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Infosys Limited, Inc. (INFY)

March 11, 2013 6:30 pm ET

Executives

Sandeep Mahindroo

Analysts

Alban Gashi - Crédit Suisse AG, Research Division

Alban Gashi - Crédit Suisse AG, Research Division

Good afternoon. My name is Alban Gashi. I'm the associate at the Data Processing and IT Services sector here at Credit Suisse. And today, we have Sandeep Mahindroo, Principal IR of Infosys. Sandeep?

Sandeep Mahindroo

Good afternoon, everyone. Thanks for being here. I'm Sandeep from Infosys. So I thought I'll provide a brief overview of what we are seeing on the business side, some key things that I want to touch upon and, subsequently, we can do Q&A.

We are still in the early part as far as the calendar year is concerned. But an important event, which is the budget has -- that event has transpired. So for the most part, budgets are closed. If you look at most of our key clients, all the leading clients with budgeting process we track. What we are seeing this year is that budgets are flat to down over the calendar year 2012 but it is not very different from what we saw in 2012 over 2011. In fact, if I look at the individual verticals, they also don't indicate something very different this year compared to last year. So, verticals like Financial Services and Telecom are seeing a decline in budgets this year over last year, which is exactly similar to what we saw in these verticals in the last year over calendar 2011.

Similarly, if I look at Retail and CPG and Manufacturing, budgets are flat to up in these 2 verticals over 2012, which is very similar to what we saw in these verticals in calendar year 2012.

Broadly, when you put it all together, because we get revenue Financial Services vertical which is the largest of the 4 verticals that we have, the bias mapping into our portfolio is slightly on the downside.

So budgets are behind us. They have been closed on our timely fashion. Budgets are flat to down. What we are focusing on is really the allocation process of our clients. So it's one thing to know that in Financial Services, budgets will be down. But the other thing, which is important for us is, how are the overall budgets in Financial Services stack up between investment banking versus retail banking versus commercial banking versus credit cards into various other areas. Because within Financial Services verticals, we have a different level of exposure to each of these sub verticals. And in fact, in each of these sub verticals, we have a different level of exposure by geography. So budgets being down in a single vertical doesn't really indicate as much until we know the allocation process, how does it stack up in each of the lines of business, each geography, by program, et cetera. And that's the process which has started in many of our clients a few weeks back, and we expect to know more on the completion of the allocation process in the next month or so.

Externally, we haven't really seen any significant changes on the external demand side relative to where we were a few quarters back. So probably, it's fair to say that the clients' sentiment is better relative to where it stood out 3 or 4 quarters back, but it's not leading to a translation and increase in the spending decisions or even a change in spending cycle. We still see elongated decision cycles, especially when it comes to large spending that clients have to make or any new discretionary project that they have to undertake. We still see a fairly long conversion time of opportunities that we are pursuing, getting translated into specific deal signings. And then the pace of ramp up on those deal signings continues to be a bit more elongated compared to what we have seen in the past.

So volatility in the entire process of conversion of pipeline into signed opportunities and then signed opportunities into actual deals continues to be a part of concern. We haven't really seen any significant acceleration in the external demand environment over the last few quarters, even though spending is -- even though sentiment is somewhat better compared to where it stood a few quarters back.

However, internally, we think that, we, as a company, are better positioned today compared to where we were a few quarters back. So as you might know that, in the middle of calendar 2011, we embarked upon a series of changes. We rolled out a new strategy called Infosys 3.0. Since then that strategy has been rolled out. It's articulated. It's getting accepted. In fact, in a few cases, it's also getting accolades from industry analysts and certain clients. So that part is behind us. The restructuring of the company into 4 large industry verticals is complete. The leadership has been appointed. So for the most part, we think that various changes that we, as a company, were putting in place in late 2011, which were probably impacting us as a company about 3 to 4 quarters back. That impact has gradually receded. So we think we are more settled as an organization today compared to where we were 3 or 4 quarters back, even though there are still some internal challenges that we have.

So one is that utilization is way too low for our liking. We, as a company, generally target utilization levels of high 70s. We are presently operating at low 70s, and that's a reflection of actual growth being much more -- much slower compared to what we were planning for coming into this year. We do expect to increase utilization over time, but we think it will be a gradual process rather than any significant increases in utilization that we might see in the short term. So increase in utilization continues to be one big focus area within the company and also a challenge in many ways, because our cost structure is way too bloated compared to the revenues that we're getting.

Secondly, the entire process of better alignment of the supply side of our operation that a more volatile and dynamic demand environment is something that we are also working towards. So unlike few years back, when we used to go to engineering colleges, make commitments to hire thousands of freshers, expecting them to join 4 to 5 quarters down the line, not worrying about how the demand environment will pan out over that period. That entire cycle is something which we think needs to change because the demand environment has become a lot more unpredictable. It has become a lot more volatile. But to that extent, we need to more finely tune our supply side in general with the volatility on the demand side. So what we have done this year is gone to colleges and made a very minimal number of fresh offers for the next fiscal year. The idea is to reduce our lines at a fresher level by hiring from colleges and increase our lines on just-in-time hiring at a fresher level. So we want to make sure that we hire people when we see specific opportunities in the market rather than going to colleges and lock ourselves by making thousands of offers even before those specific opportunities are visible to us.

So there are some internal challenges that we still are working towards and addressing. But overall, we think we, as a company, are better positioned compared to where we were earlier.

On the pricing side, we see, I would say, pricing has been stable for the most part. It varies based on the constituents within the business. So in commoditized services, like application management and things like transaction BPO, we continue to see some downward pressure on pricing because these are services which are fairly generated with the opportunity to showcase differentiation is not that high. At the same time, in some of the high-value services like consulting-led transformation or system integration, we continue to see opportunities to increase prices on a selective basis.

So overall, when we look at the entire portfolio, we see pricing has been broadly stable, with a marginally downward bias because of what's happening in commoditized services, as well as what's happening in certain verticals like financial services, which are still going through challenges because the industry has shrunk. They have let people go. The industry has downsized quite significantly over the last few quarters.

Last segment that I want to touch upon before I conclude is the impact of cross currency that we are likely to see this quarter. So the U.S. dollar has appreciated quite significantly against various currencies, specifically the European currencies, over the last 60 days or so. And the spot rates are quite different from what we had assumed in our guidance, specifically versus the GBP. The U.S. dollar has appreciated significantly. We had assumed the rate of 1.62 between GBP and USD in our guidance. I think the spot rate is close to 1.5. And to a lesser extent, the dollar has also appreciated against some of the other currencies like euro and Australian dollar. And because we get about 25% of our revenue from GBP, euro and Australian dollar put together, to the extent that these currencies have depreciated against the dollar, it creates a negative bias on our revenue growth objective for this quarter.

With this, I'll conclude and we can open up the floor for any questions.

Question-and-Answer Session

Alban Gashi - Crédit Suisse AG, Research Division

If you don't mind, Sandeep, I'll just kick us off here. As you talked about your budgets overall being down -- flat to down, overall, how should we think about in terms of the portion that's being offshored and just reallocated, as opposed to overall broad IT budgets coming down, how that impacts you? And also, what type of deals are you seeing sort of gain more traction at current levels, whether it's transformational deals, cost cutting or new opportunities?

Sandeep Mahindroo

Yes, so on the overall budget side, we are clearly seeing, once again, offshoring, which is playing out much better compared to what's happening on the overall budget side. Budgets are, as I mentioned earlier, flat to down. But offshoring-related budgets are expected to fare better. We saw it pretty much every year in the last decade or so. So even this year and -- rather in calendar 2012, which maps through our fiscal 2013, clients had flat to down IT budgets. But if you look at the numbers given out by NASSCOM recently, they talked about the industry growing at about double digit in terms of annual growth rate. So clearly, offshoring has fared much better within the overall IT budgets and we expect the same trajectory to maintain -- to be maintained over the next year or so. As far as the client focus is concerned, again, to some extent, we'll get better visibility once the allocation process comes to an end. What we do expect to see, once again, client focus being primarily on cost takeout initiatives, which means what we call business IT services there we help outline on the cost side of their operations by providing services like infrastructure, BPO application-related services. They are likely to see better traction compared to what we are seeing -- compared to what we expect to see on the consulting and related services side. Within business IT services, I think it's important to mention that what we are seeing on infrastructure and, probably to a slightly lesser extent, BPO, is very different from what we were seeing in these services about a couple of years back. In fact, specifically in the last sale side, competence of infrastructural deals has grown quite significantly over the last couple of years. And even the BPO part of our business is growing at significantly higher rates compared to what we're seeing in the IT services portfolio. So we expect client focus to be still overwhelmingly on cost takeout, patronizing of their cost structure, getting rid of redundancies, et cetera. And that will mean that consulting-led services will still continue to see some pressure. Within business IT services, we expect more traction in infrastructure and followed by BPO.

Alban Gashi - Crédit Suisse AG, Research Division

Okay. I guess it's great. And then, I guess, as you look into next quarter, you guys have looked -- are looking for around 4% growth, 3% excluding acquisitions. Sort of how much visibility do you have in that? And then just a quick add on to your comment about NASSCOM, I see that a much higher growth rate of it, you guys have been putting up, there's obviously a different focus area from the broader NASSCOM to what you guys strictly focus on, have dominance in. So could you break that out for us a little bit more?

Sandeep Mahindroo

Yes, so, normally, visibility coming into the quarter is fairly high. We have about 95% visibility of whatever revenues we project, either externally or internally, for that quarter. But, as I mentioned, that one of the challenges that, we, as a company, have seen -- one of the external challenges that, we, as a company, have seen over the last few quarters is being able to correctly predict the conversion of pipeline to signed opportunities and then being able to, again, correctly predict when those signed opportunities will ramp up, at what pace they will ramp up, et cetera. So those external challenges in terms of volatility caused by an uncertain demand environment still hold good. Even though on the visibility side, we don't really have any significant expenses compared to what we normally had coming into the quarter. As far as NASSCOM is concerned, I think they've guided for a growth rate of 12% to 14% for the offshore industry for the upcoming year, which is an acceleration from about 10-odd percent that they expect the industry to do at the end of this fiscal year. Now aspirationally, we have always benchmarked or at least we have aspired to have a growth rate which is benchmarked to NASSCOM's growth rate. So if 12% to 14% is the number for next year, aspirationally, that's the number that, we, as a company, will try and get to, along with a margin profile which is one of the best in the industry. That's the aspiration. How much we are able to actually deliver on that will depend upon, as I mentioned, what happens to the allocation process, how prepared we are, as a company, to be able to take advantage of various opportunities that we see in the market. Again, I think there are very important differences in the portfolio that one needs to keep in mind. So for example, we get 33% of our revenues from consulting and related services, which is heavily discretionary, and because client spending in that area has been significantly impacted over the last 4 to 5 quarters, it has cost us a few more extra points on the growth side compared to our peers. So that one's 33% of our overall portfolio compared to about 15% to 17%, which is probably the number as far as the NASSCOM's representation is concerned. Secondly, we get about 8% of our revenues from BPO, which is growing considerably faster than IT services for us. But NASSCOM has a significantly higher proportion of revenues from BPO, I think that's closer to 20%. So even though there are important differences in the portfolio, it actually have been one of the reasons why our growth rate has been lower compared to industry growth rate this year. There is no change in our aspiration of at least meeting, if not beating, NASSCOM's growth rate. Now whether we are able to do it or not, as I said, depends upon what we see at the end of the closure of the allocation cycles, but the aspiration continues to be intact.

Alban Gashi - Crédit Suisse AG, Research Division

I know that you just said that maintaining your margins even with the top line growing as fast as it is, sort of what areas are you investing in, just sort of track some of this higher growth areas?

Sandeep Mahindroo

So what we focus on, from a margin perspective, is to have a margin profile which is amongst the best, if not the very best in the industry. Normally, the way we approach it is that for the concerned fiscal year, we give a specific quantitative margin guidance and beyond that fiscal year, we reiterate our desire to have one of the best margin profiles in the industry. It is not really possible to have a long-term margin profile in absolute quantitative terms beyond the present year, because margin is subject to various external factors like currency, level of pricing in the industry, what happens to growth rate. And these external factors, it's difficult for us to make a prediction beyond the next couple of quarters. So long term, we focus on margin on a relative basis. We want to have one of the best margins in industry. And again, that aspiration still holds good. For the current fiscal year, we give a specific margin guidance, which is what we have done in the past as well. Now the areas that we're investing in, there's actually many of them, one is the product platform and solutions is still about 6% of our revenue and we have said in the past that we want it to be about 1/3 of our portfolio eventually. So there's significant R&D investments, platform-related investments, that we are making in that area. That is one of the reasons why our margin profile has dropped this year, because even in a slow growth environment, we have continued to invest aggressively within the business. So that's one area of investment. Secondly, Continental Europe is an area that we've invested in the past and we still continue to make investments. So it's fair to say that, to some extent, we are seeing more opportunities in Continental Europe compared to a few quarters back because that geography seems a lot more ripe and a lot more amenable to do offshore and outsourcing compared to what we have seen earlier. But still, we lack a significant footprint in multiple countries in the continent. So in the continent, we have a fairly decent-sized presence in Switzerland, followed by Germany and then, to a lesser extent, in Benelux. But we still don't have presence in many of the other countries. So that continues to be an investment focus for us, along with growing our business and investing in other emerging regions like India, China, Latin America. Similarly, from a vertical perspective, we continue to invest in life sciences and healthcare, Infosys public services, which is our focus of getting into government business in the U.S., primarily targeting healthcare-related spending. So that's an investment area once again.

Alban Gashi - Crédit Suisse AG, Research Division

As we think of these areas of investments, do you primarily focus on organic or via M&A?

Sandeep Mahindroo

So it will be both. The idea is that, over a period of time, we need to increase our addressable market, we need to increase the scale in some of these services where we are, some of these parts of the portfolio like healthcare or product platform and solutions, where we still are not very big. So the idea is to really increase the scale of -- target a larger addressable opportunity for us. We are willing to do it both organically as well as inorganically. So the way we approach it is we have to focus on making these business investments organically. And from time to time, as we come across certain targets which are a good complementary fit to our -- rest of the portfolio and which enable us to get the right scale and we get the right reference points, the right relationships. So we are absolutely open to that.

Alban Gashi - Crédit Suisse AG, Research Division

I guess specifically within your BPO, I think you said still small portion of overall revenues but it's been a very high growth area for you guys. So what excites you about that area?

Sandeep Mahindroo

So in BPO, I would say -- the 2 that I've mentioned to that one is the revenue growth, the other is margin, which I think is equally worth commenting on, at least from our perspective. So from a revenue standpoint, we are seeing, even in this year, the BPO business growing in high teens for us. That is considerably faster than the growth that we are seeing in the core IT services portfolio. Within BPO, the area where we are seeing good growth this year is what we call platform BPO, where we've worked with outlines and provide scalable services, leveraging some platform that fair better, which might be the horizontal or vertical platform. So it might be talent. It might be procured. So these are some of the offerings that we have rolled out on the platform BPO side of the business. F&A continues to be fairly strong for us, I think for the last many years, we have been positioned as one of the leaders in the Magic Quadrant on the F&A side of the BPO business. Now on the margin profile, we have been having a margin, both operating and net margin, which is closer to 20%, in fact sometimes not 20% on the BPO side. And that's because of 2 important aspects. One is the focus on transformation BPO, as we call it, within the company, compared to the transactional BPO, which continues to be the focus for the industry. So the idea is to really help our clients reengineer their value chain by providing some transformational and scalable services, leveraging Infosys platform or Infosys products, et cetera, which is one reason why our margin profile is better, because in that area -- that area tends to be a lot less price sensitive as well as requires lesser incremental headcount additions. So that's one thing why our margin profile in BPO is significantly better compared to the rest of the industry. Secondly, within our BPO business, we get almost 1/3 of our revenues focusing on our clients’ revenues or the direct side of their operation. BPO, historically, has been considered as synonymous with the SG&A side of our client operations, whether it is providing for F&A-related services, talent outsourcing or the management x [ph] factor. But we get about 1/3 of our BPO revenues providing services, which directly impact our clients' revenues or the direct cost side of their operations, which once again tends to be a lot less price sensitive. So the operating margin and the net margin profile of BPO business has actually been significantly better in the last couple of years compared to what it stood in the earlier period. And that's really the -- I mean, 20% is really the level that we hope to be able to maintain going forward.

Alban Gashi - Crédit Suisse AG, Research Division

Let's take a moment here to see if there's any questions from the audience. Okay, just I guess, finally, for me, in terms of vendor consolidation has been talked about a lot in the industry. As people like to channel more volume, specific vendor, to get pricing concessions and everything. You spoke about stability in the pricing, overall. Sort of, how do you see better consolidation sort of impacting you guys in the industry overall?

Sandeep Mahindroo

So we're not really seeing when the consolidation is being as visible anymore as it was during the financial crisis and it was very visible in the financial services vertical. We still see some select consensus of that in that particular vertical. We actually see quite a bit of certain verticals like retail and CPG, which actually is good news for us because we are seen as one of the leaders in the retail vertical globally. And we have benefited in various accounts as a result of vendor consolidation. But we are not really seeing it at the level that we saw during the financial crisis. I think many of the organizations or most of large corporates have already pruned down the number of strategic vendors to, let's say, double digits to maybe a more manageable number. That's happened for the most part at an enterprise level. In certain select programs or specific lines of businesses, where they still are dealing with a large number vendors, there is focus on reducing it -- reducing the number of vendors at the program or at the portfolio level. But then, overall, we're not seeing it, as I said, as much as what we saw a few years back.

Alban Gashi - Crédit Suisse AG, Research Division

And I guess, along those lines, has there been any irrational players in the market sort of disrupting or trying to take advantage?

Sandeep Mahindroo

So we haven't really seen anything which is very different in the market in the last few months compared to what we have seen in the past. But different companies have different strategies, they try to execute us for. There are strategies some are maybe less focused on price points, more focused on growth. So different companies have different strategies and we are seeing everyone stay true to their strategies that they followed in the past.

Alban Gashi - Crédit Suisse AG, Research Division

All right. It's great. There are no further questions. I think there may be a breakout session as well.

Sandeep Mahindroo

There's no breakout that we are doing. But I'm available in the case anyone wants to have a follow-up. Thank you. Good talking to you. Have a good day.

Alban Gashi - Crédit Suisse AG, Research Division

Thank you, Sandeep.

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