Infosys Ltd

NYSE:INFY

Earnings Call Transcript 2019-Q2

[Salil Satish Parekh, MD, CEO & Director]

Good afternoon. Thank you for joining us. I'm delighted to share with you our results. We had a strong quarter in Q2. Our growth in Q2 was broad-based across all business segments, geographies and service lines. Our large deal wins were strong at our $2 billion, with over 60% net new. On a constant currency basis, our growth quarter-on-quarter was 4.2%. Our digital revenue growth was 13.5% quarter-on-quarter and 33.5% year-on-year. Our digital business is now 31% of our overall business, and we see strong demand in various areas of digital, specifically in cloud, IoT, cyber and data and analytics.Our operating margin was at 23.7%. Our Financial Services business grew 5.8% quarter-on-quarter, Retail at 5.9%, Manufacturing at 4.8%, and like several of our sectors, are growing over 10% year-on-year. Our Financial Services business, we saw an improving demand in the U.S., based on our results in Q2. In terms of service lines, we had good traction in business process management, cloud infrastructure services, data and analytics and several other service lines.Our large client growth was strong, with our largest 10 clients growing at 5% quarter-on-quarter, higher than the company overall. In general, the demand environment looks stable. It's good in U.S., strong in Continental Europe and good in Australia. We're continuing our investments in Agile, in digital, in automation and in artificial intelligence. And also in our people, via training and compensation. Overall, we feel positive that our strategy of Agile, digital and automation and AI in core services is resonating well with our clients. And in fact, building more and more relevance for us within our client thinking. The first steps of our 3-year transformation program are being put in place and are starting to show some traction. At this stage, I would like to take this opportunity to thank Ranga for his tremendous contribution to Infosys over the past several years and wish him all the very best for the future. With that, let me hand it over to Ranga for a few remarks.

[Mavinakere Dwarakanath Ranganath, Chief Financial Officer]

Thank you very much, Salil. Hello, everyone. If I were to describe this quarter's financial performance in one single word, it is a blockbuster financial performance and operating performance. Several key financial metrics and operational metrics had a very positive trajectory that retains the revenue growth that Salil talked or the top client growth or the deal wins, the cash generation, EPS growth, many -- and the utilization and so on, had a very positive trajectory; and some of them were really multiyear high in this quarter. Let me start talking about the revenue. First half year, that is 6 months of -- first 6 months of this year as compared to the previous year's first 6 months, the revenues grew 7.1% in constant currency terms. As you know, that's pretty much at the midpoint of our annual revenue guidance of 6% to 8% in constant currency terms. Likewise, if you look at the operating margin, we closed the first half of the year at 23.7%, which is pretty much at the top-end of our annual revenue guidance of 22% to 24%. Likewise, we had very robust operational cash generation in the first half of the year, which was $1 billion. And in line with the capital allocation policy that was announced in April, which is a pay up to 70%, we have announced an interim dividend of INR 7 per share. And this quarter also, our unwavering focus on the several operational efficiency parameters yielded results. The utilization continued to be over 85%, our on-site mix reduced, per capita revenue increased 3.8% year-on-year. Most importantly, the return on equity was 24.7% year-on-year, it expanded by almost 3% as well as the EPS growth year-on-year for the quarter was 5.7%. So overall, it has been a blockbuster financial performance and operational performance for the company. Well, I couldn't have been more happy about this robust financial performance as I complete 3 years as CFO of this company. I would like to sincerely thank each one of you, the investors, the board and all the employees and my team for this wholehearted support you've provided me over the last 3 years. And during these 3 years, we've had very -- the company had very strong and resilient financial performance between fiscal '15 and '18, while the revenues expanded 26%, free cash expanded by 40%. And we had some key events, key significant milestones during these 3 years, like one of the largest share buybacks for the first time for Infosys as well as closure of AP and many such things. I'm very happy and proud of the fact that the company is in a very strong and resilient financial position as I hand over the baton to my successor. With this, let's open for questions.

[Sajeet Manghat]

This is Sajeet here from BloombergQuint. Salil, the first question. Though you came out with a good set of numbers, volume growth at 4.2% on constant currency terms, but you retained the guidance at 6% to 8%. That shows some bit of conservatism. Are you seeing a good traction in term of demand coming in? And -- or is there some tail -- I mean, headwinds, which you are foreseeing that's why you've been very conservative in keeping the guidance of revenue and margins at those levels? The second is, I want a commentary on the BFSI and the North American space? How is it doing? Where -- do you see good traction coming in? We saw revenues from both Financial Services and North America go up marginally by 30 bps -- 30 to 40 bps in this quarter. But can you give us some more idea of the kind of -- or deal wins which we have? $2 billion was the deal win in Q2, what percentage of that was digital and what was traditional order? Just to get a flavor of it.For Ranga, some questions on margins. What has been the impact of currency on margins? And has there been some salary increases off this? [ The Street ] was expecting 100 bps -- more than 100 bps improvement in margins, but it's slightly lower than [ 24% ]. So is there a buffer that you are keeping in for, or some dry order for -- to ensure that your attrition rates come down and you have spend on more -- investing on digital space from there? And Mr. Rao, if you can highlight some of the measures that you've taken to -- with respect to attrition rate and the employee-retention scheme?

[Salil Satish Parekh, MD, CEO & Director]

Let me start with the first part of your question. I think in terms of the demand, we see a strong demand outlook. As I shared, we see good fundamentals in the U.S. market. We see a good macro. We see strong macro in the Continental European market. Our deal wins are strong in Q2, were also strong in Q1. All in all, our view is that this is a fairly comfortable outlook in terms of demand and revenue growth for us. So we remain quite comfortable with where our revenues are looking today. For Financial Services and North America, I'll request Pravin to answer.

[U. B. Pravin Rao, COO & Whole]

Yes. Overall, on Financial Services, after a couple of soft quarters, we have seen growth come back. And the growth has been strong both in Americas as well as Europe. It is on the back of strong growth in existing account as well as new logos. And of the large deal wins that we had, 3 of the large deal wins this quarter was on Financial Services. So we remain very positive about this space. The momentum is strong, pipeline is healthy, and we expect the momentum to continue on the back of the large deal wins this quarter and the previous quarter as well as some of the new logos that we have opened. And coming back to the question on attrition, attrition has marginally come down, but nonetheless, it remains higher than where we want it to be. In some sense, it's a reflection of high demand for talent in this space and also a reflection of the fact that we are putting enormous amount of effort in terms of re-skilling and retraining our people. And to some extent, our people become a very attractive proposition in the market. Having said that, we have started working on several interventions in the last quarter and some of it will continue in the coming quarter as well. We have rolled out more number of promotions. We have analyzed and found out that the issue is, I mean, higher attrition is for people in the 3-year to 5-year experience range. So we're looking at some interventions for those people. We have created new career streams. We have created beta program for people with aspirations to become power programmers, technical architects and so on. So there are multiple things we are doing both on the careers front, trying to address any compensation and benefits-related things and so on. We remain confident that over the next couple of quarters, it should come back to acceptable range.

[Mavinakere Dwarakanath Ranganath, Chief Financial Officer]

Coming to the margin question, yes, sequenced, maybe the margin stayed at 23.7% as compared to Q1. Clearly, we had currency benefits. Rupee, net of the cross currency, benefited us by about 80 basis points. As you know, 70% of our revenues are in dollars, 30% is still nondollars. Then about 70 basis points of additional positive impact came from better pricing and the reduction in the on-site mix that I talked about earlier, so total 150 basis points of benefit. And that was kind of utilized for higher variable pay as well as certain compensation increases that we had planned earlier for Q2. And also to some extent, through looking at the attrition, we had certain interventions that we had to do that accounted for about 100 basis points. So comp increase, plus variable pay and certain interventions, about 100 basis points. Balance 50 basis points was really due to higher subcontractor expenses that we had, to essentially ensure our talent supply chain for the on-site projects does not get impacted. And some of the investments in the localization that we made. So 150 minus 150, so 23.7% stays 23.7%.

[Fatima Mahdi Karan]

Fatima Mahdi Karan from Business Television India. Sajeet, of course, has asked you some of the key questions already, so I'm just going to get into some of the other specifics. As far as your plans, when it goes to investments in digital going forward, could you tell us a little bit more about that; in terms of forward looking, what we're seeing there? Also can you tell us a little bit more about the acquisition of the Temasek subsidiary as well? What exactly you can share with us on that? And also how you're anticipating pricing and volumes looking for the remainder of the year. Because you've talked about how you've -- the sort of reactions you've gotten from different markets, but can you tell us a little bit more about how the picture is looking forward?

[Salil Satish Parekh, MD, CEO & Director]

Sure. On digital, we are continuing to make our investments and there was a plan we had put in place at the start of the fiscal year, which outlined investments which were related to the 5 elements of the pentagon that we've described as our digital focus areas. We're continuing to make those investments. Those investments were staggered across the year, more of them coming in the second half, but equally there were quite a few in Q2. There are 3 big bets we've identified within our digital space internally, and those are businesses we think we can scale up even more rapidly within the overall digital, which is growing at over 33%. We see very good traction for that in the market. So all indications, the investments will continue, the traction is good and we hope to continue to see some good business growth there. In terms of the Temasek announcement, we were really delighted that Temasek has chosen us to be their partner for all the digital transformation that they're going through. In that partnership, the way that they wanted to structure the agreement and arrangement was to keep a part of it for themselves; and the majority sits with us. In that sense, we own the execution of it. We have responsibility to make sure all of that succeeds. So indeed, we are grateful that they've selected us against all our major competitors. And we think that will become a model in the way we execute it, of how we will do work in Financial Services, but across many sectors. In terms of pricing. At a macro level, pricing is stable. We see our digital business showing higher margin, which I think we shared last quarter as well. So overall, we remain quite confident. We have so much investment in automation, artificial intelligence that starts to benefit us in our core service as well. So with a stable pricing and these investments, we see a reasonably bright future there.

[Mavinakere Dwarakanath Ranganath, Chief Financial Officer]

Essentially on the pricing, again, on a year-on-year basis if you look at it on a quarter -- for the quarter, it has been stable in constant currency terms, which we have seen consistently for a couple of quarters. Unlike fiscal '16 and '17, where we had constant currency terms, the pricing declined about 1.5%. It's fairly stable.

[Unknown Attendee]

Let me ask the questions one by one, it's just easier to remember. So Salil, first question to you. If I look at the breakup of digital and core, digital has grown by 13.5% and core services by 0.5%. Is that a sign of things to come, that digital is now gradually going to increase in terms of the revenue mix? And following up to what you had answered on the guidance front, the demand environment looks positive. You seem to be confident, your internals are strong, is it then a given that by Q3, Q4, you will revise your guidance upwards, Salil?

[Salil Satish Parekh, MD, CEO & Director]

So on the digital, as we laid out our strategic direction, we have an intense focus on digital but equally, we have a very strong focus on what we call core services. Our digital today is growing very nicely at over 33%. It's over 31% of our revenue. So we continue to see just the way that growth is, the way our clients are reacting to what we're putting there, we will have a larger and larger share. Notwithstanding that, our core services are also growing. So while it's a smaller growth, it's something we see good traction in. And with some of the observations in the market, some of the large deal wins, we think both digital and core services look to be in a good shape. In terms of the guidance, I'll come back to what we said earlier. We see a strong demand; what Pravin said, we see a robust pipeline. We see good traction in financial services. We see good traction across multiple sectors. So we feel comfortable about where we are with terms of revenue.

[Unknown Attendee]

Okay. You're now going to see if you're going to beat that or revise that upwards in next quarter. Okay, Pravin, a question to you. With respect to the $2 billion deal win in this quarter, can you give us an idea about what verticals that's coming in from largely? Because last quarter, you had said that there was demand in the BFS in terms of large deal wins. And also if you can give us an idea, BFS in this particular quarter, yes, definitely positive at 5.8%; but is that a result of large deal wins? Will that continue? How sustainable is the growth in North America and BFS, in addition to what Salil was talking about in terms of the deal pipeline?

[U. B. Pravin Rao, COO & Whole]

See, in terms of large deal, we had 12 large deal wins, $2 billion plus. First time we have crossed $2 billion. 63% of it is net new. 3 of them come from financial services, 3 of them come from manufacturing, couple of them from Hi-Tech and one from -- one each from several other verticals. So it's been fairly broad based. The growth in Financial Services is multifold. One is, obviously, we are seeing spend come back in North America, which was predominantly soft. We have also seen growth coming back in many of the large accounts where, in the last 1 or 2 quarters, we have seen some softness. We have seen growth come back primarily on account of higher interest rates and so on. So that's -- and also on the back of some of the large deal wins that we have won not only in this quarter but even in the last quarter, we had won a few large deals. We have also opened a fair amount of new logos in Financial Services. It's a combination of things. So as I said earlier, we see momentum both in Americas as well as in Europe. We are happy with the momentum. Pipeline is decent and pipeline is strong. In the near term, not only in Financial Services, within most of the other verticals, we will have the typical softness of quarter 3 where you'll have the impact of furloughs and lower number of working days. But barring that, I think in most -- majority of verticals, we're in a very happy place.

[Unknown Attendee]

So retail could be a concern, given that due to furloughs, we see an impact in retail largely in Q3, Q4.

[U. B. Pravin Rao, COO & Whole]

I think the retail, based on the momentum, continues to remain strong. In the last 2 quarters, we have had good growth. This quarter also, highest growth has come from retail segment. So we expect that momentum to continue. Again, we find broad-based growth both in Americas as well as in Europe. This quarter, I mean not only in retail, Manufacturing, traditionally, in quarter 3, you will tend to see some impact of furloughs and lower working days. But overall, given the momentum, I think we'll see demand again picking up in quarter 4 and beyond.

[Unknown Attendee]

Okay, last question to Ranga. Ranga, this is your last quarter. What is the unfinished task that you leave behind? Capital allocation is something that we've been asking you every quarter. There is a dividend that you've announced. So will Jan be the period that we're going to get the buyback announcement after you leave? And also that 23.7% margin growth, the -- we were expecting it to cross that guided band that you had indicated. So by next quarter, after you are gone, will you be able to cross that?

[Mavinakere Dwarakanath Ranganath, Chief Financial Officer]

Well, I think there are so many questions there. First, let me say that, as I said, there is no task left undone, as you said. I think pretty much if you look at over the last 3 years when we started the journey, clearly, the focus was on very resilient, strong financial performance, and we went through our own kind of focus on that. If you look at any paremeter, for example, free cash flow generation is a record high $2 billion last year. If you look at the ROE, that's 25%. If you look at the capital allocation policy, we returned $2 billion last year, and this year, we said we'll return up to $2 billion. And we had a bonus issue; we had a special dividend. And most importantly, I think the digital momentum and the investments that we had to make and multiple whichever financial dimension that you look. Likewise, in operational metrics, we operated at a very efficient way and built a very superior cost structure, competitive cost structure for us to compete in the market. Utilization is over 85%, on-site mix moderated and, of course, many, many parameters there. Revenue per employee increased again, it's one of the highest in recent years. So there is no un-left, incomplete work to be done. But nevertheless, coming back to your capital allocation policy, out of the up to $2 billion, we've already distributed $400 million by way of special dividend. Balance $1.6 billion, the board clearly said it would distribute for fiscal '19 in a manner that it will be deciding. And of course, in India, there are several aspects that we need to look into how the mode of distribution that, certainly, the decision will be taken at the appropriate time. Coming to the margins. We gave 22% to 24%. We are pretty much at the top end of the guidance, and 3 factors that I mentioned, yes, currency did benefit us. At the same time, we had to make certain interventions on the compensation side as well as for the investments that we had identified. As you recollect, in the beginning of the year, we said that we are going to make certain strategic investments when we reduced our margin guidance compared to last year by 1%. And we had also said the trajectory of those investments will be pretty much in the second half because it will start, but the trajectory will be pretty much in the second half. So these are principally the reasons, while we keep our laser-sharp focus on the efficiency.

[Chandra Srikanth]

Chandra here from ET Now. Salil, questions to you first. In terms of the deal wins per quarter. I mean, this quarter it's been $2 billion. The previous quarter, it was $1 billion. The 2 quarters before that, I think it was an average of $700 million. So what is the average range that one should look forward to when it comes to deal wins from Infosys? Is this going to be the trajectory that we should look for when we assess TCV of Infosys every quarter? Is this going to be the new number for you? How sustainable is this? And if you can give us an update on appointment of the new CFO. Since Ranga's term ends mid-November, by when can we expect an update on that?

[Salil Satish Parekh, MD, CEO & Director]

So on the deal wins, we report what we call large deal wins. These, by definition, are quite lumpy. Some quarters, they bunch up together and there's a cumulatively larger number. And others -- other quarters, they may not be that way. So we don't have -- it's not like revenue overall where you have a much more -- less fluctuation in that. So we fully anticipate that this will fluctuate. We don't have -- it's not easy to predict what the volatility of this fluctuation is. But these are lumpy, large deal wins. We had a very strong $2 billion. We have a good pipeline, but we do think it will be lumpy as we go forward.

[Chandra Srikanth]

Is that the reason why you haven't revised your guidance upwards? Because Q1 and Q2 are your best quarters. Do you expect some lumpiness to come in Q3, Q4?

[Salil Satish Parekh, MD, CEO & Director]

Typically, the large deal wins will have an impact on revenue over the next several quarters. So I don't think that has any sort of only short-term impact. In general, I think on the guidance, our view is we are comfortable with how we see the demand. We are comfortable with how we delivered Q1 and Q2, and many of our sectors are doing well, especially Financial Services. So we have that comfortable position as we go into the second half. They're not connected in any way with the lumpiness. Into terms of the CFO, we made a statement in the press release as well. The board is looking at that with the search. As soon as we have an update, we'll share that with you.

[Chandra Srikanth]

And any reason why you've decided not to contest the arbitration award for the former CFO, Rajiv Bansal? Do you think that's, perhaps, an overhang that you want to leave behind and just comply with the award?

[Salil Satish Parekh, MD, CEO & Director]

Well, we -- again, we have a statement in the press release, which I'll go back to. We have consulted and got legal advice, and we've decided to make the payment as per the arbitration decision, and proceed ahead.

[Chandra Srikanth]

Right. Ranga, in terms of the margins, I know you've given a breakup. But the industry, the way they've been seeing it is that with digital revenues going up, it's also a high-margin business. Do you see that happening for Infosys as well? I mean, this quarter, you had many one-offs in terms of compensation and other factors coming in, subcontracting costs. But now that your digital business is 31%, likely to go up, what sort of impact do you expect that to have on margins going forward?

[Mavinakere Dwarakanath Ranganath, Chief Financial Officer]

Well, I think coming to the digital, it's 31%; and 69% is core IT. And the digital, as we have been -- consistently been saying, though we were one of the last to call out digital, we had a very fair discipline in saying that look, it has to come at a higher gross margin, and it is so. At the same time, on the core IT, we have to -- because of the pricing and other pieces, we have to constantly put the productivity-led improvements in the core IT, whether it is automation, whether it is AI, whether it is increased offshoring and so on and so forth. And of course, the currency is another -- a plain, entire thing. I think what we have done -- for example, if the question is, look, why 23.7% has not -- and we are not seeing above 24%? Clearly, one of the pieces for this year, at least, has been the investment trajectory that we had clearly outlined in the beginning of the year. And that investment trajectory is more skewed towards the second half than the first half. So that is one of the reasons. In the medium term, I think the higher pricing points in digital as well as the higher gross margin that we see in digital, I think that is something that we continue to see at least in the short term to medium. So we don't see much of a concern there.

[Chandra Srikanth]

Right. Pravin, final couple of questions for you. There's been one client less in the $100 million bracket. If you can just clarify for us why that is? And secondly, if I look at your net addition numbers in terms of employees, it's gone up sequentially from 5,798 to 7,834. But can you give us a target for the year? I mean, TCS has gone on record to say that they are going to hire 28,000 people from campus this year, which is a 3-year high for them. So if you can tell us about your hiring numbers as well if it reflects -- if it will go up compared to previous years because the demand has gone up.

[U. B. Pravin Rao, COO & Whole]

On the $100 million account, we had a project run-off in one of the $100 million accounts, so the total revenues in the last 12 months came down. So there is nothing more to read into that. And over a period of time, we'll expect to see it coming back. And in terms of hiring, I mean, we normally don't talk about how many people we hire in a particular year. As we said earlier, the momentum -- we are very happy with the momentum. We continue to expect to see going forward a similar kind of momentum. So...

[Chandra Srikanth]

We will see the net addition numbers go up in a similar fashion.

[U. B. Pravin Rao, COO & Whole]

In a similar fashion, absolutely.

[Unknown Executive]

Thank you, gentlemen.

[Salil Satish Parekh, MD, CEO & Director]

Thank you.

[Mavinakere Dwarakanath Ranganath, Chief Financial Officer]

Thank you.

[U. B. Pravin Rao, COO & Whole]

Thank you.