UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended December 31, 2006
Commission File Number 0-22903
SYNTEL, INC.
(Exact name of Registrant as specified in its charter)
Michigan 38-2312018
(State or other jurisdiction of (I.R.S. Employer
Incorporation or organization) Identification No.)
525 E, Big Beaver Road, Suite 300, Troy, Michigan 48083
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: (248) 619-2800
Securities registered pursuant to Section 12(b) of the Act:
Title of Class Name of Exchange on Which Registered
-------------- ------------------------------------
Common Stock, no par value The NASDAQ Stock Market LLC
Securities registered pursuant to Section 12(g) of the Act: None
Indicate by check mark if the Registrant is a well-known seasoned issuer,
as defined in Rule 405 of the Securities Act.
Yes No X
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Indicate by check mark if the Registrant is not required to file reports
pursuant to Section 13 or 15(d) of the Act.
Yes No X
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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 such shorter period that the Registrant
has been 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 if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to the
best of Registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K.
---
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
--- --- ---
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Indicate by check mark whether the Registrant is a shell company (as defined in
Rule 12b-2 of the Exchange Act).
Yes No X
--- ---
The aggregate market value of the Common Stock held by non-affiliates of the
Registrant as of the last business day of the Registrant's most recently
completed second fiscal quarter, June 30, 2006, based on the last sale price of
$20.46 per share for the Common Stock on The NASDAQ National Market on such
date, was approximately $168,178,000.
As of March 2, 2007, the Registrant had 41,110,727 shares of Common Stock
outstanding.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of Registrant's Proxy Statement for the 2007 Annual Meeting of
Shareholders to be held on or about May 25, 2007 are incorporated by reference
into Part III hereof.
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SYNTEL INC.
FORM 10-K
INDEX
PART I
ITEM 1. BUSINESS
ITEM 1A. RISK FACTORS
ITEM 1B. UNRESOLVED STAFF COMMENTS
ITEM 2. PROPERTIES
ITEM 3. LEGAL PROCEEDINGS
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY, RELATED SHAREHOLDER MATTERS
AND ISSUER PURCHASES OF EQUITY SECURITIES
ITEM 6. SELECTED FINANCIAL DATA
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
ITEM 9A. CONTROLS AND PROCEDURES
ITEM 9B. OTHER INFORMATION
PART III
ITEM 10. DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE
ITEM 11. EXECUTIVE COMPENSATION
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND
RELATED SHAREHOLDER MATTERS
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR
INDEPENDENCE
ITEM 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES
PART IV
ITEM 15. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES
SIGNATURES
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PART I
ITEM 1. BUSINESS.
References herein to the "Company" or "Syntel" refer to Syntel, Inc. and its
subsidiaries worldwide on a consolidated basis.
FORWARD-LOOKING STATEMENTS
This report on Form 10-K, including without limitation the Business section,
Management's Discussion and Analysis of Financial Condition and Results of
Operations, and Quantitative and Qualitative Disclosures about Market Risk,
contains statements that 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 those listed under "Item 1A.
Risk Factors" and elsewhere in this Form 10-K, including the following:
- Recruitment and Retention of IT Professionals
- Government Regulation of Immigration
- Customer Concentration; Risk of Termination
- Exposure to Political and Regulatory Conditions in India
- Wage pressures in India
- Ability to Repatriate Earnings
- Intense Competition
- Ability to Manage Growth
- Fixed-Price Engagements
- Potential Liability to Customers
- Dependence on Key Personnel
- Limited Intellectual Property Protection
- Potential Anti-Outsourcing Legislation
- Adverse Economic Conditions
- Failure to Successfully Develop and Market New Products and Services
- Benchmarking Provisions
- Corporate Governance Issues
- Telecom/Infrastructure Issues
- New Facilities
- Stock Option Accounting
- Terrorist Activity, War or Natural Disasters
- Instability and Currency Fluctuations
- Risks Related to Possible Acquisitions
- Variability of Quarterly Operating Results
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For a more detailed discussion of certain of the risks associated with the
Company's business, see "Item 1A. Risk Factors" in this Form 10-K. The Company
undertakes no obligation to update forward-looking statements to reflect events
or circumstances occurring after the date of this Form 10-K.
OVERVIEW
Syntel, incorporated under Michigan law on April 15, 1980, is a worldwide
provider of information technology and Business Process Outsourcing (BPO)
services to Global 2000 companies. The Company's service offerings are grouped
into four segments: Applications Outsourcing, e-Business, Business Process
Outsourcing (BPO) and TeamSourcing(R). Applications Outsourcing consists of
outsourcing services for ongoing management, development and maintenance of
business applications. e-Business consists of practice areas in Web Solutions,
Customer Relationship Management (CRM), Data Warehousing/Business Intelligence,
and Enterprise Applications Integration (EAI) services. BPO consists of
high-value, customized outsourcing solutions that enhance critical back-office
outsourced solutions such as transaction processing, loan servicing, retirement
processing, and collections and payment processing. Syntel's primary BPO focus
is in the financial services, healthcare and insurance sectors. TeamSourcing
consists of professional Information Technology (IT) consulting services. Syntel
believes that its service offerings are distinguished by its Global Delivery
Model, a corporate culture focused on customer-service, responsiveness and its
own internally-developed "intellectual capital", which is based on a proven set
of methodologies, practices and tools for managing the IT functions of its
customers.
Through Applications Outsourcing, Syntel provides high-value applications
management services for ongoing management, development and maintenance of
customers' business applications. Syntel assumes responsibility for and manages
selected application support functions for the customer. Utilizing its developed
methodologies, processes and tools, the Company is able to assimilate the
customer's business process knowledge in order to develop and deliver services
specifically tailored for that customer. In 2006, 2005 and 2004, Applications
Outsourcing services accounted for approximately 72%, 76%, and 76% of total
consolidated revenues, respectively.
Through its e-Business practices, Syntel provides strategic advanced technology
services for the design, development, implementation and maintenance of
solutions to enable customers to be more competitive. Many of today's advanced
technology solutions are built around utilization of the Internet, which has
transformed many businesses. The Company provides customized technology services
in the areas of web solutions, including web architecture, web-enablement of
legacy applications, and portal development. The Company also provides Customer
Relationship Management (CRM) services, which involve software solutions that
put Syntel's customers in closer touch with their own customers. Additionally,
Syntel has entered into several alliances with leading software firms and IT
application software infrastructure providers, including Ab Initio, Actuate, BEA
Systems, Business Objects, Cognos, Hewllet-Packard, IBM, Informatica,
Microstrategy, Oracle, SAP, Serden Technologies, and TIBCO, among others. These
partnerships will provide the Company with increased opportunities for market
penetration. In 2006, 2005 and 2004, e-Business accounted for approximately 14%,
14% and 16% of total consolidated revenues, respectively.
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Syntel seeks to provide high-value BPO solutions to its customers, as opposed to
low-value, capital-intensive voice-based BPO services. Through BPO, Syntel
provides outsourced solutions for a client's business processes, providing them
with the advantage of a low-cost position and process enhancement through
optimal use of technology. Syntel uses a proprietary tool called Identeon(TM) to
assist with strategic assessments of business processes, identifying the right
ones for outsourcing. In the area of financial services, Syntel focuses on the
middle and back-office business processes of the transaction cycle. BPO
accounted for approximately 8%, 3% and 1% of the total revenues for the years
ended December 31, 2006, 2005 and 2004, respectively.
Through TeamSourcing, Syntel provides professional IT consulting services
directly to customers. TeamSourcing services include systems specification,
design, development, implementation and maintenance of complex IT applications
involving diverse computer hardware, software, data and networking technologies
and practices. TeamSourcing services are provided by individual professionals
and teams of professionals dedicated to assisting customer IT departments with
systems projects and ongoing functions. TeamSourcing accounted for approximately
6%, 7%, and 7% of the total revenues, for the years ended December 31, 2006,
2005 and 2004, respectively.
The information set forth under Note 15 "Segment Reporting" to the Consolidated
Financial Statements attached as an exhibit to this Annual Report on Form 10-K
is incorporated herein by reference.
The Company's Global Delivery Service provides Syntel with flexibility to
deliver to each customer a unique mix of services on-site at the customer's
location, off-site at the Company's U.S. locations and offshore at Global
Development Centers in Mumbai, Chennai and Pune, India. The benefits to the
customer from this customized service approach include responsive delivery based
on an in-depth understanding of the specific processes and needs of the
customer, quick turnaround, access to the most knowledgeable personnel and best
practices, resource depth, 24-hour support seven days a week and
cost-effectiveness. By linking each of its service locations together through a
dedicated data and voice network, Syntel provides a seamless service capability
to its customers around the world largely unconstrained by geography, time zones
or cultures.
Syntel provides its services to a broad range of Global 2000 companies in the
financial services, healthcare, insurance, automotive, retail, and other
industries. During 2006 the Company provided services to 81 customers,
principally in the U.S. including American Express, State Street Bank, Daimler
Chrysler, Humana Inc, and Allstate Insurance. The Company has been chosen as a
preferred vendor by many of its customers and has been recognized for its
quality and responsiveness. The Company seeks to develop long-term relationships
with its customers so as to become a trusted business partner and enable it to
expand its roles with current customers. Additionally, the Company believes that
its vertical expertise, breadth of service and cultural alignment are also
important decision factors in the Company being chosen as a preferred vendor.
The Company has a focused sales effort that includes a strategy of migrating
existing TeamSourcing customers to higher-value e-Business and Applications
Outsourcing services. Recently, the Company has focused on increasing its
resources in the development, marketing and sales of its Applications
Outsourcing, BPO, e-Business, and TeamSourcing services to expand its customer
base.
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The Company believes its human resources are its most valuable asset and invests
significantly in programs to recruit, train and retain IT professionals. The
Company recruits globally through its worldwide recruiting network and maintains
a broad package of employee support programs. Syntel believes that its
management structure and human resources organization is designed to maximize
the Company's ability to efficiently expand its IT professional staff in
response to customer needs. As of December 31, 2006, Syntel's worldwide billable
headcount consisted of 5,499 consultants providing professional services to
Syntel's customers.
The information set forth under Note 16 "Geographic Information" to the
Consolidated Financial Statements attached as an exhibit to this Annual Report
on Form 10-K is incorporated herein by reference.
INDUSTRY
Increasing globalization, rapid adoption of the Internet as a business tool and
technological innovation are creating an increasingly competitive business
environment that is requiring companies to fundamentally change their business
processes. This change is driven by increasing demand from customers for
increased quality, lower costs, faster turnaround, and highly responsive and
personalized service. To effect these changes and adequately address these
needs, companies are focusing on their core competencies and on cost-effectively
utilizing IT solutions to improve productivity, lower costs and manage
operations more effectively. As a result, designing, developing, and
implementing advanced technology solutions are key priorities for the majority
of corporations. In addition, the development and maintenance of new IT
applications continues to be a high priority. This type of work requires highly
skilled individuals trained in diverse technologies. However, there is a growing
shortage of these individuals and many companies are reluctant to expand their
IT departments through additional staffing, particularly at a time when they are
attempting to minimize their fixed costs and reduce workforces. The Company
believes that many organizations are concluding that using outside specialists
to address their advanced technology and ongoing IT requirements enables them to
develop better solutions in shorter time frames and to reduce implementation
risks and ongoing maintenance costs. Those outside specialists best positioned
to benefit from these trends have access to a pool of skilled technical
professionals, have demonstrated the ability to manage IT resources effectively,
have low-cost offshore software development facilities, and can efficiently
expand operations to meet customer demands.
Demand for IT services has grown significantly as companies seek ways to
outsource not only specific projects for the design, development and integration
of new technologies, but also ongoing management, development and maintenance of
existing IT systems.
The Company believes that outsourcing the ongoing management, development and
maintenance of IT applications is becoming increasingly critical to business
enterprises. The difficulties of IT planning, budgeting and execution in the
face of technological innovations and uncertainties, the focus on cost cutting,
and a growing shortage of skilled personnel are driving senior corporate
management to strategically pursue outsourcing of critical internal IT
functions. Organizations are seeking an experienced IT services outsourcing
provider that not only has the expertise and knowledge to address the
complexities of rapidly changing technologies, but also possesses the capability
to understand and automate the business processes and knowledge base of the
organization. In addition, the IT provider must be able to develop customized
solutions to problems unique to the organization. This involves maintaining a
combination of on-site,
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off-site and offshore professionals who know the customer's IT processes,
providing access to a wide range of expertise and best practices, providing
responsiveness and accountability to allow internal IT departments to meet
organization goals, and providing low cost, value-added services to stay within
the organization's IT budget constraints.
In today's environment, large organizations are increasingly finding that full
facilities management outsourcing providers who own and manage an organization's
entire IT function do not permit the organization to retain control over, or
permit flexible reallocation of, its IT resources.
According to International Data Corporation (IDC), the IT services market was
$446 billion in 2005 and is projected to grow at a 5.8% annual growth rate from
2006 to 2010. The 2005 NASSCOM -Mc-Kinsey report estimates that the offshore IT
service industry will grow at a 24.4% compound annual growth rate from $18.4
billion in fiscal 2005 to $55.0 billion in fiscal 2010. The report estimates
that India-based companies accounted for 65% of revenues in fiscal 2005 and that
India will retain its dominant position as the most favored offshore IT services
destination for the foreseeable future.
With the success businesses are having with outsourcing their IT services work,
many have begun exploring BPO. According to IDC, the global outsourcing market
was $384.5 billion in 2005 and is projected to grow at a 10.0% compound annual
growth rate from 2005 through 2010 to $617.9 billion. Demand for offshore BPO
services has also grown substantially in recent years. The NASSCOM -Mc-Kinsey
report estimates that the offshore BPO industry will grow at a 37.0% compound
annual growth rate from $11.4 billion in fiscal 2005 to $55.0 billion in fiscal
2010. The report identifies the banking and insurance industries as representing
50% of the potential offshore BPO market and estimates that providers have
captured less than 10% of the total opportunity, even in industries that began
outsourcing processes early on, such as insurance (life, health and property and
casualty) and retail banking (including deposits and lending, credit cards,
mortgages and loans). The report estimates that India based companies accounted
for 46% of offshore BPO revenue in fiscal 2005 and that India will retain its
dominant position as the most favored offshore IT services destination for the
foreseeable future.
COMPETITIVE ADVANTAGES
Syntel has developed mature processes to handle large, complex assignments and
more efficiently deliver higher quality IT and BPO solutions through a global
delivery model. Management believes that Syntel's global delivery model,
vertical domain expertise, focus on customer service and end-to-end products are
key competitive advantages.
GLOBAL DELIVERY SERVICE Syntel performs its services on-site at the customer's
location, off-site at Syntel's U.S. locations and offshore at its Indian
locations. By linking each of its service locations together through a dedicated
data and voice network, Syntel provides a seamless service capability to its
customers around the world, largely unconstrained by geographies, time zones and
cultures. This Global Delivery Service gives the Company the flexibility to
deliver to each customer a unique mix of on-site, off-site and offshore services
to meet varying customer needs for direct interaction with Syntel personnel,
access to technical expertise, resource availability and cost-effective
delivery. The benefits to the customer from this customized service include
responsive delivery based on an in-depth understanding of the specific processes
and needs of the customer, quick turnaround, access to the most knowledgeable
personnel and best practices, resource depth, 24-hour support seven days a week,
and cost-effectiveness. To support its
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Global Delivery Service, the Company currently has three Global Development
Centers located in Mumbai, India; Pune, India; and Chennai, India. The Company
also has a Support Center located in Cary, North Carolina. The Mumbai Global
development centers employed, including onsite deputations outside Mumbai, 3,737
persons as of December 31, 2006 and have a capacity of approximately 3,505
people. The Pune Global development centers employed 1,507 people and have a
capacity of approximately 1,887 people. The Chennai Global development centers
employed 1,423 as of December 31, 2006 and have a capacity of approximately
1,513 people.
In August 2006, the Company completed Phase One of a state-of-the-art
development and training campus in Pune, which included an office building with
950 seats, a food court and hotel. When fully completed, the facility will cover
over 1 million square feet and accommodate 9,000 employees. It will be both a
customer and employee focused facility, including such amenities as training
facilities, cafeteria and fitness center. Syntel has also acquired additional 37
acres of land that is adjacent to this campus. It has also acquired
approximately 29 acres of land in an Information Technology Park in Chennai,
India. This area of land has been designated as a Special Economic Zone by the
government of India.
TRUSTED BUSINESS PARTNER. The Syntel corporate culture reflects a "Customer for
Life" philosophy, which emphasizes flexibility, responsiveness,
cost-consciousness and a tradition of excellence. The Company recognizes that
its best source for new business opportunities comes from existing customers and
believes its customer service is a significant factor in Syntel's high rate of
repeat business. At engagement initiation, Syntel's services are typically based
on expertise in the software life cycle and underlying technologies. Over time,
however, as Syntel develops an in-depth knowledge of a customer's business
processes, IT applications and industry, Syntel gains a competitive advantage to
perform additional higher-value IT services for that customer.
DEEP INDUSTRY EXPERTISE. Syntel has developed methodologies, toolsets and
proprietary knowledge applicable to specific industries. Syntel Combines deep
industry knowledge with an understanding of its client's needs and technologies
to provide high value, high quality services. Syntel's industry expertise can be
leveraged to assist other clients in the same industry, thereby improving
quality and the value of its services. The Company domain expertise extends to
multiple verticals, with particular strength in financial services, insurance,
and healthcare. For the year ended December 31, 2006 the Company's breakdown by
industry vertical for financial services, healthcare, insurance, auto, retail
and other was 43%, 17%, 18%, 10%, 3% and 9% respectively.
DEPTH AND BREADTH OF SERVICE OFFERINGS. The Company provides a comprehensive
range of IT services, including application development, application maintenance
and support, packaged software implementation, infrastructure management
services, BPO and testing services. Syntel's knowledge and experience spans
multiple computing platforms and technologies, which enable us to address a
range of business needs and to function as a virtual extension of its clients'
IT departments. The Company offers a broad spectrum of services in select
industry sectors, which it leverages to capitalize on opportunities.
PROVEN INTELLECTUAL CAPITAL. Over its 27-year history, Syntel has developed a
proven set of methodologies, practices, tools and technical expertise for the
development and management of its customers' information systems. The Company
believes that its intellectual capital is an important part of its competitive
advantage. The Company benefits from its own experience in transitioning from a
100% onshore service provider to a majority offshore-centric service provider.
The Company employs a team of
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professionals whose mission is to develop and formalize Syntel's "intellectual
capital" for use by the entire Syntel organization. This "intellectual capital"
of Syntel includes methodologies for the selection of appropriate customer IT
functions for management by Syntel, tools for the transfer to Syntel of the
systems knowledge of the customer, and techniques for providing systems support
improvements to the customer. The Company believes its intellectual capital
enhances its ability to understand customer needs, design customized solutions
and provide quality services on a timely and cost-effective basis. The Company
strives to continually enhance this knowledge base by creating competencies in
emerging technical fields such as internet/intranet applications, client/server
applications, object-oriented software, e-commerce and data warehousing
technology. Through these efforts, the Company becomes more valuable to the
customer and is often able to expand the scope of its working to existing
customers.
FIXED-PRICED AND FIXED-TIME FRAME. Syntel has historically performed
approximately half of its services on a fixed-price, fixed time-frame basis,
which the Company believes aligns its objectives with those of its clients. The
Company delivers solutions for both enterprise-wide and departmental initiatives
on a fixed-price and fixed time-frame basis using its proprietary tools and
methodologies. The Company believes its ability to offer fixed-price and fixed
time-frame process, is an important competitive differentiator that allows the
Company and its clients to better understand clients' business needs, and to
design, develop, integrate and implement solutions that address those needs.
BUSINESS STRATEGY
The Company's objective is to become a strategic partner with its customers in
managing the full IT/BPO services lifecycle by utilizing its Global Delivery
Model, intellectual capital and customer service orientation. The Company plans
to continue to pursue the following strategies to achieve this objective:
LEVERAGE GLOBAL DELIVERY MODEL. The ability to deliver a seamless service
capability virtually anywhere in the world from its domestic and offshore
facilities gives the Company an effective ability to meet customer needs for
technical expertise, best practice IT solutions, resource availability,
responsive turnaround and cost-effective delivery. The Company strives to
leverage this capability to provide reliable and cost-effective services to its
existing customers, expand services to existing customers and to attract new
customers. Moreover, the flexibility and capacity of the Global Delivery Service
and the Company's worldwide recruitment and training programs enhance the
ability of the Company to expand its business as the number of customers grows
and their IT demands increase. The Company continues to expand the capacity of
its Global Development Centers worldwide. The Company has made a significant
migration of resources to offshore development locations. Measured by billable
headcount, approximately 73% of services were delivered from offshore centers as
of December 31, 2006 versus 52% as of December 31, 2003.
CONTINUE TO GROW APPLICATIONS OUTSOURCING SERVICES. Through Applications
Outsourcing, the Company markets its higher value applications management
services for ongoing applications management, development and maintenance. In
recent years, the Company has significantly increased its investment in
Applications Outsourcing services and realigned its resources to focus on the
development, marketing and sales of its Applications Outsourcing and e-Business
services, including the hiring of additional sales people and senior managers,
redirecting personnel experienced in the sale of higher value contracts,
developing proprietary methodologies, increasing
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marketing efforts, and redirecting organizational support in the areas of
finance and administration, human resources and legal.
CAPITALIZE ON EXISTING CAPABILITIES IN THE HIGH GROWTH BPO MARKET. The Company
will grow its expertise in the area of value-added BPO solutions, primarily in
the areas of financial services and insurance. By leveraging a mature Global
Delivery Model and domain expertise, the Company is able to deliver process
improvements as well as provide competitively priced BPO solutions. In addition
to offering its existing BPO solutions, the Company also expects to build on its
solution set to capitalize on additional opportunities.
EXPAND CUSTOMER BASE AND ROLE WITH CURRENT CUSTOMERS. The Company's emphasis on
customer service and long-term relationships has enabled the Company to generate
recurring revenues from existing customers. The Company also seeks to expand its
customer base by leveraging its expertise in providing services to the financial
services, healthcare, insurance, automotive, retail, and other industries, as
well as to government entities. With the expansion of the Company's Indian
operations, the Company is increasing its marketing efforts in other parts of
the world, particularly in Europe.
ATTRACT AND RETAIN HIGHLY SKILLED IT PROFESSIONALS. The Company believes that
its human resources are its most valuable asset. Accordingly, its success
depends in large part upon its ability to attract, develop, motivate, retain and
effectively utilize highly skilled IT professionals. Over the years, the Company
has developed a worldwide recruiting network, logistical expertise to relocate
its personnel, and programs for human resource retention and development. The
Company (1) employs professional recruiters who recruit qualified professionals
throughout the U.S. and India, (2) trains employees and new recruits through
both computer based training and its four training centers, one of which is
located in the U.S. and three of which are located in India, and (3) maintains a
broad range of employee support programs, including relocation assistance, a
comprehensive benefits package, career planning, a qualified stock purchase
program, and incentive plans. The Company believes that its management structure
and human resources organization is designed to maximize the Company's ability
to efficiently expand its professional IT staff in response to customer needs.
The Company believes that its recent investment in Pune, India campus has
positively impacted its ability to attract and retain high quality talent.
PURSUE SELECTIVE PARTNERSHIP OPPORTUNITIES. The Company has entered into
partnership alliances with several software firms and IT application
infrastructure firms, including Ab Initio, Actuate, BEA Systems, Business
Objects, Cognos, Hewlett-Packard, IBM, Informatica, Microstrategy, Oracle, SAP,
Serden Technologies, TIBCO, among others. The alliances provide a strong
software implementation strategy for the customer, combining the partner's
software with Syntel's extensive implementation and delivery capabilities.
Before entering into a partnership alliance, the Company considers a number of
criteria, including: (1) technology employed; (2) projected product lifecycles;
(3) size of the potential market; (4) software integration requirements of the
product; and (5) the reputation of the potential partner.
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SERVICES OFFERINGS
Syntel provides a broad range of IT services through its Applications
Outsourcing, e-Business, BPO, and TeamSourcing service offerings.
Through Applications Outsourcing offering, the Company provides complete
software applications development, maintenance and platform migration services.
Through its e-Business practices, the Company provides advanced technology
services in the areas of Web Solutions, Customer Relationship Management (CRM),
Data Warehousing/Business Intelligence, Enterprise Applications, Integration
(EAI) and Enterprise Resource Planning (ERP) software package implementation.
Through its BPO offerings, the Company provides a host of outsourced solutions
for business processes.
Through TeamSourcing, the Company provides professional IT consulting services.
During the past year, the Company has increased the personnel and resources
dedicated to the development, marketing and sales of its Applications
Outsourcing, e-Business, and BPO services. For the years ended December 31,
2006, 2005 and 2004, e-Business and Applications Outsourcing combined accounted
for approximately 86%, 90% and 92% respectively, of the Company's revenues and
TeamSourcing represented approximately 6%, 7% and 7%, respectively, of the
Company's total revenues. The BPO segment started contributing revenues during
the year 2004. Revenue from this segment was 8%, 3% and 1% of the Company's
total revenues for the years ended December 31, 2006, 2005 and 2004,
respectively.
Syntel's focus on customer service is evidenced by the high level of repeat
business from existing customers and the quality awards its customers have
bestowed on Syntel. In the fourth quarter of 2006, more than 95% of Syntel's
revenue came from clients the Company has worked with for at least one year.
Syntel has earned a host of quality awards, including the "CIO Award" from
General Motors, as well as "Preferred Supplier" status with DaimlerChrysler
Corporation, in which Syntel received the highest rating in each customer
service category. The Company has also been recognized by Target Corporation
with a "Best Business Partner Award". Syntel's development centers in India
earned the highest possible quality rating of the Software Engineering Institute
(SEI) Capability Maturity Model (CMM) Level 5. Syntel is also an ISO 9001: 2000
certified company, and in late 2004, Syntel earned the BS 7799 2:2002 security
certification for its centers in India, as well as neoQA Certified to Level 4.
During 2004, Syntel also earned a host of media awards, including Fortune Small
Business "America's Fastest-Growing Small Companies"; Healthcare Informatics
100; Diversity Business "Top 100 Diversity Owned Businesses in the U.S.";
VARBusiness 500; and was on the Forbes "200 Best Small Companies in America"
list for the fifth time.
APPLICATIONS OUTSOURCING
Syntel provides high-value application management services for ongoing
management, development and maintenance of business applications. Through
Applications Outsourcing, the Company assumes responsibility for, and manages
selected applications support functions of the customers. The Global Delivery
Service is central to Syntel's delivery of Applications Outsourcing services. It
enables the Company to respond to customers' needs for ongoing service and
flexibility and has provided the capability to become productive quickly on a
cost-effective basis to meet timing and resource demands for mission critical
applications.
12
Syntel has developed methodologies, processes and tools to effectively integrate
and execute Applications Outsourcing engagements. Referred to as
"IntelliTransfer(R)," this methodology is implemented in three stages of
planning, transition and launch. Syntel first focuses on the customer's
personnel, processes, technology and culture to develop a plan to effectively
assimilate the business process knowledge of the customer. Syntel then begins to
learn the business processes of the customer, and, finally, seeks to assume
responsibility for performance of a particular customer applications system or
systems. As the Company develops an in-depth knowledge of the customer's
personnel, processes, technology and culture, Syntel acquires a competitive
advantage to pursue more value-added services. The Company believes its approach
to providing these services results in a long-term customer relationship
involving a key Syntel role in the business processes and applications of the
customer.
Because providing both e-Business and Applications Outsourcing services
typically involves close participation in the IT strategy of a customer's
organization, Syntel adjusts the manner in which it delivers these services to
meet the specific needs of each customer. For example, if the customer's
business requires fast delivery of a mission-critical applications update,
Syntel will combine its on-site professionals, who have knowledge of the
customer's business processes and applications, together with its global
infrastructure to deliver around-the-clock resources. If the customer's need is
for cost reduction, Syntel may increase the portion of work performed at its
offshore Global Development Center, which has significantly lower costs. The
Company believes that its ability to provide flexible service, delivery and
access to resources permits responsiveness to customer needs and are important
factors that distinguish its e-Business and Applications Outsourcing services
from other IT service firms.
E-BUSINESS SERVICES
Syntel provides strategic advanced technology services for the design,
development, implementation and maintenance of solutions to enable customers to
be more competitive. Many of today's advanced technology solutions are built
around utilization of the Internet, which has transformed many businesses. The
Company provides customized technology services in the areas of web solutions,
including web architecture, web-enablement of legacy applications, and portal
development. The Company also provides Customer Relationship Management (CRM)
services, which involve software solutions that put Syntel's customers in closer
touch with their own customers. Syntel helps its customers select the
appropriate package software options, then customize and implement the
solutions. In the area of Data Warehousing/Business Intelligence, Syntel helps
customers make more strategic use of information within their businesses through
the development and implementation of data warehouses and data mining tools. In
the area of Enterprise Applications Integration, Syntel takes an enterprise-wide
view of its customers' environment and implements package software solutions
that create better integration, and therefore better information utilization,
between front office and back-office applications. Additionally, the Company has
effectively engaged several partnerships to provide its implementation,
customization, migration and maintenance services with leading software and IT
application software infrastructure providers including Ab Initio, Actuate, BEA
Systems, Business Objects, Cognos, IBM, Informatica, Mercury, Microstrategy,
Oracle, SAP, Serden Technologies, TIBCO, among others. These partnerships will
provide the Company with increased opportunities for market penetration.
13
BUSINESS PROCESS OUTSOURCING (BPO)
Syntel seeks to provide high-value BPO solutions to its customers, as opposed to
low-value, capital-intensive voice-based BPO services. Through BPO, Syntel
provides outsourced solutions for a client's business processes, providing them
with the advantage of a low-cost position and process enhancement through
optimal use of technology. Syntel uses a proprietary tool called Identeon(TM) to
assist with strategic assessments of business processes, identifying the right
ones for outsourcing. In the area of financial services, Syntel focuses on the
middle and back-office business processes of the transaction cycle. Syntel's
insurance BPO services include claims processing and policy administration,
among others. BPO accounted for approximately 8% of revenues, for the year ended
December 31, 2006.
TEAMSOURCING(R)
Syntel offers professional IT consulting services directly to its customers and,
to a lesser degree, in partnership with other service providers. The
professional IT consulting services include individual professionals and teams
of professionals dedicated to assisting customer systems projects and ongoing IT
functions. This service responds to the demand from internal IT departments for
additional expertise, technical skills and personnel. The Company's wide range
of TeamSourcing services include IT applications systems specification, design,
development, implementation and maintenance, which involve diverse computer
hardware, software, data and networking technologies and practices.
STRATEGIC OFFERINGS GROUP
The Company seeks to gain a competitive advantage through its methodologies,
tools and technical expertise. The Company employs a team of professionals in
its Strategic Offerings Group whose mission is to develop and formalize Syntel's
"intellectual capital" for use by the entire Syntel organization. The Strategic
Offerings Group focuses on monitoring industry trends, creating competencies in
emerging technical fields, developing new methodologies, techniques and tools
such as IntelliTransfer(R) and IntelliCapture(SM), creating reusable software
components through its Innovate methodology to enhance quality and value on
customer assignments, and educating Syntel's personnel to improve marketing,
sales and delivery effectiveness. The Strategic Offerings Group consists of
senior technical personnel located in both the U.S. and India.
14
CUSTOMERS
Syntel provides its services to a broad range of Global 2000 corporations in the
financial services, healthcare, insurance, automotive, retail and other
industries. The Company provided services to over 81 customers, principally in
the U.S. The Company also provides services to customers in Europe and Southeast
Asia, many of whom are subsidiaries or affiliates of its U.S. customers.
Representative customers of the Company, each of which provided revenue of at
least $100,000 during 2006, include:
FINANCIAL SERVICES
American Express Technologies
Ameriprise Financials
Boston Financial Data Services
Credit Suisse
Deutsche Bank
FDMS
General Motors Acceptance Corp
International Finance Data Services
Investors Bank and Trust Company
JP Morgan Chase
Moody's
Pioneer Investment Management
Reliance Money Ltd
SEI Global Services Inc
State Street Bank
Wells Fargo
HEALTHCARE
Availity LLC
Blue Cross Blue Shield of North Carolina
First Health Services Corp.
Healthcare Associates
Humana Inc
Mckesson
Wellpoint Inc.
RETAIL & LOGISTICS
1-800-FLOWERS.COM
Carillion Inc
INFO USA, INC
Lowe's Companies, Inc.
PepsiCo Inc.
Target Corporation.
OTHERS
Airlines Reporting Corp
American Greetings
Brocade Communication Systems
Deloitte Consulting
DSMI
Federal Express Corporation
Hewlett Packard
Jeppesen Sanderson, Inc.
Oracle
Symantec
The News Market
Thomas Cook
Tektronix, Inc.
Viskase Companies, Inc.
INSURANCE
Ace Ina Holdings
All State Insurance
American International Group
Ameriprise Insurance
CNA Commercial Lines
John Hancock
Stewart - Landata Systems Inc.
Unirisx
Unitrin Inc
Westfield Insurance
ZC Sterling
AUTOMOTIVE
Daimler Chrysler
Freightliner-LLC
Panasonic Automotive System Co
T-Systems
For the years ended December 31, 2006, 2005, and 2004, the Company's top ten
customers accounted for approximately 70%, 65% and 61% of the Company's
revenues, respectively. The Company's three largest customers in 2006 were
American Express, State Street Bank and Daimler-Chrysler Corporation
contributing approximately 18%, 10% and 8% respectively, of the total revenues.
The Company's largest customer for 2006, 2005 and 2004 was American Express;
accounting for approximately 18%, 16% and 16% of the total consolidated revenues
for the years ended December 31, 2006, 2005 and 2004, respectively.
15
GLOBAL DELIVERY SERVICE
Syntel's Global Delivery Service gives the Company the flexibility and resources
to perform services on-site at the customer's location, off-site at the
Company's U.S. locations and offshore at the Company's Indian locations. By
linking each of its service locations together through a dedicated data and
voice network, Syntel provides a seamless service capability to its customers.
The Global Delivery Service gives the Company the flexibility to deliver to each
customer a customized mix of integrated on-site, off-site and offshore services
to meet varying customer needs for direct interaction with Syntel personnel,
access to technical expertise and best practices, resource availability and
cost-effective delivery.
Through on-site service delivery at the customer's location, the Company is able
to gain comprehensive knowledge concerning the customer's personnel, processes,
technology and culture, and maintain direct customer contact to facilitate
project management, problem solving and integration of Syntel services. Offshore
service delivery at the Company's Indian locations provides the customer with
the capacity to receive around the clock attention to applications maintenance
and project development for faster turnaround, greater availability of
resources, expertise resident in India.
The Company has developed global recruiting and training programs, which have
efficiently provided skilled IT professionals to meet customer needs. In
addition, the Company's sales, solutions and delivery functions are closely
integrated in the Global Delivery Service so that appropriate resources can be
provided to the customer at the right time and at the most advantageous
location. Each customer is tracked and serviced through a multi-stage customer
care process. Regular meetings are held with key project management, sales,
technical, legal and finance personnel to monitor progress, identify issues and
discuss solutions. As engagements evolve and customer needs change, the Company
can reallocate resources responsively among these locations as necessary.
The Company's Global Development Centers located in: Pune, Mumbai and Chennai,
India and a Support Center located at Cary, North Carolina support the Company's
Global Delivery Service.
In January 2001, the Company acquired 40 acres of land at the cost of
approximately $1.0 million for construction of a state-of-the-art development
and training campus in Pune, India. Phase one of the construction was completed
in August 2006, which included an office building for 950 seats, a food court
and hotel. When fully completed, the facility will cover over 1 million square
feet and have capacity for 9,000 seats. It will be both a customer and employee
focused facility, including such amenities as training facilities, cafeteria and
fitness center. Syntel has also acquired additional 37 acres of land that is
adjacent to this campus. In addition, Syntel leases two facilities in Pune,
India consisting of approximately 63,490 square feet.
The Mumbai, India Global Development Center, which employed, including onsite
deputations outside Mumbai, 3,737 persons as of December 31, 2006, serves as the
hub of the Company's Indian operations. This Global Development Center provides
substantial resource depth to meet customer needs around the world, low-cost
service delivery, a 24-hour customer assistance center and development of
technical solutions and expertise. Mumbai also serves as the principal
recruiting and training center for the Company. The Mumbai Center has been in
operation for over a decade and has a capacity of approximately 3,505 people
including BPO operations.
The Chennai Training and Global Development Center employed, including onsite
deputations outside Chennai, 1,423 persons as of December 31, 2006.
16
The Chennai facility has a capacity of approximately 1,513 persons. The Company
has acquired approximately 29 acres of land in an Information Technology Park in
Chennai, India. This area of land has been designated as a Special Economic Zone
(SEZ) by the government of India.
Syntel leases approximately 88,642 square feet of office space in Mumbai, India,
under ten leases expiring on various dates from March 1, 2007 and October 31,
2011. These facilities house IT professionals, as well as its senior management,
finance and accounts, administrative personnel, human resources, recruiting, and
sales and marketing functions.
For facilitating its BPO operations, Syntel has leased 113,325 square feet of
office space in Mumbai, India under four leases expiring on dates ranging
between February 1, 2008 and January 31, 2011.
Syntel leases approximately 122,408 square feet of office space in Chennai,
India, under three leases expiring on dates ranging between April 1, 2007 and
March 31, 2009, all subject to the Company's option to renew for additional
periods.
The Company believes that space availability in Mumbai and Chennai will
accommodate short-term facility requirements and the new campus in Pune will
enable the Company to meet offshore growth requirements for the next several
years. The Company is also considering expanding its footprint in Tier I, Tier
II and Tier III cities in India to meet its growth objectives.
SALES AND MARKETING
The Company markets and sells its services directly through its professional
sales people and senior management operating principally from the Company's
offices in Santa Clara, California; Phoenix, Arizona; Schaumburg, Illinois;
Dallas, Texas; Minneapolis, Minnesota; New York, New York; Troy, Michigan; Cary,
North Carolina; Nashville, Tennessee; Natick, Massachusetts; London, England;
Hong Kong; Stuttgart, Germany and Singapore. The sales staff is aligned by
industry vertical, with each salesperson provided the authority to pursue
Applications Outsourcing, e-Business, BPO and, to a much lesser degree,
TeamSourcing opportunities. The sales team is supported, as required, by
technical expertise and subject matter experts from the Company's delivery
teams.
The sales cycle for Applications Outsourcing engagements ranges from six to
twelve months, depending on the complexity of the engagement. Due to this longer
sales cycle, Applications Outsourcing sales executives follow an integrated
sales process for the development of engagement proposals and solutions, and
receive ongoing input from the Company's technical services, delivery, finance
and legal departments throughout the sales process. The Applications Outsourcing
sales process also typically involves a greater number of customer personnel at
more senior levels of management than the TeamSourcing sales process.
HUMAN RESOURCES
The Company believes that its human resources are its most valuable asset. As of
December 31, 2006, the Company had 8,364 full time employees and its worldwide
billable headcount consisted of 5,499 consultants providing professional
services to Syntel.
A majority of the Company's professional employees have a Bachelor of Science
degree or its equivalent, or higher degrees in computer science, engineering
disciplines, management, finance and other areas. Their experience level ranges
from entry-level programmers to engagement
17
managers and senior consultants with over 20 years of IT experience. The Company
has personnel who are experienced in mainframe, client/server and open systems
technologies, and proficient in a variety of computer programming languages,
software tools, database management systems, networks, processes, methodologies,
techniques and standards.
The Company has implemented a management structure and human resources
organization intended to maximize the Company's ability to efficiently expand
its professional staff. Although the Company believes that it has the capability
to meet its anticipated future needs for IT professionals through its
established recruiting and training programs, there can be no assurance that the
Company will be able to hire, train or retain qualified IT professionals in
sufficient numbers to meet anticipated staffing needs.
RECRUITING. The Company has developed a recruiting methodology and organization,
which is a core competency. The Company has significantly expanded its
international-based recruiting team, with recruiters in Mumbai, Chennai,
Hyderabad, Bangalore, and Pune, India, to recruit for the Company's global
requirements. The Company also has a recruiting team based in the U.S., which
recruits primarily across the U.S. The Company uses a standardized global
selection process that includes written tests, interviews, and reference checks.
Among the Company's other recruiting techniques are the placement of
advertisements on its own web site and popular job boards, in newspapers and
trade magazines, providing bonuses to its employees who refer qualified
applicants, participating in job fairs and recruiting on university campuses. In
addition, the Company has developed a proprietary database of talent hosted on
the Internet, which is an automated tool for managing all phases of recruiting.
This system enhances the ability of the Company's recruiters to select
appropriate candidates and can distribute resumes directly to the recruiters.
TRAINING. The Company uses a number of established training delivery mechanisms
in its efforts to provide a consistent and reliable source for qualified IT
professionals.
Syntel also maintains an Internet-based global Computer-Based Training (CBT)
program with over 200 training courses from which Syntel employees can select to
enhance and develop their skills. The CBT topics cover the latest Client/Server
topics including Object Oriented Programming, local-area and wide-area
networking, E-Commerce, various Microsoft products, and Web-based solutions in
addition to management and related developmental areas.
The Company continued to re-skill a significant percentage of the consulting
base during the last year in the latest advanced software platforms, including
J2EE, Object Oriented, C++, C-Sharp, .NET, RMI CORBA, SAP, PeopleSoft, ETL,
Datastage, Ab-initio, Informatica and Microstrategy.
Since 1998, the Company has operated a Project Manager Training program. The
objective of the program is to develop certified project managers to ensure
consistent and quality delivery of the Company's engagements on a worldwide
basis. The 12 to 18 month program consists of lecture style classroom work,
computer based training, and on the job apprenticeships. The program trains
students on industry "best practices" as well as Syntel specific methods and
processes. Program participants must receive certification from the Project
Management Institute ("PMI") before receiving Syntel branded certification.
The Company has been accepted as a Microsoft Certified Solution Partner and
sponsors the Microsoft Certification Program and provides opportunities for
cross training of its professionals in emerging
18
technologies at its various development centers.
SUPPORT AND RETENTION. The Company seeks to provide meaningful support to its
employees which the Company believes leads to improved employee retention and
better quality services to its customers. A significant percentage of the
Company's employees have been recruited from outside the U.S. and relocated to
the U.S. This has resulted in the need to provide a higher level of initial
support to its employees than is common for U.S.-based employees. As a result of
these activities, Syntel has developed a significant knowledge base in making
foreign professionals comfortable and quickly productive in the U.S. and Europe.
The Company also conducts regular career planning sessions with its employees,
and seeks to meet their career goals over a long-term planning horizon.
As part of its retention strategy, the Company strives to provide a competitive
compensation and benefits package, including relocation reimbursement and
support, medical insurance, dental options, a vision eye-care program, life
insurance, long-term disability coverage, short-term disability options, a
401(k) plan, tuition subsidy plan, and a health club reimbursement program.
During 2005 and 2006, the Company issued incentive restricted stock to its
non-employee directors and some employees as well as to some employees of its
subsidiaries.
COMPETITION
The IT services industry is intensely competitive, highly fragmented and subject
to rapid change and evolving industry standards. The Company competes with a
variety of other companies, depending on the IT services it offers. The
Company's primary competitors include system integrator firms, application
software companies, professional services groups of computer equipment
companies, and contract programming companies. The Company's most direct
competitors include Cognizant, Infosys Technologies, Tata consultancy Services
and Wipro Technologies that utilize an integrated on-site/offshore business
model comparable to that used by the Company. The Company also competes with
large IT service providers with greater resources, such as Accenture, Electronic
Data Systems, IBM Global Services and Keane. The Company is also seeing
increased competition from non-Indian sources such as China, Eastern Europe and
the Philippines. In addition, the Company competes with numerous smaller local
companies in the various geographic markets in which the Company operates. Many
of the Company's customers choose to work with more than one IT service provider
and contract with an individual provider to work on specific engagements that
best match that provider's expertise.
AVAILABLE INFORMATION
Syntel makes available, free of charge, through its investor relations website
its Annual Reports on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports
on Form 8-K, and amendments to those reports filed or furnished pursuant to
Section 13(a) or 15 (d) of the Exchange Act, as soon as reasonably practicable
after they are electronically filed with or furnished to the SEC. The URL for
Syntel's investor relations' web site is www.syntelinc.com.
19
EXECUTIVE OFFICERS OF THE REGISTRANT
The executive officers of the Registrant, their ages, and the position or office
held by each, are as follows:
NAME AGE POSITION
---- --- --------------------------------------
Bharat Desai 54 Chairman and Chief Executive Officer
Neerja Sethi 52 Vice President, Corporate Affairs and
Director
Keshav Murugesh 43 President and Chief Operating Officer
Arvind S. Godbole 49 Chief Financial Officer and Chief
Information Security Officer
Daniel M. Moore 52 Chief Administrative Officer, General
Counsel and Secretary
Rakesh Khanna 44 President Business Unit- Banking &
Finance
R. S. Ramdas 52 Senior Vice President, Finance and
Corporate Services
Srikanth Karra 43 Vice President, Global Human Resources
Lakshmanan Chidambaram 43 Vice President, Sales
Anil Jain 48 Business Unit Head & Senior Vice
President, Insurance Vertical
Nitin Rakesh 35 Vice President and Head of B&FS BPO
Operations
20
Bharat Desai is a co-founder of Syntel and serves as its Chairman of the Board,
Chief Executive Officer and as a director. He has served as the Company's Chief
Executive Officer and as a director since its formation in 1980 and has been the
Chairman of Syntel's Board of Directors since February 1999. He also served as
the Company's President since its formation until December 2006. Mr. Desai is
the spouse of Ms. Sethi.
Neerja Sethi is a co-founder of the Company and has served as a director and as
Vice President, Corporate Affairs since its formation in 1980. Ms. Sethi is the
spouse of Mr. Desai.
Keshav Murugesh was appointed President of the Company in December 2006. He also
serves as the Company's Chief Operating Officer, a position to which he was
appointed in October 2004. Mr. Murugesh joined the Company as Chief Financial
Officer in May 2002 and continued as Acting Chief Financial Officer until his
successor was appointed in May 2005. Prior to joining Syntel, Mr. Murugesh
served as Vice President Finance at ITC Infotech Ltd from October 2000 to May
2002. Prior to this assignment, Mr. Murugesh served as Finance Head, Information
Systems Business from August 1999 to September 2000 at ITC Ltd, India.
Arvind Godbole was appointed Chief Financial Officer in December 2006 after
being appointed Interim Chief Financial Officer in June 2006. Mr. Godbole was
appointed the Company's Chief Information Security Officer in June 2006. He has
been with the Company as Corporate Controller since March 2001 and has also been
a member of the Procurement Team along with his usual functions as a controller.
From 1998 to 2001, Mr. Godbole was Deputy General Manager -- Finance with
Wockhardt Ltd., a pharmaceutical company listed on the major stock exchanges in
India, where he was responsible for accounts, audit and tax planning.
Daniel M. Moore has served the Company as Chief Administrative Officer,
Secretary, and General Counsel since August 1998.
Rakesh Khanna was appointed as Banking & Finance Business Unit President for the
Company in July 2005. Prior to joining Syntel, Mr. Khanna served in senior
management at IFLEX Solutions Ltd., a company specializing in software products
and services for banks and financial service institutions, from September 1996
to July 2005.
R.S. Ramdas was appointed as Senior Vice President, Finance and Corporate
Services in January 2006 and became a member of the leadership team in February
2006. Mr. Ramdas served as Vice President of Syntel from March 2004 to January
2006 and has served with Syntel since 1990 in various positions including
heading corporate tax, treasury, internal audit, global procurement and various
other functions.
Srikanth Karra was appointed as Syntel's Vice-President - Global Human Resources
in March 2005. Prior to joining Syntel, Mr. Karra served as HR Head for India
and Global Leader for Staffing and Relationship Development at GE Capital
International Services, a global diversified financial services company, from
2001 to 2005.
Lakshmanan Chidambaram was appointed as Head of Sales, Banking and Financial
Services and Insurance Business units in February 2006 and, in December 2006,
assumed responsibility for Automotive, Healthcare and Diversified Businesses
sales. Mr. Chidambaram joined Syntel in 2001 and has served in a variety of
sales positions.
21
Anil Jain was appointed as Business Unit Head & Senior Vice President, Insurance
Vertical in February 2006. Mr. Jain has been with Syntel since 1993 serving in a
number of client relationship and service delivery capacities.
Nitin Rakesh was appointed as Vice President and Head of B&FS BPO Operations in
February 2006 and has been with Syntel since October 2002 in various capacities
with the business BPO unit. Prior to joining Syntel, Mr. Rakesh served in
various capacities in TCG Group, a company specializing in investments, real
estate & software from December 1999 to September 2002, with his last assignment
in the group as Head of Sales, Banking & Financial Services, for TCG Software
Services.
22
ITEM 1A. RISK FACTORS
The following factors should be considered carefully when evaluating our
business.
FAILURE TO HIRE AND RETAIN A SUFFICIENT NUMBER OF QUALIFIED IT PROFESSIONALS
COULD HAVE A MATERIAL ADVERSE EFFECT ON THE COMPANY'S BUSINESS, RESULTS OF
OPERATIONS AND FINANCIAL CONDITION.
The Company's business of delivering professional IT services is labor
intensive, and, accordingly, the Company's success depends upon the Company's
ability to attract, develop, motivate, retain and effectively utilize
highly-skilled IT professionals. The Company believes that there is a growing
shortage of, and significant competition for, IT professionals who possess the
technical skills and experience necessary to deliver the Company's services,
both in the United States and in India, and that such IT professionals are
likely to remain a limited resource for the foreseeable future. The Company
believes that, as a result of these factors, the Company operates within an
industry that experiences a significant rate of annual turnover of IT personnel.
The Company's business plans are based on hiring and training a significant
number of additional IT professionals each year to meet anticipated turnover and
increased staffing needs. The Company's ability to maintain and renew existing
engagements and to obtain new business depends, in large part, on the Company's
ability to hire and retain qualified IT professionals. The Company performs a
portion of the Company's employee recruitment for U.S. positions in foreign
countries, particularly India. Any perception among the Company's current or
potential employees or foreign IT professionals that the Company's ability to
assist them in obtaining permanent residency status in the United States has
been diminished, could result in increased recruiting and personnel costs or
lead to significant employee attrition or both. For the years ended December 31,
2006, 2005 and 2004 attrition was 13%, 14% and 14%, respectively. For the same
periods, the number of net hires was 2,271, 1,566 and 666, respectively. There
can be no assurance that the Company will be able to recruit and train a
sufficient number of qualified IT professionals or that the Company will be
successful in retaining current or future employees. Increased hiring by
technology companies, particularly in India, and increasing worldwide
competition for skilled technology professionals may lead to a shortage in the
availability of qualified personnel in the markets in which the Company operates
and hires. Failure to hire and train or retain qualified IT professionals in
sufficient numbers could have a material adverse effect on the Company's
business, results of operations and financial condition.
GOVERNMENT REGULATION OF IMMIGRATION COULD IMPACT THE COMPANY'S ABILITY TO BRING
A SUFFICIENT NUMBER OF IT PROFESSIONALS TO THE UNITED STATES OR OTHER
JURISDICTIONS.
The Company recruits IT professionals on a global basis and, therefore, must
comply with the immigration laws of the countries in which the Company operates,
particularly the United States. As of December 31, 2006, 778 IT professionals,
representing approximately 52% of the Company's U.S. workforce and 9% of the
Company's worldwide workforce worked under H-1B visas (permitting temporary
residence while employed in the United States) and another 219 IT professionals,
representing 15% of the Company's U.S. workforce and 3% of the Company's
worldwide workforce worked under L-1 visas (permitting inter-company transfers
of employees that have been employed with a foreign subsidiary for at least six
months). United States federal law limits the number of new H-1B visas to be
approved in any fiscal year. Currently, the total number of H-1B
23
visas permitted is 65,000 per U.S. government fiscal year, a decrease from
195,000 of the 2003 fiscal year. In years in which this limit is reached, the
Company may be unable to obtain enough H-1B visas to bring a sufficient number
of foreign employees to the United States. If the Company were unable to obtain
sufficient H-1B employees, the Company's business, results of operations and
financial condition could be materially and adversely affected. Furthermore,
Congress and administrative agencies have periodically expressed concerns over
the levels of legal immigration into the United States. These concerns have in
the past resulted and may in the future result in proposed legislation, rules
and regulations aimed at reducing the number of work visas, including L-1 and
H-1B visas that may be issued.
The Company is also subject to various immigration and work permit restrictions
in other jurisdictions where the Company operates or plans to operate, including
the European community. These restrictions restrain the Company's ability to
increase the number of skilled professionals in certain regions and could have
an adverse impact on the Company's global strategy. The impact of these
regulations, including any changes to immigration and work permit regulations in
particular jurisdictions, could have a material adverse effect on the Company's
business, results of operations and financial condition.
THE COMPANY'S BUSINESS COULD BE MATERIALLY ADVERSELY AFFECTED IF ONE OF THE
COMPANY'S SIGNIFICANT CLIENTS TERMINATES ITS ENGAGEMENT OF US OR IF THERE IS A
DOWNTURN IN ONE OF THE INDUSTRIES THE COMPANY SERVES.
The Company has in the past derived, and believes will continue to derive, a
significant portion of its revenues from a limited number of large, corporate
clients. The Company's ten largest clients generated approximately 70%, 65%, and
61% of the Company's total revenues for the years ended December 31, 2006, 2005
and 2004, respectively. The Company's largest client for the years ended
December 31, 2006, 2005 and 2004, was American Express, which generated
approximately 18%, 16% and 16% of the Company's total revenues for the years
ended December 31, 2006, 2005 and 2004, respectively. The Company expects to
continue to derive a significant portion of the Company's revenues from American
Express. Failure to meet a client's expectations could result in cancellation or
non-renewal of the Company's engagement and could damage the Company's
reputation and adversely affect its ability to attract new business. Many of the
Company's contracts, including all of the Company's contracts with its ten
largest clients, are terminable by the client with limited notice to the company
and without compensation beyond payment for the professional services rendered
through the date of termination. An unanticipated termination of a significant
engagement, including in connection with the acquisition of a significant
client, could result in the loss of substantial anticipated revenues and could
require the Company to either maintain or terminate a significant number of
unassigned IT professionals. The loss of any significant client or engagement
could have a material adverse effect on the Company's business, results of
operations and financial condition.
The Company also has derived, and expects to continue to derive, a significant
portion of its revenues from clients in certain industries, including the
financial services, insurance and healthcare industries. Clients in the
financial services industry generated approximately 43%, 40% and 38% of the
Company's revenues for the years ended December 31, 2006, 2005 and 2004,
respectively. A downturn in the financial services industry or other industries
from which the Company derive significant revenues could result in less revenue
from current and potential clients in such industry and could have a material
adverse effect on the Company's business, results of operations and financial
condition.
24
THE COMPANY MAY BE AFFECTED BY POLITICAL AND REGULATORY CONDITIONS, INCLUDING
WAGE INCREASES, IN INDIA.
A significant element of the Company's business strategy is to continue to
develop and expand offshore Global Development Centers in India. Changes in the
political or regulatory climate of India, including the following, could have a
material adverse effect on the Company's business, results of operations and
financial condition:
- Political climate -- In the past, India has experienced significant
inflation and shortages of foreign currency and has been subject to
civil unrest. No assurance can be given that the Company will not be
adversely affected by changes in inflation, exchange rate
fluctuations, currency controls, interest rates, tax provisions,
social stability or other political, economic or diplomatic
developments in or affecting India.
- Changes in liberalization policies of the government -- The Indian
government is significantly involved in, and exerts significant
influence over, its economy. In the recent past, the Indian government
has provided significant tax incentives and relaxed certain regulatory
restrictions in order to encourage foreign investment in certain
sectors of the economy, including the technology industry. Certain of
these benefits directly benefited us including, among others, tax
holidays, liberalized import and export duties and preferential rules
on foreign investment. There can be no assurance that these benefits
will be continued or that other similar benefits will be provided in
future periods.
WAGE PRESSURES IN INDIA MAY REDUCE THE COMPANY'S PROFIT MARGINS.
Wage pressures in India may prevent us from sustaining the Company's competitive
advantage and may reduce the Company's profit margins. As of December 31, 2006
approximately 73% of the Company's billable workforce was in India, and the
Company anticipates that this percentage will increase over time. Wage costs in
India have historically been significantly lower than wage costs in the United
States and Europe for comparably skilled professionals, which has been one of
the Company's competitive strengths. However, wage increases in India may
prevent us from sustaining this competitive advantage and may negatively affect
the Company's profit margins. Wages in India are increasing at a faster rate
than in the United States, which could result in increased costs for technology
professionals, particularly project managers and other mid-level professionals.
The Company may need to increase the levels of the Company's employee
compensation more rapidly than in the past to remain competitive with other
employers, or seek to recruit in other low labor cost jurisdictions to keep the
Company's wage costs low. For example, the Company recently established a
long-term retention program for its senior executives and employees. In
addition, under SFAS No. 123R, the Company is now required to expense
stock-based awards to employees. Compensation increases may result in a material
adverse effect on the Company's business, results of operations and financial
condition.
THE COMPANY'S ABILITY TO REPATRIATE EARNINGS FROM ITS FOREIGN OPERATIONS IS
LIMITED BY TAX LAWS.
The Company treats earnings from its operations in India and other foreign
countries as permanently invested outside the United States. If the Company
repatriates any of such earnings, the Company will incur a dividend distribution
tax for distribution from India, currently 14.03% under Indian tax law, and be
required to pay United States corporate
25
income taxes on such earnings. As of December 31, 2006, the estimated dividend
distribution taxes and United States corporate taxes that would be due upon
repatriation of accumulated earnings from the Company's operations in India was
approximately $47.1 million. If the Company decided to repatriate all
undistributed repatriable earnings of foreign subsidiaries as of December 31,
2006, the Company would have accrued taxes of approximately $51.2 million.
THE IT SERVICES AND BPO INDUSTRY ARE INTENSELY COMPETITIVE, AND THE COMPANY MAY
NOT BE ABLE TO COMPETE SUCCESSFULLY AGAINST CURRENT AND FUTURE COMPETITORS.
The IT services and BPO industry are intensely competitive, highly fragmented
and subject to rapid change and evolving industry standards. The Company
competes with a variety of other companies, depending on the services offered.
In Applications Outsourcing and e-Business services, the Company primarily
competes with domestic firms such as Accenture, Cognizant, EDS, IBM Global
Services and Keane and with an increasing number of India-based companies
including Infosys Technologies, Tata Consultancy Services and Wipro
Technologies. The Company is also seeing increased competition from non-Indian
sources such as China, Eastern Europe and the Philippines. In BPO, the Company
primarily competes with other offshore BPO vendors including HCL, Wipro
Technologies and WNS. In professional IT staffing engagements, the Company's
primary competitors include participants from a variety of market segments,
including systems consulting and implementation firms, applications software
development and maintenance firms, service groups of computer equipment
companies and temporary staffing firms. Many of the Company's competitors have
substantially greater financial, technical and marketing resources and greater
name recognition than it does. As a result, they may be able to compete more
aggressively on pricing, respond more quickly to new or emerging technologies
and changes in client requirements, or devote greater resources to the
development and promotion of IT services and BPO than the Company does.
India-based companies also present significant price competition due to their
competitive cost structures and tax advantages. In addition, there are
relatively few barriers to entry into the Company's markets and the Company has
faced, and expects to continue to face, additional competition from new IT
service and BPO providers. Further, there is a risk that the Company's clients
may elect to increase their internal resources to satisfy their IT services
needs as opposed to relying on a third-party vendor like us. The IT services
industry is also undergoing consolidation, which may result in increased
competition in the Company's target markets. Increased competition could result
in price reductions, reduced operating margins and loss of market share. There
can be no assurance that the Company will be able to compete successfully with
existing or new competitors or that competitive pressures will not materially
adversely affect the Company's business, results of operations and financial
condition.
THE COMPANY MAY NOT BE ABLE TO SUCCESSFULLY MANAGE THE RAPID GROWTH OF THE
COMPANY'S BUSINESS.
The Company has recently experienced a period of rapid growth in revenues that
places significant demands on the Company's managerial, administrative and
operational resources. Additionally, the longer-term transition in the Company's
delivery mix from onsite to offshore staffing has also placed additional
operational and structural demands on us. The Company's future growth depends on
recruiting, hiring and training IT professionals, increasing the Company's
international operations, expanding its U.S. and offshore capabilities, adding
effective sales and management staff and adding service offerings. Effective
management of
26
these and other growth initiatives will require that the Company continue to
improve its infrastructure, execution standards and ability to expand services.
Failure to manage growth effectively could have a material adverse effect on the
quality of the Company's services and engagements, the Company's ability to
attract and retain IT professionals, the Company's prospects and the Company's
business, results of operations and financial condition.
THE COMPANY'S APPLICATIONS OUTSOURCING SERVICES REQUIRE INCREASED ATTENTION FROM
SENIOR MANAGEMENT AND THE COMPANY'S E-BUSINESS AND BPO PRACTICES REQUIRE
INCREASED SALES AND MARKETING.
In recent years, the Company has realigned existing personnel and resources, and
has invested incrementally in the development of the Company's Applications
Outsourcing business, with increased focus on outsourcing services for ongoing
applications management, development and maintenance. Applications Outsourcing
services generally require a longer sales cycle (up to twelve months) and
generally require approval by more senior levels of management within the
client's organization, as compared with traditional IT staffing services.
Pursuing such sales requires significant investment of time, including by the
Company's senior management, and may not result in additional business. The
Company has also invested in the development of the Company's e-Business and BPO
practices. Many e-Business engagements are short in duration (three to six
months), requiring increased sales and marketing. There can be no assurance that
the Company's increased focus on the Company's Applications Outsourcing,
e-Business and BPO practices will be successful, and any failure of such
strategy could have a material adverse effect on the Company's business, results
of operations and financial condition.
THE COMPANY'S FIXED-PRICE ENGAGEMENTS MAY COMMIT US TO UNFAVORABLE TERMS.
The Company undertakes development and maintenance engagements, which are billed
on a fixed-price basis, in addition to the engagements billed on
time-and-materials basis. Fixed-price revenues from development and maintenance
activity represented approximately 42%, 50% and 54% of total revenues for the
years ended December 31, 2006, 2005 and 2004, respectively. The Company's
strategy includes increasing the percentage of the Company's revenues derived
from fixed-price engagements. Any failure to estimate accurately the resources
and time required to complete a fixed-price engagement on time and to the
required quality levels or any unexpected increase in the cost to us of IT
professionals, office space or materials could expose us to risks associated
with cost overruns and could have a material adverse effect on the Company's
business, results of operations and financial condition.
THE COMPANY MAY BE LIABLE TO ITS CLIENTS FOR DISCLOSURE OF CONFIDENTIAL
INFORMATION OR IF THE COMPANY DOES NOT FULFILL ITS OBLIGATIONS UNDER ITS
ENGAGEMENTS.
The Company may be liable to the Company's clients for damages caused by
disclosure of confidential information or system failures. The Company is often
required to collect and store sensitive or confidential client data. Many of the
Company's client agreements do not limit its potential liability for breaches of
confidentiality. If any person, including any of the Company's employees,
penetrates the Company's network security or misappropriates sensitive data, the
Company could be subject to significant liability from its clients or from their
customers for breaching contractual confidentiality provisions or privacy laws.
Unauthorized disclosure of sensitive or confidential client data, whether
through breach of the Company's computer systems, systems failure or
27
otherwise, could also damage the Company's reputation and cause it to lose
existing and potential clients. Many of the Company's engagements involve IT
services that are critical to the operations of the Company's clients'
businesses. Any failure or inability to meet a client's expectations in the
performance of services could result in a claim for substantial damages against
us, regardless of the Company's responsibility for such failure. There can be no
assurance that the limitations of liability set forth in the Company's service
contracts will be enforceable in all instances or would otherwise protect us
from liability for damages. In addition, the costs of defending against any such
claims, even if successful, could be significant.
There can be no assurance that the Company's insurance coverage will continue to
be available on reasonable terms, will be available in sufficient amounts to
cover one or more large claims or defense costs, or that the Company's insurer
will not disclaim coverage as to any future claim. The successful assertion of
one or more large claims against us that are uninsured, exceed available
insurance coverage or result in changes to the Company's insurance policies,
including premium increases or the imposition of large deductible or
co-insurance requirements, could adversely affect the Company's business,
results of operations and financial condition.
THE COMPANY DEPENDS ON THE EFFORTS AND ABILITY OF KEY PERSONNEL, INCLUDING THE
COMPANY'S CHIEF EXECUTIVE OFFICER.
The Company's success is highly dependent on the efforts and abilities of Bharat
Desai, the Company's co-founder, Chairman, and Chief Executive Officer, and
other key personnel. The diminution or loss of the services of Mr. Desai or
other key personnel for any reason could have a material adverse effect on the
Company's business, operating results and financial condition. The Company does
not maintain key man life insurance on Mr. Desai or any other key personnel.
THE COMPANY'S BUSINESS COULD BE MATERIALLY ADVERSELY AFFECTED IF THE COMPANY
DOES NOT PROTECT ITS INTELLECTUAL PROPERTY OR IF THE COMPANY'S SERVICES ARE
FOUND TO INFRINGE ON THE INTELLECTUAL PROPERTY OF OTHERS.
The Company's success depends in part on certain methodologies, practices, tools
and technical expertise the Company utilizes in designing, developing,
implementing and maintaining applications and other proprietary intellectual
property rights. In order to protect the Company's rights in these various
intellectual properties, the Company relies upon a combination of nondisclosure
and other contractual arrangements as well as trade secret, copyright and
trademark laws. The Company also generally enters into confidentiality
agreements with its employees, consultants, clients and potential clients and
limit access to and distribution of the Company's proprietary information.
The Company presently holds no patents or registered copyrights. The Company
hold several trademarks or service marks, including: Syntel(R), registered in
the United States and Germany; Consider IT Done(R), registered in the United
States and Germany; Identeontm; IntelliSourcing(R); IntelliTransfer(R);
SkillBay(R); TeamSourcing(R); Total ERP Applications Methodology (TEAM)(R);
Latest-to-Legacy(R); New2USA.com(R); and Digital Blueprinting-Build-Optimize(R).
The Company also has submitted United States federal and foreign trademark
applications for the names of additional service offerings. There can be no
assurance that the Company will be successful in maintaining or obtaining
trademarks for these trade names. India is a member of the Berne Convention, an
international intellectual property treaty, and has agreed to recognize
protections on intellectual
28
property rights conferred under the laws of foreign countries, including the
laws of the United States. There can be no assurance that the laws, rules,
regulations and treaties in effect in the United States and India and the
contractual and other protective measures the Company takes are adequate to
protect it from misappropriation or unauthorized use of the Company's
intellectual property, or that such laws will not change. In particular, the
laws of India could change in ways that may prevent or restrict the transfer of
software components, libraries and toolsets from India to the United States.
There can be no assurance that the Company will be able to detect unauthorized
use and take appropriate steps to enforce the Company's rights, or that any such
steps will be successful. Infringement by others of the Company's intellectual
property, including the costs of enforcing the Company's intellectual property
rights, could have a material adverse effect on the Company's business, results
of operations and financial condition.
Although the Company believes that its intellectual property does not infringe
on the intellectual property rights of others, there can be no assurance that
such a claim will not be asserted against us in the future or that any such
claim, if asserted, would not be successful. The costs of defending any such
claims could be significant, and any successful claim could require the Company
to modify, discontinue or change the name of any of its services. Any such
changes could have a material adverse effect on the Company's business, results
of operations and financial condition.
FUTURE LEGISLATION IN THE UNITED STATES AND ABROAD COULD SIGNIFICANTLY IMPACT
THE ABILITY OF THE COMPANY'S CLIENTS TO UTILIZE THE COMPANY'S SERVICES.
The issue of companies outsourcing services abroad has become a topic of
political discussion in the United States and other countries. Measures aimed at
limiting or restricting outsourcing have been enacted in a few states, and there
is currently legislation pending in several states and at the federal level. The
measures that have been enacted to date have not significantly adversely
affected the Company's business. There can be no assurance that pending or
future legislation that would significantly adversely affect the Company's
business will not be enacted. If enacted, such measures are likely to fall
within two categories: (1) a broadening of restrictions on outsourcing by
government agencies and on government contracts with firms that outsource
services directly or indirectly, and/or (2) measures that impact private
industry, such as tax disincentives, restrictions on the transfer or maintenance
of certain information abroad and/or intellectual property transfer
restrictions. In the event that any such measures are enacted, or if the
prospect of such measures being enacted increases, the ability of the Company's
clients to utilize its services could be restricted or become less economical
and the Company's business, results of operations and financial condition could
be adversely affected.
THE COMPANY'S MARGINS MAY BE ADVERSELY AFFECTED IF DEMAND FOR THE COMPANY'S
SERVICES SLOWS.
If demand for the Company's services slows, the Company's utilization and
billing rates for its technology professionals could be adversely affected,
which may result in lower gross and operating profits.
29
THE COMPANY'S FUTURE SUCCESS DEPENDS ON ITS ABILITY TO MARKET NEW SERVICES,
INCLUDING END-TO-END BUSINESS SOLUTIONS, TO THE COMPANY'S EXISTING AND NEW
CLIENTS.
Over the past several years, the Company has been expanding the nature and scope
of its engagements by extending the breadth of services the Company offers. The
success of the Company's service offerings depends, in part, upon continued
demand for such services by the Company's existing and new clients and the
Company's ability to meet this demand in a cost competitive and effective
manner. In addition, the Company's ability to effectively offer a wider breadth
of end-to-end business solutions depends on its ability to attract existing or
new clients to these service offerings. To obtain engagements for the Company's
end-to-end solutions, the Company also is more likely to compete with large,
well-established international consulting firms as well as other India-based
technology services companies, resulting in increased competition and marketing
costs. The Company's new service offerings may not effectively meet client
needs, and the Company may be unable to attract existing and new clients to
these service offerings. The increased breadth of the Company's service
offerings may also result in larger and more complex client projects, which will
require that the Company establish closer relationships with its clients, and
potentially with other technology service providers and vendors, and develop a
more thorough understanding of the Company's clients' operations. The Company's
ability to establish these relationships will depend on a number of factors
including the proficiency of the Company's technology professionals and its
management personnel and the willingness of the Company's existing and potential
clients to provide it with information about their businesses. If the Company is
not able to successfully market and provide the Company's new and broader
service offerings, the Company's business, results of operations and financial
condition could be materially adversely affected.
THE COMPANY'S BUSINESS COULD BE ADVERSELY AFFECTED IF THE COMPANY DOES NOT
ANTICIPATE AND RESPOND TO TECHNOLOGY ADVANCES IN THE COMPANY'S AND THE COMPANY'S
CLIENTS' INDUSTRIES.
The Company's business will suffer if the Company fails to anticipate and
develop new services and enhance existing services in order to keep pace with
rapid changes in technology and in the industries on which the Company focus.
The technology services and BPO markets are characterized by rapid technological
change, evolving industry standards, changing client preferences and frequent
new product and service introductions. The Company's future success will depend
on the Company's ability to anticipate these advances and develop new product
and service offerings to meet the Company's existing and potential clients'
needs. The Company may fail to anticipate or respond to these advances in a
timely manner, or, if the Company does respond, the services or technologies the
Company develops may not be successful in the marketplace. Further, products,
services or technologies that are developed by the Company's competitors may
render the Company's services non-competitive or obsolete. If the Company does
not respond effectively to these changes, the Company's business, results of
operations and financial condition could be materially adversely affected.
THE COMPANY MAY BE REQUIRED TO INCLUDE BENCHMARKING PROVISIONS IN FUTURE
ENGAGEMENTS, WHICH COULD HAVE AN ADVERSE EFFECT ON THE COMPANY'S REVENUES AND
PROFITABILITY.
As the size and duration of the Company's client engagements increase, the
Company's current and future clients may require benchmarking provisions.
Benchmarking provisions allow a client in certain circumstances to request
30
that a benchmark study prepared by an agreed upon third-party comparing the
Company's pricing, performance and efficiency gains for delivered contract
services to that of an agreed upon list of other service providers for
comparable services. Based on the results of the benchmark study and depending
on the reasons for any unfavorable variance, the Company could then be required
to reduce the pricing for future services to be performed under the balance of
the contract, which could have an adverse impact on the Company's revenues and
profitability.
THE COMPANY IS SUBJECT TO CORPORATE GOVERNANCE AND DISCLOSURE REQUIREMENTS THAT
HAVE RESULTED AND LIKELY WILL CONTINUE TO RESULT IN INCREASED COSTS AND
MANAGEMENT ATTENTION.
Compliance with new and changing corporate governance and public disclosure
requirements adds uncertainty to the Company's compliance policies and increases
the Company's costs of compliance. Changing laws, regulations and standards
include those relating to accounting, corporate governance and public
disclosure, including the Sarbanes-Oxley Act of 2002, new SEC regulations and
NASDAQ Global Select Market rules. These new or changed laws, regulations and
standards may lack specificity and are subject to varying interpretations. Their
application in practice may evolve over time as new guidance is provided by
regulatory and governing bodies. This could result in continuing uncertainty
regarding compliance matters and higher costs of compliance as a result of
ongoing revisions to such governance standards. The Company's efforts to comply
with evolving laws, regulations and standards have resulted in, and are likely
to continue to result in, increased general and administrative expenses and a
diversion of management time and attention from revenue-generating activities to
compliance activities. In addition, new laws, regulations and standards
regarding corporate governance may make it more difficult for us to obtain
director and officer liability insurance. Further, the Company's board members,
Chief Executive Officer and Chief Financial Officer could face an increased risk
of personal liability in connection with their performance of duties. As a
result, the Company may face difficulties attracting and retaining qualified
board members and executive officers, which could harm the Company's business.
If the Company fails to comply with new or changed laws or regulations and
standards differ, the Company's business and reputation may be harmed.
WHILE THE COMPANY BELIEVES IT CURRENTLY HAS ADEQUATE INTERNAL CONTROL OVER
FINANCIAL REPORTING, THE COMPANY IS REQUIRED TO ASSESS ITS INTERNAL CONTROLS
OVER FINANCIAL REPORTING ON AN ANNUAL BASIS. ANY FUTURE ADVERSE RESULTS FROM
SUCH ASSESSMENT COULD RESULT IN A LOSS OF INVESTOR CONFIDENCE IN THE COMPANY'S
FINANCIAL REPORTING AND HAVE AN ADVERSE EFFECT ON THE COMPANY'S STOCK PRICE.
Section 404 of the Sarbanes-Oxley Act of 2002 and the accompanying rules and
regulations promulgated by the SEC to implement it require us to include in the
Company's Form 10-K an annual report by the Company's management regarding the
effectiveness of the Company's internal control over financial reporting. The
report includes, among other things, an assessment of the effectiveness of the
Company's internal control over financial reporting as of the end of the
Company's fiscal year. This assessment must include disclosure of any material
weaknesses in the Company's internal control over financial reporting identified
by management.
The Committee of Sponsoring Organizations of the Treadway Commission (COSO)
provides a framework for companies to assess and improve their internal control
systems. The Public Company Accounting Oversight Standard No. 2 (Standard No. 2)
provides the professional standards and related
31
performance guidance for auditors to attest to, and report on, management's
assessment of the effectiveness of internal control over financial reporting
under Section 404. Management's assessment of internal control over financial
reporting requires management to make subjective judgments and, particularly
because Standard No. 2 is newly effective, some of the judgments will be in
areas that may be open to interpretation and therefore the report may be
uniquely difficult to prepare, and the Company's independent auditors may not
agree with management's assessment.
During this process, if the Company's management identifies one or more material
weaknesses in the Company's internal control over financial reporting that
cannot be remediated in a timely manner, the Company will be unable to conclude
such internal control is effective. While the Company currently believes its
internal control over financial reporting is effective, the effectiveness of the
Company's internal controls in future periods is subject to the risk that the
Company's controls may become inadequate because of changes in conditions, and,
as a result, the degree of compliance of the Company's internal control over
financial reporting. If the Company is unable to conclude that the Company's
internal control over financial reporting is effective as of December 31, 2007
(or if the Company's independent auditors are unable to attest that the
Company's management's report is fairly stated or they are unable to express an
opinion on the effectiveness of the Company's internal controls), the Company
could lose investor confidence in the accuracy and completeness of its financial
reports, which would have an adverse effect on the Company's stock price.
THE COMPANY RELIES ON GLOBAL TELECOMMUNICATIONS INFRASTRUCTURE TO MAINTAIN
COMMUNICATION BETWEEN ITS VARIOUS LOCATIONS AND THE COMPANY'S CLIENTS' SITES.
Disruptions in telecommunications, system failures, or virus attacks could harm
the Company's ability to execute the Company's Global Delivery Model, which
could result in client dissatisfaction and a reduction of the Company's
revenues. A significant element of the Company's Global Delivery Model is to
continue to leverage and expand the Company's Global Development Centers. The
Company's Global Development Centers are linked with a redundant
telecommunications network architecture that uses multiple service providers and
various satellite and optical links with alternate routing. The Company may not
be able to maintain active voice and data communications between its various
Global Development Centers and between the Company's Global Development Centers
and the Company's clients' sites at all times due to disruptions in these
networks, system failures or virus attacks. Any significant failure in the
Company's ability to communicate could result in a disruption in business, which
could hinder the Company's performance or its ability to complete projects on
time. This, in turn, could lead to client dissatisfaction and a material adverse
effect on the Company's business, results of operations and financial condition.
THERE ARE RISKS ASSOCIATED WITH THE COMPANY'S INVESTMENT IN NEW FACILITIES AND
PHYSICAL INFRASTRUCTURE.
The Company's business model includes developing and operating Global
Development Centers in order to support the Company's Global Delivery Service.
The Company has Global Development Centers located in Mumbai, Pune and Chennai,
India and in August 2006, the Company completed Phase I of the construction of a
development and training campus in Pune, India, including an office building for
950 seats, a food court and hotel. However, the full completion of the
development of the Pune facility is contingent on the Company's funding the
continuation of the construction
32
and obtaining appropriate construction and other permits from the Indian
government. The Company cannot make any assurances that the construction of the
facility or any future facilities that the Company may develop, including any
facilities on the land acquired by the Company that is in an Information
Technology Park located in Chennai, India, will occur on a timely basis or that
they will be completed. If the Company is unable to complete the construction of
the Pune facility or future facilities, the Company's business, results of
operation and financial condition will be adversely affected. In addition, the
Company is developing the Pune facility in expectation of increased growth in
the Company's business. If the Company's business does not grow as expected, the
Company may not be able to benefit from its investment in this or other
facilities.
THE COMPANY'S EARNINGS ARE AFFECTED BY APPLICATION OF SFAS NO. 123R.
The Company began expensing stock options and other stock-based awards in
accordance with the Financial Accounting Standards Board's recently issued FASB
Statement No. 123 (revised 2004) "Share-Based Payment" (SFAS No. 123R) in fiscal
2006. SFAS No. 123R requires companies to measure and recognize compensation
expense for all stock-based payments at fair value. Stock-based payments include
stock option grants and other transactions under stock plans. The Company grants
options to purchase common stock to some of its employees and directors under
various plans at prices equal to the market value of the stock on the dates the
options were granted. In addition, the Company has issued shares of incentive
restricted stock to its non-employee directors and employees. During the year
ended December 31, 2006 the Company recorded $2.46 million of expense for
equity-based compensation (including charge for restricted stock and dividend).
The assumptions used in calculating and estimating future costs under SFAS No.
123R are highly subjective and changes in these assumptions could significantly
affect the Company's future earnings.
TERRORIST ACTIVITY, WAR OR NATURAL DISASTERS COULD MAKE TRAVEL AND COMMUNICATION
MORE DIFFICULT AND ADVERSELY AFFECT THE COMPANY'S BUSINESS.
Terrorist activity, war or natural disasters could adversely affect the
Company's business, results of operations and financial condition. Terrorist
activities, other acts of violence or war, or natural disasters have the
potential to have a direct impact on the Company's clients. Such events may
disrupt the Company's ability to communicate between the Company's various
Global Development Centers and between the Company's Global Development Centers
and the Company's clients' sites, make travel more difficult, make it more
difficult to obtain work visas for many of the Company's technology
professionals and effectively curtail the Company's ability to deliver the
Company's services to the Company's clients. Such obstacles to business may
increase the Company's expenses and materially adversely affect the Company's
business, results of operations and financial condition. In addition, many of
the Company's clients visit several technology services firms prior to reaching
a decision on vendor selection. Terrorist activity, war or natural disasters
could make travel more difficult and delay, postpone or cancel decisions to use
the Company's services.
THE COMPANY IS SUBJECT TO RISKS OF FLUCTUATION IN THE EXCHANGE RATE BETWEEN THE
U.S. DOLLAR AND THE INDIAN RUPEE.
The Company holds a significant amount of its cash in Indian rupees.
Accordingly, changes in exchange rates between the Indian rupee and the U.S.
dollar could have a material adverse effect on the Company's revenues, other
income, cost of services sold, gross margin and net income, which may in turn
have a negative impact on the Company's
33
business, operating results and financial condition. The exchange rate between
the Indian rupee and the dollar has changed substantially in recent years and
may fluctuate substantially in the future. The Company expects that a majority
of the Company's revenues will continue to be generated in U.S. dollars for the
foreseeable future and that a significant portion of the Company's expenses,
including personnel costs, as well as capital and operating expenditures, will
continue to be denominated in Indian rupees. Consequently, the results of the
Company's operations are adversely affected as the Indian rupee appreciates
against the U.S. dollar.
ANY FUTURE BUSINESS COMBINATIONS, ACQUISITIONS OR MERGERS WOULD EXPOSE US TO
RISKS, INCLUDING THAT THE COMPANY MAY NOT BE ABLE TO SUCCESSFULLY INTEGRATE ANY
ACQUIRED BUSINESSES.
The Company has expanded, and may continue to expand, the Company's operations
through the acquisition of additional businesses. Financing of any future
acquisition could require the incurrence of indebtedness, the issuance of equity
(common or preferred) or a combination thereof. There can be no assurance that
the Company will be able to identify, acquire or profitably manage additional
businesses or successfully integrate any acquired businesses without substantial
expense, delays or other operational or financial risks and problems.
Furthermore, acquisitions may involve a number of special risks, including
diversion of management's attention, failure to retain key acquired personnel,
unanticipated events or legal liabilities and amortization of acquired
intangible assets. For example, in 2002, the Company incurred a charge in
connection with a payment made to the former owners of a business acquired by
the Company in 1999. In addition, any client satisfaction or performance
problems within an acquired firm could have a material adverse impact on the
Company's reputation as a whole. There can be no assurance that any acquired
businesses would achieve anticipated revenues and earnings. Any failure to
manage the Company's acquisition strategy successfully could have a material
adverse effect on the Company's business, results of operations and financial
condition.
VARIABILITY OF QUARTERLY OPERATING RESULTS.
The Company has experienced and expects to continue to experience fluctuations
in revenues and operating results from quarter to quarter due to a number of
factors, including: the timing, number and scope of customer engagements
commenced and completed during the quarter; progress on fixed-price engagements;
timing and cost associated with expansion of the Company's facilities; changes
in IT professional wage rates; the accuracy of estimates of resources and time
frames required to complete pending assignments; the number of working days in a
quarter; employee hiring, attrition and utilization rates; the mix of services
performed on-site, off-site and offshore; termination of engagements; start-up
expenses for new engagements; longer sales cycles for Applications Outsourcing
engagements; customers' budget cycles; and investment time for training. Because
a significant percentage of the Company's selling, general and administrative
expenses are relatively fixed, variations in revenues may cause significant
variations in operating results. It is possible that Company's operating results
could be below or above the expectations of market analysts and investors. In
such event, the price of the Company's common stock would likely be materially
adversely affected. No assurance can be given that quarterly results will not
fluctuate causing an adverse effect on the Company's financial condition at the
time.
34
ITEM 1B. UNRESOLVED STAFF COMMENTS.
None.
ITEM 2. PROPERTIES.
The Company's headquarters and principal administrative, sales and marketing,
and system development operations are located in approximately 14,600 square
feet of leased space in Troy, Michigan. The Company occupies these premises
under a lease expiring in March 2007. The Company has a telecommunications hub
located in approximately 3,200 square feet of leased space in Cary, North
Carolina, under a lease, which expires July 31, 2010. The Company also leases
office facilities in Santa Clara, California; Phoenix, Arizona; Schaumburg,
Illinois; Dallas, Texas; Minneapolis, Minnesota; New York, New York; Nashville,
Tennessee; Natick, Massachusetts; Berkshire, England; Stuttgart, Germany; and
Singapore.
The Company's Global Development Centers are located in: Pune, Mumbai and
Chennai, India and a Support Center located at Cary, North Carolina support the
Company's Global Delivery Service.
In January 2001, the Company acquired 40 acres of land at the cost of
approximately $1.0 million for construction of a state-of-the-art development
and training campus in Pune, India. Phase one of the construction was completed
in August 2006, which included an office building for 950 seats, a food court
and hotel. When fully completed, the facility will cover over 1 million square
feet and have capacity for 9,000 seats. It will be both a customer and employee
focused facility, including such amenities as training facilities, cafeteria and
fitness center. Syntel has also acquired additional 37 acres of land that is
adjacent to this campus. In addition, Syntel leases two facilities in Pune,
India consisting of approximately 63,490 square feet.
The Mumbai, India Global Development Center, which employed, including onsite
deputations outside Mumbai, 3,737 persons as of December 31, 2006, serves as the
hub of the Company's Indian operations. This Global Development Center provides
substantial resource depth to meet customer needs around the world, low-cost
service delivery, a 24-hour customer assistance center and development of
technical solutions and expertise. Mumbai also serves as the principal
recruiting and training center for the Company. The Mumbai Center has been in
operation for over a decade and has a capacity of approximately 3,505 people
including BPO operations.
The Chennai Training and Global Development Center employed, including onsite
deputations outside Chennai, 1,423 persons as of December 31, 2006. The Chennai
facility has a capacity of approximately 1,513 persons. The Company has acquired
approximately 29 acres of land in an Information Technology Park in Chennai,
India. This area of land has been designated as a Special Economic Zone (SEZ) by
the government of India.
Syntel leases approximately 88,642 square feet of office space in Mumbai, India,
under ten leases expiring on various dates from March 1, 2007 and October 31,
2011. These facilities house IT professionals, as well as its senior management,
finance and accounts, administrative personnel, human resources, recruiting, and
sales and marketing functions.
For facilitating its BPO operations, Syntel has leased 113,325 square feet of
office space in Mumbai, India under four leases expiring on dates ranging
between February 1, 2008 and January 31, 2011.
35
Syntel leases approximately 122,408 square feet of office space in Chennai,
India, under three leases expiring on dates ranging between April 1, 2007 and
March 31, 2009, all subject to the Company's option to renew for additional
periods.
The Company believes that space availability in Mumbai and Chennai will
accommodate short-term facility requirements and the new campus in Pune will
enable the Company to meet offshore growth requirements for the next several
years. The Company is also considering expanding its footprint in Tier I, Tier
II and Tier III cities in India to meet its growth objectives.
ITEM 3. LEGAL PROCEEDING:
While the Company is a party to ordinary routine litigation incidental to the
business, the Company is not currently a party to any material legal proceeding
or governmental investigation.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
No matters were submitted to a vote of the Company's shareholders during the
fourth quarter of the year ended December 31, 2006.
36
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY, RELATED SHAREHOLDER MATTERS AND
ISSUER PURCHASES OF EQUITY SECURITIES.
(a) The Company's Common Stock is traded on the NASDAQ National Global Select
Market under the symbol "SYNT." The following table sets forth, for the periods
indicated, the range of high and low sales prices per share of the Company's
Common Stock as reported on NASDAQ for each full quarterly period in 2005 and
2006.
Period High Low
------ ------- -------
First Quarter, 2005 $19.530 $15.930
Second Quarter, 2005 18.730 15.750
Third Quarter, 2005 19.490 16.140
Fourth Quarter, 2005 22.000 18.380
First Quarter, 2006 22.190 17.000
Second Quarter, 2006 23.000 18.030
Third Quarter, 2006 23.120 19.260
Fourth Quarter, 2006 29.520 22.210
(b) There were approximately 610 shareholders of record and 5,000 beneficial
holders on March 2, 2007.
(c) The Board of Directors has declared a quarterly dividend of $0.06 per share
during each quarter of the Company's last two fiscal years. In addition, the
Board of Directors at its meetings dated August 14, 2006 and March 3, 2005
declared a special cash dividend of $1.25 and $1.50 per share respectively,
payable to Syntel shareholders of record at the close of business on August 31,
2006 and March 14, 2005 respectively. The Company paid total cash dividends of $
1.49 and $1.74 per share for the years ended December 31, 2006 and 2005,
respectively.
(d) EQUITY COMPENSATION PLAN INFORMATION
The following table sets forth, with respect to the Company's equity
compensation plans, (i) the number of shares of common stock to be issued upon
the exercise of outstanding options, (ii) the weighted average exercise price of
outstanding options, and (iii) the number of shares remaining available for
future issuance, as of December 31, 2006.
NUMBER OF SECURITIES
REMAINING AVAILABLE FOR
NUMBER OF SECURITIES TO BE WEIGHTED-AVERAGE EXERCISE FUTURE ISSUANCE UNDER
ISSUED UPON EXERCISE OF PRICE OF OUTSTANDING EQUITY COMPENSATION PLANS
OUTSTANDING OPTIONS, OPTIONS, WARRANTS, AND (EXCLUDING SECURITIES
PLAN CATEGORY WARRANTS, AND RIGHTS RIGHTS ($) REFLECTED IN COLUMN (1))
------------- -------------------------- ------------------------- -------------------------
Equity compensation plans
approved by shareholders 208,869 $13.07 2,300,434
Equity compensation plans
not approved by
shareholders -- -- --
------- ------ ---------
TOTAL 208,869 $13.07 2,300,434
======= ====== =========
37
PERFORMANCE GRAPH
The following graph compares the cumulative total shareholder return on the
Company's Common Stock to the cumulative total shareholder returns for the S&P
500 Stock Index and for an index of peer companies selected by the Company. The
period for comparison is for five years from December 31, 2001, through December
31, 2006, the end of the Company's last fiscal year. The peer group index is
composed of CIBER, Inc., Computer Horizons Corp., Computer Sciences Corporation,
Electronic Data Systems Corporation, Keane, Inc., and Sapient Corporation. These
companies were selected based on similarities in their service offerings and
their competitive position in the industry.
COMPARISON OF FIVE-YEAR CUMULATIVE TOTAL RETURN
AMONG SYNTEL, INC., S&P 500 STOCK INDEX
AND AN INDEX OF PEER COMPANIES *
[PERFORMANCE GRAPH]
12/31/01 12/31/02 12/31/03 12/31/04 12/31/05 12/31/06
-------- -------- -------- -------- -------- --------
Syntel, Inc. $100 $162 $202 $136 $161 $207
S&P 500 Stock Index $100 $ 77 $ 97 $106 $109 $124
Peer Group Index $100 $ 46 $ 62 $ 62 $ 63 $ 67
----------
* Assumes that the value of an investment in Syntel's Common Stock and each
index was $100 on December 31, 2001 and that all dividends were reinvested.
38
ITEM 6. SELECTED CONSOLIDATED FINANCIAL DATA.
SYNTEL, INC. & SUBSIDIARIES
(In thousands, except share data)
The following tables set forth selected consolidated financial data and other
data concerning Syntel, Inc. for each of the last five years. The selected
financial data should be read in conjunction with "Management's Discussion and
Analysis of Financial Condition and Results of Operations" and the Consolidated
Financial Statements and related Notes thereto.
YEAR ENDED DECEMBER 31,
----------------------------------------------------
2006 2005 2004 2003 2002
-------- -------- -------- -------- --------
(IN THOUSANDS, EXCEPT SHARE DATA)
STATEMENT OF INCOME DATA
Net revenues (1) $270,229 $226,189 $186,573 $179,507 $161,507
Cost of revenues 167,980 135,043 107,120 101,699 94,010
Gross profit 102,249 91,146 79,453 77,808 67,497
Selling, general and administrative
expenses 49,374 44,917 36,999 28,278 31,421
(Reduction in) reserve requirements
applicable to Metier transaction (2) -- -- -- (882) (5,698)
Income from operations 52,875 46,229 42,454 50,412 41,774
Other income, principally interest 4,894 4,592 3,773 3,168 3,191
Income before income taxes 57,769 50,821 46,227 53,580 44,965
Income tax provision (3) 6,853 20,500 5,253 13,242 12,338
Income before loss from equity
investments and investment write off 50,916 30,321 40,974 40,338 32,627
Loss from equity investments and
investment write offs (net of tax) -- -- -- 34 141
Net income $ 50,916 $ 30,321 $ 40,974 $ 40,304 $ 32,486
Net income per share, diluted $ 1.24 $ 0.75 $ 1.01 $ 0.99 $ 0.81
Weighted average shares outstanding,
diluted 41,095 40,651 40,469 40,797 39,917
Cash dividends declared per common
share $ 1.49 $ 1.74 $ 0.24 $ 1.37 --
AS OF DECEMBER 31,
----------------------------------------------------
2006 2005 2004 2003 2002
-------- -------- -------- -------- --------
($ IN THOUSANDS)
BALANCE SHEET DATA
Working capital $105,563 $120,866 $170,786 $142,207 $144,487
Total assets 197,689 198,161 226,968 185,198 183,572
Total shareholders' equity 149,742 152,278 190,642 153,406 154,844
OTHER DATA
Billable headcount in U.S. 1,405 1,341 1,145 1,138 1,111
Billable headcount in India 4,006 3,006 1,906 1,376 943
Billable headcount at other
locations 88 109 121 150 101
-------- -------- -------- -------- --------
Total billable headcount 5,499 4,456 3,172 2,664 2,155
======== ======== ======== ======== ========
39
1. 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
the Company's stock at an exercise price of $7.25 per share. The stated
exercise price was based upon the customer achieving a specified minimum
level of purchases of services (the "Performance Milestone") from the
Company over a specified performance period that ended on October 16, 2003.
The customer exercised the warrant in February 2003 and received 209,739
shares in a cashless exercise.
The customer earned the sales incentive as they met the performance
milestone over the specified performance period that ended on October 16,
2003.
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
has recorded the value of sales incentive as a reduction of revenues, to
the extent of revenues earned up to October 16, 2003.
The measurement of the 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 the year 2003.
The Company has also granted the same customer certain additional
performance warrants at significantly higher performance milestones. During
the year the time-lines specified for these warrants have expired. The
performance milestones have not been achieved and hence there would be no
financial implication due to these warrants.
2. Acquisitions
Metier, Inc.
During 1999, the Company acquired substantially all the business and assets
of Metier, Inc. The consideration for the Metier acquisition in 1999
included a $1.6 million dollar payment to the Metier shareholders, which
was to be made in April 2000, and 300,000 shares of Syntel Common Stock,
which were to be issued in September 2000. During 2000, the Company entered
into litigation with the former shareholders of Metier and consequently,
the $1.6 million dollar payment was not made and the 300,000 shares were
not issued. In April 2002, the Company reached a resolution with the Metier
shareholders wherein the $1.6 million dollar payment was not made, the
300,000 shares was not issued and the Company paid $2.3 million in
settlement and legal costs. Additionally, during the last quarter of 2002,
the Company also settled certain of the Metier related and other litigation
and in connection with these settlements, the Company reversed an accrual
of approximately $5.7 million of the accrued Metier liability during 2002
having an earnings per share impact of $0.08 per share. The final
settlements relating to the Metier liability was made during the third
quarter of 2003 and accordingly, the remaining accrual of approximately
$0.9 million was also reversed.
40
3. The tax rate for the year ended December 31, 2006 was impacted by reversal
of $2.0 million of the accrual for income taxes related to the year 2002.
Without the above, the effective tax rate for the year ended December 31,
2006 would have been 15.3%. During the year ended December 31, 2005 the tax
rate was impacted by reversal of $2.6 million of the accrual of income
taxes related to year 2001, provision for valuation allowance of $1.7
million and the tax related to the dividend repatriation of $12.3 million.
Without the above, the effective tax rate for the year ended December 31,
2005 would have been 17.8%. During year ended December 31, 2004, the tax
rate was impacted by reversal of $1.7 million of the accrual of income
taxes related to the year 2000; tax credit of $0.5 million in Syntel India
and the research and development tax credit of $0.5 million in Syntel Inc.
Without the above, the effective income tax rate during the year ended
December 31, 2004 would have been 17.3%.
41
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS.
CRITICAL ACCOUNTING POLICIES
We believe the following critical accounting policies, among others,
involve 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 years ended December 31, 2006,
2005 and 2004, revenues from time and material contracts constituted 58%, 50%
and 46%, respectively of total revenues. Revenue from fixed-price, application
management, and 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 years ended
December 31, 2006, 2005 and 2004, revenues from fixed price application
management and support engagements constituted 26%, 29% and 33%, 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 years ended
December 31, 2006 2005 and 2004, revenues from fixed price development contracts
constituted 16%, 21% and 21%, respectively.
SIGNIFICANT ACCOUNTING ESTIMATES
The preparation of the consolidated financial statements in conformity with
accounting principles generally accepted in the United States of America
requires management to make estimates and judgments that affect the reported
amounts of assets and liabilities and the disclosure of contingent assets and
liabilities at the date of the consolidated financial statements, and the
reported amounts of revenues and expenses for the reporting period. By their
nature, these estimates and judgments are subject to an inherent degree of
uncertainty. The Company bases its estimates and judgments on historical
experience and on various other assumptions that are believed to be reasonable
under the circumstances. Actual results could differ from those estimates.
REVENUE RECOGNITION. The use of the proportional performance method of
accounting requires that the Company make estimates about its future efforts and
costs relative to the 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
42
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. At December 31, 2006 and 2005, the allowance for
doubtful accounts was $2.8 million and $2.6 million respectively. 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. When preparing our financial statements, 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 reserve no longer required for any
particular tax year, is credited to the current year's income tax provision.
During 2006, the Company has reversed $2.0 million of the accrual for income
taxes related to the year 2002 and credited it to the current year's income tax
provision.
The revision in estimates noted above had an after tax impact of increasing the
diluted earnings per share for the year ended December 31, 2006 by $0.05 per
share.
During 2005, the Company has reversed $2.6 million of the accrual for income
taxes related to the year 2001 and credited it to the current year's income tax
provision.
In addition, during 2005 the Company has also reversed $0.9 million related to
the payroll tax provision and provided for valuation allowance of $1.7 million
attributable to certain deferred tax benefits, on write-off of certain
investments in 2001, which are not expected to be materialized.
The revision in estimates noted above had an after tax impact of increasing the
diluted earnings per share for the year ended December 31, 2005 by $0.04 per
share.
ACCRUALS FOR LEGAL EXPOSURES. The Company estimates the costs associated with
legal exposures that it has and the related legal expenses and records the
probable liability if it can be reasonably estimated or otherwise, the lower end
of an estimated range of potential liability. The accrual related to litigation
and legal fees at December 31, 2006 and 2005, was $0.3 million and $0.2 million,
respectively.
43
OVERVIEW
Syntel is a worldwide provider of IT and outsourcing services to Global 2000
companies. The Company's service offerings include Applications Outsourcing,
consisting of outsourcing services for ongoing management, development and
maintenance of business applications; BPO consisting of high-value, customized
outsourcing solutions that enhance critical back-office services such as
transaction processing, loan servicing, retirement processing, collections and
payment processing; e-Business, consisting of strategic advanced technology
services in the CRM, Data Warehousing, EAI, ERP and Web solutions; and
TeamSourcing consisting of professional IT consulting services.
The Company's revenues are generated from professional services fees provided
through four segments, Applications Outsourcing, BPO, e-Business and
TeamSourcing. The Company has invested significantly in developing its ability
to sell and deliver Applications Outsourcing and BPO services, which the Company
believes have higher growth and gross margin potential.
The following table outlines the revenue mix for the years ended December 31,
2006, 2005, and 2004:
PERCENT OF TOTAL REVENUES
-------------------------
2006 2005 2004
---- ---- ----
Applications Outsourcing 72% 76% 76%
e-Business 14 14 16
TeamSourcing 6 7 7
BPO 8 3 1
--- --- ---
100% 100% 100%
=== === ===
Revenues are generated principally on either a time and material or
fixed-priced, fixed-time frame basis. We believe the ability to offer fixed-time
frame processes is an important competitive differentiator that allows Syntel
and its clients to better understand the client's needs, and to design, develop,
integrate and implement solutions that address those needs. During the years
ended December 31, 2006, 2005 and 2004 revenues from fixed price development
contracts constituted 16%, 21% and 21%.
On Applications Outsourcing engagements, the Company typically assumes
responsibility for engagement management and generally is able to allocate
certain portions of the engagement to on-site, off-site and offshore personnel.
Applications Outsourcing revenues generally are recognized on either a
time-and-materials or fixed-price basis. For the years ended December 31, 2006,
2005 and 2004, fixed-price revenues from development and maintenance activity
comprised approximately 47%, 55% and 58% of total Applications Outsourcing
revenues, respectively.
Historically, most e-Business engagements were billed on a time-and-materials
basis under the direct supervision of the customer (similar to TeamSourcing
engagements); however, as the Company expanded its expertise in delivering
e-commerce engagements, Syntel has assumed the project management role and
entered into fixed-price arrangements for a significant number of new e-Business
engagements started during 2006, 2005 and 2004. For the years ended December 31,
2006, 2005 and 2004, fixed- price revenues from development and maintenance
activity comprised approximately 55%, 61% and 54% of total e-Business revenues,
respectively.
44
On TeamSourcing engagements, Syntel's professional services typically are
provided at the customer's site and under the direct supervision of the
customer. TeamSourcing revenues generally are recognized on a time-and-materials
basis as services are performed. As indicated in the above table, the Company's
dependence on TeamSourcing engagements has decreased significantly and is
expected to continue to decrease as a percentage of the total revenue base as
the Company consciously refocuses its sales efforts and migrates resources to
e-Business and Applications Outsourcing engagements.
On BPO engagements, services are provided at our offshore facility, which gives
the benefit of lower cost to the customer. BPO revenues generally are recognized
on a time-and-materials basis as services are performed. For the years ended
December 31, 2006, 2005 and 2004, the revenue from BPO engagements comprised
approximately 8%, 3% and 1% of total revenues.
The Company's most significant cost is personnel cost, which consists of
compensation, benefits, recruiting, relocation and other related costs for its
IT professionals. The Company strives to maintain its gross margin by migrating
more revenue toward Applications Outsourcing and e-Business, controlling
engagement costs, and offsetting increases in salaries and benefits with
increases in billing rates. The Company has established a human resource
allocation team whose purpose is to staff IT professionals on engagements that
efficiently utilize their technical skills and allow for optimal billing rates.
Syntel India, a wholly owned subsidiary of the Company, provides software
development services from Mumbai, Pune and Chennai, India, where salaries of IT
professionals are comparatively lower than in the U.S.
The Company has performed a significant portion of its employee recruiting in
other countries. As of December 31, 2006, approximately 52% of Syntel's U.S.
workforce (9% of Syntel's worldwide workforce) worked under H-1B visas
(permitting temporary residence while employed in the U.S.) and another 15% of
the Company's U.S. workforce (3% of the Company's worldwide workforce) worked
under L-1 visas (permitting inter-company transfers of employees that have been
employed with a foreign subsidiary for at least 6 months).
The Company has made substantial investments in infrastructure in recent years,
including: (1) expanding the facilities in Mumbai, India, including a BPO
facility; (2) developing a Technology Campus in Pune, India; (3) expanding the
Global Development Center in Chennai, India; (4) upgrading of the Company's
global telecommunication network; (5) increasing Applications Outsourcing sales
and delivery capabilities through significant expansion of the sales force and
the Strategic Solutions Group, which develops and formalizes proprietary
methodologies, practices and tools for the entire Syntel organization; (6)
hiring additional experienced senior management; (7) expanding global recruiting
and training capabilities; and (8) enhancing human resource and financial
information systems.
Through its strong relationships with customers, the Company has been able to
generate recurring revenues from repeat business. These strong relationships
also have resulted in the Company generating a significant percentage of
revenues from key customers. The Company's top ten customers accounted for
approximately 70%, 65% and 61% of revenues for the years ended December 31,
2006, 2005, and 2004, respectively.
For the years ended December 31, 2006, 2005 and 2004 the number of customers
contributing revenues in excess of 10% of total consolidated revenues were two,
one and one respectively. The Company's largest customer for 2006, 2005 and 2004
was American Express, contributing
45
approximately 18%, 16% and 16%, respectively of total consolidated revenues. In
2006, State Street Bank also contributed 10% of the Company's total consolidated
revenues. Although the Company does not currently foresee a credit risk
associated with accounts receivable from these customers, credit risk is
affected by conditions or occurrences within the economy and the specific
industries in which these customers operate.
As a result of the continued uncertainty and weakness in the global economic and
political environment, companies continue to seek to outsource their IT spending
offshore. However, the Company also sees clients' needs to reduce their costs
and the increased competitive environment among IT companies. The Company
expects these conditions to continue in the next few quarters. In response to
the continued pricing pressures and increased competition for outsourcing
clients, the Company continues to focus on expanding its service offerings into
areas with higher and sustainable price margins, managing its cost structure,
and anticipating and correcting for decreased demand and skill and pay level
imbalances in its personnel. The Company's immediate measures include increased
management of compensation expenses through headcount management and variable
compensation plans, as well as increasing utilization rates or reducing
non-deployed sub-contractors or non-billable IT professionals.
RESULTS OF OPERATIONS
The following table sets forth for the periods indicated selected income
statement data as a percentage of the Company's net revenues.
PERCENTAGE OF REVENUES
YEAR ENDED DECEMBER 31,
-----------------------
2006 2005 2004
----- ----- -----
Net revenues 100.0% 100.0% 100.0%
Cost of revenues 62.2 59.7 57.4
----- ----- -----
Gross profit 37.8 40.3 42.6
Selling, general and administrative
expenses 18.3 19.9 19.8
INCOME FROM OPERATIONS 19.5% 20.4% 22.8%
46
Following is selected segment financial data for the years ended December 31,
2006, 2005 and 2004. The Company does not allocate assets to operating segments:
2006 2005 2004
-------- -------- --------
(In Thousands)
Net revenues
Applications Outsourcing $194,474 $171,331 $143,007
e-Business 37,251 31,210 29,249
TeamSourcing 17,631 16,953 12,480
BPO 20,873 6,695 1,837
-------- -------- --------
270,229 226,189 186,573
Gross profit
Applications Outsourcing 72,502 72,411 62,696
e-Business 10,506 9,687 11,302
TeamSourcing 6,690 4,886 4,598
BPO 12,551 4,162 857
-------- -------- --------
102,249 91,146 79,453
Gross profit %
Applications Outsourcing 37.3% 42.3% 43.8%
e-Business 28.2% 31.0% 38.6%
TeamSourcing 37.9% 28.8% 36.8%
BPO 60.1% 62.2% 46.7%
-------- -------- --------
37.8% 40.3% 42.6%
Selling, general and administrative
expenses $ 49,374 $ 44,917 $ 36,999
INCOME FROM OPERATIONS $ 52,875 $ 46,229 $ 42,454
-------- -------- --------
47
COMPARISON OF YEARS ENDED DECEMBER 31, 2006 AND 2005.
REVENUES. Net revenues increased to $270.2 million in 2006 from $226.2 million
in 2005, representing a 19.5% increase. Our revenues have increased primarily
consequent to our increased workforce. Information technology offshoring is
clearly becoming a mega trend with increasing numbers of global corporations
aggressively outsourcing their crucial applications development or business
processes to vendors with an offshore presence. Syntel too has benefited from
this trend. 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 has 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 Europe, and Syntel Germany as
of December 31, 2006, increased 23% to 5,499 employees as compared to 4,456
employees as of December 31, 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
recoveries per offshore billable resource is generally lower as compared to an
on-site based resource. As of December 31, 2006, the Company had approximately
73% of its billable workforce in India as compared to 67% as of December 31,
2005. The top five customers accounted for 52% of the total revenues in 2006, up
from 45% of the total revenues in 2005. Moreover, the top 10 customers accounted
for 70% of the revenues in 2006 as compared to 65% in 2005.
APPLICATIONS OUTSOURCING REVENUES. Applications Outsourcing revenues increased
from $171.3 million, or 76% of total revenues in 2005, to $194.5 million, or 72%
of total revenues in 2006. The $23.2 million increase is attributable
principally to revenue from new engagements, contributing $86.6 million
partially offset by a net decrease in existing projects in the amount of $29.7
million and by $33.8 million in lost revenues as a result of project
completions.
APPLICATIONS OUTSOURCING COST OF REVENUES. Cost of revenues consists of costs
directly associated with billable consultants worldwide, including salaries,
payroll taxes, benefits, relocation costs, immigration costs, travel, finder's
fees, and trainee compensation. Applications Outsourcing cost of revenues
increased to 62.7% of Applications Outsourcing revenues in 2006, from 57.7% in
2005. The 5% increase in cost of revenues as a percent of revenues 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 from $31.2 million in 2005,
or 14% of total consolidated revenues, to $37.2 million in 2006, or 14% of total
consolidated revenues. The $6.0 million increase is attributable principally to
revenue from new engagements, contributing $8.9 million and net increase in
revenues from existing projects by $0.4 million largely offset by $3.3 million
in lost revenues as a result of project completion.
E-BUSINESS COST OF REVENUES. Cost of revenues consists of costs directly
associated with billable consultants, including salaries, payroll taxes,
benefits, relocation costs, immigration costs, travel, finder's fees, and
48
trainee compensation. e-Business cost of revenues increased to 71.8% of
e-business revenues in 2006, from 69% in 2005, an increase of 2.8%. This
increase 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 increased from $16.9 million, or 7%
of total consolidated revenues in 2005, to $17.6 million, also 6% of total
consolidated revenues in 2006. The $0.7 million increase is attributable
principally to revenue from new engagements and increased revenue from SkillBay
web portal, totally contributing to $7.5 million partially offset by a net
decrease in existing projects in the amount of $4.3 million and by $2.5 million
in lost revenues as a result of project completions.
TEAMSOURCING COST OF REVENUES. TeamSourcing cost of revenues consists of costs
directly associated with billable consultants, including salaries, payroll
taxes, benefits, relocation costs, immigration costs, travel, finder's fees, and
trainee compensation. TeamSourcing cost of revenues decreased to 62.1% of
TeamSourcing revenues in 2006, from 71.2% in 2005. The 9.1% decrease in cost of
revenues, as a percent of total TeamSourcing revenues, was attributable
primarily to the better utilization of TeamSourcing resources and by net
revenues from Skillbay web portal placements.
BPO REVENUES. The BPO segment started contributing revenues during 2004.
Revenues from this segment were $20.9 million or 8% of total revenues for the
year ended 2006 compared to $6.7 million or 3% of total revenues for the year
ended 2005. The $14.2 million increase is attributable principally to revenue
from new engagements, contributing $8.5 million and net increase in revenues
from existing projects by $6.0 million largely offset by $0.3 million in lost
revenues as a result of project completion.
BPO COST OF REVENUES. The BPO segment 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 year ended 2006 increased to 39.9% of the segment's revenues
from 37.8% for the year ended December 31, 2005. The 2.1% 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, as
well as travel, telecommunications, business promotions, marketing and various
facility costs for the Company's Global Development Centers and various offices.
Selling, general, and administrative costs for the year ended December 31, 2006
were $49.4 million or 18.3% of total revenues, compared to $44.9 million or
19.9% of total revenues for the year ended December 31, 2005.
Selling, general and administrative costs for the year ended December 31, 2006
include a one time legal expense related to settlement fees of $0.5 million,
provision for doubtful debts of $0.4 million, provision for a claim payable to a
customer of $0.4 million, service tax on marketing fees of $0.2 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.
49
Selling, general, and administrative costs for the year ended December 31, 2005
include a one-time special performance-based incentive program for sales teams
of $0.4 million, compensation expense related to a special dividend of $1.50 per
share on restricted stock held by employees of $0.1 million and expense related
to allowance for doubtful accounts of $1.1 million.
In addition to the above-described items, the 1.6 percentage point decrease is
primarily due to increases in revenue and increases in certain costs during the
year ended December 31, 2006 as against the year ended December 31, 2005. The
increase in revenue has resulted in an approximately 3.3 percentage point
decrease. Cost increases include increase in travel of $0.2 million,
depreciation of $1.1 million, rent of $1.9 million towards the additional new
facilities at Mumbai, Pune and Chennai in India, telecommunication expenses of
$0.3 million, office expenses of $2.0 million and professional expenses of $0.2
million partially offset by decrease in compensation cost of $0.5 million,
marketing cost of $0.1 million and consultancy fees of $0.6 million, which has
resulted in an approximately 1.7 percentage point increase.
COMPARISON OF YEARS ENDED DECEMBER 31, 2005 AND 2004.
REVENUES. Net revenues increased to $226.2 million in 2005 from $186.6 million
in 2004, representing a 21.2% increase. Our revenues have increased primarily
consequent to our increased workforce. Information technology offshoring is
clearly becoming a mega trend with increasing numbers of global corporations
aggressively outsourcing their crucial applications development or business
processes to vendors with an offshore presence. Syntel too has benefited from
this trend. At the beginning of 2004, the Company introduced the Client Partner
Program, which enabled better relationships with key customers leading to growth
in business. Further, during the year 2005, the Company has introduced Business
Unit Heads, which enables better relationship and leadership for each of its
Business Units. Worldwide billable headcount, including personnel employed by
Syntel India, Syntel Singapore, Syntel Europe, and Syntel Germany as of December
31, 2005, increased 41% to 4,465 employees as compared to 3,172 employees as of
December 31, 2004. 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 offshore
billable resource is generally lower as compared to an on-site based resource.
As of December 31, 2005, the Company had approximately 67% of its billable
workforce in India as compared to 60% as of December 31, 2004. The top five
customers accounted for 45% of the total revenues in 2005, up from 40% of the
total revenues in 2004. Moreover, the top 10 customers accounted for 65% of the
revenues in 2005 as compared to 61% in 2004.
APPLICATIONS OUTSOURCING REVENUES. Applications Outsourcing revenues increased
from $143.0 million, or 76% of total revenues in 2004, to $171.3 million, also
76% of total revenues in 2005. The $28.3 million increase is attributable
principally to revenue from new engagements, contributing $64.3 million
partially offset by a net decrease in existing projects in the amount of $6.0
million and by $30.0 million in lost revenues as a result of project
completions.
APPLICATIONS OUTSOURCING COST OF REVENUES. Cost of revenues consists of costs
directly associated with billable consultants worldwide, including salaries,
payroll taxes, benefits, relocation costs, immigration costs, travel, finder's
fees, and trainee compensation. Applications Outsourcing cost of revenues
increased to 57.7% of Applications Outsourcing revenues
50
in 2005, from 56.2% in 2004. The 1.5% increase in cost of revenues as a percent
of revenues was attributable primarily to increased compensation cost associated
with a special dividend on restricted stock and a performance- based incentive
program for delivery teams, during the three months ended March 31, 2005,
contributing an increase of 0.1 %, the salary revision, effective April 1, 2005,
in India, contributing an increase of 0.5 %, visa filing expenses, contributing
an increase of 0.5 % and increase in offshore headcount, contributing an
increase of 1.3 %. These increases were partially offset by a 0.4 % decrease due
to write back of leave accruals, related to the change in leave policy in India
and a 0.5 % decrease due to reversal of payroll tax provision.
E-BUSINESS REVENUES. e-Business revenues increased from $29.2 million in 2004,
or 16% of total consolidated revenues, to $31.2 million in 2005, or 14% of total
consolidated revenues. The $2.0 million increase is attributable principally to
revenue from new engagements, contributing $10.0 million partially offset by a
net decrease in existing projects in the amount of $1.3 million and by $6.7
million in lost revenues as a result of project completions.
E-BUSINESS COST OF REVENUES. Cost of revenues consists of costs directly
associated with billable consultants, including salaries, payroll taxes,
benefits, relocation costs, immigration costs, travel, finder's fees, and
trainee compensation. e-Business cost of revenues increased to 69.0% of
e-business revenues in 2005, from 61.4% in 2004, an increase of 7.6%. This
increase was attributable primarily to compensation cost associated with a
special dividend on restricted stock and a performance-based incentive program
for delivery teams during the three months ended March 31, 2005 and the salary
revision effective April 1, 2005 in India, partially offset by the write back of
leave accruals related to the change in leave policy in India.
TEAMSOURCING REVENUES. TeamSourcing revenues increased from $12.5 million, or 7%
of total consolidated revenues in 2004, to $16.9 million, also 7% of total
consolidated revenues in 2005. The $4.4 million increase is attributable
principally to revenue from new engagements and increased revenue of $4.3
million from the SkillBay web portal partially further increased by $1.6 million
due to net increase in revenue from existing projects and partly offset by $1.5
million in lost revenues as a result of project completion and net reduction in
revenues from exiting projects.
TEAMSOURCING COST OF REVENUES. TeamSourcing cost of revenues consists of costs
directly associated with billable consultants, including salaries, payroll
taxes, benefits, relocation costs, immigration costs, travel, finder's fees, and
trainee compensation. TeamSourcing cost of revenues increased to 71.2% of
TeamSourcing revenues in 2005, from 63.2% in 2004. The 8.0% increase in cost of
revenues, as a percent of total TeamSourcing revenues, was attributable
primarily to the higher cost TeamSourcing placements partially offset by net
revenues from Skillbay web portal placements.
BPO REVENUES. The BPO segment started contributing revenues during 2004.
Revenues from this segment were $6.7 million or 3% of total revenues for the
year ended 2005 compared to $1.8 million or 1% of total revenues for the year
ended 2004. Also, as of February 1, 2005, the Company signed a joint venture
agreement with a large banking institution, which helped it to ramp up its
business in the BPO segment.
BPO COST OF REVENUES. The BPO segment 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 year ended 2005 decreased to 37.8% of the segment's
51
revenues from 53.3% for the year ended December 31, 2004. The 15.5% decrease in
cost of revenues, as a percent of total BPO revenues, was attributable primarily
to better utilization of resources.
As a result of the continued uncertainty and weakness in the global economic and
political environment, companies continue to seek to outsource their IT spending
offshore. However, the Company also sees clients' needs to reduce their costs
and the increased competitive environment among IT companies. The Company
expects these conditions to continue in the next few quarters. In response to
the continued pricing pressures and increased competition for outsourcing
clients, the Company continues to focus on expanding its service offerings into
areas with higher and sustainable price margins, managing its cost structure,
and anticipating and correcting for decreased demand and skill and pay level
imbalances in its personnel. The Company's immediate measures include increased
management of compensation expenses through headcount management and variable
compensation plans, as well as increasing utilization rates or reducing
non-deployed sub-contractors or non-billable IT professionals.
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, as
well as travel, telecommunications, business promotions, marketing and various
facility costs for the Company's Global Development Centers and various offices.
Selling, general, and administrative costs for the year ended December 31, 2005
were $44.9 million or 19.9% of total revenues, compared to $37.0 million or
19.8% of total revenues for the year ended December 31, 2004.
Selling, general, and administrative costs for the year ended December 31, 2005
include a one-time special performance-based incentive program for sales teams
of $0.4 million, compensation expense related to a special dividend of $1.50 per
share on restricted stock held by employees of $0.1 million and expense related
to allowance for doubtful accounts of $ 1.1 million.
After considering the impact of the above-mentioned items, the decrease in
selling, general, and administrative expenses as a percentage of revenue is
primarily due to increases in revenue during the year ended December 31, 2005 as
against the year ended December 31, 2004, which resulted in an approximately
3.4% decrease partially offset by an increase in: compensation costs of $0.1
million in the USA and India, travel expenses of $0.7 million, depreciation of
$1.6 million and rent of $0.6 million towards the BPO offices at the
Hiranandani, Mumbai and the Pune facilities in India, consulting charges of $0.3
million, legal expenses of $0.4 million, professional charges of $0.5 million,
recruiting expenses of $0.3 million, provision for doubtful debts of $0.1
million, office expenses of $1.4 million, and telecommunication expenses of $0.3
million which resulted in an approximately 2.8% increase.
QUARTERLY RESULTS OF OPERATIONS
Note 17 of the consolidated financial statements sets forth certain unaudited
quarterly income statement data for each of the eight quarters beginning January
1, 2005 and ended December 31, 2006. In the opinion of management, this
information has been presented on the same basis as the Company's Financial
Statements appearing elsewhere in this document and all consolidated necessary
adjustments (consisting only of normal recurring adjustments) have been included
in order to present fairly the unaudited quarterly results. The results of
operations for any quarter are not necessarily indicative of the results for any
future period.
52
The Company's quarterly revenues and results of operations have not fluctuated
significantly from quarter to quarter in the past but could fluctuate in the
future. Factors that could cause such fluctuations include: the timing, number
and scope of customer engagements commenced and completed during the quarter;
fluctuation in the revenue mix by segments; progress on fixed-price engagements;
acquisitions; timing and cost associated with expansion of the Company's
facilities; changes in IT professional wage rates; the accuracy of estimates of
resources and time frames required to complete pending assignments; the number
of working days in a quarter; employee hiring and training, attrition and
utilization rates; the mix of services performed on-site, off-site and offshore;
termination of engagements; start-up expenses for new engagements; longer sales
cycles for Applications Outsourcing engagements; customers' budget cycles and
investment time for training.
LIQUIDITY AND CAPITAL RESOURCES
The Company generally has financed its working capital needs through operations.
The Mumbai and Chennai expansion programs, as well as the 1999 acquisitions of
Metier, Inc. and IMG, Inc. were financed from internally generated funds.
Additionally, construction of the Technology Campus in Pune, India is being
financed through internally generated funds.
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
JP Morgan Chase Bank NA for which a triple a rated letter of credit has been
provided. Remaining amounts are held by various banking institutions including
India-based banks and debt mutual funds in India.
Net cash provided by operating activities was $45.5 million; $36.4 million and
$48.5 million for the years ended December 31, 2006, 2005 and 2004,
respectively. The number of day's sales outstanding in accounts receivable was
approximately 56 days, 52 days and 61 days as of December 31, 2006, 2005 and
2004, respectively.
Net cash used in investing activities was $35.3 million for the year ended
December 31, 2006. During 2006, the Company invested $132.5 million to purchase
short-term investments and $15.5 million for capital expenditures, consisting
principally of computer hardware, software, communications equipment,
infrastructure and facilities. This was partially offset by proceeds from sale
or maturities of short-term investments of $112.7 million.
Net cash provided by investing activities was $21.6 million for the year ended
December 31, 2005. During 2005, the Company invested $27.9 million to purchase
short-term investments and $16.4 million for capital expenditures, consisting
principally of PCs, communications equipment and infrastructure and facilities.
This was partially offset by proceeds from sale of or maturities of short-term
investments of $65.9 million.
Net cash used in investing activities was $33.1 million for the year ended
December 31, 2004. During 2004, the Company invested $94.3 million to purchase
short-term investments and $12.0 million for capital expenditures, consisting
principally of computer hardware, software, communications equipment,
infrastructure and facilities. This was partially offset by proceeds from sale
or maturities of short-term investments of $73.2 million.
Net cash used in financing activities in 2006 was $58.8 million, due principally
to the dividend distribution of $61.1 million, partially offset by proceeds from
the issuance of shares under stock option and stock purchase plans of $1.9
million and $0.4 million towards
53
classification, in 2006, of tax benefits on employee stock option exercises in
financing activities as required by SFAS No. 123R.
Net cash used in financing activities in 2005 was $68.1 million, due principally
to the dividend distribution of $70.9 million and the repurchase of 35,000
shares of Common Stock for $0.7 million, partially offset by proceeds from the
issuance of shares under stock option and stock purchase plans of $3.4 million
Net cash used in financing activities in 2004 was $8.0 million, due principally
to the dividend distribution of $9.7 million and the repurchase of 100,000
shares of Common Stock for $1.4 million, partially offset by proceeds from the
issuance of shares under stock option and stock purchase plans of $3.1 million.
The Company has a line of credit with JPMorgan Chase Bank, N.A., 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 $5.0 million for letters of credit, which bear a fee of 1% per annum of the
face value of each standby letter of credit issued. Borrowing under the line of
credit bears interest at (i) a formula approximating the Eurodollar rate plus
the applicable margin of 1.25%, (ii) the bank's prime rate minus 1.0% or (iii)
negotiated rate plus 1.25%. There were no outstanding borrowings under the line
of credit at December 31, 2006 and 2005.
The Company believes that the combination of present cash balances and future
operating cash flows will be sufficient to meet the Company's currently
anticipated cash requirements for at least the next 12 months.
CONTRACTUAL OBLIGATIONS
The following table sets forth the Company's known contractual obligations as of
December 31, 2006:
($ '000)
PAYMENTS DUE BY PERIOD
-------------------------------------------------------
LESS THAN MORE THAN
CONTRACTUAL OBLIGATION TOTAL 1 YEAR 1-3 YEARS 3-5 YEARS 5 YEARS
---------------------- ------- --------- --------- --------- ---------
Long-term debt $ -- $ -- $ -- $ -- $--
Capital lease obligations -- -- -- -- --
Operating leases 14,913 4,740 8,093 2,080
Purchase obligations 6,992 6,992 -- -- --
Other long-term liabilities
reflected on the
Registrant's balance
sheet under GAAP -- -- -- -- --
------- ------- ------ ------ ---
Total $21,905 $11,732 $8,093 $2,080 $--
======= ======= ====== ====== ===
Certain agreements for lease and purchase obligations included above are
cancelable with a specified notice period or penalty, however all contracts are
reflected in the table above as if they will be performed for the full term of
the agreement.
54
INCOME TAX MATTERS
Syntel's software development centers/units are located in Mumbai, Chennai and
Pune. Units in Mumbai are located in a Special Economic Zone (SEZ), the unit at
Chennai is 100% Export Oriented Unit (EOU) and units at Pune are registered with
Software Technologies Park of India (STPI). Under the Indian Income Tax Act,
1961 (the "Act"), 100% EOUs at Chennai, units registered with STPI at Pune and
certain units located in SEZ are eligible for an exemption from payment of
corporate income taxes for up to 10 years of operations on the profits generated
from these undertakings or March 31, 2009, whichever is earlier. Certain units
located in SEZ are eligible for 100% exemption from payment of corporate taxes
for the first 5 years of operation and a 50% exemption for the next 5 years.
Effective April 1, 2003 one of the Company's Software Development Units has
ceased to enjoy the above-mentioned tax exemption. Two more development units
ceased to enjoy the tax exemption on April 1, 2005 and April 1, 2006
respectively. Provision for Indian Income Tax is made only in respect of
business profits generated from these software development units, to the extent
they are not covered by the above exemptions and on income from investments and
interest income.
The benefit of tax Holiday granted by the Indian authorities was $10.5 million,
$11.0 million and $7.6 million for the years 2006, 2005 and 2004, respectively.
On 28th February 2007, the Government of India announced Union Budget for the
Financial Year beginning 1st April 2007. Certain changes in the taxes in India
have been proposed in this Budget. Some of the changes were with respect to
introduction of a Minimum Alternate Tax ("MAT") of 11.33 %, Service tax of 12.36
% on rentals of non-residential property, increase in effective Dividend
Distribution Tax from 14.03% to 17 % and Fringe Benefit Tax on Employee Stock
Options/Restricted Options. For certain items, detailed rules are awaited.
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 Limited, 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 extra ordinary 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 December 31, 2006 the Company had fully
invested all the proceeds towards permitted investments under the Act against
this extra ordinary dividend pursuant to an approved Domestic reinvestment plan.
The Company intends to use remaining 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. If the company determines to repatriate all undistributed repatriable
earnings of foreign subsidiaries as of December 31, 2006, the Company would have
accrued taxes of approximately $51.2 million.
55
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. Conversely, in the event
of a future tax examination, if the Company does not prevail on certain tax
positions taken in filed returns, the tax expense related thereto will be
recognized in the period in which examiners position is determined to be final.
During the year ended December 31, 2006, 2005 and 2004, the effective income tax
rate was 11.9%, 40.3% and 11.4% respectively. The tax rate for the year ended
December 31, 2006 is impacted by reversal of tax reserve of $2.0 million.
Without the above, the effective tax rate for the year ended December 31, 2006
would have been 15.3%. The tax rate for the year ended December 31, 2005 was
impacted by reversal of tax reserve of $2.6 million, provision for valuation
allowance of $1.7 million and the tax related to the repatriation of $12.3
million. Without the above, the effective tax rate for the year ended December
31, 2005 would have been 17.8%. During year ended December 31, 2004 the tax rate
was impacted by reversal of tax reserve of $1.7 million, tax credit of $0.5
million in Syntel India and the research and development tax credit of $0.5
million in Syntel Inc. Without the above, the effective income tax rate during
the year ended December 31, 2004 would have been 17.3%. The tax rate continues
to be positively impacted by the combined effects of offshore transition and
reduced onsite profitability.
Syntel India has not provided for disputed Indian income tax liabilities
amounting to $2.6 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
opinions from another independent legal counsel (also a former Chief Justice of
the Supreme Court of India) for the financial years 1995-96, 1996-97, 1997-98,
1999-2000 and 2000-01 and for subsequent periods, which support Syntel India's
position in this matter.
Syntel India had earlier filed an appeal with the Commissioner of Income Tax
(Appeals) for the financial year 1998-99 and received a favorable decision.
However the Income tax department has gone into further appeal with the Income
Tax Appellate Tribunal against this favorable decision. During May 2006, the
Income Tax Appellate Tribunal has dismissed the appeal filed by the Income tax
department. The Income tax department has recourse to file further appeal.
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 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, 1996-97,
1997-98 and 2000-01 and received a favorable decision for 1995-96 and the
contention of Syntel India was partially upheld for the other three 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.
56
Syntel India has also not provided for other disputed Indian income tax
liabilities aggregating to $4.50 million for the financial years 2001-02 to
2002-03 against which Syntel India has filed the appeals with the Commissioner
of Income Tax (Appeals). Syntel India has obtained opinions from independent
legal counsels, which support Syntel India's stand in this matter. During the
year, Syntel India has received an order from the Commissioner of Income Tax
(Appeals) for the financial year 2001-02 and the contention of Syntel India was
partially upheld. Syntel India has gone into further appeal with the Income Tax
Appellate Tribunal in relation to the amounts not allowed by the Commissioner of
Income tax (Appeals). The Income tax department has also filed further appeal
against the relief granted to Syntel India by Commissioner of Income tax
(Appeals).
The Income tax department has recently completed the tax scrutiny for financial
year 2003-04 and Syntel India has received an order during the month of December
2006. Syntel India has filed an appeal before the Commissioner of Income Tax
(Appeals) against the order passed by the Income tax department. Accordingly,
Syntel India is not providing for the disputed Indian income tax liabilities
aggregating to $2.8 million for the financial year 2003-04.
Further, Syntel India has not provided for disputed income tax liabilities
aggregating to $0.10 million, for which Syntel India has filed necessary
appeals/ 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.
In December 2004, FASB Staff Position No. FAS 109-2, "Accounting and Disclosure
Guidance for the Foreign Earnings Repatriation Provision within the American
Jobs Creation Act of 2004" ("FSP FAS 109-2") was issued, providing guidance
under SFAS No. 109, "Accounting for Income Taxes" for recording the potential
impact of the repatriation provisions of the American Jobs Creation Act of 2004,
enacted on October 22, 2004. FSP FAS 109-2 allows time beyond the financial
reporting period of enactment to evaluate the effects of the Jobs Act before
applying the requirements of FSP FAS 109-2. 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 out of the retained earnings of its controlled foreign subsidiary,
Syntel Limited, to the U.S. in accordance with the Act. The Company recorded a
tax charge of approximately $12.3 million, including US Federal and state taxes
and the Indian dividend distribution tax under the Indian Income Tax laws,
related to this repatriation during the fourth quarter of 2005. Proceeds from
these extra ordinary dividends are required to be invested in the United State
for specific purposes permitted under Act pursuant to an approved written
domestic reinvestment plan. As of December 31, 2006 the Company had fully
invested all the proceeds towards permitted investments under the Act against
this extra ordinary dividend pursuant to an approved Domestic reinvestment plan.
57
TAX CREDIT
During the year ended December 31, 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
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.
In addition, during the year ended December 31, 2004, Syntel India has accounted
for a credit of approximately $0.5 million in respect of US branch profit taxes
related to prior periods up to June 30, 2004 and also reclassified in the
balance sheet $1.0 million from Income taxes payable to deferred tax liability.
RECENT ACCOUNTING PRONOUNCEMENTS
In September 2006, the SEC issued SAB 108, "Considering the Effects of Prior
Year Misstatements when Quantifying Misstatements in Current Year Financial
Statements" ("SAB 108"). SAB 108 provides interpretive guidance on how the
effects of the carryover or reversal of prior year misstatements should be
considered in quantifying a current year misstatement. The pronouncement
prescribes an approach whereby the effect of all unrecorded identified errors
should be considered on all of the financial statements rather than just either
the effect on the balance sheet or the income statement. We adopted the
provisions of SAB 108 as of December 31, 2006. The adoption of SAB 108 did not
have a material impact on our consolidated financial statements.
On July 13, 2006, the Financial Accounting Standards Board ("FASB") issued
Interpretation No. 48, "Accounting for Uncertainty in Income Taxes -- an
interpretation of FASB Statement No. 109 ("FIN 48"), which clarifies the
accounting for uncertainty in tax positions. FIN 48 requires recognition in the
financial statements of the impact of a tax position, if that position is more
likely than not of being sustained on examination, based on the technical merits
of the position. The provisions of this interpretation are required to be
adopted for fiscal periods beginning after December 15, 2006. The Company will
be required to apply the provisions of FIN 48 to all tax positions, upon initial
adoption, with any cumulative effect adjustment to be recognized as an
adjustment to the retained earnings. The Company will be adopting the provisions
of FIN 48 in the first Quarter of 2007.
The Company is still assessing, the impact of the adoption of the FIN 48. Based
on a preliminary analysis, the management believes that, adoption of FIN 48 may
result, in recording a decrease to retained earnings, between $3 million and $5
million, in the first quarter of 2007. The final analysis will be completed in
the first quarter of 2007.
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 of SFAS 157 will have on its financial position, results
of operations and liquidity and its related disclosures.
58
ITEM 7A. 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 our cash and cash equivalents and investments in
marketable securities (in thousands):
DECEMBER 31, DECEMBER 31,
ASSETS 2006 2005
------ ------------ ------------
Cash and cash equivalents $51,555 $ 99,390
Short-term investments 42,319 21,083
------- --------
Total $93,874 $120,473
======= ========
The Company's exposure to market rate risk for changes in interest rates relates
primarily to our 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 a
material impact on interest earnings for our investment portfolio. The Company
strives to 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, 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 2006, the Indian rupee has appreciated by 1.7% as compared to 2005, which
has decreased the Company's gross margin by 0.11%. For the year ended December
31, 2006, the Indian rupee denominated cost of revenues and selling, general and
administrative cost were 33% and 46%, respectively, which did not have a
significant impact.
59
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.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.
The financial statements filed herewith are set forth on the Index to Financial
Statements on page F-1 of the separate financial section which follows page 68
of this Report and are incorporated herein by reference.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE.
None.
ITEM 9A. CONTROLS AND PROCEDURES
DISCLOSURE CONTROLS AND PROCEDURES
EVALUATION OF DISCLOSURE CONTROLS AND PROCEDURES. Based on their evaluation of
the Company's disclosure controls and procedures as of the end of the period
covered by this Report as well as mirror certifications from senior Management,
the Company's Chairman and Chief Executive Officer and 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 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. Further, the design of a control
system must reflect the fact
60
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 CFO have concluded
that as of December 31, 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
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.
MANAGEMENT'S REPORT ON INTERNAL CONTROL OVER FINANCIAL REPORTING
Our management is responsible for establishing and maintaining adequate internal
control over financial reporting, as such term is defined in Exchange Act Rules
13a-15(f). Under the supervision and with the participation of our management,
including our chief executive officer and chief financial officer, we conducted
an evaluation of the effectiveness of our internal control over financial
reporting based on the framework in Internal Control-Integrated Framework issued
by the Committee of Sponsoring Organizations of the Treadway Commission. Based
on our evaluation under the framework in Internal Control - Integrated
Framework, our management concluded that our internal control over financial
reporting was effective as of December 31, 2006 and meets the criteria of the
Internal Control-Integrated Framework.
61
Crowe Chizek and Company LLC, an independent registered public accounting firm,
has audited the consolidated financial statements of Syntel, Inc. and its
subsidiaries as of December 31, 2006 and for the year then ended included in
this Annual Report on Form 10-K and, as part of its audit, has issued its
report, included herein, (1) on our management's assessment of the effectiveness
of our internal controls over financial reporting and (2) on the effectiveness
of our internal control over financial reporting.
CHANGES IN INTERNAL CONTROLS OVER FINANCIAL REPORTING. 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.
ITEM 9B. OTHER INFORMATION
None
62
PART III
ITEM 10. DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE
The information set forth in the sections entitled "Proposal 1. Election of
Directors" and "Additional information - Section 16 (a) Beneficial Ownership
Reporting Compliance" in the Registrant's Proxy Statement for the Annual
Shareholders' Meeting to be held on or about May 25, 2007 (the "Proxy
Statement") is incorporated herein by reference. The information set forth in
the section entitled "Executive Officers of the Registrant" in Item 1 of this
report is incorporated herein by reference.
The Company has adopted a Code of Ethical Conduct applicable to all of the
Company's employees, executive officers and directors. The Code of Ethical
Conduct, as currently in effect (together with any amendments that may be
adopted from time to time), is posted in the "Investors - Corporate Governance"
section of the Company's website at www.syntelinc.com. Amendments to, and any
waiver from, any provision of the Code of Ethical Conduct that requires
disclosure under applicable SEC rules will be posted on the website at the
address specified above.
ITEM 11. EXECUTIVE COMPENSATION
The information set forth under the sections entitled "Executive Compensation",
"Compensation Disclosure and Analysis" and "Proposal 1. Election of Directors -
Compensation of Directors" in the Registrant's Proxy Statement is incorporated
herein by reference.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND
RELATED STOCKHOLDER MATTERS
The information set forth under the captions "Equity Compensation Plan
Information" in Item 5 of this report is incorporated herein by reference. The
information set forth under the caption " Security Ownership of Certain
Beneficial Owners and Management" in the section entitled "Additional
Information" in the Registrant's Proxy Statement is incorporated herein by
reference.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR
INDEPENDENCE
The Company had no transactions with related persons requiring disclosure under
this item. The information set forth in the section entitled "Proposal 1.
Election of Directors" in the Registrant's Proxy Statement is incorporated
herein by reference.
63
ITEM 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES
Crowe Chizek and Company LLC served as the Company's independent auditors for
the consolidated financial statements prepared for the years ended December 31,
2006, 2005 and 2004, and all the quarters of 2006, 2005 and 2004 The following
table lists the aggregate fees for professional services rendered by Crowe
Chizek and Company LLC for all "Audit Fees," "Audit-Related Fees," "Tax Fees,"
and "All Other Fees" which pertain to the last two years.
FISCAL YEAR ENDED
---------------------------
DECEMBER 31, DECEMBER 31,
2006 2005
------------ ------------
Audit Fees $404,329 $306,250
Audit - Related Fees 16,900 8,500
Tax Fees -- 7,500
All Other Fees 41,620 23,245
Audit Fees represent fees for professional services rendered for the audit of
the consolidated financial statements of the Company and assistance with review
of documents filed with the SEC and the audit of management's assessment of the
effectiveness of internal control over financial reporting. Audit-Related Fees
represent professional fees in connection with the statutory audit services
relative to Syntel India and Syntel Germany and the 401K plan for Syntel Inc.
Tax Fees represent fees for the services related to tax compliance, tax advice
and tax planning. All Other Fees represent consultation on matters related to
transfer pricing, dividend and other advisory services.
AUDIT COMMITTEE AUTHORIZATION OF AUDIT AND NON-AUDIT SERVICES
The Audit Committee has the sole authority to authorize all audit and non-audit
services to be provided by the independent audit firm engaged to conduct the
annual statutory audit of the Company's consolidated financial statements. In
addition, the Audit Committee has adopted pre-approval policies and procedures
that are detailed as to each particular service to be provided by the
independent auditors, and such policies and procedures do not permit the Audit
Committee to delegate its responsibilities under the Securities Exchange Act of
1934, as amended, to management. The Audit Committee pre-approved fees for all
audit and non-audit services provided by the independent audit firm during the
fiscal year ended December 31, 2006 and 2005 as required by the Sarbanes-Oxley
Act of 2002.
The Audit Committee has considered whether the provision of the non-audit
services is compatible with maintaining the independent auditor's independence,
and has advised the Company that, in its opinion, the activities performed by
Crowe Chizek and Company LLC on the Company's behalf are compatible with
maintaining the independence of such auditors.
64
PART IV
ITEM 15. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES
(a)(1) The financial statements and supplementary financial information
filed herewith are set forth on the Index to Financial Statements on page F-1 of
the separate financial section which follows page 68 of this Report, which is
incorporated herein by reference.
(a)(2) The consolidated financial statement schedules of the Company and
its subsidiaries have been omitted because they are not required, are not
applicable, or are adequately explained in the financial statements included in
Part II, Item 8 of this report.
(a)(3) The following exhibits are filed as part of this Report. Those
exhibits with an asterisk (*) designate the Registrant's management contracts or
compensation plans or arrangements for its executive officers.
EXHIBIT NO. DESCRIPTION
----------- -----------
3.1 Amended and Restated Articles of Incorporation of the Registrant
filed as an exhibit to the Registrant's Quarterly Report on Form
10-Q for the quarterly period ended June 30, 2005, and
incorporated herein by reference.
3.2 Bylaws of the Registrant filed as an Exhibit to the Registrant's
Quarterly Report on Form 10-Q for the quarterly period ended March
31, 2005, and incorporated herein by reference.
10.1 Line of Credit Agreement, dated August 31, 2002, between the
Registrant and Bank One, Michigan filed as an Exhibit to the
Registrant's Annual Report on Form 10-K for the year ended
December 31, 2002, and incorporated herein by reference.
10.2 Lease, dated October 24, 2001, between Big Beaver / Kilmer
Associates L.L.C. and the Registrant filed as an Exhibit to the
Registrant's Annual Report on Form 10-K for the year ended
December 31, 2002, and incorporated herein by reference.
10.3 Indentures of Lease entered into between the President of India
and Syntel Limited (formerly known as Syntel Software Pvt. Ltd.)
on various dates in 1992 and 1993 for the Mumbai Global
Development Center and filed as an Exhibit to the Registrant's
Registration Statement on Form S-1 dated June 6, 1997, and
incorporated herein by reference.
10.4 Rental Agreement, dated February 24, 1997, between Syntel Limited
(formerly known as Syntel Software Pvt. Ltd.) and the Landlords
for the Chennai Global Development Center, filed as an Exhibit to
the Registrant's Registration Statement on Form S-1 dated June 6,
1997, and incorporated herein by reference.
65
10.5* Amended and Restated Stock Option and Incentive Plan, filed as an
Exhibit to the Registrant's Current Report dated June 1, 2006 and
incorporated herein by reference.
10.6* Amended and Restated Employee Stock Purchase Plan, filed as an
Exhibit to the Registrant's Registration Current Report on Form
8-K dated June 1, 2006 and incorporated herein by reference.
10.7* Form of Stock Option Agreement, filed as an Exhibit to the
Registrant's Current Report on Form 8-K dated June 2, 2005, and
incorporated herein by reference.
10.8* [Incentive] Restricted Stock Grant Agreement, filed as an Exhibit
to the Registrant's Quarterly Report on Form 10-Q for the
quarterly period ended September 30, 2006, and incorporated herein
by reference.
10.9* Form of Annual Performance Award, filed as an Exhibit to the
Registrant's Current Report on Form 8-K dated July 7, 2006 and
incorporated herein by reference.
10.10* Employment Agreement, dated October 18, 2001, between the Company
and Bharat Desai, filed as an Exhibit to the Registrant's Current
Report on Form 8-K dated July 7, 2006 and incorporated herein by
reference.
10.11* Employment Agreement, dated October 18, 2001, between the Company
and Daniel M. Moore, filed as an Exhibit to the Registrant's
Current Report on Form 8-K dated July 7, 2006 and incorporated
herein by reference.
10.12 Amendment to Credit Agreement dated August 25, 2003, between the
Registrant and Bank One, NA, filed as an Exhibit to the
Registrant's Annual Report on Form 10-K for the year ended
December 31, 2003, and incorporated herein by reference.
10.13 Amendment to Credit Agreement dated August 19, 2004, between the
Registrant and Bank One, NA, filed as an Exhibit to the
Registrant's Annual Report on Form 10-K for the year ended
December 31, 2004, and incorporated herein by reference.
10.14 Amendment to Credit Agreement dated August 23, 2005, between the
Registrant and JPMorgan Chase Bank, N.A., successor in interest to
Bank One, NA, filed as an Exhibit to the Registrant's Annual
Report on Form 10-K for the year ended December 31, 2005, and
incorporated herein by reference.
10.15 Amendment to Credit Agreement dated August 31, 2006, between the
Registrant and JPMorgan Chase Bank, N.A., filed as an Exhibit to
the Registrant's Current Report on Form 8-K dated August 4, 2006,
and incorporated herein by reference.
10.16 Leave and License Agreement, dated June 11, 2004, between Lake
View Developers and Syntel Sourcing Pvt. Ltd. filed as an Exhibit
to the Registrant's Annual Report on Form 10-K for the year ended
December 31, 2004, and incorporated herein by reference.
66
10.17 Lease Deed, dated September 23, 2004 between Arihant Foundation
and Housing Ltd. and Syntel Limited filed as an Exhibit to the
Registrant's Annual Report on Form 10-K for the year ended
December 31, 2004, and incorporated herein by reference.
10.18 Lease Deed, dated October 6, 2004, between Arihant Foundation and
Housing Ltd. and Syntel Limited filed as an Exhibit to the
Registrant's Annual Report on Form 10-K for the year ended
December 31, 2004, and incorporated herein by reference.
14 Code of Ethical Conduct filed as an Exhibit to the Registrant's
Annual Report on Form 10-K for the year ended December 31, 2004,
and incorporated herein by reference.
21 SUBSIDIARIES OF THE REGISTRANT.
23 CONSENT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM.
31.1 Rule 13a-14(a)/15d-14(a) Certification of Chief Executive Officer
pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
31.2 Rule 13a-14(a)/15d-14(a) Certification of Chief Financial Officer
pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
32 Section 1350 Certification of Chief Executive Officer and Chief
Financial Officer
67
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) 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.
By: /S/ Bharat Desai
------------------------------------
Bharat Desai, Chairman and
Dated: March 15, 2007 Chief Executive Officer
Pursuant to the requirements of the Securities Exchange Act of 1934, this
Report has been signed below by the following persons on behalf of the
Registrant and in the capacities and on the dates indicated.
Signature Title Date
--------- ----- ----
/S/ Bharat Desai Chairman and Chief March 15, 2007
------------------------------- Executive Officer
Bharat Desai (Principal Executive Officer)
/S/ Arvind Godbole Chief Financial Officer March 15, 2007
------------------------------- (Principal Financial and
Arvind Godbole Accounting Officer)
/S/ Neerja Sethi Director and Vice President, March 15, 2007
------------------------------- Corporate Affairs
Neerja Sethi
/S/ Paritosh K. Choksi Director March 15, 2007
-------------------------------
Paritosh K. Choksi
/S/ Paul R. Donovan Director March 15, 2007
-------------------------------
Paul R. Donovan
/S/ George R. Mrkonic Director March 15, 2007
-------------------------------
George R. Mrkonic
/S/ Vasant Raval Director March 15, 2007
-------------------------------
Vasant Raval
/S/ James Swayzee Director March 15, 2007
-------------------------------
James Swayzee
68
CONTENTS
PAGE(S)
-------
REPORTS OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
Report of Independent Registered Public Accounting Firm as of
December 31, 2006 and 2005 and for each of the three years in
the period ended December 31, 2006 ................................... 70
Report of Independent Registered Public Accounting Firm on Internal
Control over Financial Reporting as of December 31, 2006.............. 71
CONSOLIDATED FINANCIAL STATEMENTS
Consolidated Balance Sheets........................................... 73
Consolidated Statements of Income..................................... 74
Consolidated Statements of Shareholders' Equity....................... 75
Consolidated Statements of Cash Flows................................. 76
Notes to Consolidated Financial Statements............................ 77-100
69
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Board of Directors and Shareholders of
Syntel, Inc.
Troy, Michigan
We have audited the accompanying consolidated balance sheets of Syntel, Inc. as
of December 31, 2006 and 2005 and the related consolidated statements of income,
shareholders' equity and cash flows for each of the three years in the period
ended December 31, 2006. These financial statements are the responsibility of
the Company's management. Our responsibility is to express an opinion on these
financial statements based on our audits.
We conducted our audits in accordance with the standards of the Public Company
Accounting Oversight Board (United States). Those standards require that we plan
and perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the financial position of Syntel, Inc. as of
December 31, 2006 and 2005, and the results of its operations and its cash flows
for each of the three years in the period ended December 31, 2006 in conformity
with United States generally accepted accounting principles.
We also have audited, in accordance with the standards of the Public Company
Accounting Oversight Board (United States), the effectiveness of Syntel, Inc.'s
internal control over financial reporting as of December 31, 2006, based on
criteria established in Internal Control - Integrated Framework issued by the
Committee of Sponsoring Organizations of the Treadway Commission and our report
dated March 8, 2007 expressed an unqualified opinion thereon.
Fort Wayne, Indiana /s/ Crowe Chizek and Company LLC
March 8, 2007
70
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Board of Directors and Shareholders of
Syntel, Inc.
Troy, Michigan
We have audited management's assessment, included within item 9A as Management's
Report on Internal Control Over Financial Reporting, that Syntel, Inc.
maintained effective internal control over financial reporting as of December
31, 2006, based on criteria established in Internal Control - Integrated
Framework issued by the Committee of Sponsoring Organizations of the Treadway
Commission (COSO). Syntel, Inc's. management is responsible for maintaining
effective internal control over financial reporting and for its assessment of
the effectiveness of internal control over financial reporting. Our
responsibility is to express an opinion on management's assessment and an
opinion on the effectiveness of the company's internal control over financial
reporting based on our audit.
We conducted our audit in accordance with the standards of the Public Company
Accounting Oversight Board (United States). Those standards require that we plan
and perform the audit to obtain reasonable assurance about whether effective
internal control over financial reporting was maintained in all material
respects. Our audit included obtaining an understanding of internal control over
financial reporting, evaluating management's assessment, testing and evaluating
the design and operating effectiveness of internal control, and performing such
other procedures as we considered necessary in the circumstances. We believe
that our audit provides a reasonable basis for our opinion.
A company's internal control over financial reporting is a process designed to
provide reasonable assurance regarding the reliability of financial reporting
and the preparation of financial statements for external purposes in accordance
with generally accepted accounting principles. A company's internal control over
financial reporting includes those policies and procedures that (1) pertain to
the maintenance of records that, in reasonable detail, accurately and fairly
reflect the transactions and dispositions of the assets of the company; (2)
provide reasonable assurance that transactions are recorded as necessary to
permit preparation of financial statements in accordance with generally accepted
accounting principles, and that receipts and expenditures of the company are
being made only in accordance with authorizations of management and directors of
the company; (3) provide reasonable assurance regarding prevention or timely
detection of unauthorized acquisition, use, or disposition of the company's
assets that could have a material effect on the financial statements.
Because of its inherent limitations, internal control over financial reporting
may not prevent or detect misstatements. Also, projections of any evaluation of
effectiveness to future periods are subject to the risk that controls may become
inadequate because of changes in conditions, or that the degree of compliance
with the policies or procedures may deteriorate.
In our opinion, management's assessment that Syntel, Inc. maintained effective
internal control over financial reporting as of December 31, 2006, is fairly
stated, in all material respects, based on criteria established in Internal
Control - Integrated Framework issued by the Committee of Sponsoring
Organizations of the Treadway Commission (COSO). Also in our opinion, Syntel,
Inc. maintained, in all material respects, effective internal control over
financial reporting as of December 31, 2006, based on criteria established in
71
Internal Control - Integrated Framework issued by the Committee of Sponsoring
Organizations of the Treadway Commission (COSO).
We have also audited, in accordance with the standards of the Public Company
Accounting Oversight Board (United States), the consolidated balance sheets of
Syntel, Inc. as of December 31, 2006 and 2005, and the related consolidated
statements of income, shareholders' equity, and cash flows for each of the three
years in the period ended December 31, 2006, and our report dated March 8, 2007
expressed an unqualified opinion on those consolidated financial statements.
Fort Wayne, Indiana /s/ Crowe Chizek and Company LLC
March 8, 2007
72
SYNTEL, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS, EXCEPT SHARE DATA)
DECEMBER 31, DECEMBER 31,
2006 2005
------------ ------------
ASSETS
Current assets:
Cash and cash equivalents $ 51,555 $ 99,390
Short-term investments 42,319 21,083
Accounts receivable, net of allowance for
doubtful accounts of $2,828 and $ 2,575 at
December 31, 2006 and 2005, respectively 33,706 27,907
Revenue earned in excess of billings 11,947 8,366
Deferred income taxes and other current assets 13,983 10,003
-------- --------
Total current assets 153,510 166,749
Property and equipment 69,672 54,690
Less accumulated depreciation and amortization 31,358 25,504
-------- --------
Property and equipment, net 38,314 29,186
Goodwill 906 906
Deferred income taxes and other non current assets 4,959 1,320
-------- --------
TOTAL ASSETS $197,689 $198,161
======== ========
LIABILITIES AND SHAREHOLDERS' EQUITY
LIABILITIES
Current liabilities:
Accounts payable $ 7,559 $ 6,890
Accrued payroll and related costs 20,034 15,906
Income taxes payable 2,732 9,809
Accrued liabilities 9,244 7,446
Deferred revenue 5,960 3,356
Dividends payable 2,418 2,476
-------- --------
Total current liabilities 47,947 45,883
SHAREHOLDERS' EQUITY
Common Stock, no par value per share,
100,000,000 shares authorized; 40,914,676 and
40,679,481 shares issued and outstanding at
December 31, 2006 and 2005, respectively 1 1
Restricted stock,
299,584 and 268,630 shares issued and
outstanding at December 31, 2006 and 2005,
respectively 3,390 1,942
Additional paid-in capital 63,373 60,460
Accumulated other comprehensive income 3,679 853
Retained earnings 79,299 89,022
-------- --------
Total shareholders' equity 149,742 152,278
-------- --------
TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY $197,689 $198,161
======== ========
The accompanying notes are an integral part of the consolidated financial
statements.
73
SYNTEL, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
(IN THOUSANDS, EXCEPT PER SHARE DATA)
YEAR ENDED DECEMBER 31,
------------------------------
2006 2005 2004
-------- -------- --------
Net revenues $270,229 $226,189 $186,573
Cost of revenues 167,980 135,043 107,120
-------- -------- --------
Gross profit 102,249 91,146 79,453
Selling, general and administrative expenses 49,374 44,917 36,999
-------- -------- --------
Income from operations 52,875 46,229 42,454
Other income, principally interest 4,894 4,592 3,773
-------- -------- --------
Income before income taxes 57,769 50,821 46,227
Income taxes 6,853 20,500 5,253
-------- -------- --------
Net income $ 50,916 $ 30,321 $ 40,974
======== ======== ========
CASH DIVIDENDS PER SHARE $ 1.49 $ 1.74 $ 0.24
EARNINGS PER SHARE:
Basic $ 1.25 $ 0.75 $ 1.02
Diluted $ 1.24 $ 0.75 $ 1.01
Weighted average common shares outstanding:
Basic 40,819 40,528 40,216
Diluted 41,095 40,651 40,469
The accompanying notes are an integral part of the consolidated financial
statements.
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SYNTEL, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
(IN THOUSANDS, EXCEPT PER SHARE DATA)
ACCUMULATED OTHER
COMPREHENSIVE
INCOME (LOSS)
------------------------
FOREIGN
COMMON STOCK RESTRICTED STOCK ADDITIONAL UNREALIZED CURRENCY TOTAL
-------------- ---------------- PAID-IN RETAINED INVESTMENT TRANSLATION SHAREHOLDERS
SHARES AMOUNT SHARES AMOUNT CAPITAL EARNINGS GAIN/(LOSS) ADJUSTMENT EQUITY
------ ------ ------ ------- ---------- -------- ----------- ----------- ------------
BALANCE, JANUARY 1, 2004 40,016 $1 -- $ -- $54,038 $ 97,848 $ 813 $ 706 $153,406
Net income 40,974 40,974
Unrealized (loss) on investments,
net of tax (267) (267)
Translation adjustments 2,214 2,214
-------- ------ ------- --------
Total comprehensive income 40,974 (267) 2,214 42,921
-------- ------ ------- --------
Common stock repurchases (100) (1,479) (1,479)
Employee stock purchase plan 73 1,021 1,021
Exercised stock options 265 2,118 2,118
Tax benefit on stock options
exercised 1,410 1,410
Restricted stock 319 5,838 5,838
Forfeiture of restricted stock (22) (410) (410)
Unearned compensation related to
restricted stock (4,600) (4,600)
Warrants issued as sales incentive
converted into common stock 3 77 77
Dividends, $0.24 per share (9,660) (9,660)
------ --- ---- ------- ------- -------- ------ ------- --------
BALANCE, DECEMBER 31, 2004 40,257 1 297 828 57,185 129,162 546 2,920 190,642
------ --- ---- ------- ------- -------- ------ ------- --------
Net income 30,321 30,321
Unrealized gain on investments, net
of tax (70) (70)
Translation adjustments (2,543) (2,543)
-------- ------ ------- --------
Total comprehensive income 30,321 (70) (2,543) 27,708
-------- ------ ------- --------
Common stock repurchases (35) (676) (676)
Employee stock purchase plan 63 945 945
Exercised stock options 362 2,472 2,472
Tax benefit on stock options
exercised 534 534
Restricted stock 32 55 891 891
Forfeiture of restricted stock (84) (1,208) (1,208)
Unearned compensation related to
restricted stock 1,431 1,431
Dividends, $1.74 per share (70,461) (70,461)
------ --- ---- ------- ------- -------- ------ ------- --------
BALANCE, DECEMBER 31,2005 40,679 1 268 1,942 60,460 89,022 476 377 152,278
------ --- ---- ------- ------- -------- ------ ------- --------
Net income 50,916 50,916
Unrealized gain on investments, net
of tax 2,173 2,173
Translation adjustments 653 653
-------- ------ ------- --------
Total comprehensive income 50,916 2,173 653 53,742
-------- ------ ------- --------
Employee stock purchase plan 47 375 375
Exercised stock options 165 1,540 1,540
Share based compensation expense 603 603
Tax benefit on stock options
exercised 395 395
Restricted stock activity 24 31 1,448 1,448
Dividends, $1.49 per share (60,639) (60,639)
------ --- ---- ------- ------- -------- ------ ------- --------
BALANCE, DECEMBER 31,2006 40,915 $1 299 $ 3,390 $63,373 $ 79,299 $2,649 $ 1,030 $149,742
------ --- ---- ------- ------- -------- ------ ------- --------
The accompanying notes are an integral part of the consolidated financial
statements.
75
SYNTEL, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
2006 2005 2004
-------- -------- --------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income $ 50,916 $ 30,321 $ 40,974
Adjustments to reconcile net income to net cash provided
by operating activities
Depreciation and amortization 6,055 4,852 3,024
Bad debt provisions / (credits) 376 1,564 400
Realized gains on sales of short term investments (641) (1,383) (2,049)
Deferred income taxes (459) 890 1,101
Stock warrants sales incentive -- -- 77
Compensation expense related to restricted stock 1,857 1,596 884
Share based compensation expense 603 -- --
Tax benefit on stock option exercised -- 534 1,409
Changes in assets and liabilities:
Accounts receivable and revenue earned in excess
of billing (6,912) (6,446) (469)
Other current assets (7,294) (4,191) (300)
Accrued payroll and other liabilities (63) 10,621 2,637
Deferred revenues 1,082 (1,921) 783
-------- -------- --------
Net cash provided by operating activities 45,520 36,437 48,471
-------- -------- --------
CASH FLOWS FROM INVESTING ACTIVITIES:
Property and equipment expenditures (15,544) (16,392) (12,017)
Purchase of short- term investments:
Investments in mutual funds (57,563) (23,484) (72,825)
Investments in term deposits with banks (74,894) (4,434) (21,516)
Proceeds from sales of short term investments:
Proceeds from sales of mutual funds 61,938 43,255 65,866
Maturities of term deposits with banks 50,791 22,682 7,394
-------- -------- --------
Net cash provided by (used in) investing activities (35,272) 21,627 (33,098)
-------- -------- --------
CASH FLOWS FROM FINANCING ACTIVITIES:
Net proceeds from issuance of common stock 1,915 3,417 3,140
Tax benefit on stock option exercised 395 -- --
Common stock repurchases -- (676) (1,479)
Dividends paid (61,100) (70,901) (9,685)
-------- -------- --------
Net cash used in financing activities (58,790) (68,160) (8,024)
-------- -------- --------
Effect of foreign currency exchange rate changes on cash 707 344 (1,061)
-------- -------- --------
Change in cash and cash equivalents (47,835) (9,752) 6,288
Cash and cash equivalents, beginning of year 99,390 109,142 102,854
-------- -------- --------
Cash and cash equivalents, end of year $ 51,555 $ 99,390 $109,142
======== ======== ========
Noncash investing and financing activities:
Cash dividends declared but unpaid $ 2,418 $ 2,476 $ 2,433
Stock warrants -- -- 77
Cash paid for income taxes 13,145 19,134 5,543
The accompanying notes are an integral part of the consolidated financial
statements.
76
SYNTEL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. BUSINESS
Syntel, Inc. and subsidiaries (individually and collectively "Syntel" or the
"Company") provide information technology services such as programming, systems
integration, outsourcing and overall project management. The Company provides
services to customers primarily in the financial and banking sector, insurance,
manufacturing, healthcare, transportation, retail, and information/communication
industries. The Company's reportable operating segments consist of Applications
Outsourcing, e-Business, TeamSourcing and Business Process Outsourcing (BPO).
Through Applications Outsourcing, the Company provides higher-value outsourcing
services for ongoing management, development and maintenance of customers'
business applications. In most Application Outsourcing engagements, the Company
assumes responsibility for the management of customer development and support
functions. These services may be provided on either a time-and-material basis or
on a fixed-price basis.
Through e-Business, the Company provides development and implementation services
for a number of emerging and rapidly growing high technology applications,
including Web development, Data Warehousing, e-commerce, CRM, as well as
partnership arrangements with leading software firms, to provide installation
services to their respective customers. These services may be provided on either
a time-and-material basis or on a fixed price basis, in which the Company
assumes responsibility for management of the engagement.
Through TeamSourcing, the Company provides professional information technology
consulting services directly to customers on a staff augmentation basis.
TeamSourcing services include systems specification, design, development,
implementation and maintenance of complex information technology applications
involving diverse computer hardware, software, data and networking technologies
and practices. TeamSourcing consultants, whether working individually or as a
team of professionals, generally receive direct supervision from the customer's
management staff. TeamSourcing services are generally invoiced on a time and
material basis.
Through BPO, Syntel provides custom outsourced solutions for a client's business
processes, providing them with the advantage of a low cost position and process
enhancement through optimal use of technology. Syntel uses a proprietary tool
called Identeon(TM) to assist with strategic assessments of business processes
and identifying the right ones for outsourcing.
2. SUMMARY OF CERTAIN SIGNIFICANT ACCOUNTING POLICIES
PRINCIPLES OF CONSOLIDATION
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) Limited.;
- Syntel Singapore PTE. Limited. ("Syntel Singapore"), a Singapore limited
liability company;
77
- Syntel Europe, Limited. ("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 Limited. ("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 limited liability
company;
- 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 LLC (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) Limited. ("SSSSML"), a Mauritius
limited liability company formerly known as Syntel Solutions (Mauritius)
Limited.
The wholly owned subsidiary of SSSSML is:
- Syntel Sourcing Private Limited. ("Syntel Sourcing"), an Indian limited
liability company.
The wholly owned subsidiaries of Syntel Mauritius are:
- Syntel International Private Limited. ("Syntel International"), an Indian
limited liability company; and
- Syntel Global Private Limited. ("Syntel Global"), an Indian limited
liability company.
The wholly owned subsidiary of Syntel Sterling BestShores (Mauritius) Limited
is:
- Syntel Sterling BestShores Solutions Private Limited ("SSBSPL"), an Indian
limited liability company.
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
78
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".
STOCK-BASED EMPLOYEE COMPENSATION PLANS
Effective January 1, 2006, the Company adopted Statement of Financial Accounting
Standard ("SFAS") No. 123R, "Share-Based Payment," utilizing the modified
prospective method. SFAS No. 123R requires the recognition of stock-based
compensation expense in the consolidated financial statements for awards of
equity instruments to employees and non-employee directors based on the
grant-date fair value of those awards, estimated in accordance with the
provisions of SFAS No. 123R. The Company recognizes these compensation costs on
a straight-line basis over the requisite service period of the award, which is
generally the option vesting term. Under the modified prospective method, the
provisions of SFAS No. 123R apply to all awards granted or modified after the
date of adoption. In addition, the unrecognized expense of awards not yet vested
at the date of adoption, determined under the original provisions of SFAS No.
123, "Accounting for Stock-Based Compensation" ("SFAS No. 123"), are recognized
in net income in the periods after the date of adoption. SFAS No. 123R also
requires the benefits of tax deductions in excess of recognized compensation
expense to be reported as a financing cash flow, rather than as an operating
cash flow as prescribed under the prior accounting rules. This requirement
reduces net operating cash flow and increases net financing cash flows in
periods after adoption. Total cash flow remains unchanged from what would have
been reported under the prior accounting rules.
Prior to the adoption of SFAS No. 123R, the Company followed the intrinsic value
method to account for its employee stock option plans (ESOP Plans) and employee
stock purchase plan (ESPP Plans) in accordance with the recognition and
measurement principles of Accounting Principles Board Opinion ("APB") No. 25,
"Accounting for Stock Issued to Employees" and Related Interpretations ("APB No.
25"), as allowed by SFAS No. 123 and as amended by SFAS No. 148, "Accounting for
Stock-Based Compensation - Transition and Disclosure". Accordingly, no
stock-based employee compensation cost was recognized on account of ESOP and
ESPP plans, as all options granted under those plans had an exercise price equal
to the market value of the underlying common stock on the date of grant and,
with respect to the employee stock purchase plan, the discount did not exceed
fifteen percent. In accordance with the transitional provisions of SFAS No.
123R, operating results for 2005 and 2004 have not been restated. The Company
historically reported pro forma results under the disclosure-only provisions of
SFAS No. 123.
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 December 31, 2006 and 2005, approximately $13.9
million and $60.8 million respectively, represent corporate bonds and
79
treasury notes held by JPMorgan Chase Bank, N.A., 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.
FAIR VALUE OF FINANCIAL INSTRUMENTS
The fair values of the Company's current assets and current liabilities
approximate their carrying values because of their short maturities. Such
financial instruments are classified as current and are expected to be
liquidated within the next twelve months.
CONCENTRATION OF CREDIT RISKS
Financial instruments that potentially subject the Company to a concentration of
credit risk consist principally of investments and accounts receivable. Cash on
deposit is held with financial institutions with high credit standings. The
Company has cash deposited with financial institutions that, at times, may
exceed the federally insured limits.
The Company's customer base consists primarily of Global 2000 companies and,
accordingly, accounts receivable are not exposed to significant credit risk. The
Company establishes an allowance for doubtful accounts for known and inherent
collection risks related to its accounts receivable. The estimation of the
allowance is primarily 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.
SHORT-TERM INVESTMENTS
The Company's short-term investments consist of short-term mutual funds, which
have been classified as available-for-sale and are carried at estimated fair
value. Fair value is determined based on quoted market prices. Unrealized gains
and losses, net of taxes, on available-for-sale securities are reported as a
separate component of accumulated other comprehensive income (loss) in
shareholders' equity. Net realized gains or losses resulting from the sale of
these investments, and losses resulting from decline in fair values of these
investments that are other than temporary declines, are included in other
income. The cost of securities sold is determined on the weighted average
method.
Investments include Term deposits with original maturity exceeding three months
and whose maturity date is within one year from the date of the balance sheet.
LONG-LIVED ASSETS (OTHER THAN GOODWILL)
In accordance with Statement of Financial Accounting Standards ("SFAS") No. 144,
"Accounting for the Impairment or Disposal of Long-Lived Assets", the Company
reviews its long-lived assets (other than goodwill) for impairment whenever
events or changes in circumstances indicate that the carrying amount of an asset
may not be recoverable. When factors indicate that such costs should be
evaluated for possible impairment, we assess the recoverability of the
long-lived assets (other than goodwill) by comparing the estimated undiscounted
cash flows associated with the related asset or group of assets against their
respective carrying amounts. The amount of an impairment charge if any, is
calculated based on the excess of the carrying amount over the fair value of
those assets. Management believes no assets were impaired at December 31, 2006
and 2005.
80
OTHER INCOME
Other income includes interest and dividend income, gains and losses from sale
of securities and other investments.
PROPERTY AND EQUIPMENT
Property and equipment are stated at cost. Maintenance and repairs are charged
to expense when incurred. Depreciation is computed primarily using the
straight-line method over the estimated useful lives as follows:
YEARS
-------------
Office Building 30
Computer equipment and software 3
Furniture, fixtures and other equipment 7
Vehicles 3
Leasehold improvements Life of lease
Leasehold land Life of lease
Depreciation and amortization expense for the years ended December 31, 2006,
2005 and 2004 was $6.1 million, $4.9 million and $ 3.1 million, respectively.
GOODWILL
Effective January 1, 2002 the Company adopted SFAS No. 142 "Goodwill and Other
Intangible Assets". In accordance with SFAS No. 142, goodwill is no longer
amortized but is evaluated for impairment at least annually.
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.
During 2006, the Company has reversed $2.0 million of the accrual for income
taxes related to the year 2002 and credited it to the current year's income tax
provision. 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 portion of the reserve that is no longer
required for any particular tax year is credited to the current year's income
tax provision.
During 2006, the Company provided $0.4 million towards allowance for doubtful
accounts. At December 31, 2006 the allowance for doubtful accounts was $2.8
million. These estimates are based on management's assessment of the probable
collection from specific customer accounts, the aging of accounts receivable,
analysis of credit data, bad debt write-offs, and other known factors.
The revisions in the above estimates during 2006 had an after-tax impact of
increasing the diluted earnings per share for the year ended December 31, 2006
by $0.04 per share.
81
During 2005, the Company has reversed $2.6 million of the accrual for income
taxes related to the year 2001 and credited it to the current year's income tax
provision. 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 portion of the reserve that is no longer
required for any particular tax year is credited to the current year's income
tax provision.
In addition, during 2005 the Company has reversed $0.9 million related to the
payroll tax provision and provided for a valuation allowance of $1.6 million
attributable to certain deferred tax assets.
During 2005, the Company provided $1.6 million towards allowance for doubtful
accounts. At December 31, 2005 the allowance for doubtful accounts was $2.6
million. These estimates are based on management's assessment of the probable
collection from specific customer accounts, the aging of accounts receivable,
analysis of credit data, bad debt write-offs, and other known factors.
The revisions in estimates during 2005 had an after-tax impact of increasing the
diluted earnings per share for the year ended December 31, 2005 by $0.01 per
share.
During 2004, the Company reversed $1.7 million of the accrual for income taxes
related to the year 2000 and credited it to the current year's income tax
provision. 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 portion of the reserve no longer required
for any particular tax year, is credited to the current year's income tax
provision.
In addition, during 2004 Syntel India accounted for a credit of approximately
$0.5 million with respect of US branch profit taxes related to prior periods up
to June 30, 2004.
The revisions in estimates during 2004 had an after tax impact of increasing the
diluted earnings per share for the year ended December 31, 2004 by $0.05 per
share.
FOREIGN CURRENCY TRANSLATION
The financial statements of the Company's foreign subsidiaries use the currency
of the primary economic environment in which they operate as its functional
currency. Revenues, costs and expenses of the foreign subsidiaries are
translated to U. S. dollars at average period exchange rates. Assets and
liabilities are translated to U. S. dollars at period-end exchange rates with
the effects of these cumulative translation adjustments being reported as a
separate component of accumulated other comprehensive income in shareholders'
equity. Transaction gains and losses, are reflected within 'Selling, general and
administrative expenses' in the consolidated statements of income, for the years
presented and were not material.
EARNINGS PER SHARE
Basic and diluted earnings per share are computed in accordance with SFAS No.
128 "Earnings Per Share".
Basic earnings per share are calculated by dividing net income by the weighted
82
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.
EMPLOYEE BENEFITS
The Company maintains a 401(k) retirement plan that covers all regular employees
on Syntel's U.S. payroll. Eligible employees may contribute up to 15% of their
compensation, subject to certain limitations, to the retirement plans. The
Company may make contributions to the plan at the discretion of our Board of
Directors; however, through December 31, 2006, no contributions have been made.
Eligible employees of the Company receive benefits under the Provident Fund
("PF"), which is a defined contribution plan. Both the employee and the Company
make monthly contributions equal to a specified percentage of the covered
employee's salary. The Company has no further obligations under the plan beyond
its monthly contributions. These contributions are made to the fund administered
and managed by the Government of India. The Company's monthly contributions are
charged to income in the period they are incurred.
In accordance with the Payment of Gratuity Act, 1972 of India, the Indian
subsidiary provides for gratuity, a defined retirement benefit plan (the
"Gratuity Plan") covering eligible employees. The Gratuity Plan provides a lump
sum payment to vested employees at retirement, death, incapacitation or
termination of employment, based on the respective employee's salary and the
tenure of employment. Liabilities with regard to the Gratuity Plan are
determined by actuarial valuation and are charged to income in the period
determined. The Gratuity Plan is a non-funded plan. The amounts accrued under
this plan are $1.3 million and $1.1 million as of December 31, 2006 and 2005,
respectively, and are included within 'Accrued payroll and related costs'.
VACATION PAY
The accrual for unutilized leave balance is determined for the entire available
leave balance standing to the credit of the employees at period-end. The leave
balance eligible for carry-forward is valued at gross compensation rates and
eligible for compulsory encashment at basic compensation rates.
PROVISION FOR UNUTILIZED LEAVE
The gross charge for unutilized earned leave was $2.3 million; $0.64 million and
$1.4 million for the years ended December 31, 2006, 2005 and 2004 respectively.
The amounts accrued for unutilized earned leave are $ 5.0 million and $3.7
million as of December 31, 2006 and December 31, 2005, respectively, and are
included within 'Accrued payroll and related costs'.
During the year ended December 31, 2005, Syntel Limited had 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 the maximum
permissible accumulation was compulsorily encashed at basic salary. Accordingly,
an amount of $0.51 million was paid at basic salary and $1.14 million
representing the difference between the basic salary and gross compensation
rates was reversed.
83
INCOME TAXES
Deferred tax assets and liabilities are recognized for the future tax
consequences attributable to differences between the financial statement
carrying amounts of existing assets and liabilities and their respective tax
bases. Deferred tax assets and liabilities are measured using enacted tax rates
expected to apply to taxable income in the years in which the temporary
differences are expected to be recovered or settled. The effect on deferred tax
assets and liabilities of a change in tax laws is recognized in income in the
period that includes the enactment date.
RECENTLY ISSUED ACCOUNTING STANDARDS
In September 2006, the SEC issued SAB 108, "Considering the Effects of Prior
Year Misstatements when Quantifying Misstatements in Current Year Financial
Statements" ("SAB 108"). SAB 108 provides interpretive guidance on how the
effects of the carryover or reversal of prior year misstatements should be
considered in quantifying a current year misstatement. The pronouncement
prescribes an approach whereby the effect of all unrecorded identified errors
should be considered on all of the financial statements rather than just either
the effect on the balance sheet or the income statement. We adopted the
provisions of SAB 108 as of December 31, 2006. The adoption of SAB 108 did not
have a material impact on our consolidated financial statements.
On July 13, 2006, the Financial Accounting Standards Board ("FASB") issued
Interpretation No. 48, "Accounting for Uncertainty in Income Taxes -- an
interpretation of FASB Statement No. 109 ("FIN 48"), which clarifies the
accounting for uncertainty in tax positions. FIN 48 requires recognition in the
financial statements of the impact of a tax position, if that position is more
likely than not of being sustained on examination, based on the technical merits
of the position. The provisions of this interpretation are required to be
adopted for fiscal periods beginning after December 15, 2006. The Company will
be required to apply the provisions of FIN 48 to all tax positions, upon initial
adoption, with any cumulative effect adjustment to be recognized as an
adjustment to the retained earnings. The Company will be adopting the provisions
of FIN 48 in the first Quarter of 2007.
The Company is still assessing, the impact of the adoption of the FIN 48. Based
on a preliminary analysis, the management believes that, adoption of FIN 48 may
result, in recording a decrease to retained earnings, between $3 million and $5
million, in the first quarter of 2007. The final analysis will be completed in
the first quarter of 2007.
In September 2006, the FASB issued SFAS No. 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. SFAS No. 157 is effective for fiscal
years beginning after November 15, 2007. The Company is currently evaluating the
impact; SFAS No. 157 will have on the Company's financial position, results of
operations and liquidity and its related disclosures.
3. SHORT-TERM INVESTMENTS
Short-term investments included the following at December 31, 2006 and
2005:
2006 2005
------- -------
(In thousands)
Investments in mutual funds
at carrying value $13,543 $16,814
Term deposits with banks 28,776 4,269
------- -------
Total $42,319 $21,083
------- -------
84
Information related to investments in mutual funds (primarily Indian Mutual
Funds) is as follows:
2006 2005 2004
------- ------- -------
(In thousands)
Cost $12,934 $16,275 $35,456
Unrealized gain, net 609 539 650
------- ------- -------
Carrying value $13,543 $16,814 $36,106
------- ------- -------
Gross realized gains $ 641 $ 1,383 $ 2,049
Gross realized losses -- -- --
Dividend income -- -- --
Proceeds on sale of short
term investments 61,938 43,255 65,866
Purchase of short term
investments 57,563 23,484 72,825
Investment in term deposits with banks included the following at December
31, 2005 and 2004:
2006 2005 2004
------- ------- -------
(In thousands)
Cost $28,776 $ 4,269 $22,793
------- ------- -------
Maturities of term deposits $50,791 $22,682 $ 7,394
Purchase of term deposits 74,894 4,434 21,516
4. REVENUE EARNED IN EXCESS OF BILLINGS AND DEFERRED REVENUE
Revenue earned in excess of billings consists of:
2006 2005
------- ------
(In thousands)
Unbilled revenue for time
and material projects $ 9,862 $3,027
Unbilled revenue for fixed
price projects 2,085 5,339
------- ------
$11,947 $8,366
------- ------
Deferred revenue consists of:
2006 2005
------ ------
(In thousands)
Deferred revenue on uncompleted fixed price
development contracts $4,464 $3,087
Advance billing on application management
and support contracts 47 195
Advances received from customer towards
future billing 1,333 --
Other deferred revenue 116 74
------ ------
$5,960 $3,356
====== ======
85
5. PROPERTY AND EQUIPMENT
Property and equipment at December 31, 2006 and 2005 is summarized as
follows:
2006 2005
------- -------
(IN THOUSANDS)
Office building $ 7,586 $ --
Computer equipment and software 28,009 21,387
Furniture, fixtures and other equipment 21,487 11,947
Vehicles 455 1,050
Leasehold improvements 2,821 1,765
Leasehold land 1,965 1,828
Residential property 282 --
Capital advances / work in progress 7,067 16,713
------- -------
69,672 54,690
Less accumulated depreciation and
amortization 31,358 25,504
------- -------
$38,314 $29,186
======= =======
6. LINE OF CREDIT
The Company has a line of credit with JPMorgan Chase Bank, N.A., which provides
for borrowings up to $20.0 million ($15.0 million at December 31, 2005). 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 under the line of credit at December 31, 2006 and 2005.
7. LEASES
The Company leases certain facilities and equipment under operating leases.
Current operating lease obligations are expected to be renewed or replaced upon
expiration. Future minimum lease payments under all non-cancelable leases
expiring beyond one year as of December 31, 2006 are as follows:
(In thousands)
--------------
2007 $ 4,740
2008 5,409
2009 2,684
2010 1,542
2011 538
-------
$14,913
=======
Total rent expense amounted to approximately $4.7 million; $2.9 million and
$2.2 million for the years ended December 31, 2006, 2005 and 2004,
respectively.
86
8. INCOME TAXES
Income before income taxes for the Company's U. S. and foreign operations
was as follows:
2006 2005 2004
------- ------- -------
(In thousands)
U. S. $16,480 $18,410 $12,147
Foreign 41,289 32,411 34,080
------- ------- -------
$57,769 $50,821 $46,227
======= ======= =======
Income taxes consisted of the following:
2006 2005 2004
------- ------- -------
(In thousands)
Current
Federal $3,483 $ 7,382 $1,672
State 636 1,346 305
Foreign 3,193 10,882 2,175
------ ------- ------
Total current provision 7,312 19,610 4,152
------ ------- ------
Deferred
Federal (21) 931 221
State (5) 170 40
Foreign (433) (211) 840
------ ------- ------
Total deferred provision
(benefit) (459) 890 1,101
------ ------- ------
Total provision for income taxes $6,853 $20,500 $5,253
====== ======= ======
The components of the net deferred tax asset are as follows:
2006 2005
------- -------
(In thousands)
Deferred tax assets
Impairment of investments and capitalized
development costs $ 1,814 $ 1,814
Valuation Allowance (1,664) (1,664)
Property, plant and equipment 273 71
Accrued expenses and allowances 2,999 2,235
Advanced billing receipts 676 835
------- -------
Total deferred tax assets 4,098 3,291
------- -------
Deferred tax liabilities
Provision for branch tax on dividend
equivalent in India (1,819) (1,089)
Provision for tax on unrealized gains in India (75) (63)
------- -------
Total deferred tax liabilities (1,894) (1,152)
------- -------
Net deferred tax assets $ 2,204 $ 2,139
======= =======
87
Balance sheet classification of the net deferred tax asset is summarized as
follows:
2006 2005
------ ------
(In thousands)
Deferred tax asset, current $2,313 $2,139
Deferred tax asset (liability), non-current (109) --
------ ------
$2,204 $2,139
====== ======
During 2001, the Company had recorded deferred tax assets related to tax
benefits on write-off of certain investments. In 2005 the Company created a
valuation allowance of $1.7 million against these deferred tax assets, as
these tax benefits are not expected to be recognized.
Syntel's software development centers/units are located in Mumbai, Chennai
and Pune. Units in Mumbai are located in a Special Economic Zone (SEZ), the
unit at Chennai is 100% Export Oriented Unit (EOU) and units at Pune are
registered with Software Technologies Park of India (STPI). Under the
Indian Income Tax Act, 1961 (the "Act"), 100% EOUs at Chennai, units
registered with STPI at Pune and certain units located in SEZ are eligible
for an exemption from payment of corporate income taxes for up to 10 years
of operations on the profits generated from these undertakings or March 31,
2009, whichever is earlier. Certain units located in SEZ are eligible for
100% exemption from payment of corporate taxes for the first 5 years of
operation and a 50% exemption for the next 5 years.
Effective April 1, 2003 one of the Company's Software Development Units has
ceased to enjoy the above-mentioned tax exemption. Two more development
units ceased to enjoy the tax exemption on April 1, 2005 and April 1, 2006
respectively. Provision for Indian Income Tax is made only in respect of
business profits generated from these software development units, to the
extent they are not covered by the above exemptions and on income from
investments and interest income.
The benefit of the tax Holiday granted by the Indian authorities was $10.5
million, $11.0 million and $ 7.6 million for the years 2006, 2005 and 2004,
respectively.
On 28th February 2007, the Government of India announced Union Budget for
the Financial Year beginning 1st April 2007. Certain changes in the taxes
in India have been proposed in this Budget. Some of the changes were with
respect to introduction of a Minimum Alternate Tax ("MAT") of 11.33 %,
Service tax of 12.36 % on rentals of non-residential property, increase in
effective Dividend Distribution Tax from 14.03% to 17 % and Fringe Benefit
Tax on Employee Stock Options/Restricted Options. For certain items,
detailed rules are awaited.
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 Limited, to
the U.S. in accordance with the Act. The Company recorded a tax charge for
this dividend 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
extra ordinary 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 December 31, 2006 the Company had
88
fully invested all the proceeds towards permitted investments under the Act
against this extra ordinary dividend pursuant to an approved Domestic
reinvestment plan.
The Company intends to use remaining 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. If the Company determines to repatriate all
undistributed repatriable earnings of foreign subsidiaries as of December
31, 2006, the Company would have accrued taxes of approximately $ 51.2
million.
The following table accounts for the differences between the actual
effective tax rate and the statutory U. S. federal income tax rate of 35%:
2006 2005 2004
----- ----- -----
Statutory rate 35.0% 35.0% 35.0%
State taxes, net of federal benefit 1.1% 1.3% 1.0%
Tax-free investment income (0.5%) (0.2%) (0.4%)
Foreign effective tax rates different
from US Statutory Rate (20.2%) (18.3%) (19.3%)
Tax reserves (3.5%) (5.0%) (3.8%)
Valuation allowance 0.0% 3.2% 0.0%
Tax on repatriation 0.0% 24.2% 0.0%
Other, net 0.0% 0.0% (1.1%)
----- ----- -----
Effective income tax rate 11.9% 40.3% 11.4%
===== ===== =====
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. Conversely, in the event of a future tax
examination, if the Company does not prevail on certain tax positions taken
in filed returns the tax expense related thereto will be recognized in the
period in which examiners position is determined to be final.
During the years ended December 31, 2006, 2005 and 2004, the effective
income tax rate was 11.9%, 40.3% and 11.4%, respectively. The tax rate for
the year ended December 31, 2006 was impacted by reversal of $2.0 million
of the accrual of income taxes related to the year 2002. Without the above,
the effective tax rate for the year ended December 31, 2006 would have been
15.3%. The tax rate for the year ended December 31, 2005 was impacted by
reversal of $2.6 million of the accrual for income taxes related to the
year 2001, provision for valuation allowance of $1.7 million and the tax
related to the repatriation of $12.3 million. Without the above, the
effective tax rate for the year ended December 31, 2005 would have been
17.8%. During year ended December 31, 2004 the tax rate was impacted by
reversal of $1.7 million of the accrual for income taxes related to the
year 2000, tax credit of $0.5 million in Syntel India and the research and
development tax credit of $0.5 million in Syntel Inc. Without the above,
the effective income tax rate for the year ended
89
December 31, 2004 would have been 17.3%. The tax rate continues to be
positively impacted by the combined effects of offshore transition and
reduced onsite profitability.
Syntel India has not provided for disputed Indian income tax liabilities
amounting to $2.6 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 opinions from another independent legal counsel (also a former
Chief Justice of the Supreme Court of India) for the financial years
1995-96, 1996-97, 1997-98, 1999-2000 and 2000-01 and for subsequent
periods, which support Syntel India's position in this matter.
Syntel India had earlier filed an appeal with the Commissioner of Income
Tax (Appeals) for the financial year 1998-99 and received a favorable
decision. However the Income tax department has gone into further appeal
with the Income Tax Appellate Tribunal against this favorable decision.
During May 2006, the Income tax Appellate Tribunal has dismissed the appeal
filed by the Income tax department. The Income tax department has recourse
to file further appeal.
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 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, 1996-97, 1997-98 and 2000-01 and received a
favorable decision for 1995-96 and the contention of Syntel India was
partially upheld for the other three 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 to $ 4.5 million for the financial years 2001-02 to
2002-03 against which Syntel India has obtained opinions from independent
legal counsels, which support Syntel India's stand in the matter. During
the year ended December 31, 2006, Syntel India has received an order from
the Commissioner of Income tax (Appeals) for the financial year 2001-02 and
the contention of Syntel India was partially upheld. Syntel India has gone
into further appeal with the Income Tax Appellate Tribunal in relation to
the amounts not allowed by the Commissioner of Income tax (Appeals). The
Income tax department has also filed further appeal against the relief
granted to Syntel India by Commissioner of Income Tax (Appeals).
The Income tax department has recently completed the tax scrutiny for
financial year 2003-04 and Syntel India received an order during December
2006. Syntel India has filed an appeal before the Commissioner of Income
Tax (Appeals) against the order passed by the Income tax department.
Accordingly, Syntel India is not providing for the disputed Indian income
tax liabilities aggregating to $2.8 million for the financial year 2003-04.
Further, Syntel India has not provided for disputed income tax liabilities
aggregating to $0.10 million, for which Syntel India has filed necessary
appeals/ petitions.
90
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.
TAX CREDIT
During the year ended December 31, 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 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.
In addition, during the year ended December 31, 2004, Syntel India has
accounted for a credit of approximately $0.5 million in respect of US
branch profit taxes related to prior periods up to June 30, 2004 and also
reclassified in the balance sheet $1.0 million from Income taxes payable to
deferred tax liability.
9. EARNINGS PER SHARE
The reconciliation of earnings per share computations for the years 2006,
2005, and 2004 are as follows:
2006 2005 2004
--------------- --------------- ---------------
Per Per Per
Shares Share Shares Share Shares Share
------ ------ ------ ------ ------ ------
(In thousands, except per share data)
Basic earnings per share (1) 40,819 $ 1.25 40,528 $ 0.75 40,216 $ 1.02
Potential dilutive effect of stock
options and warrants outstanding 276 (0.01) 123 (0.00) 253 (0.01)
------ ------ ------ ------ ------ ------
41,095 $ 1.24 40,651 $ 0.75 40,469 $ 1.01
====== ====== ====== ====== ====== ======
(1) Represents weighted average number of common shares
As of December 31, 2006, 2005 and 2004, stock options to purchase 9,500,
66,700 and 135,700 shares of Common Stock, respectively, at a weighted
average price per share of $26.89, $24.55 and $24.13 respectively, were
outstanding but were not included in the computation of diluted earnings
per share. The options' exercise price was greater than the average market
price of the common shares and was anti-dilutive.
10. DIVIDEND
The Board of Directors at its meeting on August 14, 2006 declared a special
cash dividend of $1.25 per share payable to Syntel shareholders of record
at the close of business on August 31, 2006. The dividend was paid on
September 14, 2006. The Board of Directors declared and paid a special cash
dividend of $1.50 per share in March 2005.
91
In addition, the Company has paid quarterly cash dividends of $0.06 per
share during 2006, 2005 and 2004
Per share cash dividends paid in 2006, 2005 and 2004 were $1.49, $1.74 and
$0.24, respectively.
11. STOCK COMPENSATION PLANS
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 the 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. 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.
Effective January 1, 2006, the Company adopted Statement of Financial
Accounting Standard ("SFAS") No. 123R, "Share-Based Payment," utilizing the
modified prospective method. SFAS No. 123R requires the recognition of
stock-based compensation expense in the consolidated financial statements
for awards of equity instruments to employees and non-employee directors
based on the grant-date fair value of those awards, estimated in accordance
with the provisions of SFAS No. 123R. The Company recognizes these
compensation costs on a straight-line basis over the requisite service
period of the award, which is generally the option vesting term. Under the
modified prospective method, the provisions of SFAS No. 123R apply to all
awards granted or modified after the date of adoption. In addition, the
unrecognized expense of awards not yet vested at the date of adoption,
determined under the original provisions of SFAS No. 123, "Accounting for
Stock-Based Compensation" ("SFAS No. 123"), are recognized in net income in
the periods after the date of adoption. SFAS No. 123R also requires the
benefits of tax deductions in excess of recognized compensation expense to
be reported as a financing cash flow, rather than as an operating cash flow
as prescribed under the prior accounting rules. This requirement reduces
net operating cash flow and increases net financing cash flows in periods
after adoption. Total cash flow remains unchanged from what would have been
reported under the prior accounting rules.
Prior to the adoption of SFAS No. 123R, the Company followed the intrinsic
value method to account for its employee stock option plans (ESOP Plans)
and employee stock purchase plan (ESPP Plans) in accordance with the
recognition and measurement principles of Accounting Principles Board
Opinion ("APB") No. 25, "Accounting for Stock Issued to Employees" and
Related Interpretations ("APB No. 25"), as allowed by SFAS No. 123 and as
amended by SFAS No. 148, "Accounting for Stock-Based Compensation -
Transition and Disclosure". Accordingly, no stock-based employee
compensation cost was recognized on account of ESOP and ESPP plans, as all
options granted under those plans had an exercise price equal to the market
value of the underlying common stock on the date of grant and, with respect
to the employee stock purchase plan, the discount did not exceed fifteen
percent. In accordance with the transitional provisions of SFAS No. 123R,
operating results for 2005 and 2004 have not been restated. The Company
historically reported pro forma results under the disclosure-only
provisions of SFAS No. 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
92
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 years ended December 31, 2006 and 2005 the
Company issued 16,536 and 54,806 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 of shareholders to the date of the following annual
meeting.
In addition to the shares of restricted stock described above, on different
dates during the year ended December 31, 2006 the Company issued another
66,250 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 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 year ended December 31, 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 criteria's 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 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, $0.01 million and
$0.89 million during the year ended December 31, 2006 and 2005 respectively
of share compensation included as a separate component of shareholders'
equity to be expensed over the service period on a straight line basis.
During the years ended December 31, 2006, 2005 and 2004 the Company
reversed $0.14 million, $1.21 million and $0.41 million respectively, of
unearned compensation towards forfeiture of restricted stock on account of
termination of employees and expensed $1.45 million, $1.11 million and
$0.83 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 year ended December 31, 2006 and
2005, the Company recorded $0.4 million and $0.48 million, respectively, as
compensation cost for dividends paid on shares of unvested restricted
stock.
For the restricted stock issued during the years ended December 31, 2005
and 2006, the dividend is accrued and paid subject to the same restriction
as the restriction on transferability.
93
IMPACT OF THE ADOPTION OF SFAS NO. 123R
The Company adopted SFAS No. 123R using the modified prospective transition
method beginning January 1, 2006. Accordingly, during the year ended
December 31, 2006, the Company 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 SFAS No.
123 were in effect for expense recognition purposes, adjusted for estimated
forfeitures. As SFAS No. 123R requires that stock-based compensation
expense be based on awards that are ultimately expected to vest,
stock-based compensation for the year ended December 31, 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 for the year ended
December 31, 2006 was as follows (in thousands):
Cost of revenues $266
Selling, general and administrative expenses 337
----
$603
====
Cash received from option exercises under all share-based payment
arrangements for the years ended December 31, 2006, 2005 and 2004 was $1.92
million, $3.42 million and $3.14 million, respectively. New shares were
issued for all options exercised during the year ended December 31, 2006.
Prior to the adoption of SFAS No. 123R, the intrinsic values of restricted
stock were recorded as unearned stock-based compensation as of December 31,
2005. Upon the adoption of SFAS No. 123R in January 2006, the unearned
stock-based compensation balance of approximately $3.17 million was
reclassified to additional-paid-in-capital.
As of December 31, 2006, the estimated compensation cost of non-vested
options (excluding restricted stock) is $ 0.14 million to be vested mainly
over the next two years.
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:
YEAR ENDED DECEMBER 31,
---------------------------
2006 2005 2004
------- ------- -------
Assumptions
Risk free interest rate 4.63% 4.60% 3.72%
Expected life 5 years 5 years 5 years
Expected volatility 65.19% 68.08% 71.94%
Expected dividend yield 5.56% 8.35% 1.37%
Our computation of expected volatility for the year ended December 31, 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. The
expected dividend yield is estimated based on the dividend yield at the
time of grant, adjusted for expected dividend increases of historical pay
out policy.
94
SHARE-BASED PAYMENT AWARD ACTIVITY
The following table summarizes activity under our equity incentive plans
for the year ended December 31, 2006:
WEIGHTED
AVERAGE
WEIGHTED REMAINING AGGREGATE
AVERAGE CONTRACTUAL INTRINSIC
NUMBER OF EXERCISE TERM (IN VALUE
OPTIONS PRICE YEARS) (IN THOUSANDS)
--------- -------- ----------- --------------
Outstanding at January 1, 2006 438,251 $12.28
Granted -- --
Exercised 163,985 9.40
Forfeited 41,300 18.95
Expired / Cancelled 24,097 13.64
------- ------
OUTSTANDING AT DECEMBER 31, 2006 208,869 $13.07 4.78 $2,870
------- ------ ---- ------
OPTIONS EXERCISABLE AT DECEMBER 31, 2006 177,569 $15.08 4.41 $2,678
------- ------ ---- ------
The weighted average grant-date fair value of options granted during the
years ended December 31, 2006, 2005 and 2004 were $3.81, $2.36 and $5.78,
respectively. The aggregate intrinsic value of options exercised, during
the years ended December 31, 2006, 2005 and 2004 was $1.54 million, $2.12
million and $2.47 million, respectively. The aggregate fair value of shares
vested, during the years ended December 31, 2006, 2005 and 2004 was $0.33
million, $0.90 million and $0.98 million, respectively.
PRO FORMA INFORMATION FOR PERIODS PRIOR TO THE ADOPTION OF FAS 123R
Prior to the adoption of FAS No. 123R, 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 123R was not
reflected in our results of operations for the years ended December 31,
2005 and 2004 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 year ended December 31, 2005 and 2004 was
as follows (in thousands, except per share amounts):
Year Ended
December 31
-----------------
2005 2004
------- -------
(In thousands,
except per share
data)
Net income as reported $30,321 $40,974
Add, stock- based compensation expenses
recognized in statement of income,
net of tax 1,384 713
Deduct, stock- based compensation
expense determined under the fair
value method, net of tax (1,704) (1,642)
------- -------
Pro forma net income $30,001 $40,045
======= =======
95
Earnings per share as reported
Basic $ 0.75 $ 1.02
Diluted 0.75 1.01
Earnings per share, pro forma
Basic $ 0.74 $ 1.00
Diluted 0.74 0.99
Weighted average common shares outstanding
Basic 40,528 40,216
Diluted 40,651 40,469
Estimated fair value of options granted $ 2.36 $ 5.78
12. COMMITMENTS & CONTINGENCIES
As of December 31, 2006, Syntel's subsidiaries have commitments for capital
expenditures (net of advances) of $7 million primarily related to the
technology Campus being constructed at Pune, India and acquisition of
residential property in Mumbai, India.
The Company and its subsidiaries are parties to litigation and claims,
which have arisen, in the normal course of their activities. Although the
amount of the Company's ultimate liability, if any, with respect to these
matters cannot be determined with reasonable certainty, management, after
consultation with legal counsel, believes that the resolution of such
matters will not have a material adverse effect upon the Company's
consolidated financial position.
Syntel India's operations are carried out from their development
centers/units in Mumbai forming part of a Special Economic Zone ('SEZ') and
in Chennai and Pune, which are registered under the Software Technology
Parks ('STP') scheme. Under these schemes the registered units have export
obligations, which are based on the formula provided by the
notifications/circulars issued by the STP and SEZ authorities from time to
time. The consequence of not meeting the above commitments would be a
retroactive levy of import duty on items previously imported duty free for
these units. Additionally the respective authorities have rights to levy
penalties for any defaults on a case-by-case basis. The Company is
confident of meeting these obligations.
13. EMPLOYEE BENEFIT PLANS
Provident Fund Contribution expense recognized by Syntel India was $ 1.05
million; $0.66 million and $0.5 million for the years ended December 31,
2006, 2005 and 2004, respectively.
Expense recognized by Syntel India under the Gratuity Plan was $ 0.5
million; $0.47 million and $0.02 million for the years ended December 31,
2006, 2005 and 2004, respectively.
96
14. ALLOWANCES FOR DOUBTFUL ACCOUNTS
The movement in the allowance for doubtful accounts for the years ended
December 31, 2006, 2005 and 2004 is summarized as follows:
2006 2005 2004
------- ------- -------
(In thousands)
Balance, beginning of year $2,575 $1,213 $ 809
Provisions (reductions), net 376 1,564 400
Write-offs (123) (202) (27)
Others -- -- 31
------ ------ ------
Balance, end of year $2,828 $2,575 $1,213
------ ------ ------
15. SEGMENT REPORTING
The Company has adopted SFAS No. 131, "Disclosures about Segments of an
Enterprises and Related Information", which requires reporting information
about operating segments in annual financial statements. It has also
established standards for related disclosures about its business segments
and geographic areas. Operating segments are defined as components of an
enterprise about which separate financial information is available. This
information is reviewed and evaluated regularly by the management, in
deciding how to allocate resources and in assessing the performance.
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:
- Application 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.
Through Application Outsourcing, the Company provides higher-value
outsourcing services for ongoing management, development and maintenance of
customers' business applications.
Through e-Business, the Company provides development and implementation
services for a number of emerging and rapidly growing high technology
applications, including Web development, Data Warehousing, e-commerce, CRM,
Oracle, and SAP; as well as partnership agreements with software providers.
Through TeamSourcing, the Company provides professional information
technology consulting services directly to customers on a staff
augmentation basis. TeamSourcing services include systems specification,
design, development, implementation and maintenance of complex information
technology applications involving diverse computer hardware, software, data
and networking technologies and practices.
Through BPO, Syntel provides outsourced solutions for a client's business
processes, providing them with the advantage of a low cost position and
process enhancement through optimal use of technology. Syntel uses a
proprietary tool called Identeon(TM) to assist with strategic assessments
of business processes and identifying the right ones for outsourcing.
97
The accounting policies of the segments are the same as those presented in
Note - 2. Management allocates all corporate expenses to the segments. No
balance sheet/identifiable assets data is presented since the Company does
not segregate its assets by segment.
2006 2005 2004
-------- -------- --------
(In Thousands)
Net Revenues
Applications Outsourcing $194,474 $171,331 $143,007
e-Business 37,251 31,210 29,249
TeamSourcing 17,631 16,953 12,480
BPO 20,873 6,695 1,837
-------- -------- --------
270,229 226,189 186,573
Gross Profit
Applications Outsourcing 72,502 72,411 62,696
e-Business 10,506 9,687 11,302
TeamSourcing 6,690 4,886 4,598
BPO 12,551 4,162 857
-------- -------- --------
102,249 91,146 79,453
Selling, general and administrative expenses 49,374 44,917 36,999
-------- -------- --------
INCOME FROM OPERATIONS $ 52,875 $ 46,229 $ 42,454
======== ======== ========
The Company's largest customer in 2006, 2005 and 2004 was American Express,
which accounted for revenues in excess of 10% of total consolidated
revenues. Revenue from this customer was approximately $49.6 million, $36.2
million and $29.4 million, contributing approximately 18%, 16% and 16% of
total consolidated revenues during 2006, 2005 and 2004, respectively. At
December 31, 2006, 2005 and 2004 accounts receivable, from this customer
were $2.7, $1.1 and $1.5 million respectively. All revenue from this
customer was generated in the Applications Outsourcing segment.
98
16. GEOGRAPHIC INFORMATION
Customers of the Company are primarily situated in the United States. Net
revenues and net income (loss) from each geographic location were as
follows:
2006 2005 2004
--------- --------- ---------
(In thousands)
Net revenues
North America, primarily United States $ 258,175 $ 205,376 $167,240
India 131,372 113,571 90,230
UK 12,099 12,119 13,410
Far East, primarily Singapore 795 1,090 1,501
Germany 708 1,540 2,692
Mauritius 4,632 931 --
Inter-company revenue elimination (primarily India) (137,552) (108,438) (88,500)
--------- --------- --------
Net revenues $ 270,229 $ 226,189 $186,573
========= ========= ========
Net income (loss)
North America, primarily United States $ 14,819 $ 9,394 $ 10,459
India 35,045 19,737 28,831
UK 1,558 1,667 1,732
Far East, primarily Singapore (55) 27 194
Germany (228) (472) (242)
Mauritius (223) (32) --
--------- --------- --------
Net Income $ 50,916 $ 30,321 $ 40,974
========= ========= ========
Assets, December 31
North America, primarily United States $ 71,829 $ 107,143 $110,613
India 80,746 58,815 106,014
UK 14,680 10,019 8,892
Far East, primarily Singapore 494 555 560
Germany 651 1,136 889
Mauritius 29,289 20,493 --
--------- --------- --------
Total assets $ 197,689 $ 198,161 $226,968
========= ========= ========
99
17. SELECTED QUARTERLY FINANCIAL DATA (UNAUDITED)
Selected financial data by calendar quarter were as follows:
First Second Third Fourth
Quarter Quarter Quarter Quarter Full Year
------- ------- ------- ------- ---------
(In thousands, except per share data)
2006
Net revenues $63,496 $64,410 $69,217 $73,106 $270,229
Cost of revenues 39,162 41,470 42,635 44,713 167,980
------- ------- ------- ------- --------
Gross profit 24,334 22,940 26,582 28,393 102,249
Selling, general and administrative expenses 10,598 11,645 13,056 14,075 49,374
------- ------- ------- ------- --------
Income from operations 13,736 11,295 13,526 14,318 52,875
Other income, principally interest 889 1,338 1,298 1,369 4,894
------- ------- ------- ------- --------
Income before income taxes 14,625 12,633 14,824 15,687 57,769
Provision for income taxes 2,570 1,580 293 2,410 6,853
------- ------- ------- ------- --------
Net income $12,055 $11,053 $14,531 $13,277 $ 50,916
======= ======= ======= ======= ========
Earnings per share, diluted (a) $ 0.29 $ 0.27 $ 0.35 $ 0.32 $ 1.24
======= ======= ======= ======= ========
Weighted average shares outstanding, diluted 40,948 41,043 41,123 41,266 41,095
======= ======= ======= ======= ========
2005
Net revenues $50,732 $54,677 $58,501 $62,279 $226,189
Cost of revenues 29,704 32,754 35,298 37,287 135,043
------- ------- ------- ------- --------
Gross profit 21,028 21,923 23,203 24,992 91,146
Selling, general and administrative expenses 11,165 10,699 10,533 12,520 44,917
------- ------- ------- ------- --------
Income from operations 9,863 11,224 12,670 12,472 46,229
Other income, principally interest 1,136 708 810 1,938 4,592
------- ------- ------- ------- --------
Income before income taxes 10,999 11,932 13,480 14,410 50,821
Provision for income taxes 2,005 2,246 1,741 14,508 20,500
------- ------- ------- ------- --------
Net income (loss) $ 8,994 $ 9,686 $11,739 $ (98) $ 30,321
======= ======= ======= ======= ========
Earnings per share, diluted (a) $ 0.22 $ 0.24 $ 0.29 $ 0.00 $ 0.75
======= ======= ======= ======= ========
Weighted average shares outstanding, diluted 40,526 40,570 40,669 40,838 40,651
======= ======= ======= ======= ========
(a) Earnings per share for the quarter are computed independently and may not
equal the earnings per share computed for the total year.
100
EXHIBIT INDEX
Exhibit No. Description
----------- -----------
3.1 Amended and Restated Articles of Incorporation of the Registrant
filed as an exhibit to the Registrant's Quarterly Report on Form
10-Q for the quarterly period ended June 30, 2005, and
incorporated herein by reference.
3.2 Bylaws of the Registrant filed as an Exhibit to the Registrant's
Quarterly Report on Form 10-Q for the quarterly period ended March
31, 2005, and incorporated herein by reference.
10.1 Line of Credit Agreement, dated August 31, 2002, between the
Registrant and Bank One, Michigan filed as an Exhibit to the
Registrant's Annual Report on Form 10-K for the year ended
December 31, 2002, and incorporated herein by reference.
10.2 Lease, dated October 24, 2001, between Big Beaver / Kilmer
Associates L.L.C. and the Registrant filed as an Exhibit to the
Registrant's Annual Report on Form 10-K for the year ended
December 31, 2002, and incorporated herein by reference.
10.3 Indentures of Lease entered into between the President of India
and Syntel Limited (formerly known as Syntel Software Pvt. Ltd.)
on various dates in 1992 and 1993 for the Mumbai Global
Development Center and filed as an Exhibit to the Registrant's
Registration Statement on Form S-1 dated June 6, 1997, and
incorporated herein by reference.
10.4 Rental Agreement, dated February 24, 1997, between Syntel Limited
(formerly known as Syntel Software Pvt. Ltd.) and the Landlords
for the Chennai Global Development Center, filed as an Exhibit to
the Registrant's Registration Statement on Form S-1 dated June 6,
1997, and incorporated herein by reference.
10.5* Amended and Restated Stock Option and Incentive Plan, filed as an
Exhibit to the Registrant's Current Report on Form 8-K dated June
1, 2006 and incorporated herein by reference.
10.6* Amended and Restated Employee Stock Purchase Plan, filed as an
Exhibit to the Registrant's Current Report on Form 8-K dated June
1, 2006, and incorporated herein by reference.
10.7* Form of Stock Option Agreement, filed as an Exhibit to the
Registrant's Current Report on Form 8-K dated June 2, 2005, and
incorporated herein by reference.
101
10.8* [Incentive] Restricted Stock Grant Agreement, filed as an Exhibit
to the Registrant's Quarterly Report on Form 10-Q for the
quarterly period ended September 30, 2006, and incorporated herein
by reference.
10.9* Form of Annual Performance Award, filed as an Exhibit to the
Registrant's Current Report on Form 8-K dated February 7, 2006 and
incorporated herein by reference.
10.10* Employment Agreement, dated October 18, 2001, between the Company
and Bharat Desai, filed as an Exhibit to the Registrant's Current
Report on Form 8-K dated February 7, 2006 and incorporated herein
by reference.
10.11* Employment Agreement, dated October 18, 2001, between the Company
and Daniel M. Moore, filed as an Exhibit to the Registrant's
Current Report on Form 8-K dated February 7, 2006 and incorporated
herein by reference.
10.12 Amendment to Credit Agreement dated August 25, 2003, between the
Registrant and Bank One, NA filed as an Exhibit to the
Registrant's Annual Report on Form 10-K for the year ended
December 31, 2003, and incorporated herein by reference.
10.13 Amendment to Credit Agreement dated August 19, 2004, between the
Registrant and Bank One, NA filed as an Exhibit to the
Registrant's Annual Report on Form 10-K for the year ended
December 31, 2004, and incorporated herein by reference.
10.14 Amendment to Credit Agreement dated August 23, 2005, between the
Registrant and JPMorgan Chase Bank, N.A., successor in interest to
Bank One, NA , filed as an Exhibit to the Registrant's Annual
Report on Form 10-K for the year ended December 31, 2005, and
incorporated herein by reference.
10.15 Amendment to Credit Agreement dated August 31, 2006, between the
Registrant and JPMorgan Chase Bank, N.A., filed as an Exhibit to
the Registrant's Current Report on Form 8-K dated August 4, 2006,
and incorporated herein by reference.
10.16 Leave and License Agreement, dated June 11, 2004, between Lake
View Developers and Syntel Sourcing Pvt. Ltd. filed as an Exhibit
to the Registrant's Annual Report on Form 10-K for the year ended
December 31, 2004, and incorporated herein by reference.
10.17 Lease Deed, dated September 23, 2004 between Arihant Foundation
and Housing Ltd. and Syntel Limited filed as an Exhibit to the
Registrant's Annual Report on Form 10-K for the year ended
December 31, 2004, and incorporated herein by reference.
10.18 Lease Deed, dated October 6, 2004, between Arihant Foundation and
Housing Ltd. and Syntel Limited filed as an Exhibit to the
Registrant's Annual Report on Form 10-K for the year ended
December 31, 2004, and incorporated herein by reference.
102
14 Code of Ethical Conduct filed as an Exhibit to the Registrant's
Annual Report on Form 10-K for the year ended December 31, 2004,
and incorporated herein by reference.
21 Subsidiaries of the Registrant.
23 Consent of Independent Registered Public Accounting Firm.
31.1 Rule 13a-14(a)/15d-14(a) Certification of Chief Executive Officer
pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
31.2 Rule 13a-14(a)/15d-14(a) Certification of Chief Financial Officer
pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
32 Section 1350 Certification of Chief Executive Officer and Chief
Financial Officer
103