Infosys Q2: Why is CFO Balakrishnan changing roles?

IT giant Infosys met street expectations with its second quarter results, but hugely disappointed with a deeper cut in earnings per share guidance for the full year. Its shares slumped over 7% in morning trade.

It reported a net profit of Rs 2,369 crore in July-September quarter, up 24% year-on-year (3.5% quarter-on-quarter), while quarterly revenue rose 21% from a year ago (2.5% sequentially) to Rs 9,858 crore.

In an interview to CNBC-TV18, Infosys management- SD Shibulal, managing director and chairman and managing director, V Balakrishnan, chief executive officer, and Rajiv Bansal, vice president- finance (new CFO designate) spoke about the performance of the company and the road ahead.

Also Read: Is Infosys grooming CFO Balakrishnan for the top job?

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

Q: It has come as a bit of a shocker for the market. Why are you stepping down as a CFO?

Balakrishnan: It’s not a shocker. We have a tradition of giving way to youngsters. Rajiv is great guy. He is young. He has to find his day in the sun, so I am stepping down from that role, but I will be handling the other portfolio like India Business, Finacle and BPO. It is a tradition in Infosys and we are continuing with the tradition.

Q: Why was this reallocation required because Balakrishnan has been the CFO for a long time? He is the face for the market as well. Why did you need to do this reallocation of role?

Shibulal: Bala has been handling a very large business portfolio, which is going very well for us. For example, if you look at business process outsourcing (BPO) in this company, in this year when we are talking about at least 5 percent growth the BPO will be going 18 percent. India, if you look at this quarter, they have closed fantastic deals. He has been handling a business portfolio and a CFO’s role.

This is very much inline with our tradition. We have always given opportunity to the youngsters in this organization. This is a very young organization. He has done a fabulous job of being the CFO for the last many years. He has done a fabulous job of mentoring Rajiv. Rajiv has been with him for the last seven years and Rajiv has been groomed for this role. In tradition with what we have done in the past, giving opportunity to youngsters, Bala has handed over the responsibility to Rajiv.

Q: But these businesses, which Balakrishnan is going to look after now, don’t account for a very significant portion of Infosys revenue. Is it a step down for him?

Shibulal: It is a very strategic part of Infosys revenue. If you look at BPO, it is growing much faster than Infosys’ average. If you look at India, we have entered India only in the last four-five years. We are seeing very good traction, very different kind of business.

The kind of business, which we do in India, is very system integration oriented. A lot of government work. Finacle is very much in line with 3.0 strategy. The 3.0 strategy is all about increasing products and platform space. So, the portfolio, which Balakrishnan is handling, is very strategic for Infosys.

Q: Is it going to be challenging as a CFO, EBIT margins have slipped quite a bit in current quarter and will probably be more under pressure as you take more wage hikes during the course of the year?

Bansal: It is a dream of every financial professional in this country to become CFO of Infosys. I would like to thank the board for giving me this opportunity and trusting me. It is not easy to step into Balakrishnan’s shoes. He has been a role model and inspiration to all of us for years. He has guided us, supported us and taught us what we do.

These are challenging times for the company and the industry. We are going through a transformational journey now where we have defined our strategy. I believe that the right strategy for the company is to create a sustainable, superlative growth at industry leading margins. We have challenges. But we have to be focused on our long-term strategy and do the right things to ensure that it is a sustainable model.

I am not too worried about looking at numbers on quarter to quarter basis and get worried about a drop, 50-100 basis on quarter basis. But as long as we are focused on our long-term strategy and we believe it is the right strategy and we are making the right investments, I think that would matter. We have to cater an organisation that will sustain for a longer time at industry leading margins.

Q: The guidance that you are holding out, 5 percent, does not include Lodestone, right?

Shibulal: We have had a decent quarter in a very tough time. Our revenues grew by 2.6 percent QoQ, Rs 1,797 crore. We had good client additions. We added 39 new clients this quarter, 14 of them in financial services. Even in a very tough period, financial services revenue has grown for us. I have talked about the Indiabulls and the Ministry of Corporate Affairs. We closed six large deals this quarter, two of them were more than USD 200 million, eight transformational programmes. If you look at the Harley-Davidson deal, which we announced, it is an infrastructure led deal. We have set-up an office in Milwaukee to actually takeover that deal. So, it is an infrastructure led deal.

Consulting revenue has gone up this quarter. It has gone back to 30.01 percent. So, it is decent growth, but in a tough environment. The environment continues to be quite challenging. In my mind, between the beginning of last quarter and today, the environment has not improved. Actually it is exactly where it is. That is impacting our clients’ ability to take decisions, invest for the long-term.

But we are very confident of the future. We are investing. So, we are making investments into products and platforms. We have taken the decision to give compensation hike in a very-very tough situation; an average of 6 percent offshore and an average of 2-3 percent on onsite. The offshore is effective right now and onsite will be effective next quarter. So, we have taken that decision. That means that we are very confident of our future.

Our strategy is working. We are in execution. We have a decent set of results this quarter. We are very confident about the future. We are investing. We are investing into our employees. We are investing into intellectual property. We are investing into our client relationships.

Q: Does it include Lodestone?

Shibulal: It does not include Lodestone. While we have announced, it is not closed. We were waiting for the anti-trust clearance from Germany. It has now come. So, we will close it in the next week or so. Next quarter, we will include it.

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Q: In October-December, Will you be able to tell us about the revenue growth including Lodestone?

Shibulal: In October-December, we will be able to give you a guidance including Lodestone.

Q: Why did you have to cut your dollar EPS guidance for the full year? What was that factoring in?

Shibulal: Actually that is purely because of currency. The EPS guidance we gave was USD 3.03 as of last quarter. The currency has moved against us. So, that has been reset to USD 2.97. So, irrespective of the compensation increase, we have not changed the EPS.

The growth is only 5 percent. We started out the year with 10 percent, we are at 5 percent. Environment has not changed. We still have gone out with the compensation increase. We have not changed the EPS guidance. That means that we will have to manage it managing with the other expenses.

Q: What happened to EBIT? It surprised the street quite a bit, the correction in the EBIT margin in this quarter?

Balakrishnan: The operating margin has come down by 1.6 percent. It’s mainly because we have seen some increase in cost. But if you look at the full year, full year - earlier we said our operating margin could decline by around 200 bps. We are retaining that.

That means inspite of increase in wages, inspite of currency moving against us in the next two quarters because earlier last guidance we assumed currency at 55 and now we are assuming at 53 probably it may go to 50, who knows.

We are taking those impacts till the operating margin for the full year is not changing. For the current quarter, our cost has gone up, that will get normalize in the next two quarters.

Q: You want to add to that, what kind of costs would have led to that 160 bps erosion in margins?

Bansal: We are in the middle of execution journey for our strategy and it will require certain cost to be incurred at every point of time to ensure that the execution happens on time. There would always be these ups and downs quarter on quarter which you look at. But as Bala said they will get normalize over the next two quarters.

If you have to have certain investment in a particular quarter you do not want to hold it up or split it up between quarters just to manage and ensure an EPS which is acceptable.

The fact is that we are in the middle of execution we have to execute on our strategy and that’s the only way we will be able to have a sustainable growth. If you look at the full year guidance, we have kept this full year guidance, reset it for the purpose of rupee appreciation, but other than that we have maintain our guidance.

Q: Would margins come under further pressure once the wage hikes kick in, in the second half?

Balakrishnan: We absorb he wage increase; still we are not changing the margin guidance for the full year. What we gave in July, we are retaining that. This means we are able to get some of the levers work for us in the next two quarters to absorb that costs.

Q: No improvement in pricing, it still remains a fairly difficult environment?

Shibulal: The pricing from last quarter to this quarter has not dipped much, 0.2% reduction in pricing that is what we have seen from last quarter to this quarter, so it is stable for us at this point in time.

The environment is quite challenging for our clients, while some of the clients have seen profitability improvement, the growth is not there. This means that they are under pressure on investments, they are under pressure on investing for the long-term, also unable to take decisions. It will continue to stress out the environment.

Q: An analyst was pointing out that in the internal matrix maybe USD 100 million and USD 300 million plus clients have gone down. Are you witnessing any problem there?

Shibulal: Our growth this quarter is all around, in fact our top five grew by 7.8 percent, top ten grew by 5.7 percent and top 25 grew by 5 percent. Our USD 300 million client came down by few million dollars, so that one client is what is showing up. If you look at the million dollar client, it has gone up from 400 to 413.

In this quarter we have good client additions, there has been overall growth at every segment; top five, top ten and top 25 and the remaining grew by 0.8 percent. The growth has been led by our large clients. One client has shifted down, the USD 300 million client has become just below USD 300.

Q: Which vertical is this client from?

Shibulal: We do not generally talk about clients.

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Q: Is it telecom?

Shibulal: It is not telecom. So that has shifted the numbers a bit.

Q: You look at India and while Mr Shibulal has been saying India has been promising, this quarter has been terrible for India; in fact the reason why your numbers are subdued is because of India, what happened?

Balakrishnan: India we are sub-scale, we started this unit some one-one and half years back. We are participated in lot of deals. We won some of the large transformational deals in this country; India Post-we are going to transform some 150,000 post offices in this country. It is a huge transformational deal for this country.

We won the Minister of Corporate Affairs (MCA) deal. We are winning lot of deals, that impact will be coming in the next few quarters, next few years. But we are making a great statement in India. We are winning deals. We are participating in all the large deals.

India is all about transformation and scale. We are finding lot more opportunities. You will see the impact coming. Right now its sub-scale, you are seeing the impact but if you look at the future, we have won some of the large deals and we will participate in all the large deals. The opportunity is huge.

Q: Any specific problem with India or BPO in this current quarter which might have affected your numbers?

Shibulal: In India the scale is an issue because when you are sub-scale, you can be choppy because scale is what cushions your choppiness. Also, the kinds of deals we go after in India are purely transformational deals.

If you look at Income Tax Central Processing Center (ITCPC), if you look at India Post where we are implementing systems across 150,000 post offices, the Minister of Corporate Affairs, so these are large transformational deals, but it is sub scale, so you will be choppy.

Q: Any thoughts on how you are managing the rupee now? That was trending down nicely for you, but it has become more volatile, suddenly it sprung back?

Bansal: If you look at the period end of movement it is almost 5 percent. We will continue with our strategy of looking at it from a short-term view because it is very difficult to say where the rupee will go. With a lot of FDI investment coming into the country, the rupee may go down to 50. We need to keep our treasury tuned to the short-term strategy of looking at the rupee and making adjustments if required.

From our guidance perspective, we take the closing rate, so we factor that in. It is very difficult to put the movement of rupee in a model and then try to estimate something. So, we assume a certain rate, give a guidance and in case there is a movement then we try to manage and if we cannot we just come back and say that on a constant currency or if this impact was not there this is what it would have been.

Q: I want to ask you more about the environment. You have brought down your constant currency guidance a little bit for the full year. Do you see a lot of ramp-downs happening or is it just that the environment remains where it was three months back? No incremental worsening is happening?

Shibulal: Please remember our business is 30 percent discreet, so every year you have to actually refill the 30 percent and create growth. To create that kind of growth, you need confidence within our client base. If you look at our client base, they do not have the confidence to take those decisions.

Very large opportunities, like the six which we closed this quarter take a longer time to close. Even after closing some of these large opportunities sometimes the ramp-ups do not happen as we plan. It is the environment in US, Europe and the lack of confidence our clients are faced with.

Also, our volatile revenue is quite large, because we have 30 percent coming from consulting and system integration, about 32-33 percent coming from financial services, which is also very volatile. That is a total of 64 percent.

Even if I normalise it for some of the stability in certain parts of the business, you are still talking about a 54 percent of our business in a volatile environment. The discretionary spend is under stress. So we are operating in an uncertain environment. This quarter has been pretty decent. We have seen all around progress, but the environment has not changed from where it was last quarter to this quarter.

Q: For a lot of people Bala is being seen as someone who is being groomed for the succession plan of Infosys. You may or may not agree with that. Does the reallocation which you have done today have any ramification to Bala’s future progression in the company?

Shibulal: This company has always developed leaders. We have created a leadership institute in 2002. We have a tier-1, tier-2, tier-3 leadership system in place. We have an executive council in place. Three people are on the board. We have always developed leaders for every single position at Infosys.

Q: I am talking about the CEO position and with specific reference to Bala now?

Shibulal: Please remember that’s a nomination committee decision and they will of course do it at the appropriate period and appropriate time looking at the wide range of candidates.

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Q: How do you see Lodestone progressing in the October-December quarter onwards?

Srinivas: If you see just a reflection of the last quarter, inspite of the market being challenging and the uncertainty of the Euro zone, we have done pretty good. Sequentially, we grew 4.7 percent in constant currency.

We continue to add capability into the market. That proves to be challenging, but we are, on a relative basis, doing pretty well. In that context, as stated in terms of our strategic direction, we want to enhance the revenues from Europe. Lodestone fits in very well.

We will be able to close the transaction in a week or so. We have already begun the exercise on integration. We see a lot of synergy in terms of both enhancing the consulting capability, particularly in continent, Switzerland, Germany being the largest presence for Lodestone.

There are very few clients where there is an overlap. We believe, as we get to the details of the account planning, we should be able to drive downstream revenues in the next couple of quarters, once the plans are in place. We are very confident that there are opportunities in both the clients as well as the new clients, as we open up in the continental market.

Q: How critical a plank would Lodestone be in your overall consulting piece?

Pratt: I think it is absolutely strategic to Infosys, getting USD 350 million out of Bala is no easy field. It shows that we are serious about our strategy Infosys 3.0. One of the areas where we needed more scale was Continental Europe. With the addition of Lodestone, we can go toe-to-toe with anyone for any global business transformation programme. With the acquisition of Lodestone and the coverage that we have and the depth that we have, there is a new big four in consulting and systems integration. Accenture, IBM, Deloitte, and Infosys is the new big four. I think it is real a milestone for a company from India to achieve that designation.

Q: How is the market buzzer because pricing remains quite sticky and Shibu just spoke about the environment being as challenging as it was one quarter back?

Pradhan: Yes. It is. It is quite choppy out there. One week you will get good jobs report in the United States and in the next week, there will be something that happens in Europe. We are particularly concerned about changes that are going on in Europe. In the US, there are global businesses with a presence and a big share of revenue coming from Europe.

Emerging markets aren’t contributing like they use to. China is off the peak. It is no longer growing the way it used to and contributing to the growth in the world. So, we have a situation where the uncertainty is feeding on itself and long-term projects take a little longer, they get broken up. People are little more conservative.

Q How is your piece looking in this quarter?

Purohit: The momentum sustains. We are now working with more than 60 clients on our production platform, excluding Finacle, across the world. There are very clear indications that Infosys 3.0 strategy is moving on its charted path. We have now assembled overall a total contract value (TCV) of about USD 480 million. Last time, we were talking about TCV of USD 380 million. So, over the last three months, we have secured more business. We are building that momentum and trajectory.

The cloud business also continues to sustain very well. We work with more than 170 engagements now, more than 3,000 experts. The business is growing very well. We launched the cloud eco-system hub. That brought a significant change to the way the industry would use cloud in the future. So, I think, overall, we are continuing to see the momentum that we wanted to see. It is all going in the right direction from product, platform and solutions perspective.

Q: How would Bala’s entry into this space play along? Will you play a complementary role because he will also get into the product space?

Purohit: Bala was always there, the Finacle business always reported into him and so did the BPO and India Business. We have always worked extremely well as a team. It continues to be that way because it we will probably get him to have more attention on this. So, it’s going to be even more exciting journey going into the future.

Q: Can one say that the BFSI business is bottoming out because you seem to be seeing a little bit more traction between quarters?

Srinivas: The sector continues to face challenges. There is no easy solution for this sector in the next many quarters. However, having said that, our business, particularly the services business, has done well last quarter. There is a lot of initiative within the client set-up in terms of simplifying and taking cost out. There is a major move in that direction.

We are trying to take proactive ideas to the clients in a set up where they are looking for this initiative, both initiatives around new ideas; new business models. We have had good wins in the last quarter on platforms because that gives a flexibility of reducing the capex and have variability on their opex. So, these are some of the initiatives.

We are particularly targeting the BFSI segment, given the context which they are in. Yes, the good news is, to great degree, the bottoming out effect is already behind us. But, at the same time, I must say that the sector will continue to face challenges in the near-term.

Q: Europe has not done too badly. Despite all the macro bad news that we keep hearing, it is showing some traction.

Srinivas: True. We had some good wins in our existing clients accounts in UK, particularly in energy, financial services. In the continent, it is manufacturing. Interestingly, we see Nordics market also opening up both for financial services sector and the manufacturing sector.

At the same time, in the continent, we have seen both Germany and France starting to open up. It is still early days, but this market is opening up. As we have done in the past, we continue to invest in these markets. The Lodestone acquisition would help us in the next couple of years to scale that significantly.

Q: I was just discussing your largest client with Shibu, the fact that scaled down to USD 300 million. Are you seeing similar ramp downs from your large clients?

Pradhan: I would not read too much into that. If you look at the total number of clients, over 5 million, everything is positive. There are some movements between categories which will get noticed because of the smaller numbers at the end. But we are too concerned about that.

Q: What is the problem area? When you say the environment is uncertain, what is really the problem?

Pradhan: We get a lot of business from discretionary spend. The ability of our clients to spend large amounts of money with an outlook to the future, which is that they are safe and secured about the future of their business, they are not today and they are uncertain about it. They spend in smaller dollops or they take a longer time in deciding. Those are the things that we are looking at and saying okay this is not something that has changed in the last few quarters. In the near future, the outlook is going to continue the same way.

Q: Do you see more pressure on pricing in such an environment?

Pradhan: We are not seeing a whole lot of pressure. But you might say after the financial crisis, for instance, when everybody came and asked for price correction at the same time. There is competitive pressure of a different nature. That doesn’t all come together, but that is part of the course.

Q: How does consulting doing in the kind of macro uncertainty that we are seeing, are clients still willing to spend on something like consulting, is it growing at a pace faster than overall Infosys volumes or at a lower base?

Pratt: That’s growing faster than Infosys. Consulting and Systems Integration grew 3 percent sequentially and Infosys grew on constant currency 2.4 percent. It’s very important that Infosys 3.0 is designed to future proof the company, to create a company that will be around for 100 years. That means having equal parts of consulting system integration, business IT services products and platforms and that’s what makes us a global major.

If you look at the results of that strategy, our win rate now has gone over 50 percent, which is a very high win rate. The strategies are paying off. Volumes for the whole company have grown up 3.8 percent quarter to quarter. So that’s a very healthy growth in volumes. We still have work to do, but when our people walk in and compete against all the other members of the big four that we are confident that we are going to win.

Q: What do you have more comfort in; the US market or the European market at this point if you were to compare?

Srinivas: There are two factors; one is the macro economic situation; US is marginally better compared to Europe. But at the same time we need to also factor in the maturity of a market to take decisions, outsource offshore and in that context US and UK are far ahead. Continent market is fragmented, but that is a market which is opening up. It is a big market and you cannot ignore the fact that Europe is the second biggest market.

While there are distinctions in terms of market behaviour and opportunities, we believe that both markets have potential and because our revenue base is relatively smaller in Europe we are making a significant investment in Europe to enhance our revenue footprint. I would bet on both. We have opportunities again in our core verticals in both the markets. There is enough headroom to grow in both the markets.

Q: Where there any hiccups in the current quarter in the India business particularly or in the product business?

Purohit: In the products business overall like I gave you the view that we have been continuing to win the deals and build the book of business, some of the most respectable clients across the world have adopted our platforms. Just to give you an example, one of the largest hotel chains in Europe - their complete online commerce system is now operating on top of our commerce edge platform.

If you look at one of the largest life sciences companies we are working with them on a platform which will help them with regulatory compliance. We are very core to our clients, so when you look at the quarter that has gone by we see no hiccups in our progression on the products and platform strategy.

Probably, what you would be referring to be decimal differences in the percentages of numbers, so when we are looking at a small number as a numerator on top of a very large denominator, some minor fluctuations happen because some numbers move back and forth but there is nothing material. It has been pretty good quarter in that sense because we had some very good deals on top of our production platforms.