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Sonata Software Ltd
Earnings Call Analysis
Q2-2025 Analysis
Sonata Software Ltd
In the second quarter of FY '25, Sonata Software reported a consolidated PAT of INR 106.5 crores, reflecting a modest growth of 0.8% quarter-on-quarter but a notable decline of 14.3% year-on-year. This shortfall is largely attributed to variabilities in domestic revenue despite a steady increase in gross contributions. The consolidated EPS slightly increased to INR 3.84 per share compared to INR 3.81 in the previous quarter.
The international services arm generated revenue of $84.6 million, a quarterly increase of 2.3% and a year-on-year growth of 4.6%. Meanwhile, the domestic business showed a gross contribution growth of 2.5% quarter-on-quarter and 12.4% year-on-year, contributing INR 70.2 crores. The PAT for domestic operations reached INR 44.3 crores, marking a substantial 9.5% growth for both quarter-on-quarter and year-on-year metrics.
Operating metrics highlight a continued increase in headcount, rising to 6,908 from 6,619, with an 87% utilization rate. The company added 8 new customers during the quarter, and its top 10 clients now contribute 63% of the revenue, up from 50% in the previous quarter. Importantly, the order booking for Q2 was reported at $104 million, showcasing a strong book-to-bill ratio of 1.2.
The EBITDA margin for international business slightly declined to 18.2%, down from 18.7% last quarter, largely due to salary hikes that had a 1.1% impact. However, the company projects that operational improvements and the reduction of costs associated with large deals could boost EBITDA to low 20s by Q1 FY '26.
Sonata's long-term goal remains ambitious, targeting an international business revenue of $1.5 billion by FY '27. Key strategies include securing large deals—49% of the current active pipeline is dedicated to high-value opportunities—and strengthening partnerships with major players like Microsoft. Notably, three major deals closed during the quarter involve significant multi-year projects from top-tier clients.
Management is optimistic about the second half of FY '25, expecting it to outperform the first half due to strong performance anticipated in the healthcare and banking sectors. However, they also caution that some headwinds remain in retail and manufacturing, which could dampen overall growth. The company foresees an adjustment to profitability impacted by wage increases but expects resolutions in forthcoming quarters.
While Sonata reported substantial cash reserves of INR 500 crores, investor sentiments have raised concerns regarding returns, particularly with dividends, which have remained unchanged over the past ten quarters. Management acknowledges feedback regarding the importance of balancing growth reinvestment with cash distributions to shareholders, indicating ongoing evaluations of this aspect.
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Ladies and gentlemen, good day, and welcome to Sonata Software Limited Q2 FY '24-'25 Investor Conference Call. [Operator Instructions] Please note that this conference is being recorded. I now hand the conference over to the management from Sonata Software Limited. Thank you, and over to you, sir.
Thank you, moderator. This is Samir Dhir from Sonata Software. And I have the management team along with me on this call. We all welcome you to this conference. Today, we will share our strategy, the progress we have made in the recent quarters, our strategic plan and the financial results for the quarter Q2 FY '25 that ended on September 30, 2024. I thank you for joining us today. We appreciate your valuable time and support. It is my pleasure to share our progress regarding our vision and growth for Sonata despite the macroeconomic challenges and geopolitical issues, which are resulting in a slowdown in the tech spending across some of our verticals.
I'll update you on our strategic goals. And post that, we will discuss our progress in Q2 FY '25. So let's talk about our goals and strategy first. As you know, our objective is to be one of the fastest-growing modernization engineering firms powered by our unique Platformation framework. We aim to achieve revenue of $1.5 billion by the end of FY '27 for the international business at an EBITDA of low-20s. From a growth point of view, we outlined a few critical bets.
Number one, we will continue to win large deals, multiple large deals, building on a successful track record. If you recall in H1 of this fiscal year, we've closed 6 large deals. We will deepen and diversify our partnership with Microsoft and other partners and continue to win new logos working alongside with them and really create the next $10 million, $25 million, $50 million, $100 million clients for Sonata through that channel.
Third, continue to scale the business through deeper capabilities, build out on delivering M&As and diversify our client base by successfully integrating them. And we want to achieve these goals in our 4 focused verticals, which is Healthcare/Life Sciences; Banking Financial Services; Retail, Manufacturing, Distribution; and Technology, Media and Telecom. And in the 5 geographies, which are North America, U.K., Europe, India and Australia. Leveraging our differentiated lightning tools, IP and offerings, we are steadfast in our pursuit of our $1.5 billion goal assuring our clients of the commitment to their modernization needs.
With that, let me provide you update on the large deals first. Our large deal pursuits are a significant part of our strategy with 49% of our active pipeline dedicated to these high-value opportunities across all our verticals. 36% of our large deal pipeline are with Fortune 500 clients. I'm delighted to share 3 significant wins we had in Q2 with all of you. The first one is with one of the top financial corporations in the U.S. Sonata has been chosen as a strategic partner to deliver its data modernization program, including migration from Netezza to Snowflake. This is a key multiyear data and cloud modernization program for this large U.S. bank, which is in the top 10 of the U.S. banks.
The second large deal is with a U.S. technology giant. Sonata will enable an optimum global delivery model to deliver on AI, cloud and data services from our global delivery centers, including in India, Mexico and Malaysia. We are absolutely thrilled about this win. The third win is with a client who is a leader in a personal facility and food safety systems, Sonata will be a strategic partner for designing, building, managing and continuously modernizing their consumer-facing automation platform using a combination of Microsoft, Android and iOS technologies. Apart from these 3 wins, we also had 2 strategic midsized deals, and I'm happy to share a summary of them. While they are midsized deals, but they're also net new logos for Sonata.
The first one is our client in an Australia-based -- is an Australia-based reseller, wholesaler. We have been awarded a multiyear data modernization program as a strategic partner. And to note, this is our largest TCV-based Microsoft Fabric win in the data transformation space to date. We're very excited about this win. And the second midsized deal is for our client and the -- which is a leading food service company in the U.S., Sonata has been awarded their multiyear ERP modernization and integration program. This is the second logo we closed in the quarter, which is also a midsized deal. We're excited that our differentiated capabilities are now helping us win new logos along with midsized deals.
With that, let me provide you an update on AI, which is our strategic bet. If you recall, we had talked about the fact that 20% of our revenue will come from AI-enabled services by end of CY '27. We have now $67 million of our pipeline across 110 customers and are very excited about the new wins that we have won in the quarter. Happy to share with you, we closed a very large pharma customer as our net new client using our Gen AI capabilities in the course of the quarter. In addition, we exceeded our order booking [Technical Difficulty] AI in the quarter compared to Q1 quarter. We're enabling our clients to leverage AI in 3 ways: number one, driving efficiencies for them; number two, driving higher consumer experience and modernizing their sales platforms; and number three, driving innovative business models for them for better outreach for a larger number of consumers to increase their revenues.
For one of the health tech clients, we're harnessing the power of AI to ensure comprehensive and representative demographic coverage in clinical trials. Our clients aim to eliminate bias from the sample of people covered during clinical trials. We are using AI to ensure regulatory compliance for the customer. Our Harmoni.AI infrastructure is critical to our recent deal wins and subsequent AI model implementations. By leveraging Harmoni.AI across multiple clients, we enable Gen-AI-driven engineering scale and test acceleration. Our teams are truly at the forefront of this technology revolution.
With some of the health care, life sciences and banking customers, we're making significant progress in implementing Gen AI using small language models for cost efficiency, which also results in fine-tuning of their cloud spend, and we're also implementing Agentic AI approach in these clients. We have invested in AI cross-functional org led by Sharmila Sherikar to drive AI across Sonata and partner with technology, delivery, sales to accelerate our GTM efforts across our partnership research and continuous strategy refinement in Gen AI. Approximately 83% of our engineers are now Gen AI trained, which is a significant increase from 67% that we shared with you last quarter. This improvement demonstrates our unwavering commitment to upskilling and the immense potential AI has across our operations and our customer operations.
With that, let me provide you an update on the scale that we are building. For our investment verticals, which are Healthcare, Life Sciences and Banking, they now contribute 32% of our revenue, which is up from 13% 10 quarters back. Let that sink in. HLS and BFSI now contribute 32% of revenue, which was about 13% 10 quarters back. So our strategy to invest in these verticals has really paid dividends quite significantly for us in our growth journey. These verticals added nearly 18% of our client revenue, which did not exist 2.5 years back. We expect our invest verticals of Healthcare and Life Sciences and Banking to reach together about $250 million revenue in 3 to 5 years from now. We are very excited about the growth that we're seeing in front of us in these 2 verticals.
The following key bits are helping us scale our offerings in the modernization stack. Number one, on the cloud and data, we have continued to progress in the cloud and data pipeline, which is now 51% of our overall pipeline. To remind you, this pipeline was about 15% of our pipeline about 2.5 years back, has now jumped to 51% of our pipeline. We're seeing an increased demand for our data-driven deals. This has now grown more than 120% over the previous year. So we had 120% increase in our order book in data-driven deals Y-on-Y. Our revenue from data modernization has grown up from 13% to 23% in the last 10 quarters. Very excited about the progress our teams are making in our growth journey from a data modernization perspective.
Number two, Microsoft Fabric, which is a strategic bet we made working with Sonata, and we are a featured and launch partner for Microsoft Fabric with -- from a Microsoft perspective, which is a data analytics platform for the era of AI and went to GA in November '23. Since its launch, we have witnessed a significant pipeline build of our Fabric, which is now $91 billion pipeline across 110 clients of Sonata. We're very excited again with the fabric progress -- progress we are making on the Fabric platform working alongside with our partners. Microsoft Dynamics, which has been the core pillar of our growth for many, many years. In Q2 FY '25, we won one large deal with a telecom -- with a high-tech customer and one midsized deal with a retailer.
During the quarter, we witnessed continuous modernization success, and we're now seeing green shoots in the CE space, Dynamics CE space to take out the competing SaaS platforms and the power platform space to take out competing RPA platforms for our customers. We're very excited again on our growth in Dynamics, CE and Power Platform combined. Our SITL business continues to deliver solid performance quarter-on-quarter. And in this quarter, it delivered an ROCE of 78.4% in Q2. On a normalized basis, it will be 45.2%, but we had some exceptional item in the quarter, so we got 78.4% ROCE in the quarter.
Now coming to the awards. We were recognized as a major contender by Everest Group for our low-code application development area, and we were recognized by HFS as the Fastest Six service provider from a growth point of view in Q2 over FY '24. Very excited about our progress in our capability build and the fact that we are the Fastest Six growing company in the market today.
Update on talent. Sonata University has been at the forefront of our capability build initiatives, and it saw increased usage of and acquisition of new skills such as Gen AI. Our active headcount in the quarter increased to 6,900 people, which is compared to 6,619 a quarter before. So we added about 250 people net in the quarter. The last 12 months -- trailing 12-month attrition was at 13%, and our gender diversity is at 31%. We continue to make good progress on our gender diversity initiatives.
In the course of the quarter, we also implemented salary increase for our junior management effective July. We are planning to implement another increase for our mid- and senior management effective Q3. In addition to that, we continue even in these times on our campus hiring programs [Technical Difficulty] and we onboarded 150 campus grads during the course of the quarter. Gives you the -- goes on to show that we have continued to build our scale in the current environment as well.
With that, let me provide you an update on the Q2 FY '25 performance. The key outcomes for the Q2 FY '25 despite the industry headwinds. For the international business, our revenue grew 2.3% quarter-on-quarter, much in line with our forecast that we gave at the beginning of the year of 1% to 3% growth. We came in at 2.3%. We had a very strong order booking of 1.23 book-to-bill for the international business. In Q2 FY '25, we won 3 large deals and 6 midsized deals. We now have -- and this is a very noticeable achievement. We now have 8 clients which do more than $10 million revenue on a run rate basis annually for Sonata now. That number was about 4 less than 2 years back. Our EBITDA remained at 18.2% in Q2. Our utilization remained steady at 87%. For the SITL business, the domestic business, our gross contribution in the business grew 2.5% [Technical Difficulty].
Ladies and gentlemen, the line for the management has been disconnected. Please stay connected while we reconnect the management back. We have the line for the management reconnected. Yes, sir, please go ahead.
Apologies for the snafu. I just want to conclude. I want to take this moment to thank all our Sonatians globally for their commitment, hard work and the quality of outcomes they deliver to our clients day in and out. We are very proud of our team members. Thank you to Team Sonata.
With that, let me turn it to Jagan for his comments on our financial performance. Jagan?
Thank you, Samir, for the overview. Good morning, good afternoon, good evening all. Let me start the update on international business services for Q2 2025. In International Services, the dollar revenue grew. Our revenue was $84.6 million. With quarter-on-quarter, it grew by 2.3% and year-on-year by 4.6%. In rupee terms, the revenue stood at INR 707.9 crores, which was 2.9% quarter-on-quarter growth and year-on-year 5.7 [Technical Difficulty]. In constant currency terms, revenue grew by 1.5% quarter-on-quarter and 3.7% year-on-year.
Now the comment about the profitability in international business. The EBITDA before ForEx and other income stood at 18.2% against 18.7% in Q1 2025. The major reason for this was a salary increase given during this quarter had impact by about 1.1 percentage. However, we were able to compensate that through the savings in operational improvement and also SG&A leverage what we got during this quarter. Hence, our EBITDA came back -- dropped only by 50 bps in this quarter. The PAT for international business stands at INR 62.2 crores. We had a 4.4% degrowth quarter-on-quarter from the last quarter. The growth driven by the main top clients there, Microsoft, [indiscernible] and Quant customers. And international services, the Q2 ROCE stood at 20.3 percentage. Q1 was 18.3% and Q2 RONW stood at 23.5% compared to 21.6% last quarter.
Now the update about the domestic business. Gross contribution in Q2 stands at INR 70.2 crores, grew by 2.5% quarter-on-quarter and 12.4% year-on-year. PAT for domestic business in Q2 was INR 44.3 crores, grew by 9.5% quarter-on-quarter and 9.5% year-on-year. The DSO for domestic business stood at 35 days, same as last quarter. The ROCE in domestic business is 45.2% compared to 44.6 percentage last quarter. The reported ROCE was much higher due to onetime changes impact that happened during this quarter. The DSO of the international business continue to stand at 45 days.
Comment about the consolidated business. PAT for consolidated business stood at INR 106.5 crores, growth of 0.8% quarter-on-quarter, and 14.3% degrew by year-on-year. The consolidated EPS for the quarter stood at INR 3.84 per share compared to INR 3.81 per share last quarter. At consol level, quarter 2 '25, ROCE stood at 24.7% and RONW stood at 28.4%.
Now the comment about the cash flow. This quarter, there were major movements on the cash payout. The first one was earn-out paid to Quant. The second payment to Quant in this -- after the acquisition, this was about INR 116 crores was paid on this. Encore, we paid the third year and final earn-out payment of INR 59.4 crores. We have also had -- we also paid the incentive and increments for the employees during this quarter. We had repaid the loan to the extent of INR 48.9 crores during this quarter. We also had the final dividend payout for the shareholders in this quarter. The benefit for us was we had a decent amount of IT refund coming for us, which -- against the old assessment what was trailing for us.
Moving to other -- some important operating metrics. The total headcount moved from 6,619 in quarter 1 to 6,908 in quarter 2, net headcount addition of 289. Utilization of Q2 stood at 87% compared to same level of Q1 '25. We have added 8 new customers in Q2. Top 10 clients contributed revenue share of 63 percentage compared to 50 percentage last quarter. Number of clients, more than $3 million run rate, in Q2 is 22 customers compared to 21 last quarter. The vertical mix for Q2 is as follows: TMT is 32%, retail manufacturing is 31%, HLS is 10%, BFS is 22% and emerging is 5%. Revenue by top go-to-market was data became 23%, dynamics is 23% and cloud is 41%.
The Q2 order booking stood at $104 million, which is 1.2x of the international services revenue. This is book-to-bill. Our international services continue to have a good cash collection of about $86.7 million in this quarter. In summary, we continue to remain optimistic about the long-term growth prospects.
And thank you all for attending this call. With this, I hand over the call to the moderator for question and answer.
[Operator Instructions] Our first question comes from Rakesh Agarwal from Rakesh Mangal & Company.
Sir, what is the reason for degrowth in domestic business? This is 21% reduction. Quarter 1 was INR 1,849 crores, whereas quarter 2 is INR 1,461 crores.
Yes. We have always mentioned to you that domestic business, you should not see the turnover, we should always consider the gross contribution. Gross contribution has actually grown from INR 68.5 crores to INR 70.2 crores this quarter. The turnover depends on the contract what we signed and contract what we close. Some of these contracts may be large, some contracts may be less. So please don't see the revenue or turnover of this business. Just see -- measure it only about on the absolute amount of gross contribution.
Okay. But sir, please, I don't follow it. Can you throw some light on why -- even if the revenue has been dropped, how this gross contribution has been increased?
No, that's what. It depends upon what is the kind of deals we have. In this quarter, we have a couple of deals where the gross contribution percentage was better for us. Average, we run between 3.9 to 4.1 percentage of the gross contribution as a percentage of revenue. But some of these deals, we had a higher gross contribution in this quarter. Hence, the gross contribution amount grew, but turnover may not grow for that. We'll have a bumpy rate in terms of turnover.
Got it. Got it. And what is the revenue impact of these new 3 deals, major 3 deals we have entered or finalized this quarter? And 2 -- major 3 deals -- and international 3 deals and 2 deals. What is the revenue -- coming revenue impact?
No. These deals are large deals for us. And definitely, this will have -- these are all deals are -- normally all the large deals are between 3 to 5 years' time frame. So with the large deals coming in, we will have a good impact on the revenue growth in the coming quarters, but may not be immediately. All large deals will take a little time of transition because most of the deals have transition impact also. Once the transition is done, the revenue will become a normalized mode on the revenue transition. We cannot particularly give about a particular contract. We don't disclose that, but will have a positive impact on our revenue growth.
But when we are expecting this will impact our revenue, from which quarter?
No, I have mentioned it depends on each of this contract and what is the tenure of the contract, what is the complexities of the deal and all these things. On a very, very large deal, no megadeals that we generally give how much quarter -- how much impact will happen and which quarter the flow will happen, normalized revenue flow will happen. These are all large deals, regular large deals. There will be more and more large deals. Always we win 2 to 3 -- 3 to 4 deals every quarter. And I cannot specifically tell about how much impact this will happen. This is continuous process of winning the large deals, and it will continue to help us to grow the revenue quarter-on-quarter.
The next question comes from Mihir Manohar from Carnelian Asset Management.
Yes, sure. I mean, Samir, largely wanted to understand, I mean, the deal pipeline overall, which has been there quite good. I mean cloud data pipeline or even on the MS Fabric and dynamic side, the database has been quite strong. You mentioned 51% of our pipeline is now cloud and data versus 15%, which was there, let's say, 2, 3 years back. But how should we see this particular part of the business translating into revenue growth? Should we see the historical growth rate that we used to have, I mean, 3% to 5% kind of a growth, which was like one of the top quartile growth among the industry. Should we see that growth coming back given the deal wins, which have happened in the pipeline, which is there? That was my first question.
Sure. Do you want the answer to this first? Or do you want to complete all your questions?
I mean -- maybe I'm okay with anything.
Okay. So let's answer this first. So there are 2 things happening in the market, Mihir. So these deals that we are winning are helping us incrementally take our revenue up. If you recall, we had said when we had a degrowth quarter in Q4 that first half of the year will see 1% to 3% growth in the second half will be better than the first half. I think these deals are all adding up to us to deliver a better second half of the fiscal year compared to what we had in the first half of the year. That's point number one.
Point number two, as you know, there are headwinds in the market right now, especially in the retail and manufacturing side because that's about 30% of the business, which is under pressure because of the industry headwinds. So these deals are actually, in some ways, offsetting the pressure that is getting created and help Sonata deliver higher than industry -- average industry growth rates that we're talking about. So that's a 2-way to think about it. Our second half will be better than the first half comparatively. And second, this is also offsetting us to take the headwinds from the retail and the manufacturing sector and offset that downswing.
Sure, sure. And I mean, on this deal side, how should we see these deals from a margin perspective, given the fact that this, I think, would be more on the discretionary side of data cloud and everything. So how should we see margins from here?
So if you think of the midsized deals, they are at par with our standard margins of the company. They are overall at par and they will start at par and they will stay at par. Then some of the large deals, while their overall margin profile in the term of 3 or 5 years will be at par with the company, for the first few quarters, there might be some impact because we are ramping up, et cetera. But in general, there's not any negative headwind expected from any of these large deals. The one that we announced in May, June time frame had an impact, and we told you guys that, that will have an impact in Q2, Q3 and Q4, but that's already baked into our numbers, right? These things, we don't expect to have any significant impact even in the short run. They will probably be at par or slightly accretive.
Sure. My second question was on the finance cost. I mean you have given a very good bifurcation of the finance cost in the presentation this time. So I mean, if we can get an understanding as to how should one see each of these components of the finance cost for the balance part of the year? Because I believe the unwinding, we were expecting that unwinding to come down and even the interest on acquisition loan to come down. So how should we see these 3 components for the balance part of the year?
This unwinding has already come down. If you see in the investor deck, in Slide #24, we have given it, how much the unwinding has come down compared to Q1, and last year what was the Q2 number and what is the Q2 number. It has come down already. And the unwinding will get next year when the next payment happens, it will be fully -- it will fully disappear there. Interest cost on acquisition loan, what we have, it's SOFR plus what we have taken with the margin from the bank. So SOFR is quarterly reset, hence it will come down from next quarter by 50 bps. Once it starts coming in, our interest cost also will start coming down.
Okay. So I mean when are we going to repay the loan, which we had taken for acquisition? What is the exact...
The loan what we have taken till now will be repaid by financial year '27.
Okay. Okay. And this INR 10 crores, should we be building INR 5 crores from next quarter...
It is already there. You are talking about interest cost, right?
Interest on acquisition loans.
Interest on acquisition loans, it's not INR 5 crores. It is interest on deferred consideration that has come down by INR 5 crores from Q1 to Q2, Q4 to Q1 -- Q1 and then Q2 has already come down.
Sure, sure. And just last question was on...
Interest on loan will come down by 50 basis points, but that impact will happen from Q3.
Okay. So 50 basis points should be, I mean, INR 2.5 crores kind of a reduction, INR 2 crores, INR 2.5 crores per quarter.
50 basis points on the loan amount. Loan amount was $75 million, we are repaying back. Now whatever was outstanding, on that interest cost will come down. It will not have a 50 basis point impact on profitability. I'm talking about interest rate. SOFR plus margin, that SOFR is coming down by 50 bps.
Understood. And just my last question was on the -- I mean, quarterly variation. I mean, I understand that we are a small company when we see the international business. But however, the quarterly variation for us across verticals, I mean, across segments, TMT or retail for that matter is quite stark when you compare that to others. I mean BFSI 15% growth last quarter, this quarter, 40% growth. So why is there such a stark variation which is there for us versus...
So let me take that, Mihir. I think it's really a function of the deals that we are pursuing. See, on a small base, we closed 2 mid or large deals. We see a very strong percentage jump. And that's what is really happening. And I think that's part of the strategy we are building out because we want to build scale in these. But if you look at a slightly longer duration, Mihir, which is what I shared earlier, our healthcare and banking business together were about 13% of our business 10 quarters back.
They're about 32% of our business now. So over the last 10 quarters, as Sonata has grown, these businesses have grown faster than the rest of the Sonata, which just gives you a sense of how this business is looking like for us. That's why we are excited. And it was part of the strategy to diversify the business because retail manufacturing was about 30%, 35% of the business, and that's pretty much flat line for the last 4 months or 4 quarters. This is actually helping us offset that. But on a secular basis, we think this business will continue to grow faster than the rest of Sonata.
Sure, sure. And just one last follow-up. I mean, you mentioned second half to be better than first half. Given the deal wins which are there, should we expect second half to be substantially better than first half?
Well, it's a relative word substantial, but we do expect second half to be better than first half. Look, let's not forget that we still have some headwinds in the business because of retail manufacturing. But I think it will be better than the first half. How better? We'll report back when we come to the next quarter, Mihir.
The next question comes from Dhiraj Dave from Samvad Financial Services LLP.
So one question. Basically, I am a retail investor for almost like 8 years with Sonata Software. And this is the first time when company is doing everything good, at least cash flow-wise, acquisition-wise, we had paid something, which is incentive to the companies which we acquired, we have paid to employees, but we find there is no dividend declaration. Is there any change in policy?
Yes. There's no change in policy as such, but the Board has decided to evaluate the dividend payment in the subsequent -- in the coming quarters, sir. The reason is because of the -- our loan repayment and many other reasons are there. But the Board is going to keep evaluating in the coming quarters.
Isn't it sound something, which is kind of when we were looking at acquisition funded by debt and we are paying incentive and we are paying increment when attrition rate is 13% to employees, which is fine. We are manpower company, we should pay. No denial to that part. We have liquidity and we are paying dividend. In fact, from the turnaround time, we have started paying 2 quarterly dividend. Today, we are in great shape and we are still deliberating. So are you looking at acquisition or something that you need to hold with the cash reserve? Otherwise, it's not making sense.
Why change the policy. In fact, there was no communication. If you check discussion sometime back, whatever last 5, 6 quarterly discussion, I categorically asked there is any change in dividend payout policy. It was said, no. It won't increase because we have done acquisition, but it will be maintained. And basically, see, what happens is this gives discomfort to the investor community because we are used to certain kind of pattern with the company. And if you are changing that and without any communication, it's not fair, right?
Sir, this is not a change in the policy and the capital...
Yes, there is no change, but the point is that you are doing back dated. See, you are paying every 6 months, and that was kind of -- you are CFO, since how long Sonata has been paying 6 monthly dividend? Since almost 5, 6 years?
Everything is subject to evaluation by the Board, sir.
We know. We know that.
Depending on the business condition and our strategic priorities, the decisions are taken at the Board level. This is not a decision by the management alone. This is essentially a Board...
You please pass on the feedback that investors have concerns. And at least it should be communicated to the investors that henceforth you will be getting 1 dividend or whatever not because IT companies generally have a tendency, good companies have a tendency. So that's fine. Your Board have certain consideration.
Second part is I fail to understand that we did acquisition, we are paying incentive to acquisition company. We have IT refund, which is giving us a INR 10 crores of extra income in the other income in the kind of thing, which was not there in last quarter. And despite that, we find IT revenues -- means all this revenue growth and all that is coming, why there is no cash flow or cash growth? In fact, you see the condition of company, we have INR 700 crores cash and marketable equivalent, which is reduced to INR 500 crores. So why that is happening? See, if the growth -- it's fine to talk about all these big numbers. Why you are not saying that we will be paying X amount of dividend or we'll have a free cash flow target. Why to look at growth?
If growth is not that remunerative, in fact, if you look at the 10 quarters results, the dividend has been paid has been remained same for last 10 quarters. If it was INR 7.5 or something, it has remained that only. So all this growth, while it makes sense for all the stakeholders, as a financial investor, it doesn't make sense for me, which is fine. We have to look at long-term growth. I appreciate all that thing. But at the same time, you need to balance all stakeholders with growth and cash flow distribution, or free cash flow need to talk into consideration.
You can't tell in isolation, okay, we'll grow $1.5 billion. What's the point? Your margins are coming under pressure. If you look at IT service business in the international market, even that is -- the reason given by Samir that we have got 30% retail and manufacturing, which has a headwind, but you've got BFSI, which has increased by 6% and healthcare also increased by that. So basically, what it means is that we have taken a lower margin business. Or we have some onetime cost in building up for this scale. So if that is the case, please explain what is the kind of onetime cost about the new deals, which will help us over a period of time. So that will help us elaborating because for the last 4 quarters, we have been constantly getting that things will improve, things will improve, things will improve, but we don't find any kind of results.
We take your feedback. We have explained to you about the margin in the large deal that 3 quarters of -- 3 to 4 quarters impact will be there because we are doing an investment and we have also done a rebadging of people on site. That impacts our margin. And we also told about salary increase in this quarter because we are an employee-oriented company. We need to compensate our employees. So considering these 2, we have -- I believe we told about the impact on margin till Q4 of this year.
Secondly, when the acquisition happen [Technical Difficulty] disclose what is the total acquisition price and what is the amount we have to pay. And based on what is the performance, we have also given a clear clarity last December when they exceeded the performance -- around our condition, we have given all the details of that. We are giving breakup of all these payouts in our investor deck every quarter. We have taken your input, sir. Thanks for your input. We will definitely discuss -- take up and discuss internally, sir.
The next question comes from Amit Chandra from HDFC Securities.
Sir, my question is on the demand environment. You mentioned that we have won some large deals, the 3 large deals in the quarter and the large deal pipeline continues to remain strong. But especially, we have also maintained our long-term FY '27 target of $1.5 billion; $500 million for the IT services business. But that actually assumes a significant acceleration in our revenue growth from what we have been doing in the last 2, 3 quarters. So if you can explain how the large deals will help us in achieving that? And also your comments on post the U.S. elections is now behind, how the demand environment is shaping up, especially after the elections? And in terms of the ask rate for achieving the $1.5 billion, is it -- like is it totally organic? Or is there some inorganic component also into it?
Yes, let me take that. I think there are multiple parts to your question. So let's just talk about the macroeconomics. I think like we said earlier, the industry that we service, 4 industries we service, it is a duality in those 2 regions. So for example, healthcare and banking are doing well for us. Retail and manufacturing is not doing that well for us because of the current consumer spend-related discretionary spend slowdown that has had. And Hi-tech, while the large client has done well for us, but the other part of the Hi-tech has not done that well for us. So that's really 2 parts of the equation that we are balancing out right now.
As far as the large deals, how they're helping us, really, like I said earlier, it's helping us offset some of the reductions that we're seeing in retail manufacturing side. These deals are helping us compensate and still deliver 2% plus type of growth that we just announced in this most recent quarter. That was the second part of the question. I missed -- what's the third part of the question? Can you just go -- I think I missed one part of the question.
In terms of after the U.S. elections, do you see some changes that would help us.
Look, it's very, very recent right now. But if you look at all the industry analyst forecast, they're all talking about U.S. inflation will still be high go forward as well. Very early to say whether it will happen or not, but pre-election results still yesterday, the messaging was that industry inflation will be high. So all consumer-facing industries, retail and manufacturing included, we don't think there'll be any uptick for at least 2, 3 quarters. But our diversification strategy to help grow in banking and health care is really what is offsetting that slowdown.
Okay. And on the margins part, obviously, we had the impact of wage hike, but there was also the impact of rebadging from the large deal that we won last quarter. So like if you can quantify the impact of what was the rebadging? And has the rebadging has been completed? Or is it still like a work in progress?
Rebadging is fully baked in into our current quarter, so all rebadging is fully behind us. It's fully baked into the quarter numbers now.
Okay. And the margin aspirations, obviously, what we have is of like low 20s, and we are currently at 18%, 18.5%, so the margin expansion like mostly will happen with these large deals coming? Or is there some like more headwinds that are still there in terms of margins? And also, if you can also explain the Quant seasonality because the Quant is having like better margins. And in terms of seasonality, quarter 3 is the strongest quarter for Quant. So how to see the margins and the growth along with -- like in the context of Quant?
Yes. So let's talk about the seasonality of Quant, and I'll come to the margins right after that. So the Quant is -- current quarter, the Q3 quarter is one of their stronger quarters, and the Q4 is the weakest quarter in the year. So it's a tale of 2 cities. So Q3 will be very strong for them and Q4 will be muted for them. So that's how we see the business, which is what we have shared with you earlier also and now we're reinforcing that point. So we're not worried about the current quarter, but we do expect Q4 will be soft, but they will come back on track in Q1 again, which is our April-June quarter. That's how the revenue cycles work.
And the reason that the way it works like this because they work largely in the banking space. And the new year contracts generally take effect from January, and they don't get signed until end of January and then the ramp-up for the new deals takes time. So really, the full quarter impact comes in April time frame. That's how the Quant business cycle works. I hope that answers the one part of the question.
Second part of the question, from about 18.5% or so of our EBITDA to getting to 20%, I think there are 2 levers at play, and we talked about it earlier also. So we expect close to about 0.5% to slightly more come back as we get over the large deal hump that we have invested in for the next 2 quarters. I think Jagan talked about it earlier that by end of Q4, we expect those large related investments to come out of the business and we'll be back on track, nearly about 60 to 70 bps coming back from the large deal impact. And the second, the wage hike we have done has a cumulative effect of about 1%, 1.1%, somewhere in that zone. And that takes us typically about 2 quarters to recover that. So by end of quarter 4, early part of quarter 1, we should be able to get to our aspiration number that we have always talked to you guys about.
Okay. So like just to understand, obviously, when we acquired Quant, it was a very high-margin business. And after we have seen very strong growth coming from Quant and most of the deals that we are winning is Quant-led. So like despite that, the margins have come off like significantly from, say, 22% to 18%. So is it fair to assume that the core margins, which was ex Quant has actually come down quite substantially?
So let me just qualify some of the statements you made. So while Quant has been a significant growth driver, the deals that we announced even today, they are -- not all of them are Quant. In fact, the vast majority of them are not Quant-related. So the retail deal, we just talked about, the Fabric deal we just talked about, the Hi-tech deal we talked about, they're all in the organic business, just to clarify that point first. Having said that, in the base business, the organic Sonata business, largely the wins are happening in the healthcare, life sciences and the hi-tech space. We are not seeing any big wins in the retail space after the large -- the mega deal we announced maybe 1.5 years back. So that's on that point.
On the margin side, if you go back, we had an EBITDA of about 22%. We diluted the EBITDA by about 2% to 3%, and we had shared with you guys because we want to invest in the newer capabilities. And what are these new capabilities? We want -- we invested in Fabric. We invested in AI. We invested in leadership in sales across the geographies. We invested in newer areas within Microsoft stack vis-a-vis power platform and within Dynamics also in the CE side. So we made some strategic bets to invest in these areas because the F&O space was working well for us, but we wanted to open up new doors from a growth investment perspective. So part of that 22% to dilution, 20% was a very planned dilution. The other 2% that we diluted was because of the large deal, which we expect fully to recover by Q4 and Q1 time frame.
[Operator Instructions] the next question comes from Suraj Malu from Catamaran.
Sir, I just want to clarify one thing, like since there's a seasonality from Quant side, so the ideal way to look at the business is Y-o-Y, right? Because if I -- for example, if I look at the revenue from top 10 clients, it has grown 29% Q-o-Q, but Y-o-Y it is 8%. So just want to confirm the right way to look at it.
Yes. No, I think your point is absolutely right, Suraj. The way to look at the business is Y-o-Y basis, not only Quant, even for Sonata also. But I think on the top 10 clients, Suraj, keep in mind that the top 10 clients that we had last year are not the same this year. We have had new additions in that mix. So we have added new customers in that mix and some of the older clients of Sonata are no longer in the top 10 because they have fallen off the run rate basis. If you recall some time back, I just shared with you that about 8 customers are more than $10 million in Sonata now on a run rate basis. So our mix of top 10 is changing. So the Y-o-Y is not a like-to-like comparison to what you are seeing Y-on-Y basis, not an apple-to-apple comparison because the base clients are different.
Got it. And one thing I just wanted to understand on the sharp increase in employee expense like because for the past 2 quarters, if you look like it has jumped like 10%, 11% Q-o-Q. So I just want to understand the split, like how much is due to wage hike and like what is the reason for such higher jump?
I have explained to you the wage hike has impacted about 1.1% at the EBITDA level for us this quarter.
Got it. And like if you can explain like why is that in the absolute terms, the increase in employee expense?
The absolute number, it's difficult to share details on this. This is confidential numbers now, Suraj. But what happened is it had a 1.1% EBITDA level for us. Normally, the total increase with lower -- with junior management, mid-management and senior management will be 1.6 to 1.75 percentage every year. This year, we have done only junior management now, hence it is 1.1 percentage of the EBITDA.
And the balance impact will be in the next quarter, as you had mentioned?
Yes. Balance impact will be in the next quarter. Exactly.
The next question comes from Chirag Kachhadiya from Ashika Institutional Equities.
Couple of questions. Hope I'm audible to you. So in second half, you mentioned you are expecting to be better than H1, so which vertical you think to drive better performance in comparison to H1? And second, what furlough impact you are expecting in third quarter?
Yes, I'll take the -- Chirag, I'll take the first part, Jagan will take the second part. On the vertical side, we are expecting -- continue to expect our healthcare business will grow. We are expecting the banking business to grow. So those are the 2 businesses from a vertical perspective, we think the growth will come from. In addition, from a geography perspective, we think the U.S. geography will grow probably faster than the other geographies as well. So that's the 2 ways to think about from a growth perspective. As far as the furloughs are concerned, Jagan will take it.
The furlough will have a very, very minimal impact for us. We do have an impact, but it's not going to be a very substantial impact for us because most of our customers, except for 1 or 2 customers in the banking space, it is not expected to have much bigger impact on the other customers for us.
And from a capability perspective, as you mentioned, we are investing and there will be some margin [indiscernible] quarter perspective. So in H2, the margin pressure will be on lower side or will be -- one should consider margin rate similar to what we have witnessed in H1?
I didn't get your question. Can you repeat the question?
What I'm asking is in H2, the margin band will remain in the same range like H1 or slightly better than H1?
Q3 will have an impact of salary increase also. We will have some impact on the Q3, but definitely operational improvements will also come in there. We will have an improvement in the second half as a whole compared to H1. But to reach back to the early 20 levels what we were mentioning, we may take -- it may happen only by Q1 of next year.
And at consol level, what basis point margin impact you're expecting due to wage hike in the third quarter?
This quarter, it was 1.1 percentage. Normally, the total impact in a year will be about 1.6 to 1.75 percentage on the total increase on a normal year when the increments are given. This balance impact will come in the Q3. We are yet to finalize the total number, but that -- around that number can happen for mid-managers and senior managers, yes.
The next question comes from Harsh Chaurasia from Vallum Capital.
Sir, I have 2, 3 questions. So basically, first is when I see your retail vertical, it has been degrowing for last couple of quarters. I know there is a business condition. But when you speak about your deal pipeline, sir, can you give us some idea about like what percentage of the deal pipeline is contributed by retail and manufacturing? So what I'm implying is, so when the overall business condition improves, our run rate in the Q-on-Q growth will be much faster than our peers? This is my first question.
And my second question is basically from a margin perspective, so just -- this is a clarification. So when I see on a Y-o-Y basis, your cloud and IMS revenue has been the major contributor in the international business. So are we doing a lot of pass-through revenue type of deals, which is impacting our margins? And third is basically, when you say the 22% to 20% margin dilution was planned. So can you give the breakup of 200 bps, which we have invested in the business? So like what has been the investment on the large deal size and on the geographical expansion side, from that perspective?
Sure. Multiple parts to the question. So on the retail large deals, they are pretty much in line with other verticals, Harsh. However, the difference in retail and other verticals is that we are seeing closures in other verticals. We're not seeing the closures come through in the retail vertical and manufacturing vertical. The clients are delaying the decisions, the cycles are longer. Our ability to close is limited, not because of our capabilities, that's just because of where the business cycles are with customers. They're putting -- they're delaying every quarter to next quarter, the discretionary spend side of the equation. So from a pipeline perspective, do we have the same pipeline as other verticals? The answer is yes from a large deal point of view. But are we seeing closure? The answer is no, okay?
That's the first part of the question. The second part of the question where we have grown in the cloud, I think it's largely on the data on cloud. These are not pass-through deals. These are all data-enabled deals through the cloud platform, which are hybrid deals, which has some component of cloud and some component of data inside it, but these are not pass-through deals by any measure. They are not the impact from a dilution perspective. The only dilution we have in the business from a gross margin perspective is because of the large deal we have already shared with you guys. That will continue for 2, 3 quarters and then get normalized again.
And the third point of your question about from 22% to 20%, that investment was baked in, if you recall, even 2 years back, we shared with you. It's largely in the capability side of the company because we are trying to create new capabilities of Gen AI, Fabric, newer sales team members in some of the geographies that we invested in, especially in Europe, especially in the banking and healthcare vertical, especially in the newer areas that we outlined to you as part of our strategy. So that's where the investments of 2% has gone in from 22% to 20%, which is our target end state we want to get to from a margin point of view.
The next question comes from Prolin B. Nandu from Edelweiss Public Alts.
A couple of questions. And let me start with where the previous question ended on this 200 bps investment that we had done 2 years back. Now if I see, we have already win -- won a midsize -- or not a large deal, but a decent sized deal in data fabric as well. And AI is something that we have been investing in. We have been winning deals in BFSI domain as well. So when do you think that this 200 bps of investment we will recover? I mean, would it be '26? Or when do you think this -- we can plow back some of the margins, some of the investment that we have made?
This is Jagan here, Prolin. So this investment will continue for 2 to 3 years, another at least 3 years' time. The reason is because we have to bring in a scale for continuing the growth that again come in for the business. Secondly, there is a big technology changes and the opportunities are infusing in front of us, unless we invest and bring the scale to this, we may not be able to capture the opportunity for growth that is in the market, that can emerge in the market in the coming future. So we have to continue to invest this 2% and take at least for 3 years, we may not be able to recover this.
Sure. Jagan, you mentioned on this technology change, right? So what we have typically seen is that whenever technology changes happen, it happened at DevOps at that time. Whenever the implementation happened or whenever the benefits of that technology change percolated down to IT services company, it became more of a commodity, right? Everybody started doing it.
And right now also, the same thing is happening. Everybody is talking about AI, right, in some sense and investments there and deal wins also happening. So do you think that this AI and we talk about Harmoni, we talk about our very esteemed partnership with Microsoft. Do you think that, that will give us an advantage? And going forward, when it comes to the Gen AI service part of the Gen AI thing, would it accrue to only a few players or all the service players will benefit? And there, how do we differentiate ourselves versus the rest of the pack?
So let me take that. I think, look, for every time there's a technology change that has happened in the market. There are 2, 3 companies, which gained disproportionately. If you go back 15 years back, you can see when the digital came, a few companies came from behind and took the marketplace. Of course, everybody got a part of it, but some companies benefited more from this than the others. And what we are trying to do in the modernization space is exactly that. We're trying to capitalize that investment. It -- large will depend upon how well we execute as a team and the company. From the excitement perspective and the opportunity perspective, it is, in fact, absolutely there, but we have to execute well.
We have made the investment. We are executing to our strategy. And some of these journeys are not very linear. So some quarters will be better than the others. Some years will be better than the others, some years will be worse than the others. We are building a long-term business, and we believe what our teams are doing is really the right thing to do from building a long-term viable business out. And as you know, Sonata has missed many waves of growth, and we really want to make sure that the AI wave that is in front of us, we capitalize on that as we move forward.
Sure. Just one last point. So just to conclude, right, I mean, our top quartile growth is something that we want to come back to in second half of FY '25 and the margin that we were, let's say, before the start of this year, 20-odd percent is something that we aspire to reach in Q1 FY '26. Is that a fair conclusion on growth and margin?
Let me just qualify a little bit. I think we will have a better second half than the first half. We will not end up in the top quartile just in the second half. It might be H1 of next fiscal year, but time will tell how we deliver to that. But that's how our current calibration. But second half will be better than first half for sure from a growth perspective. As far as the margin is concerned, we can say it, by end of Q4 or Q1 time frame, we do expect to be 20% EBITDA company.
As there are no further questions from the participants, I now hand the conference over to the management for closing comments.
Well, thank you, all of you, for joining us today and listening to the prepared comments from the management team and for your questions. We just thank you for your continuous support and cooperation with Team Sonata, and we take this opportunity to thank all the Sonatians globally for their untiring efforts to scale the company. Thank you all.
Thank you. On behalf of Sonata Software Limited, that concludes this conference. Thank you for joining us. You may now disconnect your lines.