This excerpt taken from the INFY 6-K filed Apr 20, 2005.
Julio Quinteros - Goldman Sachs - Analyst
Good morning. Good evening gentlemen. My question relates primarily to the competitive landscape. Specifically there have been a bunch of scuttle recently about key accounts, increased competition perhaps, low price aggression from some of the players out there. Obviously in the results that you just presented none of this materialized or some of these risks didnt materialize. Can you talk specifically to the landscape and whether or not there are players out there who are getting more aggressive on some of your key accounts?
This is Basab Pradhan. I will answer that in a couple of different ways. One is our competitive landscape as such in the market and the other is within accounts. In the market the competitive landscape is definitely changing. We have over the last couple of years Id say, theres an increasing trend towards a sort of an amalgamation of what used to be the offshore piece of the IT services industry and what was not the offshore piece and now there is just one sandbox and everyone is competing against each other and offshore seems to be the most central thing thats happening to the IT services industry.
So we are competing against incumbent consulting firms, incumbent outsourcers and they are competing against us, on our terms with a global delivery model, very very often. So the competitive landscape is definitely changing. Now within accounts, its not a big shift because within accounts our competition tends to be on our terms so we are quite used to competing against other offshore players on an MSA who have you know, MSAs on the same account and who are competing on particular deals or we are competing to get mind share of the top executives and grow our share of the wallet in that account.
So we are in general pretty confident about holding our own within accounts. Even if it comes down to you know, a bare knuckles fight, we think we should be we will be able to hold our own and we are eagerly looking forward to the competition in the marketplace as well.
Yes, Basab would you be able just to comment on the just the two, perhaps the competitors you talk to specifically about, you know incumbent consulting and outsourcing type companies versus the competition against the pure play offshore guys? Who conceivably is being more aggressive, if you could look at it that way? Are the multi-nationals sort of holding the line or are they undercutting you guys or maybe if you look at just the offshore guys, are the offshore guys are they look at penetrating new accounts, are they being more aggressive?
It really depends on the situation in the account. If lets say a global system integrator is being incumbent, sometimes they can be very aggressive because they want to defend their turf. Whereas you know in another case probably when an offshore player wants to actually enter into an account, they see they are already using Infosys and they want to they can it varies depending on the situation. Just to give some perspective Our largest relationship is more than $80m and at approximately $75,000 average bill rate you can see that, its a fairly substantial relationship and if you look at an equivalent relationship for a global system integrator, it can be anywhere between $130m to $160m. Thats a significant relationship we are growing our relationships.
And maybe one last question for Mohan. The one thing thats a little counter intuitive with all of the wage increases that are flowing through the model is what appears to be essentially a nearly flat operating margin assumption for fiscal 06. Can you just walk us through the levers again in terms of what will preserve a flat operating margin situation when we consider wage inflation for employees and some of the other incremental initiatives that you are actually investing in? You would think that that would lead to a slightly lower margins, but in this case it does not seem to be the case.
We are estimating that cost of revenue should go up to about go up by 0.9% or 1% compared to what it was as a percentage of revenue in 05. This is the impact of the salary increases. The salary increases could be at the level of the cost of revenue, could be around 1.4% to 1.7% because a part of the increase is going to be variable in return and the growth profit level we would estimate a decline of 1.2% to 1.3%. The SG&A is expected to come down by 1%, making good a part of the decline. At the cost of revenue level we do have some leverages in other costs apart from the wage costs to employees. For example, the cost of communication, the post sale customer support which we have etc. At the operating income level we could see a small decline of 0.2% to 0.3%, primarily coming out of the flow through from the cost of revenues.
So even though we are having a flat pricing scenario we are seeing a wage increase. There is enough in the model to optimize. There is enough in the model to get some economies of scale. There is enough in the model in terms of discretionary costs to get us the kind of margins without compromising on the investments that we make. For example, in the last year at the overall level we invested 1.2% extra over what we budgeted back into the business and taking the same commitment that we made last year, we are anticipating another investment of $1.1m in the existing model, because the base of expenses has gone up, especially in the Banking business and in our consulting initiative.
We must also add that Progeon which is our majority owned subsidiary did around $6m in net income last year and this year is expected to go from $42.5m to around $80-81m with a net income of 24% to 25% and after factoring the minority interests we should get about 20%. So on an increase of approximately $38m to $40m we will see an increment of about $10m to $12m.
So if we look at all this we see that Infosys the parent company is highly profitable with high margins. We see one of the subsidiaries coming up to the profitability level of the parent. We see about three subsidiaries, Infosys Australia, Infosys Consulting and Infosys China, who between them could do between $80m to $100m, essentially not contributing to the margins at the parent level and that is having some impact on the margin because we are making investment in these subsidiaries to have new engines of growth.
Understood. And you are comfortable that bringing down SG&A another percentage point doesnt put you at risk of underinvesting for some of the important areas in terms of marketing.
Well, let me give you another way of looking at it. We do have an SG&A of costs for example in Progeon but Progeon is realizing the benefit of the SG&A of costs. The incremental exchange of costs of nearly $38m of revenue is going to be lower. There are large SG&A costs in Infosys Consulting but on the percentage basis will come down because revenues are growing. There are large SG&A of costs in Australia.
So if you look at the revenue base, out of the $2,051m, which is a mid-point within the two ranges, within the subsidiaries will hopefully will be having about something like about 180 maybe $180m, where the SG&A of costs is higher than the Infosys average and since we are going to see the benefits of the investment made in SG&A in the previous year, in the subsidiaries, the percentage of SG&A for subsidiaries will come down this year compared to the previous year. So we are not compromising on growth. We are not compromising on investment but we are getting the benefits of scale.
Understood. And finally, Mohandas can you address the timing on the ADR offering?
Well we finished this year. We have guidance in place. We will refresh the document, the SEC document with the latest information and we are in discussion with our bankers and about what we need to do. We have started a discussion to see what they advise us then we have to go to the Board and we will take a decision at the appropriate time.
Okay, so some of the rumors that you have been cancelled is untrue at this point?
Well the deal has not been cancelled. The deal is alive. The key issue is the timing.
Understood. Thank you very much. Congratulations.
Your next question comes from Joseph Vafi with Jefferies and Company.