Infosys Limited (INFY) Earnings Call Transcript & Summary

Ladies and gentlemen, good day, and welcome to Infosys Limited Q2 FY '25 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, Mr. Mahindroo.

Hello, everyone, and thanks for joining Infosys earnings call for Q2 FY '25. Joining us on this call is CEO and MD, Mr. Salil Parekh; CFO, Mr. Jayesh Sanghrajka; and other members of the leadership team. We'll start the call with some remarks on the performance of the company, subsequent to which the call will be opened up for questions. Please note that anything we say which refers to our outlook for the future is a forward-looking statement that must be read in conjunction with the risk that the company faces. A full statement and 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 turn the call to Salil.

Thanks, Sandeep. Good evening, and good morning to everyone on the call. We had a strong performance in Q2 with robust and broad-based growth, stable operating margins, strong cash generation, strong large deals and increased employee headcount. Our revenue grew 3.1% quarter-on-quarter and 3.3% year-on-year in constant currency terms. Financial Services grew at 2%; Manufacturing, double-digit; Energy, Utilities and Services at 5.8%, all quarter-on-quarter. We saw growth in all geographies quarter-on-quarter basis. Our large deals were $2.4 billion. Our overall pipeline remains strong. We saw a double-digit quarter-on-quarter increase in our pipeline of deals below $50 million. Our operating margin for Q2 was at 21.1%. Free cash flow for the quarter, $839 million. Employee attrition is stable at 12.9%. We will launch our employee compensation increase in 2 phases, effective Jan 1, 2025, and April 1, 2025. The Financial Services segment in the U.S. continues to see discretionary spend increase in capital markets, mortgages, cards and payments. We've seen slowness in the automotive sector in Europe. Apart from these verticals, demand trends remain stable with clients continue to prioritize cost takeout over discretionary initiatives. Our Q2 performance reflects our sustained strength and differentiation in the industry. We are deepening our work in generative AI, working with clients to deploy enterprise generative AI platforms, which become the launch path for client usage of different use cases in generative AI. We are building a small language model leveraging industry and Infosys data sets. This will be used to build generative AI applications across different industries. We've launched multi-agent capabilities to support clients in deploying agent solutions using generative AI. Our generative AI approach is helping clients drive growth and productivity impact across the organization. We are partnering with clients to build a strong data foundation, which is critical for any of these generative AI programs. One example, we are working with a logistic major using [ Topaz ] to power their operational efficiency improvement. Concurrently, we're supporting their digital transformation journey to help them deliver exceptional services for their customers. With a strong performance in Q2 and our current outlook, we have revised our revenue growth guidance for the financial year. The new guidance is 3.75% to 4.5% growth in constant currency. Our operating margin guidance for the financial year remains the same at 20% to 22%. With that, let me hand it over to Jayesh.

Thank you, Salil. Good morning, good evening, everyone, and thank you for joining the call. We had a strong Q2 with broad-based growth and resilient margins amidst an uncertain macro environment. Let me talk about some of the key highlights. Revenues grew sequentially at 3.1% in constant currency terms, ahead of our expectations. All geos and verticals, barring retail, grew sequentially. Europe had a strong growth and is now approximately 30% of our revenue. Inorganic contribution was 0.8% Q-o-Q, which contributed to growth in Europe manufacturing. We had another quarter of volume growth. Financial Services in U.S. continues to see discretionary spend uptick in capital markets, mortgages and cards and payments. Both EURS and Manufacturing verticals reported double-digit year-on-year growth. Overall deal pipeline remains strong. Pipeline for deals less than $50 million increased double digits sequentially. Operating margin during the quarter was stable at 21.1% driven by better operating metrics despite higher variable pay and acquisition impact. Utilization continued to improve to 85.9%, up 60 basis points sequentially. We saw headcount additions after 6 quarters and added 2,500 employees sequentially. We had second quarter -- second consecutive quarter of over 100% of free cash flows conversion to net profit. Free cash flow for H1 stood at $1.9 billion, 41% higher over H1 last year. Let me delve upon the details now. Revenue for Q2 was $4.9 billion, up 3.1% sequentially and 3.3% on a year-on-year basis in constant currency terms. This included benefit from acquisition of [ 0.8% ]. Operating margin was stable at 21.1%. The major component of sequential margin -- margin walk are: Tailwinds of 80 basis points benefit from Project Maximus, 10 basis points from the currency movement, offset by 30 basis point impact from acquisitions mainly on account of amortization of intangible assets, 60 basis points from higher variable pay and other costs. Project Maximus remains a key focus area and successes of that is visible in improved operating metrics like utilization, realization, subcontracting costs, et cetera, for the quarter. H1 revenue growth was 2.9% in constant currency terms. Operating margins were at 21.1%, 10 basis points up year-on-year basis. Headcount at the end of the year stood at 317,000 returning to a positive sequential growth after 6 quarters of decline with net additions of approximately 2,500 employees. Utilization, excluding training, increased by 60 basis points to 85.9%. LTM attrition for Q2 was up by 20 basis points at 12.9%. We are on track to onboard 15,000 to 20,000 freshers in FY '25. Free cash flow conversion was approximately 108% for Q1. H1 '25 free cash flow is 41% higher than H1 '24. DSO for the quarter was 73 days versus 72 sequentially. Consolidated cash and cash equivalents stood at $4.6 billion after paying out $1.4 billion towards dividend. The Board announced an interim dividend of INR 21 per share, an increase of 16.7% as compared to last year. Yield on cash balance was flat at 7% in Q2. ETR was at 29.6% for Q2 and 29.5% for H1. We continue to expect ETR for FY '25 to be in the range of 29% to 30%. EPS grew by 4.7% in INR and 3.4% in dollar terms on Y-o-Y basis. We closed 21 large deals with TCV of $2.4 billion. 41% of this was net new. Vertical-wise, we signed 7 deals in Financial Services; 3 each in Communication, Manufacturing and others; 2 in Retail; and 1 each in EURS and Hi-Tech and Life Sciences. Region-wise, we signed 12 large deals in America, 5 in Europe, 3 in India and 1 in ROW. H1 large deal wins stood at 55 deals with TCV of $6.5 billion, and 51% of that is net new. Coming to verticals. Financial Services saw continued growth momentum in Q2 with traction in cost optimization through large outsourcing and transformation opportunities. We saw discretionary spend uptick in capital markets, mortgages and cards and payments. Deal wins during the quarter were strong with couple -- which, coupled with expanding pipeline of small deals, gives us visibility for future growth. We are going -- we are doing a variety of gen AI projects and are seeing them getting embedded in large programs. Retail sector continues to be impacted by economic and political uncertainties. Cost takeout efficiency and consolidation are key priorities for client. Consumers spend in the upcoming holiday season will be a [ key ] indicator for future spend decisions. We are progressing well on our journey to leverage AI to deliver business value with safeguards around privacy, ethics, controls, et cetera, across areas such as enhanced customer and employee experiences, digital marketing et cetera. Communication sector outlook is challenging with clients primarily focused on cost reduction and making that investment profitable. Discretionary spend for OEMs are expected to remain under pressure. Cost optimization, vendor consolidation are on the top priorities with clients open to innovate solutions and asking for AI to amplify productivity. Political conflicts and higher interest rate continues to influence spending patterns, causing clients to focus on cost optimization on initiatives. We saw strong growth in verticals, especially in energy sector, especially there is significant traction in cloud programs with many companies adopting to -- adopting the cloud and AI strategy. Our competencies in energy transition space, human experience and industry clouds and proactive client pitches have helped us build strong pipelines. Growth in Manufacturing was strong, partially contributed by In-Tech acquisitions. Europe automotive sector has been -- has seen recent challenges, while discretionary spend remains under pressure. We have seen increased benefits of vendor consolidation. We see opportunities around supply chain optimization, cloud ERP, smart factory and connected devices across various sub verticals. We are in discussion with multiple clients for setting up AI COEs to drive AI adoption at scale. Most Hi-Tech clients remain cautious due to geopolitical tensions. Discretionary spend and new project start are slow due to cash conversion focus. We are advancing multiple AI programs from POC to implementation, focusing on customer support and sales effectiveness. Driven by our H1 performance and outlook for the rest of the year, we are revising our FY '25 revenue guidance to 3.75% to 4.5% in constant currency terms. Our operating margin guidance remains at 20% to 22%. With that, we will open the call for questions.

[Operator Instructions] The first question is from the line of Gaurav Rateria from Morgan Stanley.

First question is the reasons for change in guidance for revenue growth. Is it largely because 2Q came in better than your expectations? Or is it because the outlook for 2H has improved versus your prior expectations because of better pipeline of the smaller deal?

Gaurav, this is Jayesh here. I think there are multiple factors that led to increase around guidance. Of course, the H1 performance or the Q2 performance, as you said, and more importantly, the broad-based Q2 performance was one factor. We saw continued momentum in volume as well as the momentum in Financial Services. Our increase in the smaller deals, which is less than $50 million deals, as we said earlier, which has had a strong double-digit growth, I think all of these factors contributed to increase in the guidance.

Got it. Second question on gen AI adoption. Have you seen the gen AI actually triggering a large transformation project and leading to a multimillion dollar deal or multiyear deals? Just trying to understand that is this going to lead to a wave of a larger IT spend and increase the overall addressable market for us?

Gaurav, this is Salil. On generative AI, what we are seeing is, first, we built the capability set, 3 examples that I shared of how we're doing it with platforms, with agents and a small language model. It's also very much focused on productivity and growth as clients are looking at it. So any of our large deals, the large deals today are not that much focused on transformation, more focused on cost and efficiency. So more of the gen AI focus is productivity. Any of the large deals that we're looking at, there's a generative AI component to it. Now is it driving the large deal? Not in itself, but it's very much a part of that large deal.

All right. And last question for Jayesh. What would be the tailwinds from a margin point of view in the second half, which could help us to offset the impact of the wage hike?

So Gaurav, just to put together all the headwinds and tailwinds, the headwinds will come from compensation increase in Q4 that we talked about. The Q3 and Q4 will have regular seasonality in terms of furloughs, in terms of lower working day in calendar, et cetera. And tailwinds would be all the things that we are doing in the Project Maximus, whether pricing, whether you're talking about role ratios, optimization. It's just all of those would be part of the same bucket of Project Maximus.

Next question is from the line of Bryan Bergin from TD Cowen.

I wanted to ask, just as you think about how you built the forecast forward and the discretionary view, aside from the improvement you've cited in U.S., the FSI, have you basically held everything else muted in your discretionary review as you go through the December and the March quarters?

Bryan, this is Jayesh here. As I said earlier, I think there are various factors that has led to a margin expansion -- sorry, our guidance change starting from the Q2 performance, the increase in volumes that we saw across multiple sectors, including Financial Services. Our pipeline, which is strong large deal pipeline as well as the smaller deals, which are less than $50 million deals, which have grown double digit. So I think all of these have been baked in. Of course, there will be seasonality in H2 as we all know about in terms of furloughs, in terms of lower working days, et cetera. So all of that at this point in time is baked in, in our guidance.

Okay. And then just a follow-up, just to make sure I understand the furloughs. Can you just -- how do you think about composing the furlough activity that you're embedding in the year-end? Any difference than what you saw from last year or historical levels?

No. So we, at this point in time, have baked in the regular furloughs that we have seen over the last -- past few years.

Next question is from the line of Jonathan Lee from Guggenheim Securities.

Great. Can you share further detail around what you're hearing in the pricing conversations, both around new deals and any potential rescoping of deal terms, particularly given continued focus on cost optimization for clients?

Jonathan, this is Jayesh here. The pricing overall, the environment has remained stable. However, within the pricing environment, we've been able to make a lot of progress in terms of getting -- we're getting benefits on the track that we are running under Project Maximus, which is value-based selling. So many of those tracks have started kicking in benefits, which is visible in our numbers. If you look at our volume growth using a proxy of the headcount, you will see there will be a delta between the revenue and the volume growth, which is contributed by the pricing significantly.

And how should we think about large deal TCV momentum going forward? Are we seeing any changes to client preferences around signing of large deals perhaps maybe towards smaller deals, given some of what you called out around smaller deal strength?

This is Salil. The large deals, the way we are seeing it is the pipeline remains quite good for us today. There's a much more focus on the cost efficiency, automation, and consolidation type of work. The -- these are lumpy. So in some quarters, we see a little bit more, some a little bit less, but we don't see a change in that outlook for large deals. The point on the smaller deal that Jayesh shared was a little bit additive. We are seeing more activity there as well, which we had -- which is different from what we have seen before.

Next question is from the line of Vibhor Singhal from Nuvama Equities.

So Salil, I just wanted to pick your brains mainly on how the BFSI vertical is looking at this point of time, post the interest rate cut as [indiscernible] change in conversation in terms of any change in the approach of the clients towards discretionary trend that they might be picking up in upcoming quarters. How do you see that vertical pay out and then I have a follow-up.

Thanks. So then Financial Services, we saw last quarter a good improvement in discretionary spend. And we continue to see that in Q2, the discretionary spend is good. We also saw the results of some of the large U.S. banks look quite strong. We see still the focus is much more on the discretionary and then some cost efficiency program. We are still not seeing large transformation type of program. But given our scale and the needs that the banks have and some of our clients where we are seeing good traction, the overall feeling, when we look at Financial Services, whether it's capital markets or mortgages, cards and payments, we see good traction on the discretionary side.

Got it. Okay. My second question was on the TCV side. The TCV on this quarter -- they have [indiscernible] softer side. Would you attribute that to anything specific? Is the client policies at this point of time on the side pushing the deals out because of the pending U.S. elections? How would you read that? And how do you see the deal flow in the upcoming 2 quarters and the rest of the year?

So there, we have not seen a change in the behavior from the Q1 to the Q2 in terms of the deal timelines and so on, on large deals. These are, at least in our experience from the past over multiple quarters, they're sometimes lumpy. We see some more some quarters, some less because they are large deals. That's where we are looking. So we don't see that as -- at least we don't see any change in the data about it, including in the pipeline, which looks good as well.

But we would have liked a better deal flow, I'm assuming, for the quarter. Do you see maybe Q3 or Q4 deal flow momentum taking that? Or it will -- again it will depend on how the macro factors play out?

It will be both. So the deal flow is decent. But sometimes because the size of these deals is quite large, sometimes they bunch up in a quarter. Sometimes they spread out a bit. So we look at it a little bit more like over the half -- or over the full year, when we look backwards. And that way we get, I think, because most of them are driving revenue for the next several years. So it's not really like they convert into a quarterly movement. So we look at it more in that sort of time horizon.

Okay. Just one question, if I could squeeze in for Jayesh. Jayesh, what is the reason behind the pushing out the wage hikes to Q3? And I mean, in fact, Q4 and Q1 of next financial year. I mean you find [indiscernible] directly to some part of the organization, we would actually be sweeping FY '25 completely in terms of wage hike. So is this multiple with the overall demand environment or the kind of price that we had given last year, a breakup? Just wanted to [indiscernible] based on that.

So yes, when we look at the comp hike, we look at various factors, including what's the demand environment, what's the market practice, what's -- when did we do the last compensation, et cetera. We have taken all of that into account. Our last comp increase was in November last year. So this is pretty much almost on an anniversary, if you look at it. So that's point #1. Point #2, if you look at within this quarter, we have increased our variable pay as well. So that's another factor to consider as well, yes.

Next question is from the line of Kumar Rakesh from BNP Paribas.

My first question was to understand how is the traction on your gen AI work? So you have the Topaz platform, which you have launched. You earlier had for cloud, a similar platform, Cobalt, to build an accelerator to help customers set up the new technology. So relative to how it was at that time when Cobalt initially was launched and how it was first year of traction in terms of how many customer engagements were happening, how many customers signed up for that? Relative to that, how do you see Topaz panning out?

This is Salil. So first, on Cobalt, the way as, of course you know, there was launched and rolled out, we had very strong partnerships with the 3 big public cloud players and have today, but when it was launched as well. We had a very strong private cloud offering, which we also have expanded. And we had a set of offerings on SaaS providers, the range of them. So that was an ecosystem, which for enterprises was already in motion. And we were already playing on that, and Cobalt brought all of it together. In generative AI for the enterprise, it's a start in terms of how it will be adopted. There are, of course, as you know, several use cases, some of them with some good traction with clients. But the method of adoption, so what we have done here in Topaz, some of the examples that I shared, we have created a generative AI platform, which can be rolled out across a large organization. And then the individuals in the organization start to build out their own gen AI applications on that and building a small language model. We have a multi-agent framework, where the agents are doing or a set of agents are doing full solutions to certain business processes or certain functions. So these are different ways that generative AI is being rolled out. It's difficult to compare, in that sense, the 2. We see much deeper capability set that we've rolled out in generative AI today than what we see anywhere else. Our clients are giving us that same view. We're also seeing generative AI a lot in productivity and especially in the deal flow we see today in cost takeout. And there, almost every large deal or significant deal even has some generative AI component related to productivity. Actually it's -- while not the whole deal is generative AI. A part of the deal becomes generative AI. So it's a different way it's creating an impact from what we saw in the cloud space.

And any insight on the customer adoption? How many customers have signed up for that? How many transactions are happening or how many accelerators you have run on that?

So there, we have not publicly shared that for the generative AI. What we have shared at this approach we are taking plus that our projects today are not a POC or proof of concept. They're actual projects, while they're small in revenue, delivering impact in that space.

Got it. My second question was on -- during the press conference, you did talk about the small language model for industry-specific use cases and the data that you are working on. My understanding is that at least the bigger models that we look around are either for consumer space or for enterprise or generally for more of generate use cases, not for industry-specific use cases. So This could be a wide space from the product perspective. How do you want to position this in the end market? Would it still be just an accelerator built on top of what the other tools are there? Or you would want to eventually look at this as a set product as well?

So here, first, if you step back, our views on enterprise AI, generative AI, large language models will also play a part. But in addition, we are working on a small language model. So it's not one or the other. The reason for the small language model, we believe we have some very good data sets within Infosys. And we are taking some, let's call it, clean data sets from outside the industry and so on. These then become -- these then help train the small language model. It then becomes -- we are then building it for different industries. And it then becomes deployable in an industry for a specific client, where they can build -- or we can help them build on this small language model other business applications. So the areas -- it's a new one. We feel we have some level of leadership on that. And we have launched this to see, where it ends up.

Okay. So this will also work as an accelerator and deployment of AI applications. Is that fair?

It will also be an accelerator. It will also be a foundation on which other business generative AI applications can be built by the client or with -- by us for the client.

Next question is from the line of Rishi Jhunjhunwala from IIFL Institutional Equities.

Just one question. So you -- your growth in this quarter as well as last quarter has been fairly broad-based across verticals. There has been the commentary that you've given also suggests that discretionary is seeing some sort of pickup in some verticals. But the guidance that you've provided for the second half effectively means that there is a considerable slowdown in the overall growth momentum. Now I understand there is some bit of seasonality that comes through. But given the nature of broad-based growth that you've delivered for 2 consecutive quarters at the midpoint of the guidance not having growth seems to be a little bit counterintuitive versus what you have commented on the demand environment. So I just wanted to understand how you're thinking about it.

Rishi, this is Jayesh here. So if you look at what we have consistently said in the past is our H1 is going to be stronger than H2. H2 will have seasonality, which is furloughs, lower working in calendar day in Q3 and lower working in calendar day in Q4. So all of that is baked in, in the guidance. Our guidance philosophy hasn't changed. We run multiple models running up to the guidance, which define the bottom, midpoint and the top end of the guidance. And we say it as we see it, right? So at this point in time, this is what we are seeing in terms of guidance.

Got it. And just very quickly, given where your utilization levels are right now, is it fair to assume that going forward, the hiring trends will largely reflect how you end up growing on revenues as well since a lot of fee moderation on utilization is probably behind us?

That's right, Rishi, again. We've always maintained that 84%, 85% is our comfort level utilization. We are already about that. So we don't think at this point in time, there's any significant headroom left on that. So most of the volume growth would come from the net hiring going forward.

Next question is from the line of Jamie Friedman from Susquehanna International Group.

Congratulations on the continued improvement. But a number of the questions you're getting there about what your assumptions are about the seasonality of the year. I know you said in your previous answers, that the year is typically super seasonal in the first half. In terms of what you're contemplating for the second half, what -- if you could share maybe what your assumptions are on, say, the cost takeout narrative versus the discretionary narrative. Is that rate of change changing? And maybe some color, it's on the verticals because I see it's great to have the 2 consecutive quarters in banking, but the retail was a little bit more volatile than expected. So any comments on the typical super seasonality and why this year looks a little heavier?

This is Salil. The way we've seen it, there are 2 parts to it from what you mentioned. One, in building the outlook, we've taken a view of what we see today. So Financial Services discretionary, we saw positive. We didn't see -- we have not seen as of now discretionary in the other industries. We saw the continued weakness on Retail. And then we saw a little bit new weakness on that automotive in Europe. So all that we took it together, then we created. So we've not assumed, for example, that some new discretionary will be positive or negative in this Q3, Q4. And the other part of seasonality, what Jayesh shared earlier, one is the furloughs in our Q3 then is the calendar day situation, both in Q3. And we have an additional little bit in Q4. So that is also adding to the way we have built this outlook for the full financial year.

Next question is from the line of Nitin Padmanabhan from Investec.

So you mentioned that the deal pipeline for smaller deals which is below $50 million has sort of improved in double digits. How has it been in terms of closures for the current quarters? When the pipeline has improved, how is the closures doing in the current quarter, have you seen that improve as well? And that is the first question. The second question is around the cost of software packages. That seems to have increased on a sequential basis. How much of that would have be in third-party versus internal? Is there a significant pass-through revenue this quarter was the question around it. So any color around that would be helpful.