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Infosys: Stepping on gas

Jul 10, 2002

The markets probably got what they were waiting for. Infosys’s first quarter numbers seem to indicate prospects for the software industry improving, at least for the big names. The major pointers to the improvement in the business environment are strong volume growth, increased utilisation and steep increase in employee intake. Infy’s once gain surprised the markets, albeit pleasantly, by posting a steep growth of 12% in revenues sequentially. The markets were expecting YoY growth to be about 13%. The revenue growth is totally based on volumes growth, realisations (billing rates) having declined marginally. Thus, the business flow to Infosys has increased significantly.

The steep rise in business can be explained by the fact that the Indian software industry has well established its credentials in the western markets. Also, the value proposition of offshore work has been well established as many corporates have achieved significant cost reduction by opting for offshore services. Consequently, more and more mission critical work is being outsourced to Indian software companies. However, since the work being outsourced is increasingly getting mission critical in nature, clients prefer working with bigger names like Infosys. This view is vindicated by the fact that Infosys saw a record number of projects being started during 1QFY03. Since software projects generally begin onsite, the contribution to revenues from onsite projects increased during the quarter.

Also, the number of employees on the bench (without any projects to work on) declined steeply. The utilisation rates jumped from 72% in 4QFY03 to 79% 1QFY03. Such a significant swing in utilisation is unusual. But perhaps the most convincing information pointing to a recovery is the fact that the company has added 556 employees during the quarter as compared to 184 in second half of FY02.

Service offerings
The growth in revenues from various services offerings also brings reasons to cheer. Development has shown a significant sequential growth of 19% in 1QFY03. In the whole year of FY02, revenue from development had grown by only 10%. This service offering in fact, exhibited the slowest growth in FY02. The numbers seem to reveal that clients are going in for new development work, something that was frozen in wake of a tough business environment. If the trend continues, Infosys will certainly have its hands full and see significant volume growth.

Service offerings (Rs m) 4QFY02 1QFY03 Change
Development 2,149 31.6% 2,546 33.3% 18.5%
Maintenance 2,027 29.8% 2,324 30.4% 14.7%
Re-engineering 531 7.8% 421 5.5% -20.7%
Package implementation 748 11.0% 619 8.1% -17.2%
Consulting 258 3.8% 321 4.2% 24.3%
Testing 197 2.9% 260 3.4% 31.8%
Engineering services 190 2.8% 229 3.0% 20.5%
Other services 381 5.6% 635 8.3% 66.6%
Total services 6,482 95.3% 7,356 96.2% 13.5%
Products 320 4.7% 291 3.8% -9.1%
Total revenues 6,801 100.0% 7,646 100.0% 12.4%
Internet / E-commerce related 1,523 22.4% 2,042 26.7% 34.0%

Another bright spot was the strong growth seen in revenues from consulting services. The company’s recent tie up with Concours Group is likely to strengthen growth in this area going forward. Package implementation and re-engineering services saw revenues decline. Package implementation revenues had grown by 86% in FY02. Re-engineering services seem to be an area of concern. The company’s revenues from the area have steeply fallen for two consecutive quarters. As a result, the contribution to total revenues has halved from 10.6% in 3QFY02 to 5.5% in 4QFY03.

Industry verticals (Rs m) 4QFY02 1QFY03 Change
Manufacturing 1,170 17.2% 1,254 16.4% 7.2%
Insurance, banking & financial services 2,537 37.3% 2,821 36.9% 11.2%
Insurance 1,054 15.5% 1,200 15.7% 13.9%
Banking & financial services 1,483 21.8% 1,621 21.2% 9.3%
Telecom 1,047 15.4% 1,162 15.2% 11.0%
Retail 877 12.9% 887 11.6% 1.1%
Energy & Utilities 102 1.5% 184 2.4% 79.9%
Transportation & logistics 231 3.4% 512 6.7% 121.5%
Others 837 12.3% 826 10.8% -1.3%
Total 6,801 100.0% 7,646 100.0% 12.4%

As far as the geographical break up of the revenues is concerned, Infosys saw revenues mix change in favour of the US once gain. This is due to the fact that the US outpaced the second most dominant geography Europe with a sequential growth of 15%. Europe grew by 10%. Revenues from India grew by a steep 26%, while those from rest of the world declined. Thus, the company continues to be concentrated on the US geography. This is a cause for concern.

Margins?
However, the steep fall in operating margins is a bigger cause for concern. The company saw gross margins decline due to the onsite offshore ratio changing in favour of onsite revenues. The company claims this is due to a record number of projects starting. And since projects generally begin onsite as the project team needs to interact with the client to understand requirements, especially for a development kind of a project. Then the project is gradually shifted offshore. Thus, company expects gross margins to move north going forward as the onsite offshore ratio changes tack in favour of offshore revenues. The decline in gross margins due to increased onsite revenues have been diluted by the sharp upswing in utilisation rates.

Detailed Infy numbers

The company also saw a steep rise in staff and marketing costs. The rise marketing costs are towards building the Infosys brand. The benefits of these expenses are likely to accrue over a period of time.

To sum up, the company’s numbers seems to indicating an improvement in the business environment. At the current price the stock is trading at a 23x its FY03 estimated earnings. Thus, the markets are factoring a 23% growth going forward. Its performance this quarter could indicate that the company might be well on its way to beat its own earnings guidance and perhaps the market’s expectations too. Last time while reporting Infosys’ 4QFY02 results we had titled our story ‘Better times ahead’. We need to make a correction, ‘Much better times ahead’.

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