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Luxoft Holding, Inc. (NYSE:LXFT)

F3Q 2014 Earnings Conference Call

February 13, 2014 08:00 ET

Executives

Alina Plaia - Investor Relations

Dmitry Loschinin - President and Chief Executive Officer

Roman Yakushkin - Chief Financial Officer

Analysts

Steve Milunovich - UBS

Moshe Katri - Cowen and Company

Ryan Davis - Credit Suisse Group

Operator

Greetings and welcome to the Luxoft Third Quarter and Nine Months Ending December 31, 2013 Conference Call. At this time, all participants are in a listen-only mode. A brief question-and-answer session will follow the formal presentation. (Operator Instructions) As a reminder, this conference is being recorded.

I would now like to turn the conference over to your host, Alina Plaia, Investor Relations Officer. Thank you, Ms. Plaia. You may begin.

Alina Plaia - Investor Relations

Thank you, Rob. Hello everyone. We are happy to welcome everybody on our earnings call. On this call, we will discuss Luxoft’s financial and operating results for the three and the nine months ending December 31, 2013.

Whether you are joining us by phone or by webcast, we hope that by now you had a chance to receive and review our earnings release. This release and the updated investor presentation, which is being shown during the webcast, can be located in our website, luxoft.com, Investor Center section.

Our speakers today include Dmitry Loschinin, the President and Chief Executive Officer and Roman Yakushkin, Chief Financial Officer.

Before we begin, I would like to remind you that some of the comments on our call today maybe deemed forward-looking statements. This of course includes our business and financial outlook and the answers to some of your questions. Some statements are subject to the risks and uncertainties as described in the company’s earnings release and other filings with the SEC. Please note that we follow U.S. GAAP accounting rules in our financial statements. During our call today, we will reference certain non-GAAP financial measures that we believe are relevant for better understanding of our business dynamic by the market.

Our call will proceed as follows: at first, Dmitry Loschinin will give you an overview of highlights for the past quarter and for the first nine months of the year in terms of company’s financial and operating dynamics. He will also discuss key trends within the verticals of our focus, as well as major happenings and growth drivers of our strong performance. Then Roman Yakushkin will deliver financial overview of the company’s performance during the quarter and the nine months.

And with that, I would like to pass the call on to Dmitry. Dmitry, please go ahead.

Dmitry Loschinin - President and Chief Executive Officer

Hello, everyone. I am pleased to say that we have delivered another great quarter. Our revenues for the nine months ending December 31, 2013 increased 28% on the year-over-year basis. Our revenues for the third quarter increased by 33% on a year-over-year basis and 13% on quarter-over-quarter basis. We continued to grow our key verticals and the revenues in our main geographies. Our pipeline remains strong and we have solid tailwinds this quarter in finance, automotive and travel and navigation segments. We expanded our global presence and added delivery capabilities in Sofia, Bulgaria.

While our top three clients have grown significantly, I am pleased to say that the revenue concentration for the top 10 clients decreased year-over-year for the nine months ending December 31, 2013. You are able to once again lower the attrition and achieved new record revenue per delivery employee this quarter. We have added new solutions to our IP portfolio, such as Ulmo, reference design platform, OVU. Ulmo addresses time to market constraints for our clients in the telecom sector. OVU is showcasing the ways to address in-car user experience and safety for our automotive clients. Such solutions allow us quickly demonstrate our capabilities and proofs and concepts, that generates a lot of interest among the industry leaders and help us obtain new clients. Thus we feel very upbeat looking forward to the end of this financial year ending March 31.

And we are pleased to increase our revenue guidance to at least 26% year-over-year, which translates into at least $396 million. There are many interesting updates that I would like to share with you with respect to our verticals and practices. But before we touch upon a business overview, I would like to thank everyone for your support and interest in Luxoft’s story during our last deal. You may remember that we have completed our secondary equity offering just a few days our second quarter earnings call. It was a very successful offering completed at $34 per share, 100% premium to our June IPO price level. This stock has appreciated since then again by about 10%. In addition to increased liquidity of our shares, we are happy to welcome to our shareholder family new names many prominent asset managers. On the market level we can pinpoint several topics that drive ITO and application development space today and of course our business.

First of all, by now we all feel reasonably certainty that budgets and spend have not only stabilized, but also improved. The clients are being more aggressive with launching projects and budgets are being confirmed and committed much earlier than last year. Second of all, the types of engagements that the clients are after are changing. Our outsourcing is going through an evaluation. Fuel and labor arbitrage and stuff augmentation era as we know it is about to end. Managed services is becoming a resurgent theme based on our own business dynamics and wins as well as conversation with client. By the managed services we can see the fixed price, fixed outcome base engagements that require full project ownership and delivery of expertise from a vendor. It is one of the main components of differentiated package that vendors that they should provide to client. Third of all, we see that the level of demand for sophisticated specialized services and solutions has increased. Clients are willing to spend extra on end-to-end solutions and services that will bring them first to market and in front of their end consumers. In some cases we have noticed that clients do not mind paying extra for certain onshore capabilities. These are the main three business drivers of our growth.

Lastly, there is one more market driver that plays particularly well into our business model deepness in the emerging markets. As you know we derive about 90% of our revenues from Western Europe and North America, while our core basis is tied into the emerging Europe the best market scenario for such business model is when developed economies are rebounding and emerging economies are going through some turbulence and economic slowdown. This is precisely what we see today.

As I said earlier to have sustainable growth that our company is experiencing, we expanded global delivery model and now we are present in 13 countries around the world. We have made the decision to open our 20th location a delivery center in Sofia, Bulgaria and we are really high first developers there. As you know we are vigilant about adding new locations and having them fit our current ecosystem and ongoing talent requirements. Sofia has IT pool of about 30,000 engineers. Every year more than 3,000 graduates join IT market from Sofia’s technical universities. This city is a popular destination for engineering expertise. Global players like HP, SAP, VMware, Software AG established their operations in Sofia.

Since we hire mostly seasoned professionals the depth of such talent pool is experience of working on complex projects for customers from Western Europe and the U.S. is very important. Also Bulgaria has an attractive tax regime, robust infrastructure, convenient location, European Union legislation security environment. We believe all of these factors will be of benefit to us and to our clients going forward. We plan location to be a fully operational by March 1 and expect to grow our office by about 400 employees within next two years.

Now let’s go over some of our business verticals. I would like to speak on the cumulative nine months basis rather than highlight quarterly figures. As I believe it gives a dynamic picture of the whole year. You can find all of the detailed figures in the press release and the latest SEC filing. While Roman will guide you through the numbers as always, I would like to highlight our continued strong growth in financial services 36% year-over-year and automotive business line 80% year-over-year. We also made a good progress in telecoms and travel and aviation through the partnerships and the cross selling opportunities that we started exploiting more aggressively last quarter. So let’s talk about financial vertical. Our financial services vertical remains to be one of the major growth drivers. We continue to grow our wallet share with existing clients and win new clients due to a strong demand for managed services in the front of this technology.

We continue to market two of our products, Horizon and iStockTrack with tangible results during the third quarter. Horizon is generating a lot of interest and I am happy to report that we closed first to sales of Horizon platform, which also include our implementation services. We also won a new client based on iStockTrack from functionality and our knowledge in the mobile banking technologies. Actually, just yesterday, we won a high profile competition in London called Finovate Europe, which gathers close to 1,000 technology professionals in the financial services sector, Bank of America, Barclays, BNP, Goldman Sachs, etcetera, who vote on the best solutions incorporating the latest and greatest innovation in the sector. All presentations were live, not prerecorded.

We compared against another six to seven companies and products and Luxoft’s iStockTrack won during the live presentation, the Best of Show prize. Also we have a strong pipeline of Horizon opportunities in other areas, such as telecom, travel and other verticals. What all clients, regardless of the vertical, like about Horizon is its capacity to call these all predominant principles of data aggregation and reporting. They can see the Horizon to be unique advanced data realization platform that can speed the requirements of a non-analyst type of users, senior management, for example.

Last quarter, we were awarded a significant multi-year contract to consolidate and manage QA and testing functions as a vendor partner for a large global client. We have been increasingly active in the areas of structured products and tradings. We won significant contracts from some of our clients within the sub-domain, which illustrates our ability to succeed in the front office focused engagements. We believe it’s one of our competitive advantages today. Last quarter, we have launched our Luxoft markets asset-backed securities, ABS practice that focuses specifically on securitized products. The reason we have started this specialty practice is because we see an increased demand of knowledge of related technologies and solutions for that class of financial products. There are new participants entering these markets and they have a need to timely build up their fixed income desks. Luxoft markets will have these players quickly expand the expertise and achieve the necessary bandwidth within the desired time to market window. We became a member of structured finance industry group and participated in several ABS related events and tradeshows. We continue actively develop clients obtain through our Freedom deal last year. We came back 12 months since the acquisition we can say that we were able to grow this accounts very aggressively.

Automotive vertical, there are several exciting key aspects in the sector. The first is related to connectivity and telematics. Earlier in the third quarter, we started building an engineering center in Romania, which focus on connectivity and telematics. This area is very important for us and we feel we can make a tangible impact on our client’s business outcomes. We continue to invest into knowledge expertise platforms and solutions to be an even stronger name in the connected car space. The second is related to HMI user experience. Our TEORA chain and related graphics design and HMI implementation expertise position us well in this emerging space. We have enough success to state that by now OEMs embrace Luxoft as one-stop provider for all design specification actually my expertise, including implementation. This….

Operator

Ladies and gentlemen, please standby, we are experiencing operating difficulties, we will resume momentarily. Ladies and gentlemen, please continue to stand on, your conference will resume momentarily.

Dmitry Loschinin - President and Chief Executive Officer

Hello. Okay, I hope I am back so sorry for the technical inconvenience. Okay. Let me continue. So I was talking about our automotive vertical and just covered the connectivity and telematics space. And the second topic I wanted to talk is HMI user experience and TEORA tool chain and related graphic design and HMI implementation expertise positioned us well in this emerging space. We have enough success to stay that by now OEMs embrace Luxoft as a one stop provider for design specification HMI expertise including implementation. This end-to-end service reduces time to market that generates savings well into double digit versus our cart offering reach that. We are starting to see significant new customer opportunities in the space and sure will open many doors for us. Some of these services put by OEMs are so integral and sophisticated that they demand extremely close collaboration with software providers.

The third aspect that is related to HMI is digital clusters. Digital clusters is predicted by us are becoming a major feature in cars replacing older analog based instrument clusters such as speed meters, fuel gauges, etcetera. Significant trend for OEMs is to make a leap from basic driver information on a dashboard to fully interactive integrated 3D based experience. A new dimension that has been added to this vertical is apparent in the relation of automotive, telecom, internet and other technology domains. While all OEMs need to have the state-of-the-art premium features in their cars to stay competitive for what is from other areas compete for aligning this major OEMs to become the exclusive digital services and platform providers. We see an increased demand for technologies adopted for Linux and Android based devices as well as for expertise in remote display and other technologies that enhancing car experience for access to smartphones and tablets.

We are active participants of several key industry events last quarter. Several weeks ago we attended Consumer Electronics Show, CES in Vegas. The acceleration of interest and the multitude of topics that excited the attendees related to connected car was quite astonishing. Besides the usual prospects of all the space OEMs and their suppliers auto segment is very much of interest for companies across the consumer electronics ecosystem including semiconductor vendors, internet broadband providers, image processing companies, telecoms and chip manufacturers. All of these segments started to converge faster than ever before and we expect the velocity only to pick up more.

Especially picking up the pace is the collaboration between automotive and mobile segments not just with respect to connectivity, but also device applications and content integration. Giants such as Apple and Google are expanding their digital competition into connected car space. There are 80 million new cars and light trucks sold each year allowed us to present a significant new opportunity for software and services provider. In December, Apple signed a deal with Honda to integrate iOS into its Honda Civic car. At the CES in Vegas, Google announced they open automotive for alliance. It’s a group of technology and automotive companies including GM, Honda Motors, Audi, Hyundai and chip maker NVidia that want to customize Google smartphone and mobile operating systems for vehicles. Audi and GM are working with AT&T to bring 4G to vehicles with in-car Wi-Fi as one of the key functionality. The car data is actually to be included in the shared data plan. Any of this disruptive changes are good for lifestyle. We feel that we are very well positioned in this dynamic and interesting space.

We also attended Telematics Update Unit a leading automotive OEM for Europe where we have unveiled the proof of concept for a new demonstration that we engineered called OVU. OVU is the reference design platform for creating an in-vehicle user experience, it combines standalone knowhow that comes together in synergy to showcase Luxoft vision on technology trends and capabilities. OVU links together digital instrument cluster, head unit on mobile device. Based on smart device linked profiles OVU shows automakers to which extent car user experience can be optimized and safety can be improved by reducing driver distraction while encouraging good application development.

On the client front we have anchored based on our HMI offering and expertise in it was development in the rate setting entertainment product development one of the major brands in OEM space via one of our existing clients in automotive products. As I mentioned earlier, TEORA opens many doors for us. In the third quarter, we won a contract with one of the large global Tier 1 suppliers for automotive sector, who is a new customer for us and also might become a high potential account in the near future. Further, we successfully completed development and nationwide implementation of the navigation and emergency response platform called ERA GLONASS in Russia. The system deploys a combination of modern technologies, including telecommunications, information processing and satellite navigation solutions. One of its primary goals is to reduce the emergency response time and enable the single national emergency call system similar to U.S. 911. It also aids emergency response services to quickly receive location and other details on various emergencies on the roads and highways.

The system reduces crucial lead time between the accident and the first aid arrival by 30% on average. This platform is just a backbone for other related future development initiatives and we believe our company is well-positioned to seize such opportunities. Our pipeline looks solid for the remainder of this and the upcoming year in the U.S., European and Asian markets. We have been invited to apply for strategic supplier position in the several major players in the space and have a chance to work in the areas like digital cluster, HMI development, telematics, connectivity, safety and advanced driver assist systems. As you can see, our services are in demand for all of the hot areas within this business segment.

Let’s move to telecom vertical. The network and sector continues to show signs of specific challenges. Some of well-known industry giants has shown softening sales in emerging markets, primarily Brazil and Russia, but the overall U.S. enterprise market is stabilizing. Two themes are driving our revenues in this vertical, increasing popularity of software-defined networks, SDN, and continued interest in testing verification solutions. On the SDN front, software-defined network is still a new area as the adoption cycle is quite long. That said it enjoys growing interest as we anticipated and that’s why we continued (indiscernible) investment and actively participate in open networking foundation, ONF.

The reason behind this popularity is the fundamental need of our enterprises: one, to become efficient and flexible in core business processes; two, to reduce operating cost. This need is supported today by next generation IT infrastructure that uses cloud and (indiscernible) technologies. Unfortunately, the network remains an obstacle in this evolution of IT. Historically, it has been monopolized and controlled by several large providers and vendors. SDN will reduce such vendor look in and unleash possibilities. It will remove the software from boxes and other hardware produced by handful of OEM and replace it by virtual or cloud likely to customized apps. This transformation will allow a third-party software to make network more flexible. Change its behavior as needed to quickly achieve business goals of a given company. This is a massive shift and the process will likely to take several years. This is why Luxoft is focused to move fast to enjoy the first comer advantage and build our expertise and our brand and it is sophisticated by quickly expanded area.

With the wider adoption of SDN, demand for a related skill set, which is very unique and complex is increasing. While OEMs, telecom service providers, and specialized vendors realize they need to timely react to pace of this change, Luxoft has positioned itself as a partner within several areas relative to SDN topics in general and OpenFlow, which is the only standardized protocol available for enabling SDN. Our services and skills portfolio remains competitive and focused on an embedded core networking software. As SDN and network utilization trends mature, the interest in developing SDN applications and that’s a function of utilization, solutions growth. In line with this trend, we decided to add another product to our current offering, our internal name for it is Ulmo.

Ulmo is still a work in progress. It is an SDN application framework that is targeted at simplifying complexity of development for a rapidly evolving landscape of SDN platforms. We hope that similar to TEORA tool chain in automotive, this will become a one-stop integrated solution for SDN-related applications that shortens time-to-market. These products will join Vista in our existing IP portfolio, which is standalone with OpenFlow testing solution recently adopted for the latest version of OpenFlow protocol.

On the testing front as you remember last quarter we announced a partnership with Spirent, the world’s leader in testing and assurance services with telecoms. The partnership has been successfully launched and has already started bringing business Luxoft. Just to remind you Luxoft brings two aspects into this collaboration. First, a product used to OpenFlow conformal suit. Second, actual expertise and services in that area. We see many new opportunities going forward as well as strong interest as our join solution that we introduced to the market last quarter.

In conclusion, I would like to quickly list the works and honorable mentions that we have received during the quarter. Once again we were listed in the software 500 and global services 100 ratings and improved our position in both. We also received a nomination support from – for EIoP outsourcing center. Luxoft was listed as a star performer in Everest Capital Markets publication outsourcing e-metrics. We were listed in Gartner’s Market Trends, Bank and Worldwide 2014 as Number 8 out of 20 for top business service providers in banking and securities industry for all of Eurasia. Luxoft was listed ahead of many of our peers.

Luxoft was noted in two Forrester’s Wave reports. One was Forrester’s EMEA application outsourcing services for the first quarter of 2014. Another Wave has reviewed enterprise business intelligent platform. Our advanced data utilization to Horizon was recognized as an alternative to the larger BI vendor tool set. Luxoft was also listed for key testing by Gartner and there when the landscape of IT services provider. With this I would like to pass the call to Roman for a detailed financial overview.

Roman Yakushkin - Chief Financial Officer

Thank you, Dmitry. Hello, everyone and thank you for being here on the line with us today. I am going to give you detailed overview of our operational and financial dynamics for the three and nine months ended December 31. We are very pleased by another strong three months and cumulative nine month performance that our company delivered to our shareholders. Financial year 2014 is shaping up to be a strong one for Luxoft. We are obvious about our full year outlook as be this is why from operationally we are as strong as ever and we have many catalysts in place to fuel our growth for the upcoming quarters.

Now, let me take you through our financial highlights. Our revenue during the third quarter of this fiscal year 2014 amounted to $110.6 million compared to $97.7 million in the second quarter of this financial year. That translates into an increase of 32.5% year-over-year and 13.2% sequentially. Revenue for the nine months increased by 27.7% year-over-year to $292.1 million.

Now, I would like to highlight some of our other operational measures, performance by geographies. We would like to remind you that will book our revenues based on the allocation of the project owner not based on where the work is performed. For the past nine months of the year all our key revenue-generating geographies showed very strong growth, while their mix remains roughly the same versus the breakdown that we reported in November for the first half of the financial year 2014.

U.S. grew by 44% over the past nine months to 42% of total revenue. UK increased 27% comprising 29% of the total. Germany grew by 8% to 10% of the total, Russia increased 30% to 10% of the total. Canada decreased 23% but it is still about 4% of the total and rest of Europe increased 42% remaining at 5% of the total.

Vertical dynamics, for the last nine months of the year, our business lines performed as follows. Financial services vertical comprised 68% of total revenues that represents an increase of 36.3% year-over-year. Automotive and transport is 11.6% of total sales and an increase of 80.4% year-over-year. Travel and navigation vertical comprised 10.1% of total sales flat year-over-year. Technology vertical 9% of total revenue and an increase of 4.6% year-over-year. Telecom comprised 8.3% of total sales and an increase of 3.9% year-over-year. And energy contributed 2.4% of total sales, an increase of 13.7% year-over-year.

Our top three accounts for the last nine months of the year amounted to 58.3% of total revenues, which is an increase of 30.2% year-over-year. In the third quarter, our top three accounts amounted to 56.9% of total revenues, which is an increase of 9.2% sequentially. Top five accounts amounted to 70.5% of sales in the nine months representing 28% increase year-over-year while in the third quarter, top five accounts amounted to 68.8% of sales representing 9.7% increase from the last quarter. Our top 10 accounts amounted to 81.3% of sales in the nine months of current financial year, which corresponds to 26.6% increase year-over. In the third quarter, top 10 accounts amounted to 79.5% of sales, which corresponds to a 9.8% increase sequentially.

Now, let me share with you some statistics on the operational performance of our two largest clients, Deutsche Bank and UBS. In the nine months of financial year ended March 31, 2014, Deutsche Bank grew by 36.9% amounting to 30.7% of sales, while in the same period, UBS grew by 32.4% to 19.3% of sales. In the third quarter, Deutsche Bank grew by 6.8% sequentially to 29.6% of sales and UBS grew by 7.7% amounting to 19% of sales. 50% of our revenue came from fixed price contracts during the first nine months.

Our adjusted EBITDA amounted to $56.5 million in the first nine months of the year versus $41.3 million in the first nine months a year ago. In the third quarter, our adjusted EBITDA was $22.7 million versus $17.7 million in the same quarter of the last financial year and $19.5 million in the previous quarter. Our adjusted EBITDA margin in the third quarter was 20.5% versus 21.2% a year ago and 19.9% in the last quarter.

Operating income margin in the third quarter on a U.S. GAAP basis was 18.2% and the same percent on a non-GAAP basis. Our GAAP net income was $40.8 million for the first nine months of the year in comparison with $26.7 million in the first nine months of the previous year. In the third quarter, our GAAP net income amounted to $17.7 million versus $12.5 million last year and $13.3 million in the previous quarter. Our GAAP net income margin in the third quarter was 16% compared to 15% a year ago and 13.6% in the second quarter of this year.

Our non-GAAP net income was $44.4 million in the first nine months of the year versus $31.9 million in the first nine months a year ago. In the third quarter, our non-GAAP net income was $17.7 million versus $14.1 million last year and $15.5 million in the previous quarter. Our non-GAAP net income margin in the third quarter was 16% compared to 16.9% year-over-year and 15.9% in the second quarter of this year. Our weighted average diluted share count for the past nine months was 32.1 million shares, an increase of 1.8 million shares from the nine months of the previous financial year. Our diluted EPS amounted to $1.27 per share as compared to $0.88 per share in the nine months a year ago. On a non-GAAP basis, our diluted EPS was $1.38 per share compared to $1.05 per share last year.

Let’s now turn to the balance sheet. We have finished the nine months with approximately $42.3 million in cash and cash equivalents. During the first nine months, operating activities generated $39 million of cash. Financing activities generated $11.1 million of cash. Net cash of $12.7 million was used in investment activities. Our trade receivables as of December 31, 2013 were up approximately $87 million compared to $95 million as of September 30.

At the end of the third quarter, day sales outstanding including unbilled revenues stood at 76 days, down by nine days in comparison to 85 days at the end of the second quarter. In the first nine months, DSO stood at 78 days. Our total debt stood at $27.9 million as of December 31, 2013 versus $30.2 million at the end of previous quarter. We have finished the quarter with 7273 personnel, 6142 of which were IT professionals. We have been increasing our productivity metrics per delivery employee. For the past nine months, the revenue per billable engineer has averaged to $70,000, while during the third quarter that figure was close to $73,000. At the same time, I am pleased to report that attrition in the first nine months of the year was 10.4% versus 12.7% year-over-year, a decrease of 2.3%.

On our governance compliance front, I am happy to share with you that we have added an independent director to our Board. It is our third independent director and thereby we have fulfilled the requirements for NYSE-listed companies. We are welcoming Esther Dyson to our Board, many of you probably know Esther, she is a well known angel investor, entrepreneur and philanthropist with vast experience in technology among all the areas.

Before we open the phone line for the Q&A, I would like to give you the outlook for the full financial year ending March 31, 2014. We expect to continue delivering solid revenue growth. Based on current conditions and indications, I am pleased to inform you that we are increasing our annual guidance for both the top and the bottom lines. We expect to finish the financial year 2014 with at least $396 million in sales. This represents an increase of at least 26% year-over-year. Adjusted EBITDA margin expectation remains in the range of 17% to 19%. Diluted EPS is now expected to be at least $1.50 on a GAAP basis and at least $1.70 on a non-GAAP, up from previous $1.40 and $1.60 respectively. The EPS is based on estimated weighted average of 32,242,676 diluted share as of the end of our financial year ending March 31, 2014.

Alina Plaia - Investor Relations

Thank you so much, Roman. Now we would like to open the line for Q&A. Operator, go ahead please.

Question-and-Answer Session

Operator

Thank you. We will now be conducting the question-and-answer session. (Operator Instructions) Thank you. Our first question is from the line of Steve Milunovich of UBS. Please proceed with your question.

Steve Milunovich - UBS

Great, good morning everyone. Roman, could you talk about the stock-based compensation which was a negative number this quarter, how does that work?

Roman Yakushkin

Yes, hello, Steve, good morning. On our stock-based compensation, we have reversed the reserve on which we have previously done as part of our existing stock option plans. So this reserve was reversed and it will not repeat in current fiscal year, but we plan to include those shares in the next year program which we are currently developing.

Steve Milunovich - UBS

So going forward we’ll see more typical numbers for (SPC)?

Dmitry Loschinin

We expect to do so.

Steve Milunovich - UBS

Okay. Thank you. And Dmitry you said that your customers are committing to work earlier this year than they have in the past. Is that correct? Could you expand on that?

Dmitry Loschinin

Hi, Steve. We see that among our key accounts, the situation, the budget constraints and the budget situation is much easy than this year than a year before. And most of them already have their budget cycle finished and we also see a less – like less constraint on their side. So their overall tone is very positive with the existing accounts and I believe this is true for the entire industry.

Steve Milunovich - UBS

Okay. Your margins in the quarter obviously were extremely strong. Do you expect those to come in, in the next quarter and going forward back to kind of the range that you typically talk about or is there something that’s going to continue to keep the grade high?

Roman Yakushkin

This is Roman again. It is true that we have strong margin profile in the third quarter on our profitability level and that is due to our growing revenue per employee decrease in attrition, operational leverage continuing to kick in, also we did have favorable foreign currency scenario with Ruble being especially weak throughout the whole quarter. So that – those are the factors and more of that caused the margins being strong. Typically speaking about the fourth quarter, typically we have a seasonal pattern whereby the margins in Q4 are weaker than those for Q2 and Q3 and we have a number of reasons for that.

First reason is the number of billable hours is smaller by more than 10% in Q4 than in Q3. The other one is that the personnel tend to take more vacation in January while the company continues paying the whole compensation. Also (indiscernible) Russia specific issue which we saw some contribution text which we tend to pay bigger chunk in the first half of the year and the bulk of it goes to the first March quarter. So therefore we might expect margins not to be as strong as they were in Q2 and Q3.

Steve Milunovich - UBS

Okay. Thank you. Finally Dmitry could you comment on the political situation in the Ukraine and whether there is any operating risk here going forward?

Dmitry Loschinin

Yes, sure. The situation looks very dire in the news, in the past now it’s a bit better I guess. I’ve been personally in Kiev several times during December and January. And actually the reality is quite different. The products have been centered around limited areas in the city center while the entire city of Kiev is – wasn’t still is functioning as usual, lot of staffs in Kiev allocated down the scores far from the center. We didn’t experience any change in personnel attendance and business operation, neither our clients nor us have triggered business continuity to plans quite opposite, we continue growing our engineering teams in Kiev.

That said we ensure that we’re ready to act in the unlikely event of any major turbulence. Just want to remind you that we service our clients through our distributed goal of delivery model. We never allocate all of the work to one delivery center. Our largest clients have only portion of the employees or our engineers working for them in Ukraine. Therefore, if needed, we can rapidly move this core teams start allocation that actually – ready to go infrastructure. For that we have detailed plans from one to five business days in duration.

Again we believe that this is a very low probability of any extraordinary company in Ukraine at this point actually as you can see that the opposition and the President they are moving towards some comprising consensus. I don’t believe any of this will take any serious action in that point. I think it’s more economical equation what Ukraine is going to do in the future and who will lead the country rather than political and stability will be there at least from there – from all of those events or the situation is going to become much easier. So to sum up we continued to operate business as usual. We talked to our clients no major concern, no disruption and all of our officers (indiscernible) continued to grow.

Steve Milunovich - UBS

Alright thank you very much.

Operator

Our next question comes from the line of Moshe Katri of Cowen and Company. Please proceed with your question.

Moshe Katri - Cowen and Company

Thanks. Nice job on the turnover guys. When you spoke on FX you said you had some FX benefits that help margins, can you quantify that for the quarter?

Roman Yakushkin

Good morning Moshe. Actually we have two parts to the answer the one is the euro was versus U.S. dollar was stronger than what we had in our model and basically it’s more than $1.35 for the euro. So that gave us few basis points to the top line and on the other hand Russian ruble depreciated from roughly RUB32.5 for both as of the beginning of the quarter to RUB35 closer to the end of the quarter. So we would not be able to give exact percentage, but I would believe that it would be around 0.5% to 0.7% of the gross margin attributed to the ForEx effect.

Moshe Katri - Cowen and Company

Okay, that’s fine. And then any specific reason in your view for the attrition rate to come down that was definitely one of an areas – an area of concern for some people pre-IPO?

Roman Yakushkin

Well, we have implemented number of measures at the beginning of our fiscal year so started on April 1, 2013 and those measures include much higher penetration of HR functions our delivery units so call internal mobility platform which enabled some of our engineers to find new job opportunities within lives of not outside of box of the overall team spirit some – overall very positive turn out of the business and the business is growing. So all of those measures resulted that attrition dropped and we can see the trend to continue. I believe it also improved our economics quite a bit.

Moshe Katri - Cowen and Company

Okay, and then going back to the question about the – some of the political kind of volatility in the Ukraine, have you had any sort of client visits that were canceled or any clients that are kind of talking about this they are kind of concerned about the situation so far given what’s been going on there?

Dmitry Loschinin

Well, some did canceled, nothing major again the way we operate that 50% of the work is in a fixed price managed delivery. It doesn’t require lot of client visit and client participation in their activities. So we have some of the visits canceled at the same time I wouldn’t say this is massive, no. In general everything goes smooth, no disruption. Concern were expressed again nothing major and we continue growing in all of the key accounts which I believe has the best demonstration of the way how our clients perceived for the situation. What we did, we spoke (ph) with our key accounts, we discussed their business continuity plans including what if scenarios and I think everyone is satisfied. We have – as I have already said this distributed platform and infrastructure and other teams located outside of Ukraine and again I don’t believe it’s even theoretically possible, but if something terrible happens, we have a plan B where within three days in average, we will be able to move all of the core function to other geographies.

Moshe Katri - Cowen and Company

Okay. And just want to verify two numbers, Deutsche Bank went down sequentially in terms of mix, I think you said 29.6% this quarter. I believe last quarter they are close to 31%, 32%. Is that correct?

Roman Yakushkin

This is Roman. That’s correct Moshe. Third quarter Deutsche Bank stood at 29.6% while last quarter it was 31.4%, so it even though in absolute terms, the revenue increased by 6.8%. As the proportion of total revenue, it went down into Q3.

Moshe Katri - Cowen and Company

Okay. And then you said, UBS was 19.3%, where was it last quarter?

Roman Yakushkin

9.3% this quarter, 9.9% last quarter and 7.7% sequential growth in Q3.

Moshe Katri - Cowen and Company

Okay, alright, great. Thanks. Nice quarter.

Operator

Our next question comes from the line of Ryan Davis with Credit Suisse Group. Please proceed with your question.

Ryan Davis - Credit Suisse Group

Hey, guys. Congrats on the quarter. Could you maybe talk a little bit about the forward guidance, the revenue expectation, it looks I guess it suggests maybe a sequential slowdown, is that purely based on the seasonal factors with less billable hours and the Russian holiday and Ukraine holiday?

Roman Yakushkin

Yes, hello. That’s Ramon. Yes, this is correct. We have some seasonal factors built in Q4. Still it is Russia specific social contribution affects the margins then that we also do have smaller number of billable hours in Q4 that resulting in lower margins and lower revenue as well. So if you look at the historical pattern, then typically would have the strongest growth in Q2, in Q3 and some mild decline or flattening of the revenues in Q4 if you compare those to Q3. So that would be our natural pattern.

Ryan Davis - Credit Suisse Group

Okay, okay. And then could you talk a little bit about the slowdown in Canada and Germany specifically?

Dmitry Loschinin

Sure. In Germany, we have one-time events, which was a credit note given to one of our largest clients, which we give in your turn to five-year commitment in business expansion. So that resulted in slower growth for Germany, which was around 8% and it’s not for that the growth would be over 23% over the nine months. So for Canada, we have won multinational large clients whom we built previously exclusively via our Canadian entity. And in last quarter, we have shifted part of that billing to our regions, which declined in – which resulted in the decline of Canada, a revenue generator like Canada.

Ryan Davis - Credit Suisse Group

Okay, thank you. Now, can we get an update on the rollout of the platform-based solutions?

Dmitry Loschinin

Sure. We just mentioned the success which we had in the Horizon space though we closed the deals and the pipeline looks very solid. So the interest is generated as we initially expect that in financial services space and actually we continue billing this up which was not as expected, before that we see opportunities for deploying Horizon across other verticals. And it’s very well perceived and accepted by clients. Differentiator of Horizon there is not just the functionality but the way and the business model how we deploy it. So that is pretty much the solution which we use as a platform with very high level of flexibility and customization. I think most of the packages we see in that field they lack this type of feature. So we see some opportunities going forward in automotive space and telecom space as well as there are couple of opportunities in travel and navigation. I will say actually the numbers which we had built on the business for Horizon, we are very conservative. We are going to make this numbers. And it’s actually not so much about their revenue today, but about building the customer base which would result as much as stronger outcome next year.

So the other one, which we also mentioned the product in financial services, iStockTrack, which is a portfolio management tool, we have just yesterday won the competition and won around 70 products in the financial services space in the event called Finovate as well as we have done very well in the automotive space, especially with our product tools chain called TEORA. So overall, the strategy works. We see it as our differentiator. We are able to open some doors, close some deals, but still it’s very early stage to report significant contribution to our top line.

Ryan Davis - Credit Suisse Group

Okay, alright. That’s all I have for you guys. Thank you.

Operator

Thank you. Our next question is from (indiscernible) Capital. Please go ahead with your question.

Unidentified Analyst

Yes, good afternoon everyone. I still have actually a couple of questions on your guidance. And the first question is whether the devaluation of ruble and Ukrainian hryvnia which we see now in the January this year is already taken into consideration for your fourth quarter of the financial year guidance? As far as I understand, it will be even more material in terms of the year-over-year impact than we have seen last quarter, is that true?

Dmitry Loschinin

Good morning, Alexander. Yes, it’s partially true. The ruble impact is priced in even though we stay rather conservative as we believe that ruble might rebound as fast as it has depreciated. As for hryvnia, it has no significant – any significant impact on our financials, because all our major quarters and commitments are denominated in dollars. Therefore, we index the payments in hryvnia to the U.S. dollar. Therefore, this impact is very limited for Ukraine.

Unidentified Analyst

Okay. And in terms of Russian salaries, do you think that in case that devaluation either continues or stay at the current level, you will need at some point of time revise your overall salaries or you probably show them also into dollars that you have in the Ukraine?

Dmitry Loschinin

Well, no, we are not planning to do any shift from ruble to U.S. dollars because we believe that in Russia, the ruble is kind of stabilized in respect of currency so that all major commitments are denominated in rubles. And the only thing that we might do is basically just for the ruble inflation should it appears which we normally do every year in indexing the salaries to the inflation of ruble.

Unidentified Analyst

Okay. And when do you do that indexation like in the first quarter and the second quarter, I mean, it tells of the timing of that event?

Dmitry Loschinin

Currently, we don’t have any specific plan from that. It might happen in the future, but it’s not a guarantee we will do this.

Unidentified Analyst

So as far as understanding, it’s really driven by the competitive environment whether the competitors will do the same and you will just track whether your seller level is competitive to the others?

Dmitry Loschinin

It’s exactly right. Our decision to change the salaries responding to the weakening the ruble is pretty much based on the situation in the label market. So if label market moves up, we will have to move up to maintain our competitive position there.

Unidentified Analyst

Okay. And just to clarify once again do you understand it correctly that last quarter, sorry, last year, fourth quarter ‘12 was a little bit typical in terms of the revenue generation, because it was stronger than third quarter. And this year we should not see this effect, this effect happen once again this year, your guidance actually assumes that you expect some softer revenue quarter-over-quarter and yes that last quarter….

Dmitry Loschinin

That’s correct.

Unidentified Analyst

That untypical here, yes.

Dmitry Loschinin

Yes, it is correct that the last quarter, last year fourth quarter was a bit untypical because we had two factors one is that we had rather slow start of the year and the Q3 and especially Q4 was the time where the situation has changed and revenue started to rebound. So we had kind of bulk of that impact on Q4 and another reason is last year we had large number of expired contracts maturing in the fourth quarter and from that we may not see in the fourth quarter of current fiscal year.

Unidentified Analyst

Okay and as far as I understand, the same answer is for the question if ask you about the margin. So in the fourth quarter last year EBITDA – adjusted EBITDA margin was a little bit higher than you have right now in the fourth quarter. So it was also kind of a one-off effect because it shifted from the first half?

Roman Yakushkin

Part of that was resulted from the rebounding factor and the other thing is that you remember our commitment that we are going to stay in terms of our margins or EBITDA margin between 17% and 19% and if you make above that we are going to reinvest into the business, so in that positive dynamic this year, with start and sell initiative including the opening of the office in Bulgaria as well as some of our India expand which are undergoing that resulted a little bit lower performance compared to the third quarter last year and this third quarter as well going forward in Q4. We are going to continue some of those investments still in our target in the range which we committed to the street.

Unidentified Analyst

Okay, thank you.

Operator

Thank you. Ladies and gentlemen, we have come to end of our question-and-answer session for today. I will turn the floor back to management for closing comments.

Dmitry Loschinin - President and Chief Executive Officer

We want to thank everyone for joining this call and all of the questions you asked. We look forward to speaking to you again next quarter, when we will report our first quarter and full financial year 2014 results. Have a great day. Thank you.

Operator

This concludes today’s teleconference. You may disconnect your lines at this time. We thank you for your participation.

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