Infosys Limited (INFY) Earnings Call Transcript

Very good evening, everyone, and thank you for joining Infosys second quarter financial results. My name is Rishi, and I would like to welcome all of you. One question -- With that, I'm going to hand it over to Salil for his opening remarks. Over to you, Salil.

Thanks, Rishi. It's good to see that everyone listens to you so well. So good evening, and welcome, everyone. Thank you for joining us. Our revenue growth for Q2 was 1.5% year-on-year and 1.2% sequentially in constant currency terms. . AI revenue was a standout at 10.5% of our revenue, growing at 29% sequentially. And last quarter, it was at 8.2%. Large deals were another standout at $5.2 billion for the quarter. This includes 2 mega deals. One of these mega deals was for over $2 billion with a large international company for a period of 7 years, and this is net new. This deal is expected to contribute over 1% revenue growth in the coming financial year. The second mega deal was for $1 billion for a renewal. Our large deal pipeline is healthy and includes some other mega deals in this pipeline. Operating margin was stable at 21%. Free cash flow was strong at $922 million for the quarter. As enterprises adopt AI at scale, another quarter of strong growth in AI revenues is a recognition of our differentiated market positioning and client confidence as an ecosystem integrator. We continue to work closely with the frontier model companies, both open weight and closed models. Our deep investments in Topas fabric help our trans seamlessly navigate between models to ensure token optimization and value realization. Infosys continues to gain market share, especially where economics of the program is aligned to stakeholder interest. We remain the preferred AI strategy and deployment partner for our top clients. As AI main central to enterprise transformation in the years ahead, Infosys is well positioned to help navigate this shift. Based on our Q2 performance and revised outlook for rest of the year, our revenue growth guidance is 1% to 2% year-on-year in constant currency terms. Our operating margin guidance remains at 20% to 22% for the year. Thank you. And with that, we can open it up for questions.

Thank you, Salil. We will now open the floor for questions. Joining Salil is Mr. Jayesh Sanghrajka, Chief Financial Officer, Infosys. The first question is from Meghna from CNECT 18.

My first question is on your guidance. So you have narrowed both the lower and upper end. Could you help us understand why explain the margin performance, the benefit of rupee depreciation any offset and loss due to deflation, et cetera. And your salary hike will impact your margins in the second half. Third is your AI revenue is 10.5% of your Q2 revenue. So how many deals on have AI element and with AI jitters globally, is there a change in business? And fourth, how are your December quarter for those shaping up versus last year and with sectors look the most vulnerable?

Okay. Let me start off with some of them and Jes will also jump in with some of the other ones. So first, AI is really an incredible performance for us. It's 10.5% of our revenue growing sequentially 29%. We had laid out the AI approach in the Hexagon with 6 different areas of focus. And in this revenue mix, we see each of those areas growing well, especially things that we do where we are building agents, where we're doing legacy modernization, where we're doing process AI, where we're doing data. So those are growing exceptionally well, but all of them are doing well. And then we have the partner ecosystem with that is really gaining momentum. I think in terms of the global AI, what you asked, -- our attention is really much more on the large enterprises with which we are working. So for them, this is starting to become more and more relevant. And with the investments we made and build the Topas fabric, and the capabilities we have, plus all the changing that we've done for all of our people, which many more are certified now, ready to do work with different partners or the frontier companies. That is where we're getting the good traction with the enterprise clients. I'll spend a couple of minutes on the industries. I think what we see, and Jayesh will add more to that, we see really good strength on the financial services. We see good strength on energy utilities. We see good strength on the manufacturing. And we see some weakness on the retail, and we see some weakness on the high tech. But it's a mix of all of those that we have put together in how we see this. This will be on the guidance on the margin.

Yes. So if you look at our guidance, our current guidance. Our last guidance was 1.5% to 3%. We had clearly called out at 1.5%. We expect even more uncertainty. Our Q2 has been softer and our volume continues to remain softer. We have also seen pricing pressure on the back of competitive density and higher risk on productivity. . So all that is baked in, in our revised guidance as we look forward. On top of that, as Salil said, in some of the sectors, we see softness retail tech, where the discretionary is lower than what we are expecting. So all of that is reflected in our guidance on the revenue, which is where it's 1% to 2% now. Our margin continues to remain at 21%. I think it's a strong performance on the back of all the efforts that we were putting in project maximus. We have -- if we look at the last many years, we have been able to maintain margins despite investment in business, whether it is sales and marketing, whether it is AI investment, talent investment and all of that. If you look at puts and takes of this quarter, the margins remained flat. We had a 70 basis points of impact on post-sale customer support, which is a delta between 2 quarters. Last quarter, we had a reversal this quarter, it's an impact. So it's a difference in that. We had a 20 bps coming from our acquisitions, 1 month additional impact last quarter to only 2 months of impact, so 1 month additional on account of amortization, et cetera. That was offset by tailwinds of currency, 40 basis points coming from the currency, 20 basis points coming from a higher calendar and working day and 20 basis points from the project maximum. So that kind of sums up the margin work. As you look forward, the next half, which is H2, we will have impact coming from compensation, as you rightly said. So that will have a headwind. We will see continued intensity on pricing. So we will see that and we will continue working on project maximums to offset as much as possible from there.

The next question is from Mani Dave from ET Now.

Good afternoon. So starting with the guidance, which is revised downward from 1.5% to 3% to 1% to 2% on a constant currency growth basis. How much is the big demand and market pressure affecting and what has changed in the demand environment. Plans ahead, if I may ask, AI monetization. Well, the AI as a percentage of revenue for Infosys this time is quite strong and greetings to you all for that. . AI is helping clients improve productivity, but it can also reduce our traditional billable work. So is Infosys managing to monetize AI-led opportunities fast enough to offset pricing pressure as its traditional services business. And lastly, hiring and productivity. So can hiring plans coexist with margin protection because plans to hire around 20,000 graduates in FY '27, if I'm not wrong. How do you balance investments in talent with margin discipline?

So on the AI first, I think the AI revenues have been outstanding. As you pointed out, we have exceptional growth in that and that shows really how we've put together the AI approach with the Infosys, which is resonating with the clients and the 6 dimensions of the Hexagon in which each area that we are investing and scaling up in, and then the foundation that we built on the Topaz fabric that helps our clients. So there, we see many examples of projects that are going extremely well. These are scale projects. Even in the large deals that we referenced Almost all of them have some component, 1 or 2 of them have really full business transformation driven by AI as the fundamental element of the large use. And that large deals has been quite exceptional as well, which has helped us in a way to give support even for the next financial year with the expected revenue growth support that large megadeal will provide. In terms of guidance, we continue to see what Jayesh was sharing in terms of the competitive intensity. So there is the AI, which is giving us growth, there's AI, which is also seeing the compression, and we continue to see that. There's competitive intensity because of that. And we have been extremely clear that we will only take on the contracts where it meets our economic guidelines. And so with that in mind, and all of the margin work that's been done in terms of the initiative, we've been able to keep our margin at this level. And that is what's reflected into our guidance where we see that competitive intensity and the changes that are going on. Now the macro environment is also equally in a place where there is continuing different was. There were some interest rate increases. There was also the 10-year yield, which is now a neighboring to 5%. And there's continuing some element of talent, which creates a different type of an environment for the global economy and therefore, for the type of clients that we work with, which is essentially a Global 2000. So all of those put together we feel extremely good that the AI is going well and the large deals are good, and then we also see the competitive intensity in the market. On the hiring, I'll start off -- Jayesh some is on productivity. So first, we had 4,000 net increase in the headcount, which is very strong, which shows that our continued confidence into the future. Second, we have 8,000 college graduates we hired in the quarter. For the full year, target remains clear at approximately 20,000, so around 20,000 like last year. And we've already done more than half in the first half of the year. So we think this dynamic will continue in the way we scale. We are doing work, of course, in AI, the 10%, but we also do work in other areas. And all of those areas are growing, that's why the hiring looks pretty strong there. And then the productivity, Jayesh?

Yes. So just to add to what Salil was also saying, see hiring is a fraction of what is the attrition that you have, what is the utilization that you have and what is the demand in terms of volume that you see and the productivity benefit, right? . We have, give or take, 13% attrition. That means roughly 45,000 people in a year, they leave us, and that needs to be backfilled either laterally or fresher. So the pressure kind of makes up a little bit of that. We are working at 85% utilization, which is, in our mind, very optimum utilization, so there's not much headroom left there from the optimization perspective. And then there is a net new demand that you are seeing? And fresher typically takes 6 to 8 months by the time we train them and deploy them to the project. So we do have to plan ahead of the time to make that. And that's the reflection that you're seeing today in the net head count increases. One more point on the overall guidance perspective. I think our guidance for the year should we continue to see at the back of the fact that we did, at the beginning of the year said we will have offshoring impact of 1%. So we are looking at higher offshoring through the year. We did called out an impact of large deals with a European manufacturing client, where we did not pursue the deal because it did not meet our return expectations. So both of that put together impacted our overall growth guidance by 2% or continues to impact roughly that. And it should be always seen in that context.

The next question is from Chandra Srikant, Money Control. .

Just wanted to get a sense on the guidance cut. I don't know if it's been asked despite a healthy TCV, while you sort of narrow the guidance band? And secondly, this week, there's been a lot of talk about cyber attacks because if AI. So -- and half of these cyber vulnerabilities are being uncovered by employees or by agents. I just want to know what opportunity does Infosys see there in terms of securing systems for enterprises? And what are the challenges going forward?

So I'll start on the guidance. Jayesh will have something more to add on it. So what we are seeing in the business today is very strong growth on AI, which was at 10.5%, growing at 29% quarter-on-quarter and a very strong large deals with 1 mega deal and over INR 2 billion, which is contributing to our growth also into the next financial year. That is then combined with what we see in terms of the AI productivity and competitive intensity in the market. Plus as Jayesh shared, what we are seeing in terms of the offshore ratios, which are changing -- with the changes in the U.S. India dynamic plus what we see in terms of the choices we are making, where in the case of particular contracts, we are extremely careful to take the ones that meet our economic thresholds and guidelines. So putting all of that together is where we put the margin guidance. Our attention really is to build out at a faster and faster pace, the AI activity, which is going very well with regard to the Hexagon strategy that we've developed in each of the 6 areas and making sure that we are participating in the large and mega deals, which are business transformation deals underpinned with AI. That's the sort of deal that we won where it was something that our teams proactively identified and pursued and then the client selected us. So that's the sort of work that we want to focus on. We know there will continue to be the productivity challenges that will go on, but those will go through in some time period. The AI is here for a very long time where we want to build a very strong foundation in that. On the cyber part, the first thing, we have a strong cyber business where we are already working with several of our clients in working to use some of the frontier model capabilities to ensure that we are helping them to protect against how helping build agents which will protect against. Some of the ones that have come out this week, we have some defenses for which we are sharing with our clients. If you recall a few -- 2 or 3 months ago, there was another week or so where there was a lot of this coming up with a new frontier model that have come out. And the same thing we have been working very closely with that lab. The one model before that, we were very -- it was already with us, and we had built out the cyber defense with that. So it's a strong part of our business. It's something that we are looking to scale up even more. We did a small acquisition, you may know in the cyber in Australia, a few quarters ago, which is also building out very strongly because that is helping us to do things in an ethical way to make sure that we can unearth the vulnerbility that clients are seeing with the agents, with this approach that we take. So we see some good growth in both of those areas.

Follow-up, all. Would you draw parallels with what is happening with cyber with what happened during Y2K in terms of the opportunity this opens up for Indian IT service providers, will they take out the work of finding vulnerabilities in existing systems? And can it potentially become a very big business model?

So I think the cyber not looking at the previous one, but the cyber 1 is a huge opportunity for Infosys, but the capabilities have to be very strong. So we need to make sure we have built our own capabilities, which are both agent-based and human-based combined and working with different frontier models, which each frontier model is unearthing different things on the application layer, which needs to be addressed in a different way. You may have seen in the recent ones where some of the government sites had to be redone and so on. So those are things that are working, which our teams have an understanding of, and it is a large opportunity. So we think this will continue to be a growth area for Infosys.

The next question is from Haripriya Suresh from Reuters. .

One on revenues. I wanted to understand -- I mean, obviously, it's on a low base, but it is growing fast, and you've said that it will be half in the next 2 to 3 years. How realistic do you see because -- also because of how much deflation is in your traditional services business, how do you see that play out? . And also on -- after the perm suspension and the changes that have happened with H1B. Do you see an increase in talent retention and hiring costs in the U.S. generally. I mean over the next couple of years, it might not be immediate, but as it goes forward. And on hi-tech and Retail, what exactly happened? Because high tech Y-o-Y has seen quite like a fall as well. What happened in those particular verticals?

So on the AI -- so my sense is the growth, I think, is quite exceptional in the way that AI is building out. And we see that being sustained now, you're absolutely right. It is on a low base. And it is a small amount. And so there will be some volatility. Still growing very nicely over the coming quarters. But it's not like every quarter will be exactly like the previous. There will be some volatility in that. on a small basis. I think what we are seeing and what our attention is on is making sure that we fully deploy and leverage that opportunity for our clients, and so building out, for example, if you look at the partnership network that we have, every frontier lab, we are working closely, they're working closely with us. We are also working with open weight model companies in Topaz fabric, there are 15 different models a client can take advantage of. We can do token optimize -- token cost optimization and of course, capability, meaning even the way we are doing, let's say, legacy modernization is changing quite quickly from what it was even 12, 18 months ago to what it is today. So all of that is moving at a rapid pace, and that's our attention. The second piece of the attention is really on these large transformation mega deals, which we feel we are quite well positioned on where clients are coming to us. It's more something that our teams are working with them jointly and uncovering. It's not like an RFP that someone is responding to and making sure that's an AI transformation mega deal. Then the continuing of the AI productivity that is impacting the revenue also goes up. And that will carry on through the different parts of our portfolio. But at the end, that's for finite time. Once it is done, the productivity through the portfolio, it will be done. So that's something that we've looked at internally, but we are making sure that our focus on AI growth is where our attention remains. All of that being said, that gives us more and more confidence that the way we are looking at it for AI is where the clients are going for. And that AI transformation is where we will work more and more. What was the -- yes, the cost -- so we -- a majority of the employees that we have in the U.S. are local hires. So we had already taken some steps several years ago, which had brought us to this position. So we feel we have a good like a ratio in terms of bringing people on and in terms of cost efficiency. So we don't see a change in that. We will continue to grow that as that evolves. Having said that, in the recent quarters, we've also seen our ratios change between on-site and offshore. Hi-tech I'll start on that. So -- we have seen different client situations, both on the retail and both on the high tech -- high tech specifically in one. We don't see this across all of our industries. So for example, in financial services, energy utilities, manufacturing, we see really strong growth and discretionary growth. However, in these 2 industries, we have seen some impact.

Gross market ...

Do you want to just answer the, and we'll come back to that.

So I mean, I think both Hi-tech and Retail, like Salil said, we had some discretionary related ramp-downs and some client-specific slowdowns in a way. It was -- retail also was impacted because of the third party. We had a larger third-party component in the previous quarters, which on a quarter-on-quarter, therefore, shows up as a negative. . So those were the impacts on both of that. I think from a geography perspective, it's been broadly similar across the geography. It's not very -- at least retail, high tech has been specific, more specific to the U.S.

The next question is from Beena Parmar from the Economic Times. .

Just a follow-up on the cyber incidents. You have a large set of clients which are Fortune 500 companies. and also in the public sector space. What is the level of preparedness that Infosys or companies like yours have? And do you also see IT budgets increasing given that you said that you will plan to scale it up further. . Secondly, on the deal wins, the 2 mega deals were in which sectors and since you -- despite the healthy wins, you still lowered the guidance. Does it mean that the AI deflation is still continuing to impact? And when do you see that really going away? In terms of the hiring, besides the wage hikes, I think you're still seeing some impact on the margins. Are you seeing any increase in employee costs given that the hiring is changing and also looking at more specialized hiring. And does that really lead to employee costs going up in the next, say, few quarters?

So on the cyber, I think there -- it's more a question of building out the capabilities that we are driving to and scaling that up. And so that demand will continue like all organizations, I think we are well prepared sort of both internally and in terms of supporting our clients. But what we sort of share with our clients is these are things that are happening now every day. So it's not something you can predict of what is the likely outcome, but is better to be more prepared also build out in these specific vulnerabilities, agents and agents human, which can address them, which is being done for many clients. It's more a question of building out that capability. The next was in terms of the mega...

IT budgets will you have...

The budgets of our clients will go up. But at the end, it's not like it will go up in 1 place is not that overall will go up dispoverall, it will go up as a normal sort of a rate, but not disproportionately just because of that because also they need to manage their own budgets in a careful way. . On the large deals and the guidance, I think the question on productivity and AI deflation impact, I think we continue to see that as Jayesh and I mentioned earlier, which is really multiple effects. One is the effect of the AI productivity with our clients seeing. One is the effect that Jayesh also mentioned about how the on-site mix is changing. Another is the effect of the competitive intensity and how we have been, I would say, disciplined in taking on contracts which meet our economic guidelines and profiles. So all of that comes together in this environment that creates what we call -- what you call the AI constraints or the AI productivity. But the more critical element really is the growth of the AI because that is a secular trend, which is here. And the way we are now seeing it, this is a very fast pace of growth and even with some volatility, you're going to continue to see a very good pace of growth over the next several quarters.

Compensating for the revenue growth, right? So the traditional services growth. So I mean, do you see -- how long do you see this really lasting? .

So there -- so we have some internal views on what the mix of these 2 will be. But -- it's not something where we are more focused on what the reduction is, we are really much more focused on where the growth is because that is going to stay for a very long time, whether this stays for a short time or a long time, we know that with that growth over time, we will see the overall business in a much better shape. .

And if I can just add to what Salil was saying, while deals have been very strong. Historically, we've been on an average signing $3 billion of large deals. So that was always there in the guidance that we baked in even earlier. The 2 mega deals that we signed, 1 of that was renewal. The other 1 is a net new. And the net new is only going to ramp up from later part of Q4. So in this year, there's going to be a very miniscule amount of benefit that you will get from that deal. But the next year, as Salil said earlier, it will contribute over 1% in our revenue. .

Hiring employee costs .

Sorry -- employee costs. employee costs? .

So look, we hire across the pyramid as we have said earlier, even we are hiring at the bottom of the pyramid, which is the fresher and we're going to hire 20,000-plus employees over the years. So we are very conscious about what we are hiring and hiring the right talent to meet the right requirement. And if you're hiring at a higher cost, automatically -- generally, it reflects in the pricing. So from that perspective, we don't really see margin impact. If you see last many years, last couple of years, we have been able to maintain our margin at 21% despite all the headwinds, while investing in the business, whether it is sales and marketing, whether it is talent building, AI talent or technology investment that we have done. So we've been able to offset all of that through very meticulous operational reserve.

Thank you, Beena. The next question is from Shilpa Phadnis from the Times of India. .

Sir. As much as the IT companies are denying any impact on perm residency. If you can help us understand, will it trigger a fresh wave of attrition for you in your primary market client market? Secondly, will you saw expenses go up substantially on this? And my second question is around as much as AI is driving productivity. Do you think this will also lead to margins being squeezed in your existing contracts?

So on the first one, I think overall attrition number that Jayesh shared is lower this quarter than the previous quarter in the range of 12% to 13%. We don't see any real impact on the attrition from any of those activities. Neither do we see like a cost impact because we already have within the U.S., a mix where the majority of the people are local hires. And that's something that has been in motion for several years. So that's something that we feel good about how we can bring in more people and how we can maintain delivery excellence with our clients with that sort of a team. The second one -- yes. On the margin, I think what we see is there is a tremendous sort of desire from clients to have the AI create a benefit in terms of productivity for their activities for their work that we do with them. And we know that many of those things we can based on the investments we made, we can make it real for our clients. So given the investments we made in things like Topas fabric, we can make those benefits real for the clients while maintaining as we have done over the last several quarters, the margin profile without doing any other activity below the line and so on, we are very much focused on making sure that the productivity benefit we derive from AI and that it matches to what the clients are asking. Now there are sometimes the asks are much higher than what we can derive from the AI productivity, which is where we say that it doesn't fit our economic profile. So we are much more disciplined about that.

As much as you're doubling down on GCCs, how far are you from a $1 billion milestones? And second, it involves a lot of upfront investments from your side, people, software, takeovers. So if you can help us understand where you are on that journey.

GCC is an incredible growth area. I think this current phase we announced, I think, just last week, a very large financial services client publicly discussing our work we've done with them on the AI GCC. So there, what is happening is many -- so GCCs are being built for many years by different companies. . And in the last 2, 3 years, there's been an increased push of the AI infusion into the GCC itself, and that's where we have built an even stronger specialization, where we can help -- if you build the GCC 5, 7 years ago to help you to transform it and if you're building it now to help you to create it with that AI inside it. Because the recruitment is different, the training is different. The type of people are different the pyramids are different. So we have an ability to build and scale that up. And which is why clients are working with us more and where the GCC business is growing quite nicely for us. Thank you, Shilpa.