Tata Elxsi : Financial Reporting Document

"Tata Elxsi Limited

Q2 FY '24 Earnings Conference Call"

October 17, 2023

MANAGEMENT: MR. MANOJ RAGHAVAN - MANAGING DIRECTOR AND CHIEF EXECUTIVE OFFICER - TATA ELXSI LIMITED MR. NITIN PAI - CHIEF MARKETING AND CHIEF STRATEGY OFFICER - TATA ELXSI LIMITED

MR. GAURAV BAJAJ - CHIEF FINANCIAL OFFICER - TATA ELXSI LIMITED

MS. CAUVERI SRIRAM - COMPANY SECRETARY - TATA ELXSI LIMITED

MODERATOR: MR. SHASHANK GANESH - ERNST & YOUNG

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Moderator:Ladies and gentlemen, good day, and welcome to the Tata Elxsi Limited Q2 FY '24 Earnings Conference Call. As a reminder, all participant lines will be in the listen-only mode and there will be an opportunity for you to ask questions after the presentation concludes. Should you need assistance during this conference, please signal an operator by pressing star then zero on your touchtone phone. Please note that this conference is being recorded. I now hand the conference over to Mr. Shashank Ganesh from EY. Thank you, and over to you, sir.

Shashank Ganesh: Thank you very much, Tom. 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 that the discussion may contain forward-looking statements that may involve known or unknown risks, uncertainties, and other factors. Therefore, it must be viewed in conjunction with the business risk that could cause further results performance or achievements that differ significantly from what is expressed or implied by such 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. Gaurav Bajaj, Chief Financial Officer; and Ms. Cauveri Sriram, Company Secretary. We will start the call with a brief overview of the past quarter by Mr. Raghavan followed by a Q&A session. We would appreciate your cooperation in restricting yourselves to two questions to allow participants an opportunity to interact. If you have any further questions, you may join the queue, and we'll be happy to respond to them if time permits.

Having said that, I will hand the call over to Mr. Manoj Raghavan. Over to you, Manoj.

Manoj Raghavan: Thank you, Shashank. Good evening, everyone, and thank you for joining us for the second quarter earnings call. Today, I'm happy to report that our revenue from operations in the second quarter stood at INR 881.7 crores, which corresponds to growth of 3.5% quarter-on- quarter and 10.1% year-on-year in constant currency terms. Our EBITDA margin for the quarter was just shy of 30% at 29.9%.

Our Transportation business unit grew at 6.9% quarter-on-quarter in constant currency terms. During the last quarter, we won a landmark, multiyear large deal in the SDV space, which places us as a strategic development partner for one of the global automotive OEMs.

In the Media and Communication business, we continue to see challenges in both the key geographies of U.S. and Europe. And in such a challenging environment, our performance has been quite satisfactory. Our revenue from the business has declined marginally by 0.4% quarter-on-quarter in constant currency terms. We continue to engage with our key customers in helping them drive efficiencies in current operations and also help them create new revenue streams for their businesses.

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Our Healthcare and Life Sciences business performed well, registering a 3.2% quarter-on- quarter growth on a constant currency basis. During the quarter, we won a multiyear innovation and reengineering project of a critical care device platform for emerging markets.

I'm happy to share that in the last quarter, our industrial design unit crossed revenue of INR100 crores for the first time. The Industrial Design & Visualization business grew 4% Q-o-Q in constant currency terms.

From an HR perspective, talking about our net additions, we continue to invest in building a talent pipeline with a net add of 585 Elxsians in the quarter. So, we continue to invest in onboarding key resources. Also, our employee engagement and talent retention strategies have contributed to attrition further going down to 13.7%.

So, as we move into the third quarter, we carry the confidence of a healthy pipeline and some great conversations going on with our key customers. And I'll now hand over the floor to Shashank for the Q&A session. Over to you, Shashank.

Moderator:Thank you very much, sir. We have the first question from the line of Vimal Jamnadas Gohil from Alchemy Capital Management Private Limited.

Vimal Gohil:Thank you for the opportunity. Congratulations on a very strong comeback, especially in the automotive vertical. I'm also pleasantly surprised by the growth rates reported in health care. On the comms side, particularly, there have been some initial signs of revival in the semiconductor space globally. Semiconductor sales have picked up. Does that have any sort of positive impact on our comms vertical as a whole? Do we have some exposure there if you can just give us some sense? And I have one more follow-up after that.

Manoj Raghavan: We have a very small exposure to the semiconductor side of the comms vertical. A lot of our communications business is driven through either operators or telecommunication providers or the folks who make devices that go into the telecom market. So, these are the main focus areas for us. Yes, usually, there is a lag between semiconductor sales and general market pickup. So, I'm really hoping that what you say is true and maybe in a couple of quarters from now, we will really see the impact of that.

As of now, I think we don't see a great uptick, but we are having all those conversations with some of our key customers, a lot of deals that we are pursuing - we can't predict the closure. So that is why we're not able to give you a very firm update that, look, next quarter, things will really look up.

Vimal Gohil:Yes. So, sir, I just wanted some sense on the strong deals that we've had in auto. What would be the size over there? Any sense that we can get? And lastly, a question for Gaurav, could you give us the margin walk for the quarter? What was the impact of wage hike or what were the other tailwinds that we had during the quarter?

Manoj Raghavan: Sure. This was a pretty significant win for us. It's a new customer that we have been pursuing for, I think, 18 to 24 months. It's been a long pursuit, and we're very happy to inform that we

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have been able to close the deal in our favor. And it's a multiyear deal and a multimillion- dollar deal, a large deal in our perspective, which will definitely add to our automotive revenues in the subsequent quarters.

And more importantly, it's in a software-defined vehicle area, which is where we have also been investing significantly. So, it's a validation of all the activities that we are doing in that area. And this will also be a landmark deal for us to really take it to other customers in the auto OEM space.

Gaurav Bajaj:Vimal, this is Gaurav. I'm happy to share that our operating profit for the quarter increased by 4.8% on an EBITDA level and on a profit before tax level of 6.3% and on a year-to-year basis, it is 16.3% and 20.4%. I think we're able to drive overall optimization in terms of the cost and efficiency through various lever during the quarter. And this is in spite of the wage increase - Last quarter, we did only till the lower and the middle level. This quarter, we completed our wage hike cycle for the year, where we covered all the senior management and the executives of the company.

So, salary increase for the remaining management people for the quarter has a cost impact of 160 bps. If you also recall, last quarter, there was a partial cost towards the RSU, which was launched by the company last quarter. This quarter, we have a full quarter impact of about 50 bps compared to the last quarter. So, salary increase plus the ESOP has an impact of 210 basis points. The net adds that we have done in this quarter, including the tailwinds of the net add done in the last quarter, was largely offset by the utilization increase in the scale of the volume revenue growth plus the pyramid optimization.

So there, it can kind of optimize and offset against each other. So, 210 basis points from the salary increases plus the ESOP impact was largely offset by the other improvisations in the lever that we disposed of in this quarter, which includes the other expenses. So, we continue to optimize, rationalize our other expenses, be it travel cost, visa costs, sales promotions.

And we also significantly reduced our third-party contractors, because we now have good strength in our bench, which we have put to the billable projects. At one point at the last year, it was a bit of worry, because the attrition was high. Now attrition is also well under control. So that give us a lever in terms of rotating people third-party contractors with our own people.

So, including a reduction in the third-party and other discretionary expense optimization, we have a saving of around 120 bps. And also, there is a large cost increase in the last quarter towards various hardware tools, because there were certain deals, which we kicked off in the last quarter -at the end of the last quarter- where we need to significantly invest as part of the lab setups, other cost towards the tool, hardware and software.

Those get more or less normalized in this quarter, which gave us another 120 bps. So, this 240 bps of improvisation against 210 cost inflation kind of give you 30 basis points of improvement over the last quarter. And then - that is at the EBITDA level.

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And then if you come to the EBIT level, there is an increase in the depreciation, because we added to our facility capacity that we are having since we are adding people, we are growing. So, we added a couple of facilities as required by the company to accommodate increase in the headcount since all the people have also started to come back to office. So, at EBIT level that almost knocks off all the pluses and minuses and we continue to operate at the same 27.1% of EBIT, what we operated in the last quarter.

So, with the revenue growth, that gave you almost 3.7% kind of quarter-on-quarter growth. This quarter, on other income, we have a significant gain due to exchange gain, which came positive. Our hedging strategy worked well in terms of protecting us not only from the downside, but also provided some kind of exchange gain. Also interest yield on our investment also helped us in terms of increasing our other income.

So overall, with the other income better from the last quarter at the profit before tax level, we're able to increase our profitability by 6.3% on a quarter-to-quarter basis and on a year-to- year basis by 20.4%. So, in spite of all the cost intake, including the wage hikes, including the RSU impact, we have other levers at our disposal, which help us to maintain our profitability and improve in terms of the absolute terms.

Moderator:Thank you. The next question is from the line of Ruchi Burde Mukhija from Elara Capital. Please go ahead.

Ruchi Mukhija:I have a couple of questions. Our industrial design revenue has crossed INR100 crores milestone, but how does this change your market position and does this open new scale opportunity for you?

Manoj Raghavan: Your line was not clear. So, the question was about industrial design, crossing INR100 crores. And if this is going to help us grow our revenues and what is the question?

Ruchi Mukhija:Yes, I'll repeat the question. Hope my voice is a bit better. So, with this INR100 crores milestone, how does our market positioning change? And does this help us being eligible for new scale opportunities?

Manoj Raghavan: Sure. Okay. So, I would say just about 3 or 4 years ago, the Industrial Design business was a very small business. Our run rate would have been INR30 crores, INR40 crores per quarter. And so today, I think we have invested significantly in the Industrial Design business. And happy to say that, look, that business has really scaled up. So hopefully, on a yearly basis, if you take it, we will soon reach about INR500 crores of revenues annually. So that's the first target that we have.

More importantly, design is such a critical differentiator for us from a margin lever perspective, from a positioning perspective and any large deal that we usually bid for, there is a significant component of design, and that capability definitely helps us position the company very differently as compared to competition.

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	Tata Elxsi Limited
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	So, I'm very happy that stand-alone that business is scaling. More important, the combination
	of design and EPD business is what will help us scale rapidly moving forward. And that is the
	focus of the company.
Ruchi Mukhija:	Understood. In media vertical, you have mentioned that you are working in collaboration with
	clients to develop new offerings and partnerships. Could you please elaborate on this? What
	we mean by new offerings and partnership?
Nitin Pai:	Yes. Ruchi, this is Nitin here. Maybe I'll take that question. Some of the partnerships are
	explicit. So, you'll find that we announced two significant partnerships just leading into IBC,
	which is the global broadcasting trade show. We announced a partnership with INVIDI, which
	is the world leader in targeted advertising. What they do is essentially provide technology for
	targeting very specific subscribers, especially in the video, OTT as well as digital video
	ecosystem to deliver ads.
	So, the idea here is really that we are seeing the shift in OTT from subscriber-driven to
	advertising driven. And we believe that this will be the new revenue opportunity and the
	monetization opportunity for both broadcasters, who are running D2C businesses as well as
	operators, who are running an aggregation service for video.
	So, what we're looking at essentially is saying, look, there are two tracks that you can work
	with operators and broadcasters for. One is efficiency driven, which is to look at what are you
	spending money on now, how much of that is engineering driven, how do we help you through
	a combination of talent, capability products and offshoring, help you get to be even more
	efficient.
	I think the second strategy that we're deploying is growth and customer experience. The
	customer experience part will be driven by design and the growth part or revenue part for
	customers will be driven by how you monetize the services better - can you look at ad
	deliveries, can you look at things like FAST, which is the free ad-supported television?
	So essentially, those are the partnerships that we're crafting especially in the Media and
	Communications vertical. Of course, what we have not declared to the market is the
	partnerships that we're crafting, especially with semiconductor vendors as well as hyperscalers
	that fuels some of the digital engineering that we're doing for SDV, for connected medical
	devices and so on.
Ruchi Mukhija:	Understood. So, will there be a growth mover, let's say in 12 months or shorter time or you see
	this scaling up very gradually and will take its own time?
Nitin Pai:	Yes. So Ruchi, the partnerships are not meant to deliver immediate deals. I think they are a
	fundamental positioning tool. Because what you're trying to do is trying to make sure that
	you're relevant in the context that is changing for our customers. So, what's happening in the
	telecom industry is fundamentally you're being challenged for revenue, you're being
	challenged for growth.

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	And therefore, you either had to focus on efficiency or on new revenue streams. And I think
	we are doing both in different measures. On the revenue streams, we are partnering. On the
	efficiency, I think we are the best in the business.
Ruchi Mukhija:	Understood. Now coming to the large deal in the auto segment. As my understanding, in your
	view, incremental work was the way to go and scale the customer. But this deal sounds like an
	exception to this trend. So, do you see these kinds of deals being more in the market compared
	to past trend? Or this was a one-off unique situation where you could break through with a
	large deal in a new client?
Manoj Raghavan:	I think there's no one answer there. We do a mix of both types of deals. There are such large
	deals that sometimes when we go for a new customer, there is a pursuit that goes on and we
	close such deals. We also have deals wherein there are consolidation opportunities where it's
	more about how you can bring value proportions to customers based on the capabilities that
	you have, right, especially from an offshoring perspective.
	And how can you take a larger pie of the current outsourcing from the customer. So, you have
	both type of deals that are available. And the good part is, yes, there is a portfolio of such deals
	that we are going after. And then as I said, this deal took a long time. So, some of these large
	deals are not closing like earlier where it used to get closed in 6 months or 8 months.
	Sometimes it takes 12 months to 18 months also for closure. But yes, but we have to be patient
	and to be focused on our objectives and especially when it is critical for us and an important
	customer to have, I think we have a very good track record in such deals.
Nitin Pai:	So Ruchi, maybe I'll just add to what Manoj said. I just want to call out an important
	difference. You can think of in the IT context, renewal deals, where the contract given out to
	one vendor and when the contract period is getting over, you call out for a whole set of new
	vendors and look at who can do better.
	But typically, who can do better is in terms of cost. The kind of entries that we are talking of
	are strategic entries where we are not replacing somebody else. We're getting all new because
	the customer is moving to an all new.
	So, in that sense, there is a critical difference between the kind of entries we talk of vis-a-vis a
	classical IT situation of a renewal deal where you may come in cold and win simply because
	you're delivering the best cost on the table. And I just wanted to leave that with you.
Ruchi Mukhija:	Got it. That's helpful. The last one, we just heard your...
Moderator:	May we request you to please rejoin the queue for follow-up questions. We have the next
	question from the line of CA Garvit Goyal from Nvest Analytics Advisory LLP.
Garvit Goyal:	Congratulations on a good set of numbers. I have two questions. One on the media side, you
	mentioned we are closely engaged with key customers. So, can you give some color like for

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	how many quarters this slowdown is likely to continue, based on whatever communication we
	do have with those customers?
Manoj Raghavan:	It's very difficult to tell you how many quarters and so on. But I would say, there are fairly
	positive signs in some of our customer discussions. There are deals in the pipeline. And we
	hope that we'll be able to show some kind of growth over the next half year, I would say. But
	again, it's very, very early times. And so, I would be a little conservative on the Media and
	Communication side in H2, but we are closely working with some of our key customers.
	There are opportunities that we are going after. And definitely as compared to, say, the
	beginning of Q2, I would say, beginning of Q3, we are in definitely a better shape as far as
	deal pipeline and the opportunities that we are chasing. So that gives me a little bit of
	confidence that look, yes, things could be better for us in the H2 from a Media and
	Communication perspective.
Garvit Goyal:	Understood. And sir, secondly, on the overall business perspective, so considering this lower
	growth in other two segments. So, is it fair to assume this financial year is likely to end with
	lower double-digit kind of growth in top line? Or do we expect something good as compared
	to first half to improve our annual growth?
Manoj Raghavan:	So, every attempt will be made to continue the growth and improve on what we've shown in
	H1, right? So, though we don't give projections and so on, the focus for us as a management
	team is to see how we can better our H1 performance.
Moderator:	Thank you. The next question is from the line of Sanjaya Satapathy from Ampersand Capital.
	Please go ahead.
Sanjaya Satapathy:	Can I just ask the cost relating to ESOP? Is it already provided for, or is there something more
	to come?
Gaurav Bajaj:	It has already provided for. I mean, the way the accounting happens for the ESOP, basically
	the cost expected out of the grant option gets amortized over the vesting period. Last quarter
	since grant was only rolled out in the month of June, it was a partial quarter impact. Since this
	quarter, we have had a full quarter impact, but that is already part of the financials for the
	quarter.
Sanjaya Satapathy:	Okay. So, this kind of a quarterly expense will continue for next quarters as well?
Gaurav Bajaj:	Yes.
Sanjaya Satapathy:	Okay. And sir, the other question that I wanted to ask you is now that you have come out of
	this SEZ and you're full tax paying now, is there any kind of such investment opportunity
	available to you to kind of plan for tax going forward?
Gaurav Bajaj:	No. We continue to explore and evaluate what are the possibilities and opportunities available.
	But please remember that government is not approving any new exemption for the IT purpose
	for the SEZ. So, we have to wait and watch if there are any new schemes and the policy of the
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government comes out. But otherwise, we expect our ETR to continue at the rate what we have delivered in the last two quarters for the rest of the year.

Sanjaya Satapathy: Yes. And sir, last question is considering the new kind of deals that you are signing, and you are also starting to have centres outside of India, will your mix of offshore to on-site change meaningfully from here or it will stay around this level?

Manoj Raghavan: No, I think for Tata Elxsi, we are known for our offshore execution and our entire processes and systems are built around delivering value from best cost countries, and our business model is also not about manpower, augmentation, on-site and so on. Over a period of time, we have really been able to move more work offshore and do a lot more development activities from our centers in best-cost countries. So, I think that will continue. I don't see it moving back in a hurry to the pre-COVID times. There could be minor variations here and there, but our main business model is around our offshore execution. So that will continue.

Sanjaya Satapathy: And your deal pipeline macro areas are looking pretty good because you are one of the few companies that has added employees again in this quarter.

Manoj Raghavan: Yes. So that continues, that shows the confidence that we can't take any shortcuts in our business, right? Because our business is all about people - even if in certain areas, you don't have full confirmed visibility, you need to go ahead and invest based on your business plan and what you have. So, we are sticking to our business plans. We're sticking to what we have laid out at the beginning of the financial year. There will be all these quarterly pluses and minuses from a revenue perspective, but from a resourcing perspective, we continue to go ahead with our original plan, because we're confident that, look, we are on the right path and the investments that we're making in our people will definitely yield us results in multiple ways once the economy picks up and so on.

So that's been our focus. And we are one of the few companies who are already going out and we are talking to colleges and we are rolling out offers for the next year. So, we continue to be focused on all of those activities.

Moderator:We will proceed with the next question, which is from the line of Ajaya Jain from Astute Investments. Please go ahead.

Ajaya Jain:TCS has recently signed a $1 billion deal with Tata Motor JLR. How is it affecting us? Or is it coming into our area of operations?

Manoj Raghavan: No. To the best of my knowledge, it's not in our area of operation. It's primarily on the IT and the manufacturing support side. So, I think it's a great deal, but it doesn't affect us.

Moderator:Thank you. The next question is from the line of Ruchi Burde Mukhija from Elara Capital. Please go ahead.

Ruchi Mukhija:So, we've heard from one of your larger peers about likely possibility of volatility in the coming quarters given the geopolitical situation developing in Israel. Do you see any effect in

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your early experience of this through a client going slow on conversation, decision-making? Is this something that worries you in the near term?

Manoj Raghavan: We don't have an exposure to Israel or any country there. Of course, we have a small exposure to Dubai and Middle East. Having said that, it is pretty early. So far, we have not heard anything negative from our customers based on this. But if this spreads right, if the situation becomes volatile and if this war spreads, and there is a spike in fuel rates and all of that, associated foreign currency fluctuations, all of that could impact our business in some way.

From an end customer's point of view, it's too early. We've not heard anything so far. But I mean, if this spreads, I'm sure that there will be an impact, and it's hard to quantify that at this point in time.

Moderator:Thank you. The next question is from the line of CA Garvit Goyal from Nvest Analytics Advisory LLP. Please go ahead.

Garvit Goyal:I just want your opinion on healthcare segment, like it shows some sign of recovery in this

quarter. So how do you see the segment for upcoming quarters?

Manoj Raghavan: Again, I think some good deal wins and some positive news, especially after a couple of quarters of relatively flat performance, I think we have been able to grow our healthcare business. That is definitely positive. So, all the initiatives around our digital space and connected health and so on, that's really helped us win new customers. Having said that, yes, there are a number of deals that currently we are talking to customers and so on.

And as I said, the medical space divisions, it takes time, especially those large engagements and projects. The decision-making process is pretty long. And that continues. There is definitely a number of deals that are under discussion, but it's very difficult for me to comment at this point in time whether that will all close in the coming quarters. We are pretty hopeful, but I would still be cautious, I would say, next two quarters, and we will see the trajectory. We will see how those deals move forward. And then accordingly, we will act.

Moderator:Thank you. The next question is from the line of Bhavik Mehta from JP Morgan. Please go ahead.

Bhavik Mehta:Manoj, can you talk about how the decision making by clients has evolved, last time, when we spoke in July versus now? Has there been an improvement or as a status quo, or have you seen some more deterioration given the macro across few verticals?

And secondly, any impact of this strike in the US by UAW, the auto union, on your clients and your projects? Because this has come up only a couple of weeks back, so any impact we could see for your clients in the auto vertical in the US? Thank you.

Manoj Raghavan: Yes. Thanks, Bhavik. So, I think if you look at it segment wise and so on definitely in the automotive business, we see continued traction. We definitely continue to see closures. We

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