HCL Technologies Ltd

NSE:HCLTECH

Earnings Call Transcript 2022-Q3

[Operator]

Ladies and gentlemen, good day, and welcome to the HCL Technologies Q3 FY '22 Earnings Conference Call. [Operator Instructions] I now hand the conference over to Mr. Sanjay Mendiratta, Head of Investor Relations. Thank you, and over to you, sir.

[Sanjay Kumar Mendiratta, VP & Head of Investor Relations]

Thank you, Aman. Good morning, and good evening, everyone. A very warm welcome to HCL Tech's Quarter 3 Fiscal '22 Earnings Call. I trust you all our safe and in good health. We have with us today Mr. C. VijayaKumar, CEO and Managing Director, HCL Tech; Mr. Prateek Aggarwal, our Chief Financial Officer; Mr. Apparao, Chief Human Resource Officer; along with the senior leadership team, 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 statement that may be made in 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. Over to you, CVK, and thank you.

[C. VijayaKumar, CEO, MD & Director]

Thank you, Sanjay. Good evening, and good morning, everyone. Happy New Year to all of you. I wish you a lot of health, happiness and prosperity in the new year.As we start the year, I am very grateful for the dedication, passion and service of all the HCLites across the world, who continue to do a tremendous job taking the company higher and further, despite the continuing pandemic. I'm delighted to share that Q3 fiscal '22 has been a spectacular quarter for us with a very strong revenue growth, sustained margin performance and continued momentum in both bookings and pipeline, reflecting in our overall strength in the market. We had a fairly-large ramp-up, in terms of our talent, in the last quarter. We continue to invest in training to gear ourselves to address the current and future demand. Our employee brand has been very strong. That's been one of the very important aspects, along with the talent strategy, which has helped us attract a significant number of digital talent over the last 12 months. Our new-gen services, like digital engineering, cloud transformation, application and data modernization, were the top themes in this quarter. We had some great success in our Products and Platform business, both renewals and new licenses. Overall, growth has been broad-based, with momentum across all geographies, segments and all the industry sectors. In terms of numbers, our revenue grew 7.6% sequentially and 15% year-on-year in constant currency. We exceeded our expectations, but I always believed that we had the potential to achieve these numbers. In fact, this was the highest growth recorded in the last 47 quarters, and that, too, on a significantly large base, which is today almost 4x larger than what it was in 2010. The growth momentum was fueled by both our Services business and the Products and Platform business. Our rupee revenue grew 8.1% sequentially and 15.7% year-on-year. Our operating margin saw a small 5 basis points increase coming in at 19%. We signed 8 net new large services deals and 8 significant product deals across the geographies and the industry's sectors. We continue to impress our clients with the capabilities, which is resulting in a number of incremental small deals in our existing clients, which helps us to continue to grow our top clients. Our net new booking remains strong at $2.1 billion, which is 64% year-on-year increase. And there are also a lot of deals that are coming in, as what we call as [ rate card ] deals, which don't get quantified until we start delivering them. When we add renewals of existing contracts to the above, we see a good growth momentum in the medium term. Our client additions has, again, been spectacular across all categories, reflecting a strong demand as well as strong relevance of our offerings to our clients in this fast-changing world. Our $50 million clients increased by 11, $20 million clients increased by 13, and we added $51 million clients in the last 12 months. Our Mode 2 offerings grew 30% year-on-year and 6% sequentially in constant currency. Our pipeline is very strong. It's reflective of the demand environment. The pipeline is broad-based across all dimensions, service lines, geographies, verticals. And even if you take a cut of large deals and midsized deals and small deals, it looks quite balanced. Let me provide some color on the segments. Engineering and R&D Services led the momentum with the robust 8.3% sequential and a 19.7% year-on-year growth in constant currency. Our IT and Business Services delivered 4.7% constant currency growth, sequentially. Cloud is a very important thing, which is driving a lot of growth in the IT and Business Services. Cloud in two shapes, one is rehost and replatform, which is predominantly moving existing workloads to cloud. The second aspect is -- it's again a part of the migration to cloud journey, which is really modernizing applications and data. And the third element is building more innovations, once you are in a cloud platform. We participate in all the 3 areas, in a very strong way, and this is continuing to drive good acceleration in this business. Overall, our Services business grew 5.3% sequentially, on top of the 5.2% in the previous quarter. If you look at our Services business beyond the numbers, there are a few trends that stand out and worth talking about. One, we are seeing relatively smaller but faster deal cycles in the Digital business, which is reflective of the quick wins that the clients are looking for, especially in the front office transformation, especially in industries which were not very quick in adopting digital transformation in the last 3, 4 years. They're really accelerating that journey. Then there are opportunities that are also opening up, as our clients are facing talent supply gaps within their own organizations, leading to extension of outsourcing deals, with newer scopes, particularly in the digital deals. For example, we entered into an engagement with a leading Swiss-based financial technology firm to help their global client base meet their digital transformation and cryptocurrency adoption needs. The second trend that we are seeing is -- we're seeing a lot of momentum in our Engineering and R&D business, led by IoT and Industry 4.0 semiconductors and telecom sector transformation. For example, our leading U.S.-based telecom service provider signed a deal with HCL for network quality engineering to enhance customer experience, reduce cycle times and optimize their cost structures. We continue to see this as a business that will play a significant part in our medium-term growth. We continue to look for companies that can add to our engineering and R&D services capabilities and the growth story. As you would have seen, we just announced the acquisition of Starschema, a leading provider of data engineering services, based in Hungary. Starschema provides consulting technology, in managed-services fashion, in data engineering to some of the large G2000 companies. The acquisition combines Starschema's high-value capabilities and data-focused expertise with HCL's existing presence in industry segments, undergoing data-driven transformation. In addition, HCL will strengthen its position in data engineering, which is an integral part of the company's digital transformation and engineering capabilities and next-generation offerings. The third aspect is cloud. Cloud has become one of our key deal catalyst across segments, representing dominant winning outcomes. For example, a U.S.-based global life sciences company chose us for large cloud transformation engagement through our HCL SmartOps solution. Underpinned by our differentiated-ecosystem partnerships with all the top hyperscalers, we've been able to penetrate into new accounts, across sectors, with our cloud offerings. This quarter, we expanded our capabilities in this area by scaling our AWS business unit, significantly. We're also building deep domain and sectoral capabilities under CloudSmart offerings. This quarter alone, we saw the CloudSmart team launched more than 40 new solutions. Coming to our Products and Platform business, it came back very strongly with a constant currency revenue growth of 24.5% sequentially and 8.2% year-on-year. From a revenue perspective, while all the products did well, we had some excellent growth in commerce, digital experience, which is HCL DX, marketing with HCL Unica, and security offerings, which had some very good wins during the quarter. Despite the pandemic representing a challenge, as clients are diligently making consolidated platform investments, we are noticing a consistent growth in companies partnering with HCL Software as a very reliable and a client-friendly enterprise software product partner of choice, to help accelerate their digital transformation.The Products and Platform team delivered 1,500-plus product releases since its inception, and it enjoys an inspiring Net Promoter Score of 70-plus, and that with a massive base of 15,000-plus clients. This is a testament to the solid product performance, product innovation and the support reliability we continuously deliver to our clients. Our Product business is now close to $1.5 billion. And today, HCL Software is well positioned as a reliable and a client-friendly partner, for iconic brands and large global corporations, to leverage our products in their digital transformation journey. In terms of verticals -- in terms of geographies, Europe led the growth at 9.1% sequentially, followed by Americas at 7.3% and ROW at 4.5%. All our verticals showed high growth momentum from mid-single digit to high teens growth rates. Leading the pack was Technology and Services segment, which posted 14% sequential growth, followed by Retail, CPG and Telecom & Media, both of which grew double digits, sequentially. All our verticals grew in double digits year-on-year, with Life Sciences and Healthcare leading the pack with a 21% year-on-year growth. We continue to see healthy growth in geographies that we had called out as focus in new frontier countries. Our investments in these markets are continuing and are getting into a complete structure with a right-sized sales, sales support and delivery organizations, locally. Coming to the subject of talent, at HCL, while we continue to onboard experienced domain and tech specialists, our strategy continues to lean more towards adding net new talent at scale through the fresh talent coming out of colleges and schools. Last quarter, our net addition was 10,143 people. Helping us on this mission are programs, which have deep roots already because we started on the talent journey much ahead of the demand cycle. Initiatives like [indiscernible], New Vistas, global apprenticeship programs and scaled upskilling and reskilling programs, along with our value proposition for our employees, continues to position us very strongly for the future. We are in line to achieve 20,000 campus-hires target for this fiscal, having added more than 15,000 year-to-date. This has been made possible by a robust enablement process, created for the campus [ till company ] life cycle and a strong brand that attracts college graduates to build their career HCL. We intend to double our [ fresher ] hiring in the coming year, induced by the good demand environment that we are seeing all around. Our campus hiring program in some of our largest markets, like U.S., are also accelerating, with plans to hire over 2,000 graduates in the next 2 to 3 years. We also had a reasonable attrition number. It is 19%, on an LTM basis. It is higher than what it was in the last quarter, but we expect this to continue for some more time before it moderates. Our LTM attrition numbers may go up before moderating. In addition to all the recognitions that we've received in the global press over the last couple of years, like top 30 global employers, also the top-ranked professional services firm, globally, by Forbes. Recently, Avasant and Everest both published their reports, where they've named HCL Technologies as a leader in talent readiness and digital [ talent ] capabilities. We continue to accelerate our ] program, which is designed to establish innovation and delivery centers in emerging cities across the world. We've also seen an increase of 20% in our new Vistas headcount in India. While countries like Sri Lanka, Vietnam, Costa Rica, Romania continued to expand and scale. We also opened a new center in Hartford, Connecticut in the U.S., this quarter. This facility serves our flagship client, Stanley Black & Decker, as well as several others in the Northeast U.S. and will expand to support clients across industries, including manufacturing, aerospace and defense, insurance, life sciences and health care, supported by a smart manufacturing lab. Let me also cover another important topic on ESG before I move on to the outlook. Guided by our mission of enabling harmony between people, planet and prosperity, we, as a company, have announced a pledge to limit our greenhouse gases emission, aligned to a 1.5-degree pathway by 2030 and to reach net zero by 2040. This is our big step forward on contributing towards global effort on combating climate change, and one that we will keep all of you posted, as we progress. Looking ahead, we remained optimistic about the demand environment. And also feel very confident of our propositions and their client relevance as well as our talent supply capabilities. So looking ahead, Q4 is a seasonally-weak quarter for our P&P business. We had, earlier, guided for 0% to 1% growth. We stayed with that growth. So you will see the numbers in line with 0 to 1% growth for the P&P segment. On the Services side, we've grown 5.2% in Q2, 5.3% in Q3. We continue to see strong momentum in our engineering and R&D services, in IT and business services. Our ramp-ups continue to be over 10,000 people, every quarter. So we remain positive about the growth on the Services side as well, in the quarter 4. So overall, we remain very enthusiastic and very buoyant about the market opportunity, while remaining a little cautious on the new versions of the pandemic, for which our global BCP and HR systems remain on standby, and they're well prepared to address any escalating challenges. With that, I wish you all a great year ahead. And I will hand it over to Prateek to provide more color on the numbers. Over to you, Prateek.

[Prateek Aggarwal, Chief Financial Officer]

Thank you, CVK, and good evening, good morning, good afternoon to wherever in the world you are. And also, a very Happy New Year, Happy Pongal, Happy [indiscernible] and [indiscernible] to all the people, who are celebrating the festival season. It is a new year in many ways.Going on to the numbers, giving you some more details. Services growth has, again, given a 5% plus sequential growth for the second quarter running, the quarter -- this quarter is 5.3%, which is on the back of 5.2% last quarter. And on a year-on-year basis, it's a 16% year-on-year constant currency growth. P&P segment delivered a very strong 25% growth, on a sequential basis, in constant currency, using the seasonal tailwind and recouping the last quarter [indiscernible]. On a year-on-year basis, in constant currency, the growth has come in at 8.2%. To give you a quick overall company overview, the company revenue stood at $2,977.5 million, almost close to $3 billion, 6.7% in U.S. dollar terms, sequentially and 13.8% in -- on the year. And in constant currency, 7.6%, 15.0%. You would have seen all that. The other number to look at is EBITDA. In U.S. GAAP, EBITDA is 23.4%, but the more comparable number, which is IFRS-comparable, Ind AS-published EBITDA is 24.2%. That is the difference in the [ GAAP ] of about 80 basis points. That's the more comparable number. The Q3 EBIT is at 19%, which is basically flat -- flattish versus last quarter. It is 5 basis points up. On a year-on-year basis, it's 3.9% down. Net income for the quarter was 15.4% of revenue, coming in at INR 3,442 crores. There is an asterisk that we put there to explain the -- last December quarter, there was a one-timer benefit that we had on the tax expense line, which was a significant $59.4 million, due to a reversal of prior year provision. If you exclude that, the profit after tax for this quarter, is down about 4.7% year-on-year in dollar terms. In rupee terms, it is down about 2.9% year-on-year, which is basically coming from the EBITDA and EBIT line. The key metrics for the quarter. The deal wins, $2,135 million TCV. Towards the end of this commentary, I will walk through some more details about how we, sort of, categorized and qualified and mentioned the TCV. We will give you some more details around that. This $2,135 million, on a year-on-year growth basis, is 64%, which comes on the back of 37% -- [ 39% ] growth in the previous two quarters. This is further backed by strong net hiring, in this quarter, of 10,000-plus employees. And in the last 3 quarters, that brings the total up to almost 29,000 employees, and third-party contractors are on top of that number. Better account mining has resulted into addition of one customer, sequentially, in the 50 million-plus category and 11 on a year-on-year basis. So that's a very healthy, large client growth, as you can imagine. Just a quick word on the effective tax rate for this quarter. It is about 22.5%. And for the full year, given that we have 3 quarters actuals, we expect to land up in a narrow range of 21.5% to 22% expected tax rate for this fiscal year. Margin work is something important to discuss, and I'll put it a little simply so that it's easy to understand. The overall margin, at company level, has remained flattish, like I said, at 19%. The Services margin, however, has dropped by 190, 1-9-0, basis points, from about 18.9% last quarter to 17% this quarter. P&P margins have, obviously, offset that and that solid revenue performance, except for the higher amortization cost, which is linked to the revenue. The rest of it is pretty much flown down to the EBIT level. So I will give you the Services margin walk rather than going in for the total company margin walk. So 190 basis points is what I'm basically explaining here. There are 6, 7 -- 5 or 6, 6 factors that I'm going to call out. Number one is, we gave the second phase of the increment -- salary increments, this quarter. That took away 80 basis points from this quarter's EBIT. The second factor was the seasonal leads, that is our impact of about 65 basis points. And this is basically a seasonal impact, which should hopefully come back next quarter because it is related to the Christmas break and the Diwali holidays and the Thanksgiving holidays and so on and so forth. The third factor is we had a bunch of customers, new customers, where we are ramping up, and there is knowledge-transfer cost that we had to incur, which was not payable by the customers and we had to take that hit, and a few other investments that we had called out at the beginning of the year. So the total of that was about 40 basis points. And the fourth aspect was basically, the retention and attrition costs, so targeted retention for the people who are with us, higher backfill for the people who -- backfill costs for the people who leave us, higher bonuses to be paid, higher recruitment costs and all of that. So that is the supply-side issues that the whole industry is facing, which we are also going through. That factor alone amounts to about 85 basis points on the quarter. And the -- so these were the 4 main hits that we had to -- which were headwinds, during the quarter. And the last two factors were really the positives. We got 60 basis points positive impact from operating leverage, basically, from the sales, SG&A expense and D&A, depreciation and amortization. So that was a positive 60 basis points. And exchange also helped to the extent of about 20 basis points. So that is how the 190 basis points reduction in the Services business breaks down. The guidance remains at double digits. I know some of you have questions about double digit. Double digit is -- does not mean any specific number. It is a range, which obviously goes -- it's a wide range. But double digit is what we have maintained right from the beginning, and that's what we are maintaining on the top line. On the margin guidance, most of the stated above in the margin [ walk ], will remain there for some time and are expected to recover in the next fiscal. Only the seasonal-leave impact of 65 basis points, is what is expected to come back in the next quarter. The rest will probably take some time. And therefore, the full-year EBIT margin is now expected to be around the lower end of our guidance, of 19%, given earlier. Having said so, I must also point out that given the growth momentum in the market, which we are obviously chasing, and the supply chain challenges that we are wading through, if required, we won't hesitate in investing or spending extra, even if that means that we might have to come in 10 or 20 basis points lower than the 19% mark. I just want to say that, so that the expectations are clear, going forward. Moving on to the cash generation and cash conversion. OCF was $584 million, $130 million more than last quarter, so was free cash flow, healthy $520 million. Being OCF was 128% of net income, and free cash flow was 1-1-4, 114% of the net income. And on a last 12-month basis, for the calendar year, OCF is at $1.95 billion, close to $2 billion, being 117% of net income, and free cash flow is at $1.7 billion, which is 102% of net income. Our balance sheet remains strong, with gross cash of $2.7 billion and net of $2.14 billion. And you should remember, this is after 3 significant cash payouts that we had during the quarter. First of all, there were the additional dividends we paid out, INR 10 per share, versus the old INR 6 that we have been following before. So that took away $146 million of extra dividend payout during the quarter. And the second was, we paid for 19.6% remaining stake of Actian, and there was $100 million that we spent on purchasing that. And the third aspect was, pursuant to the RSU plan, we did purchase the trust, the ESOP trust, purchased back from the secondary market, treasury shares of roughly $95 million. So all this put together, is $341 million, which is -- and the gross and cash net position is virtually the same as last quarter, just $30 million lower after having spent this $340 million extra. Just a few other updates. The last 12-months diluted EPS is at 47.5. This is leaving out the Milestone bonus, which was a one-timer, which we had paid in January of last year. And the dividend declared for this quarter, continues to be at INR 10 per share, being the 76th consecutive quarter of dividend payout. As already mentioned, 5.5 million shares, 55 lakh shares, were bought through the stock exchanges, 495 million on 24th of December, for the purpose of the implementation of the RSU plan. And as already CVK mentioned, we have acquired a new -- announced the acquisition of a new company called Starschema, which is a Hungarian company, limited liability company, and we will be paying $42.5 million for the acquisition, which is in the data engineering space and also helps us set up -- accelerate our Eastern European or nearshore presence on -- in the right areas of data engineering and digital engineering, which are all Mode 2 services. This transaction is expected to close by March. And that's the -- some [ in-substance ] of the update I have with you -- for you today. Thank you very much. Operator, back to you.

[Operator]

[Operator Instructions] First question is from the line of Mukul Garg from Motilal Oswal.

[Mukul Garg, Research Analyst]

Congratulations on a great growth quarter, CVK. So I had two questions from my side, one each for CVK and Prateek. .CVK, if you look at the P&P business, if you could just help us understand the growth profile during this quarter, there was some slippage last quarter. How much of the growth was rated because of that? And what portion is due to the increased sell-through you are seeing at new clients? If you can also help give some sense of how to see 2022 for the vertical, especially given that like when you don't have a leadership in place right now? The second question for Prateek. two-part question, Prateek. On the margin side, if you look at the IT services vertical, the margin dip was a bit unusual, given that, historically, you have been able to absorb the wage hikes. Given the supply challenges, what levers do you have to return to the 19% type of margins for IT services vertical? And are the margins for P&P seasonal? Or do you expect them to stay on 30%, 31% levels?

[C. VijayaKumar, CEO, MD & Director]

Thank you, Mukul. Let me address your first part of the question. This is on the P&P growth. Yes, we called out close to $20 million of deals, slipped in the last quarter. So most of it came in, in this quarter that, of course, caused one important incremental revenue. But even outside that, we had a pretty good growth in this quarter for the P&P business. It's been led by a lot of new wins, many of them, we've worked through the last year and built strong value propositions, the most proof-of-concepts. And usually, they get concluded in December. So that's what happened. So we were very happy, and we came in a little better than what we expected. Now, in terms of the growth profile, I've always said that this is a very strong business, in terms of the stickiness of the clients and the quality of the products that we have. And there is a tremendous amount of innovation that we have done on these products. Many of them are finding very good acceptance. Like the newer versions that we launched in DevSecOps and the newer versions that we launched in some of the containerized version of the products, they have seen some good traction in this quarter. So some of them are still small in their base, but they offer a pretty strong growth potential in the future. So we have to interpret that in terms of two dimensions. One is the renewal rates and other one is the new license growth. I think we have a good grip on the renewal rates, and we will start disclosing the renewal rates, starting the next fiscal. And we will also overlay it with the new license. And maybe we intend to also provide you a group of 4 or 5 product teams, around which the revenue is built up, which will give you a good perspective to create a good growth model. At this point, I'm not giving any commentary on FY '23 .And leadership, we have a strong leadership. This team had a good leadership within the team, and we have an interim leadership, who is -- who are running and executing very well. We will have a new leadership structure in the next few months. I don't see that impacting growth because we have some interim model in place. And it's taking a little more time from some of the other leaders to manage it, but we're not going to let that suffer -- with the growth suffer due to that aspect.And Prateek, over to you for the second question.

[Mukul Garg, Research Analyst]

Before Prateek, maybe just a clarification. Are the growth challenges, which we saw last quarter, which due to -- bring your guidance down to 0 to 1 behind us? Or we are still facing them?

[C. VijayaKumar, CEO, MD & Director]

Yes. See Mukul, there was very -- one important aspect of this business is, there is close to 50% of new license sales for the quarter happens, in the last peak of the quarter. That is the nature of the business, and I think it's true for a lot of companies we sell software licenses, and they have a perpetual licensing model. I think this is the nature of the business. So that can swing either way. And for example, this 50% new license in the last week, can have a 10% to 15% impact on our overall revenue for the quarter. So a 5% growth quarter could become minus 10% growth quarter, but they will come back because it's just a matter of timing. So there is this one aspect we have to keep in mind, based on the experience that we had in the last quarter. We the data over several quarters. And this kind of fluctuations can happen in this business. And right now, I'll stay with the 0 to 1% growth that we had guided for, and I'm not changing anything at this point. But next year, we'll give you more data points to help you create the right model for this business.

[Prateek Aggarwal, Chief Financial Officer]

So Mukul, you had two-part question for me. The first part being on the ITBS business, where obviously the margin drop has been the highest. And you are right, typically, the absolute volume of the wage hike, we have, typically, been able to absorb over a period of 1 or 2 quarters after the hike. But this year, obviously, it's a very different supply situation out there. And therefore, it's not like normal year.To your question about levers, going forward, obviously, we would like to return to those 19-ish kind of margins like we had last quarter. But it would take time, like I said earlier, and there are various levers. Obviously, automation and other productivity measures are the biggest levers. But at this point in time, particularly for the higher-end work and the work which is usually given out as T&M rate card basis, we are approaching our customers to get some higher rates for the services that we provide. Over a period of time, the new geographies, the 7 -- plus 5, 7 new geographies, which we started, and the 5 focus geographies should, at some point, going into the next fiscal years' start, giving us some return on that investment. And this year has been -- as we called out right at the beginning, this year has been a year of investment and that should start yielding results, hopefully, in the next fiscal. Some of the -- like I explained, by going through the margins, I'll walk some of the things like seasonal 65 bps that should come back next quarter. There are some other things like new customer ramp-up and those kind of things. Typically, for those customers, we'll come back next quarter. But given the growth phase that we are going through, there will be -- I'm quite sure there will be some other customers for which we might have to incur that kind of start-up ramp-up cost. So those -- see the growth that we are obviously chasing and getting, has its own cost, and these are some of those costs, which are exacerbated at this point in time because of the supply side situation that we have as an industry. So that combination is what is affecting the margins a little bit. P&P margins. No, you should not assume the 32% will continue because you should -- realistically, you should look at the last 12 months, and that is the right expectation to set, going forward, as well. I would not -- this quarter is, obviously, there is a much higher revenue, most of it is slowing down through to the EBIT/EBITDA, which I pointed out while I was giving my commentary. So definitely, don't take this quarter's EBIT percentage as their benchmark, going forward.

[C. VijayaKumar, CEO, MD & Director]

Prateek, just one more thing I want to add, is the whole lever of freshers. As I mentioned earlier, we intend to double the freshers intake in FY '23. That, while it creates a cost bump for some time, it should eventually help us to increase the percentage of freshers versus laterals in the gross hiring numbers. So that would also be margin levers.

[Operator]

The next question is from the line of Ankur Rudra from JPMorgan.

[Ankur Rudra, Research Analyst]

Great quarter. Great execution here. The first question, CVK, clearly, we seem to be in a very strong demand environment and appears to be a market dominated by smaller deals. How is HCL positioning its sales funnel to capture more of these type of deals versus historical abilities? And are you making any changes to your medium- to long-term strategy to maintain this growth momentum, going ahead?

[C. VijayaKumar, CEO, MD & Director]

Ankur, thank you. So I think the pipeline has a good mix of large and small deals, though the skew towards smaller deals is a little higher. So basically, there are 2 -- traditionally, our engineering and R&D services had a very large number of small deals, which really contributed to the growth. So there, I think, the trend is continuing, and it has nothing changing, and the team is well equipped to deal with it. And a lot of IT services had several large deals. We still have several of them in the pipeline, but the volume of small deals has gone up, and that's being handled by augmenting our client-partner teams, significantly, including some amount of the [ COEs ] and the solutioning teams getting dedicated to several accounts, to kind of ensure that the solution and the proposal, all of that are done in a nice way for our clients. So it's really rebalancing some amount of Center of Excellence and delivery and client-partner teams to really handle the volume. I think the large deal momentum are caused by the cost-led proposition. I think it's still intact. Maybe you don't have $1 billion deals or $500 million deals, but there are several $100 million, $200 million, $300 million deals in the pipeline, which are either the large product-outsourcing deals or end-to-end integrated infrastructure and application-outsourcing deals. So those -- flavor is still existing, and it's definitely not -- that it's all only small deals.

[Ankur Rudra, Research Analyst]

Understand. And how do you feel about -- like we've obviously had very impressive TCV numbers for the last 4 quarters, but it seemed like it took us a while to see the growth pick up. Where you are, right now? What's the confidence of maintaining this sort of momentum, going forward, across your Services business units?

[C. VijayaKumar, CEO, MD & Director]

So Ankur, I think the best leading indicators are the TCV win and the net hiring that we are doing. I think, as you have seen the trend, and that's reflecting, like we've grown about 5% in headcount in the last 3 quarters. And our revenue is also growing in that range in the last 2 quarters. So I see that to be the right indicator, as long as the growth in the total TCV that we are winning. So overall, positive, and it's one of the best demand environments that we've seen. And a lot of programs -- we've been doing a lot of stress testing to see the longevity of the demand, and we feel pretty comfortable that a lot of this work is going to be around for at least a couple of years.

[Operator]

The next question is from the line of Sandeep Shah from Equirus Securities.

[Sandeep Shah, Director of Research]

Just a question about -- CVK, a few quarters back, you made a comment that FY '23 could be better than FY '22. Can you throw some color, in terms of where are we standing, both for Services business as well as Products and Platform, you said we may return because this is a year of investment. In FY '22, we may return close to mid-single digit to high single-digit growth in the Products, in FY '22?

[C. VijayaKumar, CEO, MD & Director]

Yes. Sandeep, yes. Okay. Let me first address the Products and Platform. Yes, this was a year where we scaled up our sales teams and that's showing very impressively in the bookings that we could deliver in the most important quarter, which is the O&D quarter that went by. So we expect some of those investments to start delivering results, even in the subsequent quarters. And as the composition of mature products or declining products go down, I think the growth profile of this business, fundamentally, will change.And we will provide you more metrics in the next quarter, which will help you model it. And in terms of overall FY '23 versus FY '22, I think when I talked about it, our FY '22 growth was at a certain level, and now it's significantly higher. So I cannot comment on it now. We have to do a detailed planning. And the leading indicators are booking and headcount additions, that's what you should go by. And if there is any more update, we'll let you know in the next quarter business.

[Sandeep Shah, Director of Research]

Okay. And just a question to Prateek. Prateek, what I understood is, this year, we are seeing -- we may be 10 or 20 bps below the lower end of the guidance and EBIT level at 19%. So that means we could be at 18.8%, 18.9%, if required investments are there. So that's [indiscernible] fourth quarter margin, could be actually lower by 50 to 100 bps, on a Q-on-Q basis. Despite the tailwind of 65 bps, you are saying, we'll come back in the fourth quarter. So it would lead to almost like 80 to 140 bps kind of a Q-on-Q dip in the fourth quarter margin. What would lead this? What are the headwinds and the tailwinds? And is it the ESOP cost, which you are factoring as an incremental headwind in the fourth quarter and going forward? And some color on the ESOP cost for coming quarters as well as FY '23, '24 as a whole.

[Prateek Aggarwal, Chief Financial Officer]

Sure, Sandeep. So first of all, I think you have to take the seasonality of P&P out. And like I explained, when I talked about margin walk, the P&P business, at the company level, has given something like 170, 175 basis points. And that has offset the negative of 190 basis points, on the services side. So the benefit of that 173, not the entire 173, but a smaller number, will be going into the next quarter. I mean, I don't remember what the margin for the March quarter, in P&P, last year, was, but this is a year-on-year business. The margin for next quarter will certainly, not be 32% like this quarter. So the right way to look at next quarter, is to look at the Services business, and that is why I broke out the Services 190 bps in that much detail, so that you understand that next quarter could be lower. We would certainly try to keep it at 19% and beyond. But if the environment requires both on the demand side as well as on the supply side, then I just wanted to clarify that our guidance remains at 19%, 19% to 21%. And that is what -- I repeat, that is what we would certainly hope to achieve and target to achieve. But we still have 3 months to go. And if the situation warrants and requires, we could come down to that 18.9 or 18.8, on a full year basis. And you can do the math, whatever it means for the balance, that's simple to calculate.

[Sandeep Shah, Director of Research]

Yes. And comment on the ESOP cost?

[Prateek Aggarwal, Chief Financial Officer]

ESOP, there is no -- I mean like we had said, when we went to the shareholders, very clearly that ESOP is something which is part of the LTI plan that we have, and we are just converting about -- roughly about 30% of that cash element, we are converting into these RSUs. So ESOP is not something which is really an incremental cost per se. There could be some quarter-on-quarter swings, but that's not something which is really making a huge, new thing.

[Sandeep Shah, Director of Research]

Okay. And sir, last related question. You also made a comment, Prateek, that FY '23 guidance band on margin of 19% to 21%, can have an upward bias. So is it what we try to indicate?

[Prateek Aggarwal, Chief Financial Officer]

I am sorry, are you talking about FY '22 or FY '23 now?

[Sandeep Shah, Director of Research]

FY '23. Because in your comment, you said that the guidance band of 19% to 21% for FY '23, may have an upward bias because of the investment and the growth momentum we foresee. So FY '23 could be a year of yielding results on the investments.

[Prateek Aggarwal, Chief Financial Officer]

So Sandeep, we are definitely not giving any guidance for FY '23 at this stage. We'll come back 1 quarter later in April and give you the guidance for next quarter or whatever we decide to do at that point in time. But what I said was more a directional kind of a thing, which basically -- I mean, there is a reason why we are investing. And it has a lead time. And at the beginning of FY '22, we did mention that this is an investment year. And I think we are investing at the right time, because when the demand is there, if you don't invest then when are you going to invest? So we are investing at the right time. And we certainly hope that we'll start getting the payback of those investments, hopefully, in FY '23. But at this moment of time, I'm not giving a guidance.

[Sandeep Shah, Director of Research]

Congrats on good set of numbers.

[Operator]

The next question is from the line of Sandip Agarwal from Edelweiss.

[Sandip Kumar Agarwal, Vice President]

So CVK, I had one small question. If you see our business model, it is slightly different than the other companies in the sector, the companies which we compete with. I wanted to know, where do you see -- like I have generally seen that we have a long gestation period, when we start winning the deals and when they convert into revenue. So will it be fair to assume that after the kind of momentum we have seen in this quarter, we are broadly starting to see the momentum from here on? The reason I'm asking you this question, is because we have seen in the past that once our momentum starts, we start doing extremely well. And our growth picked up very substantially. And the first 8, 9 months of lag impact of the lower growth, actually gets steadily compensated in the coming quarters. So do you see that trend for us, going forward? Or do you think the growth will be volatile? And that the past may not be true for the future? How is the way you will put it?

[C. VijayaKumar, CEO, MD & Director]

Yes. Sandip, see, I think -- of course, the booking is the best indicator. But within the booking, there can be two types of deals. One is the large infrastructure-outsourcing type of deals. Then the other one would be your cloud transformation and digital and application modernization. A lot of product development and sustenance type of opportunities. The first category generally takes longer to realize revenue because of the transition and some of the data center migrations and things like that. The second category, all the 3 or 4 things that I called out, the conversion happens relatively faster. Now, the mix of this will determine the speed at which revenue conversion happens. And given the commentary that we already said, the smaller deals are more, you should see a slightly better conversion speed, compared to what you saw in the past. Then the rest has to be extrapolated, based on the net new TCV that we announce every quarter.

[Sandip Kumar Agarwal, Vice President]

Best luck for the current quarter.

[Operator]

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

[Mihir Manohar]

Congratulations on such a great set of numbers. You talked about your partnership with the hyperscalers. If you could throw some more light on that? And how should we see that partnership? And what kind of revenue could come in from that?

[C. VijayaKumar, CEO, MD & Director]

Yes. Yes. Thank you, Mihir. See, we were one of the first in the industry to build hyperscaler-specific business units, right? We were pretty much the first [ ASI ] to build global cloud ecosystem unit, Microsoft, AWS and even other large ecosystem providers, whether it is SAP, whether it is IBM, Dell, Cisco, we have dedicated units. The focus on an ecosystem as a big enabler for all of our segments, is very high, within HCL. This is led by our CTO, Kalyan Kumar, who leads the cloud and ecosystem units. And we go to market with them. They take us to a lot of clients. Of course, a lot of these opportunities come as a small stream of work. But depending on the quality of execution, they continue to stay and ramp up. So we see this as a good enabler for our growth, and we've been investing in it for the last 3, 4 years. Now we have a very strong ecosystem partnerships across hyperscalers and other takeaways.

[Mihir Manohar]

Sure. So -- I mean my understanding is that post the cloud adoption, this IMS would emerge as a strong opportunity, right?

[C. VijayaKumar, CEO, MD & Director]

Absolutely. Absolutely. I've always said that Cloud is a tailwind for the Infrastructure business, not a headwind. That's the broad theme. And we are continuing to invest and continuing to -- there's a lot more emphasis on building scale cloud-delivery capabilities because these cloud migrations, as it picks up speed, it really needs to be in a factory model. And we are continuing to build hyperscaler-specific migration and managed services factories to scale it, and we see that as a great tailwind for our business.

[Mihir Manohar]

Understood. Yes, sure. And just last question from my side. So I think there are some talks in the media regarding the bonus -- I mean employee bonus. I mean there's clawback on the bonus side for some of the [ retiring ] employees. If you could clarify? And what can be the margin effect because of that?

[C. VijayaKumar, CEO, MD & Director]

It's very insignificant, and this was really -- it was misunderstood. The annual bonus, which should have been paid at the end of the year, based on performance, it was a good employee-friendly practice, where we paid them in advance, every month. So this was there for a small set of employees, and we have taken some corrective steps as well, because in this environment, we wanted to be absolutely sure that we are doing everything to support our existing employees and former employees. I don't see any impact to our -- anything -- there's nothing meaningful to really call it out as an impact.

[Operator]

[Operator Instructions] The next question is from the line of Surendra Goyal from Citigroup.

[Surendra Goyal, MD & Lead Analyst of India Equity Research]

Happy New Year and a good quarter. So just a couple of questions. Firstly, your comment on P&P full-year guidance. It seems to imply a significantly bigger-than-the usual [ seasonal ] decline that one would expect in the March quarter. Are you just being conservative, given the inherent volatility or quarterly volatility in this business? Or is there any other reason for it? And secondly, one for Prateek. On the seasonal-leave impact point, was it something particular this year or maybe a bigger-than-usual impact this year? Because I'm not sure, if you have really called this out in the past?

[C. VijayaKumar, CEO, MD & Director]

Yes. Surendra, Happy New Year. Thank you for your question. P&P -- I mean, as I called out, there is a lot that happened in the last quarter of the -- last week of the quarter. So we guided for 0 to 1%. We will stay with that. It all depends on how the quarter progresses and what really gets converted in the last week of the quarter. That can make a difference either way. So we have just taken that into account to stay with the guided range. And Prateek, if you could answer the question on seasonality?

[Prateek Aggarwal, Chief Financial Officer]

Yes. Yes. CVK, before I answer that, I will just add that we had publicly said about the end of the [ DXC ] relationship on the [ Holden ] product. So that's the one more thing, which is affecting the P&P revenues. And that was one reason why we reduced our guidance, from the earlier guidance, to 0 to 1%. So that's one more aspect. Now coming to the leave part, Surendra, you're right. I mean, it's not hugely different from what happened in the December quarter, in other years. But other years, we don't have the supply-side situation like we have in the last -- in this year, and that is why it has not been easy to sort of absorb it amongst 10 or 20 things that are happening. So that's the reason. Even increments, like I mentioned earlier, I think somebody asked that question. Increments also -- we have been able to absorb over a couple of quarters, 3 quarters. But this year is different. It's just a very different supply-side situation that we are all facing.

[Operator]

[Operator Instructions] The next question is from the line of Kawaljeet Saluja from Kotak.

[Kawaljeet Saluja, Senior Executive Director & Head of Research]

Kawaljeet here from Kotak. Congratulations on a good revenue growth. But I guess, the question will not be on revenues, but on margins, which seems to be the area of focus for everyone. So Prateek, you did mention that -- in response to one of the participant's question that growth has a cost. So when you're referring to growth has cost, were you referring to pricing or some [ newfound ] aggression? Or what is related to, largely, transition costs?

[Prateek Aggarwal, Chief Financial Officer]

No, I was referring not to pricing. Pricing, in fact, as I mentioned, is one of the levers we are looking to absorb the cost increases. I -- what I was referring to, is knowledge transfer and ramp-up costs. For a lot of the new customers that we've won in the last 3 or 4 quarters, those ramp-ups are something which, in today's day and age, don't get paid upfront or even over the period. It takes a long period to, sort of, recover those costs, but you have to bear them upfront, and that is the lumpy cost that I was referring to.

[Kawaljeet Saluja, Senior Executive Director & Head of Research]

Yes. But Prateek, on the transaction , hardly, we had any mega deals in the last two years, and most of the deals are year 2 or $100 million to $300 million. At times, even lower than that. So shouldn't this transition costs be absorbed in the normal course rather than calling it out separately?

[Prateek Aggarwal, Chief Financial Officer]

Kawal, I'll just say that we have not seen this 5% on a sequential basis. That also -- continuous quarters, running for quite some time. Like CVK called out, it is after 47 quarters, 12-odd years, that we are seeing -- I mean, 7.6% kind of growth. So that is what is basically making it a little difficult to bear these costs. Not difficult in the sense -- I mean, that is affecting margins, which, we all believe, is the cost to be borne in the short or medium term. And over a longer period of time, we will definitely like to come back to our usual range of 19 to 21 kind of thing, which has not been possible in this quarter. It may take maybe 1 or 2 quarters, or maybe even 3 quarters, to come back to that kind of level, which we would, obviously, aspire to, work towards target. But can't commit to, at this point in time.

[Operator]

The next question is from the line of [indiscernible] from [indiscernible].

[Unknown Analyst]

My question is regarding -- it was mentioned that we are going to change the employee structure. Currently, we have very lower segment in the freshers. So how are we exactly planning, going ahead, that, currently compared to the existing employees? We do not have that kind of freshers, but we are gradually ramping up. So how is this going to benefit us, in terms of basis points, that we are considering for the overall margins -- in terms of EBITDA margins, in the periods that would come ahead?

[C. VijayaKumar, CEO, MD & Director]

Sorry, I don't think I fully understood your question.

[Unknown Analyst]

So what I'm basically saying. As we are -- retention and higher recruitment has kindly costed 80 basis points over the -- for the 190 basis points margin fall, in this particular quarter, in the Service segment. And we are planning for going ahead to increase the overall freshers that is currently not available in the employee structure. So how is it going to benefit? And to what extent we can see that, that would expand the margins or at least minimize the fall that we have recently recorded?

[C. VijayaKumar, CEO, MD & Director]

Yes. So it's difficult to kind of model it on this call. But the broad parameters that I can give you is -- when we hire freshers, they can become billable as early as 4 months to -- in some areas, it takes over 9 months. So you should take an average of 6 months of cost of freshers before they become billable. And when we double it, there is going to be an increase in cost, but it will eventually reduce the direct costs in the projects. So that's the broad model. And I mean, just to kind of -- since there has been a lot of questions on margins. I think, fundamentally, the industry cost structures are changing, right? I mean, we can have the fresher lever for some more time, but fundamental cost structures are changing. And I don't think it's going to normalize anytime soon. So the most sustainable lever that we believe, which will help us, will be to really get rate increases. And we are already -- we increased our price risk. We -- all the new bids going at a much higher price. We have approached all our clients. So I think clients are also responding quite positively. And that's where our maximum focus, from a margin improvement or a sustainability perspective. And we will continue to incur all these costs, whether it is freshers, some transition or some additional training, recruitment. These are going to be there for some few quarters. I don't see it going away. And we are constantly now focused on how to give better rates. I think, that's what the industry is doing across the board.

[Operator]

The next question is from the line of Abhishek Shindadkar from Intra Capital.

[Abhishek Shindadkar]

Congrats on great execution. I just have one question on the purchase of property and equipment intangibles, the 63 million payment in the cash. Can you just elaborate what -- on that item? And would that have any bearing on the growth of Products business, in this quarter?

[Prateek Aggarwal, Chief Financial Officer]

Thanks, Abhishek. That is the normal run rate we have, Abhishek. Across, most quarters, it is of the region of $60 million to $65 million. Typically, most of that tends to be IT equipment, either laptops, servers, and those kind of things. Sometimes, it has some component of facilities, but that has not been a large component in the last few quarters. But it is a typical, normal CapEx. It is not -- it does not include any intellectual property purchase or acquisition or anything like that.

[Operator]

The next question is from the line of Diviya Nagarajan from UBS.

[Diviya Nagarajan, Executive Director and Research Analyst]

Congrats on a very strong quarter. Most of my questions have actually been answered, so I'm going to ask one. CVK, I think we've seen these ups and downs on the software side. And I think, your earlier commentary said that we still could be looking at inter-quarter volatility in this business, going forward. That makes it more difficult to kind of comment on what year-over-year growth could be, at least for next year. Given what you know about this business right now, how would you reassess strategy and plan for more stability in this business? How would you, kind of, out, saving some [indiscernible] stability or less volatility in the Software business? And what are you doing now?

[C. VijayaKumar, CEO, MD & Director]

Yes. Diviya, a great question. I think the fundamental nature of this business, it has a lot of perpetual licenses. That's the model, which is prevalent for these products and with these clients. So I think, changing them to some kind of subscription and term license, will be one way to make the Product business more predictable. And that's a long journey. And we've seen some very good success, even in the last two years, converting a lot of clients from perpetual to subscription-based revenue model, especially when we are upgrading the products and we are containerizing them, putting them as an overall end-to-end service, they become more predictable and more annuity type of revenue. However, like in all other software product businesses, this business model transformation is a long journey. And we are going to give you some right metrics to track it. We will probably be able to give that to you in the next quarter, and you will be able to track how we are doing. And there will be one component of the revenue, which will see a lot of stability and incremental growth, and that will be the subscription revenue. So once we break it up, I think you'll have better clarity. That's all I can share at this point, Diviya.

[Operator]

The next question is a follow-up question from the line of Surendra Goyal from Citigroup.

[Surendra Goyal, MD & Lead Analyst of India Equity Research]

Just wanted to clarify something. Such strong Services growth and fairly-sharp margin compression, sequentially, I just wanted to confirm that there was no pass-through component, which helps growth but impacts margins, or anything like that, which kind of creates an impact in the following quarter, in terms of growth, et cetera?

[C. VijayaKumar, CEO, MD & Director]

Nothing unusual. I mean, usually, there is some material revenue. That is there, every quarter, but nothing unusual in this quarter.

[Operator]

Ladies and gentlemen, that would be our last question for today. I now hand the conference over to Mr. C. VijayaKumar, M.D. and CEO, for closing comments. Thank you, and over to you, sir.

[C. VijayaKumar, CEO, MD & Director]

Thank you, everyone, for joining us today and for the confidence you placed in HCL over the last several years and quarters. I would like to also thank all our investors, who trusted us with their investments. As I look into the horizon, digital technology will continue to play a very big role in improving human life, while making the planet sustainable. And HCL is well positioned to innovate and partner with our global clients across industries, who are making it all happen. Talk to you again during our Q4 FY '22 earnings call. Thank you, and have a great weekend.

[Operator]

Thank you very much, members of the management. 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.