Infosys Ltd ADR Earnings Call Nuggets: Performance Outlook and High-Level Strategy

Infosys Ltd ADR (NASDAQ:INFY) recently reported its first quarter earnings and discussed the following topics in its earnings conference call.

Perf0rmance Outlook

Joseph Foresi – Janney Montgomery Scott: I guess my first question here is, we’ve seen some inconsistent execution over the last, I would say two to three quarters, any sense on whether that inconsistency is starting to level out and if you could provide any color on why you feel that way, that would be helpful.

S. D. Shibulal – Co-Founder, CEO and MD: So, it is true that our performance has been volatile over the last two, three quarters. We do have a higher level of level of dependency on discretional spend, but as you rightly said, it has been volatile over the last two, three quarters. In fact, I would like to say this again. We will not consider one quarter as a secular trend. We are operating with a certain number of challenges, which I outlined and these challenges create volatility in our performance. This quarter we have done reasonably well. We have not changed our guidance, we are cautiously optimistic about the coming quarters. We would like to see a couple more quarters before we consider this as a secular trend.

Joseph Foresi – Janney Montgomery Scott: Then, on the margin front, could you just walk us through the puts and takes on what you could be impacting margins over the next two or three quarters? I know you talked about wage increases, I know we’ve got the rupee moving a certain way. I think you’ve talked about investments in the past, so I’m just trying to get a feel for what the margin outlook is for the business.

Rajiv Bansal – CFO: If you look at our margins this quarter, we inevitably spoke about certain headwinds in our margin for the quarter, and to some extent that has been negated by the depreciating rupee. So, rupee has helped us to the extent of about 1.2% this quarter. Rupee depreciated on an average by about 4.9%. We had the wage impact — a full quarter wage impact which is at the height given (indiscernible) of last financial year. We had cost currency impact, because at last gain that we got when the rupee got negative by the cost currency movement. As I was saying our growth in constant currency basis this quarter is 3.4% as it is reported number of 2.7%. We lost roughly about $13.7 million of revenue by little bit of cost currency movement which also impacted the margins. We had given promotions in January – and the linked hike for that was given effective April which also impacted our margins in the first quarter. We also had realized rate drop of 0.7% during the quarter which impacted margins by roughly about 0.5%. So there have been many factors which have contributed the margin increase or decrease but I think we have done reasonably well in terms of keeping our margins at 23.5% for the quarter in spite of the (indiscernible) we spoke about in April. As we move into the next quarter, we have as I mentioned that we have given wage hike effective July 1 to majority of our people and that is going to have an impact of roughly about 300 basis points on the margins. But it could get negated by a depreciating rupee. My average rupee rate for the first quarter has been 56, and the closing rate as of 30 June has been 59.39 which is a 5% depreciation of rupee which will help me on my margin front by talking 1.2%, 1.3% and also when I see growth it would also be an uptick in utilization and some of this margin impact that we are talking about, headwinds we are talking about could get negated by the utilization update. So I think though we have some more room on the margin front. We still have some upside which we can – and some cost that we can look at in terms of increasing our margins. But I think the wage hike would impact the margins in the coming quarter. And also if we look at our utilization it stood at 74.3% we would like our utilization to be about 80%, 81%. So I have clearly about 5.72% or 6.7% elbow room on the utilization. So, a lot of margin would depend on how much is the growth for the year. And if we see a healthy growth for the year, I think a lot of the impact that we are talking about right now, headwinds could be managed in terms of the utilization going up, and the rupee depreciation that we’re talking about…

Joseph Foresi – Janney Montgomery Scott: Then just one last quick one for me on the recent reform stuff. Can you share with us any contingency plans that you may have in place or – I think you mentioned in your commentary that maybe clients are starting to put in place?

S. D. Shibulal – Co-Founder, CEO and MD: So, on the immigration front, as you know the details, the Senate has passed the bill. In the House the bill is yet to be presented. And finally, they will have to (give their) consent. There is quite a lot of uncertainty around the shape or form in which the bill will finally come through. All we can do at this point is plan for it, plan for various contingencies. The first and foremost thing from our side is to make sure that our service do not get interrupted to our clients. That definitely requires close cooperation with our clients. We are talking to our clients, especially the major clients. We are discussing with them the various aspects of this bill. We are not seeing any impact on decision-making because of the bill at this point in time. Our relationships with our clients are very long-term. They understand that this is not a Infosys issue; this is an industry issue, and which needs to be tackled. Now, the contingency plans can include changing the onsite-offshore ratio, going into a three-tier approach of delivery. That means very few people on the client site. You can have development centers in the same time zone or in the same region along with offshore. We’re recruiting more people onsite, which are local nationals, applying for green card for certain set of people. So there are multiple litigations ideas and plans which one can formulate, and some of them we are discussing with our clients, we are in the process of figuring out how to execute, but the most important thing is to make sure that this point here includes contact with our clients continue with the discussions on various aspirations of the bill, various aspects of the bill and watch the progress of the bill very closely.

 

High-Level Strategy

Rod Bourgeois – Sanford C. Bernstein & Co.: I want to ask a question about high level strategy especially with Chairman Murthy returning to the Company. Can you just articulate the latest strategic plan to drive improved earnings and revenue growth at Infosys, and if you could also, as you speak to the high level strategy, if you could articulate what the investment and longer term margin implications of that strategy would be, that would be very helpful? Thanks.

S. D. Shibulal – Co-Founder, CEO and MD: As you know, Mr. Murthy’s focus is always to create superior financial performance. We had done that in the past and current focus will also be the same, which has two parts to it, one is to create high quality growth, second is to have leading margins. So, let me address the growth piece first. We have three segments of growth, three offerings in the market, and the number one things is to provide higher and higher customer value through these offerings. At the same time, growth is important in these three offerings in various dimensions. Let me start with the smallest so that I can answer the rest. If I look at products and platform space, even if it grows at a very large percentage, it is on a smaller base. That alone – that is not enough for us to actually meet our aspirations. Consulting and Systems Integration has grown above our average – our Company average for the last, I should say, few quarters. Business and IT operations has grown below our Company average. That is the largest segment which we have. That is 62% of our revenue, and if you don’t create growth there, we will not be able to meet our aspiration. Over the last two, three quarters you have seen the deal wins pick up in that space; now, this quarter again. So, the growth in bid space comes to large outsourcing deals. We have made investment and we will continue to make investment in winning large outsourcing deals. This quarter we had seven wins, totaling to $600 million of revenue in large outsourcing space. Now the challenge in this space is; number one, this is a space in which differentiation is difficult. So we need to invest in building solutions. We need to invest in automation in productivity improvements, creating efficiencies, and use of tools and technologies to make sure that we differentiate. Number two; it is a price-sensitive space. If you see some of the industry report, a fair part of this space is rebid. That means rebids are deals where clients are rebidding at the end of the contract and they are even more price sensitive. So, we have won $600 million of deals, 7 deals this quarter. At the same time, and in the beginning of the deal, these deals are margins dilutive. Our objective is to make sure that they’re margin neutral through the life of the deal and that is where we need to focus, we need to put an energy and that is achieved through some of the levers I talked about. So, that is a focus on growth. On the margins end, there are multiple levers, which we need to modify. Number one, on the large outsourcing deals we need to drive automation, productivity improvements and things like that to make sure that on the lifetime margin is margin neutral. Second is, to look at other cost levers like onsite top real issue, reducing non-productive spend, changing various other levers wherein diving various other levers to make sure that we take out cost in the system and drive towards better financial performance in the margin dimension. So, these are the areas in which there are discussions and action plans. It is definitely too early, because Mr. Murthy has been here only for the last less than two months now, and these are the areas where discussions and action plans have been formed. But as I said in the beginning, as in the past, his priority is always superior financial performance, which is high-quality growth and leading margins…

Rod Bourgeois – Sanford C. Bernstein & Co.: Just if I can clarify the financial implications, what I heard there is that you are adding focus to winning large outsourcing deals, and if I heard you correctly, that is probably going to cause margin pressure in the short and medium term, but in the long run, if you can work on things like automation and other efficiencies you can make those margin neutral, is that an accurate summary of what I heard on the financial implications?

S. D. Shibulal – Co-Founder, CEO and MD: Yes.

Rod Bourgeois – Sanford C. Bernstein & Co.: Then, can you just define the timeframe there? Is short and medium term pressure on margins, is that a one to two year type of a timeframe before you’d have time to drive the efficiencies to make that margin neutral or is it a shorter period or a longer period in kind of one or two years?

S. D. Shibulal – Co-Founder, CEO and MD: So, there is one other dimension which I want to add, when I talked about it, not only about the large deals where we will create automation and other productivity improvements to create margin neutrality over the life of the program, there are other cost optimization measures which are being put in place. I mentioned some of them, that is removing non-productive spend, whether it’s on-site or offshore, driving a performance culture; number two. Number three, there are other levers, like for example utilization is a lever. It has gone up from 71% to 73%. So, if I can drive the utilization up through better planning, better recruitment and better deployment that’s a margin lever. You have on-site offshore ratio as a lever. It has actually gone up and I understand that it has gone up because of some of the project starts and things like that, but if we can move it back by I don’t know – maybe five points, seven points over a period of, let’s say next five, six quarters then that is a margin lever which we can look at. So, there are multiple cost optimization opportunities for us and Mr. Murthy as he said is very focused on performance, on growth and on margins…

Rod Bourgeois – Sanford C. Bernstein & Co.: Just one other quick clarification. I mean went through the puts and takes on margins in the upcoming quarters. Your current operating margin is at 23.5% are you roughly expecting your fiscal ’14 operating margin to be around 23.5%, given the move in the rupee that has been experienced over the last three months are you thinking margins will be relatively stable for the full year?

Rajiv Bansal – CFO: As I said we have not given a margin guidance or an EPS guidance for the year and the reason being lot of our margin would be driven by the growth that we see during the year. I had clearly laid out the headwinds and tailwinds that I see on the margin as we move into the next quarter and we had clearly articulated about the headwinds that we saw at the beginning of the financial year. So as I said in the first quarter we have been able to maintain our margins as same as what was in Q4 because of the rupee depreciation and also the utilization benefit which helped us, which give us a benefit on the margin. But that was negated by the wage hikes, promotions and productivity drop. The productivity drop that we saw, as we move in the next quarter we have headwinds in terms of the salary hikes that we are giving effective July 1. As Shibu was saying, in the large outsourcing deals, there is more competition, there is more pricing to deal. So there would be some pricing pressure unless we see a discretion spend come back. To that extent I think depreciating rupees had certain – negating some of the impact of the headwinds that we are seeing in the margin. And I am seeing clearly about if the rupee is inside 59.39 or up. I am clearly seeing about 1.2%, 1.3% uptick in the margins, which will help me in negating some of the margin negatives on because of the salary hike. So I think I would not like to say where our margin is going to end up in the next two-three quarters, because a lot of it would depend on what the growth is, how much is the utilization uptick that I can get, and that would help in negating some of the impact of the salary hikes. So we are all trying to increase our growth, trying to see how to get, simply the growth that we spoke about. And any growth would help us in increasing our utilization which would help us in maintaining our margins.

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