TCS confident of maintaining margins; end year at good level

TCS today posted a 4.3 percent growth in net profit to Rs 6586 crore. The dollar revenue grew 0.3 percent to USD 4374 million for the July-September quarter. While the company missed profit and revenue expectations, it managed to retain its margin at 26 percent despite many headwinds. “It was an exceptional quarter in terms of margins,” N Chandrasekaran, CEO & MD of the company told CNBC-TV18’s Reema Tendulkar. TCS reiterated its 26-28 percent margin expectation for the current fiscal.Margin improvement confidence comes from the continuous efficiency gains and investments, says Rajesh Gopinathan, CFO & MD of the company. Weakness in sterling and softness in macros were the main headwinds for TCS. Chandrasekaran expects the latter to go away post November. While the banking and financial services (BFSI) business grew in UK and Europe last quarter, retail business continued to soften.TCS is ‘extremely focused on growth’ and the priority is to exit FY17 at a ‘good level’ for the company. The third and fourth quarters are likely to be much better than Q2.There was postponement of deals worth Rs 180 crore in India, which is expected to come in next two quarters. India business will come back by next quarter, Gopinathan adds.Ajoyendra Mukherjee, EVP & HR Head says that hiring will be lower than last quarter, but adds that retention rate has improved.TCS is also preparing itself for various situations with upcoming elections in US, he adds. Below is the verbatim transcript of N Chandrasekaran, Ajoyendra Mukherjee and Rajesh Gopinathan's interview to Reema Tendulkar on CNBC-TV18.Q: It is an unusual quarter as you have pointed out and this is the most negative or cautious that we have heard you sound. Walk us through the pressure points that the company faced and what according to you led to the miss if you could quantify it?Chandrasekaran: It’s unusual because as you know for us Q2 is always the strongest of quarters. We typically do better in Q2 than what we started the year with in Q1, but during the last quarter commentary we said that there are macro events and we could expect some softness is what we had said, but basically if you look at the revenue performance there are 3 things I would like to point out, we cautioned that the banking, financial services and Insurance (BFSI) sector is some softness and it played out as we have anticipated, so we grew 1.2 in BFSI, but there are two other things that happened we had a very surprise postponement of deals in India to the extent of about Rs 180 crore.The good news is that it is not gone away it will come and it will come in Q3 and with regard to retail we saw some softness again it spread across multiple situations largely in the UK, some in US that also cause the retail to be having a de-growth of 3 percent sequentially. It is unusual in all the 3 counts because usually BFSI and retail both will have a sequential growth from Q1 to Q2. The retail revenues will also come because they are all very much baked in, they are all transformation engagement, some delays here and there, but some of it may not come in Q3 primarily because Q3 is a seasonally a quarter in which retailers stay focussed on holidays and execution in holiday so on and so forth. Some of it may spill to Q4, but both of these headwinds are things that will become tailwinds as you go into the future.On margin performance it has been an exceptional quarter, because we had many headwinds and very low growth and we had a currency British Sterling has weakened very, very sharply and against that backdrop we have delivered a margin performance of 26 percent to be in our range.Q: But coming on the point about Q3 and Q4 being better than what we have seen historically. Is it only on account of the bunching up of deferred revenues in retail as well as India or do you believe to expect a pickup in demand environment?Chandrasekaran: I think I should be realistic primarily because the election will be in November in the US. See it is very difficult to link everything to the elections, but I am generally linking the softness to the macro. I feel that the softness will give up post the macro is what I feel, but that’s more account prove it with data points for you, that’s more an assessment, because we are not seeing any cancellation of engagements. We are not seeing any account specific problems that we are facing, so I believe that all of this will happen, how much will come in Q3, how better we will do in Q3 but I believe that this year Q3 and Q4 will be better than traditional years, because of the reasons I said.Q: And eventually the macro uncertainty in North America should be lifted once the elections are out of the way. Of the headwinds that you have highlighted, which one do you think will extend themselves into FY18, what I am trying to get at is which of the headwinds which you see as cyclical, right now I am defining cyclical as 2 quarter phenomenon and which of these will be structural playing out over a longer term?Chandrasekaran: Currently, I don’t have any data point to say that any of this will extend.Q: Beyond FY18?Chandrasekaran: Yes, I think so.Q: Even BFSI in North America?Chandrasekaran: I think so, because you see the growth that we have seen in BFSI, if you look at TCS BFSI performance over the last 7 years and we can go before that, but you can definitely look at 6-7 years if you really look at it, we have given a fantastic growth and even this year if you see our uptake of digital wins in BFSI, the kind of engagement that we do from operational efficiency engagements, to deployment of analytics, to big data, to building largest cloud platform you see very many engagements we are winning and we are partnering with clients very well.And as I said in the press brief we have done very well in BFSI this quarter in UK, which proves contrary to the Brexit situation you would expect that your BFSI revenue in UK will go down, but actually not. We have done well. We have done well in continental Europe so I have said that there is some softness in global banks and that has what impacted us.Q: What would FY18 look like and how would you articulate the demand environment for this, because it is quite clear that growth this year in constant currency is going to be lower than what you saw in the prior year. I am not getting into the numbers, but doing the maths right now it is going to be lower, so the demand environment has worsen, has it significantly worsen slightly and give us some colour about FY18 also?Chandrasekaran: You have to see it quite differently from my perspective. I can only give you a philosophical answer. It is very difficult for me to give you numbers. I will tell you what my priorities are fundamentally I am a person who is very focussed on growth. I have always maintained it in the company and people who work me know that and growth is a very, very key thing that I drive.Additionally, I have always maintained that growth and margin have to go hand in hand and discipline selling to discipline execution is equally important, because you focussed on growth, sacrificing the margin and you focussed on margin sacrificing the growth you end up losing growth and margin, that’s being my belief and I so focus on both growth and margin. We are extremely focussed on growth.Let’s look at what has happened over the last two years, because these are the questions that people have whether it is media people, whether it is investors, analysts. Basic question is Chandra is giving this commentary, but performance is not matching. TCS used to go much higher, why there is a softness which is the fundamental question, but if you look at last year we have clearly explained that we had several one-offs and we are not pointing out any one-offs. All these one-offs are over behind us. I kept updating you quarter by quarter and I said that those one-offs are behind and those one-offs are behind, so whether it is Diligenta, whether it is Japan, whether it is Latin America (LATAM) those one-offs are behind.I think that technology is fundamental. Business is getting embedded in technology pretty much and every company is going through transformation and they are adopting digital in a big way. Everybody wants to drive efficiency, drive agility, speed to market and deliver a superior customer experience. They are adopting internet of things (IOT) on the one hand and the manufacturing businesses and supply chain businesses and they are adopting analytics and other cloud platforms.I think there is a significant transformation that is underway. We have made all the investments. We are participating so my priority is to exit FY17 at the right level, what is your right level I don’t know. It is important to exit FY17 at a good level so that we are positioned very well for FY18. That is an indication all I can give you is that our focus it to ensure that we deliver structurally sound.Q: Exit rate better than what we saw last year?Chandrasekaran: Don’t ask me for numbers, what I have told you exactly what we are seeing on the ground and our focus where it is.Q: The other investor concern is also the fact that there were many one offs in FY16 and they are not present in FY17 but new one off's have crept up this time. So, in that sense it clouds the visibility?Chandrasekaran: There is a big difference between the two because when I say one off\\'s, they were structural one off's, they took a long time. When Diligenta was going down it was a sequential drop for multiple quarters, same thing in LatAm, same thing in Japan. So, we were seeing those for a multi-quarter period but these are not like that. These are not any structural slowdown or structural issues.Q: I understand there would have been an Orange County settlement as well which you would have done this quarter, that could have added close to about 50 basis points to your margins. So, if it wasn’t for that one off, your margins would have been higher at 26.5 percent doing the rough math and that is a significant improvement quarter on quarter. What led to that and even in the quarter that we are in we are going to see cross currency headwinds as things stand today. How will you mitigate it? Do you still have scope to improve your productivity and execution?Chandrasekeran: The kind of margin performance we have delivered indicating what you said is exceptionally good._PAGEBREAK_Q: There was that Orange Country settlement, right?Chandrasekaran: Yes of course and that headwind was overcome in delivering our margin of 26 percent.We have significantly focused to ensure that operationally we are always disciplined and we are optionally continuing to focus. That is why you have seen in the quarter in which there is a 1 percent constant currency growth, you are seeing 90percent improvement in gross margins. Then we have seen improvements across the board in multiple line items and these things will continue. We will continue to focus on all kinds of levers whether it is automation, whether it is efficiency in the way we deliver large engagements, efficiency we will get because of the tools that we have developed over the years, many things that we will continue to deploy. It is not one thing that here you do something and you get some improvement. Philosophically we have said that we will be in the 26-28 percent. Q: For the full year you will be within that band?Chandrasekaran: Our intent is to stay within that band, whether lower end of the band, higher end of the band is also a factor of growth and so far we have not stopped any investments.Q: You spoke about BFSI, retail etc being cyclical problems and not structural but what about Brexit? How would you quantify it because that is only going to play out in March from hereon? Secondly US elections, in case there is a market adverse outcome, is that going to be a significant headwind for the Indian IT industry as a whole?Chandrasekaran: These are things on which you don't want to make a definitive prediction but based on the data I have, based on my own knowledge I would say two things, as of now Brexit has not had an impact on us. This is not to say that there will be no impact.Q: No delayed decision making as well?Chandrasekaran: Yes because we have done quite well in the UK in BFSI segment. However in UK we have had delays in the retail. I don't know whether you should connect that to Brexit. Logically I cannot connect because these are all retailers within the UK market, so I cannot really connect.The things about the US election I personally believe, technology and our IT ecosystem is extremely well integrated into the US market. So, I personally believe that there cannot be any significant adverse effect. Having said that I don't know how regulatory changes will play out, I really do not know and if that plays out we will see.Q: 26 percent margins is much higher than consensus expectations and this takes into account that you have had a one off settlement on account of Orange County which is to the tune of USD 26 million, if I add that back it would have been an EBIT margin of 26.5 percent. Take us through how you managed it, what were the headwinds and tailwinds?Gopinathan: The headwinds this quarter was very clearly the currency, especially the GBP depreciation. We went from an average of 95 last quarter to 87 this quarter. So, almost a 7-8 percent more than that kind of a depreciation. So, the net impact on margins from GBP was to the tune of close to 40 basis points. Otherwise operational improvements delivered us about 130 basis points improvement.What is most heartening about the margin performance is two fold, one, it came across the multiple units as we are organised into different profit and loss units and it is hats off to operational efficiency drivers at each of these units. Very unpowered operating structure, very unique a organisational structure and that really came through and delivered for us in this quarter. The other element of it is that the margin improvement has come for us on the gross margin level. So, our investments continue apace and this is really efficiency gains coming in across our operating business itself rather than cutting corners either on the sales side or on the investment side.Q: Can you deliver this kind of 130 basis point operational improvement on a quarter on quarter basis or operational efficiencies on a quarter on quarter basis? What gives you confidence that you will be able to achieve margins in your full year guided band of 26-27 percent?Gopinathan: The confidence in terms of defending the margin comes two fold, one, it comes from our structural strength. We have a very robust and a very resilient business model. We have been making investments across the board both from a geography perspective, service line perspective and as these investments mature they start delivering certain amount of margin resilience. The second part of it is the organisational structural itself, it is geared for empowerment at the operating level which allows people to take a very nuanced view of where they want to focus on and deliver that efficiency. So, we are quite confident about being able to systematically drive improvements in the context of the overall market. So, one off impacts of currency of macro will flow through because we are talking of quarter to quarter kind of a cycle. However at a structural level we are quite confident.The third element of it is a question of relative positioning - relatively compared to competitive field we are quite strongly positioned both in terms of client presence as well as presence across emerging service lines and markets. So, each of them is a margin lever to be exercised on a sequential basis.Q: So, 26-28 percent stays for the medium term as well for your margins?Gopinathan: Yes.Q: On the margins front we can see the employee costs have come down on a quarter on quarter basis which has given you that margin tailwind. If you could explain that for us in greater detail and when growth has been quite slow for the company the employee addition at over 9000 is healthy, take us through the rationale behind it?Mukherjee: As far as the employee cost is concerned, it is a factor of multiple things, it is s factor of how many people you are adding, it is a factor of onsite / offshore leverage, it is a factor of local versus the people who are in India and everything else and the employee pyramid. So, all that is there. There have been multiple benefits or multiple things that we have been focused on to get that kind of an improvement as far as employee cost is concerned and there is a variability as far as certain part of our compensation is concerned. So, overall these are some of the factors.Coming to the hiring side as far as this year is concerned, we said at the end of last year that our hiring this year is going to be lower than last year, that is how we started. If you look at our Q1 plus Q2 the total number that we have added at this point in time is lower than what we had done last year. At the same time this quarter it is about 22000 gross which is pretty healthy, 9400 as far as the net is concerned.One of the factors is last year we had given offers to 45000 trainees and they are the ones who are joining end of Q1 and from Q2 onwards. So, this quarter we had a significant number of trainees joining in. So, that is one which has taken our number higher. The same trainee will be joining in Q3 as well as Q4, so that is what is going to happen going forward.Q: Can you drive further declines in your employee costs say on account of onsite versus offsite as well as the other metrics? Is there scope for employee costs to be a margin tailwind?Mukherjee: Overall employee cost definitely will impact the margins. It is a question of onsite / offshore leverage and various other factors for example high cost resources in terms of business associates and things like that which we have been working on over a period of time and our focus will be to continue and try and get more and more improvement but whether it will be kind of what we have seen in this quarter, whether that continues in the next quarter and the quarter after that is something that is still farfetched at this point in time.Q: No change in your hiring targets for the year?Mukherjee: No. It will be lower than last year that is definitely true but at the same time the trainees that we had given offers to last year, all of them will come and join, we do honour our commitment. Even in 2008-2009 timeframe we had kept our commitment and got everybody in into TCS and we will continue to do that._PAGEBREAK_Q: Do you want to quantify qualitatively as well as quantitatively the demand environment as you see it and what headwinds will be going forward because retail has come up new, is that going to be a longer term pain point? How many more quarters of pain for BFSI?Gopinathan: Demand environment is I would characterise it as being complex. If you look at vertical by vertical different factors are playing out but the underlying area is that there is a very strong transformational agenda playing out in almost every vertical. So, while there might be ups and downs from a cyclical perspective and the macro impacts will come through but the transformative agenda is not being put aside. So, if you look at a vertical like lets us say energy and that had a one off kind of a huge impact there everything was off the table and therefore we saw a period of complete negative growth and a complete meltdown over a period of time, whereas that kind of a scenario does not exists in any of the verticals currently, whether you take BFSI, whether you take retail or any of the other manufacturing which is in fact continuing to do quite well. So, the transformative agenda gives us the primary driver for incremental demand and then the overall macro situation and individual event concerns are acting as a flip or a drag on it as the case be. So, it is becoming very difficult to call it in advance. However we are focused on participating in that whole spectrum across the market space and we are seeing a fairly good pockets of growth. So, even in BFSI geographically the demand environment is more diverse.European market continues to be strong for us in BFSI whereas the North American market is slightly soft. UK - the retail side of it was weaker compared to the North American side, so it is becoming a fairly heterogeneous one, which is where the ability to predict is slightly reduced.Q: Would you concur that the headwinds that you saw last year in form of Diligenta or Japan, they caused multi quarter pain for you? However this time the pressure that you are seeing in the form of retail or BFSI in North America these will be restricted to one or two quarters only? Is that a fair summary:Gopinathan: Rather than putting a timeframe to it, in its nature both are very different as you pointed out.Q: On account of that fact how long it will impact the company?Gopinathan: One was structural changes, these are more we think cyclical or more of temporary changesQ: So, how does it set you up for FY18 when the headwinds are cyclical and should play out by the end of the year?Gopinathan: At this stage very difficult for us to take a call on it. We are going into holiday season and then the budgeting season comes around. As we start getting better visibility on how the Budgets play out we should be able to come and turn it. I wouldn’t stick my neck out and put a number on it right now.Q: But all the revenues lost in India as well as retail in this quarter should be made up in Q3/Q4?Gopinathan: We have spoken about India which is easier to talk about because it is a very lumpy and project specific and India we think should comeback next quarter, but the other ones we are hopeful, but we will have to wait and see.Q: You don’t fear that there will be a loss of revenue from the retail side, India you are confident of making up, but on retail side do you believe there is a possibility of the loss?Gopinathan: We would stay back from commenting on it, but as I said at this stage it is difficult for us to take a call, India is positive so that’s why we are talking about it.Q: On North America even Chandra referred to the macro uncertainty on account of the US elections. In case there is a Hillary wins, how do you foresee the visa side of the business or any impact on Indian IT and what if there is a Donald Trump victory, how would you foresee the scenario, if you have to give us best educated guess? Mukherjee: It is very difficult to give you a guess at this point in time, because what is being said during the election process vis-à-vis what happens in senate and what happens in houses are two different things altogether, but yes there has been talk on the immigration front over a period of time from a Senator Grassley point of view. There are many different bills that have come in, but finally it did not go through and we have also talked about the way we have been preparing ourselves for various eventualities in terms of hiring onsite, in terms of looking at our mix, in terms of onsite-offshore and things of various kinds, so from our point of view we are prepared, we are preparing ourselves for various eventuality and no matter what happens you still get a considerable period of time to comply with whatever the new regulation is and we have to comply and we will be compliant to the regulations that comes in, but it is very difficult to say.Q: You believe the either situation might get worse in case there is a Donald Trump victory?Gopinathan: It is very difficult to say at this stage as to which way it will go, but yes they have been making statements, some of them are towards for example that we should tighten visas, we should have different kind of things, but what eventually it takes place once the election is over, we have seen that in the past as well, so there are statements being made and at the end it is very difficult to guess as to which way it will go.Q: High tech was also flat this time, but it wasn’t called out by any of yours as potential headwinds, why is that and what happens in high tech?Gopinathan: High tech has been weak over the period, so if you go back communication high tech technology all of those sectors were weak. Communication has been slowly recovering, high tech has still not recovered so since there was no change in status we didn’t talked about it. BFS had a relatively good year last year and then we saw sequential weakness which is why we spoke about it.Q: Let me also come in on the fact that your USD 100 million clients have come down from 37 to 36 when I look it. Could you explain why?Gopinathan: This is purely a technical one. One of our clients have done a divestiture and therefore its business is split into two. We continue to be serving them under both their new entities, but because of that we now have two small entities rather than one single large entity.Q: On attrition quarterly annualised has gone up very marginally, but 14 percent versus 13.5 percent, would like to comment on that?Mukherjee: Not really, this is more seasonal at this point in time as you July-August timeframe there are people who leave for higher studies and things like that and secondly it is at the end of the first quarter once the promotions and the increments and all these things are given out, we do see a natural kind of attrition at that point in time, but overall if I look at from my last 12 months, yearly kind of things it is 12.9 percent, which is definitely much better than what it was last year last quarter improvement in retention, so we are pretty happy with our retention levels.Q: Let me come in on this Q3 and Q4 being better than what we have seen in the past, is it purely on account of bunching up of deferred revenue. Is that the only reason why it will be better than the past track record?Gopinathan: Difficult to get into detail, but one of the tailwinds into it will be the India performance.Q: Other than that if it wasn’t for these two factors it would have been similar to what we have seen in the past?Gopinathan: I would wait to comment on it till it actually plays out.Q: What could be the extent of the loss of revenues in retail that we have seen this quarter?Gopinathan: Retail is about USD 600-650 million a quarter for us and it is down about 3.5-4 percent, so in the range of about USD 20-25 million.Q: So India would have been miss of USD 30 million roughly, retail you are saying would have been miss of USD 20-25 million and BFSI what would have been the miss?Gopinathan: That’s depend on what you would want to take as a baseline. BFSI in itself has grown positively, so it is a 1.2 percent growth, so that point is difficult to quantify.Q: So what we should easily estimate is that there will be a positive impact of USD 50-55 million on account of deferred revenues in the coming quarter retail and India?Gopinathan: I can confirm on the India side, on the others we would wait for it actually to happen.Q: No indication from your clients on what the coming outlook is going to be for the next year?Gopinathan: It early days yet, typically budget visibility starts coming towards the end of the year or in fact early part of next year. At this stage there is enough uncertainties that people typically don’t comment or our own confidence in people’s commentary is also limited. We will have to wait and see how it turns out.Q: No discretionary pullback in other sectors, only BFSI and retail?Gopinathan: Not that we can specifically look at now.Q: These were the only two verticals.Gopinathan: Please remember that it being material enough for us to call out. There are different dimensions that you cut it by geography, vertical etc, so it is not that it one of this thing, but these are the things we want to specifically talk about. Others have their own pulls and pressures.Q: Last question on digital that clearly the big growth driver, but this quarter it seems to have slowed down, just a 1.5 percent growth in dollar term?Gopinathan: Seen in context is still a 25 percent year-on-year growth and remember that two biggest sectors that have been driving digital adoption have been BFS and retail, but in no way is it going off the radar, 25 percent year-on-year is still huge growth. We are now at a run rate of close to USD 2.8 billion, 25 percent on that kind of base is still pumping big time.Q: What would be your forecast on how the annual digital revenues could be for TCS from the current USD 2.8 run rate?Gopinathan: That is difficult to say, we have not quantify it but growth rate on that should sustain. We wouldn’t expect it to slowdown.Q: Sustain is what 20-30 percent year-on-year?Gopinathan: It will continue on that trajectory for some period of time.