Exiting a large IT service contract and its implications on companies

IF a large IT service contract is terminated midway in the deal there are implications to the IT services vendor financials...lets try and understand this a little bit more..

Whenever a client terminates a large IT outsourcing contract due to extraneous circumstances (for example when Satyam like episode occurs) the effects of the annulment of the contract has implications on the company financials. As we saw in the earlier post in this blog that revenue recognition and the expense incurring is amortized on a Straight line proration basis. The extraneous event will result in realizing all the expenses in the year the contract is annulled. Now the revenue recognition depends on whether client has already been billed and paid for or is deferred. Either way there is going to be Operating margin impact on the IT services firm margins negatively.

So when some of the financial companies went belly up in the last 6 months and annuled their contract (TCS/Infy) or when client annuls some of their contract with Satyam their margins will definitely get impacted....

But inspite of these challenges companies like TCS, Infy and Wipros have reported a great run with revenue and margin growths for the recently ended Q3...Whats really going on...have their revenues been increasing when the entire market is down and new deals are few and far between...or is it some accounting gaps...

I would love to see their annual reports for FY'09 to really figure this out...For now be sure not to go long on these IT companies...you maybe in for surprise