Eclerx Services Ltd

NSE:ECLERX

Earnings Call Transcript 2018-Q3

[Operator]

Ladies and gentlemen, good day, and welcome to the eClerx Services Limited Q3 FY '18 Earnings Conference Call. [Operator Instructions] Please note that this conference is being recorded.I now hand the conference over to Mr. Rohitash Gupta. Thank you. And over to you, sir.

[Rohitash Gupta, Chief Financial Officer]

Thank you. Thank you all for joining eClerx' earning call for the third fiscal quarter of FY '18. We saw Q3 dollar revenues increasing sequentially by 1.2% in USD terms and 1.1% in constant currency terms with Q3 USD revenues coming in at $48.9 million which is our highest reported revenue in last 5 quarters.We have made substantial progress across 4 strategic initiatives that we have laid down a couple of years back. First, our onshore revenues have increased by more than 50% y-o-y in Q3. Consulting, major portion of which is onshore, has grown 2.5x over the same period. Our Fayetteville center has now started generating revenues at U.S. billing rates.Secondly, analytics business after lower growth for last few quarters has grown significantly y-o-y in Q3. Thirdly, we have made substantial progress in managed services deals with revenues from such deals increasing by 26% y-o-y in Q3. Furthermore than 1/3 of new deals sold this YTD have been managed services deals.Fourth, and lastly, IT or advanced automation services revenues has grown by more than 50% y-o-y out of which RPA revenues or robotics revenues have doubled every quarter during this YTD.We have announced a share buyback program of INR 2,580 million at a price of INR 2,000 and that program is now subject to regulatory approval. We expect that the share buyback will come to an end by March end subject to regulatory approvals.We have now also recognized incentives under software export from India Scheme of INR 65 million for 9 months of this year during the Q3 reported INR operating revenue. Please note that similar incentives amounting to INR 204 million for prior years were accounted as exceptional item during Q2. So including SEIS incentives in Q3 the INR operating revenue grew sequentially by 3%.On margin front our operating margins came down by 230 bps sequentially. The main reason for decline over last few quarters is sharp change in business mix towards onshore, consulting, managed services and robotics. So while the offshore BPO revenue has declined lately due to roll off of legacy offshore business, growth in onshore, consulting and advanced automation revenues have more than made up for the decline.We now expect that the redeployment of excess staff that has resulted due to the client roll-offs during H1 will be completed by March of this financial year. Similarly, our project for setting up third offshore site for customer operations will get completed in next few months. Although some of our YTD investments in Fayetteville staff will accrue revenue during Q4 but we anticipate that investments towards future ramp up of the center will continue to precede the corresponding revenues.All these mix changes entrants have contributed to 60 bps of the OPM decline out of 230. Secondly, we have done substantial investment in business development team this quarter to promote onshore consulting sales which was the single largest reason for OPM decline in Q3. Thirdly and lastly, legal and professional fees increase has impacted operating margin by 70 bps because of TwoFour asset purchase, recruitment fee for new senior talent and SEIS incentive related fees.We expect that majority of buyback cost in Q4 will be adjusted against retained earning and that factor hopefully will not affect the G&A line item further. So while we have achieved reversal of declining revenue trajectory during Q3, we hope that both USD revenue and OPM pool will growth sequentially from Q4 which will put us in a strong position for FY '19.Similar to trends seen in last 5 quarters, our pipeline has continued to grow on y-o-y basis and at the end of Q3 the high-probability pipeline size was 2.5x that of corresponding number at Q3 end of last year. The largest share of current pipeline is from financial markets closely followed by digital and followed by customer operations. At a service line level, campaign operations in digital and regulator services and financial markets have shown highest dollar y-o-y revenue growth in Q3.Entry deal sizes for new logos have more than tripled in Q3 on y-o-y basis due to onshore delivery and consulting-led sales focus. On pricing front our pricing for offshore FTE business has remained flat over last few quarters. However, managed service deals tend to have lower equivalent pricing in earlier years, the share of which has been increasing.During Q3 we expanded revenue footprint on y-o-y basis with 6 out of our current top 10 clients. We added 4 new logos in Fortune 500 league this quarter with 2 being in financial markets and 2 being in digital. Profit before tax declined from INR 1,179 million in Q2 to INR 784 million in Q3. So that's a decline of almost INR 40 crores. Three almost equal contributors for this decline was, number one, SEIS incentive's delta of about INR 140 million between Q2 and Q3, other income decline of almost INR 134 million due to INR appreciation during Q3, and thirdly, the reasons attributable to operating margin decline as discussed earlier. Our PAT in Q3 has declined slightly more than PBT to INR 57.5 crores as effective tax rate for YTD has moved towards previously guided FY range of 24% with Q3 effective rate coming at more than 28%. We do not expect U.S. tax rate changes to have any material impact during this year for us.Our forward hedge book remain constant at about $142 million, which is roughly around 2.9x the quarterly revenue. The average strike rate of these hedges is INR 69.3 to $1 which has further worsen by INR0.70 to $1 since Q2 due to the unfavorable movement in spot and due to continued slide in forward premiums. Based on hedges booked till now we expect that about $31 million worth inflows will convert into operating revenue as INR 70 to $1 during Q4.We had about INR 7.8 billion of cash and cash equivalent at the end of Q3. Our YTD net operating cash flow stood at INR 2.32 billion and has decreased by INR 150 million y-o-y. The EBITDA to net OCF conversion rate has increased from 65% to 70% in YTD on y-o-y basis. While we have booked lower CapEx of around INR 54 million in Q3 we expect Q4 to be higher depending upon the ramp up plan of Fayetteville facility. Our USD and North American concentration have remained largely unchanged at 83% and 65% respectively. The DSO has remained constant at 81 days in Q3. Our staff utilization based on direct production staff including trainees in Q3 further dropped to 72.9% due to decline in offshore BPO revenue creating excess staff.The utilization is likely to improve to the extent of future BPO revenue growth resulting in redeployment of excess staff. The client count in revenue buckets have remained largely the same as in Q2 but for one new entry in $0.5 million-plus bucket of a financial market client and one downward movement of digital client from $1 million to $0.5 million bucket. While the y-o-y growth of top 10 strategic clients continue to grow and show y-o-y degrowth primarily due to the loss of key clients during H1, we have been able to grow our emerging target clients consistently in double digits.For the substantial portion of this emerging growth is due to existing client mining. The company employees strength has decreased marginally by 130 employees during the quarter to be at 9,091, and we expect it to decline further in Q4 on constant offshore BPO revenue basis assumption. Our sales and business development staff count has increased by 3 to be at 85 now with addition across 3 verticals. Our attrition has marginally increased to 38% in Q3 which is likely to move to stable levels once the staff redeployment process completes. With this I would like to hand over the call back for Q&A.

[Operator]

[Operator Instructions] We have the first question from the line of Apurva Prasad from HDFC Securities.

[Apurva Prasad, Research Analyst]

My first question is on the top 5 account, what's your outlook there and, I mean, how do you see that portfolio?

[Priyadarshan D. Mundhra, Co]

Hi, this is PD. I think as we've discussed even in the last earnings call we think that the headwinds on the top 5 hopefully are largely behind us because sort of the large roll-offs that we had visibility into have now been completed. So from that perspective I think as we look -- as we go ahead on a quarter-on-quarter basis we would expect the top 5 to be stable and perhaps grow a little bit.

[Apurva Prasad, Research Analyst]

Also on the margins if you can talk about how should we see that from slightly medium-term perspective considering the investments that you're making onsite?

[Priyadarshan D. Mundhra, Co]

Yes, so Rohitash you want to take that? Okay. I would say if you look at where we've been this year it's been about 25% operating margin on an average over the 9-month period. And as we look ahead I would say there will be 2 things that will drive the margin performance, one will be business mix. So obviously it's no secret that the offshore BPO work will typically be higher margin than onshore work or some of the managed services work at least initially. And secondly I think the other big factor will be exchange rate. So the margin level that we are at today are also partly a function of the rupee having in fact appreciated against the dollar over the last 2- to 3-year period. As a management team as we've shared in prior calls our intention is to grow the absolute OPM pool as opposed to focusing on the percentage margin. And clearly where we are this quarter we think is a trough, and hopefully from here onwards in terms of absolute OPM rupees or dollars it should increase starting Q4. But in terms of a percentage range I think where we are 25% where that goes in future will be more a function of business mix.

[Operator]

[Operator Instructions] We have the next question from the line of Vishal Desai from Axis Capital.

[Vishal Desai, Assistant Vice President of IT Services]

PD, just if you could help me in terms of understanding what is the outlook between our 3 segments. And approximately, if you could give us a rough breakup in terms of what it is currently versus a year back. And second follow-up question is again on margins in terms of what the levers are going forward from here on.

[Priyadarshan D. Mundhra, Co]

In response to your first question, I think overall the mix has not changed that much because while growth rates has been a little variable it's not enough to really change the broad revenue mix across the 3 businesses. So as we've shared in the past, that mix is approximately 40-40-20 and it stays around that level maybe a percentage point up or down, but that's sort of the broad mix of the 3 businesses. In response to your other question of margin levers, I would say the biggest one that's in our hand is business mix, obviously FX is, exchange rates are another big lever but that's not something we have any influence over. The third lever is obviously utilization also. So again this quarter if you look at the utilization numbers on the metrics slide it was somewhat low, so hopefully as the utilization also improves it will reduce cost of delivering sales and therefore improve margins. So I would say those would be the 2 or 3 main levers of which exchange rate is out of our hands.

[Vishal Desai, Assistant Vice President of IT Services]

And more from a vertical perspective I was trying to get some color in terms of what kind of demand environment are you seeing amongst the 3 verticals of financial, digital and so on?

[Priyadarshan D. Mundhra, Co]

Anjan, do you want to respond to that?

[Anjan Malik, Co]

I think demand is stronger than we've seen over the last 2 years. So to the point that Rohitash is making, we feel more confident in the medium term that there's an uptick. Part of it is sort of native from our customers' budgets, part of it also comes from the changing of business mix that we're now offering to our customers which is much more a combination of technology, consulting, analytics and business services as opposed to pure BPO.

[Vishal Desai, Assistant Vice President of IT Services]

And within the digital space and financial services space if you could break out in terms of where demand is coming from?

[Anjan Malik, Co]

So PD, if you want to take that one, I mean, I guess I can talk very quickly to markets, the markets business is coming primarily from as again Rohitash alluded to it's coming from the front office as in the business side and also from regulatory and compliance. And I guess on the digital it will be the marketing organizations, right, PD?

[Priyadarshan D. Mundhra, Co]

Yes, I would say 2 areas where we continue to see good demand one is around creative asset production. And the second area I would say is all kinds of marketing analytics, including digital analytics.

[Operator]

[Operator Instructions] We have the next question from the line of Sandip Agarwal from Edelweiss.

[Sandip Agarwal, Vice President]

And PD, just to stress little bit on the demand environment question once again and also on the margin which you said. So I clearly remember you have been highlighting that your focus is on the absolute operating profit and not on the margins so much. So what I wanted to understand is that, can we reasonably assume that the bottom of the absolute profit is close by or it is almost behind. And I understand you already answered this question some time back. But just wanted to understand what gives you this confidence, is it because the margins have fallen and your onshore has gone up significantly or you have some other levers which you think will play out going forward? So that is question number 1. Question the number 2, which Anjan and you can probably jointly reply is. On the demand side what are the fundamental changes when you say that demand is looking better, is it that you have spoken about the client budgets or you are seeing some kind of traction on a particular stream of deals which are coming or what is giving you that confidence to say that the demand environment is better than what it was last year at the same time?

[Priyadarshan D. Mundhra, Co]

Okay. So let me take the first question and I will ask Anjan to respond to the second. As Rohitash shared in his opening remarks, we had almost INR 40 crore drip -- dip in pretax profit quarter-on-quarter. And of that INR 40 crores, 2/3 of it were on -- were due to factors beyond our control, one being the exchange rate adjustment, quarter-ending exchange rates, one were the SIES recognition, things that obviously hopefully will not repeat again in the next quarter. From a purely operating performance standpoint, you already shared that we think in Q4 we should continue to see some uptick in dollar revenue, point one. Point number two, I think we should see some uptick in utilization compared to where we were this quarter. So combining both of those things it would lead to me believe that we should start seeing some growth in absolute OPM on a quarter-on-quarter basis in Q4 and that is the basis behind my statement. On the demand environment, I'll hand it over to Anjan, perhaps, who can talk a little bit about why we feel better on that front.

[Anjan Malik, Co]

Yes. So to extrapolate again on the point that I was making earlier, we're seeing -- we're certainly seeing more combined budgets open up from our customers. By that I mean -- so while customers may not be looking for pure-play offshore opportunities, I think they are looking for vendors who can solve business problems by using combinations of artificial intelligence, robotics, business consulting and offshoring, so where we do combinations of onshore and offshore. I think what PD was referring to, I think, earlier is managed service or I think so was Rohitash. So for those kind of opportunities we are seeing some sorts of consolidation plays where people, clients have had, for example work that's been done in a particular way, a lot of it being done offshore, some of it being done in low-cost centers, some of it being done in high-cost centers and customers are looking for ways to run them much more efficiently in a much more holistic manner where you are not just looking to get offshore arbitrage but you are looking to automate away some things and reengineer some parts and maybe run some parts of it offshore. So we've seen a number of those opportunities come up over the last 6 months. That give us confidence that it's a combination of increasing customer demand and also for a particular type of solution offering that we're now increasingly providing. The combination of those 2 we are seeing more uptick for.

[Operator]

[Operator Instructions] We have the next question from the line of Ankur Rudra from CLSA.

[Ankur Rudra, Research Analyst]

Maybe a question for Rohitash. Rohitash, given that you are transitioning now to a more of a traditional onsite-offshore model do you -- are you considering maybe sharing a bit more metrics to understand this in a bit more detail going forward? May not be for this year, but maybe for next year onwards.

[Rohitash Gupta, Chief Financial Officer]

Ankur, if you recollect we have provided little more breakup at least on the headcount slide which gives the traction on the onshore delivery guys and that will, I think will be the key metric as far as our Fayetteville center is concerned because most of the good in future -- at least in onshore delivery is likely to come from that center. So that growth you can track from there. In terms of financials, we have -- frankly we have not thought about it. We will be ready to disclose this during next year. But take your point.

[Ankur Rudra, Research Analyst]

And just -- apologies if I'm sort of repeating this question. But in terms of your top 10, 20 customers, I'm not taking the entire emerging clients, but the top 10, 20 big customers, do you feel bit more confident about where their spending is going? I'm not talking about margins, but overall basis. Do you feel that there is bit more visibility, the kind of lack of clarity you had before, most of that is behind you?

[Rohitash Gupta, Chief Financial Officer]

Ankur, you are talking about top 10 or the top 10 within emerging?

[Ankur Rudra, Research Analyst]

Yes, top 10 and top 10 within emerging. So if you want to answer that in 2 parts, you can do that.

[Rohitash Gupta, Chief Financial Officer]

On the emerging front, as I said, most of the growth that you are seeing in that slide is actually coming from mining of existing clients, and most notably from that top view of the emerging clients actually. So we feel that that trend may continue. Obviously the logos may change because we have many more logos, many more industries which can be mined and the work is in progress. So most mining-led growth will come in emerging, that's our hope. Coming to top 10, which are the largest clients, there, I think as PD mentioned, one of the biggest downward movement factor has been the roll-offs in some of those accounts. And we think we don't have any further news of that event happening, which means that the natural growth will take over which has been happening in almost 6 of or 7 of the top 10 accounts for last few quarters, as I just mentioned and I also mentioned in last quarter call. So we are very hopeful that as long as that downward factors are arrested, the natural slow growth will return in the top 10 as well.

[Operator]

[Operator Instructions] We have the next question from the line of Soumitra Chatterjee from Spark Capital.

[Soumitra Chatterjee, Vice President of Research]

The previous participant asked the question, but if you can still elaborate a bit whether you are targeting the absolute operating margin percentage or absolute profit in dollar terms because if your business is shifting towards more onsite then the margin improvement that or the levers that you currently have will they be enough to offset this impact from the onsite mix changing?

[Rohitash Gupta, Chief Financial Officer]

Soumitra, thank you for the question. And, yes, we are focusing on the absolute number which, for example, this quarter was about INR 78 crores or thereabout. And to your question about the onshore mix and its impact on that metric, I think what we are looking at least in this YTD is the buildup of our Fayetteville center, training of resources and all those things. And as I mentioned, the revenue from that center will start only in Q4 as we speak. So I think that will lead to some growth, because it will not be only cost, there'll be some revenue offsetting that cost as well, at least in Q4. So we are very hopeful that the INR 78 crores number has to grow in absolute sense because of multiple factors both in Q4 as well as onwards.

[Operator]

[Operator Instructions] We have the next question from the line of [Luvkesh Kumar] from Banyan Capital.

[V. P. Rajesh]

Hi, this is V. P. Rajesh here actually. Rohitash, just a quick question, I'm sorry I joined late. But looking at your selling and distribution cost this quarter, it has gone up by about INR 5 crores. And if I heard you correctly, you have only already added 3 more people in the BD side, so that seems quite high a number, so could you just give more color on that?

[Rohitash Gupta, Chief Financial Officer]

So actually the number is 5, the reported number is 3, as you correctly pointed, but the number is 5 for the purpose of cost simply because we inherited some of the staff BD staff from TwoFour Consulting as of 30th September, so those few numbers were already in the 82 numbers of the last quarter. So the full cost is actually of 5, 6 resources including some very senior ones, that's point number one. Point number two, there was a little increase in travel as well this quarter due to seasonality factors. And thirdly, as we are trying to build different model of consulting in onshore there are few other types of contracted resources required to support that organization that although add to the BD cost although they don't show up in the count because count is only for the full-time employees.

[V. P. Rajesh]

Right, right. Okay, that's really helpful. So should one assume that you will be at this kind of run rate for the foreseeable future or is it going to go up even from here?

[Rohitash Gupta, Chief Financial Officer]

So it will depend on the mix, as we said, but at the current mix of onshore revenues I think this is sufficient in near term. So the absolute number of BD costs, we don't any significant increase unless the mix further changes dramatically for onshore.

[V. P. Rajesh]

Right. The second question is on your attrition rate on Page 9, this year has to be, seems to be significantly higher than what it has been historically, so if -- and you -- obviously your employee count is also coming down, so could you just comment on that as well?

[Rohitash Gupta, Chief Financial Officer]

Yes, so attrition has been at the elevated level actually for quite some time now and one of the reason is that we had these significant roll-offs for large 3 clients over last 18 to 20 months and that created some bit of excess at the point of roll-off, right, which obviously we try to redeploy but subject to shift and skills and other things matching. Due to that some people attrite more who cannot find redeployment within reasonable period of time given the demand in other companies, so I would say that that attrition number is not a very stable state what you have seen in last few quarters including Q3 and we hope that after Q4, not Q4, after Q4 we can call it a steady attrition whatever it is.

[V. P. Rajesh]

Right. And then relatedly on the staff utilization what PD was earlier commenting that the idea is to take it higher, so now you could have it two ways by reducing the number of employees just because the projects have rolled off or you could have new projects, that is the bench gets deployed on these projects. So currently this quarter you've got 73%, what do you expect it to be in Q4 or next year and what will be the driver of that given those numerators and denominators that I just talked about?

[Rohitash Gupta, Chief Financial Officer]

Yes, so it will depend on the execution and what we are able to achieve but I can give you a theoretical answer that with the current business mix and the current volume of work offshore this number can theoretically go up to 75%, but obviously the journey from 73% to 75% will depend on what we are able to practically achieve during next few quarters.

[Operator]

[Operator Instructions]. As there are no further questions I would like to hand the floor back to the management for closing comments. Please go ahead sir.

[Rohitash Gupta, Chief Financial Officer]

Thank you very much for everyone for participating in this quarter's call, look forward to talking to you next quarter. Thank you.

[Operator]

Thank you, gentlemen. Ladies and gentlemen, on behalf of eClerx Services Limited that concludes the conference call. Thank you for joining us and you may now disconnect your lines. Thank you.