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Edited Transcript of CYIENT.NSE earnings conference call or presentation 18-Jul-19 12:00pm GMT

Q1 2020 Cyient Ltd Earnings Call

Hyderabad Jul 19, 2019 (Thomson StreetEvents) -- Edited Transcript of Cyient Ltd earnings conference call or presentation Thursday, July 18, 2019 at 12:00:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Ajay Aggarwal

Cyient Limited - President & CFO

* Bodanapu Ganesh Venkat Krishna

Cyient Limited - MD, CEO & Executive Director

* Bodanapu Venkat Rama Mohan Reddy

Cyient Limited - Founder & Executive Chairman

* Piyush Parekh

Cyient Limited - Manager of IR

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Conference Call Participants

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* Abhishek Shindadkar

Equirus Securities Private Limited, Research Division - IT Analyst

* Ashish Aggarwal

Principal Mutual Funds - Senior Research Analyst

* Ashish Chopra

Motilal Oswal Securities Limited, Research Division - Research Analyst

* Madhu Babu

Centrum Broking Limited, Research Division - Research Analyst

* Mohit Jain

Anand Rathi Financial Services Limited, Research Division - Analyst, Technology

* Rajin Rajan

* Ravi Menon

Elara Securities (India) Private Limited, Research Division - VP of IT Services & Internet and Analyst

* Sandeep Shah

CIMB Research - VP

* Sandip Kumar Agarwal

Edelweiss Securities Ltd., Research Division - VP

* Shyamal Dhruve

PhillipCapital (India) Pvt. Ltd., Research Division - Analyst

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Presentation

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Operator [1]

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Ladies and gentlemen, good day, and welcome to the Cyient Q1 FY '20 Earnings Conference Call. (Operator Instructions) Please note that this conference is being recorded.

 

I now hand the conference over to Mr. Piyush Parekh. Thank you, and over to you, sir.

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Piyush Parekh, Cyient Limited - Manager of IR [2]

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Thank you, Stanford. Good evening to everyone. My name is Piyush Parekh. And on behalf of Cyient, I welcome you to Cyient's Quarter 1 FY '20 Earnings Call. We have with us the senior management of Cyient, headed by Dr. B. V. R. Mohan Reddy; Mr. Krishna Bodanapu; and Mr. Ajay Aggarwal.

 

I now hand over the call to Mr. B. V. R. Mohan Reddy to start the proceedings. Over to you, sir.

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Bodanapu Venkat Rama Mohan Reddy, Cyient Limited - Founder & Executive Chairman [3]

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Thank you, Piyush. So good evening, ladies and gentlemen. I welcome you all to this conference call. Let me first now take you through the highlights of the quarter. Highlights or lowlights, I would like to rephrase that. We posted quarterly revenue of INR 1,089 crores, and this signifies a growth of 0.8% year-on-year in rupee terms and a degrowth of about 6.4% on quarter-on-quarter.

 

In U.S. dollar terms, we posted revenue of $156.6 million, which is a degrowth of 2.6% on a year-on-year basis and a degrowth of 5.2% quarter-on-quarter basis.

 

The services revenue is at $137.9 million, which signifies a degrowth of 3.4% year-on-year, a degrowth of 6.1% quarter-on-quarter basis, and a 5.7% in constant currency, that's degrowth too.

 

EBIT for the quarter stood at INR 100.5 crores. The group EBIT margin stood at 9.2% for the quarter, which translates to about 30 basis point margin contraction on a year-on-year basis and 360 basis point margin contraction on a quarter-on-quarter basis.

 

We have moved to EBIT in place of EBITDA to account for the Ind AS 116 changes. Ajay would talk more about it shortly. Services EBITDA margin stood at 14.8%, up 160 basis points year-on-year. Services EBIT margin stood at 10.5% for the quarter, which translates to 10 basis points margin expansion year-on-year basis or 360 basis point margin contraction on a quarter-on-quarter basis.

 

The DLM EBITDA margin was at 1.9%, down 216 basis point -- 260 basis points year-on-year. DLM EBIT margins stood at negative 0.3% for the quarter, which translates to 10 basis points margin expansion on a year-on-year basis and a 250 basis point margin contraction on a quarter-on-quarter basis.

 

The good positive news at the end of the lines are net profit for the quarter stood at INR 90.5 crores or -- which translates to a year-on-year growth of 9.7% versus quarter-on-quarter degrowth of 51.9%.

 

Let me then come to the business highlights for the quarter. Cyient made a strategic investment in Cylus, which is a rail cybersecurity company. The investment strength -- the investment -- sorry, the investment strengthens our focus on digitization and cybersecurity solutions for the rail industry. Cyient successfully rolled out portfolio services and solutions for 5G deployment.

 

We continue to support 25 government schools as a part of our CSR initiatives, providing education to 15,800 underprivileged children. We also continue to support 67 cyber digital centers -- sorry, Cyient Digital Centers, CDCs as they're called, in and around Hyderabad to more than 20,000 children and 14,000 community members.

 

As a part of the initiative for Cyient Urban Micro Skilling Center for the urban poor, we provided training to a pilot batch of 300 unemployed women in various vocational courses.

 

With this, I would hand over the call to Ajay, who will take you through the detailed financial performance and thereafter Krishna will take you through the business highlights. Thank you.

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Ajay Aggarwal, Cyient Limited - President & CFO [4]

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Thank you, Mohan. Good morning, good evening, good afternoon to all of you, whichever time zone you are in.

 

Let me start with talking about the revenue. As Chairman said, we clocked $156.6 million revenue for the quarter, which is lower from the previous quarter by about 5.2%, and year-on-year, we have a degrowth of minus 2.6%. Definitely, it's a disappointing performance for us on revenue. Whatever we were expecting in terms of [transactions] coming back got shifted.

 

We had degrowth in most of our verticals, except MT&H. So services business has degrown by minus 6%. Constant currency impact is marginally by about 0.4%. If you look at our Design-Led Manufacturing business, I think that we have done better. If you combine that, overall businesses at minus 5.2% in dollar terms and minus 4.8% in constant currency terms. Where we have seen from compared to the last quarter, I think we had gap in Communication, Energy and Utilities about $2.3 million, portfolio about $1.6 million and Aerospace & Defense about $1.4 million compared to the previous quarter.

 

I just wanted to give some preface before I talk about profit and loss account. As we had talked at the time of the Investor Day, for those of you who attended our Investor Day, we have taken a program for cost optimization and profitability improvement. This is a special exercise that we are doing over 4 quarters. Some of the initiatives actions has already been taken in quarter 1. And some of the benefits of it are also realized in quarter 1. We expect significant momentum and significant momentum of the benefits of it in the coming quarter as well.

 

Overall, we will talk about it. It helped us about $3 million in terms of the savings. Net of cost, it's about $1.5 million or about 1%. Of course, some of the costs are for longer-term benefits, and the annual run rate of savings is going to be higher, especially including the actions and the initiative that we are taking in the next quarter. So this is a very critical factor that we are looking at. And we expect over the financial year '20, in the next 3 quarters, we should get the benefit of it continuously quarter-on-quarter on the margin. And full benefit of it will start coming in from quarter 1 of financial year '21.

 

In terms of the Ind AS 116, you are aware that this has come into operations on 1st April '19. We have complied with the standard. What it has meant is, wherever we had rented leases -- rents beyond 12 months, which is mandatory for this purpose, we have capitalized them in the books. The value of that is about INR 320 crores or INR 3,206 million. Since the -- some of the costs from the rent side or the SG&A side have moved to mostly depreciation and partly into the finance cost, to be fair, as Chairman mentioned, we are comparing everything at EBIT level because by construct itself, the OPM goes up and it's not a like-to-like comparison. So going forward, we will be reporting EBIT for a like-to-like comparison.

 

Coming to the hedge book. In terms of the current quarter, you would have seen we have gained on the forward contracts, that's showing up in our other income. When you look at next 4 quarters, where we have a coverage for our multiple currencies, we are covered up to next 4 quarters, that is quarter 1 of financial year '20. And we continue to be consistent with the policy. And if you see, our total contracts in all the currencies are at $134 million, and the spot rate on average basis for all the currencies for the next 12 months is about INR 5 higher compared to the spot rate today. So what it means is, at current spot rate, we have a gain of about INR 691 million or $10 million based on the hedge book as of now.

 

In terms of the overall other income, you would have observed that when we are looking at the reduction in profits compared to the last quarter, other income also has been a significant factor. If you look at our other income, from $789 million, it has come down to $282 million, but there is nothing which is worrisome here. The total reduction is INR 507 million.

 

If you remember, we had 3 things in last quarter. We had tax incentives on export of merchandise, which is something which will come for us on the next filing during the year. We definitely will have a number which is much higher than the last year, but it will show up in coming quarters. That's one one-off. And then we had some other one-offs in terms of the reversal of the liability on DLM when we had consolidated at 100% and some reversals of earn-outs, which are not payable. So as such, if you see, overall our other income is healthy. Also for the full year, if you look at these benefits, look at the forward cover position, we are very sure that our other income is going to be much higher than the last year, especially at the current spot rates.

 

If you look at our income statement, we have reported a profit after tax of INR 905 million. Definitely, the shortfall from INR 1,768 of last quarter is significant where we had other income impact, which was there as a one-off, plus we also have reduction in volumes and reduction in the margin that has taken place.

 

If you look at our EBIT margin, it has gone from 12.8% to 9.2%. Let me take a minute to explain this. Broadly on this drop, there are reasons which are sort of one-offs, which are recoverable. We had lower efficiencies in terms of the utilization idle capacity that has contributed to about 160 bps. Also on the SG&A structure, our absorption has been impacted by more than 100 bps. And we also had our New Business Accelerator investments. We have not compromised on any of the long-term investments. That's also up compared to the previous quarter. So we can clearly see that we do have some reversible trends, which have happened on the margin totaling to about 360 bps. And of course, in the next quarter, we will have the impact of the rate hike because we have given for certain levels in first quarter. And the rest of it when it comes in next quarter will be another 85 bps. So some of the reversals will have a headwind from the wage hike in the next quarter. Also on the cost optimization program, while we have savings, we have also got the impact of the cost of restructuring as well as the cost from the -- that we are running a risk share program with our advisers, so their cost is also baked in.

 

In terms of the tax, I think it is business as usual. We have done 22%, and we are quite tracking to where we expected to do for the whole year. I would just conclude this by saying that in terms of the margin, we will continue to have good focus and we will see that -- we will -- in the coming quarters, we will get the benefit related to each of these items, which are on volume. And we are going to get benefit of the cost optimization program in the next 3 quarters.

 

This is just we have provided for you that what has happened between the quarters. If you have any questions, you can reach out to anyone of us.

 

In cash, we have slipped in this quarter. At services, we generated INR 414 million, which was same as what we generated 1 year back, but it is lower than what we generated last quarter. But I don't think we have anything worrisome here. We have got our DSO. We feel that excluding some of the one-offs in terms of the -- one is the base; when the volume is low, our DSO just purely by the mathematic goes up by 5 to 6 days. We also had implementation of SAP Hana, where the whole administration of BSA got impacted because we wanted to make sure that we generate everything from the system, that did impact by 4, 5 days. We had 2 holidays, 29th and 30th.

 

So long story short, we are sure that we can get back to the DSO at least to the quarter 4 levels, which is below 90, which will release the free cash flow of about INR 100 crores. So we should be back to our conversion by H1. And in case of DLM, also we had one particular payment got shifted of about $5 million. There also we expect good cash flow in the coming quarter. So cash should not be a concern. And from the perspective of overall company, we are committed to generate 45% to 50% of conversion, both for H1 as well as full year.

 

With this, I'll hand over to Krishna for the business update.

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Bodanapu Ganesh Venkat Krishna, Cyient Limited - MD, CEO & Executive Director [5]

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Thank you, Ajay, and good evening, everyone. Just to give you a quick update on business. And what I'll do is I won't go into too many details because I just want to explain where things are and answer any questions on that and save some time for that. But I'll give you a quick highlight on where things are. One is significant developments for Q1 FY '20. The first was the reorganization of the business units. We've realigned some of the businesses to better reflect the value chains that they work in. The 2 businesses that we have done so, as one is the E&U, which is Energy & Utilities, so it includes all the work that we do for energy generation, be it equipment or plants; and then the transmission and distribution, which is the classic utilities business. So we brought both of those together because we see some good synergy there.

 

And the second thing is there are some businesses, such as the geospatial and the industrial, which we will manage really more in a -- sorry, geospatial, which we will manage in a horizontal mode because we believe that cuts across many other businesses or many other verticals we have in industrial, which is a little bit of a steady-state business for us. So we brought both in these in into a BU called portfolio because we will need some special focus on both these businesses and how we manage both these businesses.

 

The next thing is on the New Business Accelerator. This is where we develop new projects. We are still quite confident of where that is going. As a data point, 1.5% of our revenue has been invested into the New Business Accelerator related programs, which I think is a very important longer term -- not even long time, I think, mid to long term because we are also seeing some of the projects going to at least an order intake phase, which means that they will convert into revenue phase shortly. So I think even from a relatively immediate, we will see the impact of this. And this is also -- also, I wanted to reiterate that this is above and beyond the BAU investments that we make to have better processes and so on and so forth. This is really more on the technology side. And we believe that this is a big differentiator for us, and hence we invested 1.5% of our revenue this quarter.

 

Lastly, the SAP Hana implementation is in progress. We want to make sure that we have the best-in-class operating system, so we are moving from classic SAP to SAP Hana. To one of the points that Ajay made, it's taken a little bit longer and it's also created some operational challenges, for example, not being able to get all the invoices out in time this quarter, which contributed to DSO. But we have a clean line of sight to Q2, where we believe that it will stabilize and we will start to get more value and obviously, more importantly, better insight so we can manage the business better.

 

In terms of the investment pipeline, nothing has really changed. So I'll leave this with you, and we can -- if there any questions, I can answer that.

 

In terms of the industry outlook and business performance, I'd say, while we've had a challenge in Q1 with some of our clients and some of the issues that are specific to us, I will say that structurally we don't see any significant challenge in any of the industries that we're in. I'll explain what happened with us in a second, but structurally, we don't see any challenge, which gives us the confidence that we will recover very quickly in Q2 onwards out of the situation that we currently find ourselves in.

 

And in that context, I'll say, Aerospace is continuing to grow quite well. We believe that there will be about 4% growth in the overall aerospace market, which for a rather large market is quite impressive. Communications will go up 2% to 3%. 5G is starting to happen, and we're also well positioned there and we see some wins that are happening around the 5G capabilities that we've built. Energy and Utilities will also grow 2.5%, 3%. There's a lot of money that's being put into things like grid modernization, smart metering, renewable energy, et cetera. These are areas that we can support quite well. Transport is growing.

 

Semiconductor is also -- sorry, let me take it back. Semiconductor is in a little bit of a cyclical industry, and that's one place where we will see a little bit of degrowth of about 3% is what we're expecting there. But also we have to look at it in the context of the semiconductor business is a very cyclical business. Last year, it grew in excess of 20%, so it's just a little bit of a short-term correction. But that's also being driven by areas in memory chip sales, which is not necessarily an area that we focus on. Analog to digital and large digital, which are the 2 areas we focus on seem to be doing quite well still.

 

Lastly, I'd say Medical also is doing quite well. We see decent growth over there.

 

So having said that, I'll just summarize what happened this quarter. If you recall last quarter, we were anticipating that this quarter would be a slightly weak quarter. What we thought was happening or what the indications were that we had challenges in 2 accounts, which were -- or sorry, 2 industries, which was Aerospace & Defense and Communications. That's why we had a flat quarter last quarter. We believe that while we anticipated some challenges in some of the other BUs, especially E&U and comm -- sorry, E&U and portfolio, especially around geospatial business, we were quite confident that the Aerospace & Defense and Communications would come back up strongly. And that's why though there was going to be a challenge in one part of the business, the growth in the other part of the business was going to take care of the challenge that we had in this part of the business.

 

Unfortunately, I think we misread the recovery in Aerospace & Defense and Communications. The recovery is taking -- or has taken longer than what we had anticipated. But what I can assure you is that, as things stand currently, we are seeing that recovery is happening and that recovery is happening in a fairly robust manner, which gives us confidence for Q2.

 

So essentially a lot of things that could have gone wrong in Q1 went wrong, unfortunately. Some we were anticipating. But some we thought we had turned the corner, which obviously we did not. But in Q2, we are confident that we have turned the corner and we are seeing good revenue growth and visibility.

 

With the visibility that we have on revenue growth, we're confident that we will be back to at least the last year's average in Q2, which will be a decent -- which actually will be a nice growth over Q1. If you recall from Ajay's slides, there's about 250 basis points or so, which is really related to absorption and the lack of growth. So we believe that there's also going to be a good margin improvement because we're very confident that, that margin improvement is really linked to the revenue growth. So with the revenue growth coming back, margins will also.

 

We typically, if you recall, used to have a full year view over here. We will refrain from giving a full year view because we want to see how Q2 plays out. Again, I'm quite confident of what is going to happen along the lines of what I said. But I think, in a matter of prudence, we should -- we'd just wait for Q2 to play out before we talk about the full year. But I'd say, we have a line of sight to a double-digit EBIT growth for the year irrespective of the revenue growth because we have some the Readiness 2020, as we call it, which is the cost optimization exercises going quite well. And we believe that irrespective of how margin turns out, we still have a line of sight for double-digit growth on EBIT.

 

With that, I will stop here, and I will pass it on for any questions.

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Questions and Answers

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Operator [1]

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(Operator Instructions) The first question is from the line of Shyamal Dhruve from PhillipCapital.

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Shyamal Dhruve, PhillipCapital (India) Pvt. Ltd., Research Division - Analyst [2]

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So my question is on the revenue performance in last few quarters. So it's been fourth quarter out of the last 5 quarters wherein we have some or the other headwinds on the revenue part. And at the beginning of every quarter, we had sounded positive that we now don't have any headwinds from any of the clients or any of the verticals, and we anticipated decent or strong revenue growth. But -- so now entering into Q2, like what gives us confidence that we won't have any negatives from any of the clients or any of the internal negatives, like supply-side issues or anything and we would be able to report decent growth?

 

And second on the similar line. So in the presentation, you have mentioned that the, like your outlook would be double-digit EBIT with -- supported by the revenue growth. So on the -- after the Q1 performance, to report even a flat IT services revenue, we will need at least 3.4 percentage CQGR. So what -- like, how is -- like what is your view on that, like whether -- what would be the growth, like whether there would be any growth or are there any chances of even a decline on the revenue front on the full year basis?

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Bodanapu Ganesh Venkat Krishna, Cyient Limited - MD, CEO & Executive Director [3]

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So Shyamal, thanks for the question, and I completely, sort of, appreciate the point you've made that we've had some challenges in terms of where we think the numbers end up and ultimately where they end up. And I think we've had 2 or 3 quarters of relatively tepid growth. And obviously, this quarter has been a degrowth. What I'll say is we are taking into cognizance of that. It's just the nature of our business that we are having some unforeseen issues, which we were able to manage earlier given that there always used to be growth in some areas when there was degrowth in some areas. Over the last 2 quarters especially, we've gotten into a situation where we just have some issues with specific clients, which are all hitting us at once. And if you also see, our business is quite driven by our top 20 customers. So an issue in 2 of the top -- actually 2 of the top 10 customers, which are in the 1 in Aerospace and 1 in Communication, has had a big bearing on the negative. So while we have some positives, while we have some growth coming in, the big negatives that have hit us, especially in the Communications business, is taking away a lot of the positives. So that's the -- that's how it is. And I agree and appreciate that we've had some issues from where we foresee the business to start a quarter and where it ends up, but it's just the nature of where things are.

 

Now having said that, that's why I have taken a cautious view, and I'll sort of talk about the second part of your question in the same spirit that, we want to first get to Q2. Again, looking at the numbers, looking at backlog, looking at the staffing, looking at inputs available for projects, that's where we have a degree of confidence this time. But I would rather just do Q2 and I can assure you that Q2 will be quite decent, before commenting about the rest of the year. I mean mathematically, you're right that we will have to have 3-plus percent even for flat. I'll take that into cognizance, but I will say that let's get over Q2 because we are confident, but I don't want to jump ahead of myself given what has happened 2 straight quarters. That's why I'm saying look at Q2, Q2 will be good and then we can talk about the full year numbers.

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Operator [4]

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The next question is from the line of Sandip Agarwal from Edelweiss.

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Sandip Kumar Agarwal, Edelweiss Securities Ltd., Research Division - VP [5]

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Krishna, I don't want to further discuss the last 3, 4 quarters because as you already explained the volatile nature of our business. But I just want to understand one thing. Our key strength areas if you see, there have been global commentaries of extremely strong performance of those segments driven by the whole ER&D wave. But we unfortunately are not able to see that benefit in our numbers for quite some time now. So that is question number one.

 

Question number two, even the margin disappointment, which we are seeing in this quarter, is quite substantial. So while you have explained and Ajay has extremely nicely explained the parts of that, but I just want to understand that are there any kind of early signs of warning or something which would allow us to at least take control of this kind of disappointment? Like it is quite a sharp disappointment, and I'm sure that you would not have also anticipated this kind of disappointment at the beginning of the quarter. So any thoughts if you would like to share on that?

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Bodanapu Ganesh Venkat Krishna, Cyient Limited - MD, CEO & Executive Director [6]

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Yes. Sandip, so I think you're right. First, let me answer the first part of the question, which is on, globally, you're right and absolutely that the -- generally the industries that we're in are doing quite well. And if you look at the commentary on the industries that I gave, that's also a reflection of that. Just as we -- and I'll say it's been these 2 quarters because if you look at Q3 -- sorry, the 3 quarters, Q3, Q4 and Q1, we're still grappling with some of the issues and client-specific things because the problem that we have is we are quite dependent on our top 20 clients. And when we have an issue in 1 or 2 of the top 20, it reflects quite dramatically or significantly on the overall number. So that's where we are grappling with this problem. And again, I want to assure you that in Q2, we have a clean line of sight out of this, and we will see some, at least a decent growth in Q2 to come back to some good numbers.

 

So that's one part. I mean I completely appreciate what you said, but it's also -- while we're not at a scale where we can take advantage of the global -- sort of the macroeconomic, we still get affected by certain clients and that's what the issue that we faced in the last 3 quarters or so, Q3, Q4 and Q1.

 

To your second point, Sandip, on margins, right, we do see the -- we do see some early telltales. Now one of the things I'll say is, we are quite confident of Q2. And if we weren't, we would have been a lot more aggressive on some of the cost side. But we are quite confident, and I'd rather take the hit in a quarter because I think we had a decent Q4 from a margin perspective, Q1 is a little bit disappointing, but Q2 will be back to some good number. So I want to say that, one is, variabilizing our cost to that extent is very difficult. So though we saw the gap in revenue, we can't necessarily act on those because even if we acted on them in Q1, the impact would be in Q2 and that would be counterproductive where we would have some decent growth and some decent revenue numbers. Therefore, my point is, I'm quite confident of Q2, so I didn't want to take any dramatic decisions. I'd rather -- it is a hit for a quarter, but we will take it and we move on into some better numbers.

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Sandip Kumar Agarwal, Edelweiss Securities Ltd., Research Division - VP [7]

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One more question if I can squeeze, I know there would be more people who would be in queue. But just wanted to understand what is happening on the manpower side. Because we are getting continuous feedback that there has been significant momentum in the attrition. So any thought on that?

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Bodanapu Ganesh Venkat Krishna, Cyient Limited - MD, CEO & Executive Director [8]

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So attrition has actually come down by about 2.7% this quarter. But what is also happening is, we are optimizing some of the people, while I'll reiterate my comment that we don't want to take very short-term decisions because Q2 onwards we do see growth. But part of this Readiness 2020 exercise, we are optimizing manpower, so there's a reduction of manpower by about 60, 70 people this quarter -- 60, right, that was the number or something...

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Ajay Aggarwal, Cyient Limited - President & CFO [9]

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That's headcount.

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Bodanapu Ganesh Venkat Krishna, Cyient Limited - MD, CEO & Executive Director [10]

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That headcount reduction was 60. But we'll also see that number go up a little bit in Q2 because we want to make sure we bring in efficiency into the business. That's one thing that we have not done very well. So that's why attrition has come down, number of manpower has come down, but that will come down further because we're focused on efficiency.

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Operator [11]

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The next question is from the line of Abhishek S. from Equirus Securities.

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Abhishek Shindadkar, Equirus Securities Private Limited, Research Division - IT Analyst [12]

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Maybe a couple of questions, but let me start first with Krishna. So Krishna, do you believe that your strategy refresh is necessarily both in terms of account mining and since given the way we have seen the deceleration in our top accounts -- or top 5 and 6 to 10 accounts?

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Bodanapu Ganesh Venkat Krishna, Cyient Limited - MD, CEO & Executive Director [13]

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So Abhishek, I think it is a constant process. I think we are -- we do strategy for the most part at an account level from a mining new services, new offerings, new solutions, et cetera. So that is constantly going on. And if I may stretch this argument a little bit, I'd say, a lot of what -- the old business is coming down quite a bit, like the traditional businesses that we used to do around, say, mechanical engineering or around testing or data conversion is coming down. And most of the growth that's coming is because we're doing newer things for the same customers. So in that sense, I would say, we constantly do that because that's the only way to grow in a services business. But we will continue to do that more pragmatically also because I think there's some really good opportunities around the capabilities that we built in digital, like IoT or virtual reality -- augmented reality, virtual reality, analytics. Those things, we're still a little bit on the early stage, and I'll confess that we're a little bit behind the curve on that one, but we believe we're catching up and that's also one of the big growth drivers for the rest of the year.

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Abhishek Shindadkar, Equirus Securities Private Limited, Research Division - IT Analyst [14]

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Okay. And the second, which is a 2-part question I have is, one is, do you believe that on headcount optimization strategy with a high involuntary attrition when most industry peers are facing supply constraints is a good strategy to have? And the second part is, your subcon expenses have dropped almost 20% sequentially. And if I read that along with the revenue decline, is that suggesting that some of the projects are lost and -- versus your commentary of delay?

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Ajay Aggarwal, Cyient Limited - President & CFO [15]

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Yes, Ajay here. Let me take your last question first. I think if you look at the subcontracting cost, especially in Communication business, we have lot of business, which we also subcontract, including that large customer decline in revenue that we've been talking about. So when the revenue is not there, subcontracting cost is also not there. So I would say it's more of a mix issue that where the revenue is coming down and whichever areas the subcontracting ratio was higher. Beyond that, I don't think we should look much into it.

 

Your second question was on people strategy. So I think there we are doing it very, very judiciously. We are not looking at cutting people where we have the work, where we have the competency. We are only looking at, as Krishna said, the efficiency part of it. And wherever there are competencies and skills needed, we continue to hire those competencies and skills also. For example, in U.S., we have a lot of work that needs new manpower and we are going for hiring.

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Bodanapu Ganesh Venkat Krishna, Cyient Limited - MD, CEO & Executive Director [16]

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And I'll also just add to what Ajay said there and say that, look, we're also -- if you look at, the involuntary is high when there is supply-side pressure, but we're also using that to say that we need to bring in efficiency because that's the only way we can take care of our best resources. We have -- even -- in spite of all this, we've had an aggressive salary increase for the execution layer, so that's also baked in into the numbers that you saw. The rest of the salary increases will happen again in Q2, and we're quite pragmatic that it will also happen. And while we have a slight bump, it will happen in an aggressive manner because we want to retain our best people. So we're using this to really not just as a optimization exercise, but also to take some of the cost savings and put it back into developing, retaining our best talent. So the 2 areas that we are not touching in the R20 exercise, for example, is, one is, innovation and technology, which is the NBA; and the second thing is training and people development. We believe those 2 are differentiators in the medium to long term, and we won't cut on those things.

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Abhishek Shindadkar, Equirus Securities Private Limited, Research Division - IT Analyst [17]

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That's helpful. And just last a bookkeeping question. Ajay, what is the reason for the significant increase in debt on a quarter-on-quarter basis?

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Ajay Aggarwal, Cyient Limited - President & CFO [18]

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I think when you look at this leasing, there is a capitalization of about INR 320 crores on the balance sheet. And the way the accounting works, there is INR 340 crores of liabilities on the balance sheet side. It is just the implication of being there. I can assure there's no new debt that has been taken.

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Operator [19]

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The next question is from the line of Madhu Babu from Centrum Broking.

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Madhu Babu, Centrum Broking Limited, Research Division - Research Analyst [20]

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Sir, last year we had issues in the top 5 accounts, which hit the growth. So what is the outlook in the large client in Asia Pac on the Communication side? And how is the NBN rollout happening? Or are we seeing slowdown there?

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Bodanapu Ganesh Venkat Krishna, Cyient Limited - MD, CEO & Executive Director [21]

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So we are seeing slowdown there, and that's an issue that we are currently grappling with. We believe that a significant amount of restructuring that's going on in that client, there's about 9,000 or 10,000 people that they're letting go, and all this is public news. So we believe that, that's -- that whole restructuring is what's really thrown us off a little bit and has delayed the project rollout. But we believe that that's -- their restructuring is done, the new pieces of the puzzle, if I may say, that are in place, and that's where we believe that the project start will happen within the next -- or has started to happen and will continue to happen within the next few days literally. So that's one of the reasons why we're here. NBN rollout will still happen -- has to happen, that's a government mandated thing. There is money for that particular program. So that gives us the confidence among other things that we are going to have some strong quarters going forward, even in Communications.

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Madhu Babu, Centrum Broking Limited, Research Division - Research Analyst [22]

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So that reviewer for NBN has been weak and there was a lot of criticism happening. So that was, I think, the project which was kept on hanging over. So is the revenue committed now, the 2Q it will ramp up, or is it still in a docile submission?

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Bodanapu Ganesh Venkat Krishna, Cyient Limited - MD, CEO & Executive Director [23]

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Some elements of that are committed because we do both NBN and fiber-related work, and also the 5G and wireless-related work. So both of them -- the fiber has actually been committed, 5G is what we're working on right now.

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Madhu Babu, Centrum Broking Limited, Research Division - Research Analyst [24]

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Sir, for 2Q, you said the revenue will be like similar to last year, or I mean just couldn't get that commentary clearly?

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Bodanapu Ganesh Venkat Krishna, Cyient Limited - MD, CEO & Executive Director [25]

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It will be back to at least last year's average.

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Madhu Babu, Centrum Broking Limited, Research Division - Research Analyst [26]

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Okay. Last year's average revenue run rate quarterly, kind of? Or the last year because of 2Q, we did 169 million in the overall revenue?

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Bodanapu Ganesh Venkat Krishna, Cyient Limited - MD, CEO & Executive Director [27]

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We're working through the details, but at least it will be at the average of last year.

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Madhu Babu, Centrum Broking Limited, Research Division - Research Analyst [28]

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Okay, average of the last 4 quarters, okay. I'll take it that way. And just one more, sir. Even within our top client in Aerospace, we are talking of an M&A, I mean on the UTC side, a large one. So any implications from that on that account?

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Bodanapu Ganesh Venkat Krishna, Cyient Limited - MD, CEO & Executive Director [29]

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Yes. We believe that's actually very good for us because both -- it's basically UTC and Rockwell Collins merging, and both of them are clients for Cyient. So we think it will take -- now it's a very, very complex deal because there's also a spinoff of Otis and Carrier that's involved. So for now, we believe it will be status quo for the next 6 to 8 months. And once the deal closes, we will be in a much better situation. But we think it's a strong positive for us.

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Madhu Babu, Centrum Broking Limited, Research Division - Research Analyst [30]

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The Raytheon Technology is one which is I'm talking of? UTC and Raytheon.

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Bodanapu Ganesh Venkat Krishna, Cyient Limited - MD, CEO & Executive Director [31]

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Yes, UTC merging with....

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Madhu Babu, Centrum Broking Limited, Research Division - Research Analyst [32]

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Raytheon.

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Bodanapu Ganesh Venkat Krishna, Cyient Limited - MD, CEO & Executive Director [33]

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Okay. Sorry, Raytheon. Yes, UTC merging with Raytheon, but that will at least be another 1 year, 1.5 years because that's a very government-centric deal. So it's going to take a lot of time to get something through.

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Madhu Babu, Centrum Broking Limited, Research Division - Research Analyst [34]

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Sir, and last one from my side. On the capital allocation, I mean would there be an incremental higher capital allocated on the core businesses from here on? I mean because Communications, though they scaled up very well, I mean it's turning out to be a bit volatile and on the margin also a little too volatility.

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Bodanapu Ganesh Venkat Krishna, Cyient Limited - MD, CEO & Executive Director [35]

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Yes, absolutely. We will focus on a couple of areas that we believe that we have significant strength. That will absolutely be the case, be it Aerospace & Defense or some of the emerging technologies on the semiconductor, IoT, analytics. These 2 areas absolutely, but there's also some horizontals, like embedded software that we will focus on. And there was a deal on Communications that we've slowed down or put on hold on because -- for this reason. We want to first make sure that we have a solid core business before we focus too much on inorganic initiatives.

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Operator [36]

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(Operator Instructions) The next question is from the line of Ashish Chopra from Motilal Oswal Securities.

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Ashish Chopra, Motilal Oswal Securities Limited, Research Division - Research Analyst [37]

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Just one question on the margin front was, so the margins impact that we said came because of the lower volumes in terms of SG&A absorption, et cetera. So if the revenue inches up in 2Q to the last year's average, do you think that this entire loss of margin gets recouped or that will be more gradual through the course of the year?

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Ajay Aggarwal, Cyient Limited - President & CFO [38]

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So if I can take that, what we've said is definitely we can recoup whatever is the impact of the volume, but we do have a headwind that will come from the second tranche of the wage hikes. And we will again have a tailwind from what more we can get out of the Readiness 2020 cost optimization. But I think there will be at least to the extent of what we lost because of volume we should be able to recover.

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Ashish Chopra, Motilal Oswal Securities Limited, Research Division - Research Analyst [39]

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Fair enough. And secondly, on the, I think, vertical-wise revenue, so you mentioned that you were expecting a sort of come back in Aerospace & Defense and Communications, while the weakness in the others were anticipated and whereas the way it's fanned out is that in the services, we've had a decline across all verticals. But now that some of it is getting pushed over into 2Q, what about the other verticals, the E&U, transportation, portfolio, et cetera? Do you see them remaining challenged over the near term while the top 2 verticals recover or should it be more broad-based?

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Bodanapu Ganesh Venkat Krishna, Cyient Limited - MD, CEO & Executive Director [40]

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No, I think it will be fairly broad-based and what -- I mean we've looked at the numbers in many ways with a lot of, obviously, focus over the last couple of days. In most businesses, we're quite confident that they will come back in Q2. I think there's 1 or 2 businesses, like portfolio or certain aspects of portfolio where we will still have a challenge into Q2. But in general, we see that the numbers are coming back across the board. I think -- again, it's probably not the most prudent way to put it, but I'd say everything that could have gone wrong went wrong at once. Typically, we've always had ups and downs. It's just that this quarter everything went wrong. But having said that, I'm also quite confident in Q2 that most businesses have a clean, and not just a plan, but the order intake and the backlog, to say that, they will do much better.

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Operator [41]

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The next question is from the line of Sandeep Shah from CGS-CIMB.

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Sandeep Shah, CIMB Research - VP [42]

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Just a follow-up in terms of what the previous participant asked. So Ajay, if I look at the volume growth impact on the margin in this quarter, you have defined it as close to 360 bps. So is it fair to say that could be a tailwind over and above the cost efficiency tailwind, which may flow through in 2Q FY '20?

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Ajay Aggarwal, Cyient Limited - President & CFO [43]

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So what I suggest that, yes, I think I would say about 250 basis points out of this, we should be able to definitely get there. And then I think we should have a setoff between the wage hike and the further gains on the cost optimization side. But plus/minus 1% it is also difficult to predict. That will also depend on the level of volume that we achieve and some of the progress on these initiatives, including how much we end up spending in NBA, how much we really get out of this cost optimization exercise. So I would have loved to give 1 particular number, but the fact is that it is going to be a range.

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Sandeep Shah, CIMB Research - VP [44]

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Okay. Okay. Okay. And any estimate on how the cost efficiency on a full benefit basis will have a margin uptick? If you can give us what is the range in terms of the cost efficiency benefit will lead to an improvement in the margin?

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Ajay Aggarwal, Cyient Limited - President & CFO [45]

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So give us 1 more quarter. I think we will give you our view because initiatives have been taken in quarter 1. We mentioned about the impact of that, that has come in the quarter on net basis at about 1% margin. Most of it is sustainable. We have another initiative, which would be equal to or higher than this for quarter 2. Those actions have to be taken. I think that's the biggest chunk of actions, which are slated for quarter 2. So my request would be give us another quarter, we will give you a better visibility on where we are likely to end for the year from this particular initiative.

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Sandeep Shah, CIMB Research - VP [46]

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Okay. Fair enough. Just commentary in terms of Q2 being at the average of last year. So that itself also asks for a 5% Q-o-Q growth. So this time, Krishna, you believe that the visibility is much stronger to say this or there could be some open areas because of the client-specific issue or macro issue where there could be some amount of headwind which may come in, in 2Q as well?

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Ajay Aggarwal, Cyient Limited - President & CFO [47]

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See one is, if I can just -- let me explain somebody said bookkeeping question. So let me give the bookkeeping answer first, and then Krishna can say from the business side. I think what Krishna is saying is a mix of both services and Design-Led Manufacturing. So the combination of the 2 is what we are looking at. You see we had a muted growth as far as Design-Led Manufacturing is concerned. That will also take the -- it will go up. It is a range that can happen on services. So I think you have to look at it as a combination of these 2. And there are always some ranges that will play out. And that is a precise reason we are saying that we are learning every week and every month better on the visibility. So I just wanted to clarify that on how to look at the growth.

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Bodanapu Ganesh Venkat Krishna, Cyient Limited - MD, CEO & Executive Director [48]

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But I'd say, we've looked at the numbers, we've looked at backlogs, we've looked at the risks. And taking all this into account, that's where we believe we will be for the quarter.

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Sandeep Shah, CIMB Research - VP [49]

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Okay. Okay. So this growth on average basis, the commentary is on a consolidated level rather than service level?

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Ajay Aggarwal, Cyient Limited - President & CFO [50]

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Yes.

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Operator [51]

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The next question is from the line of Princy Bhansali from Anand Rathi.

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Mohit Jain, Anand Rathi Financial Services Limited, Research Division - Analyst, Technology [52]

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This is Mohit from Anand Rathi. One thing is on your non-top 10 clients and APAC region particularly, so it looks like that the weakness is across the clients, it is not specific to the certain issues as you have highlighted in the commentary. So what went wrong? I'm just trying to figure out, and this is also visible in declines across verticals. So is there a broader weakness that you're looking at compared to few issues that you are highlighting that will be solved in 2Q?

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Bodanapu Ganesh Venkat Krishna, Cyient Limited - MD, CEO & Executive Director [53]

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Mohit, so there are -- this is across, no denying in that. But also what happens in the large clients in the top 10 because of the proportion of the revenue that they constitute, those have the biggest impact. So we always have these weaknesses. I mean there's always going to be a down in a smaller client at all that gets covered up typically. So where my commentary was coming from is, the -- unless we fix those, once we fix those, the rest of them usually fall in place quite well. So the focus is really to fix the top -- like the 2, 3 clients, which are large clients where we'll have a meaningful impact. But having said that though, on the rest also there are point of time. And so I'll give you an example. In the utilities business, there is a fair amount of business that will close. A lot of it is also software customization and delivery, which has closed already or is in the process of closing, which will also get delivered in Q2. We had some of it in Q4, nothing in Q1, so that's cyclicality. So it's really not necessarily just the -- or the impact of top 10 is such that it really magnifies the numbers, and that's why we're focused on them. There's issues in other places, but we believe most of it is under control.

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Mohit Jain, Anand Rathi Financial Services Limited, Research Division - Analyst, Technology [54]

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And 1Q decline is more driven by non-top 10 or is it more inclined towards top 10?

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Bodanapu Ganesh Venkat Krishna, Cyient Limited - MD, CEO & Executive Director [55]

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It's driven by non-top 10, because I think top 10 has actually grown 270 bps quarter-on-quarter.

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Mohit Jain, Anand Rathi Financial Services Limited, Research Division - Analyst, Technology [56]

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Sir, actually, that is what it looked like that it is not related to top 10, it is basically on the long tail that we had?

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Bodanapu Ganesh Venkat Krishna, Cyient Limited - MD, CEO & Executive Director [57]

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Correct. So we will have to fix the top 10 also because that covers up the tail that we have.

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Mohit Jain, Anand Rathi Financial Services Limited, Research Division - Analyst, Technology [58]

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Okay. And second, Ajay, if you could give the impact of gross wage hike because you guys would have planned it for the year. So how much would it hit your margins at the gross level for 2Q, 3Q and 4Q delivery?

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Ajay Aggarwal, Cyient Limited - President & CFO [59]

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So we are giving the wage hike in 2 quarters. As we've said, the impact is about 80 bps in current quarter. A similar impact can be there in the next quarter and it is limited to quarter 1 and quarter 2.

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Mohit Jain, Anand Rathi Financial Services Limited, Research Division - Analyst, Technology [60]

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And next quarter, your visa expense will automatically get reversed to offset part of that decline, right?

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Ajay Aggarwal, Cyient Limited - President & CFO [61]

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I think unlike other companies, we do not have that slightly impact in 1 quarter.

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Bodanapu Ganesh Venkat Krishna, Cyient Limited - MD, CEO & Executive Director [62]

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Visas would be a negligible number, in the thousands -- or tens of thousands of dollars.

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Mohit Jain, Anand Rathi Financial Services Limited, Research Division - Analyst, Technology [63]

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Okay. So this 80 basis points will -- is the number we have to look at for next quarter margin, just from current levels, so to say, if the offsetting factors do play out?

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Ajay Aggarwal, Cyient Limited - President & CFO [64]

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That is right.

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Mohit Jain, Anand Rathi Financial Services Limited, Research Division - Analyst, Technology [65]

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And anything on NBA side? How much will you invest for FY '20?

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Bodanapu Ganesh Venkat Krishna, Cyient Limited - MD, CEO & Executive Director [66]

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We will stick to that 1.5% number.

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Mohit Jain, Anand Rathi Financial Services Limited, Research Division - Analyst, Technology [67]

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Which you have done in the quarter?

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Bodanapu Ganesh Venkat Krishna, Cyient Limited - MD, CEO & Executive Director [68]

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Yes.

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Mohit Jain, Anand Rathi Financial Services Limited, Research Division - Analyst, Technology [69]

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Sorry, 1 point...

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Bodanapu Ganesh Venkat Krishna, Cyient Limited - MD, CEO & Executive Director [70]

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1.4% we did in the quarter, but -- so 1.4% or so, we will stick to that number.

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Operator [71]

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The next question is from the line of Ravi Menon from Elara Securities.

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Ravi Menon, Elara Securities (India) Private Limited, Research Division - VP of IT Services & Internet and Analyst [72]

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Krishna, just broadly, I think that the whole strategy has been to look at a few major clients and drive growth primarily through them. Do you think that now we need to change that approach and perhaps look at portfolio, at least 2 to 3 clients for us to be meaningful in each of the verticals that we operate? And probably even then, these are some of the verticals that are smaller from big acquisitions. So I see that the whole portfolio is a little bit more rounded and we don't actually have quarters like this.

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Bodanapu Ganesh Venkat Krishna, Cyient Limited - MD, CEO & Executive Director [73]

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That's a good point, Ravi. I think it's a mix of sort of 2 things. One is, obviously, getting -- we are focused on scaling up clients across the board. If you look at the Communications business, for example, it was like a mushroom. We had a large customer on top and then not much. But this year, we will at least have one other customer in the $20 million-plus range, and we'll have 2 new additions in the $10 million-plus range. So we're doing that, for example. Or even in some of the others, like E&U, which is the same thing, and so on and so forth. So that one thing is we are focused on that, we will continue to add clients. I think the way we look at it is we just need to make sure that we're adding the right clients, so there is an ability to scale them up and grow them up rather than any client that comes our way, so that's one aspect.

 

The second aspect is, you're also right that on the smaller BUs, we need to show them up or bulk them up. So we have an initiative in place where we're looking at a growth strategy for each BU through inorganic. If we can't find ways, we're also looking at some divestment criteria because if we don't -- if it's not a profitable business or a very profitable business that's not growing, we also need to figure out how we're not going to be in that business because there's no point being in a small degrowing business. So that's absolutely a part of it, and you will see some initiatives and progress on that within the year at least, both on some acquisitions and some divestures.

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Operator [74]

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The next question is from the line of Ashish Aggarwal from Principal Mutual Fund.

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Ashish Aggarwal, Principal Mutual Funds - Senior Research Analyst [75]

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Sir, couple of things. On the growth front or on the revenue front, is it fair to assume that this quarter in absolute terms you will be at the bottom and from here on quarter-on-quarter, we will see growth? Quantum can be different, but we will not see any decline or $157 million is the absolute bottom we are looking at, at least over the next 4 to 5 quarters. Secondly, on the margin front, right, we have indicated that we're looking at double-digit EBIT growth in this year. Now that will transpire into almost, my sense, around 14% exit EBIT margins, 14%-plus type of exit EBIT margins. So wanted to understand what can go wrong? Is revenue growth paramount to achieve this 14% exit EBIT margins for us?

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Bodanapu Ganesh Venkat Krishna, Cyient Limited - MD, CEO & Executive Director [76]

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So on the first point, what I'll say is, yes, absolutely we're certain that this is the lowest that we'll hit at least in the -- or I want to see at least lowest ever, but that's a difficult proposition to make. So I'll say, in the foreseeable future, absolutely. I mean I think we've bottomed out. It's unfortunate that it was this quarter, but we had hoped that it was last quarter, but I think it is what it is and we've bottomed out and we'll see good growth through the rest of the year. So that's one thing.

 

On EBIT margin also, if you look at it, at the beginning of last year, our EBIT was also at a similar level as it is this quarter. So last year, we had a recovery. We got back to, I think the exit quarter EBIT would have been some 12% -- or 14%. This year, just with growth and doing the prudent things, we will get to 14%. But on top of it, there's other initiatives like the Readiness program, which will give us that little bit of a boost, that's -- which is the reason why we believe it will be a double-digit EBIT growth.

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Ashish Aggarwal, Principal Mutual Funds - Senior Research Analyst [77]

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No, why I was asking -- sorry to interrupt you. Why I was asking was that it looked like that even if growth returns from Q2 onwards, we will be in rupee terms towards a mid or low single-digit revenue growth trajectory in this year. Now for our EBIT to grow in double digit that would mean that we need to have almost 100 basis point margin expansion from last year. And last year, we had a benefit from -- in Q2 also coming from currency, which may not happen this year, right? And I'm sure when we are giving a double-digit EBIT margin, EBIT growth indication that is on a constant-currency basis. So my question was coming from that perspective.

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Bodanapu Ganesh Venkat Krishna, Cyient Limited - MD, CEO & Executive Director [78]

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Absolutely. No, you're right. I think that's the right way of looking at it. And we think that because of all the initiatives on optimization and efficiency, we have a line of sight to that.

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Operator [79]

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The next question is from the line of Rajin R. from Geojit Financial Services.

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Rajin Rajan, [80]

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I just want to mention like the order intake has been very low compared to last quarter. So is it on a quarterly impact or like is it going to impact for the next quarter also?

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Bodanapu Ganesh Venkat Krishna, Cyient Limited - MD, CEO & Executive Director [81]

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I think, in general, our order intake is higher in H2 compared to H1. Therefore, the Q-o-Q drop was expected. The order intake in DLM is higher by 26% year-on-year. I'll say because of the implementation of SAP, we've also not been able to verify some of the work that we've done on -- we do some of the work without an order intake. So the purchase order and the order intake -- or sorry, the purchase order and the order to start coincide at the same time. So we don't necessarily have a long lead order intake. So we are fixing this. I don't want to say the number is inaccurate. It's just that it's not been fully verified. We're fixing this. But in general, I wouldn't be very worried about it because order backlog, which is an absolute number, seems to be quite robust at this point. And we can verify that much easier than the intake because of just how SAP is working or the new implementation of SAP is working at the moment.

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Rajin Rajan, [82]

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Okay. One more question, like on the depreciation front. Is it on a onetime basis or like can we expect the same kind of higher depreciation in the coming quarters also?

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Ajay Aggarwal, Cyient Limited - President & CFO [83]

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See, one depreciation change is on account of the leasing charges that are happening. Other than that, I do not expect any higher depreciation. And also when you look at percentage terms, possibly some of it is because of absorption, for example, even the leasing will go down from 1.7% to 1.5%, 1.55% depending on the volumes coming. So we are not doing anything drastic on CapEx. CapEx continues to be in line with what we have done. And this quarter, it has not been very high. So you should not worry about depreciation. I think it's more of absorption issue.

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Operator [84]

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Ladies and gentlemen, as there are no further questions from the participants, I now hand the conference over to Mr. Piyush Parekh for closing comments.

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Piyush Parekh, Cyient Limited - Manager of IR [85]

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Thank you, everyone, for being on the call, and I would pass it on to our Chairman for his closing remarks.

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Bodanapu Venkat Rama Mohan Reddy, Cyient Limited - Founder & Executive Chairman [86]

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Thank you, Piyush. I'd like to once again thank every one of you who participated in our Q1 earnings call. It was a disappointing quarter. There's no denying at all. The Board spent considerable amount of time in reviewing the current order backlog and what we intend to execute in the coming quarters. And we feel very confident in what Krishna shared with you earlier in terms of getting back to those numbers that he articulated. Thanks, again, for your support, and have a good evening. Thank you.

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Operator [87]

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Thank you. Ladies and gentlemen, on behalf of Cyient, that concludes this conference. Thank you for joining us. And you may now disconnect your lines.