Infosys' CEO Discusses F3Q13 Results - Earnings Call Transcript

| About: Infosys Limited, (INFY)

Infosys Ltd ADR (NASDAQ:INFY)

F3Q13 Earnings Call

January 11, 2013 08:30 a.m. ET

Executives

S. D. Shibulal – Co-founder, CEO and Managing Director

Rajiv Bansal – CFO

Swami Swaminathan – CEO and Managing Director, Infosys BPO

Sandeep Mahindroo – Principal, IR

B. G. Srinivas – Head of Europe and Global Head of Financial Services & Insurance

Analysts

Joseph Foresi - Janney Montgomery Scott

Moshe Katri - Cowen and Company

Anantha Narayan – Credit Suisse

David Grossman - Stifel Nicolaus

Jesse Hulsing - Pacific Crest Securities

David Koning – Robert W. Baird

Rod Bourgeois – Bernstein

Mayank Tandon - Needham & Company

Operator

Ladies and gentlemen, good day and welcome to the Infosys earnings conference call. As a reminder, all participant lines will be in the listen-only mode. There will be an opportunity for you to ask questions at the end of today's presentation. (Operator Instructions) Please note that this conference is being recorded.

I would now like to hand the conference over to Mr. Sandeep Mahindroo of Infosys. Thank you and over to you, sir.

Sandeep Mahindroo

Thanks Salina Hello everyone. I'm Sandeep from the Investor Relations team in New York. Happy New Year to all and a very warm welcome to discuss Infosys financial results for the quarter ended December 31, 2012.

Joining us today on this earnings call is CEO and MD, Mr. S.D. Shibulal; CFO, Mr. Rajiv Bansal, along with other members of the senior management team. We'll start the proceedings with some remarks on the performance of the company for the recently concluded quarter, followed by outlook for the year ending March 31, 2013. Subsequently, we'll open up the call for questions.

Before I pass it on to the management team, I would like to remind you that anything that we say, which refers to our outlook for the future, is a forward-looking statement, which must be read in conjunction with the risk that the company faces. A full statement and explanation of these risks is available in our filings with the SEC, which can be found on www.sec.gov.

I'll now like to pass it on to Mr. S.D. Shibulal.

S. D. Shibulal

Good morning everyone. My best wishes for a great 2013. We have performed well in Q3. In dollar terms our revenue grew sequentially by 6.3%, including the Lodestone acquisition that was completed this quarter. Excluding the acquisition, our revenue grew by 4.2%. Our EPS for the quarter was $0.76 as against $0.75 last quarter. Our growth was broad-based. We added 53 new clients in Q3. We won eight large deals amounting to $730 million. Four of those were in U.S., three in Europe, one in India. They include new client engagements as well as renewal and expansions on existing programs. Our win rate in the large deal win segment accelerated in Q3 as clients leveraged our strong solutions and differentiated offerings in this space.

That is regarding the bids space. The business and IT operations space. Consulting and systems integration has done well this quarter. It grew by 15% sequential in Q3, 8% sequential without including Lodestone. In the production platform and solutions business, our contract value increased from $485 million at the end of Q2 to $603 million at the end of Q3. We have launched a total of 20 products and platforms over the last year and half, sold them to over 70 unique clients so far.

In Q3 itself we have 13 new wins and on boarded eight new clients. We are seeing stability in pricing where continued quarterly movement would change in business mix. Our growth came in spite of adverse impact of super storm sandy on billable days, longer than normal furloughs in December, and client specific ramp downs. We worked very closely with our clients and their business priorities through December to mitigate the impact of these events. During the quarter, as I said, we completed acquisition of Lodestone aimed at increasing the momentum of our consulting service as well as strengthening our presence in continental Europe.

This contributed approximately $39 million in Q3 revenue for November and December. Even though we are in the early stages of integration, it is on track and progressing well. We have already secured our first win which is under the single umbrella of Infosys and Lodestone. While we have done well in Q3, the overhang of uncertainty continues in the broader economic environment. In U.S. -- U.S. is working amidst fiscal cliff and the debt ceiling issues. European nations are continuing to battle their sovereign debt. Emerging markets are witnessing a slowdown of growth.

In my conversations with global clients, it is clear that they believe that while the worst is over, some of these events can impact their business prospects in a manner difficult to predict. Their ability in gauging the full impact of these events on their business is affecting their confidence in taking spending decisions even though they have huge amount of cash reserves. This has resulted in longer conversion time for programs and programs wins into actual revenues. Early signs indicate flat to declining IT spend in the next year’s budget. We expect a better indication of this by the end of Jan of mid of Feb.

The fundamentals of our business have remained intact. We believe that technology has surely taken center stage in the business of our clients, especially in difficult times like this. Today technology is at the heart of many of their business decisions whether in rationalizing their cost structure, increasing productivity, standardizing and simplifying processes, expanding into new markets, or in launching new sales channels. And most importantly, remaining competitive.

We continue to believe that our full suite of solution and service capability across transformational, operational innovation, will hold us in good faith in the long term. This is true even as we continue to navigate short term challenges due to the uncertainty in the market place. Now let me give you some color on the industry verticals.

In financial services, our clients expect their business prospects to be muted at least for the next one to two years. This can lead to strong focus on cutting costs through layoffs, elimination of less profitable business, monetizing assets and vendor consolidation in IT and operations. The shrinkage being witnessed at the industry level is manifesting itself in declining 2013 budgets for most of our large clients.

Meanwhile, we expect some areas such as customer-centric applications, risk management and government to continue to see robust spending and we are focusing on capitalizing such opportunities.
The retail and CPG is seeing investments towards digitization, efficiency enhancement, SAP rollout, trade promotions and big data. There is also increased focus on vendor consolidation and move to a managed services model. We had good wins across the entire roster in Q3, especially in managed services deals, transformation deals and proactive solutions. We see good market traction with our platforms like BrandEdge, ComplianceEdge and ProcureEdge in this vertical.

Coming to manufacturing, clients are focusing on long term savings as well as increasing the effectiveness of their operations through data mining, analytics and business intelligence. We expect short term growth to come from America as the US manufacturing sector has seen a resurgence driven by higher automation, falling energy prices and rising labor costs as well. Clients in Europe are discussing transformational engagement through the financial troubles in the region, while cautious of decision making. In effect, we are seeing interest in platforms and solutions with lower CapEx.

Within the manufacturing vertical in Q3, we had multiple wins across the gamut of transformation, operation and innovation.

The energy and utility and communication services space, we have initiated new programs and ramped up engagement with clients that were added in recent quarters. At the industry level, we are seeing spend being driven by ERP-led transformation, technology and infrastructure modernization, enhancement of Cloud technologies in enterprise. We are focusing on increasing our wireless media and entertainment and cable business as the traditional wireline segment continues to see challenges.

Our Finacle business grew by 8.9% in Q3. Our BPO business grew by 15.6% sequentially in Q3. As you are aware, Finacle is a product business and is representative of the non-effort based model that we are focusing on as part of our strategy, Infosys 3.0. This quarter we added 8,400 new employees. We have strengthened our engagement with employees, instituted offshore and onsite wage increases and are looking at promoting 6,000 to 9,000 employees in Q4.

So looking ahead, we’re gaining confidence due to a strong pipeline of large deals, especially in the application development, maintenance and infrastructure management. Clients are embarking on restructuring their IT and operations spend. The continental Europe region also present a strong pipeline of large deals as they move towards managed services model. We believe that our strong brand, coupled with our execution engine, enables us to remain competitive and capitalize on any growth opportunities. We continue to remain focused on delivering strong returns even in uncertain and challenging environment, keeping in mind the interests of all of our stakeholders.

Now before I hand it off to Rajiv for details on the financial performance, I would like to thank you all for your support. I have met many of you through the course of the year. We are encouraged with a positive feedback we are receiving in response to the execution of our strategies.

Thank you. Now let me hand it off to Rajiv.

Rajiv Bansal

Good morning everyone. Let me take you through the financial performance. Q3 has been good for us. Our revenues in US dollar terms we were 6.3% including Lodestone and 4.2% without Lodestone sequentially. Our operating margin in the quarter was 25.7%, including Lodestone and at 26.1% excluding Loadstone. We have done well this quarter despite the negative environmental headwinds for the [phase] during the early part of the quarter. We are also able to maintain our operating margins despite the base increases that we rolled out  for offshore in Q3.

Our pricing has gone up by 1.8% during the quarter, primarily because of change in business mix. CSI, consulting and system integration, as a percentage of revenue increased from 30% to 31.2% in Q3. We see pricing to be stable as we go along. Volumes have increased by 1.5% during the quarter. Our integration with Loadstone is going well. I had mentioned earlier, we expect this acquisition to be EPS accretive over the next 18 months. We would have an additional quarterly charge of approximately $8 million on account of deferred compensation and amortization of intangible assets.

As we mentioned earlier, we plan to institute the onsite wage increase of 2% to 3% in Q4. This will impact our operating margin by approximately 1% in Q4. In terms of exchange rate the average rupee has appreciated by 0.5% over the last quarter. We have assumed a 54.50 rate as an exchange rate for Q4 purposes. On hedging front, we have hedges of 1.1 billion as of date.

We continue to generate strong cash from operations. You would be happy to note that our operating cash flow is at 103% of net margins. Our DSO is at 62 days as against DSO of 55 days last quarter in spite of it being a challenging quarter. Though our Q3 has been an exceptionally good quarter, challenges remain in terms of time to deal closures and ramp up. We usually have visibility of 95% to 96% at the beginning the quarter, and Q4 is traditionally a soft quarter for us. We need a sequential growth of 2.8% to achieve our earlier guidance of 5%. Our revised guidance including Loadstone now stands at 6.5%. Our EPS guidance remains unchanged at $2.97. Though there are challenges, we remain cautiously optimistic about meeting our guidance.

With that I would like to open it for questions.

Question-and-Answer Session

Operator

(Operator Instructions) The first question is from Joseph Foresi from Janney Montgomery Scott. Please go ahead.

Joseph Foresi - Janney Montgomery Scott

My first question here is just, I think  in the quarter it sounded like the commentary was cautious on the quarter in general, coming from management. I wonder if you could talk about the progression of revenue through the quarter. Did it improve on sandy and what was the cause for sort of the change in tone versus the execution?

S.D. Shibulal

If you look at it when we actually entered the quarter, we had -- for the rest of the year to achieve our 5% guidance, we have to do two quarters of 3.7% growth, in Q3 as well as in Q4. And Q4 is definitely slightly more, it’s a softer quarter for us. This means in Q3 we have to do even more than 3.7%. Now once we entered the quarter two phenomena happened. Number one, we had change in currency in sudden furloughs, which was not planned before. We also saw furloughs being extended beyond our original plan, which means that we will lose revenue as well as billing days because of furlough.

Number two, the sandy impact. And many of our people were not in the office for a week or even at times two weeks. So both posed serious challenges. In the quarter ended we have to do 3.7% or more, and another quarter we have to do 3.7%. What happened -- so those challenges were articulated and so what happened was two three things. Number one, we of course have very strong relationships with our clients and we were able to work very closely with our clients to mitigate a lot of the additional gap which could have emerged because of unplanned furloughs or sandy. Both, well, we were able to mitigate most of those. Number one.

Number two, when we started out the quarter, we have not factored in any pricing increase. If you look at this quarter, the pricing increase of 1.8% has shown up because of the portfolio shift. This is not something which can be predicted on a weekly basis. That actually comes towards the end because we're running about 10,000 programs and each one of them is behaving in a slightly different manner.

Finacle and BPO grew substantially well this quarter. So the challenges we articulated were definitely there. They were based on extended as well as the number of furloughs being higher than what we had planned, and impact of the Sandy having losing billing days. Though we are fortunate enough to mitigate most of that through our relationships and ramp ups and then the pricing favored us by 1.8% growth because of the portfolio shift. And Rajiv wants to add to this -- little bit to it.

Rajiv Bansal

If you look at – we had this services growth of 3.7% last quarter. We had a volume increase of 3.8% last quarter and this quarter our volume has been about 1.5% and the services growth has been about 3.3%. So a lot of growth this quarter has come from Finacle, which is a product business, which is choppy, which depends on the license sale and the deal closures. BPO has grown about 14%. So what surprised was in terms of the business exchange and the price increase that we got about 1.8% during the quarter. And also when we actually spoke about the challenges, we also said that there are four months in the half year left for us to mitigate some of this stuff that we're seeing. We had spoken to all of you on 12 October and when we spoke to you again after some 40 days, the environment had turned bad. There were more challenges that we had seen at that point of time, but at that time also we were talking about having four more months in the half year left for us to be able to meet the guidance and that we're going to go all out and try to meet our numbers.

Joseph Foresi - Janney Montgomery Scott

Okay. Maybe you could just talk about pricing. I know you addressed it in your earlier call, but is this pricing increase sustainable? In other words, do you think that the mix shift could continue to favor you through the back half of the year? And is it fair to say that the pricing increase is not being driven by any kind of macro terms? In other words, demand is increasing or picking up so that it’s driving the pricing.

Rajiv Bansal

No, I think you should not read too much into the pricing increase because this are quarterly phenomena depending on the business mix change, depending on the deal closures and ramp-ups, which happen across 10,000 programs that Shibu was mentioning. So I think business mix change over the period of time. If you see a business mix shift over multiple quarters, then it could signify a pricing change, but I think other than that on a quarterly basis you should not read too much into it. We expect pricing to be stable, and with the quarterly movement up and down depending on the business mix changes.

Joseph Foresi - Janney Montgomery Scott

Okay, just last question from me. We've had a string of quarters where things had been more difficult. Do you feel like you've got a proper business momentum underneath your feet after this quarter and how do you think about the margin profile? I know that you've kind of kept it at the level it is. Should we expect that to continue into the next year, into 2013, and what could be the changes there?

Rajiv Bansal

The business environment continues to be challenging. The clients are still not very confident about spending anything in the longer-term investments into the IT. I think a lot of it would depend on how the economic environment of the country is, how the consumer confidence index is and how much confidence it gives to the corporates in this money. So I think the environment remains challenging. The clients we have – though the RSP activities have picked up, the deal volumes have picked up, but the deal closure times are still very long and the decision making cycles are actually much longer and goes multiple levels for approval. So that continues and that is a reason it's very difficult to forecast and predict numbers on an accurate basis at a very short period of a quarter.

Coming on the margin, we have been able to maintain margins in this quarter in spite of the wage increase that we give at offshore. However, we are giving wage increases for our overseas folks and that is likely to impact our margins by about 1% next quarter. I expect the margins, Steve, in fact if I look at moving into the next year, our utilization is still at about 71%. We would ideally like it to be around 79%  to 80%, which means that we have about 9% utilization lever which gives me a lever to have margins of about 4% into the next year if volumes pickup.

So I think we have levers on the margins, but I would expect margins to move in the narrow band of 100 to 200 basis points going into the next year. I think Shibu wants to add something to that.

S.D. Shibulal

As Rajiv was saying, and I was saying that we have done well this quarter but the world has not changed. The world is exactly what it was, there is no [singular] change in the world. And I am sure you are aware, all are aware of this. The U.S. uncertainties continue. In fact in financial services alone, I was reading reports which said that there is an over-employment of 60,000 people. And we have seen layoffs in multiples organizations. If you look at Europe, the sovereign debt issues are continuing. So our clients’ confidence has really not changed. Even though they have cash, their confidence has really not changed too much, which means that their ability to invest for long term programs, ability to take quick decisions, and their ability to even ramp up on decisions where they have taken -- cases where they have taken decisions, is still low.

So we remain quite cautious at this point. Even if I look at next year, which you know -- if I look at next year, we expect the budget to be flat or marginally down. We expect it to be more than marginally down in certain segments, like FSI. And we also expect that even after the budget closes, there will be scrutiny of the budget while it is being spend on a quarter-on-quarter basis. So we have done well in Q3. We remain quite cautiously optimistic.

Operator

Thank you. The next question is from Moshe Katri from Cowen and Company. Please go ahead.

Moshe Katri - Cowen and Company

Just to follow up on the margin question. So should we assume now that the mid-20% levels, kind of the new base for EBIT margins for Infosys compared to where we were maybe a couple of years ago, close to the 30% range. Thanks.

Rajiv Bansal

You know, as we said, we have acquired Loadstone, so the numbers that you see now include Loadstone also and Loadstone being European consulting company is going to be at lower single-digit margins. So once you see the consolidation impact, we too see an impact on margins for the group as a whole. Having said that, margin is a factor of growth because if you look at it, you know as any of the IT company would hire most of our requirement through campuses which require us to make demand projection almost about 18 months ahead of time.

We go the campuses, if we go the campuses this year, we would typically have again fall on the demand in 2015 or the revenue growth in 2015. So it is a difficult thing to predict about the growth two years down the line in this kind of unstable and volatile environment. So in case we are able to predict well and we hire only to meet our demand, I think the margins will start improving because as the utilization starts going up, we would see that the margins are improving because the cost has already built up. The only cost which will come incrementally is the differential between the onset in offshore cost for the people who have to go onsite for their starting project.

So at 71% utilization, I believe that we have enough levers for margins. But having said that, I would like to say that -- and we are in the middle of our execution of the new strategy as we talk about Infosys 3.0, it requires us to make a lot of investment in the business, a lot of investment in the product platform services in the consulting space in our frontline. And I would believe that till we reach a fairly [stable environment] in that journey, maybe the margins at the mid-20 is what should be good.

Moshe Katri - Cowen and Company

Great. Understood. And just for clarification purposes, FSI was up 6% sequentially, is there a way to kind of take out Loadstone from that and see what the number was, assuming that Loadstone did contribute to growth in FSI? And then maybe we can go through the same exercise with Europe?

S. D. Shibulal

The contribution from Lodestone was marginal for the quarter so you…

Moshe Katri - Cowen and Company

Okay. How about Europe? If you're looking at sequential growth out of Europe, maybe we can take Lodestone out and also try to get what was the number actually organically?

Rajiv Bansal

Even if you take out Lodestone, Europe has done well for us during the quarter. Our revenues for Europe had actually gone up by about 1.5% as a percentage of total revenues. So Europe has seen good growth and actually we're seeing quite a few deals that we have signed up this quarter have been in Europe. So Europe continues to do well. There are a lot of opportunities in the European market. So even without Lodestone we are seeing good traction in Europe and the growth has been quite healthy in Europe this quarter.

Moshe Katri - Cowen and Company

Okay. Then out of 53 new client additions, how many came from Europe?

B. G. Srinivas

13 new clients added during the quarter, excluding Lodestone for Europe.

Moshe Katri - Cowen and Company

Understood. And you don't have the organic number for Europe, out of Lodestone yet?

B. G. Srinivas

We have. Sequentially we were 1.2% up for Europe, excluding Lodestone.

Moshe Katri - Cowen and Company

Okay. Thank you very much

Operator

The next question is from Anantha Narayan from Credit Suisse. Please go ahead.

Anantha Narayan – Credit Suisse

Thank you and my best New Year wishes to the management team. Rajiv, just one follow-up question on the margin side. The guidance for next quarter that you've given basically implies that on an organic basis margins will probably decline by about 250 basis points for FY '13 as a whole, which seems to be a little bit higher than the earlier 200 basis points that you had guided to us, and the rupee has actually been significantly weaker than what you had estimated for the second half of this year. Can you just help us understand what has really changed?

Rajiv Bansal

I couldn't hear you. Can you speak a little louder? I couldn't get the full question.

Anantha Narayan – Credit Suisse

So, Rajiv, my question was that your guidance on margins for next quarter implies 250 basis point decline in organic margins for the year versus the earlier guidance of 200 basis points, while the INR has actually been a lot weaker than what you had initially assumed for the second half. So can you just help us understand the change now?

Rajiv Bansal

Now see when we spoke about the margin, we said the margins will move between 200 basis points to 300 basis points. When we gave a guidance in October, when we gave for $2.97, we had assumed a certain set of expenses, a certain set of revenue growth, the business mix change. So now it has moved from about 200 basis points as you’re seeing to 250 basis points. On a quarter-on-quarter basis, we have been able to maintain our margins this quarter. Next quarter is a soft quarter. We are instituting onsite wage increases and also we have taken about $13 million impact because on Lodestone. As I explained, because of amortization of intangibles and for deferred compensation, there is an impact of roughly about $8 million next quarter and that's a charge that we have to take for Lodestone. Also, Lodestone is coming at a much lower margin and once you consolidate it will have an impact on the overall margins for the Company.

Anantha Narayan – Credit Suisse

So this 250 basis point is the organic number that I was mentioning. Lodestone shouldn't impact that number, right?

Rajiv Bansal

Yeah, Lodestone’s charge will come on the IL books because when Infosys bought Lodestone, a part of the compensation – a part of the purchase price is towards the deferred compensation which is being amortized over the next 36 months. So that the charge is coming from IL books and also the amortization of intangibles impact the IL books.

Anantha Narayan – Credit Suisse

Okay. Thank you.

Operator

The next question is from David Grossman from Stifel Nicolaus. Please go ahead.

David Grossman - Stifel Nicolaus

Thank you. I'm wondering if I could just go back to the flow of revenue over the course of the quarter. It sounds like the big change vis-à-vis some of your messaging intra-quarter was an unanticipated realization benefit from a mix shift to CSI, given that your unit growth penciled out organically at about 1.5% sequential growth. So as you look at that and obviously some benefit from Finacle and BPO as well, but when you look back at that CSI activity, how much of that was tied to the contract activity signed in the fiscal second quarter? And just maybe you would help us understand, the types of contracts that we are talking about that drove that unexpected increase and what the fall through could like in the quarter?

S.D. Shibulal

So actually if you -- there are two factors to that commentary. One was unexpected negativity we saw because of the furloughs and super storm sandy. And that we were able to mitigate. Most of it we were able to mitigate. That we were able to mitigate working with our clients even in situations where clients announced unanticipated furloughs. We were able to work with our clients and definitely continue most of the critical programs. So that mitigated that -- and that we could only make out as time went by because we were discussing in the beginning of December. And it was still in progress.

The second part is [portfolios] that we are talking about. If you remember last quarter when we discussed, we had discussed about transformational wins. Transformational wins generally show up within a quarter. Within a quarter it will start showing up at least definitely in the second quarter. So what happened was that we realized at the quarter went by and especially as after the middle of the quarter, we ramped up some of the transformational wins which we had in the previous quarter.

And that portfolio shift happened during the quarter but it will show up towards the end of the quarter. So the ramp up which happened in consulting and systems integrations is predominantly due to the wins which we actually announced I think in the previous quarter.

David Grossman - Stifel Nicolaus

So if we -- going back to that fall through in the fourth quarter and beyond, front end revenue on some large (inaudible) demand sooner than expected or you expect to continue in to the second quarter.

S.D. Shibulal

David, you were not clear. I couldn’t make out, could you please repeat?

David Grossman - Stifel Nicolaus

Sure. So the question was really how this flow out over the next couple of quarters. It sounds like you have got some transformational business both last quarter, you saw some of that revenue ramp this quarter, next couple of quarters. Or is it something that was more front end related to some large business signed in the second quarter.

S.D. Shibulal

See the reflection -- the interesting things is, there is always a lag in the revenue profile change versus the win rate, win profile change, right. So last quarter we had transformational wins. If you look at this quarter, we are talking about large deal when we said that we have won about $730 million of TCV and most of it in business in IT operations space. Those will flow through in the next two quarters, right. We expect them to flow through in the next two quarters unless something unforeseen happens. So when that happens, you will see a different portfolio shift. The [basic] programs that we talked about have ramped up and probably continue to be on that ramp rate or maybe marginally higher. (Inaudible) the large deals that which we have won, will also start showing up.

So that is why the portfolio will shift quarter-on-quarter. They are reflecting wins from the past. So for example in this $700 million opportunities that are ramping up, that will definitely show up in the bid space.

David Grossman - Stifel Nicolaus

Okay. So would you expect the mix to shift back a little bit in the fourth quarter?

S.D. Shibulal

In fourth quarter the mix -- based on the wins it could shift back marginally. These will operate in a narrow range and we are running 10,000 programs at any point in time. Right, 10,000 programs. And, so some of them could suddenly ramp up, and some of them may not ramp up as we think in the current quarter, especially in a volatile environment. When the volatility is not there, we know exactly how many people will get added this quarter, but because of client uncertainties and various other things today, there is volatility in that. So I would tend to believe that it will operate in the narrow band. But this quarter win, Q3 wins where, the ones which we talked about are predominantly in the bid space.

David Grossman - Stifel Nicolaus

Okay. And then let me just go back now to your margin equation, Shibu. My calculation is that, margins based on your guidance and tax rate guidance is about down 280 basis points versus your previous guidance I think was down 200 basis points and I think one of the previous questions mentioned that currency runs probably about a 50 to 60 basis point incremental tailwind versus your previous guidance. So clearly the margin guidance has come down and I understand the impact from Lodestone and the impact from utilization on your margins. So you put a wage increase in last quarter, you’re putting one in this quarter. Help us understand how we should think about both the impact of wages in utilizations going forward because utilization at some point becomes somewhat of a discretionary item when you can increase or decrease it based on your – how much of a bench you want to keep in place. So can you maybe just quickly walk us through your thoughts going into next year in terms of how we should think about the wage increases given what you've done this year and the utilization rate?

S. D. Shibulal

So let me address the wage increase first. We gave a wage increase of 6% offshore. We had delayed it for the year and we did it in October. We also are planning to do an onsite wage increase in U.S, 3% to 4% actually right now in Q4. We did 12,000 promotions about two quarters back. We are also going ahead with 6,000 to 9,000 promotions in Q4. That is that side and leads to another merger impact. 6% increase in offshore compensation is approximately about 1% impact on the margin, and about 4% increase on around – on (inaudible). U.S. compensation would be about 1%, another 1% possibly – yeah, 1% impact on our margins.

So our operating margin has remained in a very narrow band. In fact it has come down by 0.2% without the impact of Lodestone and that 0.2% is because of the currency appreciation of 0.5%. Now if you look at the utilization, it is – I wouldn't call it discretionary actually. The utilization for us is very important for us to keep it to 70% to 80%. It's very important because it is even more important to our people that they have work to do. So it is 70% to 80%. Yes, when the prediction doesn’t happen as we think, we will end up with excess bench. The impact of the utilization is the following. The additional 8% bench which we're carrying actually has a margin impact, direct impact of 1.5% because 8% of 17% which is our offshore compensation and the indirect impact of about 2.5% because of the revenue loss.

If the revenue is there that will be give us better margins. So the impact of that 8% is approximately direct 1.5% and indirect about 2.5%, about 4% on our margins. So in the coming year – so the solution to all this is growth. If growth happens the utilization will pick up. If the utilization pick up, the direct cost – direct impact will definitely come down and the indirect impact which I talked about will accrue on the positive side. So if the utilization goes up to about 78% to 79%, we expect to gain benefit of that in the margin based on, there are many other levers that's why I'm not giving you the number ,but based on the 1.5%, plus 2.5% I talked about.

Rajiv Bansal

Just to add to that from a margin front, when we said about 200 basis points to 250 basis points, just to be more clear, there is a 0.2% impact because of rupee and 0.3% impact because of the Lodestone charge, which comes into the IL books, because this is about – when we acquired Lodestone, a part of the total purchase price is tied to the compensation, deferred compensation, which is paid only if the management stays with us till the end of third year. That under IFRS is a charge on the P&L of IL, which is on a monthly basis. This will roughly work to be about $8 million a quarter. So, for the half year the charge is about $13 million because this is effective November. So, a charge of $13 million on a half year revenue is roughly about 0.3% to 0.4% impact on the margin. Rupee appreciated by 0.5% during the quarter. If you take it for the half year, the impact is roughly about 0.2%. And that would explain the reason why the margins would move between 200 basis points to 250 basis points.

Operator

Thank you. The next question is from Jesse Hulsing from Pacific Crest. Please go ahead.

Jesse Hulsing - Pacific Crest Securities

I wanted to follow-up on dynamics related to mix shift versus rates. So from a broader perspective in these larger deals that you're pursuing, what is the broader industry trend in your view of where rates are going in the ADM side of your business? Are they pretty stable? Are you seeing them trend down or trend up? And as a follow-up to that, do you think that the mix will shift significantly to ADM because of the consulting lead-in work that you saw in Q4?

S. D. Shibulal

Okay. So, we have assumed pricing as stable for the rest of the year and there are pockets for our business which is definitely price sensitive. I would think that the application and maintenance space is price sensitive. I would think that there are certain other areas which are price sensitive. In those areas we are doing things like managed service, we are doing ticket based pricing and various other models to address those challenges. But there are areas which are price-sensitive. That is why it is even more important for us to manage the portfolio and have growth in areas where the sensitivity is lower. So, if you look at the consulting and system integration space, we operate under the pricing umbrella of the Global SIs, and that allows us to actually maintain pricing premium.

So, the whole approach, if you look at the Infosys 3.0 strategy, is actually to address this problem in the long-term. That means it's about creating a balanced portfolio, one which is a consulting and system integration, which is higher revenue productivity. Products and platform, which is non-linear in nature due to effort. And grow bids where some part of the business is price-sensitive. That's the whole approach and that is how we are trying to manage the portfolio.

Now, I don't see these, what we call ADM work, and I will never say never, but for most part will not flow from the consulting work into ADM. What we call consulting is quite comparable to what Global SIs call consulting work. It includes consulting, system integration and the packages, like I said, being Oracle, led transformational work and some of the follow-up work which we do. What we call ADM work is pure application development and maintenance which will be Greenfield development of an application within Java or.NET or anyone of those. The chance is that coming out of the consulting which we do is there, but it is very minimal.

Jesse Hulsing - Pacific Crest Securities

Thanks. And the large deals which you closed (in the quarter)?

S. D. Shibulal

The large deals which we closed, many of them this quarter or most of them this quarter, are in BIT space, which is an IT operating space. And many of them are (multi-level), some of them are infra led deals.

Jesse Hulsing - Pacific Crest Securities

For those deals, were the wins primarily self-sourced or did you win those in a bake off, RFP type process?

S. D. Shibulal

Many of them are in RFP like process. Some of them are vendor consolidations where we have won our portion and additional work from the client. And I would say maybe one of them are sole sourced. But many of them are RFP led and some of them are vendor consolidation.

Jesse Hulsing - Pacific Crest Securities

Okay. Thanks. And to follow-up on previous questions about Sandy. Were you able to quantify Sandy's impact on the quarter? You've mentioned that you it was difficult inter-quarter. Looking back, have you been able to put a number on how many hours clipped out due to Sandy?

Rajiv Bansal

As Shibu was referring earlier, we were able to mitigate most of it and the impact of Sandy has been very negligible on us.

Jesse Hulsing – Pacific Crest Securities

Okay. Thanks guys.

Operator

The next question is from David Koning from Baird. Please go ahead.

David Koning – Robert W. Baird

Hey guys. Just following up I guess on the last question a little bit too on the core ADM work. I know that's kind of your most I guess stable recurring business and I think your biggest offering too. That did go into negative mode this quarter. I think it declined 3% year-over-year, first decline in about four or five years. I guess what's the confidence that that picks up again? And maybe you can just go through why it did decline this quarter.

S. D. Shibulal

I wouldn't read it as a secular trend. First of all many of the deal wins which we had this quarter are in the bid space. Now this whole thing about ADM, focusing on ADM, going forward may not be the right approach because we will look at bids as a portfolio and the boundaries are soft. That's the whole purpose of looking into the portfolio. If you keep such hard boundaries for people or for revenue, the benefit of that service line or the offering, do not reach the clients. So it's actually a porous, slightly porous boundary line. From a bit perspective, which is actually a combination of application development and maintenance infrastructure, independent validation. BPO, I think that will be a core offering from our side and it will continue to grow. It is a must for it to grow because that is our largest offering, 60% of our business comes from there. So it has to grow.

David Koning – Robert W. Baird

Okay, great. And then I guess one other thing, just the other income line that was $92 million this quarter, how much of that is core interest income? Just so we know how to model that going forward because I know there is a lot of moving parts in that line. Just wanted to know what the core part of that $92 million is?

Rajiv Bansal

No. Almost all of it is interest income. We did not have any impact of Forex into this kind of non-operating income.

David Koning – Robert W. Baird

Okay, great. Thank you.

Operator

The next question is from Rod Bourgeois from Bernstein. Please go ahead.

Rod Bourgeois – Bernstein

Yes guys. So you received a major boost from the rupee (inaudible) mid-2011, when the rupee really began to depreciate, yet margins have dropped and they still seem to be dropping heading into the March quarter. So I guess the question is, where has your expense structure changed since mid-2011 or if the expense structure is not materially changed, then is there something that's happened on pricing on like-for-like deals even though your overall reported pricing has held up?

Rajiv Bansal

Well, there are two factors which have contributed to the drop in margins if you normalize for the rupee depreciation which has taken place. One is definitely pricing our year-on-year margin – our pricing has actually dropped by about 3.5%, which is quite significant and which flows into the bottom line. And second is also with respect to utilization. If you’re comparing with 2011, 2012, our utilization used to be in the high 70s and roughly about 79% to 80% if I remember right and today we're operating at about 71% utilization. So these two, the pricing is impacted about 3.5%, you had utilization drop of about 9% and these two very determinedly are slowing the operating margins. If you look at it, we have been able to mitigate some impact of it because of the drop in operating margin is roughly about 2.5%, though if you look at the pricing about 3.5%, utilization drop by 8%, it would have been much more.

We have actually been running it very efficiently during the year. As Shibu said, we had delayed compensation increases because we saw the utilization – very low the pricing drops are happening. So we have done a lot in terms of trying to keep our margins good and we expect that as the growth starts picking up, we would see the utilization start going up to 80%, which is where we would like it to be and pricing I believe would remain stable. We have lost about 3.5% on pricing during the year, but going forward I expect pricing to be stable. There could be quarterly movements depending on the business mix change, but I don't really see a secular trend in the pricing drops anymore.

Rod Bourgeois – Bernstein

So, on the pricing question, that's very helpful to know that pricing on a like-for-like basis has dropped in such a way that it's contributed to the underlying margin degradation. But I guess the question that raises is, what's changing in the market or in your strategy that would cause pricing to go stable after the decline that it's experienced in a pretty meaningful way over the last year?

S. D. Shibulal

So, actually more importantly the question is, what is changing in our strategy to keep our revenue realization stable. Because the pricing is definitely dependent on the market, at least for certain set of services which we offer. So, the important issue is to make sure that the revenue realization is stable or hopefully marginally going up over a period of time. So for that the important issues are the following. Number one, to have revenue growth in higher revenue productivity areas like consulting and system integration. Number two, have revenue growth in production and platform space where I expect that in medium term the effort dependency is 50%, 50% of what the other areas are. And in the areas where it is price sensitive, we move to more of a managed services model. So, if you look at the wins in this quarter then many of them are managed services wins, where the client is looking at outcomes rather than input, the effort. So by doing that, if you can increase productivity, if you can drive efficiency, if we can do it better than what we have promised the clients, some of it accrued to us. So, the strategy is about making sure that the revenue realization is stable or we can improve on it over a period of time.

Rod Bourgeois – Bernstein

All right. And if I can just ask on (inaudible). So the plan, it appears to stabilize pricing as to shift your mix towards higher end segments and then also on the unit services in the commodity segment. But barring a mix shift, which generally requires pretty strong revenue growth to make a meaningful mix shift. Barring a mix shift, what do you think happens to pricing on like-for-like deals, are we still in a position where like-for-like pricing is in (decline)?

Rajiv Bansal

See, we run pricing in a portfolio. It also depends on the opportunities that we see. Whether we're incumbent, whether the opportunity is (inaudible) into a client where the competition is very strong, we want to make a strategic entry. It's a client that we've been trying to pursue for the last couple of years. It's a different geography. So, pricing side has a mix of lot of factors. And it's not about, no two deals are alike. So, pricing strategy also depends on what the competition is and what is the kind of opportunities for you to improve your margins as you go along. So, this is not a very simple thing to say about that on a like-to-like basis how the margins are changing on deal to deal. But as we said, we expect that keeping our pricing strategy and portfolio mix, we would expect the pricing to be stable as we go into the next year.

Operator

The next question is from Mayank Tandon from Needham. Please go ahead.

Mayank Tandon - Needham & Company

I just had a question on some of the key trends looking into 2013. Could you provide some perspective on the resiliency of the European growth? I mean do you think we can see the trends continue over the course of 2013 based on client activity? Also in terms of the regulatory side, do you think that both healthcare and financial services could be important catalysts over the course of the year? And last but not least, would you consider maybe buying come captives to scale up your operations, particularly on the BPO side?

B. G. Srinivas

This is B.G. With respect to Europe, while there is definitely the macro overhang and the challenges and the uncertainties will continue into this calendar year, it's very difficult to predict on a medium-term to long-term basis how the scenario will pan out. However, currently what we are seeing is, there is less of panic, there is relatively stable environment within our clients. The clients are in the process of finalizing their budgets. The early indicators – though the budgeting process is not complete, the early indicators are flat to negative and that is the data points we have today. So we presume if the environment continues to be stable and that the deal making cycle continue as business as usual, then there is possibility of an upswing in the revenues for the year. But this is something we need to watch on a quarterly basis. It's difficult to predict in the medium-term and this is something we are watching closely. We continue to make investments into Europe in terms of accessing markets, both in Continent and in U.K. In terms of other markets, we are seeing new initiatives in client activity, both in Financial Services and Manufacturing in the Nordics. That's an area which we will look into as we go into our fiscal year starting March.

Mayank Tandon – Needham & Company

Also any comments on the regulatory side and also in terms of captive strategy?

B. G. Srinivas

Okay. The regulatory side, obviously from a Financial Services and Telco, they have the industries which will continue to invest into introducing new controls and the back systems which it supports. This is an area where we are also focusing on. However, it's again difficult to predict the discretionary spend which will go into this, but we are already working with our clients in some of these initiatives and we are also bringing in expertise to help clients actually deploy these new control measures with less overall cost of implementation, also leveraging technology. But again, like I said, while these are areas of focus, we will definitely see a revenue stream occurring because of investments in these areas. We are also looking at some of the initiatives within our clients on risk management and that's an area of focus as well. Even then overall environment in Financial Services and Telcos are under significant cost pressures. The initiatives are also on cost pickup measures. That’s something and again an area that we are looking into.

Mayank Tandon – Needham & Company

Finally, just wanted to get a sense of strategy around captives. It seems like there are opportunities to buy captives to scale up the BPO side. I wanted to see if that would be one of the priorities looking into 2013 for Infosys?

Swami Swaminathan

Hi, it’s Swami here. Yes, from a BPO growth standpoint, the growth engines are really both – all three lines, which is really organic, inorganic and as well as captives. If you remember, recall 2007 we had picked up the Philips captives and that journey is pretty much on. So the road that we are seeing in obviously coming across on all three streams of activity and initiative that we regularly launch. So, very clearly, in this year, we obviously have also started to look at emerging economies pretty closely. We have launched four geo business units. You have an India business unit and LATAM business unit. You have the Eastern Europe business unit and an Asia Pacific business unit which really focuses on selling solutions and propositions to corporations and to governments in these emerging economies. So, as a part of that obviously we continue to scan the environment on captive opportunities which we believe is a value that we can pretty much add and leverage.

Mayank Tandon – Needham & Company

Great. Thank you.

Operator

Thank you. Ladies and gentlemen, due to time constraints, that was the last question. I now hand the conference back to Mr. Sandeep Mahindroo for closing comments.

Sandeep Mahindroo

Thanks everyone for spending time with us. We look forward to talking to you again over the next few weeks. Thanks and have a good day. Bye.

Operator

Thank you members of the management team. Ladies and gentlemen, that concludes this conference call. Thank you for joining us and you may now disconnect your lines. Thank you.

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