Apr 13, 2012 03:28 PM IST | Source: CNBC-TV18

Q4 Results 2012: Shibulal defends muted guidance in 'new normal' environment

Despite their muted guidance for the year ahead, Infosys management tells CNBC-TV18 that they still aim to grow above industry average.

Despite their muted guidance for the year ahead, Infosys management tells CNBC-TV18 that they still aim to grow above industry average.

March saw one of the biggest slip-downs and high volatility for India’s second largest IT services exporter, due to which CEO and MD Shibulal forecast FY13 growth at 8-10%, which is below NASSCOM’s 11-14% growth for the IT industry. “Our visibility for the entire year now is only 65%, and with lack of client confidence on global growth and no visibility on client spending, giving guidance itself was a bold statement,” he said.

For FY13, Infosys forecasts a fall in profit margins of 50-100 points. However, Shibulal says the drop in margins could be higher in Q1 due to higher visa costs.

Below is an edited transcript of his interview with Udayan Mukherjee and Mitali Mukherjee. Also watch the accompanying videos.

Q: You are guiding 8-10% growth; the NASSCOM guidance for the sector is 11-14%. I have never known a time when Infosys is saying it will grow at a significant lower pace compared to the industry. Why did you have to guide so moderately?

Shibulal: As you can see, we have been through a difficult quarter. We have seen unprecedented convergence of multiple events during the quarter. We saw contract delays, delays in some of the anticipated ramp-ups which we had planned and ramp downs in quite a few accounts, especially in financial services and in the US.

Most of it actually happened during the end of the quarter. When we ended the quarter, we had visibility for about 95% of our business and during the quarter we catch up. But when these kinds of events happen during the end of the quarter, especially in a converged fashion, it is a difficult quarter for us and you can see what happened in this quarter.

We are in a new normal, we are operating in a pretty volatile environment. It’s actually a very bold thing to do to stand at the beginning of the quarter and make guidance. In the beginning of the year, our visibility for the entire year is only 65% and beginning of the quarter it is 95%. So to actually give guidance in this new normal, where there is global volatility and lack of client confidence is bold.

While we are seeing that the budgets are closed and actually are marginally down, the visibility in the spending, the confidence of spending by clients is actually quite low. In financial services, what we are seeing is a zero base budget, which is month to month, so to actually give a guidance in such a complex environment itself is a pretty bold statement to make.

Q: Why did you have to give guidance? Did you think that 8-10%, which is lower than the sector guidance, would be better off than not giving guidance at all? That was an option, you said it’s too uncertain, I will not guide.

Shibulal: We have always said that our guidance is statement of facts, it reflects our reality, our client base, our opportunities that are in the pipeline. We always see that statement of facts, whether it is a difficult situation or a good situation, we have a statement of facts and we should make that statement.

So our guidance, even in this year, is a statement of facts as we see it on our reality at this point in time.

Q: This point that you are making about March seeing the biggest slip down is sitting at odds with what the other IT companies are saying which is that March is when the ramp up began. Can you explain what exactly the problem is with the nature of these ramp downs and whether it’s just an existing client problem or it’s also a new client problem?

Shibulal: As I said, we have seen ramp down during the quarter especially in the financial services segment in North America. We have also seen some leadership changes in couple of accounts. While we were entering the quarter, there was no sign of ramp downs. Suddenly we are seeing the confidence in the global economy come down, but at the end of the day it is our clients who determine our fate and our reality.

It’s a reflection of what we are doing in the market also. Our dependency on the discretionary spend is comparatively higher. For example, our consulting and system integration revenue is approximately 30% plus which means our dependency on the discretionary spends is higher. Our average life span of the discretionary spend is about three-four quarter and every quarter you have to review.

Q: On this ramp down issue, is it something that you see going into the sector because your Q1 guidance also is zero to one percent which is extremely poor? So is this a lingering problem for you going into the new year?

Shibulal: Our Q1 guidance is as we see it at this point in time because we have just come through a difficult quarter; we have just come through a quarter where multiple things happened during the end of the quarter. So we entered that phase almost a month back, so we have to look at the reality as it is today and our Q1 guidance reflects what we see today.

At the same time, I want to point out that there are many positives which we see in this environment. We have added 52 new clients, which is one of the highest client additions. Out of them, six are Fortune 500 in US and four are Fortune 500 Global. Our price increase is also something to think about, because in a difficult year our pricing has gone up by 4.7% year on year which shows our focus on quality of growth. So we are continuing to focus on quality revenue and the pricing increase which we have seen through a difficult in this environment reflects it.

Our model is also changing which is also equally important. For example, our revenue from products and platform this quarter is 6.2%. Our platform revenue in Q4 FY12 is USD 25 million but we are executing the year with a total contract value of USD 350 million.

So our strategies which we have put in place, which is being relevant to the client in the transformational operation and their renovation agenda, to strengthen our strategic partnership with our clients, to make sure that we evolve our business model into new model where you have dependence on various parts of the client business. All of those are playing out very well and that gives me confidence that in the long term our strategies will be in favour of our performance.

Q: It’s not just 8-10% revenue guidance but also the 4-6% EPS guidance which is hurting investor sentiment and also the fact that you are guiding for a 9% drop in EPS in the Q1. What kind of margin compressions are you staring ahead, both for Q1 and for the full year and why?

Balakrishnan: There are multiple things. We give guidance because we don’t want any asymmetry of information between the management and the investors. When we look upon our customer base, when you look at the budgets, we have a view on what the IT budgets are and in the last few years we had a view on how they will spend that too. Today we are living in a new normal world where you don’t have visibility on the spending but you have visibility on the budgets. Last year in the beginning we gave a guidance of 18-20% and we revised it down to 17-19% because of currency movements. Then we brought it down to 16.3% and finally we delivered 15.8%, so we are living in a new normal world.

I was reading a story in Financial Times that said out of the S&P 500 companies 1/3rd of them use to give guidance for full year but now it has come down to 1/5th. So the ability of a company to predict for the long-term has come down. But what we believe is we have a set of customers, we have a long-term relationship with them, we have a greater visibility on the budget so we have a view on the spending. The spending could be volatile, so we have a data today we want to share with the investors that’s why we give guidance.

We have given 8-10% growth in revenues. The EPS compression is because we normally say our operating margin could decline by 50-100 bps in a year, it could go up or it could come down. Even last year, our operating margin declined only by 0.7% so we managed that well because we have lot of levers on our side. First quarter, especially the operating margins, could come down by around 200 bps mainly because the visa cost gets bunched up in the first quarter because we have to apply for visas. Also, in the last two years we have been hiring locals in US; we have hired some 1,200 people each year in the US and even this year we plan to hire another 1,200 people which could get bunched up in the first quarter. At the end of the day we have to invest in all the global markets where we operate, we have to create jobs there and that’s what we are doing and that could have an impact on operating margins too.

So these two things could impact the operating margins by around 200 bps and if you look at the non-operating income we had a substantial forex gain in the Q4 which will not be there in the Q1. If you put this two together, the net income level probably you can see at 300 bps compression. But if you take a full year, we believe that we can get back operating margins and it could be within our normal band of 50-100 bps.

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Q: Let me come to the problem area that you were just outlining, the discretionary spend part of it which has clearly come down in the last 15 days of Q4. Can you tell us is it a few clients or is it a directional kind of a drift down that you are seeing in discretionary, which puts you in a worse off kind of situation compared to some of your other peers in the industry?

Shibulal: Actually the ramp downs which we have seen in Q4 are not entirely in the discretionary spend. The discretionary spend is a reflection of the confidence which the clients have, so when the confidence in the global economy comes down, the discretionary spend usually slows down. We have seen a very small dip in our consulting system integration space; the dip in the other parts has been higher. So the ramp downs have happened in the operation side and that slowness in ramp ups have happened in the discretionary space spend side, and most of these have happened over the last one month.

When we look at our portfolio, it is very important to realize that our focus is to build a sustainable model. We clearly believe that in the long run if we want to build a sustainable business we have to operate in all parts of the clients’ business. You will have different properties for each of those parts. So if you look at the IT operational business, it is annuity based, long term but price sensitive and some part of that business is getting commoditized. So if you depend on that part of the business as a big chunk in the long term, you will have other challenges. That means irrespective of the global economy, irrespective of what temporary phenomena you see in the market, your strategy has to be long term, sustainable and client value based.

So we clearly believe that our strategic direction that we have taken over the last many years and articulated in the last 12 months is clearly about building a balanced portfolio. Creating revenue in three different areas is extremely important, extremely relevant to the client and extremely important for us to build a sustainable business. You will see short term challenges because of these reasons because when you have discretionary spend, when you have lack of confidence you will see it but that is not a reason to change your direction or your strategy because in the long term this is the strategy which we believe will create a sustainable business.

Q: Quarter on quarter, volumes have dropped 1.5% and pricing has as well sequentially. For the rest of the year, what is it that you are baking in in terms of volume growth and if you could break that up in terms of quarters and what your base case assumption is on pricing as well?

Balakrishnan: We believe that pricing could be stable. If the environment continues to be volatile like this, it may not go up substantially but it is not going down too because our focus always has been on high quality growth.

In the guidance, we have not assumed any price increase because that is unknown. We normally take the fourth quarter pricing and assume that that will continue for rest of the year. So most of the growth in the guidance is volume based.

Q: How does that break up? Quarter on quarter what would you say in terms of an average growth you are expecting on volumes?

Balakrishnan: If you look at the guidance, we said 0-1% in the first quarter which means around 4-5% growth in the rest of the three quarters. Typically for us, first two quarters are good. If we get some accelerated growth in the first two quarters, normally the third and fourth quarter could be soft. So it depends on how the revenue comes in. If you look at 2008-09, I think the third quarter was good and first two quarters, there were challenges.

Q: Given that there is uncertainty, will you try and mitigate that during the course of the year by being extremely cautious with salary increases to cushion your margin somewhat and also go slow on hiring so that you don’t get slapped with a big bench and very low utilisation?

Shibulal: At this point in time, based on where we are, we have taken a decision not to do comp increase at this point in time. We will revisit that as and when the situation evolves.

Q: When will you revisit that?

Shibulal: We will revisit that every quarter, we will revisit it based on what we are seeing at that point in time. On the recruitment front, we are going ahead with 35,000 people recruitment, but 13,000 of those are in BPO that means that will create a net addition of 6000 people in Infosys Limited (IL) during this year. So our recruitment is tuned to the business growth which we are seeing.

We do have a bench at this point in time because our utilisation has dropped. It is a reflection of our 18 month supply chain because we recruit form the campus, they come into our environment, go through a six months training programme and a lot of them have come into production. I believe that will be a short-term challenge which we need to address and in the long run it should be okay.

Q: Can I just ask you to quantify this budget to spend problem that you were talking about earlier in terms of how much low the budget is for this year and how much of a gap you are seeing between allocation and spending?

Shibulal: If you look at this period, it is Q1 of the calendar year. By now the budgets are finalized and they are flat to marginally down. We should start seeing spending decisions. We should start seeing new program allocations, new project starts, new decisions being made. We are not seeing that at the same pace as what we have seen in the past especially in the financial services space. In financial industry, when the profits grow up, actually the percentage spent on technology usually goes up. There is a linkage between profit growth and spend in the technology space. What we are seeing now is that is broken - that is no more true. There is a reason behind it. The profit growth is happening because of various reasons whereas they are not seeing revenue growth. The percentage of revenue, which comes out with profit for technology, is coming down and they are looking at a month to month view on spending. We are also seeing some leadership change in some of the technology organizations in some of our clients especially in the financial services industry over the last 30 days.

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Q: This is one of the weakest Q4 in a long while for Infosys and also one of the most conservative guidance held out. Would you say this is about the most challenging year that you are looking forward to, have you felt more circumspect ever in the past looking ahead into a year?

Shibulal: We are into a new normal and the organization is trying to adjust to the new normal.It is definitely more volatile and it will be more challenging than any other period which we have seen in the past. At the same time, we have stuck to our principles --that is very important to remember, we have stuck to our principles of giving a guidance, we have stuck to our principles of not having that assimilative information stating the fact as we see it, acknowledging the fact that we have been through a difficult quarter and we are looking at a new normal and a new year. We are also clearly stating our strategic direction, and we are seeing very good traction of that with our clients. It is being reflected on our revenue and margins and profits. Pricing has gone up in a pretty difficult year. Interestingly enough if you look at our PPS (Products and platform) revenue, while the revenue is USD 25 million, we are exceeding the year with a USD 350 million TCV. So there are various factors being played out and when I look at our strategy, our long term, we are quite confident that we are building a sustainable business which is extremely relevant to our clients.

Q: NASSCOM says this morning that they are not changing their growth outlook till they hear from TCS and Wipro in terms of what they are indicating. Would you concede that Infosys is in a tougher spot that its peers right now?

Shibulal: NASSCOM gave a guideline, I think their number was 11-13% when they gave it, they also stated that there is a possibility of revising it. We have given a guidance of 8-10%, as Balakrishnan and me, both said, it’s a bold thing to do in a new-normal. Our aspiration is always to grow above the industry average. We have always done it; Quality growth, that is also equally important. We believe that we should create quality growth which means growth and profitability. That will continue to be our focus.

Q: Difficult quarter for you and constant currency in North America is down 4%, what went wrong, can you give us some colour and details?

Ashok Vemuri (Head-Americas & Global, Head-Mfg & Engg Svcs): I think as we got into Q4, obviously we were waiting for the budgets to close, which did more or less happened on time with a little bit of a delay than we anticipated. But the budgets were coming in; they came in as per expectations slightly flat to slightly negative. But getting the budgets is one thing and the budget getting distributed or dispersed (is another). Funding of projects did not necessarily happen as we anticipated. So it resulted in some of the projects or some of the programmes not getting necessarily funded. Therefore the ramp ups that we were expecting as a result of deals that we had signed did not happen. At the same time there has been a shift in spending, if you will. Some of our programmes, especially in the compliance area, resulted in some of the money being moved out of the programme. So some of the projects that we are in-flight, did ramp down. There was a slowdown in the ramp up and there was an acceleration in the ramp downs.

The other thing was about the structural changes that were happening. The amount of money that was being spent outside the US by the financial services sector in previous years went down fairly dramatically. All of it was being pulled back into the US and a lot of that was being done not necessarily through service providers but also internally. So a combination of these things in financial services resulted in this.

Besides, we have been seeing these structural changes happen in the financial services business and therefore we have been investing in building tomorrow’s enterprise -- whether it is in productized applications or in ramp-ups in consulting in system integration business. These businesses/services have have found very good traction in the market and that is demonstrated in the fact that we have had a very good wins. We have had higher price realizations but they are not necessarily as scaled up or as fast moving in reducing discretionary budget environment as IT services business. So hopefully the strategy is right because that is the direction which we see the market going, we are seeing that our services and our investments are finding traction but those have to be scaled up and that is what we are thinking will happen in the next year.

Q: The only other benchmark the market has about issues in banking, financial services and insurance (BFSI) is the post-Lehman period; would you like it at all in terms of the crunch that you are seeing. Some analysts are pointing out that you are facing problems on a sub-vertical BFSI rather than the BFSI umbrella, can you quantify where it is you are facing greater struggle and whether or not this is as bad or even close to the position you had post-Lehman?

Vemuri: For financial services clients or banking and capital markets space or if you look at the S&P companies and their profitability in the banking sector, even though the results and their balance sheets are looking better than 2008, it is not real profits as I would call them. These are results of write-downs, this is a result of the stimulus money etc. Insurance as a sub-sector has not necessarily kicked in as much as we thought it would because of significant diversion of funds to healthcare from insurance. So I would characterize the financial services space to be fairly still-challenged and given that even though their financials may be looking better, it is a combination of write-downs and a combination of stimulus money which is not necessarily real. Is it as bad as it was during the crisis period? Maybe not because I think they are much more mature in terms of how they are responding to it. But our footprint has expanded in these financial services both in the US as well as in Europe. We have a significantly large traction now in Europe. We are also benefited from the fact that we have opened a large number of new accounts. If I look at the new account openings that Mr Shibulal was talking, we have about 8 of them in the US which are Fortuned 500 company. Four of them are in the financial services sector. So the traction is there, I think this is a temporary blip; we were not able to foresee that some of the ramp ups would not happen and definitely did not see the sudden acceleration in ramp downs.

Q: Europe is relatively better off, though it is not a great performance, flattish quarter-on-quarter (QoQ), are you witnessing the same ramp up issues that you are seeing in North America or are things slightly better in Europe?

Srinivas: I would say if you look at the macro-environment situation, it is still muted. There are still challenges, all macroeconomic indicators are pointing towards that. The PMI index, which reflects on the manufacturing sector is down but relatively better compared to what happened in the US. The client situation is relatively steady I must say at this point in time. We have added about five new clients during the quarter in Europe. We have seen traction in the energy sector. In the financial services again we have had some wins in the last quarter, the ramp ups have been little slower than what we have anticipated, but there have not been any significant ramp downs at this point in time. We have also seen that while the retail sector is not doing well, the investments continue to happen and even in other sectors like pharmaceuticals, the process sector, business is still as usual. It is steady, the outlook is cautious, the budget-spend across Europe, across sectors, is marginally down or flat. So to that extent, even going into the full year, we will see a cautious outlook for Europe but the business is still steady.

Q: Where would you say the greatest challenges are coming in because as you mentioned it is not just BFSI, retail has seen a slip as well, I don’t know what the experience with telecom has been this quarter?

Srinivas: In Telecom, overall revenue may not have ramped up but it is seeing opportunities. It is still not that big in terms of making a material impact compared to other sectors but there is activity in the wireless sector in the telecom industry. While retail as I said, the sector is not looking that good, the spend is still happening. There is a lot of activity on clientcentric applications, business analytics, and multichannel commerce. So the spend is definitely there. Energy sector now is looking at outsourcing in a big way as compared to what they used to do in the past. So we have some opportunities there. Financial services, when the consolidation initiatives continue in Europe, there would be opportunities. So while the outlook in terms of IT spend is not that great, the opportunity in the pipeline is still there today.

Q: Shibu was speaking glowingly about how much platforms and solutions have contributed, up to 6% of revenue now. Can you take us through what exactly is accounting for that 350 million total contract value (TCV) that he spoke about and do you have a target of what you can do in terms of percentage of revenues by the end of FY13 now?

Purohit: In our products and platform strategy, the one important aspect is that we are introducing a new business model where it created a different kind of a growth momentum. Like Shibulal said, while revenues may have clocked in at about USD 25 million, we have a total contract value of USD 350 million and our objective is to build that momentum going forward. As we speak today we have 12 platforms that are active in the market. Last year, we have also brought in a total of 34 clients on to various products and platform; 23 on platforms and 11 on different kinds of products. Finacle, which is our flagship product, has also added 52 clients. So our entire strategy going into the future would be how we scale this up to make it into about third of our business which is what has been a strategic aspiration. We are not going and looking at what would it do in a quarter or in a year?

What we are looking at is are we on the right trajectory and right path to become a third of our business. So we are very excited about next year to keep on building the momentum like we did the last year and hopefully we would be at a very different place in terms of momentum when the year ends and so other important aspect of this is this involves a lot of co-creation with clients so this is very exciting in terms of building our client relationships and working with them to create new capabilities for different markets and we have seen some instances of that in the recent past in terms of what we have done with Airtel or what we have done with GlaxoSmithKline. So it’s an evolving space but essentially a new model fundamentally based on how do you help clients, deal with their capex and convert it into a variable opex model, how you help them deal with outcomes rather than only deal with the footprints of the technology. So we are looking forward to it.

Q: What is the BPO experience been on voice-non-voice, whether attrition levels have come down this quarter?

Swaminathan: Voice continues to be around 15% of my total revenues; attrition continues to be around 34-35%. It has been a great quarter for us in BPO, 16% growth quarter on quarter perhaps one of the best quarters in the last eight quarters. Margin has seen an upswing. I continue to talk about the transactional BPO to a transformational BPO. The revenue productivity has gone up by good 17% year on year.

We have now become very much global centric in the sense it’s no more India centric we have six centres in India, 12 outside of India, 30% of my revenue come in from revenues outside India. It is the global delivery model that is working and 20% of our human resource is now based outside of India. I do think that this has been a great quarter, great year of BPO. Clients are now getting to see lot more value in BPO beyond transactional to being transformational. There is a lot of positivity and I do believe that the next we will build from where we are today.

Q: Can you give us a sense of what growth you clocked in BPO in FY12 in terms of revenues and EBIT and if you can give us some sense of what kind of growth you could be looking at for your business in FY13?

Swaminathan: In terms of revenues, on a consolidated basis we are about USD 495 million for the fiscal, 16% growth over previous year. Our next goalpost is how soon we are going to get to the billion dollar mark. We made three acquisitions, one in 2007, second one in 2009 and the last one in 2011.

They have got well integrated into the overall scheme of things. They now contribute about 20% of my revenues. I do believe that traction will continue to see moving very quickly forward in years to come. There is good feel and cheer on the BPO front at this point in time.

Q: How tough is competition in the space that you are working in right now because some of your peers have suggested that the pie is basically getting smaller so it is about who can elbow whom out?

Purohit: I don’t think this is about the pie for the reason being that this is a business model that is creating newer and newer spaces. Let me give you an example as to how clients are running their business. When we look at the entire space of what we are trying to do in digital marketing, this is not starting with the thought processing saying what is a technology spend of a client in digital marketing and how can we bring technology into that context.

It is about saying how much is the client spending on marketing and can we help the clients actually realize better value of their overall marketing spend and you bring technology to deal with that. It is not about elbowing out in terms of where are the technology spends and who is getting what share of, it is about building new capabilities.

For example, if you look at what we are doing with Airtel Money, it is not a question that there is a certain technology footprint and you are trying to see who is elbowing out whom, but the issue is you completely build a new capability for the market and we all know that emerging markets making it cashless a completely a new area.

In our products and platform strategy we are increasingly looking for more and more capabilities that we can build for our clients as they look into the future. This is perfectly aligned with our building tomorrow’s enterprise line of thinking. We have to look at new capabilities, we have to look at wide spaces because the world of tomorrow is not about how do you fat it out in terms of what we are doing today, but look at what you want to create for tomorrow. That is how we have concentrated and built our products on platform started saying build new capabilities look at new ways to create value for your clients whether it is in growth, profitability or assert efficiency.

Q: Will there be wage hikes on the BPO front? Will you be able to improve on EBIT margins on what you have delivered in the current year on the BPO front?

Swaminathan: The target is to sort of maintain the margins that we have made this year. One has not seen a very big uptick in pricing because many of the transactions are getting commoditized, but our own focus on getting to the high-end value chain of the transformational BPO is therefore we have been able to take away the linearity in the business. There is a lot more non-linear growth that is happening. I do believe that the margin should hold themselves in the next year. There will have to be a compensation increase but the timing and all we have to decide.

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