HCLTECH — earnings call

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Prepared remarks

Moderator · Conference Operator

Ladies and gentlemen, good day and welcome to the HCL Technologies Limited Q1 FY24

Questions and answers

Moderator · Conference Operator

Thank you very much.

We will now begin the question-and-answer session.

The first question is on the line of Ankur Rudra from J.P.

Morgan.

Please go ahead.

Ankur Rudra

Thank you for taking my question.

My first question is on how the demand and revenue performance played out in the first quarter versus your expectation.

Is this what you were anticipating given that you've maintained the guidance and also if you could characterize the enterprise tech spend environment, despite seasonality and the strong deal wins that you had in the past?

C. Vijayakumar

Ankur, as I said in my initial remark, while we expected the quarter to be soft, it came in lower than our own expectations.

While all the large deals that we won, we really executed extremely well.

They all ramped up.

They've all delivered good revenue growth as you can see in both Life Sciences and Manufacturing verticals.

And even in Financial services we've seen good growth.

Tech and telecom is where we saw more drops than what we had expected and we were expecting some projects to go online, but towards the second half of the quarters, that did not happen.

So we did have people, we were ready and they did not really move forward.

There were a couple of instances, one Tech and Telecom.

So it was disappointing for us to have that situation, which not only declined our revenue, but it also had a big impact on our margins.

Having said that, obviously this whole cycle, the way I'm seeing is - the discretionary spend is moderating and it is probably stabilizing at a certain level and the cost and efficiency led programs have to fill in the gap and create net incremental growth.

We believe that the state has achieved in three of our verticals, Manufacturing, Financial services and Life Sciences.

And the other verticals are a little bit lagging behind.

So we are also tracking the pipeline and the maturity of the pipeline a portion of the large cost efficiency deals.

And they seem to be on track.

While our booking has been soft, we think we will deliver a strong booking in Q2. And if I look at the revenue translation of the deals that we expect to sign in Q2, there is a certain nature which helps us get revenue quickly.

So I think that's really what we're seeing.

And it's really a new cycle that's evolving, which is really offsetting the moderation in discretionary spend with growth and efficiency led programs.

Ankur Rudra

Understand.

I understand that it's very uncertain, the demand environment is difficult for you to spread it to play out exactly as you predicted at the beginning of the year.

But do you think, maybe by maintaining your revenue guidance, you are potentially backing yourself into a corner HCL Technologies Limited July 12, 2023 if the uncertainty persists?

And while you have large deals, if the softness in smaller deals continues, you might be at risk of at least reducing the upper end of the guidance?

C. Vijayakumar

We've had a pretty good track record of looking at our pipeline, looking at our conversion and kind of, giving a guidance and meeting the guidance.

So whenever we've given guidance in the last five years, we've delivered to it.

So we believe, all the math behind it and all the judgment behind it is very robust.

And it does factor in some of the challenges in the macro environment, which we did even when we gave the annual guidance.

So I remain confident of delivering to the guidance this year.

Ankur Rudra

Okay, appreciated.

Maybe one last question on Gen AI and thank you for all the color you've shared.

Just curious about how you're seeing this playing out in the marketplace in contracts.

Given you have a high participation in some of the cost takeout deals, maybe on the cloud side, is this showing up in discussions as a source of price deflation that maybe you or competitors are driving and hence might impact your contract profitability going forward?

C. Vijayakumar

So, Ankur, at this point, most of the conversations on Gen AI are more innovation-led and we have not seen, I mean, obviously customers are always challenging us to demonstrate the art of the possible.

And at this point, I don't see anyone trying to take the contractual position of how much we have to deliver through this technology because there are too many dependencies.

So I think, there is definitely a lot of hype in the short run, but we do believe it will have some meaningful benefits in the long run.

Now, I think, one of the key benefits are going to be around efficiency.

So which means there will be some deflation, but I think it's at least two to three years away.

And I do believe, it will get offset with so many projects in a few weeks, you have 140 projects, some of them pilots, some of them implementation, some of the examples that I shared earlier as well.

So, I think there is going to be a little more uptake on small projects, which are really looking at proof of concepts and some implementation.

And maybe gradually as it matures, there's going to be some more focus on how much efficiency it can drive.

And I see that at least two to three years away at this point.

Ankur Rudra

Appreciated.

Thank you and best of luck.

C. Vijayakumar

Thank you.

Moderator · Conference Operator

Thank you.

The next question is from the line of Kawaljeet Saluja from Kotak.

Please go ahead.

Kawaljeet Saluja

Hi, thank you for the opportunity.

CVK, my question is again related to your guidance.

Now, when I look at your guidance, right, across the last three quarters, in December, you had to come and indicate that after raising guidance, that your revenues will be the lower end of the band.

In March, you ended up missing your services revenue guidance, wherein the services revenues came in at 0.6% growth.

In June, again, the numbers came in lower than what you expected.

Now, I understand that the demand environment is uncertain, but any aspects that you have seen in your revenue forecasting process, which perhaps needs strengthening or something of that sort?

HCL Technologies Limited July 12, 2023 And a related question on it is that when you look at the hurdle rate, actually last quarter, when I did ask you this question, you did mention the CQGR hurdle rate.

I mean, it was fairly modest.

Now, that seems to have gone into a fairly unrealistic level.

So why persist with the guidance when the math in itself is working against you?

C. Vijayakumar

Yes, so maybe I'll ask Prateek to answer the revenue forecasting question, and then I will come back to you on the guidance.

Prateek Aggarwal

Maybe I'll take a shot at both, and then you can add, CVK.

So, Kawal, you're absolutely right.

The ask rate has certainly gone up.

And as CVK covered right up front, the first quarter actuals have come in lower than what we had planned on.

Therefore, the ask rate which - let's say, at the lower end of the band - for example was somewhere around 2% - 2.5% odd, has now gone up to about 3.2%.

But we have done the math, and we have done the numbers I shared and CVK shared on the pipeline are what is giving us that confidence, and the stage of the deals in the pipeline is what is making us stick with the guidance.

Yes, the pipeline is one factor which we have penciled in.

Things could go better, things could go worse.

We obviously do a probability of timing, probability of winning, and all of those metrics that I'm sure everybody does.

At this point in time, we still want to retain and we are confident, as CVK already said, that we will meet the guidance.

Like you also pointed out, there are other factors.

So if at a later point in time it becomes better, then that's good for us.

If it becomes much worse, which practically we don't see happening because we've already seen, like you pointed out in your question itself, we have seen the last two or even three quarters being softer than what anybody would have imagined, say, one year back or nine months back.

So these are estimates and we'll see where we go.

So that's what I wanted to say.

On the forecasting piece itself, I think, we do have a fairly robust way of forecasting.

Obviously, like I just described, forecasting does work on certain estimates and if the environment changes during the quarters, like the last three quarters, estimates can go wrong.

I'm sure it's going wrong pretty much across the board, given the way the environment is and that's where I'll leave it.

I don't think there is something seriously broken or anything.

At the end of it, ultimately it's a judgment.

There is some hope, there is some practicality, and there is some buffer that you build in and those are the elements we continue to play with.

C. Vijayakumar

Yes, so Kawal, one thing from a revenue forecasting perspective, there's one aspect which we believe, I think the industry itself is struggling with there's really forecast this drop in discretionary spend.

So I think that's where I think we've got it wrong a couple of times.

So we continue to get the feedback and input into our planning process.

I think, there is a lot of volatility in that, and that's the only element which we believe we can improve a little bit more, based on what we've seen in the last two-three quarters.

Coming to the guidance, I think, the ask rate has gone up.

It essentially boils down to how much booking we can deliver in Q2 and what we can do in the next 45 days will determine the course HCL Technologies Limited July 12, 2023 of the year.

We have some reasonable level of confidence on accomplishing the outcomes that we expect.

Kawaljeet Saluja

So, CVK, I should thank, and Prateek, thank you for that fantastic color.

I really appreciate it.

The question really is that for you to achieve the guidance, you need a big spike up in the second quarter itself.

Do you have that confidence?

And the second related question to it is that normally in the cost takeout deals, consolidation deals, there's a free transition offered, there are timelines, like that sort of deal that you announced in insurance vertical in October, started ramping-up towards March, right?

So even if let's say the pipeline converts, isn't it too late to meet the hurdle rate that you have for your guidance?

C. Vijayakumar

So I think, the deals are different, nature of deals are different.

Some of them have an ability to convert to revenue faster and that's the nature of deals that we have and that's what is driving this.

Kawaljeet Saluja

All right.

That's the final question on profitability.

Prateek, what is the kind of a tailwind that you'll get from profitability through possibly, change in the compensation revision cycle for this year?

Prateek Aggarwal

I don't want to really talk numbers on that, but E4 and above is a significant portion of the wage bill.

I don't want to get into exact numbers, but like I said at the press conference also - we have made a plan.

We have revised that plan based on the numbers that we see for Q1. Obviously, we have revised it by baking in more actions and more cost cutbacks that we need to do.

I think, the leadership team is all apprised of the situation.

The numbers gap is obviously visible to all of us and everybody.

I think as a leadership team, we are committed that we will take the actions to meet the numbers.

Kawaljeet Saluja

Yes, and then normally if you see the past year's wage hike, generally have an impact of 50 basis points to 100 basis points, depending on how much increments we gave.

So we do believe there is some of that will flow into the savings.

Moderator · Conference Operator

Mr. Saluja, may I request you to join the queue for any follow-ups?

Kawaljeet Saluja

Yes, thanks so much.

Moderator · Conference Operator

Thank you.

The next question is from the line of Mukul Garg from Motilal Oswal Financial Services.

Please go ahead.

Mukul Garg

Yes, hi!

CVK, first, just a clarification on the whole discussion about guidance.

You mentioned about some large deal wins.

Are you factoring in a quick scale-up in these deals?

And does that mean that there is a bit of a rebadging which is involved here?

If not, then what is your degree of confidence that the muted environment won't push out the ramp-up, as Kawal also asked?

C. Vijayakumar

Mukul, I don't want to call out the very specifics about the nature of deals but given all what we have said in the last 10, 15 minutes, we should assume that the significant part of this advanced pipeline can convert into revenue relatively quicker than what you've seen in the last two, three large deals that we've done.

HCL Technologies Limited July 12, 2023

Moderator · Conference Operator

Thank you, Mr. Garg.

Please join the queue for any follow-up.

Mukul Garg

Sure.

Moderator · Conference Operator

Thank you.

The next question is from the line of Gaurav from Morgan Stanley.

Please go ahead.

Gaurav Rateria

Hey, thanks for taking my question.

So, CVK, the question is around the verticals of Tech and Telecom.

You talked about uncertainty.

So, was this largely deferrals or some cancellations, and are these behind us, or you think this will continue to be an issue in the near term?

Thank you.

C. Vijayakumar

From all what we are seeing, we think it is stabilized, but this has been so volatile, so I won't be able to give you more color on that.

It looks like these are stabilized.

Gaurav Rateria

All right, thank you.

C. Vijayakumar

Thank you.

Moderator · Conference Operator

Thank you.

Next question is from Sandeep Shah from Equirus Securities.

Please go ahead.

Sandeep Shah

Yes, thanks.

Thanks for the opportunity.

Just the clarity in terms of the guidance, CVK, so do you believe the 2Q conversion of deal pipeline into deal wins will also result into a better growth from 2Q onwards, or do you expect the growth to pick up from 3Q?

Because historically, to achieve the guidance because of the high hurdle rate, even fourth quarter is being softer.

So in that scenario, 2Q has to do a heavy lifting along with 3Q as well?

C. Vijayakumar

So Sandeep, we don't give a quarterly view, but as I said, even in the beginning of the year, the quarters will get incrementally better.

That was the commentary that I made even when we presented the guidance.

So, you should see incrementally better growth and obviously, this means there's going to be spike in one of the quarters.

So that's to be expected.

Sandeep Shah

And just last book-keeping, Prateek, what was the one-time benefit in the intangible amortization?

Is it worth, how much basis point in this quarter and will it reverse in the second quarter?

Prateek Aggarwal

No, so it will certainly not reverse in the second quarter.

It is a one-time benefit.

This is the impairment, we had taken a couple of years back in one of the products.

And the product has done well in the last two years, and we have been able to increase the royalty we get on that.

So the revenues are significantly up; therefore, as per the accounting rules, we needed to write it back - write the impairment back.

So, it's just a one-time benefit in this quarter and there are no repercussions on any of the next subsequent quarters.

Moderator · Conference Operator

Thank you, Mr. Shah.

Request to rejoin the queue for any follow-ups.

The next question is on the line of Sudheer Guntupalli from Kotak Mahindra AMC.

Please go ahead.

Sudheer Guntupalli

Yes, you could give just one clarification on the decline in tech and telecom.

So did you allude to the fact that, this is largely within the ER&D, this can be mapped to the ER&D segment?

HCL Technologies Limited July 12, 2023

C. Vijayakumar

No, if you see the decline, the numbers are quite high and of course, ER&D bore the brunt of it.

It definitely had impact on the ITBS as well.

Moderator · Conference Operator

Thank you.

The next question is from the line of Chirag Kachhadiya from Ashika Institutional Equities.

Please go ahead.

Chirag Kachhadiya

Hello, what type of orders are we taking into ER&D segment?

C. Vijayakumar

So I have Vijay Guntur, who heads the engineering services.

Vijay, if you can hear, could you just give some color on the type of orders that we are taking?

Vijay Guntur

Yes, thanks, CVK, and thanks, Chirag, for the question.

We are seeing two kinds.

One is consolidation in each of the Tech and Telecom segments.

We are seeing more consolidation deals, and hence a pipeline that is growing.

To what CVK said earlier, that is helping us gain more confidence that, when these deals fructify, realization to revenue will be quicker.

So that's one we are seeing that consolidation is on.

The second we are seeing is decision-making, which used to be reasonable, is getting a little delayed.

Those are two trends we are seeing in terms of pipeline and order booking.

Moderator · Conference Operator

Thank you.

The next question is in the line of Ravi Menon from Macquarie.

Please go ahead.

Ravi Menon

Hi, thank you for the opportunity.

As you said, it looks like the Tech and Telecom declines are more than just ER&D.

So I wanted to check, are these over pretty much?

Should we think these verticals will return to growth?

That's the first and the second follow-up on the nature of ER&D work that you do versus pure-play ER&D firms.

Most of the pure-play ER&D firms, I think haven't seen this sort of Q-o-Q decline and now you've seen this for two successive quarters.

So just wanted some color on what led to this decline?

C. Vijayakumar

Ravi, it's our exposure to tech vertical, which is primarily, which has contributed to it, Tech and Telecom on the ER&D side.

Maybe most others have exposure to some of the other industries.

I cannot comment on others, but that's our kind of hypothesis.

And maybe, Vijay, you can add a little bit more on this.

Vijay Guntur

Yes, CVK.

Certainly, our tech exposure is more, especially big tech and we've seen a lot of consolidation and rationalization of spend.

I think, from what we see in the market, that consolidation and rationalization of spend is stabilizing now.

We expect the deal pipeline that we are having now to convert.

That's what we are seeing.

Moderator · Conference Operator

Thank you.

The next question is on the line of Surendra Goyal from Citigroup.

Please go ahead.

Surendra Goyal

Yes, thanks, sir.

CVK on ER&D, is the worst over?

And should we expect it to be back into growth trajectory going forward?

C. Vijayakumar

Yes, Surendra, that's what we believe.

Moderator · Conference Operator

Thank you.

Next question is from the line of Manik Taneja from Axis Capital.

Please go ahead.

HCL Technologies Limited July 12, 2023

Manik Taneja

Hi, thanks for the opportunity.

While my question on the ER&D outlook essentially has been answered, just wanted to understand, your hiring plans in the backdrop of some of the near-term challenges that you've seen?

C. Vijayakumar

Probably, Ram, could you answer this?

R. Sundararajan

I think our hiring plans, quarter-on-quarter, we do moderate our plans to be in line with our forecast for the quarter, the revenue forecast for the quarter.

Next quarter is typically the quarter, where the fresher intake will be higher.

So that will continue as planned.

So, basis that, we will moderate our requirements for lateral hires.

C. Vijayakumar

There is also some amount of productivity-based releases that we expect to happen.

So that will also feed into some of the growth.

To that extent, we are not dependent on a lot of hiring for growth in Q2.

Moderator · Conference Operator

Thank you.

The next question is from the line of Apurva Prasad from HDFC Securities.

Please go ahead.

Apurva Prasad

Yes, thanks.

So my question is, on the revenue growth guidance the ask rate differential.

What I'm trying to understand is, the top end of the guidance, are you factoring faster acceleration?

So between the top end and the bottom end, are you factoring in faster acceleration in H2 or a spike starting Q2?

I ask this as you are entering with headwinds in Q2, as you stated earlier that, the weaker than expected second half in the first quarter in the Telecom vertical will play out full quarter for Q2 as well as the weaker booking.

So, how should we look at the difference between the lower and the top end?

C. Vijayakumar

I don't want to comment on where we will land in the guidance at this point, we will just stay with the guided range and obviously because of weak Q1, we must deliver a much stronger H2 to deliver growth.

Moderator · Conference Operator

Thank you.

Next question is from the line of Surendra Goyal from Citigroup, please go ahead.

Surendra Goyal

Yes, last quarter you had shared that the ACV for the year was plus 4% year over year.

What is it on a TTM basis at the end of 1Q?

Prateek Aggarwal

Surendra, I don't have a number on a TTM basis, but for the quarter, it is 21% lower year-on- year.

Moderator · Conference Operator

Thank you.

The next question is from the line of Rahul Jain from Dolat Capital, please go ahead.

Rahul Jain

Yes, hi, thanks for the opportunity.

I just wanted to understand your thoughts on the ERS space.

What led to this kind of an impact and how you see this segment to perform in the coming quarter?

Is there any trend related to vertical or specific to any discretionary spend thought process or these are just one-off for now?

C. Vijayakumar

Yes, we covered some of those in the previous commentary, but maybe I'll request Vijay to share it again.

HCL Technologies Limited July 12, 2023

Vijay Guntur

Yes, sure, CVK.

I think we talked about the deal pipeline is stronger.

That is the first indicator for us, and we expect that to convert to order book and hence to revenue.

The conversion cycles in our business are shorter in the R&D space.

So we expect that, we will perform better in the next quarter.

Rahul Jain

So these are your general thoughts, but is it any different from a sub-vertical perspective or this is an overall thought process that you see?

Vijay Guntur

No, the Tech and Telecom part of our ER&D business, which got impacted quite a bit, like we've been talking about, those we see conversion and we see back to growth situation in it.

Rahul Jain

Sure, thank you.

Moderator · Conference Operator

Thank you.

Ladies and gentlemen, that would be our last question for today.

I now hand the conference back to Mr. C.

Vijay Kumar for closing comments.

Thank you and over to you.

C. Vijayakumar

Yes, thank you everyone for joining us on the first quarter earnings announcement.

We do take our commitments very seriously.

So, in spite of a weaker performance in Q1, we are confident of delivering to the commitments that we have made, and we look forward to your support and look forward to talking to you during the quarter and at Q2 results.

Thank you everyone.

Prateek Aggarwal

Thank you all.

Moderator · Conference Operator

Thank you very much.

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

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