But it was also a time when profit margins got squeezed like never before... where no deal was too small and each had to be fought for. When Nilekani flew from continent to continent trying to close deals he would never have bothered about a couple of years ago. When, for the first time in many years, operating profits actually grew at a much slower rate than revenues.

As Nilekani says in the annual report, for Infosys, it was "the best of times and the worst of times".

The best of times...
In some ways, this year was in fact better for the group than FY ’02. At 39%, its topline grew faster than the year before and was by far the highest growth among the Top 10 giants. Even among software exporters, its performance was well above that of its closest competitors, Tata Consultancy Services, which grew at just 15%, and Wipro Technologies, which grew at 28%.

The company’s BPO subsidiary, Progeon, which was announced in FY ’02, finally went off the ground last year. It is exceedingly small by industry standards—Rs 21 crore in revenues by the year-end and just over 500 people—but it had already broken even by the fourth quarter.

Moreover, despite tight margins, the group’s cash situation is better now than ever before. For one, Infosys continues to remain debt-free and by the end of fiscal 2003, it was sitting on over Rs 1,600 crore of cash and equivalents—compared to just over Rs 1,000 crore last year. Meanwhile, the company has also got shareholder approval for issuing secondary American Depository Shares.

Also, in terms of the sheer number of people, Infosys is beginning to resemble a minor army of sorts. It hired 5,509 people last year—a historical high—growing from 10,738 to a whopping 15,356, and that’s after attrition. By the time the first quarter results for the new fiscal came in, it had grown to over 17,000.

But that’s only one side of the story.

The worst of times…
The other side was peculiarly and particularly difficult. Peculiar because in one of the first cases of its kind against an Indian company, Infosys’ high-profile marketing head Phaneesh Murthy, as well as Infosys, were sued by an American employee for sexual harassment and wrongful termination. Phaneesh Murthy quit last year in July—a blow in itself, given his stature in the market and the difficult times during which he left the company. Then, earlier this year, as the case came up for hearing, Infosys settled the case with Reka Maximovitch for $3 million—a huge sum even by American standards for a case of this kind—and as a reult, got into a bitter war of words and press releases with Phaneesh. That Phaneesh also led its BPO subsidiary Progeon meant a break in operations there till new CEO Akshaya Bhargava could be brought in to replace him.

But that was a blip. The greater troubles came from the market itself. Though the topline showed a healthy enough growth rate, the bottomline was squeezed. Profit after tax almost halved—from 33% in FY ’01 to 18.6% in FY ’03 (it was 31% in FY ’02).

This happened because despite what looked like a brief stabilization of billing rates in the third quarter, pressure remained relentless and margins decreased throughout the year. Infosys began the year, for instance, with margins of about 30% in the first quarter, which came down to 27.5% by the fourth quarter.

This is crucial. Over the years, the company’s operating profits have grown at the same or higher rate than revenue. In 1999-2000, operating profits and revenues grew at 73%. In FY ’01, operating profits grew 120%—higher than the revenue growth of 115.5%. In FY ’02, operating profit growth at 36%, was only marginally lower than revenue growth of 37%.

This was the first year where the two growth rates diverged significantly—revenues grew at 39%, while operating profit grew by only 22.6%. This is also the first time since 1997-98 that operating margins at the group have fallen below 40%—to 35%.

New patterns
Several factors have contributed to this. Gross margins were largely affected due to higher onsite revenues. This, in turn, happened because service lines like package implementation—which are higher onsite plays—grew significantly.

Operating margins, meanwhile, have been affected primarily due to higher sales and marketing costs. In the last two years, selling and marketing expenses have tripled—from Rs 92 crore in FY ’01 to Rs 270 crore in FY ’03. Over the last year alone, S&M budgets doubled and accounted for a whopping 7.4% of total revenues, compared to 5% the year before.

Why? Old customers continued to exert pressure to renegotiate deals. Besides, the larger orders faded away. Though the group added four really large clients (two $40 million and two $30 million companies), deal sizes continued to remain small. More important, the number of its smaller million-dollar clients grew from 83 to 115 in fiscal 2003. The problem with that is that a large number of small clients require more effort and more sales dollars per deal.

If this whole things sounds like nitpicking on numbers—it was that kind of year for Infosys, a year of watching those numbers. Next year projections—a topline growth of 22% to 24% and a possible tripling of Progeon revenues to Rs 76-85 crore. Those are now the numbers to watch out for.

TEAM DQ