Capgemini SE

PAR:CAP

Earnings Call Transcript 2023-Q1

[Operator]

Good day and thank you for standing by. Welcome to the Capgemini H1 2023 Results Webcast and Conference Call. [Operator Instructions] Please be advised that today's conference is being recorded.

I would now like to hand the conference over to your speaker today, Aiman Ezzat, CEO. Sir, please go ahead.

[Aiman Ezzat, Chief Executive Officer]

Thank you. Good morning and thank you for joining us for this H1 results call. I'm joined today by Carole Ferrand, our CFO; and Olivier Sevillia, our COO.

So we delivered another solid performance in the first half. The revenue growth was 7.9% at constant currency to reach €11.4 billion. The economic environment remains soft as expected, and 2023 is shaping up along the gradual deceleration scenario we expected for the year. Q2 with constant currency revenue growth of 5.2% is globally in line with what we expected. Bookings close to €12 billion remain healthy, with an H1 book-to-bill of 1.05 reflecting a robust commercial momentum. The operating margin at 12.4% is improving by 20 bps. The shift in the product mix towards more innovative and value-creating offers more than offset the higher operating cost base. And net profit are up year-on-year, leading to a 15% increase in normalized EPS. And finally, as anticipated, organic free cash flow generation was negative at minus €53 million.

Now these results put us among the leaders in our industry. Our revenue are now 63% higher than in the first half of 2019, and our profit more than doubled. But more importantly, we are today recognized as the business and technology partner for our clients. And thanks to our strategic positioning, we can address the structural demand for digital and sustainable transformation and gain market share. Now this first half demonstrates the strength of the positioning and how this is driving our resilience in a market which, as expected, becomes more challenging. To fully appreciate the level of resilience, it's important to keep in mind that 2023 comes after 2 consecutive years with growth of 18% in the first half. The areas of relative strength and softness in the market are the 1 we discussed at the beginning of the year. And from that perspective, Q2 is an extension of Q1.

Manufacturing and public sector remain strong with a good traction and double-digit growth in H1. In manufacturing, we clearly benefit from our leadership position in an intelligent industry, for example, aerospace and defense or in Automotive. Conversely, on the Consumer Goods and Retail and TMT, we clearly see a slowdown. And as anticipated, the distribution in financial services is becoming more visible in Q2.

From a geographic perspective, Europe has shown clear resilience throughout H1. In Q2, momentum remained particularly robust in the United Kingdom and Germany, which were close or above 10% of growth. And the North American market is softer with revenue stable year-on-year in the second quarter. By business, strategy and transformation remains double digit, which illustrates the relevance of the market positioning we have and also the importance placed by our clients on the more strategic and value-creating projects.

Now H1 is another semester with solid performance for the group, supported by the strong structural demand for digital transformation. We have maintained our investment in our portfolio of offerings and in terms of skills as well to continue to meet our clients' need for ambitious transformation. This is notably the case in generative AI. To fully leverage the demand wave that will be generated by this breakthrough technology, we have announced today an investment of €2 billion over the next 3 years. We witnessed a strong acceleration of client appetite for generative AI. Recent report by our Research Institute finds that expectations are both high in terms of value creation, but also, of course, in terms of efficiency.

Capgemini is already a leading player in the artificial intelligence and data market. We have been driving over 20% growth for several years and have built a capability of more than 30,000 data and AI business and technology talent across the group. Generative AI is not new for us. We have been working with clients on generative AI for the last 3 years, and we have successfully delivered already many projects, notably in life sciences, in consumer products and retail or in financial services. For example, the group used transformer models to generate novel medicinal molecules for drug discovery and supported various financial institutions on cold conversions for application modernization. We are now ramping up significant investments in Generative AI, and as highlighted during our last earnings call, our GenAI lab is fully set up and working with our clients to explore the now but also future possibilities of GenAI combined with deep industry expertise. On the portfolio side, it's expanding very quickly. And this morning, we launched 4 new family of offerings. Our generative AI strategy offering enables CXO to define and prioritize the most relevant GenAI use cases for that business.

Our GenAI for customer experience enhances customer experience with 4 dedicated generative AI assistants. Our GenAI for software engineering offering helps improve efficiency and quality across the whole software life cycle and our custom Generative AI enterprise offering enables enterprise to have sensitive data to have custom generative AI assistance fine-tuned with the key proprietary data in order to get maximum business value impact. And of course, we are building on long-standing partnership to create solution for our clients. In June, we launched our new global GenAI Google Cloud Center of Excellence to develop a library of 500 enterprise-ready industry use cases. And a few days ago, we launched our Azure Intelligent App Factory with Microsoft to maximize AI investments by getting them into production faster.

Big investment, of course, is in our people and portfolio of skills, so we intend to double our data and AI teams to 60,000 within the next 3 years. Leveraging our global data and AI campus, the priority will be to train our data experts on GenAI, which is in progress, of course, and our software engineers on the GenAI development tools to ensure that we fully leverage the efficiency benefits that are coming from the technology. The training extends to all businesses where GenAI will drive benefits for our clients such in BPO or in cloud infrastructure services. But ultimately, we aim to embed AI training as a key requirement into all of our development and training curriculum.

Thanks to this significant investment, we are ready to support our clients to the Generative AI business journey. Now the pipeline is already quite strong. We have hundreds of projects, including over 150 in strategy and transformation, reflecting the strong appetite and confidence of our clients for our value proposition.

Now just to take some examples, we are currently delivering a generative AI content generation engine for production to assist marketing teams of a large consumer products group. Another example we are developing a GenAI engine for medical data understanding, search and automated insights for a leading pharma company. We're also working on search engines based on GenAI to increase productivity of customer relationship manager for a large retail bank with very tangible output.

Finally, we also announced this morning that we are working with [indiscernible] Airport to elevate the passenger experience by implementing cutting-edge e-commerce and other passenger service solutions through Generative AI for customer experience offer. Finally, we are working on a number of GenAI strategy consulting assignments, which we cannot dive into detail. So we confirm all our objectives for 2023. Revenue growth of 4% to 7% at constant currency, a 0 to 20 basis point operating margin improvement and an organic free cash flow of around €1.8 billion.

Let me give you a little bit more color after this first half. So in terms of growth as discussed in the beginning of the year, the range we gave you corresponds to a gradual slowdown through 2023 with at the top end a reacceleration in Q4 with the inflection point coming in Q4. And at the bottom end, a material degradation in the second half. We clearly don't see any of these extremes. The U.S. market being a little bit softer than we expected, we now target to be around the midpoint of the range. On the operating margin, following H1, we remain comfortable with our ability to deliver the 0 to 20 bps margin improvement. And finally, on the free cash flow, we continue to target around €1.8 billion, further illustrating our strong free cash flow conversion.

Now this combination of growth and margin expansion in a decelerating market demonstrate once again that our resilience profile has materially improved and put us amongst the top performers. And the underlying market demand in terms of digital transformation remains solid, and we are extremely well positioned, which give me full confidence on our medium-term targets, both in terms of growth and margin progression.

Thank you for your attention. I now leave the floor to Olivier Sevillia, our CEO

[Olivier Sevillia, Chief Operating Officer]

Thank you, Aiman, and good morning, everyone. So let's start with our revenues by sectors. Overall, as Aiman said, we start to see more contrasts among our sectors than during the last 2 years. As highlighted, the line of relative strength and resilience, as well as the sector is experiencing more pronounced slowdown remained unchanged and further developed in Q2. More specifically, asset manufacturing and public sector continued to deliver high growth in Q2. Not surprisingly, Tech Media and Telco recorded a slight contraction during the period, while Consumer Goods and Retail and Financial Services decelerated further. Let's keep in mind that overall we gained market share in H1 in a tighter market.

Looking at our bookings, bookings reached €12 billion in H1, which represents a 4% growth at constant currency. This is a strong achievement since we had a very demanding comparison basis with bookings up 22% in H1 last year. Our Q2 sales came with a solid 1.07 book-to-bill ratio, leading to 1.05 ratio for H1. This is again a robust performance above our historical average. This is -- what is very encouraging, frankly, is that our pipeline is up double digit year-on-year, and has reached an all-time high, which is unusual in a deceleration phase of the market. To give you a bit of color, there is a number of sizable transformation deals in intelligent industry in SAP S4 in data or cloud. We also see vendor consolidation deal opportunities in some industries. On the other side, there is some reduction in smaller discussion redeals, which is not surprising in a deceleration phase.

So while the decision cycles remain longer in some industries, we see a few of the large deals being dropped, which indicates a strong underlying demand for what we offer. Worth noting the rate of deals shifting to next quarters has also stabilized.

As you will now see, we have closed many exciting deals in Q2. Again, we classify our wins against a strategic framework, which proves the relevance of our framework. And I would like to share a couple of remarkable examples of our most recent sales. In the intelligent industry category, Capgemini was selected by a large U.S.-based defense manufacturer to modernize how we schedule, plan to acquire material and produce their incredibly complex products. This will help them to transform deeply the way they do business. For this, we have combined our capabilities in advanced engineering and manufacturing methods, data acquisition, intelligence, connectivity and IT infrastructure, a quite large example of our breadth of capabilities.

Another example in the data and AI space, BMW choose Capgemini to drive its autonomous driving development platform with our partners, AWS and Qualcom. The validation of autonomous driving algorithms requires data from tens of millions of kilometers traveled. Capgemini will build and operate data driven development platform using Big Data and HPC technologies. Such a cloud-based platform will perform the massive parallel processing and simulations needed to address every edge case in autonomous driving. We are pretty proud of that.

Thank you. I hand over now to Carole.

[Carole Ferrand, Chief Financial Officer]

Thank you, Olivier, and good morning, everyone. Let me start with the highlights of our H1 results. Group revenues reached €11,426 million in H1, a reported growth of 6.9% and 7.9% at constant rates. Operating margin stands at €1.413 million or 12.4% of revenues, up by 20 basis points year-on-year. After other operating income and expenses, financial and tax expenses, which I will further detail in a moment, the net profit for H1 amounts to €809 million up 21% year-on-year. Normalized EPS stands at €5.80, up 15% year-on-year.

Finally, organic free cash flow is slightly negative as anticipated by €53 million and in line with our road map for the full year.

Let's have a look now at our quarterly revenues. After 2 years of record growth, the more challenging macroeconomic environment led to a gradual slowdown in H1, in line with our expectations. Organic growth reached 4.7% in Q2, down as anticipated compared with Q1. This brings our H1 organic growth to 7.3%, which is a strong performance considering the [indiscernible] challenging comparison base of 17.2% organic growth in H1 last year. Taking into account the group's scope impact, the constant currency growth reached 5.2% in Q2 and 7.9% in the first half. FX turned into a visible headwind this quarter, leading to an overall negative impact of 1 point in H1.

Finally, our reported growth in Q2 and H1 reached 3.2% and 6.9%, respectively. As a reminder, M&A should have had between 0.5 points and 1 point to our revenue growth in 2023, and we expect FX to represent a headwind to close to 2.5 points for the full year.

Moving now to our H1 revenues by regions. The United Kingdom & Ireland region reported robust growth of 12% at constant exchange rates. This performance was mainly driven by public sector and manufacturing consumer goods and retail and financial services sectors. The Rest of Europe regions remained very dynamic with growth of 11.4%. This was mainly driven by manufacturing and public sector, while Financial Services, TMT and Energy & Utilities continue to perform well.

France reported revenue growth of 9.2%, driven primarily by strong growth in manufacturing, in addition to continued growth in financial services, consumer goods and retail and public sector. Revenues in North America reported a moderate growth of 3%. The manufacturing and services sectors were still dynamic. By contracts, the financial services sector reported limited growth, while TMT and consumer goods and retail sectors contracted slightly.

Finally, revenues in Asia Pacific and Latin America region increased by 4.8%. This growth was driven exclusively by Asia Pacific region's momentum, now essentially organic, which was fueled by the manufacturing, consumer goods and retail and financial services sectors.

Q2 revenue growth by region is basically a prolongation of trends already at play in Q1. We still benefited from a robust momentum in Europe overall as opposed to flat growth in North America and virtually the same in Asia Pacific and Latin America. Continuing now on our revenues by business lines. Strategy & Transformation Services posted growth in total revenue of 12.2% at constant exchange rates compared to H1 2022. This ongoing sustained momentum reflects the importance placed by group clients on most strategic and value-added projects. Application and Technology Services recorded solid growth in total revenues of 8.1%, while operations and engineering total revenue grew by 6.1%.

Moving now to the headcount evolution. Our total headcount stand at 349,500 employees at the end of H1, slightly down by 1% year-on-year. This is also a bit lower than at the end of 2022. As discussed at the beginning of the year, after a period of high growth and high attrition in '21 and '22, the priority was to regain efficiencies. The first benefits are already visible, notably in the utilization rate, which is trending up since Q2. The offshore leverage reached 58% at the end of June. Finally, attrition is further decelerating as planned. Last 12 months attrition is down to 20.9% at the end of H1.

Now moving to our operating margin by regions. The operating margin in U.K. and Ireland is remarkably stable at the high level of 18.4% in H1, flat year-on-year. In North America, our operating margin is slightly down by 30 basis points year-on-year, but still stands at a robust 15.2%. Operating margin in all other regions are improving visibly by 40 basis points in France to reach 11.1%, 70 basis points in the Rest of Europe region to reach 10.5% and 50 basis points in Latin America and Asia Pacific to 12% to 10.2%.

Moving on to the analysis of our operating margin, we are pleased to see that our price and mix strategy is more than offsetting the overall increase of our operating cost base. Gross margin is stable at 26.2% of sales despite the inflationary environment. The higher sales and marketing are more than offset by operating rate on G&A. Consequently, operating margin improved by 20 points in H1, in line with the 0 to 20 basis point improvement targeted for the full year.

Moving on to the next slide. Net financial expenses are substantially lower year-on-year with €22 million in H1 '23 compared to €71 million in H1 last year. Interest income on our cash is increasing with the rising interest rates, while our bond debt is entirely at fixed rates. Income tax expenses decreased from €327 million in H1 '22 to €330 million in H1 this year. Our effective tax rate is down to 27.8% compared with 29.9% in H1 '22 when adjusted for the tax expenses of €29 million related to the U.S. tax reforms.

Let's turn now to the recap of our P&L from operating margin to the net income. The other operating income and expenses are up €29 million year-on-year at €262 million. The increase in share-based compensation and restructuring costs was partially offset by lower integration costs for the period. Our operating profit is up 8% to €1.151 billion or 10.1% of revenues. After financial and tax expenses, our net profit amounts to €809 million, up 21% from the same period last year. Consequently, the basic EPS amounts to €4.70, up 20% year-on-year. The normalized EPS stands at €5.80. This represents a 15% year-on-year increase on the H1 2023 EPS adjusted for tax expenses related to the U.S. tax reform at €5.03.

Finally, a few words on the evolution of our organic free cash flow and net debt. As you know, our cash generation pattern is highly skewed to the second half of the year. This year, our organic free cash flow is slightly negative in H1 as anticipated. As previously discussed, the higher operating margin is more than offset by the higher cash tax rate and some pension one-offs. Additionally, the tighter liquidity environment is fueling pressure on working capital requirements. Leaving aside this one-off capital pressure, working capital pressure, our cash generation is up year-on-year by €150 million. There were no material M&A transactions completed in H1, and we returned €559 million to shareholders in H1, which corresponds to the 2022 dividend as we had no buyback activity during the period.

Consequently, the group net debt stands at €3.2 billion at the end of H1. This compares with €4.1 billion a year ago and €2.7 billion at the end. Considering our strong liquidity position, we redeemed at maturity on July 3, so after H1 closing, our €1 billion bond loan issued in 2015.

Aiman, back to you.

[Aiman Ezzat, Chief Executive Officer]

Thank you, Carole. And to allow a maximum number of people in the queue to ask questions, may I kindly ask you to restrict yourself to 1 question and a single follow-up. Operator, could you please share the instructions?

[Operator]

[Operator Instructions] And your first question comes from the line of Sven Merkt from Barclays.

[Sven Merkt, Barclays]

So last quarter, you said you expect to be at or above the midpoint of the guidance. Now it sounds like you're more expecting the midpoint of the guidance. So what has changed? And then my follow-up question is on the headcount, which has been down 2% sequentially in Q2. And really, the question here, what are the hiring plans now from here and the implications for growth for the second half?

[Aiman Ezzat, Chief Executive Officer]

Thank you for your question. Of course, a very good question regarding the guidance. Yes, we did say we expect to be at the midpoint or above and now we are on the midpoint. First, on the good news is that the resilience in Europe continues to be very good. And we see sectors like manufacturing and public sector still holding very well, and the positioning we have around intelligent industry is definitely fueling our growth in manufacturing. Now what has changed, I think, in our perspective is that the U.S. market is a little bit softer than what we expected. We see more clients in cost cutting in the U.S., and that basically has put a bit more pressure on the U.S. market. That for me is the main change. It doesn't change the underlying trend because the pipelines remain strong. So for us, it's just on the inflection point will happen because the reacceleration in the U.S. would be faster than anywhere else. But yes, a bit more softness in the U.S. market. That's kind of what has changed a little bit the outlook for the year.

And on the headcount growth, again, I always have this discussion with all of you around the headcount because you have to read which headcount as well is not just the overall number. I mean here, the biggest reduction that we have is in offshore. I mean we have a number of countries onshore where accounts are still growing. And what we have in offshore is not surprising. Although, for example, our billing headcount is increasing in offshore year-on-year. We have a decrease because this is where we had the highest attrition and the highest growth. And this is where we have the biggest potential for optimization. And the market being soft, we don't need to buffer and overload on headcount, so we continue to give us opportunities to continue to optimize headcount, even though we have continued to increase the billable headcount year-on-year.

So the outlook will resume headcount growth as we see basically more opportunities for growth. But right now, we are basically optimizing our headcount as we see it for the year, and we're optimizing our overall operating model to be able to go in a bigger uplift in terms of margin going into 2024.

[Operator]

We'll now take your next question. And your next question comes from the line of Frederic Boulan from Bank of America.

[Frederic Boulan, Bank of America]

Just a commentary around new pipeline. I mean, as you flagged it's unusually strong, still we've had sequential revenue decline now for 2 quarters. Can you share a little bit how you see the kind of sequential revenue panning out in the next couple of quarters? And give us a bit more detail on how you expect that recovery to take place. Because as you say, we have a bit of an unusual situation where despite the revenue contraction and the current bookings, pipeline is very heavy. So a bit more color on that would be very helpful.

[Aiman Ezzat, Chief Executive Officer]

Yes. So I don't comment sequential revenue because for a simple reason, we have seasonality. So it's very difficult. It's something I don't comment. What I can tell you, one, we expect growth in both Q3 and Q4, and we expect them to have more or less the same profile. So for me, we continue to grow this year, including in the second half, and we continue to grow in both quarters, which I think is important in terms of basically showing resilience even in the software environment, especially U.S. market, which is really softer than what we expected. So for me, the fact that the pipeline is strong, it showed that it's just to hold up around client decision. If I take a typical deceleration scenario, the pipeline shrinks bit by bit. And we have to rebuild pipeline as the market starts turning around and move back to an acceleration phase.

So for me, what is positive here is that the rebound could be quite strong as soon as we pass the inflection point. The only thing, and frankly, we have been open around that since the beginning of the year, the inflection point could come in Q4 or could come in the first half of next year. And that's -- for the moment, what we don't see happening for the moment this year. We still see a question from clients, which basically is delaying some of this large decision-making. So the scenario is pretty much what we expected, just a little bit softer in the U.S. than what we have shown.

[Frederic Boulan, Bank of America]

And if I can ask a quick follow-up on the previous question on hiring. So the kind of move to offshoring is reversing a little bit understandably because attrition is higher there, so it's easier. But once we move back to a growth phase, should we expect your kind of strategy to push offshoring to resume? And also, is it a question for OpEx because ultimately, that has helped margin expansion, right? So does it put some pressure on OpEx?

[Aiman Ezzat, Chief Executive Officer]

Yes, so 2 things. One, the move also have not decreased because the billable headcount in offshore is increasing year-on-year. So what is decreasing is the buffer we have, right? Again, in the crazy last 2 years where there was so much attrition, we were buffering resources on projects, on accounts. I had to put additional people because I could not train people on the fly as soon as somebody would resign. So when you have high attrition, you have high attrition on accounts, and you need to add additional resources that are pretrained to be able to fill the job as people live. This we can take out because now attrition has normalized, and it's at a low level. It's half of what it was at peak. So for me, I don't need to have this buffer on account. I don't need to have this buffer in pre training, etcetera. So the only thing I'm optimizing my resources in a market environment that's a bit softer, and I don't need to carry this buffer because that's just additional cost and additional pressure on the P&L.

I think we start in a soft market, we can reaccelerate very quickly in terms of growth. And we have kept our young graduates pool. So we are training them. And these are the people who basically will support our growth as the market starts turning. So we feel quite comfortable in terms of being able not only to address the growth trajectory when the inflection points happen, but to be able to scale the resources without basically blowing up our operating cost. I mean one of the good things is that we have anticipated the slowdown, and this is when we started basically slowing down our recruitment since Q3 last year, and that's what's enabling us to be able to be quite resilient.

[Operator]

We'll now go to your next question. And your next question comes from the line of Charles Brennan from Jefferies.

[Charles Brennan, Jefferies]

Can I just ask a couple of questions around AI? Firstly, you gave us a number of examples in the prepared remarks, but can you put some sizing around some of these contract opportunities? Are they just pilot exploration phase opportunities at the moment, or are they more substantial in size? And then secondly, when we think about the investment that you've highlighted, how do we think about that in the context of your margin aspirations going forward? Are there any implications there for your medium-term outlook? And do you think now is the right environment to continue to target margin improvements?

[Aiman Ezzat, Chief Executive Officer]

Both good questions, Charles. So on the first one, it's interesting how some of these are moving faster into production and to scale up. Compared to digital phase, what I see with some of these is that after 6 weeks or 8 weeks, we can move to larger projects. It doesn't mean that it's going to be 100 million projects. That's not what we're talking about. But we move very quickly from [indiscernible] if you want, or tests, to production. I talk about that case around how we're helping a retail bank around all their relationship management, basically to be able to increase the productivity of the relationship manager. Frankly, we started it lasted a few weeks. After a few weeks of [indiscernible] the clients now want to move that quickly to scale with quite a bit of productivity. So what we see compared to digital fit is these things moving into larger programs very quickly because we can scale up quickly and the box tend to be shorter in terms of time. Same thing. We have been working with an insurance company in the U.S. around the software development life cycle. We have been working on different areas and different examples. And now we're going to generalize that very quickly. to the whole insurance company basically environment. So what we see is now, it remains not huge projects for the moment, but we clearly see that the movement from box to production and to larger say larger programs is much faster than we have seen with digital.

On the investment side, investment for us is a lot of around people. It's skills, it's offerings, it's training. That's what we're investing in, in relationships, in solution centers, in centers of excellence. And this investment is productive because the high demand we see in Generative AI, especially the impact it has in clients is seen as being quite high value. And this should be able to drive a pretty good margin. We continue to be comfortable with that, that we will reach our 14% by 2025. So we still feel comfortable around that.

[Operator]

We will now take our next question. the next question comes from the line of Michael Briest, UBS.

[Michael Briest, UBS]

Just a follow-up on margins, more short term, you're obviously delivering the top end of the range at the moment. Given the sort of revenue outlook perhaps deteriorated a bit, are you going to sort of be looking to optimize margins this year? And get do you think you're more likely to get to the high end of the range? And the follow-up would be around the pricing environment. You're not alone in seeing this deceleration and demand weakening, and you talk about some bit of transformation deals or consolidation deals. Is there any deterioration in the pricing environment, or are things quite steady compared to where they were at the start of the year?

[Aiman Ezzat, Chief Executive Officer]

Carole, on that [ph].

[Carole Ferrand, Chief Financial Officer]

On the first one, so on the margin side, -- so as you've seen, Michael, we have a very, very strong H1 achievement. So despite the strong pressure on inflation and despite also the embarked one-off impact of 22 lateral premium costs, we have -- we are achieving a 20 basis point improvement. Aiman mentioned, we continue to invest. So the price and the mix of revenues is continuing to play its role, and it will continue in H2. And we are in the same process of with attrition coming back to nominal range. It's what we said at the end of Q1, we are now capable to focus on efficiency gains, with a smooth, much more easier environment to manage on the field. So globally speaking we are confident in the full year guidance we provide. So I'm not guiding on H2, but we are fully confident on our margin full year guidance.

[Aiman Ezzat, Chief Executive Officer]

Okay. Olivier, on the pricing environment.

[Olivier Sevillia, Chief Operating Officer]

Frankly, overall pricing is holding well in RI value creation categories, which is a large fraction of what we offer in the market. Of course, there are some pockets of vendor consolidation where pricing is a bit more challenged, but we have all the levers to improve productivity on what we sell later on in delivery. So I'm not that worried about this.

[Michael Briest, UBS]

Okay. But the guidance obviously implies if you do the low end, that margins will fall in the second half. Is that something you think is likely?

[Aiman Ezzat, Chief Executive Officer]

Yes. I mean, again, it's just we are comfortable with the margin guidance, but it's 20 bps. So it's not like we have 1 point of margin guidance 20 bps, Michael. So it's pretty tight. But no, we are comfortable with the margin.

[Operator]

We'll now go to our next question. And your next question comes from the line of Laurent Daure from Kepler.

[Laurent Daure, Kepler Cheuvreux]

Yes. My main question is on your comments on the second half. Basically, you're alluding to roughly 2 points further deceleration. I was wondering based on your comments, if you expect the acceleration to be broad or more concentrated with a really weak U.S. over H2. And my follow-up is on the 2 small areas where you had some weakness in Q2, which were LatAm and operation and engineering. If you could give us a bit more details. I know it's small, especially for LatAm, but you did a great job in past years. So what is happening there?

[Aiman Ezzat, Chief Executive Officer]

Okay. So the first question on the deceleration from a geo perspective. There's a deceleration overall. I mean we cannot. But we see more resilience in Europe and definitely more softness in the U.S. I think the cost-cutting exercise by some companies definitely driving a somewhat softer market in the U.S., but the rebound will be as strong from my perspective. On Europe, the resilience is pretty good, but overall, it's a softening in the market. The perspective, the economic perspective being a bit softer, we see definite decline becoming a little bit more cautious. And as you know, this is not really at all Capgemini-specific.

From a color perspective on the -- I mean in LatAm, it's a bit softer. I mean, we have 1 of our 2 regions in LatAm. We have a South LatAm and North LatAm. North LatAm is a little bit softer, linked more to 1 client environment. But we do expect that to start improving again by the end of the year and moving into next year. In the operation and engineering, I mean, you have to remember that we focus in areas like cloud infrastructure service or other on transformational deals. So as there is some delay in this transformational deals, putting a little bit pressure on growth in this area because some of these transformational deal decisions are a bit delayed, they tend to be larger deals. That's what's holding up a bit the growth in there.

The engineering side, you know that. You have definitely very strong growth in areas like aerospace, automotive, life sciences and yes, there is softness in tech and to a certain extent, in telco, right, and which for us would weigh a bit more on the U.S.

[Operator]

We will now go to our next question. And your question comes from Adam Wood from Morgan Stanley.

[Adam Wood, Morgan Stanley]

If I could maybe start with a follow-up to Charlie's question around the investments in AI and the margin targets, €2 billion is a fair amount to be investing. Could you just square the circle for us and still being able to hit the 14% in '25 slide on investment? Is it over a longer period of time? Are you taking money from other projects? Or are you assuming that AI deployments in your business can drive efficiencies that will offset the money that you're investing. Just give us a bit more detail on that, that would be helpful.

[Aiman Ezzat, Chief Executive Officer]

So Adam, I mean part of investment is basically adding people. So if you're going to double our headcount in data and AI from 30,000 to 60,000 that is part of the investment. This is -- we're hiring people. We're increasing our costs, but this is productive investment. So for me, it's investment is going to generate more revenue and generate more profit. It is not [indiscernible] that we're going to recover over a very long period of time. So a lot of it -- some of it is very productive investment that generates revenue and profit in the very short term. It's not something that will have a payback over many, many years.

[Adam Wood, Morgan Stanley]

And maybe just could you talk about the competitive landscape when you're bidding for these projects? Is it the moment that the deals are quite small, so where you're working with strategic partners is actually not very competitive. And where I'm coming up from this is I think you flagged before that the big differentiation on margins for you is where you've done a number of projects and you start to productize and industrialize the offers and ahead of competitors. So just interested to see where you think your offers are and how you're scaling up versus the main peers?

[Aiman Ezzat, Chief Executive Officer]

Well, I mean, it's always when you scale up, of course, on the larger program, this is basically when you have the lift and the strong exploration lever from a revenue and potentially margin. But at the front end, these are quite profitable because it's fair in terms of more resources. As you know, they're not very large, and clients are really in a hurry. I mean the demand is extremely high in the market in terms of clients wanting to be able to quickly be able to get the benefits out of GenAI. So this allows to have pretty good pricing. We're not sacrificing margin or pricing on this like that because the demand today, from my perspective, are basically the available capacity. So for me, it's pretty good business with good margins, small at this stage. But as we scale up, I think it will be quite good from the group, including from a productivity. And remember, it's becoming a high investment area for the client. Because it's high returns for the clients as well. I mean when we see the value it has around customer service in terms of speed to market, if you help a pharma company accelerate, it's drug development cycle, etcetera.

The benefits for companies are so huge. And basically, they are ready to put the money on the table to be able to get quickly to the benefits. And I think this is what's a little bit different in this technology wave. And this is why we are very, very positive around this, and the fact that we are ready to invest a lot. Because we see really the demand and especially the very quick payback that clients can see in a number of these areas.

[Operator]

We will now go to our next question. And your next question comes from the line of Mohammed Moawalla from Goldman Sachs.

[Mohammed Moawalla, Goldman Sachs]

Firstly, just in terms of understanding the regional dynamics, clearly, U.S. has softened, as you said, more than you expected. Is there kind of flattish still kind of -- do you think it could deteriorate further? I know you said in the past, Aiman, for the group you still expect kind of positive growth kind of in the cycle at the low point. So I'm just trying to understand that there's a worst behind us in the U.S. or could we kind of be at these levels for a bit longer? And in that context, what gives you the kind of confidence that the resilience in Europe can continue? I know there may be mathematically still some deceleration. So just trying to understand those dynamics. And then the follow-up is really around the kind of headcount growth. So to the earlier questions on AI. If you're sort of talking about more kind of front-loading some of this hiring, how should we think of the kind of linearity of the margin over the next couple of years?

[Aiman Ezzat, Chief Executive Officer]

Okay. On the dynamics in the U.S., I mean, the U.S. market will soften further in H2, so not committing at all the fact that it's going to remain flat. And we see it will continue to grow on the -- when the cycle slowed down at the group level, commit that every single geography in in our country, every single business will continue to grow. So I think we see it in the growth mode in it too, which is quite positive, both in Q3 and Q4. But the U.S. will continue to soften a little bit before it rebounds. So what we look at it really from a global diversification. We have our business -- take a business like Japan is still growing way above 20%, which is great. So we have this global diversification from a geography perspective, from a business perspective, from an industry perspective that giving us that resilience. Again, remember my comment, even in the U.S., even in engineering and U.S., our manufacturing business is still growing at 13%, 14%. And -- so it shows that there's a question around market. There's a question around industries. There's a question around business line, and this is why the diversification we have from the portfolio across many aspects, that's what building more and more resilience in terms of our business.

On the hiring and the margin, I do -- I mean, again, right now, we are targeting to improve margin, both in 2024 -- in 2024. So right now, we're not talking about back ending the margin to get to 14% in 2025. We manage our economics pretty well, we're managing our ramp-up and investments pretty well. And as I say, we're doing investment because it is productive and will have generate more revenue and profit versus investing and hoping for the best in coming years. So we're still on a trajectory that will continue to improve margin, both in '24 and '25.

[Operator]

We'll now go to our next question. And the question comes from the line Toby Ogg from JPMorgan.

[Toby Ogg, JPMorgan]

A couple from my side. Just coming back on the U.S. market. you mentioned there that you expect the U.S. market to continue to soften in the second half. So I guess question here is what gives you the confidence that you built in enough softening that sufficiently accounts for any potential further weakening on the cost cutting dynamics in the U.S. And then secondly, just for Olivier. Actually, just on your comment earlier that the rate of deals shifting has stabilized. Could you just give us a little bit more detail on that point specifically. Is that -- is that across the whole group? Is that in a specific area? What's driving that stabilization? And when did you start to see that?

[Aiman Ezzat, Chief Executive Officer]

Listen, on the softness, I remember, I mean, we -- the shift we have is not very large. It's just a little bit more softness than yes. We knew the U.S. market will be softer this year, and we anticipated it. We expected more resilience in Europe, so the scenario is pretty much playing like we expected. It's a bit more softer because some of these -- some of the aspects and some of our mix in the U.S. is also not favorable. For example, in terms of in terms of telco and tech, in terms of financial services, of course, exposure to U.S. financial services market. I mean that's what's driving a bit more softness as well in the U.S. because some of the verticals, which are big for us in U.S. are also softer. So it's a combination of the two. I think we have pretty good visibility on the business for the second half, and we are pretty confident in terms of what we gave you in terms of guidance. And from a cost perspective, we are pretty flexible and agile, and we have anticipated already, as you have seen in H1, the softness. And we have already anticipated basically the adjustment that we need to do to ensure that we deliver the right margin in the second half.

Olivier, on the deals.

[Olivier Sevillia, Chief Operating Officer]

Before answering specifically on the U.S. or geographical nuances that I may see, if I step back a bit, indeed, the pipe, as I told before, has grown double digits year-over-year. And it's atypical for a deceleration phase. The have been 3 decades in this industry with Capgemini, btw. We have seen many deceleration and acceleration phases. And what is really striking this time is that okay softness in discretionary spend is well like in previous deceleration phases. What is not there is that clients are not dropping deals. They are just shifting deals quarter after quarter for some clients. And it's more and more pronounced in the U.S. than it is in Europe, which makes me think that clients are in a wait and see mode in some particular industries, but they are not on the bench, we are on the starting block waiting. So to some extent, when the tipping point will happen, maybe Q4 is a bit too early, I think the demand will resume very strong because the fundamentals are there. So it's all about how do we handle the next 2 quarters. So the pipe in the U.S. has grown as well compared to last year. The shift is not materially more than in Europe on clients, I believe, are on the starting block waiting.

[Aiman Ezzat, Chief Executive Officer]

Okay. Thank you all. This was the last question. So we look forward to seeing you and interacting with you over the coming -- do we have a question or was this the last? This was the last, okay. Thank you, all. Looking forward to interacting with you over the coming days and weeks. Have a great day. Bye-bye.

[Carole Ferrand, Chief Financial Officer]

Bye-bye.

[Operator]

Thank you. This concludes today's conference call. Thank you for participating. You may now disconnect.