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How to decode IT companies' results

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Mobis Philipose Mumbai
Last Updated : Feb 06 2013 | 7:52 AM IST
Software results are different from the average quarterly results report simply because of the huge volume of data presented.
 
It's not that all companies provide the same data but some such as Infosys are much more transparent. But even the least transparent software firm provides ample data for a reasonable performance evaluation.
 
To start with, it makes more sense to do a quarter-on-quarter or a sequential comparison. First, the software industry is dynamic, with technology and trends changing rapidly. This would be best captured in a sequential comparison. 
 
A typical IT company financials
Rs croreQuarter Ended
Dec 04Sep 04
Income from Services500460
Cost of Services320300
Gross Profit (1)-(2)180160
Selling, General & Administration Expenses7572
Operating Profit (EBITDA) (3)-(4)10588
Depreciation  3028
Operating PBT (5)-(6)7560
Other Income1015
Profit before Tax (7)+(8)8575
Tax1010
Net Profit (9)-(10)7565
 
Besides, it's possible to do a sequential comparison since the business isn't seasonal in nature. For perspective, a sequential comparison is not possible for cement companies, especially the December quarter versus the September quarter, as construction slows down during monsoon resulting in a drop in cement offtake during the September quarter. The software industry has no such problems, which makes a sequential comparison possible.
 
Normally, a double-digit sequential revenue growth is considered extremely good, while even high single-digit growth numbers are healthy.
 
But much depends on the trend in a particular quarter - Infosys, usually the first to announce quarterly results among software firms, is generally seen as a industry benchmark for revenue growth.
 
Most software firms break up revenue growth between price and volume, which are important pointers. It's worthwhile to compare volume growth of different companies. Also, like most other industries, a company's ability to raise prices is a positive sign.
 
Next in line is the gross profit, more specifically the gross profit margin (gross profit/sales x 100).
 
Needless to say, higher the gross margin, the better. gross margins reflect the impact of pricing increases/decreases, changes in staff costs and whether the company has increased its proportion of higher value services.
 
Some other factors which impact the gross margin is the utilisation rate of software engineers. A higher utilisation simply means that there are fewer non-revenue generating employees and would, hence, result in higher margins.
 
Also, much depends on the proportion of work done offshore in India and work done on client sites (onsite) abroad. Offshore work enjoys higher margins, so the offshore-onsite mix is a key figure to look out for.
 
Many times, when companies take a hit in gross margins, they try and make up by containing selling, general and administration expenses, also known as SG&A expenses. One should check if these measures are sustainable and if benefits would continue even in the future.
 
At the same time, for some companies such as Hexaware Technologies, SG&A expenses are at rather high levels relative to its peers. In such cases, a drop in these expenses would be a welcome sign.
 
Other income is largely dominated by forex movement, reflecting the impact of translating US dollar receivable and cash balances at quarter-end rates and also the result of forward cover positions.
 
In the last quarter ended December 2004, the rupee appreciated by an average 2.8 per cent against the dollar. The impact on individual companies would depend on the amount of forward cover taken - the more the cover, the lower the risk of an appreciating rupee.
 
But an appreciating rupee impacts not only other income but also revenue and operating profit numbers. This is because in the case of offshore work, revenue is generated in dollars, while expenses are borne in rupees. An appreciating rupee negatively impacts profitability.
 
Some other factors to look out for include the increase in headcount (staff). A large increase necessarily means the company expects growth in future quarters.
 
Similarly, one should also check the number of clients added during the quarter. Companies also give extensive client data, making it possible to asses which of its clients have driven growth.
 
Finally, some companies provide the luxury of an estimate of revenues and net profit for the next quarter. This 'guidance' is, at times, coveted more than the actual results.

 

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First Published: Jan 11 2005 | 12:00 AM IST

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