Infosys beats expectations on Q2 FY2017, cuts full year outlook

Profile picture for user gonzodaddy By Den Howlett October 13, 2016
Summary:
Infosys beat market expectations for the quarter from good execution but disappointed the market with another reduction in its forward outlook.

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Vishal Sikka, CEO Infosys

When I recently met with Vishal Sikka, CEO Infosys, I went armed with field reports saying that Q2 FY2017 was probably OK. The company was in its quiet period and, despite our long association, he could make no comment, which I have to respect.

Even so, I got the sense that he was relaxed on the Q2 outcome. It has since become apparent that Infosys has decided to grab the volatile forecast bull by the horns and downgrade its forward looking position for the rest of the year to growth of 8-9%. Analysts might not like it given the high hopes of the earlier part of the year, but it is exactly the right thing to do. Why?

When you look at the many industries that Infosys plays in, there are macro related problems in all of them. Mention on the analyst call was made about the impact of Brexit and the current political uncertainty in the US as factors impacting retail. Utilities, which was a tough market last year is, apparently, in much better shape this year. Banking and financial services took a battering when RBS cancelled their contract with the company and there is continuing softness in that market. Yet despite these concerns, Infosys achieved an across the board 82% (excluding trainees) utilization rate, a solid achievement.

In short, Infosys is operating in a series of volatile markets where things can change rapidly but, at the same time, has plenty of levers it can push and pull to keep revenue and margins on track with expectations. It is also navigating a structural change that reflects the broader changes in the outsourcing markets.

Once again, Sikka devoted most of his remarks to emphasizing the fact the company is moving from a services to a services and software business but reminded analysts of the difficulties attached to this:

Most companies that are managing transformation have the benefit of doing so with a cash cow business as a buffer. We don't have that. Our core business is changing and we have to change within those constraints.

Referring to the recent loss of leaders, Sikka was frank in acknowledging that in a transformation as big as that which Infosys is attempting to navigate, some people make it and some don't but he noted that attrition in the leadership has shrunk from something like 11.5% to single digits and said he is 'quite satisfied' with both the composition of the leadership team and the manner in which the company is executing against what it sees in front of it.

What did that mean for the quarter?

Revenue was up 3.4% to $2.587 billion compared to the previous year, while operating profit was $644 million from $610 million, up 5.5%. Clearly, the company did a good job keeping costs under control and in that regard, Infosys management talked about a reduction in the use of contractors, which is often a drag on profitability. To give an indication of the way in which currency fluctuations are impacting the bottom line, Infosys reported a currency gain of $119 million in the quarter compared to a loss of $242 million last year. Pipeline remains strong with six deals totaling $1.2 billion won in the quarter.

My take

The markets won't be happy with what they heard but they should not be surprised. If anything, I would argue that Infosys is demonstrating remarkable resilience as it goes through a long haul transformation. Setting expectations lower is both sensible and prudent, providing management with a breathing space while it stabilizes both the internal situation and firms up on sales execution under the new organization.

My one concern lays in Infosys ability to break through with its client facing new/renew strategy coupled to innovation such that growth can be accelerated into double digits. On the call, management said it was happy with progress being made to introduce its platform plays including AI, but the problem for Indian heritage companies like Infosys is that they are not seen as thought leaders in the way that firms like Accenture and Deloitte are. That makes it hard for Infosys to command a seat at the top table of even the largest companies with whom it provides services. How Infosys solves for this problem will be a defining part of its journey.