Cyient Limited (532175) Earnings Call Transcript & Summary

Ladies and gentlemen, good day, and welcome to the Q2 FY '22 Earnings Conference Call of Cyient Limited. [Operator Instructions] Please note that this conference is being recorded. I would now like to hand the conference over to Mr. Krishna Bodanapu, MD and CEO. Thank you, and over to you, sir.

Thank you very much. Good evening, ladies and gentlemen, and welcome to Cyient Limited Earnings Call for the Second Quarter of Financial Year 2022. I am Krishna Bodanapu, Managing Director and Chief Executive Officer of Cyient. Present with me on this call are Mr. Ajay Aggarwal, the Executive Director and Chief Financial Officer; and Mr. Karthik Natarajan, the Executive Director and Chief Operating Officer. 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 in our investor update, which has been e-mailed to you and is also available on our website. This call will be accompanied with an earnings call presentation. Details of the same have already been shared with you. With this, let me take you through the highlights for the quarter. In U.S. dollar terms, we posted a revenue of $150.1 million, which was a growth of 11.2% Y-o-Y and 4.6% Q-o-Q, 5.6% Q-o-Q in constant currency. In rupee terms, we posted a quarterly revenue of INR 1,112 crores. This signifies a growth of 10.8% Y-o-Y and 5.1% Q-o-Q. Services revenue stood at $124.6 million, a growth of 9.2% Y-o-Y, 5.5% Q-o-Q in constant currency or 4.5% in dollar terms. Workforce Delta, which was an acquisition, contributed to about 0.5% of this growth. DLM revenues stood at $25.5 million, a growth of 22.3% Y-o-Y and 5.4% Q-o-Q. Group EBIT margin stood at 14%, up 301 basis points year-on-year or 90 basis points Q-o-Q. In the last 7 years, this is the highest EBIT margin that we have delivered. Free cash flow generation or free cash generation for the quarter was at INR 2,050 million or INR 205 crores, a conversion of 97% on EBITDA and of course, 169% or so on PAT. Finally, PAT stood at INR 121.3 crores or INR 1,213 million for the quarter. This is a growth of 47% -- sorry, 44.7% Y-o-Y or 5.5% quarter-on-quarter. And this also is among the highest PAT that we have delivered from -- purely from operations. Coming to the highlights for the quarter. We strengthened our digital solution suite, which we have branded as INTELLICYIENT through the acquisition of Workforce Delta. Workforce Delta is a consulting company with expertise in advising and executing workforce management programs for companies globally. This acquisition is in line with our strategic path of enabling digital transformation for our clients through the INTELLICYIENT framework. We expanded our digital solutions portfolio for the Aerospace industry with PPAP4Aero, which is a global AS9145, which is an aerospace certification supplier compliance software framework. The Microsoft Azure ITAR is again the compliance framework for aerospace and defense in the U.S. The ITAR compliant SaaS cloud app and global support services solutions reduced cost while ensuring the quality of manufactured parts for aerospace. And again, with the anticipated ramp-up and what's happening in aerospace, this positions our digital offering for aerospace very well. We were recognized as a rising star in the Connected Mobility Consulting and Services in the ISG Provider Lens Internet of Things - Services and Solutions Study. We enhanced our additive manufacturing solutions with the implementation of an SLM 280 System in Florida. The additive manufacturing is, again, a key aspect of digital offerings for us given that a number of our customers are very high precision, high-end manufacturing companies. The ability for them to manufacture just in time, especially for aftermarket, replacement parts and prototypes become very, very important. And therefore, this is a key element of our digital offering. And this is a system that actually is quite unique in the sense that it has the ability to create parts from 5 different [ materials ] like titanium, magnesium, of course, steel, alloys and so on and so forth. We achieved Select Tier Status in the Amazon Web Services Partner Network. This partnership differentiates Cyient as a provider of specialized demonstrated technology proficiency and customer success. We also joined the TM Forum to collaborate with global service providers. The TM Forum is a forum of 850 members, including 10 of the world's largest telecom service providers. And we will become a member of a very small group within that, which helps define the future of networking standards, technologies, et cetera. We continue to significantly strengthen the management team. I'm also very happy and proud to announce that Rajaneesh Kini joined us as the Senior Vice President and Chief Technology Officer. Rajaneesh will lead the Technology Development at Cyient and be responsible for our technology vision, building competency and the relevant and market-ready solutions. And Rajaneesh comes with a lot of background in engineering and R&D. And I'm quite confident that with his leadership in place, we will continue to accelerate our solution development into the future and for many years to come. With this, I would like to hand the call over to Mr. Ajay Aggarwal, who will take you through the detailed financial performance for the quarter. Thank you, and over to you, Ajay.

Thank you, Krishna. In the beginning, let me say, it's a well-rounded performance that we have got in this quarter, in line with our interpretation. On all the lines, revenue, profit and cash, I will talk about all 3 of them. I think quite a well-rounded performance. Let me start by talking about the revenue. As Krishna said, we had $150.1 million as the total revenue in this quarter. And quarter-on-quarter, if you look at the constant currency growth, it's about 5.6%. What we have got from our new acquisition, Workforce Delta that we have announced, that has been about $900,000 or 0.7% of the revenue. That's also included on this. In terms of the DLM also, I think we have a similar growth of about 5.4%, and we have clocked $25.5 million. And the way we are looking at , I'm sure Karthik will talk about it, the way we are looking at the demand, the order intake and pipeline, we are very confident of being able to continue this growth traction. And it is quite well-rounded. You may see a little blip in the EMEA, but that's because of some cyclicity of orders in DLM. On the services side, the EMEA is also positive. In terms of our profitability, this has been extremely, extremely gratifying quarter for us. And this is really, in some ways, whatever we have been trying to do to improve our margin. We have clocked 14% as the EBIT margin, which is about 90 bps higher quarter-on-quarter and 301 bps higher year-on-year. What has happened in terms of margin is that we have got extremely good set of operational improvements that have come in. We have got the benefit of the growth, which has also kicked in. And we are confident that from all the parameters which are building up to this kind of 14% margin, which also includes the services 15.5%, I think that structural -- cost structure and structural buildup to be able to continue to be 15%, 15.5% margin in this year and get back to 17% in the next few years, that's very much there. In terms of DLM, we have done about 6.8% as the margin. The profit after tax, as Krishna said, is INR 121.3 crores or INR 1,213 million and this is an increase of 5.5% quarter-on-quarter and 44% year-on-year. Our earlier highest profit also included some of the one-offs, including the government benefits and things like that. So it's very close to -- we are getting quite close to what we have done in the past, and we will see the journey from here will be the new milestones only. Tax, there are no surprises. We are doing well, in line with what we have anticipated and what we are trying for. In terms of -- I'll let you read the EBIT bridge. We have provided you what exactly has happened. Primarily, I think company is focused on the operational improvements. We are also letting go of some revenue. You would see that our offshoring is moving very nicely. I think in the last 4, 6 quarters, we have moved about 6% in offshoring. Currently, we are at about 52% of offshoring and we are continuing to see that offshoring will improve. We are also -- that also creates a little bit of headwind on the revenue, but our focus is on profitability. We're also trying to see that how can we let go of some of the less profitable business. So all these initiatives are really helping us. In terms of the headwinds, I will say, there are 2 things which are happening. One is looking at the whole dynamic in the market and the attrition rates, we continue to make sure that we are providing differentiated merit increases, and we'll continue to do some of it in quarter 3 and quarter 4 also. And we are also making sure that Krishna has talked about, this technology landscape, the new chief technology officer joining us. And we'll continue to invest about 1% to 1.5% of our revenue into the investment. Last comment I would make is that if you look at this margin, this is after bringing in some expenses like travel and other overheads, which were not novel at the sort of in the earlier quarter. But we are also making sure that we are back to normal training, normal retention initiatives, normal investments in the business and there will be continued... [Technical Difficulty]

Sir, you may please go ahead.

Can you check with everyone that they can hear us?

Yes, sir. This disturbance was from Mr. Reddy's line and he is currently muted. You may please go ahead.

Thank you. Sorry for the disturbance, guys. So what I'm saying is that the tailwinds will continue in the next 2 quarters and headwinds will also remain in terms of making sure we have the retention of people and we have some investments in technology in the coming quarters. In terms of the free cash flow, which is coming up, we have a cash balance of INR 1,403 crores. I think that is the highest that we have done and we have done extremely good conversion in this quarter. We did have a muted quarter 1. But if you look at overall for H1, we have -- we have clocked 70%-plus kind of conversion, and we will continue to have that kind of conversion. One thing I want to mention is we have really got a good reduction of about 9 days in our DSO. And we are confident that not only we will sustain it, we will further improve it. With this, I hand over the call to Karthik for the business update.

Thank you, Ajay. Thank you, Krishna. Good evening, everyone, and I hope all of you are safe and healthy. And I just want to start out by saying that I hope you remember that your company has announced a new organization structure same time last year, around October. And we said we are restructuring ourselves as transportation, communications and utilities and portfolio of sectors. And I think that's really playing off in terms of what we expected. We expected the portfolio of sectors to be the fastest growing and followed by communication and utilities and the transport due to the challenges that we have seen on aerospace. And also from a broad-based demand driver standpoint, I think engineering and R&D probably is in the cusp of secular long-term growth aided by the sustainability, which is around 2050 carbon neutral program. I think everybody wants to accelerate that. I don't think we as a community can wait till 2050. It has to be accelerated actually by a decade, and also followed by the supply chain disruptions caused by semiconductor. I think that's really creating significant opportunities for players like us. And third is, of course, the digital transformation. I think this is definitely on steroids, and we are really seeing a growth on the digital as we started setting up [indiscernible] unit last year. If you remember, we have shared the same thing around the same time last year. And also followed by hyperconnectivity, I think the world will be a lot more connected and -- thanks to fiber and 5G. And I think pandemic has taught all of us how lot of things can be done remotely with e-commerce growing, I think [ people can connect on the ] supply and demand irrespective of all them need to be at the same place. I think this will only drive a significant amount of investments, especially in U.S. and other geographies on the connectivity part. And having said that, our current performance on Q2 and if you look at transportation as shown, 2.6% quarter-on-quarter growth, if you look at the third column on the left -- from the left. And aerospace has come back to growth trajectory. Like what we have said, it is not in a hypergrowth mode. But at least it started coming back as compared to what we thought about a year ago and which is a good sign. And communication and utilities continue to grow, and we're confident that this will grow double digit for year-on-year. As you can see, about 12.5% that you are seeing as of Q2. And portfolio of sectors, I think this is where the acceleration is happening, aided by semiconductor, automotive, medical devices, mining. I think all of them are seeing all round growth. I think that's definitely visible in terms of what we've seen in Q2. And overall, we have grown about 11.2% year-on-year in Q2 as compared to 9.9% that we have shown in Q1, which is definitely an acceleration that we are seeing on the demand side. And also we have talked about setting up a large deal factory. We are still halfway through, and we started seeing some early green shoots. And we have closed about 6 deals of [ $63.5 ] million and 4 from services and one from DLM and one from what we call them as [ multispec ], which is on the engineering to manufacturing. And that's something which is definitely an early signal, but we will be able to win a lot more deals on the B2S side. So if we really start getting down to specific verticals and communications and utilities, I think this is definitely going to be on the hyperconnected one that we are talking about. And you will see investments across the broadband networks and especially in NAM and Europe. And also, as you would have seen, the TM Forum and other investments that we are making, I think it is definitely starting to pay off. And we also set out on network transformation led by technology. I think that's going to be our growth trajectory over the next 3 to 5 years. And we're also recognized by PEAK Matrix from Everest Group as a 5G contender. I think that's definitely a great recognition from analysts. And many of our investments are around the private wireless and technology transformation for networks, I think all of them are paying off, as we anticipated. Utilities have definitely started coming back to the party, which is a good sign and we have been able to work on some of the cloud native next generation spatial information system, and we have been able to bring in data transmission and system integration kind of projects, and we are continuing to see a momentum from the utilities side across U.K., Australia as well as in North America. DLM has seen a quarter-on-quarter growth, and we talked about last quarter there was a specific issue. But I think it is turning the growth trajectory as we anticipated. The supply constraints continue to be a challenge and -- due to the semiconductor and some of the electronics components. But I think this is definitely on a robust growth trajectory as we expected. Transportation, I think the aerospace, I'm sure this question is definitely going to come. How are you seeing the aerospace growth? And I think the domestic travel has come back to 70% to 75% and which is still patchy, really. For example, U.S. could be about 85%, 90% and Europe could be about 70%,75%. And rest of Asia could be around 60%, 65%. But the intercontinental flights have still not come back, and they are still less than 50%. I think both are important for the industry to come back to growth trajectory. We started seeing some early green shoots and we hope it continues to grow for us in the next 2, 3 quarters. And rail, we have seen some of the -- couple of customer-specific issues, and that's the reason why you've seen negative growth for this quarter. But I think we are confident that we should be able to -- we will get this issue fixed in the next 2 to 3 quarters. Portfolio of services. As you can imagine, the medical devices and technology, I think this is going to be -- I mean outgrow something for us, and we are confident that we'll see more than 20% growth in this particular segment, though it is small, but we are confident that this is going to be an area that we are strengthening across digital-embedded and design-led manufacturing [indiscernible]. And semiconductors, this is going to see a patchy growth, and we are seeing increased demand. We're also constrained by supply, and we are trying to see how do we balance it out. And due to the semiconductor [ blip ] that was seen in the last 12 months, it's likely to continue for 2 more years. And by this, creating some new demand, and we are trying to prepare ourselves to address this demand. And we are confident that this will also start seeing more than double-digit growth for the year. So continuing on the portfolio of sectors, automotive and off highway and I think driven by the sustainability I talked about, which is the electrification and 2/3s of the new vehicles sold will be electric, and we have closed one of the large deals this quarter and which is again on the electric platform customers. We're very interested to look at disrupting the whole electric vehicle platforms and we'll share more details as we start getting to -- get the confirmation from customers to talk about it. And continuing to see momentum across mining and natural resources. And this is one of the acquisitions that we have done with IG Partners. I think that's playing off well. And we are seeing the growth from both consulting and engineering services as well as on the digital transformation. I think this is a sector which will continue to grow at more than 40%, 50% year-on-year. Geospatial, barring 1 customer, I think this has seen about 15% growth, but still this is yet to get into the growth trajectory and probably rail and geospatial are the 2 siblings which has to really start getting into the growth trajectory as we exit this financial year. So with that, I would just summarize saying that I think we have a good organization structure and the leadership team in place. And we have a great strategy, and we started talking about pillars of growth. And interestingly, our pillars of growth, which is about 1/4 of our revenue, is growing at 30%, and if we're able to get that to about 1/3 of our business growing at 30%, I think that would really help us to confidently say that we'll start seeing a double-digit growth for the next few years. So that's what I will [indiscernible].

Thank you, Karthik. If I may just give a quick outlook for the rest of the year. We will -- we'll continue to expect that the services business will grow in double digit for the year. We have a line of sight to that and the mathematics also support that, that we will have good growth in Q3 also. As you know that Q3 is a little bit of a challenge for us because of number of working days. But this time around, we're quite confident that the demand that is there and the ramp-ups that has happened, that challenge will be overcome. Of course, like-for-like, there will be a dip in the capacity, which will have -- put a little bit of pressure on margin because now for the same person, we have fewer number of days that we can be productive. But that's a point in time thing. But overall, as a company, we are confident that we will grow quite nicely in Q3 and of course, in double digits for the year. DLM will be in the range of 15% to 20%. And we do continue to have some significant supply chain challenges there. So there's a little bit of a right shift that is now impacting us, and that's why we're a little bit muted there, but we're very confident it will be in that 15% to 20% range. For the year, we expect margins to improve by at least 300 basis points compared to 200 that we've talked about that we saw at the beginning of the year. Like I said, there's still some interesting dynamics at play given that attrition is also something that is of concern, we will have to relook at our salary structures. So we are really looking at our salary structure, et cetera, as we speak. Therefore -- and also like I said, in -- while overall, there will be growth in Q3, per person productivity or per person availability of capacity actually comes down and therefore that also puts a bit of pressure on margin. That's why we are quite confident that we will do at least 300 basis points. And the margins will -- we believe that in the current steady state, and I'll explain that. But in the current steady state, margins are between 13.5% and 14%. Of course, this quarter we were at the higher end of that range and will continue to be there for the rest of the year within that range. So these are good sustainable margins. And we also believe that once there's a little bit more stability that comes to the recruiting side of the market, margins will then further increase. But also I want to say the services margins are looking quite good at about 16%, and we will continue within that range for the rest of the year. Other income will be in line with previous years and the effective tax rate will be around in this 25% to 26% range. So overall, net-net, I think we're going to have a reasonably good year, a reasonably strong year on growth, but of course, a very strong year on profitability, and we're quite confident that we have the line of sight towards these numbers to the rest of the year. With that, I'll hand it back to the moderator to moderate the questions and answers.

[Operator Instructions] The first question is from the line of Sandeep Shah from Equirus Securities.

Congrats on a good margin execution as well as great turnaround. Just the question in terms of, I think we are saying services revenue growth will continue at a double digit. So in that scenario...

Sandeep, I'm sorry. We're not able to hear you very well. We're not able to hear you very well.

Is it clear now?

Yes, this is better.

Yes, yes. So just the question in terms of the services business growth. So I think we are reiterating our double-digit growth. So I believe that is in U.S. dollar terms, and that requires close to a 4% compounded Q on Q. So you still believe that despite furloughs, we can achieve this run rate as a whole? Or you believe 4Q could be heavy lifting and Q3 could be slightly softer as a whole? And a question in terms of margins, are you saying the second half at consol level could be between 13% and 14%? What could be the tailwinds and the headwinds, which could be there? And at services, I think what I get to understand for the second half we're guiding for close to 16% range as a whole?

Okay. Let me try to answer that. I'm sorry but it wasn't very clear again, but let me try to answer that. On the growth of services, we continue to be confident. You're right. I mean Q3 has a bit of a headwind with the number of working days, et cetera. But also that's been quite negated by the number of new people that we are adding, that is the capacity increase. Like I said, the challenge is really in the capacity per person because of number of working days. But the total capacity, we are actually hiring quite aggressively and of course, it is a difficult market, and therefore, we have to be a little bit prudent. We're still giving up a few percent of growth every quarter because of the supply side challenges, but we'll past that effect. But net-net to your question or to answer your question, we are quite confident that we will hit double digit for the year based on the demand, based on what is going on at the moment. Also on the margin, I'd say for the year, we're saying 300 basis points will be improvement in margin. But really, the 13.5% to 14% is the range that we will be for the rest of the year. I mean we started off a little bit pessimistically. We have done much better. But there are a couple of headwinds that we will start to run into. First is that there is some degree of normalcy that's returning. Some of the costs around travel, around marketing, around events, et cetera are coming back. That's one, a relatively smaller one. But more importantly, one is we will have to do one more round of salary corrections. I wouldn't say one more round of hikes in general because I think we will do it in a nuanced manner, so it doesn't put things out of control. But we will have to do one more level of at least corrections, which will have an impact. And the second thing is we also continue to invest quite aggressively. I mean I think one of the things that I'll also point out and perhaps Karthik will talk a little bit more detail is, if you look at our growth, our growth has really come from some of the newer technologies and areas that we focus on. We call it the 5 pillars of growth. And the 2 obvious ones there are digital and embedded software. That's where a lot of our growth is coming and that combination of that business is growing almost 30% year-on-year, which means that now it's also -- I think we have to face up and say that we were a little bit late to some of these technologies and some of these [ trends ]. But we're really catching on, and it's now given us a lot of confidence that we are going to be very, very strong players, even the acknowledgment from ISG we are leaders in technology or in ranking technology companies. We are a strong player now, and it's given us a lot of confidence that we should continue to aggressively invest in building technology, building capability, capacity, bring the right people for the newer areas, which is what we'll continue to do in Q2. So a combination of normalcy returning, salary adjustments and investments are the headwinds that we're going to face.

Yes. This is helpful. Just last few quarters, you were highlighting there is a scarcity of talent for us in terms of digital engineering. So can you give us some color in terms of how are we making sure that those things do not occur? So what are the plans in terms of reskilling, upskilling on digital engineering as a whole?

Yes. So I think the shortage of the digital and embedded software that part of the equation continues. So I think -- but having said that, though, we are getting a lot more -- or we're getting a lot better at, one, creating our own supply that is reskilling people, upskilling people, taking people with maybe half the capability but spending 3, 4, 6 months on training them. I think that's one. The second thing is it's -- in this business, it also is a virtuous cycle in the sense that if we get the right kind of people, then we can hire better people and more people and I think we're also in that virtuous cycle now because we've built a reasonable sort of C team and therefore, we're able to attract better people. And the third thing is, I think we're also able to go to different sources, not just the traditional sources of either laterals or freshers, but also train people, get people with similar backgrounds, but then be able to get them on with the right training, et cetera. So that helped. I don't want to say we are out of the woods yet. I think there's still a lot of pressure on these skills. And like I said, we're giving up at least 1 point or 2 or 100 or 200 basis points of growth every quarter, but we're working hard on solving that.

Okay. And last question, if I can squeeze in. Just on the aerospace, wanted to understand because last few quarters, we are seeing a positive growth, and this quarter it has picked up. So is it largely concentrated towards defense or commercial aerospace? And within commercial aerospace, is it more towards the [ avionics ] and the maintenance overall? So can you throw some color on the nature of growth which is coming within aerospace?

Yes, I think -- well, Karthik let me hand this over to you on the color of growth in aerospace.

Sure. Yes, thanks, Krishna. Sandeep, I think what we are seeing that is, I think, the aftermarket revenue, which is coming back. That's what we expect first to recover. And followed by new aircraft manufacturing that is going to come back to the previous levels. So the ramp-up is happening. So manufacturing and engineering is the second one. And third, the avionics upgrade and working on integrated avionics with cloud. I think some of these areas are going to be seeing the growth and also with electrification on mobility across aero, rail and auto, and we will also see that that's going to come back because sustainability is going to be critical for this whole industry. So there is an investment led by a lot of governments, and that's where we really drive the next set of growth. So the profile of growth will be lot different than what we have lost in the last 18 months. But we are really confident that this will really start bouncing back in the next 12 months.

The next question is from the line of Vikas Ahuja from Antique Stockbroking.

Congrats on a decent quarter. Just one broader question I have. That is with so much of momentum around the R&D space and most industry analysts talking about meaningful pickup in spend, do you think maybe next year, we may see a meaningful pickup in bookings growth profile, which could be for multiple years to follow? And we can come in line with somewhere closer to some of your -- what your peers are reporting? Or do you think that we are still some time away from that kind of a profile?

Karthik, I'll let you answer that.

No, I think because what I would really say that is the some of them are secular for the next 3, 4 years. For example, communications, utilities, semiconductor, automotive, medical devices and mining. And we're seeing that actually the growth will continue for the next 2 to 3 years. And as far as the other segments, whether it is rail or aero, I've covered in terms of what I talked about in aero and we need to recover back to the previous levels of 2019, which is likely to happen by 2023. And I think the real demand drivers are essentially led by what I talked about, the hyperconnectivity, the digital transformation and the time to market, which is one of the key elements that customers realize that this is an opportunity for them to significantly reduce their time to marketing. Some of the cases, they're talking about 30% to 50% reduction. And that's something which is likely to continue for this entire decade. And in fact, what I would really call it as, this is going to be a decade of [indiscernible] as far as the engineering and R&D is concerned. And led essentially by technology transformation and with the sustainability build on the agenda and apart from the digital transformation.

Just some little colors on bookings. Do you think that bookings can actually meaningfully accelerate toward maybe next year or maybe follow the -- maybe the current kind of a run rate?

Yes. No, because I would say we'll wait for another 2 more quarters before we start seeing the colors. And I think definitely, the momentum is back and purses are open for many of the customers, which is a good news and need to see the size of the needs and the opportunities that are going to come onto the table. And digital is still probably small to start with, and when it becomes big, we need to see how the digital transformation is going to really start getting big.

The next question is from the line of Abhishek Shindadkar from InCred Capital.

A couple of questions. The first one is on the transportation both on a Y-o-Y basis and especially for the services business, anything you could call out in terms of the weakness for that [indiscernible]? I mean, is it centered around any customer or any comments would be helpful. The second thing -- the second question is on the bookings number. Now the services bookings on a H1 basis are up 15% and heartening to know that you are doing the $120 million per quarter. Now how much of this is -- I mean can you segregate this, how much of it is because of the change in the organization structure because of clients or recovery from the clients? What I'm trying to understand is the changes in the organization structure is, whether it is reflected in the bookings number or we are yet to see that? And the third is more strategic question on the DLM piece. Krishna, with so many -- with the PLI opportunity in India and we have a DLM business, is there a strategy where we can capture that market? Just wanted to get your thoughts. I mean, have we thought in that direction? Or where we -- are there any conversations?

Karthik, I'll let you answer the first part, and then I'll answer the DLM and India part.

Sorry, I couldn't get your name.

This is Abhishek from InCred Capital.

Okay. So Abhishek, I think what I would really say that is order book is not necessarily a reflection of the structure because I think it really started coming along well. We have the right leadership in place. We are happy with the progress that we made in the last 12 months. And I think we are really trying to put the company on 3 specific core growth objectives. One is driving large deal and second is driving the 5 pillars of growth that Krishna talked about. And third is about how do we really take our top 2 return accounts and make them to grow disproportionately. I think that's essentially what is playing out. I would really say that I will wait for another 2 or 3 quarters before we say that this is secular. But I think the structure has really played out well because there is a clear accountability in the front end and everybody is absolutely excited to really drive the growth independently. I think that really played out well so far. And sorry, I missed your second question, Abhishek.

The first question -- sorry, Karthik, on transport, what is the -- year-on-year growth is muted and what are some of the challenges that we see there?

Yes. I think, transport, I would say the aerospace is going to see about 3% to 5% growth and rail also will see around the same number. And probably, we could have grown by double-digit on rail, and it is driven by a couple of customers' projects setting to the ramp-up, and we hope it starts coming back by end of this financial year. And I think probably we will see definitely a better growth for the next year to come with aero recovery in full steam and rail also starting to join the growth trajectory. And we are confident that next year will be a lot better than this year for transport.

And Abhishek, the last part of your question around DLM, the problem with some of the India business is we have to be very careful with the margin. We've taken a very conscious call that we need DLM to be at about 10% EBIT where we still have a couple of -- about 200 basis points to make up. Much of the India business comes at a much lower margin. And therefore, we have to be very careful in terms of what we go after and what we choose to go after. I think our play has been more a global play because I think that's the only way that we will make margins that are acceptable to all of us, frankly. And therefore, our focus is not so much on the India business. I mean when there is a good opportunity and there is a good margin that we could make and sustainable business, we'll go after it. But the idea is not to just focus on the India business because then the margins will not be something that either you or I will be happy about them. And that's just the reality of the pressures that the India-based products and services do take. And therefore, we've consciously chosen to be very, very careful. I wouldn't say stay out of it, but very careful out there. Having said that, given the growth in some of the spend in India like defense, for example, that's driving some of our -- a lot of our global business because a global OEM, for example, has offset obligations with India and therefore, would purchase a fair degree of equipment from India and therefore, from us. So I would say it's a combination of -- we have to be focused on the right kind of business but also focus on the global OEM sources in India.

That's helpful. And just a follow-up to what Karthik answered on transportation. So the right shifting of business is because of -- is it because the client -- challenges at the client end or whether it's a fulfillment challenge at our end or it's a combination of both? If you can just highlight that, that could be helpful.

Yes, I would say about 70% has to do with the customer shifting it to the right and about 30% to do with our supply too. So I think that's where it played out.

The next question is from the line of Mukul Garg from Motilal Oswal AMC.

Krishna, Karthik, just wanted to focus on the supply side again. In this quarter, your net adds were a bit lower versus what we did in Q1, despite your attrition and utilization both picking up a bit. Is there some element of incremental departures being higher than what they usually have been versus you guys adding up less people because of availability issues? If you can help us kind of dissect between these 2. And if you can quantify the revenue impact in Q3? And any potential shift -- revenue impact in Q2 and potential shift in Q3 because of this?

Yes, I think that would be difficult to quantify. Like I said, we are growing about 200 bps lower than what we would if we had a perfect supply situation. So I would still stick with that number. I think for the most part, the revenue is not lost, it's being right-shifted, and therefore, it is still there. But we just have to anticipate our -- our challenge continues to be the fact that we are hiring in newer areas. So it's taking a little bit of time to catch up. Last quarter, we had net hires, I think we had about 300 people that we added net for the quarter. So yes, incrementally, attrition has picked up a little bit and there's reasons for it. But what we're also seeing is we are ending up -- net-net, we've added people and that will continue into Q3 and Q4. And some of the attrition challenges because attritional challenge also is driving the net being lower than what we need or what we would like it to be. But I think some of the attrition challenges are also being addressed, and those will also mean that in Q3 and Q4, we will have a better net outcome of [indiscernible]. So net-net, I'd say we are giving up a little bit growth, but for the most part, it is right shifting rather than loss. And there is a business that if we can't tackle, we are also being a little bit choosy because we also need to use this opportunity to build momentum. So we're not going after any available business, but really business that we consider strategic in the longer term.

Sure. And the second question was on the direct cost side, if you look at the direct salary cost, it was flat versus last quarter. And even on a Y-o-Y basis, it was up only 5%. And if we include the other costs and subcon as well, the Y-o-Y compare goes down to 3.5%, which is in line with the Workforce addition of about 400 people versus Q2 FY '21. So how much support are you getting from the shift to offshore in your salary costs as a percentage of revenue? And where else are you being able to absorb this cost because we have at least seen 3 merit increases over the last 1 year, so could you just clarify that part?

I would say that the way we internally look at it, we look at the whole business on gross margin. And if you look at the charts that you are circulated, you will find there is an improvement of about 300 basis points in margin year-on-year. That has the complete effect of whatever has happened in terms of utilization that has the mix impact and we are doing less work on the subcontracting. And of course, the reason is to be able to focus on the quality of margins. And I think that's -- and of course, the offshoring where if you see year-on-year, we have improved by 5%, 6%. So -- and when it comes to the merit increases, if you see, that the gain that we would have in terms of the offshoring possibly will take care of most of the merit increases. So the way I would look at it is net of the headwinds and tailwinds in terms of utilization, change in mix, also the impacts of merit increases, year-on-year, we have improved our margin by about 300 basis points. That's what I would like to comment on.

Sir, just to clarify, you are saying that the offshore shift has kind of compensated or -- kind of compensated for most of the merit increases over the last 1 year. I'm just trying to dig into this because the attrition is clearly at extremely elevated levels. And you -- as you mentioned also, you need to do monetary interventions to control, and that should be reflected in the direct cost. For last both the quarters we have seen merit increases play out, but that has not really impacted your gross margins. In fact, it has improved only.

See the way we look at it is not from the cost angle, I will again say that if you look at year-on-year between the operational efficiency, utilization, offshoring, everything, we would have improved by 5% to 6%. And then the investments that we have made in terms of the increases and other headwinds, net-net, the effect is about 3%.

The next question is from the line of Sulabh Govila from Morgan Stanley.

I had a couple of questions. So first one is regarding the margin expansion this quarter. So if -- Ajay, if you could highlight the reason for sharp expansion in gross margins this quarter. And for the coming quarters, we understand the headwinds that are there, which is in the form of higher attrition and the intervention that you're planning for specific skill sets and travel cost increase apart from lower billing days. So if you could also highlight what are the tailwinds which could offset some of these headwinds in the coming quarters, please?

Yes. So I would say that from the quarter perspective, if you look at our earnings update itself, we have provided the bridge very specifically in terms of what has happened in terms of the margin. I would say, net-net, the expansion is on account of the operational improvement. And just -- yes, I'm just bringing that up. Everybody can see it, right? So if you see this, in terms of the revenue mix, plus change in operational matrix, plus optimization lever where we have let go of some -- we have ceased some accounts which are low margin and other things. So all this adds up to about 4%, right? This is the increase that's there from the operational improvement. In terms of the headwind, we are very clear, about the 300 basis points out of that, we have invested between the investments and the merit increases. And net-net, we have improved by about 100 basis points or 97 bps, something like that. So that's what it is. Most of it is from the operational improvements. You have questioned about what will happen going forward. You're right, we will have a little headwind in Q3 in terms of continued spring levers, as I said in the earlier comments, and what Krishna explained. I think both -- if you look at this impact of merit increases as well as higher investments, I would say really will not increase substantially because we have already started normal travel in some of the areas that we talked about. But in terms of merit increases, I think similar level of investments will continue. In terms of the operational improvements, we will be able to compensate at least the merit increases. But in terms of the other headwind on number of billing days and all that, net-net, we may -- the best case would be we get very close to where we are and Workplace, it could be 50, 75 bps reduction quarter-on-quarter. And then again, quarter 4, you get back to the normal days availability. Again, I think some part of the merit increases, investments will continue. And then we will get again the benefit of the volume and the efficiency. So I would say, as we said earlier, on the services side, between 15% and 15.5%, we will be able to sustain that margin. There are going to be a few changes in these numbers in case of H2, a, because we are making accelerated investments for long term. And b, we have 2 headwinds. One is in terms of number of days in quarter 3 and also the ESOP plan that the shareholders have approved, that will also take about 40, 50 basis points in quarter 4.

Got it. Got it. And then the other bit is on the headcount growth again. So the kind of growth that we've seen in the past couple of quarters, let's say, on the headcount [ side ] do you think that is enough for the kind of growth that we are envisaging for the year or for the coming quarters? And would we be comfortable in achieving the guidance with the kind of run rate that is there? So what are you assuming in terms of the additions in the next couple of quarters?

I think we have to increase our intake and I think we're continuing to work on that. We've made the right progress. This quarter after a long time we've added meaningful number of net new additions and not just because of freshers or anything like that. These are -- much of them are laterals also. So when we talk about what happens through the rest of the year, I think we're taking these things into account. And we're also maintaining a degree of prudence on the addition of manpower with this. Again, till it happens, I don't want to say it has happened. Therefore, taking all this prudence into account, at the same time being -- not just being -- not just, sorry, sandbagging, but just being prudent, I think these are the numbers we'll come up with. And we are quite confident that we'll achieve them at a minimum and really the idea is to do better than that. But at least, let's start with the minimum of what we will achieve.

Sure, sure. And then one last bit as a clarification from my side. On the revenue growth guidance that you've talked about, it wasn't clear to me earlier. Is it on a CC basis or a reported basis?

It's on a CC basis.

The next question is from the line of [ Vivek Jain ] from Anand Rathi.

Good quarter. Two things. One, I think I heard Ajay in the opening remarks, sir, did you speak about 17% kind of margin over the medium term, is that correct?

Yes, I did say that in the short term, our objective is to remain 15%, 15.5% kind of margin for the services and get back to 17% in the next couple of years.

17% EBIT for services?

Sorry, say that again.

17% EBIT for services. Is that so?

Services, correct. That is correct. That is correct. And what will happen is between services and group, there'll be about 150 bps drop because of DLM. And we think that will continue, and that we won't let it be much different than that.

So 15.5% approximately for the group over a medium-term kind of a margin? And second, sir, on the Ajay sir side, sir, our depreciation and the gap between EBITDA and EBIT is also a little on the higher side, while on the EBITDA side, we are doing quite well. The translation to profitability or net profit is on the lower side. So is there a way where you -- and given the kind of intangible assets you have on the book, is there a path wherein you can sort of reduce the D&A? Or should we expect this kind of elevated D&A to continue for a few more years?

As far as the intangible assets amortization is concerned, that will purely depend on what acquisitions we do and what proportion we have of intangible assets. But in terms of the CapEx, I can definitely say from a level of 2.5% to 3%, we have come to a level, if you see this quarter, we have reported about 1.7% kind of CapEx on services side. And overall, also for the group, I think we are plus 2%. I'm very sure this year we will be really tracking to that. That will also play out in the depreciation. That's my only comment on that. Intangible assets are absolutely dependent on which acquisitions and what composition they have in terms of goodwill and intangibles.

[Operator Instructions] The next question is from the line of Neerav Dalal from Maybank Kim Eng Securities.

A couple of questions. One, what would be our current mechanical versus embedded mix? And what would that have been over the last couple of years? And the second thing is that we've done investments in the business, which is reflecting on the G&A side. So we just wanted to understand what the type of investments are these? And how should one look at that going ahead?

Karthik, you want to take that, first, the embedded versus mechanical and how that's changed and the second is what kind of investments.

Yes, sure. Thanks, Neerav. Thanks, Krishna. I will say that I think it's about 60-40 and we will be changing towards 50-50 now, Neerav, in terms of -- the growth in embedded far outweighs mechanical. I think that's where currently we are bullish about the growth of these 5 pillars. So that's definitely seen in terms of what we are looking at. Sorry, I missed you second question, Neerav.

Yes. In terms of the investments that we've made, that is showing up in the G&A if I'm not wrong. So I just wanted to understand what would be these investments? And how should one look at it going ahead?

Yes. So we are definitely doubling down on digital and technology solutions area. I think as Krishna talked about, we've already onboarded a CTO, and we are definitely driving the tech solution. I think as I said, this decade is going to be led by technology investments and solutions. I think that's where it's about people, it's about building solutions, it's about partnerships and it's about trying to really invest in some of the customer engagement. I think it covers all of them. And the same thing is true for digital as well. I think we've definitely identified about [ fixed ] solutions that we want to build, which is going to be critical for our growth. And we are really making that as part of our investment strategy. And also in embedded and the networks and semiconductor. So as we said, we have identified these 5 pillars of growth and we realize the importance of having the investments about the subject-matter experts and the solutions that we need to build, and as well as the partnership that we need to build. So that's where the investments are [indiscernible].

Got that. But just on -- so if there are subject-matter experts and so we are working on certain softwares and all of that. So we are still showing that as part of G&A and not the part of gross margins or S&M?

You are absolutely right. From the perspective of the accounting, this is mainly the time and effort of the people as you rightly pointed out. And what we are trying to do is to be able to capture it, we internally have another line item called investment. But you're right, it's all mainly people costs, effort costs and it will all be part of SG&A, while SG&A has become SG&A and investments now.

Since at this stage of development, [indiscernible] corresponding customer, it makes sense to expense it and not to capitalize it or deal with in any other manner.

The next question is from the line of Amit Chandra from HDFC Securities.

Sir, my question is on the supply side issue that is there in the market. And also we have been seeing the subcontracting cost rising across the industry. But we have been saving on the subcontracting side over the last 2 quarters. So what is driving that and what's the strategy here? So are we -- for like ramp-up deals at the on-site location? Are we not hiring subcontracting? Or is it any like project-specific issue that is impacting the expenses on the subcontracting side?

See, there's 2 things going on there. One is the reason why we do subcontracting is primarily not just for on-site but field work and on-site. I mean if it's on-site, designs work and the quite -- we will do it ourselves. So one is structurally, we've brought down the contracts where there's a lot of dependence on subcontracting because they tend to be of a lower margin and unless we have -- if subcontracting is 80% of a project, it doesn't make sense. If it's 20%, it might still make sense. Because of the design, we end up making up the numbers, et cetera. So one is structurally, we have brought down the subcontracting and that will -- that remains and that will continue. Last quarter and this quarter, we've had 1 or 2 projects where because of the lockdowns in Australia, there hasn't been much progress on field work. And that's why that further brought it down. It will go up a little bit in the coming quarters because some of these projects -- again, we're doing those projects because there is enough engineering work that overall, the project has a fairly good margin and something that we will -- that is acceptable to us. But again, because of the lockdown, the fieldwork because subcontracting is really for the fieldwork, not for the -- sort of the office or the engineering work. The fieldwork because of lockdowns has come down, and that has actually [indiscernible] depressed that. But again, I want to say, structurally, at one point, I think we were even at 11%, 12%, that won't happen again. We will remain at sort of 6%, 7% kind of a range.

Okay. And sir, the second question is on the aerospace vertical. So how has been the performance of the top line there? And how has the ramp up in growth ex of that? So if you can clarify? And is there any like new engagements that we are entering into with the top clients?

See, I think what Karthik had also said about aerospace. We're seeing some early signs of recovery. It's all happening on aftermarket, which is essentially to support the operations of existing fleet. That is starting to pick up, which is a good sign because I feel that traffic is starting to pick up. Of course, intercontinental traffic, the very long distance traffic has not picked up as much and will take some more time. But actually, the way our business works that has less dependence on us. And we end up working a lot of programs which are [indiscernible], which is the short-haul aircrafts. Now that happened. But I would say -- and year-on-year, I think we've had a bit of a growth also in aerospace. But I would say we still are a few quarters away before we can say that aerospace is now back to from a $30 million a quarter run rate to a $50 million a quarter run rate. I think all the green shoots are there. I mean things are lining up, but I would say still a couple of quarters away before we can say that with confidence. But I'd say, obviously, the worst is over, that is a fact. But more importantly, the green shoots have started to happen and there will be a slow acceleration here in the next couple of quarters also.

The next question is from the line of Karan Uppal from PhillipCapital.

Just one question on margins. So we have seen very significant shift to offshore in last few quarters. Now with the reopening of the economies in west, do you think that offshore can scale back to previous levels and whether it will have any implications to the 15% to 15.5% service margin band in the medium term?

I think the offshore shift is structural and I think both -- that's where the demand is and that where we've also put in a lot of effort to make sure that that happens. So we are quite confident that we will -- I mean there will always be a little bit of swing in either direction. But we are quite confident that this is continuing. I mean just to give you a flavor, if you look at the jobs that we're currently recruiting for, 92% of the jobs are offshore and only 8% are on-site. Sort of at the peak, we would have even had a -- sort of 25%, 30% would have been on-site, when our on-site was 60% and offshore 40%. So therefore, we're quite confident that this will be there. And for 2 reasons, right? One is our reason, I think we've gotten a lot better at making sure that we're taking the right kind of business. And secondly, that's where the demand has -- I mean structurally demand has -- what work from home has done is shown people that remote working is possible. Now remote working, unless there is some regulatory [indiscernible] like in aerospace, you have to have U.S. citizens on U.S. soil. But in general, most customers are saying if you can work from home, why does home have to be in the U.S., home can be in India. And I think that has been a fundamental shift, and we'll see a lot more of that going forward.

Let me just add to what Krishna said. I think when you look at internally in terms of our exercise of budgeting, actually, we have looked at, in H2 that is going to further improve. So not only it is sustainable, I think we feel that will be another driver of improvement for our margin. And when we are looking at some of the key goals, as Krishna said, what do we need to do for profitability, there are 2 things with our sales team which are being focused, one is on the offshoring. And also what we have not baked in is the conversations with the customers in terms of the pricing because right now, if you see the challenges of attrition are global in this space and the in-house cost of our customers is also going up. So that's another area we'll work in H2. We have not baked in into this currently, but we are sure that whatever efforts we make in H2, part of it will come in H2, and that will definitely be a driver of margin improvement in the next year.

Okay, sir. Just a follow-up, so you said that further expected to improve? So right now, we are at 50-50 on-site, offshore. So how much more can it improve from hereon? Any color there would be helpful.

[ We have that ] in our internal budget. Normally, we don't talk about our internal budgets, but we have taken about 2%, 3%. That's what we are seeing. Over a longer period of time, still, I think there is room here.

[Operator Instructions] Ladies and gentlemen, due to time constraint, we take that as the last question. I would now like to hand the conference back to the management for closing comments.

Thank you very much. Once again, thank you for your time and listening to this call and for your engagement. Obviously, things continue to get much better. Like I said last time, I think we had turned the corner, both from growth perspective and efficiency perspective. And we will continue to focus on that. I think there are some good things that are going on in our business at a fundamental level. We do have a challenge of supply, and we have addressed a number of those things and we'll continue to do that. I want to assure you that things are looking quite good and things are looking much stronger than where we were 6 or definitely 12 months ago. And firstly, I'll say a big thank you to all of you for your support and confidence. Without which we might not have survived the onslaught that was happening last year with where the markets were. Of course, the recovery has been good, and we also have -- we are also riding on that wave of recovery. But I can assure you that this time we're thinking how to make it a lot more sustainable and not just the bounce that the market is giving us or the bounce that is available in an immediate sector. So at this time, it will be a long run. We're quite confident of how things are evolving, and thank you for the support, and we'll keep engaged on how things evolve.

Thank you.

Thank you, everyone.

Thank you very much. On behalf of Cyient Limited, we conclude today's conference. Thank you all for joining. You may now disconnect your lines.