Black Box Ltd Q2 FY2023 Concall Summary

Key Takeaways

• Revenue growth strong, margins squeezed: Revenue grew 16% YoY and 14% QoQ, but gross margin compressed to 23.4% as supply chain costs and component shortages bit, dragging EBITDA margin to 3.2%.
• A painful but deliberate reset underway: The company took severance costs to shift onshore roles to India, betting the move turns accretive from late Q4 FY23; a capital reduction scheme also aims to clean up the balance sheet.
• The demand story is holding: Management sees no compression yet, calling ICT infrastructure "largely nondiscretionary," and points to a strong pipeline in 5G, private LTE and data centers.
• Promoters doubled down: Promoters subscribed to warrants worth ~INR 225 crores, taking their stake to 71.14%, with funds directed at debt reduction and growth.
• What to watch next quarter: Whether the gross margin improvement initiatives actually land by Q4, the pace of labor cost easing, and any sign that the demand pipeline converts at the current 14–15% clip.

Margin Reset: The Cost Story

• Gross margin hit: Gross margin fell to 23.4% in Q2 from 25.4% in H1, driven by inflationary pressures, non-availability of components, and higher supply chain costs.
• Supply chain bites costs, not revenue: Higher procurement costs are the problem; the company can still source and deliver, so the top line is protected even as project costs escalate.
• The India shift: The company let go of employees outside India and moved operations to centers in India, incurring an exceptional loss as severance costs. The favorable P&L impact is expected from the end of Q4 FY23 onward.
• Severance to continue near-term: One-time severance costs, based on tenure and local HR policies in the US, Europe and India, are expected to persist over the next quarter or so before turning accretive.
• Capital reduction scheme: The board approved a scheme to set off accumulated losses against capital reserve and securities premium in the standalone books, subject to shareholder, NCLT Mumbai and other regulatory approvals.

Verma: “Largely, it has affected our costs because the costs have gone up. It has not affected our revenues because we are able to procure and deliver and keep our customers happy.”

Demand & Order Book

• No demand compression seen: Management has not yet witnessed a compression in demand, arguing that ICT infrastructure is largely nondiscretionary spend.
• Pipeline drivers: Demand for 5G, private LTE, and data centers is expected to remain strong, with a very healthy pipeline and increasing project ticket sizes.
• Data center tailwind: The company is bullish on the data center build-out business, with many large projects in the pipeline, including a $30 million+ deal for a global cloud provider or social media company with an 18–24 month completion timeline.
• Deal wins: Won deals with an upward value of $30 million during the quarter.
• Cloud revenue anchor: At least 35–40% of consolidated revenues are cloud-led, cloud-driven or cloud-delivered, carrying average margins of ~25%.

Verma: "We have not yet witnessed a compression in demand in our sector of the business. Black Box largely is in the ICT infrastructure business, which is largely nondiscretionary."

Revenue Trajectory & Targets

• Current run rate: The exit run rate is close to INR 6,000 crores, growing at ~14–15%, driven by demand and pipeline.
• FY24 revenue target: Management expects revenue to cross the INR 7,000 crores mark by FY24, based on continued 10–15% growth, and feels "reasonably confident" in that trajectory.
• Growth durability: The 14–15% growth rate is expected to continue "at least in the foreseeable future."
• Medium-term strategy: The company aims to increase market penetration in existing geographies and add new clients, going deeper in ASEAN, ANZ and Europe rather than opening new markets.

Margin Recovery Path

• The ambition: Management targets a 300–400 bps EBITDA margin improvement over the next 12–18 months, taking margins to the 9–10% range, driven by 200–300 bps of gross margin recovery plus SG&A leverage.
• Gross margin initiatives: The company continues to focus on various gross margin improvement initiatives and is hopeful of achieving the desired outcome by the end of Q4 FY23.
• Labor cost easing: The heated market for labor is expected to slightly ease off over the next few quarters, with management starting to see that trend already.
• Supply chain normalization: The supply chain phenomenon is expected "not to go away in the short term, but over the course of the next few quarters to ease out."
• Global Excellence Centre: The company recently invested in a Center of Excellence in Bangalore, scaled from 0 to 500 people, to address labor shortages and support the onshore-to-offshore shift.

Verma: "We do expect the heated market for labor to slightly ease off with respect over the next few quarters. We're starting to see that trend."

Business Segments & Acquisitions

• Technology Products (KVM): The company holds a leadership position in KVM products used in broadcasting, utilities and air traffic control, with R&D in Ireland and Bangalore, and is partnering with Philips for healthcare and hospitality applications.
• Cybersecurity acquisition: A smaller acquisition in the cybersecurity space was completed, with $4–5 million in revenue and 35–40% margins, performing well and expected to double revenues over the next 12–24 months.
• Geographic expansion: The company invested over the last 12–24 months, including during COVID, in opening markets in Europe, ASEAN and ANZ, both organically and inorganically.
• Acquisition philosophy: The company continues to look at inorganic opportunities regularly, but focuses on economics over ego, with deals needing to make clear economic sense.

Verma: “We focus on economics and not on the ego and emotions of acquisitions, and it should make economic sense for us.”

Balance Sheet & Promoter Action

• Promoter warrant subscription: Promoters subscribed to warrants totaling around INR 225 crores; the entire amount was received, with the last tranche of INR 37 crores received in Q1 FY23. Promoter shareholding stands at 71.14% as of September 30, 2022.
• Use of funds: The warrant proceeds were directed at debt reduction and growth requirements.
• Capital reduction scheme: The board-approved scheme to set off accumulated losses against capital reserve and securities premium is subject to shareholder, NCLT Mumbai and other regulatory approvals.
• PAT loss: The company reported a PAT loss of INR 23 crores in Q2 FY23 and INR 7 crores in H1 FY23, driven by lower EBITDA and the exceptional severance costs.

Guidance & Commitments

Key Metrics