Mastek Limited-Q1 2011 Earnings Call Transcript

PARTICIPANTS

Sudhakar Ram: Chairman, Managing Director and CEO: Management
Farid Kazani: Group CFO and Finance Director: Management  
Mrinal Sattawala: Group President: Management
Abhinandan Singh: Head - IR: Management
Biplab Chakraborty: B&K Securities: Analyst
Pratish Krishnan: Bank of America Merrill Lynch: Analyst
Hasmukh Gala: Quest Investments: Analyst
Shradha Agrawal: B&K Securities: Analyst
Abhishek Shindadkar: ICICI Securities: Analyst

PRESENTATION 

Operator: Good afternoon, ladies and gentlemen, I am Gopal, moderator for this conference. Welcome to the Post-Results Conference Call of Mastek Ltd. We have with us today the Mastek management team. At this moment all participants are in listen-only mode. Later we will conduct a question-and-answer session. Please note, this conference is recorded.

I now would like to hand over the conference to Mr. Abhinandan Singh, Head - Investor Relations, Mastek. Please go ahead, Mr. Singh.

Abhinandan Singh: Thanks, Gopal. Welcome everyone to our post-results conference call. The quarter under review for us is our first quarter of the fiscal 2011 as ours is a June ending year. Present with me on this call are Mr. Sudhakar Ram, our Chairman and Managing Director; Mr. Mrinal Sattawala, our Group President; and Mr. Farid Kazani, our Group CFO.

We'll begin today's forum with brief opening remarks by Mr. Ram, and then we'll open the lines for your questions.

After the call ends, within a few hours we should have the audio replay of the call available for listening to in case some of you have missed the call, and the access number is mentioned in the conference call invitation that was sent to you earlier. The transcript of the call should be now available in a few weeks – in a few days, sometime next week.

With that I would request Mr. Sudhakar Ram, our Chairman and Managing Director, to initiate the call. Over to Mr. Ram.

Sudhakar Ram: Thank you, Abhi, and welcome all to Q1 results earnings call. As you are aware that this has been a disappointing quarter, there were some rude surprises that we ourselves faced, and there was a set of events that actually bunched together quite unexpectedly causing revenue decline as well as possibly the first loss that we have posted since we went public.

So before I get into a qualitative thing, I'd like Farid to take you through the numbers explain the deviation between our last quarter Q4 financial year 2010 and Q1, so that you get a feel and put the whole thing in context. So over to you, Farid.

Farid Kazani: Yes. Thank you, Sudhakar. I'll just cover some of the headline numbers and also give you all a brief summary analysis on what has happened during the quarter in terms of the profitably.

Overall, total income ended up with `151 crores as against `165 crores last quarter. In terms of profitability, and I'll calculate PBT out here. Against `2.6 crores profit as last quarter, we ended up with `11.3 crores of loss PBT in this quarter. If I add back the forex gain between both the quarters, the real comparison actually in the PBT before forex, is actually `7.5 crore profit last quarter as compared to `14.9 crore loss in this quarter.

So, I'll try and give you a quick brief on where exactly the impact have happened and let me start with the revenue. We've seen revenue, obviously, larger impacts in the U.K. and in India/Asia-Pacific. In the U.K., it has been largely due to the impact of a drop in revenue on some application development project in Capita and in India/Asia-Pacific it's been due to some accounts where we've had specific issues. One of which is a revenue reversal that we had to take in a specific client linked to the delivery and confirmation issue, and second is in terms of certain projects overall that have happened in India/Asia-Pacific.

There's been a minor impact in the U.S. If I have to give you a recollection, it's U.K. which has been down by a little over `6 crores to `7 crores, India/Asia-Pacific by close to `6 crores and U.S. by roughly around `2 crores. So, that's the bridge for the revenue impact of `14 crores between the last quarter and this quarter.

On the PBT before FX, the bridge is roughly around `22 crores and the larger part of the impact is on account of salary increase and some bit on the headcount that increased in this quarter. We had mentioned at the start of this quarter, in fact in the last analyst call that we had to give a salary increase with a clear objective to retain our best talent, and we had gone ahead and given salary increase from July 1, which was close to an average of 20% for the offshore employees and roughly 3.5% for the onsite employees. The impact of salary increase and headcount put together is roughly around `11 crores to the P&L in this quarter compared to last quarter.

The second major impact is on account of higher product development expenses that according to this quarter, which is roughly `3 crores higher and that's primarily in for the expenses that we are incurring in our insurance vertical linked to roll out of our program with Foresters in North America.

As I mentioned the India/Asia-Pacific saw a reversal of revenue and that accounts for roughly `1.5 crore. The project overall in India/Asia-Pacific and some bit of in North America accounts for roughly `3 crores. The difference of around `4 crores is linked to the balance revenue shortfall that happened where the gross margins obviously have not come in. So this accounts for roughly around `22.5 crores.

The other headline numbers include the order book position, which ended up with `312 crores as against `306 crores and that is a positive sign keeping in mind that’s a lead indicator of how we will expect to perform in the next few quarters.

On the headcount, we ended up with 3,360 employees with a net addition of 117 employees where we had actually 3,243 employees in the last quarter.

This is as far as brief summary analysis, and we are looking at taking necessary actions some bit of it has already been kicked off and I will ask Sudhakar to take you through a little more details on that. Thank you.

Sudhakar Ram: Thanks, Farid. Clearly we are looking at an urgent and focused action, set of steps, to get back on to growth and profitability. Broadly the actions are in three areas. One is in sales, with Sattawala coming onboard, the fact that we already had a strong sales team, I think we’ve put a renewed focus in terms of more tighter controls, better sales processes, regular reviews and so on, which should help us increase our own coverage in the field and our focus is to add new accounts.

Top of that we have revamped our account management processes to ensure that the coverage on our top strategic accounts is much better, the kind of sea level relationships that we build, enhancing that we can actually mine more revenues aggressively in these accounts. The third thing which we’ve brought into place is an integrated go to market approach between the services businesses that we have, especially in North America, with the Insurance Product Solutions business to ensure that all the existing insurance accounts both in Life and Annuity as well as Property and Casualty are penetrated with a strong wider basket of portfolio offerings, so that we can grow these accounts more aggressively. So we are taking steps, this has already started at the beginning of the quarter, and this should help us improve order book and improve the revenues going forward.

On the projects front, while typically we've had strong margins, this quarter saw almost three or four different things coming together which have impacted us. Some of them are one-time, but we are putting in steps to see how we can improve margins even on the accounts, which are doing well to counter the salary increases and provide for the investments that we have.

So there is - under CDO, there is a concerted action plan which is put in place to improve margins on existing accounts. The third area is obviously in terms of discretionary costs. We have kept it under check, but we will put it under a microscope now to ensure that only the necessary expenses in terms of travel and other discretionary expenses are done till we get over this setback, and we will obviously continue to invest in the Elixir development especially with the customer commitments we have in Foresters and the great break we got in the North American market.

I think we do see market opportunities, so we do need to continue investments in product development. So while it may take us a couple of quarters to get back both top line as well as bottom line, and get to a healthier position, fundamentally the business is sound. The kind of account that we are going after, the differentiation that customers perceive in our service offerings and now that we have the breaks in North America also, we're pretty confident about our mid to long-term prospects, but we do need to weather these short-term issues and come back onto profits, which is what the entire team is committed to doing. So that's pretty much what I had as a opening comment, so I'll open the floor up to questions now.

Q&A

Operator: Biplab Chakraborty, B&K Securities.

Q: Biplab Chakraborty: The top line has been shrinking over the past eight quarters or so. I was wondering if you could share your thoughts about reversing this trend.

A: Sudhakar Ram: I think what we covered in terms of set of steps is exactly around that. So right from July onwards, we have reorganized ourselves. We have put lot more sales focus and the teams are in place, including at the leadership level, Dutta coming on board. We have Barry who is running the U.K., Mike Dufton in North America, and the next level of leadership in insurance, in BT, reinforcing Capita and so on.

So we have actually strengthened the leadership team across and improved our sales presence during this quarter, quarter and a half. Now, what we are attempting to do is obviously one is to get new deals and the focus is both on insurance, working new partnerships and government as well as going after the broader Financial Services segment. So that thrust continues.

The second, which was not as effective in the past is while customers used to come to us because of our strong delivery record, we were being barred rather than we really selling. So we have reinforced the account management process and increased our coverage on our larger accounts, increased the level of relationship which is already in force and that's leading to a better pipeline visibility today. But it will take some time for it to translate to order booking. So that's already in place.

The third is while we do have a strong services portfolio, though we are a solutions company, obviously all our customers also use us for services, not just in application development maintenance, but also in testing and data warehousing, and so on. We are not going with a systematic campaign to go after our existing P&C accounts, who have bought our billing or policy admin solutions as well as our Vector accounts to see how we can improve the footprint, get them to buy a larger portfolio of services from us.

So those are three steps which are underway from July onwards, and we have seen that it is helping us build the pipeline, but obviously it's not translated to very strong results as yet, but we do expect that to pay out in the coming quarters.

Q: Biplab Chakraborty: If I may follow-up on that maybe your thoughts on the levers that you think are available to return Mastek to profitability, and if I may what would a reasonable time frame for the same if you could share your thoughts?

A: Sudhakar Ram: Yeah. I think the levers are clear. The first lever is to get our top line back because our utilization has dropped and we have the bandwidth both from a sales perspective and from a delivery perspective we have very strong bench strength. So we have the bandwidth, which can support a much larger base of business. So getting back on to revenue growth, which obviously the first step is the order book is the first lever.

The second lever is we do expect to be able to improve productivity on some of the key accounts and manage some of these risks on the existing programs, but program has its share of risk but we have put in tighter risk management processes to be able to manage that better. So improving margin, growth margins on existing projects is the second lever.

The third lever is other discretionary expenses. Now how fast this will return us to profit is something that we can't exactly talk about right now, but the attempt is to get back in the next two quarters, later three quarters.

Operator: Pratish Krishnan, Bank of America.

Q: Pratish Krishnan: I just don't understand this – some of this revenue loss from Capita, you mentioned about some development work being stopped. Can you elaborate on this?

A: Sudhakar Ram: It's actually not stopped. I mean, we've had a new arrangement with Capita on the Elixir development. We got into a capacity deal. The level of development work and the level of staffing has come down by about £1 million this quarter as compared to the previous quarter. Still there is a fair amount of revenue, which is being generated on Capita on the product implementations. So, it's just a reduction not a stoppage.

Q: Pratish Krishnan: So, (indiscernible) the revenue run rate has now come down, is that the way one should get it?

A: Sudhakar Ram: That's correct.

Q: Pratish Krishnan: This was driven by whom? I mean, this (indiscernible) Zurich was one of the clients which was being transitioned to the new platform?

A: Sudhakar Ram: That's right, and that has been implemented, and now there are other customers which have to come online.

Q: Pratish Krishnan: So those have not come online or probably there are delays?

A: Sudhakar Ram: No, there is a process here because Elixir implementations, any insurance platform implementation takes time. So it's going as per our planned schedule. It's just that the nature of work coming to us has changed, profile has changed this quarter.

Q: Pratish Krishnan: So, the original contract value which were announced, I mean, would that change now?

A: Sudhakar Ram: The contract is still active. Basically, it's not the one-year contract, it was billed over a two-year – I mean the entire contract value is over a two-year period.

Q: Pratish Krishnan: Yeah. But you would have assumed something in the order book for this year. So I'm just wondering, I mean, would that assumption change or anything.

A: Sudhakar Ram: Not really, our order book position remains intact.

Q: Pratish Krishnan: Despite the cut in the…?

A: Sudhakar Ram: Yes.

Q: Pratish Krishnan: Second is revenue reversal from the APAC clients I mean, may be Farid can explain, frankly we have not seen a revenue reversal, so what I just wanted…?

A: Sudhakar Ram: No, basically, it's actually we had to put – between the client and us, we decided not to go ahead with the contract, because there were some issues which both of us couldn’t resolve. So we had started work on it, but we decided it was not feasible to continue working. So we had to stop the contract and reverse the revenue.

Q: Pratish Krishnan: Yeah. So when you say it's reversal, then this was recognized last quarter or…

A: Sudhakar Ram: That's right. The last two quarters, so it has been recognized over two quarters and that we had to reverse.

Q: Pratish Krishnan: So is there any deter for payment issue which one should probably be aware of?

A: Sudhakar Ram: No, it's all reversed out, so there is nothing there.

Operator: Abhishek Shindadkar, ICICI Securities.

Q: Abhishek Shindadkar: Sudhakar, I have seen the bookings number – not a significant jump in the bookings number. So is it that we have started to build the bookings number in third quarter or is that you know how should we read into those numbers?

A: Sudhakar Ram: See if I look at the bookings numbers, that’s actually the good leading indicator for us. Now one part, we – I agree with you that it's not moved up robustly, but I mean when you look at the `110 crores, in constant currency terms it's about `322 crores. So there has been a marginal shift in the booking number. There have been some paperwork issues, booking could have been better if all our contracts were exactly signed as of September end. But this is something that we expect to improve in the next two-three quarters. So this has been our complete focus that we want our order book to be very strong by the end of this financial year, so that we have good platform for growth next year. So that’s a bit what I’ve talked about in July when we started the year and that remains our focus.

Q: Abhishek Shindadkar: Okay, but then marginal conversion of the bookings has started to take place, right?

A: Sudhakar Ram: Marginal conversion of bookings to revenue you are saying?

Q: Abhishek Shindadkar: Yes.

A: Sudhakar Ram: Obviously, yes.

Q: Abhishek Shindadkar: The second thing which I would like to know is, we estimate that the prices – the billing rates have declined substantially, probably 5% to 7%. So is that a cause of concern and what are we doing in terms of…

A: Sudhakar Ram: Given the nature of our business and the fixed price things, it will be difficult for you to compute billing rate, but as far as our thing goes, there has been no change in billing rates through the quarter. We took a hit on one account in January, which we talked about in terms of a reduction on billing rate that was in the U.S. That is the only thing. If you do a last year comparison that will be lower, but on an overall basis there has been no issue on billing rates, but the margins have come down because of these revenue reversals and project issue. FX has also created its own fluctuations, but billing rates have remained steady.

Operator: Shradha Agrawal, B&K Securities.

Q: Shradha Agrawal: Couple of questions. First, Farid, would it be possible for you to share the constant currency revenue number for this quarter?

A: Farid Kazani: When we look at it in terms of dollars, `151 crores translate to around $32.8 million and if you look at it in terms of constant currency, it will be close to around $33.6 million or $33.7 million.

Q: Shradha Agrawal: So you're meaning to say that in constant currency, Mastek would have actually declined by almost like 9%, 9.5% in revenue?

A: Farid Kazani: Little less than that, in rupee terms, it declined by 9% actually.

Q: Shradha Agrawal: Secondly, in terms of following up on the earlier question as to where do we stand against our earlier communication of at least £25 million of booking from Capita in the next two years. So is there any change when you talk about some development work being stopped on Capita-Zurich account?

A: Sudhakar Ram: See, as of now, there is no change in the contract, and we do expect that the contract terms will be adhered to.

Q: Shradha Agrawal: So you still maintain that £25 million run rate from Capita?

A: Sudhakar Ram: That's right.

Q: Shradha Agrawal: Apart from Zurich, what is the status of implementation of other account? Are we in the process of implementation?

A: Sudhakar Ram: Yes, the next account, the development work – the customization work is going on.

Q: Shradha Agrawal: That account would be prudential?

A: Sudhakar Ram: No, it’s a co-op.

Q: Shradha Agrawal: How about the status of implementation of the third account then?

A: Sudhakar Ram: No, right now, the work is on the second one.

Q: Shradha Agrawal: So you still expect some kind of lag to happen on the third account?

A: Sudhakar Ram: See, these are developmental schedules, Shradha. So they will – this is planned by Capita and they will be executed as per their plan.

Q: Shradha Agrawal: Sir, that's right, but then I'm really curious to understand why Mastek has been hiring people quarter and quarter despite we not seeing a very significant jump either in the order book or any positive feelers coming in from our clients, so why such kind of a hiring coming in from our client, so why such kind of a hiring coming in from the company?

A: Sudhakar Ram: See a part of the – in fact most of the increase this quarter has been on trainees. That as a company we do need to flatten the pyramid, so we have been taking on trainees, who are undergoing training, and they'll come into productive use during this year.

Q: Shradha Agrawal: But what is the visibility we have to hire in people?

A: Sudhakar Ram: See basically we have, what you see is a 12 month order book.

Q: Shradha Agrawal: Right.

A: Sudhakar Ram: Our visibility is based on a complete order book picture as well as the pipeline, which is not obviously visible to you.

Q: Shradha Agrawal: I mean, so if I look at your order book number versus our historical trend of order book to next quarter's revenue of 35% to 40%, so where do we stand now in terms of that number?

A: Sudhakar Ram: I don't think – I mean that would have changed in any way. They're still in that 30%-35% range so…

Q: Shradha Agrawal: Secondly, Farid, I mean, I'm not really sure of what do you mean by project overrun in this quarter?

A: Farid Kazani: There have been some accounts where we've had higher cost linked to the delivery that has happened in some project in India and Asia Pacific, and one account in North America. So that's what exactly I mean by project overrun.

Q: Shradha Agrawal: So this is a one-off cost of close to `3 crores?

A: Farid Kazani: Yeah, `3 crores, yeah.

Q: Shradha Agrawal: Secondly on the tax number, I mean what is your assumption on tax for the entire FY '11 and '12, if you could share something there?

A: Farid Kazani: If you look at the tax for this quarter is been roughly around `2 crores, and the future tax will be based on how the revenue and profitability stands out for the U.S. and U.K., and that's exactly where we pay tax. So it's difficult to hazard a guess right now. It will all depend upon the top line and the profit that comes out of the business in U.K. and U.S.

Q: Shradha Agrawal: Yeah, but as of now we do not expect the company to come back to profitability at least for another one, two quarters, is that a right assumption?

A: Sudhakar Ram: I mean, yes, you can make that assumption, but the tax is not linked to just the Mastek Limited group number. Obviously we pay taxes on our local revenue and profit in U.K. and the U.S.

Operator: H.R. Gala, Quest Investments.

Q: Hasmukh Gala: I am not sure whether my name had come earlier because the line is so bad, half of your discourse I could not hear. I believe that your transcript will be proper. My question relates to the new paradigms which are coming on the horizon in the IT services area, like cloud computing, et cetera. Now, how are we prepared to address those when our clients demand that?

A: Sudhakar Ram: In fact we are building up expertise in that area. And there may be certain specific solution offerings that we are actually getting ready to prepare for the cloud around the government and financial services verticals that we have. But it's premature to talk about it because these are internal projects right now.

Q: Hasmukh Gala: In this IP-led enterprise solutions which we are harping upon as our main trust area, when it comes to the competition, who are the major players against which we have to contend?

A: Sudhakar Ram: Largely in insurance CSC, Computer Science Corporation, and now Oracle. And in government, it's people like Logica…

Q: Hasmukh Gala: Which is the first one? Computer, CSC?

A: Sudhakar Ram: Sorry?

Q: Hasmukh Gala: Which is the first one?

A: Sudhakar Ram: CSC, which is a U.S. company.

Q: Hasmukh Gala: Okay, CST?

A: Sudhakar Ram: CSC, Computer Science Corporation.

Q: Hasmukh Gala: And Oracle?

A: Sudhakar Ram: Oracle, yeah.

Q: Hasmukh Gala: And in government vertical?

A: Sudhakar Ram: It's Logica in the U.K., yeah.

Q: Hasmukh Gala: Logica, okay. But there aren't any Indian companies which are…?

A: Sudhakar Ram: Not very directly. TCS does something in insurance in U.K., but by and large on a global basis, we face CSC and Oracle.

Q: Hasmukh Gala: These are the major competitors?

A: Sudhakar Ram: Yes.

Q: Hasmukh Gala: Now sir, apart from the financial services as one of the additional verticals that we intend to get into, don't you think that in order de-risk our business model from this two main verticals, should we not expand to some other verticals and lend some sort of sustainability to our revenue?

A: Sudhakar Ram: We are looking at that. In this quarter, one of the new additions we have won is actually in the healthcare business in the U.S. based on our expertise on NHS. So, we see that it’s a small deal for us now, but we see it is strategically important to us and over the next year or two that’s something we know that healthcare is going to be a major IT spender, so it gives us a good base.

Q: Hasmukh Gala: Which space, sir?

A: Sudhakar Ram: Healthcare.

Q: Hasmukh Gala: Which is another one?

A: Sudhakar Ram: The other one is in financial services.

Q: Hasmukh Gala: Sir, does your business model and the kind of engagements that you get into, does it render, I mean make it possible for you to render the high-value IT enabled services to the same set of clients, having given the license of your product?

A: Sudhakar Ram: What we do is actually use our IP along with partners who have that BPO capability. For instance, Capita is one such partner, who has leveraged our IP in the U.K. market. We announced the relationship with Genpact in the U.S. and so, we are hoping to do some business along with Genpact going to market with them in the next year or so.

Q: Hasmukh Gala: Will you sir, give some guidance for this FY '11?

A: Sudhakar Ram: No.

Q: Hasmukh Gala: You don’t give any guidance.

A: Sudhakar Ram: Yes.

Q: Hasmukh Gala: What kind of capital expenditure plans we will have?

A: Farid Kazani: Nothing major actually because we don’t need any further capacity expansion and our normal CapEx, which is maintainable CapEx is roughly between `10 crores to `15 crores per annum.

Q: Hasmukh Gala: Because the type of business model we have I think you don’t need to recruit very many people I believe.

A: Farid Kazani: That’s one reason and we already have capacity with us.

Operator: Biplab Chakraborty, B&K Securities.

Q: Biplab Chakraborty: Sorry to beat this to death, but if you could please give some more idea about rather the reasons behind project overrun that will be really helpful. My second question would be about the declining share of fixed price project if you could please throw some light on that.

A: Farid Kazani: The project overruns are part of any fixed price project. If you have an Elixir implementation or a billing implementation, you fix price it and sometimes the world goes over what you thought it would be. So in some you gain and some you lose, so it's part of life. The fixed price has actually gone down as a percentage in the last couple of quarters, but one or two deals can change that whole picture. So that would vary quarter-on-quarter. But as you know our normal attempt is to do I think 50% of our business on a fixed price basis.

Operator: Abhishek Shindadkar, ICICI Securities.

Q: Abhishek Shindadkar: Sudhakar, in terms of hiring are we done with our hiring for '11 or I mean what is management's view on hiring, sir?

A: Sudhakar Ram: We are not a headcount driven business. So our hiring will be based on order booking and the kind of skill sets that we need. We have those skill sets in-house and we have the capabilities we won’t hire. So there is no – we don’t plan hiring except as a derivative of the order book and revenue projection.

Q: Abhishek Shindadkar: If I do the math and just to follow-up on Shradha’s question, you said that next two quarters, the profitability seems to be more or less similar with you, which implies that apart from (various costs), the decline is probably from the volume or probably the revenue line. So is the math right or there is something else which we’re missing out.

A: Sudhakar Ram: Basically if you look at the profitability there aren't going to be too many changes from a profit perspective in the short run, but we are looking at increased order book and therefore an impact on revenue. In fact, there are deals, which we expect should close in this quarter or next quarter, which could have a good impact on revenue going forward.

Operator: Shradha Agrawal, B&K Securities.

Q: Shradha Agrawal: Just one short question, how has the attrition been for this quarter?

A: Sudhakar Ram: It's been much better given the wage hike.

Q: Shradha Agrawal: What that number would be?

A: Sudhakar Ram: We don’t share the number, Shradha.

Operator: There are no further questions. Now I hand over the floor to Mr. Sudhakar Ram, Chairman and Managing Director, Mastek for closing comments.

Sudhakar Ram: Thanks once again for your interest in Mastek and continued support. We've been going through some tough times over the last seven to eight quarters, but we are pretty optimistic that we have the team and place as well as the strategy in place to be able to reverse this trend within the next couple of quarters. So, stay tuned and we do hope to share good news with you by the next couple of quarters. So, thanks once again. Bye.

Operator: Ladies and gentlemen, this concludes your conference for today. Thank you for your participation and for using Door Sabha's conference call service. You may disconnect your lines now. Thank you. Have a pleasant evening.