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Sonata posted yet another quarter of weak operating performance in Q1. IITS revenue was below our estimate, declining 0.9% QoQ CC. IITS EBITDAM inched up by 10bps QoQ to 16.6%, albeit below expectations. Sonata secured three major deals in Q1, including the USD73mn TCV with a US-based TMT client. It reported total order bookings of USD105mn and book-to-bill ratio of 1.28x. Growth during Q1 was led by a large TMT deal ramp-up, continued strength in HLS, and demand for data and AI services. However, performance was impacted by softness in retail and manufacturing, budget pressures at a key BFSI client, and broader macroeconomic slowdown. Domestic business faced the impact of a slowdown in the IT/ITeS sector, and several OEMs planned the shift to a direct engagement model for large clients. The management refrained from providing specific growth outlook, citing challenges in RMD, a large BFSI client, and macro uncertainty. However, it remains hopeful of positive revenue growth in IITS in FY26. It expects to achieve near-20% EBITDAM in IITS by FY26-end, led by large deal ramp-ups, improved utilization, offshore shift, and pyramid rationalization. Factoring in the dismal Q1 performance, we cut FY26-28E EPS by 1-9%. We retain BUY with unchanged TP of Rs475 at 22x Jun-27E EPS.

Results summary IITS revenue grew 0.6% QoQ to USD81.8mn (down 0.9% CC), a tad below our estimate of USD82mn. Among verticals, TMT and HLS grew 15.0% and 17.4%, while RMD, BFSI, and Emerging declined 2.6%, 12.5%, and 32.9% QoQ, respectively. Among geographies, Europe declined 5.3% QoQ, while the US and RoW grew 0.6% and 11.8%. IITS EBITDAM was up by 10bps QoQ to 16.6%. Overall EBITDAM declined by 120bps QoQ to 5.4%, missing our estimate by 6.6%. IITS headcount grew 0.4% QoQ to 6,393. LTM attrition inched up QoQ to 16% (vs 14% in Q4). Gross contribution fell 12.6% QoQ in the domestic business, mainly due to seasonality, softness in IT and ITeS, and margin pressure from focus on new customer acquisition, as a large OEM plans to go direct. SSOF declared an interim dividend of Rs1.25/sh. What we like: Deal intake, TMT growth. What we do not like: Revenue/margin miss, client-specific issues in BFSI and Hi-tech.

Earnings call KTAs

1) The BFSI vertical faced growth challenges due to budget-related constraints and cost pressures from a large client. The management expects weakness to persist in a large client in Q2 as well, which could weigh on BFSI growth. It indicated that apart from this client-specific issue, BFSI is doing well. However, it refrained from providing any outlook on BFSI growth, considering the uncertainty over recovery in the large client. 2) The RMD vertical continues to face challenges due to tariff uncertainties and regulatory changes, with potential for further negative impact In the healthcare vertical, Sonata is able to disintermediate and dislodge incumbent vendors, especially on the pharmacy side, due to its capabilities in data and AI. 4) It has recently hired heads of its retail and manufacturing vertical as well as its BFSI vertical in the US, for strengthening its sales leadership. 5) Sonata has significantly increased its contribution in the BFSI and HLS verticals, both now comprising over 30% of revenue (up from 13% three years ago). 6) The management is focusing on i) consistently securing large deals and large accounts, ii) expanding in BFSI and HLS, and iii) deepening capabilities in data AI and modernization engineering. 7) Pipeline for AI was ~USD46mn in Q1. AI order book stood at USD8.2mn. Pipeline for Microsoft Fabric is USD39mn. 8) To negate the impact of a large OEM planning to go direct, the company is making progress across four strategic areas, which are: a) new partnerships and wins with AWS, Google, Oracle, etc; b) scaling security operations center for India-based clients; c) accelerating growth through the Microsoft SMC channel; and d) winning large integrated SITs that combine platform engineering and services. 9) Quant performance exceeded the original target, although it was lower than the revised target. It has signed a new agreement with incremental performance obligations for three years. 10) As of Q1FY26, cash stood at Rs6bn, down from Rs7bn in Q4, mainly due to Quant earnout payout and loan instalment repayments. Net cash was negative at Rs625mn. The company has taken an additional USD35mn loan in the quarter. 11) It plans to pay a quarterly interim dividend from this year. 12) Wage hike will be implemented in phases – junior/middle management from Aug-25, and senior management from Oct-25.

Update on AI/Gen AI

1) The company expects AI-enabled services to contribute 20% of revenue over the next three years. It is actively pursuing AI-led opportunities across >100 clients and is working toward AI opportunities across engineering, industry differentiation solutions, and internal operations. 2) Sonata launched AgentBridge, making it one of the first mid-tier firms with enterprise-grade agentic AI workflows. 3) In engineering, Sonata deploys its platform Harmoni.AI workbench to embed AI into client delivery, and uses IntellQA, an AI-powered automated test-case generation platform. 4) Around 95% of the workforce is trained in AI.

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