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HCL Technologies Ltd
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Ladies and gentlemen, good day, and welcome to HCL Technologies Q2 FY '21 Earnings Conference Call. [Operator Instructions]. Please note that this conference is being recorded. I now hand the conference over to Mr. Sanjay Mendiratta, Head of IR. Thank you, and over to you, sir.
Thank you, Aman. Good morning, and good evening, everyone. A very warm welcome to HCL Tech Q2 Fiscal '21 Earnings Call. Trust you all are safe and healthy. We have with us Mr. C. VijayaKumar, President and CEO, HCL Tech; Mr. Prateek Aggarwal, Chief Financial Officer; Mr. Apparao, Chief Human Resource Officer; along with the broader leadership team at the call to discuss the performance of the company during the quarter, followed by the Q&A. In the course of this call, certain statements that will be made are forward looking, which involve a number of risks, uncertainties, assumptions and other factors that could cause actual results to differ materially from those in such forward-looking statements.All forward-looking statements made herein are based on information presently available to the management and the company does not undertake to update any forward-looking statements that may be made in the course of this call. In this regard, please do review the safe harbor statements in the formal Investor Release document and all the factors that can cause the difference. Thank you, and over to you, CVK.
Thank you, Sanjay. Good morning, good afternoon, and good evening, everyone. I hope all of you and your families are safe and are in good health. I'm very happy to report that we've had a fantastic Q2. We delivered 4.5% sequential constant currency revenue growth and delivered an EBIT margin of 21.6%. We saw a broad-based growth across the portfolio. It's also noteworthy that our EBIT margin in this quarter is at a 22 quarter high. Our stellar performance is a result of 5 key factors: First, the intensity of the technology spend in the market as companies calibrate their business models to the new normal is increasing. We've witnessed many large deals in this quarter, including 15 transformational wins, which represent a significant modernization and digital transformation initiatives for our clients.Second aspect is our client relationships and the stickiness of the client relationships, who have continued to show confidence in us by giving us several new programs and expanded scope, many of them with very quick closure cycles.Third aspect is the early lead and the leadership that we have in the digital foundation business. As the world got into the pandemic, digital foundation, enabled by hybrid cloud, digital workplace, networks and cybersecurity became super critical prerequisites for any bold plans for enterprise transformation, and this has increased attention from all the key stakeholders and client organization. So the programs also get a lot of attention. We saw something rather come up in almost all the clients in the past quarter; fourth aspect is our continued focus on automation, the right shoring and all the supply chain efficiencies and all the cost management initiatives; and the fifth and most importantly, the hard work and dedication that our employees have invested despite all the odds. Driven by these factors that I articulated, we posted a truly all round performance this quarter. All our engines fired with positive sequential growth in every reporting category. In terms of business segments, IT and business services grew 4.9% sequentially in constant currency. This was led by digital foundation in Mode 1 and digital and analytics and cloud-native offerings in Mode 2, primarily driven by modernizing digital foundation and accelerating digital transformation. Engineering and R&D services also saw great traction in the last quarter. This segment grew 3.6% quarter-on-quarter in constant currency, enabled by incremental product innovation requests as well as new engagements. The third segment production platform grew at 3.1%. This is a reflection of the stability and the positive traction that we are seeing in this business. In Q2, HCL Software, for example, did 5,000 sales transactions, a number of unique clients signed increased to over 12,000 in the last year. If you slice this performance by Mode 1, 2, 3, we saw an impressive 4.3% sequential growth in constant currency in Mode 1, led by digital foundation and a 6.9% quarter-on-quarter in constant currency, driven by Mode 2 largely digital and analytics business and our cloud-native business. We also saw very good growth of 2.1% Q-o-Q in constant currency in Mode 3, despite it being a seasonally weak quarter for this segment. Geographically, rest of the world led the performance in Q2 with a record-breaking growth of 9% Q-o-Q in constant currency. Americas and Europe also continued its strong growth momentum at 4.9% and 2.2% quarter-on-quarter, respectively. In terms of verticals, our growth was led by Life Sciences and Healthcare verticals at 8.6% quarter-on-quarter constant currency. Retail and CPG vertical also recovered very smartly and registered a robust growth of 8.4% sequentially. This reflects our strong participation in areas that are critical for this segment, including e-commerce solutions. Financial Services registered a broad-based growth across clients to deliver a 2.6% quarter-on-quarter growth. Our top business headlines this quarter are a happy mix of recognitions and milestones, setting us well for future success. I'm very happy to share with all of you that just yesterday, HCL Technologies has earned the prestigious designation in Forbes Fourth Annual List of the World's Best Employers 2020 ranking. Overall number -- 30th rank overall globally, and making us the top-ranked company among the multinationals headquartered in India. HCL Technologies is the only Indian company to appear in the top 50 group of this ranking and we are truly humbled by this recognition. We also received recently the highest governance quality score of 1st decile from Institutional Shareholder Services. This score indicates higher quality and relatively lower governance risk. The score is derived after reviewing 4 key tenants of board structure, shareholder rights, compensation and audit and risk oversight. A few weeks back, we announced our intent to acquire DWS Limited, a leading Australian IT business and management consulting company. DWS provides a wide range of IT services including digital transformation, application development, program and project management and consulting. We expect this acquisition to strongly enhance HCL's contribution to digital initiatives in ANZ region, while also strengthening our client portfolio across key industries.This quarter, we also expanded our cybersecurity capability footprint through the opening of our first European Cyber Security Fusion Center in Gothenburg in Sweden. The center will help European organizations comply with the local regulations concerning data sovereignty. Given the strong momentum in the cloud business, we're continuing to invest in our partnerships with hyperscalers to make our market differentiated propositions even stronger. From a cloud business perspective, we launched a new IP to accelerate deployment of SAP environments on Google Cloud platform. We also became the only certified SAP competency partner for 4 hyperscalers, Google Cloud, AWS, Azure and IBM. HCL has become one of the early partners to qualify for Azure Migration Program Partner status for Windows Virtual Desktop Engagements, a Workplace Solution by Microsoft. HCL is also now a Microsoft Cloud Adoption Framework Enterprise Scale Certified Partner. CAF is a proven Azure framework designed to create and implement business and technology strategies to succeed in cloud, which will help in accelerating the client's cloud adoption journey. We also expanded our collaboration with AWS by joining the ISV Workload Migration Program. This helps us to migrate ISV's Workload to AWS via a repeatable migration process and accelerate their clients -- their journey to cloud. On IBM Cloud, we had set up our partnership 2 years ago on hybrid cloud, recently expanded this partnership to include IBM Public Cloud with focus on certain regulated industries. Now moving to some color on our bookings and pipeline. Our booking TCV in Q2 is similar to the same quarter last year, and is 35% higher than the last quarter. We signed 15 net new transformational deals, led by industry verticals, including Life Sciences and Health Care, Energy and Media and Telecom. All the deals are -- all the 15 deals are mentioned in our Investor release. I also want to highlight that these deals are new deals and exclude renewals. We also had robust renewals during the last quarter. From a pipeline perspective, we are witnessing good deal creation activity across all verticals and geographies. We are also witnessing the good momentum in the cost transformation and vendor consolidation deals and continuing interest in digital foundation and the transformation opportunities. Overall, our Q2 pipeline grew by 20% Q-o-Q, and currently, it stands at an all-time high. Looking ahead, we have revised our revenue and margin guidance upwards. Our constant currency revenue guidance for Q3 and Q4 is expected to be in the range of 1.5% to 2.5% on an average basis. This will enable us to deliver a positive growth for the full year compared to what we had reported at the end of Q1. EBIT guidance stands revised upwards to 20% to 21%. Overall, we remain confident of our performance in the remaining fiscal of this year. We have a robust pipeline and are very positive about the market opportunity, especially from our vantage point of a diverse service mix, segmental leadership, strong client relationships, strong network of partner ecosystem and a robust operating model to manage our costs effectively. We're also committed to making all the right investments in the market to capture the market opportunities that are emerging. We are very committed to investing in our employee growth, both through learning and opportunities as well as salary increments, which will start reflecting from October onwards. The variable compensation for the full year is expected to be similar to that of last year. With that overall high level commentary, I'll pass it on to Prateek to provide more financial color on our performance. Over to you, Prateek.
Thank you, CVK. So obviously, a very, very healthy report for the quarter. Let me start off with something which is not so number intensive, while I will get into the numbers later on as you expect me to. So I just wanted to start off with governance as a topic. And why it is material now is because I think in line with the best governance standards, HCL set a new standard this quarter by coming out at being the only one to come out and communicate publicly through our mid-quarter update that our revenues and EBIT were expected to be materially better than the wins that we had guided back in mid-July. I think that is one of the hallmarks of this quarter, and just wanted to start off with that. And potentially, those are the kind of actions that ISS, as the Independent Shareholder Services body, has given HCL the highest governance rating of 1, which means low governance risk. Moving on to some of the numbers. Like we said in the mid-quarter guidance, we said we would be higher than 3.5%. That was at the end of 2 months of actuals what we saw and the third month also came out very positive. And we finally closed the quarter at 4.5% quarter-on-quarter growth in constant currency terms. In year-on-year terms that translates to a negative 0.4% in constant currency terms again. In U.S. dollar terms, we are now at $2,507 million, $2.5 billion, which is a $10 billion run rate, which we had achieved earlier, but then due to the pandemic went a little lower. And we are happy to regain that $10 billion run rate again. In U.S. dollar terms, that translates to a 6.4% growth on a sequential basis quarter-on-quarter, and on a year-on-year basis, that is 0.8% positive growth. EBITDA came in very strong, 26.6% for the quarter. This EBITDA of 26.6% is 103 basis points improvement on a quarter-on-quarter basis and 322 basis points on a year-on-year basis. And Q2 EBIT was at 21.6%, that too is up 108 basis points on a quarter-on-quarter basis, and on a year-on-year basis, it is 165 basis points. To give you a quick margin walk, just to cover the highlights. The net improvement is 108 basis points, but we did have a negative impact coming from the ForEx exchanges, particularly from the rupee appreciating. That gave us about 24 basis points hit. And we also invested this quarter in SG&A investments, mainly in the P&P business. And that took away about 32 basis points as well. We saved some 7 basis points in the D&A, depreciation and amortization. So actually, the net -- I mean, on a gross basis, the productivity or the efficiency, the operational efficiency that we delivered during the quarter was about 157 basis points. This 157 basis points came from multiple factors, largely driven by the excellent revenue growth of 4.5% in constant currency. We had not taken any drastic steps last quarter, which was the right call, since a large portion of the revenue came back this quarter, and that resulted in higher utilization and therefore better margins. Our Mode 2 business has been growing well, and the margin increase in that business is also helping drive the overall company margins. If you see the last year's second quarter, Mode 2 margins were about 14%. And in this quarter, it's 18.5% and this business had crossed the $0.5 billion revenue mark in this quarter, therefore, a run rate of $2 billion plus now. Some volumes coming back also helped margins and some COVID recoup especially in our ERS business, which had some supply chain challenges last quarter also helped. So all in all, a great quarter from a EBIT or EBITDA perspective. In terms of profit after tax, net income was at $424 million. This increased by 9.7% sequentially and 12.7% on a year-on-year basis and translated to about 16.9% of revenue; last quarter, it was 16.4%, which included a onetime benefit from a certain land disposal that we had done. So in that respect, it's more than 50 basis points improvement on a normalized basis. The next highlight is on the cash flows, and this is something which is a clear standout kind of a number. Not only for this quarter, but on a longer term, if you take a look at the LTM last 12 months. So for the quarter, we delivered OCF of $643 million, which was 152% of net income and a free cash flow of $578 million, which was 136% of net income for the quarter. In terms of last 12 months, the operating cash flow was close to $2.7 billion, $2,692 million to be precise, which was 161% of the net income in the last 12 months. Similarly, free cash flow for the last 12 months was $2,444 million, close to $2.5 billion, and that also was 146% of the net income for the last 12 months. This is the sort of concept that I had started sharing almost a year back that our cash flows are expected to be much higher compared to the net income because as per accounting rules, the net income has several components, which are noncash in nature. So that is what we had tried to capture in moniker called Cash EPS, and this is what you can see delivered in the last 12 months, $2.7 billion of OCF, which is also helped by the excellent work that we have been able to deliver on the DSOs, days sales outstanding and which currently stands at 79 days, including the unbilled, which has dropped by 7 full days compared to the 86 that we were running at in the last 3 quarters. So 7 days improvement in DSO has completely changed the shape of the cash generation. And on a Y-on-Y basis, this is an 11 days improvement in DSO. And so all of this cash flow has generated -- we ended last quarter at $1.33 billion of net cash. And you will remember that this was after paying out $812 million, the second tranche to IBM for the seven products that we had acquired from them. And that $1.33 billion is now increased by $500 million in 1 quarter to a level of $1.83 billion now, which is up 250% on a year-on-year basis now and gross cash stands now at $2.25 billion. We used $200 million out of the solid cash that we generated to pay off some of the short-term loans that we were holding. So the increase on a quarter-on-quarter basis in gross cash is about $300 million, using up $200 million out of the $500 million that we extra generated. Moving on then to the EPS numbers, earnings per share, the reported earnings per share for the last 12 months is now at INR 45.2, which is up 22% on a year-on-year basis, and the cash EPS is now at INR 60.30, which is up by 36% on a year-on-year basis. Now happy with the cash generation as well as the net income that we are generating, the Board has chosen based on some of the feedback we got from some of you and a lot of investors also on a direct basis, we have -- the Board has gone ahead and doubled the dividend per share on a per quarter basis. So, so far, we were giving INR 2 per share per quarter, and you will remember, last year same time, we had come out with a bonus issue, 1:1 bonus, doubled the number of shares, and we had continued with the INR 2 per share on double the number of shares. And now this year, we are doubling the dividend on those doubled number of shares. So it's, in that sense, a quadrupling in a short period of 4 or 5 quarters, whichever way you count it. So going forward, also, we intend to maintain the INR 4 per share per quarter. And that's the good news that I have to share with all the investors, who hopefully will like what we have done. The revenue guidance, CVK has already spoken about. On top of the 4.5% that we've already delivered, which at the lower end of the earlier guided range is kind of 3x the 1.5% that we had mentioned. We are keeping for the balance half of the year similar kind of growth despite having delivered much higher this quarter, which basically, the 2% to 3% extra that we delivered this quarter, we are carrying forward the same rate of 1.5% to 2.5%. In year-on-year terms, FY '21 over FY '20, it basically means a growth of 0 to 0.7% versus the last time minus 2.3% to minus 0.8% that we had given last time. So that's an increase of 2.3% at the lower end and 1.5% on the higher end. Annual margin outlook has also increased. Earlier, we were at 19.5% to 20.5%, and we have increased that by about 50 basis points for the full year, and now stands at 20% to 21%. The ETR continues to be at 24%, and that brings me to the close of all the numbers. Thank you very much for your attention, and over to you moderator for Q&A.
[Operator Instructions] The first question is from the line of Ankur Rudra from JPMorgan.
Nice to see the dividend going up. I just had 1 main question. You've done very well on all accounts. The demand environment seems to be moving up quite significantly. And as Prateek you mentioned, the cash conversion has been the highlight of the quarter. Any change to the overall way you're thinking about capital allocation going forward with dividend may form a part of that, that we can expect?
So Ankur, the big change is already in the announcement that we already made. The rest of it is something that typically, the Board will see from a quarter-to-quarter perspective, largely in the last quarter, I would say. But we have set out which was part of the ask, we have set out a more definitive guidance almost in terms of what we intend to do in the future. So we'll stay there for now and see how it develops from there.
Okay. And maybe just 1 question, CVK, your thoughts on -- you've seen this pandemic period changing the nature of demand quite a bit. How is your addressable market for your type of services expanding given your roots in foundational infrastructural services?
Yes. Ankur, I believe the addressable market does increase in a meaningful manner in 2 dimensions: One, there were sectors which were less open to adopting global delivery models and outsourcing. For example, the health care from a service provider perspective. Given the current cost pressures, that's 1 segment which has opened up, and we already saw 2 good wins in the last quarter; the second element is certain geographies, which had started opening up more to global delivery model and offshoring. I think that trend is going to become a little bit more pronounced as we move forward. The third element will be on the digital foundation itself. The opportunities to partner with the hyperscalers. And because of the strength of partnership, I think we are also able to reach lot more clients than we would have ever reached before. There is a lot of marketing investments made by hyperscalers, and there is a certain amount of pipeline that we are seeing that's getting built through that relationship as well. These are just a few points. There could be others, but these are the few highlights.
The next question is from the line of Pankaj Kapoor from CLSA.
Congrats on a good execution. CVK, I had 2 questions to you. First, given the accelerated adoption for cloud. Do you also...
Please use the handset sir, the audio is not clear.
Yes. So given the accelerated adoption for cloud, do you also see a concurrent impact on your legacy business, which may be optically pulling down the growth? That's my first question.
Yes. Not much of an impact. I did talk about this even last quarter. Of course, some of the legacy data center business migration to cloud would accelerate. But the cloud migration brings itself a holistic set of opportunities, which actually extends far beyond the data center, the whole digital foundation, network, security, all of this has to be enhanced. And the migration itself is a continuous program because there is a huge amount of legacy estate. And it also opens up opportunities for us to play in the application modernization space in the clients where we were delivering some of the foundational services. So overall, I see it as a tailwind in the net-net, all these things put together, it's still a positive impact to the overall business.
Got it. And CVK, second question was on HCL Software. You have now completed a year there. So what has been your learning in terms of your ability to, say, provide add-on services to the product portfolio that we acquired? And related to that, do you see a need to do any incremental investment in sales like you did in this quarter?
Yes. Of course, first year, there has definitely been a lot of learnings. I will have Darren share that. However, from a cross-sell perspective or upselling perspective, the first year, the focus was to ensure we are able to transition a large percentage of customers to be directly working with us. And that has gone extraordinarily well. So we've seen very, very strong migration and very similar to what we had expected. Darren, could you share a few learnings from the broader software perspective?
Sure. I think, CVK, I think you summarized it pretty well. I think as we were going through the -- in the first year, like any transition, I think, first, you want to make sure that you take care of the basics. And so there was an enormous amount of focus on before we start thinking about all the upsell, cross-sell, all of those opportunities, let's make sure that we make this a smooth, successful transition for those customers of these products. And that's showing them a clear commitment to their success that will be a good partner to work with. And then just as importantly, that we're really on a pretty accelerated modernization and innovation journey with these products. So they're betting on the right technology that's going to be future-proofed for the long term. So that, I'd say, has probably been the #1 real learning with 12,000 plus customers we've had to go customer-by-customer. I think what we've really been relentlessly focused on is working that list, a customer by customer, deal by deal. And that first things first, the best strategy is to execute really well through that. I think second then, and I think really coming to your question, we have begun to look opportunistically for opportunities where we can drive synergy across different parts of the HCL portfolio. But I think the principle that CVK set from the very beginning and we've communicated in this forum and other investor forms, is we have to respect the customer. And first thing we have to do is make sure we're addressing what the customer is looking for. There are many customers that are looking for services-only solutions. There are many customers that are looking for software-only solutions. And so I think where we've been looking for those synergies is in that sweet spot of customers, where bringing software and services together can bring incremental value. And again, a great example of that was we had a customer recently on our commerce software actually upgrade from an older version of the software to a newer version. And they've successfully gone live. It's a great example where they were a long-time customer of this software. They were looking for a single vendor to provide the overall solution to them. It wound up generating a large-scale services opportunity and then a transformational opportunity in terms of really helping to upgrade them for the future. I think that's just 1 concrete proof point, but I think those are the kinds of examples that we're looking to replicate.
Understood. And Prateek, I think, if I may squeeze in 1 question for you. How much of the margin gains that you have made in the current quarter you think is structural and which you can defend? And how much of this can actually go off once the costs like travel, et cetera, normalizes?
Yes, Pankaj. So some of the costs and travel is absolutely the right example because we have gained almost a couple of percentage points there. Now when things get back to normal, whenever that is, one would expect that cost to sort of increase at some point in time. But one also expects that it would not go back to the level at which it used to be. So there are other discretionary costs like that. At the same time, this COVID pandemic has introduced new costs as well, so costs of testing, cost of maintaining your offices in a certain way and so on and so forth, right? So all said and done, I think most of this has been driven by real productivity, which should be structural. At the same time, there were salary increments that we had held back for about a quarter. Our normal cycle used to start in July. This year, it is now starting in October. And that will also be an impact in the second half, which is already budgeted and kind of factored into the guidance and so it's something which is known. There are a few other new things which are cropping up, which are very new, and it's a little too early right now to sort of put a number to that. So we will have to keep working on those things as well as we go through the second half.
The next question is from the line of Sandip Agarwal from Edelweiss.
Congratulation on a great execution and performance and wish good health to every one. My first question to CVK is that you mentioned these are at all-time high. Is it more to do with the increase in size of our business, which is a natural thing or you think it reflects a substantial uptick in demand? And also related question is that if it is a substantial uptick, then why we are doing these hikes in 2 parts for some employees from October 1 -- I understand that we are still better off because we are still holding back only a quarter's period in that. And my related question is, why the guidance is so muted for Q3 and Q4, which doesn't look like an upsell kind of guidance or new opportunity kind of guidance. I wanted to just understand how much of it is seasonality, how much of it is fear of second wave of the pandemic or you think conservatism is a most part of it? So if you can help there.
Yes. Sure, sure. Let me start with the pipeline. Obviously, one always expects the pipeline to continuously increase. But I would say that the increase is a little more than whatever regular growth in revenues are. So to that extent, it's a little bit incremental from a total pipeline perspective. The second is on the salary increases, it's not -- there is no real delayed increase because as per our normal operating plan, the employees up to E3 level get their increments in July, which is now going to happen in October. And the E4 and above get their increments on October 1, which has now moved to January 1. So we've permitted uniform a 3 months shift in the appraisal cycles. Coming to the guidance for Q3 and Q4, Q3 has certain seasonality, which I'm sure all of you are aware, on the services business relating to furloughs and some of this. And the product business actually has a positive seasonality in Q3. However, what we have seen is some of the business also got preponed and got signed in the previous quarter, especially some of the commerce type of transactions. And we think the seasonality in the product business will somewhat moderate compared to what it was in the previous few years because we have -- our sales policies got nothing to motivate anyone to kind of close everything in December, very different from what it was in the previous operating model. So these are the 2 factors which makes us go to 1.5% to 2.5%. I think you have to see this on an increased base of a 4.5% growth. And the higher pipeline will take some time to convert them into deals and then deals will take some time to convert to revenues. I think it's a good 6 to 9-month kind of a window from pipeline to deal to revenue. So we've kept all this in mind. Of course, there is definitely some caution because several countries are going into a second lockdown. That's also being considered into our projections.
The next question is from the line of Prashant Kothari from Pictet.
My question is [indiscernible]
Mr. Prashant, your audio is breaking, sir, request you to use the handset, please?
My question is around this new tech pipeline spend the industry participants are talking about that after COVID, maybe the growth rate for the industry will kind of have a step change. I just wanted some kind of top-down thoughts on that. Do you really see that happening from the customer side? Or is it that the customer revenues will kind of constrain that the new upside tick from happening?
If you look at from a macro perspective, the overall tech spend is increasing in a low single digit. That's what all the industry reports and research reports are talking about. Now obviously, the spend on new technologies is increasing at maybe close to 17% to 20% year-on-year, and the demand for some of the traditional services is flat or in some areas marginally shrinking. So keeping in line with the trend, we believe the spend on new technologies will accelerate. That's what we are seeing. Now where is that money going to come from? I do think compared to what the increase in tech spend forecasted prior to the pandemic to what is being forecasted now, I think that is going to be a small increase because this is a very big priority area for almost all the clients. So to that extent, we will see a little more funding coming into the tech spend. In terms of the tech cycle, I think some of the key themes, which are very strongly playing out. I mean, of course, cloud migration is something which is very, very visible. But it's not just cloud migration, it's really strengthening the whole digital foundation. There are numerous network opportunities. There is significant amount of work happening in increasing the employee experience, consumer experience, which is driving good traction on the digital workplace offering. And in every vertical segment, there are a few programs, which are really being accelerated, whether it is customer experience and all the retail facing clients or supply chain transformation or optimization in manufacturing and logistics industries. E-commerce platforms are significantly being scaled up in retail CPG. So there is a specific 2 or 3 ideas, which are getting increased attention and investments, which is driving our DNA revenues and pipeline. I hope I was able to give you a view of the tech cycle changes.
Okay. Yes, that's good. And just one more on the margin side. I think Prateek mentioned that there's some new factors which are also cropping up, which are difficult to quantify as of now. But can you just name these new factors, which could have some implications for margins?
Prateek, you want to take it?
Yes. So what I was kind of referring to in passing was things like the H-1B changes that are happening. And of course, something which just cropped up about a week back. So we haven't had time to do too much of planning around it. But that is something that is going to be some kind of issue going forward. Obviously, it has a 3-year renewal cycle that it will play out. But some of it is already applicable, and we will have to plan on how do we address that, either by moving work to some of our centers in the U.S. or to Canada, Mexico, et cetera, or back to India and things like that. So we are relatively better off compared to some of our peers because we have a high localization index and more than 2/3 of our people are local with the same side they are PRs, Permanent Residents or citizens. So to that extent, we are insulated. But 1/3 people who are Visa dependent, we will have to see when is that.
The next question is from the line of Ashwin Mehta from AMBIT Capital.
Congrats on the set of numbers. One question on the R&D side. So in the backdrop of 9% for last quarter, how much of the pickup in R&D is supply side? And secondly, in terms of outlook going forward, do you see an improvement in terms of growth here?
GH, would you want to take that question?
Yes. So in this quarter, we have 2 types of growth, one is certainly driven by the demand in second quarter in our verticals like software, high-tech and also medical devices. We do see demand-driven growth. Some portion of the growth was also due to the reversal of some of the work or supply side issues we had during the previous quarter. So those problems were not there during this quarter. So I would say, by and large, it is demand-driven. We continue to see growth in the next few quarters as well.
Okay. Okay. And just the second question, so if I look at the difference between your Mode 3 and products and platform revenues, that should ideally be the HCL part of products and not the acquired products. So one thing I noticed is that the revenue seemed to be falling there. And secondly, the margins in that part are materially lower than your services margin. So what explains that while there's an improvement over the last few quarters on margin, but what explains such low margins on the -- on this difference?
Yes. Ashwin, let me take that question. See, you are right, the difference between the P&P segment and the Mode 3 segment is really the organic IP that we've built and that's what we are reporting under that. This has 2 components: One is the DryICE; and the second one is on our ERS business. We have a focused group driving products. Now while there is good products, we are also continuing to invest a little bit more and building product management teams and a little more marketing around that. So that's why -- I mean, we have not really focused on improving margins there. We are really focusing on how do we drive more growth. That's really the focus on that segment about that difference.
Ashwin, just to add on to that. If you do the math, the revenue in both the quarters is almost exactly same at $57 million for the quarter, and margins for this quarter are 18.2%. So it's not very materially different from the rest of our business, cyber services are a little lower than obviously the rest of the products.
Yes. I was actually more looking at it from a Y-o-Y perspective, so that explains.
The next question is from the line of Mukul Garg from Motilal Oswal Securities.
Congrats on the great quarter. CVK, I just wanted to get your thoughts on one of your larger peers, which has just split the company into 2, while I understand that you may not want to comment on individual competitors. You have clearly benefited in the past from similar actions than the other companies, especially in the infra practice. So it would be great to hear your thoughts on whether similar market share gain opportunities exist in the current environment or not? And then I have a follow-up question.
Yes. I think this particular development really increases the opportunity to deepen our partnership especially on some of the hybrid cloud and some of the newer investments they are making. I think it's a good outcome from that perspective. On the services side, of course, there are some areas where we compete and that was there, and that will continue. I think it's -- overall, I would consider it to be a positive development even from HCL perspective.
Got it. And the second question was a 2-part question. Basically on the Cloud segment. We are seeing hyperscaler delivering massive growth. What's the kind of growth you are seeing in your cloud practice? And whether it's a rising tide lift all boat type of an environment or are you seeing clients gravitate towards best of the breed service vendors? And the second part was, do you see a scope to capture a larger share of opportunity on Google Cloud, which you guys are repeatedly highlighting versus what is there on either AWS or on an Azure?
Okay. Overall, cloud offers very good opportunities. I would -- we have partnerships with all cloud providers. There are certain areas where we partnered in certain verticals and certain solutions that we have built along with our partners. So I would not like to comment on one specific partner versus another partner. And from a client perspective, the way we are coming across, and the customers are looking at us like a trusted adviser on the overall tech architecture and the -- what is the right place for the workloads. And many customers continue to adopt a multi-cloud approach. Especially the large customers, barring a few exceptions, almost all large clients are looking at a multi-cloud kind of an approach and a hybrid cloud approach. So all of this makes the service providers like us, very, very important in driving the clients cloud journey and partnering with them in this whole big migration cycle.
The next question is from the line of Shashi Bhusan from Axis Capital.
Congrats on a good quarter...
Sir, you're not audible clearly. Can I request you to use the handset?
Congrats on the quarter, sir. Can we have more granular understanding of product portfolio growth outlook? Can this segment achieve company-level growth rate in possibly, which is say, 1 or 2 years? And if not, any reason for that? And if yes, what we need to do more to achieve that?
Shashi, our overall commentary has been these markets are in segments, which many of them are in a very good growth segments like commerce and a couple of security products that we have. So I think in certain products, we are confident of a good growth trajectory. And some of the products would be more or less stable. That's how we see. It's too early for us to take a view whether this will grow at the company level growth rate or not. Obviously, that's always our desire to ensure that the product business also grows. But I would not comment on it now. We continue to work on product innovations and making them more and more relevant to customers. And we continue to see a very positive reaction from our customers. So all of this augurs well in the long term, but it's too early to kind of provide a view on the long-term perspective on the growth.
A question for Prateek, our current dividend payout means almost like 40% to 50% payout, so is this a new normal for the company? And is my understanding correct of Darren? Or is there room for improvement in the same maybe next financial year or so?
So Shashi, let me put it this way. I don't want to define a new normal. We've just made people step forward by doubling what we were doing so far. And give us some time to settle down to this normal and then we will define the new normal, if you like.
The next question is from the line of Rahul Jain from Dolat Capital.
So how you plan to -- plan a change in various work of business here, post pandemic kind of a thought, in terms of growth aspiration, go-to-market strategy or partnership model or the pricing model. So what are our proactive initiatives on these? And Darren, do you see our ticker should be faster in product business given the nonlinearity nature and right mix of offering that we have?
So Rahul, was your question on the products and platform? Or it was more broader?
So the first aspect was more to deal with how we -- with this digital acceleration thought process, how the growth aspiration of the business and go-to-market strategy and pricing model, these things changes for a general overall business perspective. And especially for the product business, given the nonlinearity nature, do we see the ticker should be even faster than the services business?
Yes. So let me answer the first one and then maybe Darren can provide a little more perspective on the second. I mean our overall strategy is very agile. As we see more opportunities, as we see more traction and pipeline, we will obviously enhance our investments to align with the demand that is there in the market. So like what is happening now is very similar to what happened 4 years back in terms of a few technologies where the adoption increased. The only thing now the speed of this adoption is changing. I mean the technologies themselves have not significantly changed. The speed of adoption of some of this is changing. So depending on where we are seeing traction in terms of solutions, in terms of partners, in terms of verticals, we will continue to strengthen those aspects. So as we keep planning on a quarter-to-quarter basis and annual basis, that's what I would say. And Darren, if you want to add any further color from a P&P perspective?
Again, I think you've summarized it pretty well. We will see some different dynamics by product. We will see some nonlinearity in the sense that in some products, I think you've mentioned them, products like commerce and security, there were definitely positive demand drivers that we've seen in the COVID era. And so we did receive, I think you saw that this quarter, the beneficiary of some deals coming in earlier than we anticipated. So I think, again, in some products, we're going to see that. I would make maybe an overall comment that, I think, we're seeing at a pricing level, we're seeing pretty good stability, at least in the product business, we're not seeing a lot of pricing pressure. In fact, probably at the margin, we're seeing prices continue to have just a moderated increase in the market. I think in terms of the overall go-to-market strategy, certainly, it's changed for everyone. We're a very transactional business. And that means every day, we have to be in the market doing deals with customers. So leveraging new technologies, new channels, digital marketing, finding new ways to reach customers, I think we've seen a lot of innovation over the last 6 months, and I think that will certainly continue going forward.
The next question is from the line of Sudheer Guntupalli from ICICI Securities.
Congrats on a good quarter. Just a couple of points on the growth within the portfolio. One recurring theme we had noticed in this earnings season is that Europe has been a strong driver of the comeback partly because of 2 reasons: one, some of the major geographies within the -- major economies within Europe have recovered quite well from COVID; secondly, in the last quarter, most of the IT companies have reported a very sharp drop in revenue, including HCL from Europe. So that segment, ideally, we would have expected to see a stronger comeback. It has not happened. And second, same thing within the financial services as well. Most of the global banks have been spending -- tech spends have remained quite resilient throughout June and September. However, if I look at the kind of growth delivered in financial services in this quarter, it's also below the company growth. So CVK, can you please explain these 2 points?
Yes. Sudheer, Europe, especially the July, August, September quarter is normally a lean quarter for Europe due to the vacations and all of that. Probably it's the trend that's reflected in the numbers. Otherwise, I think the pipeline and the demand environment in Europe is very good. And Rahul, if you're on the call, why don't you take the financial services question?
Yes. So financial services, I think we had a 2.6% growth this quarter. We will keep in the back of the mind that last quarter, we had a slight decline but the decline was not as sharp as we had seen for other peers, right? So we grew at 2.6% on top of a lower decline in the last quarter. And that's the reason why you're seeing over the peer level numbers higher than what you're seeing for us. We continue to see good demand across the board, across our clients, across geographies actually also. The demand continues to come from both service transformation and digital transformation as well as digital foundation deals we were facing across our clients. More importantly, we are also seeing good deals coming in some of our vertical propositions like payments and open banking. Our pipeline continues to be good. So I think the growth that you're seeing, 2.6%, you have to keep at the back of the mind that we had a sharp -- less sharp decline last quarter versus some of the peers that were there. And therefore, the number is 2.6%, is on top of that lower decline last quarter.
Sure. That's helpful. And CVK, the other question is on DWS acquisition. So if I exclude the last 12 months, I think growth rates of this company before were quite strong. So is it safe to assume that COVID has resulted in the hit on last 12 months revenue? And second part is, what -- if you can throw some more qualitative color on the nature of services provided by this company, it will be very helpful. And lastly, on the valuation of it, I think you seem to have acquired this entity at quite an attractive valuation, if let's say, if it's a fast-growing entity in the digital services, can you give some color on how you are able to acquire it at such an attractive valuation?
Yes. So first is the nature of services are largely application services. And in the application services, a lot of consulting work, especially in the government segment, that's the biggest differentiator why we wanted to acquire this company. And because if you see in Australia, the government is a big spender, and we are not there meaningfully in that segment. And to really participate in any meaningful manner, having a strong client base and references and teams which have engaged with these clients will be very helpful. So that's one of the drivers, and that could be the primary strategic rationale, apart from a little more benefit on localization and driving the localization in that geography. In terms of growth, of course, I think this company, while it has grown well in the last few years, there are clients who are looking at a global delivery model and some of those aspects. A couple of clients who are the nongovernment clients, they have slightly scaled down work or looked at some global delivery options. So we thought that will be a good opportunity for us to be providing more holistic services for these clients. And the valuation is driven by the growth and the margins. Obviously, the service portfolio is very attractive, but growth and margins are what it is. And that's the reason whatever valuation survey we came up with, it's still a good premium over the prevailing stock price, like it's a publicly traded company.
The next question is from the line of Sandeep Shah from Equirus Securities.
Congratulations on a good execution. Just on the product side after completing 4 quarters, any experience to share in terms of some of the low growth products like Lotus Notes and Domino's, after coming into brand of HCL Software, what exactly are we doing in terms of regaining the wallet share there?
Darren, would you want to cover that?
Sure. No, it's a great question. In a product like Domino, it's hard to give just one simple answer because there are a lot of different dynamics. Since we first got involved with the product, we've had 2 major releases. So we released Domino Version 10, we released almost a year ago now, Domino Version 11. What we've also done, start repositioning the product, modernizing the underlying architecture and building adjacent product components. And so for many of you that are familiar with Domino, the first thing you think of is e-mail. Well, when you really look at how large enterprises around the world are using Domino and driving value from it, a much higher percentage are actually in the workflow applications. It's the applications for supply chain, for HR processes, for other internal operations. That tends to be the most sticky use case and the highest value use case for Domino. And so we've also pivoted in terms of really focusing on those capabilities and that value proposition. And so given that it's such a large product with such a large customer base across so many different markets, again, to give you a summary of some of the key learnings, certainly, and it probably goes without saying, we have faced headrooms in some pockets of this product portfolio. Especially as it relates to many e-mail customers and the demand that we've seen around the move to Office 365. And so where we've really seen the opportunity, both for long-term stability as well as growth opportunities around some of those areas that I mentioned. So we rolled out earlier this year, a new product component called Volt. Volt actually is a low-code tool that runs on top of Domino. We sold it over to 100 customers in the first 6 months. We have some other new announcements that will be coming out later this quarter. And so again, if I'm trying to give you a balanced view, there are definitely some geographies where we're on defense with the portfolio. There are other geographies, markets like Japan and Germany, markets across Latin America, few other European countries, where we see very stable performance and even some limited pockets of growth. So I'd say it's a work in progress. There are headwind areas, and then there are other areas where I think we're seeing really good adoption of customers embracing the vision and sort of the new innovation that we're bringing to that product portfolio.
Okay. Just, CVK, in terms of the digital acceleration, the kind of understanding we are getting in the first phase, it would be more about cloud migration, which may continue for another couple of years. And thereafter, it may be more about the application modernization across the landscape. So are you believing that in the second phase also HCL Tech will be able to compete and get its wallet share? Or you believe the growth rate should be higher in the first phase for us versus in the second phase because we are slightly a late entrant in terms of the application market?
Well, I don't think this is a sequential equation because, of course, cloud migration is the first step. And then as a part of cloud migration, customers could look at application modernization. And so it could happen along with cloud migration. But irrespective of cloud migration, the opportunity in application modernization is very, very strong. And we continue to do very well in that space. If you see our Mode 2 has grown 6%, almost 15% year-on-year. And I think we are -- I mean, even in a lot of large clients where we are not an existing provider, we are coming in as a challenger, and we are seeing good wins. Even though some of this starts as a smaller engagement, but very good client recognition and good opportunity to scale the business. I would say that we are equally bullish on both opportunities as we move forward.
Okay. And just last, as feedback, I think free cash flow now being at a new normal of $1.8 billion to $2 billion. I think committing a 50% payout should not be a difficult task for the Board because still you will have an idle cash of close to around $500 million to $1 billion to address the M&A opportunity, unless at a Board level, we keep discussing a large size M&A as a whole.
I think we will come back -- sorry, Prateek, you go ahead and answer. Go ahead.
No, no, I will just take the given feedback, feedback taken.
Okay.
Ladies and gentlemen, that will be the last question for today. I now hand the conference over to Mr. C. VijayaKumar for closing comments. Thank you, and over to you, sir.
Yes. Overall, we believe we are in a very strong position in addressing the market opportunities that are evolving. We are very happy with our continued consistent execution, which has happened over the last 4 years and it continues even in this difficult environment. So thank you for joining the call, and have a good evening.
Thank you very much. Ladies and gentlemen, on behalf of HCL Technologies Limited, that concludes today's conference. Thank you for joining us, and you may now disconnect your lines.