L&T Technology Services Ltd

NSE:LTTS

Earnings Call Transcript 2021-Q3

[Operator]

Ladies and gentlemen, good day, and welcome to the L&T Technology Services Q3 FY '21 Earnings Conference Call. [Operator Instructions] Please note that this conference is being recorded. I now hand the conference over to Mr. Pinku Pappan, Head of Investor Relations. Thank you, and over to you, sir.

[Pinku Pappan, Head of Investor Relations]

[Technical Difficulty] Quarter FY '21 earnings call of LTTS. I am Pinku, heading Investor Relations. For those of you who have joined from India, thank you for participating in this late hour. We apologize for having to hold the call at this time. Our financial results, investor release and press release have been filed on the stock exchanges and are also available on our website, www.ltts.com.I hope you have had a chance to go through them. This call is for 60 minutes. We will try to wrap the management remarks in 25 minutes and then open up for Q&A.The audio of this call will be available for replay on our website approximately 1 hour after the call ends. Let me introduce the leadership team present on this call. We have Keshab Panda, CEO; Amit Chadha, Deputy CEO; Abhishek, COO; and Rajeev Gupta, CFO.We will begin with Dr. Panda providing an overview of the company performance and outlook.Amit will talk about the verticals and the deal pipeline, followed by Abhishek, with an update on operations. And finally, Rajeev will walk you through the financial statements. Let me now turn the call over to Dr. Panda.

[Keshab Panda, Whole Time Director]

Thank you, Pinku, and thank you all for joining this call today. I wish you all a very Happy New Year and hope you are all keeping safe and well.I talk briefly about our performance in the quarter and the outlook. We grew revenues by 6.8% quarter-on-quarter with broad-based growth across all our segments. 3 of our verticals: industrial products, plant engineering, and telecom & hi-tech grew in excess of 5% sequentially.Our operational performance was also good. The EBIT margin expanding 100 basis points -- 150 basis points quarter-on-quarter to 15.2%. Again, in line with what we had guided in Q1, but we see a sequential margin improvement from Q2 to Q4. Free cash flow generation continues to be robust with our DSO remaining with a narrow band.Last quarter was significant for us in terms of large deal wins. We had won our largest -- the highest order booking ever, helped by a USD 100 million-plus deal we signed. We own total of 7 deals better than USD 10 million. Coming to the guidance, the deal pipeline is healthy, and we see sequential growth continue across all the segments like this quarter. We hope to cross the quarter 4 FY '20 revenue mark in Q4 of FY '21.We raised our FY '21 revenue guidance. We now expect [ the USD ] revenue decline of around 6.5% in FY '21 compared to FY '20. The digital engineering opportunity is large. In each of our segments, we are leveraging new ways and digital technologies, which are about 50% of our revenue to gain competitive differences and market share.I'm also happy to share with you that Zinnov rated LTTS as a leader, not only ER&D, the conventional ER&D, but newer areas like Digital Engineering, IoT, AI, and Digital Thread which forms the backbone of new product development today.Before I close, let's pick -- touch upon the transition. We announced last quarter that from 1st April, Amit will step in as CEO, I have been helping Amit transition into the CEO role, and he will provide the update on our vertical performance in addition to large deals pipeline we have.As I look back, at the last 11 years, building this company has been my biggest passion. And I would like to thank all the employees of the company and the people who have worked with me for having shared this same passion.I also want to take this opportunity to thank the investor community during the last 5 years for your patience and understanding the engineering services business and for supporting and encouraging LTTS in all the way. I have strong conviction that this is just the beginning of our journey, and the next set of leaders will take the company to greater hikes. I will always be available to assist and guide the leadership team whenever required.Thank you, once again. And I now hand over to Amit.

[Amit Pal Singh Chadha, CEO & MD]

Sure. Thank you, Dr. Panda. I wish you all a very healthy and Happy New Year. I'll talk about the demand outlook and large deal pipeline at each of our 5 verticals. Starting with transportation, we had a sequential growth of 3.1% with all 3 subsegments, aero, auto, and traction of off-highway growing.Aero turned the corner in quarter 3, growing sequentially in line with what we had talked in quarter 2. Growth was led by the defense part, while the outlook in commercial auto is still challenged, we see consolidation and product software opportunities here. Within transportation, the auto segment had a bit of a soft quarter in quarter 3 on account of seasonality. The spending continues to rise in electric, autonomous and connected vehicle space. We signed up with a few new-age EV logos for some very interesting work involving both electric and autonomous vehicles, in which the opportunity continues to be in localization, value engineering, and electrification. For transport, overall, we won 3 deals greater than $10 million in quarter 3, and we see multiple deals in the pipeline, consolidation opportunities in some cases, and new old and others in the autonomous and EV space. We see the momentum of transportation picking up as we head into quarter 1 of next fiscal.Moving on to plant engineering. We have a good quarter with 9.2% quarter-on-quarter growth with the momentum strengthening versus the previous quarter. In FMCG and chemicals, we see traction in the areas of EPCM services relating to brownfield expansion, low-cost automation of plants, and discussions around sustainability.In the O&G segment, companies are looking to increase reliability and performance and want to leverage digital technologies to achieve the same. Talking about large deals, we are aware of the $100 million deal in Q3, we got from an oil and gas major. We see large deal potentials with others in oil and gas as well as chemical sector through the engineering value center model.The growth momentum will continue in plant engineering, with opportunities in the pipeline as well as the ramp-up of the $100 million deal, which will start in the February, March time frame.Now on to industrial products. This is another segment where the momentum improved from quarter 2 to quarter 3, we had growth of 5% plus quarter-on-quarter in quarter 3, demand was driven by digital in creating smart products, value engineering of existing products, and productivity improvement initiatives on the shop floor. We are seeing and setting up specialized labs in creating solutions in the area of cybersecurity and best automation for our customers.The sustainability trend is driving more spend towards alternative energy sources like wind and solar, and we are leveraging our domain and technical strength to assist with the technology framework and optimization in this area.We signed 3 large deals in IT in quarter 3, and we see additional deals in the pipeline in the digital space, which gives us confidence about growth continuing in industrial products. On to telecom & hi-tech, we see growth recover -- we saw growth recover in Q3, in line with what we had guided in quarter 2. The quarter 3 number also includes the Orchestra acquisition. So overall growth in telecom & hi-tech was 14% quarter-on-quarter, of which organic growth was 3.7%.In semi or semiconductor, we are seeing an improvement in the deal pipeline driven by strength towards new generation chips that leverage 5G and AI, giving us opportunities in design, chip verification, network interoperability, et cetera. In media, there is traction in design of software for applications and media devices, including technologies like RDK, Android, as well as consolidation opportunities in the legacy product maintenance area.In telecom, with the help of Orchestra, we are participating in network virtualization and 5G-related activities. Coming to large deals, we won 1 large deal with a net new client in the telecom & hi-tech area in Q3, and we are working with a few large deals in the 5G space in telecom and semicon. Overall, we see growth continuing and expect the momentum to increase pace by quarter 1 with the conversion of some of the large deals in the pipeline.Lastly, Medical. We had a soft quarter of 2.3% quarter-on-quarter, there was some caution in spending as elective surgeries got pushed back yet again because of resurgence of COVID cases in the U.S. The outlook remains positive, however, with opportunities in digital product design, digital manufacturing, and regulatory compliance. New growth areas for us are in the areas of precision medicine, population health management and telehealth. We won 2 large deals here in Q3, one over $25 million-plus vendor consolidation deal with a prominent OEM, which will help us expand our existing engagement to multiple geos.We see good deals in the pipeline and expect growth to bounce back in Q4 and beyond.To summarize, Q3 saw signed PC, which was double of the previous quarter. Driven by the $100 million deal as well as others that we signed. We are seeing a continuous flow of deals with speed of decision-making close to pre-COVID levels. We, however, are watchful about the lockdowns in Europe and Japan. And though we have not seen any impact so far, there could be a slowdown in decision-making in the current quarter.That said, our deal pipeline has grown sequentially over the previous quarter. We expect this to help us continue the growth momentum. Before I close, on behalf of employees of LTTS executive management and I personally would like to thank Dr. Panda for his leadership and guidance. Some of us like myself, having worked with him for more than 2 decades, although there was -- I was about more than a decade with him have always been inspired by his driving motivation to take LTTS to the top.When we started this journey in 2009, IT was a known industry and engineering services with a possibility. Dr. Panda under your leadership, LTTS is today emerged as the largest pure-play engineering services company based in India.We congratulate and thank you for your guidance, and we look forward to continuing the journey under your guidance. Thank you so much again. I now would like to hand over to Abhi.

[Abhishek Sinha, Whole Time Director & COO]

Thank you, Amit. Greetings and a very Happy New Year to everyone. It has been 3 full quarters since we have been managing business with pandemic.And I would like to provide an update on some of the initiatives and progress on the operations front. Firstly, let me talk about training and up-skilling, which is an area where we have made very good progress. We had invested in setting up a global engineering academy 3 quarters back with a vision to provide deep technical training and certifications in line with our customer needs.We couldn't have thought of a better and more timely investment. As a result, we have been able to provide cross-skilling and up-skilling to over 9,000 employees, which in turn helped us grow the business in the digital and leading as technologists faster.Another area I want to highlight is our focus on design labs. We continue to invest in technology solutions for and with our clients. Once such investment done helped us get enrolled as the only India-based service provider and one of the 6 globally authorized partners in the world to support Amazon, Alexa Voice Service integration for connected devices, spanning multiple domains in industries.Another example of investing along with the clients is the opening of its hub development center to provide our auto customer drive support and developing intelligent next-generation solutions. As you know, we leverage our labs to win new business. We also have an in-house asset management portal where we keep building an inventory of reusable lists, which have seen good traction in the last few quarters. Many of our engineering labs have been enabled to be demoed virtually to our global customers without them having to physically visit our development centers.Now let me shift gears to discuss utilization. We have improved this metric over the past 2 quarters, going from 71% in Q1 to 75% in Q2, and then 77.5% in Q3, which has been one of the primary levers for the EBIT margin improvement. We are also keeping a close watch on attrition, which is at 10.7%, YTD is the lowest level in the past 2 years.Finally, on work from anywhere or what we like to call WFX. Our employees have been getting back to office since June 2020 in a gradual way.Today, around 66% or 2/3 of our employees in India are working from office at least once a week. Through our trademark [ omnibus ] WFX methodology, we have trained and WFX-certified, more than 200 of our project and program managers in areas like productivity management, team morale management, customer trust enhancement, and security, which are essential in today's times.So to summarize, we have tried to adapt to these challenging times and become operationally more resilient. We will share the progress with you as we move forward.I would like to hand it over to Rajeev now.

[Rajeev Gupta, Chief Financial Officer]

Thanks, Abhi. Good evening to all of you, and wish you a very Happy New Year. Let me walk you through our quarter 3 FY '21 financials, starting with the P&L. Our revenue for the quarter was INR 1,401 crores, growth of 6.6% on a sequential basis.We had a second consecutive quarter of margin improvement with EBIT margin rising by 150 basis points to 15.2%. The improvement was driven by a combination of higher utilization, improvement in offshore revenue mix, and better operational efficiency, partly offset by reinstatement of variable pay in full and higher subcontracting costs. While the margin improvement at the EBITDA level was 200 basis points, there was an additional 50 basis points impact at the EBIT level due to amortization on account of Orchestra Technologies acquisition starting from Q3. This explains EBIT margin improvement of 150 basis points on a sequential basis.Moving to below EBIT. The other income was lower on a quarter-on-quarter basis, primarily due to lower export incentive scheme, partly offset by higher ForEx gains. Net income for the quarter stood at INR 186 crores, which is 13.3% of revenue, up 12% on quarter-on-quarter basis, driven by higher revenue and operating margin.Moving to balance sheet. Let me highlight the key line items. Goodwill and intangible assets have increased due to OT acquisition.DSO was fairly steady at 73 days at the end of Q3 compared to 72 days in Q2. The annual days reduced from 20 days to 17 days sequentially. So combined DSO, including unbilled, stood at 90 days, well within our target range of less than 95 days.Improvement in DSO has resulted in cash and investment rising to INR 1,450 crores plus. And this is after the payout of FY '21 interim dividend and the payout of acquisition -- payout for acquisition of Orchestra in October 2020.Let me now talk about cash flows. The year-to-date free cash flow stands at INR 962 crores, which is roughly double our year-to-date net income. This performance was largely driven by a sharp reduction in DSO in the first half of the year. That is over Q1 and Q2. We aim to maintain combined DSO within our target range of less than 95 days. So to that extent, the free cash flow conversion on a sustainable basis which moderate from what you see currently.Moving to revenue metrics. The dollar revenue grew 6.8% in Q3. And if you look at the performance by segment, we had a broad-based performance, as Dr. Panda and Amit highlighted. Growth was led by industrial products, telecom & hi-tech, and plant engineering. The segmental margin performance also saw improvement across the board. All segments improved margin by 100 basis points, plus except for telecom & hi-tech, which would be equally strong, but for the impact from earn-out provisions due to Orchestra acquisition.Moving on to operational metrics. Utilization has seen an improvement of 210 basis points on a sequential basis, while on-site offshore mix improved in favor of offshore by around 200 basis points sequentially. Fixed price and T&M mix remained broadly within the range of 40-60. Client profile, which is number of million-plus accounts across categories showed a sequential improvement in the $1 million-plus range, while others are either marginally down or flat. I'd like to highlight that this metric is on a last 12-month basis and not on a quarterly annualized basis. So to that extent, it will take longer to reflect the quarterly implement, we are seeing in every category. As LTM includes the Q1 FY '21 revenue, which had a sharp dip.In terms of client contribution to revenue, here again, this is on an LTM basis, and it appears that top accounts have declined sequentially. However, we have seen growth across top 5, top 10, and top 20 on a sequential basis, which is in line with the overall company growth of 6.8%.Headcount increased by 167 people sequentially, while attrition remains flat at 10.7%. Our realized rupee for Q3 was at 73.7 largely flat on a sequential basis.Before I end, let me give some color on the EBIT margin trajectory we are seeing going forward. Similar to what I had indicated in Q2 on the positive side, we will continue to improve utilization and achieve better operational efficiency across parameters like employee pyramid, productivity, and attrition. We see scope to increase margins in segments like telecom & hi-tech while continuing to push for better growth in high-margin segments like medical, industrial products, and plant engineering.On the adverse side, we have headwinds from rupee appreciation, wage hikes, on-site localization, and other expenses that are linked to growth. For example, usage of third-party contractors, subcontracting, et cetera. Overall, we aspire to take EBIT margins to the earlier range of 17% on constant currency basis and continue to work sequentially to improve margins.With that, now I hand it over to the moderator for any questions.

[Operator]

[Operator Instructions] The first question is from the line of Vibhor Singhal from PhillipCapital.

[Vibhor Singhal]

Yes. Congrats for a great set of numbers. Sir, my question was primarily on the outlook that we see [Technical Difficulty] in terms of different verticals because generally, what we see that the -- I mean post any financial crisis or because of any kind of external elements because of its corporates are basically forced to cut down their spend. We see the R&D spend comes with a lag of maybe with the 1 or 2 quarters. And this was specifically for segments is what we have historically seen. So do you see that kind of a trend this time as well and that they are basically put out across the globe. So those trends are slowly coming back and not just be keeping the lights on kind of spend, but also incremental spend, which could lead to strong growth momentum for us in FY '22 and beyond?

[Keshab Panda, Whole Time Director]

Amit, can you take that question, please?

[Amit Pal Singh Chadha, CEO & MD]

Sure. Sure, sir. So if the question is -- and you were cutting even out with your question. So if your question, if -- I'll repeat it. Is that, do we expect growth to becoming growth in spend? Is there a lag? Or is it coming back to pre-COVID levels, correct?

[Vibhor Singhal]

Yes. So specifically, speaking sir, basically [ is there some historically, is this some timing correct ] that R&D spend from the recovery is a lag? And if it is, then is that like behind us? Or do we expect maybe to people recover maybe in the coming quarter?

[Amit Pal Singh Chadha, CEO & MD]

So there is -- so #1 is that we definitely are seeing R&D spend, the R&D spend back as we stand today, that is number one. #2 is that the spend that we're seeing coming back is in 2 areas. One is digital engineering. And the second 1 is legacy engineering. And in both these areas, there is -- we see consistency in spend coming back across all the verticals, except commercial aerospace that we believe will take a little bit more time.We are focusing for commercial aerospace. We are turning around, and we are focusing on the defense area in the U.S. but outside of that, all other sectors as we see today are high cost spends that they used to have. Are we exactly at where they were, are they higher, slightly lower, but broadly, we are seeing them back at where they used to be? We do believe that that will provide us a tailwind as we move forward towards both.

[Vibhor Singhal]

Sure, sir. So just my second question if I could squeeze in is on the plant engineering division. I think you've done phenomenally well in that segment, and that continues to be a good strength. Up till now, I think we've seen on the base of the deals also is being driven by the oil and gas segment and of the likes of it. In terms of retail and CPG segment, how far do you believe we are from a full segment recovery and we could see some, let's say, greenfield expansions or from those kind of strength coming back in this segment for us?

[Keshab Panda, Whole Time Director]

So in terms of plant engineering the attempt that I will ask Amit to answer this. See, like our growth is in oil and gas -- overall plant is growing, not just oil and gas. We are growing in FMCG segment as well. If the FMCG segment has done reasonably well. Some of the learning we had in FMCG segment, we have taken into oil and gas, the [ large bills ] we own, that is because of that.So these 2, we always draw a line between what is common between all these segments, specialty chemical, oil and gas or FMCG and those common service offering, we take one, 2 others. So that has given us there. Earlier, if you see 1, 2 years ago, our dependency more on the greenfield project and brownfield projects. And if there is a ground, that's something we don't control. But what we control is, we understand the plan very well. We understood what technology required for the plant very well. So then how do we take that for the customers the efficiency improvement, then we take over complete plant as a whole. I think that model is working well. More and more is going to be in that area, I would think moving forward.

[Operator]

The next question is from the line of Sandeep Shah from Equirus Securities.

[Sandeep Shah, Director of Research]

Yes. Just wanted to understand, as the decision-making has come back to pre-COVID levels if you guys believe that the FY '22 or CY '21 could be a year of pent-up demand? Or do you believe it is too early to expect the same? And a related question is just on the fourth quarter. If I look at implied guidance, it comes to around 3.2% Q-on-Q, of which, if I'm not wrong, 1.5% to 1.8% growth may be driven through $100 million deal, 9.4% may be through cost currency.So the rest of the business outside this -- outside the $100 million deal and a cross-currency tailwind, would be just 1% to 1.5%. So is it conservative because your deal wins are robust even outside the $100 million deal? And then I have a last question on margins after this?

[Keshab Panda, Whole Time Director]

Yes, on the deal side, Amit, can you please discuss about the customers buying and what's going on. And Rajeev will answer the margin part of it. He will talk about Q3 to Q4, how we look at it overall. Can you do that?

[Amit Pal Singh Chadha, CEO & MD]

Sure. So Sandeep, as far as decision-making is concerned, as far as that is concerned, we are seeing decision-making happening at a faster pace than it was in Q3 and Q2, right? So that is point number one. Point number two, is there pent-up demand that we'll all of a sudden see a big rush coming in. The answer is that things have been gradually coming back quarter-on-quarter, and that shows up in our results as well, right, also in our deal closures, et cetera.So as we go forward, we continue to be optimistic about the future in terms of growth, right? So that is point #1. Point #2 is the $100 million deal that we talked about. I also mentioned that the ramp-up will start in a gradual manner, at the end of February, early March is when it will start.So the full -- and it will take time for it to ramp up completely. So the guidance that we had -- Dr. Panda has provided right now, and we have provided, is where we are -- we are comfortable in sharing you right now. Of course, we will try and -- we will make all efforts to make sure that we bounce back faster, stronger, better, et cetera. That is 2. Third, is that regards -- regarding the deal in quarter 4. EBIT, I will request Rajeev to cover.

[Sandeep Shah, Director of Research]

Yes. Rajeev, just want on the Rajeev's...

[Amit Pal Singh Chadha, CEO & MD]

There is 1 more point I want to say, look at this way, that the $100 million deal has not contributed revenue till now, this is -- we are taking over from a western company. They have been doing for the last 20 years. Now there's a knowledge transfer. There are a lot of things, process understanding, doing that, it takes time. One thing for sure, this deal is going to contribute in a big way next year.Whereas actual revenue, how much we are going to do in February and part of March, how much will be part of February and March, I think that we are still working on it. So that is one of the reasons we want to make sure that we give a guidance where we know for sure. We don't have a luxury of not meeting what we talk to you. So we are very careful about that. And based on that, what I see today, we have given a guidance.

[Sandeep Shah, Director of Research]

Yes. Fair enough.

[Keshab Panda, Whole Time Director]

Anything you want to add, Rajeev.

[Rajeev Gupta, Chief Financial Officer]

Dr. Panda, I think I'll just let them pose the question on margin, and then I will add to it.

[Keshab Panda, Whole Time Director]

Yes. Yes. Okay, that's fine.

[Sandeep Shah, Director of Research]

Yes, Rajeev, my question on margin is the implied guidance indicates that our revenue run rate would be similar in the Q4, it was pre-COVID level. And in the earlier quarters, we have said whenever we go to that kind of run rate. Our margin can improve to the pre-COVID level, which is close to 16.5% to 17%, is it fair to say that by fourth quarter itself, we can aspire to be there or it may take slightly longer time and when are we planning for a wage inflation? Because it looks like if it's not coming in fourth quarter, we are not giving any rate hikes in FY '21.So do you believe this may be a risk to the attrition because the -- across industry, there could be a play round of base inflation in a span of 2 or 3 quarters?

[Rajeev Gupta, Chief Financial Officer]

Sure. So I think you've got 3 questions. Let me respond to each 1 of them. So as far as -- we've always maintained over the last 2 quarters that we will exit Q4 FY '21 at Q4 FY '20 levels, right? And you've sort of computed and the implied guidance for Q4. To be specific, I think as far as the revenue, we see the trajectory to come back to Q4 FY '20 level. And at the back of it, right, I think what we endeavor to do is also to have profitability come to levels of Q4 FY '20, and that's how we see it.The second part is, in terms of the wage increases, we will see wage increases effective April 1 for junior grades. And for senior grades, we will see that effective July 1. As far as attrition, we've been around 10%, 10.5%, 10.8% range. We believe that Q4, there may be a slight uptick on attrition. I think the attrition has been rather tepid over the last couple of quarters. But we see that going up slightly but it's not concerning at this point in time that I would call out there. I hope that responds to your question.

[Sandeep Shah, Director of Research]

Yes. All the best, Dr. Panda. It's always informative to talk to you.

[Operator]

The next question is from the line of Pankaj Kapoor from CLSA.

[Pankaj Kapoor, Research Analyst]

I just wanted to understand the large deals in which you have signed with the oil and gas major. Any color in terms of how the commercial construct of this deal is different from previously signed deals or the other license that you typically had one, because it's a significantly larger in size. So maybe in terms of any kind of a pass-through to this? Or is this pure-play services any color that you can give there, that would be useful?

[Keshab Panda, Whole Time Director]

Pankaj, this is like this. The deal what we got now. This is, again, I did explain last time our sustenance engineering and digital -- use of digital -- new technology for the performance improvement and so on. So the difference -- earlier what we did -- only the clear difference and earlier, what we did and now what we -- earlier was upstream, this is downstream.Okay. We got a lot of investment in opportunities not happening, then oil price has gone down or limited investment is happening there. So we realized we are not going to wait for oil price to come back to 60, of course, it comes to -- it has increased now to 50 to 53 now. So we said when this oil price is lower now, what are the options available to us and what technology offering we have, we can go to different areas. So this is the downstream what we are doing it for the refinery and that's where, I think, much more opportunity. And imagine the 2 biggest plants is what we have taken over and which we are providing services.And I strongly believe this is a great opportunity for this segment as a whole, we see do it well, and there's no question that we've -- I'm sure we'll do it well. This can be taken to multiple refineries from the same customer itself.So this is a different type of deal, and we need to have a -- we are creating a center very close to the plant. And then we have a center -- major part of the employees are going to work from India. So both -- combining both together, and then -- this is the first time the customer decided to do this because of cost pressure, and we have done good jobs in customer. They have been working for a long-time. They know us well. So decided to switch to a supplier who's been doing for the last 20 years, this [ sister ] to LTTS. So I think there's a lot more things we learned in the process of doing it. And I believe this is a great opportunity for a engineering services company like us.

[Pankaj Kapoor, Research Analyst]

I understand that Dr. Panda, this is really useful. My question actually was more around the -- any kind of high investment that we need to make, as you mentioned, we'll be putting in some people for the transition, et cetera. So my question was more around that, how could be or how much would be the margin impact of this deal, that was the one which I was looking for. And...

[Keshab Panda, Whole Time Director]

It doesn't have a margin dilution, we don't have big investments, there is no major investment there and there is no dilution in margin, Pankaj.

[Pankaj Kapoor, Research Analyst]

Understood. And Rajeev, my second question was on this quarter margin profile. You had several good levers playing out like utilization, offshore mix, et cetera. And SG&A, we were also playing well, I was curious to know why -- what were the headwinds there because the margin expansion could have been far higher, given the kind of movement in these dealers. So what were the brands in the margins? If you can highlight and I you can give some consecutive color on that, that would be useful.

[Rajeev Gupta, Chief Financial Officer]

Sure, Pankaj. I think you already highlighted as far as the tailwind side, I mean, we saw utilization improved, so offshore revenue mix improved. In terms of the headwinds, as we have mentioned in the previous quarter commentary, this quarter, as we are now moving towards pre-COVID levels, we did provide for variable pay in this quarter. So that was the headwind. The other is, we did see increase in subcontracting costs as we service increase in revenue. Those are the clear 2 impacts. And the third is, we had to take earn-out provisions for focus for technologies, while that's not significant, but those are the 3 headwinds to talk about.

[Operator]

The next question is from the line of Vimal Gohil from Union Asset Management.

[Vimal Gohil, Research Analyst]

Sir, my first question is on digital engineering. You cited Zinnov. And one of the reports, they have released mentioned that digital engineering is expected to grow at almost 20%, 25% over the next maybe 3 or 4 years.I just want to know how LTTS is planning to capture this trend? And what is the proportion of work that we do in digital engineering as a percentage of our total revenue? If that data is possible?Secondly, you spoke about 1 of the margin headwinds that you spoke about was on-site localization. Given the current situation we are in, and I mean in this pandemic, probably 1 thing is proven that things are moving as smoothly virtually as well. I mean, you're winning $100 million deals effectively virtually right now.So I just wanted to know what is the rationale behind going back to further aggressively increasing on-site localization because that is going to put pressure on margins. So these are my 2 questions.

[Keshab Panda, Whole Time Director]

Yes, I think I would -- the other part I would ask Amit to answer, but 1 thing I'll tell you the -- as you know report saying that 20%, 25% increase, we are in the -- if you see 2019 to 2025, the digital engineering or the new tech engineering, see we are at 20% growth. Whereas if you see legacy engineering we are in the near-spend is growth is only 2%. That is if you see in 2030 or so, the legacy engineering is good almost go to die down, anything we do in the new tech engineering or it's called digital engineering. So we are today, we have 49% of our business comes from digital engineering right now. So we have -- we are going -- we are moving much faster than what the industry is growing, and we'll continue to maintain that moving forward. Amit, do you want to add and take this, please?

[Amit Pal Singh Chadha, CEO & MD]

Sure, sir. So when we talk about digital engineering, we divide that up into multiple parts. Digital engineering for us is product design, cloudification, analytics, creating cybersecurity modules, and products, as well as remote design collaboration, right? So these are elements as far as product is concerned, including looking at the total experience to the product from customers, the user, employees, putting it together, as well as looking at the AI/ML part of it, et cetera.So that is 1 part, the digital product for us. Then the second part for us, so the digitalization manufacturing, which is on the top floor, which is smart manufacturing. And some people call industry food or to other people have got different names for it, IIoT, et cetera.So we have been spending energy, time. And like Dr. Panda said, we've been investing in this area by creating a lab, second reusable assets; third, finding patents for ourselves and our customers. Fourth, setting up a training academy that Abhi alluded to in terms of training our people. So all these 4 have been going on in parallel and the Zinnov rating is just an indication of what we've been able to do.We -- our wins that we have had in the industrial products, growth that we have seen is also backed by the work we have won in digital in that in discrete manufacturing in that area.In addition to that, 5G rollout, as well as OTT for hi-tech, will continue to be areas for us in digital that will grow.So those are the various components, or subcomponents, whether if I look at the digital fees for ourselves. Rajeev, do you want to take the localization part?

[Rajeev Gupta, Chief Financial Officer]

So the only part that I will add for localization. See, this is also a measure that we're taking to mitigate any H1B-related challenges. So this is a thought-through step. I mean, and also, we will try to see this over a period. So that's what I will add to as far as that venture question is concerned.

[Operator]

The next question is from the line of Salil Desai from Marcellus Investment.

[Salil Desai, Executive Officer]

I'm sure -- sir, I'm not sure if this has been discussed in the earlier calls. But Dr. Panda, after 1st of April, do you have a role -- in sort in the company would you be mentoring the...

[Keshab Panda, Whole Time Director]

I'm sorry, I don't know, the line is not very clear. Are you saying after March 31, am I going to be around in the company?

[Salil Desai, Executive Officer]

Yes. I mean what role would you have if any?

[Keshab Panda, Whole Time Director]

No, I'm not going to be in LTTS. As you know, we announced in the market that I'm going to be Non-Executive Director for LTTS, right? That we have already announced in our stock exchange filing last quarter when we did, we did that. And this is very close to -- I'm very passionate about this company, it's very close to my heart. And a team of people, we all work together to build what we did.But be rest assured, that nothing we are going to lose it -- leave it to, I mean, loose end, making sure that whatever the foundation we created, 538 patents and the customers and if you see, 1 more, I will request all of you to have a look at it.Zinnov came with digital engineering services ready for 2020, all the companies around the world where they can and then in that, they have taken AI, Digital Thread, OTT, IoT, you see the positioning what we have in LTTS. This company, 2014, we created the independent company, L&T Technology Services. Today, in a very short time, anything on the new technology, our positioning has been -- I think we are always relative zone. And we'll do everything possible. I will do everything possible to make sure this company's flag continue to fly high.

[Operator]

The next question is from the line of Pritesh Vora from Mission Holding.

[Pritesh Vora, Vice President]

Congratulation on good sets of number and quarter-on-quarter amounts. My question is, our background feedback, we have got it, we understand that a lot of OEM have come to realize that a lot of cost saving can be done and synergy can be attained. Because the work anyway is done by outsourcing personal sitting in-home or their own personnel working from home. So the bill -- so the dividing line between Employer and outsource the employee, as well as the employee, is falling very fast, which will improve the growth over the sector -- in the sector over the years. How are you reading this development?

[Keshab Panda, Whole Time Director]

Listen, I think our customers are all -- we don't do very little work in India, right? Customers are outside and the cost factor and some of the lab investment, multi-vertical knowledge, what you have, it is very difficult for a customer to do a German customer or the French customer, not going to send people somewhere and these all their employees to work in a place, their local employees who are there today and get the productivity and innovation of what we have been doing it.It is working from home, it's helping in 1 way to ask company like us, what they believed earlier cannot be done from home or offshore they're believing that this can be done from offshore. That's a very positive move. And if you see our -- we believe that the revenue ratio offshore to on-site, that should work into our advantages, that's what we want. There is customers working from home. We work from home, we are saying it's not something. But I think if you extrapolate to IT, that's conclusion we get here.In engineering, one has to -- we have a power electronic lab and we have the different labs we have, [ pay down labs. ] We have lab on the EV lab, we have. So this labs value created, it goes a lot of pack and got into this to create that. It is not something just put people at home or here or any country it can be done.There's a lot of multiplicate -- a lot of complication there. So I don't think we are worried at all in this if at all, I think, it is going to help. It's going to help us more than what we did in the past. That's how I look at it.

[Operator]

The next question is from the line of Prashanth Uppuluri from Foyston, Gordon & Payne Inc.

[Prashanth Uppuluri, Senior Research Analyst]

My question is a little bit more from a longer-term perspective on margins. And what is it about your transport and hi-tech verticals that makes the margins appear to be structurally lower than the other verticals? Is it because of lower billing rates in these verticals or the mix of work? And what are the trends you see on both these counts? And kind of related question is, could you compete with, with these subverticals?

[Keshab Panda, Whole Time Director]

I would like Abhishek to answer that on the margin front, transportation, telecom, let him make attempt to do that. And on the -- who do you complete part, Amit will answer or I would answer later. Abhishek, can you take this question, please?

[Abhishek Sinha, Whole Time Director & COO]

Yes, Dr. Panda. See, I think the question you asked on was, first, let me talk about the transportation vertical. So transportation vertical, the fact is that as the pandemic broke, clearly, more automotive in which customers ask for discounts and probably any other sectors.And that clearly showed in the drop that we saw in Transportation segment in Q1 and Q2. But as you can see, we are picking up there, definitely. We believe that by Q4, we will come closer actually probably cross the numbers. That's one.The second one, I think, on the transportation sector is, I mean, all of you know, aerospace business took a big hit in terms of the pipeline and Amit already mentioned that. I think that is something that has hit us very hard, despite that, like I'm already saying, by Q4, we'll pull it back to the overall transportation segment will pull it back to the levels that was in Q4.So I don't think there is a structural issue with the Transportation segment. Of course, there are more captives, most of the OEMs, Tier-1s in automotives have captives that creates some competitive pressure from a internal -- from a competition perspective in transportation, while for some of the company -- we look at definitely Tata Elxsi, TCS, HCL, KPIT, some of the competition in India.And of course, we look at companies like IV and others in the global companies as well very closely watch them, especially in areas like [ a strict partnering there ] we believe that we have very strong differentiated offering.Coming to telecom & hi-tech. I think there is work to do this. We have I mean the numbers are in front of us. We are not where we would like to be. Having said that, this specific quarter despite the Orchestra Technologies acquisition. We were still on the positive territory. I strongly believe that we will keep moving forward in the hi-tech segment as well from a margin perspective with every passing quarter over the next couple of quarters. I don't see any challenge there given the kind of pipeline we have and the kind of I mean that OT coming in and the initial.

[Amit Pal Singh Chadha, CEO & MD]

Let me help. Thank you, Abhishek. See, I think if you see outsourcing dollars happening more happens in Transportation segment and Telecom & Hi-tech segment. We to take, this is segment transported from 3 components off-highway, automotive, and aerospace. And this is crowded. They two work on the mechanical side is highly crowded. Any company will look at it, they are into transportation, doing piece of business in mechanical engineering or some subsystem design, system design.Whereas, if you -- what we have done it now, this is a tough feel though, unless you attend to agree minute unless you have a clear differentiator and this is going to be a difficult game to play it. We have made an investment for some time, this is a segment we entered late because other industrial, medical plants, all that came from L&T legacy, a lot of experience we got from there.In this segment, they are now focused on more on the electric vehicle. So we have taken what we learned from industrial to automotive. Now we are taking that to aerospace. This is a positive thing. We believe that's going to grow. Connectivity of IoT, this is again a big area now. That's going to help, but we have telematics and connectivity, that's the area we are focusing on.Then in Airbus -- sorry, in the Aerospace segment, the commensal aerospace will take some time. Commercial that to come back. Whereas, we are looking at it on the military side, on defense side, ITAR side. So we have a few wins we had with a sizable different margin point of view.So I think we improved from Q2 to Q3 if you see 100 basis points we improved. And our goal is to continue to do only profitable growth, profitable business, so we continue to grow and which we cannot afford to -- because this is a growth engine, it's going to grow. On telecom & hi-tech, again, the component, if you divide into we had telecom infra, we had semiconductors. So the 1 segment is profitable, both segments are equally profitable, I would say, but we had OT platform, which Rajeev talked about it. And onetime deal, we have taken for the knowledge, understanding that technology, which is going to help us on the media entertainment side.For example, we believe these are going to build competency, it's going to have long run. So it is a margin lag at the level of what we would have got. So it's a transactional one-time deal, low-margin bill, which has impacted a bit, but our goal is, sequentially, quarter-on-quarter, we start growing margin in both the cases.

[Prashanth Uppuluri, Senior Research Analyst]

That's a very helpful response. If I can just follow up a little bit on that. Do you see more greater competitive intensity in RFP pipe deals in these 2 verticals? And I'm looking at margins pre-COVID, I mean, unless it's concerned about the past couple of quarters. But from a more longer-term perspective, if I go back even say 2, 3 years, what is it about these 2 verticals that keeps their margins on a comparative basis, lower than what you see intake plant engineering or industrial products.

[Keshab Panda, Whole Time Director]

See I think on the transportation, Amit, why don't you answer this? Both transportation and telecom $ hi-tech. Please do that.

[Amit Pal Singh Chadha, CEO & MD]

Yes. So on transportation, if you look at it structurally, right? And if we look at the kind of work that we do and the type of work that we do, there is a little bit of onshore work that including a defense part that we do that's being done in the U.S., right?And then there were local delivery centers here. The new wins that we are having in automotive, that's in the areas of EV as well as autonomous and electrification in [ TNOH ] and inside entertainment in aero -- in software area and aero is all improving the offshore ability of the work that's happening.So structurally, earlier, if you go down, like you said, 2 years, 3 years, there was a higher percentage of work being done onshore in transportation, that's clearly in moving offshore. And as we move forward, you will see that there is headroom for us to grow, and we will improve the margins, right? That's number one.Number 2 is, and I'll also say one more thing on transportation, and Dr. Panda alluded to it. See, our differentiated operating in auto [ TNOH ] and aero, the new offering that we have got is all-around software, right? And a lot of that is very, very differentiated because we're bringing it from our IT, we're bringing it from telecom. So we're differentiated from traditional player. And therefore, we'll see improvement in terms of growth as well as margins in this area. But structurally, on-site is more, and that's really going down.Now let's go to telecom. Telecom, like was mentioned before, we have been in a very competitive marketplace.And therefore, if you look at it, we have had a challenge in terms of margin there, not just because of being competitor, but also because we had a division that is working out of, again, a non-India location, servicing the telecom & hi-tech market. That particular center also now has been drawn down. And the work will be moved offshore. There is a one-off transaction that we did to build technology in the areas of OTT in April of last year, April '20, and that again is now rather as we get to -- as we move forward that particular thing would also get smoothed out. And therefore, you are seeing there will be headroom for us to be able to improve our margins. So that's where we are.

[Operator]

The next question is from the line of Kunal S from Bank of America.

[Kunal Tayal, Vice President]

Amit, I wanted to call out on, I think, the statement you made in your opening comments that you might need to watch the pace of decision-making this quarter or in Q4. So just to better understand that comment, I mean, is it specific to lockdowns, new wave of lockdowns that are coming? Or is it because of general business uncertainty. And if it's because of lockdowns, would you still think that the list this time around uncertainty could be lesser than what customers are foreseeing during the first wave. And maybe the final card, did you mean that this is for Europe or U.S. as well?

[Amit Pal Singh Chadha, CEO & MD]

Sure. So Kunal, thank you so much for that. Now one, we are seeing -- we are watching the lockdowns in Europe, and I will quantify U.K. -- Germany, U.K. These countries that are -- there are announced lockdowns till early Feb, right? That's what they have done publicly. And even Japan has announced a lockdown till end of January, early February. So we are watchful of those lockdowns and whether they will get extended. And therefore, impact of that on decision-making in terms of speed of decision-making is what we've said we are watchful about.We do not think that to your second question, we do not think at this stage, that we will come to March-April levels of 2020. But we are watchful at this stage. I mean, it's not that we are concerned, but we are watching at this stage. And at this stage, we had baked that in into whatever we have committed in terms of way we will end up.

[Kunal Tayal, Vice President]

Got that. And maybe just a quick follow-up on the variable pay part of it. Broadly, the upward division this quarter. Are you in the ballpark that you expect to be going ahead as well? Or is there room for taxes even from here?

[Rajeev Gupta, Chief Financial Officer]

Let me answer that. This is Rajeev here. So yes, we'll be in the ballpark to what has been in Q3. Hope that answers your question.

[Operator]

Thank you very much. We'll take that as the last question. I would now like to hand the conference back to Mr. Pinku Pappan for closing comments.

[Pinku Pappan, Head of Investor Relations]

Thank you all for joining us on the call today. We hope we were able to answer most of your questions. If you have any follow-up queries, please reach out to me on email. Wishing you, again, a very happy and prosperous 2021 and safe times. Goodbye, and have a great day.

[Operator]

Thank you very much. On behalf of L&T Technology Services Limited, that concludes the conference. Thank you for joining us. Ladies and gentlemen, you may now disconnect your lines. Thank you.