Infosys Limited (NYSE:INFY) Q2 2024 Earnings Call Transcript

Infosys Limited (NYSE:INFY) Q2 2024 Earnings Call Transcript October 12, 2023

Infosys Limited reports earnings inline with expectations. Reported EPS is $0.18 EPS, expectations were $0.18.

Operator: Ladies and gentlemen, good day and welcome to the Infosys earnings conference call. As a reminder, all participant lines will be in listen-only mode and there will be an opportunity for you to ask questions after the presentation concludes. Should you need assistance during the conference call, please signal an operator by pressing star then zero on your touchtone phone. 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.

Sandeep Mahindroo: Hello everyone and welcome to Infosys’ earnings call for Q2 FY24. Joining us on this call is CEO and MD, Mr. Salil Parekh, CFO Mr. Nilanjan Roy, and other members of the leadership team. We’ll start the call with some remarks on the performance of the company for Q2 followed by comments from Salil and Nilanjan, subsequent to which we’ll open up the call for questions. Kindly note that anything we say with reference to our outlook for the future is a forward-looking statement which must be read in conjunction that the risks that the company faces. A full statement explanation of these risks is available in the filings with the SEC, which can be found on www.sec.gov. I’d now like to pass it on to Salil.

Salil Parekh: Thanks Sandeep. Good afternoon, good evening, good morning to everyone on the call. Thank you very much for joining us. We’ve had a strong quarter in Q2. Our growth was 2.3% quarter-on-quarter and 2.5% year-on-year in constant currency. Our operating margin was at 21.2%. Large deals was at the highest ever for us at $7.7 billion and 48% of this was net new. Our Q2 large deals include four mega deals. It does not include the MOU we signed and announced for $1.5 billion. We see that with our large deal wins in the past two quarters, we are winning market share in the area of cost efficiency, automation, and AI. This is a testament to our strong position as partner of choice for clients. With a clear focus on client relevance, as the economic environment changed, we rapidly pivoted from delivering transformation projects to also delivering productivity benefits and cost savings at scale.

These large and mega deal wins help us to build a strong foundation for our future. We continue to see an overall environment where digital transformation programs and discretionary spends are low and decision making is slow. This is impacting our volumes. The adoption of Topaz, our generative AI capability set, is helping us deliver more value and to increase market share. We’re currently working on over 90 generative AI programs. Our work is with proprietary and open source large language models. We continue to make investments in generative AI as we look to help our clients navigate the way forward with deep capability. We’ve trained 57,000 employees in generative AI. We’ve announced the launch of our compensation review program for all employees effective November 1.

Our margin expansion program is being driven comprehensively across the company. We have five areas of focus: pyramid, automation, critical portfolio, indirect cost and value, and we have 20 specific tracks within these five areas. We are delighted to welcome Rafael Nadal and Iga Świątek as our brand ambassadors. We are thrilled to be recognized on Kantar’s list of most valuable global brands at number 64. With the continued reduction in digital transformation programs and discretionary spend and the ramp-up of our large and mega deals towards the end of our financial year, we are changing our growth guidance for this financial year to be growth of 1% to 2.5% in constant currency. Our operating margin guidance for the financial year remains unchanged at 20% to 22%.

With that, let me hand it over to Nilanjan.

Nilanjan Roy: Thanks Salil. Good evening everyone and thank you for joining the call. Q2 revenue growth was 2.5% year-on-year in constant currency. Sequentially, revenues grew by 2.3% in constant currency and 2.2% in dollar terms. While we saw continued softness in underlying volumes, revenue for the quarter was supported by stronger growth in the balanced portfolio and improved realizations from one-timers. H1 revenue growth was 3.3% in constant currency terms and operating margins were at 21%, which is the midpoint of our guidance range. A highlight for Q2 was the large deal TCB of $7.7 billion, of which a sizeable 48% was net new; consequently, our H1 large deal TCB is at $10 billion, which has already exceeded the total large deal signings for FY23.

I will talk about this in more detail later. As announced in the previous quarter, we have launched Project Maximus, which is a margin improvement plan across five pillars and over 20 tracks. This program has been well received across the organization and we have been able to identify certain new opportunities across the pillars. We have also seen some early benefits in some areas, like utilization and optimization of overhead. We remain confident that this program will create a more meaningful impact on operating margins in the future. Operating margins for Q2 were 21.2%, an increase of 40 BPs sequentially, bringing H1 margins to 21%. The increase in operating margin sequentially was due to 0.5% from cost optimization benefits comprising of high utilization [indiscernible], etc., 0.3% from revenue one-timers, 0.1% from [indiscernible] depreciation offset by a 0.5% increase due to third party costs [indiscernible] and other items.

Client metrics remain strong with the number of $50 million clients increasing to 80 and $100 million clients at 29, reflecting our strong ability to manage top clients while providing them multiple relevant services. We are rolling out a [indiscernible] compensation hike for employees effective November 1. Headcount at the end of the quarter stood at 328,000 employees, a decline of 2.2% from the previous quarter. Our focus on improving operating efficiency has resulted in improvements in utilization, excluding trainees, from 81.1% to 81.8%, which we believe has room for further optimization. LTM attrition for Q2 reduced further to 14.6 while quarterly annualized attrition was flattish sequentially. Free cash flow for the quarter was robust at $670 million and the conversion to net profit for Q2 was robust at 89%.

Our unbilled revenues dropped for the second consecutive quarter and consequently the third party led to an increase in DSO by four days sequentially to 67. Consolidated cash and equivalents stood at $4.2 billion at the end of the quarter. The Board announced an interim dividend of Rs18, an increase of 9.1% compared to last year. EPS grew by 1.7% in dollar terms and 4.6% in rupee terms on a year-on-year basis. Yield on cash balances was 6.7% in Q2. ROE was 20.9%, an improvement of over 8% under the current capital allocation policy started in FY20. We had an excellent outcome in our large deal wins thanks to our strong client relationships and the relevance of our service offerings. We signed 21 large deals in Q2, including four mega deals.

As mentioned, the total large deal TCB was $7.7 billion with a strong 48% net new. We signed six large deals in retail, five in manufacturing, four in telecom, three in FS, two in life sciences, and one in new [indiscernible] verticals. Region-wide, we signed 12 in America, eight in Europe, and one in RoW. Coming to vertical segment performance, the outlook continues to remain uncertain in the financial services sector with slowdown in areas like mortgages, asset management, investment banking, cards and payments. Q2 growth was impacted by spend reduction in some large clients which was partially offset by ramp-ups of large deals wins in areas like cost optimization and vendor consolidation. We remain cautiously optimistic about the medium term outlook due to the movement to cloud, led by increased need for real time insights and analytics.

Growth challenges in the communication sector continued, coupled with increasing opex pressures. Risk of inflation, high interest rates and supply-demand imbalances are creating near term uncertainties. Delays in decision-making continue. Our strong large deal signings and pipeline will help support growth in the medium term. The recent deal with Liberty Global reinstates our positioning as a leader in partnering with clients to provide significant savings, as well as innovative ways to transform the landscape. EURS clients are taking a conservative approach to discretionary spend, and the trend is likely to continue through the year. In energy, spending remains cautious due to the economic slowdown, with focus on cost take-out and ROI. Utilities, especially in North America, continue to feel the press from high interest rates, resulting in delays in capital intensive programs.

European utility players continue to make investments on legacy modernizations. While the external environment continued to be volatile, the manufacturing sector continued to show double-digit growth year-on-year in Q2. Our capabilities in areas like digital transformation, cloud ERP, supply chain, smart factory, etc. are resonating well with clients, resulting in benefits, with vendor consolidation in turn leading to stronger deal signings. While pressure on discretionary spend continues, there are opportunities in areas like [indiscernible], transformation, cost consolidation, etc. which is resulting in a stronger pipeline. In the retail segment, budgets continue to remain tight as clients continue to focus on budget consolidation, cost and efficiency.

Interest on gen-AI is growing and clients are evaluating our Topaz offerings to modernize their enterprise and re-factor, re-engineer and deploy code. While we had a very strong sequential growth in Q2, the underlying softness in volumes and discretionary spend continues. We have revised our revenue growth guidance for FY24 to 1% to 2.5% in constant currency terms. Our deal signings and strong pipeline lays the foundation for acceleration in growth beyond FY24. We retain our margin guidance band for the year at 20% at 22%. With that, we can open up the call for questions.

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Q&A Session

Operator: Thank you very much. We will now begin the question and answer session. [Operator instructions] The first question is from the line of Bryan Bergin from Cowen. Please go ahead.

Bryan Bergin: Hi, good evening. Thank you. I wanted to just start with the growth guidance reduction. I’m trying to understand if the reduction is more due to the delay of the large deal ramps versus what you had expected three months ago, or if it’s more due to incremental volume perhaps in other program efficiencies.

Salil Parekh: Hi, thanks for the question. This is Salil. I think it’s a combination of those points. There is–the way the large programs start off, there is delays in starting them. There was also–as we were assigning these deals, the cycle was a bit longer in closing them, so that had a bit of slowness, and we are seeing discretionary spend which is coming down, and we saw that continuing on–transformation programs being slowed, that continuing on in this quarter, so it was a combination of those projects.

Bryan Bergin: Okay, appreciate the color. Then just on margin, Nilanjan, understanding you have the wage increment that you just announced here, but you also have margin tailwinds through Project Maximus, so can you give us some color on where you’re finding comfort within the margin range that you’re referring to here today? I know you’re right at the midpoint here to the first half. Do you expect to be above or below that as you go through the second half?

Nilanjan Roy: Yes, so like I said, we had a good quarter two, and then as I explained in my margin walk, we had a 50 basis point improvement from our Project Maximus on cost optimizations, and that gives us comfort for the rest of the year, and that the program is–of course this is a much longer program, which will take not only this year but into next year as well. We also realized that we have apparent inefficiencies – our utilization is still low, so [indiscernible] help us and of course offset the wage hikes, etc. We have a good program over the next 18 months to see where we end up, and of course our aspirations continue to be to improve margins from where we are presently.

Bryan Bergin: Thank you.

Operator: Thank you. The next question is from the line of Kawaljeet Saluja from Kotak. Please go ahead.

Kawaljeet Saluja: Hi, thank you. I have a couple of questions. My first question is can you quantify the revenue of one-timers, and are these revenue one-timers in third party items bought for service delivery to clients or those are separate?

Nilanjan Roy: Kawaljeet, in the margin walk, we talked about a 40 basis point impact on margin from revenue one-timers, so it’s going to be around that figure or slightly more than that. These large deals will fall through straight to margins. What was the second part, Kawal?

Kawaljeet Saluja: The second part of the question is that can you detail other verticals to which the mega deals belong, and the other question related to the deals is that normally you expect the direction of revenue growth and deal wins to synchronize, whereas actually they are moving in the opposite direction, so what needs to change for the synchronization to happen again?

Salil Parekh: Yes, so Kawal, we don’t give out which segments the mega deals are falling under. The second part was you were saying, where will revenue and large deal announcements synchronize? Is that the question?

Kawaljeet Saluja: Yes, absolutely. I mean, they seem to be moving in different directions. With the $7.7 billion in regard to large deal wins, you would have expected a happier picture on growth outlook, whereas things seem to have changed there, so what needs to change for the synchronization of growth and all the deal wins and growth to happen?

Nilanjan Roy: Sure, so I think one is, of course, mega deals, as you know, post signing they have a runway in terms of [indiscernible], in some cases they may have re-badging, so that would take some time to have regulatory approval, so you can’t even do people transfer. Then of course there’s a transition period and then of course post-transition, then of course there is a transformation element [indiscernible], so these are all steps in the process and as you can imagine, being such large deals, these cannot overnight be turned on in terms of us taking over the entire landscape, etc. [indiscernible], and therefore it takes a couple of quarters really before they start leading into the revenue figure. Like I said, this will set us up well for FY25 fundamentally, and as Salil said, in the near term, in the quarter there was of course the underlying volume sluggishness, and of course we have to recognize that part as we [indiscernible] for this year.

Kawaljeet Saluja: Okay. What’s the deal pipeline like after the recent conversion of pipeline into mega deals, so how does the pipeline look like? Is it significantly lighter, or does it stay remarkably strong?

Nilanjan Roy: It’s a strong pipeline, of course, at 7.7, and I think you can–it can’t be higher than the previous quarter but it’s a very strong pipeline, and of course we will continue to have enough in the funnel to start refilling this.

Kawaljeet Saluja: Just a final question on deals. I think the past experience of mega deals and the transition of that into profitability has not been very encouraging, but if I look at your comments and Salil’s comments, all of you have highlighted that your profitability aspiration is to improve your–you want to improve your profitability. Now at the same time, you have those mega deals as well, so how does the profitability dynamics play out, especially given the past context?