Sonata Software Limited (SONATSOFTW) Earnings Call Transcript & Summary

Ladies and gentlemen, good day, and welcome to the Sonata Software Limited Q1 FY '22 Results Update Conference Call. [Operator Instructions] Please note that this conference is being recorded. I now hand the conference over to Mr. Srikar Reddy from Sonata Software Limited. Thank you, and over to you, sir.

Yes. Thank you, Faizaan, and good morning everybody who have joined us today for the analyst call post the announcement of our results for Q1 FY '22 yesterday. I have with me today Mr. Jagannathan, our CFO; Mr. Sathyanarayana, our Head of Finance; Mr. Raju, Chief Delivery Officer; Mr. Sujit Mohanty, Head of our India business; and Mr. Ranganath Puranik, our Chief Growth Officer from the U.S. Before I hand over the mic to Jagan to take you in greater detail the financials, which have been already loaded and released to the stock exchanges yesterday, I'll share some quick highlights and talking points for the business performance for the quarter. So overall, in the quarter, I think the demand side has looked extremely robust. Our deal flow and pipeline across the board apart from the travel vertical has looked good. So overall, I think that looks promising. And I did mention last time that we had some in the quarter supply side headwinds, both starting with the COVID-related and people falling sick and not being available to do work and managing the additional supply-side dynamics of getting more people. Our attrition has been a little higher than the normal. I think it's been close to 20% last quarter. So these have actually, I would say, prevented us from delivering to the demand, which was there in the quarter. We are absolutely bring in plans to sort out the supply side, both from retention and creation of capacity in advance and also opening up closer global delivery center, both from a risk minimization aspect, which our clients were looking for and not wanting to be limited to 1 or 2 country-specific delivery centers. There are local regulations which are coming in, especially in Europe, which is preventing, I would say, some data to go out of Europe. And third is get access to talent. So we are looking -- we have put together a very comprehensive plan to execute on the supply-side dynamics. We have a onetime revenue gain last quarter because of the provision we had made for the provident fund, which is no more required when we transferred the fund, but also we have had, I think, I would say, based on whatever I just explained, a lot of expenses, which would not be normal, which were both COVID-related capacity expansion exercises and also additional expenses we had to incur. We took additional medical insurances, additional life insurances for COVID-specific and a lot more support to our people over and above the insurance cost, which would be repaid on COVID. So those, I think, onetime, I would say, costs have, I would say, canceled for the onetime gain, which we have obtained on the reversal of the provision, which I had made for the provident fund. Looking forward, as I said, the supply side -- the demand side looks robust. And the focus for us is really to manage the supply better in the next 2 quarters. So I think that's where we are focused on as an organization. We have hired -- continued to invest, hired some senior resources, hired Kartik Visweswaran as the Senior Vice President and Chief Digital Officer, driving both transformation of digital of our current clients and large digital opportunities going forward. So we are creating that unit around when he came on board this month. We've hired a Head of Sales for the Australia region, Biju John, again, very experienced professional, more than 20 years in the Australian market. So -- and then I think we've hired another 10, 12 people on site, both for sales and presales last quarter. So we continue to invest. The other, I think, interesting aspect, which we announced last week, is the acquisition of Encore Software Services based out of San Jose in the U.S. with a delivery center in Chennai. That's a very qualitative level. One is, it's a very robust business, solid set of clients. The management team is very experienced and veterans of the industry, having set up and run from the late '80s, early '90s, these kind of operations. So a very solid management team, gets us access into new industry verticals, mainly in the health care providers and the logistics and an access to a new delivery center in Chennai. I think -- overall, I think, on a full quarter basis, that should be adding about USD 2 million, USD 3 million to the revenue on a full quarter basis, maybe about $500,000 of EBITDA to the bottom line as we go forward. The GBW business, the CX business, as I said last time, looks extremely promising. Obviously, they are impacted by the opening and closure of markets in different parts of the world. And they've had, I think, last quarter focus on, I think, ramping up capacity to serve the new clients acquired. So there was also an impact on their margins last quarter. So overall -- and our India business looks extremely promising, continues to grow. The cloud business starts to grow. The annuity business is growing, and the new lines of alliances that we have talked about like Amazon, Google and the SI business continue to show promise. So that looks extremely robust and should continue its growth trend. So net-net, I would say, as a summary, I think the demand side looks good. We are all focused in the next few quarters on ensuring that we have a good solid supply side and robust engine operational, and that's what we are focused on. So that's, I would say, in a nutshell summary of the performance for the quarter and where we are and some of the highlights for the quarter. I'll hand it over to Jagan to take you through the detailed financials and then have -- answer to any questions you may have. Thank you all, again, very much.

Thank you, Srikar. Good morning, all. Nice connecting with all of you today morning. Thanks for joining the call today morning. I will now take you through the brief financial performance for the quarter for our business. Then Srikar will -- after that, questions will start for that. The consolidated financial performance for the quarter. We had a revenue CQGR growth of 5.2 percentage and EBITDA CQGR growth of 3.7 percentage and PAT CQGR of 3.5 percentage. Our PAT has grown well compared to the revenue growth for this quarter on a consolidated basis. The international services, the revenue growth was -- revenue growth CQGR was 1.8 percentage, and in dollar terms, it was 1.5 percentage and in constant currency it was about 1 percentage. The EBITDA and -- the EBITDA growth was 3.2% and PAT growth was 2.5 percentage for the quarter. The domestic business, the revenue growth was 6.6 percentage. EBITDA CQGR growth was 5.7 percentage. If you see, interestingly, our -- Srikar has been highlighting that domestic business has to be measured on gross contribution, not on the revenue. Gross contribution has grown by 3.8 percentage CQGR for this quarter. Our PAT has grown on a healthy 6.8 percentage quarter-on-quarter. The financial summary. This is uploaded also. We will cover this in the -- we have broadly highlighted the revenue growth. We had the revenue of INR 323.9 crores in INR terms this quarter, and the domestic business was INR 946.2 crores this quarter. The EBITDA -- the PAT for this quarter has been INR 86.7 crores compared to INR 83.1 crores last quarter. The operational performance. U.S. business continued to be at 51 percentage of our total revenue, and Europe is -- including U.K. is about 25 percentage. And the rest of world remains at 24%. There is no change in this. This quarter, if you see the contribution from ISV industry continue to be at 33 percentage and travel vertical continues to be at 10 percentage, not much of a change in this quarter for any of these major verticals other than others. Others is the rest of verticals like utility services, agri, tech and all those things are there. The common -- our key verticals have remained at the same level as that for quarter 4. The revenue wise -- competency-wise has also been given here. So the strong momentum -- strong revenue potential is reflected in that. The high digital services has contributed to the business growth for this quarter also. The Microsoft services and the digital platform services continue to be the focus area, which has contributed to the major revenue for as such. The on-site/onshore mix for this quarter remained at the same level. And there is no change on the mix between T&M and a fixed price project for this quarter. The IP-led revenue continues to be growing for us. It is remaining strongly at 35% for this quarter. The operation metrics, new customer additions. If you see, we had a strong customer addition during this quarter. The -- this quarter, we see the potential, the demand side -- as Srikar was highlighting, the demand side continues to be good. There have been some constraints on utilization and people addition for us on the supply side, which we are addressing in the coming quarters. The client addition has been very healthy for us in this quarter. We have added 13 clients during this quarter. The top 5 clients continue to contribute more. However, the head count addition has also been healthy. We have added around 240 people in this quarter, which is almost like a 5 percentage of our head count on this quarter. As Srikar was mentioning, we have also added on on-site and sales head count has been beefed up during this quarter. With this, my update on financials comes to an end. I hand it over back for the question-answer session. Thank you.

[Operator Instructions] First question is from the line of Mohit Jain from Anand Rathi.

First is regarding the top line versus non-top. So there appears to be this big decline in others or from non-top 5 clients, so to say, or maybe non-top 10. So what happened there during the quarter? And what kind of recovery should we expect from 2Q onwards?

Sorry, I didn't understand. What was the question?

The top 10 and top 5 clients have grown well. Top 5 essentially have done very well. But if you look beyond top 10, there was a big decline in the quarter. The point was, is there something specific that happened in that segment where we saw a big decline for the quarter or some completion, some client loss or something of that sort? So that is one regarding this quarter, which is 1Q '22. And then what kind of recovery should we expect in IT services from second quarter onwards?

Right. I think -- yeah, 1 mean, we have to analyze the individual details of each client and what happened, whether it was a supply side issue or whether it was some projects ending and then we are waiting for the ramp-up for the next one to start. So we can give you that detailed analytics. But as I said, for us, the demand side looks extremely robust. And if we manage the supply side well, we should, I mean, go back to the kind of top line and bottom line growth, even factoring in for additional costs, which may come in to get our supply side correct and manage it well. So as we sit here today, I think the growth going forward looks promising based on the deal flow we have currently and actually orders which are booked, which are waiting to be executed and the supply and the demand pipeline, which we are visualizing kind of stuff. So overall, I would say, I think we are quite optimistic about getting back to about a 3% or 4% growth quarter-on-quarter.

Okay. And sir, second was on the IT Services segment margin. So in terms of cost increases and utilization has just started coming off a bit. Should we expect that margins structurally will be like a little lower this year? And therefore, our historical numbers will not give us the correct picture? Or do you think that this quarter had one-off -- enough one-off [ for the structure ] of any potential data headwinds?

I mean I would say that the top line and bottom line may have a more linear growth. Earlier we could have had a little more nonlinear growth, but every percentage of top line could have had maybe a 1.1% increase in bottom line kind of stuff. So factoring on all that, even if you have these one-time adjusted for this quarter, because I think we are going to be doing 2 or 3 or 4 things actually. One is all these global centers we are going to be opening up will add to the initial ramp-up costs. I mean once they stabilize, they'll start driving the revenues, but there will be initial ramp-up costs as we create a certain capacity in each of these places. Secondly, as I said, we are going to be hiring in advance, I mean, so that we don't get surprised by this kind of stuff going forward and preparing talent rather than waiting for business and then getting talent. So that could add to some kind of cost pressures. So I would -- as we sit here today would look at a more linear relationship between absolute margin growth and absolute revenue growth. So that's what I would forecast as we sit here today.

Okay. And sir, something on the acquisition side. Like what are the details there in terms of any growth number? It appears that you got it at a very good price. So what are the details...

That I don't know. Don't say it loudly.

I am saying -- so any details that you can give in terms of growth or margin or...

No, as I just said, see, it's about -- I guess, about a $15 million, $14 million annuity business. I think it has an EBITDA of about 15%, 18%. And it's a very steady business, annuity and so on and so forth. So the growth really comes from 2 or 3 possibilities. One is, what else can we do to these clients because these clients could have earlier been restricted by the size of the company to expand and grow into more areas and do more. So that's one possibility. The second possibility is for them now with a bigger balance sheet and a larger company behind them to go for larger deals in their same verticals which they are currently operating in. So these are the 2 things. We are not seeing any cost to us. That means we'll take any of their to our clients. But these are the 2, I guess, big growth drivers to that business. But as I said, the business is a very robust business. So it's a very solid business, a very, very experienced management team. Business has been in existence for more than 12, 13 years. They've all, as I said, ran these big, big operations for companies like Syntel and so on and so forth. So overall, very sound management team, very experienced in running this kind of business. And as I said, this access to the whole Chennai now in the current context of supply side will, hopefully, reduce the pressure on that. So I hope I've shared enough information with you, Mohit.

Yes. So there is no change in working capital or anything of that sort, when you acquire that entity? That is pretty much...

No, no, no. They were cash surplus, actually, rich on cash. So no working capital.

Okay. And sir, last, on domestic side. This quarter, obviously, you saw this [indiscernible] expansion because of the depressed last quarter as well. What kind of growth are you looking at for the domestic business on a...

Domestic this quarter, I think, the margin we grew, I think, on the gross contribution side. My feeling is we almost grew 8% to 10%, I think. So we'll continue to look at that. I think at least 5% to 6% gross margin growth. Maybe -- this quarter, maybe 3% to 4%, but I think Q3 looks extremely promising and Q4 may not be as good as Q3, but still far better than Q2. So I think that business looks very solid. So we should grow like 4%, 5% quarter-on-quarter.

4%, 5% when you look at EBITDA of the domestic business. Is that what you're referring to? Or...

Yes, yes, EBITDA, yes, absolutely.

Absolute EBITDA on a quarter...

Yes.

[Operator Instructions] The next question is from the line of Baidik Sarkar from Unifi Capital.

I'm sorry if this is a repetition, and I missed this in your opening comments. The sequential growth in our Microsoft services have sharply -- is sharply below Microsoft's own growth. I'm just trying to understand, is this a supply side issue from our end...

Yes, it is. That's what I made at the beginning. It is a supply side issue, not a demand side issue.

Got it. Got it. Fine. What's the commentary from your -- from TUI coming on in the context of what's happened in Q1...

No, it's still like maybe now this Delta variant and markets are opening up, shutting down, Spain opened up, Spain shut down. So it still looks, let's say, wavy. My feeling is, as I said last time, I said second half, now we are looking at even January kind of stuff. But finally, I mean, the disease has to be either stabilized or has to really go away. I mean otherwise, obviously, people are not keen on taking holidays. Either they go to the other side and they are quarantined or come back and are quarantined in their home country kind of stuff. And those rules are still extremely unpredictable as we speak today. And as I said, they continue to invest in that thing. So that's stable. So what I said last time is the growth will come when their operations start. Right now they're not running any system, more or less. They are like 20% operational. So the revenues from the operational systems and support of that, that's what is going to give the bump-up. And that we have to wait. Otherwise, whatever they're investing for the future, that's carrying on.

Sure, sure, sure. Just a bookkeeping question for Jagan. What was the EBITDA before other income and FX for our IT services business? And going forward, if it's possible to kind of report this on a stand-alone basis, it will make interpretation really that much better, Jagan?

Sorry, I didn't -- your voice was a little feeble. Can you repeat the question please?

Yes. My question was, what was your EBITDA margin before other income and FX in your international services business? And going forward, I was opining if it was possible to just report that as a stand-alone basis pre-other income.

Yes, yes, yes. Definitely. Pre-other income, the EBITDA margins will remain at the same level. In fact, there can be a little improvement also from that. So the business as such hasn't -- in spite of all the cost increases and, as Srikar was mentioning, we are trying to beef up the resources to back up for the existing people to protect the revenue and the customers...

My question was what's the margin.

Margin will be somewhere -- the EBITDA -- reported EBITDA is somewhere around 27.5%. This should be close to 25%, 26%.

25%, 26%. This is pre impact of other income?

Yes, yes, without other income impact, ForEx impact. This quarter, it may be a little more because of the -- as Srikar was telling, on the PF reversal was there. On a normalized basis, this will be the margin, around 25% if you can take.

25%. Sure. And lastly, congrats on the sharp ramp-up in the annuity portion of your domestic business. How should we see the gross contribution from whatever is annuity? How should we understand the margin curve of this business better?

Sorry, I didn't get the question.

So I'm just trying to understand, in terms of the annuity business in your domestic product reselling, what are the gross margins we make on that business? How should we understand the profitability of this better?

It's safe to assume that it's the same gross margin. I mean, instead of saying that one has got a higher gross margin than the other, it's just that one has more predictability than the other.

Sure, sure. And it's fair to assume that the ramp-up in your annuity and the cloud is almost similar in terms of salience. So is the interpretation right that whatever is annuity is necessarily driven by cloud ramp-ups and that obviously has a long runway of growth going forward?

Yes. At a high level, I mean, even earlier, the contracts were for 3 years, but now the cloud contracts are a little bit more stickier than purely a volume licensing contract. Both were for the long-term kind of thing. So that's a good assumption to make, Baidik.

Okay. And what would our cloud mix be? I'm assuming Azure would be #1.

Yes, Azure would be -- yes, Azure is still way, way, way above it. I mean Amazon and Google are just something we started like 6 to 9 months ago. I mean, they're like the huge -- they are the huge runway businesses. But the Azure and the Azure-related cloud would still be significant.

The next question is from the line of Prakash Chellam from Marathon Edge.

Just wanted to understand. If you talk about your domestic business, could you just give us a sense of what contribution does MS Azure reselling do to the business? And what sort of profitability and credit risks do you see in that given this whole growth wave that we are seeing in the cloud demand in India?

Okay. I don't know. Sujit, are you on the call? Can you take that question.

Hello. Can you hear me?

Yes. I can hear you.

Yes. If you don't mind, can you just repeat the question again?

So in the domestic business, we are seeing a huge shift towards cloud globally and in India. Given that you have strong relationship with Microsoft, can you just give me a sense of what is the contribution of Microsoft Cloud Azure reselling within your domestic business? What sort of growth you're seeing on it? And is the profitability profile there extremely different from the rest of your domestic business? If you could just comment on that, please.

So in Microsoft business, most of the customers, whether it's Microsoft or partners like us, for us, the MS Azure business is one of the key drivers. So any time we go for a contract, MS Azure is a very critical component of the contract. And most of the volume growth will come from that because the consumption of the cloud is one of the very key things which OEM like Microsoft will always focus on. So that will always be a growth driver. Now coming to the profitability, it is -- there is nothing very specific about this particular product line. I mean in Microsoft, they have 4 business lines. This is one of them. So when you sign a contract, the overall profitability, there is nothing specific that we have to mention about this particular business line. And in future, as I said, we continue to believe that this will be one of the growth drivers. And in most of our large contracts, Azure will have a major play as far as the percentage of that business from the customer is concerned.

Sir, if I could just progress on that a little further. Do you do any other cloud reselling apart from Azure? I mean, do you sell AWS or Google or somebody else?

Yes. AWS...

But the majority is -- okay. And wouldn't that business be sub-10% sort of EBITDA margins with credit risk? Or is it higher than that? And is it substantially higher than the rest of your distribution business or domestic India business from a margin perspective?

Yes. From a margin perspective, if you see, most -- I mean, any of the cloud business -- I mean, in the Indian market, the retention margins are almost same in each of the business, whether it is AWS, whether it is Google, whether it is Microsoft. As far as risks are concerned, it's a customer risk. It has nothing specifically to do with any OEMs. So when you get into a business, that due diligence and that development process which you do before getting into a contract, whether we should go with this contract or not, that remains the same irrespective of the technology or the OEM the customer is looking for.

And could you give me a sense of -- you said that the margin profile is similar across the 3 providers, cloud providers, if you do reselling and value-added reselling. Could you give me a sense of what sort of EBITDA margins are we talking about? Are we talking about 5%, 7%, 10%? And second, when you say you're seeing tremendous potential there, are we talking about 100% plus sort of growth rate that you're seeing in India year-on-year or more like 50% on the cloud component reselling? And third, how much of cloud today for you in this $300 million odd that you do in the domestic India business?

So let me just take one question. Our EBITDA margins are as published, still about 2%, 2.5% in the business, Baidik (sic) [ Prakash ]. Yes. So I'll hand over the rest of the questions...

For the cloud portion of it, is that higher than the overall business? Or is it lower than...

No. I mean, it is not significantly higher. I mean it could be marginally higher, but it's not like 2.5% and 5%. No.

Got it. Okay. All right. And what component of your business is it? And what sort of growth rates do you enjoy of the domestic business? Is it cloud or is it...

That 70-odd percent is cloud business now, Baidik (sic) [ Prakash ]. That's in the investor deck, 74% or whatever. Yes.

73%. Yes.

73%. Yes. Yes.

73%, when you say cloud, is it just cloud hosting reselling or it includes cloud software products?

This includes the cloud software products also, not just the -- all the 3, IaaS, SaaS and PaaS.

Okay. And what would the cloud just hosting platform portion be out of this? Because there's just demand for people just shifting space on the cloud. So is this a large portion of the 73% or small portion?

Still a very large portion is still the IaaS part, Infrastructure as a Service.

Which is the hosting piece, is that right?

That's right. That's right.

Okay. Got it. Got it. And so the overall growth rate of the domestic business probably mirrors that growth rate of -- in the industry.

Yes. That's correct.

The next question is from the line of NG Puranik from Enam Securities.

Great quarter, as always. Nice to see you bringing in some interesting changes to your businesses. So I want to understand the Encore acquisition from -- what that will do to you? One is the -- they bring the current relationships and current businesses to you. So in terms of service lines, will they add to your service lines? Because at the end of the day, when you go and sell your services, the larger deal is a function of number of service lines you have, and that too, high-spend service lines, mission-critical service lines and new service lines. Combination will make the deal larger and that will in turn help you grow your $1 million account and creates a platform for size and scale. So I wanted to understand this, will they add to any services? Then the vertical also will have a greater mix?

Right. All the things you said are all correct that they are a robust business. They bring the clients. They bring the vertical knowledge. They get our access to these vertical industries. They -- I think one thing they bring, which we already have, I think, which can be a good combination, at least in the U.S. market, is their cloud horizontal capability. I think that should combine the story of the overall cloud services strategy in the U.S.

So what do you mean by cloud horizontal? Is that an effective migration service -- cloud migration services?

Mainly, yes, cloud migration, cloud development.

Cloud migration and development.

Cloud development. Maybe cloud development, cloud migration. They are both in the Azure space and the Amazon space.

Okay. So when you said cloud development, what exactly happens there?

People want to build -- either modernize their current on-prem app on the cloud. So that mean you need to architect those apps. One is a lift and shift. They just move it as it is to structure cost.

Is it building applications on cloud? Or is it...

Yes, it is either rearchitecting existing applications on the cloud or building brand-new applications on the cloud.

Building brand new applications. So the larger percentage of their business comes from, what, development, cloud development?

Development and -- yes, development and testing, yes, on the implementation and other things. It's...

So in a way, it will add to your new service line?

That's right. That's correct.

So that can add to what kind of a service -- contact size? For example, if you are bidding a customer for $2 million to $5 million, will that take you to $5 million to $10 million?

Yes. They can themselves go and bid for those now because that is still balance sheet side.

Okay. They can themselves -- sir, another...

They have been tired of going to larger customers because somebody is saying you're only $15 million, $18 million, so how can I...

So what is the kind of names they are bringing to you, Fortune 500 companies?

Their names are on their website, Puranik. They are all in the midsized provider space.

Midsized provider, that is, Fortune 1000...

$1 billion to $5 billion revenue.

$1 billion to $5 billion. I see. And how many clients they have, $1 billion to $5 billion?

The $1 billion to $5 billion, they will have about 6 clients.

6 clients. One other question in this connection I have is, you said they are in the business from '80s to till now. It's nice to be staying relevant for so many years, being a legacy player and modernize yourself and stay current and relevant. But I want to understand why after 30 years, their revenue is only $15 million.

No, no, no. Their business -- no, I said, they ran Syntel and all that. They set up one other business which they sold off to somebody. This is their third venture. Yes.

Third venture. How old is this venture?

This venture is 11 years old.

11 year old. Not bad. $15 million, $1 million per year. So that's not a good -- bad number. So what -- you have time for another question or time out?