The Hindu Business Line : Growth triggers are in place

Patni Computers is showing signs of turning into an aggressive software services player since the listing of its American Depository Shares on the New York Stock Exchange in December. Subsequent to this listing, the company is sitting on cash reserves of $290 million that can be utilised for augmenting growth.

In early February, it also announced its financial guidance for 2006 (January to December). Though its revenue growth at 24-25 per cent is broadly in line with the industry, its post-tax earnings growth is expected to be significantly higher at 40-45 per cent. Business Line caught up with Mr Vijay P. Khare, Executive Vice-President and Patni's Global Delivery Co-ordinator at Mumbai, ahead of the Nasscom Summit.

Excerpts from the interview

Why did growth in profits trail revenues and not meet expectations in 2005?

The net profit growth has lagged behind revenue growth. Some of this has happened mainly because of the integration that we went through of the telecom business (following the acquisition of Cymbal), primarily a lower margin business. Overall the combined entity's margins would be lower than the old entity. That is one factor.

At the same time, we are strongly focussed on making our operations more efficient and we have a programme that is under way looking at basically two or three things — how do we make sure that we are able to boost productivity apart from services delivery, usage of tool sets, automation and things like that.

Second, in terms of pricing structure we are in a stable kind of pricing mode. We have to make sure that we are managing our costs properly in the light of the fact that we are not going to see a huge increase in terms of pricing.

Certainly there's going to be some upward bias in pricing but that's not going to be material enough to absorb all the costs unless we do some cost containment.

We said that we would hire more people at the entry level, which would enable us to flatten the employee pyramid a little more. We will look at some of the inefficiencies that our system may have had in terms of the way in which things are estimated so that we will get better returns.

What will be the triggers for this growth?

There are a number of triggers. First is the various initiatives that I talked about for better realisations and containing the costs. That will clearly have a better effect on margins. We will be faced with salary pressures in terms of increases and that will definitely dilute some of them.

But overall, we do expect some gains to come on the gross margins side itself.

Second, is as we grow in size, our fixed costs will certainly increase. We are not expecting to save on our proportionate spend in terms of sales and marketing. As a percentage of revenues we expect to hold that.

On our G&A (general and administrative) costs, certainly we do expect some efficiencies to come in because of the sheer scale and size and also because of the fact that we are now moving into our own facilities as against the present leased facilities and they are more efficient and depreciate faster. Because of that we will see some impact.

As a composite measure, that's the reason we feel that our operating margins will go up in percentage terms and that's what we have guided.

How much of the improvement in margins will be due to offshore transition and higher utilisation?

On the utilisation front, we are operating in a stated band. We are not talking in terms of significantly moving outside that band. Over the successive quarters, our delivered efforts offshore have been moving up. We went through a phase when we absorbed the Cymbal integration where in it dipped due to the fact that it was more onsite.

It has now come back to the earlier levels. We expect that trend to continue. When we say that is more offshored that has a beneficial impact on the margins percentage. On the other hand, pricing is showing an upward bias and realised pricing has been moving up over the last few quarters, not by a big amount but by some 100-200 basis points. That gives us some benefits.

For the year as a whole, we expect the operating income/margins to go above the levels we reported last year.

We have not guided in terms of operating margins range. Even a 100-basis point change will be a significant kind of a boost in terms of revenue growth versus the earnings growth.

What has been the impact of client-side restructuring, such as MetLife?

I think what we have guided for Q1 is of a modest growth. It is because of different factors. For instance, when you start talking about the inorganic moves that are happening in our client space, they come with positives as well as pressure. On the whole it has not caused any significant impact on our business for the last year. It has evened out. However, when we talk in terms of specifics, the impact of a fairly large project ending with one of our top ten customers has been the reason why the Q4 growth has been relatively neutral.

Similarly when you talk about Q1 expectations, with some of our customers at least, there will be some budgeting processes that tend to be a little slow in Q1.

In the past we have always seen that growth happens faster in Q2 and Q3. I think that trend will continue this year also and that's why we have given a modest guidance for Q1. We expect to make up for that.

But it so happens that the new initiatives that a client takes up are mainly sanctioned in the earlier part of the year and when the projects ramp up later they get to the full spend in Q2, Q3 timeline and complete in Q4. It does tend to take that kind of a curve. This is typical in case of initiatives that are discretionary.

When it comes to spend, it has to be undertaken and when you take up multi-year projects and continuous maintenance kind of spend, then that tends to be relatively well known and tends to be on an average same for quarter on quarter. But if you overlay the discretionary spend and the budgeting process on top of it, that is the reason why our Q1 guidance is kind of muted.

How do you plan to reduce your dependence on GE, your largest customer?

GE has been a $100 million customer and we have talked about it. We have said that we expect it to be a mature business. In fact, what will happen is that as the ownership of Genworth, the insurance business (spun off from GE) changes, we will take out that also. There will be a further decline in terms of GE business in percentage terms, say from 50 per cent at one point of time to around 20 per cent now.

Has there been a churn in the top ten and top five customers?

There has been a churn in the top 10 and there have been one or two entrants in the top five. For instance, for one of our large insurance customers, we ran a fairly large project for them. It was a deviation from how they normally spend. We did this fairly large project and as it came near completion, the client came into the top ten category of customers. Once the project was over, they are out of it now.

The longer-term run rate of that customer is much lower and doesn’t remain a top ten client any more. So these kinds of things happen in some situations. The other thing that can happen is that you may have a customer who’s walked in to good relationship but now that they are at a fairly optimal level in order to keep going with us so that the offshoring programme is at a healthy level and the next year spend is going to be almost similar.

And there’s another customer, who is in a growth mode. Last year both of them were at the same level. But the other customer can overtake and displace the earlier and can figure in the in the top-ten. We had one new entrant in the top five customers last year.

How do you view revenue growth prospects from top ten clients? Do you see a better chance for revenue mining for non-top 10 clients or will you look at the existing top ten and then ramp them up?

Both. Our existing top ten, with the exception of GE, which is a mature account, does have several growth possibilities. We are not saying that those relationships are at the maturity stage right now. We would definitely want to leverage growth opportunities in them. Outside of the top ten, there are several of the customers who are getting into the strategic views of the offshoring programme and who have the potential to make it to the top-ten.

Some growth will be driven by that. A good way to look at that would be to study our non-GE business growth in 2005, which was well over 50 per cent and that has been in the top 10 as well as the other customers.

How good is your customer retention rate?

We have not talked about our number of five million and ten million dollar customers. The count of these multimillion customers is moving up as compared to a year ago. We may share that data at some point of time.

What tends to happen is that when a customer gets to a million to two million dollar level you are reasonably certain that you will be getting into a reasonably fair relationship. Even after taking away the project-oriented fluctuations of it, you will still retain them at the million- dollar level. The customer that really enters project level relationship might give you large business for one year, but that will typically be the order of a million or less than the million over a 12-15 month period… may go back and come back.

If you don’t recognise the revenues from the customers for the past 12 months, you drop the customers. That kind of a churn will be there. The one million dollar customers tend to be giving us continuous business the most and the mining possibility are there. We have a robust planning process by which we do this analysis so often that what is that we need to do in order to maximise our share of customers. The account management ensures that we are there.

How many employees do you plan add this year?

We have talked about a 25-30 per cent employee growth for this year while our revenue growth is 24 per cent. But some of it is going to be happen because of the additional growth in the BPO space because productivity is lower. As offshoring becomes more and more of offshored as it increases in terms of percentage, we will need to add more people in order to achieve this.

How do you plan the ADS proceeds?

We have talked about it. We will be using some of the resources for the facility expansion and then also in terms of inorganic kind of moves. In addition to the visibility definitely there are some other advantages that we see such as 1) our customers are outside of India and are fairly committed to the verticalised strategy. We have said internally that we will attract the top talent in the US and India in all vertical areas. This ability for attracting and retaining the global talent we do it lot better. 2) We do want us to get benchmarked against the best in the world. While the listing on the NYSE helps us get near to the best in the world. Your processes have to be of the kind that are robust and benchmarked against the best in the world. This is another important reason for our ADS Keen on mining, financial services and education.

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