Sterlite Technologies Ltd

NSE:STLTECH

Earnings Call Analysis

Earnings Call Transcript 2025-Q1

[Chetan Wani, executive]

Ladies and gentlemen, good day, and welcome to the STL Q1 FY '25 Earnings Conference Call. I'm Chetan Wani, and I'm responsible for Investor Relations at STL.

Today, we are joined by Ankit Agarwal, Managing Director and CEO Optical Networking business, STL; and Tushar Shroff; Group CFO, STL to walk us through the Q1 FY '25 results and to answer any questions that you may have.

[Operator Instructions] You can also download a copy of the presentation from our website that is www.stl.tech. You may please note that this call is being recorded.

Before we proceed with this call, I would like to add that some elements of today's presentation may be forward-looking in nature and must be viewed in relation to the risk pertaining to the business. The safe harbor clause indicated in the presentation also applies to this conference call.

I now hand over the call to Ankit Agarwal for opening remarks. Over to you, Ankit.

[Ankit Agarwal, executive]

Thank you, Chetan. Good day, everyone, and thank you for joining us for our quarter 1 FY '25 earnings conference call. As we enter quarter 2 of FY '25, directionally, our strategic priorities remain the same. On the Optical Networking business, we shall continue to focus on driving growth by increasing OFC market share and connectivity attach rate. We'll focus on rapidly building data center suite of products to have the huge potential in that space. We shall also continue to drive our technology and cost leadership in the Optical business.

On global Services business, we shall continue to build new capabilities for value-added services. We shall stay focused on improving our project mix to improve profitability and we'll work towards completing the demerger of our services business.

Lastly, in our STL Digital business, we shall continue to scale the business through conscious investments in building new technology and domain capabilities while we keep our focus on maintaining our profitability. STL has always endowed to be a responsible leader in ensuring a connected and inclusive world. Through our various initiatives in education, women empowerment and healthcare, we have positively impacted millions of lives since FY '19.

To highlight some of these key initiatives, we started RoboEdge in 2023 with an intention to power students with next-gen skills and focus on robotics to enable career growth, and we've been able to cover more than 11 schools and 3,500 students, which have benefited already. Next to the right is our Jeewan Jyoti program, founded by Mr. Jyoti Agarwal to empower underprivileged women by training them in various vocational skills to make them financially independent. So far, more than 5,000 women artisans have been benefited from this program.

We also started a hybrid healthcare program during COVID, providing primary health care as well as telehealth facilities to marginalized communities in rural parts of select districts of Maharashtra, and we impacted more than 1 million lives. To its left is a forestation and water replenishment program, where we are working with 26 Gram panchayats for creating or rebuilding 95 order structures. Efforts have resulted in replenishment of 2.69 million cubic meters of water in Maharashtra. Under this project, we have created urban and rural forest by planting maintaining more than 3 lakh plants and we sincerely continue to drive such initiatives going forward.

On the ESG front, we are committed to our goal of being net zero emission organization by 2030. We presented some of the accomplishments on this front and to mention a few achievements since FY '19. We have diverted more than 250,000 metric tons waste away from landfills. We have reduced emissions of more than 34,000 tonnes of carbon dioxide equivalent. We have recycled 860,000 cubic meter of water during these years. We are proud to share that we have even one more than 100 ESG awards for our work.

We are the world's first optic fiber 5 manufacturer launch externally verified eco-labelled methodology. When compared to standard products, these eco-labelled products utilize approximately 52% less energy, carry 75% less global warming potential and use approximately 18% more recycled content, and 25% more packaged -- recycled package material. These products also reuse and recover almost 20% more waste and enhance the longevity of the network by nearly 13 years, thereby benefiting both the clients as well as the environment.

On the next few slides, let's talk about the Optical Networking business and our specific efforts toward becoming the top 3 players in the optical connectivity business. Now as we reflect on FY '24 in the last quarter, as per CRU's latest estimates, OFC consumption for 2023 declined by 7% globally. This was led by almost 12% decline in North America market. As we have shared previously, the inventory at multiple layers played a major role during this time and a suboptimal factory utilization was a trend across the industry. Despite a lower fresh demand during the last few quarters, we observed robust and continued fiber deployment, resulting in healthy inventory digestion. Various analysts reports estimate steady demand improvement as well as demand scenario to stay robust for the medium and long term.

As we look at the future projections from CRU, the medium-term demand in the optical fiber cable volume is expected to go up to 662 million fiber kilometers by 2028, up from 536 million fiber kilometers in 2023. This projects a healthy 4.3% annual growth in global demand and a strong 7.1% growth in annual demand from 2023 to 2028 if we exclude China. The positive demand outlook by CRU, along with our continued client commitments on increasing fiber deployment and steady STL order book additions is indicative of our recovery in the coming quarters.

Let us also look at a major technology trend that is AI and its anticipated demand on fiber demand. As we discussed on previous earnings calls, AI and machine learning are gradually taking the center stage and swiftly blending in with all mega technology trends. While data storage consumption and bandwidth requirements has spurred the demand for data centers over the last few years, 2023 will be remembered as the coming of age of AI. ChatGPT reached 100 million users worldwide in just 2 months, a goal that took Facebook 4.5 years. Industry reports suggest that 2/3 of global network traffic sell involved AI by 2030.

For the growth of AI and technology used to sustain and succeed, the technology backbone shall need massive amount of data center capacities that smoothly manage this data explosion. As we understand more, the evolution of AI is actually reshaping the data center designs, and architecture. It's estimated that the overall optical connections and fiber requirements in AI data centers will be significantly higher than traditional CPU-based data centers. If we look at some of the key layers in the data center architecture, typical optical connections in the AI data center is estimated to be 5x compared to traditional data centers and rack density may be as high as 1.5x.

The fiber channels required to store -- in the storage layer, approximately estimated to be 1.5 to 2x of the traditional storage layers in traditional data centers. Overall, network and connectivity may require as high as 18x higher fiber content in the AI data centers. Overall, data center capacity in the world as well is expected to grow at a rapid pace up until 2030 at least.

In summary, in this era of the AI revolution, fiber shall need to be at the core of connectivity within and outside data centers. This fiber explosion within data centers and higher fiber requirement for data center interconnectivity presents a massive opportunity for a company like ours and have set an ambitious target that approximately 25% of our revenue should come from our data center suite of products in the medium term.

Apart from the AI-driven investments that I just spoke about, globally, the fund infusion that we are seeing in 5G network creation, FTTH deployments as well as cloud data center build-outs continue to be very strong. 5G remains one of the fastest-growing technology in the world, and tower fiberization is at the core of 5G, not just in India but also globally. 5G subscribers are expected to grow rapidly in the medium term across geographies and we can see 5G subscriber addition in North America, Western Europe and India, expected to be robust all the way up to 2029.

As per recent report from Analysys Mason, the average fiberized mobile sites of towers in India stands at 38% in 2024, which is expected to increase to 63% by 2029. With higher 5G subscribers and higher number of 5G towers at higher tower fiberization requirement, 5G clearly is at the core of global expansion and should continue to drive demand for more optical fiber. FTTH connectivity remains -- demand for homes and businesses globally remain strong as well.

In the U.S. alone, approximately 100 million homes await fiber-to-the-home connections. Europe FTTH passes expected to grow by 4% at the least for the next 5 years, and India is expected to lead the global growth in FTTH installations with 26% CAGR expected between 2023 and 2028. Data center deployment is expected to continue attracting strong investments with data center capacity in North America projected to grow by more than 10% CAGR between 2024 and 2029, while Europe is expected to grow at 8.5% CAGR to 2027.

In India, the existing data center capacity is expected to more than triple between now and 2028. As we saw previously, the data center connectivity requirements will continue to drive the demand for optical connectivity products. The demand outlook is also expected to be supported by other factors, such as what we have witnessed in terms of improved telecom tariffs in India, especially between Airtel and Jio, resulting in improved financial health and investment capability of the Indian telecom companies.

The existing antidumping duty on Chinese products in India and Europe and overall industry shift from copper to fiber. On top of that, we also have the mega government projects, such as the BEAD project in the U.S., BharatNet project in India and other such programs in Europe, Australia and other geographies, which will also overall increase the demand for optical connectivity products.

Coming specifically to the North America and the U.S. region. At STL, we have been optimistic on the demand in North America region. CRU has projected that the North American optical cable demand is expected to grow at approximately 13% CAGR till 2028. The fiber deployment in the region stays strong at more than 9 million homes passed in 2023 alone and will be between 9 million to 12 million incremental home pass addition expected in this year 2024. The telecom and Internet provider companies in North America have set aggressive ambitions on FTTH home pass additions for the next 2 to 3 years and have announced these targets publicly.

For instance, AT&T in the very near term intends to add 19 million new homes. Lumen plans to add another 9 million homes, Frontier has already announced 5 million new homes to be passed. In addition, the government spending through BEAD and other programs shall only add to the fiber deployments planned by the private sector. As for the latest update, the program is progressing steadily and is showcased in the coming page. Some analysts expect BEAD funding to begin by the start of 2024. All in all, it is estimated that North America -- in North America, nearly as much fiber will be deployed in the next 5 to 6 years as has been deployed throughout history.

As a technology-driven company for the past 3 decades, we have meticulously and passionately built capability across the optical fiber value chain. Our business and reason for existence is deeply rooted in fiber and technology has made the core of it, right from creating ultrapure glass preform, state-of-the-art optical fiber drawing, optical fiber cable and more recently, optical connectivity products. We are truly offering glass to gigabit connectivity. Our passion for innovation has resulted -- has driven us to solve industry challenges like attenuation, bend sensitivity, compatibility, duct space, labor availability and the TCO reduction and created advanced fiber solutions that will support everything from immersive entertainment to add scale gen AI experiences.

Some of our solutions are truly first in the world or sometimes first in India such as India's first multicore fiber Multiverse, which offers 4x the capacity in the same fiber, Stellar Fiber with superior bending performance. We are amongst the first companies globally and amongst India's first to develop the world's slimmest fiber mutualized advanced fibers with diameters of 180 and 160 micron. We're also proud to share our progress on the IP portfolio but during quarter 1 FY '25, our total IP patent portfolio increased a total of 715 patents, including filed and granted. We filed 32 new patents during this period and a record 24 patents were awarded to us in the U.S. and India. We continue to push the boundaries and drive product innovation relentlessly to achieve many more first in the future as we move forward in our journey to become one of the top 3 optical networking companies globally.

Let us now reflect on our market share in optical connectivity rates. Basis CRU consumption data during H1 CY '23, we had 8% market share on optical cable demand, excluding China. Our C1 '24 market share, however, was observed at 6%, amidst challenging market demand environment. We believe that the market share shall normalize as the fresh demand steadily picks up and as we have also intensified efforts to regain our market share. We are happy to share that we have recorded our highest ever optical connectivity attach rate during the last quarter at 23%. We are continuously working on new product developments and commercialization in optical connectivity space to further increase our attach rate.

Coming to the financial performance for the Optical business. In line with our guidance, Q1 FY '25 revenue stands at INR 810 crores, which has marginally improved on a quarter-on-quarter basis. EBITDA for the quarter stands at INR 88 crores at 10.9% of revenues. EBITDA margin reflects substantial improvement on Q-on-Q basis, and stands lower on a Y-o-Y basis due to lower cable volumes. The Q-on-Q EBITDA improvement is indicative of success of various cost optimization measures undertaken by the company.

Having completed our capacity expansion as shared in previous discussions with strategically located manufacturing assets and continued focus on cost structure optimization, product innovation and focus on data center product portfolio development as well as approvals from Tier 1 customers. We are very well positioned to capture the significant market share going forward and grow the business as the demand picks up.

Now let's discuss the progress in the Indian market and the growth of the Global Services business. In the Global Services business, quarter 1 FY '25 revenues stood at INR 355 crores, a selective order intake and execution focus has helped us achieve quarter 1 FY '25 EBITDA of INR 25 crores and EBITDA margin of 6.9%. We continue to build our capability towards value-added services to improve our margin profile and reduce the fund involvement.

On the project execution side, we have made substantial progress on all key projects during this quarter. Among major India public projects, our BharatNet project in state-of-the-art Telangana is 69% complete, including all packages. The data center project with a PSU stands at 93% completion. Among the major India private projects, fiber rollout for a large Indian telco Phase 2 is now 59% complete, fiber rollout for a modern optical network for another private customer is 98% complete. With an extensive large project experience, we are well positioned to tap BharatNet Phase III opportunities in the coming quarters.

Now let's discuss about STL Digital business and their performance. In STL Digital, we are continuing the growth momentum. We are continuously working with new customers for growing our business in the U.S., Europe and India across technology and service verticals and absorbed a healthy fresh order flow during the last quarter. We're working with our 25-plus global customers and 40-plus active technology partners for business growth. We expect the future growth to be driven by robust order book of more than INR 377 crores, healthy order pipeline and execution strength backed by the right team of leadership and consultants.

In line with our expectations and despite a tough industry environment, we achieved a quarter 1 FY '25 revenue at INR 71 crores, displaying a growth on year-on-year basis. The EBITDA loss for Q1 FY '25 stands at INR 17 crores. The EBITDA loss is trending down with on year-on-year basis and also suggests improved margins Q-on-Q basis.

I will now hand over to Tushar to talk through the financials.

[Tushar Shroff, executive]

Thanks, Ankit. Good day, ladies and gentlemen. In line with our guidance, the consolidated quarter 1 revenue stands at INR 1,218 crores, that is INR 1,218 crores, showing improvement on a quarter-on-quarter basis. The quarter 1 EBITDA stands at INR 93 crores and EBITDA margin stands at 7.6%. As guided, our EBITDA margin has improved on a quarter-on-quarter basis for quarter 1 after the tax losses stands at INR 47 crores after the tax losses have reduced on quarter-on-quarter basis.

The new order addition during the last quarter was robust with us covering the several large orders from market customers. We won the large long-term orders from the leading U.K. telecom companies for optical interconnect and connectivity solutions. We secured large deals in Italy for optical fiber cable and specialty cable products. In India, we won large long-term orders for fiber optic supply and deployment for a large private telecom operator. We also won the large orders for our service business from an Indian public sector enterprise.

On the back of Global business, our revenue mix was well diversified during Q1 FY '25. We expect revenue mix to improve towards North America and Europe as the demand for optical products pick up in a global market. We are happy to share that despite a significant order [indiscernible], our open order book stands at INR 9,883 crores, which is INR 9,883 crores at the end of Q1 FY '25 backed by steady order wins, our order book is well diversified across our customer segments and all of our businesses. We placed before you an average version of reported numbers for year result. We are happy to share that the net debt has reduced by reduced to -- reduced by INR 769 crores from FY '24.

With reference to Global Service demerger, we are progressing as planned on process of demerger. During the NCLT convened meeting on 10 July 2024, the scheme of demerger received 99.98% approvals from the equity shareholders and 100% approval from the secured and unsecured creditors. The final NCLT approval are expected in indicative time line of next 3 to 4 months and the resulting company is expected to get listed by the year-end.

In summary, we have a clear focus areas identified to drive business forward. In Optical Network business, we will target to drive the technology and cost leadership and pursue our ambition to be a global top 3. We will increase the sales in our focused market to grow our optical network business and fill the volume gap. We'll continue to increase the optical connectivity business with a growth and attach rate. We focus on rapidly building our data center product portfolio. In Global Service, we will continue to focus on select project in tech to improve the profitability and optimize the net fund involvement. In STL Digital, we will continue to scale the business and grow our revenue along with a focus on profitability.

With this, now I hand over the call back to Chetan. Thank you.

[Chetan Wani, executive]

Thank you, Tushar. Ladies and gentlemen, we have come to the end of our presentation, and we shall now move to the Q&A session.

[Operator Instructions] We will take the first question from the line of Nikhil Choudhary. Nikhil, please go ahead and ask your question.

[Nikhil Choudhary, analyst]

After a long time on Ankit, Tushar, we have seen first Q-on-Q growth. So congratulations on that. But one thing here, the growth looks like is driven by interconnect business, where the attach rate jumped from 11% to 23%. So Ankit, basically, if you remove the interconnect port, the core business was flattish or decline, right? So 2 questions here. First was how the demand is trending on the core business, excluding interconnect. And what's the outlook there? And second thing, what's the outlook on interconnect after a long time, it increased to 23%. Can it go further up?

[Ankit Agarwal, executive]

Thank you, Nikhil, for your question. So I think you've summarized it quite well. I think as we've been guiding our focus markets continue to be U.S., Europe and India. And as we have said in the past, particularly in the U.S., we had seen -- it's been an interesting situation where on one side, the inventories have been high but the deployment, especially fiber-to-the-home deployments have been very, very strong, in fact, amongst the highest. So when I look at the market demand, that I continue to be very positive about. It's a triple play in terms of demand from the telecom operators, money coming in from private equity players into Tier 1, Tier 2 service providers as well as government-funded projects, some from the past and BEAD, which is expected to start trickling in, in probably Q3, Q4 onwards and then probably more significantly into next calendar year. So from a demand perspective, definitely U.S. and Europe will be our key drivers.

I do also expect that in India, there will be continued focus on fiber-to-the-home deployment, fiber to enterprise deployment as well as even when operators are talking about fixed wireless, you will still need a fair bit of fiber connectivity, which will be required up to that last 100 meters, 200 meters. So that's something that we do see. Principally our demand being positive.

And then the fourth trigger and all of this will be the data center connectivity. As we just shared in our -- one of our slides, we're actually seeing a very interesting shift from so-called regular data centers to DCs, which are being built for more and more AI capability, which will definitely require much more connectivity between the servers and the racks, et cetera. So I would say principally, we remain positive about the demand. We do see the inventory levels coming down and certainly, between -- I would say, between the next 1 to 2 quarters, this should result in improved demand for our optical cable products. On the connectivity part, see, principally, I want to reiterate that we do endeavor to sell our cable and connectivity together as a solution. That's really where we believe we create value for our customers and then for STL. So that continues to be an endeavor.

We are -- we continue to be focusing on our investments in building the technology, building the product portfolio and also the IP. And so I would say that this is something that we'll continue to focus and prioritize but I won't be able to give a specific guidance on connectivity. It will be both a function of how cable also steps up and how we are able to win more orders, both in Europe as well as in the U.S.

[Nikhil Choudhary, analyst]

Sure. Second and third are smaller question on the other 2 segments. Services saw Q-on-Q jump but the margin dipped more or less in line with expectation, but relatively higher than what we were thinking. So what should be a steady-state margin in services? And in the Digital segment, Ankit, despite of being lower base, our revenue declined high single digit on Q-on-Q basis, while I understand there are challenges in IT industry still such a sharp decline was relatively higher. So those 2 are my final question.

[Tushar Shroff, executive]

So Nikhil, with reference to the service business, steady-state margin that we have been expecting is in the range of 8% to 10%. EBITDA margin of 8% to 10%. That is what we are targeting for this particular financial growth. However, during this particular quarter, because it's a mix of the various orders, which results into the margin. So there is a change in the mix, which has resulted in terms of the impact on the margin for this particular quarter but the -- overall, for the financial year, we are looking at 8% to 10% in terms of sustainable EBITDA margin for this particular business.

With respect to the Digital business, yes, this particular quarter because of the last couple of months and a couple of quarters, we have seen that the industry has witnessed slowdown in our IT sector and -- which has also impacted us. But however, we see that this current financial year, we expect to grow this particular business over a period of time. So overall, we are targeting that we should be able to have at least 5% to 7% kind of growth in Digital business. That is what we are expecting.

[Chetan Wani, executive]

We will take the next question from Balasubramanyam A.

[Balasubramanyam A., analyst]

Congratulations for Q-on-Q improvement. Sir, my first question is regarding this BharatNet Phase III? And how much is addressable market for us out of INR 1.39 lakh crores? And the second question is, like, is there any delay in BEAD program due to political situation in U.S.?

[Ankit Agarwal, executive]

So I think on the current RFQ and the opportunity right now from the spend perspective is INR 65,000 crores. And I think it's important to remember that we would address this from 2 or 3 levels. For us, it's an opportunity definitely on the services business in terms of the entire deployment and then the maintenance. The second part would be supply of cables both for our services requirements as well as other partners or players in the project, and then, of course, the fiber itself to various cablers. So this is something, which is an opportunity across the board.

I think it's a bit too early for me to share. We are in that phase where next 2, 3 months, I think, where there will be more developments regarding this project. But certainly, I would say there's a strong intent from the government to take this project forward and to make sure that the project is successful. In terms of the BEAD project, I think definitely, there is strong intent. The BEAD project was passed, which was bipartisan. So we don't see or expect any impact or slowdown of the BEAD project, particularly linked to the political situation.

I would say that probably versus our own estimate earlier in this financial year to now, we do see that the impact of BEAD ultimately to cable requirements, connectivity requirements has probably got pushed out by 3, 4 months or so.

[Balasubramanyam A., analyst]

Got it, sir. Sir, we have won a lot of large deals in U.K. and India. So like what kind of environment levels for inventory reduction on global operator levels? And when we can expect normal cease, whether it's Q3 or Q4?

[Ankit Agarwal, executive]

Yes. So as I said, we've been tracking this quite closely with our customers and also with the distributors. I would reiterate that the inventory topic that we've been talking about is largely a phenomenon in the U.S. and probably to a smaller extent in Europe and U.K. So I would say that what we are speaking about inventory, that is what we're seeing probably another 1 to 2 quarters more before we see the inventories normalize. But I think when we talk about interest, RFQs or requirement requests coming up, I think that is moving in a good direction. And the underlying demand of the market, especially in the U.S., we continue to be bullish on for the next 4 to 5 years.

We have, as we've shared in one of the slides, we have won some good projects across U.K., Europe that we've been talking about, which is both on the cable as well as connectivity. So as I said, our whole objective is to look at cable and connectivity together as a solution, and that's certainly something we are confident that the customer will see value in and will also be valuable to STL.

[Balasubramanyam A., analyst]

Got it, sir. Sir, my next question regarding any improvement in OF and OFC prices. And because our revenue is majorly impacted by volumes, how much volumes have been dropped in this quarter? And we have seen some improvement on Q-on-Q basis, it's because of realization side or increase in capacity utilization side?

[Ankit Agarwal, executive]

Yes. So I would say that overall, we won't be able to give specific volume details. But what I can share is that principally, we've had a flattish quarter in terms of volumes. On the cable side, but we've seen the positive growth on the connectivity side. So I think that's how you should think about it. Definitely, the -- from a pricing perspective, again, I would say flattish to slight reduction. Again, that's also a function of where the mix of our sales has been.

Our U.S.A. has been on the lower side compared to Europe and India. So that has also reduced our overall realization at STL level. So as the U.S. market improves as those exports increase as well as what we produce locally there and we continue to sell to that extent, the realization would improve again.

[Balasubramanyam A., analyst]

Sir, my final question is, any kind of impact because of anti-dumping [ duty ] by European commissions, does one of our competitor only exempted by European commissions. So what kind of impact we can see not only our company, the entire Indian market players?

[Ankit Agarwal, executive]

Sure. So I mean, look, one, I think it's important to remember that this is a provisional. So at least I can speak for -- on behalf of STL, we are very, very confident on the merits of our case. We believe that with the right calculation levels, we do not believe there should be a case for antidumping and we are making all our representations with full effort. In terms of being prepared for it, one, I would say very confidently that we have one of the most advanced facilities for fiber optic cable in Italy from where we can serve our European customers. We have invested in this facility significantly since we did the acquisition of Metallurgica a few years back.

So we are very well set up to meet all our customer requirements with their lead times, et cetera, and product requirements. So from our perspective, one is meeting the customer requirements. We are very comfortable. In terms of the duty itself, as I shared, we are definitely working on it and to see that we make sure that we put our full effort towards what is provisional duty currently.

I won't be able to speak about rest of the industry. Of course, different players have got different rates applied to them provisionally, and I'm sure the entire industry will work towards seeing how these can be removed or minimized.

[Chetan Wani, executive]

Thank you, Bala. Can I request you to join back the queue for next question, Bala. We'll take the next question from [indiscernible]

[Unknown Analyst]

Congrats on a robust set of numbers. Just wanted to know how you are planning to restructure your costs? And is it across businesses? And is the demerger a part of the cost restructuring?

[Tushar Shroff, executive]

So the way we have been looking at the cost structure is, overall, we are looking at the fixed cost, we are attempting to see that how we can optimize in terms of the fixed cost that we have at the company level whether in terms of manpower spend or in terms of whether it's other expenses in terms of whether it's a logistic cost or whether it's a packaging material cost, all of that, which are fixed in nature, we are trying to address all of that by working with innovative solutions that we may be looking at to find that better way of managing the business. So we are targeting to reduce fixed cost at least to the extent of 4% to 5% on a sustainable basis.

[Unknown Analyst]

And this is across business, sir?

[Tushar Shroff, executive]

Yes, across the businesses.

[Unknown Analyst]

And additionally, sir just there's a coverage anticollision opportunity in India, where the railways will be deploying 4G. So we just wanted to know if there's any kind of opportunity there for us.

[Ankit Agarwal, executive]

Yes. I mean I'm familiar with the specific opportunity. We will definitely evaluate that. I think broadly, I would make a view that not just BharatNet, there are multiple very interesting opportunities for the services business. Just given the massive experience we have, whether it's on previous BharatNet projects, whether it's on system integration projects for the Indian Navy, Indian Army, I think we are very, very well placed with our experience to capture some of the new opportunities that we're already starting to see in our pipeline.

[Unknown Analyst]

Right, sir. And just last question. On the Italian plant we have, what is the capacity? And how do you see that going up? If you can share.

[Ankit Agarwal, executive]

Yes. I won't be able to comment on specific capacities, but what I can share is that since we had acquired that facility, we have invested in scaling it up. And it's truly a world-class facility, now it's probably one of the largest facilities in Europe. So we are very well set up to cater to our customer requirements. And certainly from a product portfolio perspective, we are very well set up.

[Chetan Wani, executive]

Thanks, Advait. We'll take the next question from Suhan Joshi. Suhan, please go ahead.

[Suhan Joshi, analyst]

Yes. First question is with regard to the freight cost, the freight costs have increased by 2x, almost across the geographies. So how are we impacted by this? I mean, any impact on bottom line or all the freight escalation enters the pass-through status?

[Tushar Shroff, executive]

So we have seen that the freight impact in our financials. What we have seen is that at least 2% to 3%, which we have seen that increase in the freight during this particular quarter. There is some part of the element is also with reference to the air freight that we had to incur to serve the customer better. I think it's a mix of the rate increase as well as in terms of the change of mix from the airfreight to sea freight that is also being impacted but yes, in this quarter, we have seen a little bit of impact on the freight cost.

[Suhan Joshi, analyst]

So going forward, are we planning to structure the contracts in a way that we can, hence, for looking pass on these costs to the customers? Because I think post-COVID has been -- have been a continuous issue, right?

[Ankit Agarwal, executive]

I mean I would break in 2 things. I think, of course, there is some element of this linked to the X impact, and that has both caused some of the increase in costs as well as the insurance cost, also lead times or just travel, transport times have gone up. So I think that's anyone's guess by when those things normalize but that is expected to normalize over the next few quarters.

What we are doing on our own basis is both just looking at how do we reduce our logistics cost? How do we reduce our container requirements itself? How do we become more efficient at the same time, look at other types of contracts that we could go to minimize the costs, look at various routes? So that's the work we are doing. Typically, our customers, especially in our global customers, they would typically want it on a delivered basis. So it's up to us at STL to make sure that we can optimize our costs.

[Suhan Joshi, analyst]

Okay. My second question is with regards to the data center business. What growth run rate are we targeting? I mean, will it compensate to some extent to a decline in volumes of OFC since Internet companies are investing heavily in data center business. So I presume the growth run rate will surpass every other business, right?

[Ankit Agarwal, executive]

Yes. So as I said, I think principally, I think we definitely are very excited with the kind of opportunity we're seeing in the data center space. And as we shared, because of this massive boom towards essentially generating AI, there is a direct implication to how data centers are getting structured. And as a result of that, need for fiber optics, cable and connectivity within the data center. So I think that flow is principally what we try to share through some of the slides. As a result of that, we are looking at how do we increase our presence in this space.

So that was essentially the message that we had shared, and we have taken a target that 25% of our revenue in the medium term should come by our sales to this sector. So it was more something we wanted to share with our investors that strategically, this is the direction we are excited about. This is the direction we are leaning towards. It's not so much about bridging any gap. It will take us some time to build the portfolio, get the technology, get the IP. And definitely, we will update you probably quarter-on-quarter as we are progressing on that.

[Chetan Wani, executive]

Thanks, Suhan. We'll take next question from Ketan Athavale.

[Ketan Athavale, analyst]

Sir, I wanted to know our margins, which have been impacted since last few quarters. So what are the factors contributing to that besides optical -- slowness in optical business. So that is the first question.

[Tushar Shroff, executive]

Yes. So if you see the couple of quarters, last 3 quarters, our margins have been impacted mainly on ONB business because of lower capacity utilization that we have seen. Presently, since we have not been able to utilize all our facilities, to the optimum level, which is impacting because of the higher fixed cost that we have, operating costs that we have. We have not been able to leverage in terms of the fixed cost that we have. So that is impacting the overall the margin profile of ONB business.

[Ketan Athavale, analyst]

Okay. So when -- by when can we see previous level of margin? And how do we expect like the other expense to trend going forward?

[Tushar Shroff, executive]

So I think we expect that U.S. to pick up in the next 1 or 2 quarters. That is what because the inventory levels are going down. And as we see that the U.S. starts picking up, there are 2 advantages to it. One is that we'll be able to utilize our U.S. facilities to the full extent as well as we'll be able to utilize for some of the non-BEAD requirement, we'll be able to utilize our India facility. So it has the 2 benefits. One is fully utilizing the U.S. facility as well as the India facility so -- which will help us in terms of taking a better utilization and which will improve the margin profile.

However, in terms of the overall cost structure, as I have mentioned in earlier question, that we are targeting to reduce it by at least to the extent of 4% to 5% on a sustainable basis. That's over a bit of time. That is what we have been looking at.

[Ketan Athavale, analyst]

Okay. And coming to BharatNet. So if my understanding is correct, about 6,000 maybe optical, 12,000 may be EPC and the rest about 40,000 will be network equipments. So will we participate in that as well? Can you clarify.

[Ankit Agarwal, executive]

Just to -- I mean, clarify, as I said earlier, our primary focus will be -- we've had extensive experience on Phase I and Phase II. Government is still showing various corrigendums in terms of various terms of the tender, various conditions, various milestones, et cetera. So we continue evaluating in terms of making sure that the terms are something that make business sense for STL. So from that perspective, it's too early for me to comment on what all will be our scope or what size will be. But clearly, as I said before, we would be focused both from the services business as well as on the optical business to make sure that we are a key participant in the project.

[Ketan Athavale, analyst]

Okay. And just last question. So on the balance sheet, you have an unallocated liability of discontinued operations. So can you clarify what is it exactly?

[Tushar Shroff, executive]

So these are basically very specific liabilities, which are related to some of the discontinued business that we have, mainly on account of those contractual liabilities, which is not due or disputed for some of the discontinued business that we have. So -- the last couple of years, we have discontinued some of the businesses where due to certain issues with the vendors, we have not been able to close on those liabilities. And those -- since those are a disputed liability, which we have accrued in the financials, but still not being settled at this point in time.

[Ketan Athavale, analyst]

Okay. So by when can we expect it to go off balance sheet? These are contractual liabilities, right?

[Tushar Shroff, executive]

Yes, some of the contractual liabilities but disputed for the service surrender by some of the vendors.

[Ketan Athavale, analyst]

But just by when can we expect them to go off balance sheet? Can you comment on that?

[Tushar Shroff, executive]

No, it will be -- it will depend on what kind of a settlement that we agree with a partner, correct? So if you are able to come to amicable settlement, then probably the liability may reduce or will have settlement over a bit of time. But it is a -- we -- when we'll be able to make the settlement with some of the partners that we have, that is an important aspect.

[Chetan Wani, executive]

We'll take the next question from Rohan Patel. Rohan, please go ahead?

[Rohan Patel, analyst]

Am I audible?

[Chetan Wani, executive]

Yes.

[Rohan Patel, analyst]

I just wanted to ask our margins for collapse since like peak we achieved in 2018 and 2019, which was around 23%, 22%, and which has fall down to 8%. So there's a drastic change. So I'm just new to this company. So can you explain what has happened?

[Ankit Agarwal, executive]

So look, I think the -- one, I think probably, if you're looking at the data from back then, that would be a consolidation of optical business and largely the services business, which should be as one data point. And that would be a mix of profitability of probably at that time, some mix of optical business as well as some high-margin services projects that we were executing at that time. Nevertheless, I think one time to -- if you also reflect as recent as a couple of years ago, we had a very, very healthy business in optical business. We did north of INR 5,000 crores plus, and we had 20% EBITDA margin, which we demonstrated. This was essentially when we had a healthy factory utilization, which was for us typically north of 75%, 80%. And at that utilization, we are very comfortable to have industry-leading margins at close to 20% plus.

So that's the little bit of history in brief. We're happy to have a separate conversation. Currently, our factory utilizations are lower. They are sub-50%. And so that's -- as the volumes pick up, especially in Europe and U.S. and maybe to some extent, more in India, we are confident that structurally, this is a business that we can operate at 20% EBITDA margins.

[Chetan Wani, executive]

Thank you, Rohan. We'll take the next question from Saket.

Okay, got dropped. Okay. Rohan, you can continue if you had another question.

Okay. Saket has joined back. Saket, you may go ahead with your question.

[Saket Kapoor, analyst]

Sir, I joined a bit late, sorry, if I -- if my questions are repetitive. Sir, firstly, for the interconnect part of the story, what have been our achievement for the last financial year? And what are we looking forward for this year in terms of revenue? And how is the market growing as per our expectation, if you could give some color on this?

[Ankit Agarwal, executive]

Yes, sure. Thank you, Saket. So we did share some guidance, of course, the number we have shared is 23% is the attach rate, which is our highest ever. So we obviously quite excited about this. We're proud about it. At the same time, principally, this is a product that we believe creates value for a customer as cable and connectivity together. It enables a lower cost per home pass. It enables faster deployment, lower requirement of trained manpower, so it has multiple benefits.

One part to also remember, particularly about the interconnect business is that there is much more opportunity as more and more operators connect fiber to the home. When they go from home pass towards home connect, that's especially when there is specific more opportunity. In addition, what we also see is that as we start building our product portfolio, and also including building a product portfolio for the data center space, this is also an area of future growth for STL.

So overall, I think it's something where we continue to invest. We continue to build a portfolio. We have had some success, some good success in Europe and U.K. recently. We want to continue to grow both in Europe as well as U.S., and we are also exploring other markets as well to scale this up. And we're definitely looking at how do we provide a great solution for our customers. We provide a unique solution. And we're also building a lot of our own IP so that we can continue to scale this up in the future.

[Saket Kapoor, analyst]

So sir, just to brief it down, what should be the revenue profile from this by that we can [indiscernible] a broad number for the year?

[Ankit Agarwal, executive]

We won't be able to give a guidance, Saket, for confidentiality reasons. But as I can at least share with you that we are confident that this is a business that should grow versus last year. We do believe that we won't be able to give guidance to a specific attach rate for the year, but definitely, we are working very hard to ensure that we have a good attach rate. And at the same time, of course, we also want to grow our cable business.

[Saket Kapoor, analyst]

Sir, when we look at your numbers on a Q-on-Q basis, at least the EBITDA part of the story looks a bit encouraging. But again, coming down the line to the finance cost, part that also has been lower for this quarter. So taking into account how the first quarter has been. What -- where are we sir it means coming to the -- main reversion for us in terms of turning the tables and started reporting better numbers, where are we in midst of that? And what are the factors that are still pending as impediments for us to our growth journey -- back to our growth journey, sir?

[Ankit Agarwal, executive]

So, Saket, I think what we have been sharing as a guidance and strategy that principally remains the same. I think we have been very clear in terms of our focus markets, Europe, U.S., India, that remains the same. We do see some pretty interesting opportunities like the BEAD project in U.S., the BharatNet project in India, which can be additional tailwinds to the market. At the same time, we've been very focused on what is in our hands and in terms of our own cost efforts, that's something that Tushar spoke about, we've been driving in a very focused way, last 12 months. We'll continue to drive it to make sure that we're really at a very cutting edge in terms of cost competitiveness and we've been looking very closely at every line item to make sure that we are cost competitive.

So I think as those efforts all to continue to yield results on the cost side as our factory utilization improves and ideally goes back to 75%, 80% levels, probably in the next coming quarters, I think that's when you will really see that positive development. As we just shared on the previous question, when we run at those kind of utilization levels, we are confident of achieving the 20% EBITDA, which we have demonstrated as recent as 1.5 years, 2 years ago.

So that's directionally what I can share for now. We are confident that the market is moving in a better direction. We believe that our efforts on the cost will start yielding -- will continue to yield results and really essentially as the volumes pick up of cable as our connectivity attach rate continues to be maintained, we definitely feel positive about the future.

[Chetan Wani, executive]

Saket, having conscious of time, we'll take the last question from the line of Mr. Krunal. Krunal, please go ahead.

[Krunal Shah, analyst]

Are you able to hear me?

[Chetan Wani, executive]

Yes.

[Krunal Shah, analyst]

So my question is on STL Digital. We saw a decline in revenue quarter-on-quarter. So just wanted to understand the reasons for the same as well as you know there's a change in the top management in STL Digital. So how does that affect our organization in that sense? So if you can throw some light on that?

[Ankit Agarwal, executive]

Yes. So I mean, look, structurally -- Krunal, I'll take the second question. Structurally, we've always driven the business as very focused business units. So we have the optical business unit. We have our system integration business and then we have STL Digital business. So we're very clear in terms of our 3 business units, and we have very clear leadership, and we drive it as P&Ls and also we do segmental reporting. So we're always structured with very strong leadership, very strong second line succession planning. All of that is how we drive our businesses.

So equally, when we had the exit of previous CEO for the Digital business, we're very happy to share that Naveen Bolalingappa stepped up. He is now taking over as the CEO for this business. And I'm very, very confident that he has more than 20-plus years of experience in TCS and various other organizations. He has worked very closely with Raman, and he really understands how we are going to drive this profitable growth going forward. So principally, as a business, STL is very excited about the business. I think we have a strong leader in Naveen, and we're very excited that through him, we'll be able to deliver this profitable growth that we have committed.

[Krunal Shah, analyst]

Got it. So just the EBITDA breakeven that you were targeting by year-end, does that still stay on?

[Ankit Agarwal, executive]

Yes, for the Digital business, yes, that's directionally what we have also spoken about and also now with Naveen coming on leadership, that's what he's driving as well.

[Krunal Shah, analyst]

Got it. Got it. And the reason for the quarter-on-quarter decline in revenue.

[Tushar Shroff, executive]

So I think the quarter-on-quarter is an impact of the what we have seen in the industry as such because the industry last couple of quarters, industry is going through the volatile cycle, and it has also impacted us. In terms of new order book, which is going to impact us in terms of revenue. But we are confident that we should be able to revive our order book for the coming quarters, and that should help us in terms of sustaining digital growth in this particular year.

[Krunal Shah, analyst]

So what would be your order book now? I think you had shared the number last time also, if you can share the number this time.

[Ankit Agarwal, executive]

I think it has been provided as a part of the presentation. So there has been a little bit of change in terms of the order book number that you may see as compared to the previous presentation. It's mainly impacted because of the way the revenue recognization happens in the IT sector, which is gross to net and due to the gross to net impact, we had to descope some of the order backlog. That is also one of the impact that you have seen in this particular quarter financials.

[Krunal Shah, analyst]

Got it. And just one last clarification. We had initiated a lot of cost cut initiatives during the beginning of the year, beginning of last year. So has that impact been fully factored in, in the quarterly costs? Or is there some more impact left?

[Tushar Shroff, executive]

Yes. So we are continuously working on cost optimization. As I mentioned that we are looking at -- if you see June '23 numbers vis-a-vis, June '24 numbers, there has been sustained reduction in terms of employee cost as well as in terms of other expenses, right? So we continue to drive the cost optimization effort. And as Ankit mentioned, that is one of the levers that we are trying to see that how we can be a cost leader in manufacturing our products. So from that perspective, this is a continuous journey for us in terms of optimizing the overall cost.

[Chetan Wani, executive]

Thanks, Krunal. With this, we come to the end of the question-and-answer session. And now I hand over call back to Ankit for closing remarks.

[Ankit Agarwal, executive]

Thank you. Thank you, Chetan. I'd like to thank everyone for attending today's call and for showing your interest in our company and all your questions. Despite the challenging market environment, we have managed to make progress on our key strategic priorities. I'm happy to share that we have also reduced our net debt by INR 769 crores. Through our focus on customer centricity and cost leadership, we have gained traction and orders across the optical business by delivering purpose engineered solutions to our customers, we have achieved highest ever optical connectivity attach rate of 23%, as I mentioned earlier.

We have identified AI data centers as a future growth area, and we're gearing up to make a substantial impact in the emerging and exciting AI-driven data center segment. We continue to focus on all factors in our control, including become lean and agile organization, which Tushar just spoke about and driving technology leadership. We will continue to aggressively pursue business opportunities presented to us in our focus regions based on the strength of our high-tech manufacturing, our innovation, our industry-leading products and our amazing talent that we have.

Lastly, we believe that we are well positioned to execute and deliver robust results and create shareholder value as the demand normalizes. I hope we were able to address and clarify all your queries and comments. For any future questions and discussions, do feel free to contact the Investor Relations team, which includes myself and Tushar. We really look forward to continuing the conversation with you in the near future. Thank you. Jai Hind.