Infosys Ltd (INFY) 2003 Q1 法說會逐字稿

Good morning, ladies and gentlemen, and welcome to the Infosys Technologies conference call for the first quarter fiscal year 2003-2004.

At this time, all participants in a listen-only mode. Later, we will conduct a question-and-answer session. This call is being recorded at the request of Infosys Technologies. Participants who have any objections to such a recording may disconnect at this time.

I would now like to turn the call over to Mr. P.R. Ganapathy, investor relations officer. Mr. Ganapathy, you may begin.

Thank you very much, Alsa. Morning and hello, ladies and gentlemen. Thank you for joining us to discuss the results of the quarter ended 30 June 2003, which is the first quarter of our fiscal year 2003-2004.

I have with me from a conference room in Bangalore, in India's telecom plateau, Mr. Nandan Nilekani, President and CEO of Infosys, and members of his senior management team. We'll start with some comments from the management team on the results of the quarter and then we'll open up the call for questions.

Before I hand over the call, I have a customary duty to perform in reminding you that anything we say that refers to our outlook for the future is a forward-looking statement and is therefore subject to risks such as those listed by our filings with the SEC. You may read those filings at www.sec.gov.

With that I'll now turn over the call to Bangalore, Mr. Nandan Nilekani, President / CEO of Infosys.

Thank you, and good morning, and good afternoon everybody, and welcome to this call on the Infosys results for the first quarter ended June 30, 2003. We like to welcome all of you.

We have had decent results for this quarter. We had first quarter revenues of $233m, which is up about 49.26% from the corresponding quarter last fiscal, and earnings per share has gone to 44 cents as opposed to 33 cents in the corresponding quarter in the last fiscal.

This quarter we have added 22 new clients to our client base, and in terms of employees, we have had a growth addition of 2,175 employees, including more than 300 laterals, and a net addition of 1,739 employees. In this quarter, we have had strong growth in volume which has exceeded our initial expectations which has led to the higher revenue and the higher earnings from that guidance.

We have had a change in our offshore mix. It has changed by almost 2% because the volume growth has about 14% volume growth has been in the offshore bill amendment for services as compared to 6% for the on site bill amendments, and this has contributed to a 2% work in the offshore.

We also had a number of other initiatives to improve our efficiency and reduce our efficiency and discretionary expenditure and optimize it. We have reduced some of the costs of our on-site subcontractors, we have reduced some of our on-site non-billable people, and we have done other rationalizations which have been able to generate savings. At the same time, we have used the savings to pay for higher salaries for our India based employees. So a substantial part of the savings from our various initiatives have actually been flowed back into the organization in terms of increased salaries for our employees. I think that is something which we have been able to do well this quarter.

We have also proactively hedged on net receivables with forward contracts to mitigate the impact of our position on the margin, which Mr. Pai will explain in detail later.

Our business opportunities continue to grow as offshore becomes mainstream. At the same time, I think the pricing continues to be challenging, the economy continues to be uncertain and we believe that we will have to look at the future with some amount of caution at all these developments.

With all the changes that have happened, we have also revised our guidance for the quarter and for the year. We have given a guidance for the quarter ending September 30th of between consolidated net revenues between $237m to $239m and for the year between $966m and $982m. On the earnings per ADS, we have said earnings for quarter ending September 30th at 45 cents per ADS and between $1.81 and $1.82 for the fiscal year ending March 31, 2004.

Now, essentially the original earnings guidance was between $1.70 to $1.73. So our revised earnings guidance has been $1.81 and $1.82, and these can really be attributed to two things; the scale benefits we think we'll get on enhanced revenue which we think will give us about 7 cents, within 5 to 7 cents, and the reduction in tax which we estimated earlier at 5.3% is now estimated at 4.8%. That's giving us about 4 cents. So both these things two put together have contributed to the enhanced earnings estimate of $1.81 to $1.82 for the quarter.

The other thing is that, from a macro perspective, the two changes from our last call of April 10th have essentially been the cessation of hostilities in Iraq and the SARS crisis no longer being an issue, as most countries in the world have now been declared SARS-free. Apart from that, I think the other part we talked about remains the same. That is, offshore growth becoming mainstream, pricing pressure, the economy remaining uncertain and growing competition from global majors.

With this I request my colleague, Kris Gopalakrishnan, Chief Operating Officer, to give some more details. Kris?

Thanks, Nandan. Looking at utilization. The utilization, excluding trainees, have been 83.9%. This is up from the previous quarter of 82.1%, but including trainees, the utilization has actually gone down from 77.8% to 77.3%. Right now it's 77.3%. So we have actually added more people this quarter, and that shows in the utilization including trainees. This gives us a cushion for the future.

Fixed price projects have come down marginally from 37.2% of revenues to 35.9% of revenues. On site, of course, has come down. In revenue terms, it has come down from 55.5% to 54.2% and if you look at the clients, the number of $14m clients have gone up to three from two $30m clients to four from three and $113m clients, the top client contribution to revenues is 5.7%.

The software revenues grew by 7.7% this quarter. This growth is comprised of volume growth of 9.6%, and a price decline of 1.9% compared to quarter ending March 31, 2003. We have had client additions in all the sectors, all vertical segments we are working on, the financial services industry, in manufacturing and automotive, in retail, in banking, et cetera.

We have continued the good performance in Proteon. We have two client additions in Proteon.

Mohan?

Thank you, Kris.

We'll talk about the margin as far as prices go. In the services area, on-site declined by 0.9%, offshore by 0.4% and blended by about 2.5%. Products came down because the (INAUDIBLE) bank condition came down. But for comparison purposes we will take services because the volatility will be less.

If you look at the gross profit, the gross profit is at 43% (INAUDIBLE), as it was 43% the previous quarter, but human interest cost has gone up to 42.9% and this increase has been mitigated by decline in subcontractor cost to 2.4% from 3.6%.

Depreciation has come down to 3.7% from 4.8%. This is an increase in other costs like software purchases, customer support, et cetera.

SG&A expenses have gone up 15.1 with sales and marketing going up to 7.5, but G&A expenses have come down from 8.1% to 7.6%. The sales and marketing percentage as a percent of revenue is 7.5%.

If you look at operating profit, operating profit is 27.4% as against 27.5. Other income basically arises from treasury and exchange differences, and we have had exchange differences of 0.7%. (INAUDIBLE) has appreciated by an average of 1.5% for the quarter. On a quarter end-to-quarter end basis, it's appreciated by 2.4%.

So the impact of appreciation of the rupee of 1.5% and the impact of the appreciation of rupee for transition purposes of 1.6% as mitigated by gains and forward contracts. So we have covered forward for the entire three foreign (INAUDIBLE) as we get into India so that we could mitigate this risk. For the next three quarters, we have more than $250m going forward at an average rate of about 47.03. So unless we have a translation adjustment which is a large negative, I think we are hedged some part of the (INAUDIBLE) gains that we could make.

We have provided for two investments satisfied of 0.4m and for (INAUDIBLE) corporation of $1m. Totally, $1.4m has been provided. Our PBD has come down to 29.7%, and tax as a percentage of revenue is about 4.8%, and I think I'm going to explain that for the rest of the year the tax portion be around 4.8%. So net income is about 25%.

I will end now, and if you have any questions, I'll answer them as we go along. Thank you.

Thank you. We will now begin the question-and-answer session. If you have a question, you will need to press the "1" on your touch-tone phone. You will hear an acknowledgement that you have been placed in queue. If your question has been answered and you wish to be removed from the queue, please press the pound sign. Your questions will be queued in the order that they are received. If you are using a speakerphone, please pick up the handset before pressing the numbers. Once again, if there are any questions, please press the "1" on your touch-tone phone. One moment, please.

We have Mr. Gupta from ABN Amro. Please go ahead.

Hi. I have a couple of questions. One is, could you give us an update on the development in the new services alliance that you have started? Mainly as to integration as you are also saying, et cetera.

Second is, given that a new development is taking place in the technology field that Microsoft established has started dispensing in 2004, is there any plan, similar plan at Infosys management also? Thank you.

There are a number of new businesses that we started over the last three to four years. If you look at enterprise solutions, it was started a few years back, and that has good traction. It has been going well and has been doing well over the last years. Even though at this point in time, the environment is not very supportive of consulting. Other than that, the technology consulting and various other consulting practices which we have are doing fairly well.

In the last 12 to 18 months, we have started three new services. One is IMS, which is increment management services, providing the most interest to management for large customers and, you know, we have a full stage process for introducing a new service, which is the idea of conceptualization which is refinement and result.

It will take about 18 to 24 months. They are now reaching the end of the final stage. In fact, by the end of this financial year, IMS and the other two services, which I will mention, will be in the roll-out stage.

The other service is system integration. System integration, today's focus on building solutions. We have rolled out, I think three solutions so far. One is (XP roll-out). A second is an identity management solution which they are about to roll out, is being built along with one of our Reliance partners. Another new service that we introduce is IVS. IVS is independent validation service, and that also is doing fairly well.

If you look at this year's revenue, I think the new services that were introduced last - 12 months back, that is, 12 to 18 months, would contribute probably about 5% of the revenue. Thank you.

Regarding your question on stock options, yes, we have seen some interesting developments taking place about stock options, including the Microsoft announcement. We are closely monitoring the situation, but we have nothing else to say at this stage.

Thank you very much.

Our next question comes from Mosha Katri from S G Cowen. Please go ahead.

Hi. Good morning. Mosha Katri at SG Cowen. I have a three-part question. One, can you talk about your ongoing relationships with your existing legacy client base?

I'm assuming one of the reasons for your pricing or margin pressure in the past year or so was from repricing of those engagements. If that's the case, where are you in that process? Are we 70% done? Or where we are, that's number one.

Number two, you haven't spoken a lot about volume discounts this quarter. Maybe you can address that as well?

Then lastly, again, we haven't heard a lot about competition or competitive concerns from you. Could it have been that, you know, our concerns or the market's concerns over the intensifying competitive environment offshore has been a little bit overblown? Thanks.

Hi. This is Basab Pradhan. The first two questions, really we see them as the same, two sides of the same question, which is our rates getting mark-to-market in the sense that the market rates have been soft in the last few quarters and therefore clients have taken that opportunity to sort of mark down our rates as well.

Now, because it's a mark-to-market, it depends on where the market rates go, and we don't have a crystal ball to see where that will go in the future, but most of the adjustment has happened already.

So you've been able to flush it out at this point?

Yes. And whatever is there, whatever we expect is incorporated in our guidance.

Okay. Can you talk a little also about my third part of the question?

Yes. Actually, I just close out on this part. You see in our model and in our guidance, we have assumed in April 1% decline in our revenue productivity, which was a composite of both price cuts from existing customers as well as newer business being contracted at lower prices, as well as changes in service mix.

Our actual price productivity dropped this quarter, was, as Mohan mentioned, .9% on onsite productivity and .4 on offshore productivity. On the blended business, it was 2.5, not because of the price cut but because the mix went towards offshore. So we have continued to estimate 1% per quarter price cuts, a revenue per decline for Q2, Q3, and Q4 and we think we have factored all the factors that you mentioned in that estimate.

Coming to the second question, it's really for others to discuss, decide whether it's overblown or not, but there are two points of view that we are articulating. One that the global delivery model is not something that you can create overnight. There's tremendous intellectual property involved, there is tremendous process technology know-how, knowledge management, client facing capabilities, and also an organizational structure that where a project that is done for a single customer throughout the world is done seamlessly by teams that are well networked with each other. Therefore, for somebody who wants to replicate that, there are many challenges and it's not just a question of having a bunch of guys in some part of Bombay or Bangalore.

The other point is that for income banks, we believe that the more work is more offshore, it will drive the revenue per employee down and therefore, the revenues will actually go down. We also believe that the SG&A costs will become even more difficult to support and therefore, it will have some disruptive influence on their business.

So these are the two things that we see, but whether the threat is overblown or not is something that you have to assess.

One more follow-up. I think you provided guidance for earnings and revenues for fiscal '04. Did you provide any guidance for gross or operating margins for fiscal '04?

I think if you look at the predictions in the earnings, you'll find that what we estimate is possibly a decline in our operating margins. The operating margins will be -- is currently about -- operating income is 27.-

5.

Yeah, 27.5%, and it will be possibly in the range of 1% to 1.5% as we go along for the rest of the year. We are trying to mitigate the impact of any pricing decline by getting benefits of scales in SG&A and also in other cost of revenue. We also think that the salary cost will balance out over a period of time and the increase of 1.5% we saw this quarter could well come down to something like 1.2%, 1.3% as the mix of people changes.

That's great. Thanks a lot.

Our next question comes from Ani Dange from CLSA. Please go ahead.

Hi there, Aniruddha Dange from CLSA My question is to Basab mainly. What are you observing when you are negotiating with clients in terms of the IT spending, as well as the pressure for the cut costs and for the cut rates? And secondly, what proportion of projects are you seeing competition coming from the MMC as well setting up shop in India? And is that competition being generated from India, or is it from the U.S. officials of these MMC's?

Okay. Aniruddha, first question. You are talking about really what's happening in the market, IT spends and so on.

Yes.

So IT spends are flat to down. They have been and, you know, some analysts this year say that it actually might be up, but who is to say what will actually happen? But what we know is that clients are extremely focused on getting cost savings. This is no different from the last two or three quarters. So we're now in familiar territory, if you will, and in a way, it's good news that it's not getting any worse. That's all I can say. But we'll have to see how the next few quarters pan out.

On the competition side, in our core business of strategic sourcing, we are seeing global system integrators, but not as much as we see Indian competition. That's our traditional competition, and in most strategic sourcing deals we see Indian competition, that's the usual companies.

So maybe in, say, 20%, 25% of the cases is where you see MMC competition?

Less.

Okay. My second and last question is that basically over the last few quarters, if I have to just see the absolute numbers, you have added about 800m rupees every quarter in terms of revenues. What could lead to our addition in revenue over the next three quarters, which is less than this number? If the U.S. situation remains status quo, then what could be the factors which could lead to a drop in growth or drop in absolute addition in revenues?

Rupee appreciating, because 89% of the billing is in dollars and because of the appreciation from 1st of April to the end of this quarter, first quarter, we're already seeing a decline of MMC, 95 to 98 per rupee for the rest of the year. Two, not much growth in volumes. I mean, it's a no-brainer. Not much growth in volumes.

Do you see that happening, I mean, because percentage, too, I understand that the base effect kicks in, but in absolute terms, do you see that the volume growth could be all the volume, addition could be lower compared to the last three, four quarters?

I think we want to stick to what we have said regarding this for the next three quarters, until the next three quarters.

Okay. Thank you.

Until the next quarter at least.

Your next question comes from Sandeep Dhingra from J.P. Morgan. Please go ahead.

Hi. Good evening. Congratulations once again on a great quarter. A couple of questions. One is, are you seeing any change in customer behavior in the last few months? In the sense, are you seeing more urgency to offshore, are you seeing any of the project ramps which were slow being able to pick up? I mean, any change in the way customers are behaving?

Well, the answer is if it's in the last three to six months, I would say no. I mean, the pressure on savings, cost savings, is high. The direction is offshore. The insistence on business cases before IT spends, it's constant in the last six months. I don't see anything new in that direction.

And in customer ramps, one of the issues in the industry we've heard often is the ramp-ups have been slow. Are you looking at the growth in the last couple of quarters? Do you think you are seeing your ramp-ups live up to schedule or are you satisfied with the way customers are ramping up?

Actually ramp-ups have been quite rapid. So I wouldn't say that we're dissatisfied with our ramp-ups.

Okay. Another point I think which was made on the morning phone call was that you said incremental profitability for, you know, on new contracts has been improving. Now, I just want to put that in perspective. Is the incremental profitability better than the current average or lower than the current average, if you could throw some color on that?

We did not make that statement. What we said was on incremental revenues, the margins are the same as are existing revenues. We should see a time when, on incremental revenues, the margins were less. This time at operating levels, the margins are almost similar, at the net level it's higher because of lower tax. That's what he said.

Okay. So basically, you are saying is the incremental revenue margins are similar to current average?

Yes, that's what we said, but we have to watch out for the trend because, you know, some of the expense optimization benefits are there. Some of the salary hikes are also input to manage that to slightly more than that. So, you know, but at this point in time anyway, there is no further decline that we have seen compared to the last quarter.

Sure. And just on the hiring side, I think you mentioned you had a lot of (INAUDIBLE) join in the last quarter. If you look at developing history, we've generally had (INAUDIBLE) join more in the July, the July-September quarter. So is this a change in trend? I mean, did you (INAUDIBLE) joining dates earlier?

Hi, this is Kay Mahia. The pressure to lateral ratio continues to remain at about 80/20, which is our general pattern.

Okay. Have you got any sense on how many offers you made last year and how much you've exhausted?

Last campus we had made some offers. They will start coming in July, August, September, et cetera. Some have already come in June. So it depends on the universities.

Okay. Any hiring targets for the year that you can share with us?

For the year, we're looking at 2,500 to 3,000.

Okay. Thank you.

For the rest of the year.

Okay. Thank you.

Our next question comes from Girish Pai from SSKI Securities. Please go ahead.

Hi. This is Girish Pai from SSKI Securities. I had a few questions on your margin. You mentioned cost optimization as being one of the reasons why your margins have moved up. How much more leeway do you have on that? How much more can you cut costs or optimize costs to improve margins from here on? We said expense optimization, and the difference as we see it is cost could be something that you see you could cut which could hurt you, but expenses basically discretionary - are where the values aren't great. So what we have done is rationalize and optimize expenses.

How much more can we do? Well, we have a group set up. We look at various sets of expenditures constantly. We also have an activity-based costing system that we use to work, and all this makes sure that our eye is right on the ball. I cannot give you a number right now but all I can say is that we are working on that and it's a continuous process. Just one in term, on the subcontractor costs, that's been reduced by about 120 basis points quarter on quarter. Do you see further cuts coming through there going forward? What do you have put in place in the company to actually bring that number down?

This quarter at the gross level, we saw a benefit of about $2m in net. That means we are replacing them with our own employees. Net benefit has been about $500,000.

Now, going forward, we have done one more thing which is in some cases renegotiate with some of these subcontractors. So, we may see marginal benefit continuing, you know, on the renegotiations, but as we replace them with employees, we should see some more benefit there. We have not quantified it at this point.

Okay. Is there any pricing discipline emerging for the last three months? Do you see some kind of pricing (INAUDIBLE) amongst the different players, or do you think the competitiveness continues and competitive intensity continues to remain the same on pricing?

Yes. I think there is some convergence in what companies are quoting and then negotiating and settling for. So, you know, you can call that discipline or just sanity, I guess.

Okay. Just one last question.

You know, the Iraq war and SARS situation created some shut down problems. Do you think it's going to have an impact on volumes with a lag, you know?

Thankfully it was short. So we see customer visits picking up and everything. So I think we should be able to mitigate it. I'll let Nandan answer that.

Yeah, I think basically what happened was we had a complete slow down of visitors from around, say March 15th to May 15th, but since then I think the visits have resumed and going back to prewar levels. But in any case, I think the impact of that and all that has been factored into the guidance.

Okay. Thank you.

Our next question comes from Ashis Kumar from Breen Murray. Please go ahead.

Yes, good evening. A couple of questions actually. Have you walked away from any sizable opportunities recently due to margin considerations? And then I've got one or two other questions.

Yes, we have.

Okay. You've indicated that pricing declined quarter over quarter by 1.9%, and in the quarter just prior to that I believe the number was 5.1%, right? Does this indicate that, at least on a sequential basis, the decline in pricing is sort of flattening out?

The pricing decline actually was .9% for our on-site billing and was .4% for our offshore billing.

On a blended basis it fell by 2.5%, but that was because the mix changed and the offshore ratio went up by 1.9%. So it's really a blend change rather than a price impact.

I think it's difficult to say whether it stabilized. We do believe that a fair amount of it has been flushed out, but I think given the uncertain economy that we are in and customers' profit pressure, we can never really take a 30-day view on this.

Okay. And the provisions that you talked about in the quarter, is that an after-tax number?

The provision is before tax because we made a valuation at low end for the investment at this time because we already had some, you know, differed tax assets on the balance sheet, and we made some valuation on those.

But these revisions did run through the P&L?

Yes, at the gross level.

Okay. Finally, the 98% repeat business seems a little high. Can you explain that, what one should expect and what caused that number to be as high as it was?

Actually, when we define that, we define new business as a business that we have got in this financial year. So typically in the first quarter of the financial year, it's similar. In fact, if you look at last year, same quarter, it was higher than this year's first quarter. As the quarters progress, as we count new customers from April 1, it sort of goes down.

Okay.

So I think I wouldn't worry too much about it.

Thank you very much. Good quarter.

Our next question comes from George Price from Legg Mason. Please go ahead.

Thank you very much. I guess I just want to clarify a couple of things.

First, I think from the prior comments that you've made, just that new incremental deal pricing is not falling any further; it's stabilized. If you can just confirm that.

I mean, it's hard to make a statement across all services vertical, but by and large, that is accurate.

Okay.

I guess you talked a little bit about the traditional competition. You know, maybe if you could give a little bit more color in terms of what some of the larger companies, Accentures, EDS's, et cetera, are doing in terms of the pricing that they are going to market with and, you know, are they gaining any traction? Is that having any impact?

Well, as Basab mentioned earlier, in most of the strategic sourcing deals, the competitive sectors really are local brethren and not so much the international companies.

In cases where we are competing against them, we do believe that they are willing to be quite aggressive on the offshore prices, and we have a couple of anecdotal evidence of that but not really a pattern that we can discern. But I think it's also possible, and this is just a speculation that where they want to prevent the entry of Infosys, then it's possible that they are taking an even more strategic view on the loss leader pricing.

Okay. How about on the people side? Obviously there aren't really any of the larger firms that have the kind of scale there that you have, but still they seem to be pretty aggressive in terms of the hiring that they intend to over the next year or two. How are they doing in terms of competition for talent and people?

You mean hiring in India?

Yes.

Yeah. Well, I think certainly they have become part of the landscape, but I don't know whether underground hiring is what's in the bulletins.

It's there, but I think we have encountered this kind of recruitment competition for the last 15 years because multi-nationals have been coming to India and setting up software facilities from 1987, whether it was Texas Instruments, IBM, H.P., Verifone, Oracle, Novelle, et cetera. So we don't see this as being particularly different from that.

The other thing I want to just add is that, as we mentioned earlier, a large part of the savings that we got from our efficiency and cost drive actually flowed back into the system by increasing the Indian salaries for a large number of people which we believe is part of the retention and effectiveness part of Infosys.

And that actually leads to my final question which was on the salary increases, did you quantify what that was exactly, what kind of salary increase?

The entire salary cost went up by approximately about 0.9% in terms of dollars for delivery, from 42 to 42.9. As far as the sales and marketing is concerned, it went up to 4.6 to 3.9 because of larger bonus accrual because the variable to date is higher, and I think this captures all the cost increases, but we have realized some benefit from the reduction of on-site spend. So if you max it out, the salary costs have gone up by 1.5% of revenues.

Okay. Do you think that salary increases, are you going to have to see additional salary increases, or is this kind of it for now?

Well, I think we said earlier that salary increases for this year as a percent of revenue will be between 1% to 1.4%, in the first quarter it's 1.5%. And as the quarter goes on and more and more people join the average salary tends to come down a little bit. We should be in, like I said earlier, at about 1.2% - 1.3%.

Okay. Thank you very much for the time.

Our next question comes from Sar Deep from UBS Warburg. Please go ahead.

Yeah, hi. I just want (INAUDIBLE) is very strong. Now is it, focus on certain verticals or is it fairly broad based across the verticals that you have seen plans ramping up?

This has been fairly broad based. But in terms of geography, we have seen actually more traction in North America.

I see. I also see that you're regular telecoms vertical has seen a little bit of a decline. Is it a quality servicing issue or is it something which is (INAUDIBLE) not your trend?

We believe it's quarter specific. Though we think the telecom, especially because we have expanded to service awareness, we have added good marquee names, et cetera. The sector seems to be picking up. So likely we should see the benefit of that also.

Okay. Thanks a lot.

Any more questions, Alsa?

We have David Grossman from Thomas Weisel Partners. Please go ahead.

Hi. A couple of questions. First on the revenues. You been your revenue guidance, I guess, by about 5%. And I was just curious if you could maybe get into a little more detail as to where that upside came from, vis-a-vis, our expectation was that new customer starts, faster ramps, or just volumes from existing customers?

If I understood you correctly, it sounds like you think the operating margins could compress another 100 to 150 basis points throughout the fiscal year. And if I did understand you correctly, can you tell me, or help us understand what changes throughout the year that results in that margin compression? Is it pricing on your existing contracts that rations down throughout the year or are there some other dynamics that impact the margins as we go through the fiscal year?

Yes. The increase in revenue happened both from existing customers and new customers. We had anticipated lower volumes but we had higher volume growth, but we made a prediction we looked at the revenues for second and third and fourth quarter. We looked at the verticals which could rise and we found that, you know, there could be a $20m increase in revenues for this year. At this point in time, sitting where we are, sitting and seeing what we are seeing.

As far as margins are concerned, like I said in April 10th, we are anticipating a decline of 1% per quarter. In our model we have built in that decline of 1% a quarter for the next three quarters and also made up for the slow decline in the first quarter. So that impact will be there in the operating profit. So that's why I said the operating profits could decline by about 100 to 150 basis points because of pricing decline.

All right. So the biggest difference between the first quarter and the balance of the year would be pricing?

Yes. We do not anticipate any major cost increases because salary increases had already over factored this term and our variable component depends upon increased revenues. So that cushions it to some extent.

And the catalyst in your view in terms of why revenues came in, you know, higher or volumes came in higher than you thought in the first quarter?

David, sorry. One of the things I want to say is this is, the rupee is obviously a critical factor for the next three quarters. We have taken a major hedging position to hedge out receivables unless the rupee goes down by more than, let's say, 2% which will be comfortable (INAUDIBLE) , but if the rupee appreciated more than this, then I think we have to relook at those (INAUDIBLE) and look at our cost picture.

Okay. And then just again on the revenues in terms of, any kind of insights into what perhaps was the major catalyst for the higher volumes than you anticipated during the quarter, as well as your expectations for the year?

We had thought that SARS and the Iraq war may have some impact on the revenues but luckily it was very short and, you know, nothing impacted the revenues, and the volumes really picked up because of that (INAUDIBLE) increase.

And then on the tax rate, it looks like your effective tax rate during the quarter was about 16%. I don't know, Nandan, if I understood you correctly. Does that mean that added about a penny to the quarter and you think that allowed about a penny a quarter to keep it flat for the balance of the year?

The tax rate will come down to something like about 15.5%, 16% for the rest of the year. It is down basically because of the fact that our overseas factor is down. We are factoring in the pricing decline and when we (INAUDIBLE) this year, we found the impact to be quite serious.

So we have considered that going forward. That's why you see the tax frozen as 4.8% of revenues for the first quarter and for the rest of the year. I think we're comfortable about that.

Okay. And just one last question on just getting back to the competitive dynamic. I think you've pretty clearly outlined that your primary competition still comes from your domestic competitors. I guess two questions.

One is, what impact, if any, have the larger international firms had on the market, both in terms of wages and pricing? Your comments seem to suggest very little, and possibly if you could comment on what your expectations are over the next 12 months based on activity you are seeing?

Then secondly just perhaps give us an update on your local competitors and how much capacity you think there is in the industry, domestically. Do you think that their utilization rates are fairly full right now or do you think that they have dropped off in the last six months?

Well, the question is the first part of the question, let's see. Entry into the market of credible competition will have an impact, and, you know, most of these global competitors are credible competition certainly. They don't have as much credibility with the offshore global delivery model, but they have been around for a while.

So from that perspective, there is certainly, you know, more, more players in the market, more options for clients, and clients like to play one against another. But from a supply/demand perspective, I think demand is still very, very strong. So entry of all these players and their capacities isn't going to have that much of an impact. It's not going to be a glut kind of a situation.

The second part of your question, I missed some part of it. Kris, do you want to --

See, there are really few large companies in India, and these companies have the capacity to ramp up if needed. You've seen that Infosys has recruited 2,000 people, more than 2,000 people in the first quarter. So, it's not going to be constrained by the ability to ramp up if needed.

Infosys has the benefit of being the best employer and things like that in the last year. We received, I think, the last 12 months we have received probably about 600,000 applicants actually.

Okay. Thank you.

Our next question comes from Julie Santoriello from Morgan Stanley. Please go ahead.

Thank you. Just wondering if you can comment on the mix of services revenue in the quarter, how that may have changed and what kind of impact that had on margin?

Development has gone down from 31.2 in the last quarter to this quarter, 27.8. Maintenance has gone up a little bit, 26.3 to 26.9. Re-engineering has gone up similar to maintenance, 5.4 to 6.7.

Other services which includes package implementation, consulting, testing, engineering services, the new services like Infrastructure management, system integration, et cetera, have gone up from 32.3% to 35%, and products declined because, you know, the Pinnacle product had a not so good quarter this year, though overall they have been doing very well. So 4.8 to 3.6.

The impact on margin is not because of these services really except for maybe the package implementation. The package implementation service gets good margins for us.

Do you have any reason to expect to see an improvement or an increase in development revenues this year?

We believe that in this environment, the clients are electing to look at new development projects, there is more focus on doing more with what they have. There is emphasis on utilizing fully the licenses they have purchased as a package implementation service seems to be very attractive at this point.

So we don't think, you know, we will see a growth on the development side. Most of the strategic sourcing projects which look at offshore outsourcing tend to also look at, you know, maintenance and things like that.

Okay. And just lastly on this same topic. Of these different services lines that you mentioned, can you help us understand where pricing pressure is the worst and where it's the most stable?

Well, there's pricing pressure on everything, but if you'll separate the two things, maintenance has higher pricing pressure because the sole name of maintenance outsourcing is to reduce the cost, and there's no other value that is being sought from the outsourcing.

Everything else, development, package implementation, there's a certain value that the company receives at the end after the package is implemented or it's developed and your capabilities can differentiate yourself and you can resist the price pressure a little more.

Okay. Thank you.

Our next question comes from Raul D'Aoust from Citigroup. Please go ahead.

Yeah, hi. There's so much of noise out there, at least has been over the last one quarter on billing rates and you've seen numbers like $16, $18 per hour. There's so much confusion also because some companies reported on a monthly billing rate and some companies do annual, some companies give per hour.

Could you, Mohandas, give us a basic calculation as to what would be your per hour rate based on this quarter's offshore rate? And also if you could break that up into how much is for the normal business and how much is for the high end, or high end consulting and package implementation business?

That's a very good question, Raul. I'm sick. Basab will answer the question.

The revenues for offshore on the services were $52,800, and we counted on the basis of 183,075 hours in the month, not 168, right?

They should be on 24 hours calculations and things like that, over which the development and maintenance would be the bottom and package implementation and others would be higher.

If you look at on-site, too, we hit 129,300 for services and I'm thinking the products updated because products went offshore and products have greater volatility. So this 129,300 and that is calculated on the basis of 168 hours and we take a 12-month period, unlike others. We don't take 11-month period, we do not use utilization, and we do not use anything.

These are very simple metrics, take the per capital revenue, divide by 12, you get the monthly revenue, divide the number of hours in a month and this depends on people working.

Right. So I mean, if say, you had saved one offshore 52,800, (INAUDIBLE) less than $24, that is the blended for all the services. What would it be for pure custom maps, development, maintenance, reengineering?

We have, you know, some of this, but we are not discussing that. We are not giving that out. Raul, you have to retain some mystique.

Okay, fine.

Secondly, there was a question which was asked earlier in the morning also. How much more can you move offshore? We've gone from 70% to 65% in terms of referring to now going back up. Can you go back to 70%, the way you used to be around seven quarters back?

We are not looking at it in that way. We are looking at what is the yield per employee, what is the margin per employee, because some services done on site will give you higher margin per employee, in terms of the dollars return.

So, you know, trade moving to offshore may not be in some cases the right decision to take. So in that sense, yes, because the strategic sourcing, maintenance, et cetera, we have seen a shift to offshore.

We also work for activity with customers to, you know, look at some of them, strategic sourcing contracts and move work offshore, but that may not it be right strategy for the future, and we will look at, depending on the mix, depending on which customer, et cetera, what is the right way to take this forward so that it benefits the customer as well as Infosys.

Right. I mean, there's no one or two quarter trend also that you can guide us to?

Well, if you ask me right now, we are looking at increasing offshore, but what I'm saying is that's not, you know, a long-term strategy.

Okay. Fine.

I'll ask a couple of questions that came in on the email now.

Thank you. Please go ahead.

There's a question about telecom business and some of the trends that we're seeing in that area, either regionally or by type of client that's interesting.

Telecom has gone down from 16.3 last quarter to 14.6 as a percentage of revenue. Over the last 12 months, it's marginally down 15.3% to 15%, but as I said before, you know, we are seeing signs of improvement. We also have broadened the client base and, you know, in Q1 actually we added a fairly substantial, a fairly large customer also to our customer list. So we think that this is a good sector to be in.

Any regional trends, U.S. versus non-U.S.?

Regional trends in telecom, not really actually. It really depends on the customers. Some of those customers are global also.

Thank you. Another question was, what's the average ramp-up time for larger plans and how does this compare to the past?

Most companies are now, they are serious about doing this. They will ramp up more aggressively than in the past. I'd say on average they ramp up more aggressive.

Okay. Great. Thank you.

Alsa, we'll take one last question and then we'll hang up.

Yes. Our last question comes from Subratin Bassu from ICICI. Please go ahead.

Hi, glad to squeeze that one in. One, if I could just go back to the last quarter's guidance, you had mentioned that you expect, that you are forecasting a drop of 200 basis points in gross margins to be compensated by 100 basis point improvement in SG&A.

Now, during this quarter we have seen a 100 basis point drop in gross margins compared sequentially, and I would imagine that most of your increase in salary expenses has kind of continued during this quarter and also you are making moves of reducing your subcontract expenses. So, is it fair to say that you are pretty much over the hump as far as increases in cost of goods sold of concerned?

Well, I wouldn't say over the hump or below the hump. All I say is for the rest of the year, what we have practiced and what we believe at this point in time could possibly happen. That's the best estimate we have got.

We have to see. The economy has to pick up. There is a big world outside. We have a limited ability to play the numbers, by, let's say optimizing expenses, increasing utilization, et cetera. But, ultimately, the market is a major determinant.

What I'm trying to get a sense for is that in April when you were looking at your gross margins and predicting a 200 basis point fall in those margins and at this point in time would you say that there was more pressure, less pressure around the same levels on the cost side?

Obviously, one quarter is over and we've done reasonably well. So that leaves three quarters. So I think that we are comfortable with what we have done. Let's wait and see.

All right. Thanks. Good luck, gentlemen.

Okay. Thank you very much, ladies and gentlemen, for participating in this call. This call will be archived and available at the replay numbers and on the web for about a month. A transcript will also be available on our website.

Of course, I'm available during the U.S. days to answer any questions and there is a telephone number for investor relations, too. Mr. Balakrishnan, Vice President of Finance, will be available at that number. We look forward to speaking to you next quarter at the quarter ending September 30th. Thank you and have a great day.

Thank you, ladies and gentlemen. This does conclude today's teleconference. Thank you for participating. You may now disconnect.