HCL Technologies Limited analyst Q&A

We will now begin the question-and-answer session. The first question is from the line of Vibhor Singhal from Nuvama Equities. Please go ahead.

CVK, I just had two questions. One, I think this quarter, we were expecting a decline because of the project moving from onsite to offshore, but adjusting for that, how is the BFSI segment looking like? How is the growth overall in this segment in terms of the pickup in demand ; I mean we had a very strong BFSI performance last year, do you expect that momentum to continue or even get better ? And a similar comment if you could provide on Manufacturing. What led to this decline in the Manufacturing vertical in this quarter and how do we see it going forward?

Yes. Thank you, Vibhor. Let me address the Financial Services question. Apart from the one item that we had called out last quarter, the progress played out exactly as we had expected . As you know, Q2 will have a little more impact because of the state street divestiture . After that, we expect FS to show some growth because a couple of big wins that we had in the quarter were in financial services, which would start contributing to incremental revenues in Q3 and Q4 . Still the large outlook in financial services seems to be cost efficiency kind of driven programs, but a lot of them are not just straightforward cost efficiency, but it is led by level of modernization and tech transformation. That's what we are seeing in financial services. We're not seeing the general discretionary spend really picking up. It remains somewhat similar to what we saw in the last quarter. In Manufacturing, we have talked about the two elements of the Q1 outlook, one was of course offshoring of a large program, the second one was a traditional year -on-year productivity that kicks in in April. This is a little more concentrated in the Manufacturing vertical. So, that was one reason. Second, we saw in fact a significant weakness in the Automotive segment, contrary to all the expectations, because we see a lot of stress with the automotive firms in Europe and that has contributed to the second element. The third, which is it's mostly a BAU thing - our asset revenue has declined some 10-odd million and pretty much all of that seems to have happened in the Manufacturing vertical. Now, moving forward, as I mentioned, we see good growth in Manufacturing in the second quarter. So, we should continue to see good traction in Manufacturing henceforth.

So, apart from this, these three things that you mentioned, the overall outlook in the Manufacturing remains as it was, let's say last year?

That's right.

I just have one follow up question for Prateek. I think we would probably be taking the wage hike in due course of the year, either Q2 or Q3. If you can probably shed some light on that as well as to when we are planning it? Given that we are at 17.1% margin in this quarter and there is the impact of these hike yet to come, what are the operating levers that you're looking at to be able to manage the margins in that 18% to 19% band? I know Q3 will be a bump up because of the product business; however, despite that it seems to be a bit of a tall ask what are you looking at in terms of the levers to achieve that number?

Thanks for that question, Vibhor. I think I don't want to speculate too much about the wage hike timing and one-term, etc. Like Ram mentioned at the press conference, it is still a decision which is work-in progress. So, that is a work-in-progress which we will decide during the quarter. But at an overall level there is a certain quarter wise trajectory that we have had. If you look at the last couple of years, our Q1 is typically soft on the top line which kind of translates to the bottom- line EBIT as well. Then we have Q2 which is a pickup. Q3, like you rightly pointed out, is the peak. So, Q1 is the sort of trough, Q3 is the peak and the other two are somewhere in the middle. That's what we would expect to play out even in this year. I will leave it there because there is a long list of levers. We have talked about it enough times and all those levers continue to be available and at play. I will leave it there, Vibhor.

That was very helpful. So, in nutshell, we don't see any threat to over 18% to 19% guidance and we are comfortably pleased to meet that number.

Our guidance continues to be 18% to 19%.

Thank you. The next question is from the line of Sudheer Guntapalli from Kotak Mahindra. Please go ahead.

Hi, CVK. Thanks for the opportunity. So, you mentioned that the performance during the quarter was better than initially anticipated . Was this driven by the faster velocity, shorter cycle deals which would have come through during the quarter or something else?

It's difficult. It's a little bit contribution from a lot of things. It's not that we have hugely over - performed from our expectations. It is slightly above our expectations and it's a lot of small things which has added up. I wouldn't really call out any trend or anything like that.

You seem to be confidently suggesting that all verticals and geographies will sequentially grow in Q2 with just one exception. So, are you suggesting that the demand situation has bottomed out and seeing a gradual improvement from here on?

The only exception is Financial Services as I have called out and from a demand situation perspective, our going in assumption for the year was that discretionary spend would be similar to the last year and we maintain the same thing. I don't think the environment has changed in any meaningful way during the first quarter to project any optimism. Of course, our forecast for Q2 is based on the deals that we won and the execution that is underway. That's why we feel confident of our more broad-based growth in Q2.

Thank you. The next question is from the line of Ravi Menon from Macquarie. Please go ahead.

CVK, just wanted to check about the Manufacturing vertical performance. Last year, despite the productivity improvements, we have shown good growth. Even the year before that, there was only a slight decline, just about 0.5% Q -o-Q in CC terms. This year seems to be a lot more pronounced. Could you give some more color on what happened in the automotive sector? Is there any decline in the ASAP acquisition's revenue specifically?

Yes, Ravi, I think you guessed it right. Our ASAP acquisition did not deliver to the way we expected in the first quarter. But we are very confident of the overall investment and the outlook in that segment. I do believe the EV segment is going to undergo some stress due to various factors, especially in Germany. Given the ASAP acquisition, we expect the Q2 to be a good growth quarter and if you are trying to compare it to last year and other years, usually there are lots of elements. Assets are one thing, cost of $10 million, kind of an impact from Q4 to Q1. And that's not something which we can predict/define year-on-year. Then the productivity benefits - it’s pretty much similar and a repetitive thing every year. The growth can be influenced in one year because of a new deal ramp up, etc. So, it's very difficult to draw a one-to-one correlation.

Prateek, a question on the margin. Your IT Services' margin seems to be holding up well with the shift offshore probably leading it, but the R&D has seen a sharp decline. Can we recover the R&D margins fairly quickly or do you think this will take a few quarters?

Well, I am pretty sure we will recover most of it quickly. As you can see, it's a mathematical truth sitting out there . The costs have remained pretty much flat quarter -on-quarter, whereas there is a $20 million decline on the revenue line which has percolated down to the margin. So, sometimes that can happen when it is not expected, and it happens during the quarter. You don't have enough time to take the corrective action. I am sure they will take corrective action during the current quarter and see some growth hopefully.

Last question, if I may, on the fresher addition. How many trainees are you planning to hire this year?

There is a full year plan for this year. We have planned for is 10,000. Q1 we added about 1,100. That's in line with what we have planned for Q1, but a fresher addition through the year is always going to be something that we will plan quarter-on-quarter. We do make our plans based on what we do on campus and what we do off campus. Off campus is going to help us get that flexibility to moderate quarter-on-quarter to meet the demand that we have. But the going position for the year is 10,000 that we are still going as per plan.

Thank you. The next question is from the line of Sandeep Shah from Equirus Securities. Please go ahead.

CVK, the first question is any experience to share when the deals in ADM or IMS come for renewal and what are the clients asking for in terms of any benefits to be passed on from GenAI?

Yes, my answer may not be very popular, but I will still give it. More than the expectation from the clients on GenAI, I think it's the competitive intensity which is kind of driving some irrational behavior. That's all I would want to just say. In GenAI, customers, especially for running production landscapes, are a lot more pragmatic in what can be done and what needs to be done with a lot more thought and in a very gradual manner. I think we are working very well. Our AI Force platform is addressing the end -to-end lifecycle of software development and application operations, and a lot of our DRYiCE solution suite is also now integrated into the AI Force platform, where the earlier through machine learning runbooks were getting created, but now it's a lot easier through generative AI. So, that's all part of our AI Force platform. We are committed to implement AI Force platform across all our customers as and when we get the approvals. From then on, it's a journey and the customers recognize that. I would leave it there.

Prateek, just the question in terms of the announced acquisition in May of 2024, I do agree it will take another six to nine months to close and not forming part of the guidance. Are you worried it may dilute our margin substantially? And so, it may change our comfort range on the EBIT margin at 18% to 19% whenever it gets consolidated.

Our guidance is organic, both on the top line and on the bottom line. So, whenever the deal closes, like you said, six to nine months from the date we announced, that revenue is not in the 3-5% guided range, and neither is the margin. As far as accounting of any new acquisition goes, most of the EBIT DA that comes with the acquisition gets provided as amortization of intangibles. So, most acquisition s' P&Ls for the first one or two years are not really EBIT accretive or show any meaningful EBIT in the first couple of years. Hope this explains that.

So, this purchase consideration would be largely allocated towards intangibles rather than tangible assets, right?

Intangibles include goodwill which doesn't amortize. So, in any acquisition, a substantial part, more than 50% definitely goes towards intangibles.

Last question, CVK, what will it take for clients to relook the discretionary projects in terms of reducing the leaking buckets or to start the projects which are put on pause? Based on your interaction with the client, what are the events which they expect to become more constructive on discretionary projects?

I think even now there is some amount of discretionary spend happening, but for customers to become a little bit liberal and open-minded in doing new work, I think it's largely driven by the economic pressures, whether it is interest rates or inflation and things like that. And it varies from segment to segment. So, I think it's just the macro factors . While some companies have delivered very good profitability, but there is still a conservatism that is there, which I think will loosen up a little bit with some signals and some real changes in the macro.

Thank you. The next question is from the line of Dipesh from Emkay. Please go ahead.

Two questions. First about the vertical technology and services seem returned to good growth paths. So, if you can help us understand what is driving it because that vertical was relatively soft for last four-five quarters. Second is about the GenAI – what is our growth strategy and how are we different compared to some of the peers ? AI Force, you said, we intend to implement across client base. If you can share some statistics around where we are in that journey?

I have been indicating that we were seeing some green shoots of growth coming from Tech and Services, and it helped us grow in this quarter. At this point, there are certain programs both on the digital business side and some on the execution of the other programs that we had won, two- three quarters ago that are helping. We also see a lot of momentum with the hyperscalers in enabling their infrastructure creation and support. We are also seeing some green shoots in the Engineering Services as well, but it didn't contribute meaningfully to the last quarter. We hope it will contribute in the next quarter. Now, coming to generative AI, if I kind of summarize all the different use cases, one is very, very efficiency led. The second one is really innovation led driven by the leverage of data. So, our HCLTech AI Force is a comprehensive platform, which addresses all the efficiency -led benefits, both on IT processes and business processes. So, this is one platform, if a customer can implement it within their enterprise, then all the functions within the organization can leverage it to drive their efficiency programs using one consolidated platform which is secure, which has got ways to look at implementation of responsible AI and traceability of the decisions. So, I think this platform is very comprehensive. While we started with Azure OpenAI, now it's expanded into several other LLMs. I think it's going to be quite pervasive across. I don't believe the industry has a similar platform. We definitely have an edge in this. The second aspect within an enterprise will be how the internal organizational data, which is across different functions without going out (external to the organization ), being leveraged to drive generative AI programs and innovation. That is where HCLTech’s Enterprise AI Foundry, really helps any enterprise's AI journey, which is not just the efficiencies addressed by HCLTech AI Force and all the innovation around data is addressed by Enterprise AI Foundry. Now these two are leading edge, which even our hyperscaler partners recognize as a very strong offering from our side. And we have also aligned our HCLTech Enterprise AI Foundry with all the tech OEMs like Dell, HPE and others. They also see a lot of value in this solution, especially where we need to implement a private AI stack. Right now the implementations in maybe a dozen customers of AI Force are still early stages. I think it's all about getting the basic solution in place and then continue to drive adoption. And adoption is going to be a multi-year journey. I hope that was helpful.

It is helpful. And just on follow up, in terms of let's say now customers we have for AI Force, whether there would be any immediate revenue benefit ? Also, for time being, focus would be about adoption and revenue maybe over a period we try to monetize?

Yes, I think there are two different opportunities. The AI Force is going to be implemented and it's going to be more driving efficiency within the enterprise. At some point there is a value for the IP that we provide on an ongoing basis to the clients. Whereas in enterprise Data Foundry, any solution that we are implementing will give us benefits like how the small project 's discretionary spend does. This is going to be one more category where we will see customers spending and right now we do quite a bit of projects in this space. Double-digit TCV for two deals is what we have , b ut it's still early days . I would not extrapolate anything, but some meaningful wins are happening in this space. I believe that we have an edge over a lot of other service providers in this space.

Thank you. The next question is from the line of Nitin Padmanabhan from Investec. Please go ahead.

I had a clarification on State Street. So, I think in the press conference, you mentioned that there was an impact on BFSI this quarter from State Street. And next quarter we should have a 0.8% impact on revenue. So, did I hear that right? Because when I see the headcount fall of 8,000 and State Street is out, the acute headcount cost remains the same on a sequential basis. So, it feels like people have left towards the end of the quarter. So, the question is one, is there any impact on revenue in the current quarter due to State Street and should we assume that 80 bps for the whole of next quarter?

Yes, just to clarify what we mentioned in the press conference and then Prateek can respond to the rest of the questions. We talked about the decline in Financial Services was due to offshoring of a large client. That was the main contributing factor which was as planned and as we had indicated in the beginning of the quarter. The finer details on the State Street cost and revenue, Prateek will address.

Yes, so I think we covered this , Nitin, in the press conference that you referred to. There is an 80-bps at a company level and at a services level, the same translates to a 90-bps impact in Q2. That is exactly what we had told you at the beginning of the last quarter announcement.

The second thing to clarify was, in this quarter, I think we mentioned $70 million is the gain on other income due to State Street, but I think the consideration was $170 million. So, the rest comes in the next quarter. So, that was one on the State Street side. And I had another one, which is, CVK, you alluded to some weakness in Germany on the EV side. Could you help contextualize that a little better as to what exactly you are seeing? And finally, I think yesterday there was this ISG call and even on the TCS call, there was this talk about the impact of GenAI on ADM and Infra. So, when ISG put that number at around 30% of cost savings, TCS put it at 5% to 20%. Just wanted your thoughts on this because you have usually been very candid about these things. So, just wanted your thoughts on how, what are your observations on this space?

So, maybe I will address the two questions on the weakness in Europe and the GenAI impact on ADM savings, and Prateek will address the State Street related questions. Weakness in Europe was led by Manufacturing. I did talk about the three items in Manufacturing - productivity, assets and softness in the automotive segment. Automotive segments, especially large automotive firms who have significant software development capability, I think due to their own current stress have ramped down on a couple of projects which had a sharp impact in our ASAP revenue. We believe we have amazing talent and the leadership in ASAP. We need to broad base the ASAP capabilities to our global clients and that's what we are working on. I do believe this will get offset soon.

So, are you seeing this as cuts on EV related programs overall, or it is just specific?

Well, there is definitely one specific thing, but overall, the EV market is softening. Some of the investments are getting a little bit not prioritized as it used to be. But of course, the long -term trend, I do strongly believe in it. It could be the economic pressures on some of the industrial customers is what is causing this. On GenAI, I have been fairly clear on the four areas and the kind of impact it will have. The first is DPO and testing. I believe the benefits would be to the extent of 50% and we ourselves have delivered programs or delivering programs which is promising 50% savings from their current outsourced spend on DPO and testing. We have examples for both. The second aspect is in ADM. I think ADM and all the operations needs to be looked at differently. In ADM, we expect productivity improvement anywhere from 10% to 30% by adoption of a GitHub Copilot. The GitHub Copilot adoption journey is also a very gradual journey. Usually, customers look at a cohort of maybe 100 to 200 developers . They look at all the metrics and really make sure the productivity that is being measured which is accrued due to the GitHub Copilots, is calibrated and proper benchmarks made. Then that itself is significant to change management to achieve and then they scale from there to a much larger 1,000 to 2,000 developer kind of capacity. So, this is a journey, and we believe 10% to 30% is the productivity saving that would come through. Even one of the most advanced companies in this, have their own internal goal to achieve 10% productivity on the software development. The third element is the infrastructure application operations. This is where you are normally working on live systems which is running mission -critical applications and infrastructure landscape. So, the GenAI's incremental value from the existing automation, machine learning, and AI-led automation that has already existed in a very mature implementation where we have used machine learning and traditional AI technologies , the incremental benefit you would see would be in the range of 10%. That's what we expect. Of course, in areas like Service Desk etc, which is also in infrastructure support, maybe the opportunity is a little higher. And the fourth element is all the business innovation and the data-led AI journeys, which will really be a good growth driver because here every application needs to be modernized with a GenAI approach. And that's for the existing applications. Then even to leverage GenAI in an effective manner, a lot of customers need to continue their modernization journey and the streamlining of data. So, I think there are a lot of prerequisites that are becoming more and more important as we complete these POCs for a number of customers.

Thank you. The next question is from the line of Gaurav Rateria from Morgan Stanley. Please go ahead.

The first question is for CVK. Just trying to understand all the projects that we are delivering on GenAI, how to understand if it's all an incremental demand that is coming to us or it does it reflect that some projects are being prioritized on GenAI but something else is being deprioritized? Trying to understand if it is an incremental net positive for the industry and for us.

Eventually it will be an incremental positive, especially the fourth category that I have talked about. I would think it's incrementally positive. These spends, like I am aware of one bank, which is looking at half a billion dollars outlay for GenAI programs. So, this is something which is coming top down. They believe it can be a very disruptive capability that they can leverage. So, while that is just one example, but it just shows the kind of thinking that customers are going through. Of course, from thinking, to executing and to giving us the program, there is a time gap. So, I personally think it will create a new spend trajectory.

Related question, CVK, on the prerequisite that you mentioned that once you complete the POCs, you will have a lot of the work coming around modernization, which would be prerequisite for companies to implement the GenAI. Does it mean that the second stage could mean a much larger project than that you have right now on POC stage and much longer engagements?

I see it more like the cloud journey where it kept growing incrementally. That's how I see this come up.

We would need to end our question -and-answer session at this point. Thank you. Ladies and gentlemen, I would like to hand the conference over to Mr. C. Vijayakumar – CEO and MD for closing comments. Over to you, sir.

Yes. Apologize that we have run out of time. I am sure you have a lot of questions. Nitin will be very happy to respond to your questions as appropriate offline or in any other conversation. And thank you for joining us today and for all the interesting questions. We want to bring to your attention that on the 28th of August, we have an Investor Day planned in Mumbai, and you will get invites, and we really look forward to seeing all of you during the investor day. And thank you for joining us and thank you for your ongoing support and have a pleasant evening.

Thank you.

Thank you. On behalf of HCL Technologies Limited, that concludes this conference. Thank you all for joining us. You may now disconnect your lines.