Shift in business model driving high margins: HCL Tech

CFO Anil Chanana said the wage hike was offset by greater efficiencies and savings on depreciation and general and administrative expenses and a general

Over the past year, HCL’s net margins have gone up from the 25 percent range to over 30 percent. “The company has started a shift in the business model from time and material services to outcome-based services. The new model is risky but if you know it well, it supports high margins,” CEO Gupta said.

Q: How did the quarter pan out?

Gupta: We had another good quarter of continued and sustained performance. If you look at the calendar year we actually crossed USD 5 billion of revenues. Three of our businesses crossed USD 1.5 billion milestone for the 12-month period.

Infrastructure services called USD 1.5 billion. Europe as a geography crossed 1.5 billion. Manufacturing vertical crossed 1.5 billion. If you look at our service portfolio, which grew this quarter, infrastructure grew by about 6 percent, application services grew by about 2.5 percent, engineering services grew by 2.1 percent. BPO had 13.1 percent growth, although from a small base, but still nevertheless very strong. Our net income grew by 7.1 percent on a quarterly basis.

So all in all I would say a balanced growth across service lines, across verticals and on all parameters of performance whether it is revenue, EBIT or net income. A lot of this has just got to do with our continuous sustained strategies on the market side and on the industrialisation program that we continue to drive internally.

Q: Last quarter, you had indicated that the impact of a wage hike increase might be felt in this quarter, but looking at your EBIT margins which is again continuing with the overall growth in profitability that we have seen over the last many quarters continues. How did you manage? Where did you absorb this wage hike?

Chanana: This is the beauty of our business model, which is run-the-business (RTB) as well as change-the-business (CTB). In RTB, when engagements get into a steady state, we get good the margins. We did have a 70 basis point impact of wage hikes along with lower utilisation and currency headwinds, but we could offset it through the efficiencies, through engagements moving into a steady state and through our savings on the depreciation, and G&A front. At the same time, we invested in sales and marketing.

Q: The last many quarters we have seen your margins go up significantly from somewhere around 15.5 percent back in the March 2012 quarters it has gone up. Do you still see there is more headroom to grow as far as your margins are concerned?

Gupta: We are playing in an optimal range and given that there is such a huge market opportunity sitting in front of us we will continue to look at what makes sense in terms of scaling up existing momentum markets and the new trends we see and therefore invest in them.

It is important to realise the commercial construct of the business model. The point that we have been making around managed services, outcome-based fix price. In the calendar year, you will see a sharp shift from time and material to managed-service fixed price. So while it appears a lot more riskier, but in the long run if you know the business and if you continue to deliver RTB on a year-on-year basis there is more money and margin to be made. Because you can obviously improve efficiency in there and there is a significant difference in the composition of that number.

It has gone up from 50 percent -- what it used to be to about 54 percent for the end of the calendar year here and that is one large contributor to the margin at the direct level. The industrialisation program at the G&A level, consolidation facilities and basically taking out waste using LEAN as a methodology. In all, what we do over there is driving increased cash being taken out from G&A and being invested back into sales and marketing which is key to us.

Q: Looking at the kind of margins you are generating would you be reinvesting that into your business?

Gupta: We continue to do that. We continue to look at whether it is customer acquisition which is sales and marketing, whether it is pre-sales activities along with that or it is even an investment in new trends which we believe are going to be important as we go forward, because it is important to continue to sharply focus on the momentum markets.

Make sure that we continue to have good win rates, execute on them well, both from a customer satisfaction standpoint as well as from a financial standpoint, but at the same time continue to invest in what we believe would be the next drivers for growth in the future years.

Q: A word on some of the key verticals which contributed to this sort of revenue growth we have seen in this quarter that you might want to talk about?

Chanana: It was a very obvious growth if you look at it. Look at the financial services, which was way ahead at 3.8 percent quarter-on-quarter. Manufacturing was 5 percent quarter-on-quarter, retail 10 percent quarter-on-quarter, utilities sector and the public services sector, which grew at something like 30 percent quarter-on-quarter. So it is a huge growth.