Tata Elxsi Limited (500408) Earnings Call Transcript & Summary

Ladies and gentlemen, good day, and welcome to the Q1 FY '26-'27 Earnings Conference Call of Tata Elxsi Limited, hosted by E&Y. [Operator Instructions] Please note that this conference is being recorded. I now hand the conference over to Mr. Shashank Ganesh from E&Y. Thank you, and over to you, sir.

Thank you very much. Good evening to all the participants on the call. Good morning if you're logging in from the Western side. Before we proceed to the call, let me remind you this discussion may contain forward-looking statements that may involve known or unknown risks, uncertainties and other factors. Therefore, it was reviewed in conjunction with the business risk that we cause further results performance or achievements that differ significantly from what is expressed or implied by such forward-looking statements. To take us through the results and answer your questions today, we have the senior management of Tata Elxsi, represented by Mr. Manoj Raghavan, Managing Director and CEO; Mr. Nitin Pai, Chief Marketing and Chief Strategy Officer; Mr. Nalin Rana, Chief Financial Officer; and Ms. Sneha V., Company Secretary. We will start the call with a brief overview of the past quarter by Mr. Raghavan, followed by a Q&A session. [Operator Instructions]. With that, I would like to hand over the call to Mr. Manoj Raghavan. Over to you, Manoj.

Thank you, Shashank. A very good evening to everybody who has joined us today for FY '27 investor call. I hope all of you are fine and doing well. I'm pleased to announce that Tata Elxsi has passed a key milestone of crossing more than INR 1,000 crores of quarterly reporting operating revenues, by delivering INR 1,21.1 crores in the first quarter of FY '27. In constant currency terms, our revenue grew by 6.5% year-on-year and 1.3% quarter-on-quarter -- the growth was led by our major verticals, transportation and media and communication, which grew 6.7% and 11.5%, respectively, year-on-year in constant currency. We see this performance as a reflection of the strength and relevance of our unique design-led and AI-enabled engineering capabilities, supported by large strategic engagements in the chosen industries. We posted an EBITDA of INR 216 crores, which grew at 15.7% year-on-year and an EBITDA margin of 21.2%. The media and communication business delivered robust growth a 4.7% quarter-on-quarter natural currencies and 2.9% quarter-on-quarter in constant currencies, which translates to a year-on-year growth of 22.2% in natural currencies and 11.5% in constant currencies. The strong performance was enabled by the ramp-up of key engagements, which we announced in the previous quarter, in large programs with global operators and broadcasters. Our transportation business, which contributes more than 55% of the SDS segment revenue, reported a resilient performance in otherwise challenged macro environment, the growth of year constant currency and 13.3% year-on-year in actual currency. This was led by large automotive OEM engagements and strategic off-road and aerospace deal wins. We continue to strengthen our pivots towards OEM and today, 78% of our automotive revenue is from our OEM customers. The Healthcare business exited near flat with a minus 0.3% quarter-on-quarter in constant currency, reflecting the muted global health care business environment. The anticipated momentum was staggered by the delayed deal awards from some of our key customers. We, however, remain excited about the long-term prospects of this segment. We continue to invest through scaling our newly launched platforms such as VITAL, AnaTel, reimagining our offerings with AI and GenAI and taking center stage in med tech and health care events setting ourselves to capture emerging opportunities. In the quarter gone by, we have accelerated our efforts to expand platform-led offerings, our NEURON platform portfolio has enabled Sky in Europe to transition towards zero-touch network operations with enhanced cybersecurity delivering up to 30% to 70% efficiencies in various parameters. Our AI-led material intelligence platform VITAL also in a strategic deal with a global medtech company. We are executing upon our future focused strategy, and we'll continue to intensify our investments in specialized talent rigorous upskilling, AI-powered platforms, tools and infrastructure that strengthens our human plus AI plus domain proposition. These forward-looking investments will enable us to stay at leading edge of technology advancements while accelerating value creation for our customers. The U.S. region performed well for us across verticals, led by new deal wins and deal ramp-ups. Some of these strategic programs demand quick ramp-up at onshore for transition support and initial stabilization. We have incurred additional cost of deploying forward teams as well as specialist third-party contractors to help accelerate transitions and mitigate with our delays for our engineers. This is partly reflected in our on-site offshore ratio and bottom line performance and should ease over the next 2 to 3 quarters. We are firmly focused on sustainable growth, deepening our engagements with key customers and positioning ourselves to shape and win strategic long-term deals and add marquee customers. We look forward to carrying the growth momentum to subsequent quarters while remaining steadfast on our operational rigor and business discipline. Thank you, and over to Shashank for the Q&A session.

[Operator Instructions] Your first question comes from the line of Bhavik Mehta with JPMorgan.

A couple of questions. Firstly, wondering if you can give some outlook honestly, verticals, given the middle is contract still remains in place. So how are the discussions with clients evolving on spending intentions for the next few quarters? And if you can say to an account 3 verticals, how it different? And then secondly is on margins. You did talk about some onshore investments and subcontractors as well. So how should we think about margin trajectory going forward? I mean there is onetime time which is the base now is caring for the next few quarters. So any color on the margin outlook on for the...

Sure. I think -- I mean, upfront, let me tell you, I think it was a reasonable quarter for us because 2 of our larger businesses, which is transportation, and the media and communication vertical had a pretty decent performance. I think the median communication vertical has been sort of underperforming for quite some time. And I think some of the deals that we have closed in the previous quarters, we're finally able to ramp up and achieve the full ramp-up situation. So I think there are, as we speak, there are deals that we are chasing. There are some pretty large consolidation deals in the media and telecom space. And some of these, we are very, very confident that we should be able to swing in our favor. So I think over the next 2 to 3 quarters, we strongly believe that we will be able to continue our growth in the mid and communication verticals. From the transportation vertical, Yes, I think the Europe situation is a little -- we have to wait and watch given the challenges in the German market and so on. We have not been affected as much and the deals that we have closed, we continue to execute. There is some slowdown in the new deals. But having said that, I think for us, the U.S. market, we were able to really significantly grow, not just the automotive revenues but also the adjacency revenues. -- including the off-road and farm and equipment as well as the Aerospace and Defense segment. So overall, when we look at it from a transportation business, we are hopeful that, yes, there is softness in Germany in particular, but we strongly believe that all the other adjacencies and the efforts that we're putting in other markets, including Asia, including India, I think we have seen some pretty very good deals that we have closed over the last couple of quarters, and these ramp-ups are happening as we speak. So I strongly believe that look for both our media communication and transportation, we should see growth over the next 2 to 3 quarters, right? That visibility is coming, as we speak. Health care, again, it's a little bit of a like a moving target. It's a smaller business for us, less than 10% of our revenues come from healthcare. But it's a very, very important business for us because we strongly believe we have built fantastic capabilities including a lot of AI, GenAI-related tools that we have built for this particular market. And that is a good -- when we talk to customers and -- as you know, this -- in this particular industry, the deal pipeline, the deal closures, it would take some time. There are some very good conversations happening. I wish we had a better story to say. And we are really hopeful that look Q1 would be a good story. Unfortunately, some of the deals that we have been discussing. We have still not been able to close it and complete the paperwork and so on. So having said that, we are still in the midterm to long term. This is an area that we're investing in. we have built fantastic capabilities. And we strongly believe that this will eventually in this financial year, we will see growth in the Healthcare and life cycle -- life sciences space. So this is somewhere we are definitely continuing our investments and so on. On the margin side, maybe I will request Nalin to give you an overview yes, I think we have some one-timers that have hit us in the quarter. But definitely, we have a plan to grow back and -- and if you look at it over the 4 quarters, really look at how we can get back to our margin profile. So I will hand it over to Nalin to answer that question.

Thanks, Manoj. So if you look at our EBIT margin, so our EBIT margin has decreased 330 bps on a sequential basis and 80 bps on a -- increased 80 bps on a Y-o-Y basis. So looking at the change in margin in 3 buckets, right, to give you some color. So the first bucket is cross currency gains that we have got in the quarter. That's about 40 to 50 bps. Then we have, in this quarter, around 150 bps of one-off costs are short-term costs. And there's a third bucket of 220 bps, which is towards investments in people, go-to-market and capabilities. Now taking these -- the second and third buckets 1 by one, right? So 150 bps -- so 150 bps this quarter, we had to incur some transition costs for some of our large consolidation deals that are taking place. Second one is there was some onetime costs that we also took towards retention of select employees who we believe are sort of critical for the business. Third one here. there were costs in relation to a particular customer that we had to incur in this particular in this quarter, which we do not anticipate going forward. And the fourth is upfronting of certain annual costs. So these are absolutely standard costs pretty much fixed on an annual basis, but we had to for various reasons, upfront some of these costs in this quarter. So this bucket, the way we should think about it is most of these would go away in the next quarter. Some of these will transition over the next couple of quarters. Then there's this third bucket of about 220 to 230 bps. Now this is on account of a few factors. One is investment in on-site sales and delivery. In this quarter, we saw significant ramp-up in some of our U.S.-based deals. So we had to ramp up our delivery there. A lot of this ramp-up we had to do through subcontractors because of, a, the short time lines. We also visa restrictions that are existing in the industry. In addition to this, we have applied for Visas of our own people, who will sort of supplement these contractors or replace them over a period of time, right? Then there were costs -- again, for these deals, there were costs related to ramp-up of these deals. Then we are as mentioned by Manoj earlier, ramping up our investments in specialized talent, AI tools and infrastructure. Lastly, we had very recently a Chapter 11 in one of our customers which sort of led to higher provisions for the quarter, which you can also sort of see in the -- you'll be able to see sort of in the financials. Then the second bucket, the this bucket, the way I would think about it is these are a little more stickier, but also should go away over a period of time, right? So subcontractors, we look to make -- optimize those by moving some work streams offshore or our own employees replacing the subcontractors over a period of time. and finally leave only the critical sort of resources that are there. And similarly, customer-related ramp-up costs as sort of our deals get ramped up and stabilized, I think this should also stabilize over a period of time. So these -- so just to recap, around 150 bps, they should go away more quickly. Second bucket should move away should sort of improve over a period of time.

Your next question comes from the line of Vimal Jamnadas Gohil with Alchemy Capital Management Private Limited.

Sir, just 1 follow-up on the margin question. In the other expenses line item, which is about INR 135-odd crores -- are there any ForEx losses also that are being -- that are built in this particular quarter?

Yes. So this is what actually I referred to there's other expenses largely increased because of 2 -- I would attribute it to 2 items. One is a Chapter 11 at one of our customers where we had to provide for the receivables on a conservative basis. The second one related to upfronting of certain sort of annual costs. So not -- I would say not a big ForEx item, but these are sort of the 2 main drivers.

Okay. Fair enough, sir. Sir, I missed out on the auto OEM contribution in this quarter. How much was that? .

78%. .

78%. All right. And sir, lastly, we've been talking about revenues from adjacencies when can we possibly see some sort of quantification of disclosure as to how much are we getting from these adjacencies?

I think in this financial or at some point in time, we will definitely be able to disclose. Hopefully, by end of the financial year, we should be in a position to tell you exactly.

Your next question comes from the line of Ravi Menon with Axis Capital. .

Congrats on really good performance in the media and communications segment. So I want to check what's a time like in transportation? Are you saying Automakers, especially look at new hybrid platforms, what sort of role can you play in that? And in the medium-term engine segment, one of your top customers is undergoing a corporate restructuring any changes to your engagement that might come either positively or negatively from that?

I think coming to the MCV, yes, I think we are discussing with our customers at this point in time. There's no clarity in terms of if it's going to affect our business or not. If you ask me, I would say that it will only help us. It is -- it could be positive, because there are -- we have not deeply penetrated the NBCU piece. So that is an opportunity for us to really go there. So at this point in time, there's nothing that we can -- there's nothing to inform in terms of is it going to affect us or not. We are keenly watching that space. automotive customers perspective, we've already discussed. I think globally, yes, both in the U.S. and in APAC, Japan and India. I think we've seen a we've seen traction is definitely there. There are a lot of -- there are large deals that we are bidding for. Continental Europe is a little bit of a wait and watch as we speak -- that -- though there are opportunities that they have built, there are large deals that we have placed, but given the uncertainty in the market, we're not sure on the pace at which some of these decision will happen. So I think there's a little bit of a wait and watch there. But otherwise, overall automotive industry, I think we should see some good growth coming in minus Europe. .

And how the overall headcount is down a little bit. So what is the sort of adding plan, especially for fresh college graduate this year? And how does that compare to the last year's fresh college graduate hiring?

I think we are on a wait and watch, right? I think our utilization is just about 5% also right now. We still have some leeway to go. We have been hiring freshers, as we speak, but the numbers have been pretty small. So I think we will -- hiring fresh grads. We will only look at it as our -- what do you say, the growth momentum picks up, right? So -- so it will be very, very moderated the way we go ahead and hire. And especially with now AI and Jane also coming in, that is -- we won't want and go and hire a huge bunch of freshers. So it's -- as I said, it's a wait and watch. We are hiring freshers, but it's a very moderate level. I think last quarter we would have added about 100, 150 engineers from the colleges. So it's a small number that we add.

And given the current market, I think it's actually preferable to hire laterals because it's still fairly easy.

Yes, lateral is only very, very specific where there is a need, right? Most of our focus is utilizing our bench and utilizing our existing team members -- and of course, focusing on retaining our key talent, right? That's what we are focused.

And could you talk a bit about the sales investment that you've made?

So I think both in U.S. as well as in Europe, we have added sales head count -- we've also added advisers to support us in some of the large deal pursuits. Apart from that, we've also spent in terms of events that we participated in to build our brand and also to gain visibility in the larger market space. These are specialized events. We're not going after those large events and so on there are -- for each of our industry verticals, there are those specialized events which are there, and that's something that we are focused on and spending money.

Your next question comes from the line of Moez Chandani with AMBIT Capital.

My first question was on your overall growth expectations for FY '27. I think you've said last quarter that you probably would be aspiring for a high single-digit sort of number. Is that something which will still be aspiration given issues that you've outlined in transportation? Or do you think it'll be more closer to the mid-single-digit number for the year?

No. So our aspiration continues to be the same. We are -- we just need our health care business also to fire up, right. And then I'm sure that we will be able to get to that get to that sort of a growth rate that we are aspiring. So I think we're not changing our aspirations.

Okay. Understood. And then secondly, just broadly on -- I think in a previous question, you briefly touched upon AI and if that's impacting some of your hiring, but -- how are your conversations with clients being on the AI implementation? What are your clients saying? And is that impacting, say, our volume growth or your T&M projects going forward?

So maybe I'll take that question, Moez. This is Nitin here. I think AI, in general, on one hand, in product engineering, given the fact that the industries that we operate in are largely mission critical, especially automotive a car has been very careful and measured in the first place, especially when it comes to implementing it into the SDLC process into products that will deploy in the future. So there is a certain amount of care and caution that's being exited. But having said that, I think we are driving a very strong path of providing a path of transformation, aided by 2 parts. One is the platform-led offerings that we are building. So what we are saying is it's not so much about AI for itself. Each of these industries require solutions that are tailor-made to their context that provide for coverage of certain aspects of cybersecurity of FMEA and so on that are very specific to those industries. So to that extent, I think what we're doing is we're taking a very domain plus AI, if I may, view of each of the industries, and we're saying, "Look, we don't have to transform all at once, but we will provide a platform led approach that allows you to take the SDLC part by part and still connected up at the end." So what we're actually seeing is that kind of a measured calculated adoption. And I think we're doing very well there. So to that extent, I don't see deflation. I don't see shrinkage. I don't see any of that. We rather see opportunities. But having said that, I think the overriding problem is and point is, the spend that has been earmarked for I, unfortunately, is also kind of curtailing R&D spend, if I may. So I think that's the larger perspective rather than anything else.

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

So my question is on the increased investments that we have been doing. So if you can elaborate a bit more on kind of what the investments around. So these are mostly like platform investments? Are they spending more on R&D? Or is it more related to the client specific engagements that we have. As you said, we are investing more in subcontracting investing more than on-site and is it fair to say that the new deals that we are taking and they are like initially lower margin deals?

Yes. So these investments definitely are around building specialized talent pool, right? That is definitely there. We talked about the AI infrastructure that is needed that they are building -- so -- and also all the tools and the cloud investments that are needed to deliver value to our customers, right? So it's a combination of all of that, which are the investments. Now of course, in some of the large deals that we have taken, there is also the transition costs, right? There is some bubbling of cost that happens because these are typically 3- or 5-year deals where in the first quarter of commencement of the deal, there is some amount of bubble cost that comes in. So these are all the investments that we are doing and that has sort of affected our margins in this quarter.

Okay. And in the transportation vertical, obviously, OEM is now 78% of the automotive revenue. So within the OEM bucket, how we're seeing the top line and the top line moving. And also, if you're seeing some softness in some of the OEM accounts, especially what is happening in the European region. So if you can provide no commentary on what is happening with the OEMs and...

Yes. So the top customer has been pretty steady for us. So that's definitely a positive. And I've already indicated the softness in the OEMs in Germany. I mean, we have -- there are large deals that we've already closed. Those ramp-ups are going a little slow there. So as a result of which, our what we would have expected that we will achieve in Q1, we have not reached that. But I'm hopeful that over the coming quarters, we will be able to ramp up to the expectations, right? The good part is, we've had a good recovery in the U.S. as well as in the APAC region, and all that has actually contributed to the growth in the automotive segment for us.

Okay. And sir, lastly, on the subcontracting part, if you can quantify the subcontracting cost and what is a positive revenue in this quarter versus last quarter?

I'm not sure whether we can give specific details of the subcontracting costs.

Amit, maybe, this is Nitin here. I can just provide 1 slice, which is, if you look at our on-site offshore ratio, you'll see that the ratio has shifted by about 1% or 90 basis points, 5.9% -- so you can kind of -- and this all happened within 1 quarter. So you can look at that part and assume that a fair part of that is what we contracted out. And that has an associated impact on margins. .

Your next question comes from the line of [indiscernible] with RK Investments.

Can you hear me?

Yes, sir. Speak.

Yes. All right. A couple of questions. Maybe you addressed the first one a bit earlier. So first is there is this growing concern, right, of the detector impact on software coding, maybe especially on engineering R&D it might kick much harder than traditional IT -- so what -- I mean, is there a pressure? And how are you ensuring that the data axis margins are projected? And the second question is related to your slide on transitioning to platform led engineering, in terms of these proprietary platforms NEURON, [indiscernible] So if you could -- I want to know how aggressively you're sort of supplying it to address the pricing pressure, anything on what are the clients looking for? Is there more demand using more with less pricing something like that and you have some color on.

Sorry to interrupt. The line for the management has been disconnected. Please stay connected while we reconnect the line for the management. Ladies and gentlemen, we have the line for the management reconnected. Karthik sir, could you please repeat your question once again?

Yes. Okay. And I was talking about the whole reflector impact of using autonomous tools on the software coding and the fact that it might hit the engineering R&D higher than traditional IT saving rate. So I wanted to understand how Tata Elxsi is protecting their margins in such impact like this? And the second question is on the slide on transitioning to a platform led engineering. So wanted to understand how aggressively you are deploying these platforms like NEURON, in terms of addressing this price pressure. Anything more on how the clients are using these proprietary platforms...

So Karthik, is Nitin here again. Maybe I'll take those 2 questions. So on the first part, as far as the impact of AI on the LDLC. I think the point that I was trying to make is working with B2B customers in the chosen industry that we operate in, which is health care, media, telecom, as well as automotive and transportation. You tend to have 1 very large core basis. Two, these have been built over many, many, many years. So this is not fresh call. Three, these are fairly complex and built by multiple teams, right? So first, you understand the scale, size and complexity of the problem. Like they say, a car has 100 times more code than Boeing [indiscernible] 747 does, right? So that's the complexity you're talking of. Two, while we tend to think of software coding as the biggest part of what work is done, the reality is that product planning, feature planning, architecture, requirement requirements capture, requirements mapping, regulatory alignment to the multiple countries that these products were deployed in actually is a bigger part of the problem than actual coating. Coding is just one part of the whole cycle. And that is where we believe that while AI can come in and you can say that, look, software code, I can write C++ code, I don't know, 20% faster, 30% faster and so on. But the net impact of that part of saving in the entire life cycle is not too high. That is part one. Part 2 is customers are not as much focused on cost savings as they are on, whether it delivers productivity or quality. Because in the ranking of CPQ, cost, time and quality, right? I think the industries that we operate in inverted, it's quality, time and then cost comes last. So to that extent, I think the proposition stays strong, which is Tata Elxsi, leading-edge technology capabilities deep domain expertise now backed by AI. I think that is the proposition that we're offering, all of course, delivered from India at scale. I think this is the real if I may, tagline that we are delivering on, right? And I believe that is still very, very relevant now and going forward. Your second question was to do with our own platforms. You would think about it, there are -- 2 types of investments that we're making. One is in platforms like TETHER and NEURON and so on, which go into the customer products and services because it's transforming their products and services. And I think NEURON -- that's why we took a lot of time to craft the value that our customer is deriving. So the press release that we made this Sky, I think absolutely clearly calls out multiple dimensions on which we are delivering market where efficiencies, whether it is autonomous operations, whether it is customer experience and so on. The same is with our connectivity platforms because these are customer facing. Investments that we're making in platforms like VITAL or AnaTel or DevStudio are more through it, how do you accelerate the software development life cycle of a customer. So this is something that end consumers will not see. This is something that provides efficiencies but more focused on quality and time savings rather than on cost, right? So that is the view we are taking. Adoption Traction is fantastic. Reception is fantastic. -- adoption, we believe will be thoughtful and calibrated simply because customers are not going to jump in the first platform they see. I think they're taking a very careful long-term view of what are we doing, what are we working with? How do we make sure that what we are taking on and routing is supported for the long term. So I think these are decisions that customers take very thoughtfully and carefully and hopefully, the proposition that Tata Elxsi provides both as a brand and as a capability stands us well.

So if I have to summarize, you're saying the first 1 is not much of a defect impact as such because the cost of R&D stuff is much, much lesser in the whole pipeline. And the second one, you're saying it's a long-term view. It doesn't have anything to do with the billing rates right now really...

Right. But it definitely is making a positive impact on our win ratios and venerability. Was it definitely having a definite halo effect even as we speak on what we offer to customers and what customers believe we are capable of for their long-term transformation. .

Your next question comes from the line of Sulabh Govila with Morgan Stanley.

Yes. Am I audible?

Yes, you are.

So I had 2 questions, both on the investments that you've made in the quarter. So one is on the on-site investments and delivery that you spoke about. So historically, we've excelled at an offshore entice delivery model. So should we see that this investment on the on-site front as a change in the nature of demand versus what we used to do earlier. And this is more structural? Or you would say that this is more technical and specific to a few projects?

Yes. I think as we said, some of the large consolidation deals that we have on needed on-site refers us to be available. But over the long term, -- the business model is to move a lot of that work offshore. So we're not moving away from a business model perspective. We would be in a if 5, 5 being offshore and 25 on site today, I think it was 4, 26 or so, it's just a 1% item. But we will over the subsequent few quarters, as Nalin explained, we will be able to move a lot of this work back offshore, and we are not changing our business model if that is the question.