MindTree: Other income fillip

Performance summary

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• Topline expands by 13% QoQ during 2QFY08, largely due to 13% QoQ increase in volumes and 3% QoQ improvement in billing rates.
  

• Operating margins expands by 0.4% QoQ - higher volumes and pricing along with 4% QoQ rise in utilisation helps profitability.
  

• PAT grows by 32% QoQ during the second quarter – aided by margin expansion and higher other income.
  

• Adds 28 new clients and 464 employees in 2QFY08. Annualised attrition up 0.5% to 15.7%.

(Rs m)	1QFY08	2QFY08	Change	1HFY07	1QFY08	Change
Sales	1,615	1,820	12.7%	2,870	3,435	19.7%
Expenditure	1,359	1,524	12.1%	2,308	2,884	24.9%
Operating profit (EBDIT)	256	295	15.5%	562	551	-1.9%
Operating profit margin (%)	15.8%	16.2%		19.6%	16.0%
Other income	62	103	64.5%	26	165	530.3%
Depreciation	79	81	2.5%	111	160	44.4%
Interest	9	18	90.0%	17	27	58.9%
Profit before tax	230	299	30.2%	460	529	15.0%
Tax	24	28	16.8%	(7)	52
Profit after tax/(loss)	206	271	31.7%	467	477	2.3%
Net profit margin (%)	12.8%	14.9%		16.3%	13.9%
No. of shares (m)					37.8
Diluted earnings per share (Rs)*					24.1
P/E ratio (x)*					21.8

What is the company business?

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MindTree Consulting is a mid-size Indian IT and R&D services company. The company has two business units that focus on software development – IT Services and R&D Services. Around 76.5% of the revenues come from IT services and the balance 23.5% come from R&D services. It has offices in the US, UK, Germany, Switzerland, UAE, India, Singapore, Australia and Japan. MindTree’s IT services business comprises of IT strategic consulting, application development, data warehousing and business intelligence, application maintenance, package implementation and application product engineering. The R&D services division is organized into two sub-divisions: Engineering, which provides product realisation services to technology and product firms including product architecture, product design, and product re-engineering and product assurance. Research, which conceives and develops intellectual property in short range wireless communication segment, licenses and customizes those intellectual property for the clients.

What has driven performance in 2QFY08?

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Volume growth drives topline: MindTree recorded a 13% QoQ topline growth during 2Qfy08, largely due to 13% QoQ growth in volumes and 3% QoQ growth in pricing. Onsite volumes grew by 6% QoQ while the growth in offshore volumes was 14% QoQ. Onsite billing rates went up by 3% QoQ while offshore billing rates were up by 4% QoQ. The IT services segment recorded a 13% QoQ growth in sales. R&D services, which were lagging in 1QFY08, recorded a 13% QoQ growth during the second quarter. The onsite revenue proportion has come down by 2% QoQ in 2QFY08.

In terms of geographies, US recorded a growth of 8% QoQ whereas India, Europe and Asia Pacific regions recorded growth of 39%, 24% and 16% respectively. The company in a bid to strengthen its position in Europe opened a center in the Netherlands.

R &D Service offerings	1QFY08	% of total	2QFY08	% of total	Change
Storage and servers	147	40.6%	160	39.2%	9.2%
Consumer appliances	97	26.9%	112	27.4%	15.2%
Communication systems	38	10.6%	45	11.0%	17.4%
Automotive and industrial systems	65	18.1%	78	19.1%	19.3%
Others	14	3.8%	13	3.3%	-1.8%
Total	362	100.0%	409	100.0%	13.1%
IT Service offerings	1QFY08	% of total	2QFY08	% of total	Change
ADM	1,078	86.0%	1,195	84.7%	10.8%
Consulting	60	4.8%	48	3.4%	-20.3%
Package implementation	21	1.7%	54	3.8%	151.6%
Testing	44	3.5%	66	4.7%	51.1%
IMS	49	3.9%	45	3.2%	-7.7%
IP licensing	1	0.1%	3	0.2%	125.1%
Total	1,254	100.0%	1,411	100.0%	12.5%

In terms of business segment, while Transportation and Hi-tech segments recorded growth of 11% QoQ apiece, the growth in banking and financial services segment was little lower at 9% QoQ. Growth in the manufacturing segment was 13% QoQ in 2QFY08. MindTree added 28 new clients and a net off 464 (gross 784) employees in 2QFY08. The attrition levels have gone up by 0.5% in 2QFY08 to 15.7%. This is a worrying factor as, three quarters back, the company was among those that had the lowest attrition levels.

Marginal expansion in operating margins: MindTree’s operating margins expanded by 0.4% QoQ during 2QFY08. This was aided by a 4% QoQ increase in utilisation levels and 2% QoQ fall in SG&A expenses (as percentage of sales). The cost of revenues (as percentage of sales) increased from 63% in 1QFY08 to nearly 65% in 2QFY08. This was mainly due to partial wage hike affected during the quarter. In 1QFY08, the company had affected a wage hike to 53% of its junior offshore employees, which contributed to 40% of the total workforce. Now in 2QFY08, the company has given salary hikes to 53% of the employees and remaining 7% of the employees will get their salary hikes in 3QFY08. So the impact of hike in wages will be spread over the financial year. The impact of salary hikes given on EBITDA margins in 2QFY08 was 2.5% QoQ.

Segmental Performance

(Rs m)	1QFY08	2QFY08	Change
IT Services-Revenues	1,254	1,411	12.5%
% of total revenues	77.6%	77.5%
PBIT margins	19.3%	17.1%
R&D Services-Revenues	362	409	13.1%
% of total revenues	22.4%	22.5%
PBIT margins	4.5%	14.3%
	1,615	1,820	12.7%

Higher other income boosts bottomline: MindTree’s PAT increased by 32% QoQ largely during the second quarter. This was due to a 65% QoQ growth in other income. PAT margins also expanded by 2.2% QoQ. On a YoY basis, other income has risen by 300%. This is mainly because the company had higher investments due to proceeds from IPO. The company also recorded a forex gain of Rs 33 m in 2QFY08 as against a loss of Rs 4 m in 1QFY08. This gain was mainly due to mark-to-market adjustments on forward contracts on the basis of hedge accounting.

What to expect?

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At the current price of Rs 525, the stock is trading at a multiple of 11 times our FY10 estimated earnings. The company has reiterated the FY08 guidance (given at the end of 1QFY08) of topline of US$ 178 m to US$ 180 m and bottomline performance of US$ 22.5 m to US$ 22.6 m. On the positive side, the R&D division has taken off nicely in this quarter and the company expects the same to continue in the next two quarters as well. While in the short run the major challenge will be to manage consistent appreciation of the rupee against the US dollar, in the long run the challenge will be in terms of containing attrition and nurturing talent.