Infosys Ltd (INFY) 2003 Q3 法說會逐字稿

Welcome to the Infosys Technologies investor conference call for the third quarter fiscal year 2003/2004. (OPERATOR INSTRUCTIONS). Please note that this conference is being recorded. I would now like to turn the call over to Mr. P. R. Ganapathy, investor relations officer. Mr. Ganapathy, you may begin.

Good morning and hello ladies and gentlemen. Thank you for joining us to discuss the results of the quarter ended December 31, 2003, which was the third quarter of our fiscal year 2003/2004, and is also the fifth complete year in terms of quarters that we have reported since we listed on NASDAQ. I'm sure you have had a chance to look at our press release and the various data sheets that we've posted on our Web site, www.Infosys.com.

I would like to take this opportunity to announce the appointment of Mr. Sandeep Shroff as general manager of investor relations. Sandeep has several years of experience in the financial services industry; he was an analyst covering among other things our sector and some of the other offshore services players, and I'm sure that interacting with him, you'll find a rich resource with which to understand offshore (indiscernible) services and Infosys. He can be reached at 510-742-2960. He'll be based in the Fremont office. His e-mail ID is Sandeep_Shroff@infosys.com. It has been a pleasure interacting with you all over these last five years, and over the next month or so I will be transitioning (indiscernible) to Sandeep. I'm sure you'll find interacting with him very fulfilling.

To move on to the call today, I have with me at a conference room in Bangalore Mr. Nandan Nilekani, CEO and President of Infosys and members of his senior management team. We will begin with some comments from them on the quarterly performance and their outlook and what they see from the marketplace, and then we will turn it over to you all for questions. Just before I hand over to Mr. Nilekani, I have a small duty to perform in reminding you that anything that we say that refers to our outlook for the future must be read in conjunction with the risks that we face, and these risks have been detailed in our filings with the SEC. And so they must be looked at in a realistic fashion.

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

Thank you (indiscernible), and I'd like to welcome all of you to this earnings call for the results for the quarter ended December 31, 2003. This has been a good quarter for Infosys. Our revenues for the quarter went up to 275.9 million, up 38 percent from the corresponding quarter last fiscal, and earnings per ADS has gone up to 54 cents as opposed to 40 cents in the corresponding quarter last fiscal. This quarter we've added 30 new clients across many industries, especially in telecommunications service providers and in financial services. And we have also added a gross addition of (indiscernible) employees and a net of about 3100 employees for the quarter, across both Infosys and Progeon. And today the Infosys/Progeon combination has over 23,000 employees.

This quarter, while we have been able to meet on all the metrics of growth, earnings, (technical difficulty) collection of 56 days, utilization of 82.5 percent, etc., (indiscernible) has also been the quarter that we have gone through our reorganization. We have in the U.S. reorganized our units into vertical IBUs (ph) along different business lines like banking, capital markets, insurance, health care, life sciences, etc. And we believe that this is a way for us to deal with our goal of going up the value chain, of meeting increasing expectations from clients, of dealing with fast-changing economic conditions, and a (indiscernible) scenario where the (indiscernible) the global delivery model and is now looking for us to enhance it using our business knowledge and leveraging technology.

This quarter also has been significant with our (indiscernible) acquisition of Expert Information Systems from Australia. And we are working towards a seamless integration of this and we are delighted that the CEO of Expert, and now the CEO of (indiscernible), is here on this call with us, and we would be happy to take any questions about our Australia strategy. Our efforts, also, in terms of driving work offshore has worked well, and offshore utilization has gone up to 67.8 percent of the (indiscernible) as compared to just 63.9 for the same quarter in the previous year.

So I think this the quarter has been good both in terms of us meeting and exceeding our financial performance, as well as in doing a lot of strategy changes both in terms of acquisition, as well as in terms of restructuring, so that we have laid the foundation for the growth for the coming years.

With this I'll ask Kris, our Chief Operating Officer, to go into some of the operating details. Kris?

Thanks Nandan. Geographically, Europe has increased to 20.7 percent of revenue from 18 percent of revenue. This is due to increased -- over the last two quarters we have increased marketing (indiscernible) in Europe proactively, and it's started yielding some of results. (indiscernible) package implementation. Service again has shown improvement over last quarter. Last quarter was (indiscernible) percent of revenues and this quarter it's 14.8 percent of revenues. Over the last 12 months, package implementation has gone from 10 percent of revenues to 13.8 percent of revenues, actually. So clearly, our objective of moving up the value chain, providing services at the upper end of this value chain, is working.

In terms of the services which have been introduced over the last three or four years, this all adds up to now about 28 percent, 30 percent of revenues, actually. In terms of on-site offshore, Nandan talked about the percentage on-site coming down from 32.6 percent to 32.2 percent in terms of (indiscernible). In terms of billing rates, on-site has come down marginally by 0.6 percent, blended has come down by 0.7 percent. But basically the (indiscernible) in prices (indiscernible) are not involved in any major renegotiations downward (indiscernible) prices and things like that. Our largest client contributed 5.5 percent of revenues. We have 2 clients giving us revenue of more than $50 million over the last 12 months and 130 clients with whom we are doing business for more than $1 million.

So definitely, repeat business from our existing clients is a significant contributor to the growth. Repeat business is 92 percent. And we have also added 30 new clients, as Nandan mentioned. Our attrition stands at 10 percent versus last quarter at 9.1 percent, for a marginal increase in attrition. We have added 545 (indiscernible) employees; that is people (indiscernible). Again, one of the largest numbers in Infosys history.

With this, let me hand it over to Mohan.

Thank you Kris. Our guidance for the fourth quarter is to 290 to $293 million and 55 cents as against 54 cents for this quarter. I want to add that the guidance for the fourth quarter does not include any exchange variation. We had an income of $3.5 million before tax (indiscernible) in the third quarter, and we have not (indiscernible) any exchange variation because a part of an exchange variation is due to translation differences which we will not be able to know. We have hedged our receivables to the extent of the $107 million for this quarter, and we also get about approximately 20 percent of revenues from non U.S. source currencies. So to that extent there is a natural hedge because this currency would move the other way.

As Kris said, pricing has been stable. There has been a slight decline in on-site which is not a cause for any great concern. Our gross profit is at 43.5 percent. That's against 43.9 percent the previous quarter. The decline has been because of an increase in offshore (indiscernible) basically because of variable compensation. The bonus component is higher this quarter than the previous quarter. SG&A expenses are at 15 percent as against 15.3, with (indiscernible) and marketing being 7.5 as against 7.2. The slight increase is to the bonus component. G&A has come down to 7.5 from 8.1. The decline is primarily due to a decline in (indiscernible) for (indiscernible). Operating margin is 27.4 percent. And other income which is non-operating income is 3.4 percent, (indiscernible) income of 2 percent, and the balance is exchange differences. So the rupee has been more stable in the third quarter than in the second and first quarter. We have made a (indiscernible) for investment of about $500,000.

Profit before taxes is about 30.6 percent. Taxes are 5.1 percent, which is approximately 13.99 percent on the profit before tax. Net income is at 25.6. Cash flows continue to be strong. Our cash balance has grown by $80 million this quarter as against the profit it has grown on a consolidated basis by $(indiscernible).5 million. We have had about $15 million received on exercise of stock options by our employees. We have spent about $18-odd million for CapEx expended this quarter. We (indiscernible) that we will spend 100 to $120 million on CapEx. In the nine months we have spent 48.6. And this quarter which is (indiscernible) we are on a (indiscernible) 23,209 employees. We are at the highest number of employees, as Kris said.

With this, I would like to open the floor for questions. Thank you.

(OPERATOR INSTRUCTIONS). Julio Quinteros, Goldman Sachs.

A real quick question, Mohan, for you. Can you go through the contribution expectations that you have for your Australian acquisition that you just made in the fourth quarter?

(indiscernible) first quarter of the Australian operations being in our revenue base, so we assumed a revenue of about $8 million. And we assumed a net income of between 8 and 10 percent.

Okay, great. Now, on the comments that you made about the AR provisioning, can you walk us through that again? It sounded like you had some AR provisioning declines associated with some overdue expenses. Is it because you collected the expenses or because you're just writing those off?

It is just because we are (indiscernible) in case anything goes above 180 days. In the event something goes above 180 days, there's an automatic (indiscernible) requirement (indiscernible) it triggers off an even (indiscernible) by the CEO. And the CEO's review leads to collection in the next quarter. So we have a natural hedge against any deterioration and that has resulted in (indiscernible) this quarter.

Okay, great. Real quickly I think for Kris, if you can just go back through the comments you made about renegotiations. It sounds like you don't have any major renegotiations or you didn't have any in the December quarter. Will there be any that we need to be concerned about in the next 12 months?

Well, I think the renegotiations this year have not been as significant as people have been thinking, because at last (indiscernible) we probably had 17, 18 clients out of (indiscernible) now and about 300 clients the beginning of the year who came for renegotiation. It's not as significant as people make it out to be, but there could be one or two sporadic chances of clients coming for renegotiations, and that trend is expected to continue. We are told by the head of worldwide sales that pricing continues to be stable now and he does not see the threat of any renegotiations in the near term.

Mohan, maybe I can just jump the gun here a little bit. As far as fiscal 2005, are you ready to give us a little bit of a preview on the outlook for '05, or maybe it is too early?

I think it's a bit too early, but I will request our CEO to make some remarks about the prospects that he sees for the future year, from wherever he is today.

That's great. Thank you.

Thanks Mohan, for giving me this opportunity to do some forecasting. I think -- you know, on a broad sense, the few messages that we have are -- one, that the outsourcing trend continues to gain momentum in spite of the backlash, and that it is becoming a mainstream point of view for many corporations across the world. We think that the U.S. economy has grown much better in the last quarter. And while we do not see IT spending -- instead of going up too much, we do believe that IT spending will get real reallocated to activities like offshore outsourcing. To that extent, we think that trend is going to continue. From our side we have geared up in terms of creating the vertical units and focusing on business solutions which we believe is the way for us to go up the value chain in the coming years. Also, we are ramping up in terms of employees. As I mentioned earlier, we added a gross of more than 3,300 employees across Infosys and Progeon this quarter. So I think while I can't give specific numbers, I think we do believe that there is (indiscernible) in outsourcing, and we are gearing up both from an organizational structure point of view as well from a capacity point of view to deal with that.

Nandan, maybe I can follow-up real quickly then. From a different perspective, about a year ago this time of the year, actually a little bit sooner than that, we had heard that margins in India were going to zero. Clearly that's not the case, and you guys are doing a pretty good job of holding the line on the operating margins that you have. Either you or Mohan can answer this question, but as you look at fiscal '05, the margin projection that I think the Street is kind of looking at is maybe still down. The materiality of that, I guess, is really the open-end question as far as how much those margins come down, if at all. Can you just comment directionally about margins, then, for fiscal '05, obviously, without getting and into any specifics, if it all possible?

There are three items which could impact the margins to move. The first is pricing, and right now we see pricing to be stable. The second is employee compensation. The situation remains the same in as much as there is rate inflation for the (indiscernible) management level. At the entry level, there is no significant rate inflation. And the third, the rupee/dollar rate. We have managed to hedge the rupee dollar rate in this entire year the last 12 months, by taking forward covers. So the impact has not been as significant as one would think it would be. And we don't think that going forward there are reasonable expectations that some hedging techniques would minimize the impact, if any. So the only significant feature would be any wage increase, and we have a variable compensation plan which make this possible to ride out any significant wage increases. In case the Company (indiscernible) should do very well, we will see people getting much much more. In case (indiscernible) is impacted, the variable compensation would insulate the Corporation to some extent. So I think we are positive about margins being stable -- stable, fluctuating in a narrow band in the near future.

Congratulations on the quarter.

Moshe Katri, SG Cowen.

I wanted to congratulate you for a very impressive quarter. I have a couple of questions here. One, what sort of wage inflation number do you think we should incorporate in our FY '05 models? I know we're not talking about estimates, but what is your estimate or guesstimate for wage inflation in '05? That's number one. Number two, the turnover rate seems to be inching again, not a huge increase. What is -- I mean, I'm assuming you have some internal, ongoing internal efforts to be able to kind of maybe just stabilize it at this sort of level? Maybe you can talk about that? And finally, Europe grew, I think, at a very healthy 74 percent year over year. It seems that Europe, the whole offshore concept seems to be taking off in Europe, which has been liking the US. Can you talk a bit about your ongoing European effort, your headcount in Europe? Where do you see the demand coming through and where do you see the next (indiscernible) to grow in Europe, which countries? Thanks.

The normal wage inflation on the (indiscernible) basis has been within 10 to 15 percent on salaries payable in India and about 3 to 5 percent on salaries payable overseas. Salaries payable overseas (indiscernible) 30 percent of revenues and salaries payable in India about 12 to 13 percent of revenues. If you work on that impact on that basis, the impact on revenues could be between 2 to 3 percent, which is typically insulated by, partially by reduction in other cost of revenue and by a decline in G&A expenditures. So to the extent that we're able to have a blended rate which is higher because of going up the value chain, in terms of increased business from package implementation (indiscernible) that higher value services which have great greater margin, this could be insulated. And (indiscernible) exactly what we have been doing, except that last year when the margins came down from 30 percent to 26 percent, (indiscernible) a huge pricing decline of 6 to 7 percent per year, plus the rupee appreciated by 4 to 5 percent. So this had a significant impact for the last two years and that's why margins came down. Now as far as growth in Europe is concerned, I would request Basab, head of Worldwide Sales, to add his bit.

Thanks Mohan. This is Basab. In Europe, Europe is actually one of the first business units that was formed under the restructuring plan that we just concluded. So it's been actually in that structure for about a year. Some of the measures that we have taken in the market have yielded results. We have significantly increased our presence in the market in the quality and number of people in the field, and that has yielded positive results for us in Europe.

Can you go into specific by countries, where do you see the strongest trends in Europe today? And maybe you can go into some details in terms of your headcount in Europe, and maybe the number of salespeople that you have on the continent, as well?

I will just give you some color on the country by country growth. The UK has been definitely our strongest market in Europe. If you look at our growth this quarter over last quarter, the UK was 26 percent sequentially, actually. And we're also making strides in newer markets like Switzerland. Overall, there is bullishness across the continent of course, in terms of our revenue. And hopefully as the economy improves next year, the efforts we have made in the market in the continent -- Germany, France and some of the other countries -- will also pay dividends.

Do you have any comments on my question regarding turnover rates?

The turnover rate was 10 percent. We have seen a slight increase from 9 to 10 percent since the last quarter. Primarily the reasons for attrition continue to be the same, that is, opportunities, (indiscernible), and of course personal reasons.

Adam Frisch, UBS.

Just a couple of questions on the pricing pressure. I know you alluded to it a couple of times, but you said it was relatively stable; on-site was a little bit down but no cause of concern. Can you just clarify how much it was down and why it's not a cause of concern? And then to kind of take it to the next level, when do you expect it to actually increase and do you expect the increase anytime soon, and what would make it go up?

On-site came down sequentially by 0.6 percent and offshore was stable. Offshore went up slightly but it's too insignificant (indiscernible). On a blended basis it was 0.7 percent. As far as the second part of the question, I'll ask Basab to answer that.

(technical difficulty). Just also the reason why 0.6 percent is not significant, because one is quarter over quarter and also the service mix for Infosys can change quarter to quarter, and the range of rates we have on-site could be different. So there's absolutely no cause for concern on the on-site rate dropping. At the current time, we think that for the foreseeable future we think prices will be stable. At some point we will come back to you and then let you know if we have the opportunity to actually take it up, or we think pricing power is returning to the vendors here. But at this point, we can't say that.

What kind of things would you need to see in order to increase pricing? Just kind of give us some benchmarks or some (indiscernible) here, what we can look for.

This is Kris. Some of the things we can probably look out for is inflation going up, wages going up in the market, (indiscernible) increasing, supply and demand situation (technical difficulty). Some of the external parameters we would also look for. And at that point we may feel more comfortable going back to the plan for higher prices.

Okay. If I could just switch to the U.S. operations for a second. Can you talk about your U.S. operations here, how many people you have, where they're basically dispersed and what they're doing, and what you expect that headcount to be 12 months from now?

We have about 4800-odd people who are outside India at this point of time, of whom 3900 could be in the U.S. But you must remember that these are people who go there, a large number of these people go there for short-term and come back. They're not permanent residents there. The permanent residents in the U.S. could be anything between 4 to 600 people. Our model is predicated upon people going short-term to the U.S. for specification, coming back here and doing their work here. So, we will always be having this kind of movement to and fro, but the significant thing is that we have been driving more work offshore. So to that extent, our offshore (indiscernible) is at 32.2 percent as against 35.6 percent the same quarter last year. So we managed to drive -- I'm sorry, on-site (indiscernible) effort; we managed to drive more work offshore and this is helping us in terms of being more (indiscernible) because it results in greater value for the client. In terms of for better percentage margins, (indiscernible) cannot be on a per capita basis.

Do you -- what is the headcount that you predict for 12 months from now in the U.S., the permanent headcount, the 4 to 600 people number? What would that number be in a year?

We don't think the permanent headcount would decrease -- increase in any significant manner, because that's not the model that we operate. We have a bench on-site. (indiscernible) for 4800 people, what could have an (indiscernible) of something like 100, 110 people. We do not think (indiscernible) increase in any significant manner.

Can you also -- last question here -- can you also talk about any M&A plans that you have where you think that you would need to beef up your current operations?

Yes, we do have M&A plans all the time. You know, we have a team which works full-time on scanning the landscape to see what is a good company to invest in. You know, it takes some time (indiscernible). We need to have a candidate (indiscernible) cultural compatibility issues that we have, and it also means -- culture also means that they must be able to have good growth rates, good margins, very clean balance sheet, good management -- it's a long list.

Sure. (multiple speakers) are you focusing your efforts on geography or skill sets at this point?

No, I think we focus both in Asia Pacific, Europe and America, and we are seeing -- like our CEO said -- about 130 companies in the last three or four years. We came close to some acquisition in two or three cases, but we finally made it in Australia. And you know, we fell in love at first site down under because of the (indiscernible) down there, and it's worked out. Basically it was a perfect match because it's a great Company, well run, well managed, very good margins and good (indiscernible) for growth.

Mayank Tandon, Janney Montgomery.

I had a couple of questions on your move up the value chain. Could you talk specifically about the nature of the contracts out there these days, in terms of are you having to compete against Accenture and IBM on just general contracts that have an offshore component, or are these exclusively offshore-centric deals?

This is Basab. I would say we end up competing against them on select deals of both kinds, both outsourcing deals where the company has made up its mind that they want to do this offshore, and also system integration deals where the company perhaps doesn't care as much where the work gets done, but are definitely interested in getting a quality product on time at a decent price.

Actually, the nature of my question has more to do with what are the kind of deals out there? Are the clients separating deals between on-site and offshore or are they looking for just the best solution and then bringing in different vendors to bid on these contracts, not really caring how the project is executed?

I think currently in the customer mind there is a very high awareness of the global delivery model and the price performance benefits of being able to leverage offshore. So in fact, in almost every situation, the customer is designing needs from the assumption that a part (indiscernible) could be delivered offshore. In a sense therefore, the offshore is becoming (indiscernible) as sort of a prerequisite in most deals, and is very inherent. Having decided that offshore is part of it, typically the companies choose to call some offshore pure plays like Infosys and others, and of course call a couple of the bigger incumbents. So that's typically the mix that we see when there's an outsourcing strategy being played out.

This would also be on some of the maintenance type contracts, or does that tend to be more the domain of the pure play offshore (multiple speakers) --?

This could be for maintenance; this could be for enterprise deployment of (indiscernible); this could be for (indiscernible) development; this could be for infrastructure. I think the important thing is that this is now applying across the board, across services. And every major situation the customer is asking for offshore -- in fact, there is one situation where a very large automotive company is bidding for its benefit (indiscernible) thing to be outsourced, (indiscernible) 401(k) plan. And (indiscernible) offshore. I think they're seeing the offshore sort of permeating into the supply chain of every company.

So competitively, how has the landscape changed? Are Accenture and IBM more competitive today on the offshore front, or would you say the environment is very similar to, say, two or three quarters ago?

The incumbents are very reluctant (indiscernible), because the offshore model is fundamentally (indiscernible) to them. And usually they are going into offshore because the customers are leading them by the nose to doing that. And what is happening is that while they are offering offshore, it generates a lot of inherent conflict of interest internally between the local operations and the offshore operations, and we believe that it (indiscernible) a lot of this option. So I think in a sense the rules of the game have changed; offshore is a way of life, and a company that (indiscernible) offshore are fundamentally better placed than those whose model is on-site-centric, and now are being forced by the marketplace to change the way they do things.

A very general question again, in terms of moving up the value chain. What are some of the challenges you as a company face when you take on some of these higher end systems integration engagements? Is it more the execution of the on-site offshore model driving resources offshore, or are there other management challenges you face in some of these larger and more sophisticated contracts?

I think at the end of the day, moving up the value chain is nothing but delivering service to the customer. The customer (indiscernible) that these services (indiscernible) paying a better price. And (indiscernible) value chain is all about, right? It's all about getting better prices. And we think that there are a number of ways to get those better prices. What we're trying to do is, along with our organizational restructuring, we are bringing a lot more focus on the solutions approach, where our business units are encouraged to go to the markets with specific solutions that are (indiscernible) a customer of higher value. They are focusing on working in alliances. We have stepped-up our alliance activity. We are working with -- (indiscernible) an alliance team working with majors like Microsoft, SAP, (indiscernible), many others. And we are of course looking at potential acquisitions. So I think -- we also -- we have a very strong stockpile of technological R&D from R&D labs (indiscernible) labs, and now we are looking at leveraging that intellectual property to make our customers' businesses more efficient and more effective. So I think essentially for us going up the value chain is differentiating through solutions, through intellectual property, through alliances, through acquisitions, and essentially creating much better solution so that customers will (indiscernible) more money.

The amount of effort onshore on-site offshore, does that tend to be pretty similar to your other type of work or is that more heavily weighted to on-site at this point, but will move offshore over time as you develop your delivery?

Different services do tend to have a different ratio of on-site and offshore. For example, in our enterprise systems (indiscernible) we are almost close to 50-50. But I think one of the things that we're doing is that we're looking at each service value chain and desegregating its components and trying to understand which of them are best done locally and which of them are best done offshore. So as we go up the experience curve in each service, we will expect the offshore content to go up. And in any case, since this is a gradual shift in the mix, it does not change that much the overall on-site/offshore mix, and therefore does not really materially impact the cost structures.

Just one final question on wages. When do the wage hikes go into effect in this fiscal year? And also, any impact from the poaching (ph), or the perceived poaching by some of the larger integrators in India causing the turnover rate to go up a little bit?

Typically our salary increases happen in the month of April for the new financial year, but if you'll notice our compensation pattern in the last couple of years, it's (indiscernible) gone to a variable compensation linked to individual business units and corporate performance. And therefore, if the Company does better, then employees also get paid more. And that's alignment of interest. So that's as far as the compensation goes. To the other question, yes, our attrition has gone up compared to last year. We are losing some people, but we are taking every effort both in terms of addressing employees (indiscernible) needs as well as their aspirations, to make sure that we retain the best and the brightest.

Mitali Ghosh, Merrill Lynch.

Just focusing a but more on the moving up the value chain. You know, you did mention, Nandan, that essentially it means getting higher prices for the work that is done (indiscernible) providing more solutions. So is it fair to assume that while moving up the value chain would assume higher prices, it is not necessarily going to result in higher percentage margins? And to that extent, Infosys is really focusing more on actually profit growth than percentage of margins?

Obviously, if you deliver higher prices with a lot of on-site resources and costs also (indiscernible), then the margins will be lower. So when we look at this value chain, we're looking at both implement of the prices as well as implement of the contribution from each effort (indiscernible).

I guess what I'm driving at is the fact that -- you know, for example (indiscernible) consulting. While it is likely to get much higher prices, particularly one finds margin percentages are off all the leading global consultants (indiscernible). So, your services which are likely considered higher up the value chain like IT outsourcing, systems integration, consulting, etc. -- aren't they all typically more margin percentage in nature?

Which ones?

Systems integration consulting.

I think we have to look at this with a fresh mindset. What we are saying is that essentially the whole business of fulfilling customer through IT services is going through a paradigm shift. Essentially every service that you can deliver to the customer in the old-fashioned way can now be reconfigured to be delivered using the global delivery, and that's really what we're doing. And we believe that, therefore, the historic margins may or may not be applicable as we reconfigure these services. And even in consulting, while I agree with you that consulting on-site would not have the same margins (indiscernible) high price points, the whole idea of that consulting is to generate downstream business. And because it's dealing from consulting (indiscernible) rather than a pure outsourcing relationship, the idea is that not only do we get higher prices on the consulting but we get higher prices on the downstream work, which we have done offshore which has good margins. So I think that's really the strategy.

The second question is really on your guidance for next quarter, which if we exclude the revenues from the acquisition that you have made, then they're really looking at (indiscernible) percent kind of quarter on quarter growth. I just wanted to understand what are the uncertainties that you are really building into this guidance, and if you could take us through some of the bottlenecks that you think might happen?

We think that business is basically about managing constraint. All the constraints that we had in the first two quarters was lack of adequate people to meet (indiscernible) of clients. So we have added on a lot more people; we want to grow a bench to meet any certain requirements of clients, but to an extent that constraint is slightly reduced. The second constraint could be our ability to increase our sales (indiscernible) of our guidance is based upon what we see as (indiscernible). But you must remember where the beginning of the quarter, as the quarter progresses, the revenues become that much more clear. At the beginning of the quarter we typically have about 85 percent to 90 percent clarity on the revenues, in terms of income which is there and which can be felt it. As the quarter goes on, it increases in most cases. So you must see our guidance in this context.

(indiscernible) 90 percent clarity. Then to that extent, isn't that a fairly high visibility that one has? What I'm trying to get at is -- yes?

Let me explain this. We are system based. We have got a system on which all product managers put in their expectations of revenue, and (indiscernible) we stand up and talk. And we tell our sales force to go all out and to sell. And you know, they try their best to increase the revenue, and we work like that. But our guidance is based upon what is there on the system. And typically this is the ratio that we are seeing.

I guess one question for Basab. What is it (indiscernible) driving the demand that you're seeing at this point in time, and how sustainable do you feel this really is? Is it that people are really doing a lot of development work, or are (indiscernible) focusing on outsourcing some of the maintenance? Another concern I have is in package implementation, which tends to be a bit (indiscernible). And I was wondering whether because package has gone up this quarter, is it one of the reasons why next quarter could be a bit muted?

The prime driver of demand growth is that offshore is now mainstream in this industry. It is -- there's almost no CIO today who is either not doing offshore outsourcing in his shop or is not being questioned by his CEO of when he is going to start. So, it so mainstream that it cuts across industries, it cuts across all kinds of service offerings, whether it's package implementation development, maintenance, what have you. So I would say this is a (indiscernible) increase in demand for offshore outsourcing that will -- in the last two years in a fairly depressed IT spend environment, you have seen how we have grown and how the whole offshore outsourcing part of the industry has grown. In the coming years if the economy improves and if IT spends improve, we think the good days will continue.

So you are seeing (indiscernible) much of new development work?

Mitali, can we hold your questions? We'll come back to them after we go through the other questioners who are waiting?

Okay, sure.

David Grossman, Thomas Weisel partners.

If I could just ask a couple of questions about the expenses. I think, Mohan, you talked about the sequential gross margin compression being partially a result of bonuses, variable compensation. Can you help us understand how the variable compensation flows through the P&L? Is there some seasonality to it, and what impact it may have on margins going forward?

David, we have configured our compensation plan in such a manner that (indiscernible) set on a base level of revenue. The inflow of compensation to employees is higher than the growth rate of revenue from that point. This is to make sure that we are insulated on the way down, and at the same time on the way up, the (indiscernible) to them is much higher than the growth rate of revenues. So we think if we grow revenues faster than the way we are budgeted, it means that our expense level in other areas will be less. To that extent we can afford to pay more to our employees, and by this we align our employees' interests almost perfectly with ours. For example, in this quarter the total employee cost as a part of our cost of revenues was at 45.4 percent, as against the last -- 45.4 percent as against the last quarter when it was 43.6 percent. So there has been an increase, there has been an increase of something like 1.8 percent, and this has come entirely because of the bonus factor which kicked in. The bonus is on three grounds -- first is that we have a bonus for the growth of revenues at the corporate level; second, the bonus is paid on the unit performance along with the margin level; and the third is based upon individual performances. So we have (indiscernible) metric that kicks in, and the model works quite well to align interests. We have countered increases in employee costs because of variable cost by making sure that other costs have come down. You'll notice that other costs of revenue have -- (indiscernible) gross margin has declined by 0.4 percent whereas the employee cost has gone up by 1.8 percent. So 1.4 percent has been the decline in the other cost of revenue. By this, I think we have a good model going forward.

Maybe just going to another line item, looking at the amortization expense, just to digress for a minute. That seems to have kind of bounced around. Is there some variability in that number as well?

No, the amortization was very specific to an event that happened this quarter. We had a review of our banking group and we felt that the (indiscernible) product did not have the carrying cost it had on the balance sheet, so we amortized that. (indiscernible) amortization in this quarter. Right now we don't have any intangible assets to amortize.

Going forward, what would we expect on a quarterly basis from amortization?

I think from amortization, we don't have any intangible assets amortized, so there is nothing to amortize. In terms of the (indiscernible) compensation, we had a small amount, and even that is gone. So both these balances become zero.

How much was the incremental piece that you took of the assets that you amortized during the quarter?

This quarter we had amortization of $2.6 million as against $3.3 million, and the extra amount that we took was something like about $1.2 million this quarter compared to (indiscernible) happen in case we didn't have this (indiscernible).

Okay. Just on the tax rate, can you give us a sense of how that may trend next year? I guess you've been -- you did 16.5; it's been bouncing around again this year. Can you give us a sense of what it may look like next year?

Yes. We have two streams of revenue on which we pay tax -- one is the offshore revenue, and the significant, very significant part of the offshore revenue is exempt from tax until 2009, with declining percentages from 2007 onward. Next year, that is fiscal year 2005, a part of our facilities will come into the tax net. But that will be to the extent of only 6 or 7 percent of revenues, which will not be significant. Our offshore tax is basically based upon the other income that we have, the non-operating income that we have. The non-operating income would be taxed at 35 percent. On the on-site basis, our tax rate to revenues has been something like 3.7 percent. But this year (technical difficulty) something like 14, 14.25 percent of tax, compared to (indiscernible) tax. And going forward, the percentage should not shift significantly.

I'm sorry, I guess I didn't follow all those numbers. So going forward, I think you just reported, at least on the U.S. GAAP, a tax rate of about 16.5 percent. Is that a good number for '05, or do you think based on some of the parameters you just outlined that goes up?

I think going forward, barring any increase in non-operating income which we cannot (indiscernible) now -- because of exchange variation because that was (indiscernible) tax charge on that -- we should expect something like maybe 14, 14.25 percent on the pay tax income.

Okay. In terms of the headcount, you had pretty robust net adds, obviously, during the quarter. Can you give us a sense of kind of what you would expect to add in the fourth quarter, in terms of headcount?

This is Hema here. We expect to add another 1500 employees in the fourth quarter.

Is that net or gross?

Gross. (indiscernible), of course, Progeon and Infosys Australia.

I'm sorry; including or excluding?

Excluding Progeon and Infosys Australia.

Maybe one question for Nandan. I know there's been several questions on the general pricing environment. Looking at your unit volume growth, which has been extremely high over the last several quarters -- and I think others in the industry are experiencing similar volume growth -- I think we can arguably say that demand trends are extremely strong right now. And looking at some of the wage numbers, it would seem to appear there are some constraints on supply as well. Since we have a pretty favorable environment right now, and I know you've talked about pricing stability but have been somewhat reluctant to talk about the ability to raise prices. What is the governor right now on pricing going up, given what appears to be a very favorable environment right now both from a supply and a demand perspective?

I think there are really two or three factors for pricing going up. One is, obviously, if the demand/supply becomes (indiscernible), in the sense that there is a shortage of skills (indiscernible) of people and that drives price up. Frankly, I don't see why that should happen in a hurry. Because if you go back to the '90s, I think when this offshore model was not fully recognized, I can understand that pricing could've gone up because of shortages. But in today's model with global delivery being accepted as the global approach for outsourcing, it's difficult -- and supply being quite high -- it's not clear to me why pricing should go up from a demand/supply perspective. The second thing is that pricing can go up if our customers start loosening their purse strings, but our customers themselves are facing -- continue to face immense pressure in terms of raising their prices and raising their growth, so they obviously would like to keep a tight lid on what they buy from their vendors. So I think really the best way for us to do something with pricing is really to change the value perception of what they buy from us. Which is why our whole effort internally to focus on business solutions, to focus on alliances, to focus on leveraging (indiscernible) IP, is that if we really can sort of unlock the intellectual capital of what we have and come up with better solutions and convince the customer that these better solutions merit a better price, that's the best way that we think we can get pricing power, and not really based on macro issues.

It sounds like from your comments earlier on the call that you think that you can continue to do that without having to change the mix of effort on-site versus offshore. Is that a fair assumption?

I think -- it's really a lot of that has to do with the scale of our operations. The fact is that we have 5000 odd people on-site and another 15 or 17,000 people offshore. Even if we want to embed a lot of solution activity inside that and that requires on-site to go up by a few hundred people, it won't really make a difference on the macro balance sheet.

Mahesh Vaze, SSKI.

I have (indiscernible) questions. First, (indiscernible) have come down from (indiscernible) this quarter. What exactly is happening (indiscernible)? Secondly, I wanted to understand what is the (indiscernible)?

You said the product revenue has come down this quarter compared to the previous quarter? (indiscernible)?

(indiscernible) it has been coming down for some time. In fourth quarter, it was almost (indiscernible) million rupees. (indiscernible)

(multiple speakers)

Yes, it's come down from $8.67 million to $7.25 million this quarter, and that's because the banking business -- the enterprise banking business has been flat for some time. And you know, the revenue recognition is choppy because even though you may bill and get revenue, recognition is spread over the implementation (indiscernible). So there has been some choppiness but the business has not been growing. What was the second question?

The second question (indiscernible). What is the current strength (indiscernible)?

We have about, from pure business consulting perspective we have about 120 people.

Mahesh Vaze (indiscernible)?

They're based out all over the world, actually. In all geographies (indiscernible) in the new structure. They're in the different business units also.

Mahesh Vaze (indiscernible)?

Yes, we are doing some of the back office research with a small group in Bangalore.

Michael (indiscernible), (indiscernible) Research.

I just wanted to ask a couple of short numbers question. What percentage of your European business is based in the UK?

All this data is on a fact sheet that we have on the Web. Our UK business is 8.4 percent of revenues.

Excellent, thank you. There's another piece of information which is also missing from the fact sheet which is the annualized off-site and on-site per capita rate. Given last quarter on the call (indiscernible) 131 and 54 K annualized, I was just wondering what they were in the quarter, please?

I will just give you the number in a minute. Just hang on for a minute.

(indiscernible), I know you had like an enormous amount of questions on pricing, but just to sort of ask one final one -- in the fourth quarter in fiscal '02, you had a pricing drop of 4.8 percent overall, and then last year you had a 5.1 percent in the first calendar quarter. What you're saying is that you don't expect a drop of -- you're expecting a drop of zero percent, basically, in the first quarter this year, despite (indiscernible) 5 percent drops the last two years in a row?

Yes. This quarter we had $130,269 as against $131,110 on the annualized basis (indiscernible) 0.6 percent. Yes, the fourth quarter of last year we had a drop in per capita revenues both on-site and offshore. There were many reasons for that. One reason was that some clients came back and renegotiated, asking us to take incremental business because their year runs from January to December, whereas our year runs from April to March. That is one. The second reason was there was some pricing decline because of some shift in businesses. Some of the per capita, higher per capita revenue business has come down during that period. It does not mean there's a trend that every fourth quarter there would be a decline nor a trend that every first quarter of the subsequent year there would be an increase. We do think that at this point of time, the prices are stable. But on a quarter on quarter basis, there is a possibility of variation because of the fact that there are different per capita (indiscernible) for different revenues. And depending upon which part of the revenue would grow, we would see some slight change.

Okay. Sorry, the other -- the off-site number was not given (indiscernible) --

The off-site number second quarter was 53,980, and the third quarter was 54,007.

Ashish Thadhani, Brean Murray.

Nice quarter. My question has to do with operating margin. To the Company's credit, operating margin is above that of industry peers. In your view, would it be a reasonable expectation that the current range should narrow over time? And secondly, does Infosys believes that its investment strategy is broadly comparable with the same set of peers, more aggressive or less?

We would think that in any industry the operating margin would be in a range, with very high-quality companies being at the top of the range. And in our going forward, that will be the story. And it is our intention to make sure that operating margin is at a good level. As far as investment goes, yes, we hear this statement from some competition that they're making significant investment in sales and marketing. We have 264 people outside India selling all the time, very high-quality people. We make significant investments in them. For example, our sales and marketing is at 7.5 percent; that is $75 million on $1 billion of revenue, which is significant for a company of our size. So we intend to invest in sales and marketing on an ongoing business, and we shall do what is adequate investment to make sure that the model is robust and strong.

We have time for just one last question.

I was actually thinking that we conclude at this point. Do we have one last question (indiscernible)?

George Price, Legg Mason.

Thank you. Actually at this point all of my questions have been answered.

Thank you, ladies and gentlemen, for participating on this call. We look forward to speaking with you in the course of this quarter and then after that of course, when we announce results for our year and quarter ended March 31, which will be in early April. Thanks and have a great day.

Thank you ladies and gentlemen. This does conclude today's teleconference.