Infosys: $1 bn, and counting

Infosys has announced strong results for the third quarter and nine-months ended December 2004. However, while the company has upgraded its FY05 EPS guidance to Rs 68.7 per share, a YoY growth of around 47 per cent, the revenue guidance stands reduced at 46 per cent YoY, from 47 per cent-48 per cent as was earlier projected. Consolidated revenues have crossed the $1 billion mark in 9mFY05.

Financial performance (Consolidated): A snapshot...

(Rs m)	2QFY05	3QFY05	Change	9mFY04	9mFY05	Change
Sales	17,493	18,756	7.2%	35,035	51,423	46.8%
Expenditure	11,883	12,576	5.8%	23,585	34,740	47.3%
Operating profit (EBDITA)	5,610	6,180	10.2%	11,450	16,683	45.7%
Operating profit margin (%)	32.1%	32.9%		32.7%	32.4%
Other income	296	463	56.5%	1,216	916	-24.6%
Depreciation	606	739	21.9%	1,723	1,871	8.6%
Profit before tax	5,300	5,904	11.4%	10,943	15,728	43.7%
Extraordinary items	(1)	4		(89)	3
Tax	826	934	13.2%	1,770	2,401	35.6%
Profit after tax/(loss)	4,474	4,973	11.2%	9,084	13,330	46.7%
Net profit margin (%)	25.6%	26.5%		25.9%	25.9%
No. of shares	267.9	267.9		266.6	267.9
Diluted earnings per share* (Rs)	66.8	74.3		45.2	66.4
P/E ratio (x)					29.7
(* annualised)

What is the company's business?

Infosys is India's second largest software services exporter and has a presence in a vast array of offerings, which include software development (22 per cent of revenues) and maintenance (30 per cent), IT Consulting (4 per cent), package implementation (15 per cent), products (3 per cent) and BPO (3 per cent). Infosys' management is acclaimed for its corporate governance practices and has been a source of competitive advantage for the company in its rapid growth over the past years.

What has driven performance in 3QFY05?

Volumes drive topline: Strong sequential growth in the topline in 3QFY05 was mainly a result of growth in both onsite and offshore volumes. While the former grew QoQ by 11 per cent, the latter improved by 13 per cent.

However, there was a marginal negative bias witnessed on the billing rates front. While onsite rates decline by 0.5 per cent sequentially, offshore rates were down marginally. The management maintains that (almost) stability in billing rates is likely to continue going forward as well.

Utilisation rates (including trainees) remained at their 2QFY05 levels of 71.4 per cent. This seems a result of the fact that while the company hired a net of 2,300 employees in 3QFY05, this was almost half of what the company added in the previous quarter and was the lowest addition in the past four quarters.

Now, what is concerning is that the utilisation levels (excluding trainees) dropped by 170 basis points to 79.3 per cent during the quarter. The ultimate reason for this can be the fact that Infosys witnessed a QoQ decline in revenues from its top clients. For instance, the top client, which contributes to around 5 per cent of Infosys' consolidated revenues, witnessed a sequential 5 per cent decline in revenues during the quarter.

Revenue streams: Development disappoints, consulting enthuses!

	2QFY05		3QFY05
	Rs m	% of total	Rs m	% of total	Change
Development	4,391	25.1%	4,145	22.1%	-5.6%
Maintenance	5,108	29.2%	5,646	30.1%	10.5%
Re-engineering	1,137	6.5%	1,144	6.1%	0.6%
Package implementation	2,641	15.1%	2,888	15.4%	9.3%
Consulting	525	3.0%	713	3.8%	35.8%
Testing	997	5.7%	1,144	6.1%	14.7%
Engineering services	350	2.0%	413	2.2%	17.9%
Business Process Management	420	2.4%	525	2.8%	25.1%
Other services	1,417	8.1%	1,576	8.4%	11.2%
Total services	16,986	97.1%	18,193	97.0%	7.1%
Products	507	2.9%	563	3.0%	10.9%
Total revenues	17,493	100.0%	18,756	100.0%	7.2%

Another important facet of Infosys' topline growth in this quarter is that revenues from development services declined sequentially by 6 per cent.

This comes after strong growth in revenues from this segment that was witnessed in the preceding two quarters. Growth in this segment indicates an increasing focus towards discretionary spending, or to put it simply, it means that clients are demanding new software development, something that has taken the backseat during the years of slowdown in technology spending.

The decline in 3QFY05, thus, comes as a surprise. However, one enthusing factor was the strong growth in the company's consulting revenues. It indicates that Infosys is finally witnessing some traction in this high-end services segment, which was missing in the past few quarters. The company added 38 clients in the quarter and the active client base now stands at 434.

Low S&M aid margin expansion: Infosys consolidated margins improved by 80 basis points to 32.9 per cent in 3QFY05. This was largely a result of the decline in sales and marketing expenses. As a per cent of revenues, these expenses were down from 7 per cent in 2QFY05 to 6 per cent this quarter.

This is a sign that the company is able to realise scale benefits of its S&M expenditure made in the past and we expect this to be a guiding force in paring the pace of margin decline in the future. Employee costs increased from 49 per cent in 2QFY05 to 51 per cent this quarter.

Higher margins and other income aid net profits: Apart from the expansion in operating margins, as discussed above, a higher other income helped Infosys post a relatively higher (than revenues) growth in its net profits in 3QFY05. This was largely a result of higher foreign exchange gains (Rs 208 mn) that Infosys earned in 3QFY05, against Rs 64 mn in the previous quarter.

Performance in the recent past...

	4QFY04	1QFY05	2QFY05	3QFY05
Sales growth (%, QoQ)	7.4	12.4	15.3	7.2
Development expenses (% of sales)	52.4	53.1	53.0	52.9
Selling expenses (% of sales)	6.8	6.9	7.0	6.2
Operating margins (%)	33.3	32.2	32.1	32.9
Profits growth (%, QoQ)	2.0	15.8	15.2	11.2
Employees (Nos.)	25,634	27,939	32,949	35,229
Utilisation (%)	70.2	73.4	71.4	71.4

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