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Software 2QFY02: Growth at a cost

Nov 6, 2001

The 2QFY02 results seem to indicate the software sector has shown marginally higher growth compared to the 1QFY02. However, this has been at the cost of operating margins. The revenue growth of the top software companies barring Hughes showed a much healthier growth compared to previous quarter. In 1QFY02, the combined revenues of Infosys, Wipro, Satyam, HCL Tech and Digital grew by 4.9%. The sequential growth figure for 2QFY02 was 5.7%. However, our sample of 12 companies including second rung companies showed a sequential growth of 3.6% in revenues compared to 3.1% in 1QFY02. The second rung software companies continued to bear the brunt of the slowdown. With only a few managing to post a sequential growth.

Revenues: Better growth
(Rs m) Quarter ended
June, 2001
Quarter ended
September, 2001
Change in
2QFY02
Change in
1QFY02
Infosys 6,125 6,501 6.1% 9.0%
Wipro* 5,210 5,683 9.1% 0.8%
Satyam 4,119 4,266 3.6% 6.6%
HCL Tech 3,692 3,724 0.9% 1.7%
Digital 703 807 14.8% 12.4%
Polaris 701 705 0.6% -9.7%
Hughes 634 536 -15.5% 2.3%
Silverline 556 442 -20.5% -8.9%
Mphasis 422 430 1.9% -17.4%
VisualSoft 285 234 -17.9% -17.0%
Aztec 250 193 -22.8% 1.7%
Mastek 193 193 0.0% 2.5%
Total 22,890 23,714 3.6% 3.1%
* Revenues for Wipro Technologies only

Once again like in 1QFY02, the growth in topline came mostly from maintenance. The other service offering that saw increase in demand was package implementation. Software design and development did not show much of a pick up in demand. While Infosys saw a marginal growth in demand for development, Satyam saw a steep decline. Very few companies like Infosys and Digital also registered a growth in the e-commerce domain. This reversal in the trend could be healthy for the Indian software companies as e-commerce was expected to be the next growth engine. Most of the software companies had been showing a decline in revenues from the service offering for the past two quarters.

Wipro and HCL Tech that focus on R&D services exhibited strong growth in revenues. While Wipro’s R&D services grew by 9%, HCL Tech’s technology development group contributed to 49% of the revenues, this translated to a YoY growth of 41% (sequential numbers not available).

The BFSI (banking, financial services and insurance domain) continued to be a dominant vertical. The revenues from telecom vertical showed de-growth for most of the companies. The software companies earn their revenues from services to equipment manufacturers like Cisco and telecom carriers. While the equipment manufactures have been adversely impacted due to the slowdown, the impact on carriers has been far subdued. The troubled state of equipment manufactures could have been the reasons for Hughes hard landing. Hughes’ products are used by OEM (original equipment manufacturers) in their equipments and they might have postponed their sales for the time being.

Operating Margins: Pricing pressure
  Quarter ended
June, 2001
Quarter ended
September, 2001
Change
Mphasis 23.4% 29.1% 5.7%
Aztec 25.6% 30.5% 4.9%
Digital 29.1% 30.8% 1.7%
Polaris 23.0% 23.8% 0.8%
Infosys 39.3% 39.8% 0.5%
Wipro 28.5% 28.3% -0.2%
Mastek 35.8% 34.8% -1.0%
Satyam 36.2% 34.5% -1.7%
HCL Tech 32.1% 25.7% -6.4%
Silverline 32.2% 25.6% -6.6%
VisualSoft 33.9% 22.0% -11.9%
Hughes 34.4% 17.4% -17.0%
Aggregate 32.9% 31.4% -1.5%

However, this growth was at the cost of operating margins. The aggregated operating margins (excluding other income) for our sample declined from 32.9% to 31.4%. This could indicate pricing pressure the software companies have been facing in wake of the slowdown in demand.

Infosys managed to improve its billing rates in the quarter. The blended billing rates went up by 2.6% during the quarter. The increase in the onsite billing rates was 3.4% and the offshore billing rates in risen by 1.7%. Wipro too, saw a strong 4.5% realisation growth in onsite billing rates and a 2.5% growth in offshore billing rates. However, the top rung software companies only managed this feat.

These companies also saw an increased contribution of offshore development to revenues. For Satyam the contribution of onsite revenues increased from 41% in 1QFY02 to 45% in 2QFY02. The trend was similar for Wipro. The contribution of offshore revenues declined from 50% to 48% in 1QFY02. However, Infosys continued to show an increase in contribution from offshore revenues. However, the increase was marginal. The increase in contribution onsite revenues could be due to the companies taking on work in areas of systems integration and package implementation. These require onsite presence to be executed. However, the operating margins for onsite business are lower than that for offshore development.

The companies that had higher operating margins on the back of a significant contribution of product related sales to revenues, were the hardest hit. This included Hughes and VisualSoft. Many of the company’s like Hughes, Wipro and Aztec tried to keep costs under control by aligning the number of employee with the current demand.

The bottomline for the sample however, declined marginally by 1.5%. This is inspite of the sizeable income most of the company saw due to rupee devaluation during the quarter. Had the component of other income been missing the companies could have seen a steeper drop in profits. However, the most heartening fact was that the new client addition did not show much of a change compared to 1QFY02.

Net profits: Other income fail to support
(Rs m) Quarter ended
June, 2001
Quarter ended
September, 2001
Change
Infosys 1,900 2,016 6.1%
Wipro 2,077 2,157 3.9%
Satyam 1,215 1,341 10.4%
HCL Tech 1,323 979 -26.0%
Digital 192 223 16.1%
Polaris 156 154 -1.3%
Hughes 187 63 -66.3%
Silverline 175 139 -20.6%
Mphasis 74 114 54.1%
VisualSoft 92 47 -48.9%
Aztec 68 70 2.9%
Mastek (33) 41 -
Total 7,459 7,344 -1.5%

The next two quarters are likely to be tougher for the software industry. The impact of the September 11 attacks will be reflected in the numbers for 3Q and 4Q of FY02. This could mean that the topline growth for the sector could be lower. Also, the operating margins may decline further due to increasing competition.

However, a lot of software companies including Infosys, HCL Tech and Mphasis are adding IT enabled services to their portfolio. This could add some pace to the topline and improve the operating margins for these companies.

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