HCL Tech signed 27 deals and had the highest-ever booking this quarter
Congratulations on a good set of numbers. Also, for this quarter under review, you are Indias third largest IT company having overtaken Wipro. If I look at the organic growth, the analyst community is of the view perhaps it is muted especially in the constant currency terms. Why is that the case and is that going to be the trend going forward?
C Vijayakumar: This quarter, our performance was exactly as planned. We had planned to grow 2.7% quarter on quarter on a constant currency basis and organically. In the beginning of the year, we had articulated that half of our growth will come from organic and another half is really a ramp up of the acquisitions and things like that. We are pretty much on track. This quarter, we had the highest ever booking. We have signed 27 transformational deals and that is going to help us incrementally demonstrate better growth in coming quarters.
If I were to talk to you about the new deals, 27 is higher than normal. If I look at the last four quarters, mid teens is the average growth rate. Is 20 plus going to be the new normal or is this an aberration?
C Vijayakumar: We have a good pipeline. It is better than what it was in the last quarter. In my earlier commentary. I had said that deals sizes were coming down but at this point, we have slightly larger deals in our pipeline. I would not pay too much attention to the number of deals. Overall, we had the highest booking quarter ever.
If you have won 27 deals and have highest-ever booking, why are you not changing your guidance? Is it a case of HCL Tech not wanting to jump ahead of itself?
C Vijayakumar: Last quarter, when we did the planning, we obviously had the pipeline for the full year and had some view of the pipeline at least for the next six months. Some of this was already baked in into our guidance. We are going to look at a couple of more quarters and see if there is a need to change anything.
If 50% of your growth has to come from organic, then 50% is obviously from inorganic. A lot of it is being pushed into the next three quarters because you have not delivered on that front in the first quarter?
C Vijayakumar: No, if you were to equate 2.7% constant currency growth across four quarters, I think we will be fine.
Is there more pressure on you now as far as margins go? Just simply looking at the deal pipeline because the street is perhaps thinking that may be the margins are lower or may be the pricing is lower?
Anil Chanana: In terms of margins, the performance has been very good. If you look from the EBITDA perspective, our margins came 20 bps higher than last quarter. Our EBIT margins came 10 bps higher and our net income margins actually came 40 bps higher. The margin performance has been very good and on top of it, we have maintained our margin guidance between 19.5% and 20.5%.
But the momentum will have to come for the next quarter?
Anil Chanana: That is correct. Momentum is there and we have given a very interesting analysis for the first time this quarter. Mode 1, Mode 2, and Mode 3 separate revenues and margins and we are the only company which is reporting these revenues and margins in this manner. The margins in Mode 3 are 25% plus. The margins in the digital services — which is Mode 2 and includes digital cloud, IoT and cyber security — is slightly below the company level margins because it is in an investment phase. Mode 1, which is the traditional services, is in line with the company level margins. It is depicting the way the things are going to come. so Mode 3 most stable stream of revenues, more predictable stream of revenues, annuity based revenues giving better margins.
In fact, the stated vision of the company is that Mode 2 and Mode 3 has to start matching Mode 1. We have seen it to be a little north of 26% for the quarter under review. When are you expecting to reach 50%-50% equilibrium?
C Vijayakumar: Not 50-50, but in next two to three years, we want to get 40% of our revenues from Mode 2 and 3 and I think we are pretty much on track. Strategies are working well, especially in Mode 2. We are seeing a lot of interest in very large clients. A lot of them who had multiple providers for their application services are now looking at a couple of providers and the biggest criteria to shortlist the two is to scale the digital capabilities. That is where we are standing out. We are very positive about our ability to win in that space and that is going to drive more growth in Mode 2.
Mode 3 is IP strategic partnerships and the IP that we have created and some of them have very high market potential. We have a mix of mature and high growth products in Mode 3 and their margins are high.
Before I get to IP and I also want some colour on IMS. You are the only company who is now on a quarterly basis going to start providing this kind of data. But a trend that we started seeing from the annual result of last year is that the margin is coming lower in Mode 2. Is that going to stay on or what?
Anil Chanana: It is in an investment phase. It will take two-three years to reach the company level margins.
What is that?
Anil Chanana: I mean the company level margin between 19.5% and 20.5.
You are saying it could take a year?
Anil Chanana: Two to three years.
What about IMS? throw some colour on that?
C Vijayakumar: IMS is really a very strong service line for us. We have a highly differentiated positioning. We are the leaders in infrastructure management services. There is a significant amount of strategies and initiatives to modernise infrastructure landscape and we have propositions around software defined infrastructure, digital workplace and next generation networks. All of this is really fitting very well into what large clients want to do. While large clients want to adopt some amount of public cloud, they also want to create a very flexible infrastructure within their data centres. It is largely a private cloud and a hybrid operating model and we are just playing very well into that place.
Every large deal that we won including the Nokia win had a significant amount of the next generation infrastructure components going into the solution.
The quarter under review has also been one which has been very volatile for all kinds of markets — be it equity market or the currency market or the commodity market which have an impact on the money markets as well. Your announced results on a day when Donald Trump said America has grown at 4.1% which is quite a phenomenal level of growth. For a company like HCL Tech there is definitely going to be some currency impact on this kind of a news flow?
C Vijayakumar: Before talking about the currency impact, this buoyancy in the economy and the reduction in taxes is definitely allowing some of the organisations to think of modernising a lot of legacy, infrastructure and application landscape. That will mean very good opportunities for service providers like us.
So you are saying make America great again is actually translating on ground, there is something that is happening?
C Vijayakumar: Yes, I would say that.
If I talk about the currency, one expectation is that the US dollar is going to strengthen?
C Vijayakumar: Yes, US dollar will strengthen. That definitely helps us. It means our cost will come down and margins will improve but we are generally comfortable in that 19.5-20.5% range. Not everything that is coming because of the increase in dollar rate is going to flow to the bottom line because sometimes customers will expect a reduction or new deals will get priced based on the new dollar rupee conversion. Some cost will go up, some investments will happen. I do not expect that to flow down to the bottom line. We will remain broadly within our guided range.
And the policy will stay? You will reinvest all the gains from the currency movement?
C Vijayakumar: That is correct.
We hear all of you are now hiring a lot more in America. The H1-B Visa norms are becoming more stringent. May be the spouses will not be allowed to go. They can cancel visas if they want. What are the impact of the new visa norms?
C Vijayakumar: If you follow the norms, I do not think there is any challenge. We as a company have a very large onshore presence. We have 10 delivery centres. We started investing in US delivery centres almost 10 years back and today we are over 14,000 people onshore and of that 63% are locals. Our localisation ratio is the highest in the industry and while sometimes the visas may get delayed, we do not see any major hassle.
So no dramatic drastic change in your workforce is what you are basically trying to say.
C Vijayakumar: That is right.
But with the US economy recovering, do companies like HCL Tech have any choice but to rejig their portfolio geographically to emphasise certain markets?
C Vijayakumar: For us, more than 61% comes from the US. We are pretty strong in Europe. We are in ANZ, Singapore, Hong Kong, Malaysia, Middle East and South Africa. We are going to intensify focus on Europe because Germany seems to be a market which is lot more open to looking at global delivery of services and we have signed definitive agreement to acquire a company in Germany. All of that is going to help create some new countries where we will grow and US will continue to be our bedrock.
US is 60% plus. You are looking to increase your exposure in Germany via inorganic growth. What other geographies might you be looking at?
C Vijayakumar: Australia is another one. We are already present there. We have a substantial presence but we believe given the rebid market that is available in the next three years we will expand further in Australia, in both organic and inorganic manner. Canada is a market where we did not focus so much in the past but are doing so now. South Africa is another geography we will focus on. Every year we focus on a couple of geographies.
Buybacks are the flavour of the season from IT companies back to back we are seeing buybacks little change in your capital allocation policy?
Anil Chanana: There is no change actually I mean we are very consistently maintaining the capital allocation for policy, we stated we will be delivering 50% of the net income to our shareholders and in the last 12 months I am very happy to report that we sort of paid out something like 54% so we are ahead so far as in terms of our guidance, in terms of payouts.
On a lighter note tell me what did you make of it when you saw that premium actually get eroded in one or two trading sessions when the buyback news came?
Anil Chanana: You cannot look into the stock market and work out a pricing. It is ultimately a distribution to the shareholders.
It is a feat for HCL Tech. I am sure you are all very proud to be Indias third largest IT company for a quarter. How big a moment is this for HCL Tech?
C Vijayakumar: Actually it is business as usual. We have a good strategy and we are executing it. The strategy is continuing to deliver results.
Your plans to close to the gap in number two and number three after that?
C Vijayakumar: Hope for the best.