Europe looks good; won't clip pricing to drive rev: Infosys

IT bellwether Infosys surprised the street with better-than-expected results for the third quarter. It raised full year guidance sending its shares soaring 12 percent in morning trade.

The Bangalore-based company reported a consolidated net profit of Rs 2,369 crore, unchanged quarter-on-quarter (down 0.1% from year ago), while revenue rose near 6 percent sequentially (12 percent YoY) to Rs 10,424 crore in Oct-Dec.

Pleased with third quarter results, Infosys management - SD Shibulal, CEO & MD, Rajiv Bansal, CFO, BG Srinivas, global head (Financial services and insurance), V Balakrishnan, Head (Infosys BPO, Finacle & India Business unit), Ashok Vemuri, global head (manufacturing and engineering services) and Basab Pradhan, head (global sales, marketing and alliances) spoke to CNBC-TV18 about the future prospects of the company.

Below is the edited transcript of the interview with CNBC-TV18

Q: It is the best quarter that you had in five or six quarters. The Street is happy. Would you call this as a turnaround quarter for Infosys?

Shibulal: We have done well in Q3. Our growth is 6.3 percent including Lodestone, 4.2 percent excluding Lodestone. Earnings per share (EPS) is USD 0.76, up from USD 0.75 last quarter. The growth has been all around. We have added a number of clients, one of the highest client additions in many quarters - 53 new clients. Each of the verticals have grown.

The offerings have also grown. We have eight large deal wins and bids amounting to USD 700 million. Consulting and system integration grew by 15 percent Q-o-Q. In the products and platform space, we have added USD 100 million of total contract value (TCV) and today that stands at USD 600 million. So, it has been all-round performance. Pricing has gone up 1.8 percent, which is a reflection of the portfolio shift.

I can clearly say that this is a result of the execution of the strategy over a period of time. For example, in the last quarter we had eight transformational wins, which led to revenues this quarter. In the middle of Q3 we had seen some headwinds. We had seen headwind of extended furloughs and number of furloughs going up. We had also seen the headwind of Super storm Sandy.

There was no power for about a week or two in eastern part of the US. Our people have worked extremely hard and it is also a reflection of our relationship with our clients. Because we have strong relationship with our clients, because our people have worked extremely hard, we have been able to address or mitigate those headwinds which we saw in the middle of the quarter.

The result of the deals which we won in the previous quarters is showing up. The environment is still challenging. The US is still going through challenges. The financial industry which is a very large segment for us is still undergoing challenges. Europe is unstable because of the economic challenges. We have done this in a challenging environment. We remain cautiously optimistic. We have maintained our guidance for the year at 5 percent organic, which implies a growth of 2.7 percent next quarter.

Q: This is a first quarter where you are not changing your guidance in a while, you have delivered better numbers in terms of volume growth and pricing, could it be something in the environment or your confidence in your clients is changing and your challenging time is troughing out, that I think is what your investors would be wanting to know today?

Shibulal: This quarter is a reflection of many things that we have done in the past. We have got more executive strategies on four verticals, three pillars. In this quarter BPO and Finacle has done exceedingly well. Both have grown quite strongly for this quarter.

So, it is a reflection of all-around growth. It is a reflection of execution of our strategy yielding results. It is a reflection of our deal-wins in the past yielding revenue in this quarter and mitigating many of the headwinds, which we saw in the middle of the quarter.

Q: Any milestone payments that came into the revenue contribution for this quarter as well. I know you don’t talk specific clients, but there are large milestone payments as well?

Shibulal: No.

Q: What is it that you are baking in for the next quarter in terms of where you hold margins? What are the comparable margins for Lodestone as well? What did the blended come to?

Bansal: We have maintained our margins, we instituted wage hike for offshore at average about 6 percent in the quarter, but inspite of that we have been able to maintain our margins. The only drop of 0.2 percent is primarily because of the rupee appreciation of 0.5 percent during the quarter.

All of us have worked very hard this quarter in terms of bringing in more efficiency into system and delivering on the top-line and the bottom-line. Going forward, in January we had committed to give on-site wage increases of 2-3 percent and that is going to impact our margins. So, we have baked in about a 1 percent drop in operating margin for the next quarter as of now.

In terms of Lodestone it is too early to give average numbers. Lodestone, it has a very soft quarter, Q4 is typically a very soft quarter for consulting European company, so their margins are still low single digit margins.

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Q: Would you expect to see some pressure on the blended margins then?

Bansal: We would. Including Lodestone, I expect a margin drop of about 1.3 percent because we are going to have an impact of about 0.3-0.4 percent because of the integration because they are coming at lower margin.

Lodestone would become EPS accretive over the next 18 months. We also had to take a charge of about 8 million every quarter because of the consolidation, because we have in terms of our deferred compensation and amortization of intangibles. All that has been baked in the guidance we have given.

Q: I keep asking you whether this is a turnaround quarter and you are detailing a lot of good things which happened in the current quarter. Are you then saying there are a lot of good things came together in this current quarter and one should not extrapolate this to the next few quarters?

Shibulal: The environment continues to be challenging. It has not changed. If you look at the environment, there are challenges in Europe and in US. Clients’ confidence in taking decision is still low. That does have an impact on our business. We remain cautiously optimistic for the rest of the year and many things that we have done in the past have yielded results in Q3.

Q: You have gone through a bit of January, any early signs of how the IT budget for calendar year ’13 is shaping you, do you derive confidence from that?

Shibulal: We expect the budget will be closed by February. In our mind we expect that the budget will be flat or marginally down. More importantly, we believe that in the next quarter, because the environment is still challenging, closure of the budget by itself does not mean anything because there will still be quarter-to-quarter scrutiny on the budget.

The investments will be revisited because the environment is not stable enough for them to take very long-term decisions. Our dependency on the discretionary spend continues to be there. At the same time, we believe that because of the pressure in the environment because of the focus on cost, offshore Indian outsourcing will continue to be a darling for the business.

Q: Specific to BFSI, are you facing greater pressure with regards to how demand is trending or do you think that is stabilising?

Shibulal: The confidence of BFSI to take the long-term decisions has definitely impacted. At the same time, there is spend in the regulatory space because the regulatory challenges whether it is KYC, those kinds of areas there is spend. That has been continued. Very large investment decisions are hampered by the uncertain environment.

Q: Given the demand outlook and the fact that you still expect things to be quite choppy between quarters are you changing your targets in terms of hiring at all? Are you looking at voluntarily increasing attrition, just lowering the employee base a little bit or are you comfortable with the kind of base you have right now because that is putting quite a bit of pressure on your cost?

Bansal: It does put pressure on the cost. Your utilisations are still at 70-71 percent, which is not a very good thing, which means we are building up so much of cost when we are putting our numbers. It is not about letting go of people or voluntary attrition. The fact is that we are very meritocracy driven organisation and in that we have to let go of low performers. That is a culture, which has been there in the company for many years so, it is not about voluntary attrition, it is not about asking people to leave, it is about building the right model for the future.

We need these people, we have made investment in these people, we have trained them, they are ready to be built the moment the opportunity comes. As we get into the new year and we had a good quarter, we have kept our guidance same and if you see the trend continuing it gives us a lot of confidence for making investment in the next year. We are re-looking at our investment strategy and our cost structures very carefully but that is with a much long-term perspective. We intend making changes in the way we do businesses. We intent changing the way we run this whole models together.

Q: Pricing has gone up 1.8 percent in the current quarter but going forward there has been a lot of talk that Infosys is already getting more aggressive on pricing to insure volume growth. As a CFO is your target to hold EBIT margins around 25-26 percent as they are today or would you be willing to look at pricing sacrifices going forward?

Bansal: We were always aggressive on pricing, it is a portfolio mix. It is not that we like leaving money on the table just because we are not flexible. We were always a very flexible organisation. There was always a lot of portfolio mix that we run very carefully. It is completely wrong to say that we are dropping our prices to get volumes. Secondly, as a CFO I am looking at a sustainable long-term high growth at superior margins.

If I have to make an investment in the current quarter which will help me in the next year I would make that investment. So what I am telling the analysts and investors is that don’t focus on quarterly margins. Quarterly margins will go up and down because we need to make certain investments in the business at right time. If we stop making those investments just because it is going to hurt my current quarter margins but it is going to give me results in the future quarter, I should make those investments.

Q: How do you think the year 2013 will shape up? Would it be as challenging as 2012 or does it open a window of hope?

Shibulal: The global economic recovery is going to be protracted and will impair our ability to make long-term decisions for some of our clients. But definitely there is interest in boosting efficiency, productivity and implementing regulatory changes. We await the announcement of the Budget to get a feel about next fiscal.

Q: Is volume growth still a challenge? In this quarter, the growth in volumes has been just under 2 percent. Does that remain a challenge? 

Shibulal: I wouldn’t consider that secular trend because our overall growth is pretty strong at 4.2 percent. Our growth has been broad-based so a lot of small clients have actually grown. We have added net 25 new clients this quarter. We are at 53 gross clients and net 25 new clients in Infosys alone excluding Lodestone. 

Q: Has some of the pressure on the books begun to ease? 

Shibulal: This quarter witnessed no reductions in scale but saw furloughs. Our ability to work with our clients and our focus on people have aided in mitigating those headwinds and boosted performance in Q3.

Q: What is your outlook on pricing for 2013 which saw an increase in this quarter? Is it sustainable or is it as a one-off?

Shibulal: I expect the pricing to remain stable within a very narrow band. The pricing is a reflection of the portfolio. In this quarter, our consulting and system integration went up by 15 percent  resulting in higher revenue-productivity. 

Q: Some analysts are going to FY14 believing that there is the potential for doubling of revenues. Does the enthusiasm need to be tempered?

Shibulal: As I said, we remain cautiously optimistic. 

Q: What is your biggest challenge on the margin front? Do you think it is managing the small on-site wage increase, utilisation ratios or volatility in pricing?

Bansal: Our primary challenge is pricing followed by utilisation. So, we have to relook at our operating models to ensure that we hire just in time and the right skill-set. We have been able to increase our utilisation over a period of time. On the pricing front, we have managed our portfolio in a manner that it does not impact my realised revenue productivity on a sequential and long-term basis.

Q: What is your hiring target for FY14?

Bansal: For FY14, we have not announced any targets, but we have made close to 6,000 offers on campus.

Q: Has Infosys has turned the corner for a much better visible performance going forward? 

Shibulal: If you look at Q3, the result of the strategic execution is definitely evident. The deal that were clinched in the have yielded fruit in Q3 and we have increased our range of products and platforms. But the fact remains that we operate in a very volatile environment.

Q: But you made a statement a few days ago that the environment might be improving on the margin. Was that misinterpreted?

Shibulal: Actually, the environment continues to be challenging. We remain cautiously optimistic.

Q: How much growth do you expect from Europe in this quarter?

Srinivas: Overall, in spite of the macroeconomic situation in Europe being challenging, we have done pretty well, including Lodestone. We also added close to 42 clients and this has built-up the positive momentum. 

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Q: Any relief in telecom yet?

Srinivas: The fix line carrier continues to be facing challenges. We have had some good wins in the wireless sector. Overall as a sector whether it’s US or Europe, telecom will face challenging times at least in the near future.

Q: Are you feeling more confident or less cautious going into 2013 about the environment generally?

Balakrishnan: It is a mixed bag because microenvironment is still challenging whether it’s Europe or US. They are largest market for us. The challenges continue, but if one looks at the micro level, clients are slightly getting more confidence. They are actually spending money on where they want to spend. That is why, there is some momentum. Next year even if the budget remains flat, off shoring will increase. Every company is looking for efficiency.

The returns are coming down in banks, financial services & insurance (BFSI). Most of the banks returns have come down from 40 percent to 4 percent. If they have to improve the return on equity then the only way is to cut cost. That will mean more off shoring.

Even if one takes Europe, it is in a mess. There are lots of challenges in Europe but the spending is increasing. They are all doing off shoring to gain some efficiency in their operations. Thus, it is a mixed bag. The world goes into a big tailspin and one will have an impact. The world continues and the customers continue to face challenges on the cost side. I think offshore industry will do well.

Q: Has there been even a marginal improvement in your confidence as a management?

Balakrishnan: Yes. We have done well in this quarter. In the last few quarters we have seen challenges both at vertical level and also the geography level. We are seeing good traction in Europe today and also in the financial services. Even CSI has done well this quarter. So, overall things have changed. However, one has to balance the challenges and opportunities. That is where we are very cautiously optimistic.

Q: BFSI has grown just over 6 percent sequentially. There were some concerns that BFSI would be lagging your internal targets. Can you walk us through what exactly happened both in terms of volumes and pricing?

Srinivas: Overall the sector continues to and will face challenges for the next two years. However, it is looking at significant cost-takeout initiatives. In the last six months where we have participated in helping clients, we have built on the growth momentum.

There were some concerns during quarter which we faced about furloughs. Those did happen, but subsequently there has been a re-look and it was held back. So, we have had some ups and downs but overall the deal wins.

The deal momentum growth has helped us. We have also seen traction in our platform portfolio for the BFSI sector. These are early days but here are more propensities to discuss radically new ideas, business models in the current scenario. They are looking for ideas because the cost-takeout measures include letting people go, include revisiting real estate. They are looking at all opportunities both on IT as well as operations.

Q: Are you struggling more on volume growth for Banking, Financial Services and Insurance (BFSI) or are you facing more challenges with regards to pricing? Is it a very aggressive pricing environment?

Srinivas: Pricing will be in the preserve, there is no doubt about that. However, we have been able to manage that and hold onto the margins even in current scenario. There have been very few instances of any kind of discounts. So, pricing overhang will continue, but we have been able to offset that with our portfolio of service offerings, platforms and consulting led services.

When we compete in large outsourcing deals we can compete as well. We also had internal schedules to reduce efforts. This takes to deliver over traditional services. That has helped us offset some of the pricing pressures we face, so that we are able to manage the margins.

Q: Business Process Outsourcing (BPO) and the India business has done well. Though the base is not as big, but have they fired on all cylinders this quarter?

Balakrishnan: I think so. In India, we almost doubled the revenues sequentially. We had won couple of transformational projects like the Ministry of Corporate Affairs (MCA) project and the Department of Post. Those started happening now and you are seeing some revenue growth because of that.

The challenge in India is that most of the work is with the government today. Maybe around 95-96 percent of revenues come from government contracts. That has got its own challenges because it takes longer time for the contracts to get finalized and even the ramping up takes time.

So we are re-looking at India and making sure we have a better portfolio of private plus government sector. We have a good book under government sector. I think next year also we will do well with the current order book.

India is doing well. India is a great market, big opportunity and of course BPO is doing exceedingly well. They will grow at 20 percent this year. They have a net of 20-22 percent, the average revenue productivity of USD 35,000. One cannot see best BPO operation in this industry with any company except Infosys.

Q27: You have seen how the system works from the top. The criticism right now against Infosys is that they are not focusing enough on cost cutting. Increased costs are putting more pressure on your EPS performance rather than what is happening with volumes and pricing. Is that being addressed?

Balakrishnan: If you look at this industry the biggest lever for industry comes from growth. Cost cutting will only take you to some level. Revenue growth is very important. If you get the growth I think cost issue will automatically get addressed. What is the current status today? The utilization is very low.

We hired people ahead of requirements, when the market changes we have to hire. So we are sitting with a large bench and that will get washed out when the growth comes. So if we are able to grow at the same pace, probably in next three-four quarters the bench will get absorbed, it will get washed out, then you will look much better. So growth is biggest lever. If you get the growth back I think the cost is not an issue.

Q: It came as a surprise, the 1.8 percent uptick in pricing. Is it sustainable or one shouldn’t read too much into it?

Pradhan: I don’t think we should read too much into it. We have a broad portfolio of services and products that have license fees associated with it. So, I don’t think we should read too much into single quarter’s pricing.

Q: How does it break up though in terms of on-site and offshore and where you saw a greater appreciation?

Pradhan: Pricing in general is stable. It is a fairly competitive situation out there. The outcome one sees in revenue productivity that we report isn’t in a single quarter. It is not really linked to how we are seeing long-term pricing across MSAs.

Q: Has there been any improvement in the large deal landscape because you did get a USD 100 million client?

Pradhan: In the last few quarters we have really picked up our game on that. Some of what you see this quarter is attributable definitely to revenues sort of working its way in from deals.

Deals, we have closed over the last many quarters. In a way what we set out to win large deals, our transformation deals and Platforms and Solutions (PPS). All that is working its way in. Overall if you look at the industry itself the deal sizes are still, the trend is downwards. It has been for a while, but that’s not all bad news.

We are very comfortable with the current deal size. We don’t think it is really good for clients to do a big black box kind of outsourcing. Here we call it your mess for less kind of outsourcing. So, we think we have a really good chance of winning these deals.

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Q: Shibulal was pointing out that budgets don’t necessarily imply demand outlook for the rest of the year. But is your conversation with clients picking up any early trends in terms of how they would want IT budgets to move?

Pradhan: There are many trends, one secular long-term trend is the role of technology in business and that continues to be very important and is getting more important overtime. More businesses will spend more on technology and technology-led services. The other thing is the economic uncertainty in places that have two impacts; one is that discretionary IT spends tends to get under pressure and secondly they don’t really know because it is uncertain. So that’s what we are seeing in the market more than anything else.

Q: How is the US shaping up with 1.6 percent sequential growth? You would like to see it a bit higher, is it still a sluggish market?

Vemuri: I would like to see that higher as well. But given a quarter where we had hurricane Sandy, the elections and the overhang of the fiscal deficit, I am happy with 1.6 percent growth. USD 1.2 billion in revenue, good traction across all our industries, especially happy with the way our public sector business is shaping up, as the government expenditure is moving from less defence to more civil and the expenditure on affordable care act (ACA). So our strategy on the products and platforms that we build for the healthcare business as well as State and federal government is finding good traction and fruition.

Q: Any sense on how Q4 will shape up?

Vemuri: We have had eight large wins in this particular quarter. Four of them are from the US markets. Hopefully we will build the traction on them and will see that scale up. Some of the deals that we have done in the previous quarter should also begin to kick-in. Q4 is particularly a slow quarter. As the budget and expenditure plan gets finalised, we hope to see that get converted into actual deals.

Q: Manufacturing grew 4.6 percent which is solid, but can you get it up to say the 6 percent kind of BFSI kind of run rate, the vertical that you used to lead earlier?

Vemuri: Manufacturing has benefitted more from a BPO business rather than a service business. Primarily, because manufacturing expenditure gets reduced at the end of the year due to the furloughs and shut downs. But we are seeing traction in the high-tech sector and that will continue to grow.

We are seeing some good wins in the European market especially given the turmoil in Europe, we are seeing a lot more opportunities to do transformational and innovation deals and that will continue to help us boost. We see manufacturing as a very large sector, we do resources, we work with mining companies, we do a lot of engineering work and that has a tendency to pick up in the middle of the year, not necessarily at the start of the year.

Q: Did any of the top clients’ win come from that 4.5 percent manufacturing growth?

Vemuri: Yes, a bulk of those wins are from the manufacturing sector and predominantly from Europe.

Q: Lots of deals are coming up over the last two months for renegotiation. Will you get your fair share of the deals on the renegotiation table or could you be losing market share?

Pradhan: No, in fact there is no uptick as such. This has been a constant string of renegotiations. In fact some of the deal wins that we saw in the previous quarter included some accounts where we were not the incumbents and won the deal against the incumbents. So for them they are rebids. At least two deals are big for us in retail and consumer packaged goods (CPG) one against established incumbents. I do not think they will pick up that much, because it is already happening. But we have a good shot at winning those.

Q: Any sense you can give us of volume growth you expect to see from the US for the rest the calendar year?

Vemuri: It will be pretty consistent with what we have seen tracking in the last couple of quarters. As our transformation and innovation agenda, the strategies that we are putting in investments that we are making, we will get into a place and are increasingly getting into where our traditional competitors will not be aware. We have an advantage in terms of the success that we have had. It will open up a completely different part of the business world that we have not so far addressed.

It will change our outlook for discretionary spend, the impact of discretionary spending and what the budget cycle will do because as we focus more on the revenue side of the balance sheet, we are finding ourselves in a different place. With the success of the strategies and the investments that we have made in the last couple of years coming to fruition and beginning to find traction and acceptance, we think that will accelerate our business.