Why did Infosys cut its FY12 dollar guidance?

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Why did Infosys cut its FY12 dollar guidance?

IT major Infosys reported a better than expected numbers in the third quarter of FY12. However, the company disappointed with its dollar revenue guidance for the fourth. In an interview to CNBC-TV18, the management discuss the quarter gone by and give their outlook going forward.

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IT major Infosys reported a better than expected numbers in the third quarter of FY12 . However, the company disappointed with its dollar revenue guidance for the fourth quarter.

The company posted a net profit of Rs 2,372 crore in the third quarter, a growth of 24.5% as compared to Rs 1906 crore in the previous quarter.

Its revenues moved up 14.8% to Rs 9,298 crore from Rs 8,099 crore, quarter-on-quarter.

In an interview to CNBC-TV18, Infosys management including SD Shibulal, chief executive officer and managing director; V Balakrishnan, chief financial officer, BG Srinivas, senior VP, head Europe, global head-Mfg, Engg Svcs, Ashok Vemuri, senior VP, head-America, global head Fin Svcs and insurance, Chandrashekar Kakal, senior VP and global head-biz IT Svcs and Basab Pradhan , senior VP, head-global sales, speak about the quarter gone by and give their outlook going forward.

FY12 $ guidance downer: Is Infosys headed for re-rating?

Below is the edited transcript of the interview with CNBC-TV18's Udayan Mukherjee and Sonia Shenoy. Also watch the accompanying videos.

Q: The investors are a bit disappointed that you chose to give flat dollar guidance for the Q4. Why did you do that?

Shibulal: In Q3, we have done well. We have grown 3.4% in reported currency and 4.4% in constant currency. The operating margins are up by 3% from last quarter to this quarter.

We have had good client additions. We have added one of the largest number of clients this quarter, 49 new clients have been added. Six of them are in Fortune 500. That is good client addition.

The quality of revenue is very important to focus on. Our revenue productivity has gone up again this quarter by 0.8%. If you look at year-on-year, our revenue productivity is up by 5%. That means even in a very tough environment we are able to maintain the quality of revenue. On nine month basis, our revenue productivity has gone up by 6%. So, we have been able to maintain the revenue productivity and the quality of revenue in a pretty tough environment.

There were good deal wins in Q3- five large deals, two of them above USD 500 million. Most of the growth is happening in the areas of investment. Europe grow by 13.7% quarter-on-quarter this quarter. Life science and healthcare have grown above the company average, almost double digit both of them. Overall, in a tough environment, I believe we have done well.

The environment is very uncertain. There is no definitive answer to the Euro zone crisis at this point. Client confidence is down. Budgets are getting closed, the early indication is that we will be flat with marginal down.

Spending is going to be choppy because the spending is going to depend on the clients' confidence and the environment as we go along. So, in that situation, we need to remain cautious. That is the reason we have given a flat guidance for Q4.

Q: The temptation for a lot of investors would be to now extrapolate the Q4 guidance into the new year saying if Infosys is saying Q4 is cautious, they will be cautious in April when they speak about FY13. Would it be a wrong assumption or a correlation to draw from what you said for the Q4?

Shibulal: As we have always said our guidance is as we see it at point in time. There are number of data points will come between now and April. We will do our client survey between now and April. The budgets will get closed. The spending pattern will emerge. So, all of those factors will come into the guidance. In April, we will give a guidance as we see it at that point.

Q: When we spoke last in the middle of the quarter, you said that the final dollar number will be closer to the lower end of the band, when you speak about flat-to-negative budgets what could it mean for Infosys in terms of dollar revenue growth going forward, factoring in some cross currency kind of movements?

Balakrishnan: It could mean positive and negative - positive in the sense when there is too much of pressure in the system, when people look for efficiency, offshore is a big game. That is why we keep saying customers' budget is not important for us; it is their share of offshoring within the budget that is the most critical data point. And if you look at Europe, Europe is not a big outsourcer like US. The level of offshoring in Europe is still much lower and that economy is going through troubled times now than the US.

So the level of offshoring in Europe could increase. When spoke about two large USD 500 million deals we signed this quarter, one of it is from Europe. So there are a lot of opportunities and even in tough times, offshoring could increase. The challenge is how confident the clients are in spending the budget even if they have budgets. But if clients don't spend because of the environment that is what is creating the volatility, which is why we are cautious.

What happened in Q3 is that clients have the budgets. When we initially gave guidance we were comfortable with that guidance because clients had the budget, we thought they would spend. But when the environment turned bad they because very cautious on spending hence we said we will be closer to the lower end of the guidance and that is where we ended with. So it will be both positive and negative, it is too early to comment on next year but if the environment remains stable probably we will grow better next year.

Q: The last time when we spoke you indicated that this year would be a more balanced 4% plus volume growth. This time because of seasonality there is a bit of a blip but how do you see the trends in the next couple of quarters?

Shibulal: This quarter we have grown by 3.1% in terms of volume.
Actually, I think this year if you look at it there is no correlation between volume and revenue growth and it was more evened out through the year. At the same time, we have been able to maintain or improve the quality of the revenue. Our revenue productivity went up by 5%. Next year, we expect the pricing to be stable for all practical purposes, unless there is any totally unplanned event.

Q: On the account of the margin performance this time around, how much of it has been courtesy pricing. I heard you mention there was a little bit of a bump-up this time. How much of it has been courtesy pricing and how much of it has been courtesy the rupee and what could we expect to see as a stable margin performance from here?

Balakrishnan: It was mainly the rupee. If you look at the average rupee rate compared to Q2, Q3 we expect the rupee to depreciate by 11% that means operating margin benefited around 4.4%. We had some increase in other cost to the extent of 1.4%, so net-net we had a benefit of 3% on operating margin. For the rupee, we assumed it at Rs 52 for the next quarter. We believe that currency will be volatile and the chances of it depreciating are higher. There are multiple reasons.

For a country which is running a trade deficit for a sustainable period of time the currency cannot appreciate; it could appreciate in the short-term but in the long-term it has to depreciate. Secondly, in a volatile global economic environment, India is seen as an emerging market risk to that extent, the inflows could be lower. Thirdly, India's growth story itself gets impacted because of the paralyzed political system we have today. So if we put all that together, the chances of rupee depreciating are higher.

In fact, the regulator had taken some steps on the derivative front, on opening up the debt market front - that would help get some inflows. So one is witnessing some short-term appreciation, but if a medium-term view is taken, the rupee could depreciate further. So our hedging position today is around USD 877 million. We normally hedge for two quarters. If the whole industry is taken under consideration, I think we have better management of currency and the impact on the margin because of currency movement is extremely low.

Q: Do you see this quarter Q4 picture being consistent with Q3 in terms of deferment of spending or are there significant delays in freezing of budgets that you expect going into the new year?

Shibulal: If one looks at where we were at the beginning of Q3 versus right now, there was a marginal degradation which reflected in the middle of the quarter saying we would be closer to the lower end. At this point of time, we have given a guidance already considering that.

That has already flown in our models. If utilization is taken under consideration, we are at 76% which means we have enough talent in the system to take on an opportunity which comes along. We are very closely in touch with most of our clients. We expect the budgets to close by latest by middle of February. So it is already in progress.

We are very closely associated with most of our large clients in the budgeting process. We see that happening and we expect most of it, almost all of it to get closed by the middle of February. The early indicators are flat or marginally down; at the same time, there is more interest in off-shoring and working with us.

Q: In terms of utilizations, do you see it go up to 80% kind of levels? Also, do you think 31% plus EBITDA margins are sustainable?

Balakrishnan: Utilization, excluding trainees, we are comfortable with the range between 76% and 80%. At the peak, we went to 81-82% but that will be running the model too tight. So we are comfortable somewhere within the band. On the margin front, we are comfortable because our focus is on high quality growth. We are focused on balancing the revenue growth in the margin. We are highly focused on margins.

So look at some of the indicators today. We added 49 new clients. In the last nine months, we added 120 clients - last full year we added only 140 so customer additions is very good. The top 25 clients are growing faster. Attrition rate has come down from 17.4% in the beginning of the year to 15.4%. We added more laterals. We signed five large deals- profit is more than USD 500 million. Our focus on platform, solutions and products is very high.

Today we have a TCV of close to USD 300 million on platforms and solutions. We are focussed on high quality growth. As long as we do that, we should be more comfortable on the margin front. The only volatility maybe the currency that we will have to look at but looking at how the way the rupee is behaving, I think in the next few quarters at least the rupee could be under pressure so we are comfortable on the margins.