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Executives

Puneet Jain - Analyst, JPMorgan

Tom Holler - CSO

Analysts

Virtusa Corporation (VRTU) JPMorgan Global Technology, Media and Telecom Conference May 16, 2013 8:40 AM ET

Puneet Jain

Good morning, this is Puneet from JPMorgan Computer Services and IT consulting team, glad to have here with us Virtusa’s Chief Strategy Officer Mr. Tom Holler, welcome Tom.

Tom Holler

Thank you.

Question-and-Answer Session

Puneet Jain

The format of this presentation is going to be fireside chat. I’ll start with a few questions and then we’ll open the floor for questions from audience. So Tom, for the benefit of investors who might not be as close to story, could you may be start with Virtusa’s history, it’s service capabilities and positioning in the market.

Tom Holler

Sure. So Virtusa is a global IT services company. We provide end-to-end services in the areas that we chose to focus on. The services include IT and business consulting, technology implementation and application outsourcing.

Little on the history, the company was founded in 1996 by our current CEO Kris Canekeratne. At the time he found the company, his vision was to bring software innovation to the market using the global model. Back in ’96, the global model was heavily leveraged but mostly from lower level services like maintenance remediation and testing Kris’ vision was to offer higher value services leveraging the global model.

In the early days, our primary market were ISVs where we develop software product, design and develop software products. And when we did that we would build the product much as like a platform. So it could scale across multiple vertical markets, multiple geographies, multiple operating systems without having to go back and rewrite the core. We also focused with the ISVs on consumer experience management.

Moving forward, we took that concept to the enterprise in the early 2000s and what we found in the enterprise is that they on average we have 2000 applications that they would run their global enterprise with. As you can imagine, with that thousands of applications, but there is tremendous amount of redundancy, many applications basically performing the same function. So with our software innovation approach, we were able to go to the enterprise and identify for the enterprise taking a horizontal view across their applications where the redundancies were. And we would take and reuse harvest out and reuse best in class assets, import those capabilities across (silent) applications creating a platform dramatically reducing total cost of ownership, accelerating time-to-market, improving the end consumer experience for our client. That was a differentiator then and it remains a core differentiator for us in the marketplace today, what we often refer to as platforming or IT rationalization.

Today, we have over 7,000 employees. Our delivery centers are primarily in India and Sri Lanka. Our clients are generally North America, Europe and Asia. Today, we offer a whole suite of services as I mentioned from consulting to AO but we are very focused on four core areas. The IT rationalization that I mentioned which reduces cost of ownership, accelerates the time-to-market, improves customer experience. We are very focused on industry specific transformational solutions. We are focused on Millennial enablement and we are very focused on regulatory and compliance solutions for the market.

We’ve had a great track record, our 10 year revenue CAGR is 30%, last week we reported our fiscal year results for fiscal ’13, where we grew revenue by 20% tope line, we grew operating income by 37% and EPS by 40%.

Puneet Jain

Okay so this trend of providing customer, enhancing customer experience for your clients or some firm say consumerization of enterprise IT. We have heard about that trend from some of other large IT services firms. So help us understand how differentiated your services are, what you have done, specifically in which areas you have invested to differentiate your services.

Tom Holler

Sure. So, over last decade, we were very focused on modernizing applications and extending enterprise services digitally to the end consumer with the focus on what’s meaningful for the end consumer, how does the end consumer want to engage with the enterprise and how can you enhance that experience so we can work on the revenue side of the business to attract, retain and expand relationships for the end user, for our clients.

And this IT rationalization is a big part of it and personalization and consumerization concepts have always been a key part of our domain. And if you think about what we have done is we are very much middle office to end user focus. And doing that, we have gone through this massive way of application modernization through our IT rationalization and digitally extending enterprise services, first to the internet. And now we are the natural preferred provider for our existing customers to now extend that to the mobile channel.

While extending it to the mobile channel is only the tip of the iceberg. So a lot of what we refer to as Millennial Technologies, mobile, cloud, social, analytics combined with big data, speed data, gamification, we're seeing a lot of interest from our clients today to be able to leverage those technologies to better engage with their end consumer. But extending what you're doing on the internet through the mobile platform is only a quick way to extend your channel, the real play here is there's a paradigm shift using these the emergence of these Millennial Technologies along with the emergency of a consumer now that is digital savvy sort of the Millennial consumer that wants to be engaged with the enterprise in a different way. They want to be engaged at a personal way. Before you would extend enterprise services and you would target a collection of consumers into finer market. Now you have to, your market is the individual, so the individual who's digital savvy who wants to not only be able to interact with the enterprises 24/7 on device of choice they also want the enterprise to understand their personal preferences, their likes, their dislikes, their peer group influencers. They don’t want to be marketed to as a mass market anymore; they want to create a dialogue. And leveraging these Millennial Technologies especially with social and analytics is going to create a massive paradigm shift in the way these enterprises reach out to their consumers. And we're very well positioned in our expertise around the Millennial Technologies and our history of consumer experience management.

And we're in front of many opportunities and we're consulting with many customers today to help them develop a roadmap on how they're going to address this paradigm shift. Because if they don’t consumers also have less loyalty now. So if you don't understand me as a consumer and market to me what's relevant, when it's relevant I’ll change my loyalties and move. I'll give you a quick example just to put, some clarity working with the life insurance company today and we developed a mobile channel for them and they use Facebook and other social media to try to market themselves differently to these Millennial consumers but with very little incremental result.

And the problem is they really didn't engage at a personal level. So we're helping to do, is understand the consumer profile so we're helping them understand. So you think about a consumer where, do they go to college, they graduate, get a job, they get married, they buy a house, they have children, they change jobs, their kids go to college, they retire someday. So different products at different points, when there's changes in life status is very relevant and helping a life insurance company know when those life changes happen so they can real time market what's relevant for that consumer and enter in a dialogue.

So that's an example of leveraging Millennial Technologies and marketing to the new consumer, Millennial consumer that wants to be known at a more personalized experience. And we think that this is going to create a massive paradigm shift in the way enterprises market and also they have to change your core business processes because the application, modernization way that I talked about that we benefited over the last decade is still plenty of room ahead, just in the current system application modernization. But as they retool their business processes to be able to manage the (value) for data, real time, back and forth communication, when data is doubling every 18 months now. And the analytics saw their core business process have to be reengineered and the platforms that they run those business process have to be reengineered.

So we think that there's yet another massive wave of application modernization just like the way we're currently helping our clients with. So it’s not just extending digital services and consumer experience management. But it's the application layer that has to completely modernized once again. So we believe that, we're very excited about the futures even help the enterprises address this paradigm shift both in terms of personalizing consumer experience but also our ability to help modernize our applications.

Puneet Jain

Could you also help us size the magnitude of work you do in these areas including developing these solutions as well as integrating them with clients or legacy systems?

Tom Holler

So what really has fueled our growth has been application modernization using our IT rationalization capabilities and industry specific transformational solutions. And when I say industry specific, we focused on a few core verticals and by group it's banking, financial services, insurance, media and information and communication and technology by having deep domain expertise and deep technology capabilities squarely focused on the intersection of business and technology for the industries that we focus on we developed a host of specific transformational solutions. So by way of example, we're expert in claims management for insurance, we're expert on client on boarding financial services; we're expert on case management which crosses the industry.

So when we compete on an opportunity we compete from a position of strength, because we have a deep domain, we know the business processes and we've developed transformational solutions to address those business processes. So that makes us very formidable, its allowing us to get in front of larger and larger transformational engagements which is really fueling the growth of the company and you combine that with IT rationalization.

So if you think about IT rationalization, it dramatically reduces your cost of ownership when you modernize these applications. But on the ASM the support and maintenance, what we're finding is that we're taking share away from our competitors. And why is that? Because pre-recession, a lot of work was moving off shore and still continues to do that, but now what enterprise we are looking for is getting inside the value curve.

So how can they free up resources to spend on these transformational solutions. And we can demonstrate that we can take over applications support and do it much more productively than our competitors because we will use our asset re-use and concepts for IT rationalization to get inside the value curve and reduce their application supports. So we win business and they free up resources to invest with us in transformation; as that too are very complementary and the cost reduction and the revenue initiatives.

Millennial Enablement Services, we are still very really on. We do a lot and as you expect in social and analytics around that; in mobile. But we are still just early days on that. And that’s where we think that long term there is going to be massive opportunities leveraging our existing capabilities complemented with our approach. And our consulting organization is instrumental too helping our customers understand billing roadmap to visualizing the future end state in allowing us to win more and more large transformational engagements, which are around specific industry solutions but also now will be around the Millennial Enablement.

Puneet Jain

Just curious, like how do you benchmark your performance on a client project versus peers like? Which parameters, metrics you see to assess whether you are doing a better job than peers?

Tom Holler

Good question. I would say that there are two tracks there. The client benchmarks us and we love when the client benchmarks us, because they typically measure delivery excellence in quality and productivity. And especially on both of those, but productivity is real differentiated for us because of variety, rationalization, and getting inside the value curve. And when our customer measures us we always end up on top of the league tables.

We also survey our customers typically quarterly to measure our client elite, and get a lot of feedback for our clients on that. We also measure in that promoter score. We have also started instituting that it was really cool; this yam-jam sessions, with our clients. We do this internally using a yammer where you set up a session and you bring in what our customers, the key customers and our delivery teams. And they will just real time, just collaborate back and forth, brainstorming questions back and forth. And also not just about the process engagement we are doing but also in areas of co-creation.

What more could we do? Where is the main business from? So that is a very powerful tool that we are just now starting to benefit from. And then internally, we measure ourselves as you’d expect. You know we have dashboards. We have applied gamification to our engineering teams. So every engineer has a tool that we have developed internally. So it measures typical things like asset reuse, defect density, quality adherence to process. But against those measurements, it also benchmarks you against your peers.

So if you are in a center with a thousand engineers you know how you’re performing and we have leader board set up. So as you are performing you know relative to your peers and you can see yourself on a leader board, so it’s a form of gamification. And if your codes are not performing well, you will get a little sad face or happy, I mean all this, these get you on badges, right. And it really creates a very dynamic environment. Yet the thing, most of our employees in our development centers at Millennial, they love this. It just keeps them engaged and they want to do better and perform better. They want to earn these badges. We have a whole collaborative environment using yammer and other social tools internally, same environment that they experience at their home, they can experience within the walls of Virtusa.

And of course, we benchmark ourselves against how we are doing relative to competitors. So our top management teams always have account plans. They look at the areas that we’re expert at and how we are doing against competitors and are we growing faster to the competitors in the areas that we should be growing faster to the competitors. So you try to measure your wallet share, your win rate, and benchmark yourselves on your account plan and how you’re going to bring; not just the initial solutions that the customer hired you for, but how you are going to educate the customer on your whole suite of solutions that are relevant to them. And then set goals and making sure that we over time can bring our whole suite of services to benefit the enterprise and measure our teams against that was well.

Puneet Jain

Switching gears a little bit. You obviously are growing at faster rates, but overall offshore industry appears to have slowed down in last couple of years. NASSCOM estimates industry grew low-teens last year and expect all low mid-teens for this year. So is this new normal for offshore growth or do you expect the overall industry growth to accelerate from these levels?

Tom Holler

Well, I would say that the IT offshore services market is still very low penetration and there is tremendous amount of opportunity ahead for the market. I think, pre-recession levels, growth is maybe twentyish percent. Post-recession has slowed down to the low to mid-teens as you suggest.

And I think it is like, it will be there this year. I think it might be there for another year. It’s hard to say but I expect that there could be an increase in growth rate longer term. And in my mind, what slowed it down is frankly, a big part of it, is the recession.

When you go through a recession the first thing enterprises do is stop everything, anything that they can. And then they go through sort of a re-tooling of their organization which causes a lot of disarray. They have to right-size their own cost structures; there is management changes, so there is less focus on discretionary spend. The severity of this last recession made that tail longer. So what happens is when you come out of a period like this, you have less resources in the enterprise? So we need to deliver on transformational solutions, it’s actually a catalyst for IT off shoring.

But I think this has been more elongated than the prior recession we saw. We saw that as a catalyst but it happened much more quickly coming out of it; but Europe is still soft and just now sort of finding the bottom and we're seeing some positive signs there now. The banking industry as you know are still right sizing their cost structures, regulatory and compliance has really been a distraction for them. We think it will be a catalyst for spending IT services especially this fiscal year. But they have spent a lot of money and just with lawyers and accountants; we are trying to figure out what it means to them. But now some of that spend; now they have little bit more clarity and deadlines and visibility into what they need to do, they’ll start spending more.

Now some of that maybe a shift from other programs, but I think we are kind of settling out and still somewhat having an impact on the industry growth rate this year potentially in the next year. But I think longer term; there is no reason not to expect that it could accelerate again.

Puneet Jain

Quickly if you can talk about state of discretionary spending this year. What do you expect for client discretionary spending related to what they did last year?

Tom Holler

Yes, I think that there is some thought that discretionary spending slowed down. But for Virtusa, we saw a lot of discretionary spending last year. I think part of it is because of our industry specific solutions. There is still a need to transform enterprises and to drive revenue. And combining that with our IT rationalists, you can help save costs and actually fund some of these things. So for Virtusa, we have seen a good balance of discretionary spending as well as kind of recurring maintenance type of business. And that trend continues in the fiscal '14, I think we will see a nice balance, we will continue to win a lot and take share away on the ASM stocks where they are recurring; keep the run-the-business, keep the lights on type of business.

But we have a lot of visibility, particularly in our non-top ten accounts now, in our pipeline on a lot of transformational initiatives that our clients are going to take on and we will be the beneficiary of. So I think the discretionary spend environment, I don’t see any significant slowdown, potentially a little bit of a pickup; but for us, it has been strong in fiscal '13 and we expect it to continue to do well in fiscal '14.

Puneet Jain

So, over the last couple of years, your growth has been driven dramatically by last accounts. But this year like you just said you expect faster growth in non-top ten clients. So, why those clients grow faster this year? What will be different this year related to past years?

Tom Holler

So, we are very fortunate that over the last few years we brought on many new accounts in very high quality, global 2000 type of enterprises that spend a lot on IT services and spend a lot on off shoring IT services. And what happens is when you bring on a new account, you are hired because of a particular expertise that you have. You also remember all these large enterprises already have their preferred partners. So our competitors are already in there, so we have to be differentiated to win a new client, but we win it for a particular solution. So you get in, you deliver your solution and you try to look for an extension of that solution for more inline work and over trying sort of radiate out and other parts of the enterprise.

So, at times you go in and successfully complete your project. But you may not get that second project because you have to prove yourself. And then overtime, the more you do, the more you go across your organization, the more relevant you become, the more you prove yourself. And so what happens in a life cycle of our customer, if we get in successfully, complete the first engaging; you may or may not get the second engagement. But once you are in a client for two to three years, that means you are doing some work across the enterprise in larger engagements, and you become technically more sticky and more relevant and you have more relationships up and down across the organization.

So when we are with the client for two to three years, that client is likely to be around for the next ten years. I mean that's our history. And in that, group of 80 plus clients that are non-top ten, a large majority of those customers are in their second and third year with us. And that's when you start seeing that tipping point, that inflection point. So we expect to cross many of those clients that will win large transformational engagements and part of it is just the natural evolution of a life cycle with a client. And we are just well positioned today to be able to leverage those relationships that we have built over the last two to three years in these enterprises.

Puneet Jain

Sounds like most of the growth or expansion in those accounts will stem from new work for clients, rather than Virtusa replacing someone else.

Tom Holler

I think it’s mixed and I think there is a lot of net new transformational work that's been funded that were well positioned because of our focus area in select industries. But what we find is, when we grow these accounts to the next level in that third year; part of it is taking share. So, I think especially on using IT rationalization, getting inside the value curve beyond what their current providers are doing. Once we have demonstrated that which we typically have after being in an account for two years or so, we can win some of that business which will again then becomes a funding source that allows them to invest in this more strategic revenue generating transformational solutions. So, it’s a mix but you’re right, the net new will be, I think, there will be a lot funding.

Puneet Jain

Largest client, insurance client, that grew significantly and much faster, much quicker than what we had anticipated. So, was the ramp in that client in line with your expectations from year ago? Did you predict that this account is going to grow more than 100% rate?

Tom Holler

Going into last fiscal year, certainly we had contemplated it in our forecast, but frankly not the levels that it grew to. Part of the reason was that the client was still settling out exactly what they wanted and when they wanted, what countries they wanted to be in. So, what we’re doing for that client, we’re building probably what is the world’s largest property and casualty claim system.

This global insurance company works in over 80 countries but they are deploying this in 80 countries. And as you can imagine, managing claims in 80 countries using (despaired) systems is huge overhead, huge cost. Because our capability is frankly from building product for private companies, because of our deep domain and insurance particularly around the business processes in property and casualty and our technology expertise in areas like BPM and others, all converge together, so we could go in and demonstrate to them that we’re best in class. There is no vendor better than us to build this global claims management system as a platform. Put as much of the commonalities in the platform so you don’t have to replicate it time and time again each country. And then on a business logic layer, create applications that are specific to each country’s for local regulations, currency et cetera, and put as much commonality as you can to platform once. So you could be shared across 80 counties and then rolled out over time.

So, we ramped faster than we had anticipated and again part of that was clients solidifying their plan. And so this is a great example of us bringing our domain expertise, our technology expertise, our productization capabilities in platforming, industry domaining and bringing a end-to-end transformational solution. And that’s a type of approach we’re taking to all of our clients around specific industry domain based transformational solutions and why we believe that we can continue to fuel growth greater than industry, now complimented with these Millennial Enablement services that we think long term will be very meaningful.

Puneet Jain

So, given this client has grown so much and is your largest customer now, where does that account go from here? Like, should we expect that account to grow above average, above Virtusa average rates in fiscal ’14? Or do you think it might moderate a little bit given on the call you talked about you just completed last transformation work with them?

Tom Holler

You know obviously, we ramped much quicker than any of us had anticipated, and frankly even the clients hadn’t anticipated. So we sort of reached the, close to the optimal level in terms of team size, we think we’ll be able to maintain that as we do these country rollouts and continue to manage the platform and take on the maintenance streams of the platforms. So incrementally, growth will come through finding other (optic), continue to maintain at the steady state that we’re at, in levering our relationships now to find additional engagements within the enterprise. But, it’s not going to grow like it did in fiscal ’13 because we ramped very quickly. Probably what we should have been in two years, we got to in one year. And now we can run that more or less steady state for the next 3 to 5 years as we do these multi-country rollouts, while looking for other opportunities within the enterprise.

Puneet Jain

Let’s talk about this immigration build. Well, it was great to hear on the call that you are not an H1B dependent employer, which significantly reduces your exposure. But I guess you also file, you have like lot of employees on L1 visas also.

Tom Holler

Right.

Puneet Jain

And with that, given that the bill increases application fee for L1 visas along with higher rejection rates that the whole industry is seeing on L1, how comfortable you are with continuing with the same strategy of like, resource?

Tom Holler

Our strategy has always been to hire within our local geographies naturalized work force. Now that typically means citizens or H1Bs that we put on green card that are very naturalized with our clients, which by industry standards resulted in our visa dependency both when you combine H1s and L1s to be a lower percentage of our work force than most of our competitors.

Now having said that, it’s still high. If you look at the proposed bill, it suggests that in the first year you need to be less than 75% of visa employees, in the second year 65%, in the third year 50%, often referred to as 50-50 rule. We are already compliant in the first two years. So if the bill were to pass in its proposed state, it won’t impact us for two years. And because we’re already below 65% it’s not, it won’t be hard for us at all based on the way that we have always operated our business, to bring down the percentage slightly to meet that 50%. So we are not concerned about the percentage caps, because we are already well below. And it has always been the way the DNA of the company, to hire a lot within the local geographies that we are operate in. And you are right on the H1Bs, we have always been less than 15%. Because HB dependency has always been a parameter out there and if you go over to have certain compliance and other issues, so we always stay below that.

Puneet Jain

And given that, like, the world is moving towards more protectionism rather than less protectionism. So irrespective of fate of this bill, do you think, like, the overall industry and yourself as well, will you look at your employee base and try to reduce visa dependence?

Tom Holler

That would make a lot of sense, right? But I would suggest that’s probably a better question to ask our competitors what their plans are. Because I don’t like to be speculating if that would influence them, if the bill say doesn’t pass, but because of the risk that always potentially out there, it seems logical they might want to moderate their percentage.

Puneet Jain

Alright, any questions from audience?

Unidentified Analyst

(Question inaudible)

Tom Holler

Sure, so the question is on the form nature of our contracts. In terms of fixed price in timing material, we were predominantly timing materials, it has been around 80%, 20% fixed prices historically. And it’s really based on our customer preferences, right, I mean we are quite happy with fixed price engagements, but it’s whatever our customer wants to do. In terms of passing on visa costs, was that part of the question?

Unidentified Analyst

Yes.

Tom Holler

So, today most of our customers will those pass on travel and visa costs. Directly reimbursable; that’s the majority of our class, not all of them though. In the future, if visa costs do go up because of this proposed bill, I expect that we will be able to recover some of that, but I am not sure that our customers are going to be too comfortable reimbursing us for the majority of the increment, if you will. So if visa costs do go up as the proposed bill suggests they may, that will increase our visa processing costs, absolutely. It won’t really have much of an impact this fiscal year because the bill probably won’t be pass until late in the year if at all. And so it’s really more of a cost that will be associated with next fiscal year, which gives us ample time to plan and look for other operating levers to be able to mitigate any impact that might have on us. Does that answer all of your questions? I know there are few parts to it.

Unidentified Analyst

(Question inaudible)

Tom Holler

Sure. I don’t think it’s so much mixed by clients; it’s more mixed by service. So if you look at applications support and maintenance, you can highly leverage the offshore model, you might be 90% right. But for transformational solutions, Millennial Enablement solutions, some of the IT rationalization application modernization that we do, earlier in the lifecycle those engagements, you tend to be heavier onsite and then you start getting more leverage over the time with the global model. So, historically, Virtusa had always prided itself on being one of the best in class in terms of being the lowest percentage on site below 20%. But as we are moving into these larger and larger transformational engagements, which is a great thing for us, it is requiring us to deliver more onsite, especially on the front end of those engagements and it has taking our onsite percentage to above 20%. I don’t recall last quarter, it might have been 22%. And we think that it will go up slightly from here, the onsite percentage, largely driven because we are very focused on growing our non-top 10 clients and getting into many transformational solutions with them. And again those will early in the lifecycle of those transformational engagements which will drive up our onsite percentage this fiscal year. But longer term, the benefit of these transformational engagements as you get the downstream maintenance and support, so the life cycle, you'll see more onsite initially on these engagements shifting to more of a offshore model with this application support but as we continue to grow the company and have a balance of continuing to win transformational engagements. We think that we'll probably balance up may be as high as 24-25% onsite before we become steady state.

Puneet Jain

All right, we'll stop here, thanks Tom.

Tom Holler

Okay thank you, thank everybody for attending today.

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