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Infosys' Last Quarterly Results Before Arrival of New CEO: Any Surprises?

What do Infosys’ Q1 FY 2015 results indicate about its current performance and its general health as a new CEO arrives? (a full breakdown of the results are available here)

  • Revenue growth of 7.1% was in the 7% to 9% guided range for the full year, albeit at the low end. This was the third quarter in a row of decelerating growth, in both reported and constant currency growth (6.6%)
  • Operating margin of 25.1% was up 162 bps y/y, down 40 bps sequentially. At the beginning of the quarter, the company had indicated that operating margin for the quarter would drop by 220 - 250 bps due to the impacts of wage increases (6%-7% for offshore employees; 1%-2% for onsite), visa costs and rupee appreciation. As it turned out, two factors limited the operating margin sequential decline to 40 bps
    • A 3.4% improvement in utilization
    • A change in the company’s reporting of the useful life of certain assets (to longer depreciation time frames) to comply with the new Companies Act. This accounting change had a 110 positive bps impact on operating margin this quarter and should benefit FY15 overall margins by ~80 bps.

So, at first glance, a reasonable quarter, but the slight slowdown that we have noted continues.

Among the positives this quarter:

  • Some service lines had a particularly strong quarter, notably IT infrastructure management and testing services, both of which were back to (NelsonHall estimated, in US$ terms) growth of over 20%. Overall, most of the y/y growth this quarter came from Infosys’ ‘BITS” (Business and IT Services) lines, reflecting ongoing market demand for opportunities to take out costs and restructure existing IT spend, or initiatives to ensure meeting compliance demands - - with discretionary spend opportunities continuing to be spotty according to vertical
  • Looking at the verticals, the revenue engines continue to be manufacturing and banking & financial services (between them contributing an estimated $93m of the incremental $142m in revenue. And Infosys’ telecoms sector business had a particularly strong quarter: last quarter, we noted seemed to stabilizing: this quarter saw its best topline performance for over four years, with a (NelsonHall estimated) y/y growt of nearly 10% in dollar terms
  • On-site volumes were up 2.2% sequentially, indicating increased project start-up activity.
  • Utilization (excluding trainees) is back in the 80-82% target range
  • Infosys signed five large deals with a combined TCV of $700m (of which three in the Americas)
  • Pipeline has improved.

A pressing issue is attrition: TTM attrition has been steadily increasing for the last eight quarters; Infosys acknowledges that attrition is “a matter of concern”. The company is seeking to address this by introducing a quarterly promotion cycle to promote eligible employees quickly, also a fast track career path for high performers and increasing the variable payout. The level of attrition (TTM is now 19.5%) is arguably less important than the caliber of people who are departing: if it is the high performers who are doing so, the impact is obviously greater. The high number of senior execs who left the company after the reappointment of N. Murthy - and his subsequent comments about the capabilities of most of them – cannot have helped general morale, and a short term priority for incoming CEO Dr. Sikka is clearly employee morale. But the measures that have been introduced, combined with the end of the period of uncertainty about the selection I the next CEO, should help in reducing attrition over the next two quarters.

And Infosys’ PPS business continues to be soft, with Finacle in negative growth and the platforms business yet to deliver any substantive contribution.

Departing CEO SD Shibulal took the opportunity of the earnings call to highlight that when he took over in August 2011, Infosys was also faced with some company-specific issues (including investigation by the U.S. Attorney’s Office and U.S. DHS relating to visa matters; this would have been a huge distraction for management). Less well known is that the company had a shortage of onshore resources and had to increase its usage of subcontractors. He reminded listeners that the company was also in the midst of putting new organizational structures in place in support of its ‘Infosys 3.0’ transformation. During his tenure, Infosys made its first ever strategic acquisition: Lodestone Consulting. Equally important is that Infosys is, at last, making the investments to strengthen its (local native) onshore business development and account management capabilities. Of the ~300 people that Infosys announced it was looking to hire from business schools, 172 have been hired to date. And it has also hired ~150 account managers. Arguably, Infosys should have made these investments earlier (the model has so obviously worked well for Cognizant) – but the positive news is that it is doing so now.

So, what shape is Infosys in as Dr. Sikka takes over? While this quarter was perhaps not as strong as H2 FY 14, the company continues to put in the groundwork in a range of initiatives to improve its competitiveness. Overall, SD Shibulal’s claim that “Infosys today is stronger than what it was few years back” is merited. Under Dr. Sikka, we expect the focus to shift from correcting cost structures to investing in pursuit of growth. As a reminder, Infosys is sitting on a cash mountain of nearly $4.2bn.

(see also: "What Does its Selection of CEO Indicate for Infosys?": http://research.nelson-hall.com/blogs-webcasts/nelsonhall-blog/?avpage-views=blog&type=post&post_id=198#sthash.oCJaH6UW.dpuf)

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