Cyient Limited (532175) Earnings Call Transcript & Summary

Ladies and gentlemen, good day, and welcome to the Cyient Q4 FY '20 Earnings Conference Call. [Operator Instructions] Please note that this conference is being recorded. I now hand the conference over to Mr. Ajay Aggarwal from Cyient for opening comments. Thank you, and over to you, sir.

Good evening, ladies and gentlemen. Thank you so much for taking the call. It's quite late evening today. But just because of the COVID scenario, we just finished our Board meeting, and we will be talking about the results for the quarter ended 31st March, and we will also be talking about the full year. I am Ajay Aggarwal. Present with me on this call is our Executive Chairman, Mr. Mohan Reddy; Managing Director and CEO, Krishna Bodanapu; and also our President and COO, Karthik Natarajan. Before we begin, I would like to mention that some of the statements made in today's discussions may be forward-looking in nature and may involve risks and uncertainties. A detailed statement in this regard is available on our investor update, which has been e-mailed to you and is also posted on our corporate website. This call will be accompanied with an earnings call presentation. And with this, may I invite Mr. Mohan Reddy to provide a brief overview of the company's performance for the quarter and the year ended March 31, 2020.

Thank you, Ajay. Good evening, ladies and gentlemen. Thank you again for joining us this late on the conference call. As Ajay said, given the COVID situation and the restrictions on travel, none of our directors could travel to India. We have 3 foreign directors: one is -- one lives in Washington, D.C., the other 2 in Europe. So we had to accommodate their time constraints. We just finished the Board meeting, and we thought we'll probably take the opportunity of updating all of you on the results. Let me briefly go. What I have in front of me is that we posted the quarterly revenue of INR 1,073.6 crores. This is a de-growth of about 2.9% quarter-on-quarter basis. In U.S. dollar terms, it's about $149.2 million. That's a de-growth of 3.8% on a quarter-on-quarter basis, or it's about 3.7% on a constant currency term. The services revenue were at $132.3 million, which again signifies a de-growth of 5.6% quarter-on-quarter basis or 5.4% on a constant currency basis. The normalized EBITDA (sic) [ EBIT ] margin stood at 8.4% for the quarter, lower by 118 basis points on a quarter-to-quarter basis. The services EBITDA (sic) [ EBIT ], excluding one-off, stood at 9.6% for the quarter, lower by 100 basis points on a quarter-to-quarter basis. The DLM EBIT stood at minus 0.5% for the quarter. Normalized net profit for the quarter stood at INR 754 million or INR 75.4 crores, which is a de-growth of about 30.4% on a quarter-on-quarter basis. Next, let me then take you through the highlights for the full year. For the full year, the total revenue stood at INR 400 and -- sorry, INR 4,427.4 crores or INR 44,274 million, signifying a de-growth of 4.1% for a full year basis. In dollar terms, the revenue was $625.2 million. It's a de-growth of about 0.5 -- 5.3%, or on constant currency terms, it's at 4%. The services revenue stood at $550.7 million, signifying a de-growth of 5.1% in U.S. dollars and 3.7% in constant currency terms. The DLM revenue for the year stood at $74.6 million, a de-growth of 6.6%. Normalized group EBIT stood at INR 4,084 million or INR 408.4 crores, down by 23.4%. The normalized group EBIT margin stood at 9.2% for the year, down by 2.32%. Services margins, excluding one-off, stood at 10.5% for the year, and the DLM margins stood at minus 0.2% for the year. Normalized profit for the year stood at INR 372.7 crores, it's down by about 23.9%. Continued focus on cash flow has yielded good results, with cash conversion of 56.9% for the full year. The cash flow was at INR 410.2 crores. The total dividend payout for the financial year '20 was at INR 15 per share. Let me come to a few business highlights for the quarter. Cyient remains focused on maximizing the remote working, work from home across all geographies to aid social distancing and ensuring safe working environment for business-critical employees, who needed to be on site. In India, 92% of the employees are enabled work from home, 96% of the employees are either work from home or from customer locations in other geographies. We've managed to secure work-from-home approvals from 94% of our clients across top 65 accounts. All these metrics are as of 30th April 2020. We signed an agreement with Hitachi Rail to deliver a series of project engineering services to support and accelerate the evolution of its signaling technology and enhance its project execution capacity in April 2020. Our Mysore facility will support manufacturing of COVID-19 diagnostic kits and X-ray system assembly. We are providing the Telangana State Police with drone-based surveillance technology to help implement the COVID-19-related lockdown in Hyderabad. On the CSR front, Cyient's contribution of INR 2 crores to Telangana Chief Minister Relief Fund -- sorry, Cyient contributed INR 2 crores to Telangana Chief Minister Relief Fund to support government's effort for fighting COVID-19 pandemic in April 2020. I'm extremely delighted to report Cyient received the 2019 Haritha Haram Award from CII Telangana State Annual Meeting. We continue to support the 28 government schools, provide education to about 18,500 underprivileged children. We continue to support 17 -- 70 -- sorry, 70 Cyient DLM centers, which are called CDCs around Telangana and Andhra Pradesh. On the awards front, Cyient won the Supplier Innovation Award for the seventh consecutive year and Suppliers Highest Productivity Award for the fourth consecutive year at the Annual Pratt & Whitney Supplier Summit 2019. With this, I would like to hand over the call back to Ajay, who will take you through the detailed financial performance for the quarter and the year. Thank you. Ajay?

Thank you, Mohan. Before I go to the financial update, 2 more updates I will add. First is, as you had seen, we had notified the stock exchange that in the Board meeting of 6th April, the Board of Directors had approved the appointment of Mr. Mohan Reddy as Executive Chairman of the company. He has volunteered not to draw any salary from the company. Second one also, in today's concluded meeting, the Board has approved the removal of the cap of 49% on the foreign holding subject to the shareholders' approval and the regulator's approval. With this, I move over to the financial performance. If you see in terms of our revenues, we have a de-growth of 5.6% quarter-on-quarter. This is not in line with the anticipation that we had, and I will explain to you in detail what happened, what were we expecting and why we could not get to that number. Stand-alone DLM growth is 12.7%, and this was anticipated to be higher. In terms of overall DLM, 12.4%, this is including the manufacturing facility at U.S. If you look at the vertical view of the quarter-on-quarter performance, you would see that A&D and Communication, I think, more or less, have been in line with our anticipation, both have shown about little growth in Aerospace & Defense, and I would say, if you take the currency into account, Communication is almost flat. Where we had more challenges was one in the SIA business and in E&U business as far as quarter-on-quarter decline is concerned. This is basically, if you see, the gap between what we anticipated and the final growth is about 7%, that is about $12 million. And looking at what we were anticipating a minimum growth for the group of 2% versus what we have ended up around 5% is 7% or $11.7 million. We did have the impact of the COVID. While we have been able to implement work from home and other continent measures, it did take us some time to respond to that. And also I think how could we get the approvals from the customers, that took time. Also, we had to put the IT controls and things like that. So I think that is one factor that has impacted us. In terms of our DLM, Mysore, of course, it was again on lockdown. And we had some issues on raw materials, especially coming in from the part of the Asia which got affected much earlier. Also, I think we had a lot of material ready, which could not be dispatched at the month end, and that is not part of the revenue. Also in semiconductor, again, the same thing. It has dependence on supplies from China and that part of the world. Because of that, we had an impact of about $1.5 million. We also had an anticipation of -- we were anticipating we'll be able to recognize the revenue towards license for E&U, but then later, we realized it's a combined offering with services and the way we have to take it is along with the implemented initiatives. So revenue is there, but it has to be -- it will be showing up in the coming quarters. And we had more challenges on E&U side in this quarter, about $3 million, and mainly, coming from North America due to the -- especially relating to the field work kind of challenges. So that's how we had -- while we were looking at momentum on growth to continue, most of it is COVID, some of it is still our internal issues, last 2 items. But I can assure you, and Krishna will also talk about in his presentation, that we have spent a lot of time in the last few quarters, including in the last few months to make sure that whatever are the learnings we implement, this is for financial year '20. So this year, we are seeing de-growth, if you see, for many years, we have been giving a growth of double digits. That's our CAGR for 5 years and 10 years. This year has been outlier where finally, we have looked at the constant currency real-term growth -- de-growth of about 3.7% in services. And there, we had -- it was quite -- other than MTH, which is positive, and E&U in constant currency which has grown by about 3%, I think we had challenges from most of these. We have been talking about our challenges in A&D and Communication. And I think that's what -- but the good thing is in the last 2 quarters, I think we are getting better in terms of predictability and getting a complete handle on what is going on. Yes, those are some of my comments on this. In terms of the hedge book, we have made onetime exception we had made in March, where when the rupee was depreciating by almost 5%, we have taken additional cover of 10% for financial year '21. So our hedge position is 80%. This is only onetime policy change, only applicable for financial year '21. And based on this, our total forward cover position coverage is about $141 million. If you look at right-hand chart, you will see while we have difficulty at current spot rate of INR 75.6 in terms of the dollar, we are losing more than a rupee, we are gaining about INR 4, INR 2 and INR 1 each in Australian dollar, British pound and euro. And overall, we are gaining about INR 2 or so. So I think this is the correct -- this is the current position of exposure. We still should be positive at the current spot rate. But we have done an analysis internally for the next year based on how the other income moves based on the spot rate and how do we get the benefits of operating profit for roughly about 25 basis points for every INR 1 change of rupee and assuming other currencies are not headwinds, we have found that we should be neutral for the next year from the volatility of foreign exchange. In terms of other income, I would say, overall, this has been a good year for us on other income. While in the quarter, you will find there is a marginal drop, it is mostly led by these unrealized foreign exchange losses. I want to confirm these are notional in nature. This is just a restatement of some of the loans that are in our subsidiaries, which are in euro and dollar. And they have natural hedge because of inflows. So it is just a notional loss that we have got in the quarter. Otherwise, I think we continue to be very prudent on our treasury. All our investments are based on the principle of preservation of capital. So that is going well. Overall for the year, the only thing is while we were expecting the export benefits to come in quarter 4, due to the lockdown, they shifted in quarter 1. Otherwise, this number of INR 1,250 million and INR 206 million for the quarter and year could have been higher by about INR 50 crores. We have drawn those scripts as we speak now in this particular week, and they will be showing up in our profitability statement in quarter 1 when we convert those scripts into cash as we have been very prudent in terms of accounting any such benefits only on cash basis. This is in terms of the profit and loss account. I would say that we had some one-offs in this particular quarter, as part of our evaluation for the year. And we have been prudent to provide about INR 60 crore on the balance sheet in terms of the strengthening of the balance sheet. And we have also got some gains from reversal of some of the earnouts, which are not applicable. So net-net, the impact on the PAT is about INR 302 million or $4.1 million and that also impacts on respective categories, some of them show up in the EBIT, some of them show up on PBT and some of them are on tax. And thus, what we have done, we have prepared a table, if you can just show the table. We have prepared a table for you to be able to clearly understand each of these one-offs. Show the earlier table, please? So let me just take a minute to explain what are these one-offs. There are 6 one-offs in this particular period. And 7 and 8 item numbers pertain to previous year's one-offs, just to make a comparison to be like-to-like. So we have taken the impairment of intangible assets, one for our operations in Singapore while operations continues. And -- but we have assumed that the future revenue is going to be lower than our original projection. So we have taken the hit of about INR 109 million on that. Second one is the similar thing that has happened in case of the asset under development, which is the case of the BlueBird. While we have supplied the BlueBird to the government, we continue that business. But as prudent, whatever investment we have made, that is INR 222 million or $3 million, we have provided for that. Also, we had an acquisition in U.S. called CERTON, and we had IP platform for which an intangible asset was created. For that, another provision of INR 73 million has been created. This is out of the prudence based on the -- how these things in future will continue. All of these operations continue but we have taken and prepared our balance sheet for the worst case in each one of them. Fourth item is, there is a trade write-off for the joint venture that we have. It's a small joint venture that we have, and we had some trade receivables. This is shown in Serial #5. I'm talking about Serial #5. So Serial #1 to 4 -- 1, 2, 3 and 5 appears on EBIT adjustment. Serial #4 is an item which we have taken as one-off other income. That's why you would see that our other income would have been higher by INR 333 million, that INR 120 crores would have been more like INR 153 crores had we not called out as one-off. So we are not taking them in our normalized PAT. These are some of the acquisitions where based on the share purchase agreement, the amounts payable are not due. But there have been some one-offs in these, especially AnSem, for example, where we have seen because of COVID and some other considerations, there has been little -- lower performance. The performance is growing. This is a good business. But just that we did not meet those milestones for now, they were very aggressive. We have got that [ credit ] back of this. And there is a complete agreement with each of the sellers also, I just wanted to bring that to light. Last item is we have one-offs of tax of about INR 194 million or about $2.1 million. These are pertaining to practically previous years. There are 3 items. I can explain here. There are 3 items, which are there. Okay, we can go to that table, no problem. So we have 3 items: one is we had to provide for the deferred tax for the future years in terms of the tax change to 25%. While our tax rate continues to be 23% to 24%, we have delivered a little lower than 23% for the year as a whole. We are confident that for the next 2 years, we will be in this bracket of 23% to 24%. But we did have -- once you go to 25% regime, 3 years from now, then we have to restate our deferred tax liability. That's the first item. Item number two, we had very long outstanding items of dispute and litigation with the tax department. So under this scheme -- onetime scheme that has been made available to us, once we settle that, we get our cash returns for that entire assessment period. So the INR 44 million gives us a cash flow of INR 55 million in H1 because of this. Other tax provisions. These are more of the settlement that arose from assessments and other provisions. So I just want to say that this is extreme conservative. We have absolute clean position on tax, and our tax rate at normalized rate will continue to be 23% to 24%. So I would leave this table for all of you to read. We have calculated it about an hour back. So these items and then 2 items for the last year will give you a very clear idea of how we have arrived at normalized EBIT, normalized PBT and normalized PAT. In terms of the total performance, you would see that there are a few things I would like to highlight. Yes, I think we were definitely looking at something like 100 basis points improvement in this quarter. But there has been a decline on the other side. I can only assure you that from the efficiency measures and whatever program we had launched for the quarter as well as for the year, we are absolutely on track. And whatever gap is there, it is because of the volume. You saw that $11 million plus of revenue that we lost and the corresponding loss of that in terms of the gross profit is what is reflected in our lower margin. For the services, our margin is 10.5% as against 9.2% for the group. And just to understand, for the full year, actually, if you see, if you take off the impact of the volume, practically, this number will be about 13% for the services, and this will be 12% for the group. Because if you take the absorption impact on the depreciation, the absorption impact on our SG&A and some of the utilization challenges that we get because of the unanticipated revenue being lower, especially in quarter 4, I think we lost about 270 bps. Otherwise, our margin would have been tracked with what we were internally expecting to be about 12%, which is about 200-plus points higher. The kind of comfort I'm providing is in terms of our efficiency growth and in terms of R2020 program that we took, I think we feel we have got annualized saving of about 3.5%. What is showing up in the P&L is about 2.2% because this program has full impact in the coming years. But we are doing a lot to improve the margin. In terms of the normalized PAT, I already explained some of the items. Overall, the number -- normalized number is INR 3,727 million. And this is a -- this is lower by 23.9% year-on-year. I would let you read this bridge. We have provided you complete details of what has happened in terms of the movement of the margin, both for the quarter and for the year. And I've also tried to give you the guidelines in terms of what happened from our anticipated margin to the actual margin. And anyone of you, if you have further clarification, we can take in Q&A or we can talk off-line. In terms of cash generation, as Chairman mentioned, I think we had a good year and a good quarter. This has been the highest ever free cash flow that we have generated. Our cash and cash equivalent stands at INR 9,518 million. The cash flow conversion for quarter 4 has been at 74%. So that's another good thing. And we feel that going forward also, we are anticipating that we should be able to at least maintain 50%-plus conversion in H1 also. That's what we are targeting. In the current uncertainty, what we are able to plan right now is more for the 2 quarters ahead, and Krishna will talk about it more. But from our perspective, we are trying to make sure that we take care of this COVID opportunity to rightsize our cost. There is a lot of focus on cost optimization and cash so that despite the challenges that would come from the demand side of the customer and some supply side challenges because of the uncertainty that is there around the working arrangements, we will be able to maximize the cash flow as well as optimize the profit in this particular situation. With this, I'll hand over to Krishna.

Thank you, Ajay. Good evening, everyone, and like Chairman and Ajay said, thank you for being on the call this late in the evening. But I'll say the first thing is just some lessons learned from what happened over the last year or so and what we will do going forward. I'd say there are 3 buckets of things to make sure we get to not just better predictability but also better execution. The first is on the strategic lines. The -- within Karthik's organization, we've created a team that is a lot more focused on our operational efficiency issues to make sure that we get to our revenue achievement, EBIT achievement and sustenance; the structural changes in the delivery and sales team to get to more revenue accuracy and forecast accuracy; also how we're doing contracts and restructuring them, we're looking at. There are some process-related changes that we've done, including the fact that we have -- the SAP system is finally up and running. This is the first quarter that the results came completely out of the system without any intervention. And we believe that now it's a matter of time that we can -- or sorry, we just need to pull in the time because even this quarter, it took us a while to get the results, though it all came from the system. And lastly, we have a cost management program, which is -- which we are working on quite a bit in terms of making sure that we are planning our costs and we are tracking them. If you go to the next slide, it's the M&A slide, nothing's really changed, and it's probably not the right time to talk too much about M&A, so I will skip on that. Just to give you some color on the industries that we work in, the first is Aerospace & Defense. Again, I think there's no secret here that this industry will be quite impacted with what is going on. If you read the commentary of Boeing and Airbus, they're saying that their claims will be 50% less -- or there will be 50% less deliverables at least in the immediate future. So we just have to brace for that and the impact that it has on us. We will have a significant impact. It's not going to be 50% on us, hopefully, but we will have a significant impact. And we just need to brace for that. At the same time, the silver lining there is the defense part of Aerospace & Defense is actually holding up quite well. And we believe that, that's going to be an area of focus. And we are working with our sales team to really bring focus to that part of the business. The Communications industry, we will see just a medium-term impact. We believe that this is one industry that for the year will still do quite well because all said and done, investments in 5G, investments in broadband, et cetera, will only have to increase, considering what's going on in the world. But having said that, in the immediate term, we do have some issues because if you look at the -- there's a lot of field-related activities because we have to get our inputs from what exists in the field, and our outputs goes to the construction companies to actually build the network once we have designed them. Therefore, there is a field challenge, and that's why though in the immediate term, we do have a little bit of a challenge, we believe from a longer-term basis, this is one industry. And when I say longer, I'll take that back -- from a midterm basis and especially in the second half of the year, we believe that this industry would be a strong performance. In terms of energy and utilities, energy is sort of 2 different things going on. The mining sector is actually doing quite well, whereas oil and gas has significant challenges with where we are pricing it. So we think that overall, it would be tepid in the energy segment. Utilities will do well while we had a challenge in, as Ajay explained, we had a fairly significant challenge at the end of the year because of some execution issues and field issues. Again, I'd say in hindsight, a lot of this COVID stuff has been lingering around in the field towards end of February, early March in various customers or in various geographies, which we didn't necessarily think the impact would be quite significant. But the field stuff is lingering, and we need to work around that. But in utilities, there's a lot of investments going on. Utilities are being updated. There's a lot of technology that's being put in. Therefore, we are quite confident of it. Transport like Aerospace, we believe, will have a little bit of a medium-term impact also because as you can imagine, anything that brings a lot of people together in a closed confined space will not be very -- sort of palatable to people. So we believe transport will have a slight issue in the medium term. But we also think that transport is an infrastructure-related sector. Therefore, a lot of spend will go into the transport sector going forward. So we assume that there will be an uptick, and we are also seeing -- I'm sorry, we are seeing our customers with some reasonable deals. The portfolio business has 2 components. The industrial segment is going to be hit hard in the immediate term because there are supply chain challenges, there are CapEx spends that are coming down. But also at the same time, a lot of the equipment that we designed goes into infrastructure type of projects, be it construction, road works, et cetera. So we believe that, that will recover also in the medium term, but we will have some short-term issues. Geospatial, we have challenges with field work again there because this is really -- the way I'd look at the geospatial business is capturing the realities on the ground into virtual database, which is essentially what we do. And we don't have the access to the realities in terms of the raw data, and that's why we have an immediate-term challenge. So from a medium to long term, I think this is actually one industry which will see some good growth given that geography and tagging and proximity are going to become that much more important. The semiconductor industry has -- again, there are certain areas in the semiconductor industry that are doing quite well. And there are certain areas where we will have a challenge. For example, there's a lot more being spent on network equipment, computing equipment, which consume a lot of chips, whereas there is -- we believe that there will be a challenge on some of the consumer type of applications. Medical & Healthcare is a little bit counterintuitive because a lot of the spend in Medical & Healthcare is going towards COVID-related activities, and there's an absolute stoppage in the non-COVID-related activities, which is a lot of the equipment that we provide because elective surgeries have come down, people are waiting for things to smoothen out before a lot of the -- those things are done. Now there's an interesting statistic that 1 out of 5 doctors in the U.S. are currently in furlough because they don't want people coming into the hospital risking infection if they don't have to. So in that sense, I think there are some good opportunities there because there's a lot more around technology, digital, telemedicine. But we will have to see how things work out in the medium term over there. So having said that and before I stop, I want to say we don't give guidance, as you know. And we typically, at the beginning of the year, give a broad framework in terms of how the year looks like. This time, I think it is not going to be prudent to do that because while we have a fairly good handle on how the first half of the year is going to look like, I think the second half of the year is still up in the air and, therefore, it's not very prudent to give a yearly outlook. Having said that, and in the spirit of transparency, I'll say that the first quarter looks challenging. We will have a de-growth in the first quarter. We believe that the de-growth -- we are at least planning for a de-growth between 15% and 20% quarter-on-quarter, which is quite significant -- but I think in the spirit of being transparent, we wanted to also convey that because I think there's a lot of hypothesis on what the numbers will be. And -- but in our case, we are bracing for this. We're not -- I'd say what will happen, we have to see, but I think in prudence and being cautious, we are bracing for an impact of 15% to 20%. There are, of course, a number of actions that we're taking in line to this, in terms of what we can do with subcontracting facilities, sales, marketing, travel. There's a lot of things that we are doing at this point. We also won't do any salary increases, at least in the first half of the year, we certainly won't do it. If we do something in the second half, it will be for a small set of people at the -- more at the early career stages. We also have initiatives to improve utilization, et cetera. So what we are working towards is we will see the drop in Q1, we will see growth start coming in Q2, and we have confidence in that based on the current backlog and order book. And we believe that while EBIT margins will be a fairly significant challenge in Q1, coming to Q2, they will improve quite significantly, and they will be back to Q4 levels in Q2. And we hope, we plan and we commit that we will only improve them for the -- from there in the second half of the year. With that, I will hand it back to the moderator to facilitate the Q&A.

[Operator Instructions] The first question is from the line of Urmil Shah from IDBI Capital.

Krishna, thanks for sharing the outlook for Q1. It would be very helpful if you could qualitatively call out which of the verticals would be more severely impacted. And basically, I'm trying to gauge, while the second half is uncertain, how the vertical spread would be for FY '21?

Urmil, I think the challenge that we will see in the -- through the year, I would imagine, is primarily in Aerospace. I think that is a fairly significant challenge, and that's something that we know for a fact. Now if I look at some of the others, like especially if I look at comms or utilities, we will have a challenge in Q1 and maybe in Q2. Because the challenge there is not the lack of order book, we have a fairly significant order book in both these businesses and also in some elements of the portfolio where the geospatial element is there. The challenge is really going to be because of the fact that we can't do any -- sorry, the fieldwork is severely restricted because of all the restrictions that are in various places. So A&D will be a challenge through the year is what we anticipate. We anticipate that comms, utilities and some elements of portfolio will have a challenge in the first quarter or maybe into the second quarter depending on how the opening up happens. But in the second half, they will actually do quite well. Transport also, we believe that has a challenge in the immediate term just because of some customer-related challenges. But transport also will do quite well over a period of time into the second half of the year. So the real risk is -- not risk, the challenge is in Aerospace, and you know what's going on there. But also, we're trying to mitigate it. I would say, whatever I'm telling you is sort of the downside scenario because we want to be prudent, that's what we know best. And I think the view that we are taking is that we prepare for the worst but, of course, hope for the best. So that's the view that we have right now.

Sure. And just to understand, as regards to A&D, comms and utilities, would that impact be higher than the company level impact we are talking for Q1?

It is -- A&D will be. I think the rest will be a little bit more muted. A&D will be at high risk. See, the problem with A&D is -- and I'm sure you read enough about it that the deliverables are down quite a bit, which has a fairly significant impact across the supply chains. And also, one is -- we believe -- one of the things that we had done well in A&D business is we were doing a lot of the sustenance work, that is, as planes were coming back for repair, overhaul, et cetera, et cetera, we were doing the work around the engineering for MRO. Now with the planes itself not flying, even the sustenance keep the lights on, business has gotten dramatically hit. Whereas if you look at a lot of the other business, like comms, for example, we help networks run and keep them running. It's just a matter of time because when the COVID -- once the COVID impact goes, we'll actually see very good growth there. But the challenges in Aerospace, it looks like, structurally, still the air traffic will be down for a while.

Sure. Sure. And my last question is to Ajay. I mean if you could run us through how -- what are the kind of levers -- well, Krishna did mention about it. But to what extent they can help considering the impact of lower revenue on EBIT margin? And we had spoken about improvement in EBIT margin for this year. Given the current scenario, what -- how -- by what period you think that improvement will -- is likely to get delayed?

See, I would say there are 2 parts from the perspective of the levers to improve the margins. Definitely, this is sort of quite a drastic situation in terms of what has happened already in quarter 4, and then what we are seeing happening in the world in quarter 1 and quarter 2. So as Krishna said, from the cost structure perspective, we have made a plan so that if the worst comes through, then what are the actions that we can take. And we need some kind of calibration depending on which zone of de-growth that we hit. So we are looking at some kind of a red zone of de-growth, a yellow kind of zone and a green kind of a zone. And then accordingly, we are seeing what actions will be taken. So Krishna already said that in terms of no salary increases, and maybe, obviously, since some of the variable pays are linked to the performance in the company, they definitely will get impacted. So that's one action, and that definitely helps on the margin side. But also on the utilization and efficiency, I think it's important that our cost base has to be resized, but that will mean that we have to do a lot of hard work in quarter 1 and continue to do what we did in the last year in terms of improving the efficiency and utilization. And that will require some investments also upfront. But I think with all those efforts, with these ranges of the scenarios coming on revenue, while I will prefer to look at a scenario where we -- our worst-case preparation goes wrong, and we don't have to take all these cost actions. But we are very confident that with this kind of scenario, we will have 2 bad quarters in terms of time to get back to the quarter 4 level of margin. But then we can quickly, at least from quarter 3, we would have taken the actions to make sure that we can at least sustain or slightly improve the margin from quarter 4 levels.

So I'll just say that we -- based on what -- how things look like today, quarter 3, we believe we can get back to quarter 3 margins. We still -- I won't comment on the revenue yet because we -- it's too uncertain at this point. But from a profitability perspective, in quarter 3, we'll get back to quarter 3. That's the plan that we're working towards. I mean again, if the world collapses, that's a different story. But based on a pessimistic view of things that we currently have, that's still what we believe we can achieve.

[Operator Instructions] The next question is from the line of [ Madhu Babu ] from [ Sierra Street Capital ].

Sir, my question is regarding the Aerospace. So how much is in the commercial airline vehicle project, sir -- I mean supporting the commercial airline? Or we do have couple of projects in the defense side as well? How much is related to that? And secondly, some of the smaller verticals, this question is to Mr. Karthikeyan, considering that we have a sizable experience in the technology. So how easily we can scale up some of the smaller verticals like the industrial equipment and all these?

So on the first one, I'd say, it's about 80/20, 80% or so of the work that we do is for commercial engines and -- commercial aerospace, sorry, and 20% of the work is for defense right now, give or take. I mean it might vary at a certain point. And like I said, the idea is really to focus on that defense piece because there is still a lot of engineering going on. It's easier said than done, but I think there are some actions that we are putting in place. And also, the advantage that we have in that is that the U.S.-based workforce, because a lot of defense spend will also happen in the U.S. Therefore, the advantage as far as the U.S.-based -- or U.S. citizens in the capability that we have for Aerospace is going to be a big differentiator or a good differentiator as well. On the second piece, we have a plan on how we will focus on the smaller verticals. We -- it did not -- we weren't as aggressive as -- on the smaller verticals because we thought that there was still a lot of opportunity in some of the bigger verticals, which still holds, I think. Even Aerospace might -- will take probably 12 to 18 to 24 months to recover back. But we are looking at how we can accelerate that, not that the market will recover, but just how we can grow our share with the new customers. But the idea is also that we will focus on some of the smaller verticals that we have because I think there is a good value proposition. And also, there are opportunities, which we earlier wouldn't have addressed because of various reasons. But I think now it becomes quite interesting for us also to look at. So we are looking at various smaller verticals, be it medical, semiconductor. I think there's a fairly robust plan on semiconductor, how we could grow that business, especially given that chips will go into a lot more things. With the whole remote working and the remote world, there'll be a lot more semiconductor consumption. So we will share the details as they evolve, but that's a part of our plan is how -- is to focus as much as some of the other sort of verticals that we did not in the past.

Yes. And my second question is to Ajay. So sir, will -- the debt will include lease liabilities, sir. [indiscernible] in the balance sheet? So how much is the actual debt and how much is lease liabilities? And though we have paid a good dividend last year, around INR 15, so considering then the outlook for first half is still unclear, can we plan an open market buyback sort of in the medium term because we have a decent net cash and balance sheet?

Madhu, I'm not sure I understood your question. Are you saying we have so much of cash...

Open market buy back...

Not for a debt. There are 2 debts in the balance sheet: INR 355 crores and INR 286 crores, but we increase -- we include lease liabilities also in the debt. So what is the actual debt? And what is the actual net debt on the balance sheet as on 4Q?

Actual debt and...

Actual net debt.

Net debt on balance sheet.

So the net debt in the company, if you look at -- if I can talk in the dollar terms, we have about 1 -- $30 million of cash. And in terms of debt, we have about -- net debt of $50 million. So once -- $30 million minus $50 million, that is about $80 million of net cash that we have.

Yes, so that's almost INR 580 crores, so considering that the first half is going to be very weak. And as per regulation, we can ideally even go ahead and do a buyback, would you like to look at the open market buyback for the next 6 months to -- at least to protect the stock?

We have evaluated various options. But right now, I think we want to be in this particular position, H1, we may not take any of these corporate actions looking at the situation right now and would like to look at conservation. And also why Krishna said that at this time, we don't talk about M&A, I think there is a team within the company, which is dedicated in looking at some kind of opportunities. And we are also seeing that, over and above this cash, we can definitely do some kind of good investment activity. So our focus is on that side, but nothing is ruled out, but it is unlikely.

The next question is from the line of Sudheer Guntupalli from Motilal Oswal Securities Limited.

You have a list of exceptional items. I have questions on a couple of them. Firstly, in terms of the impairment of intangible assets under development. This is a little surprising given the fact it's an impairment of something which is still under development and not an actual asset. So to begin with, why does that sizable cost incurred when the orders were not even materialized, and we were not even sure we could monetize them?

Let me explain to you that this is more of a technical term. Normally when we acquire, this is about the acquisition of what you have all heard as CERTON, our Avionics company in Melbourne, U.S. And as part of the acquisition, there is a software platform, and this was a product that was sort of...

[indiscernible]

Okay. Yes, we'll do that. So I think in this particular case, we have started a joint venture with the Israeli technology partner for supply of niche technology into India. And based on our experience of 3 years, we have definitely supplied the commercial products, so definitely, that has happened. But how we look at the outlook and the uncertainties in that particular market? We have been prudent to provide for it. So I think it was a change in outlook in terms of the defense work, which has been this -- it's not that...

So I'll just add to that. I'd say the -- 2 things happened there. One is we did sell INR 10 crores worth of equipment to the Indian Defense -- Indian Army. So it was something that was progressing. But looking at the current situation and where the spend of the Indian Armed Forces is going to be, et cetera, and what our take on that was, that's why we thought it was prudent. So I think like Ajay said, it's a technical term. Ultimately, we actually commercialized it and sold it. That's why we invested a little bit more also last year or I think -- yes, some time early last year. So that was one. The second is, what will also happen is, given that Ajay said, we're going to remove -- the Board has approved removing the foreign investment cap. The -- we will not be qualified as an Indian company, given that our foreign holding is already close to 49%. And once the cap comes off, it will likely go beyond 51%. So there is a good chance that we won't qualify as an Indian company, which will also make our chances of success much lower. And obviously, we weighed in a lot of these options and then came up with the final solution that was that -- we'll still continue to sell that product. And if we're able to, then -- well and good. But the prudent thing was to provide for it, considering both the market with -- where the government is and where the spend is, has changed quite significantly. And two is, our situation with being a non-Indian -- potentially being classified as a non-Indian company could disqualify us from some of the tenders.

Sure. Sure. Sir, second thing is on the reversal of earn-outs. So our understanding is that whenever there is a case of contingent consideration payable, first of all, the earn-out entry is booked only when the payout is reasonably certain. Just want to check, did we prebook this payout earlier, which we are reversing right now?

No. So if you look at the capitalization of goodwill, it is based on the upfront payment and the deferred payment. So typically, in these cases, we have 70% which is upfront and about 30% which is linked to the future milestones. So what we capitalize is whatever is the most likely consideration that we negotiate. And some of that terms -- in terms of how it gets dispersed are more of execution issues. And if you see overall our experience also, you will find these as exceptional in 8 out of 10 or 9 out of 10 cases, we have paid the earn-outs.

Sure, sir. Sure. One last question, if I can squeeze in. So we have been talking about recovery in growth and cost optimization for some time. However, quarter-after-quarter, our performance has been disappointing, not just in stand-alone terms, but even versus a broader set of our peers. So if you do a root cause analysis and introspect about it, when do you think we'll be able to go beyond these issues and perform in line with the industry, if not outperform it?

So I think that's a difficult question to answer just because of the uncertainty that we face. So I -- the way I would look at it is -- I would look at it quarter-by-quarter, at least for the next quarter or 2. So we were quite transparent in terms of what we think the quarter will turn out to be. We will focus on efficiency and optimization. And I think I would err on the side of caution to say, this is when we will outperform at -- anybody else. I mean the intuitive answer is next quarter, but obviously, that's a very dangerous thing to say. So I'd say, let's take it a quarter at a time. Right now, there's just way too much uncertainty to do that. Having said that, as -- our commitment is absolutely that. I mean we take a lot of pride that 4 out of the last 5 years, we did outperform competition -- most of the competition. And we were always in the top quartile in -- 4 out of the last 6 -- 5 or 6 years. So we -- that is the ambition. That is -- we hit a roadblock, obviously last year. You're absolutely right. We had some misses. And that's why we've introspected a lot in terms of what we can do better. So the commitment is absolutely there. I will also say that we will -- sorry, we will target on making that happen some time this year, probably in Q3 or Q4. But it will take some time before I can commit to it. I mean especially given that we are coming off of a weak quarter, I don't want to make a commitment that we can't keep at this point.

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

Just the question about this 15% to 20% decline, which we speak about in the first quarter. Can you give us a color of how it will look like in services? And how it will look like in DLM? And also some color in terms of your volume versus pricing pressure within this year?

See, I think right now, I won't get too much more into the details on DLM versus services. I think both will be within that range. And it's, again, there's way too many parts, but plus or minus, both will be within that range. Now in terms of the volume versus price, price is still quite marginal. And I think given the drop in volumes in some of our customers, we have taken into account a number of things -- sorry, we have taken -- given the drop in volumes, we have taken into account the fact that there won't be significant price drops because volume and price have to be looked in conjunction. Where there are price drops, we will -- we have already factored them in. Again, they are fairly minimal. But wherever there are price drops, we have already factored them in. And we've also put a little bit of buffer on what the potential price drops could be. So I'll say that most of the drop is really coming because of volume rather than in price.

Krishna, it looks like that the business looks really sensitive to this kind of a slowdown, because at one end, the engineering R&D is a core work, where such kind of a sudden drop to a volume looks like that most of our business looks like is a noncore to the client. And that is why it is happening. How do you explain this kind of a volume? Because it looks like in Aerospace & Defense, it could be a decline of more than 15% to 20%. So is it the project cancellation? Is it a systematic risk on the client? What are you factoring while predicting these kind of a big decline in the volumes?

See, if you look at the volume that both Boeing and Airbus are predicting, the drop in volume for them is 50%, right? So when there is a 50% drop in volume, and a lot of this is public information, and there is a 50% drop in volume, they don't have a choice but to also significantly reduce the core programs. I mean, yes, it is important for the long-term sustenance of the organization to invest in new programs, but they just don't, at this point, have the cash flow to invest in a lot of the -- even the very core programs. So I think it's not fair to say that it's not because our -- you must have seen Caterpillar's results, for example. Caterpillar's revenue dropped by 20% quarter on -- year-on-year, I think, in their Q1. Again, that's -- when that happens, they don't have a choice but to cut down on a number of things, including the new product development. So I think it's not fair to say that what we do is not core because I'm sure we've talked about what we do in great detail in the past. It's just that the nature of which businesses that we work in and the challenges that they are facing in the immediate term is leading to this drop.

Okay. Fair enough. Just if we do the calculation based on what you have said, it looks like the whole year, we will have a revenue decline of mid-teens to high teens. And in this scenario, also, we are talking about margin improvement.

Well, I don't think it's -- one is I don't think that's the case. I don't think we should extrapolate it yet. See, at this point, it's just -- there's just way too much uncertainty in terms of how each industry and each business will evolve. So I would -- again, I would err on the side of caution. I would -- we have to take it a little bit slower because there is potentially good recovery that is happening starting Q2. So I would say before jumping to that conclusion, I would wait for a little while.

Okay. So just further to that, when you say 2Q increase, because you also said that Aerospace may see 12 to 24 months of recovery. Communication portfolio, Transportation will all see a 1Q and 2Q also kind of a headwind. So what makes you confident about the 2Q recovery? And a question to Ajay. Ajay, what should we think the commentary -- so as per the reported margins of this quarter on which we should build the model or what we have reported in the presentation, also had some one-offs in terms of the margin. Because what you said in terms of the non-extraordinary charges, it looks like you are taking about the EBIT only in the BSE filing not in the presentation.

So what we have explained in terms of our EBIT, we said we are -- for the quarter, we have 8.6% normalized EBIT, right? So that is the number -- that is the normal number after excluding the one-offs. And then we also said that for the services, it is higher by about 1%, 1.5% because that is the gap because of DLM.

Okay. Got it. And the question in terms of 2Q, how -- why we are so confident about the recovery in the volume or in the revenue growth?

So that's a good question because what we see is Aerospace, yes, will be flat. People are talking about various shapes -- and Aerospace is probably, best case, U-shaped recovery or an L-shaped recovery. So we're not -- Aerospace, we're not anticipating great growth for the rest of the year after the trough. But the -- some of the other industries, like comms, utilities, et cetera, where there is a clear order book, and the challenge that we have really is more on the supply side that we're not able to do fieldwork or we're not able to get inputs from the field, or construction has slowed down, therefore, our outputs have slowed down. We see that those things are easing in Q1 going into Q2. And therefore, a fair amount of growth will come in utilities, in this one -- sorry, Communications, and also in transport, we also see that there have been some production challenges. There have been some slowdown in production. All those will -- we see that some of those things are coming off, and that's what gives me confidence. So it's not -- I mean, Aerospace, let's face it, right? It's just the situation that air travel is in and, therefore, aircraft sales is in, et cetera is quite -- something we have to manage with.

Okay. Okay. And last question, if I can squeeze. Ajay, last time on a cost optimization program, you have given us a color that close to 400 bps worth of cost, which was unlikely to recur in FY 2021, of which you have given a breakup of 150, 200 bps would be a benefit out of the cost optimization and close to another 150 to 200 bps of some severance costs, some early expiry of the facilities and some consultant costs, which will not repeat. Out of which, you were deducting 150 to 200 bps of wage hikes. So now wage hikes is unlikely to be there, you still bang on to that 350, 400 bps worth of tailwinds, which can come in the FY 2021?

See, now with this revised scenario, in terms of the onetime cost versus what gains we had, as I already explained earlier, we had about onetime cost of about -- if I can round it off, about 1.5%. We got a gain for in-year saving of 2.5%. That's on an annualized basis, if the volumes will continue, would have been 3.5% to 4%. That is pre-COVID scenario, and that's what my original budget also had. Now with this post-COVID scenario, now given with this uncertainty, I think, one is, some of those processes and some of the tools and some of the rigor that we did in each of those areas, whether it was about efficiency and utilization, whether it was about sales efficiency, whether it was about G&A optimization, I think all of them are there, and they will stay in dollar terms. The problem is, the moment the base and the scale goes down, these percentages don't work. So we will be able to provide you the guidance in terms of the fact that we will, again, start cost optimization this year with this revised cost structure for the volumes that we are expecting for H1. Based on that, we are working to make sure that by Q2, we get -- by the Q2 end, we should be like-to-like with where we are in quarter 4. It means that 15%, 20% drop, we have to make sure that we also get those utilization, efficiency and all other things also in line. So that's what we are saying, is that we will get back to quarter 4 levels in Q2, and then we will sustain it or marginally improve. Some of these percentages are clearly a function of the scale.

Okay. Okay. So for the full year, we are saying from 9.2%, which we reported as an EBIT margin in FY '20, we will see an improvement in that 9.2% in FY '21, despite the headwind on the revenue?

No, I am saying, H1, there will be a decline because in quarter 1 with this de-growth, all the initiatives -- so quarter 1 will be the quarter of preparation and work that has to be done. So a lot of that will go in -- not getting some kind of breakeven margin to what we are expecting in quarter 1. But in quarter 2, with those investments and efforts, we will restore back to those levels. That means that you are looking at 3 quarters at quarter 4 level and 1 quarter where the investment will go to get back to at least this quarter 4 level.

Because your presentation is saying we expect your margin to strengthen in FY '21. That's why I'm saying about this.

No. What we are saying is -- I stand corrected. What we are saying is by quarter 2, we'll try to get back to the levels. And in H2, either we will sustain or improve. So I stand corrected...

Yes. I'll just add. Q1, we will have to put in a lot of work. Q2, we will see better margins, we'll probably get back to our Q4 margins. And in H2, we will get back to Q3 margin. That's the current prognosis that's in there. Again, this is based on what we see today and what we think we can take the actions out of. If revenue gets a little bit better, then we have some good tailwinds.

[Operator Instructions] The next question is from the line of Sandip Agarwal from Edelweiss.

Now just one question, Krishna, I have, we [indiscernible] on the margin front for some reason for quite some time and I will not sideline COVID-19 because it is definitely something, which no one has anticipated. But my question is that if you see last 3 years also, we are continuously losing on margins for one or other reason. So have we lost margins structurally somewhere? That is question number one. And question number 2 -- again with the commentary which you made, it seems like we will again -- we are again [indiscernible] earlier strategies after this pandemic and it seems that we are now going to focus on smaller verticals versus the large. But even if you focus on the smaller vertical, and we can -- we are able to grow them faster, the base effect or the current contribution itself will negate all the work from there. So do you -- have you done that math in the sense that how long it will take for us to stabilize? So that is -- I'm asking -- I'm not asking any specific number or outlook, I'm just trying to understand how long it will take before we can go back to a reasonable growth and reasonable margins?

Yes. On the first one, I'd say, structurally, I think there have been some changes over the last 3 years, and that's why even margin has come down. But I think we recognize that last year, and the whole exercise around structuring we did was to address that. We would have seen good outcome of that this year. But now with the COVID situation that's just gone and we need to relook at it from scratch basically. And that is what we are doing. That's just a reality that we are faced with. So I think you're right, margin has changed structurally, and we just need to relook at our operations to make sure that it supports that kind of a margin structure. The second thing -- but having said that, I'm quite confident we took a lot of the hard decisions over the last year or so. And we are committed to making sure we continue them because I think, when structurally there's a change, we just have to make sure that we bring in certain discipline and certain actions in place to get back to the margin numbers. On the second question, it's not a change in strategy. It's just, I'd say, we will focus on the same buckets, which is that we also think that going forward, some of the smaller businesses have good synergies with what we do, have good fungibility of skills with what we have. And therefore, especially at time like this when there's a lot of disruption, see, the way we have to look at it is in status quo, it doesn't give us an opportunity to go disrupt somebody else's business. But when there is so much disruption in the market, it gives us an opportunity to get into new businesses and do something different in those businesses to become successful. So that's why I would say that it is our plan, and we'll create a separate structure. And we'll come back with you on how we do it. But the idea is we don't get an opportunity like this to disrupt the business because fundamentally, on the ground, there is a lot that is going on. And when that happens, it's a great opportunity for us to go -- be successful in a business that we have not been successful previously. I'd say we chose not to focus on some verticals because we didn't have a clever plan of how we could be successful. Now with all the disruption, we see a line of sight of how we could build a business in those verticals.

The next question is from the line of Shradha Agrawal from Asian Markets Securities.

So one question. Last quarter, we had given a pricing discount to one of our Transportation clients in anticipation of good volumes pickup from that account. So how do we stand in that particular case?

We're tracking a little bit behind now. They also have some serious issues in their businesses. But what we think is because of all the work that we did last quarter, we are very well positioned. So we will remain a very key part of their whole engineering chain and their whole engineering space. The volumes might not pick up immediately to the extent that we thought because of -- their production has stopped, their deliverables have been pushed out, et cetera. But we're quite confident that in the medium term, we will be where we need to be. It's just that in the short term, yes, we will see it -- we won't see the volumes that we're anticipating.

All right. And secondly, on the receivables bit. So do we foresee any chances of providing for doubtful debts on any of our receivables? And how do we look at demand for credit extension from some of our accounts?

So we provided what we needed to. Wherever we saw a risk with any of the customers, we've already provided for. So that's one of the reasons why we had the hit in Q4 that we did. In terms of credit period extension, et cetera, we're taking it case by case. There are some customers where we would extend that because of relationship, because of their financial strength, because of -- there might be a very specific reason why they're asking for it. In other cases, we have refused because if we see that it is too much of a risk, then we've refused it. So we'll deal by -- we'll deal with it on a case-by-case basis.

We take the next question from the line of Mayank Babla from Dalal & Broacha.

So I had a question around the inventory, which is around INR 2,267 million. I believe that's for the DLM business, where the top line is around INR 5,500 million approximately. Seems to be a bit high. Could you just throw some light over there on us?

So it is primarily because we have some large orders that go on for a period of time. And we've built up the inventory because we get some fairly good benefit of buying in scale, et cetera. The holding cost is covered for by the customers, so we can buy in scale. We -- the auditors also have done a fairly thorough check on the inventory. There was a little bit that we had to write-off, which we wrote-off. But otherwise, we're quite confident that this inventory will be consumed during the course of the year. Also, I'd say on that, we -- at the same time, there is a fair amount of opportunity there to do better inventory management, and that's a very important element of that business for cash flow and optimization. And in that spirit, we also hired a gentleman called Rick, who is the -- now the VP of Supply Chain for this business. He comes with a lot of experience in some of the largest electronic manufacturing companies. So one of the objectives that -- of bringing in Rick is also that we make absolutely optimal supply chain-based decisions because that's where the value really in that business is.

Right. And just so the CapEx this quarter was around INR 242 million, which was a sudden jump from the previous few quarters. So could you just explain that?

It is the purchases for laptops and work-from-home equipments and all the stuff. But we did buy some of the equipment on leasing and some on the CapEx, whatever was available. Can I take the details and come back to you, please?

Sure, sir. Sure. Sure.

Offline, we'll come back on that. But that was also -- that is the only headwind that we are all kind of aware of.

Ladies and gentlemen, due to time constraint, that was the last question. I now hand the conference over to the management for closing comments.

So once again, this is Mohan Reddy. Thank you very much for staying up so late. We really appreciate a fairly -- substantially a large number of investors participating in the call. We were at some point of time, close to 200 people on the call, I believe. Thank you very much for your interest in the company. So yes, these are very challenging times and the way in which we are handling the situation is bracing realism on one side, but steadfastly work with a great amount of optimism that at the end of it, we'll come out very strong. With that, I'll conclude the call by thanking you again and wishing you -- all of you to stay safe and stay healthy. Thank you.

Thank you. Ladies and gentlemen, with that, we conclude today's conference. Thank you all for joining us, and you may now disconnect your lines.

Thank you.