Rising Rupee, Employment Delays Won't Hinder Infosys

While attending Infosys's (INFY) earnings call, I got a feeling that the management was playing defense and hence was cautious about future guidance. Even though the company achieved another milestone of hitting $1bn in revenue per quarter, the mood amongst the analysts was not enthusiastic.

NOTE : As the Income statement and balance sheets are not completely visible in this blog, to get a better view them, click on this link.

Quarter Highlights:

1. The new Mysore facility was not completed in time. This has prevented 2,500 employees from joining the company in time. This is the reason the employee strength was 80,500. The employee strength on Mar-31/2007 was 72,200 and the company was expecting around 11,000 net additions by now. The company still expects the net addition of around 30,000 employees by Mar-31/2008.

2. The attrition rate has climbed to around 12% and the company expects it to be around 12 to 15% in the future. One of the reasons cited for high attrition rate this quarter is the employees with 2 to 3 years' experience are leaving the company and joining the MBA programs.

3. The tax rate for the quarter was around 15% and that for the corresponding quarter in 2006 and 2005 were 11.5% and 10.32%. One of the reasons cited for higher tax rate was reduction in visa processing costs.

Analysis of its quarterly income statement: The USD was Rs41.00 in the middle of August and declined to around Rs39.00 by the end of quarter. It was as high as Rs46.5 in August-2006 and declined to around Rs46.00 by the end of Sep-2006. This represents an average decline of about 10%. The EPS per ADS was $0.36 for Q2-2006 and has grown to $0.48 for Q2-2007. This represents a 33% increase. The table that gives the comparison of the income statements for the last three years' Q2 results.

		9/30/2007		CHANGE		9/30/2006		CHANGE		9/30/2005
	Revenues	$1,022.00		37.00%		$746.00		42.37%		$524.00
	Cost of revenues	$591.00		39.72%		$423.00		42.42%		$297.00
	Gross profit	$431.00		33.44%		$323.00		42.29%		$227.00
	Operating expenses
	Selling and marketing	$71.00		47.92%		$48.00		37.14%		$35.00
	General and administrative	$77.00		22.22%		$63.00		36.96%		$46.00
	Amortization of intangible assets	$2.00		100.00%		$1.00				$0.00
	Total operating expenses	$150.00		33.93%		$112.00		38.27%		$81.00
	Operating income	$281.00		33.18%		$211.00		44.52%		$146.00
	Other income	$38.00		171.43%		$14.00		55.56%		$9.00
	Income before income taxes	$319.00		41.78%		$225.00		45.16%		$155.00
	Provision for income taxes	$48.00		84.62%		$26.00		62.50%		$16.00
	Net income	$271.00		36.18%		$199.00		44.20%		$138.00

The growth in revenues has certainly slowed down and the company's guidance for the fiscal 2008 was 35% growth. With the appreciating rupee, the costs have grown more than the revenues, which further decreased the growth in gross profit to 33.42% compared with 42.29% last year.

I was impressed with the company's handling of its general and administrative expenses. It has grown by 22%. This has evened the spike in sales and marketing expenses and has kept the overall operating expenses in control.

As mentioned in one of my previous blogs. The other income is growing at a very rapid space; it was $38mn, which accounted for around 10% of the overall income. Other income seems to be gaining a lot of momentum and is becoming a crucial factor for the bottom line. It was just 6.2% of the operating income in Sep-30/06 and 6.1% in Sep-30/05.

Analysis of its balance sheet:

			9/30/2007		CHANGE		9/30/2006		CHANGE		9/30/2005
	ASSETS
	Current Assets
	Cash and cash equivalents		$1,837.00		460.06%		$328.00		-1.80%		$334.00
	Investments in liquid mutual funds		$4.00		-99.35%		$615.00		15.82%		$531.00
	Trade accounts receivables , net of allowance		$646.00		42.29%		$454.00		49.34%		$304.00
	Unbilled revenue		$107.00		44.59%		$74.00		80.49%		$41.00
	Prepaid expenses and current assets		$81.00		65.31%		$49.00		28.95%		$38.00
	Deferred tax assets		$2.00		0.00%		$2.00		0.00%		$2.00
	Total current assets		$2,677.00		75.89%		$1,522.00		21.76%		$1,250.00
	Property plant and equipment		$914.00		69.26%		$540.00		24.14%		$435.00
	Goodwill		$139.00		52.75%		$91.00				$8.00
	Intangible assets, net		$18.00		0.00%		$18.00				$0.00
	Deferred tax assets		$29.00		123.08%		$13.00				$9.00
	Advance income taxes		$77.00		1440.00%		$5.00				$0.00
	Other assets		$43.00		38.71%		$31.00				$32.00
	TOTAL ASSETS		$3,897.00		75.54%		$2,220.00		28.03%		$1,734.00
	LIABILITIES
	Accounts payable		$9.00		125.00%		$4.00		300.00%		$1.00
	Income taxes payable		$64.00		3100.00%		$2.00		-88.89%		$18.00
	Client deposits		$1.00		0.00%		$1.00		-50.00%		$2.00
	Unearned revenue		$91.00		35.82%		$67.00		67.50%		$40.00
	Other current liabilities		$342.00		86.89%		$183.00		42.97%		$128.00
	Total current liabilities		$507.00		96.51%		$258.00		36.51%		$189.00
	Other non current liabilities		$0.00				$5.00		0.00%		$5.00
	Minority interest		$0.00				$2.00				$12.00
	STOCKHOLDER'S EQUITY
	Common stock par value		$64.00				$62.00		100.00%		$31.00
	Additional paid in capital		$694.00		45.49%		$477.00		42.39%		$335.00
	Accumulated other comprehensive income		$334.00				-$49.00		-296.00%		$25.00
	Retained earnings		$2,298.00		56.86%		$1,465.00		28.85%		$1,137.00
	Total stockholder's equity		$3,390.00		73.40%		$1,955.00		27.95%		$1,528.00

The book value seems to be growing at a very healthy pace of 73.4% compared to 27.95%. Another nice point to note is that the growth in accounts receivable has slowed down. It was 49% last year and is around 42% this year.

Major increase in comprehensive income : This has been one of the biggest changes in the company's stockholder equity's breakup. But very little is ever said about it.In fact there was not a single question in today's call on this topic.

Accumulated other comprehensive income was as follows :

Sep-30/2006 : ($49mn)
Mar-31/2007 : $90mn - six month growth was $139mn
Sep-30/2007 : $334mn - six month growth was $244mn

So what constitutes other comprehensive income :

1. Gain thru foreign exchange : The functional currency of Infosys and Infosys BPO is the Indian rupee. The functional currency for Infosys Australia, Infosys China and Infosys Consulting is the respective local currency. The financial statements included in this Annual Report are reported in US dollars. The translation of rupees to dollars is performed for the balance sheet accounts using the exchange rate in effect at the balance sheet date, and for revenue and expense accounts using a monthly average exchange rate for the respective periods. The gains or losses resulting from such translation are reported as other comprehensive income/loss.

2. Gratuity: INFY adopted Statement of Financial Accounting Standards ("SFAS") No. 158, Employers' Accounting for Defined Benefit Pension and Other Postretirement Plans - An Amendment of FASB Statements No. 87, 88, 106, and 132R effective March 31, 2007. Pursuant to the adoption, funded status of the defined benefit plan is recognized in the statement of financial position as an asset if the plan is over-funded or as a liability if the plan is under-funded. Changes in the funded status of a plan are required to be recognized in the year in which the changes occur, and reported in comprehensive income as a separate component of stockholders' equity. Further, certain gains and losses that were not previously recognized in the financial statements are required to be reported in comprehensive income, and certain disclosure requirements were changed. Incremental impact of adopting SFAS No. 158 on individual line items have been disclosed in the financial statements.

Conclusion: Even though the company is facing an uphill task against the strengthening rupee, its other comprehensive income is also growing steadily and the gain in foreign exchange is one of the factors contributing the gain in other comprehensive income. When these two are balancing each other and the company is able to grow its employees as planned, it certainly will attract investors' interest.

Comments

[ThomasVictor]

However good Infosys is, I agree with a recent MarketWatch article that people are expecting the Rupee to rise further against the sliding US Dollar. So the entire software offshoring group of stocks will stay depressed.

So I was thinking I should invest in non-software ADRs,maybe HDFC and ICICI banks! Good Lord! HDB is down more than 11% today (Oct 16) IBN down over 7% plus all software ADRs are also down!!

Any clues as to what is going on?