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"We have been conducting surveys with the top 25 or 30 customers of Infosys, we’ve been conducting multiple surveys and the last one was some time around April 7th or so. Based on the input and wisdom from these surveys and based on the data that we have on hand, the management of Infosys has got an estimate for revenue growth of 30%." - Narayan Murthy, Chairman, Infosys.

The topline grows at over 100% and so does the bottomline in the financial year 00-01. That's great. However, the concerns about the future growth has stuck on a see-saw. The company in question is none other than software giant Infosys. The slowdown in the US economy has put a question mark over the future growth of the company. The concern is not unfounded as it derives over 2/3rd of its revenues from the North Amrican markets. The earnings guidance provided by the Infosys's management has only vindicated those concerns. The management lowers its revenue forecast by 2/3rd, obviously not a small number to ignore. This becomes even more important as earnings guidance by a leading player like Infosys puts in perspective what lies ahead for the sector as a whole, going forward.

In the following write-up we will try to understand what the data suggests and decode the future ahead.  

Decoding growth@30%
Infosys management has forecast a 30 percent growth in topline for FY02. According to the company's estimates, total income for the current quarter ending June 2001 is going to be in the range of Rs 580–590 crore and Earnings Per Share (EPS) will be about Rs 27-28. For the full fiscal, the total income has been forecast to be in the region of Rs 2,500-2,560 crore and EPS around Rs 118-121. This represents a growth of about 30 percent over FY01. 

The guidance given by the Infosys managent is a composite of several factors. The first is the overall economic scenario. The second is the kind of repeat businesses the company expects to get from its existing customers and the growth of those accounts. The third is the new accounts that the company has got and further business it expects from them. And, also the kind of work the company does and the various segments it works in. So, taking all these things into consideration and putting that into a model, the company has come out with this estimate of 30% growth, which it considers to be a very precise guidance.

Volume vs Rate variance - which would drive the future growth?
In the fiscal 2001, for the 103% growth that the company clocked, a look at the growth figures suggests that the growth due to volumes last year was 60%. The rate variance or the growth due to increase in rates, was approximately 41.4%. Next year again, the company is looking at basically volume driven growth.

According to Infosys' management, most of that increase is going to come actually from volume and hardly anything from the revenue productivity or the pricing changes. The company added 122 new clients during the year FY01. Of the 85 clients added during the first nine months, 26 clients were startup clients. But on realizing the high risk this segment was fraught with, the company shifted its focus on more mainstream (brick-and-click) kind of companies. This was reflected when in the last quarter it added 37 clients, of which only five are startups and 32 are from mainstream. This marks the qualitative shift in the kinds of customers that were acquired in the last quarter. This also points towards the fact that in the coming days the growth would be driven more by volumes rather than price increases or so, as traditional companies remain price-conscious.

Increased offshoring and repeat businesses to come handy
The Infosys management has said that the company would require around 3.5% to 4% increase in per capita blended rates, in order to maintain the margins, assuming that there is an increase in salary costs for next year. The company sees a possibility of a couple of percentage points coming from economies of scale or stricter cost control, and the balance from rate increases. However, it says that even if the rate increases do not happen and the per capita revenue is flat, but there is a greater degree of offshoring, then it would be able to protect the margins. What does this suggest is that the margins would depend upon the mix, significantly. But in any case, given a range of earnings, EPS earnings for the next year within Rs 118-121, the company is confident of taking care of any such fluctuations. This confidence stems from the robust model, of computing the visibility, the company has where it can look at the repeat business, which is about 85% and this fiscal it was about 81%. Also,   it keeps itself in constant discussion with its clients, and be a part of the budget cycle, so about 60% of the thing comes from that. Then the company also looks at new segments and that’s how it generally comes up with about 60% visibility for the next four quarters. What, in fact, Infosys has done this time is that it has done that exercise and then it has discounted that by its own estimation of the cancellation rates based on the data that it has had. So the 30% growth rate that the company has arrived at is based on, one, the traditional Infosys estimation model for future revenues, which has been working for the past six or seven years, and then applying a certain discount factor for cancellation.

Gross margins remain intact with no pressure on billing rates
The company has clearly said that there was no pressure on the billing rates because of the slowdown on IT spending worldwide and that the existing clients have not asked for any price revisions. The average billing rate this quarter for onsite work on an annualized basis was about $115,000, and offshore, it was $60,900. The weighted average for the actual mix was $81,000. The onsite billing rate went up by 11% sequentially for this quarter while offshore rates moved up 11.1% sequentially. The blended improved by 13.1% sequentially. The company's net margins stood at 32.1 percent, highest in the industry.

The gross margins onsite were in the range of about 32% to 38% and offshore were in the range between 60% to 70% with the various clients, during the fiscal FY01.  In case, in the future, if the mix were to change, there could be an increase in the gross margins, if the business becomes more offshore-centered. Growth in margins, much like the fourth quarter of the fiscal, will be driven by the offshore business, as more and more new clients are expected to look for offshore works, in the wake of a gloomy outlook on global IT spending.

The company's gross margin in the fourth quarter FY01 rose to 49.6% as compared to 47.3% in the third quarter. That was mainly because of the fact that offshore revenues increased to 51.7% as against 48.6% in Q3 FY01. In Q4 FY01, in terms of the billed effort, that is total software months built, there had been a growth of 9.1%, even though the topline grew by only 5.1%. The reason for the slower growth in topline revenues, as compared to a higher growth in total effort, was that most of the growth happened offshore. Offshore billed person-months grew by 13.1% for the quarter as against only 1.2% onsite, coupled with a blended* decline in per capita revenues by 3.8%, because the company's exposure to the venture capital funded companies did come down in this quarter. The billed effort, onsite for the fourth quarter was 5,188, offshore 11,616, making a total of 16,804. In quarter three onsite was 5,124, offshore 10,272, total 15,396, and increase of about 9% in billed effort months. That means the company billed about 1,408 more person months in the fourth quarter over the third quarter, an increase of 9.1%. That’s about 4% or so, basically because of the fact that there was a decline in per capita revenues, as also the mix changed in favor of offshore. The rate variance for the negative $2.19 million, that is negative 1.9% and the volume variance in terms of revenues was 7%, giving an overall variance of 5.1%. In productivity terms, the Q3 per capita revenue was Rs 6.02 lakh while in Q4 it was down to 5.72 lakh.

* Blended rates refer to weighted avg. billing rates

However, per capita revenue dips
Infosys Technologies' per capita revenue has taken a beating. In productivity terms, the Q3 per capita revenue was Rs 6.02 lakh while in Q4 it was down to 5.72 lakh. This could be attributed, partially, to the the change in the mix of clients the company signed on during the last quarter of FY01.  

Another factor which led to the fall in productivity was the fall in utilization rate. The utilisation rate of the employees including trainees dropped to 64.9 percent in Q4 FY01 from 66.7 in Q3 FY01. The reduction in the utilisation rates was due to the accelerated hiring. However, the utilization rate, excluding trainees in the fourth quarter was 73% and in the previous quarter was 77.6%. Year to date, utilization excluding trainees was 78.3% as against 79.4% the previous year.

Notwithstanding the drop in utilization rates to 73% in quarter four as compared to 77.6% in the third quarter, the company's gross margin moved up. This was due to the fact that more work moved offshore during that period. During the said quarter, offshore revenues moved up to 51.7% as against 48.6%. This coupled with some tough cost control measures helped boost up the margins. This could protect the company in troubled times, as even at lower levels of utilization, the company has shown its ability to retain high profitability. Of the 27%, the employees who were not billed, consisted of the bench as well as people on leave, as well as people who are in management, in research and development, internal IS projects, etc. In absolute numbers, Infosys had a employee strength of 9,831 as on March 31, 2001.

Accelerated hiring a strategic move
Despite the fact that about five percent of the Infosys' some 9,831 employees are on the bench, the company has announced that it would not lay off any employee and believes that this hiring is strategic for tapping new growth opportunities. Also, to achieve the targeted 30 percent revenue growth for the current fiscal, the company needs to add some 2,500 engineers. And, with nearly 5 percent of its total employees on the bench, it  needs to add only 2,000 more. Infosys added about 4,442 employees during the year to take the total number of employees to 9,831 as on March 31, 2001. The company added some 37 new clients during Q4 2000- 01, the highest in any of the quarters. Total number of the clients added during the year stood at 122.

Investments remain a cause of concern
The fact that some of the investments which Infosys made in the technology startups have come a cropper raises serious concern. During the fourth quarter of FY01, the company had to make provisions for its investments in Alpha Thinx, a Vienna Based company operating in the wireless Internet space, which recently filed for liquidation. Earlier, during the Q3 FY01, the company made provisions for its investments in another start-up, EC Cubed, which too filed for liquidation. Infosys made a provision of about Rs 15.29 crore for these investments in FY01.

Visibility for FY02
For the current quarter, the company is said to have a visibility of about 60%. Traditionally the number the company has projected for the year, it always has had 60% to 65% visibility for the year, and it is confident of having the same level of visibility this time also, this is keeping in mind the slowdown in IT slowdown globally.

Estimation Model: what does it tell?
On the existing customers, where the company is seeing cuts, the company's estimation model gives it a fairly good idea about estimating how the cuts would affect external spend and particularly how the cuts would probably affect offshore. It is like if   the cuts are say x percent, which is a small number, then what it is finding is that they gravitate a lot more towards offshore, because here is a viable way, a good way to get their projects executed because the cuts are x percentage. And, as the cuts move to a fairly large y percent its finding suggest that external spend in general comes down, because there is a need to try to make sure that people are preserved and so on and so forth by these IT groups. So it’s really company dependent and the percentage of the cuts dependent, because there is a certain amount of costs that are fixed on infrastructure, there are a certain amount of costs which are fixed on the hardware and software upgrades that they’re talking about, and then of course the people related costs. So the external discretionary spend, most of the cuts will come out from the external discretionary spend. Also, because of the slower pace of the decision making, the urgency has not been there to make sure that that external discretionary spend goes through, even if there is an interesting RoI, simply because the urgency is not so much there because of the competitive landscape is working out. 

Based on the above findings the company's estimates are that it will grow at 30% and based on the various controls of cost, it believes that it wll be able to achieve a net margin of around 30%, lower from 32% recorded in the last quarter of FY01. Further, it believes that it will have to recruit anywhere between 1,500 and 2,000 people, in order to deliver that 30% growth rate. The company says that if the per capita revenue productivity improves by anywhere around 4% or 5%, it still would need approximately 2,600 people or so, which means that the current bench of 1,100 people or so, and adding another 1,500, plus also, it would be very much possible to achieve the growth rate of 30%. 

Cost control to get a thrust
To ensure that the margins remain intact in the future, the company has brought down the salary increases offshore, from 25% last year, to 15%. Then given the fact that the Indian salaries form about 12% of the total revenues, this 15% contributes about 1.8% to the diminishing of margins. The onsite figures, which would be about 25% or 26%, from a 6% or so, in terms of salary increases, would account for another 1.6% impact on the margins. So, the overall figure comes somewhere around 3.4%. This suggests that if the company can get a per capita productivity of about 4%, it couldl be in a position to protect its margins.

A contractually obligated pipeline or a relationship building model?
The company does not have any contractually obligated pipeline, instead it depends on the relationship building model. This involves sitting down with clients, understanding the initiatives the company is participating in and the kind of money that its clients are spending on these initiatives. So on the figures that the company is projecting, the confidence level is that that 60% or 65% visibility is already there.

Derisking@work

Segmentwise exposure
As part of the de-risking strategy, Infosys has reduced its exposure to start-up companies. The start-up and venture capital funded companies accounted for seven per cent of the total revenues for Q4, down from 9.3 per cent for Q3. E-business engagements comprised 25.8 percent of revenues in the fourth quarter as against 28.3 percent in Q3.

Geographical exposure
Region-wise, North America accounted for 73.5 percent of the company's revenue during the year, down from the previous year's 78 percent. The contribution of the European market went up from 14.8 per cent in the previous year to 18.8 per cent in the year under review. Revenues from rest of the world went up by 0.5 per cent from 5.8 per cent to 6.3 per cent. Revenues from fixed price projects came down by four percent to 28 percent while the time and materials' share went up by similar percentage to 72 percent.

Client concentration
The exposure to top client accounted stood at 6.8% in the Q4 FY01, lower from 7.7% in the previous quarter. The company's exposure to top five clients stood at 26.4% in the fourth quarter of FY01 as against 28.1% in the previous quarter. However, the exposure to the top ten clients went up to 43.4% as against 42.5%, during the said period. The reason for this was the fact that the growth in the Q4 FY01, essentially came from client six to ten, as compared to the previous quarter.

* "This quarter" refers to the quarter ended March 31, 2001
* "Last quarter" refers to the quarter ended December 31, 2000

Change in client's profile
To protect itself from the vagaries of any slowdown in future and expand its client list, Infosys management has indicated the its client's profile could change so that the ratio of new business to repeat business becomes higher. It is to be mentioned here that Infosys' top ten clients are in telecom and financial services and they have been the worst hit.

Relationship model to augment future growth
Towards the end of March 2001, the company saw some good traction in customers signing off, taking decisions, a few interesting size projects. But the bulk of the customers that the company has signed on are on the basis of classic relationship models, where Infosys will start off with one or two projects or engagements and then would typically tend to ramp up. In most of its customers,  looking at historical perspective, Infosys had tended to ramp up in the third or fourth quarter, after the engagement has started.

Growth challenged
The two segments in which Infosys is active have taken major hits in the recent times. One is the Telcos (Telecom Companies), essentially the telecom equipment manufacturers. The company's major clients from the sector like Nortel, Lucent and Cisco, are going through troubled times. Another sector which is facing a tough time and where Infosys is doing a fair amount of work is the financial services industry. In the financial services industry, the two areas, which have gotten particularly badly hit are Investment Banking and Asset Management / Broking kinds of companies. So what exactly the company is seeing is that it will be growth challenged in these segments as currently together they account for over 50% of its business (see the table Revenue by Industry Class). However, the company is finding fairly interesting traction in new customers wanting to sign on with it. Surprisingly all of the new customers that are signing on are also broadly in these segments. But the company is confident as it says that these new customers are signing on with it, are signing on with a clear understanding of the reasons why they’re getting into it currently, which means that they know what the environment is and they know that they want to do strategic offshoring kind of initiatives.

* "This quarter" refers to the quarter ended March 31, 2001
* "Last quarter" refers to the quarter ended December 31, 2000
* "This quarter last FY" refers to the quarter ended March 31, 2000

growth@30%, sounds reasonable 
Though it would be too early to say that company's earnings guidance is a bit too conservative, the way US IT companies have been issuing profit warnings and have been announcing layoffs, it does lead one to believe that in this bleak scenario, achieving even a 30% growth rate would require tremendous efforts. 

Amit Singh

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