Infosys Limited (NYSE:INFY) Q4 2024 Earnings Call Transcript

Infosys Limited (NYSE:INFY) Q4 2024 Earnings Call Transcript April 18, 2024

Infosys Limited isn’t one of the 30 most popular stocks among hedge funds at the end of the third quarter (see the details here).

Operator: Ladies and gentlemen, good day, and welcome to Infosys Limited 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.

Sandeep Mahindroo: Hello everyone, and welcome to Infosys earnings call for Q4 and FY ’24. 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 we’ll open up the call for questions. Kindly note that anything we say that refers to our outlook for the future is a forward-looking statement, which must be read in conjunction with the risks that the company faces. A complete statement and explanation of these risks is available in our filings with the SEC, which can be found on www.sec.gov. I’d now like to pass on the call to Salil.

Salil Parekh: Thanks Sandeep. Good evening and good morning to everyone on the call. For the financial year ’24, our revenue growth was at 1.4% in constant currency terms, our operating margin for the full year was 20.7%. For large deals, we had an excellent year and the fourth quarter. For the full year, we were at $17.7 billion in large deals, comprising of 90 deals. For Q4, we had $4.5 billion in large deals. This is the highest ever large deal value in the financial year for us. This is a reflection of the trust our clients have in us. We see good traction in cost efficiency and consolidation deals. For Q4, our year-on-year revenue growth was flat in constant currency and declined by 2.2% quarter on quarter. Our operating margin for Q4 was 20.1%.

We had a one-time impact in Q4 that Jayesh will comment on. We’re seeing excellent traction with our clients for generative AI work. We’re working on projects across software engineering, process optimization, customer support, advisory services and sales and marketing areas. We’re working with all market-leading open access and closed large language models. As an example, in software development, we’ve generated over 3 million lines of code using one of generative AI large language models. In several situations, we’ve trained the large language models with client specific data within our projects. We’ve embedded generative AI in our services and developed playbooks for each of our offerings. We’re committed to ethical and responsible use of artificial intelligence.

We became the first IT services company globally to achieve the ISO 42001:2023 certification, testifying to a commitment to excellence in AI management. All of our work in AI is part of our Topaz offering. Our cloud work is growing well. We continue to work closely with the major public cloud providers and on private cloud programs for clients. Cloud with data is the foundation for AI and generative AI and Cobalt encompasses all of our cloud capabilities. Data is the other foundation for AI and generative AI. We see data structuring, access, assimilation critical to make large language models and foundation models to work effectively, and we see good traction in our offering to get enterprises, data ready for AI. We are delighted to announce a strategic acquisition of a company in the engineering services space this quarter.

Some examples of the work we are doing for a large U.S. company, we’ve engineered an enterprise grade generative AI platform that has been rolled out to over 60,000 users. We’re working with a large bank and helping them roll out an internal enterprise-wide, company-specific generative AI instance of a knowledge assistant. We continue our focus on our margin program. We saw good impact of this during the financial year. Our employee attrition was low at 12.6%, down from 20.9% in the previous year. As we look at the start of the financial year ’25, we see the discretionary spending and digital transformation work at the same level. We see focus on cost efficiency and consolidation continuing. Our large deal wins in the prior financial year will help us in financial year ’25 for our revenue.

We also see normal seasonality as we plan this financial year in terms of guidance. With that, our revenue growth guidance for financial year ’25 is 1% to 3% growth in constant currency. Our operating margin guidance for the financial year ’25 is 20% to 22%. With that, let me hand it over to Jayesh.

Jayesh Sanghrajka: Thank you, Salil. Hello, everyone and thank you for joining the call. At the outset, I must say this is an incredible privilege and honor to be the CFO of this iconic organization and would like to thank Salil, Nandan and the entire board for their confidence in me. As I step into my new role, my areas of focus will be further strengthen collaboration with business to increase our market share, work with Salil and rest of leadership towards tighter execution and continue to steer Maximus program, expand operating margins and improve cash flow in the medium term. Coming to our Q4 results. Revenues were flat year-on-year in constant currency terms, sequentially, revenues declined by 2.2% in constant currency and 2.1% in dollar terms.

During the quarter, we had a renegotiation and rescoping of contract with one of our financial services clients, which led to slightly over 1% impact on Q4 revenues. While the part of the work got rescoped, over 85% of the contract is still with us. FY ’24 constant currency revenue growth was 1.4%, normalized for the impact of revenues from the FS client, the revenues for FY ’24 were within our guidance range of 1.5% to 2%. Operating margins for Q4 were at 20.1%, a decline of 40 bps sequentially, bringing the FY ’24 margins at 20.7%, well within the guidance band of 20% to 22% for the financial year ’24. The major components of Q-o-Q margin works for the quarter are as follows: headwinds of 180 bps comprising of 100 bps from the one-time impact of contract renegotiation and rescoping; 80 bps from additional impact on salary increases, higher brand building and visa expenses, partially offset by tailwinds of 140 bps, comprising of 60 bps from lower post sales customer support, lower provision for client receivables, et cetera, 40 bps from Project Maximus and 40 bps relating to Q3 impact from cyber incidents.

Headcount at the end of Q4 was over 3,17,000, which led to further increase in utilization excluding trainees to 83.5%. LTM attrition for Q4 reduced further by 0.3% to 12.6%. Unbilled revenues dropped for the fourth consecutive quarter to $1.7 billion. This is a reduction of $291 million in FY ’24, which is reflecting in increased cash flows. Free cash flows for the year was $2.9 billion, which is a 14% increase over FY ’23. Free cash flows for Q4 was extremely strong at $848 million, which is the highest in last 11 quarters. This is a result of our focus on improving working capital cycle. DSO for the quarter was 71 days compared to 70 days in Q3. Consolidated cash and cash equivalents stood at $4.7 billion at the end of the quarter. Yield on cash was at 7.1% in Q4 and return on equity improved to 32.1%.

ETR for the quarter was 22.2% after accounting for favorable orders, we expect the FY ’25 normalized ETR to be within 29% to 30% range. We had another strong quarter in terms of large deal wins, $4.5 billion of TCV from 30 deals including two mega deals. 44% of this was net new. We signed eight large deals in communication, six each in BFSI and retail, four each in manufacturing and life sciences, two in URS. Region wise, 16 were from North America, 10 from Europe and four from rest of the world. We ended FY ’24 with our highest ever large deal of TCV $17.7 billion, comprising of 52% net new and eight mega deals. This is a clear validation of relevance of our service offering, deep client relationships and leadership strength. The board has declared a dividend of INR20 for FY ’24 along with special dividend of INR8 per share.

With this, the total payout for FY 2024 will be 85% of FCF in line with the capital allocation policy. The Board has approved the capital allocation policy for the next five years, effective FY ’25, the company expects to continue the policy of returning approximately 85% of free cash flows cumulatively over five-year period through a combination of semi-annual dividend and our share buyback special dividend subject to applicable laws and the credit approvals. Under this policy, the company expects to progressively increase its regular dividend per share. Project Maximus, our comprehensive margin expansion program continued to run well across five pillars. This is reflected in more stability in margins for FY ’24 over ’23 compared to the previous years despite the headwinds from lower growth in FY ’24.

Some of the tracks where we have made progress are value-based selling, automation and AI and sub-tracks within the efficient pyramid like lower subcons, higher utilization and higher ratio. We continue to focus on optimizing various tracks to increase operating margin in the medium-term. Coming to the industry verticals, we continue to see macroeconomic effects of high inflation as well as highest interest rates in BFSI. This is leading to cautious spend by clients who are focusing on investing in services like data, digital, AI and cloud. Financial services firms are actively looking to move workloads to cloud, pipeline and deal wins are strong and we are working with our clients on cost optimization and growth initiatives. Manufacturing witnessed a double-digit and broad-based growth in FY ’24.

There is increased traction in areas like engineering, IoT, supply chain, smart manufacturing and digital transformation. In addition, our differentiated approach to AI is helping us gain mind and market share. Topaz is resonating well with the clients. We have a healthy pipeline of large and mega deals. In retail, clients are leveraging GenAI to frame use cases for delivering business value. Large engagements are continuing S/4HANA and along with infra, apps, process and enterprise modernization. Cost takeout remains primary focus. Clients in communication sector continue to be cautious with growth and challenges. New CapEx allocation remains under check, while the budget remains tight. We see opportunities in cost takeout, AI and database initiatives.

Growth in coming quarters will be led by ramp-ups of previously won deals. URS clients are taking cautious approach with focus on cost optimization in AI-driven efficiency. We are witnessing more deals around vendor consolidation and infra managed services. Deal pipeline of large and mega deals is strong due to our sustained efforts and proactive pitches of our cost takeouts and digital transformation, etc., across the subsectors. Macro concerns in Hi-Tech continue leading to delays in deal closures, decision making and planned repurposing spend. Discretionary programs are kept on hold. In FY ’25, therefore, we expect growth to accelerate from FY ’24 levels in financial services and telecom verticals due to large deal wins. Manufacturing sector, while still showing a healthy growth, we’ll see lower growth than FY ’24.

Hi-Tech is expected to remain soft. Driven by our current assessment of business environment, including continued software, discretionary spend and ramp-ups of mega deals won earlier, we expect FY ’25 growth to be 1% to 3% in constant currency terms. Our operating margin guidance for the year is 20% to 22%. Guidance for FY ’25 does not factor in today’s acquisition of in-tech. With that, let me open the call for the questions.

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Q&A Session

Operator: Thank you very much. [Operator Instructions] The first question is from the line of Moshe Katri from Wedbush Securities. Please go ahead.

Moshe Katri: Thanks. And Jayesh, welcome and congratulations in terms of your new role and interested…

Operator: Sir, sorry to interrupt you, your voice is not coming clearly. May I request you to speak a little louder please?

Moshe Katri: Yes. So my first question has to do with the June and September quarters that tend to be seasonally the strongest in the industry. Can you provide any color on sequential growth for March and June given your guidance for fiscal ’25? Thanks.

Jayesh Sanghrajka: So Moshe, this is Jayesh here and thank you for the wishes. If you look at within our guidance range of 1% to 3%, we expect normal seasonality’s, which means that H1 would be stronger than the H2.

Moshe Katri: Okay. And then given focused, you indicated that the fact that – the Fed’s cutting rate is going to be kind of delayed and pushed out and that’s impacting demand for discretionary spending. Is our clients also talking about the past few weeks, the political instability in the Middle east? That’s also kind of a – one of those negative headwinds there?

Salil Parekh: Hi, Moshe. This is Salil. I think I understood the question. We spoke a little bit about the outlook in terms of discretionary and digital. And I think your question is, is the current Middle East situation what clients are talking about. So in general, the sense we’ve had in discussions with clients is on the discretionary work and the digital transformation work. It’s about the same mindset as it was in the past financial year recently, like in Q4, Q3. Now, I’m sure we’ve not specifically heard any commentary on this situation, but I’m sure that’s something that people are thinking about. But it’s one among many factors that are playing out, is my guess.

Moshe Katri: Understood. Thank you.

Operator: Thank you very much. Next question is from the line of Ankur Rudra from JPMorgan Chase & Company. Please go ahead.

Ankur Rudra: Hi. Thank you and welcome, Jayesh on the new role. So the first question is, Salil, the environment clearly appears disciplined. Now, the main thing that we find a bit difficult to understand despite that, the lack of revenue acceleration, despite very impressive, last contract signings that you’ve enjoyed for close to a year now. Could you maybe elaborate a bit more on the persistent disconnect and if the large deal signings is something that we should pay attention to if this environment continues?

Salil Parekh: So thanks, Ankur, it’s Salil. What we are seeing first on large deals is especially for cost efficiency and consolidation. We are proving to be a good choice for clients and that’s where we are seeing a tremendous benefit for what is going on. The next, in terms of what we’ve given is guidance. So first, what we see is the digital transformation or discretionary thinking from clients is remaining similar, which is – which was slow in the past, in Q4, in Q3, we see that continuing on. So that gives some of the ways where revenue is less within our guidance outlook. The large deals prove a positive part of that outlook and those are the puts and takes. Now we see in financial services, the coming year appears better.

This is not like on digital or discretionary alone, it’s across the industry, whereas on manufacturing, we are seeing which we had a good growth in financial year ’24, we’re seeing – we’ll still have growth, but a slower growth in financial year ’25. And those are the sorts of puts and takes which give us this type of a guidance with some things which are supportive and some things which are constraining.

Ankur Rudra: No, thank you for the additional color. I mean, maybe just ask in another way. You just report your large contract signings on your contracts above a certain threshold, if we were to look at the overall contract signing, would that – would the momentum there be more similar to the revenue momentum we see?

Salil Parekh: So there, we don’t, as you know, disclose the other non-large deal signings. Again, the overall color of the pipeline and the deal wins is good. But what it doesn’t take into account is when some things on a digital transformation or on discretionary slow down, so that doesn’t come into the game when you look at some of the deal wins at whatever sizes. Those are the puts and takes that we see as we build the forecast for next year.

Ankur Rudra: Understood. Just one last clarification. The 100 basis point impact you highlighted, Jayesh, is that revenue impact, combination of the impact of the rescoping, which is probably one-time and a penalty, because the – it seems a lot more than 15% of one client.

Jayesh Sanghrajka: Hi, Ankur, and thanks for the wishes at the beginning. You know, that 1% impact or over 1% impact, the revenue is reflecting into the margin pretty much directly in terms of 100 basis points. So that’s the majority or vast majority of the impact.

Ankur Rudra: Okay. So that’s not a revenue impact, that’s a margin impact to clarify that.

Jayesh Sanghrajka: No, it’s a revenue impact. That’s what I said. It’s a revenue impact of 1%, which is flowing down to margins directly.

Ankur Rudra: Okay. Let me repeat, my question was 1% seems a lot more than 15% of one client, because I think you’ve said you’ve retained 85% of scope. So this seems to be more than the impact of rescoping. Is that a one-time impact which will reverse and then the rescoping only will be part of this? That was the question, essentially.

Jayesh Sanghrajka: Yes. So, Ankur, when you descope 15% of the impact, it doesn’t mean that the – I mean, 15% of the work doesn’t mean that 15% of the revenue goes away in one quarter, right. It depends on how much of work you had done, how much of the impact you are therefore taking, right. There’s no penalty per se. It’s a question of how much of work I’ve done and how much of that goes away, it’s pretty much.

Ankur Rudra: Okay.

Jayesh Sanghrajka: On that [indiscernible] 15% has gone away in one quarter, right. So it’s a 15% of the overall work which got rescoped.

Ankur Rudra: Okay. Appreciate it. Thank you and best of luck.

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

Kawaljeet Saluja: Hi. I have a couple of questions, or maybe slightly more than that. The first question is on the guidance in itself, it has been more of quite a series of misses in FY 2024. What are the learnings you have incorporated when you basically have taken a stance or taken another stab at guiding for FY 2025? That’s the first question.

Salil Parekh: Hi, Kawal, this is Salil. So what we’ve attempted to do in the guidance is, look at what we have seen, for example, on digital work and discretionary work, which is reducing or slow in the coming financial year, where we don’t see the change. And then layer in, what we see in terms of the large deal wins into the financial year ’25. And then, as in sort of most years, we have a view of seasonality, where the H1 is stronger than the H2 for us at Infosys, typically we see that impact with a slower Q3, Q4. So that’s how we have attempted to build the guidance that we put in 1% to 3%.

Kawaljeet Saluja: Okay. Is the –

Jayesh Sanghrajka: Kawal, if I may add, when we started the year last time, we were also coming from a very high growth environment, right? So, we had that – that kind of a exit trajectory that was also helping from a guidance perspective, whether it was getting baked in a guidance perspective. Today, when we are looking at it, we are coming out of a 1.4% growth. And therefore, I believe, that – that kind of tailwind is not there in any case in the guidance.

Kawaljeet Saluja: Okay, fair enough. The second question that I had is that, can you detail the reasons or factors that led to the rescoping of projects with a large client? Typically, your large deals do carry execution risks. So what are the learnings from the past large deals that you have signed, which have incorporated in the current crop of large deals here?

Salil Parekh: This is Salil. First, I think what we have seen across the board is, we have had tremendous success in the large deals and various delivery of that. Some of the learnings we are putting in place, in general, not from a specific deal, is more to do with how we understand complexity, how clients look at complexity and how we make sure that we remain aligned in that. On the specific deal, there is no other comment. We’ve made a statement in all our press notes, so there’s no other comment on that specific situation.

Kawaljeet Saluja: Okay. The final question that I had, it’s to you Jayesh, that last year there was a mention that the endeavor would be to expand operating margins. I think the guidance band for FY ’25 is unchanged. So is there a timeline when or which – within which you intend to expand or increase your operating margins and what are the factors or the type of environment that is required to push through the margin expansion as such?

Jayesh Sanghrajka: Yes. So Kawal, even if you remember the last time as well, we had said our endeavor is to improve margins, our operating margins in the mid-terms, right and we still maintain that. We haven’t changed from that. The Project Maximus is in works. We have seen encouraging results as you can see, even from the walk of this quarter or the previous two quarters, we have called out the benefit that we have got from Project Maximus. If you look at FY ’25 guidance and the puts and takes of those guidance is, we do bake in the revenue growth that we are envisaging. On top of that, we had a comp flow through of last year. We did our comp increase from November. So there’s a full-year impact or additional seven month impact coming in, in the next financial year, plus the comp that we will do for this financial year.

So those are the headwinds. And in terms of tailwinds, our utilization is still tied below our comfort level of 84%, 85%. We – our subcons are still higher from where we think we can operate in an optimum level of 5% to 6% efficient pyramid. We can improve ROE ratios, in an ideal scenario, if the growth is better, the ability to improve ROE ratio is much better. But even in a constrained environment, we are improving ROE ratio. So those are the factors on efficient pyramid. On the GenAI and automation, we are – we have done a lot of progress and we are doubling down on that. So I think all of those are baked in, in the current guidance of 20% to 22%. But our endeavor is, continues to improve operating margin in the mid-term.

Kawaljeet Saluja: Okay. Thank you for answering my questions and I wish you a good 2025. Thank you.

Operator: Thank you. The next question is from the line of Kumar Rakesh from BNP Paribas.

Kumar Rakesh: So my first question was on BFSI. So even if we adjust for this contract renegotiation, the vertical seems to have still declined by about 3% to 4% while some of your peers have started talking about recovery in BFSI and they have also saw the recovery in the March quarter. So is there something outside of this contract renegotiation also, which happened in the vertical, which is specific to you?

Jayesh Sanghrajka: So Kumar, if you look at BFSI, I think, one, is we have a larger BFSI portfolio. Second is our discretionary share on the BFSI has been higher and that is what is impacting our overall profit from the growth perspective. I don’t think it’s significantly different from the company’s overall headwind. BFSI also has a similar headwind in terms of the discretionary work that we do with the clients. In addition to that, we do have exposure to mortgages, et cetera, which has – as we have called out earlier, which has remained softer in this environment. But as you hear from us, we have called out that we expect BFSI in FY ’25 to be better than FY ’24. So we do see some encouraging outlook there.

Kumar Rakesh: Okay. And from the depreciation part itself, is the impact fully reflected in this quarter? Or there could be more impact going into the next quarter?

Jayesh Sanghrajka: The impact is completely taken in this quarter.

Kumar Rakesh: Okay. Got that. And my second question was around the margin guidance, which you have spoken about. So your global peers as well as domestic peers, all of them usually have spoken about margin expansion – confidence around margin expansion this financial year itself. So I appreciate your target of medium-term margin expansion. But would you say you are confident of margin to have bottomed out around the levels where you currently are seeing? Or the kind of mix you have in the order book holds you back from giving any directional sense on that?

Jayesh Sanghrajka: So I mean, Kumar, we are not guiding which part of the 20%, 22% we will be. As I said earlier, our endeavor is to improve margins from where we are, but we are not giving the financial year ’25 guidance. If you go back to the puts and takes, we do have some headwinds in terms of compensation, some of these large deals ramping up during this year as well as we have tailwinds coming from pricing, coming from efficient pyramid, the automation and GenAI we are deploying. So we will not leave any stone unturned on this project, but we have not yet guided in terms of where we will end up in this year within as well.

Kumar Rakesh: Got it, Jayesh. Thanks a lot and best wishes in your new role.

Jayesh Sanghrajka: Thank you, Kumar.

Operator: Thank you. Next question is from the line of Keith Bachman from Bank of Montreal. Please go ahead.

Keith Bachman: Hi, good evening and good afternoon. I also wanted to ask two questions that are related and I’ll ask them together. The first is, could you just talk about how you see utilization trends unfolding this year? It seemed to me that with the way the market is fairly weak, that the utilization should go higher. And similarly, that wage hikes with the market being fairly weak on the employment front across many parts of tech that it seems to me that wage hikes should be lower. And maybe I’ll just stop there and then I’ll ask my follow-on question. If you could just talk about those specific puts and takes that would influence margins.

Jayesh Sanghrajka: Yes. So Keith, if you look at our utilization, our utilization including trainees was at 77% last year, which has gone up to 80.7% for the full year and we are exiting at 82%. So that clearly shows a significant 5 point increment from the utilization perspective. We have been able to deploy all the freshers – a large number of freshers back to production. So that’s on utilization. Our comfort level on utilization, including – or excluding trainees is around 84%, 85%. So we still have some headroom there. On the compensation, whenever we decide on compensation, we take multiple factors in account of inflation, peer practices, et cetera. So we will take all of that into account during the year when we decide on compensation. At this point in time, we haven’t decided on the quantum of the timing and we just did our last compensation in November last year.

Keith Bachman: Okay. Well, this surprises me – I’ll make a statement and then I’ll ask my follow-up question. For the tepid revenue growth, I’m surprised that margins wouldn’t go higher during the course of the year relative to this past year given those forces and others. My following question though relates to GenAI and there’s two parts to GenAI: there’s demand side and supply side. So I’m not asking about demand. My supply side is, are you factoring in increasingly GenAI as you’re undergoing software development activities on behalf of your clients? Is that helping your productivity yet or is it still too early? And along with that, if you are using GenAI to facilitate or enhance your efficiency on code development, is that a negotiation that’s starting to unfold with your clients that they’re asking for lower billing rates, if you will, related to that efficiency. Is that happening yet or is it still too early?

Salil Parekh: So thanks for that. This is Salil. On generative AI, on the projects we are working on, we are starting to, we have already seen benefits on productivity in software engineering. What we’ve seen there is, and – so it’s really more focused on a narrow data set, in this case, the software capability within an enterprise, within a client base, not sort of broad based today. And there we are seeing impacts and benefits. What we see is typically, we’ve not seen so far the rate discussion, but we can certainly see in some instances benefits where clients can do more work in terms of creating more output, for the same type of an effort. So there is definitely a productivity benefit, but we’ve not seen something, which has come back on the rates in that sense.

Keith Bachman: Okay. Perfect. Many thanks for your help, and best of luck during the year.

Operator: Thank you. Next question is from the line of Gaurav Rateria from Morgan Stanley. Please go ahead.

Gaurav Rateria: Hi, thanks for taking my questions. My first question is with respect to the ramp up of some of the mega deals that, were supposed to start towards the back half of fourth quarter. Have you seen them starting on time, and do you expect these to kind of create some momentum in the coming quarters?

Jayesh Sanghrajka: Hi, Gaurav. So what we had envisaged at the beginning of the quarter of the mega deal starting in Q4, have started as planned.

Gaurav Rateria: Got it. Secondly, on guidance, visibility, typically when you start the year, you have a certain level of visibility, maybe let’s say 65, 70, whatever that number is. Given that you are entering this year with significantly larger deal wins, would you be prepared to say that, visibility would be slightly higher than the usual year for FY ’25?

Jayesh Sanghrajka: So Gaurav, if you look at over the years with the portfolio mix changing, where our discretionary portfolio has become larger in terms of our portfolio mix, the visibility has obviously come down from the annual perspective. Some of these projects are short duration, et cetera, and discretionary in nature. So to that extent, you do have – that lack of visibility, if I may use that word, versus the years earlier. But yes, compared to that, if you look at the large deals, large deals does benefit from a long-term perspective. So you do have a foundation of large deals, but at the same time, you do have smaller deals which are discretionary and can be, you know, where we are still seeing some of them being reduced, or being stopped or scaled up.