Infosys Ltd. Q3 FY2025 earnings call

• Revenue grew 1.7% Q-o-Q and 6.1% Y-o-Y in constant currency in Q3. - Operating margin at 21.3%, up 20 bps Q-o-Q and 80 bps Y-o-Y. - Free cash flow for the quarter was an all-time high of $1.26 billion. - Headcount grew by over 5,000 sequentially to over 323,000 employees worldwide. - Clients are turning to Infosys for enterprise AI to transform business. Developed four small language models for different areas, over 100 new generative AI agents, and working with generative AI partner ecosystem. - Project Maximus has led to benefits like increased realization by 3.6% over nine months.

In Q3, revenue grew 1.7% quarter-on-quarter and 6.1% year-on-year in constant currency terms. Verticals and most geographies grew year-on-year. European and Indian markets, as well as the manufacturing business, saw double-digit growth. Financial services in the U.S. continued strong growth, and European financial services revived in Q3. Retail and consumer product industry in the U.S. showed improvement with easing discretionary pressures. Automotive sector in Europe remained slow. Revenue contribution: Financial services in the U.S., European financial services, manufacturing, retail and consumer products, etc., contributed to the overall revenue growth. In constant currency, North America returned to positive growth at 4.8%, Europe grew at 12.2% Y-o-Y, financial services had third consecutive quarter of volume growth, large deal TCV was $2.5 billion with 63% net new.

• Revised revenue growth guidance to 4.5% to 5% in constant currency for FY '25. - Operating margin guidance remains unchanged at 20% to 22%.

• Third-party costs can impact margins. - Seasonality factors in Q4 that may affect results. - Wage hike impact on margins could be a risk if not offset by other factors.

Q: Can you comment a bit about if there were any one-time items in your revenues or margins this time?

A: There were no other one-offs either on revenue or cost in this quarter.

Q: Just if you can talk a bit about the guide, now the guide increase is positive, but if you look at the implied number for Q4, it implies a negative number. Is this primarily due to seasonality or also partly from the third-party sales led business which might shrink which you've baked into the guide this time?

A: There are two parts, one is third-party seasonality baked in Q4 guidance as Q3 was significantly higher and Q4 has lower working days, and both are baked in the guidance.

Q: You mentioned a lot about your small language model and agentic AI. Can you talk a bit about how on a structural basis this might impact the volumes of your work, the need for productivity pass back and if this will be net additive or dilutive to the amount of work Infosys can do for its clients?

A: At this stage, it looks to us like this will give us over time more growth. The small language models and agents are creating opportunities for growth as they are deployed in client work.

Q: Just have one question on the third-party items, the pass-through revenues. Will this line item continue to grow with the top line or is there a limit?

A: At this point in time, we don't expect this to change significantly, but it's dependent on large deals that come in where end-to-end solutions are provided.

Q: I wanted to start on pricing. How do you think that progresses from here as you pursue this value based pricing strategy and what is a reasonable level of potential pricing impact you'd expect going forward? And then just more broadly, can you comment on the competitive pricing situations in the market?

A: It's difficult to predict, but our endeavor is to keep improving. The pricing environment is stable at this point.

Q: Utilization remains modestly above your normalized range around 86% ex trainees. Can you comment, is this a new normal? Will this move lower as hiring continues?

A: 83%, 85% is where we would like to be, and we don't expect it to change significantly either ways.

Q: I'm sorry, I had dropped for a minute. So in case I'm repeating the question. Just wanted to understand the growth in top five clients, right? So it has declined pretty sharply in this quarter, down more than 6% Q-o-Q in dollar terms. And even on a year-on-year basis, there hasn't been much growth. So just trying to understand what exactly is happening there?

A: The sequential change in the top five clients is pretty much furloughs largely, and there could be currency impact as well.

Q: Last quarter, you called out improvement in your smaller deal pipeline, but it doesn't sound like that continued into this quarter. What do you think is driving that difference particularly given some of the improvement you called out in discretionary demand?

A: Our overall deal pipeline has grown because large deals pipeline has also become stronger and pipeline outside of large deals have remained stable.

Q: One of the industry players called out AI driven productivity pass back to a large client of theirs. Have you seen any such instances in any of your large clients?

A: In general, whenever there is a productivity benefit, there is always sharing with clients, and we are not seeing a difference in the way it's being treated for AI driven vs others.

Q: The first question is on the expected growth rate for Q4, which as per the guidance comes in the negative territory. So should we assume that this is the reality for business now that the overall business mix that we have at this point of time in general Q4 is going to be a sharply, let's say, lower than what Q3 does despite the fact that Q3 itself would be lower because of the furloughs and the holiday season that we see?

A: Q3 was benefited by some third-party revenue, and Q4 has lower working in calendar days and some furloughs, so Q3 and Q4 are impacted.

Q: Just want to check in terms of impact of the wage hikes, will it be full impact next quarter or will it be staggered? And what is the margin impact that you see of wage hikes?

A: Wage rollout is in two phases, first from 1st January and second from 1st April. India wage increases on average 6%-8%, overseas low single-digit. We haven't really called out a margin impact yet.

Q: How are you characterizing linearity, the linearity narrative now? Because I see you're taking up the headcount, which seems quite constructive. Was wondering the automation impact contemplation relative to linearity?

A: We see benefits from automation and pricing, and are positive with employee growth as it shows expansion of work overall.

Q: The net new number, which was quite robust. Does the net new reflect either the similar like vertical operating group, or service lines as the current base of business, or is there something that is like net-net new going on in the new bookings?

A: We are positive on net new, demonstrating expansion with existing or new clients, and seeing good traction in areas like cloud, generative AI, SAP S/4HANA, and cost takeout.

Q: When we entered FY '25, we had a lot of support of the mega deal, large deals, which have ramped up in the first nine months of FY '25. With those largely into the ramp up stage, and might gone into steady state. Do you believe FY '26, we may have to worry or do you believe FY '26, as some of the industry peers are calling out, better than FY '25?

A: We see positive underlying with better view on financial services, retail, and good deal pipeline, but don't give specific guidance beyond March 31.

Q: Any color in terms of deal pipeline below $50 million, which has grown 10% Q-on-Q in the 2Q, any update on the same. Second in terms of margin, do you believe the likely reversal in the third-party, could be enough to offset the wage hike impact in the third quarter? And also in terms of the recruitment, which we have done in this quarter. Can you throw color? Is it more pressure driven, or is it more lateral driven?

A: Small deal pipeline remained stable. We will have headwinds from compensation and tailwinds from third-party cost and currency. Recruitment is combination of freshers and laterals, hiring 15,000 plus freshers for the year and expecting 20,000 plus next year.

Q: If I recall correctly, last quarter you mentioned that sub $20 million deals had a very strong pipeline. So can you just comment, did you actually see the positive impact of that in 3Q, and how does that deal pipeline look like at this stage?

A: Sub $50 million deals' pipeline was strong, and converted deals will start showing results in Q4 onwards, pipeline remains stable.

Q: My question is on cost to serve your clients, and what I mean by that, is how is AI changing your cost to serve today? And I'm not talking about AI deals, I'm talking about the broader or questioning the broader portfolio. And how do you envision that changing say a year from now?

A: AI is being applied in areas like software development and customer service within Infosys, and benefits will support margin activity, but no external quantification.

Q: You call out SAP as being a strong area for you, and I think it's candidly strong for a number of different vendors or suppliers. Presumably GenAI will help with deployments over time, because there's a notion of software development as the SAP ECC customers migrate to the cloud. And so as that develops into more robust capabilities for Infosys. How does that change your pricing to the customers, say a year from now for deployment of SAP work?

A: Benefit from GenAI in SAP work will be shared with clients, so we will get some benefit and client will get some benefit.

Q: If I recall correctly, last entire year, we mentioned that, because of high interest rates and inflationary environment in the U.S. This vertical had a pretty subdued growth. So we saw a pretty strong sequential growth here. How do you see the sustainability of growth in CY '25? And post the U.S. election outcome, do you see any client sentiment changing particularly in this vertical?

A: Retail in U.S. and CPG are seeing revival due to strong holiday season sales and consumer sentiment change, and should reflect in growth in next few quarters.

Q: In terms of the GenAI rollout, are you seeing any specific verticals where the impact is slightly higher in terms of volume gains, or increase in pricing?

A: Generative AI discussions are broad-based across almost every industry, with clients actively looking at it.

Q: I just wanted some more clarity on this third-party software packages, which have risen to around 9.5% of revenue, for the current quarter. I think in your comments, you alluded to retail vertical taking up some of that. If you can give some more color, is there any more - are there any more verticals you would like to call out and also geographies?

A: We can't break third-party software packages by geographies and verticals. It depends on large deals where end-to-end solutions are provided.

Q: If I look at your utilization, it's around 86%. So what would be your comfort zone going forward, at least for the next quarter and the next year? And how would we - and how would we get there?

A: Utilization comfort level is 83%-85%, and we don't expect it to change significantly either ways.