Tata Consultancy Services Limited analyst Q&A

Thank you very much. We will now begin the Qu estion & Ans wer session. We'll take our first question from the line of Ankur Rudra from JPMorgan. Please go ahead.

Thank you very much for taking my question. Just maybe a few questions, maybe starting with demand. It seems like this was a challenging quarter for international business, slightly soft on our headline numbers and also signings. Could you maybe elaborate in terms of the nature of demand environment? Has it begun to perhaps deteriorate overall after a couple of promising quarters? And should one assume that recovery perhaps had pushed out a bit from here?

Thanks, Ankur. As we explained, demand continues to be around areas of cost optimization and discretionary spend demand stays where it was and in fact, what we saw is in some of the cases, the deal duration has slightly increased. But otherwise, we don't see a demand drop in a big way. We also mentioned that BFSI North America has done well this quarter. Tech and Services has done well for the second consecutive quarter. | 13 We had challenges in a couple of accounts in Life Sciences and Health Care, more client-specific where we were quite big , and large account in UK as well. So, barring those instances which are more client specific, I would say the environment has been quite similar to the previous quarter.

Okay. Thank you, Krithi. And maybe just on Financial services, if you could dig in a bit deeper and add some more colour in terms of which are the segments of the broader Financial services portfolio where you're seeing strength? And I think you also mentioned Manufacturing a little bit concerned if you can elaborate on that one as well. Thank you.

Yes, what is your question, Ankur, on Manufacturing?

I think there was some comment that Manufacturing has begun to see some signs of weakness, I was just curious if you could add to that?

Okay. First on BFSI , in North America, we see all around growth . Actually, both North America and Europe, UK, we see good growth in banking. And capital markets have been weak. Insurance has grown and regulations and risk and compliance have also grown in banking. And then Europe, it's more or less very similar trend. UK, again, the capital markets has always been a problem. But also, as I said, the UK is probably more a customer -specific situation than an overall trend. Otherwise the good thing is banking is coming up. Insurance is coming up, which we hope will sustain in the coming quarters. In manufacturing, what we mentioned is there is an overall supply chain issue, like because of that it's impacting the demand situation. But we believe it will be a short term issue. And once these issues are resolved, we expect our demand to pick up in the coming quarters -- because many of our customers have long order book. And their health is strong, and the order book is strong for our customers.

Thank you so much. Just if I can squeeze in a last question on margins. Clearly, there's been a lot of moving parts this time. Maybe the first part of the question would be, if you could highlight the -- I mean there | 14 appears to be a bit of a margin trade-off here going through at least on the CMT side, perhaps because of one deal. Are they expected to be any sort of synergies ? Is the worst of that deal margin impact behind us? Number one. Number two, overall, if I look at segmental margins, both on manufacturing and CMT, both are opposite directions of significantly out of long-term trends. How long will that last? When will we see this coming back to long-term trends?

So, let me give you the margin break-up, and that will cover most of your first part of the question. So, margins at 24.1% are a sequential decline of 60 basis points. And the headwinds were in form of the higher third -party expenses on account of a large transformational project. And that project is running at its peak. And that impact is about 60 basis points. We had incremental investments in talent and infrastructure, that combined impact was about 70 basis points, and this was offset by mainly currency and some one-offs not recurring from Q1. Your second part of the question in terms of segmental margins, the CMT one, as you called out, the large projects’ transformational impact does reflect out here. There's nothing else to call out. The trends on the overall margin versus on the segmental one except for in the CMT vertical are on similar sides, one or two segments had a slight positive.

We'll take our next question from the line of Apurva Prasad from HDFC Securities.

Thank you for taking my question. As a first off, deepest condolences from my side, too. Krithi, just to tie in with your comments of improvement in discretionary and optimism going forward, how should we think of growth visibility or acceleration beyond the current calendar, especially in absence of mega deals. If I look at bookings for the first half TCV, it's down 20% of course, with no mega deals that is compared to the comparable period earlier. So, any comments on how is the pipeline around some of those mega deals and/or the ACV and duration of what you've been booking? | 15

Apurva, on the TCV front, as you would see, it's better than Q1 and like we explained last quarter and the previous quarters also, TCV always has some lumpiness, like what we expect to close in the last quarter sometimes gets pushed to the subsequent quarter and we have always been maintaining that $7 billion to $9 billion TCV is a comfort range and particularly in the absence of a mega deal. If you were comparing with last year Q2, we had mega deals amounting to almost $2 billion. So, in the absence of those mega deals, I think it's a comfortable number, and from a pipeline perspective, our pipeline is nearly at an all-time high and both what we call a qualified pipeline and the overall pipeline. The pipeline is strong across all geographies and industries. TCV is within our comfort range, and it has shown sign s of improvement. And as I said, it may not easily be comparable with last year because we had 2 mega deals also come in last year.

Secondly, how much of the weakness this quarter relative to the previous quarter is sort of emblematic of macro versus the temporary client-specific factors that you mentioned. How long is this expected to last?

The overall trend on the demand environment has remained stable compared to last quarter. There are 2 to 3 accounts where we had some client-specific situation, but all happening at the same quarter is probably a little unfortunate for us. But I think that is a one quarter phenomenon, so we should rebound from that situation. So that's the way I would put it. I won't be able to split between how much is the overall environment specific and how much is client specific. But we are confident that in near term, probably Q3 is also a seasonally weak quarter, but Q4 onwards, these factors should ease out.

And just finally, how is the GenAI pipeline converting to bookings and revenue, especially as one of your competitors is talked of numbers, which is not too different from our own pipeline. So, if you could comment on that in terms of how integral it is becoming part of deals? And just finally, on margins, Samir, how much of the long-term growth | 16 strategy in growth markets, how should we think about margins from that point of view?

See, we have not been disclosing the AI / GenAI TCV, but it has been improving very well, almost doubling every quarter and the pipeline also remains very strong. As of this quarter, the engagements in AI / GenAI, including the POCs, POVs, and production, we are doing more than 600 engagements, which increased from almost 270 last quarter. It's a very significant increase in the number of engagements. And we saw engagements that went into production also jump , which is a sign of maturity. Last quarter, we had 8 engagements that went into production. And this quarter, we have almost 86 engagements going into production. So, we are finding all -round improvement and becoming mainstream. And also, the quality of engagements, like we have always been talking about engagements in terms of Assist, Augment, and Transform and we're seeing more and more engagements in the higher order of Generative AI, namely Augment and Transform. We unveiled our WisdomNext™ platform and that's also getting a lot of traction with the customers. So, we are quite comfortable and pleased.

Apurva, Samir here. From a long-term perspective, we stay committed to our 26 to 28 % guiding beacon , and that will factor in any big bets, whether it is growth market s or anything else, which we'll be taking into account. On an overall portfolio basis, we'd like to deliver the guiding beacon which we talk about.

Thank you.

Thank you. We'll take our next question from the line of Sandeep Shah from Equirus Securities. Please go ahead.

Yes. Thanks for the opportunity and deepest condolence for TCS and Tata Group. Krithi, just some bookkeeping questions. I wanted to understand and reconcile as you are saying, the BFSI has been showing signs of revival in the US and North America, but this quarter, North America as a region has not shown a growth, while Europe has shown | 17 a growth. So, can you reconcile, is it fair to say challenges in non -BFSI segment are bigger in North America?

Yes. So, what you said like if I split BFSI across geographies, North America has done well. And I did mention that there is a softness in the UK and Europe because of a client situation for us. But the overall BFSI still continued to grow. And the other geography, I did talk about life sciences and health care, in North America having a softness because of one-off client issues. So that probably dragged the overall North America revenue growth. Similarly, like the BFSI growth in Europe has held in while few other verticals have been soft in Europe, the growth of BFSI has helped overall Europe growth as well.

Okay. And just on the BSNL deal, one of the comments of CFO has been it's at a peak rate. So is it fair to assume BSNL deal revenue in the second half would be materially lower versus first half? And this could be a growth headwind in the second half on a consolidated level?

So, Sandeep, it's running at its peak and we would expect maybe a quarter more where it would remain at similar levels. And as you rightly know, the transformational program is going on, then revenue will start tapering down.

Okay. So, this would also be a margin tailwind in the fourth quarter, maybe third quarter could be, again, a difficult quarter in terms of showing upward trend on the margins?

So, while we don't call out deal specific margins, but as you rightly pointed out, third-party expenses are incrementally going up as part of the deal. So, once it starts tapering, that should reflect on both revenue and margins.

Okay. And the last question with the tax ruling change on the buyback, how are we looking at capital allocation? Are we still looking in terms of incline towards buyback or we are more inclined towards dividend? | 18

So overall, our capital allocation in terms of returning back substantial free cash flows back to our shareholders remains the same. The Board considers in terms of the mechanism of it, whether it should be buyback or special dividend, taking into account preferences of various varied group of stakeholders or shareholders, which we have, and they will take a decision based on that, when it is taken up for consideration.

Okay. Thank you and all the best.

Thank you. We'll take our next question from the line of Vibhor Singhal from Nuvama Equities. Please go ahead.

Good evening. Thanks for taking my question. So, Krithi, just to dwell a bit more on North America. If I look strictly in terms of dollar revenue terms, we fell by almost $60 million in our North America revenue, almost half of it assuming came from the health care segment, which was down almost $28 million. So, which are the other verticals in which we saw some kind of weakness in US specifically? And was that also of a similar nature like health care or client -specific issue which you expect to may be recover in a couple of quarters? Or do you think there is a more structural issue to some of the shortfall in the revenue, maybe like the telecom sector?

From a client-specific perspective, we called out it's essentially what we saw in health care. It's a life sciences ’ client-specific issue. We saw growth coming up in BFSI. We had growth come up in Energy, Resources, Utilities also and even Technology and Software Services grew. And in the Consumer Business Group, we had issues in terms of demand being slightly soft because of the discretionary spend cut. And we also saw in manufacturing some labour and supply side challenges in near term. Telecom has been a slightly long-term trend. We are hoping that it will recover once the interest rate environment becomes better, there will be motivation to invest on the capex. We are hoping for a good holiday season, having a good holiday season would be good trigger for investment to resume in Consumer industry. | 19

Got it. So, by that count should -- are we sticking to the commentary that we mentioned last quarter, the retail sector has also possibly bottomed out for us and next quarter onwards, we could see some green shoots in that sector as well?

For next year, we are hoping we can …because these macro uncertainties ease and economic environment improves, we are hoping things should start improving. At this time, it's only half the year is over. It will be too early for me to call out if next year is better than this year, but we are hoping for the situation to improve with all the macros also improving.

Got it, Krithi. Thank you so much. Just one last question from my side on the headcount addition. I think another quarter of strong headcount addition. So how to read into this going forward? I mean are we looking at maybe it's not similar, but still a positive headcount addition in the coming quarters? Is that more related to the kind of growth demand environment that you are seeing? Or is it just a backfill of the negative number that we had for the past three to four quarters?

I think we will from a trainee addition standpoint, which is our strategic addition, I think that we'll continue to hire freshers in the coming quarters, including Q3. Now for other lateral intake from the market we'll decide based on the market situation.

Got it. So, on the lateral side, is it like we are focusing on specific technologies that we are looking to hiring? I know we kind of gave a number that we've trained so many people on GenAI, is that the area that you're looking to hire lateral people or is it more across the board?

See, we are working on various technologies and various transformational programs which are across technologies, right, from SAP S4/HANA to GenAI to very specific skill sets on certain projects. All of that is something we continue to hire in the quarter.

Got it. Thank you so much. Thanks for taking my questions and I wish you all the best.

Thank you. | 20

Thank you. We'll take our next question from the line of Kawaljeet Saluja from Kotak Securities. Please go ahead.

A couple of questions actually from my side. One, Krithi, how's the furlough situation going to be this year from the initial conversation with clients? Is it any different than what you have seen in earlier years?

Okay. On furlough, we at this time from whatever we know, it's similar to last year. We don't expect this to be any different compared to last year.

Got that. The second question is on the BSNL deal. Now there are various numbers -- I mean, various sizes, which are being discussed. I think your company announced a $1 billion in terms of deal size. Whereas when I read your annual report, there was a specific mention of an additional 20,000 sites, which will be rolled out as part of deployment. I'm just trying to understand the overall size of the scope of the deal. And if it's a $1 billion, then I guess in the last four quarters itself, the bidding would have reached around $750 million, so with that as a backdrop, how do you end up with, let's say, flattish deployment or another quarter of strong robust revenue from BSNL in the December quarter?

Kawal, overall, 100,000 sites need to be deployed. We are around the halfway mark on that. And that is the incremental information we can share on it. There is still scope to go and like we have been sharing in the past, the entire scope of deal is from manufacturing, installation and beyond in terms of acceptance. So, there are various milestones also which are intermediately built into the deal. I will not be able to comment on how much of it is already recognized, but back calculations probably can be done. But on client-specific color, we'll abstain from giving specific revenue numbers.

Got it. Now Samir on this, specifically, when you look at the revenue dynamics, right, these large transformation contracts, the revenue profitability dynamics may not be synchronized at least from the | 21 financials, when I look at the CMT vertical, the absolute EBIT has been flat, whereas the revenues have grown, leading to an impression that it's been no margin kind of a business. Does this dynamic change as the transformation program hit specific milestones here?

During the transformation program, we don't expect the dynamics to change considerably.

Fair enough. The last question that I had is for Krithi, again. Krithi, you mentioned client -specific challenge. Actually, can you just elaborate what this client-specific challenge would be? And did it have any margin impact?

No. In this particular case, we had a scope reduction. We had a very significant presence, and the client had a more abrupt scope reduction, leading into our revenue decline.

But does that scope change, let's say, as you move early into the next year or is it just...

The client decided to reduce the quantum of our transformation work, they were doing. And because of that, the program was stopped. So will they pick up the program again, we will know only once the situation turns positive, Kawal.

Okay. That's clear. Final question, I don't know if it was asked earlier, but I did hear about a specific instance of focus on growth market. All of us know that growth market may not be the most profitable one. So how do you intend to balance the aspiration of expanding into India or some of the other regions in Asia Pacific and the profitability aspirations you have?

Like our experience is that, yes, the profit margin in growth markets may not be as high as the major markets. At the same time, we've been able to manage overall at the portfolio level. And also, it's a market where growth will come in and the kind of transformative engagements, we do are very interesting. | 22 And as the volume picks up, Kawal, my guess is we'll be also able to manage the margin. Currently, the volumes are low, because of which the SG&A expenses in these markets are slightly higher. Our expectation and the way we would operate is that as the volume picks up, we should be able to manage our cost and improve the margins also.

Just to add to it, we could drive growth in one portfolio and drive efficiency in another portfolio. Our intent would be to deliver a combined mix of growth and profitability in the aspirations which we have set.

Thank you so much for your responses, appreciate it.

Thank you. We'll take a next question from the line of Rishi Jhunjhunwala from IIFL Institutional Equities. Please go ahead.

Yes. Thanks for the opportunity. Just a couple of questions. Firstly, if you look at our SG&A expenses as a percentage of revenue, they are pretty much at an all-time low. And in the past four to five quarters, we have seen sequentially even the absolute a mount coming down. Just wanted to understand, is it more a reflection of how things have slowed down in the past four, five quarters and hence, you are trying to rationalize that or more a reflection of how the next three, four quarters might look like and kind of managing investments there?

So, if you look at it from an absolute perspective, SG&A expenses have been in the stable level. If you look at it from a year -on-year perspective, there has been investment in infrastructure as well as travel expenses going up. And I'm assuming you're talking about from an absolute one because as percentage of revenue, due to inclusion of some of the non-services revenue, will also have an impact. But overall, SG&A is one of the levers in terms of stable management of margins.

Okay, sir. And just secondly on deals, right? So last quarter we had indicated that there were delays in deal closures and so possibly that could have been reflected in better wins this quarter. There hasn't been any material uptick, but you mentioned 7 billion to 9 billion is a comfortable range in which you are operating. Just wanted to | 23 understand in order for our growth to accelerate to maybe high single digit or close to double digit over the next 12, 18 months. Do you still need this number to go up substantially or the overall budgets might just reflect that even if it is not getting reflected in the TCV?

No, let's say, for the current revenue trajectory we are in about 9 billion, I'm not saying 7 billion will be comfortable consistently. But close to the range, we have to get close to our book -to-bill ratio. If it gets somewhere around 1.1, 1.2 would servi ce the growth that is required. So that's the reason we are coming up with a number of almost $7 to $9 bn. But also, Rishi, idea is that when you say seven to nine, there will be a couple of quarters where you will have a mega deal come in. So, it will also give additional bump to the overall number. For instance, last year, we had TCV of almost more than 40 billion. This year, we had somewhere between close to 16 billion and 17 billion in TCV in H1, with some large deals coming in and with all the better deal closure, we may be closer to the mark than we were last year or if it is lesser, will not be less by a big number and as I said, 1.1, 1.2 book -to- bill is a decent number for sustaining the growth.

But would you have mega deals in the pipeline, which could potentially...

There'll always be a few mega deals in the pipeline, Rishi.

Okay. All right. Thank you so much.

Thank you.

Thank you. We'll take our next question from the line of Ravi Menon from Macquarie. Please go ahead.

Thank you for the opportunity. I wanted to touch upon one of the markets that you're already strong in that is th e Airline Industry. We had heard about how they want to go direct-to-consumer, and I guess, those plans have been put on hold as they struggled on that front. Do you see some of those kinds of investments coming back? | 24

Yes, definitely from what we understand, those investments are coming back.

And in manufacturing, where you spoke of were you talking about aerospace specifically or any other segments?

Definitely, the labor issue is around aerospace. Supply chain issues are in auto as well as aerospace.

Thank you so much. And one last question on BSNL deal. I think if I understood correctly, by next year Q1 that's supposed to end? And is there a maintenance phase after that?

Yes, there will be a maintenance phase, see currently, the existing deal we are on track to in fact close by Q4, okay? And Q1 there could be some residual work, and some maintenance work will be there.

Thank you so much, best of luck.

Thank you. We have a next question from the line of Gaurav Rateria from Morgan Stanley. Please go ahead.

Thanks for taking my question. The first question is for Krithi. You did talk about optimism around discretionary spend returning back. So apart from macro data points, what are you seeing either in your portfolio or client conversation or the pipeline that gives you more confidence around return of discretionary spend over a period of time?

See, there are a couple of things. One is there is a lot of optimization work going on. Some of the investments around technology debt have not taken place. For instance, there's a workaround technology modernization, mainframe modernization, that spending, and 1 good thing is with the Generative AI becoming more and more mainstream, Generative AI is also being seen as an important lever thro ugh which modernization could be expedited and accelerated. So that's one and the second is our client conversations in terms of enhancing customer experience. That's also in some cases that which should have happened last year did not happen. So, the optimism comes from the | 25 backlog of work, which some of our customers have not been able to carry forward because of the current environment they are in.

Got it. The second question is on margins. I know that you gave us the details, and that had a component of capacity building an infrastructure-related investments that had some impact on the margins -- kind of coming back gradually, would you expect margins to return to the range that you talked about in the near term or will it be more like a medium -term phenomenon . Basically, you have levers around India business, sort of tapering down on that contract, which can lead to some margin expansion on top of it some capacity creation has happened. That also kind of can lead to a margin expansion. So, trying to understand 26% is it more of a near -term phenomenon or more like a longer-term margin aspiration that one should think about?

Gaurav, we'd like to get to 26% to 28% or nearer to 26% as soon as possible. Given how the macros are stacked up we can't tell you whether it is in the immediate quarter or two quarters or three quarters or four, but we'd like to get to it. We exited at 26% in Q4 of last year, I'd be really happy if we can exit this year Q4 also at 26%.

Thank you very much.

Thank you. We move on to the next question from the line of Nitin Padmanabhan from Investec. Please go ahead.

Hi, good evening. You mentioned that the deal tenures have sort of expanded. So, is that in specific cases or is that a very broad-based kind of phenomenon?

Nitin, I think probably what I meant was a deal cycle, like the time to close the deal, we saw an expansion. It's not the tenure of the deal. It's the time to close the deal has expanded between Q1 and Q2 in some other cases.

Got it. And you mentioned that the headwinds that we have seen this quarter in some cases, it could sort of stabilize in the next quarter and then possibly improve I think that was more Life Sciences. But broadly, do you get the sense that in all the areas where you have seen | 26 headwinds in the current quarter that's more or less peaked out and things can incrementally improve for those specific areas?

See, we've never given a short -term commentary or near -term commentary, Nitin. But we believe that once the uncertainties are clear and once we enter a more stable situation , w e believe the growth should also return. Current, we believe the short -term freeze or cut down in the discretionary spend comes out as a market uncertainty. One that eases the investment should return, but I don't want to say that it will immediately happen in Q3, but we believe in the medium term, it should happen.

Got it. And lastly, you mentioned that 86 sort of projects on GenAI have gone into production compared to 8 in the last quarter, what are the average sizes of these projects? Are they very large or...?

No, at this time, Nitin, many of them tend to be small, but we do also get some large projects. For instance, for 1 of our clients, we established an AI office. It's a program that sets the overall architecture, sets the guardrail and ensures the risk and regulatory framework, legal framework and then looks at all potential POCs and then evaluates the POCs and then create s a backlog and works with each group to deliver. Such projects will be more long tenured and the value could be higher. So, if you are doing 1 single POC or 1 single program, the value may not be very high. But where they are long - standing and long-term projects, the value also could be high.

Got it. Are you seeing any large AI projects where enterprises are sort of looking to build some sort of a broad infrastructure framework where the entire org could sort of use irrespective of the partners, the broad individual building blocks, which is enterprise-wide?

That's what I mentioned . These AI offices, we are trying to create an overall infrastructure. It's more a technical infrastructure as well as the framework and guardrail that's required. When I said AI office, that's what these programs tend to do, Nitin.

In the case where an enterprise seeks to create an AI office broadly, typically, how large will these projects be? | 27

See, it can vary, like deal size can vary based on the core size of the organization, tenure of the deal, it could be $10 million to $20 million, $30 million based on the tenure and size of the organization.

That's very helpful, Krithi. Thank you so much and all the very best.

Thank you.

Thank you. Ladies and gentlemen, that was the last question for today. I now hand the conference over to the management for closing comments. Over to you.

Thank you, operator. • We are very pleased with our second quarter performance, growing at 5.5% Year-on-Year in Constant Currency, amidst the challenging geopolitical situation. • Deal momentum continued to be very strong in Q2, with our order book at $8.6 billion for the quarter. • Operating margins were at 24.1%, declining 60 bps sequentially. • Our LTM attrition in IT services was 12.3%. • I would like to thank the 612,000+ TCSers whose valuable work is helping us achieve excellence every day. With that, we wrap up our call today. Thank you all for joining us. _________________________________________________________________________________

This transcript has been edited for readability and does not purport to be a verbatim record of the proceedings.