Emphatic show

BS Compass

MphasiS's results for the second quarter ended September were much better compared with the lacklustre show in the June quarter.

Sequential revenue growth was almost in double digits at 9.76 per cent, but more importantly operating margin jumped almost 200 basis points which led to a 30.5 per cent growth in net profit.

Just like in the June quarter, the results were dominated by the company's call centre subsidiary, MsourcE, which grew revenues 19 per cent sequentially.

Significantly, the call centre operations was back in the black at the operating level, with a margin of 4.33 per cent.

The margin in the June quarter was -3.8 per cent, which means that MsourcE's operating profit margin improved by over 800 basis points last quarter. In the June quarter, its operating margin had improved by over 650 basis points.

Clearly, MsourcE is on a fast paced recovery path, and seems well on track to post a double-digit operating margin in the second half of the year.

For a change, the IT services business didn't perform too badly. Its revenues grew a decent 6.03 per cent and gross margins improved by 160 basis points.

Much of the revenue growth came from a top few clients - revenues from the top 5 grew 16 per cent sequentially, while revenues from the rest of the company's clients fell 5.25 per cent.

SG&A (selling, general and administration) expenses jumped by 170 basis points as a percentage of sales, negating the gain in gross margins.

The increase in SG&A was primarily because of an increase in manpower costs, including sales staff. One point of concern in the IT services business is that the receivables position jumped to 81 days last quarter from 71 days in the June quarter.

The revenue growth of 6 per cent may not be sustained, considering that the December quarter will have the Thanksgiving and Christmas holidays.

But in order to meet the (implied) FY04 revenue growth guidance for the IT services business, MphasiS needs to post sequential growth rates of just two per cent in the next two quarters.

For the MsourcE business also, the required growth rate in the next two quarters at 12 per cent is much lower than growth posted in the last two quarters.

But the main issue is whether the upward trend in profitability will be sustained. Besides, the company has benefited from high non-operating income lately thanks to forex gains, which may not be sustained.

On the whole, though, with ample room for improvement on the utilisation front and with pressure on pricing having ceased, earnings growth could well keep pace with revenue growth.

Hughes Software

Hughes Software's September quarter results were more or less in line with the guidance it had given.

Besides, even the upward revision in the guidance was expected, so it's not surprising that the Hughes stock has fallen a bit after its results were announced.

Based on the revised earnings guidance, the Hughes stock trades at almost 22 times, which is rather stretched when compared to peers.

Coming back to the September quarter results, much of the incremental revenue growth came from the volatile products business.

Revenues from product sales jumped 51 per cent q-o-q, after two consecutive quarters of declines.

Since a big chunk of products revenues flow straight into the bottom line, EBITDA margins expanded by around 70 basis points last quarter.

But since products revenues have been volatile in the past, one can not expect a similar trend going forward. Revenues coming from parent company, Hughes Network Systems, fell 4.9 per cent on a q-o-q basis.

The diversification away from HNS is obviously a positive sign, especially with the non-HNS side of the business growing at a healthy 9.2 per cent.

Surprisingly, BPO revenues were flat at a time when most of the company's competitors have been growing at strong double-digit rates.

After facing a tough time last year, Hughes Software has bounced back well thanks to an improvement in the telecom vertical.

However, as the chart indicates, this has been priced in the stock. And at 22 times FY04 earnings, there may not be much strength left in the stock.

With contributions from Mobis Philipose