INFOSYS TECHNOLOGIES LTD.

Annual Report Analysis

The Infosys Annual Report 2007-08 contains a human touch with the
key theme being various company initiatives towards attracting,
training, retaining and empowering talent. FY08 was another
watershed year for Infosys with robust business performance
(industry-leading dollar growth), judicious expenditure management
and strengthened financial position. Infosys, the behemoth, continues
to move from strength to strength. Our analysis of the Annual Report
revealed following interesting findings.
Income statement – robust growth and unparalleled size and
profitability

ä In dollar terms, stand-alone revenues increased by 34.1% yoy

comprising 27.5% growth in volumes (onsite – 26.2% & offshore –
28.2%) and a 5.3% improvement in per capita revenues (onsite – 4.3%
& offshore – 7.2%). The rupee revenue growth was reduced to 19% due
to 11.2% appreciation of the currency. It was the second consecutive
year of 5%+ blended pricing improvement.
ä The onsite:offshore revenue mix shifted towards the latter (from
~52:48 to ~51:49) due to higher volume growth and pricing
improvement. The onsite:offshore effort mix was ~30:70. The revenue
contribution of fixed-price fixed-time frame contracts increased to 33%
from 28% in the previous year.
ä Top 10 clients grew 38.8% yoy and the non-Top 10 clients grew by
33.6% yoy in dollar terms demonstrating a balanced growth across
customers. About 97% of revenues represented repeat business. Product
revenues were Rs5.97bn (3.6% of consolidated revenues) representing
11% yoy growth.
ä Consolidated GPM at 44.8% was lower by 150 bps than 46.3% earned
in FY07. The decline was due to more than proportionate increase of
26% in employee cost driven by a similar increase in year-end
headcount and annual salary increments. Judicious expenditure on
overseas travel, sub-contracting and software packages mitigated the
impact of higher employee cost.

ä Consolidated OPM was stable yoy at 31.4% due to 120 bps savings
from lower sales and marketing (S&M) cost. The S&M expenditure
declined 1.4% yoy despite 10% increase in employees cost (11.7%
increase in headcount here). Infosys curtailed all the other S&M
expenses such as brand building, commissions, professional charges and
overseas travel. General & administration (G&A) expenditure was
steady yoy at 8% of revenues.

ä During the year, Infosys spent Rs2.01bn on R&D, about 1.3% of its
revenues. The company filed for 10 patents in India and the US and has
119 patent applications outstanding in both countries at the end of FY08.
ä Other income jumped 89% in FY08 to Rs7.04bn driven by 116%
increase in interest and dividend income that formed 97% of the total.
Realized yield on deposits and mutual funds was 9.5% against 7.4% in
FY07. Other income constituted material 13.2% of the consolidated
PBT.
ä The net profit of FY08 and FY07 includes a tax reversal of Rs1.21bn
and Rs1.25bn respectively with respect to overseas jurisdictions.
Excluding the tax reversals, the effective tax rate would have been
15.1% in FY08.
ä During FY08, two more SEZs at Pune and Mangalore commenced
operations. About 6% of revenues were delivered from SEZs.
ä Infosys had 3.03mn options outstanding at the end of FY08 under its
two ESOP plans (1998 plan and 1999 plan) representing an insignificant
potential dilution of 0.5%. About 87% of these outstanding options have
been vested.
ä Pro forma net profit for FY08 after deducting employee stock-based
compensation using fair value method under SFAS 123 stood at
Rs46.46bn implying no material change from the reported figure.
ä The parent company added net 13,659 employees and gross 22,671
employees in FY08. Company recruited from 1,079 engineering colleges
and made 18,146 campus offers. The attrition at 13.4% was lower than
last year. Consolidated year-end headcount stood above 91,000.
ä The company has 47 marketing offices at the end of the year.

ä The total subsidiary revenues recorded far higher growth than the
parent company.
ä The five subsidiaries added net Rs10.46bn (6.3%) to consolidated
revenues after netting off the Rs7.73bn subcontract business between
them and the parent company. The gross revenue contribution was
10.9% and the yearend employee count was 19.4% of the total.
ä With a combined 10.4% NPM, these subsidiaries continue to dilute
profitability of the consolidated company. However, the subsidiaries
appear to have earned a higher combined GPM than the parent
(consolidated GPM higher than stand-alone GPM).
ä Infosys China and Infosys Consulting reported significant losses as
they remain in the investment phase.
ä The Mexico subsidiary was set-up during the year with a development
centre to serve the North American clients.
ä During the year, Infosys acquired 100% equity in Phillips BPO for
Rs1.07bn. The acquired entity has skill sets in finance and
administration space and global presence with centres in Poland,
Thailand and India. This acquisition added ~Rs750mn to Infosys BPO
revenues but diluted the profitability with its negative NPM of 2.7%.
Excluding this, NPM of Infosys BPO would have been 17.8%.

Special dividend and increase in payout ratio reflects company’s

confidence in growth
ä For FY08, apart from an interim and final dividend of Rs6 and Rs7.25
respectively, Infosys declared a special dividend of Rs20 per share to
acknowledge company’s achievement of greater than US$1bn in
consolidated profits.
ä The total annual dividend payout of Rs19.02bn (excluding tax) is the
largest in the corporate history of India.
ä Company also decided to increase the dividend payout ratio (DPR) to
30% of net profits from 20% effective FY09. This raise in DPR reflects
Infosys’s confidence in generating adequate future cash flows from
business to cover the growth drivers (capex and strategic investments)
and enhanced shareholder returns (dividends).
ä The payout in the last two years was near the dividend policy rate of
20%.

ä Infosys’s balance sheet continues to remain strong, debt-free and

highly liquid. The C&CE constituted 46.7% of total assets. More
importantly, it has been covering an increasing proportion of revenues
and operating expenditure thereby lending further strength to balance
sheet and safety to business.
ä DSO stood at 72 against 64 at the end of FY07 reflecting more than
proportionate increase in debtors. The largest client contributed 21.4%
of debtors.
ä The parent company incurred a capex of Rs13.7bn during FY08
comprising Rs11.81bn on physical infrastructure and Rs1.89bn on
technological infrastructure. Capital expenditure commitment stood at
Rs6bn at the year–end. The capex at the consolidated level was
Rs14.94bn.

ä During the year, Infosys added 45.12 lakh sqft of physical

infrastructure space taking the total available space to 164.77 lakh sqft
representing 77,754 seats. An additional 83.63 lakh sqft is under
construction that would provide 26,881 seats. Infosys expanded capacity
at Brno, Czech Republic and set-up a nearshore facility in Mexico and a
new campus in Thiruvananthpuram. Company also paid for acquiring
land in Chennai and Hyderabad.
ä In FY08, company issued 7,85,896 shares on exercise of stock options
by employees under the two ESOP schemes. As a result, equity capital
increased by Rs3.9mn to Rs2.86bn. The total founder holding was at
16.5% at the end of the year.
Cash flows – more than sufficient to cover growth, dividends and
contingencies

ä CFO constituted 87.6% of pre-exceptional profit and 24.5% of

revenues in FY08. The yoy growth in CFO at 16% was below that in the
net profit.
ä Strategic investments include payments for purchase of business, IPRs
and minority interest in subsidiaries.
ä The dividend outflow comprises interim dividend of FY08 and the
final dividend of FY07 including the taxes. The payment of the final and
special dividend of FY08 amounting ~Rs18.2bn including the taxes
would occur in FY09 from the year-end cash balance.
ä Infosys generated >Rs20bn in cash for the last two years. This along
with already sufficient liquidity (to cover business and financial risks)
on books would have prompted the Board to raise the DPR.
Corporate Governance – leading across industries
ä Of the 15 directors on the Board of Infosys, 8 ie >50% are independent
ä All the Board committees are made up of only Independent directors
ä The independent directors hold about 1,32,200 equity shares and
options of the company
ä The CEO and CFO certification confirms the adequacy of company’s
internal control systems
ä There has been no qualifications by the auditors

Re-organization to sustain competitiveness

ä In November 2007, Infosys re-organized its business units to deepen
transformational capabilities, broaden customer base and strengthen
current portfolio. Key highlights of the re-organization are:
ä Six vertical industry business units (IBUs) and five horizontal business
units that cut across all verticals were formed
ä European business was divided into industry verticals and integrated
within the IBUs
ä New Growth Engine (NGE) unit formed to expand business in
Australia, China, Japan, Middle East, Canada, South America and Latin
America
ä India Business Unit formed to focus on India and tap the growing
domestic market
ä Increased focus on delivery excellence
ä Consolidated consulting skills
ä Consolidated sales and marketing functions
As a part of the above re-organization, an Executive Council comprising
the CEO, COO, CFO, executive board members and select unit heads
was constituted. EC members will participate in formulation of business
strategy, framing policy for strategy deployment, management and
operational supervision and risk mitigation strategies.
Current valuations above fair value; maintain SELL
The IT sector (BSE IT) has rallied 31% in the last three months
outperforming Sensex by 29%. The bounce back was led by the sector’s
relative attractiveness, compression in valuations by 40-50% and the
one-year extension of STPI tax exemption. Infosys has led this
outperformance by rallying 40% in the above period, far ahead of the
peers. The excess stock performance has been fuelled by company’s
better positioning (due to lower forex cover) to take advantage of the
depreciating rupee. We expect company to upgrade FY09 guidance, but
based solely on the higher Re/$ assumption.
The business fundamentals remain challenging. We maintain SELL and
our target price of Rs1,670 represent 10% downside from current levels.