated revenues. Revenue
from this customer was $35.6 million during the nine months ended September 30,
2006, contributing approximately 18% of total consolidated revenues, as compared
to $24.3 million during the nine months ended September 30, 2005, contributing
approximately 14.8% of total consolidated revenues. At September 30, 2006 and
December 31, 2005 accounts receivable, from this customer were $3.8 million and
$1.1 million respectively.
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,
-------------------- ---------------------
2006 2005 2006 2005
--------- -------- --------- ---------
(in thousands) (in thousands)
NET REVENUES
North America, primarily United States $ 65,967 $ 52,542 $ 188,558 $ 147,029
India 34,641 29,880 98,252 84,313
UK 3,186 3,138 8,341 9,612
Far East, primarily Singapore 1,375 592 3,107 1,352
Germany 85 439 538 1,270
Inter-company revenue elimination (primarily India) (36,037) (28,090) (101,673) (79666)
--------- -------- --------- ---------
TOTAL REVENUE 69,217 58,501 197,123 163,910
========= ======== ========= =========
NET INCOME/(LOSS)
North America, primarily United States 5,369 4,188 10,775 9,142
India 9,449 6,755 26,340 19,779
UK 245 506 1,058 1,516
Far East, primarily Singapore (402) 84 (379) 124
Germany (130) 206 (155) (142)
--------- -------- --------- ---------
INCOME/(LOSS) AFTER INCOME TAXES $ 14,531 $ 11,739 $ 37,639 $ 30,419
========= ======== ========= =========
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,
------------------------ ----------------------
2006 2005 2006 2005
--------- ---------- --------- ---------
(in thousands) (in thousands)
Income before income taxes $ 14,824 $ 13,480 $ 42,082 $ 36,411
Statutory provision 35.0% 35.0% 35.0% 35.0%
State taxes, net of federal benefit 1.1% 1.3% 1.1% 1.3%
Tax-free investment income (0.7%) 0.0% (0.7%) (0.2%)
Foreign effective tax rates different from US
statutory rate (33.4.%) (23.4%) (24.8%) (19.6%)
--------- ---------- --------- ---------
EFFECTIVE INCOME TAX RATE 2.0% 12.9% 10.6% 16.5%
========= ========== ========= =========
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.
The provision for income tax contingencies 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, 2006 and September 30, 2005, the effective
income tax rate was 2% and 12.9% respectively. During the nine months ended
September 30, 2006 and September 30, 2005, the effective income tax rate was
10.6% and 16.5% respectively. The tax rates for the three months and nine months
ended September 30, 2006 is impacted by reversal of tax reserve of $2.0 million.
The tax rates for the three months and nine months ended September 30, 2005 were
impacted by the reversal of a tax reserve of $2.6 million and a provision for
valuation allowance of $1.7 million attributable to certain deferred tax
benefits, on the write-off of certain investments in 2001, which are not
expected to be materialized.
Syntel India has not provided for disputed Indian income tax liabilities
amounting to $2.46 million for the financial years 1995-96 to 2001-02. Syntel
India has obtained an opinion from one independent legal counsel (a 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 1995-96 to 1997-98 and
1999-2000 to 2001-02, which support Syntel India's position in this matter.
Syntel India filed an appeal with the Commissioner of Income Tax (Appeals) for
the financial year 1998-99 and received a favorable decision. The Income tax
department appealed this favorable decision with the Income Tax Appellate
Tribunal ('ITAT'). During the three months ended June 30, 2006, the ITAT
dismissed the appeal filed by the Income tax department. The Income tax
department has recourse to file further appeal and hence there is no change in
the relevant provision for tax.
A similar appeal filed by Syntel India with the 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 the
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 to 1997-98 and 2000-01 to 2001-02 and has received a favorable decision
for 1995-96 and the contention of Syntel India was partially upheld for the
other years. Syntel India has gone into further appeal with the Income Tax
Appellate Tribunal for the amounts not allowed by the Commissioner of Income Tax
(Appeals). The Income Tax Department has appealed the favorable decisions for
1995-96 and 1998-99 and the partially favorable decisions for the other years
with the Income Tax Appellate Tribunal.
Syntel India has also not provided for other disputed Indian income tax
liabilities aggregating $4.32 million for the financial years 2001-02 and
2002-03, against which Syntel India has filed an appeal with the Commissioner of
Income Tax (Appeals). The contention of Syntel India was partially upheld by the
Commissioner of Income Tax (Appeals) for the financial year 2001-02. Syntel
India has gone into further appeal with the ITAT for the amounts not allowed by
the Commissioner of Income Tax (Appeals). The Income tax department has filed
11
further appeal against the relief granted to Syntel India by the Commissioner of
Income Tax (Appeals). The appeal for the financial year 2002-03 is not yet
decided. Syntel India has obtained opinions from independent legal counsels,
which support Syntel India's position in this matter.
Further, Syntel India has not provided for disputed income tax liabilities
aggregating to $0.10 million, for which Syntel India has filed necessary appeals
or petitions.
All the above tax exposures involve complex issues and may need an extended
period to resolve the issues with the Indian income tax authorities. Management,
after consultation with legal counsel, believes that the resolution of the above
matters will not have a material adverse effect on the Company's financial
position.
UNDISTRIBUTED EARNINGS OF FOREIGN SUBSIDIARIES
The Company intends to use accumulated and future earnings of foreign
subsidiaries to expand operations outside the United States and accordingly
undistributed earnings of foreign subsidiaries are considered to be indefinitely
reinvested outside the United States and no provision for U. S. federal and
state income tax or applicable dividend distribution tax has been provided
thereon.
The American Jobs Creation Act of 2004 provided a special one-time favorable
effective federal tax rate for U.S.-based organizations. The Company repatriated
cash dividends of $61.0 million during 2005 out of the retained earnings of its
controlled foreign subsidiary, Syntel India, to the U.S. in accordance with the
Act. The Company recorded a tax charge of approximately $12.3 million, including
U.S. Federal and state taxes and the Indian dividend distribution tax under the
Indian Income Tax laws, during the fourth quarter of 2005. Proceeds from these
extraordinary dividends are required to be invested in the United States for
specific purposes permitted under Act pursuant to an approved written domestic
reinvestment plan. As of June 30, 2006, the Company had fully invested proceeds
from these cash dividends towards permitted investments under the
Act.
If the Company determines to repatriate all undistributed repatriable earnings
of controlled foreign corporations as of September 30, 2006, the Company would
have accrued taxes of approximately $44.5 million.
12
12. STOCK BASED COMPENSATION
SHARE BASED COMPENSATION:
The Company originally established a Stock Option and Incentive Plan in 1997
(the "1997 Plan"). On June 1, 2006 the Company adopted the Ammended and Restated
Stock Option and Incentive Plan (the "Stock Option Plan") which amended and
extended the 1997 Plan. Under the plans, a total of 8 million shares of Common
Stock were reserved for issuance. The dates on which options granted under Stock
Option Plan are first exercisable are determined by the Compensation Committee
of the Board of Directors, but generally vest over a four-year period from the
date of grant. The term of any option may not exceed ten years from the date of
grant.
For certain options granted during 1997, the exercise price was less than the
fair value of the Company's stock on the date of grant and, accordingly,
compensation expense is being recognized over the vesting period for such
difference. For the options granted thereafter, the Company grants the options
at the fair market value on the date of grant of the options.
The shares issued upon the exercise of the options are generally new share
issues. In some instances the shares are issued out of treasury stock purchased
from the market.
On January 1, 2006, the Company adopted Statement of Financial Accounting
Standards No. 123 (revised 2004), "Share-Based Payment," ("SFAS 123(R)") which
requires the measurement and recognition of compensation expense for all
share-based payment awards made to employees and directors including employee
stock options and employee stock purchases related to the Employee Stock
Purchase Plan ("employee stock purchases") based on estimated fair values. SFAS
123(R) supersedes the Company's previous accounting under Accounting Principles
Board Opinion No. 25, "Accounting for Stock Issued to Employees" ("APB 25") for
periods beginning in fiscal 2006.
The Company adopted SFAS 123(R) using the modified prospective transition
method, which requires the application of the accounting standard as of January
1, 2006, the first day of the Company's fiscal year 2006. The Company's
financial statements as of and for the three and nine months ended September 30,
2006 reflect the impact of SFAS 123(R). In accordance with the modified
prospective transition method, the Company's financial statements for prior
periods have not been restated to reflect, and do not include, the impact of
SFAS 123(R). Share-based compensation expense recognized under SFAS 123(R) for
the three and nine months ended September 30, 2006 was $0.97 million and $1.89
million including charge for restricted stock.
SFAS 123(R) requires companies to estimate the fair value of share-based payment
awards on the date of grant using an option-pricing model. The value of the
portion of the award that is ultimately expected to vest is recognized as
expense over the requisite service periods in the Company's Statement of Income.
Prior to the adoption of SFAS 123(R), the Company accounted for stock-based
awards to employees [and directors] using the intrinsic value method in
accordance with APB 25 as allowed under Statement of Financial Accounting
Standards No. 123, "Accounting for Stock-Based Compensation" ("SFAS 123").
RESTRICTED STOCK:
On different dates during the quarter 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 shares 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.
On different dates during the year ended December 31, 2005 and nine months ended
September 30, 2006 the Company issued 54,806 and 14,036 shares respectively, of
incentive restricted stock to its non-employee directors and some employees as
well as to some employees of its subsidiaries. The shares 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 25% of
the shares issued on or after the first, second, third and fourth anniversary of
the grant dates. Generally, the shares to non-employee directors are granted for
their future services starting from the date of the annual meeting to the date
of the following annual meeting.
In addition to the shares of restricted stock described above, on different
dates during the quarter ended September 30, 2006 the Company issued another
54,500 shares of incentive restricted stock to some employees as well as to some
employees of its subsidiaries. The shares were granted to employees for their
future services
13
as a retention tool at a zero exercise price, with the restrictions on
transferability lapsing with regard to 20% of the shares issued on or after the
first, second, third, fourth and fifth anniversary of the grant dates.
During the quarter ended September 30, 2006 the Company issued 142,500 shares of
performance restricted stock to some employees as well as to some employees of
its subsidiaries. Each such performance restricted stock grant is divided in a
pre-defined proportion with the vesting (lifting of restriction) of one portion
based on the overall annual performance of the Company and the vesting (lifting
of restriction) of the other portion based on the achievement of pre-defined
long term goals of the Company. These stocks will vest (have the restrictions
lifted) over a period of 5 years (at each anniversary) in equal installments,
subject to meeting the above pre-defined criterias of overall annual performance
and achievement of the long term goal. The stock linked to overall annual
performance would lapse (revert to the Company) on non-achievement of the
overall annual performance in the given year. However the stock linked to the
achievement of the long term goal would roll over into a common pool and would
lapse only on the non-achievement of the long term goal on or prior to the end
of fiscal year 2012.
Based upon the market value on the grant dates, the Company recorded $5.84
million during the three months ended June 30, 2004, $0.89 million during the
year ended December 31, 2005 and $0.01 million during the nine months ended
September 30, 2006 of unearned compensation included as a separate component of
shareholders' equity to be expensed over the service period on a straight line
basis. During the three months ended September 30, 2006 and 2005 the Company
reversed $0.0 million and $0.25 million, respectively, of unearned compensation
towards forfeiture of restricted stock on account of termination of employees
and expensed $0.51 million and $0.32 million, respectively as compensation cost
on account of these stock grants and during the nine months ended September 30,
2006 and 2005, the Company reversed $0.14 million and $1.03 million,
respectively, of unearned compensation towards forfeiture of restricted stock on
account of termination of employees and expensed $0.94 million and $0.81
million, respectively, as compensation cost on account of these stock grants.
The recipients are also eligible for dividends declared on their restricted
stock. The dividends accrued or paid on shares of unvested restricted stock are
charged to compensation cost. For the three months ended September 30, 2006 and
2005, the Company recorded $0.39 million and $0.02 million, respectively, and
during the nine months ended September 30, 2006 and 2005, the Company recorded
$0.41 million and $0.46 million, respectively, as compensation cost for
dividends paid on shares of unvested restricted stock.
For the restricted stock issued during the year ended December 31, 2005 and nine
months ended September 30, 2006, the dividend will be accrued and paid subject
to the same restriction as the restriction on transferability.
IMPACT OF THE ADOPTION OF FAS 123(R)
We adopted FAS 123(R) using the modified prospective transition method beginning
January 1, 2006. Accordingly, during the nine months ended September 30, 2006,
we recorded stock-based compensation expense for awards granted prior to, but
not yet vested, as of January 1, 2006, as if the fair value method required for
pro forma disclosure under FAS 123 were in effect for expense recognition
purposes, adjusted for estimated forfeitures. As FAS 123(R) requires that
stock-based compensation expense be based on awards that are ultimately expected
to vest, stock-based compensation for the nine months ended September 30, 2006
has been reduced for estimated forfeitures. When estimating forfeitures, we
consider trends of actual option forfeitures. The impact on our results of
operations of recording stock-based compensation (including impact of restricted
stock) for the nine months ended September 30, 2006 was as follows (in
thousands):
Cost of revenues $ 783
Selling, general and administrative expenses 1,111
-------
$ 1,894
=======
Cash received from option exercises under all share-based payment arrangements
for the three months ended September 30, 2006 and 2005, was $ 0.56 million and $
0.15 million, respectively and for the nine months ended September 30, 2006 and
2005, the same was $ 1.23 million and $ 1.92 million, respectively. New shares
were issued for all options exercised during the nine months ended September 30,
2006. Prior to the adoption of FAS 123(R), the intrinsic value of restricted
stock were recorded as unearned stock-based compensation as of December 31,
2005. Upon the adoption of FAS 123(R) in January 2006, the unearned stock-based
compensation balance of approximately $3.17 million was reclassified to
additional-paid-in-capital.
As of September 30, 2006, the estimated compensation cost of non-vested options
(excluding restricted stock) is $ 0.18 million to be vested mainly over the next
two years.
14
VALUATION ASSUMPTIONS
We calculated the fair value of each option award on the date of grant using the
Black-Scholes option pricing model. The following assumptions were used for each
respective period:
THREE MONTHS ENDED SEPTEMBER 30,
-------------------------------
2006 2005
----- -----
Assumptions
Risk free interest rate 4.53% 4.19%
Expected life 5.00 5.00
Expected volatility 47.81% 69.01%
Expected dividend yield 6.80% 8.93%
Our computation of expected volatility for the nine months ended September 30,
2006 is based on a combination of historical volatility from exercised options
on our stock. Prior to 2006 also, our computation of expected volatility was
based on historical volatility. Our computation of expected life in 2006, was
determined based on historical experience of similar awards, giving
consideration to the contractual terms of the stock-based awards, vesting
schedules and expectations of future employee behavior. The interest rate for
periods within the contractual life of the award is based on the U.S. Treasury
yield curve in effect at the time of grant.
SHARE-BASED PAYMENT AWARD ACTIVITY
The following table summarizes activity under our equity incentive plans for the
nine months ended September 30, 2006 (in thousands, except per share amounts):
WEIGHTED AVERAGE
WEIGHTED REMAINING AGGREGATE
AVERAGE CONTRACTUAL TERM INTRINSIC
SHARES EXERCISE PRICE (IN YEARS) VALUE
------- -------------- ---------------- -----------
Outstanding at January 1, 2006 438,251 $ 12.28
Granted -- --
Exercised 134,905 9.12
Forfeited 32,700 23.45
Expired / Cancelled 31,036 10.01
------- --------------
OUTSTANDING AT SEPTEMBER 30, 2006 239,610 $ 12.67 5.25 $ 2,292,662
------- -------------- ---- -----------
OPTIONS EXERCISABLE AT SEPTEMBER 30, 2006 196,110 $ 11.28 4.89 $ 2,117,392
------- -------------- ---- -----------
The weighted average grant-date fair value of options granted as of September
30, 2006 and 2005 was $3.53 and $3.21 respectively. The agregate intrinsic value
of options exercised as on September 30, 2006 was $7.30 and fair value of shares
vested and outstanding as on September 30, 2006 $4.66.
PRO FORMA INFORMATION FOR PERIODS PRIOR TO THE ADOPTION OF FAS 123(R)
Prior to the adoption of FAS No. 123(R), we provided the disclosures required
under FAS No. 123, as amended by FAS No. 148, "Accounting for Stock-Based
Compensation -- Transition and Disclosures." Employee stock-based compensation
expense recognized under FAS 123(R) was not reflected in our results of
operations for the three and nine months ended September 30, 2005 for employee
stock option awards as all options were granted with an exercise price equal to
the market value of the underlying common stock on the date of grant. Our ESPP
was deemed non-compensatory under the provisions of APB No. 25. Forfeitures of
awards were recognized as they occurred. Previously reported amounts have not
been restated.
The pro forma information for the three and nine months ended September 30, 2005
was as follows (in thousands, except per share amounts):
15
THREE MONTHS NINE MONTHS
ENDED ENDED
SEPTEMBER SEPTEMBER
30, 2005 30, 2005
------------ -----------
NET INCOME
As reported $ 11,739 $ 30,419
Stock based Compensation expense recognized in statement
of income, net of tax 290 1,111
Stock based compensation expense determined under the
fair value method, net of tax (327) (1,419)
------------ -----------
PRO FORMA NET INCOME $ 11,702 $ 30,111
------------ -----------
EARNINGS PER SHARE, PRO FORMA
Basic earnings per share $ 0.29 $ 0.74
Diluted earnings per share $ 0.29 $ 0.74
EARNINGS PER SHARE AS REPORTED
Basic earnings per share $ 0.29 $ 0.75
Diluted earnings per share $ 0.29 $ 0.75
WEIGHTED AVERAGE SHARES OUTSTANDING
Basic 40,576 40,487
Diluted 40,669 40,588
13. PROVISION FOR UNUTILIZED LEAVE
During the year ended December 31, 2005 Syntel India changed its leave policy,
resulting in a reduction of the maximum permissible accumulation of unutilized
leave from 150 days to 60 days. The balance exceeding maximum permissible
accumulation is compulsorily encashed at basic salary. Accordingly an amount of
$0.51 million was paid at basic salary and $1.14 million was reversed being the
difference between the basic salary and gross compensation rates.
The gross charge for unutilized earned leave was $0.29 million and $0.41 million
for the three months ended September 30, 2006 and September 30, 2005,
respectively, and $1.45 million and $1.23 million for the nine months ended
September 30, 2006 and September 30, 2005, respectively.
The amounts accrued for unutilized earned leave are $4.81 million and $3.70
million as of September 30, 2006 and December 31, 2005, respectively, and are
included within 'Accrued payroll and related costs'.
14. RECLASSIFICATION
Certain prior period amounts have been reclassified to conform with the current
period presentation.
16
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 Business Process Outsourcing business
segments. Net revenues in the three months ended September 30, 2006 increased to
$69.2 million from $58.5 million in the three months ended September 30, 2005,
representing a 18.3% increase. The Company's verticalization sales strategy
focusing on Banking and Financial Services; Healthcare; Insurance; Telecom;
Automotive; Retail; Logistics and Travel has enabled better focus and
relationship with key customers leading to continued growth in business.
Further, continued focus on execution and investments in new offerings such as
our Testing Center of Excellence have started producing results. The focus is to
continue investments in more new offerings. Worldwide billable headcount,
including personnel employed by Syntel India, Syntel Singapore, Syntel U.K., and
Syntel Germany as of September 30, 2006 increased by 33% to 5,130 employees as
compared to 3,847 employees as of September 30, 2005. 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 revenues per offshore billable resource are generally lower as
compared to an on-site based resource. As of September 30, 2006, the Company had
approximately 71.3% of its billable workforce in India as compared to 64.2% as
of September 30, 2005. The Company's top five customers accounted for 51.1% of
the total revenues in the three months ended September 30, 2006, up from 44.5%
of its total revenues in the three months ended September 30, 2005. Moreover,
the Company's top 10 customers accounted for 70.7% of the total revenues in the
three months ended September 30, 2006 as compared to 64.4% in the three months
ended September 30, 2005.
APPLICATIONS OUTSOURCING REVENUES. Applications Outsourcing revenues increased
to $49.4 million for the three months ended September 30, 2006, or 71.4% of
total revenues, from $43.9 million, or 75% of total revenues for the three
months ended September 30, 2005. The $5.5 million increase was attributable
primarily to revenues from new engagements and net increase in revenues from
existing projects by $22.1 million, largely offset by $16.6 million in lost
revenues as a result of project completion. The revenues for the nine months
ended September 30, 2006 increased to $142.4 million, or 72.3% of total
revenues, from $124.7 million or 76.1% of total revenues for the nine months
ended September 30, 2005. The $17.7 million increase for nine months ended
September 30, 2006 was attributable principally to revenues from new engagements
contributing $65.4 million largely offset by $47.7 million in lost revenues as a
result of project 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 63.0% of total Applications Outsourcing revenues for the
three months ended September 30, 2006, from 58.0% for the three months ended
September 30, 2005. The 5.0 percentage point increase in cost of revenues, as a
percent of revenues for the three months ended September 30, 2006 was
attributable primarily, to offshore wage increases, cost related to a special
dividend of $1.25 per share on restricted stock of $0.12 million and increased
offshore headcount. Cost of revenues for the nine months ended September 30,
2006 increased to 62.4% of total Applications Outsourcing revenues, from 58.1%
for the nine months ended September 30, 2005. The 4.3 percentage point increase
in cost of revenues, as a percent of revenues for the nine months ended
September 30, 2006 was attributable primarily to onsite wage increases effective
January 2006, offshore wage increases effective April 2006, visa filing
expenses, cost related to FAS123 (R), cost related to a special dividend of
$1.25 per share on restricted stock of $0.12 million and increased offshore
headcount.
E-BUSINESS REVENUES. e-Business revenues increased to $9.9 million for the three
months ended September 30, 2006, or 14.3% of total revenues, from $7.9 million,
or 13.6% of revenues for the three months ended September 30, 2005. The $2.0
million increase was attributable primarily to revenues from new engagements and
net increase in revenues from existing projects by $4.1 million largely offset
by $2.1 million in lost revenues as a result of project completion. The revenues
for the nine months ended September 30, 2006 increased to $27.9 million, or
14.1% of total revenues, from $22.7 million or 13.8% of total revenues for the
nine months ended September 30, 2005. The $5.2 million increase for nine months
ended September 30, 2006 was attributable primarily to revenues from new
engagements and net increase in revenues from existing projects by $8.7 million
largely offset by $3.5 million in lost revenues as a result of project
completion.
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, finder's
fees, trainee compensation, and travel. e-Business cost of revenues decreased to
68.3% of total
17
e-Business revenues for the three months ended September 30, 2006, from 71.6%
for the three months ended September 30, 2005. The 3.3 percentage point decrease
in cost of revenues as a percent of revenues for the three months ended
September 30, 2006 is principally attributable to increase in e-business revenue
by 2 million during three months ended September 30, as compared to three months
ended September 30,2005 partly offset by increase in offshore wages, cost
related to FAS 123(R) and cost related to a special dividend of $1.25 per share
on restricted stock of $0.05 million. Cost of revenues for the nine months ended
September 30, 2006 increased to 73.7% of total e-business revenues, from 66.7%
for the nine months ended September 30, 2005. The 7.0 percentage point increase
in cost of revenues, as a percent of revenues for the nine months ended
September 30, 2006 was attributable primarily to onsite wage increases effective
January 2006, offshore wage increase effective April 2006, visa filing expenses,
cost related to FAS123 (R), cost related to a special dividend of $1.25 per
share on restricted stock of $0.05 million and increased offshore headcount.
TEAMSOURCING REVENUES. TeamSourcing revenues decreased to $4.2 million for the
three months ended September 30, 2006, or 6.1% of total revenues, from 4.7
million, or 8.1% of total revenues for the three months ended September 30,
2005. The $0.5 million decrease was attributable primarily to revenues from new
engagements and revenue from the SkillBay web portal which helps clients of
Syntel with their supplemental staffing requirements contributing $2.2 million
offset by $2.7 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, 2006 increased to $13.5 million, or 6.8% of total
revenues, from $12.3 million or 7.5% of total revenues for the nine months ended
September 30, 2005. The $1.2 million increase for nine months ended September
30, 2006 was attributable principally to revenues from new engagements and
revenue from the SkillBay web portal contributing $6.0 million largely offset by
$4.8 million in lost revenues as a result of project 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, finder's fees,
trainee compensation, and travel. TeamSourcing cost of revenues decreased to
58.4% of TeamSourcing revenues for the three months ended September 30, 2006,
from 72.8% for the three months ended September 30, 2005. Cost of revenues for
the nine months ended September 30, 2006 decreased to 63.3% of total
TeamSourcing revenues, from 70.7% for the nine months ended September 30, 2005.
This decrease in cost of revenues, as a percent of total TeamSourcing revenues,
for both periods was attributable primarily to the better utilization of
TeamSourcing resources and by net revenues from Skillbay web portal placements.
BPO REVENUES. This segment started contributing revenues during the first
quarter of 2004. Revenues from this segment were $5.7 million or 8.2% of total
revenues for the three months ended September 30, 2006 as against $1.9 million
or 3.3% for the three months ended September 30, 2005. The $3.8 million increase
was attributable primarily to revenues from new engagements and net increase in
revenues from existing projects. The revenues for the nine months ended
September 30, 2006 increased to $13.3 million, or 6.8% of the total revenues,
from $4.2 million, or 2.6% of the total revenues for the nine months ended
September 30, 2005. The $9.1 million increase was attributable primarily to
revenues from new engagements and net increase in revenues from existing
projects by $9.4 million partially offset by $0.3 million in lost revenues as a
result of project completion.
BPO COST OF REVENUES. BPO cost of revenues consists of costs directly associated
with billable consultants, including salaries, payroll taxes, benefits, finder's
fees, trainee compensation, and travel. Cost of revenues for the three months
ended September 30, 2006 increased to 40.1% of BPO revenues from 37.6% for the
three months ended September 30, 2005. Cost of revenues for the nine months
ended September 30, 2006 increased to 40.1% of BPO revenues, from 33.9% for the
nine months ended September 30, 2005. Both the 2.5% and 6.2% increase in cost of
revenues, as a percent of total BPO revenues, was attributable primarily to
increased billable headcount due to increased operations.
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, 2006 were $13.1 million or 18.9% of total revenues, compared to $10.5
million or 18.0% of total revenues for the three months ended September 30,
2005.
The 0.9 percentage point increase is primarily due to increases in revenue,
three specific charges, and increases in certain costs in the three months ended
September 30, 2006 as against the three months ended September 30, 2005. The
increase in revenue has resulted in an approximately 2.8 percentage point
decrease. Selling, general and administrative costs for the three months ended
September 30, 2006 include a one time provision for a claim
18
payable to a customer of $0.4 million, cost related to a special dividend of
$1.25 per share on restricted stock of $0.2 million and write-offs of assets of
$0.2 million. Combined, these three items account for 1.2 percentage point
increase in selling, general, and administrative expenses as a percentage of
revenue. Cost increases include increase in travel of $0.2 million, depreciation
of $0.5 million rent of $0.6 million towards the additional new facilities at
Mumbai, Pune and Chennai in India, telecommunication expenses of $0.1 million,
office expenses of $0.8 million and professional expenses of $0.2 million
partially offset by decrease in legal fees of $0.1 million and provision for
doubtful debts of $0.5 million, which has resulted in an approximately 2.5
percentage point increase.
Selling, general, and administrative costs for the nine months ended September
30, 2006 were $35.3 million or 17.9% of total revenues, compared to $32.4
million or 19.8% of total revenues for the nine months ended September 30, 2005.
Selling, general and administrative costs for the nine months ended September
30, 2006 include a one time legal expense related to settlement fees of $0.6
million, provision for doubtful debts of $0.1 million, provision for a claim
payable to a customer of $0.4 million, cost related to a special dividend of
$1.25 per share on restricted stock of $0.2 million and write-offs of assets of
$0.2 million.
Selling, general, and administrative costs for the nine months ended September
30, 2005 include a one time special performance based incentive program for
sales teams of $0.4 million and compensation expense related to a special
dividend of $1.50 per share on restricted stock held by employees of $0.1
million.
In addition to the above described items, the 1.9 percentage point decrease is
primarily due to increases in revenue and increases in certain costs in the nine
months ended September 30, 2006 as against the nine months ended September 30,
2005. The increase in revenue has resulted in an approximately 3.4 percentage
point decrease. Cost increases include increase in travel of $0.2 million,
depreciation of $0.7 million, rent of $1.4 million towards the additional new
facilities at Mumbai, Pune and Chennai in India, telecommunication expenses of
$0.3 million, office expenses of $1.5 million and professional expenses of $0.2
million partially offset by decrease in compensation cost of $1.2 million,
marketing cost of $0.2 million and consultancy fees of $0.6 million, which has
resulted in an approximately 1.5 percentage point increase.
INCOME TAXES
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 for income tax contingencies 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, 2006 and September 30, 2005, the effective
income tax rate was 2.0% and 12.9% respectively. During the nine months ended
September 30, 2006 and September 30, 2005, the effective income tax rate was
10.6% and 16.5% respectively. The tax rates for the three months and nine months
ended September 30, 2006 is impacted by reversal of tax reserve of $2.0 million.
The tax rates for the three months and nine months ended September 30, 2005 were
impacted by the reversal of a tax reserve of $2.6 million and a provision for
valuation allowance of $1.7 million attributable to certain deferred tax
benefits, on the write-off of certain investments in 2001, which are not
expected to be materialized.
FINANCIAL POSITION
CASH AND CASH EQUIVALENTS : Cash and Cash equivalents reduced from $99.4 million
to $37.2 million primarily due to the payment during the three months ended
September 30, 2006 of a special dividend of $1.25 per share amounting to $51.3
million.
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. These amounts are held by various
banking institutions including US-based and India-based banks.
Net cash generated by operating activities was $20.7 million for the nine months
ended September 30, 2006, compared to $27.8 million for the nine months ended
September 30, 2005. The number of days sales outstanding
19
in net accounts receivable was approximately 64 days and 65 days as of September
30, 2006 and September 30, 2005, respectively. The decrease in the number of
day's sales outstanding in net accounts receivable was due to increased
collections.
Net cash used in investing activities was $27.1 million for the nine months
ended September 30, 2006, consisting principally of $96.9 million for the
purchase of short term investments and $9.3 million of 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 $79.1 million. Net cash provided by investing activities was $20.6 million
for the nine months ended September 30, 2005, consisting principally of $39.2
million for the sale of short term investments partially offset by $11 million
of capital expenditures and the purchase of short term investments of $7.6
million.
Net cash used in financing activities was $57.0 million for the nine months
ended September 30, 2006, consisting principally of $58.6 million in dividends
paid out partially offset by $1.6 million of proceeds from the issuance of
shares under the Company's employee stock option plan and employee stock
purchase plan. Net cash used in financing activities was $66.6 million for the
nine months ended September 30, 2005, consisting principally of $68.4 million in
dividends paid out and $0.7 million in common stock repurchases, partially
offset by $2.5 million of proceeds from the issuance of shares under the
Company's employee stock option plan and employee stock purchase plan.
The Company has a line of credit with JP Morgan Chase Bank NA, which provides
for borrowings up to $20.0 million. The line of credit has been renewed and
amended and now expires on August 31, 2007. 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 (i) a formula approximating the Eurodollar rate plus the
applicable margin of 1.25%, (ii) the bank's prime rate minus 1.0% or (iii)
negotiated rate plus 1.25%. There were no outstanding borrowings at September
30, 2006 and 2005.
The Company believes that the combination of present cash balances and future
operating cash flows will be sufficient to meet the Company's currently
anticipated cash requirements for at least the next 12 months.
CRITICAL ACCOUNTING POLICIES
We believe the following critical accounting policy, among others, affects the
more significant judgments and estimates used in the preparation of our
consolidated financial statements. The Company has discussed this critical
accounting policy and the 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,
2006 and 2005, revenues from time and material contracts constituted 58% and 51%
of total revenues, respectively. 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, 2006 and 2005, revenues from fixed price application management
and support engagements constituted 26% and 29% of total revenues, 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 required
through 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, 2006 and 2005, revenues from fixed price development contracts
constituted 16% and 20% of total revenues, respectively.
20
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 assumptions 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 the Company makes estimates about its future efforts
and costs relative to its 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 collection 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. 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 expense.
During the three months ended September 30, 2006 and September 30, 2005, the
effective income tax rate was 2% and 12.9%, respectively.
ACCRUALS FOR LEGAL EXPENSES AND EXPOSURES. The Company estimates the costs
associated with known legal exposures and their related legal expenses and
accrues reserves for either the probable liability, if that amount can be
reasonably estimated, or otherwise the lower end of an estimated range of
potential liability.
UNDISTRIBUTED EARNINGS OF FOREIGN SUBSIDIARIES. The Company intends to use
accumulated and future earnings of foreign subsidiaries to expand operations
outside the United States and accordingly undistributed earnings of foreign
subsidiaries are considered to be indefinitely reinvested outside the United
States and no provision for U. S. federal and state income tax or applicable
dividend distribution tax has been provided thereon.
21
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. Forward-looking statements include statements
containing words such as "could", "expects", "may", "anticipates", "believes",
"estimates", "plans", and similar expressions. 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
- Exposure to Regulatory and General Economic Conditions in India
- Intense Competition
- Ability to Manage Growth
- Fixed-Price Engagements
- Potential Liability to Customers
- Dependence on Key Personnel
- Risks Related to Possible Acquisitions
- Limited Intellectual Property Protection
- Potential Anti-Outsourcing Legislation
- Terrorist Activity, War or Natural Disasters
- Adverse Economic Conditions
- Failure to Successfully Develop and Market New Products and Services
- Benchmarking Provisions
- Corporate Governance Issues
- Telecom/Infrastructure Issues
- Confidentiality Issues
- New Facilities
- Stock Option Accounting
- Instability and Currency Fluctuations
The Company does not intend to update the forward looking statements or risk
factors to reflect future events or circumstances.
RECENT ACCOUNTING PRONOUNCEMENTS
In July 2006, FASB issued Interpretation No. 48 (FIN 48) Accounting for
Uncertainty in Income Taxes, an interpretation of FASB Statement No. 109, to
create a single model to address accounting for uncertainty in tax positions.
FIN 48 clarified the accounting for income tax by prescribing a minimum
recognition threshold a tax position is required to meet before being recognized
in the financial statements. FIN 48 also provides guidance on derecognition,
measurement, classification, interest and penalties, accounting in interim
periods, disclosure, and transition. FIN 48 is effective for fiscal years
beginning after December 15, 2006. The Company has not determined the effect, if
any; the adoption of FIN 48 will have on its results of operations or financial
position.
In September 2006, the FASB issued Statement No. 157 (SFAS 157), Fair Value
Measurements, which addresses how companies should measure fair value when they
are required to use a fair value measure for recognition or disclosure purposes
under generally accepted accounting principles (GAAP). SFAS 157 is effective for
fiscal years beginning after November 15, 2007. The Company is currently
evaluating the impact; SFAS 157 will have on the Company's financial position,
results of operations and liquidity and its related disclosures.
22
In September 2006, FASB issued Statement No. 158 (SFAS 158) Employers'
Accounting for Defined Benefit Pension and Other Postretirement Plans, an
amendment of FASB Statements No. 87, 88, 106, and 132(R), which requires
companies to recognize the overfunded or underfunded status of a defined benefit
postretirement plan as an asset or liability in its balance sheet and to
recognize changes in that funded status in the year in which the changes occur
through comprehensive income, which is effective for fiscal years ending after
December 15, 2006. The Company is currently evaluating the impact; SFAS 158 will
have on the Company's financial position, results of operations and liquidity
and its related disclosures.
23
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.
The Company is exposed to the impact of interest rate changes and foreign
currency fluctuations.
INTEREST RATE RISK
The Company considers 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 Company's cash and cash
equivalents and short term investments:
SEPTEMBER 30, DECEMBER 31,
2006 2005
------------- ------------
(in thousands)
ASSETS
Cash and cash equivalents $ 37,212 $ 99,390
Short term Investments 38,579 21,083
------------- ------------
TOTAL $ 75,791 $ 120,473
============= ============
The Company's exposure to market rate risk for changes in interest rates
relates primarily to its investment portfolio. The Company does not use
derivative financial instruments in its investment portfolio. The
Company's 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 its investment portfolio. The Company protects and preserves its
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, the
Company's future investment income may fall short of expectations, or the
Company may suffer a loss in principal if the Company is forced to sell
securities, which have declined in market value due to changes in interest
rates as stated above.
FOREIGN CURRENCY RISK
The Company's sales are primarily sourced in the United States and its
subsidiary in the United Kingdom and are mostly denominated in U.S.
dollars or UK pounds respectively. Its foreign subsidiaries incur most of
their expenses in the local currency. Accordingly, all foreign
subsidiaries use the local currency as their functional currency. The
Company's 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, the
Company's 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. The Company is 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, 2006, the Indian rupee has
depreciated, against U.S. dollar, by 1% as compared to the three months
ended June 30, 2006. The impact of this rupee depreciation positively
impacted the Company's gross margin by 18 basis points, operating income
by 24 basis points and net income by 24 basis points, each as a percentage
of revenue. The Indian rupee denominated cost of revenues and selling,
general and administrative expense was 28% and 33%, respectively, which
did not have a material impact on the operating results of the company.
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
significant impact.
24
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, 2006 as
well as mirror certifications from senior management, the Company's Chairman,
President and Chief Executive Officer and Acting Chief Financial Officer have
concluded that 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 over financial reporting (as defined in Rule 13a-15(f) under
the Exchange Act) during the last quarter that materially affected, or are
reasonably likely to materially affect, the Company's internal control 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 Acting 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 Acting 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. Further, the design of a control
system must reflect the fact that there are resource constraints, and the
benefits of controls must be considered relative to their costs. 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.
CONCLUSIONS. Based upon the Controls Evaluation, our CEO and Acting CFO have
concluded that as of September 30, 2006 our disclosure controls and procedures
are effective to ensure that material information relating to Syntel and its
consolidated subsidiaries is made known to management, including the CEO and
Acting 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 in the United States of America.
25
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 1A. RISK FACTORS.
There have been no material changes in the Company's risk factors as disclosed
in the Company's annual report on Form 10-K for the year ended December 31,
2005.
ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS.
None.
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.
Exhibits
Exhibit No. Description
10.1 Form of Restricted Stock Grant Agreement.
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.
26
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 6, 2006 /s/ Bharat Desai
----------------------------------------------
Bharat Desai, Chairman, President and
Chief Executive Officer
Date : November 6, 2006 /s/ Arvind Godbole
----------------------------------------------
Arvind Godbole, Acting Chief Financial Officer
27
EXHIBIT INDEX
EXHIBIT NO. DESCRIPTION
Exhibit No. Description
10.1 Form of Restricted Stock Grant Agreement
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.
28