TCS - Q1 FY24 - Quarterly Earnings Call

Key Themes:

• Last quarter, we had called out the growing caution among the clients, resulting in deferments and pauses in discretionary projects, particularly in North America and Europe. That has continued in this quarter.

• Clients are taking a month-on-month approach, resulting in very limited visibility on their future spending, even within their own organizations.

• Maximum caution in North America and Continental Europe

• The flavor of the quarter was Generative AI. Gen AI promises to transform most knowledge work by assisting and augmenting people and improving their productivity.

Deals:

1. Two consecutive quarters of strong deal booking despite the weak market, not even including the BSNL deal, and this quarter execution also, largely played out in line with your expectations, and we are seeing market situation improved a bit. How do we reconcile it with your tone in general on the demand situation? Is there a bit of conservatism you're baking in your tone to provide a buffer for any unexpected shock, especially since you have just taken charge? - No. We are not being conservative or optimistic here. We are telling what we are seeing in the market.

2. After two quarters of 10 billion plus TCV, I just wanted some more understanding on your media comment earlier, when you said long-term is good, short-term cannot call. Is that based on more client-specific factors or deals deferred earlier have seen more cancellations in the near term? So essentially, what I am asking is, the softness of the project prioritization that you referred to, has that become more broad-based across clients or that has become more concentrated within the pockets? - While the impact could vary from one account to another, the review and reassessment of discretionary projects itself is a broad-based trend depending on the individual situation.

3. Around two very strong quarters of TCV, now based on the deal ramp schedule, does this provide you with greater visibility of second half versus first half? - Our second half would depend on what happens in Q2 and how the momentum further builds over that.

4. On last quarter's increase in onsite costs and whether that was due to new project starts. Have we continued to see new projects start this quarter and that got offset by some pressure on the book of existing business? Or we didn't really see any new project starts and cater it, that's why we kind of ended flat quarter-on-quarter on CC terms? - We saw new project starts with deal wins continuing to ramp up. The net impact on revenue is due to the uncertainty on the existing projects or customers pausing their spend.

5. On the deferral of contracts. Is this due to this whole change in model to Agile versus Waterfall? Is that causing people to be able to take this pause versus earlier you would really have for any deliverable, there would be months probably still to go. So you couldn't really halt everything mid-flight and now it makes it a lot easier to put these pauses? - Not necessarily related to any methodology. It is more related to customers’ business outlook, However, in Agile engagements we execute smaller chunks of work at a time so to that extent, you can say that it is easier for customers to defer the next phase of work. Otherwise, it has little to do with the project delivery methodology.

Generative AI:

6. On the Gen AI, how should we realistically expect to see the impact of all the work you are doing from a two to three-year window? Is this something which will help you accelerate your revenue growth or should we see this more as a defensive move which will help you defend your revenues because there is a bit of a deflationary nature to the Gen AI deployment? Or is this something which will play out more on the talent side and structurally moderate the pace of people addition? - I think all of the things that you said will play out. You need to be looking at all these dimensions. But I think what is interesting for us is the fact that it can deliver things faster and the whole time-to-market element could be completely redefined.

7. On generative AI, while you definitely talked a lot about the demand opportunity for the customers, I understand, you are also running multiple projects internally as well, to assess AI augmented processes, how they are going to save cost or productivity for you. Can you share some of the details on that? And is that a possibility that, our own productivity benefits within TCS could start to prove much ahead of the revenue opportunity from generative AI comes through, eventually? - It’s difficult to call out some of this, but sufficient to say that, we have multiple teams, in almost every vertical working on pilots and internal projects.

• 8. Any particular investments on the consulting side and delivery side to leverage the demand that you think from generative AI projects?

• We are building our in-house capability in Gen AI

• We have our R&I team that is working on developing patents and very unique capabilities.

• We are leveraging our contextual masters, because we want to marry the technology capability with the domain capability delivery services.

• We are striking partnerships with all the hyperscalers.

• We are committed to train 100,000 of our associates to be capable of leveraging this technology.

• We also constantly look for new partnerships and other kinds of investment.

• But, at this time, our investments are more in terms of ensuring our associates and our contextual masters and domain experts work together, to think of the right use cases and the right solutions for our customers.
  

9. You think Gen AI would be a needle mover on revenues either for this year or the next. And if it is showing up in contract discussions at all, maybe as a source of price aggression in cost takeout deals?

• I don't know. It is not showing that much as being a differentiated feature in our contract discussions. But, you know, everybody is curious about its value.

• There is always a question around, to explain, how much of this Generative AI capability needs to be developed at the enterprise level in-house and keep the knowledge and the learnings in-house and how much of it can go outside for its larger public cost is a debate.

Growth:

10. What are some of the near-term levers that you have, especially when operating leverage impact is lower due to softer growth? - We will continue to use levers like utilization. Productivity and realization become the other levers. And some of our discretionary spend is now at a critical mass, where we can start looking at optimizing them as well.

11. You entered 1Q with softness owing to events that played out in the month of March, especially in the US on banking side. And then you built momentum through the quarter to deliver what you delivered. Is it fair to say that you are entering the next quarter 2Q with slightly better momentum and better visibility than you did in the last quarter? - I wish, I can could say that, we are in a much better place, but I do not want to give that optimism at this time.

12. On M&A, if you look at this one growth strategy that we have not leveraged much historically Do you see now is a good time to use either to build capability, let's say around Gen AI or maybe scale up opportunities from captive transaction as many corporations are looking for resource optimizations? - Our approach does not change. We have always looked at M&A if we have to augment some capability that we didn't have internally, and if we thought that by acquiring a company, we'll be able to further expand our services to a larger set of our customers.

Hiring/ Attrition:

13. So was there any fresher hiring this quarter or was the recruitment mostly lateral to backfill that ? - No. We continue to hire freshers and we'll hire this quarter as well and that will continue.

Industry Outlook:

14. Last time when we announced our results, the banking crisis in America and Europe was just cooking. Now, is this issue still being referenced to by clients as a concern or is this subject largely behind, based on your client conversations? - We don't hear this as a concern anymore

15. Now that the major panic or stress factor in the last quarter is behind us, is it fair to assume that September quarter will see a decent growth unlike June? – No comments

16. What are you hearing from your clients in terms of what are the signs they are looking for which can make them change their view on these pauses or kind of pushouts? Is this something which people will still have patience for some time before they start pulling back their tech spending or do you think the uncertainty being where it is, if things don't worsen materially, the demand can come back on a shorter notice? - It is a near-term uncertainty which is causing the clients to re-look at the programs and pause them wherever they think the ROI is not strong or is going to take longer time. And once they have clarity, we would see a certain class of projects, either cost optimization or transformation projects picking up momentum.

17. What is keeping this spend up in the manufacturing segment? And are we not facing the kind of delays that we are facing in, let's say, BFSI or other verticals, in the manufacturing segment? And do you think that manufacturing might continue to remain stable in the coming quarters as well? - Manufacturing is doing well because of the low base and the delayed pickup in demand and growth compared to other industries. And as the supply chain situation also eases slowly, customers are able to see the growth.

18. In retail, we had seen a lot of weakness in the past couple of quarters. And again, not just for us, for the entire industry. Are there any signs of that segment bottoming out? If not today, maybe in a couple of quarters' time? Just a little bit colour on these two verticals? - The essential retail is doing well. But if it is luxury or fashion or other specialty retail, we find that there is a softness in demand in such sub-segments of the industry.

19. Is it possible to compare the current client behaviour to any of the prior periods, such as perhaps post dotcom or GFC or taper tantrum or anything? Or is it completely novel? - I don't know if I can compare with any other cycle in the past. Every cycle has its own nuances. I would say today there is an uncertainty because of which customers are reviewing or assessing the ongoing programs. At the same time, they realize that there is so much of technology debt within each one of those industries.
And unless they carry out those transformative programs, they'll have a competitive disadvantage.

Margins:

20. How do you see the trajectory of the claw-back? Will it be similar to what we saw last year or there are higher tailwinds or headwinds this year as we move in the coming quarters? - In a typical year for us, we take the biggest headwind, which is the increment up front. We then typically claw back the margins through the rest of the year. With the current macro uncertainties, it would be difficult to estimate how exactly the margin recovery will play out quarter on quarter.

21. On the regional market side, we have seen that, one-third of the contribution on a TTM basis has come from this segment, where the profitability is lower by 400 bps versus company average. And some of the large deals in India market that we know like BSNL and GM probably may not have higher margins. So you think this segment growth, faster growth would put further pressure on profitability in the coming period? - You have to see these as large opportunities for long-term value creation with those customers. So it is a combination that we will have to look for. On a net-net basis, our approach is to take some of these projects, execute well and see that it adds to the overall capability creation and value creation, which is consistent with our philosophy.

22. on contract profitability. How is that progressing? I realize that, gross margins have continued to take a hit, probably due to wage hikes this time. But if you look at the full year in FY‘24, I know you expect margins to be clawed back. But do you think there is any chance that margins on a full year basis might actually not expand in FY‘24 or might even decline despite the supply easing up? - Given the current macro, it's difficult to give a color in terms of how it would end up exactly.

Source: https://www.tcs.com/investor-relations