Seeking Alpha
We cover over 5K calls/quarter
Profile| Send Message|
( followers)  

VanceInfo Technologies Inc. (NYSE:VIT)

Q3 2012 Earnings Call

November 15, 2012 7:00 AM ET

Executives

Sheryl Zhang – Head, IR

Tiak Koon Loh – CEO

Christine Lu – CFO, HiSoft

David Chen – President

Sidney Huang – CFO

Jeff Wu – EVP and Chief Globalization Officer

Analysts

Moshe Katri – Cowen & Company

Jason Kupferberg – Jefferies

Steve Zhang – Macquarie

David Grossman – Stifel Nicolaus

James Friedman – SIG

Operator

Hello and thank you for standing by for Pactera’s Third Quarter 2012 Earnings Conference Call. At this time, all participants are in listen-only mode. After management’s prepared remarks, there will be a question-and-answer session.

I would now like to turn the call over to your host for today’s conference Ms. Sheryl Zhang, Head of Investor Relations of the company. Ms. Zhang the floor is yours.

Sheryl Zhang

Thank you, operator. Welcome to Pactera’s first ever earnings call, the third quarter 2012 earnings of HiSoft and VanceInfo will be discussed in this call. Today’s call will last 75 minutes including Q&A. I’m joined today by Tiak Koon Loh, our CEO, who will go over HiSoft’s third quarter highlight, Christine Lu-Wong, CFO of former HiSoft, who will then go over HiSoft’s third quarter financial results, David Chen, our President, who will go over VanceInfo’s third quarter highlight, and Sidney Huang, our CFO, who will go over VanceInfo’s third quarter financial results and provide Pactera’s outlook information.

Before we discuss our results, I would like to remind everyone that the discussion today will contain forward-looking statements made under the Safe Harbor provisions of the U.S. Private Securities Litigation Reform Act of 1995 and within the meaning of Section 21E of the Securities and Exchange Act of 1934 as amended.

Forward-looking statements are subject to risk and uncertainties that may cause actual results to differ materially from our current expectations. Potential risks and uncertainties include, but are not limited to those online in our public filings with the SEC. Pactera doesn’t undertake any obligation to update any forward-looking statements except as required under applicable law.

In today’s call, we will discuss various non-GAAP financial matters as defined by the SEC’s Regulation G. Other consolidation of the differences between GAAP and the non-GAAP financial matters can be found in our earnings release and at the end of the earnings call presentation data posted in the Investor Relations section of our website.

I will now turn the call over to our CEO, Tiak Koon Loh.

Tiak Koon Loh

Thank you, Sheryl. Hello, everyone. I’m very pleased to report strong Q3 results. We’ve grown in nearly all target regions and sectors. Following previous quarter trends we continue to experience strong broad based demand for our services with especially strong demands coming from the domestic BFSI sectors and the overall technology sector. Revenue from the technology sector grew 36% year-over-year. Based on these results, net revenue recorded 11% quarter-over-quarter growth and 35% year-over-year growth. Our non-GAAP net income per ADS also increased to $0.33 in the third quarter of 2012 compared to $0.26 in the third quarter of 2011.

Moving onto geographic performance. Greater China business representing 23% of total revenue continued its momentum to drive growth for the company. In the Asia South region, we consolidated account in Australia in the third quarter and the region is now contributing 8% to our revenue. The U.S. market grew steadily despite the macroeconomic uncertainties and we are proud to record a 22% year-over-year growth in the region. However, in the coming months we may be seeing signs of potential softness for the market in Japan and Europe.

I would now turn the call over to Christine to walk you through the HiSoft Q3 financials. Christine?

Christine Lu

Thank you, Tiak. Good morning and good evening, everyone. Before highlighting some of HiSoft’s financial results for the third quarter of 2012, I’d like to reiterate that unless otherwise stated all financial figures are stated in U.S. dollars.

The third quarter net revenues were $79.6 million, up 35% from the same period last year. IT services and R&D services represented 58% and 42% of total revenues respectively and grew 36% and 34% year-over-year respectively. These robust results were driven by growth across all service lines, verticals, and key geographic markets.

GAAP gross profit in the third quarter achieved a 35% year-over-year increase, reaching $28 million. Our non-GAAP gross margin remained stable at 36% compared to 35.9% in the third quarter last year. Our adjusted EBIT was $11.2 million, up 42% from the same period a year ago. Adjusted EBIT margin was 14.1%, compared to 13.4% in the third quarter of 2011. The improvement was due in part to shifting our service mix toward higher value-added services. Non-GAAP net income was $10.6 million, up 28% year-over-year. Non-GAAP diluted net income per ADS was $0.33 compared to $0.26 in the same period last year.

In the third quarter of 2012, we incurred $2.5 million of expense related to the merger of equals, transaction with VanceInfo. This was included in our GAAP expenses, but excluded from non-GAAP expenses.

On balance sheet items, as of September 30, 2012 our cash and cash equivalents, restricted cash, and term deposits came to $120.7 million. Operating cash flow was a net inflow of $5.1 million compared to an inflow of $1.5 million in the corresponding period of 2011.

Days sales outstanding, DSO, year-to-date as of September 30, 2012, was 96 days, only three days higher from the same period in 2011 despite the percentage revenues from our domestic China business increasing from 17% to 23% over the same period.

Lastly, as my tenure ends at HiSoft, I’d like to express how proud I am to have worked for this organization from pre-IPO stage to present, and to have worked under the very capable leadership of Tiak Koon Loh. I have full faith and confidence in the Pactera leadership team and moving forward I know that great success lies ahead for them. Thank you and best wishes to all.

Now, let me turn the call to David to report to you on VanceInfo’s Q3 highlights. David?

David Chen

Thank you, Christine. Thank you, everyone for joining us today. Here I want to share with you some highlights of VanceInfo for Q3 2012 business performance. In this quarter our R&D services accounted for 45% of our total revenue. Although that revenue contribution came down from 49% in the same period of last year, the absolute number actually could still grow by more than 25% year-over-year.

In Q3, year-over-year revenue growth from application management services was 36% and accounted for 37% up of our total revenue. In line with our strategy compared to the same period of last year, our Consulting and Solution services has struggled for the three consecutive quarters.

In this quarter, the year-over-year revenue growth in this service line was 108%. The growth was mainly from Greater China and Asia-Pacific markets. From the verticals perspective, revenue from BFSI vertical increased by more than 114%. Now, we started to see healthy return on our strategic investment in domestic BFSI vertical.

And, for a combined company with expanded customer base and the service lines, we’re confident that Pactera will become the leader in the China for the – in this sector. Revenue from Telecom industry and Hi-Tech industry accounted for 35% and 32% overall total revenue respectively. This quarter for other verticals, Travel, Transportation verticals consistently contributed a healthy margin and a strong growth.

Geographically, running from customers headquarter in Greater China contributed 51% of total revenue increasing by approximately 50% year-over-year. Demand in China still remains robust. Revenue from Customers’ headquarters in U.S. and Europe made up 42% of our total revenue.

And last, I want to say that we are excited about the birth of Pactera, which is an exciting development and milestone not only of the company, but also of Chinese IT services industry. To save time for more Q&As, I won’t be able to elaborate on this for now. Thank you for your support and trust as always.

And I would like to turn the call to Sidney, to go through VanceInfo Q3 financial performance as well as the guidance for Pactera for the next quarter. Thank you.

Sidney Huang

Thank you, David. Hello, everyone. Let me spend a few minutes to go through the third quarter VanceInfo financial results and fourth quarter Pactera financial outlook on a combined basis.

As David has mentioned, our third quarter top line growth continued to be robust, led by our domestic business particularly in the financial services vertical up 114% on a year-over-year basis and 16% sequentially. The growth was partially offset by slowdown of our top three customers, which was discussed last quarter.

Gross margin was 31.4% in the third quarter, reflecting the extra bench, and severance costs incurred in connection with certain large customers. Excluding this effect, the gross margin would have been relatively stable from the second quarter level. Our non-GAAP operating margin was 8.9% in the third quarter, a little lower than the second quarter level, mainly due to the lower gross margin discussed earlier. Comparing to the same quarter of last year, the non-GAAP operating margin improved due to the heavy investment in BFSI vertical last year.

Our third quarter non-GAAP EPS was $0.19, which is within our guidance range as the negative headwind was anticipated at the time of our last earnings release.

Now, let me turn to the combined Pactera financial outlook for the fourth quarter 2012. Before I get into the numbers, let me explain the mechanics of the consolidation for the combined entity in the fourth quarter. This combination between HiSoft and VanceInfo is a merger of equals in most aspects. However, the purchase accounting rules still require us to identify an accounting acquirer, which in this case is the former HiSoft. Therefore, for accounting purpose, the fourth quarter guidance incorporates the whole quarter of the former HiSoft’s results, but only 52 days of the former VanceInfo results that will incur after the transaction closing on November 9th.

Now, as you can appreciate, it is still too early to produce the interim results for the former VanceInfo between October 1st and November 9th. So the Pactera fourth quarter outlook is inherently more difficult to forecast.

In spite of this complication we decided to provide a very preliminary and cautious view on the fourth quarter numbers. So investors will have some ideas of combined metrics. For example, the former HiSoft shareholders should begin to look at the EPS numbers on a post split basis which effectively reduces the EPS by a ratio of 1.3622. Therefore, our current non-GAAP EPS guidance of $0.22 to $0.24 for the fourth quarter implies a $0.32 to $0.33 EPS on a pre-split basis. For the shares outstanding. The current guidance assumes a total of 88 million shares on the combined fully diluted basis, but the weighted average will only incorporate 52 days out of 92 days for 44 million shares issued to former VanceInfo shareholders.

Finally, we understand that investors who probably care more about pro forma of Q4 outlook rather than to accounting outlook. So, we will like to reiterate that pro forma top line and the bottom line outlook should remain within our previously guided range. Our business is on track. Client services are strengthened and a comprehensive integration process is underway. We look forward to providing you with some more informative outlook for combined business in February 2013.

With that, I’ll turn the call back to Jeff for closing remarks. Thanks.

Jeff Wu

Thank you, Sidney. I do move forward to further integrate two companies operationally and culturally, we’ll continue to remain firmly focused on identifying synergies between the two companies in the areas of revenue expansion, cost saving, and margin expansion. Last but not least, I would like to express my heartfelt appreciation for Christine for her tremendous contribution during her tenure with HiSoft. She has played a significant role in our growth into a listed company and helped us develop the cost, budget planning, financial control, compliance and corporate governance infrastructure of the company in the past years. We are grateful for Christine’s contribution. I wish her all the best in the future endeavor.

That concludes our prepared remarks. We’d now open to address questions. Operator?

Question-and-Answer Session

Operator

Ladies and gentlemen, we will now begin the question-and-answer session. (Operator Instructions) Your first question comes from the line of Moshe Katri with Cowen & Company.

Moshe Katri – Cowen & Company

Thanks. Sidney, just going back to your Q3 outlook, you said EPS roughly to $0.22 to $0.24, can you talk about the outlook for – the combined outlook for margins and revenues?

Sidney Huang

Right. The combined revenues is guided at the $136 million I believe in the press release, and on the margin front – I would actually suggest not paying too much attention for this fractional quarter because it is fractional and there is possibly – we haven’t got our interim results as of November 9, but I will suspect that – the two sub-periods might not be equal from a margin perspective. So, we will – once we have the interim results, we will have better color on the margin, but I think what we said on our last call when we announced the merger, we have committed that we will improve our operating margins, improve our SG&A cost savings by at least 75 basis points in two quarters and 200 basis points in six quarters, and that commitment is still in place, but I think Q4 results will be a little messy. But, as I said, we still reiterate it that the combined pro forma guidance should still within the original range.

Moshe Katri – Cowen & Company

All right. I know it’s too early to talk about next year, but in general, when we’re looking at the combined entity, should we expect from the top line at least, are we looking at Vance – maybe kind of pruning some businesses that have been problematic i.e. should we expect to combine top line growth next year, below the averages of both companies, because again you can probably afford to get rid of some businesses that are not profitable. And then maybe you can talk about it, kind of the broad view on what we should look for an EBIT margin number for the combined entity?

Tiak Koon Loh

Okay. So let me talk about the – talk about the top line piece and obviously when Sidney talk about – having a better visibility we’re going to get in February, so I will try to attend these questions based on currently what I can see. It is fair to expect that the top line growth next year will not – definitely will be below than the average top line growth of the combined vehicle, this year which is in the mid 30s, is that right. This has been a predominant year. I think from a couple of angles, let’s talk about some of the things that we’re seeing that – HiSoft is – had certain exposure in Japan and so there’s best and full.

We are really beginning to – I know some of you must have heard of the little fishing island and we are having a bit of challenge there. We see a slowdown in client activities in Japan, not to the extent of the earthquake, but definitely a slowdown. So we think Japan is going to be impacted probably into Q1, because a lot of this decisions have been pushed back on certain contract signings until fall.

Then the other pieces, Moshe you mentioned is that – one of the challenges that we’re facing right now is really to look at the quality of the revenue – some of the client concentration issues are also resulted in the DSO problems and also margin issues. We want to take this opportunity on our combined platform to really digest and really segment through, and really differentiate between the qualities of different type of clients and most probably in doing so, we will forego – certain growth in certain clients and as such the growth rate for next year will not be at high.

Now, on the other front is, we believe that under margin side, we are really committed to the market on the operating expense level, on the SG&A that there is going to be same time improvement. So, I will say on the combined basis next year, you should not expect our operating margins to be any worse of – than what you’re seeing this year because we’re variables on the improving margin trend.

We will on a stable margin trend, we believe that the synergy is going to have those on the operating expense. So, it’s fair to assume that on a full year basis, now we should be seeing at least fresh margin trend, but what is being said – I think there will be certain amount of one-time expenses as part of the MOE, which will be classified outside, and that will most probably differ from the figures, but operationally that’s what we’re looking at.

Moshe Katri – Cowen & Company

So somewhere in the 12% to 13% range, right?

Tiak Koon Loh

I think on a pro forma basis, I think our combined – I don’t have it here. Let me quickly take a look. On a combined basis, our pro forma – if we were to get in – like what we guided are in a range we should be able to – I think adjusted EBIT of 11.9 – 10.9 on a combined basis.

Moshe Katri – Cowen & Company

I’m sorry, you said 10.9 to 11.9. Is that what you said?

Tiak Koon Loh

10.9, yes. Adjusted EBIT on a combined basis is 10.9.

Moshe Katri – Cowen & Company

Understood.

Tiak Koon Loh

About 10.9.

Moshe Katri – Cowen & Company

Good luck. Thanks. Thank you and good luck.

Operator

Your next question comes from the line of Jason Kupferberg with Jefferies. Please ask your question.

Jason Kupferberg – Jefferies

Thanks guys. I just wanted to ask if there has been any notable uptick in employee turnover since the merger was announced either on the HiSoft side or the Vance side.

Tiak Koon Loh

We are not aware of any notable turnover as a result of the merger.

Christine Lu

No, on the HiSoft.

Jason Kupferberg – Jefferies

Okay. Okay, good. And then just coming back to the...

David Chen

Yeah, as we mentioned before the merger came as a very positive news to employees. Most employees in China like to work for larger organization which support presidents in multiple markets. So, it’s – we don’t foresee not only now, but we don’t even foresee major turnover down the road.

Jason Kupferberg – Jefferies

Okay, good. And just to circle back on the projected cost synergies here I know you reiterated 200 basis points I think over the next six quarters or so, which is encouraging. I’m curious now that your three months or so and since you initially announced the merger. Do you have any reason to believe that 200 basis points could potentially prove conservative?

Tiak Koon Loh

It’s too early to tell Jason.

Jason Kupferberg – Jefferies

Okay, okay. And just lastly on DSO, I think it was up year-over-year in the quarter for both of the respective companies. As you generally look forward into 2013 and beyond, how should we be thinking about the combined DSO here and I realize some things could happen with Huawei over time here but just as a general statement, how should we be thinking about DSO, because I will say that they have a lot of implications for your free cash flow as a combined entity.

Tiak Koon Loh

Right, if you look at little more details in the DSO, our large customers do is stand out, is the main contributor of the longer DSO. So, hopefully as the contribution percentage of the large customer reduces, while other business is growing faster, we will see DSO improving next year. That’s certainly our target, I mean not only on this one particular customer but also part of the strategy is to optimize our business mix and move to higher quality services and customers.

Jason Kupferberg – Jefferies

Okay.

Tiak Koon Loh

So, DSO is on top of our priority list.

David Chen

So, Jason if I may add on just to give you a stand, if you’re really a performer, combined DSO days is pretty good actually it is in the 120 is that right, I mean, the nature of the China business, if you look at a combined company we had now almost a 40% concentration on China business, 38% to 40% concentration on China business having a DSO there probably in the 120 that’s pretty good compared to our peers, because the nature of the China businesses have long DSO. Now, I want to also link out two points. I think there is a lot of question being asked about margins, DSO and growth.

They’re all, this to me, I think from next year, this is a very important piece of the strategy that we decide to select. The challenge that we’re having right now is some of the large client that we have had lower margin, longer DSOs, but obviously give us a good churn of our top line, is that right? Now, we decide to be selective about it. What it means that our top line will not looks good. DSO, they will improve, our margin will improve. Now, however, we want to still continue to draw down the line of aggressive growth in that arena, then we will be, DSO based and margins improvement, very modest, is that right? And that – that is the strategy that we need to deliver over the next 90 days.

And I think, when we come in factory, I think we would be able to share with you, folks that are, what we think is the most to drive a successful growth and value for our shareholders in a longer run.

Jason Kupferberg – Jefferies

Okay. Thank you guys.

Operator

(Operator Instructions). Your next question comes from Steve Zhang with Macquarie. Please ask your question.

Steve Zhang – Macquarie

Hi. Good evening and thanks for taking my question. So, going back to what you have said about that you expect that even margin for 2013. I know when we met last time, you seemed like you guys were a little more optimistic in terms of operating margin expansion perhaps to 75 bps in the two quarters and then above that in the 18 months. Has anything changed during that period that that has caused us to feel a little more cautious in terms of operating margin expansion?

Tiak Koon Loh

Well, I thought we’ll be firm in our commitment to improve margins. Yeah, so I don’t know why you had an impression that we changed our view.

Steve Zhang – Macquarie

Okay. Because I was under the impression that...

Tiak Koon Loh

Yeah, we’ll remain committed to the SG&A cost synergies that we anticipated before.

Steve Zhang – Macquarie

Okay. And, second on the labor cost situation, how are you seeing that going into 2013 and what are your plans for rate increases?

Tiak Koon Loh

Well, I think given that the Chinese economy has been slowing, we – I think the wage inflation situation has been moderating. So, we have not seen any notable inflation trend at this point – just on the wage cost front. So, hopefully next year we’ll have a relatively stable year from a wage inflation point.

Tiak Koon Loh

Stable means that it will still grow in Beijing, in China.

Tiak Koon Loh

Mid-single digit.

Steve Zhang – Macquarie

Okay. Thank you.

Operator

Your next question comes from the line of Stephen (inaudible). Please ask your questions.

Unidentified Analyst

Hi, gentlemen. Just curious – I’d love to hear a bit about how you’re planning on handling the cultural integration of the two companies given that the cultures of the two are quite different?

Tiak Koon Loh

Yeah. So, I – no two companies have similar culture and also different suddenly, but I think a light in certain way. I think one of the piece that we are looking is that I think we look at our – let me talk a bit about how we look at digital integration. We really took at, I look at integration in three pieces, the most critical and most – probably the most crucial piece right now is really the operation integration, which means getting a ERP systems getting your job grading and putting all your HR systems for everybody into one place.

So, operational integration part is one piece and then the other part is a culture integration that you mentioned. And that is – it’s not two quarter exercises, it’s going to be a multiyear exercise. Where I am seeing is that I thing it’s going on well and lastly because of the fact that at the highest level Chris and I and all has strong commitment to the MOE. We started on a very good basis of vision of what we want the company to be. Up to currently until now we are not seeing any huge attritions, any unusual attrition or stop at junior levels, middle level or senior level. We are putting a lot of efforts in defining work streams around cultural elements, employee, cultural integration things and so far.

We are doing whatever we can, but I think the work on bringing the two companies to be more aligned culturally it’s not going to be a two quarter exercise, it’s going to be a multiyear exercise. The last piece of that which I think is the most critical piece where really – that really try to division of the merger was really together to become a stronger, a better company. And that needs a strategic integration and that can only be contemplated only when operational integration is more or less complete, which I believe will bring us into Q2.

By that I mean to say that how would you now being bigger try to really find a competitive landscape? What are the new areas of offerings? How would you want to change the way you engage the market, you engage the ecosystems. And to me this has the bigger importance because it will change our operating model, our business model, which ultimately would sell volumes whether we’re going to be competitive both in China and globally in three to five years. So to me there are three pieces.

So we’re very focused right now on cultural integration, which is a multi-year exercise going on. Operational integration that is really where we’re spending a lot of time on and we expect that to be completed by the end of Q2, and then the strategic integration piece. We’re thinking about it. We are contemplating it, but nothing has really happened yet.

Unidentified Analyst

Okay, thank you. And when you talk about – you and Chris having a clear vision of what you wanted to accomplish with this merger, it might be too big of a question to talk about all of that but maybe you could talk about what is the culture of Pactera that you want to have?

Tiak Koon Loh

Okay. To me that one thing that comes to my mind is very simple, and services business. I have been in the services business for 31 years. The first thing in our culture is the customer first. You’re going to be committed to customer success and I think this is one pathway. I think we’re culturally very similar. HiSoft and VanceInfo as an organization was very centered around the customer. And this to me was very easy part of culture to come together. We all are very committed both globally and domestically.

So I will say the first piece on my culture element must be around that. The second piece is, I think as the Chinese companies – China based companies going on a global foot scale and footprint, I think the way we – our business ethics sense the integrity in the way we work and so far it’s going to be very important. So, even I expect the similar high standards of reporting, compliance, transparency that we had always been – these two companies have been adhering and demonstrating. That is without a doubt will be a key piece of our cultural element.

And then, other elements that comes up very strong is that when we lay those signs where we are, now the largest, most IT services company in China, in terms of work for, you’ve got to work really as a team. It’s not a collection of companies, is that right? So, you do look at what we’ve done in the past. Our both companies has always maintained a basis of integrating, bringing in M&A company and not operating in our standalone subsidiaries and so on. So, the whole culture will be around teamwork, together one team – one vision. So, these are the key important elements of culture that we need to develop really.

Unidentified Analyst

Okay. And then last, it would be helpful to hear to the degree you’re willing to speak about it, just about your operational integration, and what’s been difficult there or what’s been easier than expected and when you have – really have the HiSoft’s IT operations, and you have VanceInfo operations and how are you blending those two?

Tiak Koon Loh

What? This could be a question that I could take the whole night but we can reduce it. Okay, one of the couple of key things operationally, the one of the most important thing is the ERP system. You got to bring everyone to a project accounting system on one project accounting system. And that – if you – if you don’t do that, the lost percent of your project profitabilities and stuff like that. So that is a very – is the heart of the whole – the whole operation.

The second piece is around, you have two different salary levels, rating systems. Some guys on the other side, you call them AVP, this side you call them Managing Directors and stuff like that. They are paid slightly different, you rationalize that on one common salary bending that so far. So the whole HR systems and migrating them to one common systems, so these are the two most importance piece

Interestingly, the last piece which most people thought was the most difficult was not difficult. It was really about the pricing piece of the market and so forth, because we being a smaller player, compared to the Indian players, we all participate in the part of the market whereby the pricing rates are being set for. It is almost very industry centric, is that right? So we don’t know a very different pricing levels whereby one of us was serving Microsoft, $15 an hour and the other guy was $22. The market has already over the years ago – the outsourcing market it’s a very much mature market especially for U.S. clients and the rally to a total pricing point. So our pricing level is about more or less the same. So we do not have a huge commercial exercise of re-looking at our pricing strategy. It was very much intact, it was, is that right? So if you saw two pieces, one piece was easy, two piece – the first two piece are the ERP and the HRP means a lot, the last means was relatively easy.

David Chen

Just, we also have spent past couple of months even before closing we have identified all key processes and the approach is we will – for each process, we will identify one set of process from one side. If it’s a preferred process, the entire company will follow that process. We try not to rebuild something in between. That will also eliminate a lot of integration issues so far because the two companies are in very similar businesses. So, so far we have not seen any major challenges in this process. We have set different key processes which system we will follow. Sometimes it’s the Vance system. Sometimes it’s the HiSoft system. But we are – we have reached consensus on most of those integration items.

Operator

Your next question comes from the line of (inaudible) with JPMorgan. Please ask your question.

Unidentified Analyst

Hi. Thanks for taking my question. You mentioned that there are different levels of salary and designation between the employees of the two companies. So in bringing these together at similar parity, do you see any wage inflation?

Tiak Koon Loh

Sorry, let me make sure I get your question. You’re saying that, do we see wage inflations at different salary levels, is that right?

Unidentified Analyst

In confirming the two comparison?

Tiak Koon Loh

Okay, very minimal. Okay, got it, got it. I got your question. While we do – for example, the difference is likely the way we pay people. Let’s say for example, a three years experienced person in the market if he commands and say, I want $10,000 a month in VanceInfo and in HiSoft, that’s roughly what we’ll pay him because if we were not paying him that amount, we would not have been able to attract staff anyway.

So we are almost commercially evolved because we’re also spread in the market, we are not a small player. So we don’t have to rally around a market rate. But the way we have designed that for example in HiSoft, we have 17 salary levels, E1 to E17 for example, and for VanceInfo that’s G1 to G10, is that right. Each, each level have a bigger, what we call, step – what we call a level within a band, bigger band.

So in doing so we have now – we decide whether should we follow the 17 levels or the 10 or we create a 13, is that right, more than – rather than fact that, we are paying people for the salaries differently and we now need to mark up one guy and it’s actually – it’s more a pending issue.

Unidentified Analyst

Okay, thanks. That was very helpful. Another question, going forward, which verticals will be the growth verticals for the combined entity?

Tiak Koon Loh

Okay. The two most important vertical to us, we still continue to be technology, which still represent a very substantial portion on revenue. But obviously the very exciting one, which we’re growing rapidly is the BFSI, which is banking which today account about 20% already on a combined basis. And to us especially the domestic China desk is a very attractive industry sector.

Unidentified Analyst

Okay, thanks. That was very helpful.

Operator

Your next question comes from the line of David Grossman with Stifel Nicolaus. Please ask your question.

David Grossman – Stifel Nicolaus

Thank you. Tiak, maybe I can just go back for a moment to your comments earlier about the margin. If I heard you right, you said that the pro forma operating margin for this year as a starting point would be about 10.9%. And if that’s right, can you give us a sense on at least where you sit right now, now that we’re three or four months into merger planning and integration. How much visibility do you have on the margin expansion, particularly on that first 75 basis points and where is that first 75 basis points coming from?

Tiak Koon Loh

Okay. Sidney you want to take it?

Sidney Huang

Yeah, we, on our last call, we listed out a few key areas. One is for example professional fees because we won’t need two sets of auditors or two sets of lawyers et cetera, and then also on facilities consolidation, optimization we are combining some of the facilities in various cities so that we can have better utilization of those facilities basis.

In some areas for example, we actually have fairly major government subsidized facilities, we’re underutilized, right. So that’s another very important piece. And then the third will be just the back office function consolidations that’s where we will have – we will have better efficiency and we will have – we have frozen our head counts for sure and we are in certain cases, certain redundant positions can be eliminated, but that’s a small part. The major synergies will come from holding the SG&A constant while the company is still growing. So adding those few pieces together you’ll get a fairly meaningful SG&A synergies to establish.

David Grossman – Stifel Nicolaus

And how much visibility you have on that 75 basis points, from where you sit today?

David Chen

Yeah. So on that David, I think to answer you, but if you are talking about 75 basis point, two quarters, we have pretty good visibility because costs is very much a control item, is that right. Sidney mentioned some of those things so, we committed on a 25 basis points optimization of the SG&A and right now, we are very comfortable that we will achieve the 75 basis point two quarters.

David Grossman – Stifel Nicolaus

Okay. And then, perhaps I can go to the – back to the fourth quarter revenue guidance on a pro forma basis, I just back of the envelope that that’s somewhere in the – I don’t know 16% to 18% range in terms of pro forma revenue growth on a combined basis, not on the hybrid basis or partial quarter. Does that sound about right?

Tiak Koon Loh

Sorry, could you repeat that again?

David Grossman – Stifel Nicolaus

So Sidney, if you combine both HiSoft and Vance’s revenue for the fourth quarter together, rather than taking a partial quarter for Vance, if you just pro forma it full quarter, what is the year-over-year growth rate assumed in that guidance?

Sidney Huang

I don’t have it in front of me. Yeah, okay, yeah, but my sense is you are probably right.

David Grossman – Stifel Nicolaus

Somewhere in the mid to high-teens?

Sidney Huang

Just the growth – year-over-year growth.

Tiak Koon Loh

Year-over-year?

Sidney Huang

Yeah.

Tiak Koon Loh

Yeah, I don’t have it in front of me. We will get back to you on that, David.

David Grossman – Stifel Nicolaus

Okay. And I know -.

Tiak Koon Loh

Yeah, but David I think, it would come in the other way, Sidney guided on a pro forma basis, our guidance impact – we guided on the whole that whole year we’re going to – is that right. And we are now three quarters into holding, is that right, which mean to say that fourth quarter we have more or less be in line of the guidance to meet the full year. So I would think it should be better than that 16% or 17%.

David Chen

Keep in mind David that we have – we still have some large customer headwinds that already occurred in Q3 and will probably continue somewhat in Q4, which again was already reflected in our guidance range. And also I think one other reason is Q4 last year, we have a very high revenue – it was a very high revenue quarter.

David Grossman – Stifel Nicolaus

Right. And Sidney could you just remind us what you’re thinking about in terms of those top customer headwinds in the fourth quarter, in terms of what sequentially we should expect in terms of revenue from those clients. You think it’s flat or you think it’s actually down sequentially. And if so how much do you think it will be down?

David Chen

Well, in the third quarter it was down sequentially, but we actually having to sit in a meeting on a combined basis next week to review this account, but we remain committed to serving this customer. We are not planning in any way to scaling back. We are still working with this customer. But I think it’s also function of how the customer’s own strategy and its cooperation with other partners. So yeah we don’t have a clear guidance on any single customer, obviously, we don’t know actually give this kind of guidance.

David Grossman – Stifel Nicolaus

Okay. Good. And just one last question, I think you did mention that you hadn’t seen any notable attrition. Can you give us a sense of what the attrition rates were in the quarter for each company?

Tiak Koon Loh

We actually won’t no. For VanceInfo we actually cut back, remember we – some large customers businesses slow down so we actually had to cut some employees. So that attrition would be a little misleading, but excluding that it would be a fairly normal quarter from attrition point of view.

David Grossman – Stifel Nicolaus

And what would that basically about in terms of percentages, what would a normal quarter look like for you?

Tiak Koon Loh

We actually – we historically, we do not disclose the attrition rate, probably because it’s just blended rate might be a little misleading, because we have different types of business. We used to break them into three categories the management and higher level, the senior consultants, technicians, the senior guys and attrition at VanceInfo was very low historically in single digit.

And then we have another category full service, full cycle offerings, which includes the development, testing, architects, designing work in those full cycle development centers to the attrition was somewhere in the teens. And then you have the more plain vanilla testing centers, BPO business where the attrition would be over 30%. So it’s – historically, we actually do not disclose the blended rate, but we can consider on a combined basis, we may actually decide to disclose that on a going forward basis.

David Grossman – Stifel Nicolaus

Okay. That’s very helpful. Thank you very much.

Tiak Koon Loh

You’re welcome.

Operator

Your next question comes from the line of Moshe Katri with Cowen & Co. Please ask your question.

Moshe Katri – Cowen & Company

Hey, thanks. Just a follow-up to David’s question, just to be clear the 10.9% EBIT margin, adjusted EBIT margin that you talked about for next year, just to -?

Tiak Koon Loh

No, no.

David Chen

No, no, no, this year.

Tiak Koon Loh

No, I think that was referring to the pro forma.

David Chen

Pro forma, but EPS, Moshe.

Moshe Katri – Cowen & Company

Yes, go ahead. Sorry.

Tiak Koon Loh

No, it’s for this year.

Moshe Katri – Cowen & Company

Okay. I was actually asking for -.

Tiak Koon Loh

And it was -.

Moshe Katri – Cowen & Company

– EBIT margin number for calendar year 2013? What sort of a number -.

Tiak Koon Loh

Okay.

Moshe Katri – Cowen & Company

– should we focus on, and that’s why I said initially 12%, 13%?

David Chen

Yeah.

Tiak Koon Loh

I see. Moshe, let’s – I think let’s hold that off a little bit because we are still in the middle of the integration. So I would really prefer to give you a more definitive guidance early next year. But as we mentioned, we’re committed to the cost synergies, but we also need to look at how we’re going to optimize the business mix, as we mentioned earlier, right. What are the key focus of growth? What are some of the areas that we might want to deemphasize? And then we can come up with because the operating margin is not only driven by the cost synergies, but also driven by gross margin, right. So I think we need to spend some more time, if you look at business mix and have a more – have a better analysis on the gross margin trend and then we’ll get you the operating margin trend. But certainly it will be a meaningful improvement from this year.

Moshe Katri – Cowen & Company

But it’s fair to say that we’re starting – we’re going to start pretty low in Q1 and then gradually move higher, right?

Tiak Koon Loh

Right, Q1 because of the seasonality and Chinese New Year and then just the nature of China business tend to be very slow in Q1, so Q1 is always slow.

Moshe Katri – Cowen & Company

All right, all right. Thanks.

Operator

Your next question comes from the line of James Friedman with SIG. Please ask you question.

James Friedman – SIG

Hi, a couple of questions. Could you describe what you anticipate or I know you addressed this to some extent, but if you can elaborate on what you anticipate the customer concentration profile of the combined entity will be, I think it seems like you have a 10% customer, am I correct in that?

Tiak Koon Loh

Right, we’ll have one, actually maybe one or two. The largest customer will come certainly below 15% and I don’t have it -.

David Chen

Yeah, the largest customer – so James, are you refereeing to this year or next year?

James Friedman – SIG

2013.

Tiak Koon Loh

Okay, I think it’s safe to assume that the largest customer – the largest customer, these are pro forma, combined basis, more than – slightly more than 15%, you can anticipate that the – that concentration to come down, so it’s actually going to be at 15%. The second customer will probably hover around the 10% level. This is roughly what we are thinking.

James Friedman – SIG

Sidney, you had said in the past that – and this maybe a dated figure, but that you need 200 heads in a delivery center for it to be profitable. Do you have any delivery centers currently that are not profitable, so that you can consolidate those into the 2013 or 2014 that you have after the merger?

Sidney Huang

Well, are you referring to site office or I think I was probably talking about when we get to 200 people, the cost structure and the margin profile will be optimized. I don’t think below that we will lose money. We don’t lose money at most of our businesses, just have probably lower margin. But just on the sites, yes we mentioned that we are consolidating some sites. So when you have a very small site it could be certainly less than optimal from a margin perspective.

James Friedman – SIG

Okay. And then as you reduce some of those facilities, should we anticipate any charges?

David Chen

Right, it’s certainly if there is unexpired lease, there will be some early termination cost, which will be reflected in the merger integration cost.

James Friedman – SIG

Got you. Okay, and then the last thing is with regard to the government subsidies, it seems like you have similar profile in terms of percentage of revenue. Well, first could you state whether that’s the case and then we’ve seen like HiSoft generated those subsidies more regularly whereas with Vance it was a little bit more lumpy. What should we anticipate going forward?

David Chen

I think on certain large items we are on a similar cycle, but HiSoft some of the HiSoft subsidies are indirect meaning for example government provides free office space, right. So those benefits would be actually reflected throughout the year instead of in any particular quarter. I think those companies may see more subsidies in the fourth quarter and the first quarter. Those are the two quarters where we probably see most government subsidies.

James Friedman – SIG

That’s interesting. Okay, congratulations on the merger.

David Chen

Thank you.

Tiak Koon Loh

Thank you.

Operator

(Operator Instructions) Your next question comes from the line of (inaudible). Please ask your question.

Unidentified Analyst

Hi Tiak, congrats on the merger. Can you hear me?

Tiak Koon Loh

Yes.

Unidentified Analyst

Okay, great. Just wanted to clarify on the 10.9% combined operating margin for 2012 is that including or excluding the one-off costs and merger costs?

Tiak Koon Loh

No, those should exclude that.

David Chen

Yes.

Unidentified Analyst

Okay. And I think earlier on you also mentioned that you’re committed to the guidance of 75 basis points of margin expansion in two quarters. So is it fair to say then that 2013 adjusted operating margin should be at least 75 basis points above your 2012, 10.9% operating margin?

Tiak Koon Loh

Yes, absolutely. I mean in fact, we hope we exit the year with better margins. I mean this is – 75 basis points is in mid year.

Unidentified Analyst

Okay, great. Thank you very much.

Tiak Koon Loh

You’re welcome.

Operator

There are no further questions at this time. I would now like to hand the conference back to today’s presenters. Please continue.

Sheryl Zhang

We would like to thank everybody for joining us on the call today. If you do have any further questions, please don’t hesitate to contact us. Thanks. Thank you.

Operator

This concludes today’s conference call. You may now disconnect.

Copyright policy: All transcripts on this site are the copyright of Seeking Alpha. However, we view them as an important resource for bloggers and journalists, and are excited to contribute to the democratization of financial information on the Internet. (Until now investors have had to pay thousands of dollars in subscription fees for transcripts.) So our reproduction policy is as follows: You may quote up to 400 words of any transcript on the condition that you attribute the transcript to Seeking Alpha and either link to the original transcript or to www.SeekingAlpha.com. All other use is prohibited.

THE INFORMATION CONTAINED HERE IS A TEXTUAL REPRESENTATION OF THE APPLICABLE COMPANY'S CONFERENCE CALL, CONFERENCE PRESENTATION OR OTHER AUDIO PRESENTATION, AND WHILE EFFORTS ARE MADE TO PROVIDE AN ACCURATE TRANSCRIPTION, THERE MAY BE MATERIAL ERRORS, OMISSIONS, OR INACCURACIES IN THE REPORTING OF THE SUBSTANCE OF THE AUDIO PRESENTATIONS. IN NO WAY DOES SEEKING ALPHA ASSUME ANY RESPONSIBILITY FOR ANY INVESTMENT OR OTHER DECISIONS MADE BASED UPON THE INFORMATION PROVIDED ON THIS WEB SITE OR IN ANY TRANSCRIPT. USERS ARE ADVISED TO REVIEW THE APPLICABLE COMPANY'S AUDIO PRESENTATION ITSELF AND THE APPLICABLE COMPANY'S SEC FILINGS BEFORE MAKING ANY INVESTMENT OR OTHER DECISIONS.

If you have any additional questions about our online transcripts, please contact us at: transcripts@seekingalpha.com. Thank you!

Source: VanceInfo Technologies' CEO Discusses Q3 2012 Results - Earnings Call Transcript
This Transcript
All Transcripts