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Sonata posted a mixed operating performance in 1Q. IITS revenue was flat qoq at $82mn (0.1% CC), in line with our estimates. However, IITS EBITDAM declined by a sharp 480bps qoq to 15.4%, significantly below our expectations, owing to absence of one-time compensation expense benefit in 4Q, unanticipated delay in large deal ramp-up affecting utilization, investments in AI talent transformation and advisory, and higher CSP bundled deal costs. It recorded order bookings worth $97mn (~18% AI-led) with book-to-bill of 1.18x, while 16 large deals were in the pipeline as of end-1Q. The company is strengthening its leadership team – it is hiring a Chief AI officer, senior client partner at the top TMT client, and leader for SEA and ANZ, along with internal hiring to lead alliances and partnership alliances (especially MSFT). Management expects sequential margin expansion through FY27 as one-offs normalize, with domestic gross contribution supporting stronger performance through the year. We cut FY27-29E EPS by ~3-8%, factoring in the 1Q show and the slower earnings recovery. Considering limited upside after a 14%/18% up-move in 1M/3M, along with continued growth challenges and margin pressure in IITS, we downgrade the stock to ADD from Buy while retaining our TP of Rs340 at 14x Jun-28E EPS.

Results summary

IITS revenue was flat qoq at $82mn (0.1% CC), meeting our estimate. IITS EBITDAM contracted by 480bps qoq to 15.4%. IITS revenue was led by BFSI (up 22.5% qoq in USD terms), while all other verticals declined—TMT (-6.0%), RMD (-3.5%), Healthcare (-0.5%), and Emerging (-0.5%). Across geographies, US, Europe, and RoW each saw 0.5% sequential decline. Overall EBITDAM declined by 300bps qoq to 5.2%, below our estimate of 7.3%. Net profit stood at Rs1.1bn, below our estimate of Rs1.3bn. IITS headcount was flat qoq at 5,795. Gross contribution was up 4.2% qoq at Rs785mn. Utilization was down by 330bps qoq to 88.5%, mainly due to unexpected delay in rampup of a large deal. Sonata declared interim dividend of Rs1.25/sh. What we like: Domestic gross contribution growth. What we do not like: Margin miss, Softness in TMT and RMD.

Earnings call KTAs

1) Despite mixed demand environment conditions, the strengthening AI pipeline, growing AI order bookings, expanding partner ecosystem, and sharper micro verticals focus grant Management confidence on the medium-term growth trajectory.

2) Sonata continues to execute its 3-pillar strategy in the domestic business: i) driving growth in the Microsoft SMC segment, ii) expanding AI-led partnerships with other ISVs, given multiple GTM motions for each, iii) securing large SI deals.

3) The company does not expect any further customer losses from OEM direct billing, with the headwind from the large OEM partner is now largely behind. Management expects the domestic business to maintain its growth momentum.

4) AI momentum continues to build, with AI-led deal pipeline of $340mn and AI order book of $21.7mn in 1Q.

5) Cloud accounts for 62% of the IITS business (vs 39% in 1QFY26); primarily driven by cloud migration and cloud-led legacy modernization.

6) Output-based contracts constitute 21% of engagements.

7) Around 21% of engagements are output-based.

8) Steady-state ETR is expected to be ~25%

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