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Firstsource Solutions Ltd
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Ladies and gentlemen, good day, and welcome to Firstsource Solutions Limited Q1 FY '23 Earnings Conference Call. [Operator Instructions] Please note that this conference is being recorded.
I now hand the conference over to Mr. Ankur Maheshwari from Firstsource Solutions. Thank you, and over to you, sir.
Thank you, [ Nirav ]. Welcome, everyone, and thank you for joining us for the quarter ended June 30, 2022, earnings call for Firstsource. Do note that the results, the factsheet and the presentation have been e-mailed to you, and you can also view this on the website, www.firstsource.com.
Before we begin the call, please note that some of the matters we will discuss on this call, including our business outlook, are forward-looking, and as such are subject to known and unknown risks. These uncertainties and risks are included, but not limited to what we have mentioned in our prospectus filed with SEBI, and subsequent annual reports that are available on our website.
With that said, I will now turn the call over to Vipul Khanna to begin the proceedings.
Good evening, everyone, and thank you for joining us today. Hope the summer and now monsoon are keeping you all well. Here's a quick snapshot of the quarter. Our revenues degrew 2.7% year-on-year in constant currency and came in at INR 14,724 million, $491 million. Operating margins were 8% and EPS degrew by 36.6% year-on-year. The macro environment remains dynamic and the past 6 to 7 months have been unprecedented, making it challenging for us to forecast certain portions of our business accurately.
Successive and substantial interest rate hikes, multi-decadal high inflation rates and increased fears of recession are impacting parts of our BFS business. The headwinds primarily to our U.S. BFS business are worst than we originally anticipated. As such, we have reassessed our growth visibility and lowered our FY '23 guidance to 2% to 4% growth in constant currency. Excluding mortgages and the full year impact of acquisitions of last year, we expect to grow between 16% to 19% in constant currency.
The key factors in the guidance revision are: one, the outlook for the mortgage industry has considerably worsened since we last spoke. This will translate to a steeper Q2 and Q3 decline in mortgage volumes than we previously anticipated. We believe that this business will bottom out in Q3 and that we have factored in the downside risk with these lower numbers. In the collections business, the macro indicators continue to point to a gradual increase in delinquency rates. And as such, we continue to expect growth to pick up in the second half of this fiscal. However, the inventory building up slower than we anticipated, hence, we're trimming our growth expectations.
The mortgage business is expected to impact growth guidance of 3.5% to 4% and collections by about 1%. Notwithstanding these challenges, we're confident that our long-term strategies to diversify our business and grow continue to yield results. The demand environment across other segments is strong and is reflected in the strength in rest of our businesses. Given the significant revenue volatility, we expected our margins to decline in H1 and then pick up in H2. The sharper fall in revenue and higher restructuring costs have accentuated the impact on margins for this quarter and the next one. We are super focused on rationalizing our direct and direct cost, which we anticipate will result in a positive impact to the operating margin by about 200 bps from Q3. Overall, we are confident of getting an operating margin of 11.5% to 12% by quarter 4.
Taking into account all these factors, we expect to achieve operating margins of 10% to 10.5% for the year. This includes an 80 bps to 90 bps positive impact from the recent amendments to Ind Accounting Standard 37 on accounting of onerous contracts. Dinesh will share more details for this in a few minutes.
Let me now talk in detail about our segment performance. In Q1 FY '23, our Banking and Financial Services segment degrew by 11.9% year-on-year and 13.3% in constant currency. Our mortgage business contributed about $32 million of revenue in Q1. This implies a contraction of 28% Q-on-Q and 48% year-on-year. Since we last spoke, the market activity has de-accelerated sharply. Weaknesses in refinances and purchases pushed the market composite index, a measure of mortgage loan application volumes, down to the lowest level since 2000. In fact, the refinance index was down 80% compared to a year ago. The recent outlook published by the Mortgage Banker Association reflects a further reduction of 10% and 11% for calendar '22 and calendar '23, respectively, from the Q1 forecast for the same period.
From discussions with our clients, a key variable that has changed between the March and June quarters is the consumer outlook on home purchases. Despite pent-up demand, high inflation and economic uncertainty have dampened home purchases at least temporarily. A majority of our clients have continuously rightsized their businesses in the last 2 quarters to align with the rapidly changing market conditions, resulting in lower volume growth to us. We were expecting the mortgage business to bottom out in second quarter of this fiscal and then stabilize thereafter. Now considering the current volume forecast, our expectations have shifted out by 1 quarter with further declines in second quarter and business likely bottoming out in Q3.
In H1 of this fiscal, our margins will be impacted by the lagged alignment of the [indiscernible], people restructuring costs and the higher fixed costs. Aligning our operating costs with lower volume trajectory has been a top priority for us. We have and we continue to reduce the direct costs. The restructuring costs will taper down by Q2, and we are realigning our support functions and leadership as well as rationalizing our tech and facilities infrastructure. We anticipate to start realizing the savings from the infra and support cost rationalization from Q3.
Amidst the painful recalibration of the mortgage industry to this economic cycle, we see a number of silver linings of our business. Clients need more structural and deep impact cost solution and our pipeline for such longest conversation continues to build up. Offshore [indiscernible] and digital are key value levers in this pipeline. In this quarter, we added 4 new clients for origination and servicing across our traditional target segment as well as couple of exciting proptech companies.
In our collections business, the macro data continues to show consistent improvement. According to the most recent data from the Fed, delinquencies increased to [ 1.76% ] from 1.60% in the previous quarter. This is the third straight quarter increase, although the metrics is still lower than pre-pandemic level. On the other hand, we also note that high inflation and higher interest rates, in general, have a negative impact on repayment ability and credit demand. Coming out of the unique economic and society conditions of the pandemic, card issuers are fine-tuning their strategy between first and third-party collection and between traditional and digital.
Our collections business is tightly linked to the outcomes we deliver to our clients. In this period of exceptional volatility, it has been difficult to establish a strong trend for both our clients and for us. We continue to expect strong volume growth in H2 of this fiscal year, but it's likely to be lower than our earlier estimates. Irrespective, we continue to make solid progress in diversifying this business. We recently secured a win with one of our key BFS clients in the U.K., and I'm encouraged by the collection services demand in that geo. We have set fast in building a presence in fintechs and utilities. We added 3 new clients during this quarter, and the sales momentum is expected to remain strong through the year.
We continue to invest in building our digital collections platform incorporating annul recommendation strategy, newer payment methods and increased API leverage. We are also seeing strong demand for our recently opened Mexico nearshore location. The U.K. BFS segment is growing strongly. I had shared that reintegrating the GTM focus for this U.K. business is a priority for me in this fiscal year, and I'm pleased to report that it is working. We had a strong quarter of new offering wins and growth with our U.K. BFS plan. We also opened the collection service lines with a key client, providing great validation of our market efforts in the last year. The ramps for these are underway and should deliver steady state revenues by Q2.
We recently closed an exciting business transformation deal with a leading fintech in the U.K. The demand environment, pipeline activity and digital adoption remains strong despite the political uncertainty and tough economic conditions. The talent market continues to be challenging. We are focused on execution, expanding our delivery network and smaller nodal centers within U.K. and at the same time, easing out a shift towards offshore. We reaffirmed our top ranking within the U.K. CS segment [indiscernible] industry awards.
Our Healthcare segment continues to grow consistently at 18% Y-o-Y and 13.3% in constant currency terms. In the last 4 quarters, HPHS segment had a number of significant wins. We are now sharply focused on executing and scaling on the recent wins. For our HPHS business, the growth thesis continues to be hinged on expanding into the top 10 health plans, growing our digital intake business and creating [indiscernible] solutions for mid-market health plans. Our targeted market making efforts continue to yield strong opportunities. The pipeline, especially for large deals from top tier health plans is healthy. We also had a few new plans this quarter. In addition to the Everest Group and ISG recognizing us as a leader, [indiscernible] has recognized us as a disruptor in the healthcare payer operations market, starting our digital-first approach, innovative solutions and strong execution.
I'm also pleased that the demand pipeline for Mexico and Philippines as healthcare clients increasingly consider supplements to [indiscernible] especially for the Medicaid business. The provider segment is gradually emerging from COVID and its residual impact. As anticipated, the public health emergency has been further extended until end of this calendar. The talent supply challenges for this industry are acute and hospital margins continue to be under pressure. As a result, clients have [indiscernible] strategic broader core solutions. For the provider business, our strategy is, one, to focus on our competency of eligibility services and receivables management to continue to gain market share; and 2, expand wallet share with our large portfolio clients by developing adjustment capabilities, including offshore for mid-revenue cycle services.
We continue to invest in go-to-market capability and digitizing our offerings to increase engagements with patients and their caregivers. Provider revenue for the quarter was flattish. The strong sales momentum of Q4 '22 continued in this quarter, including the addition of 3 new clients. This segment has long implementation cycles, and we expect revenue yield to increase in H2 from the new sales of the last 2 quarters.
Finally, our Comms, Media and Tech segment grew by 0.9% Y-o-Y and 5.9% in constant currency terms. Our U.K. portfolio continues to perform strongly. We continue to scale with distinct clients, including adding new lines of business with our largest clients. During this quarter, we rolled out a large office automation program with a leading comms client. We are excited by the impact it creates on the clients' operation and by the opportunity to leverage the showcase engagement.
Our North America CMT portfolio is also scaling up nicely. And in this quarter, we added 1 new account in the Tech segment. We've shared that FY '23 will be a year of transition of our revenue composition. These are clearly unusual and volatile times and it's challenging to forecast. Having said that, I'm disappointed to speak with you once again about lowering our guidance. This is a mean, and I'm fully aware that we need to provide better clarity on the growth outlook of our businesses. If you step back, I'm very confident that our underlying business is strong. The strategic focus we established a couple of years ago remains on track. We'll continue to invest in our 3 core industries of banking and financial services, healthcare and CMT, consolidating the leadership position we have in the chosen sub-segments and systematically adding growth adjacent [indiscernible].
We'll push forward on digital solutions and services to take disruptive offerings to market in each of the industry and above all, build a purpose-led, scalable and agile organization. We continue to diversify our business profile and form a strong base for sustained high-quality book. By the end of fiscal '23, mortgages will be between 13% to 15% of our business, down from about 28% in FY '22. Ex mortgage, we expect solid growth in Q2 and expect the trend to continue delivering 16% to 19% growth for this fiscal.
On operating margin, we are confident of returning to a run rate of 11.5% to 12% by Q4, while maintaining our investments in the growth areas of Europe, healthcare and CMT. In addition to the significant cost actions on the mortgage cost base and the planned margin improvements on last year's acquisitions. We have taken the opportunity to fine-tune our operating model in certain areas and recalibrate the timing of some of our investments.
I'll now pass the call over to Dinesh to cover the financial details.
Thanks, Vipul. Hi, everyone. Let me take you through some of the financial highlights. Revenue for the Q1 came in at INR 14,724 million or $191 million. This implies a degrowth of 0.8% in rupee term and 2.7% degrowth in constant currency. On the margin front, operating margin came in at INR 1,171 million or 8% of the revenue for the quarter, which is 35% degrowth on a year-on-year basis and implied margin decline of 417 basis points. Profit after tax came in at INR 851 million or 5.8% of the revenue for the Q1 FY '23. This is 36.7% year-on-year degrowth with a margin decline of 328 basis points.
In Q1 FY '23, we generated INR 1,408 million of cash from operations, and our free cash flow was INR 1,238 million, after adjusting for CapEx of INR 170 million. On a closing cash balance as of June 30 was approximately INR 1,935 million. DSO came in at 59 days versus the 57 days last quarter. Net debt as of June 30, '22 stands at INR 7,333 million or $92.9 million versus INR 8,013 million or $105.7 million as of March 31, '22. Repayment of around $12.8 million debt during the quarter has been done. Tax rate for the Q1 was around 18.8%. For FY '23, we expect it to be within the range of 18% to 20% for the year.
On the ForEx hedging, we have coverage of GBP25.9 million for the next 12 months with average rate of 114.4 per pound. On the other side, the dollar coverage is for $52.5 million with average rate of 79.1. Let me slightly brief on you on the change in the Accounting Standard 37, which was effective from April 1, '22. This was the Ind-AS 37, which has been amended.
Consequent to this amendment to cost that directly related to a contract consists of now both the cost. First was the incremental cost of fulfilling the contract. And the second is allocation of all other costs that relate directly to the fulfilling contract. So up to the previous standard, the only the direct cost was considered for their arriving at on that contract.
Now on what the indirect or allocation of cost also has been considered. This is the change which have come into now. Therefore, in evaluating whether or not a contract has became onerous both direct and indirect cost of fulfilling a contract have to be considered. And as per the transitional provision of Ind-AS 37, the effect of the commencement of the reporting period is to be reported as adjustment to the opening balance of retail lining.
The adoption of this commitment has resulted in a reduction of INR 783.4 million net of deferred taxes in the opening retail lining with a corresponding provision for onerous contract as prescribed in the Rule 22. Accordingly, we estimate this will result in a lower charge in the profit and loss by 55% to 60% of this value in FY '23, and balance will go to FY '24 and some portion maybe in the FY '25. The liability for this onerous contract is mainly on account of unabsorbed indirect allocated cost comprising facilities costs, depreciation on fixed and intangible assets, technology costs, utilities and some specific geography support service costs. This is the change which has been done in this quarter, and that's the accounting treatment we have done. With this, I open up for the Q&A.
[Operator Instructions] The first question is from the line of Manik Taneja from JM Financial.
The first question was just a quick clarification question on the traditional business. We see a sequential decline in...
Sir, sorry to interrupt you, but then your audio is not coming clear.
I hope this is better.
Yes. Thank you. The line for the participant dropped. The next question is from the line of Divyesh Mehta from Investec.
Hello. Am I audible?
Yes sir.
Okay. So my first question, can you actually say again the guidance decline, where is how much basis point impact coming from mortgage and collection? And also can you share accounting standard what was the impact coming from this change?
Okay. So the guidance revision about 3.5% to 4% is coming from mortgage and about 1% is coming from collection, which is primarily from trimming of the growth expectation for H2 of the year. On the impact of the accounting standard change, we expect this year, that will positively impact our operating margin by 80 to 90 basis points.
Okay. And so my next question is that in the credit card repayment business, the delinquencies, as you said, are increasing. But if you look at the various banks commentary, all of them have been highlighting that customers now have a larger chunk cost saving bigger question. So they are not expecting a big change in that number. So what is driving your reasoning that repayment side can see a strong growth?
So look, both things are happening, right, as I mentioned for the last 3 quarters, from the very low at the peak of mortgage that people have a lot of surplus cash, delinquencies quarter-on-quarter have been increasing. At the same time, people, as the spend has increased, you will see more of that sort of coming through in the delinquency rates. We had anticipated volume growth. We've been continuously calibrating with our clients. That's partly the reason we have recalibrated down some of the growth expectations, but we still expect there will be additions and increased volume coming through to us.
And the second factor is since, as I've been mentioning, we've been adding new clients in utilities, fintechs, et cetera, as those implemented and as those volumes come through from us, right? As even new clients, they slowly start placing more volumes from you, that kind of balance kind of builds up. And as that builds up, those 2 factors combined are what are driving our collection forecast. We have been careful in incorporating how much lift we take from existing clients. And that's the balance we've been trying to strike in our forecast looking at the volume growth today we have and as we look at the guidance from our clients.
Okay. One last question, sir, when you said that 13% to 15% of the business will be mortgages, that was by end of '23 for FY '23 or for the whole FY '23.
So for whole of FY '23.
Manik Taneja from JM Financial.
I'm sorry, I got disconnected the last time around, and I don't know whether I have finished my question properly or not. So my first question was with regards to the healthcare business, we've seen a sequential decline on the healthcare side. The understanding was that we won a few [indiscernible] and thereby one will see continued growth. So from that standpoint, if you could help us understand why there's the sequential drop here? Is there any onetime elements of revenues in [indiscernible] call that out? And the second question was with regards to the underlying shift towards India. If you could talk about your comments there, given the labor or the starting candidate [indiscernible].
Yes. So Manik, the second comment to clear first. Clearly, both the U.K. and U.S. markets have talent shortage at the frontline level. And to that extent, I mentioned about Mexico Center getting opened in March. Philippines, you already had, but we're seeing good demand on a couple of deals that we are scaling up there. And I think that recognition of considering fourth contact center or sensor processes in Mexico and definitely for chat and back office for India, we see an uptick of demand in healthcare. We see that in mortgage, and we see that in BFS and CMT clients in U.K., right? I can almost see that as a broad trend. Obviously, the scale is small, and you may kind of tease it out, right, the scale buildup is small. But as the year goes by, we do expect that some of our existing business will convert to offshore as well as the new wins, it's an increasingly important part of the new solution that we're putting together between Philippines, Mexico and India as far as our healthcare mortgage and CMT business is concerned.
On your first question, healthcare, it had a couple of very strong quarters of growth coming into Q3 and Q4 of last year. This quarter has been sort of flattish, largely because HPS took a little bit of a breath as we kind of focus on executing some of the deals and putting our shoulder behind sort of all that it takes to implement between technology and people. Provider business, it's kind of dealing with some of the remnants of COVID, not necessarily in terms of consumer behavior, but the government intervention in the reimbursement cycle are kind of going away in an inconsistent manner across different states. So there are some minor puts and takes from a timing standpoint of when approvals come through, right, from different states on a provider business, then it kind of flow through to our clients and hence to us because it's outcome driven. So nothing secular or structural out there. We expect strong growth to pick up from Q2 onwards in healthcare. And overall, at the end of the year, we expect strong growth from HPHS and decent growth from the provider segment.
Sure. One last clarification question on the healthcare HPHS business, over there, should one expect a typical seasonality wherein 3Q and 4Q should do much better than first half year given the vagaries of the involvement by patient engagement cycles with the American healthcare system?
So there is definitely an uptick in Q3, and it bleeds over into Q4 because open enrollment period for majority of the population is leading up to December, right, so that they're ready for next year. It's not significant, but it's definitely an uptick that we see in Q3, Q4 historically across our health plans around.
The next question is from the line of Dipesh Mehta from Emkay Global.
A couple of questions. First about the guidance. In the guidance, I think you alluded about weakness to persist in H1 and recovery in H2. So can you help us understand let's say, next 3 quarters, how the trajectory looks like, both from a revenue perspective and margin perspective, whether we are making too much for Q3, Q4 and which again carry some risk in terms of guidance? Or you believe Q2 onwards, we will see sequential growth playing out and margin also will start recovering?
Second related question is about, let's say, 2% to 4% constant currency Y-o-Y when we say, what kind of [indiscernible] we are building for next 3 quarters? Second question is about the healthcare business, to some extent, you alluded, but if you can provide some sense about provider business, it seems weakness persisted for provider business for some time. Some of your peers seeing healthy recovery over the last couple of quarters, maybe mix change or some other differences, but our recovery seems to be very soft compared to some of our peers. So if you can provide some sense.
So guidance. Overall, we expect that growth will pick up through the year. At an overall level, Q2 will be flattish compared to Q1 and then will kind of pick up. And that's largely because mortgages will decline next year and it'll kind of mute away the growth in other sectors. So ex mortgage, we expect [indiscernible] growth in other businesses in Q2, and that trend will continue. And when the mortgage decline starts to arrest after Q2 that will kind of show up more in the growth at the overall level. So on your question of what is the compounded quarterly growth rate? At this stage, we expect that will be between something like 3.2% to about 4% between Q2 to Q4. yes. So that's on the guidance.
As far as margin is concerned, A couple of factors which are playing up on the margin. One, as the margins decline, we have a direct cost base in the mortgage business, especially that we need to tackle, which we are tackling. There is an impact of restructuring costs that we have in this quarter and kind of it will taper off by next quarter.
So that imbalance of direct cost, which is going heavy on Q1 and slightly less in Q2, that will kind of finish off by end of Q2. That's one positive factor to the margin. Second, the actions we've taken on our indirect cost, whether it's leadership support as well as leadership and support or infrastructure. Those actions have been implemented. Obviously, they have long notice periods and cycles from our facility and technology reduction. Those we expect to kick in from Q3 and Q4.
And as I mentioned, we expect that will lift our margins from Q3 by about 200 basis points. So between the reduction of load in direct costs, the restructuring cost tapering off and the gains from indirect cost, we do expect that our operating margin should start to come back to around 11.5-ish, 12% by Q4 to end the year overall between 10 to 10.5. That's kind of the margin ramp that we see from Q1 to Q4.
On the healthcare business provider. So I think I had mentioned we had a strong sales quarter in Q4, after about 10 quarters, we had a high sales in Q4. We continued with pretty much the same trajectory of growth in Q1 as well. But this business has a longish implementation cycle, right? You get prospective placements from a client. You don't work on what whatever their previous vendor or in-house might be working on. You only get fresh placements, and there is a cycle for those placements to work their way through the different value chain, the service value chain. And by the time you recognize revenue, it kind of gets to be about sort of 6 to 9 months in terms of meaningful revenue. So those gains will kick off towards the second half of the year. That's one comment.
Second, our business, as we have been saying, is kind of we are the leaders in eligibility and building an RM business. That has its own nuances. It's completely an onshore business. Since the last couple of quarters, we've stepped back and broadened the scope of where we play. We put in a new team, we are digitizing our offering, and we're also building up capabilities for mid-revenue cycle so that we can start to kind of cross-sell to our existing clients on some of the mid-revenue cycle opportunities where offshore plays an important part. So we also see growth in some of our competitors who have much broader offering and also they have offshore presence in that. And that's one of the targets we are doing to increase our business. Our core business is obviously linked to how the macro conditions and the public health emergency play. But given the fact that sales have increased, gives us confidence that as the year goes by, some of those remnants will kind of wash itself out through the RPM cycle of the U.S. industry. Dinesh, anything else to add on healthcare or Ankur?
No, I think [indiscernible].
Vipul, just one follow-up on margin. Let's say, in Q1, we delivered 8% EBIT margin. You indicated revenue to be flattish in Q2 considering mortgage business headwind likely to persist in the near term. Do you think this margin is also likely to remain closer to Q1? Or you think now improvement will start from Q2 onwards?
No, improvement will start from Q2, Dipesh, because some of the cost actions we have taken and some of the restructuring will taper off. So for instance, this quarter, and Dinesh can validate the comment, in this quarter, we had about 60 bps of impact from restructuring costs. That will taper down to about 35%, 40% in Q2, right? So some of those direct cost benefit will come in and we'll see a lift in the margin from Q2 itself. Dinesh, anything else to add on Q2 margin?
No, that is right. I think the Q2 onwards, we will start seeing a margin improvement. So a lot of cost actions have been taken and some of the costs have been already been taken out. So we'll see the improvement.
Dipesh, do you have any follow-up question?
No, thanks.
Next question is from the line of Shradha from Asian Market Securities.
A couple of questions from my end. So can you quantify the mix of servicing and origination in the mortgage business this time around?
Yes. So Shradha, for the year at this time actually for the end of this year, we expect we'll be between 2/3 servicing and 1/3 origination. At this point in time, we are at about 40-60 between origination and servicing.
And, Vipul, if you really look at what happened in this quarter, we had guided to mortgage being at USD30 million to USD33 million run rate in 1Q, and that is where we actually landed up. The business in this quarter was more to do with other businesses than mortgage actually. Is that understanding right?
Partly, but look, we were expecting that we will taper off. We'll kind of find the new equilibrium from Q2. But towards May and June, we see sliding down of revenue. And hence, we are seeing a significant decline that you see mortgage quarter-on-quarter between Q1 to Q2. That has an impact on cost and margins significantly, right, because your revenue starts to tail off sort of mid-quarter from where we want it. So yes, we are broadly slightly lower than where we wanted for Q1, but it's the Q2 and the lower weight for Q3 and Q4, which is a big driver for our guidance revision.
Right. And what kind of a decline are we building in for 2Q, if you can give some sense on that? And do you expect a further decline in 3Q over 2Q or I mean, 3Q should be more steady state or vis-a-vis Q2?
So at this stage, we are expecting Q2 on mortgage to be closer to between, let's call it, 25 million to 26-odd million. It will bottom out from there slightly in Q2, not a whole lot. That's how we see at this point in time and then gradually pick up a little bit, it'll pick up from Q4.
Right. And sir, just on the leadership restructuring, what you actually do we mean there? I mean, has there been some voluntary attrition of people that we have seen at the leadership level or what exactly do we mean there?
So I mean 2 parts. One, that the whole support infrastructure, right, that is built up to support a business that had scaled up to a business which was running at about $200-plus million right. Now that's a business which will pretty much halved. So to that extent, we are realigning the support infrastructure across the functions for a lower base. And second, as the business for mortgage has declined, obviously, across the pyramid, we've had to reduce some of the talent cost there. So at the senior level, we have stability, but at the operating level at some of the solutioning and stuff level, we've had to kind of recalibrate the business to the new reality of the volumes.
Right. And just one last bit on the 2 acquisitions. How about cost synergies playing out in both StoneHill and ARSI, can you talk more about that?
Sorry, Shradha, the cost synergies?
The cross-selling synergies in with acquisitions, how is that playing out?
Yes. So the ARSI acquisition is playing out well, right, it's integrating well. We had mentioned that they had lower margin than us, and we'll kind of take us this financial year to kind of bring them to parity by end of the year. I think that is on par mostly.
On Stonehill, clearly, they have also been impacted by the industry significant decline in the industry on their revenue. And given it's a platform-based business, it has impacted their margins pretty significantly. And we've had to recalibrate that cost as well in Q1 to this new reality. The good thing is that because they had lesser exposure to origination and they are mostly Q3 and due diligence, which are secondary market activity, we saw that they stabilized in June and in July, also, we've seen strength in their business.
So at least there is stability now. And they obviously will recover a little bit ahead of the core business, given once there's stability in the secondary market transaction, it shows through in volumes of [indiscernible] to Stonehill. So revenue-wise they're stabilizing. Margin-wise, they were worse than where we anticipated primarily because it's a platform business. And I think it will take us till the end of the year to bring them back to a reasonable level of margin.
Right. And just one last thing. The guidance is on constant currency basis, it is up 2% to 4%. And assuming 250 bps cross currency has been given a 30% exposure to [indiscernible]. So in dollar terms, we might actually see a decline in revenue this year [indiscernible] right?
Dinesh?
I don't think we have done that working, but yes, it can be because the rupee is at INR 79.80, so if the year-on-year basis, tax achieved plus I think dollar GDP also trending lower. It is not 1.22 and 1.24. It can be, but we've not done the working, I think we'll share with you once we have gotten.
And sir, last time, you had indicated that the guidance...
Shradha...
Yes. Please start the answer.
No, what I'd say Shradha is that we have about [indiscernible], right, and that obviously will be exposed to this movement, to that extent, we will have an impact on our [indiscernible].
And the last time you had split out the guidance in terms of organic and inorganic. And we had expected almost 600 bps contribution to commence some acquisitions. Is that number still the same? Or has there been a change of mix between inorganic and organic contribution?
Looking good question. I think first of all, as I mentioned, excluding the impact of both mortgage and full year impact of acquisitions, we expect growth of 16% to 21% for this fiscal, which means that other businesses are performing strongly. On the inorganic impact, I think you'll see some trimming. As I mentioned, ARSI is part of the collection cycle. So there will be slight trimming there. And then Stonehill has also been impacted to some extent. I don't have a quantified, we can answer later, but I think it will be slightly lower than the 6% impact that we expected from the acquisitions.
The next question is from the line of Sachin Kasera from Svan Investments.
One thing is that if you could give us some sense on your region from more like a 2-, 3-year perspective because of this heavy dependence on mortgages, we had a very big impact on our numbers. So are we looking to build the company so that we are more diversified, both in terms of geography as well as internal verticals so that we, again, don't have the same set of mistakes. So if you could just give your broad vision of post this month that we are seeing on heading how do we see the company say in FY '25?
Yes. Thanks, Sachin. So let me just quick comment on mortgage before I get to the overall region. So look, mortgage is a volatile business, right? It's a more dynamic business. It's linked to economic cycle. and we know that. Typically, these cycles are 4 to 5 years, right? These cycles work in that form of interest rates decline, refinance becomes very viable, et cetera, et cetera. But given the unique circumstances of COVID, their interest rates went down to record low, demand picked up significantly.
This cycle got compressed, and you saw some tremendous growth in our business in the last 2 years. And on the other side of the cycle that the economies come out of this, and you've seen sort of successfully increasing actions and the pace of the actions which Fed is now doing has not been done in the last 40 years. So with those sort of actions, the decline is also very [indiscernible], right?
So the cycle instead of 5 years has got compressed to 2 years on way up as well as the way down and which has given less time to the industry, our clients and us to prepare for this kind of thing. But fundamentally, solid business, right? And as we go forward, we think from the start of the cycle to now, we have almost doubled the base of our clients. We have a diversified client base. We want to expand into other parts of the mortgage chain so that we are not totally at the sort of originations become the smaller part.
There are other pockets and products like home equity, home improvement, other parts of the value chain that can play and also take this expertise and expand into consumer lending or other parts of BFS, right? So take from mortgage and go over the parts of [indiscernible].
So take this core and we can expand into multiple ways, right? That's one of the strategies coming out of this cycle that once we have the foundation of the mortgage business, where do we take it. At a broader level, as I mentioned, by end of '23, mortgage will be about 13% to 15% of our business, which means that the rest of our business is less linked to economic conditions. That's why we've been investing in healthcare growth, we like health care, both payer and providers.
We've been investing in CMT, and we've been investing in different parcels of PMC, for instance, digital media, tech, et cetera. And we are also starting to think about, as I already talked about delivery dependency kind of coming on to other places. So I think from a vertical standpoint, within the broad verticals of healthcare, BSS and CMT, we are finding segments where we think we have an legitimate claim to kind of win or right to win and expanding into that.
Again, reiterating what I said. If you take x mortgage, if it's 16% to 19% growth, going into next year, when mortgage becomes a smaller base and it has stabilized, I'd expect that we will deliver even at the reported level or at the reported level, we'll deliver good top quartile growth for the [indiscernible] industry. We will be able to kind of give that consistently once we have this portfolio realigned after this year's aberration.
Sure. Secondly, we have a significantly good exposure to the U.K. economy, you again [indiscernible] that Europe itself that you're seeing some sort of recession condition. And the pound is also depreciated. So what is the take on this? And can this also give us a negative surprise, maybe if things deteriorate from ASA Q2 or Q3? And could again lead us to some sort of a revision guidance or outlook negatively.
Yes. So look, yes, the U.K. economy is also going through a pretty soft phase. There is political uncertainty. There is economic conditions, high inflation, high energy prices, which are impacting the economy and the public there. No different as such from the U.S. economy. In general, when companies have pressure, outsourcing is a good answer. It is playing out in U.K., it is playing out in U.S. ex mortgage. So we've seen good demand. Q1 was a very strong quarter for U.K. And looking at the ramp-up that we have in play as well as the pipeline, we feel good about the growth in U.K. for this year and going into next year. The softness in the economy, we are seeing demand in BFS, we're seeing demand in CMT. And in small ways [indiscernible] utility segment, we're seeing demand there as well in the U.K. market.
The impact of pound softening that we play in our financials, Dinesh has kind of covered most of it from a pond exchange exposure. So for now, I don't expect any downside risk from the U.K. economy condition driving on our revenue and margins. Dinesh, feel free to add to it.
No, I think we've pulled that through because I think the consolidation level, you may have revenue impact, but bottom line nor was significant. And all offshoring is that you know that we already cover 1 year at average rate of 114, while your current GBP is around 95, 96 [indiscernible].
Sure. And so one question on the net debt. It had gone up significantly last 2 years because of the acquisition. So what is the percent there would we now look to reduce net debt before we do any major acquisition?
I think this quarter, we reduced the debt because all the cash flows have been utilized only for that purpose. And I think I said in the past also, I think the debt level is like hardly to like 40%, 50% of the working capital which we have. And we've not taken really the long term debt for acquisition and more a cash flow which utilize. And I think it's better to protect the interest rate, we have converted some of the working capital to adapt, which is 2 and 3 years. But purely, these are money utilized for working capital. So I think I'll say that these are all debt, which is for working capital and in that way. I don't think there's anything else specifically.
No. So the surplus cash that we generate post the payout, we intend to look at some acquisition opportunities or we plan to reduce that [indiscernible].
So we continue to look very systematically for adjusting growth areas. And as part of that, inorganic is always a strategy. Nothing imminent, nothing planned for now, but we continue to look into market, continuously evaluate opportunities that become aligned to our growth trajectory. So at this point in time, nothing specific to report on that aspect.
Sure. And just last question on this margin in healthcare. Q-o-Q, I can see some significant competition, don't need to cover that, but there seems to be a significant compression in the margins that the healthcare vertical versus the March quarter. So I don't know if you commented on that...
Sure. No, happy to comment. So a couple of reasons for healthcare margin compression. One, the Q4 margin was higher because there were one-off items that had taken the margin up for Q4. As that effect normalizes, that kind of shows up in Q1. Second, given some of the wins and the focus and execution, we have had the kind of starting implementing cost comes before revenue. That is another part of normalization, which we'll see. And then third, as I mentioned in the past, digital intake is one of our go-to-market strategies for large health plans. It's a competitive business. It has a long lead implementation side still because it's dependent on technology and stuff. That business is kind of at this stage going through its implementation phase and it's impacting the margins. once it scales up, once we have a better [indiscernible] execution in that business, that will also contribute positively to the margin. But this quarter, it impacted the margins for HPHS business. So these are the 3 reasons why we saw a sequential decline on health are margins.
So fair to say that Q4 was little high because of one-offs and this quarter, it's low again because of one-offs. And hence, the compression looks much more magnified.
Exactly.
Would you be able to quantify this one-off, approximately how much was the one-off in Q4 on the positives and how much of the negative side this quarter?
Dinesh, you have that.
I think we need to have an exact in a percentage term, but I think there are 3 reasons which Vipul said, I'll suggest that 25% region for the last year, but the 75 percentage for the current year, which is mainly the investments and I think due to the new businesses which you have taken where we have a cost of growth cost which comes into play. So I think that was the most bigger reason.
Next question is from the line of Chirag from [indiscernible] Institutional Equities.
Hello. Am I audible?
Chirag, there is disturbance coming from your line. Can I request you to speak through the handset?
Now it's better?
Slightly better.
Yes. So sir, I have a few questions. With respect to the margin levers, which we can use to maintain our performance of what you guided, is throw some light, what are the levers we have. And also, ex mortgage, if our business model is under transition phase from next 3, 4 year perspective, then also will this lever will impact? Or will it be changed? And also guidance from 3 to 4 years perspective on top line sir.
Yes. So margin levers available to us, as I mentioned, one, direct costs for mortgage business needs to be realigned to the new revenue base, which we have been doing. That's well underway. Second, our technical infrastructure as well as physical infrastructure, obviously needs to be recalibrated down. That's the longer reduction cycle.
We've initiated those actions. We will see some benefit in H2 and we'll see some more benefits come through in next year as those actions are gaining. And 3, obviously, when you transition this level of business to growth, the SGA as a percentage for the company, it becomes bigger. Once this effect was down, the NGA itself will normalize as a percentage, and that will add the scale effect to the margins. So between those 3 factors is where we see margin coming back to historical levels by end of the year.
As we change as the business becomes more diversified, does it change our margin profile? No, I think it continues in the same way. I have said in the past that we think we'd like to get to a place where every year, we can improve our margins by about 25-odd basis points through operational efficiency, et cetera. We have delivered that in leading up to FY '22. This is a year of aberration. And I think we'll continue that journey once this kind of wears off from FY '24 onwards.
And the same for revenue. If you look at revenue, FY '22 ex mortgage, we grew 14%. This year, ex mortgage, we are saying we will grow 16% to 19%, not counting the impact of acquisitions. And we do expect to continue in the same way to deliver double-digit growth, right in line with top quartile BPM company for the next 4 to 5 years. And I think the foundation of business, and if you look at last 2 years trend, we are reasonably confident that we are on track to deliver that.
Chirag, we are unable to hear you, may I request you unmute your line please.
Sir, do we started the wage inflation, pricing to the contracts on client side, I mean, increasing the project cost and all the other due to inflationary environment?
Yes. We have been at it since last year. Some of our contracts have automatic sort of kick in, especially for onshore delivery, as index changes, price changes. For others, we have been negotiating. There are obviously some lag in some of this. But in general, I'm pleased with sort of how clients have responded to the rising wage inflation.
[Operator Instructions] Next question is from the line of Sonaal from Bowhead Investment Advisors.
I have 2 questions. Firstly, on a Q-on-Q basis our depreciation has declined. What is the reason for the same? And what would be, let's say, a recurring depreciation or the depreciation for the next quarter? My second query was you mentioned that you have been able to get some price increases and some of these price increases are part of a contract. So in outcome-based contracts also, are there such clauses of price increases, like in your collection business, what is there a direct pricing based on outcome considering there has been inflation? Or would the pricing be same because its outcome based?
Yes. Let me answer the pricing part, and then Dinesh can answer the depreciation question. So look, in general, in outcome-based pricing, there isn't an auto inflation and hard to get price increases as your cost of input increases for outcome. The lever there is operational excellence. Since we have the flexibility to continue to fine-tune our operating model, continue to bring in innovation, that's the value lever to countering prices in general. It's mostly on the input base [indiscernible] where we kind of have either automatic or negotiated price increases.
On the depreciation front, I think that some of the facilities which are completed the depreciation period, so there is a slightly lower charge this quarter. And I think as you see in the CapEx, which we are invested, probably it will be rangebound. I don't think it will increase to that number of Q4 level, but I think it will be range INR 2 crores, INR 3 crores here and there. We did a INR 69 crores the last quarter, we are at INR 64 crores. I think it should be in that range of INR 65 crores to INR 68 crores. I don't think it will be materially changed.
And sir, lastly, I don't know so maybe you answered this. But in case of the healthcare business, we won't be expecting growth in this quarter. If I remember correctly based on my past discussion, and why didn't that materialize.
So as I said, healthcare business will grow strongly this year, right? We have the deals we are implementing. We know that. Partly, as I said, this has been a quarter of execution on healthcare on the health plan side. It's kind of it didn't show up in revenue primarily because we have one other deals we're focused on executing. The pipeline is there. We know the action on pipeline, it will pick up Q2 onwards on the health plan side. And on the provider side, we had projected that the growth will come in later part of the year. The sales have happened, they'll start to kind of kick in later part of the year. Next year, in provider, you'll see more expression after the COVID impact going away. So it's been a little bit of a flattish quarter on healthcare, but nothing structural, and we aren't worried about growth in this sector.
My question wasn't actually about structural part. I was trying to just understand, so this healthcare, are you seeing that was in line with your expectations when you had our Q4 call or has it been [indiscernible] in Q1 compared to your expectations?
Understood. Understood your question now. Now I think broadly in line with our expectations. This isn't something which we not expected.
The next question is from the line of Manik Taneja from JM Financial.
Just wanted to understand the fact that you spoke about us aspiring to match peers on growth for the high growth PPO company, should we probably expect that [indiscernible] given the fact that while mortgages will have reduced to much smaller size, but we have the top line, which is not such a very high growth account. So we're almost 30% of your portfolio is held, so probably have some good growth. In that context, do you expect to get that double-digit growth in [indiscernible]
So Manik, I think I got the thrust of your question, your voice was a little bit in and out. you're saying that with the reduced mortgage portfolio, are we confident of getting double-digit growth next year?
Yes, that's correct. That's correct, Vipul.
Okay. Yes. So Manik, as you just said, if you look at it, like last year, FY '22, ex mortgage, we grew 14%, this year, ex mortgage and even excluding the collections and mortgage acquisition, we are projecting 16% to 19% growth. The foundation for healthcare, CMT and BFS business, including U.K. and the collection business, I think our good businesses, they are showing what they've shown in the last 2 years and I feel good that we'll be able to deliver the medium-term growth that we've been talking about the low to mid-teens.
Sure. And just one last clarification question with regards to the 2% to 4% Y-o-Y [indiscernible] growth outlook that we provided for the year, do you expect the second quarter to be a flat quarter at the overall composite level on a year-on-year basis?
On a year-on-year basis...
I think you don't understand the comment that you made around the second quarter performance, should we expect it to be sequentially flat, should we probably expect a Y-o-Y flat quarter... If you could clarify.
I said... Okay. So it will be sequentially flat Y-on-Y, I think it will show up growth. It will sequentially flat because mortgage will be a decline while other businesses will increase. So that's the math of it. Does that answer your question?
Sure. I'll take the discussion offline because I just asking rate for future will be very significant assuming 2Q flat on sequential basis, but I'll take it offline.
Next question is from the line of Sonaal from Bowhead Investment Advisors.
My question was pertaining to [indiscernible] business. So as you know [indiscernible] the third part business and the things which you get based on outcome basis, so that business then do well in the last few quarters, but now since people are talking about the slowdown, would that be a major part of your growth drive this year? And when do you expect that business to pick up because there's some large relationship [indiscernible] investment.
Yes. So you're right that collections is countercyclical business, right, when the economies go soft, collections in general does well because people start to fall behind and stuff and you have more higher collections than when the economy is good and everybody is kind of making lot of money and has a lot of cash.
So that's the classic economic cycle. This one, because the coming of pandemic and people had a lot of cash surpluses, the buildup of that is something which is taking time. It's not following predictable patterns. That's why we are a little careful instead of forecasting what we originally thought. But in general, we expect the volumes to increase.
Our clients are telling us to be prepared for volume increases. It's showing up in delinquency. And as I said, we've also been diversifying beyond credit cards as new payment methods come into BNPL fintechs come into play. We've been targeting them and we've had some very good wins in the last 2 or 3 quarters with those fintechs because a chunk of the customer spend is now coming through those new payment methods as opposed to the traditional credit cards.
And we want to make sure that we start young with them and as they grow, we grow with those payment companies. And that will become a reasonably chunky portion of our revenue as we go into this year and next year.
Sir, my other question was a little bit mathematical from your healthcare business side. So let's take your healthcare business renews to be 100 [indiscernible] presuming no acquisition on the base for FY '23 [indiscernible] is the same. Now because of health [indiscernible] benefits, if the base was 100, just with that going away, what would be your revenue? Would it be 110. would it be 5, would it be 115? Just to understand the impact of this one-off versus the various initiatives we have taken. That would give us a good perspective of how the [indiscernible] shaping [indiscernible].
Yes. Sonaal, it's a little bit of a complex answer. Public health emergency is one of the contributors going into this mix, right. I'm happy to take it sort of offline on how this plays out. But in general, if I was to give you an answer, yes, we should see good single-digit impact once this full remnant of COVID is kind of steamed from the system, but there are multiple sort of complexities. And when you add the fact that it's a state-by-state answer and political leaning, et cetera, play into that as well. So it's a little bit of a complex equation that we deal with. But we can take more offline, and I'll give you more color on that.
And sir, when do you expect this to be off or it's been already announced that there is in date for this?
So what they've been doing is because it's a political decision, they've been kind of pushing it out, right, earlier, they said it'll be February, then April. Now it's kind of look at midterm elections coming there. They said it will be more towards the end of the year. So they keep taking a call to say, extending it. But as I said, it's not as black and white because some of the states have already started to prepare for that, depending on whether which is geopolitical leaning, some of the states have already started to plan and put in place or stopping some of those reimbursements. It's kind of a mixed bag answer, not a big milestone event, which will kind of say it this now goes up or this goes down.
Great. And sir, in terms of just to understand your forecasting of your revenues, what assumptions are, what kind of assumption around this method have you assumed in your forecast of mortgage? Is this contributing significantly or not assume anything on this front while giving the forecast for these assumptions.
Sorry, Sonaal, so you're saying what are the assumptions which have gone in the...
No. So regarding this particular measure of health and agency because you said that it will have a single-digit benefit. I'm trying to understand, when you're guiding for this, are you assuming significant benefits from this in FY '23? Or you're not assuming this measure because we don't know when the measures will go and it's been postponing. So have you assumed anything? Have you done something in between or you assume the full recovery in the forecast or from the benefits.
At this stage, we haven't assumed any uplift from the milestone coming through. We expect this kind of slowly kind of unwind its way through the year. So we don't expect a big chunk or a big uptick just because of that demand. It will be the other factors of building our business where we think we'll see growth.
Ladies and gentlemen, that was the last question for today. I now hand the conference over to Mr. Vipul Khanna for closing comments.
Thank you. Thank you, everyone. Look, I know this is a year which is a year of aberration. It is a difficult period. But I think the actions we've taken, the investments we've been doing building our businesses, give us confidence that we'll kind of work through this and deliver the growth that we are now talking. So thank you for your engagement, and I look forward to talking to you again.
Thank you very much. On behalf of Firstsource Solutions Limited, that concludes this conference. Thank you for joining us. You may now disconnect your lines. Thank you.