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Infosys Fades on U.S. Economy Concerns

A strong earnings report can't offset future economic doubt.



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strong second-quarter financial results failed to impress investors, who overlooked how well the company has weathered profit pressures caused by currency fluctuations that had caused concerns earlier in the year.

Shares of the Indian tech services giant were recently trading down $3.42, or more than 6%, to $51.87, after Infosys reported second-quarter revenue of more than $1 billion for the first time in its history and raised full-year guidance for the second consecutive quarter.

The stock loss erases most of the gains the stock had made in previous days.

Judging by Infosys management's interaction with analysts in a conference call following the financial data release, questions linger about how a U.S. economic growth slowdown -- or possible recession -- would affect Infosys' business in its largest market, the U.S.

"Infosys is a strong company, but we downgraded it from a buy to a hold because we think that (demand) visibility is weakening," says S&P analyst Dylan Cathers. "And the headwinds of rupee appreciation, wage growth and uncertainty around the state of the U.S. economy give us pause. There are more question marks now then there were six months ago, or even three months ago."

Net income rose to $271 million, or 48 cents a share, from $199 million, or 35 cents a shares. On average, analysts had been expecting Infosys to earn 46 cents a share.

Infosys managed to offset the falling dollar and wage inflation by shifting more work --including higher margin consulting projects -- to low-cost project sites in India. The utilization rate of its offshore employees, a measure of how active they are on billable projects, increased to 74.3% from 73.7% in the first quarter.

The company also raised its billing rates, buffering its profit margins against the 13%-15% increases in wages. Infosys' blended revenue productivity, a measure of its pricing power, rose by 1.9% in the quarter, up from a 1.1 % gain in the previous quarter.

A higher utilization rate and price increases helped boost the gross margin, and the operating margin increased several percentage points over first quarter levels. Margins also benefited from lower costs for visas of employees working in the U.S. This cost is typically most pronounced in the first quarter.

Revenue rose 37% to $1.02 billion, also topping forecasts, as the company saw continued growth in demand from its primary client bases in financial services, telecommunications and retail.

"We have seen good all-around growth in demand, in terms of geographic regions, the services we provide, and the industry verticals we serve," said Chief Financial Officer V. Balakrishnan. "We see that momentum continuing."

Growth was strongest in Europe, where Infosys has taken on new projects with telecom services providers and a large retailer in the U.K.

During the conference call, Infosys' management stressed that they have not seen any clients delay or cancel specialized consulting projects or general IT services contracts that "keep the lights on." The comment was clearly intended to soothe investor worries that an economic slowdown or problems in credit markets, namely in the U.S., would diminish growth prospects.

Underscoring that point, Infosys raised its full-year revenue growth target for the second time. The company expects revenue to rise to 34.5% to 35% from its previous range of 29% to 30%. This implies full-year revenue of at least $4.43 billion, well above analysts' forecasts.

Infosys projected annual earnings of $1.98 to $1.99 a share, up from its earlier estimate of $1.92 to $1.94.

But this guidance was clearly more conservative than investors had hoped. Management reinforced this conservative perspective by saying that they would have to wait until January to see how clients' budgets would affect future IT spending.

"I think they try to give the message that there is no slowdown, but they are being cautious, conservative in their outlook," says Moshe Katri, an analyst with Cowen. "But judging by the rally in the stock ahead of the release, I think that the investor base was looking for more upbeat tone to the call."