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Virtusa Corporation (NASDAQ:VRTU)

F4Q13 Earnings Call

May 8, 2013 5:00 PM ET

Executives

Staci Mortenson – IR

Kris Canekeratne – Chairman and CEO

Ranjan Kalia – EVP and CFO

Raj Rajgopal – EVP, Business Development and Client Services

Analysts

Joseph Foresi – Janney Montgomery Scott

Mayank Tandon – Needham & Company

Brian Kinstlinger – Sidoti & Company

George Price – BB&T Capital Markets

Puneet Jain – J.P. Morgan

Harold Bengar – William Blair

Moshe Katri – Cowen and Company

Vincent Colicchio – Noble Financial

Operator

Good afternoon, ladies and gentlemen. Thank you for standing by. Welcome to the Virtusa Corporation Fiscal Fourth Quarter 2013 Earnings conference call. At this time, all participants are in a listen-only mode. Following the presentation, we will conduct a question-and-answer session. Instructions will be provided at that time for you to queue up for question. I would like to remind everyone that this conference is being recorded.

I would now like to turn the call over to Ms. Staci Mortenson of ICR. Please go ahead.

Staci Mortenson

Thank you. Good evening and welcome to Virtusa’s Fourth Quarter and Full Fiscal Year 2013 Earnings conference call where we will be discussing our financial results for Virtusa’s fourth quarter and fiscal 2013 year ended March 31, 2013.

On the call with me are Kris Canekeratne, Chairman and Chief Executive Officer; Ranjan Kalia, Executive Vice President and Chief Financial Officer; and Raj Rajgopal, EVP of business development and client services of Virtusa.

Certain statements made in this call that are not based on historical information are forward-looking statements, which are made pursuant to the Safe Harbor provisions of the Private Securities Litigation Reform Act of 1995.

During this call, we may make express or implied forward-looking statements relating to among other things Virtusa’s expectations and assumptions concerning management’s forecast of financial performance, the growth of Virtusa’s business, the ability Virtusa’s clients to realize benefits from the use of Virtusa’s IT services, and management’s plans, objective and strategy.

These statements are neither promises nor guarantees but are subject to a variety of risks and uncertainties, many of which are beyond Virtusa’s control which would cause actual result to differ materially from those contemplated in these forward-looking statements. Existing and perspective investors are cautioned not to place undue reliance on these forward-looking statements which speaks only as of the date hereof.

Virtusa undertakes no obligations to update and revise the information disclosed during this call, whether as a result of new information, future events or circumstances or otherwise.

Other statements in this call also include certain non-GAAP financial information as defined by the SEC. We present constant currency revenue to provide a framework for assessing our revenue performance excluding the effect of foreign currency rate fluctuations. We also present a reconciliation of cash, cash equivalents, short-term and long-term investments that we believe provide insight into our total cash position and overall liquidity.

For additional disclosure regarding these and other risks faced by Virtusa, see the disclosures contained in Virtusa’s public filings with the Securities and Exchange Commission and our earning press release.

With that, I’d like turn the call over to Kris.

Kris Canekeratne

Thank you, Staci. And thank you for joining us on our fourth quarter and fiscal year end 2013 conference call. It’s a solid fourth quarter wrapping up a strong fiscal year characterized by industry living revenue growth and significant upgrading margin expansion.

For the March quarter, revenue was $89.9 million, an increase of 4% sequentially and 21% year-over-year. EPS was $0.35 compared to $0.23 in the year ago period. For the full fiscal year 2013, total revenue increased 20% to $333.2 million, operating margin expanded 130 basis points and EPS increase 40% to $1.11.

Our growth for the fourth quarter and the full fiscal year 2013 was given by our IT rationalization expertise, industry-leading transmission solution, regulatory and compliance services and leadership position in Millennial Enablement. Within differentiate offering, we have been successful in expanding our presence within our client base and winning larger engagements.

I’m very pleased with the progress our teams have made specifically in the areas of increasing thought leadership, strengthening client relationships, and delivering on our strategic goal.

We operate in a changing and dynamic marketplace that differentiation is of paramount importance. As a company, we have investors in furthering our own differentiation by expanding our domain expertise in selected industry groups and working with clients that are the leaders in their respective industries.

As a result, we have developed significant thought leadership, establishing ourselves as a credible business partner on large transformational programs at the intersection of business and technology. This has enabled us to engage not just the IT organization but also take on a strategic role with business sponsors as they’ve often own the budget and have the most complex problems to solve. This is enabling us to take on a larger percentage of the overall engagement and significantly increases our revenue opportunity.

Let’s spend a little time on this and how it relates to three key pillars of our growth platform – Millennial Enablement, transformational services and the opportunity we have to expand within our client base.

The influence of the Millennial regeneration is reaching a tipping point. Millennials currently account for one-third of the US workforce and within six years will account for more than one-half. As they age, they are emerging as the dominant consumer and employee demographic [inaudible].

Alongside their ascendancy is the maturation of the technologies that they have grown up using. These technologies mobile, social, Big Data, gamification, and cloud have matured and are now ready for widespread enterprise production. Our Millennial strategists and solution expert are helping our client understand the power and possibilities of these maturing technologies and how they can transform the end-user experience.

Industry leaders will employ these technologies not as ancillary systems but as their foundational platform. Up until now, most enterprises have looked these enablers from a siloed and tactical viewpoint often simply mobile enabling their website. This approach has led to mixed results and in most cases alienated its really savvy consumers.

By helping our clients develop millennial experiences that leverage the synergies within these enabling technologies, we are unlocking the power that comes through their combination and integration. They are orderly seeing the reality of this transformation within our client base. A large life insurance company was struggling with how to attract millennial. They tried shifting the advertising campaign, launched a Facebook and introduce a mobile app. But they were still failing to connect because they are first of all reactive, primarily marketing-driven, and did not provided consumer experience commensurate with the customer expectation.

Having demonstrated availability to provide innovative leadership through our help in modernizing their contact centers, we were asked by their CEO to help shift their approach to interacting with this rapidly growing consumer demographic.

The Virtusa team consisting of industry experts and millennial strategists worked with their CIO to develop a millennial experience that would not only transform how they interactive with customers but would also drive revenue growth through increased cross selling.

We showed the client’s business and technology senior leadership of the millennial customer interaction was no longer simply in market and firm model but it evolved into one that was based on establishing a customer dialogue and ongoing relationships to deliver up high targeted and personal digital experience. In conjunction with our team, the various business units are we thinking the customer experiences they are providing and launching an effort to move innovation from the realm of special projects and embedded tenants [ph] into their core DNA.

To be successful businesses will need to evolve and change many of their core business processes and their underlying application platforms to attract and retain millennial customers and employees. This paradigm shift in enterprise computing is widely thought to become the largest application modernization initiative within the enterprise since the advent of plans over architecture. Using investments we have made and the expertise we have developed in these core technologies Virtusa is poised to be the industry leader in Millennial Enablement.

The second management theme driving our business is solid execution of the entire [ph] strategy of providing transformational services to our clients that we can demonstrate a clear difference to our best-in-class industry solution, compliance and regulatory offering and IT consolidation and rationalization services.

The investments we have made over the years to provide thought leadership by building domain expertise and strengthening of a business consulting team, combined with our different theater solutions have enabled us to pursue and win large transformational program in the industries we serve. We had great success here in fiscal year 2013 and expect this will be a key growth driver for us in fiscal year 2014 and beyond.

Compliance and regulatory reform in financial services and healthcare [ph] are two great examples of areas we are taking on a leadership role. For example, in banking, one of the key solution area is related to know your customer or key advisory compliance. This generally covers many compliance areas including anti-money laundering, Foreign Account Tax Compliance Act, commonly known as FATCA, and essentials checking but now is also extending into areas such as credit scoring and creditworthiness.

So both [inaudible] by fee and its required activities is under increasing scrutiny and being enforced by the addition of new rules and regulations that’s fundamentally move accountability from the consumer to the financial advisers or institution. Controlling and ensuring compliance of this new standard on a continual basis is driving significant change in the related support systems of retail banking divisions.

To help our clients meet the new standard being created by [inaudible] beyond leveraging the financial consulting and technology expertise we have in master data management and case management to provide comprehensive service offerings for our client. Our programs are designed through remediate current issues and define and implement the requirements for automated compliance business processes and enterprise consumer experience management solution.

We’re also playing our Big Data and data analytics experience to create iterative reporting tools that will allow our clients to continuously evaluate customer information and activity to help identify anomalies in accounts.

Banking and financial services firms allocating an increasing percentage of their budgets of regulatory reform and compliance initiatives during calendar year of 2013 and this represents a significant opportunity for Virtusa. Our leadership position in this area will help drive growth in the financial services and banking sector during this fiscal year.

In healthcare, there is a 2014 mandate for ICD-10 testing. While many health insurers are far along in their remediation effort, a significant amount of testing still remains to be done. The provider community is even further behind in their readiness. Virtusa is working on what we feel is a unique service offering, focused on end-to-end collaborative healthcare testing between pair and provider communities.

We are experiencing a significant interest level from the market and has KYC [ph] with several healthcare communities we see this opportunity as a key factor in the anticipated growth of our healthcare business over the next two years.

Additionally, our ability to rationalize and consolidate our clients IT application provides enduring benefits. Our platforming [ph] approach helps our clients reduce total cost of ownership, accelerate time-to-market and provide a more holistic and cohesive consumer experience.

In today’s dynamic business environment of a unique approach and differentiation has become a competitive advantage for our clients as they move more of their core business processes on to fuel builder [ph] platform, reduce application redundancy and improve IT efficacy. This remains a key underpinning of how we can intersect technology with key business initiative and create tangible benefits for our clients.

Finally, we have a solid client base that recognizes Virtusa as an innovator and a thought leader. While we continue to see opportunity for growth across our top 10 clients, our expectations are that for fiscal year 2014, the remainder of our client base will be a growth driver for our business. This increase diversification across our enterprise client base opens up more opportunities to find those areas where business and IT intersect and point a greater role in their millennial, transformation, and compliance and regulatory initiative.

As we become KYC [ph] integrators with our clients’ lines of business and IT leaders, it is becoming increasingly important to work in closer proximity to our clients. To that end, we are investing in developing near-shore services to augment our onsite capabilities and we recently opened to near-shore centers.

The first is in Singapore to service several Asian plants. The second is a new technology center in Albany, New York. This center is strategically located to be easily accessible by our clients across the northeast. Albany is a great location as there are more than 15 colleges and universities in the area, enabling us to source technology talent.

The addition of our near-shore centers fulfills an important element of our global delivery model by enabling us to increase client intimacy and deliver certain services that can only be performed in close proximity to our clients.

Before I turn the call over Ranjan, I want to reiterate how pleased we are with the progress we made in fiscal year 2013 against our strategic goal and our fiscal year results. We are well-positioned to drive above market growth rates in fiscal year 2014 by delivering on our ongoing stated objective of delivering meaningful operating margin expansion.

We enter fiscal year 2014 with a solid plan foundation from which to grow, a position of thought leadership in our focused industries and expanded opportunity as we capitalized on our ability to provide industry-leading solutions at the intersection of business and technology. We are also very pleased with the progress we have made with team member engagement resulting in higher retention and numerous supports for HR best practices.

Now let me turn the call to Ranjan who will provide more details in our results and current first [ph] quarter and fiscal year 2014 guidance. Ranjan?

Ranjan Kalia

Thanks, Kris, and good evening to everyone. Let me start by summarizing the results of our fourth quarter and full year fiscal 2013 before providing our current guidance for the first [ph] quarter and full fiscal year ending March 31, 2014. All of the numbers being discussed our US GAAP expect with regards to use of constant currency revenue metrics.

Revenue for our fourth fiscal quarter was $89.9 million, a 4% sequential increase and reported currency and 5% in constant currency. Our sequential revenue growth was broad-based across all industry groups. On a year-over-year basis, the revenue increased 21% in reported currency and 22% in constant currency. Constant currency normalizes the movement of the British pound against the US dollar in each competitive year [ph].

Gross margin during the fourth quarter was 35.9% compared to 35.6% in the prior quarter and year ago period. Our operating income for the fourth quarter was $9.4 million, an increased from $9.1 million in the prior quarter. And from $7.1 million in the year ago period. This resulted in an operating margin of 10.5% for the fourth quarter of fiscal 2013 compared to 10.6% in our prior quarter and 9.5% in the year ago period.

The small sequential operating margin change was primarily driven by investments in two new delivery centers, one in Singapore to support a development for some large clients and the other interventional [ph] technology park in Albany, New York, to expand our near-shore presence.

The year-over-year 100 basis points increase was primarily due to an FX benefit mainly from our INR hedging programs, subcontractor efficiencies and the reduction in discretionary spending, partially offset by an increasing investments in client-facing [ph] resources and increased facilities cost as just described a moment ago.

Fourth quarter, other income was $900,000 inclusive of an FX transaction gain of $175,000, which was not included in our prior guidance. This was primarily due to the strengthening of the US dollar against the British pound on intercompany and customer balances denominated in US dollars.

We had an income tax expense of $1.3 million in our fourth quarter ended March 31, 2013, which equates to an effective tax rate of 12.3%, lower than our prior guidance of 22.5%. The lower than anticipated effective tax rate was due to the successful mitigation of certain tax exposures, the timing of the election of core developer status of our Hyderabad campus permitting us to realize certain tax holidays, and the changing geographical mix of profits compared to our prior guidance.

Net income for our March quarter was $9.1 million, an increase compared to both $7.4 million in the prior quarter and $5.8 million in the fourth quarter of fiscal 2012. Diluted earnings per share was $0.35 in our fourth quarter of fiscal 2013, an increase compared to both $0.29 in the prior quarter and $0.23 in the year ago period.

Turning to the balance sheet. Ending cash at March 31, 2013, was $95 million inclusive of cash equivalents in short-term and long-term investments.

Cash flows used for operating activities were $1.7 million in the fourth quarter.

Our DSO, including unbilled receivables was 84 days compared to 78 days in the prior quarter. The increase was primarily driven by the timing of a milestone payment with one of our larger clients.

Capital expenditures were $3.3 million in the March quarter. Depreciation and amortization expense in the quarter was $2.5 million.

Now, let me turn to some additional quarterly financial and operational metrics beginning with those related to our fourth quarter 2013 revenue. Revenue across our industry groups was as follows, BFSI increased 26% year-over-year and represented 60% of revenue.

Sequentially, BFSI increased 3%. Ongoing global banking challenges impacted the growth and there’s more to go [ph]. Communications and technology grew 7% sequentially, representing 27% of revenue.

Strength in the quarter came from a large client in Europe and new healthcare clients. Media information and other grew 4% sequentially and contributed the remaining 13% of revenue. Growth was dividend by the healthcare information services portion of this industry group.

For the March quarter and full fiscal year 2013, we had three clients contribute greater than 10% of revenue. For the fourth fiscal year 2013, EIG [ph] and JPMC both contributed 14% and BT contributed 11% of revenue.

During the March quarter, we commenced work with four new clients, one in communication and technology and three in BFSI. We ended the fourth quarter with 6,336 IT professionals, an increase of 6% sequentially as we start to support fiscal year 2014 demand.

Global utilization excluding trainees was 78% in our fourth quarter flat sequentially on year-over-year.

I would now like to briefly summarize our financial results for the full fiscal year 2013 as compared to full fiscal year 2012.

Revenue was $333.2 million, an increase of 20% on both reported and constant currency. Operating profit was $32.9 million, an increase of 37% as we continue to realize operating leverage while driving significant top line growth.

Income tax expense was $7.5 million, which equates to an effective tax rate of 20.8%. Net income was $28.4 million, an increase of 42%. The increase in net income resulted in diluted EPS of $1.11 compared to $0.79.

Cash flow from operations was $22 million and capital expenditures were $11.8 million. Now, I will provide our current guidance for our first fiscal order and full fiscal year ending March 31, 2014.

Revenue in the first quarter of fiscal 2014 is expected to be in the range of $89.5 million to $91.5 million. Diluted earnings per share in the first quarter of fiscal 2014 is expected to be in the range of $0.26 to $0.30. Earnings per share anticipates an average share count of approximately 26.1 million.

For the full fiscal year ending March 31, 2014, we need to be in the range of $376 million to $392 million. Diluted earnings per share for fiscal year 2014 is expected to be in the range of $1.22 to $1.38 cents.

Full fiscal year 2014 EPS anticipates an average share count of approximately 26.2 million. Our current guidance is based on the following setup assumptions, annual effective interest rate yield is expected to be approximately 3% of our average projected cash balance including short- and long-term investments.

We have not considered any potential impact to other income associated with foreign exchange gains or losses. Indian rupee foreign currency hedge contracts are in place for the majority of our Indian rupee expenses for the fiscal year ending March 31, 2014. The weighted average Indian rupee conversation rate for the full fiscal year ending March 31, 2014, is approximately 54.3.

On a quarterly basis, our assumptions are that the weighted average Indian rupee conversation rate for the first quarter of fiscal 2014 will be INR53.1 and then improve to INR54.8 for the remainder of the fiscal year.

In addition, guidance does not consider the possible impact of having ineffective hedging contracts for the remainder of the fiscal year. Our first quarter fiscal 2014 guidance anticipates a British pound and the US dollar conversation of $1.52 which does consider the impact to revenue and cost from hedging contracts already in place for our first quarter.

We expect our effective tax rate for the first quarter and full fiscal year 2014 to be approximately 25.2%. Our effective tax rate is sensitive to the geographical mix of profit for the fiscal year and to the mix of profit between our Indian subsidiaries and is subject to change.

We anticipate the total capital expenditure spending in our fiscal year 2014 to be approximately 4% of revenue. Now, I would like to spend a moment providing you with our current talks [ph] on our fourth quarter and full fiscal year 2014 guidance.

We expect offshore IT spending growth to continue with advice [ph] for transformational program at our next generation digital platforms, automation of customer facing processes, IT rationalization as well as regulation and compliance initiative.

Our expectation remains that we can grow faster than the industry. IT projects are now more alignment business than ever before. It is critical that the service providers are able to engage not just with the IT organization but business sponsors as well.

HR and lean principals are on the rise again as enterprises have limited resources to invest and are looking to ensure program are delivered expecting outcomes and ROI.

Virtusa’s investments in near-shore technology centers strengthens our position as we help our clients execute on these transformational initiatives. From a vertical perspective, in insurance, we are seeing spending on legacy modernization and business transformation programs associated with billings, selections and claims processes, as well as those that provide a 360 degree view of the customers.

Banking IT budgets are expected to be flat to modestly up with an increased allocation towards compliance initiatives. In media, we are seeing mainstream adoption of social platforms, opening up opportunities and analytics for behavioral targeting whereby enterprises prepare personalized programs.

We are seeing opportunities in our healthcare business driven by the accelerated adoption of the global delivery model to reduce current operating costs. The advent of healthcare exchanges and healthcare-related compliance initiative are also expected to drive client investments.

Our first quarter sequential revenue growth will be impacted by seasonal revenue decline in our communication and technology vertical driven by the budgeting cycles at one of our larger clients.

In addition, we are expecting some slower project grants in media and information as other programs come to their natural conclusions, but believe this industry group will be a growth driver overall for the Company’s fiscal year 2014.

For fiscal year 2014, we continue to expect market leading revenue growth with broad-based expansion across all the geographies and industry groups. As we have been discussing with you, while we have an opportunity to grow our top 10 clients, the opportunity we have to grow our remaining client is even more significant. Our fiscal year 2014 guidance includes increasing contribution from these emerging clients.

Turning to margins, first quarter of fiscal 2014 onsite effort is expected to increase, impacting gross margin sequentially. But our expectation is that we will see gross margin improvement throughout the full fiscal year.

Consistent with the prior years, SG&A expenses in the first quarter will be a few hundred thousand dollars high sequentially as we kick off some annual sales and marketing initiatives.

For the full fiscal year, we are accelerating our investments in sales and marketing to continue to grain share. We are also making investments in our near-shore centers to increase our service delivery capabilities.

Partially offsetting these investments will be ongoing G&A leverage. In total, we expect to deliver at least 100 basis points of operating margin expansion at the midpoint of our guidance change.

In conclusion, this was a strong fiscal year for Virtusa with 20% revenue growth, 130 basis points operating margin expansion and 40% EPS growth. As we look forward, enterprises continue to move spending to new generation service provider like Virtusa that bring a combination of technology expertise with business and domain consulting to help them succeed.

For fiscal year 2014, we will continue to build shareholder value by delivering on our commitment of growing EPS faster than revenue.

I will now turn the call over to the operator to begin the Q&A. Thank you.

Question-and-Answer Session

Operator

Thank you. (Operator Instructions)

Operator

(Operator Instructions) We’ll take our first question from Joseph Foresi with Janney Montgomery Scott.

Joseph Foresi – Janney Montgomery Scott

Hi. What I wanted to ask was – and maybe we should just get this question out of the way, maybe you could just give us your own portion of the immigration bill, if you can give us any color around any exposure you have to it and any impact or any changes that you’re taking place in your business right now to address that bill.

Kris Canekeratne

Hi, Jo, this is Kris, I’ll provide you with some color. So as you know of this immigration bill and should it pass, there are four areas, the first area is the 50-50 rule that requires companies not to employ more than 75%, 65% and 50% of the US workforce on H and L visas in the first, second and third year progressively once again after the bill passes or should the bill pass, higher wages for H and L workers, all placement limitation clause and increases in visa processing cost.

Let me spend a moment and address each one of these points from a Virtusa perspective. So on the 50-50 rule, we have no exposure at this time on the 50-50 rule. If a large number of US employees and our resource management program calls on ongoing expansion of naturalized team members to service our onsite plans. On higher wages for H and L workers, we have always adhered to employment practices that are merit-based as opposed to visa-category wage and therefore do not have exposure on the wage issue.

On the outplacement entity, we have not been and are not an H-1 dependent business and therefore do not have any exposure to the outplacement limitation. On increasing or the increases or the proposed increases in visa cost should this bill pass, we have some exposure to increase visa cost but expect that we will have ample time to work through this to minimize the impact.

Joseph Foresi – Janney Montgomery Scott

Thank you. That was very helpful. My second follow up question was just on the pipeline as you head into next year, it seems like you’ve got some moving parts with maybe a little bit of slowdown in banking but that being compensated for healthcare and then there’s always the timing on the telecom side. Could you just give us quantitative or qualitatively some feel for what the pipeline looks like heading into next year versus what you saw the beginning of last year and any color you can give on your ability to continue to mine revenues from your existing client-base?

Raj Rajgopal

This is Raj. Our pipeline is definitely stronger than it was at this time last year. If you remember last year, we had some uncertainty in the market and we’ve seen a strong lift in both the number of deals as well as the – probably a modest increase in the deal size. We also have many more large deal opportunities as well as more opportunities to expand within our client-base and this is fairly broad-based and across all industry groups and geos and the visibility that we have entering into fiscal year 2014 is very consistent with that in prior years and that’s what was used to be as our guidance.

Joseph Foresi – Janney Montgomery Scott

Okay. Thank you.

Operator

We’ll go next to Mayank Tandon with Needham & Company.

Mayank Tandon – Needham & Company

Thank you. Good evening. Kris and Ranjan, the guidance range is fairly wide but I guess it’s consistent with your history; I want to get a sense in terms of what are the assumptions at the low-end versus the high-end of the ranges.

Ranjan Kalia

So, Mayank, absolutely it can be that the guidance ranges and the revenue and EPS are very consistent with what we’ve used in prior times and, in fact, we even did a quick [ph] year survey and you look at it on the revenue side, I think most of the peers [ph] that do our guidance are usually in the 1.9% range up and down and we are in the – about a 2% range, so very consistent even [ph] at the market.

In terms of what will help us to get to the high end, it will be – the big piece that will drive us to the high end would really be the growth drivers behind our top 10 client portfolio. As we talked about this, our non-top 10 are really expected to grow a lot faster than the top 10 in FY14. That’s something that we consistently worked on in FY13 and we believe is going to start to show fruition in FY14. But if also the top 10 growth accelerates versus what we have in the guidance, then that forces us to get us to the high-end.

Mayank Tandon – Needham & Company

Got it. And the margins would follow revenue growth as well, right, so the higher end would imply more margin expansion on 100 basis points at the mid-point? Is that fair?

Ranjan Kalia

Yes. Absolutely, Mayank. If you run the guidance, the implied will be in the guidance inside and we’ll say that it’s 150 basis points at the high end.

Mayank Tandon – Needham & Company

Got it. And a quick follow up question, Kris, you talked about the regulatory drivers, I wanted to get a sense if this is incremental or is it taking away from some of the other opportunities that you would typically see with your clients, in other words, can you quantify the potential impact from the regulatory work for fiscal ‘14?

Kris Canekeratne

Generally speaking, we are seeing that some of our large enterprise clients are shifting some of their budgets from maybe keep-the-lights-on programs and other – sort of keep-the-business-running programs moving going to compliance and regulatory reform. I think this data is highlighted in banking and financial services, perhaps more so than anywhere else as you well know in healthcare reform has been going on for several years and today especially around things like know-your-customer or KYC initiative is a fairly significant initiative within the retail bank within banking to very quickly put in programs to be able to comply on these initiatives with the AML over the spectrum and a variety of others.

So we feel that as the year progresses, more and more of the financial services clients in our banking clients will have larger budgets allocated for programs specifically in around compliance and regulatory reform. We do believe that some of these budgets will come at the expense of other programs and some of this is actually happening real time.

Ranjan Kalia

If I can build on that, so one of I think the positive things which is on perspective is that our capability in addressing compliance and regulatory issues is significantly higher than probably a competition given some of the acquisitions we made in the past. So positioning as our clients move their spend towards compliance regulatory issues is very good especially around this talk about Dodd-Frank, the Consumer Protection Act, client onboarding is a very critical issue for them, FATCA, AML, et cetera. So we feel we are very well positioned compared to our competition as our clients shift their budgets towards some of these initiatives.

Mayank Tandon – Needham & Company

Thank you.

Operator

We’ll go next to George Price with BB&T Capital Markets.

Unidentified Company Representative

George, we can’t hear you. Maybe we should move to the next. We’ll come back to George.

Operator

One moment. We will go next to Brian Kinstlinger with Sidoti & Company.

Brian Kinstlinger – Sidoti & Company

Great. Thanks so much. A couple of question, the first is related to the guidance, you’ve often said 100 and 150 basis points is what you plan to increase your margins. The FX move is quite favorable I think and maybe you’ll give us numbers on that what it was last years, but I think it’s some 300 to 400 to 500 basis points improvement on the rupee anyway. So I’m wondering at the low-end why you don’t have 100 basis points of margin improvement there. What would cause you even in in a12% revenue gross scenario to not grow 100 basis points?

Ranjan Kalia

Sure. A fair question, Brian. So, yes, I mean, in the P&L and all, low bid and high bid, there is a strong FX INR benefit that’s there but that’s also being taken by the investments that we have to make in onsite effort and, in fact, on the guidance side of the low-end, what the assumption is that if the onsite effort sensitivity will probably be higher because the revenue will be lower, so your onsite sensitivity will be higher so that actually ends up using that benefit even much larger and therefore you end up getting to the low point. That’s really in the implied guidance up to 60 basis points at the low-end operating margin expansion and the high-end is 150. So it’s really, out of onsite effort, makes sensitivity plays out.

Brian Kinstlinger – Sidoti & Company

Well, sure, I appreciate that but however, the reason you guys say you won’t grow more than 150 basis points is because the investments you’re making is that part of the 100 and 150 but now you’re saying that those investment, with this huge move in FX this year, this doesn’t seem plausible to me that you wouldn’t grow 100 basis points. So I don’t know if you can comment again, but it just doesn’t make a lot of sense, at least, from my perspective.

My second question really is one on your top customer that you can see from the third quarter to the fourth quarter ramped up substantially in percentage of revenue, can you give us a sense – I think that you talked about this large project with 80 countries last quarter on the conference call where only one or two had started, maybe give us an update on that project, how fast do you think it will ramp and will this large customer, and you assumed it will grow faster than the entire client-base.

Kris Canekeratne

Yes. So Brian, we have actually based these with some of the expansion that we’ve had across several clients during the year, while we don’t specifically comment on any one specific project or plan, we are very pleased that the progress that is being made I think based on our remarks from maybe a call or two ago is one of the largest claims transformational programs in the world that’s basically a three- to five-year transformation, we’ve just concluded about the first 14 months or so of that transformation.

We have had several successes in terms of launching out the program covering a few countries and there are many, many more countries to go over the duration of the program. So we believe that this program gives us a great beach end [ph] at this client. It gives us an opportunity to demonstrate our differentiation especially around our best-in-class solution, and then from there to be able to expand and create many base boards [ph] in line to the program as well as horizontally across the enterprise.

So in line within the program, they are clearly taking on large aspects of work around things like application support and maintenance on improving their QA efficiencies and efficacy, loading out of the salient benefits of platforming which gives them significant benefit around multiple geographies, multiple languages, multiple currencies and to be able to reconcile their claims processes a lot more efficiently.

And then as we do that work, it gives us an opportunity to expand and radiate into other parts of this enterprise. And perhaps even more importantly within the industry sort of alleviates us very quickly as the best-in-class provider for large transformational programs whether that be in claims processing, whether it be policy administration, whether it be in things like case management and automation. So this is really a tremendous opportunity for the Virtusa, not just with this client but across the industry as well.

Brian Kinstlinger – Sidoti & Company

Great. I’ll get back in the queue.

Operator

And we’ll go next to George Price with BB&T Capital Markets.

George Price – BB&T Capital Markets

Good afternoon, guys. Can you hear me now?

Kris Canekeratne

Yes, we can hear you, George.

George Price – BB&T Capital Markets

Yes, sorry about that technical difficulties. It sounds like Brian got to some of my questions on margins so perhaps I’ll circle back on that offline, but I did want to follow up on a couple other things, first, you talked about some client specific kind of things coming – going on in the first quarter revenue growth impacted by telecom, in telecom, in terms of revenue budgeting cycle in one of your clients, some media programs that were coming to a natural conclusion, I think you said which sort of implies that there’s not follow on work that you’ve identified as part of that. Can you give us a little bit more detail about what’s happening there and maybe how that – you expect that to play out going forward?

Unidentified Company Representative

So, George, us reporting to this with regards to the Q1 guidance. The two pieces of that is that the communication and technology vertical, if you look at it always at this time of the year communication and technology vertical has a seasonal depth primarily because inside of it we have a large client that goes to its budgeting cycle, very consistent with what happened last year.

The new piece is – and the media and information there, we have a large clients there were some of the projects have come to their natural conclusions, just the new ramp ups and really started that we are forecasting in the Q1 and they are expected to start in Q2 and that’s why we believe that media information and other will be a strong growth driver for the full year. And it’s just how it’s ramping up later on in Q1, Q2.

George Price – BB&T Capital Markets

Okay. Okay. Very good. And then the second question I had is just in terms of – you mentioned also with an increase in DSO was due to a timing of the milestone payment with one of your larger clients, has that payment occurred?

Unidentified Company Representative

And so [inaudible], we talked about it last year that we have been able to win some large deals at one of our larger clients out in Europe and in regards to that those large deals there are some milestone payments. Those milestone payments got billed earlier on in the month of May and then after that, the collection process starts.

George Price – BB&T Capital Markets

Okay. So do you anticipate that that’s going to hit before the end of fiscal 1Q ‘14?

Unidentified Company Representative

The billings that we did, yes, we are expecting those will be paid by FY14. But this is a large client so there’ll be another piece of large milestone payment that will be coming up in June from them.

George Price – BB&T Capital Markets

Okay. So would you expect, I guess, directionally, DSO is going to show a little bit of improvement, are they going to worsen, are they going to be about the same?

Ranjan Kalia

I mean, look, it certainly our goal to continue to have – we know when we get into these larger deals, there is going to be a DSO impact on those larger deals that we’ll bring to the company, therefore, what we got to do is we got to define more DSO efficiencies in those non-larger deals. And so our expectation is our goal to really continue to bring the DSO back into the highest [inaudible] range which is where we used to be.

George Price – BB&T Capital Markets

Okay.

Ranjan Kalia

But I think it will take a few quarters for that to happen.

George Price – BB&T Capital Markets

Okay. Last one if I could, just maybe given the cash, any thoughts on M&A at this point and where – I mean, would that be – I’m assuming that would probably be the primary you see to identify for the cash and where in particular are you looking the hardest? Thank you.

Unidentified Company Representative

Hi, George, it’s our strategy around M&A remains the same. We basically do M&A for strategic reasons and those strategic reasons have to do with either enhancing our service capabilities, our geographical reach, our [inaudible]. We will continue to look for opportunities that would bolster certain areas that are of strategic importance for Virtusa and that would be most likely the primary use of the cash should we find the ideal type of entities that we are looking for.

Operator

We’ll go next to Puneet Jain with J.P. Morgan.

Puneet Jain – J.P. Morgan

Hey, thanks for taking my question. Could you talk about how much visibility you have on expected ramp in non-top 10 clients for this year?

Ranjan Kalia

So, Puneet, we don’t break their visibility from our top 10, our non-top 10 but I can tell you that the visibility that we have to our full revenue is very consistent than what we had versus last year. In fact, over and above, that gets us the comfort for even the non-visibility piece is built in terms of [ph] processes around pipeline management that we’ve been able to put over the last 12 months are much more stronger than we have them last year. So from that perspective, our pipeline management process we even feel even better for the non-visibility piece.

Puneet Jain – J.P. Morgan

Right. I understand. I ask because the guidance range, the unknown in the guidance range stemmed from growth in large clients, I think you said, so that’s why I thought visibility in smaller clients could be higher which seems to be the case, is that –

Ranjan Kalia

Well, Puneet, what I said was actually the growth is really broad-based where in FY14 we will see more growth coming from a non-top 10 versus our top 10.

Puneet Jain – J.P. Morgan

Right. All right. And second, did you have any part of the business convert from TMM [ph] to fixed price during the quarter, any large contract that might have converted to fixed price?

Ranjan Kalia

No, we – the fixed price increase that you see in the quarter is because of this large deals that we have in our large telecom client. Our deal is primarily a fixed-price deal that’s why you see the increase in the fixed-price element. But there was no conversion.

Puneet Jain – J.P. Morgan

Okay, thank you.

Operator

We’ll go next to Rahul Bhangare with William Blair.

Harold Bengar – William Blair

Hi. Most of my questions have been answered but I just wanted to ask you on the discretionary spending environment so that consulting reaccelerated in the quarter, are you seeing improvement on the discretionary set of things?

Kris Canekeratne

So you know, quarter-by-quarter, we’ll see changes. We are seeing our clients, especially our large enterprise clients investing more into transformational programs especially programs that have an impact on being able to retain and attract new consumers. Many of those programs would typically start with consulting engagements they have helping them envision what the one, two, three year go-forward plan is on these large strategic transformations, many of them have to deal with enabling the enterprise form for billing the other [ph] consumers.

In the second category, we are investing into transformational programs around improving automation, improving efficacy, reducing some of the disparity that they have within their enterprise ideas states. So much of this stock discretionary spend around identifying the opportunities, building the roadmaps, et cetera, and then they’ll move much more towards implementation cycles and then support and maintenance cycles.

So quarter-by-quarter, we could have some variance, if you will, between consulting spend and – or discretionary spend and keep-the-lights-on spend, but overall we are finding that enterprises are spending on large transformational programs and much of the spend comes from the discretionary side at least initially.

Harold Bengar – William Blair

Okay. Thanks. And then if I could just ask you about the New York delivery center, how big is that planning to be and what kinds of services are you planning on delivering from there?

Kris Canekeratne

Yes. So our initial plans are to basically have approximately 100 people out of our Albany center, now that will obviously grow and/or shrink depending on demand, but right now, our visibility is quite strong for us to staff in that center and to execute for our plans in the northeast from the [inaudible] center that’s basically within a couple hours from New York City.

Harold Bengar – William Blair

When do you expect that center to be operational?

Kris Canekeratne

It is up and running right now. It’s already operational.

Harold Bengar – William Blair

Okay. Great. Thanks, guys.

Operator

We’ll go next to Moshe Katri with Cowen and Company.

Moshe Katri – Cowen and Company

Hey, guys, thanks. Can you talk about the British Telecom, kind of an update on the relationship and where we are here?

Kris Canekeratne

Moshe, you’re very faint but – this is Kris and I think your question as update on British Telecom and where things are.

Moshe Katri – Cowen and Company

Yes.

Kris Canekeratne

So British telecom continues to be a very important client to Virtusa. We have a tremendously strong relationship with them. As you know over the past few years, they’ve had a declining spent environment on the IT side. We have steadily grown our footprint within British Telecom despite their declining spend environment. We’ve recently taken over some very important and critical platforms for British Telecom. So clearly, we continue to grow and scale our footprint within BT. We expect that for the full year 2014 that BT will be a growth account for Virtusa.

Moshe Katri – Cowen and Company

Okay.

Kris Canekeratne

And overall, we feel very good about both the relationship, the quality of execution that we’ve had and the visibility and the pipeline opportunities that we see within the account.

Moshe Katri – Cowen and Company

Great. In light of the guidance that you provided for Q1, and looking at your near-term visibility compare it to the same time of last year, do you feel the same, do you feel better or do you feel worse?

Ranjan Kalia

So Moshi, in certain ways it’s very similar. We know on all the pieces, communication and technology and the BFSI, the one piece different is the media and information where it’s just all the projects that we were expecting several weeks back that they would have started and they’re just going to start a little bit later in the quarter. So that’s really the only change that we see.

Moshe Katri – Cowen and Company

Okay. And then in financial services, it seems that we’re kind of almost after a spending freeze of about 12 or 24 months we’re kind of, I don’t know, almost embarking on a kind of a mini-spending cycle. Do you see that in your business and maybe you can kind of provide some details on that?

Raj Rajgopal

This is Raj. Yes. We are definitely seeing, as I said, a kind of a modest growth in the spending environment. However, I think what’s really happening is a lot of the spending is going towards compliance and regulatory and customer experience improvement initiatives. So on the compliance initiatives, probably, we are seeing a slight delay in actually converting those compliance budgets into actual projects, so we are actually expecting that the ramp up in spending will accelerate in Q2, Q3 and Q4 with Virtusa [ph]. So while they have decided to make these investments in compliance, the actual projects are taking longer to form up, so we actually do expect and actually seeing that transition to our pipelines.

Operator

We’ll take our next question from Vincent Colicchio with Noble Financial.

Vincent Colicchio – Noble Financial

Yeah, Kris, you said you’re going to ramp up your sales force this year. Could you give us some more color? Will that be front-end loaded? And also, are there any particular areas you’ll beef up relative to others?

Kris Canekeratne

So, yes. I mean, we have been adding on the S&M. In fact, if you look at it from an S&M asset percentage of spending, we are ramping up our S&M spending in FY14 and with some of the S&M, we even accelerated it later part of Q4, Q1 because we believe that this is also going to be a year for Virtusa to continue to gain market share, I mean, to a certain extent, the environment is very different similar to what we saw back in – even in FY10. And so, yes, we are ramping up on investment in S&M, yes, we are ramping up the headcount. And just to build on this I think, a large part of it has to do with the correction that we’re seeing across the solutions and services that we’re offering so clearly. There is a lot of resonance in the market from Millennial Enablement and we will continue to invest behind that to be able to take this to market faster.

There’s a lot of enthusiasm and interest in transformational solutions especially the ones that we are best-in-class are. Compliance and regulatory initiatives are obviously the key spend area and one that we feel we are very well positioned for. And then IT rationalization expertise has always been a strength are of our and there is a duality in each of the enterprises we’re working, they have to figure out a way to reduce and compress some of their sort of key-the-lights-on spend so that they can divert some of this into either regulatory and compliance initiatives or consumer experience initiative and that’s really where we feel that there is a significant opportunity for Virtusa because we can play on both sides of the equation.

Vincent Colicchio – Noble Financial

Okay. Thank you.

Operator

And that will conclude today’s question-and-answer session. I’d like to turn the conference back over to our speakers for any additional or closing remarks.

Kris Canekeratne

Thank you all for joining us today and I want to take this opportunity to thank our team members for their dedication and hard work. Thank you once again.

Operator

This concludes today’s conference. We thank you for your participation.

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