HCLTECH — earnings call

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Prepared remarks

& MANAGING DIRECTOR · MR. PRATEEK AGGARWAL – CHIEF FINANCIAL

MR. PRATEEK AGGARWAL – CHIEF FINANCIAL

OFFICER · MR. SHRIKANTH SHETTY – CHIEF GROWTH OFFICER,

MR. APPARAO V V – CHIEF HUMAN RESOURCES

MR. SHRIKANTH SHETTY – CHIEF GROWTH OFFICER, AMERICAS, LIFE SCIENCES AND HEALTHCARE INDUSTRIES MR. ANAND BIRJE – PRESIDENT, DIGITAL BUSINESS SERVICES MR. ANKIT NAVIN JINDAL – HCL TECHNOLOGIES LIMITED MR. ASHISH K GUPTA – HCL TECHNOLOGIES LIMITED MR. JAGDESHWAR GATTU – PRESIDENT, DIGITAL FOUNDATION SERVICES MR. RAHUL SINGH – PRESIDENT, FINANCIAL SERVICES AND DIGITAL PROCESS OPERATIONS MS. ROSHNI NADAR MALHOTRA – HCL TECHNOLOGIES LIMITED MR. VIJAY ANAND GUNTUR – PRESIDENT, ENGINEERING AND R&D SERVICES MR. SANJAY MENDIRATTA – HEAD, INVESTOR RELATIONS, HCL TECHNOLOGIES LIMITED HCL Technologies Limited April 21, 2022

Moderator · Conference Operator

Ladies and gentlemen, Good day and welcome to the HCL Technologies Q4 and Annual FY'22

Questions and answers

Moderator · Conference Operator

Ladies and gentlemen, we will now begin the question-and-answer session.

First question is in the line of Sandeep Shah from Equirus Securities.

Please go ahead.

Sandeep Shah

Firstly, thanks for good payout starting with this year and hope this continues going forward.

So congratulations.

Just the first question in terms of guidance, which is roughly 12% to 14% in constant currency.

If I'm not wrong, we may be building a higher growth in the services business versus products and platform.

So if you can throw some light in terms of what are we making in terms of different segments?

C. Vijayakumar

So we've given you a guidance for the whole business and we will stop at that.

We are not going to break up services, products, and things like that.

Sandeep Shah

But is it fair to say the growth outlook for products and platform maybe marginally going up or you still believe we do not have too much of visibility entering FY'23 for that segment?

C. Vijayakumar

As an overall business, we've given you a very clear guidance.

It factors in the ups and downs in different parts of the world, different verticals, different segments.

So, it's a model based on a number of factors and the pipeline win, the book that we have, all of that.

So I cannot add anything more.

HCL Technologies Limited April 21, 2022

Sandeep Shah

Prateek, in terms of the margins, what I'm saying is, last year FY'22, you had 100 bps worth of discretionary spend.

Is it fair to assume that may not continue this year plus, generally, we are not making incremental inorganic investment on products and platform, so saving in amortization cost may also continue.

So from an exit rate of 18% EBIT margin, is it fair to assume achieving a midpoint of the guidance is not out of reach?

Prateek Aggarwal

I'll kind of repeat what CVK already said.

We have given you a range and a range means a range, I'm not going to be more specific within the range.

I will add this though that the investments we talked about last year, do continue and there would be probably some incremental spend on that, because we are talking about at least 12 countries- five focus countries and seven new frontiers.

So while a lot of what we wanted to do has been done, as that engine matures and starts driving forward, there will be a little bit more.

But that is all factored into the guidance that we've given.

The discretionary spend you talked about is not going away, it continues.

But hopefully, in a few quarters time, it will start delivering the fruit of the investments and start delivering some return on that investment.

I leave it there.

Moderator · Conference Operator

Our next question is from the line of Kumar Rakesh from BNP Paribas.

Please go ahead.

Kumar Rakesh

My first question was in the prepared remarks CVK you talked about that the product and platform segment needs proactive investments.

Can you please elaborate what kind of investments we are looking at, it's quantum and by when we are expecting the results of those investments coming around?

C. Vijayakumar

First of all, whatever investment that we plan to make, that is already part of our margin guidance.

The second aspect, I will give you a little more flavor.

We have a number of products, there are a few products which we have identified as products where we should invest to create the right acceleration and there are market opportunities.

So selectively there will be a few areas.

And as we have a large portfolio of products and we invest close to $200 million+ in R&D, we have the flexibility to dial down the investment on some and dial up the investment on others.

That's the broad background to that comment.

Kumar Rakesh

This segment over the last couple of years barring FY'22 had seen very strong growth.

In the recent quarters, you talked about that this segment is volatile.

What essentially is driving that volatility and how do you see you're addressing that from leadership perspective?

C. Vijayakumar

The software product business is about $1.4 billion in size.

The revenue comprises of three components.

One, which is the largest components is the subscription and support revenue we get for the products.

About 67% of the revenue comes from subscription and support services and about 5% comes from professional services around products, and the remaining comes from product license sales.

So our endeavor has been to convert the product license sale which comes in as a lumpy revenue whenever we sell products into a subscription-based service model, and some of the products are also now available as cloud native solutions where customers can deploy these products on the three hyper scaler partnerships that we have.

So some of these strategies will play out over a period of time.

Our business strategy is to convert more product HCL Technologies Limited April 21, 2022 licenses into more subscription-based revenue models.

And this is a transformation most software companies go through when they move from an on-premise to a SaaS model.

And we are in the very, very early stages of the journey.

And it's a multi-year journey, which will really reduce the volatility in the business and make it more predictable, and it's more subscription- based service model.

Kumar Rakesh

You said that we are in the early part of this journey.

So is it fair to say a large part of our revenue in this segment is still coming from the product licensing segment?

C. Vijayakumar

As I talked about, less than 30% comes from product licenses.

67% or two-thirds comes from subscription and support services and 3% to 5% from professional services.

Moderator · Conference Operator

Next question is from the line of Ankur Rudra from JP Morgan.

Please go ahead.

Ankur Rudra

Thank you, CVK for the elaborated guidance and also improved payout.

Just one quick clarification, was the payout this year one-off, Should investors look any change in your sustainable payout ratios going forward?

C. Vijayakumar

It's in line with our guidance of minimum of 75% of our net income.

We haven't done any acquisitions, we don't intend to do any.

So the obvious option was to pay out.

As a strategy, capital allocation is a lot more tuned to payout at this point in time.

And there is not too much of a CAPEX plan or there isn't any acquisition plan of any reasonable size.

So we wanted to make sure we payout as much as we can.

Ankur Rudra

Secondly, if I just look at the overall business especially in the last two years, clearly looks like the case of between products and services.

Services seems to be an all-time high and grew on last decade or so.

But on products, it's clearly been quite volatile.

So given it's been three years since the IBM deal, seems like almost half the period has been surprisingly volatile and the business does not display tangible signs of either sustainable growth or margins.

How are you thinking about this now – do you think it's still calling a startup, or are you thinking about rationalizing this going forward?

C. Vijayakumar

I think it's like any software startup when it has its ups and downs and the fundamental hypothesis of our strategy is to really have market permission to play in the software product space, which is completely established.

And the second hypothesis is we are going to get access to a very large client base in especially large clients in different geographies where we don't have presence.

Here, in the first three years, we had really not focused on the expansion into the client base.

In the last six months, we've definitely turned our attention to what we can do more to the same clients.

And we're already seeing good relationships and good delivery of some of the product roadmaps for our clients.

We've seen a few RFPs, which we would have never got, because we've been working with these clients, trying to get into their large spend bucket.

But we're already seeing us being invited.

We've had some wins.

But at this point, I see a good pipeline building from the large clients.

So, I think this is also going to play out, but that revenue impact will show up in services.

And product business itself, we should treat it like a product HCL Technologies Limited April 21, 2022 startup and it will have its ups and downs.

The good part of it is two-thirds of the revenue is stable and growing.

Less than 30% of this which could be a hugely fluctuating, depending on the quarterly bookings and things like that.

As we move forward, we will make this more predictable as we move a lot of on-premises software into a subscription-based model or a SaaS- based model.

That journey is in the beginning, like most software companies, this will be a multi- year journey.

And we will also start publishing what our subscription revenue is in the coming year, starting from Q1. So your real metric should be how is our subscription revenue growing.

I think that's really the baseline for this business.

Ankur Rudra

My broader question also was sounds like it's a very different business than what we thought it was.

Given what you've seen over the last three years, should it be within a services organization?

C. Vijayakumar

Yes, so basically, it's a separate organization that we've set up, we call it as products and platform, we have separate sales channels, the marketing is separated, we have all the corporate functions catering to this in a dedicated way.

So, it's really a software startup within a larger services business, which has got enough flexibility and agility that is needed for a software product business.

So, at this time we don't see it like something which should be completely a separate entity.

I think the current operating model is serving its purpose.

We have great collaboration between services and the software, product team, and synergy benefits are at the tip of the iceberg.

That's what I would say.

Moderator · Conference Operator

Thank you.

The next question is from the line of Nitin Padmanabhan from Investec.

Please go ahead.

Nitin Padmanabhan

I had two questions.

So, one was on the Products business, historically, you have mentioned that 75% of the business is sort of going low-double digit, 25% is sort of declining high-double digit.

So, when you sort of overlay that with what you have explained today, how would you visualize this business on a going forward basis, in terms of the pain points that you're trying to tackle?

So, just to summarize, do you think that the declining businesses should sort of fizzle away in two years and the growth business really should take over maybe in a year or two?

So, that's one.

The second is by when do you think the leadership will be in place considering it is a completely different org and the last and final on the services side was typically Q1 has been weaker due to productivity benefits, and so on, so forth.

Do you think that trend still continues or there is some change at this point as you see it?

C. Vijayakumar

So, I think the product mix assumptions that we had, and the way we expect it to play out remains the same Nitin.

Obviously, there is again, in both the segments, there is a subscription and services revenue, and product license revenue.

So, depending on the new product sales, things can fluctuate quite a bit, but as time passes, this should get evened out, as we are really transforming this business model turn from an on-prem, one-time software sale to more of a subscription based and SaaS based solution, that is the response.

On the organization structure, we have already implemented a new organization structure, 2-in-a-Box structure, with two HCL senior leaders.

One, Rajiv Shesh who's taken over as the Chief Revenue Officer, starting this HCL Technologies Limited April 21, 2022 quarter, and Kalyan Kumar, who has been our CTO has taken over as the Chief Product Officer of this business.

So, this is the long-term structure, which we think is going to give the rhythm and the scale of running a large software portfolio, as well as it has the leadership to innovate and to really transform this business from an on-premise to the newer models.

So, that structure is already in place and coming to your services, the question on the quarterly trend?

Yes, usually there is a certain seasonality in Q1. I think I would expect it to be similar in nature.

Moderator · Conference Operator

Thank you.

We have our next question from the line of Ravi Menon from Macquarie.

Please go ahead.

Ravi Menon

Thank you, gentlemen congratulations on really strong performances on the services side, I have one suggestion, that is, if you could disclose the geography and vertical segments just for services, and maybe separately for products that will help us see the actual impact because when in a quarter like this, where there was revenue decline, it's difficult to make out how this was performed at an individual geography or vertical?

You talked about the products being a startup, and just want your sense on, if you were to think about it, all established HCL as you got a license to play.

Now, should we think about three to five years of right to win and are we thinking about our own products?

Could you talk a little bit about what sort of organic investments are we doing here?

C. Vijayakumar

Yeah, so Ravi, first one good suggestion, we will look at it and come back.

Obviously, in a quarter like this, you are not able to figure out which vertical is firing on the services side and which is not.

But I think the year-on-year trend should give you a reasonable visibility.

In terms of the long term, yes, it is.

It is like a startup now.

Definitely, we are also bringing together all the software product businesses, which were operating like separate business groups, while HCL Software was the biggest division, we had Actian, we have DRYiCE, we have Industry Software Group.

So, in the new structure, all the four business divisions come together under one cohesive 2-in-a-Box structure with the Chief Revenue Officer and Chief Product Officer.

We have altogether 60 Plus products in this portfolio.

There are 20 products, which we believe have a very strong market momentum, and mindshare, where we will continue to invest and grow that and that will really become the bedrock of our growth moving forward.

So, I think that's why I call it as a startup because these 20 products, they have like in AI, machine learning, analytics, like Cloud Data Warehouse, we have Avalanche, which is again a terrific product.

We have modernized the commerce product, we have modernized Unica, some of the world's largest companies, fortune 10, three of them use Unica as a marketing automation platform.

So, some of this will also migrate to cloud transformed.

So, I think it's a transformation journey.

For traditional products, we have a very, very defined strategy on how to sustain that we call it as Horizon-1.

So, we have a strategy to sustain those products and Horizon-2 is where we see good growth and Horizon-3 are really disruptive ideas, which will get infused into some of the products that we already have.

That's how we see it.

It's a long term journey and when we've taken a very strategic decision to invest in this, and we have taken some big bets, so we will walk the course.

We feel pretty confident of the strategy and the outcomes to mid-to-long term.

HCL Technologies Limited April 21, 2022

Moderator · Conference Operator

Thank you.

The next question is on the line of Gaurav Rateria from Morgan Stanley, please go ahead.

Gaurav Rateria

Two questions.

First, for CVK.

On Europe, you're seeing macro to be more volatile than last year.

But whereas when we look at your deal flow, a lot of the large deal wins have been announced actually in Europe.

So, what are you seeing on the ground in terms of deal pipeline, decision making cycle and conversion trends.

Second question is for Prateek in terms of 18% to 20%. ban, what would be the impact of salary hike?

Will it be similar to last year and what will be some of the offsets?

Will pricing be acting as a tailwind this year?

Thank you.

C. Vijayakumar

Yeah, on the deal flows, it seems like it's in proportion to our overall business.

Of course, 60% is from North America, or 28%-odd from Europe.

I think it's pretty much in proportion.

Even my forecast for growth is also fairly secular.

Now, maybe it's just coincidental that this quarter we called out four or five deals and three of the four is in Europe but I don't think you should read anything specific.

We have pretty strong pipeline in US.

We are already looking at a strong booking quarter in AMJ.

So, we are really in a good situation from a secular growth.

Prateek Aggarwal

Gaurav just to add on to that one, it could just be a question of which client gives us the permission to announce by name, and which doesn't.

So, don't read too much into it.

On your other two questions, we have factored in normal kind of increments for now but kept some space.

I know question behind your question, which we discussed here in Noida and we met, is related to the higher inflation, which could make it higher than normal kind of increments, but we've kept some space, we'll see what transpires over the space of next one or two quarters.

Secondly, on the pricing side, as we have mentioned before, we find customers are receptive to our request for price increases, especially in the Mode-2 kind or Change-the-Business kind of things and which we are reaching out.

It does take time to get that down on paper, and then start realizing it in the P&L.

So, while those efforts are well and truly underway, it will probably take quite a few quarters to fully come back to us.

The wage increments and the costs of hiring and attrition and all of that, obviously come first, whereas the pricing increases when it come later.

All of these factors, whether it is increments or pricing are built into the guidance that we've given on the margin side 18% to 20% and that is one reason why it continues to be a wider band.

Moderator · Conference Operator

Thank you.

Next question is from line of Prashant Kothari from Pictet.

Please go ahead.

Prashant Kothari

I just wanted some sense on the margins.

I mean, we've seen the margin guidance kind of going up and down in a not a very wide range, but they're still kind of going up and down over years.

I just wanted some sense on how you think about that, one in terms of the overall industry in terms of the ability to make margins based on the competitive scenario and secondly, kind of looking internally in terms of our ability to do better than others in terms of our operating efficiencies, how to reflect upon that, where we are today versus where we were like a few years back.

Thank you.

C. Vijayakumar

Prashant first of all, our margins have been stable.

If you look at the last five years, it's been fairly stable except there has been COVID-induced savings in the last couple of years, which HCL Technologies Limited April 21, 2022 gave us a little bit of spike and in FY22, we made a conscious decision to invest almost 1% of our revenue into some specific areas, which is kind of played out.

But FY22 saw a significant talent supply-demand situation, which obviously kind of took the cost structures a little higher.

So, that decline is somewhat in line with the industry, barring that 1% which we consciously invested.

Given the current talent supply situation we are already at 17.9%.

So, we got it 18% to 20%.

We hope to see the margins increase incrementally from here based on all the interventions including rate hikes and whole talent strategy.

So, that's really the commentary, and Prateek you want to add anything.

Prateek Aggarwal

Yeah, Prashant.

I would also like to bring your attention to the much higher depreciation and amortization charge that we as HCL have, especially if you compare it with some of our larger peers.

It is a factor which is 5% plus and if you look at our EBITDA numbers they are not reflective of the EBIT of 18.9%.

Our EBITDA is at 24%, which I think is a fairly decent number, it is just that because of the investments that we made in building that products business, that has a significant amortization charge, which you will appreciate is non-cash charge and therefore, the cash flows that I talked about, at the beginning of the call, do reflect the real cash generated by the business of which EBITDA is always a better indicator.

So, I would definitely invite your attention to the EBITDA numbers as well.

Prashant Kothari

Sir would you say that our competitiveness or our efficiencies is kind of largely remained the same kind of relative to the peers that we kind of compete against?

C. Vijayakumar

Yes, in fact, our competitiveness has improved because of very stronger application and data modernization and skill sets and the some of the solution accelerators, which are part of that and our digital engineering capability in engineering services, is highly differentiated and we are also the leaders, as we called out earlier, on the Engineering and R&D services.

And the biggest proof point for our competitiveness and successes is that in the last three quarters, we delivered 5.2% CQGR in our Services business, which is highest among our peer group.

So, which is the real proof point of our success in the market, and the new demand environment.

Moderator · Conference Operator

Thank you.

Next question is from the line from the Mihir Manohar from Carnelian Asset Management.

Please go ahead/

Mihir Manohar

Thanks for taking my question and congratulations on a good set of numbers on the IT services side.

My question was specifically on the demand environment.

I remember that in last time call there was a greater sense of optimism on the overall demand environment whereas as of now, I am not seeing that sense of optimism.

So, just wanted to get into some sensor understanding and how are you seeing the demand environment as of now?

Is it still mid-teen kinds of an industry growth being there.

C. Vijayakumar

Yeah, I think from our vantage point, I mean, compared to the commentary in December to now, we feel actually more optimistic, because our pipeline is higher than what it was in December.

It's the second highest that we've ever had.

Our booking forecast for this quarter is very, very robust.

So, demand environment commentary, I would disagree, we are very positive and that HCL Technologies Limited April 21, 2022 really seven or eight big themes which are playing out and if you felt it was less optimistic, let me clarify that we remain more optimistic than what we were in the last quarter.

Moderator · Conference Operator

Thank you.

Ladies and gentlemen, due to paucity of the time that would be our last question for today.

I now hand the conference over to Mr. C.

Vijayakumar for closing comments.

Thank you and over to you, sir.

C. Vijayakumar

Thank you and we've had a very satisfying year.

We started with the double-digit guidance we delivered 12.7% constant currency numbers.

Of course, the operating environment from a talent supply perspective was more challenging than what we expected in the beginning of the year.

So, we came a little lower on the margins, but as we move forward, as we look at our client relevance, our competitiveness in the market, in the Services business, we feel very positive about the outlook and that's really giving us the confidence and comfort to commit to a guidance of 12% to 14% which is, in our view, a very good outlook based on the demand environment and thank you for your support and I look forward to continuing to interact with all of you.

We have an Investor Day coming up in mid-May and we look forward to seeing all of you.

We are going to be in person in Mumbai and look forward to seeing as many of you as possible during the Investor Day.

And thank you for the time and have a great evening.

Moderator · Conference Operator

Thank you.

Thank you very much.

Ladies and gentlemen on behalf of HCL Technologies Limited that concludes this conference.

Thank you all for joining us and you may now disconnect your lines.