Virtusa Corporation's CEO Discusses F1Q14 Results - Earnings Call Transcript

| About: Virtusa Corporation (VRTU)

Virtusa Corporation (NASDAQ:VRTU)

F1Q14 Earnings Call

August 1, 2013 5:00 PM ET

Executives

Staci Mortenson – IR

Kris Canekeratne – Chairman and CEO

Ranjan Kalia – EVP and CFO

Raj Rajgopal – President, Business Development and Client Services

Analysts

Moshe Katri – Cowen and Company

Joseph Foresi – Janney Montgomery Scott

Mayank Tandon – Needham & Company

Harold Bengar – William Blair

Puneet Jain – J.P. Morgan

Operator

Good afternoon, ladies and gentlemen. Thank you for standing by. Welcome to the Virtusa Corporation Fiscal First Quarter 2014 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 questions. I would like to remind everyone that this conference is being recorded.

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

Staci Mortenson

Thank you. Good evening and welcome to Virtusa’s First Quarter of Fiscal Year 2014 Earnings conference call where we will be discussing our financial results for Virtusa’s first quarter ended June 30, 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, President 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 expressed 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 of Virtusa’s clients to realize the benefits from the use of Virtusa’s IT services and management’s plans, objectives and strategies.

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 results 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 speak 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 framework for assessing how 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 insights 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 SEC and our earnings press release.

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

Kris Canekeratne

Thank you, Staci. And thank you for joining us on our first quarter fiscal year 2014 conference call. It is a strong start of the year cash rise by year over year [inaudible] relating the revenue growth and significant operating margin expansion.

Growth was broad based across all geographies and verticals and they made good progress against our strategic client expansion objective. For the June quarter, revenue was $90.5 million, an increase of 19% year over year and EPS was $0.29 compared to $0.24 in the year-ago period.

The business environment overall remains stable and we see increasing budget allocation for global best-of-breed partners like Virtusa who deliver fragility and innovation. Growth for the first quarter was driven by our key strength and differentiators and generates tangible business benefits for our clients including our IT rationalization expertise, industry-leading transformational solutions, regulatory and compliance services and our leadership position in millennial enablement.

We continue to be in momentum across our client base to our focus on large consummation programs as to the intersection of business and technology. Clients continue to realize the strategic benefits of working with a partner that brings deep industry domain knowledge across core business processes by providing end-to-end capabilities from consulting and implementation to outsourcing services.

Key elements of our growth platform include millennial enablement, transformation of services and IT rationalization. Our highly-targeted solution combined with our industry and domain web consulting expertise differentiates us in our selected vertical market and provides us with significant expansion opportunity across our client base.

We are pleased with the progress we are making across each of these enablers and the impact our thought leadership is having on strengthening client relationships.

First our millennial solutions are focused on helping our clients create a user experience that is commensurate with the expectations of [inaudible] savvy consumers and employees. Specifically, our millennial consultants and solution exports assist our clients in understanding how to leverage their investments in technologies like mobile, social, big data, unification and cloud to improve their customer and employee experiences and thereby enhance revenue and improve operating efficiencies.

We are seeing rapidly increasing interest in our millennial solutions and have helped clients derive significant value in many areas including reinventing how companies interact with their customers and moving them from traditional market and sales models into immersive and interactive relationship based sales models.

Modernizing contact centers to handle the proliferation of channels and platforms, overhauling traditional content management solution and introducing consumer experience management systems that provide a rich digital experience and transforming the employee experience by introducing internal social platform, increasing collaboration and applying gamification techniques to improve performance.

For example, we have been engaged with a leading and new allocation [ph] publisher to build industry leading digital offering. Our millennial strategist walking in unison with our client’s premium team co-created a broader vision, predicated and crafting and targeting young adults by carefully understanding how digital pioneers interact through digital channels.

The new vision directly leverages the combined power of mobile, social, gamification and adaptive learning techniques to create a personalized classroom and study experience for the millennial student.

Second, our industry and domain transformational solutions continue to differentiate us and have positioned us very well to capitalize our emerging trends across our industry. For example, many enterprises are moving towards targeted sourcing that enables them to align an entire business process, platform or application with a best-in-class partner.

This is in direct contrast to how enterprises use to divide our horizontal load, cash and application development [inaudible] or application supported maintenance to different providers.

The new approach allows the business owner to align business outcomes with their partners, eliminate the need to manage a complex set of relationships and drive efficiencies. This value-added sourcing approach directly intersects our strength and capabilities and moves buying divisions to business owners focused on business outcomes and efficiency as opposed to commodity and arbitrage.

This trend is not only expanding our addressable market opportunity but also enabling us to develop more meaningful partnerships with both business and IT leaders.

In addition combining innovation agility with best-in-class solution is a key element driving our leadership position in transformational services offerings. Cloud computing is another emerging area that represents long-term opportunity for us and our clients.

We are concurring with our clients to help accelerate the use of cloud technology to improve business capability, speed development and lower operating cost. These technologies open up new possibilities as enterprises are no longer constrained by computing capacity.

As Virtusa, they are focused on building competence in key corporate platform such as force.com brochure [ph] and Amazon web services in order to deliver solutions that leverage these technologies and complement our deep industry knowledge and business process expertise.

For example, we build a global collateral management platform for a leading, networking and communications provider. By leveraging force.com, this significantly reduced both time to market cost of implementation significantly.

Another key engagement in cloud computing is the leading healthcare services provider. The hospital inventory systems that we are building are being developed and deployed and tally on the cloud thereby providing unparallel flexibility and on-demand scaling capabilities not available this on-premise system.

As our clients have increasingly embraced cloud infrastructure, we are identifying significant opportunities to cloud enabled complex business applications and platforms. We believe that we are the forefront of this year and our targeted service offering are well positioned to lead clients through this journey.

Our innovation is also helping enterprises measure, predict, and influence outcomes using complex analytics and big data. They are leveraging our experience in business [inaudible], our expertise in master data management and our deep industry knowledge and consulting expertise to create powerful solutions for our clients.

As an example we are seeing an increased investment from healthcare insurance companies who are looking for ways to better harness value from the significant volume of data they are collecting to help control cost, improve quality of care, empower their customers to make better choices and meet regulatory and compliance mandate.

We recently walk with a provider organization to analyze the best [ph] data sourcing including health plan, claim and anonymous patient records to write at a completed pricing model for specific patient services and providing compelling offers of patients who visit their town centers.

We then [inaudible] this information available to members to census [ph] mobile act to transparently compare cost and other pertinent information about similar procedures. The initiative we just discussed are great examples of why we are confident in our ability to grow out our non-top 10 client base at a faster rate than our top 10 clients.

This proves itself our interest in the quarter and our expectation is that this will continue for the remainder of the year. This [Inaudible] a topic of interest, I want to make a quick comment on immigration and reform. Client engagement is strong and our pipeline continues to expand nicely.

As the bill stands now we are well positioned based on the current provision. Many of the initiatives we have been working on over the past year or so to improve our service delivery such as our increase US camp [inaudible] and our Albany, New York mutual center are only going to help our compliance, shoot the bill passed and currently written.

Before I turn the call over Ranjan I wanted to share with you how our internal millennial initiatives are helping us gain recognition in our major hiring geographies. Just yesterday, we received Asian Best Employer Brand for 2013 recognized under the category of Excellence in HR Through Technology from millennial enablement across our people practices.

The Asia Best Employer Brand Award recognizes outstanding performance in the workplace across Asia and we were chosen out of a short list 133 leading companies. In conclusion we remain positive on our outlook and continue to expect that we will drive above market growth rate in fiscal year 2014 by delivering meaningful operating margin expansion.

Now let me turn the call to Ranjan who will provide more details on our results in second 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 first quarter of our fiscal year 2014 before providing our current guidance for the second quarter and full fiscal year ending March 31st, 2014.

All of the numbers being discussed are US GAAP except with regards to the use of constant currency revenue metrics.

Revenue for our first fiscal quarter was $90.5 million in line with our guidance. On a year-over-year basis revenue increased 19% both in reported and constant currency. This was a 1% sequential increase in reported currency and flat on the constant currency basis. Constant currency normalizes the movement of the British pound against the US dollar in each competitive year.

Gross margin during the first quarter was 36.1% an increased compared to 35.9% in the prior quarter and 34.9% in the year ago period. Our operating income for the first quarter was $8.9 million compared to $9.4 million in the prior quarter and an increased from $6.9 million in the year-ago period. This resulted in an operating margin of 9.9% for the first quarter of fiscal 2014 compared to 10.5% in our prior quarter and 9% in the year-ago period.

The sequential operating margin change of 60 basis points was primarily driven by compensation increases due to higher on site effect, increase facilities costs and an increase in marketing and business development investments. Partially offset by improvements in utilization and an FX benefit mainly from our INR hedging programs. The year-over-year 90 basis points operating margin increase was primary due to an FX benefit mostly from our INR hedging programs, increase utilization, lower traveling expenses and lower Visa cost partially offset by an increase in compensation expense to support the revenue growth and increase facilities costs.

First quarter other income was $1.1 million inclusive of an FX transaction gain of $400,000 which is not included in our prior guidance. This was primarily due to the strengthening of the US dollar against both the Sri Lankan and the Indian rupee on inter-company and customer balances denominated in US dollars.

We have an income tax expense of $2.5 million in our June quarter which equates to an effective tax rate of 25.3% in line with our prior guidance. Net income for our June quarter was $7.5 million compared to $9.1 million in the prior quarter and $6.1 million in the first quarter of fiscal 2013.

Diluted earnings per share was $0.29 in our first quarter of fiscal 2014 compared to $0.35 of the prior quarter and $0.24 in the year-ago period.

Turning to the balance sheet, ending cash at June 30th 2013 was $80.7 million inclusive of cash equivalence and short-term and long-term investments. Cash flows used for operating activities were $1.8 million in the first quarter.

Our DSO including unbilled receivables was 91 days compared to 84 days in the prior quarter. This increase was primarily driven by collections on a few large programs with blue chip global enterprises. Capital expenditures were $1.7 million in the June quarter. Depreciation and amortization expense in the quarter was $2.6 million.

Now let me turn to some additional quarterly financial and operational metrics beginning with those related to our first quarter 2014 revenue. Revenue across our industry groups was as follows, BFSI increased 26% year over year and represented 63% of revenue.

Sequentially, BFSI increase 6%. This industry group is expected to be a growth driver of fiscal year 2014. Communication and technology grew 9% year over year representing 26% of revenue and declined 5% sequentially.

This sequential change was in line with our guidance driven primarily by the budgeting cycle and one of our larger clients. The media information and other grew 5% year over year and contributed the remaining 11% of revenue. As expected sequentially M&I declined due to some slow project clients and other programs came to their natural conclusion.

We continue to believe this industry group will show healthy growth rates in fiscal year 2014. For the June quarter, we have three clients contributed greater than 10% of revenue. During the June quarter, we commenced work with four new clients, two in BFSI, on in communication and technology and one in M&I.

We ended the June quarter with 6,279 IT professionals, an increase of 17% year over year. Global utilization excluding trainees was 80% in our first quarter, up sequentially and year over year.

As we look at the 2014 fiscal year, our utilization target is in the high 70s to low 80% range. Now I will provide a current guidance for our second fiscal quarter and full fiscal year ending March 31st, 2014.

Revenue in the second quarter of fiscal 2014 is expected to be in the range of $93.3 million to $95.3 million. Diluted earnings per share in the second quarter of fiscal 2014 is expected to be in the range of $0.28 to $0.32. Earnings per share anticipate an average share count of approximately $26.3 million.

For the full fiscal year ending March 31st, 2014, we expect revenue to be in the range of $378 million to $392 million. Diluted earnings per share for fiscal year 2014 is expected to be in the range of $1.24 to $1.36. For fiscal year 2014, EPS anticipates an average share count of approximately $26.3 million, slightly higher than our previous expectation.

Our current guidance is based on the following set of assumptions. Annual effective interest rate deal is expected to be approximately 3% of our average projected cash balance including short and long-term investment. 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 31st, 2014. The weighted average Indian rupee conversion rate for the full fiscal year ending March 31, 2014 is approximately 54.7.

Our assumptions are that the weighted average Indian rupee conversion rate for the second quarter of fiscal year 2014 will be INR54.1 and then improve to INR55.9 for the remainder of the fiscal year 2014.

In addition, guidance does not consider the possible impact of having ineffective hedging contracts for the remainder of the fiscal year 2014. Our second [inaudible] quarter fiscal 2014 guidance anticipates a British pound to US dollar conversion of $1.51 which does consider the impact to revenue and cost from hedging contracts already in place for our second quarter.

We expect our effective tax rate for the second quarter to be 26%. Our full fiscal year 2014 effective tax rate is now expected to be approximately 25.8% slightly higher than our previous guidance. Our effective tax rate is sensitive to the geographical mix of profit for the fiscal year and is subject to change.

We anticipate the total capital expenditures 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 touch on our second quarter and full fiscal year 2014 guidance.

We see ongoing demand for our differentiated services such as transformational programs around customer experience, next generation digital platforms that power the millennial experience, regulatory compliance and TCO reduction.

Yearly IT budgets have been finalized and while the overall macroeconomic environment has its challenges, our clients are spending against their budgets and investing in flexible global models particularly with best-of-breed partners who are HR innovator.

Our investments in innovations combine with our industry expertise are also driving our business. Virtusa has been the leading engine of implementing innovative technologies to help our clients transform their businesses.

For example, we are using cloud technologies to increase productivity and reduce implementation cycle times. We are also helping our clients organize vast amount of structure and unstructured data to develop insights to complex analytics to improve decision making.

We see opportunities to expand our revenue per client more in lined with industry averages. As we scale the company, we are participating in larger programs and our [inaudible] has continued to increase. We expect each sequential revenue growth to accelerate to approximately 4% in the second quarter driven by meaningful expansion in our non-top 10 clients and strength in our C&T and M&I industry groups.

We expect some slower project clients in the banking segment as some programs come to the natural conclusion but expect growth through time in the back half of the year. For fiscal year 2014, we continue to expect market leading revenue growth with broad-base expansion across all our geographies and all of our industry groups.

Our initiative is to grow our non-profit portfolio faster than our top 10, remain on track and both are expected to deliver strong growth for the full fiscal year 2014. Turning to margins, second quarter fiscal year 2014 gross margins are expected to be impacted sequentially due to annual compensation increases partially offset by resource optimization initiative and an FX benefit due to our INR hedging program.

However, our expectation is that we will see gross margin improvement throughout the remainder of the fiscal year 2014. Our SG&A assumptions remain relatively consistent with prior guidance.

In conclusion, we are off to a strong start in fiscal year 2014. As we look forward, enterprises are increasing investments for strategic partners that bring a combination of technology, industry expertise, innovation and agility to help them succeed. We believe we are well producing to capitalize on such trends.

For fiscal year 2014, we are confident in our ability to drive industry growth rates while realizing margin leverage. I will now turn the call over to the operator to being Q&A. Thank you.

Question-and-Answer Session

Operator

Thank you. (Operator Instructions) Our first question comes from Moshe Katri with Cowen and Company.

Moshe Katri – Cowen and Company

Nice quarter guys. Can you talk a bit about the revenue metrics buy the various regions, specifically the US, Europe, et cetera? You haven’t provided that. And is it also possible to do the same thing by service offerings as well? Thanks.

Ranjan Kalia

Sure. I want you on the back [ph] to provide that but they are all included in the data sheet that’s on our website. So just in terms of North America, North America is 74% of our revenue mix, Europe 20% of our revenue mix and the rest of the world is 6% of our revenue mix.

Moshe Katri – Cowen and Company

Is there anything specific in terms of sequential growth in these regions that you want to point out?

Ranjan Kalia

Sure. Moshe, we had previously talked about that we had expected Europe would be a soft quarter. In fact it’s a sequential decline, primarily as you know, this is BT’s budgeting cycle. So we know historically has always seen a downtick within Q4 and Q1 in Europe and that’s what transpired this quarter. We are expecting Europe to grow starting Q2 and for the whole year.

Moshe Katri – Cowen and Company

Okay. And then can you do the same thing for by-services?

Ranjan Kalia

Yes. So, in terms of our service mix, our consulting and implementation as consistent with tri-quarters at 43% and our application outsourcing is consistent with tri-quarter at 57%.

Moshe Katri – Cowen and Company

And then looking to fiscal year 2014, can you kind of gauge, can you give us kind of some color on margin expansion, gross margin expansion and then reiterate what you said in the past? I’m assuming you’re so comfortable in terms of where margins will be down the road.

Ranjan Kalia

So, Moshe, just like I say, we are expecting Q2 would be a sequential growth margin decline as we absorb the compensation, annual increases which we do historically in the Q2 period.

If we do have hedging benefits that will offset some of those increases but for the full year, we expect gross margins to stat to return to the Q1 level and exceed slightly in Q3 from the Q1 level.

In terms of operating margin, the guidance still continues to call for at least 100 basis points year-over-year expansion.

Moshe Katri – Cowen and Company

Got it. Thanks guys.

Operator

Our next question comes from Joseph Foresi with Janney Montgomery Scott.

Joseph Foresi – Janney Montgomery Scott

Hi. I was wondering if you could talk a little bit about, we’ve seen some of your competitors’ sight in pick-up in demand this quarter with some pretty good numbers. Are you seeing that pick-up take place in your business? And then, on the slowdown in the work that’s coming off, can you give some order of magnitude in what’s the size of that is [ph] the next quarter?

Kris Canekeratne

So Joe, we are clearly seeing strong momentum in terms our kind especially in the industry that we offer it in investing and spending more specifically on transformational programs and programs around regulatory and compliance initiative. We also reduced that keep the lights on spend, and then reinvest some of those savings into customer facing [ph] and consume experience initiative that we call, "Millennial Enablement."

So overall, we see strong demand for our services and this is also for the collaborated by our pipeline, and a lot of the progress that we have made. Ranjan [ph] will spend a moment giving you some insight into how the pipeline has been building over the year, and comparing it to what we had in prior years [ph].

Ranjan Kalia

Thanks, Kris. Yes, by playing that technically [ph] larger than this time last year. And if I look at the pipeline dollars that have been added per month, this is almost double compared to the same time last year.

Also what we’re finding is that clients are spending against their budgets. So we have seen actually a reduction in the number of days to close a deal compared to our quarter growth. And this is in line with what we had predicted last quarter, that this guided [ph] that February, March and April was slow months for us, and we expected that pace to pick up the pace of HAP [ph] closing to pick up and that actually transpired as we have predicted.

In addition what we are seeing is a much more deal, a larger deal in the pipeline as well as more opportunities in the pipeline to expand the good and existing client base.

So what this indicates is that we should be able to sequentially grow in the second half of the year. This is not against the expanding across all industry groups in all GEO’s [ph]. And we have very strong visibility against our FY ‘14 guidelines. And this is actually consistent with the way we’ve been doing this in prior years.

Raj Rajgopal

So, Joe just to sum it up, all of these adds up in the guidance that we have provided which calls for a robust sequential growth rate of at least 3% to 5% from Q1 to Q2.

Joseph Foresi – Janney Montgomery Scott

Got it. Okay. And then you talked about the natural slowdown in some business that was kind of low enough. Could we get some color on the order of magnitude in when that, I guess natural slowdown begins to taper off?

Raj Rajgopal

So, Joe, what we have talked about it that historically Q1 is a slow growth quarter for Virtusa similar to what we saw last year. The same how it’s played out, our guidance played out in the actuals.

And as we are exiting from Q2, we are really starting to see some of the pick-up that we have with all of these [ph], but call for in our previous guidance as starting to shape up like that.

I think that the only thing that we’ll probably be soft would be on the banking segment. But even the banking segment as we get all of Q2, we believe Q3 and Q4 will be strong. But other than that, the banking segment we’re really expecting a broad base growth in Q2.

Joseph Foresi – Janney Montgomery Scott

Perfect. Can you talk a little bit about, just maybe update us on your exposure on the Immigration Bill?

Kris Canekeratne

Yes. So just to remind everyone and we had talk about this during the last quarter as well. There were four areas in the original eight-page Immigration Bill that simply wrote the 50-50 rule, the higher wages by each and every workers, the outplacement limitation across [ph] and increase in visa cost.

If this bill passed through the Senate, there was an addition to this bill, the 12,000-page bill as we now know of it, they finally passed it to Senate introduced the 11 outplacement provision, although it is still not completely clear what percentage threshold the bill wants to [ph] constitute dependency.

So as we take a look at this, as I said during our last earnings call, we have no exposure to 50-50 rule. We have all of this adhered to employment practices on night based [ph]. So we really don’t have any issue around the higher wages. If not being and or not [ph] an H1 dependent business. So therefore we don’t see any exposure to the outplacement limitation that 5VH1 [ph] provision goes.

But should this bill passed the way it’s currently written? There will be exposure to withhold that in [ph] pretty much the entire industry around L1 outplacement or L1 Dependency.

Again as I’ve said, it’s not completely clear as to what constitute over independency. I think they’re going to get more clarity about that over the next few weeks or months perhaps.

But as this bill has been going through and all the way passed through the Senate, it is stored in the House. And it is expected that the House will pass its own version. So by that [ph] I’m not sure of what will be in the bill that passes through the House. It appears more likely that the House will pass a series of business changes on Immigration Reform, based in the comprehensive closed-under bids [ph] Senate Bill.

At the end of the two bills, one from the Senate and one from the House, then obviously there would be a special committee that will be created to resolve the differences before it can go to the President.

The President has urged Congress to have something on schedule before the end of November but the early [ph] month work remains.

So net in that [ph] as we take a look at this, if the bill as it stands into final version that made its way through the Senate, there will be some exposure on the L1 Dependency Code.

As we’ve been speaking with clients and talking to many of our buyers, the clients continue to expand with providers like us who can provide obviously no [inaudible] services that hasn’t changed. As Raj mentioned earlier, our pipeline has grown the deal size that have expanded, a deal cycle times of close [ph], the time to close has shortened

So overall, the buying environment continues relatively on the kit [ph]. And in the event that this one provision is a part of the final bill that passes, we have strategies in place that will enable us to service our clients without disruption.

Joseph Foresi – Janney Montgomery Scott

Okay, thank you.

Operator

Our next question comes from Mayank Tandon with Needham & Company.

Mayank Tandon – Needham & Company

Thank you, good evening. Just a few quick ones, Ranjan first, before I get a sense of the margin expansion, so you’re saying 100 basis points at the mid-point of the guidance range. How did that breakdown between gross margin expansion for the year and then some SG&A leverage?

Ranjan Kalia

So, Mayank, when you look at our gross margin actually expanded from Q4 to Q1, we’re about 36.1 but beyond [ph] guiding that in Q2 sequentially, the margins will go down. And will start to pick them up again in Q3 and Q4, pretty much returning to the Q1 or exiting slightly above the Q1’s level. So we’re not providing gross margin guidance right now. But in terms of directionally that’s where we see the gross margins will end up.

And for the full year similar to last year if you look at it, the margin profile for Virtusa last year, we had relatively flattish operating margin expansion in the first half, and we pick those up in the third and fourth quarter. And the guidance go up for similar back for this year [ph].

Mayank Tandon – Needham & Company

Okay. So based on what you said though, it would seem that that gross margin will be up year-over-year based on the current guidance. And would you say that delta would be mainly the Rupee impact?

Ranjan Kalia

No, it’s couple of things. Not only the Rupee impact. Yes, the Rupee impact is there, but you got to remember that some of the Rupee impact for us gets invested back in increase on outside effort [ph]. So we’re continuing to drive gross margin expansions through research optimization.

So the Rupee benefits get invested in lot of different places outside FX, we visa cost [ph], new facilities that we’re operating. So it’s really a part of our model.

Mayank Tandon – Needham & Company

Okay, that’s fair enough. And then on the headcount front, I saw a headcount down sequentially, anything noticeable there? And also if you could just comment on the attrition rate which have been trending down, but it climbed up this quarter?

Ranjan Kalia

Mayank, you’re probably absolutely right it did. But it’s primarily because when you coming into it [ph], we were in a slow growth quarter. We drove utilization higher and which that meant that headcount was a slight decrease. We’re expecting headcount growth to continue linearity to the company revenue starting Q2.

Mayank Tandon – Needham & Company

Okay. And finally, Kris, I know you gave us a lot of color on demand and if you already gave this, I apologize, but wanted to get your sense of any incremental impact on a regulatory side both in the health care and banking verticals over the course of fiscal ‘14.

Ranjan Kalia

Yes. This is Ranjan, I’ll take that call. Yes, on the health care side, we’ve have some nice returns [ph]. This segment is actually done well for us [ph]. And the growth driver for this is the Affordable Care Act and its implications around consumer that promote [ph] health care, compliance needs, analytics to support reduce reimbursements et cetera. So we’ve seen the regulatory drive some revenue for us. But also actually testing [ph] is a growth opportunity for us and the pipelines that’s moving in this area.

On the BFSI, we do see BFS segments again to grow in the second half of the year. And one of the key areas that is going to be driving demand in BFS is the increase allocation towards the compliance initiatives.

Again, given that significant compliance capabilities, we do believe that we are well-position to service the demand. We actually have active compliance engagements across all of our geographies. And these programs are in the areas of fat care, EML, disclosure of interest, KYC, Dodd-Frank, direct reporting [ph], et cetera. And this pipeline is continuing to build. And we have significant marketing programs that are for the design to increase this pipeline.

Mayank Tandon – Needham & Company

Is this spend incremental [ph]? Sorry, I was just going to ask you, is this spend incremental or are you seeing that it is cannibalizing some existing discretionary budget?

Ranjan Kalia

Yes. To some extent it is actually moving budgets away from existing programs. And moving them towards these in some clients, and the other clients is incremental. So it’s a combination.

Mayank Tandon – Needham & Company

Great. Thank you.

Kris Canekeratne

Just a bit on that overall budgets across things downstream that they service [ph] are actually up.

Mayank Tandon – Needham & Company

Great. Thanks, Kris.

Operator

Our next question comes from Harold Bengar with William Blair.

Harold Bengar – William Blair

Hi, thanks for taking my question. I was wondering if you could just talk about the competitive environment and touch on pricing by service line.

Ranjan Kalia

Sure, Harold. We don’t really discuss pricing by service line. And especially where Virtusa really plays in the higher values services any way. But this really guided before end, that guidance continuous to hold that, we see a stable pricing environment there. When you find pocket of competitive pricing in there, we’ll have to take some price decreases, but overall, our company level pricing continuous to be stable.

In terms of the overall competitive environment I’ll have Ranjan.

Ranjan Kalia

Yes. So again, the environment is competitive but no different than in prior quarters. We actually manage to maintain our win grades [ph]. In fact win grades actually have increase that had over the last six months.

Harold Bengar – William Blair

Got it. And just on financial services sequential growth is pretty solid during the quarter. Was that growth more broad based or was it driven more by selective set of customers?

Ranjan Kalia

Well, it was actually you’re right, it was actually a little bit of better than our expectations. It was really driven by our two clients in the banking segment for us.

Harold Bengar – William Blair

Okay. Thank you.

Operator

At this time, we have one question remaining in the queue. (Operator instructions) Well, take our next question from Puneet Jain with J.P. Morgan.

Puneet Jain – J.P. Morgan

Hey, thanks for taking my question. So given top 10 clients declined in the first quarter, should we expect significant pickup in growth there in second quarter? Sorry. Go ahead.

Ranjan Kalia

No, no. So, yes, Purneet, we had always talked about that our top 10 client would grow a lot slower than the non-top 10. And in fact our non-top 10 will grow higher than the company average.

So for the first half, we are expecting the top 10 growth to be lot slower. But then even the top 10 growth picks up in the second half.

Puneet Jain – J.P. Morgan

Right. So you expect top 10 or non-top 10 clients to grow at above average rate in second quarter also, sequentially, yes?

Ranjan Kalia

That’s right. That’s right.

Puneet Jain – J.P. Morgan

All right. And so, what’s driving this growth acceleration in those smaller accounts? Is it that because of improving budgets, increased discretionary spending? Are you seeing growth there or you’re gaining share from other lenders?

Raj Rajgopal

So I think it’s all of the above Puneet. So let me put all of that [ph] behind this. So first and foremost, we have some very targeted offerings around servicing trends [ph] while embracing the distal frontier basically around [inaudible]. So that’s resonating particularly well.

We believe we have leadership positioned in that area. And that’s really driving the need through [ph] discretionary budget that have opened up specifically to transform these businesses to meet the emerging needs of this native [ph] are just simply creating a much better use [inaudible]. So that’s one group of services and solutions that’s resonating particularly well.

And as we talk about on several quarters, we have a set up transformational solutions that are second to none. And when we compete in the industry around things like planed on boarding, our case management [ph], policy administration, regulatory and compliance initiatives, specific offerings and health care, we have very deep expertise. And once again, these are areas that large enterprises actually redirecting and diverting some of their spend to it.

Finally what we are seeing which is actually very appealing forward if you observe is that as a result of our strength in rationalization and consolidation, what we are now starting to see is that we are being now evaluated and very often selected for things like application support and maintenance budgets within the large enterprises that we service. Because we are one of the few enterprises, one of the few service providers that can go in and help them reduced their cost of operation through rationalization, consolidation. And then help them divert some of those savings into transformational program.

And as a result of this, we are starting to see very strong momentum that that being the pipeline that there have been [ph] the large enterprises that we serve today. Already they intresepting [ph] new accounts and new opportunities in existing accounts and are going after new programs within both new and existing accounts. That’s what’s really driving a large part of the momentum forward to occur [ph].

Puneet Jain – J.P. Morgan

Understood. Two more real quick, so Ranjan, I think you mentioned utilization target of high-70’s to low-80’s, never seen like what you saw utilization above [ph] 80% level. So could you reconcile that target, that comment with potential decline in utilization, as it is more distributed delivery and expand your service offerings?

Ranjan Kalia

Yes. I think, Puneet, that’s a fair observation. So that’s really 80% low 80% has been a goal for us on utilization for a while. And we’ve been working behind it. And what we’re really seeing is because the deal sizes are starting to increase, we have more opportunities opening with the optimization. And that’s really helping us to really increase our utilization.

We believe that we can continue to be in that band of high-70’s to low-80 even with a little bit of more distributor model than we probably had last year. And that’s primarily driven by because we’re playing in larger deals.

Puneet Jain – J.P. Morgan

Understood. Last one, you’re also sharing a lot of interest in your short delivery centers among IT buyers, you also set up a center here in New York last quarter. Could you talk about clients’ response you’re getting to that center?

Kris Canekeratne

Yes. So we set up a center here in Albany, but the response has been very, very strong. We have one of our clients who were basically the primary partner with us as we opened the center. They have continued to go in and scale within [ph] the Albany center that we have. But beyond that what we are finding is that for certain categories of work, they have a strong preference to be able to get that work executed here in the US.

And that type of opportunity can be extremely well-served from our center in Albany, New York. And we expect that the center we can have a growth [ph] and extend as we service our enterprise guidance.

Puneet Jain – J.P. Morgan

Right. Thank you.

Operator

it appears there are no further questions at this. I’d like to turn the conference back to our speakers for any additional or closing remarks.

Kris Canekeratne

I’d like to thank all of you for joining us on our call this evening. And also thank all of our global team members for their ongoing dedication to our clients and the service they provide. Thank you.

Operator

This concludes today’s conference. Thank you for your participation.

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