Tech Mahindra Limited analyst Q&A

We will now begin the question-and-answer session. The first question is from the line of Ravi Menon from Macquarie. Please go ahead.

Rohit, you talked about 160 basis points impact. There is no impairment that we've called out. So, could you explain what exactly is this 160 basis points impact and is that entirely in the SG&A line?

So, one -time exception -led similar to last quarter as we had called out, there are certain portfolios across the organization that we're looking at, there are certain contracts that we look at from a long -term perspective, it doesn't align with the strategic vision we have. So, we've upfront taken actions on those, either terminating those or boxing them separately. Based on that, we've taken certain impacts which was there last quarter and the same follow through. So, we said that between Q2 and Q3, we'll pretty much close those actions and that's what we've done. From an impairment perspective, that's a year -end exercise where we look at all our portfolio investments that we've done historically, and that as sessment will happen in the current quarter as a part of our year -end financial close and basis that we'll keep you updated if there's any charges associated with it.

Is there any revenue impact as well, Rohit, due to this closure of contracts?

No, not significant this quarter. We had it in last quarter, which we've articulated. I think this quarter the one -time revenue is more around certain product revenues which won’t be repeated, so that's what I highlighted from a top line perspective.

Ravi, we don't see telecom as having bottomed out. We still see a significant amount of volatility at least for the next couple of quarters. But we do feel that the worst is behind us, right. If you look at the very significant drop that we had in 2023, we don't think we're looking at the same magnitu de of drop in 2024. But it is still a sector that is stressed, and it is still an area where we are seeing volatility in the current quarter and beyond.

And one question is on Europe. Really strong performance there. Do you have some color on what sort of deals you're winning there; what verticals are being tracked?

Look, I would say that in Europe, our performance in this quarter really is a bounce back from the very poor performance we had in the previous quarter. I would still sa y that from a year-on-year basis, we are still down in Europe. So, I would not prematurely call it a victory or a recovery. There is a lot of work that we are doing in Europe to systematically look at our clients base, to look at the various segments in wh ich we operate. As you know, in Europe, we have a strong telecom business, but also a significant right-to-win in Manufacturing, we are investing to build up a BFSI business. So, in the long run, I'm sure that our Europe business will be very robust. But t he performance in this quarter is just a bounce back from an exceptionally poor Q2 and not really a sign of great recovery.

Just to add, some of that one-time revenue is also in Europe. So that is causing a little bit of an increase.

The next question is from the line of Gaurav Rateria from Morgan Stanley. Please go ahead.

My first question is for Mohit. You made a comment around that you embarking on this three track plan and making significant investments and changes. How to think about the duration of these investment cycle -- is it going to be multi-year investment cycle, and when do you think that we'll start reaping the fruits of that?

So look, I think as you know I have been in this position only for about 33, 34 days now. So, we are at the very early stages of detailing our plan for revenue, plan for margins and a plan for the organization. But, if you look at the things that we' re talking about from an organizational perspective, right, we're talking about taking in fresher talent every year which means that we have to build out a training infrastructure from what we have. We've got a new CMO, so we're making significant investments from a brand perspective. There is some rationalization of policies that I had alluded to that we have done, plus we're building out capabilities in sectors like BFSI. So, all of this will require investments. I expect that when we come back to you in April and we are looking at extended earnings call in April where we will be able to give you a first sort of flush of how long we reckon this turnaround period will take and what we expect to deliver in the coming quarters, in the coming years. So, please do give us a little bit more time to come back to you with the timelines.

Second question is around different companies have highlighted different pockets of green shoots they are seeing in the part. So it'll be great if you could flush ou t the detailing in terms of where you are seeing some green shoots from a demand perspective, which other segments that you think will be the ones that will bounce back fast?

So look, like I mentioned, we are still seeing near term volatility in our revenues for this quarter and for the next quarter. I feel that the market environment though is slightly more positive than it was six months ago, but it's too early to call it green shoots or to point to any sustained recovery in any part of the b usiness. We still see significant volatility and so it's too early I think to call for a definitive signs of green shoots or definitive signs of a recovery. In sectors like telecom, like I said, I feel that the worst is behind us, but that is very differen t from saying that we are seeing green shoots, or we are seeing growth.

Rohit, how to think about margins -- have we bottomed out in our margin profile and from here on we should see sustained improvement even after taking into account the investment plans that we have, if you could just give us some puts and takes on that, that'll be helpful?

I think the way to think about it is a normalized number, right now, 7% EBIT, and from here on, I think Q4, as I mentioned, we will go through our annual impairment exercise, which we do for all portfolio companies, leaving that, from an operational perspective, we should start looking to see that this as a bottom, and when we make our plan in April, I think as Mohit said, we will share more details of how we see this trajectory to go more around the next year and more importantly the long-term, and the long term will be very, very critical for us because the investments we make now will start giving us return for a longer duration. So, we'll share both next year as well as the long -term plan with you as we come back to you in April, but from a bottoming perspective, yes, operationally, this is the bottom except some of the portfolio company reviews that we'll do from an impairment perspective.

The next question is from the line of Kawaljeet Saluja from Kotak Securiti es. Please go ahead.

Mohit, I have three questions for you. The first question, Mohit, is that margin is a function of two things -- one is the price and second is the execution. Now, let's basically assume that you can execute as well as you visualize here in your new structure and the improvements that you have made. The balancing factor remains about price. Now, when you look at Tech Mahindra's pricing, how does that compare versus the industry? And is pricing of contracts going to be a handicap for you in your profitability journey?

I think this is a very valid question. The way we're also thinking about margin expansion is across multiple parameters. So, the way we think about it is there are five levers that we need to pu ll from a margin expansion perspective. The first, as you rightly said, is operational parameters. And these operational parameters have been defined previously, they're pyramid, they're the onsite -offshore mix, subcons, utilizations, things like overhead. Beyond this, we need to move into what are the factors that we use to drive productivity, and which is around lean, it's around automation, it's around the use of GenAI, it's also about being able to drive reuse across the range. Beyond this, we need to l ook at how we change the nature of contracts itself, can we be moving into more outcome -based engagements, can we be moving into more team and squad-based structure, so really changing the way we price for teams rather than pricing for individuals. We're o bviously looking at margin -dilutive contracts as you know, historically, in TechM. We are looking to build out a discipline around pricing and around contracting, that should give us the benefit. And then there is a point that you mentioned, which is around the price realization itself. Here, I believe that we have to have a focus on high margin services. It's in engineering, it's in enterprise apps, it's in cloud, our services around data and AI, which as we change our mix, we feel that it will help us imp rove our margins. There's also the additional things that we're doing around in our geographies. As you look at it now, the delta with the best-in-class peers is very significant from a margin perspective. So, I do feel that we have room to move across these five parameters that I mentioned, but obviously reaching best -in-class margins is something that will take time. I do feel that we can narrow the gap in the shorter-term.

Mohit, do you want to break down that gap between the difference in pricing versus peers versus the execution or that's something -

I would say that the gap is largely in execution and not so much in pricing or the mix.

The second question I had is about the portfolio of a contract and bu siness that you have. Now, there was a fair bit of rationalization and clean up exercise undertaken in the last six to nine months. Are you happy with the current portfolio or is there further surgery required?

I think it's too early to tell. There is some tweaking that will be required in parts of the portfolio and there will be some strategic decisions that we will need to make. And again, this is something that we'll be sharing in April. But there is nothing dramatic or earth shaking that we're looking to do, it will be more in the nature of streamlining.

The third question, Mohit, is on the telecom portfolio. Now, Telecom portfolio is good in a technology shift cycle but not so good in a sustained kind of a cycle. What's y our perspective on which kind of a cycle are we in telecom? And second is that generally it's assumed that telecom is not a great portfolio to have, it's a handicapped portfolio which will keep on underperforming, given the fact that spends do not go up. S o, do you agree with that assessment? And if yes, then, is there something in the telecom portfolio of existing clients that can be done to stimulate growth?

I just want to mention that telecom practice is very central to TechM and obviously we have invested over the past few decades very strongly in the practice, and I feel that we have world-beating credentials in the sector, but the reality is that the sector itself is stressed, and client spends have been very tight. Now, it is possible tha t the poor environment will result in a significant amount of consolidation and cost take out deals in the future and we will play in it. We are also looking to build out our platforms from a Comviva perspective that help our clients increase their ARPU, a nd to increase the longevity of their contracts, help them from AI and from a next -best action perspective. So, these are all the things that we're looking to do. But the reality is that telecom for our peer group and for us has been a low spend sector ove r the past 12 months and this sector that professional services firms, tech services firms have struggled in. So, our experience from a spend perspective is within the range of what our peer group has seen.

The next question is from the line of Vibhor Singhal from Nuvama Equities. Please go ahead.

Mohit, just to follow up on the previous question, I think telecom sector, I think you gave a very good comprehensive view of this. I would just like to maybe just extend it and basically take your views on specifically the Manufacturing and BFSI capabilities for us. You mentioned these are both a billion-dollar portfolio for us. Manufacturing specifically, I think has been quite stagnant, if I look at the last five years, we haven't gone anywhere in terms of overall size of revenue, whereas BFSI of course I'm sure you would know so much about the industry. So, where do you think are the capabilities of TechM maybe lacking that we've specifically in these domains, organically, the growth has not been that great, and any specific pockets that you were able to identify or white spaces which you would probably want to fill in to be able to drive the growth to the levels over the next two years?

So look, Manufacturing, I feel that historically again given the heritage of our parent, we have a very, very strong practice. If I look at it from an industrial Manufacturing perspective, it goes all the way from the product perspective, things like product design where we have a significant digital capability, but also physical capability given Pininfarina we have done a lot of work from a production perspective, so whether it's factory of the future or the green factory or the work that is going on from a supply chain resiliency perspectiv e. We do a lot of work from a performance perspective, which is the after -sale warranty, spare parts management, there's a lot of BPS work that we do in the sector. And finally, we also work on the experience side. As more and more manufacturers go to dire ct-to-consumer business models and as they look to build on their e -commerce capability, there's a range of capability that we have in TechM across product, production, performance and experience, and we're looking to build on this. What we're also doing i s that we're working very closely with our colleagues on the M&M side and the broader group side because the group does have a range of global relationships, whether it's supplier relationships or co -development or partner relationships, everybody from chi p manufacturers to car brake manufacturers we're looking to see how we can leverage these group relationships to build our capabilities. The Mahindra group is recognized as an innovator from a Manufacturing perspective, whether it's in energy consumption a nd sustainability or the factory of the future that we have built together in Chakan. So that is all things that we'll be looking to use and credentials we will be looking to use to build out our Manufacturing practice. It is a real area of focus for us. A nd I feel an area where we have a natural right-to-win. As far as the BFSI business is concerned, like I said, we have a billion-dollar business, we have a range of capabilities through some of the acquisitions. So, we have I believe the only digital engin eering capability in financial services, thanks to our CTC acquisition, we have a very high end buy side and custodian consulting capability through Cit isoft, we have a transaction processing capability through Target, and obviously we have our own organic capabilities. So, I feel that we are able to stitch together a compelling narrative using these capabilities. We have put together a very good team and we are working together and myself leading a global vertical interlock to start building solutions to s tart reaching out to clients. I'm very confident that we have a compelling story to take to banks and insurers across the world. But again, it will take time. Our peers have built out their business over decades, we are just starting out, but I'm confident that this is a story we can build on.

Just one small question for Rohit. You mentioned that the adjusted margins for this quarter was at around 7% for the 150 basis points exceptional item. Now, I don't want the numerical details per se, b ut if I compare it to the year -on-year margin, last year same quarter we did 12% margins. So, assuming that the 7% margin is the core margin of the company, any specific heads that you would probably want to highlight, whereas that 500 basis points gone this year because the 7% is excluding the exceptional items, maybe the growth is lower because of that, I think the numbers got impacted, but given that utilization is also at around 88%, where do you believe large chunk of this margin has gone out so that i t's easier for us to build in as to when the recovery margins happen, where are the pockets that we could be probably looking at?

I think broadly if you look at it the wage inflation that we saw the annual hikes that we did at the beginning of the year with the market that we saw through the year didn't come up with equal and price increases. That's a big value drop. So, that contributed significant portion of it. And additionally, I would say with the service revenue, that has dropped through the year from where we started, we were at 1,668 last time to where we are now, that service revenue drop has contributed to kind of a deleverage in that context and caused the pressure from a cost perspective, not off at the same pace. That both has caused the decline and then outside of that, as Mohit mentioned, I think we're looking at getting that back into the right equation, and once we get that back into the right equation, working on all the operating levers that we've kind of devised for ourselves.

And as utilization at 87.6%, do you think they peaked out?

We still have the opportunities to get value there, but as we chart out a plan in April, we'll share more credentials around it.

The next question is from t he line of Sudhier Kundapalli from Kotak Mahindra Asset Management Company. Please go ahead.

The track one and track two you mentioned, which is sales growth and margin improvement, do you think at least over the next one year or so we'll have to trade off one for the other? If yes, what will be your trade off or do you think we can have a Goldilocks kind of a scenario where both growth and margins can improve in tandem assuming a stable macro?

So, look, I think it is very hard to tell. I mean, obviously we are hoping for a Goldilocks where we can use and it's obviously much easier to deliver a credible margin improvement story if we also have growth. But at the end of the day, I think as our top team, we are very clear that if we have to make a trade off, we will deliver the margins because we don't want to do substandard growth or get into poor contracts or do marginal deals just for the sake of showing growth. So, we hope we can deliver growth and margins in the long term, but in the near to medium term if we have to do a trade- off, we would focus on not doing suboptimal deals.

Just a quick clarification from Rohit. So, why is Comviva seasonality being called a one- off? Our understanding is that this is s ort of pass-through revenue which is seasonal. Is that understanding incorrect, or this is a pure one off relating to revenue from some discontinued business plan?

So, one-off is not Comviva. I said one-offs in certain product deliveries that happened in other side of the business which was additionally supplemented by an increased quarter-over-quarter on the Comviva seasonality along with retail offset by the furloughs.

Just one more clarification. Of the 500-bps odd margin contraction that we had seen over the last 12 months, is there any element of the earn out component payments to, let's say, some of the companies which we acquired over the course of calendar '20?

Sorry, can you just repeat that question?

So, I was saying the margin fall that we had seen in over the last nine to 12 months of that 500, 600 basis points, is it partially also contributed by any earnout components we would have bagged. So, some of the portfolio companies which were acquired over calendar '21 and calendar '22.

No, As I explained, the main drivers are what I mentioned, wage, not accompanying for the pricing increase, and then the service revenue dropped, while there are certain macro positions that have impacted certain portfolio companies more than the others. But the earnout or any other accounting information there is not in practice.

The next question is from the line of Rishi Jhunjhunwala from IIFL institutional Equities. Please go ahead.

I have three questions. See, firstly, if we look at our utilization is pretty much at like 10-year high barring one or two quarters in Fiscal ‘22, and on the flip side, if we look at our subcon expenses, it is a decade low as a percentage of revenues, and still, our overall headcount is declining sequentially and even on a year-on-year basis by 7%. So, just wanted to understand our strategy around managing employee pyramid -- is it clearly a reflection of how we expect revenues to play out over the next two, three quarters where growth could still continue to be challenging or are we stretching it significantly and then if demand comes back not having adequate capacity?

The headcount decline that you've seen quarter -on-quarter is largely because of BPS and that's largely a seasonal issue because of the holiday season and the changes that happen. Overall, we are moving from more of a subcon focus to more of an employee focus, which is why you're seeing a decline in the employee numbers. If you remember last quarter, we were actually asked a question saying, why are you the only company in the industry that is adding headcount when everybody else is dropping headcount, because we added freshers in the last quarter? So, I don't think there is any overall better narrative that you can read into these quarterly fluctuations. We are looking to add freshers, we are looking to build a pyramid, we are hopeful that we will see the market will turnaround, but we recognize the current reality. So, I think apart from the fact that we are shifting from subcons to employees, there really isn't anything broader that you should read into this.

The second question is just in terms of TCV. So, on a trailing 12 months, we are down about 40%. If we look at the industry on an aggregate basis, there hasn't been a lot of sharp decline on a year-on-year or a trailing 12 months basis as well. How much of this decline do you attribute to the changes that we are trying to make, and as a result, in how much time do you think we will potentially go back to how industry is able to grow the TCV?

Look, I think part of it is the lumpiness. So, if you recollect, we had a very good quarter, the previous quarter where we did over 600 million in large deals TCV. So, part of it is just the lumpiness within a quarter, but part of it also reflects, again, our sectoral split on our industry exposure, and part of it also reflects the fact t hat we are being more deliberate, I would say, cautious or careful, we're being more deliberate around the contracting that we do. But again, I don't see any broad competitiveness issues in the market or any sort of structural challenges in our client enga gements. So, this is just the natural ebb and flow and the natural lumpiness of large deals.

If we look at the last eight quarters or so, our interest expense is almost quadrupled, whereas our debt and lease liabilities have remained largely flat. So, what is the reason for such a high increase in interest expense?

The interest expense, I mean the rates being caught when we started these were almost zero, 1%. So, over a period of time there's been increase in the interest rate, right now is more like 6%, 6.5%. Interest rate expenses has caused the majority of that increase, but the absolute loan amount has not changed.

No, I'm just wondering, I mean, we are anyways net cash company in a big way. So, do we really need to carry that kind of a debt at that interest anymore?

Ladies and gentlemen, we will take that as a last que stion. I would now like to hand the conference over to the management for closing comments. Over to you, sir.

Thank you everybody for joining. Again, want to just recap, I think, as you look through the year, we've done a lot of actions in terms of looking at our portfolio, certain choices that help us stand in long-term and what the company strategy is going to be. We will come back to you in April with an extended earnings call where we share our strategic plan in a little bit more detail. We're working through the detailing around it within the organization with the leadership team and take you through how we'll position the company from a long-term perspective and walk through all the contours of that plan. So, that's where we're working on and we'll share more as we get together in April. So, I thank everybody again for joining and your continued support to the company.

On behalf of Tech Mahindra Limited, that concludes this conference. Thank you all for joining us. You may now disconnect your lines.