TCS cautiously optimistic about FY09

India's largest IT exporter, Tata Consultancy Services or TCS has announced its first quarter numbers. It has posted consolidated net profit of Rs 1,243.6 crore for the quarter ended June 2008 as against Rs 1,255.9 crore in previous quarter and revenues of Rs 6,411 crore versus Rs 6,094.7 crore (US GAAP).

S Ramadorai (CEO and MD), S Mahalingam (Executive Director and CFO), N Chandrasekaran (COO), Phiroz Vandrevala (ED and Head-Global Affairs) and Ajoyendra Mukherjee (Head - Global Human Resource Development) speak to CNBC-TV18.

The management said uncertainty is likely to prevail through the rest of the year. It said that the Q1 volume growth of 1.3% has been in line with expectations. The IT major expects volumes to pick up in the second half of the year.

Some recovery is expected in Q2 and they are watching the on-ground very carefully. The company is watching out for the results of the big financial institutions. Their deal pipeline remains good and the growth momentum is still intact.

Major markets of US, UK and Europe are growing. Sentiment stays cautious in BFSI or banking, financial services and insurance segment, but is improving. Transformational deals are taking a bit longer due to slower decision making. TCS has a strong pipeline in BFSI, and is working on some large deals.

The business is likely to see some ramp-ups from two of four clients with issues. The company is confident that it will see sustained long-term growth.

TCS is sitting on long-term hedges of USD 2.1 billion; maximum forex loss is seen at Rs 90 crore over the rest of the year.

Excerpts from CNBC-TV18's exclusive interview with TCS management:

Q: The volume growth of 1.3% this quarter seems a bit on the lower side, given your historical averages; by when do you see volume growth starting to accelerate again?

Ramadorai: I think this is in line with our expectations; we had certain issues with some of the BFSI clients, which made up the other segments. The volume growth in manufacturing or retail or life sciences, have been much above the company average and international business has a healthy growth both in terms of volume as well as the result of the exchange.

Fundamentally, we see that later half of this year will see growth and some of the problems with our existing customers are behind us; out of the four, two are behind and in two more we hopefully will see corrections in the next two quarters or so. So all in all, we believe that in the second half of this year, we shall see some growth.

Q: Q4 and Q1 now have been mildly sluggish, do you think Q2 will be sluggish as well before growth picks up or will the first signs of recovery be visible in Q2 of this year?

Ramadorai: Some recovery will be visible in Q2, but then the situation on the ground has to be watched very carefully, both with regards to the results of the financial institutions as they come out as well as the real happenings with the oil and fuel prices and the implications of that. Having said that, the deal pipeline is good and the momentum with regard to growth is certainly there, but how it translates in this quarter has to be seen.

Q3 and Q4 should be better than what it is and we would be comfortable with that.

Q: Ramadorai spoke about two of the four clients actually improving a bit and two will follow. Can you give us a few details without mentioning names of the kind of improvement that you are seeing in the clients, which became a little sluggish or sticky in the last couple of quarters?

Subramaniam: In the last quarter we talked about a couple of clients with whom we have certain issues, I think we have turned that around. We are seeing growth momentum picking up with those two clients, and I hope that they will continue to take decisions on the transformation engagements. The other thing we talked about in yesterday’s analyst call is also the other third client, with whom we have issues with respect to the demerger, so that is all getting sorted out, we are working it out. Hopefully, this quarter should see positive growth in these three customers.

Overall major markets are growing especially US, UK and Europe and we see a good pipeline. The BFSI sentiment continues to be cautious and we exercise cautious optimism over growth, but we see that things are picking up, transformational deals that used to take about six months of decision cycle are taking little longer.

Q: You have changed the method by which you account for depreciation. If you take that out, what would the margin picture have looked like in this current quarter?

Mahalingam: The total amount involved there is about Rs 49 crore. Basically we are adjusting it for the working life of the assets as we have it. We were very aggressive earlier and therefore we looked at it and made sure that it is inline with our usage. If you remove that, it has essentially introduced 67 bps impacts and therefore from the last quarter to this quarter, the operating margin fell by about 26 bps, almost flat and you add 67 you are getting about 93 - that’s the impact.

Q: Going into Q2, will you hold margins at these kinds of levels?

Mahalingam: We have seen the performance essentially in terms of a Cost Containment Programme and it has been realised in a situation where expenses went up because of the exchange factor. So if I add all that, we had about Rs 78 crore. We believe that the programme would continue to work and we should see the margins at this level.

Q: There has been some talk in the market that you are facing difficulties with one of your clients in the insurance space, AIG specifically, are there any issues that are cropping up?

Subramaniam: I do not want to comment anything specifically on a particular client or a particular project, but overall growth momentum is better than what we had in the last quarter. Major markets are growing. While the decision cycle is taking a little longer that what it used to and we are what we are with respect to banking, financial services and insurance or BFSI pipeline, we have a fairly strong pipeline where we are working on a number of large deals as well and hopefully things should turn around.

Q: You spoke earlier about how things are returning to normal with a couple of the difficult clients, have they started work with you or has work been continuing and now the first signs of ramp up are visible?

Ramadorai: Exactly. The work is continuing and we are going to see some ramp ups. That is the first on the two out of the four clients. On the third one, with regard to the demerger, we are closing the deals with the newer entities and hopefully that should start either during the end of this quarter or early into the next quarter.

On the fourth, we anticipate a little bit of a slowdown but we think that we would be made up by growth in other sectors during this quarter and the subsequent quarters. So all in all, the problems, which we face with regard these four clients, have solutions and we are quite happy with the same. But then the momentum with regard to building more business with the existing clients or newer opportunities with regard to the deal pipeline are quite comfortable; that was the thought process behind telling you that Q3 and Q4 are likely to see volume growth.

Q: Given that the base would be low for Q1 and Q2 as well, are you expecting significant volume growth in the second half of the year that will make your overall annual growth quite respectable?

Ramadorai: I think the objective is to show growth in line with the industry projections, but more importantly the sustained long-term growth opportunities are what we are going to be looking at.

We do not give any guidance as you know, but the fundamentals and our new organisational structure is extremely agile, extremely strong and the customers want to transact business with an organisation that is very responsive. Those are some of the opportunities and those are some of the positions we are taking. Communicating our value proposition on continuous basis and you are going to see some momentum for sure.

Q: You did indicate last quarter that you were doing a bit of handholding with clients which were going through a difficult phase. Has that continued through Q1 where you are making some near-term compromises for a long-term relationships?

Ramadorai: I think the revenues were back-ended for long-term contracts. We were not giving away anything other than back-ending the revenue stream by way of investments. Occasionally, it may still happen but not to the extent as in the past. But we will see growth and we are not unduly concerned about some of the things we did in the past because those were investments for the future essentially.

Q: You have seen a pricing fall for the second quarter running, is it possible that during this year pricing remains sticky?

Mahalingam: As we have said, pricing would be stable and we are watching every renegotiation. As we clarified in our discussion yesterday pricing hasn’t dropped from time and material perspective. If there are any transformational deals, we will look whether prices would be even better. The pricing that we put out is the combination of many factors, which ultimately comes up with a realisation.

Q: How are you dealing with the currency now, because this quarter some of your other peers in the industry have seen a few blow ups in their face with their hedging and forex situation – how are you approaching it now that the picture has changed somewhat between last quarter and this quarter?

Mahalingam: Hedging ultimately is insurance and one has to look at it in that fashion and we are continuing to run the course with our objective. The objective mainly is to protect it at a certain rate so that our expenses can be met. The expenses in the Indian rupee can be met and the margin delivered. At the moment we are sitting on close to USD 2.1 billion in terms of US dollars and much smaller amounts in Pound Sterling and Euro.

These are long-term hedges because some of our contracts run for a longer-term. This year and each quarter if it turns out to be Rs 43 per dollar, I think it will be good for our revenue purpose but there will be a small loss and we essentially have indicated that, over the rest of the year if that happens, it will be around Rs 90 crore with about Rs 50 crore Q2 and Rs 20 crore each in the remaining quarters.

But there is still good news for a simple reason that we are participating in upsides in most of our transactions because of the structure that we have and therefore I think we have protected our objectives

Q: You are not unwinding any of your hedges or your total hedges significantly?

Ramadorai: We do that because whenever I indicate any figure, that of course would be maximum and then there would be certain actions that we would take without getting into exotic or any of these kinds of structures and try and make sure that we get what we desire in terms of protecting a certain level which is our main objective.

Q: If you could talk a little bit about what’s happening with your BFSI clients because the newsflow from the US continues to be consistently bad, when its not Fannie Mae Freddie Mac, it’s Citi and when it’s not Citi, it’s Lehman Brothers, - are you getting some sense of comfort that the end of the pain is anytime in the near future or you think this will remain a problem vertical for most part of this current financial year?

NG Subramaniam: My take is that yes, it is going to be a period of uncertainty that is going to prevail through this particular year. But what we see in our clients is that earlier they used to take decisions by 24 hours, or by an hour. But today now they are willing to take a look at it over a quarter, which is a good sign. We are looking at a few deals where the decision making process is getting delayed because, they are also very cautious about how their performance is going to be. So from my perspective, it is going to be a mixed bag in banking financial services segment and the oil price rise and the overall impact it has on the economy is not helping either, but if I look at the product side of my banking and financial services business, I think we are where we should be in terms of our business plan, our investments in terms of the service orientation and the investments in the web-to-data technologies is on track and we will be launching those products shortly and we have received excellent analysts feedback from Forestell, Gardner’s and others and we are working on some of those deals which are in the final stages and between now and the same time next quarter, we should be able to announce some of those deals.

Q: Do you foresee any other client specific issues coming up aside of the 4-5 which happened in the last couple of quarters is there a possibility that some more client specific issues might crop up during the rest of the year?

Ramadorai: If you ask me today, no; but then you also mentioned that everyday if it is this, then something else is bad. So you have to be watching the situation on the ground extremely closely, so long as our customers do not face the issues we are seeing, we should be in goods shape. On the other hand if they do announce some dismal performance, what are the implications of that we need to quickly re-group and study that and we are pro-actively dealing with our top customers. At the end of the day focus and do the things right and continue to demonstrate your value proposition is the theme and cost efficiency is the internal focus, these are the ways we are running our business.

Q: How would you sum up your view for the rest of the year; is it cautious, is it optimistic or cautiously optimistic?

Ramadorai: I would sum up as cautiously optimistic; little more tilted towards the optimistic side based on what we have seen in Q4 as well as Q1 - that is how I would like to summarize.

Q: I was asking Mr Ramadorai about what is going on with the four-five distressed clients that you have at this point perhaps you could give us little bit more colour on that, what exactly has happened with those clients between last quarter and this quarter?

Chandrasekaran: It is three clients and I had indicated during the last quarter results. With two clients we have had specific issues and we expected to see revenue decline in Q1 and that happened with both of those clients. The third situation is a demerger that is happening with a large European bank. With these three clients we had revenue drops from Q4 to Q1 and with two of those clients we have turned the corner and we will grow in Q2. With the third client there is going to be a further deep in revenues in Q2 and we have quantified, we have talked with the client and understood exactly what are all the programmes that they are going slow on or deciding to cut the budget on and we have quantified that shortfall but apart from that there are no other specific client issues.

Q: For the client going through the demerger, do you think you will see growth in Q3 or would it come even after that?

Chandrasekaran: We will start to see growth towards the end of Q2-Q3 onwards. What is happening is this client, which is going through the demerger, the contract is being rewritten or redrafted with three of the new owners. The contract terms remain the same, it is just that it is going to be three different master contracts and already we are in discussion with three of those new owners on ramp ups in the coming quarters.

Q: How is the environment though? I was talking to Mr. Subramaniam a while back and we were discussing the BFSI environment there. Is it giving you any sense that in the next couple of quarters things will visibly improve or it remains a bit of a shaky environment even from an IT outsourcing perspective?

Vandrevala: From an IT outsourcing perspective, as Mr. Chandrasekaran mentioned, except for these three specific clients, it’s been pretty business as usual. What worries is the news that seems to come out everyday. So you do not know if anybody else is going to get distressed. But as we sit today; it is business as usual except for these three particular situations.

The interesting thing is if you look at BFSI on a global basis, whereas we have this issue in the US, we are seeing pretty much good traction and pipeline and growth in UK, Europe and the emerging markets. So there is traction even in BFSI but there is a little bit of a geographical distress maybe in one particular area. That’s all.      

Q: How has Europe been for you, in this quarter have you seen reasonable growth in Europe because the European economic data which is coming in is not very encouraging but for you business has been fine?

Vandrevala: The interesting thing is that if you look at our numbers, is that our is a mature market US, Europe and UK grew higher than the company average and the US was the highest it was at 9%. So the emerging markets there were issues in India because Q4 is always traditionally higher, Latin America had an issue with this clients that Mr N Chandrasekaran referred to but the mature markets have pulled their weight higher than the company average.