HCL Technologies has reported a dismal performance for both, the June quarter and full year FY03. While topline has grown poorly by 1% in 4QFY03 on a sequential basis, that for FY03 has risen by a meagre (relative to its peers) 13%. Also, the bottomline performance for FY03 has been disappointing as the same has fallen by around 16% YoY. Bottomline growth for 4QFY03 seems good but it includes a substantial other income portion, excluding which the bottomline growth sinks deep in the red.

Rs m	3QFY03	4QFY03	Change	FY02	FY03	Change
Sales	4,658	4,710	1.1%	15,888	18,009	13.3%
Other Income	161	589	264.8%	1,099	896	-18.5%
Expenditure	3,696	3,923	6.1%	12,585	14,314	13.7%
Operating Profit (EBDIT)	962	787	-18.2%	3,303	3,695	11.9%
Operating Profit Margin (%)	20.7%	16.7%		20.8%	20.5%
Interest	-	-		-	-
Depreciation	226	233	3.1%	581	861	48.3%
Profit before Tax	897	1,142	27.3%	3,822	3,730	-2.4%
Extraordinary items	(191)	-		-	(186)
Stock-based sales incentive	(4)	(11)		4	(17)
Tax	63	90	42.0%	407	347	-14.9%
Minority interest & income of equity investee	(35)	(84)		233	(129)
Profit after Tax/(Loss)	604	958	58.6%	3,652	3,053	-16.4%
Net profit margin (%)	13.0%	20.3%		23.0%	17.0%
No. of Shares	285.4	285.4		285.4	285.4
Diluted Earnings per share* (Rs)	8.5	13.4		12.8	10.7
P/E Ratio (x)	19	12		13	15
(* annualised)

For 4QFY03, the marginal rise in HCL Tech’s topline is mainly brought about by a 19% growth in its inorganic businesses while its organic business declined by 2% QoQ. The decline in organic software business revenues in 4QFY03 is brought about by a 2.7% decline in billing rates while volumes grew by a marginal 3.2% sequentially. Notably, the organic business constituted of around 75% of the HCL Tech’s software revenues in the June quarter, and has been seeing tough times for quite some time now. While the company has not disclosed reasons for the 13% rise in its topline for FY03, we believe that it has been brought about by the growth in its inorganic business while the organic business continuous to depress the overall picture.

The BPO business, which contributes to around 9% of total revenues, grew by 4% QoQ. Within this, while the organic BPO business grew by 46%, the inorganic BPO business actually declined by 14%. Going forward, the company is likely to continue its focus on the fast-growing BPO space, and its addition of 635 employees (to take permanent employees in this business to 1,466) in the June quarter is indicative of this. For FY03, the growth in the BPO business has been a substantial 223%.

On the profitability front, while the sequential growth for 4QFY03 seems substantial at one glance, if we remove the effect of a large increase in the company’s other income, profit growth actually falls to the negative. However, for FY03, the decline in profits has been severe because of the extraordinary item, which occurred due to reduction in the value of its investments in HCL Perot Systems and venture capital funds.

One peculiar relationship that shows in HCL Tech’s results is the relationship between its employee growth and topline growth. While, for software services companies, as growth in manpower is associated with a consequent increase in revenues, HCL Tech’s seems to be going in the other direction. A look at the graph below should suffice. The company added a net of around 1,300 employees in the June quarter alone. While this is a sequential growth of around 15% in manpower, revenues have grown by a marginal 1%. This is then the reason for the depleting margins of the company that have fallen by around 400 basis points in this (4QFY03) quarter. Sequentially, HCL Tech has also witnessed a fall in its utilisation rates from 74% to 70% for offshore and 93% to 92% for its onsite efforts.

Between all these disappointments that HCL Tech has shown in FY03, there were two major positives for the company. First was a US$ 160 m outsourcing deal that it won (along with Infosys) from British Telecom for provision of software development and maintenance services to the latter. Secondly, HCL Tech also signed a multi-year IT co-sourcing (infrastructure management, maintenance services, etc.) contract with AMD, a leading global supplier of integrated circuits for the PC and communications markets.

At Rs 160, the stock is trading at a P/E multiple of 15x its FY03 earnings. While the valuations look enticing at one glance, the company’s disappointing performance on the core business side does not seem to justify the same. While HCL Tech’s non-organic business have brought some respite to the company’s overall performance, going forward, their contribution to the bottomline is still likely to take some time. Combined with that, the continuous pressure on the pricing front is likely to relegate HCL Tech’s financial performance to extreme volatility. Investors thus need to look beyond valuations.