Cyient Ltd

NSE:CYIENT

Earnings Call Transcript 2023-Q2

[Operator]

Ladies and gentlemen, good day, and welcome to the Q2 FY23 Earnings Conference Call of Cyient Limited. [Operator Instructions] Please note that this conference is being recorded.

I now hand the conference over to Mr. Krishna Bodanapu, MD and CEO. Thank you, and over to you, sir.

[Bodanapu Krishna, executive]

Thank you very much, and good evening, ladies and gentlemen. Welcome to Cyient Limited Earnings Call for the Second Quarter Financial Year 2023. I'm Krishna Bodanapu, Managing Director and Chief Executive Officer. Present with me on this call are Mr. Ajay Aggarwal, Executive Director and Chief Financial Officer; and Mr. Karthik Natarajan, Executive Director and Chief Operating Officer.

Before I begin, I would like to mention that some of the statements made in today's discussions may be forward-looking in nature and may involve risks and uncertainties. A detailed statement in this regard is available in our investor update which has been mailed to you and is also posted on our corporate website. This call will be accompanied with an earnings call presentation. The [indiscernible] also already been shared with you.

Before I start the highlights for the quarter, may I take a minute to brief you on the exceptional items. A lot has gone on this quarter, very good things that must have gone on this quarter. And therefore, before we start looking at the context of the [indiscernible], we start looking at the numbers. I just wanted to give you a bit of context of how this all stacked up and how we should be looking at these numbers [indiscernible] numbers I just want to give the [ advantage ].

On M&A, on acquisitions, all 4 acquisitions concluded in -- have been concluded in Q2 and the integration is progressing quite well. I'm quite pleased with how the integration is progressing. All M&A are accretive at an EBITDA level. We will show you the detailed numbers in a bit. And on an annualized basis, we are expecting that this will add about $150 million to our revenue again, given that the [ peak ] that happened and the consolidation start at various points of time. As we talk about the future and the guidance, we will also give you a little bit more insight into how it will all happen.

As you know, the Board [indiscernible] made this announcement a few weeks ago that the Board of [indiscernible] met and has decreed that the global [indiscernible] manufacturing business that we have, which is [ signed DLM ] must be restructured in a different manner. We believe that there's a number of excellent things that are happening in that business right now. The acceleration of technologies like IoT and AI and ML [ is trying ] $1 trillion market for electronics in the very near future. So that's a huge opportunity for us.

Then there is a whole [ China Plus One ] strategy at the companies. [ Companies are ] looking at actively engaging with non-Chinese EMS players. And this has significantly increased the attractiveness of India as the market and India's share is expected to increase from 1% to 8% [ as in $50 billion ] per year in the next 5 years. And of course, the push of the government of India for making India Atmanirbhar Bharat is putting a lot of opportunities in place for electronics that are made in India.

With a focus on high -- complex, low-volume electronic, we believe we have an excellent niche. But -- also, I want to say that there are significant synergies between the [ signed ] core services business and the DLM business. A common set of clients, a lot of engineering content, the type of [ panic action ] that we do and the whole [indiscernible] strategy. And therefore, we still want to maintain [indiscernible] because there is a fair degree of commonality.

Having said that, I'm looking at the enormous potential to maximize shareholder value. The Board has approved the formation of a sub-committee to look at all the options. We understand that with the current shareholding of Cyient, that is the services part of Cyient, DLM might not be the best fit based on how some of the economics of that business work, some of the revenue flows of that business work and margins of the business work.

So therefore, we believe it is best to have a structure where it is an independent business with, of course, the [indiscernible] reasons that I've talked about. And therefore, the key options that are being considered are [ an IPO ], or partnership with the strategic investor or a potential spin-off. We are looking at all these options but the choice will be made by the sub-committee based on the management's recommendation, of course keeping the best interest of our shareholders in mind.

We're very excited about the [ spin-off ] potential, both in terms of value for Cyient but also for DLM because that business has a significant opportunity to accelerate it with [indiscernible] the business update, he'll also talk about the order intake and the order book which means that for us to execute that potential, we will be -- we will need capital, we will need flexibility, and we don't want to [indiscernible] because of the DLM market.

Most of it, not all of the wage hikes planned for the year are done. We will not have any material headwinds for the rest of the year [indiscernible] wage hikes.

During the previous quarter, we had a class action lawsuit was filed in a U.S. District Court against one of Cyient's subsidiaries. We are fighting this [ vigorously ]. I want to reiterate that we're very confident in what we've done. We've gotten [indiscernible] that we have a very, very strong case and therefore we're going after it with all vigor and with all our resources. We also accelerated the discovery process [indiscernible] of all the data and filing of all the [ exploration ]. Therefore, this quarter we had an exceptional item in terms of the cost that we incurred on this lawsuit. It will continue for a few quarters, but not at this level because this quarter, we accelerated some of the discovery phase which has led to a little bit of higher cost than what we would have normally anticipated.

Therefore, now coming to the highlights, I take you to the highlights of this quarter. In Q2 FY '23, we posted a revenue of USD 174.8 million, which is a year-on-year growth of 20.4% in constant currency, which would be 16.4% in U.S. dollars; and Q-on-Q growth of 10% in constant currency or 8.2% in U.S. dollars. In rupee terms, we posted a quarterly revenue of INR 1,000 -- INR 1,396 crores that signify the growth of 25.6% year-on-year or 11.7% quarter-on-quarter. .

The services revenue stood at USD 151.1 million, which is a year-on-year of 25.8% in constant currency, 21.3% in USD; and in Q-on-Q growth of 12.3% in constant currency or 10.2% in USD. Service revenue growth without acquisitions is 11.5% year-on-year in constant currency or 3% quarter-on-quarter in constant currency. The DLM revenue stood at $23.7 million, which was a de-growth of 7.3% year-on-year or a de-growth of 3.3% quarter-on-quarter.

Normalized group EBITDA -- and I want to quickly highlight while we're also talking about EBITDA because of the acquisitions and the nature of how our amortization works with the acquisition, our EBIT will be skewed for a little bit, will be skewed for about a quarter or so because amortization is coming in but the full impact of the acquisitions are not coming in.

And therefore, we also want to give you a sense of the EBITDA to give you a sense of where the margins of the acquired entity and Cyient lie. And we thought EBITDA was a good reflection of that. Of course, we will talk about EBIT also in a minute, but the normalized group EBITDA margin, excluding the impact of one-off, M&A, [indiscernible] exceptional items, stood at 16.4%, up 84 bps quarter-on-quarter and down 226 bps year-on-year.

Normalized group EBIT margin stood -- excluding the impact of M&A and exceptional items at 11.9%, up 42 bps quarter-on-quarter, down by about 210 bps year-on-year. Normalized PAT was at INR 110 crores, which is the de-growth of 5% quarter-to-quarter, or 9% year-over-year.

Ajay will take you through these numbers in a lot more detail, but I want to say that as a core business -- as the core services side business, we are on track. We've delivered the numbers that we have been talking about, which Ajay will talk -- will take you through in a little bit more detail. I just would request you to bear with us on these numbers and the presentation this time because of all the M&A that has happened and unfortunately, the consolidation of each one of the target kept happening during various points of the quarter, and therefore, we just have to make sure that we [ delivered ] another quarter before the actual -- a normalized and steady-state numbers come through. But in the spirit of transparency, of course, we will take you through those numbers during the course of -- the rest of this call.

The Board also approved an interim dividend of INR 10 per share which is in line with our philosophy and in our principles of giving back a certain amount of profit to the shareholders every year and doing it [ in parts ] as an interim dividend in Q2 and of course, our final dividend.

I also want to give you 2 highlights for this quarter. Cyient partnered with Honeywell, with the Manufacture Anthem, which is the first cloud-connected cockpit system. It's a very large deal. We also [ made ] a press release on this a few months ago. And we're delighted that we'll be able to build this product, which is the future of aviation and it's a multiyear deal for Cyient. A lot of it will [ through ] Cyient DLM because there's a big manufacturing component, but there's also a lot of [indiscernible] that's associated with it.

In a nutshell, it's a platform that will be virtually modified for any type of aircraft: passenger, cargo, business jets, et cetera. And it is a platform that helps pilots much more effectively fly planes, [indiscernible] a very high-end technology, and we are very proud that we will be able to do this for many years to come.

We're also thrilled to be recognized by ISG as a Rising Star in IoT, integrating our digital technology capabilities under [indiscernible]. This is really accelerating our [ clients' ] digital transformation. And again, Karthik will talk about some of the key initiatives and some of the key outcomes that have come because of the focus that we have put in the last 2 years with [indiscernible].

With this, I would like to hand this call over to Ajay, who will take you through the detailed financial performance for the quarter. Ajay, over to you.

[Ajay Aggarwal, executive]

Thank you so much, Krishna.

Just to continue from where Krishna left, we see very [indiscernible] capability through these acquisitions, and we have talked about them as and when these acquisitions have happened. Really gives us really good growth engines for future. Second, I think, in terms of the capital allocation, which is a significant improvement, which will show our ability to the earnings growth at much higher rate.

So I wanted to give you confidence to the -- all the investors and the analysts and they have been confident about these [indiscernible] being very accretive on the EPS side, very accretive on the EBITDA side. And then for the EBIT side, because of monetization [indiscernible] the synergy revenue start kicking in and we will also see that accretive at that level.

So with that, let me give you a flavor of a number, Krishna [indiscernible] talked about one of the highest growth quarter-on-quarter, 25.8% as we have seen the currency fluctuation, the right numbers' impact [indiscernible] 25.8% this year-on-year and 12.3% this quarter-on-quarter. And we've also disclosed the numbers for services and DLM.

DLM has a marginal de-growth of 3.3%. I would say that it is a [indiscernible] issue. We are improving on the supply side, and you will see that we have 1 of the best ever pipeline and backlog for DLM and you would see that growth continuing [indiscernible] and with these 2, I think, group growth is at 20.4%. And if you see, in terms of the services core, I can exclude the acquisitions and DLM. We have [indiscernible] about 3%. There also, I think we have been committed to make sure that we have provisioning around [ cash for the policy ] of accounting. If you can get that, including that it will be more like 3.5%. Some of the [indiscernible] is a good momentum on the core business, then it is same [indiscernible].

And as far as this year is concerned, as you know, we have added in this quarter, 1 month of [indiscernible] and 2 months of [indiscernible]. And we add all of them of our [indiscernible], we will have 14% to 15% revenue growth and we talk about the output will also [indiscernible] be going forward so that's around it both. If you see the chart below, I would only like to call out when you look at the growth of some of this is impacted by the margin, but -- at the exchange rates, but if you look at NAM at 20%, EMEA adjusted for currency is 34%, Asia Pacific is about 11 percentage just for the currency [indiscernible] period, so I think [indiscernible] growth across the [indiscernible]. Some of the EMEA growth, of course, is also fueled by the addition of the acquisitions which are based in Europe.

In terms of the hedge book, again, as we spoke in the last call, we continue to be on the same policy. It's working well for us. This is our total hedge book, it's about $150 million, a 12-month forward and a little bit of about 20% of net inflows for the next 12 months thereafter, and that builds up to $150 million or $156 million in constant currency. [indiscernible] quarter-on-quarter dip but don't read too much into it, that's just because of the currency fluctuations.

And except INR to dollar, in all the currencies, we have a nice gain in our forward cover. What it means we see how when you look at [indiscernible] a positive other income because of our [indiscernible] position. And also for the next 4 quarters, what we are looking at is about $3.5 million of gain at the current rates, which are also mentioned on this [ chart ]. So as we have been saying that [indiscernible], a huge catastrophic event. We feel that our EPS is nicely protected for the next 12 months forward from the currency perspective.

In terms of income statement, I think I would like to say that -- if I could just go to our next slide first, and I'll come back to this. Krishna talked about we have 2 one-offs in this quarter, 1 is we have this exceptional item where we had the [indiscernible] that was incurred in quarter 2, which is about 1.8% impact, and you've disclosed the value also here.

And another one impact that we have done with the acquisitions, we have a one-time acquisition-related expenses, that's purely for acquisitions. They are not integration related which are in the P&L, which are separately there in the margin which is there. So they're only falling out only relating to the acquisition of the target, and that's about 1.7%.

So if you take these 2, one we are calling an exceptional item, and another one is one-off which is not likely to repeat. Then we have restated our numbers to show for each of the line items that what is our reported unit, what's our normalized unit. [ Same ] for the percentages. And we also reported the PAT and the normalized PAT.

So with this background, if you go back to the earlier slide and [ explain to you ]. So I think the line number that I would like you to see is that for the core, we have improved our margin at about 112 basis points. [indiscernible] we did have a headwind of [ 1.5% ] because of the wage hike that happened in this particular quarter. And as Krishna mentioned in the beginning, most of the wage hike is over now by which 19% plus wage hike is over. And we have been able to offset that by improvement in offshoring. There has been pricing increase. There has been focus on improved offshoring. And we also [ got ] some other benefits out of automation and other initiatives. So it's very nice that within the bottom, we have been able to offset whatever the [indiscernible]. We did get some other benefits in terms of volume absorption, [indiscernible] on currency, but they have been [ plus and minus ]

Overall, I think from the operational efficiency, we have been able to take care of the wage hike. We'll continue to work very hard to make sure that we are working on each of these levers to give a quarter-on-quarter improvement in terms of our margin. DLM also has done some margin in [indiscernible], we have given 8.3% margin in DLM which is up by about 410 bps. And you will see that we have a good traction in DLM in the coming quarters as well.

Finally, I would say the normalized PAT is what you should look at [ if you exclude ] 1 exceptional item for the [indiscernible] and 1 one-off expenses for M&A in terms of acquiring these entities, then our normalized PAT is stated here. [indiscernible] the number [ INR 1,103 million ], what Krishna already talked about. And which is at about 7.9%. So I would say this is how we have tried our best to explain to you and we make sure this also gives you a very clear understanding of where the margin has increased and where the margin has not [indiscernible] a tailwind and headwind has been on the margin.

Only 1 more thing I would like to highlight what Krishna mentioned, if you look at EBITDA level, I think we have [indiscernible] very well. I think most of the [indiscernible] are at company's level of EBITDA. However, when you look the -- there are 2 aspects, 1 is [indiscernible] amortization for the stand-alone entities before they were acquired, which hits the EBIT and second is the DNA that shrinks because of the [indiscernible] balance sheet. So they have been provided for, but I just want to call out that those case is built on the synergy that [indiscernible]. So I would request for some time as look at the EBITDA. We will disclose [indiscernible] 70 bps is the dilution in terms of the acquisition, but this is mainly on account of that dilution in terms of the amortization of the [indiscernible] that we have created on the balance sheet. And also, this has some impact of the integration cost that we will incur. We had planned about 3% of integration costs in this period. So this is the summary also how to [ read ] the profit and the margin. Thank you for your patience, and we would be happy to take any questions.

Lastly, on the cash generation, I would say that our free cash flow what we have generated, given the quarter and [indiscernible] there is an improvement. And we have -- we are moving to getting back to 50% [ plus ] free cash flow generation. This quarter, it is 35%. If you take the one-off, it is much higher than that. And we are working on all elements of free cash flow, including the days receivables. We see there is a potential to further bring it down and get back to the levels of free cash flow that we have generated in the past.

With this, I'll hand over to talk over to Karthik to talk about the business performance.

[Karthikeyan Natarajan, executive]

Thank you, Ajay. Good day, everyone. Hope all of you are enjoying your festive season.

And following on what Krishna and Ajay talked about and time to deep dive a little more on business performance. And I would say all in all, it's a great execution, [indiscernible]. And if you just look at ARC which is aerospace, rail and communications, and we've seen a growth of 0.9% in constant currency quarter-on-quarter. I think this growth is led by aerospace and followed by communications and rail transportation continue to see a challenge [indiscernible] talked about earlier. The good news is communications has definitely grown by 25% year-on-year in constant currency and aerospace has been close to the double-digit growth of the year as well as for quarter 2.

And from the Mining, Energy & Utilities, I think this is [indiscernible] talked about in the last quarter, and we have seen a growth of 3.9% in constant currency. And year-on-year, there is a slight dip, but it is likely to be a positive growth for the full year, and I'll talk about it in the next few slides.

The New Growth Areas, which is essentially the medical devices, semiconductor, automotive and HiTech [indiscernible] definitely ramping up very well with 9% constant currency growth and 33% year-on-year growth. And all in all, leading to 3% growth in constant currency [indiscernible] and at 11.5% year-on-year.

Also to provide a color if you look at we have had the highest [ billed hour ] in Q2 in terms of volume and, which has grown 6.8% quarter-on-quarter. Most of this growth happened in offshore. And that's the reason why you're seeing the revenues growth at [ 3% ] and which is also shown in terms of our profit margin improvement. And we also improved our offshore mix and the utilization [indiscernible] by 370 bps and [ that helped to counter ] the headwinds of about 150 basis points of [indiscernible] that Ajay talked about. So the EBIT for services improved by 112 bps and that really has been achieved through a lot of [indiscernible] improvement that we've been able to bring in the quarter and services overall including acquisitions and we've grown at 12.3% quarter-on-quarter and 25.8% year-on-year in constant currency. And the group level, 10% quarter-on-quarter and 20.4% [indiscernible] year-on-year level.

If you look at the order intake, I think that's definitely one of the highest order intake that we have for the group for the last 4 years, and this is about [ $247 million ]. And the services have grown by 5.6% in dollar terms from [ current ] constant currency that has grown by 13%. And DLM, Krishna talked about, which has grown by 253%. I think we have definitely keep building a nice order book as far as DLM is concerned. And we continue to see the traction in this business, and we talked about some of the new structuring part. We'll have more details on that in subsequent [indiscernible].

And also to conclude on the large deals, we have closed about 5 large deals $105 million. I think this is again continues to build the momentum as we talked about in the past many quarters.

To give you a little more outlook on the business performance and I think the market dynamics are definitely more [ fluid ] and more uncertain. And Ukraine/Russia conflict or high energy prices or higher inflation and -- but I can really get into some of the specific verticals.

And if you look at aerospace, I think the demand is steadily increasing and the supply chain challenges continue to be [indiscernible] for many of our customers but the opportunities are seen both on commercial as well as defense area and some of the interesting areas in urban air, mobility and space are creating new opportunities for us, and also hybrid or electric -- electrification of aircraft. I think that's the new opportunity that we are seeing.

Apart from significant opportunities we have seen through the aftermarket and on for revenue, I think this will help us to grow roughly about 10% for the full year, while we have seen [indiscernible] for Q2. [indiscernible] we continue to see challenges and due to the consolidation that has happened in the industry and also some of the issues related to the infrastructure side that is happening globally due to the challenging [indiscernible] I think we are hoping that some part of this will be covered by Q4 and we are still keeping a close [indiscernible], some of the areas we want to modernize our offerings on signaling and [ devops ] and automated fare collection and sustainable transportation and mass mobility area. So we are cautious about how the rail business would recover over the next few quarters.

[indiscernible] communication, I think this has been [indiscernible] nicely for us for the last 4 to 8 quarters and the network rollout momentum [ from ] fiber and 5G, I think the demand continues to be high. And also we have seen serious opportunities around high energy consumption of 5G radio. I think this is going to create a huge challenge in Europe, especially. And we have some of the solutions, which have been built through the Celfinet acquisition that we made. We are looking at how do we monetize some of these offerings by working with some of the customers to look for ideas to reduce them in the consumption.

And also 3G plus 4G and 5G [indiscernible] and this would also create new opportunities for setting up some of the old technologies as well as rolling out for the Cloud-RAN or Open-RAN. I think these are new opportunities that are very [indiscernible] continue to grow this particular segment.

Mining safety concerns and tough mine operations are paving way for sustainable mining and at the same time, all the energy transition and clean energy, carbon neutrality. All this will need new [ materials ] like copper or lithium or sulphur and how we think some of them can be supported for our customers. And also most of the offerings are around autonomous operations, digitalization, safe operations, intelligent asset management are continuing to see momentum in our business. I think this business has grown nicely for Q2 at close to 70%, and we are confident that we will continue to see this in [indiscernible] for the rest of the year.

Energy & Utilities. I think that a significant profit that is made by the utility companies due to the high energy prices in Europe. And this will also make them to investor on carbon-neutral technologies, that's something that we are really excited about with Citec acquisition that we made on energy. How we think we start to get new technologies like hydrogen battery storage and carbon capture technology investment areas as well as integration of all the new energy sources into smart and micro grids are likely to accelerate, and we feel that this will give us new opportunities for us to pursue.

Go to growth areas, and this is the segment which is technical doing very well for us and led by Automotive & Mobility and the investment in software virtualization as well as the service-oriented architects and software defiend vehicles are new growth areas for us. Healthcare and Life Sciences, which is likely to -- which has already shown growth of about 80% to 90%, and we are seeing this momentum continue and influenced by the regulatory changes that are happening globally. And we see continuous opportunities in terms of predictive, proactive personalized health systems. I think that's a bigger opportunity that we are trying to [indiscernible].

HiTech, which was the net wire geospatial business, and we are trying to reposition this business to drive more system integration capabilities and applications and cloud analytics opportunities. For the last mile tech companies, which really drive their business around the location-based solutions as well as pace and sustainability initiatives, and we hope this business should start getting into the growth path by end of this year and should start showing the growth for the next year.

Semiconductor and I think the demand from automotive and IoT and connectivity, Krishna talked about continue to be high. And this business has grown about 40% to 50% so far. And we continue to see this business building the momentum that started in the beginning of the year but [ slow ] the rest of the year as well. Also some of the splicing diversification investments that are happening through the US chips act, Europe Japan is likely to create significant new opportunity for us across plant designs and boarding up designs to the fabs that are being set up and as well as new designs that going to come up. And we are bullish on how this is going to continue to pan out for the next many quarters.

And last, the DLM business, we continue to build on our order book, and we talked about multiyear large deals. And the supply chain challenges continue to be there, but we are hopeful that H2 will be far better than what we have seen in H1. We talked about some of the positioning that we are taking in the market, especially around the innovative technology solution that we are investing on. I just want to share a few examples in terms of how are we really changing our orientation and engagement with our customers. So just to put to you the tailings DAM management solution is supposed to include the safety of mining environment. And there was a recent failure at the DAM, which has resulted in about 6 to 8 lives being lost and there were more than 30 to 40 people who are still in critical stage. And how we think some of them can be better predicted and our solution is likely to help the mining customers. And this is the combination of our ability to understand the ESC requirements as well as the standard data that can be integrated with digital platforms. I think this is going to be a sign of things that we are going to build upon across many of the segments.

And also the network testing, which is cloud-based data driven device performance, functional RAN and Core of network functions. I think this is another opportunity that we have begin up as an offering for us that can be taken to many of the communication customers that we have today.

Autonomous Industrial Systems, I think this is another interesting area where perception-based technologies can be integrated with [ off-way ] customers and how do you think we built autonomous tracks that are autonomous construction vehicles, and we are helping the customers to bring this technology and also create artificially [indiscernible] model for assisting the control of some of these equipments in the more complex working environment like mining and other things.

Last but not the least, the digital platforms and asset data management. I think this is one of the wins that we had in the earlier quarter. And where we are bidding and integrated their base cloud solutions with automated smart accelerators that would really help in driving the digital transformation across mining, energy and CPG clients. All in all, I would say, a decent execution quarter, and we are really working on getting that execution better in H2 of this financial year and we'll probably leave some time for Q&A. And back to you, Chris.

[Bodanapu Krishna, executive]

Thank you very much, Karthik. And if I can summarize with the quick outlook. We want to be a little bit more granular at this time on the outlook, considering what I said earlier that the number of things that are going on and the various points of time that these acquisitions are coming in into science and therefore, into the consolidation. So what you have on the top is the FY '23 outlook, we continue to stand with our outlook that we will grow in the 13% to 15% range in constant currency for the group in organic terms. DLM, we're actually quite happy, I would say, that we can of the forecast a little bit further because we have some good order intake that is coming. But more importantly, we've been able to secure the material supply. So high single digits up to 10% is what we are now expecting in DLM. So we want to reiterate the 13% to 15% growth in constant currency. Through the course of this year, we will add 14% to 15% in revenue because of acquisitions, again, in constant currency.

In terms of the margin, again, we'll [indiscernible] to what we said. We expect the full year normalized EBIT margins for the organic business to be in the 13% to 14% range. Obviously, with the work that we have to do, we understand what it is, but we still have a larger site or we have a clear confidence on at least the lower end of that guidance and really what we want to do is get towards the mid effect. We still hope to get. Our normalized EBITDA, and again, we want to talk about EBITDA for a few quarters also, just to give you a sense of where things are with all the acquisitions. Therefore, I'd say normalized EBITDA for the full year will be 16% to 17% for the group. And as Ajay had mentioned, the acquisitions are exited.

So after doing all this math, we want to say that we believe that or we are confident that the Q4 normalized EPS will be INR 14 to INR 15 for FY '23. I'll come to the next slide in a second. And of course, the tax rate is expected to be 27% and on line and free cash flow conversion will be in line for the full year after we take into account what has happened in [ Q4 ]. We also want to give you a quick overview into what we see for the next year because I think a lot of these things will start to settle in and therefore, we've already started planning for the next year because there is going to be a lot of work for us.

In FY '24, we have visibility to $1 billion run rate, which is obviously quite exciting and therefore, we're working very judicially to get to that run rate in the -- hopefully in the middle of the year rather than the later this year, but we keep you updated. And for EPS, taking everything into account and the -- how the acquisitions will play out. We are confident that EPS will at least be INR 60. I want to repeat and say with confidence that the EPS will at least be INR 60 for the next financial year that's FY '24.

With that once again,thank you very much for the patience in hearing what has happened during the quarter, but more importantly, the outlook, which is quite exciting for us into the next couple of quarters to around us this year and next year, and we will now open it up for any questions that we can answer. Thank you.

[Operator]

[Operator Instructions] The first question is from the line of Krishna [indiscernible] from Anand Rathi.

[Unknown Analyst]

First was on the aerospace side. So you guys have shown confidence on the double-digit growth kind of a number. But if you could give some more details on what is happening on the aerospace sort of side -- from [indiscernible] manufacturing perspective. And second, while our growth rate seems to be improving, our order intake is still slow for the second quarter. So how should we -- and again, this is related to services because DLM, I think we have done well on the order side. But how should we relate to numbers from an outlook perspective?

[Bodanapu Krishna, executive]

Thank you for the question and I'll ask Karthik to address that.

[Karthikeyan Natarajan, executive]

Thanks, Krishna. I think your observation for Q2 is a seasonal thing. And typically, Q3 is a strong quarter for order intake. So that's when I gave both dollar as well as the constant currency number of 13% because we're still tracking it on the dollar orders today. And to answer your first question on aerospace, I think we are seeing a lot of opportunities around aftermarket. As you would have seen in the last 2 years with passenger minds, slowly tagging along. It also means many of the aircraft, which has not been taken for service or repair overall. I think they are all coming to what we call the let have more shop visits. I think that is really growing by 20%.

So our aftermarket business is definitely very strong and some of the customers who are associated with the agent programs that we are doing it for the last 8 years. I think really shaping alone well in terms of their demand, which is flowing to us. So that's 1 change that we have seen.

Second, about the embedded and digital solutions that are required for the aerospace and defense, I think that continue to be robust because they want to improve the productivity, they want to really drive a lot more disinitiatives than what we've done in the past. We are working with prorogated customers to help them to build a road map on Industry 4.0. How do they roll out when they want to grow from x to 4x in terms of production capacity over the next 3 years and we are involved and having them to build the road map. I think that's another example in terms of when we are seeing that kind of growth. And another one is about integrating the cabin management with sensors and which will probably include the comfort level of the passengers and how we think we can probably have a lot more services that can be delivered through the interest that can be integrated to their cabins. So some of these opportunities are new. We have not seen them before. I think that's what is driving the growth for us. Apart from defense, which is likely to get stronger, as you can imagine in terms of what is happening globally. And this is one segment where there's going to be a lot more investment that's going flowing and just to make sure that the country wants to protect their borders, and they want to make sure that their passengers are safe, and this is going to drive significant growth in Europe as well as in North America on the different side of the business.

[Unknown Analyst]

Sir, how big would that be for aerospace vertical?

[Karthikeyan Natarajan, executive]

Sorry, I couldn't get your question. .

[Unknown Analyst]

The defense part of it, how big could that be for aerospace vertical?

[Karthikeyan Natarajan, executive]

It is probably about less than, I would say, 15%, 20% of our aerospace business comes from defense and which is likely to see growth as part of what is happening globally.

[Unknown Analyst]

Understood. And Ajay, sir, we expensive item, this is like a onetime payout on the legal side? Or is there something which can come in 3Q in 4Q as well?

[Ajay Aggarwal, executive]

I think it could continue in Q3 and Q4 as well. But as Krishna said given the pace of activity that happened in this quarter. We see that this should be complete but will continue in Q3 and Q4 as well. We'll continue to report the upgrade and the [indiscernible].

[Unknown Analyst]

And Q4, the quantum is likely to be similar? Or will it like fade away gradually in Q4?

[Ajay Aggarwal, executive]

As I said, that's what we expect that there is a peak of the activity in terms of preparation, but difficult to say right now, our expenses should go down for quarter 3 and quarter 4.

[Unknown Analyst]

Okay. And on the banker fees, this is purely onetime done inducted in Q2?

[Bodanapu Krishna, executive]

Yes, 100% it is onetime done inducted in Q2.

So if will just add on -- not on the case, would be actually out accelerated some of the discovery process because, obviously, we are also keen to get it done and over with. That's why we believe that Q2 is the peak and it actually nominal, its quite a bit [ in between peaks ] and obviously report it, but we're also quite confident that we will be able to manage it.

[Unknown Analyst]

And just -- in continuation, is there a liability amount which is attached to this case, like how big could...

[Bodanapu Krishna, executive]

No, I think it is difficult -- it is a difficult case so it is very difficult to say. But again, I want to be very clear to say that, look, it's something that we are very, very confident. So we're not taking any provisions or anything that is we are confident that what is happening here on the right and there are some very good people at [indiscernible]

[Operator]

The next question is from the line of Nitin Sharma from [ MacPro Research ]. .

As there is no response from the line, we'll move to the next question, which is from the line of shraddha from Asian Market Securities.

[Unknown Analyst]

Congratulation on the big quarter. A couple of questions. Firstly, what is the normalized margin expectation that we are building in for FY '20 [indiscernible].

[Bodanapu Krishna, executive]

So right now, we believe that we will see a little bit of margin improvement, but it's not a significant improvement. We still are working on that. We're looking at at least the base case scenario before, we obviously gonna to refine that number and provide you a better insight as things go by. Right now, we're just assuming a slight increase in maybe a 50 bps increase in EBIT for next year. But obviously, there's a lot more work to be done. So that can only get better, which we will update you as we have better insights. But we wanted to get a sense because there's a lot going on and we didn't want to ease things -- easing at sort of a little. So that's why we wanted to provide you at least the base case and then we'll refine the base case. But the margin on this base case because there's some very, very good growth that will come in both organically and also good because of the tax addition is giving us the full impact of integration. So that's how we built up so I'll only asset.

[Unknown Analyst]

Sir, the reason I'm asking this because [indiscernible] and take for very high margin businesses. And you've indicated that in the first year of integration, margins could be lower and probably spend more towards company level margins. But both the first year integration, I believe those margins should send back to the original margin level. So from that perspective, I think 25% margins can be quite better than what the 50%normalized EBITDA margin we're talking about for FY '2?

[Bodanapu Krishna, executive]

Well, yes, you are right. So that's why I said we want to work a little bit more before committing [ definitely ]. But also in Cyient, I'll say that you are absolutely right, the margins are much higher. But also the impact is relatively small because Celfinet is about 20 -- sort of 700-some million to $750 million. Celfinet is about $25 million. So it should be the impact of that is going to be quite muted investments. And that's why we're just improving in term of what the translation we use at least to give you a direction of where next year is heading.

[Unknown Analyst]

Right. And sir, one clarification. When you say acquisition, do you also include the strategic buyout deal that we have called out last quarter?

[Bodanapu Krishna, executive]

Yes, actually. That's also very small. I think that would be best than or it would be 1% or so [indiscernible]

[Unknown Analyst]

Right. And how has the ramp-up which is happening there because this would expected to be 1 of the top pipelines gradually...

[Bodanapu Krishna, executive]

The ramp-up is going quite well. Actually, that's been one of our growth accounts. Actually, we've talked about in that would be anticipation. So the ramp-up is actually going quite well. And we -- the trials on the account for which we will be a strategic buyout will actually end up being one of our top 10 customers, most likely maybe this year, but definitely next.

[Unknown Analyst]

Okay. And sir, just last one question. The rail transportation business, you do see consistent decline. So I was assuming that the offshoring shift that we were assuming in the large account of that business, that might have stabilize by now. But do you see this offshoring thing which is impacting the overall revenue? Or is it some budget cut impact also that is playing in this vertical?

[Karthikeyan Natarajan, executive]

Yes. Thanks Shraddha for the question. I think as I said, there are 2, 3 factors. One is the consideration of the major companies, which is lesser R&D spend as compared to what we would have done individually. And probably they are trying to rationalize where they want to keep some platforms where they want to let go of some of the old platforms or legacy platforms, they would have had in [indiscernible]. And second, there is also a significant -- the infrastructure trend that we talked about and which is likely to be -- they have a huge order book. And they're trying to prioritize the orders, they want to indicate where they can get some cash flow. I think that has been one of the challenges for them from their end customers, and that is impacting that. And the third part, what you talked about was offshoring, which is definitely true. And probably the first 2 is likely to improve as we start exiting end of this year. And also as I talked about, the other element was the highest ever buildouts that I talked about in terms of volume. And I think the volume growth is something that we are really happy about, and we hope the same momentum continues as we start getting in the next year.

[Unknown Analyst]

In terms of your optimism on growth for FY '22 amongst the verticals that we operate in. Do you think aerospace would be driving growth for us in organic business in '24 because communication growth seems to have tapered off this quarter. So maybe on a high base, '24 growth number for communication might not be update. So will it be aerospace or will it be some other verticals doing that have lifting for us in '24?

[Bodanapu Krishna, executive]

May I suggest, for '24 numbers, we will wait for another quarter before getting into the details. So we're starting to critically work just because of -- obviously, we've put in a lot of resource behind the acquisitions and therefore, in our side is we did a lot of preliminary work. And that's where it give us the confident but to get into the details and considering the past year calls, I believe today is also a very busy day for everybody. So I'll maybe request that we hold off '24 questions for the next quarter call.

[Operator]

[Operator Instructions]The next question is from the line of Sameer Dasani from ICICI Prudential Management.

[Sameer Dasani, analyst]

Few question. One is on telecom vertical, right, we have seen on a Q-on-Q basis until last quarter, very good growth momentum. So this quarter, it has been -- is it a one-off because commentary today is that growth momentum is continue. So how do you see this growth? First is that? And second, DLM, obviously, H2 is always better because of the seasonality, do you expect similar things going forward?

[Bodanapu Krishna, executive]

Yes. So Sameer, I think what we have seen for Q2 was one of execution issue that we got into, and that is [indiscernible] stop we hope that we continue to build the momentum for H2 on the communications business. And the demand would also be slightly patchy in some customer segments. So that's what I've seen us not grow as fast as what we have done in the first quarter of this year given for the past 3 quarters as well. So on your second question on DLM, I think we are definitely seeing a better update and visibility compared to what we started out this year. And we are confident with the current order book as well as be [ subject chain ] visibility. I think both are equally critical to see how we improve on our execution for H2.

[Sameer Dasani, analyst]

Okay. So we will see a recovery in that -- we will see that seasonality, right? Improvement in DLM?

[Bodanapu Krishna, executive]

Yes.

[Sameer Dasani, analyst]

And lastly, this question is more of the guidance that -- not guidance but a number that you mentioned $1 billion revenue on visibility. So sir, look at current numbers and if I try to do the math, if you look at -- even if I assume that you will reach $1 billion by Q4 FY '24, it gives me around 4% to 4.5% to future GR. So how confident are we of that number? And does this include -- and I'm assuming that this includes some macro issues, some buffer on that also. So if you can just explain that?

[Bodanapu Krishna, executive]

No, absolutely. I think also, I'll just quickly say that we'll also get one more, if I'll call it a bump because Citec will be fully integrated in Q3. So that itself will give us another fairly significant bump because Citec numbers like Ajay said, is only for 1 month, and that has been our biggest acquisition. So -- but having said that, we're quite confident with where we stand, even taking into account the macro situation because we've looked at industry by industry on what we do and where we stand and how does the macro impacted. You just look at can I just give one example lets say the semiconductor industry where we're doing a lot of work for the transition of chip manufacturing from China to the U.S. and Europe. Europe will also announce, I think, a $50 billion investment into semiconductor plants, which will translate to a lot of engineering work for us. So we're also doing at these things because these industries are also a bit more -- they're not -- the reason why a plant is going from China to Europe or the U.S., there is a very strong strategic reason. So it's not necessarily just a sort of a nice-to-have project. This is a strategic project. And therefore, we're quite confident that even if the worst case macro situations turn out that's a different story. In Russia and proximate upon somewhere, obviously, all bets are off. But outside of that, we're quite confident that even in an environment where we will have some challenges on the recession, et cetera. Many of the industries that we're in, we will do quite okay because, again, they're based on -- a lot of the work is based on operations of things like power plants, which have to continue no matter what, are based on things like the transition of the semiconductor industry or like Karthik explained of the aerospace industry, which is still much, much better on its peak, and therefore, there's a lot of work on operations and MRO. Therefore, we're quite confident in the certain medium cases of the macro of curse it is the worst case scenario [indiscernible]

[Sameer Dasani, analyst]

Yes. So I've included my 2 months of Citec of $175 million, plus $15 million 2 months impact. And if I look at $190 million to $250 million, it's again 4% to 4.5% CAGR. So I get your answer. And also just last question on the broader backlog, right? All companies, if I look at broader IT services plus the R&D and the oil companies are speaking about growth slowdown in Q3 and Q4? And how do you see that impacting your business? And in that scenario, how does your guidance or outlook changes?

[Bodanapu Krishna, executive]

Karthik, do you want to explain what is the reason?

[Karthikeyan Natarajan, executive]

Yeah. So Sameer, I think we are still as of now we did not see significant cancellations barring on our 2 projects which got differ towards the right. So we are still keeping ourselves closely aligned with customers, and we are definitely looking at the implications of difficult winter in Europe and probably the fed rate hikes in the U.S. and how we think that's going to pan out and what is going to be the implication of it from our customers.

I think we are still seeing a cautious view from our customers. Yes, I think they are really relooking at the budgets. We'll have a better view by end of this quarter, which is by December/Jan for us to have a better view for the next year. But we are still confident that at this point of time, we are seeing momentum, and we want to continue to build on that momentum.

[Sameer Dasani, analyst]

And on the deal signing, also, you don't see any delays, or do you see that?

[Bodanapu Krishna, executive]

I think what we are seeing there is there are some delays, and there are some high increases from customers organically. So which means they are open to work with partners. And some of those issues have definitely seen, but we did not see significant program cuts or there is a major flagship in terms of their approach that they are taking for the near term.

[Operator]

The next question is from the line of [ Mihir Manohar ] from Carnelian Capital.

[Unknown Analyst]

Congratulations on good set of numbers. I just wanted to understand your though process behind DLM, and now we have decided to separate DLM from this company. So what is the thought process that has gone behind it? And how are you looking at this business strategically? And also if you quantify something in number terms, how are we looking at DLM business over the next 3 to 5 years or what kind of inquiries are you getting? And what is that being the thought process that have got in separating it from the company? Yes. So that was the only question.

[Bodanapu Krishna, executive]

So thank you for that question. The idea behind it was, as you know, that DLM financials and the way the whole business works is very different from the services business. And that has brought in a certain degree of uncertainty, and it has brought in a certain degree of how our investors are doing at Cyient. So it took a long hard look at what is the right thing for Cyient and the shareholders decide to look at the DLM business. And I've said what is the best way to structure it such that Cyient still has a control on the business or still has a good connecting to the business because for the reasons that I've said, we are winning a lot of deals, including the aerospace projects that I've talked about because DLM is a part of Cyient. Design that manufacturing is a very interesting thing. Our customers are using a [indiscernible] transition so [indiscernible].

So taking everything into account, we had a lot of discussions with the Board, and we said we wanted to structure it in such a way that it can have its own independent because with all the order book that Karthik probably talked about, but also with what macro -- what's happening there with China, plus one, India, pervasive [indiscernible] electronics more and more, we're going to grow very, very well over there. So we will require capital.

And we understand that Cyient shareholders might not be very happy with us investing significantly in the DLM business. And therefore, we thought it would be best to separate it out because it will need to raise its own capital for growth. We are working on a plan where that business can grow about 5x within the next 5 years with the margins that we already have so its a very significant growth, but also to require capital, both as you know, CapEx because we will be able to build 1 or 2 more factories that our customers are also asking us for other options like Vietnam and Mexico and so on and so forth.

And it will also need working capital because that is a working capital [ impact ] business. So before that really scales it starts to make very large dent on size DLM and we thought it was best to structure it separately and really let it grow. I mean, I think really on leads to potential because we are in that path with the order book that Karthik talked about. And we believe in the process time, shareholders will also benefit generally because there'll still be an ownership from Cyient hopefully depending on which option we come up with. And over a period of time, there will be another great source of capital for time to leverage on as we grow the services business. But from a growth perspective, about 5x in 5 years, otherwise, I'd be quite disappointed in this business.

[Unknown Analyst]

Sure. That's really helpful. If you can throw some more light like year-on-year capital efficiency part also, I mean, when you look at current numbers on the capital efficiency, for this particular segment, DLM, and doesn't look encouraging. I mean so how would the capital efficiency pan out? And given we are seeing increase in inquiries in India for this part of the business. I mean we are talking about 5x revenue, that's really good. But how should we as investors see the margins and capital excellency for this part of the business?

[Karthikeyan Natarajan, executive]

Absolutely. I think as Krishna explained, one of the constraints we have been doing is that there is one business, which is 15% to 18% potential business and services. And there is another business, which possibly is 6% to 8% margin business, and we've been trying to take it to 10%. We put a lot of constraints in terms of what margin business can be. And if it goes to 3x, 5x in 3, 5 years. I think what is important is if its not be a 3% margin business. It has to be at a very different margin profile. And that return on the assets have to be much, much higher than what they are.

So once we've changed the -- some of those rules of the game and not worry about the dilution of the services margin. We feel that current ROP which is about 12%, 13%, we can really make into 20% plus. And that is the one thing which will be a good reflection of capital.

[Operator]

Thank you. gentlemen, this will be the last question, which is from the line of Sandeep Shah from Equirus Securities.

[Sandeep Shah, analyst]

Just if I look at the performance of the services business, excluding the accusations in the first 2 quarters, the first quarter was close to 2.5%. This quarter, it grews to 3%. While the implied group guidance on services on organic basis will be higher than 13%, 15%, which will require 3% and 4% kind of growth. So just expansion to Sameer's question. In the second half, generally, it seems very weak for the engineering R&D because of [indiscernible] and the fourth quarter could be a part of Citec and IT budgets, which will have an impact because of the macro issues. So how confident are you in terms of good execution in services in the second half as well considering all these factors?

[Karthikeyan Natarajan, executive]

Sandeep, I think like what I answered earlier, I think we continue to see momentum on various sustainability initiatives that we are part of across, whether it is mining or energy and other customers that we have associated with. I think some of these programs are very long term and taken a tougher to delay them, so they will continue to be there. And we are hoping that the communication should start getting back to the growth trajectory like we spoke about.

And aerospace would still it is not at the peak that we had in 2020. So we are still hoping that, that should check along that is still a long cycle business, and we expect that to continue. So I think I understand the question of uncertainty and challenges, we are likely to see. And you probably have a better view as we closed Q3 already in Q4, and we can definitely talk about more with certainty by the time we get to the next call.

[Sandeep Shah, analyst]

And Karthik, just -- I missed your -- one of the comments on the railways of which one of the factors will be consolidated [indiscernible] has been rationalizing the engineering R&D spend that can be offshore. What was the second element on infrastructure, which you said because there is a growth outlook, we were expecting a bounce back in the second half. Now we expect the bounce back to happen early in the fourth.

[Karthikeyan Natarajan, executive]

Yes. No, I think that is led by increase in the interest rates globally, and most of them are funded by the government. And they need to pay it at 0% or 1% interest rate, that be 3% or 5%. I think that's going to really have some more prioritization that's likely to happen globally. And if they have 4 or 5 programs and which ones they want to prioritize for the near term. So that is likely to be the scenario.

And also given the energy crisis that we are likely to see in Europe. And what we are also hearing is they may probably reduce the number of trains that have run and how we think they can reduce the number of trips they make in a day. And given the challenges that I like to be seen with energy being seriously critical for the winter season. So I think those are the 2, 3 factors that I have talked about.

[Sandeep Shah, analyst]

Okay. And just the last question, Ajay. I think we've been trading at 13%, 14% EBIT guidance. But now we led the world on an adjusted basis versus [indiscernible] guidance did not due to adjusted basis EBIT margin because at that time also, we were knowing there would be M&A related cost which would flow through the EBIT [indiscernible]. So why there is a change in maybe guide for EBITDA and...

[Ajay Aggarwal, executive]

So if I can just answer that, we did not know the impact of these numbers, and that's why we are looking at the number for the sustainable and some of these are ongoing operations because these things are really one-off. And that's why we're saying if you take this off because the numbers will also have an impact on the yearly numbers. That's why we're saying, if we take this off and therefore, we can come up with them for whatever the sustainable operation is, what is the number, and that's why we're saying without taking these one-offs.

[Operator]

Ladies and gentlemen, due to time constraints, that was the last question for today. I would now like to hand the conference over to the management for closing comments.

[Bodanapu Krishna, executive]

Thank you very much, and thanks to everybody for taking the time on what I understand is a busy day with that number of calls. I want to thank everybody for your support in understanding these numbers. It's been an exceptional quarter for us, but also we are very, very excited that it sets us up for some very exciting growth for the future as we talked about. We will continue to engage with you and provide you a good visibility into what that is and how things are going to do evolve. So thank you very much for all this support.

May I again invite you to the Investor Day, which is on 18th of November in Hyderabad. It should be an all-day session. And for those of you who do attended our previous Investor Days, you will recall that it will be a good mix of internal presentations and strategy on operations and financials, but also to show you some of the things that we do and more importantly or most importantly and say also met with some of our clients to talk to them about where they see the business growing and Cyient base in the business.

So [ Mike ] would send out -- I mean, Mike has already send out an invite and I'm sure we'll send a you reminder. So please register for it. It will be a pleasure again to show you with a lot of time what we do in person.

With that, thank you very much. Thank you for the support, and I want to say to everybody that we're very excited where we stand and I think we have a very strong set of quarters coming up. Thank you.

[Operator]

Ladies and gentlemen, on behalf of Cyient Limited, that concludes this conference. Thank you for joining us, and you may now disconnect your lines.