Cyient Limited (CYIENT) Q2 FY23 Earnings Concall Transcript

Cyient Limited (NSE:CYIENT) Q2 FY23 Earnings Concall dated Oct. 13, 2022

Corporate Participants:

Krishna Bodanapu — Managing Director & CEO

Ajay Aggarwal — Executive Director & CFO

Karthikeyan Natarajan — Executive Director & COO

Analysts:

Krishna Thakkar — AnandRathi — Analyst

Shradha — Asian Market Securities — Analyst

Sameer Dosani — ICICI Prudential Asset Management — Analyst

Mihir Manohar — Carnelian Capital — Analyst

Sandeep Shah — Equirus Securities — Analyst

Presentation:

Operator

Ladies and gentlemen, good day and welcome to the Q2 FY ’23 earnings conference call of Cyient Limited. As a reminder, all participant lines will be in a listen-only mode. [Operator Instructions] Please note that this conference is being recorded.

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

Krishna Bodanapu — Managing Director & CEO

Thank you very much and good evening ladies and gentlemen, welcome to Cyient Limited’s earning call for the second quarter financial year 2023. I am Krishna Bodanapu, Managing Director and Chief Executive Officer. Present with me on this call are, Mr. Ajay Agarwal, Executive Director and Chief Financial Officer and Mr. Karthik Natarajan, Executive Director and Chief Operating Officer.

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

Before I start the highlights for the quarter, may I take a minute to brief you on the exceptional items. A lot has gone on this quarter, very good things that [Technical Issues] have gone on this quarter and therefore before we start looking at the context or before we start looking at the accounts and the numbers, I just wanted to give you a bit of context of how this all stacks up and how we should be looking at these numbers. So before the numbers, I just wanted to give you the markets.

On M&A, on the acquisitions, all four acquisitions concluded — concluded in Q2 and the integration is progressing quite well. I’m quite pleased with how the integration is progressing. All M&A are [Technical Issues] at an EBITDA level. We will show you the detailed numbers in a bit. And on an annualized basis, we are expecting that this will add about $150 million to our revenue again, given that the [Indecipherable] happens and the consolidation starts at various points of time, as we talk about the future and the guidance, we will also give you a little bit more insight into how much you all have [Phonetic].

As you know, the Board and we have made this announcement, a few weeks ago that the board of IAS [Phonetic] met and has agreed that the global telecom product manufacturing business that we have which is Cyient DLM must be restructured in a different manner. We believe that there is a number of ex-listings that are happening in that business right now. The acceleration of technologies like IoT and AI and ML is currently a trillion-dollar market for electronics in the very near future. So that’s a huge opportunity for us.

Then there is a whole China Plus-One strategy of companies. Companies are looking at actively engaging with large Chinese EMS players and this has significantly increased the attractiveness of India as a market and India’s share is expected to increase from 1% to 8% adding $50 billion per year in the next five years.

And of course the push from the Government of India for Make in India or AatmaNirbharBharat is putting a lot of opportunity in place for electronics that are made in India. With a focus on high-complex, low-volume electronics, we believe we have an excellent niche, but also I want to say that there are significant synergies between the site, core services business and the DLM business, our own set of clients, a lot of engineering content, the type of manufacturing that we do and the whole build [Phonetic] to spec strategy and therefore, we still want to maintain and be with the business, because there is a fair degree of commonality. Having said that, I’m looking at the enormous potential to maximize shareholder value. The Board has approved the formation of a subcommittee to look at all the options. We understand that in the current share-holding of Cyient that is the services partner side, DLM might not be the best fit based on how some of the economics of that business or some of the revenue flows of that business work in margins of that business work.

So therefore we believe it is best to have a structure wherein, it will be an independent business, but of course the tight coupling with Cyient, because of the reasons that I talked about and therefore the key options that are being considered of an IPO. Our partnership with the strategic investor or potential spin-off. We are looking at all these options and the choice will be made by the subcommittee, based on the management’s recommendation of course keeping the best interest of our shareholders in mind. We’re very excited about the spin off because it’s our leverages a lot of potential, both in terms of value for Cyient, but also for DLM because that business has a significant opportunity to accelerate. Kartik will give you the business update and will also talk about the order intake and the order book, which means that for us to execute that potential, we will need capital, we will need flexibility and we don’t want to skew Cyient financials because of the DLM market.

Most if not all of the wage hikes are planned for the year end [Phonetic]. We will not have any material headwind for the rest of the year because of wage hikes. During the previous quarter, we set a class action lawsuit was filed the U.S. District Court against one of our subsidiaries. We are fighting this vigorously. I want to reiterate that, we’re very confident with what we’ve done and we’ve gotten advise that we have a very, very strong case and therefore we are going after it with all rigor and with all our resources. We also accelerated the discovery process as it’s called, wherein the filing of all the data and filing of all the [Indecipherable].

Therefore, this quarter we had an exceptional item in terms of the cost that we incurred on this lawsuit. It will continue for a few quarters, but not at this level, because this quarter, we accelerated some of the discovery phase, which has led to a little bit of higher cost than what we would have normally anticipated.

Therefore now coming to the highlights. And I will take you through the highlights of the quarter, in Q2 FY ’23, we posted revenue of $174.8 million, which is a year-on-year growth of 20.4% in constant currency, which would be 60.4% in U.S. dollars and Q-on-Q growth of 10% in constant currency or 8.2% in U.S. dollars. In rupee terms we posted a quarterly revenue INR1,396 crores. This signifies, a growth of 25.6% year-on-year or 11.7% quarter-on-quarter. The [Indecipherable] revenue stood at $151.1 billion, which is a year-on-year growth of 25.8% in constant currency, 21.3% in USD and Q-on-Q growth of 12.3% in constant currency or 10.2 with USD. Service revenue growth without acquisitions is 11.5% year-on-year at constant currency, or [Indecipherable] quarter-on-quarter in constant currency. The DLM revenue stood at 23.7 million, which was a de-growth of 7.3% year-on-year, or a de-growth of 3.3% quarter-over-quarter.

Normalized group EBITDA and I want to quickly highlight why we’re also talking about the EBITDA, because of the acquisitions and the nature of how our amortization works in the acquisition EBIT will be skewed a little bit. EBIT will be skewed for about a quarter or so because amortization is coming in, but the full impact of the acquisitions are not coming in, and therefore we also wanted to give you a sense of EBITDA to give you a sense of where the margins of the acquired entities and Cyient are. And we thought EBITDA was a good reflection of that. Of course we will obviously talk about EBIT also in a minute, but the normalized group EBITDA margin, excluding the impact of one-off M&A costs and exceptional items stood at 16.4%, up 84 bps quarter-on-quarter and down 226 bps year on year. Normalized group EBIT margin stood — excluding the impact of M&A and exceptional items was at 11.9%, up 42 bps quarter-over-quarter, down about 210 bps year on year. Normalized PAT was at 110 crores, which was a de-growth of 5% quarter on quarter, and 9% year-on-year.

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

The Board also approved an imputed dividend of INR10 per share, which is in line with our philosophy and in our principle of giving back a certain amount of profit to the shareholders every year. I’m doing it quite as much as an interim dividend in Q2 and of course the final [Indecipherable]. I also wanted to give you two highlights for the quarter. Cyient partnered with Honeywell to manufacture [Indecipherable], which is the first cloud-connected cockpit system. It’s a very large deal. We also made a press release on this a few months ago. And we are delighted that we’ll be able to build this product, which is the future of aviation and it’s a multi-year for Cyient. A lot of it will go Cyient DLM because that is big manufacturing company, but there’s also a lot of engineering that’s associated with it. In a nutshell, it’s a platform that can be virtually modified for any type of aircraft, passenger, cargo, business jets et cetera. And it is a platform that helps pilots much more effectively fly planes, again [Indecipherable] very high-end of technology and we’re very proud that we will be able to do this for many years to come.

We’re also thrilled to be recognized by ISG as a Rising Star and IoT integrating our digital technology capabilities under Intel Inside suite of solutions. This is really accelerating our clients’ digital transformation. And again, Karthik will talk about some of the key initiatives at some of the key outcomes that have come because of, the focus that we’ve put in the last two years with digital. With this I would like to hand this call over to Ajay, who will take you through the detailed financial performance for the quarter. Ajay, over to you.

Ajay Aggarwal — Executive Director & CFO

Thank you so much, Krishna. Just to continue from where Krishna has left, we feel very excited the way one has achieved creating new capability, through these acquisitions that we have talked about them as and when these acquisitions have happened. And this really gives us really good growth engine for future. Second, I think in terms of the capital allocation, this is significant improvement which will show us the ability to improve earnings growth at much higher rate. So I wanted to give confidence to all the investors and the analyst that we are very confident about these acquisitions being very accretive on the EPS side, very accretive on the EBITDA side and then for the EBIT side because of amortization once the synergy revenue start kicking in we will also see that it’s accretive [Indecipherable].

So with that, let me give you a flavor of the numbers. Krishna briefly talked about one of the highest growth quarter-on-quarter, 25.8% as we have seen the currency fluctuations the right numbers to look at our constant currency numbers 25.8% year-on-year and 12.3% quarter-on-quarter and we also disclosed the numbers for services and DLM. DLM has a marginality of 3.3%. I would say that it is a security issue, we are improving on the supply side and you will see that we have one of the best ever pipeline and backlog for DLM and you will see that growth continue and rising. In these two, I think the Group’s growth is at 20.4%. And if you see in terms of the services good, I’d say exclude the acquisitions and DLM, we have grown at about 3%. There also, I think we have been [Indecipherable] to make sure that we have some provisioning around as per the policy of accounting, if you look at that, including that it will be more like 3.5%. So on ratio, it is a good momentum on the core business, and the same as true in the DLM and acquisitions with further Act.

And as far as this year is concerned, as you know, we have added in this quarter, one month of [Indecipherable] and two months of testing [Phonetic] estimate. When we add all of them, for this year itself we will have 14% to 15% revenue growth and we talk about the outlook will also tell you how it will be going forward. So well-rounded growth if you see the chart below, I would only like to call out when you look at the, you know the growth, some of this has impacted by the margin, by the exchange rates. But if you look at, NAM had 20%, EMEA adjusted for currency in 34%, Asia Pacific is about 11% adjusted for the currency for probably reasons. I think this is a good growth, accordingly. Some of the EMEA growth of course is also fueled by the addition of the acquisitions, which are based in Europe.

In terms of the hedge book again as we spoke in the last call, we continue to be on the same policy. It’s working well for us. This is our total hedge book. It is about $150 million, 12-month forward and little bit of about 20% of net inflows for the next 12 months thereafter. And that builds up $150 or $156 million in constant currency. You will see there is a quarter-on-quarter dip, but don’t read too much into it. That’s just because of the currency fluctuations and except INR to Dollar in all the currencies, we have a nice gain and forward covers what it means. You will see when you look at our other income, positive other income because of our hedge book position and also for the next four quarters, what we are looking at is about $3.5 million of gain at the current rates, which are also mentioned on this particular chart. So as we have been saying that unless there is a huge catastrophic event, we’ve seen that already EPS nicely protected for the next 12 months forward from the currency perspective.

In terms of the income statement, I think I would I’d like to say that if I just go year next slide first, and I’ll come back to this, Krishna, I talked about that we have two one-offs in this quarter. One is we have this exceptional item, where we had the legal fees that was incurred in quarter two, which is about 1.8% impact. And it shows the value of the here and another one is that when we have done these acquisitions, we have one-time acquisition-related expenses. These are purely for acquisition, they not integration related, which are in the P&L which are separately there in the margin, which is there. So we are only pointing out only relating to the acquisition of the target and that’s about 1.7%. So if you take these two, one we are calling as exceptional item and another one is one-off, which is not likely to repeat. Then we have restated our numbers to show for each of the line items that you know what is our reported EBIT what is our normalized EBIT same for the percentages and we also reported the PAT and the normalized PAT. So with this background, if you go back to that earlier slide and explain to you.

So I think the headline numbers that I would like you to see is that for the [Indecipherable] we have improved our margins at about 112 basis points. You will see, we did have a headwind of about 1.5% because of the wage hike that happened in this particular quarter and as Krishna mentioned in the beginning, most people’s wage hike is over now. I would say, 90% plus of the wage hike is over and we have been able to offset that by improvement in offshoring. There has been pricing increase, that has been focused on improved offshoring. And we also got some other benefits out of contribution and other initiatives. So it’s very nice that you know within the quarter we have able to offset whatever was the wage hike. We did get some other benefits in terms of volume absorption, little bit on currency, but they have been plus and minus.

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

Finally, I would say, normalized PAT is what you should look at. If you exclude one exceptional item for the legal fees and one-off expenses purely for M&A, in terms of acquiring these entities then our normalized PAT is taken here which is the number [Indecipherable] that Krishna already talked about, and which is at about 7.9%. So I would say this is how we have tried our best to explain to you. There is an annexure that also gives you a very clear understanding of where the margin has increased and where the margin has not — where the tailwind and headwind has been on the margins.

Only one more thing I would like to highlight what Krishna mentioned, if you look at EBITDA level, I think we are doing very well. I think most of these acquisitions are at companies level of EBITDA. However, when you look at the, there are two aspects, one is depreciation and amortization for the standalone entities before they were acquired, which is the big, and second is the D&A that’s hedged, because of the investments that balance sheet. So they have been provided for. But I just wanted to call out that those cases are built on the synergy revenues. So I would request for some time, lets look at the EBITDA. We will disclose at EBIT level also, 770 bps is the dilution in terms of the acquisition, but this is mainly on account of that dilution in terms of the amortization of the assets that we have taken on the balance sheet. And also, this has some impact of the integration cost that we will incur. We had planned about 3% of integration costs in this period.

So this is the summary, in terms of how to read the profit and the margins. Thank you for your patience and we would be happy to take any questions. Last thing on the cash generation. I would say that our free cash flow what we have generated during the quarter and the DSO, you will find there is an improvement and we have, we are moving to getting back to 50% plus, free cash flow generation. This quarter it is 35% [Indecipherable]. The one-off is much higher than that and we are working on all elements of free cash flow, including the days receivables. We feel there is the potential to further bring it down and get back to the levels of free cash flow that we’ve generated in the past.

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

Karthikeyan Natarajan — Executive Director & COO

Thank you, Ajay. Good day everyone, hope all of you are enjoying your festive season and following on what Krishna and Ajay talked about and trying to deep dive a little more on business performance. And I would say all in all, it’s a great execution that we have been able to bring in for the Q2 fiscal ’23. And if you just look at from ARC, which is Aerospace, Rail, and Communications and we have seen a growth to 0.9% at constant currency quarter-on-quarter. I think this growth is led by Aerospace and followed by Communications and Rail transportation continued to see a challenge, like we talked about earlier. The good news is Communication has definitely grown by 25% year-on-year in constant currency and Aerospace is very close to the double-digit growth for the year as well as for quarter two.

And from the Mining, Energy, and Utilities. I think this is a new configuration, we talked about in the last quarter and we have seen a growth up 3.9% in constant currency. And year-on-year, there is a slight dip but it is likely to be a positive growth for the full year and I will talk about it in the next few slides. The new growth areas which is essentially the medical devices, semiconductor, automotive, and high-tech, I think they are definitely ramping up very well with a 9% constant currency growth and 33% year-on-year growth. And all in all, leading to 3% growth in constant currency, services are chronic and at 11.5% year-on-year. Also to provide a color, if you look at, we have had the highest to build out in Q2 in terms of volume and which has grown at 6.8% quarter-on-quarter. Most of this growth happened in offshore and that’s the reason why you’re seeing the revenue growth at 3% and which is also shown in terms of our profit margin improvement. And we also include our offshore mix and the utilization which include 370 bps and helped to counter the headwinds of about 150 basis point update that Ajay talked about.

So the EBIT for services improved by 120 bps and that has been achieved through a lot of efficiency improvements that we have been able to bring in that in the quarter. And services overall including acquisitions and we have grown at 12.3% quarter-on-quarter and 25.8% year-on-year in constant currency. At the Group level, 10% quarter-on-quarter and 25.4% [Phonetic] at the year-on-year level. If you look at order intake, I think this is definitely the highest order intake that we had for the Group, over the last four years, and which is about 247 million and the services has grown by 5.6% in the order [Phonetic] terms. If we look at in constant currency, that has grown by 38% and DLM Krishna talked about which has grown by 253%. I think we are definitely building a nice order book as far as DLM is concerned and we continue to see the traction in this business and we’ve talked about some of the restructuring part. We’ll have more details on [Indecipherable] conversations.

And also to conclude on the large deals, we have closed about five large deals 105 million. I think this is again, continuing to build momentum as we talked about in the past many quarters. To give a little more outlook on the business performance. I think the market dynamics are definitely more fluid and more uncertain and due to the industrial conflict on higher energy prices, inflation and, but I can really get into some of the specific verticals and if you look at Aerospace, I think the demand is steadily increasing and the supply chain challenges continue to be an issue for many of our customers. But the opportunities are seen both on commercial as well as — areas. And some of the interesting areas in the urban area mobility and space creating new opportunities for us and also hybrid or electrification of aircrafts. I think that’s the new opportunities that we’re seeing. Apart from significant opportunities, we have seen through the aftermarket and MRO revenues. I think this would help us to grow roughly about 10% for the full year, while we have seen 7.8% for Q2.

Rail, I think we continue to see challenges and due to the consolidation that has happened in the industry and also some of the issues related to the infrastructure spend that is happening globally due to the challenging environment and high-interest rates, I think we are hoping that some part of this would recover by Q4, and we are still keeping a close tab on some of the areas we want to modernize our offerings on signaling and DevOps and automated fare collection and sustainable transportation and mass mobility area. So we are cautious about how the rail business will recover over the next few quarters.

So if you go to Communications, I think this has been building up nicely for us for the last four to eight quarters and the network rollout momentum across fiber and 5G, I think the demand continued to be high. And also we are seeing serious opportunities around high energy consumption of 5G radio. I think this is going to create a huge challenge in Europe, especially, and we have some of the solutions, which are being built through this [Indecipherable] acquisition that we made. We are looking at how do we monetize some of these offerings by working with some of the customer ideas to reduce energy consumption, and also 3G plus, 4G, and 5G all radios cannot be put live and this would also create new opportunities for setting up some of the old technologies as well as rolling out for cloud RAN or Open RAN. I think these are new opportunities that we are able to continue to grow this particular segment.

Mining, I think our safety concerns and tough mine operations are paving way for sustainable mining and the same time all the energy transition and clean energy, carbon neutrality, all this would new materials whether like copper, lithium, or sulphur and having been some of them have been supported for our customers. And also most of the offerings around autonomous operations digitalization, safe operations, intelligent asset management are continuing to see momentum in our business. I think this business has grown nicely for Q2 at close to 70% and we are confident that as we continue to see the similar rate of growth for the rest of the year.

Energy and Utilities, I think there is significant profit that has made that the utility companies, due to the higher energy prices in Europe, and this will also make them reimbursed on carbon-neutral technology and that’s something that we’re really excited about with [Indecipherable] observation that we made on energy [Indecipherable] we start looking at new technologies like hydrogen, battery storage, and carbon capture technology investment areas, as well as integration of all the new energy sources into smart and micro-grids are likely to accelerate and we feel that this will give us new opportunities for us to pursue it. To go to the new growth areas and this is a segment, which is definitely doing very well for us and led by automotive and mobility and the investments in software virtualization service-oriented architecture and software-defined vehicle definitely growth areas for us.

Healthcare and Life Sciences, which is likely to — which has growth about 80% to 90% and you are seen this momentum continue and influenced by the regulatory changes that are happening globally and we see continuous opportunities in terms of predictive, proactive, personalized health systems, I think that’s the bigger opportunity that we are trying to going after [Phonetic].

Hi-Tech, which was the Nest while geospatial business and we are trying to reposition this business to drive more system integration capabilities and applications and cloud analytics opportunities. But the last hi-tech [Phonetic] companies which really drive that business around the location-based solutions, as well as space in sustainability initiatives and we, hope this business should start getting into the growth path by end of this year and should start showing the growth for the next year.

Semiconductors and I think the demand from automotive and IoT and connectivity that Krishna talked about, continue to be high. And this business has grown about 40% to 50% so far and we continue to see this business, right in the momentum that started in the beginning of the year and throughout rest of the year as well. Also, some of the supply chain diversification investments that are happening through the U.S. Ships Act or even in Japan is likely to create significant new opportunities for us across plant design and putting up designs to the fabs that are being set up and as well as new designs that will come up and we are bullish on how the semiconductor to pan out for the next many quarters.

And last the DLM business, we continue to build on our order book and we talked about multi-year last piece and the supply chain challenges continue to be there, but we are hopeful that H2 would be far better than what we have seen in H1. We talked about some of the positioning that we’re taking in the market, especially around the innovative technology solutions that we are investing on. I just want to share a few examples, in terms of how are we really changing our orientation and engagement with our customers. So just to put few the tailings dam management solution is supposed to improve the safety of mining, environment, and there was a recent failure of the dam, which has resulted in about six to eight lives being lost and there are more than 30 to 40 people are still in clinical stage and [Indecipherable] some of them can be better predicted and our solution is likely to have the mining customers. And this is a combination of our ability to understand the AUC department [Phonetic] as well as the data that can be integrated with digital platforms. I think this is going to be a sign of things that we are going to depend upon across many of the segments.

And also the Network Testing, which is cloud-based, AI-driven device performance functional ran and host of network functions. I think this is one of the opportunities that we are picking up as an offering for us that can be taken to many of the communication customers that we have today.

Autonomous Industrial Systems, I think this is another interesting area where perception-based technologies can be integrated with off-highway customers and how [Indecipherable] Autonomous trucks or autonomous construction vehicles and we’re helping the customers to bring this technology and also create artificial ingredients model for assisting the control of some of these equipments in the more complex work environment like mining and other things.

Last but not the least, the Digital Platforms and Asset Data Management. I think this is one of the wins that we had in the earlier quarter and where we are building a integrated web-based cloud solutions with automated smart accelerators that would really help in driving the digital transformation across mining, energy and CPG clients.

All in all, I would say a decent execution quarter and we’re really working on getting that execution better in H2 of this financial year and we’ll probably leave some time for Q&A. And back to you Krishna.

Krishna Bodanapu — Managing Director & CEO

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

Because the margin, again will go to what we said. We expect the full-year normalized EBIT margins for the organic business to be in the 30% to 40% range. Obviously, with the work that we have to do, we understand what it is, but we still have a line of sight or we have clear confidence to receive [Phonetic] the lower end of that guidance and really what we want to do is get towards the middle but we still hold to that.

Normalized EBITDA and again we want to talk about EBITDA for a few quarters also, just to give you a sense of where things are with all the acquisitions. Therefore, I say normalized EBITDA for the full year will be 16% to 17% for the Group as Ajay had mentioned, the acquisitions are accretive. So after doing all this math, we want to say that — we believe that or we are confident that the Q4 normalized EPS will be INR14 to INR15 rupees for FY ’23, I’ll come to that in the next slide in a second. And of course, the tax rate is expected to be 27% alongside and free cash flow conversion will be in line for the full year after we take into account what happened this quarter [Phonetic].

We also want to give you a quick overview into what we see for the next year, because I think a lot of these things will start to settle in and therefore we’ve already started planning for the next year, because there is going to be a lot of work for us. In FY ’24 we have a [Indecipherable] to a $1 billion run rate, which is obviously quite exciting and therefore we’re working very judiciously to get to that run rate, hopefully in the middle of the year rather than later end of the year. But we will keep you updated. And for EPS taking everything into account and how the acquisitions would sell, we’re confident that EPS will at least be INR60. I want to repeat and say with confidence that EPS will actually be INR60 for the next financial year that’s FY ’24.

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

Questions and Answers:

Operator

Thank you very much. We will now begin the question-and-answer session. [Operator Instructions] Ladies and gentlemen, we will wait for a moment, while the question queue assembles. First question is from the line of Krishna Thakkar from Anand Rathi. Please go ahead.

Krishna Thakkar — AnandRathi — Analyst

Hello sir. First one on the Aerospace side. So you guys have shown confidence on the double-digit growth kind of number, but if you could give some more details on what is happening on the Aerospace from [Indecipherable] perspective not from manufacturing perspective, and second, while our growth rate seems to be improving our order intake is still slow for the second quarter. So how should we — and again this is related to services because DLM, I think we’ve done well on the order side, but how should we read these two numbers from an outlook perspective?

Krishna Bodanapu — Managing Director & CEO

Thank you for your question. I will ask Karthick to address it.

Karthikeyan Natarajan — Executive Director & COO

Thanks, Krishna, I think your observation for Q2 is a seasonal thing that typically Q3 is a strong quarter for order intake. So that’s why I gave both dollar as well as the constant currency number of 13% because we are still tracking it on the dollar orders to date.

And to answer your first question on Aerospace, I think we are seeing lot of opportunities around the aftermarket. As you would have seen in the last two years with passengers miles slowly ticking along, which also means many of the aircrafts, which has not been taken for service or repair or overhaul, I think they are all coming to what we call them as more shop visits. I think that is really growing by 20%. So our aftermarket business is definitely, very strong and some of the customers who are associated with the agent programs that we were doing it for the last eight years, I think there’s really shaping along well in terms of their demand, which is going to last. So that’s one — that we have seen.

Second about the embedded and digital solution that are required for the aerospace and defense, I think that continues to be robust because they want to improve the productivity. They want to really drive lot more digital initiatives that what you’ve done in the past. We are working with one of the Japanese customer to help them to build a road map on industry product zero [Phonetic]. How do they rollout, when they want to grow from X to 4 X in terms of production capacity for the next three years and we are involved in helping them to build a roadmap. I think that’s another example in terms of where we are seeing that kind of growth and another one is about integrating the capital management with centers [Phonetic] and which will probably increase the comfort level of the passengers and how we can probably have lot more services that can be delivered through the centers that can be integrated to [Indecipherable]. So some of these opportunities are new. We have not seen them before. I think that’s what is driving the growth for us.

Apart from defense, which is likely to get stronger as you can imagine, in terms of what is happening globally. And this is one segment where that would be lot more [Indecipherable] that’s going to flow in and just to make sure every country wants to protect their borders and they want to make sure that their defense systems are safe this is going to drive significant growth in Europe as well as in North America, on the defense side of the business.

Krishna Thakkar — AnandRathi — Analyst

Sir, how big, would that be for us in particular? Sorry, I couldn’t get your question, Krishna. The defense part of it, how big could that be for Aerospace, vertical?

Karthikeyan Natarajan — Executive Director & COO

It is probably about less than I would say 25% [Phonetic] of our Aerospace business comes from defense and which is likely to see growth as part of what is happening globally.

Krishna Thakkar — AnandRathi — Analyst

Understood. Thank you. And Ajay sir, on the exceptional items, this is like a one-time payout on the legal side, or is there something which can come in 3Q and 4Q, as it?

Ajay Aggarwal — Executive Director & CFO

I think it could continue in Q3 and Q4 as well. But as Krishna said given the phase of activities that happened in this quarter, we feel that this should be the fees but it will continue in Q3 and Q4 as well. And we will continue to report the update and the [Indecipherable].

Krishna Thakkar — AnandRathi — Analyst

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

Ajay Aggarwal — Executive Director & CFO

As I said we don’t expect that there will be peak of the activity in terms of preparation. But difficult to say right now, our sensex should go down in quarter 3 and quarter.

Krishna Thakkar — AnandRathi — Analyst

Okay. And on the banker fees, this is purely one-time done and dusted [Phonetic] in Q2?

Ajay Aggarwal — Executive Director & CFO

Yes, 100% it is one time done and dusted [Phonetic] in Q2.

Krishna Thakkar — AnandRathi — Analyst

Okay, perfect. Sir. Thank you.

Krishna Bodanapu — Managing Director & CEO

Sorry, if I may just add on, [Indecipherable] we actually have accelerated some of the discovery process, because obviously we are also keen to get it done and over with, that’s why we believe that Q2 is the peak and it actually nominal quite a bit and it will be obviously reported. But we’re also quite confident that we will be able to manage it.

Krishna Thakkar — AnandRathi — Analyst

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

Krishna Bodanapu — Managing Director & CEO

No, I think it is a litigated case. So it’s very difficult to say. But again I want to be very clear to say that, look, it’s something that we’re very, very confident. So we’re not taking any provisions or anything, because we are confident that what, what has happened there is right and we have got some very good people advising us [Indecipherable] for as multiple times.

Krishna Thakkar — AnandRathi — Analyst

Alright sir, thank you. And all the best.

Operator

Thank you. The next question is from the line of Nitin Sharma from Mac Pro Research [Phonetic]. Please go ahead. Nitin Sharma, please go ahead with your question, your line is unmuted. As there is no response from the line, we’ll move to the next question, which is from the line of Shradha from Asian Market Securities. Please go ahead.

Shradha — Asian Market Securities — Analyst

Yeah, hi. Congratulations on a good quarter. Couple of questions, firstly, what is the normalized margin expectation, that we are building in for [Technical Issues].

Krishna Bodanapu — Managing Director & CEO

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

Shradha — Asian Market Securities — Analyst

So the reason I’m asking is because [Technical Issues] a very high margin businesses. And you had indicated that in the first year of integration margins could be lower and probably spend most of its company level margin but for the first year integration, I believe those margins should tend back to original margin level, so from that perspective, I think 24 margins can be estimates, lot better than what the 16% to 17% normalized EBITDA margin you’re talking about for FY ’23.

Krishna Bodanapu — Managing Director & CEO

Well yes, you are right. So that’s why I said, we want to work a little bit more before committing definitively, but also selfie net [Phonetic], I’ll say that you are absolutely right, the margins are much higher, but also the impact is relatively small because selfie net [Phonetic] is about sort — 700 some million dollars $50 million, selfie-net is about $25 million. So, excuse me, the impact of that is going to be quite muted investment. That’s why we’re just being prudent in terms of what our calculations to use at least to give you a direction of the next year.

Shradha — Asian Market Securities — Analyst

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

Krishna Bodanapu — Managing Director & CEO

Yes, absolutely. We do, we do, but again, that’s also very small, I mean that would be less than or it would be a percent of so [Indecipherable].

Shradha — Asian Market Securities — Analyst

On the ramp-up process happening there, because this was expected to be one of the top pipeline [Speech Overlap], please go ahead, please go ahead.

Krishna Bodanapu — Managing Director & CEO

[Speech Overlap] Sorry, the ramp-up is going quite well actually, that’s been one of our growth accounts that we talked about, in fact [Indecipherable] anticipation. So the ramp-up is actually going quite well and we — the client or the account for which we did the strategic buyout will actually end up being one of our top 10 customers most likely maybe this year but definitely next year.

Shradha — Asian Market Securities — Analyst

Great. And sir, just last month, the rail transportation business. you do see some decline. So I was assuming that the offshoring ship that we were seeing in the large account business that might have is stabilized by now, but do you see this offshoring thing which is impacting the overall revenue or is it some budget-cutting part that is playing in these verticals?

Ajay Aggarwal — Executive Director & CFO

Thanks, Shradha for the question. I think as I said, there are two or three factors, one is the consolidation of two of the major companies, which is resulting in lesser R&D spend as compared to what they will individually, and probably they are trying to rationalize where they want to keep some platforms where they want to let go off some of the old platforms some legacy platforms, they would have had indirectly along with them. And second, there is also significant — the infrastructure spend that we talked about and which is likely to be, they have a huge order book and they are trying to prioritize orders they want to execute where they can get some cash flow. I think that has been one of the challenges for them from their end customers and that is impacting that. And third part, what you talked about was offshoring which is definitely true, and probably the first two is likely to improve as we start exiting end of this year. And also as we talked about the other element was the highest-ever build hours that I talked about in terms of volume. And I think the volume growth is something that we are really happy about. And we hope that same momentum continues as we start getting into the [Indecipherable]. [Speech Overlap]

Shradha — Asian Market Securities — Analyst

Mr. Karthik sir, in terms of your optimism on growth for FY ’24 [Phonetic] amongst the vertical that you are operating, do you think aerospace could be driving growth for us in the organic business in 2024 [Phonetic]? Because communications growth seems to have tapered off this quarter, so maybe on a high base 24 [Phonetic] growth number for communications might not budge [Indecipherable]. So will it be Aerospace or will it be another vertical doing that heavy lifting for us 2023?

Krishna Bodanapu — Managing Director & CEO

May I suggest for ’24 numbers, we will wait for another quarter before getting into the details. We’ve started preliminary work, but just because of obviously put a lot of resources behind the acquisitions and therefore in all segments, we did a lot of preliminary work and that’s what gives us confidence, but to get into the details and considering the positive of cons, I believe today is also a very busy day for everybody. So I’ll maybe request that we hold off ’24 questions for the next quarter’s call.

Shradha — Asian Market Securities — Analyst

Great, great. Thanks, Krishna. That’s it from me. Thank you.

Krishna Bodanapu — Managing Director & CEO

Thank you, Shradha.

Operator

Ladies and gentlemen, in order to ensure that the management is able to address questions from all participants please limit your questions to two per participant. If you have a follow-up question you may rejoin the queue. The next question is from the line of Sameer Dosani from ICICI Prudential Asset Management. Please go ahead.

Sameer Dosani — ICICI Prudential Asset Management — Analyst

Yeah, thanks for the opportunity. A few questions, one is on the telecom vertical, right? We have seen on Q-on-Q basis until last quarter, a very good growth momentum. This quarter it has been — is it, is it a one-off because commentary suggest that growth momentum will continue. So how do you see this growth? First is that and second, DLM obviously H2 is always better because of the seasonality. Do you expect similar thing going forward? Thanks.

Krishna Bodanapu — Managing Director & CEO

Yes. So, Sameer, I think what we have seen for Q2 was one of execution issue that we got into and that is behind us now and we hope we continue to build the momentum for H2 on the communication business and that demand would also be slightly taxing in some customer segments. So that’s what I have seen not grow as fast as what we have done in the first quarter of this year, even for the past three quarters as well.

So, on your second question on DLM. I think we are definitely seeing a better supply chain visibility as compared to what we started off this year and we are confident with the current order book as well as the supply chain visibility. I think both are equally critical to see how do we improve on our execution for H2.

Sameer Dosani — ICICI Prudential Asset Management — Analyst

Okay. So we will see a recovery in that — we will see that seasonality right improvement — in DLM.

Krishna Bodanapu — Managing Director & CEO

Yeah.

Sameer Dosani — ICICI Prudential Asset Management — Analyst

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

Krishna Bodanapu — Managing Director & CEO

No, absolutely. I think also I’ll just quickly say that we also get one more if I will call it a pump because CTET [Phonetic] will be fully integrated in Q3 so that itself will give us another fairly significant CTET [Phonetic] numbers like Ajay said it is only for one month and that has been our biggest acquisition. So, but having said that, we are quite confident with where things stand even taking into account the macro situation because we’ve looked industry by industry on what we do with where we stand and how does the macro impacted. If you just look at just give one example of the semiconductor industry where we’re doing a lot of work for the transition of ship manufacturing from China to the U.S. and Europe, Europe will also announce I think a $50 million [Phonetic] investment into semiconductor plants, which would translate to a lot of engineering work for us.

So we’re also looking at these things because these industries are also a bit more nuclear. It did not — the reason why a plant is going from China to Europe or the U.S., there is a very strong strategic reason. So it’s not necessarily just sort of a nice to have projects. It is a strategic project and therefore we are quite confident that even — of course it will be worst case macro situations, turn out then that’s a different story, if Russia drops a nuclear bomb somewhere obviously all bets are off, but outside of that we’re quite confident that even in an environment where we will have some challenges with recession et cetera, many of the industries that we are in will do quite okay because again they’re based on — a lot of the work is based on operations on things like power plants which has to continue, no matter what, or are based on things like the transition of the semiconductor industry or like Karthik explained of the Aerospace industry, which is still much much below its peak and therefore, there’s a lot of work on operations and [Indecipherable]. Therefore we’re quite confident in sudden immediate cases of the macro of course if it is a worst-case scenario, then that is a different story.

Sameer Dosani — ICICI Prudential Asset Management — Analyst

Yes. So I’ve included my two months of [Indecipherable] or $175 million that’s $15 million two months impact. And if I look at 192 to 250, it’s again 4% to 4.5%. So I get your answer. And also just last question on the broader macro right all companies. If I look at a broader IT services, plus the R&D, all companies are speaking about growth slowdown down in Q3 and Q4. And how do you see that impacting your business and in that, in that scenario, how does your guidance or outlook changes? Thanks.

Krishna Bodanapu — Managing Director & CEO

Karthik do you want to answer that?

Karthikeyan Natarajan — Executive Director & COO

Yes. So, Sameer. I think we are still as of now, we did not see significant cancellations barring one or two projects, which got deferred towards the right. So we are still keeping ourselves closely aligned with customers that we are definitely looking at the implications of difficult winter in Europe. And probably the Fed rate hikes in U.S. So how do we think that’s going to pan out and what is going to be the implication of it from our customers. I think we are still seeing a cautious view from our customers see us, I think they are basically looking at the budgets will have a better view by end of this quarter, which is by December to January for us to have a better view for the next year, but we are still confident that at this point of time, we are seeing momentum and we want to continue to build on that momentum.

Sameer Dosani — ICICI Prudential Asset Management — Analyst

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

Karthikeyan Natarajan — Executive Director & COO

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

Sameer Dosani — ICICI Prudential Asset Management — Analyst

Understood, understood. Thanks. Thanks for the answer. Good luck for the future.

Krishna Bodanapu — Managing Director & CEO

Thank you very much.

Operator

Thank you. The next question is from the line of Mihir Manohar from Carnelian Capital. Please go ahead.

Mihir Manohar — Carnelian Capital — Analyst

Yeah, hi, thanks for giving the opportunity and congratulations on good set of numbers. I just wanted to understand your thought process behind DLM. I mean we know you have decided to separate DLM from this company. So what is the thought process that has gone behind it and how are we looking at this business strategically and also if you quantify something in number terms, how are we looking at this business over the next three to five years and what kind of inquiries are you getting and what is that been the thought process that has got in separating from the company. So that would be — that was the only question.

Krishna Bodanapu — Managing Director & CEO

So thank you for that question. The idea behind it was, as you know, the DLM financials and the way the whole business works is very different from the services business and that has brought in a certain degree of uncertainty and it has brought with it a certain degree of how our investors doing Cyient. So we took a long hard look at what is the right thing for Cyient and the shareholders decided to look at the DLM business and said okay, what is the best way to structure it such that Cyient still has a control on the business or still has a good connect into the business, because for the reasons that I said we are winning a lot [Indecipherable], including the — project that I talked about because DLM is a part of science, design and manufacturing is a very interesting thing, our customers are using us quite a bit transitions so many many things like that. So taking everything into account, we had a lot of discussions in the board and we said we wanted to structure it in such a way that it can have its own independence because with all the order book Karthik already talked about but also was with [Indecipherable] what’s happening there with China plus one India pervasiveness, or prevalence of electronics, more and more we’re going to grow very, very well over there.

So we will require capital and we understand that science shareholders might not be very happy with us investing significantly in the DLM business and therefore we thought it would be best to separate it out because it will need to raise its own capital for growth. We are working on a plan where that business can grow 5 X within the next five years with the margins that we already have. So it’s a very significant growth but also it will require capital both as you know, capex, because we will need to build one or two more factories and our customers are also asking us for other options like Vietnam and Mexico and so on so forth, and it will also need working capital because that is a working capital-intensive business. So, so before that really scales, it starts to make very large dent on the Cyient P&L, we thought it was best to structure it separately and really let it grow. I mean I see really unleash the potential because we are in that spot with the order book that Karthik talked about and we believe in the process science shareholders will also benefit generously because we still have ownership from Cyient hopefully depending on which option we come up with an over a period of time. That would be another great source of capital for Cyient to leverage on as we grow the services business, but from a growth perspective about 5 X in five years. Otherwise, I would say quite disappointed in that business [Phonetic].

Mihir Manohar — Carnelian Capital — Analyst

Sure Krishna, that’s really helpful. If you can throw some more light here on capital efficiency part also, I mean you know when we look at the current numbers on the capital efficiency for this particular segment DLM it doesn’t look encouraging. I mean so, how would the capital efficiency pan out given we are seeing increasing inquiries in India for this part of the business, I mean we are talking about financial revenue that’s really good, but how should we, as investors see margins and capital efficiency for this part of the business?

Ajay Aggarwal — Executive Director & CFO

Absolutely. I think besides as Krishna explained I think one of the constraints, we have been doing is, there is one business, which is 15% to 18% potential business and services and there is another business which possibly is 6% to 8% margin business and we trying to take it 10%. We put lot of constraints in terms of what margin business can be. And in fact goes to create 5 X in three to five years. I think what is important is, it will not be a 15% margin business, it has to be a very different margin profile, and that in turn on the assets have to be much, much higher than what they asked. Once we’ve changed those, some of those to the game and not worry about the dilution of margin, which is about 12%. We can easily make into 20% that would be one thing, which is be a good reflection of capital allocation.

Mihir Manohar — Carnelian Capital — Analyst

Sure, sure. That’s really helpful. Thank you very much. That’s it from my side. Thank you very much.

Krishna Bodanapu — Managing Director & CEO

Thank you very much.

Operator

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

Sandeep Shah — Equirus Securities — Analyst

Yeah, thanks for the opportunity. If I look at the performance of the services business, excluding the acquisitions in the first two quarters. The first quarter was close to 2.5% this quarter, close to 3% while the implied growth guidance services on organic basis will be higher than has been 13% to 15% which may require 3.84% kind of growth. So just extension to Sami’s question in the second half generally, it usually for the engineering R&D because of [Indecipherable], and the fourth quarter could be a part of CIBC IT budgets, which we have an impact because of the macro issues. So how confident are we in terms of good execution and services in the second half as well, considering all these factors?

Karthikeyan Natarajan — Executive Director & COO

Sure, Sandeep I think like what I answered earlier. I think we continue to see momentum on various sustainability initiatives that we have part of across whether it is mining or energy and other customers that we associated with. I think some of these programs are very long-term and we cannot afford to delay them so they will continue to be there, and we are hoping that the communication should start getting back to the growth trajectory like we spoke about and aerospace would still, it is not at the pace that we had in 2020. So we are still hoping that that should check along that is still a long-cycle business and we expect that to continue. So I think I understand the question of uncertainty and challenges we are likely to see and you probably have a better view as we close Q3 or early Q4. And that we can definitely talk about more if it certainly by the time we get to the next call.

Sandeep Shah — Equirus Securities — Analyst

Okay, okay, and Karthik, I missed your one of the comments on the railways of which one of the factors, the consolidated entity has been rationalizing the engineering R&D spend, that can be offshore, what was the second element on infrastructure, which you said? Because railway growth outlook, we were expecting a bounce back in the second half. Now we expect to bounce back to happen only in the [Speech Overlap]

Karthikeyan Natarajan — Executive Director & COO

No, I think that is led by — led by increase in the interest rates globally and most of them are funded by the government and when they need to pay it 0% or 1% interest rate [Indecipherable] 3% or 5%. I think that’s going to really have some more prioritization that’s likely to happen globally, and while they have four or five programs and which ones they want to prioritize for the near term. So that is likely to be the scenario. And also given the energy crisis that we are likely to see in Europe and what we’re also hearing is they may probably reduce the number of trains that running and how do you think they can reduce the number of trips they make in a day. And given the challenges that are likely to be seen with energy being seriously critical for the winter season. So I think those are the two or three factors that I talked about.

Sandeep Shah — Equirus Securities — Analyst

Okay, okay and just the last question. I think we are [Indecipherable] a 13% to 14% EBIT guidance. But now we use the word on an adjusted basis versus your guidance did not be the adjusted basis EBIT margin so at that time also we were knowing there would be M&A related cost which would flow through the EBIT [Indecipherable] so why there is assuming [Indecipherable].

Krishna Bodanapu — Managing Director & CEO

So I think I just answered that. See we did not know the impact of these numbers, and that’s why we are looking at the number for the sustainable and sort of ongoing operations because these things are really one-off, and that’s why we are saying, if we take these off, because the numbers will also have an impact of the yearly numbers, that’s why we are saying if we take these off and therefore, we can come up with for whatever is sustainable operation is what is the number and that’s why we’re saying without taking these one-offs.

Sandeep Shah — Equirus Securities — Analyst

Okay, thanks, and all the best.

Krishna Bodanapu — Managing Director & CEO

Thank you.

Operator

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

Krishna Bodanapu — Managing Director & CEO

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

May I again invite you to Investor Day which is on the 18th of November in Hyderabad. It will be an all-day session. And for those of you who attended our previous Investor Days, you will recall that it will be a good mix of internal presentations on strategy, on operations and financials, but also to show you some of the things that we do and more importantly or most importantly, I’d say, also meet with some of our clients to talk to them about where they see the business growing in science [Indecipherable] in the business. So [Indecipherable] will send out an invite or has already sent out an invite and I’m sure we’ll send you multiple reminders. So please register for it. It would be a pleasure again to show you with a lot of pride, what we do in person.

With that, thank you very much. Thank you for the support and I want to say to everybody that we’re very excited by the [Indecipherable]. And I think we have a very strong set of quarters coming. Thank you.

Operator

[Operator Closing Remarks]