Infosys has over-performed (once again!) its guidance and has grown topline by 6% and bottomline by 7% on a sequential basis. The company has also revised its FY04 EPS guidance from a 12% growth to a higher 16%. While margins continue to remain under pressure, some stability seems to have set in on the pricing front.
On the margins front, the company is expecting stability due to its cost-rationalization efforts. Also as the contribution of revenues from the relatively high margin services (IT consulting, package implementation, etc.) increases, pressure on billing rates is likely to reduce and consequently further fall in operating margins could be arrested.
While operating margins may still take a while to stabilize, Infosys continues to be optimistic on the business volume growth front. The company is aggressively recruiting manpower to cater to the anticipated demand for its services. In the June quarter alone the company added nearly 1,700 employees on to its rolls. This optimism is not without reason. Infosys is expecting increased interest from clients in offshoring their requirements to India. Also, as large sized orders flow in, the company will be one of the biggest beneficiaries as it is ramping up its operations to meet anticipated demand.
The company in order to take advantage of this trend has scaled up investments towards its selling and marketing infrastructure. Selling and marketing expenses have risen by 16% sequentially for 1QFY04. Also, total expenses have increased by 8%, higher than the revenue growth of 6%. On the software development expenses front, the growth of 8% is mainly due to increase in salaries across middle and top-management levels. This salary hike has been done for retaining talent in times when global majors are attracting quality manpower from Indian software companies. This rise in expenses is putting pressure on the margins but we reiterate that it is just a short-term concern. As the company is able to get large sized contracts and move up the value chain, thus making optimum utilization of its investments, pressure on margins will reduce.
Expending to grow…
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In 1QFY04, Infosys added 22 (28 in 4QFY04) clients to its list. More important is the fact that the company managed to keep the levels of repeat business at a high (98%). The management is of the opinion that large-size orders are in the pipeline and these are likely to flow in once the uncertainty regarding the global economy clears. Also, as conservatism on the part of clients in outsourcing their business operations to India reduces, companies like Infosys are likely to be the biggest gainers. The increasing competition from MNCs who have been implementing the Indian offshoring model by setting up bases in the country will also increase the veracity of the Indian model and make it more dynamic.
On the service offerings front, application development witnessed a decline during the quarter. This is likely to be a concerning factor considering that development is a bread-and-butter work for the company and any decline in this segment might hamper growth prospects. However, revenues from all other service offerings continue their growth. Maintenance has shown a significant sequential growth of 9%. In the previous quarter, the sequential growth for this service offering was a mere 0.3%. This signifies the fact that clients are, on account of cost rationalization measures, stressing on maintaining their existing systems and are not spending much on new applications. Notably, Infosys’ revenues from package implementation grew by just around 2% during 1QFY04 (36% in 4QFY03).
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The fact that Infosys is moving up the value chain is exhibited by the strong growth (20% sequentially) witnessed in the company’s revenues from consulting segment. Consulting service’s contribution to Infosys’ revenues has also seen a growth, from 3.9% in 4QFY03 to 4.4% in 4QFY04. This augurs well for the company in its move towards treading in the domain of global software services majors. However, high-end services like consulting and package implementation still contribute a miniscule amount to Infosys’ revenues when compared to the contribution they make to revenues of global majors like IBM or EDS. Infosys has realized this fact and is consistently increasing its revenues from these segments.
Revenues for Infosys’ banking product, Finacle has dropped significantly by 20% sequentially. During the quarter, one major win for Finacle was its selection by the National Commercial Bank of Saudi Arabia for its delivery channels initiative. Also, the company launched Fulcrum - the Finacle User Forum comprising all customers of the Finacle suite of banking solutions in the South Asian region. Finacle is a preferred banking solution for banks in India. However, it has yet to make a mark in the global banking space.
Infosys has recognition for underpromising and overperforming. And they have done it again for the quarter gone by. Also, the company has revised up its earnings guidance for FY04. It now stands at Rs 168, up from Rs 161-163 that they had announced in their FY03 earnings announcements. More important is the fact that this upward guidance comes at a time when the uncertainty regarding the global economic slowdown still prevails and clients are keeping their purse strings tight. Yet Infosys is anticipating growth going forward and its ramping up on the people and infrastructure fronts indicates this.
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