Virtusa's CEO Discusses F2Q14 Results - Earnings Call Transcript

| About: Virtusa Corporation (VRTU)

Virtusa Corporation (NASDAQ:VRTU)

F2Q14 Earnings Call

November 4, 2013 5:00 PM ET


Staci Mortenson – IR

Kris Canekeratne – Chairman and CEO

Ranjan Kalia – EVP and CFO


Mayank Tandon – Needham & Company

Joseph Foresi – Janney Capital Markets

Rahul Bhangare – William Blair

Brian Kinstlinger – Sidoti & Company

Puneet Jain – JPMorgan

Vincent Colicchio – Noble Financial


Good afternoon, ladies and gentlemen. Thank you for standing by. Welcome to the Virtusa’s Fiscal Second 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 given 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 Mortenson of ICR. Please go ahead.

Staci Mortenson

Thank you. Good evening and welcome to Virtusa’s second quarter of fiscal year 2014 earnings conference call where we will be discussing our financial results for Virtusa’s second quarter ended September 30, 2013.

On the call with me are Kris Canekeratne, Chairman and Chief Executive Officer, and Ranjan Kalia, Executive Vice President and Chief Financial Officer.

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, Virtusa’s forecast of the financial performance of OSB Consulting LLC, Virtusa’s ability to stimulate and integrate the operations of OSB, the growth of Virtusa’s business, the ability of Virtusa’s clients to realize benefits from the use of Virtusa’s or OSB’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 could 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 a 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 Securities and Exchange Commission and our earnings 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 second quarter fiscal year 2014 conference call. We had another strong quarter characterized by year-over-year industry leading revenue growth and significant operating margin expansion.

For the September quarter, revenue was $94.3 million, an increase of 4% sequentially and 17% year-over-year. EPS was $0.28 compared to $0.23 in the year ago period. We are very pleased with the progress that our teams have made and our ability to differentiate our services in areas that help our clients, modernize, transform and rationalize their ideal state both in terms of accelerating innovation and running our client’s businesses more efficiently.

This quarter, was further validation that our core growth enablers are targeted, effective and resonate particularly well in the geographies and industries we serve. Specifically, they are meeting our client’s needs to immediately reduce operating costs and free up budget to transform and modernize their businesses.

Our differentiated services are providing clients with significant value enabling us to pursue and win larger engagements, expand our wallet share and strengthen our positioning as their strategic partner.

Additionally, the success we are having is enabling us to expand our presence in the industry’s reserve and grow our market opportunity. As a result of the progress we have made against our strategic objectives and the momentum we have, we have increased our organic revenue guidance for the full fiscal year.

Just a few weeks ago, we hosted our annual event for our top-25 clients. The theme this year was on building a millennial experience and all attendees were senior division makers. Participants came with the objective of better understanding the transformational journey required to provide it through millennial experience for their consumers and employees.

Some have already launched initiatives while others are looking at how to initiate programs over the coming years. They all realize that they have an opportunity to be disruptive and lead or risk being left behind by their competition.

What was most gratifying to us was that the investments we have made in establishing Virtusa as their thought leader in building millennial businesses, create up the foundation for us to have rich and meaningful discussion with our top-25 clients where Virtusa was regarded as the clear partner of choice.

We also spoke to our clients about success stories and cutting edge initiative that are breaking down barriers and blurring the lines of competition within adjacent industries. As thought leaders, many of our clients are quickly identifying ways to expand their reach or are developing new businesses that provide a millennial experience to intersect the ever increasing number of digitally savvy consumers.

We have been engaged with one of the largest European Railway Infrastructure Company as an example to help modernize and create the foundation to provide in millennial experience.

We are leveraging our expertise in IT rationalization, data analytics and millennial capabilities around Solo Mo to create a big data platform which brings together all the railway asset information with their geographic locations into a single platform.

The consolidate information and analytics are presented to a highly intuitive and interactive math based interface and generate business insight that allow far better division about managing the asset lifecycle. This rich source of insight that we made available as a service to industry partners and customers which will dramatically improve the quality of digital savvy consumers while sharply reducing maintenance costs across the railway industry.

Delivering a millennial experience is becoming a business imperative and Virtusa’s differentiation is enabling us to take on a leadership role in the industries we serve.

Additionally, Virtusa’s unparalleled IT rationalization and consolidation services help our clients run their businesses more efficiently and industry leading transformational solution including compliance and regulatory offerings help our clients innovate and transform their businesses.

In particular, we have been building out our financial transformation or FT capabilities. Typically, FT programs are deployed to reduce the cost to perform corporate finance transactions, provide a more consistent internal and external financial reporting environment and improve data quality to increase the efficiency and effectiveness of the finance option.

We have been building out and broadening our capabilities to become more helpful service FT provider and to capture a greater portion of FT programs, these generally are very large.

Today, we are pleased to announce the acquisition of OSB Consulting which further strengthen and expand our capabilities in this area.

Based in New Jersey, OSB has a 10-year growth of FT professionals that include business consultants, program management and functional and technology skills required to execute large FT programs. In addition, they have domain experience around many SAP finance related modules which complement our skill set.

We are already partnering with OSB on several large transformational programs and have seen firsthand, the synergies in combining the strengths of both firms. We will immediately begin focusing on jointly expanding across several large programs already in place as well as pursuing to build new programs. We are very excited to welcome the OSB team to Virtusa and expand our digital market and the result of this combination.

Another area within transformational solution, where we are gaining traction is around client onboarding. The very important part of compliance regulation for KYC or Know Your Customer, an area where Virtusa is building meaningful differentiation. We are currently working with a global brokerage firm to automate key workflow processes and improve operational efficiency.

By leveraging our BPM expertise, we are designing the client onboarding process with compliance checks, documentation and full auditory capability to meet KYC legal and risk requirement. As a result, we are delivering meaningful business benefits to our clients including Global System and Unified Processes, resulting in improved operational efficiencies.

Transparency for all business areas involved in onboarding and other automated processes and greater control over the complete onboarding life-cycle and smarter client management.

The work we have done has been very well received and we are building a strong reputation as a result of successfully executing these strategic programs.

Our expertise is increasing in demand across a wide range of financial services companies and we are seeing our pipeline for these transformational services grow.

Finally, our expertise in IT rationalization and application modernization is enabling us to take a new approach to application development, support and maintenance providing significant benefits to our clients and increasing revenue streams for us.

Of the last few years, it has become increasingly apparent to us that there are more effective ways to provide application development, support, maintenance and QA. By systematically applying our platforming approach to rationalize and consolidate IT applications into fewer and fewer co-platforms and timed outcomes to SLAs of identified ways to drive meaningful efficiencies for our clients.

In addition, over the past 18 months, we have invested in strengthening our market pacing leadership by adding senior team members to pursue new IT rationalization and consolidation opportunities in our existing client base and identify new clients in the industries we serve.

Our disruptive approach is allowing us to capture new recurring revenue business as clients are looking for ways to reduce operating cost beyond that of traditional offshoring.

A great example of this is the work we are doing with an existing client, a global provider of credit research. The client has multiple, large and complex business critical application that are used by thousands of employees around the world. These applications have multiple inter-dependencies, replicated co-business processes and are not well documented.

The plan is looking for a true business partner to take end-to-end ownership for SLAs as well as drive continuous improvement and cost reduction across the complex and redundant application portfolio.

In this competitive replacement, we create a program based on SLAs and KPIs to transition to engagement, identify rationalization consolidation opportunities and take proactive steps for incident prevention.

In a very short period of time, our SG&A adherence exceeded target significantly and reached levels that were not met by the previous vendor despite being in place for over three years.

What started out as a three-year multi-million dollar deal to support a select number of applications and application platform, expanded within two months to include additional applications and platform, dramatically increasing the benefits of rationalization consolidation for our clients and a meaningful step-up in annual revenue for Virtusa.

Overall, we are pleased with our performance in our second fiscal quarter. The visibility we have combined with the momentum across our client base, our differentiated services and unparalleled experience developing customer centric solution, gives us the confidence to raise full year organic revenue guidance.

We will continue to focus on the three areas of our growth platform, IT rationalization consolidation, industry leading transformational solutions, and services that deliver in millennial experience to expand our market opportunity, extend our differentiation and strengthen our position as thought leaders in the industry.

Now, let me turn the call over to Ranjan, who will provide more details on our results and third 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 second quarter of fiscal year 2014 before providing our current guidance for the third quarter ending December 31, 2013 and full fiscal year ending March 31, 2014.

All of the numbers being discussed are U.S. GAAP expect with regards to use of constant currency revenue metrics.

Revenue for our second fiscal quarter was $94.3 million in line with our guidance. Revenue increased 17% year-over-year and 4% sequentially both reported in constant currency. Constant currency normalizes the movement of the British Pound against the U.S. Dollar in each comparative period.

Gross margin during the second quarter was 35.8% compared to 36.1% in the prior quarter and 34.3% in the year ago period. During the second quarter, we provided our annual offshore rate increases and as expected this had a sequential impact on our gross margins. This was partially offset by productive initiative and FX benefits.

Our operating income for the second quarter was $9.8 million compared to $8.9 million in the prior quarter and an increase from $7.4 million in the year ago period. This resulted in an operating margin of 10.4% for the second quarter of fiscal 2014 compared to 9.9% in our prior quarter and 9.2% in the year ago period.

The sequential operating margin increased of 50 basis points was primarily driven by an FX benefit mainly from our INR hedging programs, high utilization and G&A leverage, partially offset by annual rate increases.

The year-over-year 120 basis points operating margin increase was primarily due to an FX benefit mostly from our INR hedging programs and increased utilization. Partially offset by increased in compensation expense due to annual rate increases and increased recruitment cost in support of revenue growth.

Second quarter other income was a gain of $100,000 inclusive of an FX transaction loss of $1 million or $0.03, which was not included in our prior guidance. This was primarily due to the significant strengthening of the Indian Rupee against the U.S. Dollar during September 2013 and the weakening of the U.S. Dollar against the British Pound on inter-company and customer balances denominated in U.S. Dollars.

We had an income tax expense of $2.4 million in our September quarter, which equates to an effective tax rate of 24.3%. This differs from our previous guidance of 26% due to the benefits from discreet items and had a positive $0.01 impact versus our prior guidance.

Net income for our September quarter was $7.4 million in line with the prior quarter and an increase compared to $5.8 million in the second quarter of fiscal 2013.

Diluted earnings per share was $0.28 in the second quarter of fiscal 2014, this compares to $0.29 in the prior quarter and $0.23 in the year ago period.

Turning to the balance sheet, ending cash at September 30, 2013 was $110.4 million inclusive of cash equivalents and short term and long term investments.

Cash flows from operating activities were $23.7 million in the second quarter. Our DSO including un-built receivables was 78 days compared to 91 days in the prior quarter, a 13-day improvement. Capital expenditures were $1.8 million in the September 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 second quarter 2014 revenue. Revenue across our industry groups was as follows. BFSI increased 12% year-over-year and represented 59% of revenue. As expected BFSI decreased 3% sequentially, we expect strong sequential growth in the third and fourth quarters of fiscal 2014.

Communications and technology grew 31% year-over-year representing 30%, and increased 21% sequentially.

Strength in the quarter was primarily driven by transformational projects and some of our healthcare analytics and telecom clients. Media, information and other grew 14% year-over-year and contributed remaining 11% of revenue.

In the third quarter, we expect to see sequential declines as certain projects come to their natural conclusion but then expect this industry group to return to growth in the fourth quarter.

For the September quarter, we have three client contribute 10% or greater of revenue. During the September quarter, we commenced work with three new clients, one is BFSI and two in communication and technology.

We ended the September quarter with 6,459 IT professionals, an increase of 16% year-over-year. Global utilization excluding trainees were 82% in our second quarter, up sequentially in year-over-year. This is in line with our targeted utilization range of high 70% to low 80%.

Before discussing guidance, I wanted to spend a few moments on the financial details related to the Acquisition of OSB Consulting LLC. Looking at the deal structure, Virtusa acquired substantially all of the assets of OSB were approximately $7 million in cash, with contingent earn-out consideration of up to an additional $6 million based upon OSB’s achievement of certain revenue and profit targets during calendar year’s 2013, 2014 and 2015.

We currently expect OSB to contribute approximately $1.5 million in revenue in the third quarter of fiscal 2014 and $4 million for the full fiscal year 2014.

On a U.S. GAAP basis, which includes all transaction related charges and acquisition related amortization, we expect the impact of the acquisition to be neutral to our earnings per share for the third quarter and for the full fiscal year 2014.

We expect the acquisition to be slightly accretive in fiscal year 2015. Now, I will provide our current guidance for our third fiscal quarter and full fiscal year ending March 31, 2014 which now includes OSB.

To note, the company is raising its organic revenue guidance for the full fiscal year 2014. Revenue in the third quarter of fiscal 2014 is expected to be in the range of $100 million to $102 million. Diluted earnings per share in the third quarter of fiscal 2014 is expected to be in the range of $0.32 to $0.36.

Earnings per share anticipates an average share count of approximately 26.5 million. For the full fiscal year ending March 31, 2014, we expect revenue to be in the range of $390 million to $396 million.

Diluted earnings per share for fiscal year 2014 are expected to be in the range of $1.25 to $1.33. Full fiscal year 2014 EPS anticipates an average share count of approximately $26.4 million.

Our current guidance is based on the following set of 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 with the majority of our Indian Rupee expenses for the fiscal year ending March 31, 2014. The weighted average Indian Rupee conversion rate for the full fiscal year ending March 31, 2014 is approximately 55.9. Our assumptions are that the weighted average Indian Rupee conversion rate for the third quarter of fiscal year 2014 will be 58.8 and then decrease to 56.5 for the fourth quarter of 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 third quarter fiscal 2014 guidance anticipates the British Pound to U.S. Dollar conversion rate of 1.61 which does consider the impact of revenue and cost from hedging contracts already in place for our third quarter.

We expect our effective tax rate for the third quarter to be 25.5%, our full fiscal year 2014 effective tax rate is now expected to be approximately 25.3%, slightly below our previous guidance.

Our effective tax rate is sensitive to the geographical mix of profit for fiscal year and is subject to change. We anticipate the total capital expenditure spending in our fiscal year 2014 to be approximately 3% of revenue.

Now, I would like to spend a momentum providing you with you with our current thoughts on our third quarter and full fiscal year 2014 guidance. Our clients are increasingly looking to invest in transformational programs around customer experience, revenue to incompliance, next generation platforms and cost efficiencies.

Our differentiated IT services positions us well to intersect all of these opportunities. We see increasing opportunities to participate in larger programs, for example, our expertise in IT rationalization is enabling us to take a new approach to areas such as application support and maintenance.

We are now capturing programs that previously weren’t available to us and these are creating recurring revenue streams. The OSB acquisition is another example of how we can further increase our addressable market opportunity and capture a greater portion of our client’s budgets.

Europe is now more open to outsourcing and offshoring and companies are focused on transformational initiatives around customer experience. We’re seeing an increase in demand for healthcare analytics driven by compliance, cost reductions and quality of paid initiatives associated with Affordable Care Act.

We are leveraging our software engineering and analytics expertise to provide solutions that need new market requirements for both payers and providers.

For the second half of fiscal year 2014, we expect our organic sequential revenue growth rates to accelerate from current levels, driving the increase in our top-line guidance. Our organic growth will be driven by meaningful expansion in our non Top-10 clients and growth across all industry groups with particular strength in C&T.

Fiscal year 2014, we continue to expect market leading revenue growth. As we execute against our straightest strategy of becoming a significantly larger company. We have been focusing on adding new clients that can scale to strategic levels and grow our non Top 10 portfolio faster than our top 10. These initiatives remain on track.

Turning to margins, as previously guided, we continue to expect slight gross margin improvements organically throughout the remainder of fiscal year 2014. Our SG&A, as a percentage of revenue is consistent with our prior guidance. We’re taking the opportunity to leverage some of the FX benefit we expect to get in the second half of fiscal year to make incremental investments in our delivery centers, recruiting and people programs to support our anticipated revenue growth.

Our operating margin growth trajectory calls for meaningful expansion in Q3 and Q4 of fiscal year 2014. During fiscal year 2014, the OSB acquisition is expected to deliver healthy EBITDA margins and after absorbing acquisition and amortization, we expect an immaterial impact on Virtusa’s operating margins.

In conclusion, our client portfolio continues to perform well, allowing us to grow above industry growth rates.

The transformational programs we are capturing increasingly require innovation, not just cost savings and this was a key differentiator for Virtusa. We continue to execute around this value proposition which positions us well against our long-term strategy of growing faster than the market.

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

Question-and-Answer Session


(Operator Instructions). And we’ll go first to Mayank Tandon with Needham & Company.

Mayank Tandon – Needham & Company

Good evening Kris and Ranjan. Couple of questions, first could you just talk about, and you touched on the pipeline and some of the opportunities that you’re focused on? Maybe just compare that with – how did that pipeline in bookings look, say three or nine months ago and how do they stack up right now as you’re going into calendar ‘14?

Kris Canekeratne

Hi Mayank, thank you. So overall we’re finding that they’re seeing good growth in our pipeline driven by general pipeline as well as an increase in growth in our big deal pipeline. Much of this is a direct result of the focus across our key growth enablers including the resonance that we have with things like IT rationalization and consolidation which is helping our clients, run their businesses better or more efficiently or perhaps more cost efficiently.

It has to do with a lot of the transformational programs that we offer, where we are testing clients are industry leading across several areas in banking and financial services, in insurance, things like planned onboarding, compliance and regulatory initiatives in banking and financial services, areas like policy administration, gains processing etcetera, in insurance, portals and big data initiatives across the industries that we service.

So much of this has resulted in strong pipelines, growth in our pipelines from six months ago or 12 months ago. And due closure rates have also been consistent. This is what’s really giving us confidence notwithstanding that momentum and the progress that we have made to be able to raise our organic guidance for the full fiscal year.

Mayank Tandon – Needham & Company

And to be clear, in your case, the acceleration over the second half of fiscal ‘14 is that purely a seasonal issue or was it just a function of this year playing out that way where you had these clients, waiting on some of these programs until your second half?

Ranjan Kalia

Mayank, actually if you look at Virtusa, it’s really played out like that for the last two years. And that’s what we actually had called out in the guidance in the beginning of the year that we believe that the back half would be much stronger than the first half. And that’s how the trajectory is playing out. So I will let you make a call, but I think for the last two years, the back half acceleration has been consistent.

Mayank Tandon – Needham & Company

Okay, and then just one final question from me on the upcoming quarter. And read into whether we may see a budget flush in the December quarter?

Ranjan Kalia

Mayank, in our business we really don’t see too much budget flush. Sometime you do see furloughs and vacation impact which we try to incorporate in the guidance. But we don’t really see any meaningful budget flushes.

Mayank Tandon – Needham & Company

Thank you. Good job on the numbers.

Ranjan Kalia

Thank you.


And we’ll now to go to Joseph Foresi with Janney Capital Markets.

Joseph Foresi – Janney Capital Markets

Hello. I was wondering, just on the pipeline side of things, you mentioned big deals. I wonder if you could give us any quantitative numbers either around the flow in and out of the pipeline like you’ve given in the past or just around those big deals and maybe where are you seeing them?

Kris Canekeratne

Joe, let me first give you some color behind this. So, overall on our aggregate pipeline, we have grown considerably in the 12-month period of comparison. But beyond that, the large deal pipeline of Virtusa has grown even at a faster rate.

And we believe the reason for this is our focus on initiatives that are helping our clients run their businesses a lot more efficiently and effectively. And I don’t mean programs that just simply help them reduce the cost of running these programs through arbitrage but very specifically our ability to work with them to rationalize and consolidate their application initiative and thereby creating more sustainable and enduring benefits.

So, this has enabled us to intersect larger programs within our existing client bases as well as looking for new opportunities that we can demonstrate a profound impact and benefits through IT rationalization and consolidation.

So, those are some of the drivers, beyond that we are seeing strong traction for our industry leading transformational solutions across the industries we serve, compliance and regulatory initiatives, now sort of moving into the IP phase of some of these initiatives and they are very well-positioned to capture that that’s also impacting our pipeline growth.

And finally, the work that we have been doing for quite some time and now helping our clients to intersect the millennial experience requirements that are driving very significant IT investments so they can better service digitally savvy consumers.

Joseph Foresi – Janney Capital Markets

Got it. So, is the pipeline increase, are you gaining market share or are you seeing renewals get broken up and taking market share for some of the larger players or is this all already new business in new areas?

Kris Canekeratne

That’s a great question, right. So, there is a macro trend that may have gotten masked but we shared this even on prior calls and let me reiterate this. So, what we are seeing as the trend in the industry is that large enterprises, especially those that have had a lot of experience with outsourcing and offshoring are moving away from horizontal outsourcing initiative and identifying and selecting partners that can align within vertical businesses and provide multiple layers of offshoring outsourcing.

So, very specifically, it’s two or three years ago large enterprises would do horizontal sourcing primarily from an arbitrage perspective. Take AFM and find a partner, do application support and maintenance. Take QA and find another partner, do QA. Take application development maintenance and find a partner to do it across businesses, across on vertical lines of business.

What we’re finding today is that many of these clients who have already done this are seeing some of the peril if you will of having multiple partners working across different areas of the same business. And they are seeking partners who can align themselves within these vertical businesses to create significant value alongside business outcome.

And they are finding that especially with Virtusa’s skill and size and the track record that we’ve had around service excellence that we’re incredibly well positioned to pick off these vertically oriented outsourcing initiatives. And that’s clearly reflected as a part of our pipeline increasing.

Joseph Foresi – Janney Capital Markets

Perfect. Last question from me, maybe you could give us a little bit of color of how you are viewing the margin trajectory over the next few quarters, just gross versus the operating margin? And then as we look forward, what should we be thinking about on the foreign currency transaction gain loss line, I think that might have clipped your earnings a little bit this quarter. So, I’m wondering if you could give us some color on those two metrics.

Ranjan Kalia

Joe, like I talked about in my script. The gross margin trajectory for Q3, Q4 would be consistent getting to kind of the Q1 levels that we ended Q1 at – we ended Q1 at about 36.1%.

And we’re calling for a meaningful expansion on the OBM line item. So, at the midpoint of the guidance if you roll in the numbers, you would probably ask for almost 100-basis point improvement in OBM quarter-over-quarter. So the margin should increase by 100 basis points at the OBM line item quarter-over-quarter, Q2 to Q3 and that should trajectory should continue again in Q4.

Joseph Foresi – Janney Capital Markets

Okay. I’m sorry, go ahead.

Kris Canekeratne

So, overall the guidance still is calling for 100 basis points margin expansion year-over-year.

Joseph Foresi – Janney Capital Markets

Got it. And then in the FX transaction line with the gains and the losses, how should we think about the hedging?

Ranjan Kalia

So, the FX is – we don’t guide to that.

Joseph Foresi – Janney Capital Markets

All right.

Ranjan Kalia

It is a balance sheet translation. It’s not easy to guide and probably it shouldn’t be guided. And in this case, the big change that happened was really how there would be change in the month of September. That was the significant driver for the loss.

Joseph Foresi – Janney Capital Markets

Got it. Thank you.


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

Rahul Bhangare – William Blair

Hi, good evening. Thanks for taking my questions. I was wondering if you could talk about just your current visibility to the bottom end of your guidance and maybe what factors would get you if at all to the high-end.

Kris Canekeratne

Sure, sure. So, Rahul, obviously, our guidance visibility now where we stand year-over-year is very consistent. And we believe and this is once again a bottoms-up process which incorporates project starts, project stops, vacations, furloughs all that. So, we believe the revenue visibility is very consistent with prior years in fact it’s very consistent with whenever we go out for guidance on the quarters.

Ranjan Kalia

With regards getting to the high-end, I think the bigger drivers for us in the high-end would probably be performance, by client portfolio and DSSI C&D. That’s what will get us to the high-end.

Rahul Bhangare – William Blair

Okay. All right. And just beyond the great growth within your non-Top 10 clients. Could you maybe comment on your wallet share wins at and your largest clients?

Kris Canekeratne

Yes, so, clearly we’ve seen very robust growth. And we had planned for this and we had shared this with you even in the start of the fiscal year that we felt that there was a tremendous opportunity in our non-Top 10 clients, especially those clients that were now entering year two and three.

There we had an opportunity to go in and start expanding our presence within that account base. So, they’re actually very pleased that our client base is broadening and strengthening giving Virtusa significant opportunities to continue our trajectory in terms of expansion.

Having said that, what we are seeing within our Top 10 clients and as you well know specifically in banking we had shared with you, even earlier that we would see a slower start to banking which is clearly reflected in our numbers and would expect in the second half of the year that even the banking sector would resume growth. And then we’re very confident that we will see that.

So, within our top 10 accounts, what we are seeing is the opportunity for us to expand exponentially into recurring revenue stream has expanded. The opportunity for us to go in and provide transformation services specifically around things like client onboarding and finance to services, this has to do a bit things like know your customers, set initiatives, etcetera has expanded. Compliance and regulatory initiatives has been more and more into the implementation phase. We’re clearly seeing more activity in our pipeline across through the area.

And then, beyond that we see significant opportunities for IT rationalization on the one hand and on the other hand, both creating a millennial experience so our plans can better service both consumers and employees especially that are digital – that are sophisticated digitally savvy consumers.

Rahul Bhangare – William Blair

Great. Thanks guys, good luck.


We’ll go next to Brian Kinstlinger with Sidoti & Company.

Brian Kinstlinger – Sidoti & Company

Hi, good afternoon. Thanks for taking my questions. My first question is on the large deals. I’m wondering if they’re coming from existing or new customers, I’m wondering if your win rate is higher or lower on these large deals or is it that it’s a rationalization as you suggested Kris. Is there not much competition from your Indian peers?

Kris Canekeratne

Great question. And the short answer is that we’re seeing larger deals across our existing account base as well as in new clients. We think a part of that has to do a bit how targeted we are especially across the services or our growth enablers, IT rationalization being one of them, but transformational programs across the industry, it being another and then intersecting opportunities to help our clients build in millennial experience. So, we’re seeing all three of these permits throughout the client base, existing client base.

Within our existing client base we are seeing opportunities to take on application support and maintenance as well as application development program and QA program on their IT rationalization can provide the next wave or next phase of cost efficiencies and general efficiency improvement to help our clients better run their businesses.

We’re destined to seeing an incidence – an increased incidence rate of active maintenance and QA opportunities in our existing client base. And generally speaking these programs are larger in size and scope, generally have to do with taking over multiple applications within the enterprise and helping them consolidate and rationalize them. And then leveraging this infrastructure for the future of what needs to be done which is very specifically targeted to helping our clients build millennial experiences.

So, much of that is in the existing client base. We see opportunities like IT rationalization and consolidation even with new clients. But the new clients may find that transformational programs resonate particularly well simply because we now have industry leading expertise and capabilities across many transformational areas of the enterprise. And we also see our millennial experience opportunities with new clients.

Brian Kinstlinger – Sidoti & Company

Then, can you speak of the win rate on these bigger deals and/or competition from your Indian peers?

Kris Canekeratne

So, generally speaking we find that our win rates are very healthy, that’s obviously one of the reasons as to why we are increasing our full year revenue guidance. We don’t provide very specific details and metrics around win rates. I think you have seen our win rate reflected in the execution and the progress that we have made.

When it comes to competition, we find that very often on the transformational programs that we have best in class services, our competition stems from multiple constituencies, some that are more local, some that are very large consultancies. And in some instances even the offshoring providers that try to compete in some of these transformational program.

And overall, when it comes to IT rationalization and consolidation, I think we are pretty tough act to beat, given the fact that we have been doing this for so long. We have so many cards on our bags and so many success stories about how we got in and ring out efficiencies and improved ways of running the business more efficiently and cost effectively which enables our clients in doing best in innovation and transformation.

Brian Kinstlinger – Sidoti & Company

Okay, that’s helpful. I’m curious, apps outsourcing didn’t grow that much but consulting grew aggressively sequentially. And I’m wondering if apps outsourcing follows consulting work, I didn’t really thought about it that way but I guess seeing that it is such a strong quarter for you sequentially and I guess I’m curious what’s going on with apps outsourcing?

Ranjan Kalia

Brian, if you look at the app sourcing, outsourcing being at 55%, it continues to be in our targeted range. The only – the primary reason really for the change was really the change that we saw in the banking segment which we had called for in the previous guidance. If you really take out the banking segment out of the AO, AO would have grown once again.

Brian Kinstlinger – Sidoti & Company

Okay. And the shelf and support staff, it looks like it’s been increasingly – increase significantly over the last few quarters. I’m curious if the quarterly number is included the acquisition already? And then I guess you mentioned Europe we’re hearing that from a lot of firms out there that that’s why demand is strengthening. I’m curious if that is the place that you’re being extra aggressive in hiring sales force?

Ranjan Kalia

I mean, the SG&A increase, we’re really targeting pretty much across our dual portfolio that we have. And the other reason for the SG&A increases are also some of the delivery infrastructure that we are adding, we expect to continue to add more delivery infrastructure in the back half opening more delivery centers. So that’s also a piece of the SG&A investment.

Brian Kinstlinger – Sidoti & Company

Okay. And I guess, two more from me. The first one is, your top customer, I’m curious, if you look over the next two years, do you think they’ll grow faster, slower or in line with the overall growth rate of the company?

Kris Canekeratne

So, we expect clearly the opportunities that we have within our top 10, especially those kinds that scale significantly. We believe that there is, still very strong opportunities for us to grow. But we feel that the growth enabler for us would be those clients that are now starting to enter year-two and year-three.

And we find that we both have a stronger base there, as well as significant opportunities for us to expand within those clients, perhaps that are faster clip than the clients that are today, some of our top clients.

Having said that, we also feel that there are opportunities for Virtusa to continue to expand and grow within our existing client base as we take on larger and larger application support and maintenance initiatives as well as application development and maintenance opportunities.


Now we’ll go to Moshe Katri with Cowen & Company.

Unidentified Analyst

Hi, Toby Shay (ph) in for Moshe. Can you please – most of the questions have been answered. Can you please talk a little bit about recent trends at BT. Do you still see growth into next year, this year and possibly next year? Thank you.

Kris Canekeratne

Yes, so, as you know Shay, we’ve continued to make strong progress at BT. There we’ve continued to provide outstanding execution across the portfolio of work that we have been doing. Our service excellence has been recognized numerous times at BT and that has resulted in us being able to take on a larger percentage of their overall spend, of wallet share within BT.

And they’re also finding that much of the work that we have done there and the reputation that we have garnered, as a result of it is enabling us to open up in a much broader way accounts in Europe. So, we’re seeing Europe as an overall portfolio and the opportunities that we have in Europe increasing for Virtusa both at BT and outside BT.

Unidentified Analyst

Thank you.


We’ll now go to Puneet Jain with JPMorgan.

Puneet Jain – JPMorgan

Hi, thanks for taking my question. So Kris, we agreed that the trend of millennial enterprise is among client’s top priority. But could you talk about typical size and nature of projects you do in that space?

Kris Canekeratne

So, absolutely, Puneet. So there are some programs, let me back up a little bit right. So, there are some programs that have to be done to be able to provide a true millennial experience. And it’s no longer about simply taking your web based channel and then creating a mobile extension to that.

There has to be backward integration done to the underlying application foundation or the platform to be able to provide a true millennial experience. So, on the one side we’re seeing large programs around application, consolidation and rationalization or modernization to be able to create the infrastructure on top of which you can provide the millennial experience.

Those programs are generally large, they are transformational in nature. And they actually intersect the complexity of the enterprise that we work with. So, that results in much larger application development or platform development or platform consolidation initiative.

Then on the other side you find smaller opportunities today, where you can actually demonstrate what it really takes to build a true millennial experience. This is the combination of using things like Solo Mo Technologies, using analytics, using a lot of the capabilities available on tablets and handhelds that are not available on a desktop or a laptop, things like swipe gestures etcetera, the completely different paradigm.

So, some of those initiatives start out smaller but at the moment you have to provide a skilled solution that reaches millions and millions of people. That’s when these programs are getting larger and larger and larger. So two years ago, we were sort of at the inception of this we were sort of demonstrating, prototyping, showing plans, what the future could look like.

Today, the activity level has increased where not only are they investing in modernizing the infrastructure which are large programs, they are also investing in transforming the way they provide these services to consumers with a millennial experience. And we’re finding very significant traction on both those sides.

Puneet Jain – JPMorgan

Good, good. And a follow-up on BT, looks like that account expanded a lot in this quarter, given both Europe and communication businesses were up? So, is that right? And could you also comment on recent news articles in the Indian Media about Virtusa winning $100 million TCV contract there?

Ranjan Kalia

Yes, so Puneet. You’re right. I mean, we did see strong growth acceleration at the BT. If you remember, this would be – we have been actually been talking about even earlier this year that we’ve been building the pipeline in BT and some of those pipelines are now transforming into revenue realization. I’ll let Kris comment on the second piece.

Kris Canekeratne

So, yes, Puneet. We also saw some of the news articles that had come out. We obviously don’t comment on any client specific deal. We have shared with you in the past that our pipeline has expanded especially with larger deals within our existing client base and this is true across multiple industries, multiple geographies, where our clients are expanding with us.

One, because of the track record of service excellence that we have had are also because they’re able to pursue things like application development maintenance or ADM, KSM, QA opportunities that are larger where we can provide more value through IT rationalization consolidation, which we are finding to be a strong competitive differentiation for us in larger deals and larger engagements.

Puneet Jain – JPMorgan

Thank you.

Ranjan Kalia

And I’ll just add, BT is one of the clients where we are seeing this recurring revenue stream type of work that we were previous not able to bid for and get for.

Puneet Jain – JPMorgan

Good, good, thank you.


And we’ll go now to Vincent.

Kris Canekeratne

Operator, do we have any more questions?


Yes, we do. We have a question from Vincent Colicchio. Your line is open sir.

Vincent Colicchio – Noble Financial

Yes, Kris. I realize the acquisition was relatively small. But can you give us some sense of the historical growth at OSB, for example they’re growing consistently in the past two years?

Ranjan Kalia

Vinny, I’ll give you a little bit of a color from our growth perspective. So, OSB had a very strong September quarter and that strong run rate is expected to continue for the December quarter close. They have very good revenue visibility. Like Kris had talked earlier, we’re all working together in a finance transformation project. So that’s really what brought the two companies together. But they had a very strong September quarter that’s expected to move forward too.

Kris Canekeratne

Vinny, what’s really most interesting for us is that finance transformation is an area where large enterprises are spending on large investment pay. And across multiple programs, multiple accounts, we saw some of the same players, in other words OSB and Virtusa both participating in related but independent areas of finance transformation.

So, to a large extent, we were very complimentary. And we work together what we realized was it by pooling and combining that we can greatly expand our addressable market within finance transformation programs initiative. And that’s really what led to the acquisition like Ranjan said, they have very strong visibility. They’re seeing very good progress. And they and us are working across several clients now who are investing very significantly into overhauling and modernizing and they’re finance reporting on predictability and in general the finance programs within these large enterprises.

Vincent Colicchio – Noble Financial

Okay. Sounds like a good acquisition. My others questions were answered. Thank you.

Kris Canekeratne

Thank you.


And there are no other questions at this time.

Kris Canekeratne

Thank you for participating on Virtusa’s second quarter fiscal year 2014 earnings call. I want to take this opportunity to thank our global team members for their dedication and devotion to our clients. Thank you all for joining us. And we look forward to updating you at the end of our third quarter. Thank you.


And this does conclude our conference. Thank you for your participation.

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