Infosys Limited (INFY) Earnings Call Transcript & Summary

Ladies and gentlemen, good day, and welcome to the Infosys Earnings Conference Call. [Operator Instructions] Please note that this conference is being recorded. I now hand the conference over to Mr. Sandeep Mahindroo. Thank you, and over to you, sir.

Hello, everyone, and welcome to Infosys earnings call for Q1 FY '24. Joining us here on this call is CEO and MD, Mr. Salil Parekh; CFO, Mr. Nilanjan Roy; and other members of the senior management team. We'll start the call with some remarks on the performance of the company for the quarter by Salil and Nilanjan. Subsequent to which, the call will be opened up for questions. Finally, note that anything which we say that refers to our outlook for the future is a forward-looking statement, which must be read in conjunction with the risk that the company faces. A full statement explanation of these risks is available in our filings with the SEC, which can be found on www.sec.gov. I would now like to pass it on to Salil.

Thanks, Sandeep. Good evening, and good morning to everyone on the call. Thank you for joining us. We had a strong quarter in Q1. Our Q1 growth was solid at 4.2% year-on-year and 1% quarter-on-quarter in constant currency. We had 21% growth in manufacturing, 14% in life sciences. Our Europe region grew by 10%. Our operating margin for the quarter was strong at 20.8%. We generated robust free cash flow of $699 million in Q1. Our large deal value for Q1 was $2.3 billion, 56% of this was net new. We had 1 mega deal win in Q1. Our value of deals of financial services was 50% of the overall large deal value in Q1. We announced a mega deal of $2 billion value after the close of Q1 and before our results before today. With a strong large deal and mega deal wins, we are building well for the future. Our pipeline of large deals is strong, and we continue to have mega deals in our pipeline. We are delighted that Topaz, our AI and generative AI platform is resonating well with our clients. We are working on 80 generative AI projects for our clients at this time. The work we are doing encompasses large language models for software development, text, document, voice and video. Internally, we have developed generative AI tools using an open-source model for software development. We are working with open-source and proprietary generative AI platforms and modules. We obtained 40,000 employees on generated AI. We see opportunities for new work and for productivity improvements through this technology. All of these elements are available within our Topaz set of capabilities. We see this area of generative AI and Topaz being really transformative for our clients. As we look ahead with the large and megadeal successes and our strength in cost efficiency, automation and consolidation, we feel confident. In the short-term, we see some clients stopping or slowing down work on transformation programs and discretionary work. This is especially so in financial services, in mortgages, asset management, investment banking and payments, and in the telecom industry. We also see some impact in the hi-tech industry and in parts of retail. Even as we won 2 mega deals recently and have a strong pipeline of large and mega deals, we received revenue from some of these and other large deals towards the later part of our financial year. Keeping that in mind, we are changing our revenue growth guidance for this financial year to growth of 1% to 3.5% in constant currency. As a consequence of a mega deal wins overall traction in cost efficiency, automation, a differentiated digital cloud and generative AI capabilities, we are well positioned for the medium-term and especially towards the end of our financial year and the period after that. We have launched a broader and comprehensive margin expansion program. The program will work across 5 areas: [indiscernible] efficiency, automation and generative AI improvements in critical portfolios; reducing our indirect costs and communicating and driving value across the portfolio. Our senior leadership is mobilized on this. We're working on this program with our clients, our employees and partners, and we're taking steps for the short, medium and long-term, while keeping the overall strategic direction of the company in mind. We have an ambition to improve our operating margin in the future periods. Our operating margin guidance for the financial year remains unchanged at 20% to 22%. With that, let me hand it over to Nilanjan.

Thanks, Salil. Good evening, everyone, and thank you for joining the call. We entered FY '24 on the backdrop of uncertain macroeconomic environment with clients reassessing the IT spend and continue to focus on cost and efficiency programs. Q1 revenue growth was 4.2% on a Y-on-Y basis in constant currency. Sequentially, revenue grew by 1% in constant currency and 1.4% in dollar terms. Operating margin for Q1 was 20.8%, 20 basis points lower sequentially. This was primarily due to a 70 basis points of benefit from cost optimization, including utilization, automation, which was offset by a balanced 90 basis point impact from employee-related costs, including higher variable pay, promotions, et cetera. Client metrics remained strong with the number of $50 million clients increasing to 79, and $200 million clients at 15, reflecting our strong ability to mine top clients by providing them multiple relevant services. Headcount at the end of the quarter stood at 336,000 employees, which is a decline of 2% from the previous quarter. A substantial portion of attrition has been backfilled by training and reskilling existing pool of talent and deployment of pressures. Consequently, our utilization, excluding trainees, improved to 81.1%, which has further headroom for growth. We will calibrate the hiring for FY '24 based on available pool of employees, growth expectations and attrition trends. Free cash flow for the quarter was robust at $699 million, and the conversion to net profit for Q1 remained strong at 96.6%, led by strong collections. DSO increased by 1-day sequentially to 63. Consolidated cash and equivalents stood at $4.5 billion at the end of the quarter. This is before the payout of final dividend that happened in the first week of July. EPS grew by 6.6% in dollar terms and 12.4% in rupee terms. Yield on cash balance was 6.71% in Q1. ROE increased to 32.8% in Q1, a 1.8% increase year-on-year, which is a reflection of our strong cash generation and capital allocation policies. Largely, momentum continued, and we signed 16 large deals in Q1: TCV of $2.3 billion, with 56% net new. 3 deals each were in FS, EURS and communication; 4 in retail; 2 in manufacturing; 1 in life sciences vertical. Region wise that's offset by 11 in America, 4 in Europe and 1 in ROW. Coming to Vertical segment performance. Financial services vertical witnessed continued softness in areas like mortgage, asset management, investment banking, cards and payments. Large and super regional banking clients in U.S. have been resilient during this quarter. Large banking clients are focusing on vendor consolidation, cost takeout and self-funding transformation programs. Many financial institutions are looking at outsourcing the noncore business that includes taking away existing employees across technology and operations. While delayed decision-making is impacting the vertical, our recent deal wins, and the strong pipeline will help create momentum and opportunity for future growth. In retail, cost efficiency and consolidation continues to remain top priority for our clients. There is intense focus on leveraging AI to accelerate digital transformation for enhanced customer and employee experience, predictive analytics and real-time insights. While decision cycles are long, large deal, the pipelines remain in infra-apps and process modernization, cloud and workload migration. Communications sector is witnessing continued impact from budget cuts, delayed decision making for newer spend and slow ramp-up. Growth challenges for the clients persist due to increasing OpEx pressures. Cost optimization and vendor consolidation, our top priority for clients who are open to innovative solutions and are asking for AI to amplify productivity. OEM clients are showing greater interest in revenue-generating services, decreased time to market, increased product quality and improved customer experience. Large deal pipeline and this vertical remains very healthy. Outlook for the energy, utilities, resources and services vertical continues to be positive, though they slowdown in decision-making. Energy clients are coming to us for large-scale transformation programs such as business capabilities for energy transition and journey to net 0. Utilities, clients are focused on in-flight transformation programs or those required for regulatory compliance. Service clients are focused on consolidation and M&A, cloud cost optimization and legacy transformation. Our investment in industry cloud and solutions in the energy transition area had helped us differentiate in these sectors, win multiple deals and build a very strong pipeline. Manufacturing clients are focusing on controlling the spend and awarding deals which are focused on differentiation. Despite the volatile environment, deal pipeline is strong. Areas like engineering, IoT, supply chain, cloud, ERP and digital are seeing increased traction. There's a need to increase pace of migration to cloud, increasing productivity by transforming to smart factories and transitioning to smart products. We are seeing opportunities across auto, aerospace and industrials. We have revised our revenue growth guidance for FY '24 to 1% to 3.5% in constant currency terms. This was due to lower-than-expected volumes, which will ramp down in discretionary spend, coupled with lower mega deal volumes arising from delayed timing and longer ramp-up times due to regulatory approvals and transition. Margin guidance remained at 20% to 22% for FY '24. We continue to aspire for higher margins over the medium term with the razor-sharp focus on cost optimization and efficiency improvements. As Salil mentioned, we have launched a new margin maximization program across the 5 pillars comprising over 20 flagships. With that, we can open up the call for questions.

[Operator Instructions] The first question is from the line of Kawaljeet Saluja from Kotak.

My first question is the fact that in the prepared remarks, both Nilanjan and Salil, both of you mentioned that the guidance cut is partly due to a delay in volumes or the delay in timing of mega deals. But as far as I remember, your guidance at the lower end was not predicated at -- or not predicated on mega deal project, which is 4%, and 7% was predicated on mega projects and volumes flowing through. So I'm just trying to understand, if you can just delayer your guidance -- basically just highlight what percentage of the cut is attributable to your projection of change in deal in the external environment, and what percentage is really delayed signing of mega deals here?

Yes. So Kawal, as you know, there was a guidance of 4% to 7%. Of course, the higher end of the guidance had a larger amount of the mega deals. And the 4%, of course, was predicated a lot on the base volumes, which by default would be in quarter 1, quarter 2. And this is where we have seen discretionary spend cuts in quarter 1 in some client, and of course, in Q2 as well, some of that softness continues. I mean, as you know, if you have to meet the year, quarter 1 and quarter 2 are very critical for that really to happen. So fundamentally that's the base reason and we exit the year, of course, at the higher end, there was the impact of mega deals. And our guidance on both ends have come down. And one of the reasons the top 10 that has come down is also largely also due to the delay in mega deals signing and the transition times. But the pipeline, as Salil said, is very healthy. We got 2 under the belt, and we are as confident as we exit the year.

But Nilanjan, just to try you know, when you basically spoke in the last quarter, you did highlight that 1Q would be weak, and we expect pickup in 2Q, whereas right now, you're saying that 1Q and 2Q are strong quarters. I'm just trying to understand the disconnect in commentary. The second part to the question underlines is that -- 2 consecutive quarters, 2 competitive misses. I guess last time around as well, there's a lot of pushback saying that the environment has deteriorated and how you built any extra cushion into your guidance, et cetera. So what are your learnings in the last 2 quarters? And what are the steps you have taken to ensure that the forecasting process is a little bit more robust than what the guidance cut in the last 2 quarters indicate?

Yes. Kawal, see, when we give the guidance, we see the outlook at that point of time. We have assemblance of what is a pipe. We assume some convertibility. There's an existing book of business. But like I just said, in Q1, from a sequential basis, we are lower than where we thought we would end up to be, right? Because like I said, Q1 and Q2 was critical for us to meet that guidance. And we have seen these discretionary cuts in clients in some sectors which we've just called out, right? And that's, what I would say, the base business. And on the other side, there is the mega deal impact. We've got a good pipeline and some of these deals, which was supposed to kick in earlier, are getting delayed later into the year as we speak.

Okay. Okay, that's clear. Just a final comment, how the pipeline after the conversion of the $2 billion mega deal as such? Can you just comment on the pipelinen for DSO?

So Kawal, this is Salil. The pipeline, we still have a good pipeline of both large deals. We have some mega deals in the pipeline as well. We see a lot of the work that we're doing on cost, on efficiency, automation in consolidation. Those are tracking well with clients. There are some transformation programs, which are funded from within the cost efficiency. Those are also something that we're tracking through. So we do see with the 2 mega deals signed, a good pipeline today of large deals, and we have mega deals in the pipeline as well.

Right. And just finally, is the upper end of the guidance band in any way predicated on future mega deal closures? Or it's based on the deals closed up to now?

So here, the way we build this guidance or our view of the 3.5 is based on what we have closed today in large and mega deals. And then we have a way of estimating based on what we see into the future as an aggregate not as a one-off or not as a binary discussion, but in aggregate with what we'd see as a probability, and also the probability of when that work will transition in the revenue side. So those are what we see in the pipeline are baked into it.

The next question is from the line of Yogesh Aggarwal from HSBC.

Salil, just a couple of questions. Firstly, on banking. Your banking weakness has been there for a few quarters, and now most of the companies are showing weakness as well. Whereas if you look at the clients itself, most of their financial reserves, the big commentaries and the data is not that weak. So where is the disconnect, you think? Are they spending more with captives or smaller subcontractors? Where is this market share loss coming from?

Yogesh, I think what we see in our financial services or banking part of financial services, there are different clients of ours that have different patterns in terms of their own pressures within their business. Some of our clients have had good results, but there are some which have had more difficult economic situation. Also with the mix from geography between Europe, Asia Pacific and U.S. When we break it down into specific subindustry area, when you look at asset management, when you look at investment banking, when you look at payments or mortgages, those are the ones where we're seeing the impact. Our sense is generally our clients are not spending on those projects. It's not that they're spending somewhere else. Typically, they're choosing not to spend at this time. And as the environment changes, we will see how that pattern changes.

Okay. Okay. And just a quick follow-up. The revised guidance now at the lower end, I wanted to ask you, you have already won 2 mega deals. And the lower end of the guidance suggests almost negative or flattish growth for the next 3 quarters, which would also mean that for 6, 7 quarters now revenues will be flat. So what are the assumptions for the lower end of the guidance, I wanted to know?

See, here as Nilanjan was sharing about the guidance, the approach is really focused on what we've seen in terms of volumes, discretionary projects in quarter in Q1 and an overlay then of the actual mega deals and large deals we have already won, and the estimate that we're looking at. So we are -- some of those deals have start dates have moved out, whereas the volume and discretionary project slowing is still in quarter. So our view is based on how that plays out between those trends, we saw the 1% in terms of the lower end of the guidance when you combine that and then, of course, the high end we talked about earlier.

The next question is from the line of Ankur Rudra from JPMorgan.

Salil, thank you for the updated guidance. I just wanted to get a sense of, obviously, the ask rate for the next 3 quarters has now moderated from, maybe it could have been 2% to 4%. With the same old guidance, it's 0% to 1.5% as discussed. Just curious about the discretionary cuts and the delays you referenced in your guidance change description. Has this happened more towards the latter half of the quarter? Has there been a linear change over the course of the quarter?

So there -- Ankur, the way we've seen it is there will be no difference in the pattern at the beginning or the end of the quarter. It's more focused on the industry that we referenced in our opening remarks between Nilanjan and me. We have seen in different places the discretionary work and some transformation work, where it will either slowed or stop based on different industries.

Okay. And also, I just want to get a sense of maybe asking this in a slightly different way. Obviously, the guidance change is quite drastic. Is this just the change in environment of spending over the course of the last 3 months? Or is this also a difference in the way you measure the likelihood of success of when the deal ramp up, or the win rate of future deals? Just curious about that and if this guidance is more conservative anyway versus the last time you said it?

So there, it's a combination, as you pointed out, of the environment in terms of the discretionary or transformational projects in the quarter. And then some of the mega deals and large deals, we saw a delay in decision-making in closing and also delay changes in the start time or ramp-up of the profile of that deal. We've actually not seen any change in the win rate. And in fact, internally, we had a good win rate in Q1, and we continue to see good traction, whether it's consolidation, cost efficiency on the win rate side.

Appreciate that. Just one clarification, if you could. I know this $2 billion framework agreement that you referenced is the second large deal. Could you clarify if this is fully contracted? And is this type of deal historically also been disclosed in your PCVs over the last few quarters or years?

The deal, we have first laid the announcement, and I'm sure you've seen, we have completed the contract signing of the deal. That's when the deal was announced. These types of deals were also included in the past within a large deal mix. Of course, in the past, there was no requirement of disclosing the specific values.

Okay. Understood. Last question if I can. On margins, they were obviously flattish this time, and it doesn't -- I mean it seemed like you've done well given what the growth has been. The 5-point margin maximization plan you've highlighted, is this you playing offense or defense on margins? In other words, is Infosys confident of potentially expanding margins in F '24? Or is it more for margin defense because growth outlook doesn't look very strong, at least at the lower end of guide?

Yes. So like we said, I mean, this is a 2-year program we have started. It is quite comprehensive. It's just not looking at cost, it's looking at portfolio. And this is now being led personally by Jayesh with 20 tracks, 20 leaders. Of course, our aspiration continues to be that we will aspire for higher margins than where we are today. So I mean from that perspective, it is offensive -- on offense, I would say offensive, but on offense, this thing to increase our margins. That's the intent.

The next question is from the line of Apurva Prasad from HDFC Securities.

Salil, just wanted a broad further on the guidance. In the last quarter, you had referred to a achieving top-end basis, the strength of pipeline and factors that are binary. So are those binding factors still in the pipeline or converted by transition is taking longer? So what I'm trying to get at is how should we really reconcile the change in revenue guide in the last 3 months between delay and volume cuts, which is as large as $600 million?

So there, we've already announced 2 mega deals, which is a positive. We have large and mega deals in the pipeline. The way we've seen it is really the 2 points you mentioned, which is the volume discretionary work in quarter and the delay in the start of the realization transition of some of the large and mega deals, those are what have translated to the change in the guidance.

Any way that you could split those factors, how much of an impact would that have been?

We will not be in a position to quantify that further between those 2, unfortunately.

So okay. And just how would you characterize the business environment and your client conversations at the end of the quarter as compared to how it was at the beginning of the quarter?

So there, it's really -- the way we see it is, our pipeline for large and mega deals is in excellent shape as we closed the quarter. We see good traction for mega deals and our large deals. The focus is much more when you're talking to clients on efficiency or cost or consolidation. We have a real traction with them. We see less discussions on digital transformation. And then in general across the client base for those industries that I referenced in the opening remark, we see where there are discretionary programs where the client feels that they can slow them or pause them for some time, we see that action. So those are the 2 sort of actions we are seeing very good traction, in fact, on the large and mega deals.

Apurva, does that answer your question?

Yes. Yes, thanks.

The next question is from the line of Kumar Rakesh from BNP Paribas.

My first question was more of a clarification. So can you just confirm the process of deciding the revenue growth guidance? Is it the same, which was last fiscal year versus this year? Or have you changed some of the assumptions for the processes that you follow?

Rakesh. This is Salil. So we've following the same approach that we followed over the last several years as we build sort of outlook of our guidance that we share with the market.

Great. Got it. My second question was on the margin side. So this quarter, we had a slight decline on the margin sequentially. Now wage hike is yet to be lend out. So how confident are you on holding on to the current margin or the margins which we had last year? And the cost saving program also you're going to be running? Or there would be more of headwinds than tailwinds on the margin side?

As you saw my margin walk, right? We actually had a 70 basis points benefit from utilization, cost optimization. So we are seeing the tailwinds of that. And the big part of that, we actually put back into employee-related compensation, which is variable pay. That's a big part promotion. So it's not that we are moving that to the market. That's a conscious decision for us to plow it back towards employee. So as we look ahead, we are actively considering compensation hikes as well we announced an update conference earlier. And the new program that kicks in, we think in optimization will give us the necessary tailwinds to be well within the margin guidance band.

My last question was around the volume commentary which you gave. So last quarter in April when we had the discussion. You had talked about that volume through the quarter, you were seeing signs of improvement. However, in this quarter, you have seen performing much below your expectation. So what has -- which are specific pockets you are seeing the weakness specifically? Is it more client specific or the entire industry working a much shorter weakness?

It is a client-specific like this time. In fact, we saw slightly more resilience in the U.S.-based clients. Europe turned out to be slightly weaker. So it is very client specific actually across. I mean, it's sort of a leaking bucket in a number of clients. There's no large sort of a dropoff. And this is largely with the 3D effect the discretionary part, right? So it is some programs which can be pulled back and are discretionary in the nature, those are the ones we are seeing.

The next question is from the line of James Friedman from Susquehanna.

Salil, I think many investors are wondering, Salil, I appreciate your thoughts. Does it seem to be that the soft demand was primarily due to macro factors, which are presumably temporary? Or is it potentially something more profound like perhaps related to the relevance of services or lion's share? So is this just macro it's going to go away? Or is it a question of services in itself?

So this is Salil. Thanks for the question. The way we see it today, we see this demand environment, especially on discretionary that we've been discussing so far, as a function of the macro environment. We can see, for example, if you look at different industries, manufacturing growing at 21%, other industry is doing well, whereas financial service is weaker. So our service portfolio, we believe, works well. We've already transformed the company, moved it predominantly into a digital business. We are very strong on cloud with our cobalt offering. And now with generative AI and broadly with AI, we've launched our Topaz offering. My sense is that those are resonating well with clients. And the places where we see the constraints have been more with the macro. Even some of the large and mega deals we are winning -- we're winning against a fairly intense competition where we are demonstrating our capabilities, whether it's on transformation or on cost or efficiency or consolidation.

The next question is from the line of Abhishek Bhandari from Nomura.

I have 2 questions. First of all, Salil, congrats to you for this $2 billion mega deal. And if you could share some more details around this project given that it is probably the largest you announced anywhere globally. Is it pure services deal? Or there is an element of any hardware purchase along with it? And do you think this will get into revenue translation more in the second half of this year?

So thanks for the question. On this specific deal, what we have shared in the public domain is as per the filing with the stock exchange, it really focuses on work that we are doing related to AI and automation-led development, modernization and maintenance services. We don't have anything more to add to that comment.

Sure. And do you think this goes into revenue translation in second half?

Yes. So again, there, we don't have anything more on the specific deal. It's not the general comments we've talked about the large and mega deals. We do see, in general, across our larger and mega deals, the revenue coming through in terms of the transitions and revenue realization more towards the later part of the year.