HCL Technologies Ltd

NSE:HCLTECH

Earnings Call Transcript 2019-Q4

[Operator]

Good day, ladies and gentlemen, and a very warm welcome to the HCL Technologies Limited Q4 FY '19 Earnings Conference Call. [Operator Instructions] I now hand the conference over to Mr. Sanjay Mendiratta from Investor Relations team. Thank you, and over to you, sir.

[Sanjay Mendiratta]

Thank you. Good evening, and good morning, everyone. Welcome to the HCL Technologies earnings call for the Q4 and fiscal 2019. We have with us Mr. C. VijayaKumar, President and Chief Executive Officer HCL Tech; Mr. Prateek Aggarwal, Chief Financial Officer; and the other members of the management team.I now hand over the call to Mr. C. VijayaKumar to take it further. Thank you.

[C. VijayaKumar, President & CEO]

Thank you, Sanjay, and good evening, and good morning to all of you, and thank you for joining us for our fourth quarter and full year earnings commentary. So just a small deck to take you through this. I'm moving to Slide 5.This captures the performance summary for the quarter and the full year. Fourth quarter has been a very good quarter for us, 3.3% constant currency growth, and this is coming after a 5.6% sequential growth in Q3. So it's been a very good quarter driven by several elements, I will talk about this in the subsequent section. Our EBIT percentage came in at 18.9%, lower than the last quarter, and our net income was $360 million for this quarter.When you look at the full year, it's been a fantastic year, what I would really call as a blockbuster year in terms of performance. If you look at the 2 previous years, FY '17 and '18, we gave a guidance and we met the guidance. And FY '19, we exceeded the top end of our guidance. It's been a fabulous performance from this year delivered through several initiatives and several good progress that we have made over the year.Our constant currency growth is at 11.8%, which translates to 10.1% in U.S. dollar terms. Our EBIT is $1.68 billion, which is 19.5% the operating margin. This is an industry-leading growth, I'm sure all of you would agree. And exceeding the upper end of the guidance is a pride moment for all of us tonight.Moving forward, I wanted to just capture the 3-year trend. While this year has been a great year, if you look at the 3-year trend again that HCL has delivered the highest growth among all the top service providers in the industry. So we are very, very happy with the outperformance that we have seen over the last 3 years.Our EBIT growth over 3 years just stands at 10.4%, net income has grown 8.8% from a 3-years CAGR perspective. We also had a very healthy cash EPS 3-year CAGR of 16.5%. Our EPS has also grown from INR 60 to almost INR 74 this year.Moving on to Slide 7, some of the key highlights for this quarter. Once again, we hit a record booking this quarter. This is the third time we've set an all-time booking record in this fiscal. So it's -- we're really seeing a good accelerating trend in terms of bookings.While we have done very good bookings, the pipeline at the end of March 2019 is at least 10% higher than the pipeline that we had at the end of March 2018. And this is the qualified pipeline that we measure through our internal systems.Q4, we won about 17 transformational deals, led by Retail; CPG; Manufacturing; Public Services, which is our utilities, government and travel, transportation and logistics vertical; and Financial Services. We won 78 deals during the year, which constitutes to a significant uptick in the total booking performance compared to the prior year.This quarter we also closed an acquisition on the digital space, some of that we will talk about in the subsequent session. We also launched one of the industry's leading products called Actian Avalanche. Actian is a company which we acquired a few quarters back. It's all quietly integrated and it's created a good momentum in the data space. So Actian Avalanche is a cloud data warehouse operational data store, which is -- which delivers some breakthrough levels of speed and performance. We expect this to be a game changer for the Actian's business going forward.Moving forward, some of the key wins. Some of that we have announced during the year. One of them, of course, is a very large technology manufacturer in the U.S., which is an integrated deal consisting of a number of services from technology to engineering to business services that we now call as digital process operational services. This has been one on back of very high competence what we demonstrated in from bringing in automation to the enterprise operations. So the extension of what we do in IT operations into enterprise operations with significant amount of robotic process automation, process simplification and AI and machine learning, which is driving the wins. Some of the products that we've created in our digital process operations business over the years, specifically a product called EXACTO is that the pivot of transformation that we are delivering in this deal.We also won a large deal from a Danish pharmaceutical giant. This is truly an end-to-end digital deal, which is where there are several service providers, and they have kind of changed the landscape with HCL having the prime place for the digital opportunities that we are going to execute on in this client. Of course, we also won a large integrated telecom and media conglomerate in the U.S., which is a digital workplace deal. We also won a large deal in the government segment in the U.S., which is delivering security operations, which will get delivered through our CyberSecurity Fusion Center that we recently launched in Dallas and Frisco in Texas. This also encompasses enterprise architecture services for the customer, which is promising to deliver a lot more downstream work in terms of digital development in agile operations.We also won a Fortune 10 British multinational investment bank where we had significant component of DryICE, which is a cognitive virtual assistant embedded in this deal. So there are several deals. I just took this opportunity to call out a few that we concluded in the last quarter.So if you look at our Mode 1-2-3 performance, when we had the analyst conference in -- about 3 years back, we said our aspiration is to grow the Mode 2 and Mode 3 business to about 35% of our revenues in 3 to 4 years.Right now, we stand at 28.4% of our revenues come from Mode 2 and Mode 3, 17% from Mode 2 and 11.4% from Mode 3. And with the current acceleration that we have seen, we are well on the way to hit the 35% mark in our Mode 2 and Mode 3 services as we move forward in the subsequent quarters.The very interesting or very important thing that I want to point out is our Mode 2 services, which is all organic growth, is 28.7% year-on-year in our Mode 2 services, which is the digital analytics, Cloud Native, Internet of Things and cybersecurity services. Significant growth across all. And Internet of Things, we've almost doubled our revenues last year, driven by very strong capabilities in embedded engineering, which is core to our engineering business. This is really pivoting us to be a prime player in IoT WoRKS where we are the leader across multiple segments.Similarly, the digital and analytics sectors is very, very strongly getting embedded in all our client engagements as we have chosen our top clients, and we've been very successful in modernizing our services portfolio in us mining our top clients. It is showing significant traction towards our Mode 2 business as well as our applications business. Our Mode 3 business is about 11.4%, it's a 44% year-on-year growth.If you look at the rest of the color of the revenues, all the geographies grew in double digits. You will see ROW at 0.9% or minus 0.9%. But excluding India, it will have still delivered double-digit growth. Our application services is the highlight of the quarter, which grew 5.2% quarter-on-quarter on back of strong scaled digital projects that we have won, which has got into execution phase, and some of the accounts that we won are nicely scaling up as we speak.Of course, the icing on the cake is the Infrastructure Services, which has delivered a solid 7.3% quarter-on-quarter growth, and this is on the back of 10.4% sequential growth in the previous quarter. Overall, while we've started with a little bit of tentativeness in our Infrastructure business, in the beginning of the year, we delivered a good 11.1% year-on-year growth, which is quite satisfying.In terms of verticals, across the board we have done very well, Technology & Services, Retail & CPG, Telecom, our Life Sciences and Healthcare and Public Services, all of them clocked in very impressive growth rates from an LTM constant currency perspective.Financial Services, as I had indicated earlier, we had 2 client-specific situations, which is continuing to make the growth softer in the Financial Services, but if I exclude those 2 clients, we have a pretty good growth, which could be somewhat similar to the company average growth rates. However, from the pipeline and the momentum that we see the same strong traction for, not just digital deals, but integrated stack is what is really giving us a lot more optimism in this segment.Manufacturing, I think, our worst is over. I expect to see healthy growth moving forward, while this year we've remained more or less flat in the manufacturing vertical.If you look at the client wins, we've had a very impressive progress in clients. We added 2 clients in the $100 million category. I only see this accelerate as we get into FY '20. We added 4 clients into -- in our $50 million category, 25 moving to 29. We added 4 clients in the $40 million, and close to 37 customers in the $5 million-plus category and 13 additional customers in $10 million-plus taking the count to 166.And if you look at our top 5, top 10, top 20, very good growth. Our top 10 customers contributed about 1/4 of our business and then our top 20 customers contribute to 1/3 of the -- our overall revenue. So it's a very healthy growth. And of course, the top 5 is about 17%.If you look at the recognitions that we had, we've been rated very, very prominently across Gartner, IDC, Everest, [ Genalt ], ISG, all industry analysts have rated us very, very highly in most of the quadrants. We have mentioned some 56 Mode 2 reports, it's a 51% increase over FY '18. We were very subtle in our marketing for our Mode 2 services, but now the analysts are recognizing the value that we are bringing to our clients. And it's, again, while the services are the same, a lot of digital engagements are also outcome-based engagements where we are putting a lot of skin in the game and we are executing to what the client really wants to achieve in the digital transformation program, and this is where some of the recognitions on consulting and augmentational chain management have become very important, and we prioritize that and acquired stronger generation during the last quarter.I will spend a little bit of time on the FY '20 and what business trends that we are seeing. I would want to categorize this into 4 categories. One is market opportunity. I'm sure all of you know, but to kind of put a context to what is giving us the optimism as we get into FY '20, digital transformation as a spend is growing at 18% to 1.2 trillion in 2019. While the traditional spend is moderating at about 2% to 3%, the digital transformation spend is what is picking up. And if you really break down the digital transformation spend, there are 2 very key themes which are becoming very obvious. Two very big themes. One is of course the modernization in the Financial Services, that's one big trend. At least 80% of the spend in the increase to digital transformation spend is going to -- actually 25% is going into the Financial Services.The second big trend that we are seeing is some of the laggards like discrete manufacturing and process manufacturing, they are using IoT and Industry 4.0 solutions to significantly modernize and transform their businesses, and that is an area of business of big strength for HCL. While we have delivered -- demonstrated significant proof points in Internet of Things, our core engineering capability and the PLM and all the capabilities that we have today puts us on a very strong footing to capitalize on the digital transformation spend in the manufacturing in both discrete and process manufacturing segments.Of course, it's very obvious the shift in market buying pattern was more driven towards as a service outsourcing and our Cloud Native capabilities to not just private cloud but Platform-as-a-Service, our investments in Pivotal, all of that is driving significant traction with our customers. I think it's becoming quite evident, most large enterprises are gradually pivoting towards the hybrid operating model. While it's very good to adopt the public cloud to improve agility, when you want to balance the total cost of ownership and agility, the obvious choice seems to be driving the businesses to adopt hybrid cloud with an emphasis on building software design stacks within the enterprise while creating a hybrid model extending into the public cloud.And cybersecurity, IoT WoRKS and digital reality, virtual reality and augmented reality are driving good transformational opportunities in multiple industry segments, and our engineering DNA along with our strong capabilities that we have built in our Mode 2 proposition puts us in a strong footing to capitalize on this.And of course, last but not the least, the Infrastructure business is going through significant transformation. Infrastructure is becoming the digital foundation of any modern enterprise business, really a hybrid cloud and a platform-centric approach, which is also helping generate some good momentum in the infrastructure business as it is reflected in the last 2 quarters while the traditional outsourcing deals are having a certain rhythm of its own and the dynamics which plays into it, but there's a significant modernization spend in infrastructure where we are well equipped to kind of grow the business.And digital workplace where the emphasis on shifting from device to user to experience that's another area where we have differentiated offering. And close to 60%, 70% of the infrastructure deals that we've won have been on the digital workplace. So overall, FY '20 will continue to be a good year enabled by the digital transformation strength.However, a couple of points of caution, which is around geopolitical factors. I'm sure all of you are aware, delays in visas, increasing rejection rates and request for evidence, of course, it just creates a little bit of pain in the execution cycles. We also believe that while 2019 was a good year from a spend perspective from U.S. customers, I would think that the expansion beyond the normal economic cycle would be a little bit limited compared to calendar '18.We are also seeing some client businesses getting impacted by the said -- what, tariff situations in the near term, and that could put some pressure into our existing clients who would be expecting to reduce their spend on typically the run-the-business kind of scenarios.Of course, there are certain uncertainties on the currency, driven by geopolitical factors. However, the most relevant thing is the cost drivers, I mean, industry attrition is increasing. I think if you look at the Indian heritage providers, overall attrition has gone up by 2% while our attrition, the way we measure it, is coming down from a year-on-year perspective. And of course, there is a big shortage in digital talent. U.S. unemployment rates are at the lowest at this point, so there is going to be some dynamics around our cost structures. So while there's still the positive trend from a digital transformation and momentum in the market, there is going to be challenges around labor market and labor availability during the year.We have built the strategy around this, which then we drive around 4 dimensions. We are looking at 2 elements, scale growth opportunities and integrated propositions. Given the breadth of our full offerings that we have at the infrastructure, application, digital process operations and the products and platform strategy, coupled with a strong engineering capability, is helping us drive significant success in the integrated full stack deals.If you look at the pipeline now, it has close to 40% of the pipeline is on integrated stack, and I do believe that is the way industry is going to move forward, creating more platforms, which is really enabling -- enabled through our engineering and digital platform engineering services, along with all other investments that we have made, we believe we are well placed to capitalize on some large integrated deals that would come. And we're trying to build around the same strategy.We have a very focused cost management strategy, including increasing pressures onshore in different geography, scaling up the pressure adoption in India, a lot of emphasis on cross-training, all of that is a big focus area as we get into FY '20. We continue to increase our localization, not just by hiring local people but invest in talent right from the colleges in different geographies to enable this. Of course, diversity is a big agenda, diversity and inclusiveness. All of this is going to help position us differently in the changing geopolitical dynamics, and we have several strategies revolving around these 4 themes as we get into the next year.With that commentary, I will hand it over to Prateek for the next set of updates.

[Prateek Aggarwal, Chief Financial Officer]

Thank you, CVK. Good evening, good morning, good afternoon, wherever in the world you are. I'll go through some of the financial numbers in some detail, and carry on with some important messages towards the end as well in terms of further guidance.So Slide #17, we have already -- CVK has already covered it. The highlight of this page is obviously the 11.8% constant currency growth, which is beyond the guided range of at the top end 11.5%. So we've exceeded that. The great news also is that the organic growth guidance, which we have provided of 4.25% to 6.25%, we have been able to beat the top end of that guidance as well. So great story on the top line.On the bottom line as well, EBIT, we have been within the guidance at 19.5% for the full year. Looking just at the last quarter, Quarter 4, March quarter, we had a great story on the growth side, 3.3% on a quarter-on-quarter basis, which is on top of 5.6% last quarter. And on a year-on-year basis, that is actually 15.3%, which is kind of hitting the ball outside the park.EBIT was flat on a quarter-on-quarter basis in dollar terms. EBIT percentage came in at 18.9%. That is 63 basis points lower on a quarter-on-quarter basis, and most of that, 2/3 of that is due to the impact of foreign exchange, largely the rupee but also from mostly European currencies, which impacted our margins on a quarter-on-quarter basis by 43 basis points. The balance, 20 basis points, is really the seasonality in our Products business, both IT partnerships as well as Actian and some of the other products as well, which because the previous quarter was a high end -- the March quarter tends to be our seasonal weakness, that was the real -- that's where the 20 basis points basically came from.Moving on to the next slide, which kind of shows the balanced portfolio that we have. But when you look at it as Mode 1-2-3, which is the green part -- the pastel green part, the Mode 2 at 17%, 11% for Mode 3. This is the full financial year that I'm talking about. And the others are on the slide. In the interest of time, I'm going to skip, move on quickly on this slide.Moving to next slide, I will request Anand Birje who's here with us for the call today to talk about the acquisition we closed on 1st of April, Strong-Bridge Envision. Anand?

[Anand Birje, Head of Digital & Analytics and Corporate VP]

Thank you, Prateek, and good morning, good evening to everybody. As Prateek mentioned, we've had a fairly strong year in our Mode 2 services in the year gone by. And most of our digital capabilities, we've thus far built organically, and I think we are now poised to look at acquisitions. And this was one of our first. It's a company that is headquartered in Seattle and operates largely in the U.S. market, which is a prime market for us. They are focused on helping enterprises develop digital transformation strategy, prioritization of digital spend, along with agile program management, which is really how do you manage programs on more accretive spend basis and will benefit realization more accretively in the digital execution that enterprises adopt. And finally, underlying all of that is the organizational change management. All of these 3 elements are becoming very key as enterprises are adopting PLM programs, and we were really getting pulled into a lot of these conversions with our existing customers regarding their execution. So it's the strong consulting company that brings strong capabilities in each of these areas, and the teams are distributed across geographies that we operate in across the U.S.Over to you Prateek for the rest of the presentation.

[Prateek Aggarwal, Chief Financial Officer]

Thanks, Anand. Moving onto Slide 20, a quick look at the cash conversion. So we had -- for the quarter, we had a cash conversion of 93%, which is for the FY '19 it was at 93%, net income to operating cash flow. And we have EPS, earnings per share, which is at INR 73.6 per share, which is a healthy growth of INR 70.5% year-on-year. We also published the cash EPS, which is basically adding back the amortization expense in the P&L as well as adjusting for the MAT payout, minimum alternate tax payout, versus the tax cost in the -- taken in the P&L.So adjusting for that, the cash EPS is at INR 82.90 - INR 84.9, which is again a very healthy 15.2% increase on a year-on-year basis. The return on equity for the year is at 24.9% and return on invested capital is at 28.6%. We have added the exact definitions that we have used towards the end of the document for your reference.The payout ratio for the year was in line with the commentary of 50-50 capital allocation. This year in rupee terms it came out to be 52.6% for the fiscal year.Going forward, the guidance for the next year, while the total guidance is at 14% to 16% in constant currency, the breakup of that between organic and inorganic is the organic is the 7% to 9% out of that 14% to 16% and the balance, 7%, is really what we expect the inorganic to be. That 7% includes obviously the big deal, which we announced in December of the 7 products from IBM, that is included, assuming that the deal closes by the end of May. And therefore, we are building in basically 10 months. That obviously is subject to regulatory approvals, as you are aware. It also includes the flow-through impact of all the acquisitions that we closed last year because some of the acquisitions, Actian and H&D was not there for the full year, and the Strong-Bridge Envision that Anand just spoke about, which has closed in 1st April. So we have factored in all the benefits from all the deals that we have announced so far.And the [ 14.16 ] is the -- is what the total works out to, including those 2 parts. That EBIT guidance is at 18.5% to 19.5%, that is factoring in the 19.5% that we achieved for the full year fiscal '19 as well as the last quarter, which is at 18.9%.Having given the commentary on all of that, I do want to flag off that every movement in this current quarter, April to June, and as we get near to the closing of the deal that -- IBM's 7 products, we have and we continue to invest in additional people, processes, technology systems and facilities and everything to keep us ready, so that we start the new deal on a very strong note. We are kind of just weeks away from it, and we are well prepared for this, we believe. And given that, we expect the deal to give us the revenue only for 1 month out of the quarter and the investment is pretty much there in most part for the full quarter, we do expect to be down, which is June quarter, margin will be lower than the guided range.So that is all factors therein, and I just want to sort of flag that off in advance. It should not be a surprise next quarter. I also want to flag off that once we close that acquisition, we will have $912 million of payable on the books, which is obviously a monetary liability, and we might take up to about $200 million of additional debt. This debt amount, when we announced the deal was about $300 million. We have been able to bring that down to $200 million. So total, we will have about $1,100-plus million of liability. And as is common for monetary liabilities of the balance sheet, this will be the value at every balance sheet date, giving rise to ForEx gains or losses, as the case may be. It will therefore make sense to hedge this ForEx exposure, which we plan to do in line with the board-approved hedging policy.During the 12 months post close, so for the period from June to mid-April, this will therefore give rise to ForEx cost given that there is typically a premium on the rupee-dollar exchange rate. And that ForEx cost is expected to be -- it's for the one time because it's only for the period between when we close the deal to the 1-year period beyond that, so the 12 months, it's onetime cost. This is estimated to be something like $30 million for the 12 months, and given the 10 months in this fiscal year, we would expect that amount in this fiscal year to be near about $25 million or so.The third thing that I also want to flag off as we go into the next financial year is some changes that we are planning in our segment reporting going forward. Given the changes -- significant changes that have happened in our business over the last 3 years, we are planning to change the segments going forward. Products and Platforms, as you know, have become a larger part of our business. It's already at 11% for the full fiscal year. And especially once the acquisition of the 7 IBM products closes end of this month, that will make it even higher. And we are therefore planning to start reporting Products and Platforms as a separate business segment going forward. So that's the first change. The second one is, Engineering and R&D Services, ERS as we call it, most of ERS is also related to delivering or supporting and maintaining our customers' products. So that another business that we would classify as a separate business segment going forward. We have reported the ERS revenue parts for the longest time separately, but now we would like to carve out ERS as a separate business segment in its entirety. So that's the second segment, which would appear in our reporting going forward.As far as the rest of the business is concerned, which is basically IT and Business Services, that will be the first segment. As we have seen in the last several years and as CVK also mentioned in his comments to you a little while back, a lot of the deals that we see, which we have already closed, which we have signed in the last few quarters and some pipeline as well, we find that they are more and more and more integrated across service lines. The move to businesses that we started 4 to 5 years back typically also tend to be across service lines. So it is becoming -- the lines are blurring as far as those service lines are concerned, and we believe this is the right time to clump it into one business segment called IT and Business Services or a name to that effect.And we will, over and above that, those 3 business segments, we will continue to report a Mode 1 and Mode 2 breakup of the IT and Business Services because Mode 3 is for [ PAP ] business all together anyway. So Mode 1 and Mode 2 is what we continue to report going forward as well.That's it from my side for now. And we can now go to Q&A.

[Operator]

[Operator Instructions] First question is from the line of Diviya Nagarajan from UBS Securities.

[Diviya Nagarajan, Executive Director and Research Analyst]

Congrats for a good end for fiscal '19. Just trying to understand the key assumptions that are behind growth for your Mode 1 and Mode 2 and Mode 3 in your fiscal '20 guidance, if you could just give us a breakup. And in terms of margins as well, given that we also have the IBM IT deals coming in as part of the guidance, could you help us understand what are the key investment areas that's dragging down margins? What should we expect this margin accretion from the IT deal, some strategy on that would be helpful.

[C. VijayaKumar, President & CEO]

Diviya, let me get started with the first one. In terms of how do we expect the growth to be starting up into the next year, of course, the inorganic contribution is very, very clear, it's the follow-through impact of what we did last year and the consummation of the IBM deal. So that will contribute to whatever numbers in the respective segments.Now if you look at the organic growth of 7% to 9%, I would expect it would definitely be significant amount of the growth would come from our Mode 2 services. Even if we see FY '19, almost 35% of the incremental revenue has come from our Mode 2 services. I expect that trend to be impacted from a larger team perspective, how much of the business momentum gets converted to billing and revenue recognition and things like that is secondary, but the business momentum will continue, and we will see a very favorable contribution from Mode 2. And of course, Mode 1 has its own dynamics, of course, due to various elements, and but we still expect to see a good, maybe a low single-digit type of a growth in Mode 1.That's the commentary on the color of growth. While we don't really commit to a certain number in each of the modes, but directionally, this is where they are heading. And as I said, Mode 2 and Mode 3, we expect it to contribute to 35% of the revenues in the next year, which is FY '20.Now coming to the margins or the investments, I think a lot of emphasis is, I mean, of course, we started this focused investment around the core Mode 2 propositions 3 years back, and it has given us some stellar results. We really created some compelling propositions as we've created a huge mind share among analysts on some of our new capabilities and which is specifically in IoT and in digital and cloud, we've created a very strong mind share in our existing customer base on a regular B2B digital foundations partner and digital transformation partner, which is reflected in our client partner accounts growth and things like that.So largely, the investments will continue, given that it is helping us to accelerate our organic growth, and we're seeing good outcomes. So we are not scaling down our investments in Mode 2. We continue to invest while creating competencies, is something that we have done. But you need to have these competencies available across the globe in all your segments or markets that we're operating in. So to that extent, we will continue to invest in Mode 2.And of course, since we've had a good booking momentum, a lot of new deals, we've seen a little more investment in the early parts of the deal to ensure that we transition well and we meet the client expectation, and some of the optimizations will follow through.Actually, these are the 2 broad elements, which is really contributing to the margin guidance from where we are today.

[Diviya Nagarajan, Executive Director and Research Analyst]

Thanks. Just as a follow-up to that, as the year has progressed, we've seen margins kind of dip below what you had guided as the range for fiscal '19. Could you kind of break it out, give the main rationale for why that happened, and what gives us the confidence that we don't see a similar phenomenon into fiscal '20?

[C. VijayaKumar, President & CEO]

Diviya, [ the reason we have ] our margins were full year, 19.5%; Q4 is about 18.9%. This is well within the guided range for FY '20.

[Operator]

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

[Ankur Rudra, Research Analyst]

Congrats on the revenue momentum achieved there. If you could maybe elaborate a bit more on the margin question asked. First of all, in the quarter, we've seen Mode 3 margins decline quite sharply and revenues were also down. And Mode 3 especially, margins have been falling almost every quarter. So where should we expect Mode 3 steady-state margins to be, is the first part. And second part, in your margin comment, you did say that the combination of large deal expectation in Mode 3, and I would expect Mode 2, is also lower margin, so maybe a mix from there. If you could elaborate how much of the margin deflation built into the FY '20 guidance comes from these parts?

[Prateek Aggarwal, Chief Financial Officer]

So margins on Mode 3 for the full fiscal are 22.8%, and I would expect that number to sort of remain in that region going forward as well because that, that is the inherent profitability of that particular business. To your question about Q4, that's just the seasonality playing out. So there were quarters, previous quarters which were at 25%, 23% and so on, so forth. Yes, JFM, which is Q4, just happens to be sort of seasonally a weak quarter for those businesses.Going forward, we would expect this to actually trend up, especially with the deals closing, which would be a little higher than the Mode 3 overall 22.8% that I spoke about.

[Ankur Rudra, Research Analyst]

And the second part of my question, Prateek, was -- what are you -- if you could potentially quantify the -- what the weakness baked in for the FY '20 guidance? How much is it from continued weakness in Mode 3 versus large deals ramping up, which you alluded to, versus also Mode 2 mix increasing, which is a lower-margin business?

[Prateek Aggarwal, Chief Financial Officer]

Yes. So again, on the Mode 3, I already said it would actually be accretive. So it would increase beyond the 22.8% on an overall basis. And while I won't get into specific numbers, if that's what you're really looking for because the guidance is at a total level, and we are not kind of, for example, on the top line, we are not going to split it by verticals, geo, or service line and things like that.Similarly on the bottom line, we are not splitting it really across modes. But as I think CVK already alluded to and you also mentioned, Mode 2 continues to be an area of focus where we will continue to invest strongly from an organic point of view. I wouldn't call that a low-margin business like you just said. That's not reflective of the reality of that business. It so happened because of the extra EBIT -- extra investments that are going into that business, the EBIT is where it as we have published. But inherently, that is the high-margin business, just like the rest of our business.Mode 1. Equally, there we have a lot of large deals already announced, plus large deals in the pipeline as well. Those tend to get affected when the growth is so high as it is and guided to be going into the next year, there is always some impact in the initial quarters. And already, I talked about in my commentary about Q1, which is June quarter, would be lower than the guided range. So we have factored all of that in because of those circumstances because that large deal, we have to be ready for it, to execute on the date of closing of the deal. It is not a switch that you can turn on and off at will. You have to be ready for it when it closes, and you can't time it from the dot.

[Ankur Rudra, Research Analyst]

Understood. Last question from my side, sorry. IBM, you had said in December, would be margin accretive. Now that you've had time to digest the amortization mathematics around it, would you stick to that statement? Could you clarify how much it is earnings accretive now that you have more visibility?

[Prateek Aggarwal, Chief Financial Officer]

So it remains very accretive. See the thing, the nature of these things is the numbers we had at the end of December were based on September, October, November kind of time frame. Those numbers change every day, every month, every quarter. So when the deal closes is when we can actually do a proper purchase price allocation as it is called. And that is when it determines how much is customer relationships, what is the value of the contract we are getting, what is the deferred revenue and what is the goodwill and so on and so forth. Based on this then the amortization gets determined.Obviously, we have a good idea of what that range looks like, and therefore, we have -- and we have obviously baked something into the guidance that we are providing. So based on that I am reaffirming that it is accretive, it is much more than the 22.8% of the Mode 3 profitability which is showing for FY '19. FY '20 will be much beyond the 22.8%.

[C. VijayaKumar, President & CEO]

I want to just to add to what Prateek is saying. Of course, nothing materially has changed since December from our assumptions on the overall business case perspective. The only variable is there is going to be some hedging costs, as Prateek explained, that is only FY '20. That's the only variable. Other than that, it continues to, all the projections and expectations that we've provided, follows through.

[Operator]

The next question is from the line of Srini Rao from Deutsche Bank.

[Srinivas Rao, Research Analyst]

Congratulations on a good quarter. Two questions. First, you're -- offer any feedback and even some opening commentary on that, on your geo, geographic splits? U.S. seems to be weak and looks muted, so that -- if you can speak more on that? And also, your Financial Services vertical, which also seems to be a bit weak. So that's my first question.Second, you talked about hybrid cloud and the fact that, that underpinned sort of digital services. I know you haven't given that in the past, but can we get a sense of are you expanding your data center footprint physically? Any investments going into that? If you can either quantify or give any color on that, that would helpful.

[C. VijayaKumar, President & CEO]

Sure. Okay. Srini, good questions. Geography perspective, U.S. quarter-on-quarter is 1.1%, but look at the year-on-year numbers, it is 15%-plus. FY '18 -- FY '19 over FY '18 is 13.8%. The seasonality impact from the [ PNP ] business is larger in the U.S., so that could be one reason why it's a little softer. Across geographies, we are seeing good momentum. In Europe, especially in Germany, we are seeing a lot more opportunities after our H&D acquisition, not just in the traditional services market. We are even opening up accounts and client engagements on our Mode 2 services, even in a geography where we are making baby steps. So that's on geography. Financial Services. If you take out the 2 clients, it is growing somewhat closer to the company growth rates. Maybe -- I mean after I finish this commentary on hybrid cloud, I will request Rahul to provide a little bit more color on Financial Services. On hybrid cloud, we are definitely not building data centers, we never did it, and we will not do it. This is about building solutions, which drives agility. And it's really a good balancing act between agility and total cost of ownership. And If you look at even these public cloud providers, almost every large hyperscale provider has launched a hybrid stack, right? Either it is an Azure on-prem stack or AWS has got a version coming. Pretty much everyone is launching a hybrid stack. That's really a trend that we are seeing in the industry. Because it does not require us to build data centers. It is modernizing the infrastructure in our client data centers, building software-defined stacks, pairing them with public cloud providers and being able to manage workloads with an end objective of providing agility and a meaningful total cost of ownership. Maybe with this, Rahul, you can provide us a little bit more granularity between -- on the Financial Services? I'm sure it will help everyone.

[Rahul Singh, President of Financial Services]

Sure. Thanks, Vijay. So on Financial Services, I just want to add to what CVK just mentioned. So the muted growth that you see this year is really a reflection of 2 of our accounts that we've had a certain amount of challenges. But if you were to exclude that, the business continues to perform exceedingly well. A lot of our banks, especially the banks in the retail segment has started adopting digital in a big way. And we are seeing a lot of digital analytics deals in those segments. In fact, if you've been following HCL Financial Services, you do know that we had a large number of wins, which came in last year. And our Financial Services business has grown almost 12% to 13% last year.The banks which came in and new, which we acquired new last 2 years back, have also grown exceedingly well this year, especially around digital and analytics. So if you exclude the impact of the 2 banks, mostly in the capital markets area, where we've had certain amounts of challenges, the rest of the business is performing exceedingly well. Another thing to note is that CVK spoke about integrated deals and at least some of the integrated deals, both in the funnel as well what we've executed last year, are in Financial Services. So we believe looking quite well. However, the numbers this year, have been impacted, as we mentioned earlier, on account of 2 banks.

[Operator]

The next question is from the line of Pankaj Kapoor from JM Financial.

[Pankaj Kapoor]

Prateek, just persisting on the margin question again. You mentioned in the first quarter of FY '20, you are baking in the investments in preparation for the transaction. So I'm just curious to understand does it mean that given the acquisition is going to have a materially higher margin profile, this margin decline in the guidance -- the lower guidance of margin is only for this year? And does it mean that we can go back to the 19.5%, 20.5% kind of a band in the years going forward?

[Prateek Aggarwal, Chief Financial Officer]

Pankaj, first of all, the impact that I'm talking about is only for the first quarter, which is the June quarter and thereafter, as we have discussed before, the deal itself is margin-accretive.So it's only a timing factor really in the first quarter because obviously, we have to prepare in advance to be ready for Day 0 to be executing well on the deal. And in this quarter, it happens to be 2 months or rather 3 months of investments 2 months in advance, and 1 month of revenues is what we have baked into the forecast.Going forward, I don't want to hazard a guess. We have given the guidance for the fiscal and we'd like to stick to that and deliver to that.

[Pankaj Kapoor]

So but you are saying that this is something more of a onetime kind of impact that we are seeing, especially in the first quarter, which could be adjusting the trajectory. And there are no structural or any kind of a long-term investment or something which you are planning that is driving this kind of lower-margin guidance?

[Prateek Aggarwal, Chief Financial Officer]

That's right, I think we...

[C. VijayaKumar, President & CEO]

I think that we should at this point -- sorry. We should probably take it as year-specific. I mean of course, there is some elements of first quarter impact in investments in the anticipation of the deal.And continuing investments in Mode 2 is another one and of course, we have large deals under execution, and we want to make sure we're doing all the right things to transition them safely. I would at this point, treat it like a this-year element and obviously, I don't think anyone is in a position to provide a view. I think the year after, I mean there are several positives and negatives that will come into play as we get into the next year.

[Operator]

Our next question is from the line of Ashish Chopra from Motilal Oswal Securities Limited.

[Ashish Chopra, Research Analyst]

CVK, my first question was actually around the organic growth that's baked into your guidance. So last year, you did almost 6.5% and maybe excluding the voluntary India discontinuation, it would have been closer to 7.5%.So my question really was that after quarter after quarter of record deal wins, the 7% to 9% growth still looks to be more or less the same range as we ended up in the last year, if we were to exclude the India piece. And plus, if we look at the exit growth, the 15% growth on an organic basis then that would be double digits. So is this guidance mainly baking in some of the macro concerns or just caution as well, like you highlighted in your opening remarks? Or why should it be still slightly in the range of last year's?

[C. VijayaKumar, President & CEO]

I just want to correct our organic growth in FY '19 was around 6.5%. This is after including some reductions in the India business, right? So that's how the year was. And India business will continue to decline to maybe even in the next year, there is some decline.So I don't think we're getting any incremental EPS benefit due to India or not India. You should really look at this 6.5% and compare it to 7% to 9% organic growth. Of course, I know you possibly are multiplying [ 2278 ] into 4, and possibly, you will add the incremental revenue from IBM acquisition. I do believe, even after all that, we will have some good growth. And of course, some of the businesses have seen very strong acceleration in the last couple of quarters. So you will see some softness of that in the first quarter. So generally, all that is baked in and the increasing momentum, of course, the momentum has also created some good growth in the current year. And especially the deals that we booked in the first 3 quarters. The 2 quarters are completely into the run rate, the third quarter, a very large part of it is in the run rate, which is why you'll see a higher-than-expected growth in this quarter and exceeded the guidance.So just given all that, 7% to 9% I think is a good organic growth momentum, from what we have seen now. And while I talked about the overall commentary, I mean for the macro elements, but as I always said, when we do the planning, more than the macro, the biggest driver is what we see in each of our [ clients ], their budgets, and their outlook for what they are expecting to do through the year and some of that has changed from December to now. So all of that is baked in, I would say. And I'm not really baking in some macro pessimism, apart from what we are really seeing from our specific clients and their spends.

[Ashish Chopra, Research Analyst]

Fair enough. And here on the margin, since you alluded to the issues around maybe attrition being higher for the rest of the industry and some geopolitical issues around visas, would that have any role to play in the guidance, which is maybe 100 bps lower than last year?

[C. VijayaKumar, President & CEO]

Yes. I mean there is definitely, costs are going up. I mean but some of it's baked into our run rate because if you see this quarter, we are at 18.9%. The cost of replacement, the cost of fulfillment on-site. I mean you are hearing this from the industry, so some of that impacts us as well.

[Ashish Chopra, Research Analyst]

Okay. I guess lastly, maybe to Prateek, on the bookkeeping side, since you mentioned that we are pretty much in the range in line of amortization expense from the IBM acquisition, could you share with us what would that ballpark range be?

[Prateek Aggarwal, Chief Financial Officer]

Ashish, purchase price allocation tends to be a very involved exercise, and it is not the same number for each year. I think the best thing to do is to wait for the deal to close. We are weeks away from it, hopefully. And once the deal closes, we'll come out in the accounts and in any case, give you the required details. At this point of time, I would continue to guide that it could be north of the 32.8% of Mode 3. It can be significantly north of that, the EBITDA is what I'm talking about.

[Operator]

The next question is from the line of Parag Gupta from Morgan Stanley.

[Parag Gupta, Executive Director]

Yes. So I had just 2 questions. CVK, firstly for you, you talked about some caution in the market but not necessarily building that in. But if I were to just think about your organic growth rate, do you think this will likely be back-ended more in the second half versus the first half, just the way it was in FY '19? Or are you seeing a different trajectory for FY '20?

[C. VijayaKumar, President & CEO]

Thank you. I think that was a very good question. I do see the growth pattern to be somewhat similar to what we saw in FY '19. The growth would be back-ended, which is the core organic growth. Of course, the impact of acquisitions, you will see the surge, which is mostly in the first half. The organic growth, you will see some softness in the first quarter because you had a good uptake model, some projects are executed and some of them are transition. So second half I expect it to be better. This is a trend that we see -- that we've seen in the last year.

[Parag Gupta, Executive Director]

Yes. Okay. And the second question around margins. So based on what I have heard so far, it seems like Mode 3 margins will go up. Mode 2 margins, while there are some investments, should improve. So it seems like the bulk of the dip in margins is likely to happen in Mode 1, which you characterized coming from ramp-up of last year. But if I were to just break up the impact of the large deals, how much of this is because of higher costs? Or how much of it is because of lower realizations? How much of it is because of additional investments? If you can give some sense of what is leading to the lower margins on the back of these large deals ramping up?

[C. VijayaKumar, President & CEO]

So just a one point, Parag, before I answer it more broadly. I think while Mode 2 margins are whatever it is, but the proportion of Mode 2 revenue going up also has a certain impact to the overall margin profile, while Mode 3 will be significantly more accretive. So there is going to be pressure in Mode 1 because of scale-up of these. Obviously, the whole cost structure's changing. Some of that is built into our run rate. So that would also cause some pressure on Mode 1. That's the way you should look at it.I don't think -- I mean of course, there is -- from a Mode 2 perspective, I don't see any changes in realization impact. We are getting better and better rates and our objective will be to improve the gross margins but not really cut down on the investment that we need to make to make sure we are continuing to build other capabilities here.Mode 1 renewals, usual pressures are there. Of course, we kind of mastered the way of dealing with it. It may impact us in one quarter, but we will bring in the optimization levers. Nothing more to add on this front.

[Operator]

The next question is from the line of Ravi Menon from Elara Securities.

[Ravi Menon, VP of IT Services & Internet and Analyst]

Congratulations on a really good quarter. You had touched on briefly -- you talked about hybrid cloud, just wanted to get a sense of your [ recurring fee per annum ]. Do you think that we've passed that, that hump of, the threat of hybrid cloud or public cloud adoption cannibalizing some of our data center operations?

[C. VijayaKumar, President & CEO]

Thanks, Ravi. I would request Kalyan Kumar, who also -- he's the one who runs the infrastructure practice and the Cloud Native practice to come up to give you an [ answer] on that.

[Kalyan Kumar]

So as CVK mentioned, that when we define hybrid cloud, we're not considering hosting. Hosting, I think a lot of times, when you think of hosting and hybrid cloud. Hybrid cloud is the way you build your cloud platform. But you [ leverage ] software-defined is at the data center, it could be hosted in the customer's data center or now hosted at third-party data center.Now in the infrastructure utility market, being a public cloud, it's on a hyperscaler model. And currently, most of our deployments, we're working with VMware on the IaaS side to deploy software-defined data center. And that accelerates as we're in the public cloud or we're in the AWS EC2 or Azure. And we are in the [ half-stack ] as CVK mentioned in the previous discussion on using [PaaS on a half-open shift]. So you can architect this where you can create a hybrid architecture at an IaaS level or a PaaS level, depending where the endpoints lie. So again, it has 0 impact from an operations perspective because we're still managing the operating system in the layer above. That's still going to happen, perhaps you are on an IaaS in the data center or IaaS on the cloud. In the PaaS, we have more high-level services like platform reliability engineering and site reliability engineering where we integrate and operate the whole stack as part of our hybrid cloud services. So I think as CVK said, the evolution continues to happen. We're seeing even cloud providers, like an Azure stack in the data center. AWS just announced Outposts, which is putting gear back into the data center. Google launched Anthos and hence, we're clearly seeing that the direction is to go to the hybrid model, so I think the market will reset and continue to evolve in this way.

[Ravi Menon, VP of IT Services & Internet and Analyst]

Great. Thank you. And secondly, on the margins and if I can try to ask that differently. So I think that if you look at Mode 1 with some downward pressure from the [ DBA ] side and you addressed that. And in Mode 2, while there are investments, we have modeled continually for that. Looking directionally, as the business scales up, we should see margins expand because investment, in actual terms, they're not gaining, but as a percentage they should keep coming down?

[C. VijayaKumar, President & CEO]

So Ravi, if you look at it from FY '18 to FY '19, the margins on this business, the EBIT margins have increased. So obviously, as we scale up, we expect the margins to improve. But we are conscious of making all the right investments because this is something that will define our services business in the long term. So we would not compromise at all, we will do all the right things. But of course, long term, it will continue to improve the margins. Gross margin is already higher than our regular margins in regular business.

[Operator]

The next question is from the line of Mukul Garg from Haitong Securities.

[Mukul Garg, Research Analyst]

Maybe first, I wanted to just get a clarification on the large wins, which you guys have been declaring, and if we look at 3 out of last 4 quarters, you've had record deal wins. And while I understand that you have stopped breaking out the absolute number. And if we look at your earlier numbers, which you guys still report it, it used to be around $1 million, $1.5 million quarterly. Should we assume, and if we look at a couple of your large players, they are now close to 1x trailing book-to-bill in terms of their deal wins. So should we assume that, that HCL Tech is also coming in at a similar ballpark range in terms of quarterly deal wins versus revenue?

[C. VijayaKumar, President & CEO]

Yes. I have honestly not analyzed, Mukul, on how other providers' book-to-bill ratios are translating. But I think we have toggled between giving you the TCV numbers to revenue guidance, et cetera. But I think you really need to have some degree in several things like quantum mechanics to really arrive at the TCV to the exact revenue conversion. So the best, we found the most practical way to do that is to bake that into the guidance. And we have given you guidance last 3 years. We have met the guidance. So I think that's really the right metric we want to go. Any other metric would be misleading, will be quite gross in nature and very difficult for you to make a direct correlation. I would leave it at that, Mukul.

[Mukul Garg, Research Analyst]

So sorry to push back on this. But if you look -- [ if when ] you talk about record deal win from historical perspective and compared to revenues to provide them.Is it fair or would you be able to provide a ballpark range, maybe between $2 billion to $3 billion quarterly or something like that? Or you think it is a little difficult to share it, even that kind of a ballpark broad range?

[C. VijayaKumar, President & CEO]

I think the ballpark broad range you said is ballpark correct.

[Mukul Garg, Research Analyst]

Okay. That's helpful. Thanks. The other point and the follow-up to this was -- I mean if you look at your commentary on Mode 1, you're talking about low single-digit growth rate. So should we assume most of deal wins which are happening and which are going to provide incremental revenues, are coming in or have a very, very high share of Mode 2? Or is it still the case that most of large deal wins are able to replace previous deals, which are coming towards the end of their life? Ideally, this kind of a deal and profile, your Mode 1 revenue growth should have been higher?

[C. VijayaKumar, President & CEO]

So the base is also increasing. It does have some good components of Mode 2 as well. So I find it very difficult to kind of break down this deal wins. A lot of them are integrated, only when we get into execution, with project planning, resource allocation, all of that, which will drive the revenue. I know the industry is classifying most of the mega deals, even though they're taking over a traditional landscape, when it's going to be the traditional landscape for the next couple of years until they modernize, they still classify it as digital or Mode 2. We have consciously avoided doing that. We are completely focused on the work that we do to modernize. The revenues coming from that alone gets classified as Mode 2. So we are a lot more selective about what we classify as Mode 2. So if you look at our proportion of what TCV in Mode 1 would be, it's still quite high. Maybe slightly lower than the revenue percentage, but it's still quite significant.

[Operator]

Thank you. That was the last question. I now hand the conference over to the management for their closing comments.

[C. VijayaKumar, President & CEO]

Okay. Thank you, everyone, for joining. And overall, we've had a great year. More importantly, we are really looking forward to a fantastic year in FY '20, continuing our industry-leading growth momentum. As a team, we are aspirationally setting a $10 billion goal. So wish us all the very best for that. And in closing, I just want to leave you with the message, which is if you are a Man U fan, please try downloading the new app. That will really show the power of our digital capabilities. With that, thank you very much for joining this call and bye.

[Operator]

Thank you. Ladies and gentlemen, on behalf of HCL Technologies Limited, that concludes this conference call for today. Thank you for joining us, and you may now disconnect your lines.