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Virtusa Corporation (NASDAQ:VRTU)

Q1 2015 Earnings Conference Call

August 05, 2014 05:00 pm ET

Executives

Staci Mortenson - ICR

Kris Canekeratne - Chairman, Chief Executive Officer

Ranjan Kalia - Chief Financial Officer, Executive Vice President, Treasurer, Secretary

Raj Rajgopal - President

Analysts

Joseph Foresi - Janney Montgomery Scott

Puneet Jain - JPMorgan

Anil Doradla - William Blair

Brian Kinstlinger - Maxim Group

Abhishek Rathore - Cowen & Company

Vincent Colicchio – Noble Financial

Elizabeth Colley - Needham & Company

Operator

Good afternoon, ladies and gentlemen. Thank you for standing by. Welcome to the Virtusa Corporation Fiscal First Quarter 2015 Earnings Conference call. At this time, all participants are in a listen-only mode. Following the presentation, we will conduct a question-and-answer session. Instructions will be provided at that time for you to queue up for questions. I would like to remind everyone that this conference is being recorded.

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

Staci Mortenson

Thank you. Good evening and welcome to Virtusa's first quarter of fiscal year 2015 earnings conference call, where we will be discussing our financial results for Virtusa's first quarter ended June 30, 2014.

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

Certain statements made in the 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 and TradeTech Consulting Scandinavia AB and its subsidiary TradeTech, Virtusa’s ability to assimilate and integrate the operations of OSB and TradeTech, the growth of Virtusa’s business, the ability of Virtusa’s clients to realize benefits from the use of Virtusa’s, OSB’s or TradeTech's IT Services and management’s plans, objectives and strategies.

These statements are neither promises nor guarantees, but are subject to a variety of risks and uncertainties, many of which are beyond Virtusa’s control which 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 framework for assessing how our revenue performed excluding the effect of foreign currency rate fluctuations. We also present a reconciliation of cash, cash equivalents, short-term and long-term investments that we believe provide insights into our total cash position and overall liquidity.

For additional disclosure regarding these and other risks faced by Virtusa, see the disclosures contained in Virtusa's public filings with the SEC and on our earnings press release.

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

Kris Canekeratne

Thank you, Staci. Thank you for joining us on our first quarter fiscal year 2015 conference call. Strong start to the year over year for Virtusa, the overall demand environment is solid, our service offering are highly differentiated and our client base continue to strengthen.

For the June quarter, revenue was $112.3 million, an increase of 1%, sequentially, and 24% year-over-year in reported currency and EPS with $0.31.

The strength of our Q1 performance, the investments we are making to grow our business, our differentiated value proposition and the increased strength of our pipeline position us well for accelerated sequential growth.

Our growth strategy and targeted areas of investment continue to be focused on helping enterprises, grow revenue by expanding the addressable market, improving their operational efficiencies, reduce costs and lower risk. We are doing this through our new technologies services targeted at enabling our clients to deliver a distinctive, millennial experience and industrial leading transformational solutions that increase our IT efficacy and reduces IT costs. In addition, we are driving more sustainable and predictable revenues stream for Virtusa by building recurring revenue program.

Let me start by sharing how effectively of our new technology solutions are resonating in the market. In Big Data and Analytics, we are delivering solution across all the industries we serve. Our clients are recognizing the benefits of leveraging data and are taking a more analytical, predictive and prescriptive approach to drive their business leadership.

We are pleased with the investments we have made to strengthen our expertise in Big Data solutions and our ability to lead our clients on these initiatives. We are seeing strong momentum in this area and big data has become an important part of our differentiated services strategy and growth platform.

For example, we are working with a leading price comparison services company in the U.K. who has embarked on a transformational journey to revamp their end consumer experience. While data is one of their key assets much of it has been decentralized and therefore hard to manage, analyze and leverage.

We are up building and enterprise data warehouse that will capture all the data in one place and provide the foundation for applying analytics and measurement, helping them better understand consumer behavior and buying pattern and greatly enrich the end customer experience.

We are also deploying this new Big Data solution in the cloud leveraging our experience with cloud-enabled data warehousing, [EPL], analytics and visualization technologies. This expertise along with our agile methodology, were key factors in why Virtusa was chosen by this client.

Transformational program continue to be a driver of upper growth as we help our clients reduce costs and risks. Virtusa has a long history in key transformational areas and yet built a portfolio of industry leading solution. In particular, we have had success in clients on-boarding by creating unified processes to transform the customer experience while meeting regulatory requirement and improving operational efficiencies. This business continues to robust for us across our verticals.

For example, they are working with one of the largest pharmacy healthcare providers successfully delivering a single integrated client on-boarding platform. Their critical on-boarding function used to be a manual process that took four to six months to complete. The new implementation is designed to automate the work flow across 27 different teams, eliminate their need for filling 50-plus documents and capture all the data and reforms in a single application significantly reducing the cycle time of the on-boarding process.

In addition, the platform provides smart, guided processes, eliminating guess work, delays inaccuracies and potential penalties. Another example of our industrial-leading transformational solution is in claims processing. We were recently selected by a top-10 healthcare peer to transform how they interact in the new consumer-focused healthcare market.

They are helping automate their entire [pricing], adjudication and demonstrate by providing a more flexible network, benefit and reimbursement solution. As consumer rather than company play a greater role in purchasing healthcare products in the future, they are enabling this plan to provide higher customized benefit plan for individual participant. This solution will offer a far superior consumer experience and meet the stratifications of the Affordable Care Act. We are very enthusiastic about the opportunity to bring our claims expertise to one of the leading healthcare providers and continue to expand our presence in the rapidly evolving healthcare market.

We also have been making investments in our integrated development and ASM capabilities to deliver transformational programs that drive meaningful benefits to our clients by improving their business as usual operations. We do this by leveraging our differentiated IT application, rationalization and consolidation approach to continuously improve the efficiency of applications we support thereby reducing IT costs. This is just another example of how we are helping our clients better manage the end-to-end lifecycle of critical application, improve IT efficacy and their consumer experience.

These capabilities provide a significant opportunity for Virtusa's growth as we can expand the lifecycle and value of the overall services we deliver to our clients and reduce application, development and maintenance costs.

Specifically, we are working with our clients to identify opportunities that our integrated development and ASM capabilities can be distractive to their business as usual approach. These are large non-discretionary budgets usually controlled by the CIO.

Today, we are in meaningful discussions with many clients leading to a significant increase in RFP and a pipeline that is rapidly growing. We believe these opportunities will continue to increase Virtusa recurring revenue stream and in enable us to expand our addressable market within our client base.

Our millennial and transformational solutions are increasingly being embraced by clients across the geographies we service. This is enabling us to diversify our client base while reducing client concentration. We are pleased with our momentum, particularly our recent growth in Europe and the rest of the world, and these geographies now make up one-third of our revenue compared to less than 25% to years ago.

We have opened new show centers in Asia to add another level of support to multinationals with large operation in this region. This expanded presence has enabled us to win several large engagements over the last few quarters.

In Europe for example, we have been able to leverage our success in transformation programs to win an increasing number of opportunities. We were recently selected by one of the world's largest telecommunications companies to help them improve their customer experience, reduce IT and operational costs, ensure compliance with government regulations and improve the client on-boarding process.

We leverage some of the system (Inaudible) practice to allowing business stakeholders to build a business case to rationalize the IT infrastructure, modernize legacy system and transform their business. In addition, we are providing end-to-end application, support and maintenance across the refined system set.

We are also pleased with our efforts to grow our non-top-10 clients faster than our top-ten meaningfully reducing our customer concentration. At the end of Q1, 52% of our revenue was in [from] our top-client compared to 61% a year ago.

For fiscal '15, we expect to see growth overall from our top-10 clients, with this in mind, our largest banking client has communicated to us that the focus area for Virtusa going forward will be around our core areas of strength. Now they are already established and have proven differentiation.

While we will continue to deliver services and personal business in key growth areas for this client, we will be limited from bidding on and expanding into more traditional, commodity base outsourcing services. Notwithstanding, the status of this banking client, DSSI remains an area of strength for Virtusa, we have built a significant pipeline including large opportunities with high TCV.

As such, we expect this industry growth to have strong growth of approximately 20% in line with the company's overall FY'15 revenue guidance. Finally, I would like to mention a recent report that highlights how our engineering teams leverage Virtusa's proven software development productivity and employee engagement platform to improve the software development productivity, personal excellence, innovate and accelerate the product delivered to our clients.

The May 2014, Everest Group report titled, In Search of ADM productivity noted Virtusa's innovative use of its engineering and employee engagement platform to measure aspects such as developer productivity, technical debt, reuse and personal excellence.

Virtusa's approach has delivered impressive results, including in 97% reduction in defects, 45% reduction in customer order creation and a 14% increase in cost savings in various client engagements we have been involved in.

The Everest group report noted, and I quote, " Virtusa has developed a robust approach for productivity enhancement that is particularly for organization, the complex multi-vendor outsourcing environment by combining top, down, central governance with bottom-up engagement of employees using tactics like gamification, enterprises can drive positive productivity improvements"

Overall, we are pleased with Pleased with our performance in our first fiscal quarter and are well positioned for strong growth throughout the remainder of fiscal year '15. Our value proposition is resonating and our track record of sales excellence continues to bode well for us to grow and expand within our blue chip client base.

Our ability to help clients grow revenue by expanding the addressable market and deploying transformational solutions that improve operational efficiencies, reduce costs and lower risk is enabling us to gain the mindshare of key decision makers and build a stronger, more diversified client base. The progress we are making is directly visible in the strength of our pipeline and gives us confidence we will continue to grow ahead of our industry.

Now, let me turn the call over to Ranjan, who will provide more details on our results and second quarter and fiscal year 2015 guidance. Ranjan?

Ranjan Kalia

Thanks, Kris, and good evening to everyone. Let me start by summarizing the results of first quarter fiscal year 2015. Before providing our guidance for the second quarter and full fiscal year ending March 31, 2015, all of the numbers being discussed our U.S. except with regards to use of constant currency revenue metrics.

Revenue for our first quarter was $112.3 million a 1% sequential increase in reported currency and in constant currency. On a year-over-year basis, revenue increased 24% in reported currency and 22% in constant currency.

Gross margin during the first quarter was 35.3% compared to 38.4% in the prior quarter and 36.1% in the year ago period. Our operating income for the first quarter was $11.2 million or 10% margin compared to $12.5 million on an 11.3% margin in the prior quarter and $8.9 million or a 9.9% margin in the year ago period.

Our first quarter operating income included a net pretax gain of $1.2 million. This resulted from a $1.8 million reversal often estimated earn-out liability associated with the TradeTech acquisition, offset by a chart of approximately $600,000 for the increase of our estimated earn-out liability associated with our OSB acquisition.

Offsetting this gain, we accelerated investments in sales and marketing, discretionary, training and employee retention programs to prepare our increasing revenue growth. In addition, we also expended on enrollment in a larger program at an existing client which included taking on subcontractors. These subcontractors are expected to transition off the program as we move work offshore over the coming quarters.

First quarter other income was $1 million inclusive of a $200,000 FX transaction loss. We had an income tax expense of $3.2 million in our first quarter ended June 30, 2014, which equates to an effective tax rate of 26.4% in line with our prior guidance of 26%.

Net income for our June quarter was $9 million compared to both, $10 billion in the prior quarter and $7.5 million in the first quarter of fiscal 2014. Diluted earnings per share was $0.31 in our first quarter of fiscal 2015, compared to $0.35 in the prior quarter and $0.29 in the first quarter of fiscal 2014.

Turning to the balance sheet, ending cash at June 30, 2014 was $194.8 million inclusive of cash equivalents and short-term and long-term investments. Cash used for operating activities was $2.5 billion in the first quarter. Our DSO including unbilled receivables was 80 days compared to 74 days the prior quarter.

Capital expenditures were $4.4 million in the June quarter. Depreciation and amortization expense related intangible in the quarter was $3.6 million.

Now, let me to do some additional quarterly financial and operational metrics related to our first quarter of fiscal 2015 revenue. Revenue across our industry groups and geos was as follows, BFSI increased 13% year-over-year and represented 57% of revenue. Sequentially, BFSI increased 4%. During the quarter, we saw sequential growth across all segments in BFSI.

Communication and technology grew 64% year-over-year and declined 2%, sequentially, representing 34% of revenue. As previously discussed, we were impacted by the seasonality of the budgeting cycles one of our large appliance for the remainder of fiscal 2015 we expect to see strength in this industry group by clients.

For the remainder of fiscal 2015, we expect to see strength in this industry group, driven by clients we have added over the last 18 months were focused on transformational programs.

Media information and other declined 8% year-over-year and 6%, sequentially, contributing the 9% of revenue.

North American revenue grew 9% year-over-year and 1%, sequentially, making a 66% of total revenue. European revenue grew 74% year-over-year and declined 2% sequentially making up 28% of revenue. Rest of world increased 42% year-over-year and 18%, sequentially, and comprised 6% of total revenue. As we continue to grow, we are pleased that our top-10 client concentration continues to decline and for the June quarter, we had one client contribute greater than 10% of revenue.

During the June quarter, we commenced work with five new clients, two in BFSI and three in communication and technology. We ended the first quarter with 7,535 IT professionals an increase of 5%, sequentially.

Global utilization excluding trainees were 79% in our first quarter, compared to 84% in the prior quarter. Utilization was impacted by the increase in our IT professionals headcount as we ramp up to support our expected gold for FY'15 and beyond.

Now, I will provide our current guidance for our second fiscal quarter and fiscal year ending March 31, 2015. Revenue in the second quarter of fiscal 2015 is expected to be in the range of $116 million to $118 million.

Diluted earnings per share in the second quarter of fiscal 2015 is expected to be in the range of $0.33 to $0.35, earnings per share anticipates an average share count of approximately $29.3 million.

For the fiscal year ending March 31, 2015 we expect revenue to be in the range of $474 million to $486 million or approximately 21% growth at the mid-point. Diluted earnings per share for fiscal year 2015 is expected to be in the range of $1.46 to $1.58. Full fiscal year 2015, EPS anticipates an average share count of approximately 29.4 million.

Our current guidance is based on a set of assumptions including tax rate, interest income, foreign exchange rates and capital expenditures that can be found on the second page of our data sheet located in the Investor Relations section of our website.

Now, I would like to spend a moment providing you with our current thoughts on our second quarter and fiscal year 2015 guidance.

Overall, quite IT budgets remained steady, with programs focused on clients' dual mandate of revenue growth through millennial initiatives, including operating efficiencies through platforming. Virtusa continues to be well positioned on both sides of these strategies.

We have been making strategic investments in extending our presence internationally. The result is that we have seen a meaningful mix shift towards international revenue with these segments making up 34% of our revenue in the current quarter versus 22% in Q1 fiscal year 2013. We continue to believe this diversification will be a growth driver going forward.

Our expectation for fiscal year 2015 remains that we will continue to see strength in our communication and technology industry group, broadly driven by clients more focused on transformational programs. We expect BFSI to grow at company average, driven by financial services and insurance.

While banking is expected to improve year-over-year, our fiscal year 2015 guidance incorporates a more measured approach at our largest banking client.

As discussed previously, offsetting some of this growth will be continued performance in our M&I industry, where some large programs are coming to their natural conclusion while we ramp-up new clients signed over the last two years.

For fiscal year 2015, we are raising the mid-point of our revenue guidance to reflect the strength of our business and contribution from the appreciation of the British pound.

Turning to margins for fiscal year 2015, we now expect slight gross margin expansion, driven by a decreased use of subcontractors and increased utilization which will fund INR appreciation.

We continue to maintain our goal of meaningfully expanding operating margins while funding investments in areas such as facilities expansion, sales and marketing and training and development to grow our the long-term.

Turning to the second quarter, our expectation is that we will see meaningful sequential revenue growth driven by our BFSI and C&T industry groups and that EPS will grow at a faster rate than revenue.

In conclusion, our first quarter results position us well for strong sequential growth throughout fiscal year 2015. Our differentiated service offerings and delivery excellence are enabling us to capture an increasing percentage of our addressable while meaningfully expanding our operating margins.

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

Question-and-Answer Session

Operator

Thank you. (Operator Instructions) We will take our first question from Joseph Foresi with Janney Montgomery Scott.

Joseph Foresi - Janney Montgomery Scott

Hi. I was wondering if you could start by (Inaudible).

Kris Canekeratne

Sorry Joe, we can't hear you.

Joseph Foresi - Janney Montgomery Scott

I am sorry; can you hear me better now? I apologize.

Kris Canekeratne

Yes.

Joseph Foresi - Janney Montgomery Scott

I apologize for that. I wonder if you could start by lining up what you see as headwinds and tailwinds. I know you talked about the M&I groups natural line to business. Then you also talked about some pretty steady growth internationally, but if we could just get a sense of what's on the positive and the negative size. Any type of quantification you can give us that would be helpful.

Ranjan Kalia

Joe, if we look at our guidance, most of the guidance is relatively consistent with prior guidance that we issued. If you look at BFSI and C&T are expected grow very well. C&T we talked about would be declining industry group. In fact, their growth rate has moved up a tad better than last time.

Inside the BFSI, you know, Kris talked about is we have taken a little bit of a more measured approach because of some of the size and scale changes that you seeing at our largest client, but that's probably, I would say, the biggest change. Other than that Kris will talk about it. We see a strong growth in the pipeline, especially the pipeline for the larger deals.

Joseph Foresi - Janney Montgomery Scott

Okay. On the margin front, can you just maybe help us understand what the trajectory is throughout the year? I know what guidance calls for, but how should we think about the margin trajectory from to 2Q to 3Q to 4Q.

Kris Canekeratne

Joe, the trajectory is relatively consistent for us this year versus last year. We usually always have a slower first half and then we pick up in Q3 and Q4. You got to keep in mind what happens for us is in Q1, there is a seasonality revenue impact. Q2 in when we have the annual par increases. Then starting Q3 and Q4 not only we have a expectation that the sequential revenue growth would be strong, but the pyramid starting to line up much better starting to absorb the part is much better and that starts to lead to an operating margin expansion in the back half.

Joseph Foresi - Janney Montgomery Scott

Okay. Then the last question from me, you talked about some lumpiness in growth from some of your larger customers and it's declining as a percentage of revenue. Are your top customers, let's say the top-three are all expected to grow this year and maybe could just give us a break of what's going and going on in most optimistic.

Ranjan Kalia

Like talked to you, I mean, if you look at it what we are excited about is that our top-10 client portfolio continues go. Virtusa was a company if you remember where our top-10 client concentration used to be in 70%. Like Kris talked about it and you know it's coming to the low 50s. There is only one customer that even crosses the 10% benchmark which means that our portfolio is getting much and much more diversified.

Inside of this, we talked about last time, we have a large insurance client where we have had upgrade in our status and that upgrade in our status meant that the match of the cards, so that will have an impact from that client [serving].

The third is, we have a large banking client, which will have a year-over-year growth impact, but all that is getting very significantly offset by the growth in the new client that are being picked up over last two years, not only the acceleration of revenue is there but the larger deal size pipeline revenue accelerations there.

Joseph Foresi - Janney Montgomery Scott

Okay. Thank you.

Operator

Thank you. Our next question comes from Puneet Jain with JPMorgan.

Puneet Jain - JPMorgan

My question, so going back to this large client, the product line which is turned down along with - other account, so.

Kris Canekeratne

Puneet, there is a lot of echo on the line.

Puneet Jain - JPMorgan

Is it better now?

Kris Canekeratne

Yes. There is still echo, but let's try it.

Puneet Jain - JPMorgan

The question really was about your non-top clients which seem to be growing at very high margin this year. Is it broad based, but there is like lot of clients in that category growing or is it driven by three, four clients which are ramping up fast and driving…

Kris Canekeratne

Puneet, it's I would say, relatively broad based at non-top-10, growth that we have and it's also not necessarily not concentrated around one vertical or so, so inside of it it's spread across several segments, so we do feel good about the non-top drought that has not only been strong last year, but the guidance calls that to be strong this year too.

Puneet Jain - JPMorgan

Kris, you talked about Big Data. Last quarter you talked about capabilities in SoLoMo. Talk to us about visibility and margin profile…

Kris Canekeratne

I am sorry, Puneet, I missed the question. Can you repeat that one more time?

Puneet Jain - JPMorgan

Let me get back to you dialing from my cell. There is some problem with my headphone. Sorry about that.

Kris Canekeratne

Okay. We will wait for you. Operator, we can take the next question in the meantime?

Operator

Thank you. In the meantime, we will take Anil Doradla with William Blair.

Anil Doradla - William Blair

Hey, guys. Thanks for squeezing me in. A couple of questions, on the gross margin front, I don't think I totally understood it well, but what was the key reason for the 300 bps sequential drop and I have a follow-up.

Ranjan Kalia

Anil, we had walked through in the last guidance of 300 bps, the change that we were going to have. There are a couple of pieces to that change that we had talked about in the guidance is one. At one of our significant large property and casualty insurance client, where we have a very program going, we were upgraded in our status to become a preferred vendor and that matching the rate cut, so that had an impact on the pricing for that client, so that was one piece of it.

Then the second piece is, Q1 is always a seasonal quarter for us, because we have a large client and that is that budgeting cycle, so that always has an on revenue growth and therefore it has an impact on the gross margin and then the third piece was the M&I performance. This is the piece that we talked to on our Investor's last quarter that our expectation was that there will be a shift in our gross margins from Q4 into Q1.

Coming into Q1, the gross margins are, I would say, in that range. They are probably a little bit down versus what we said in the guidance. Like I said in my script, the one big piece is that we picked up another large program and that large program had a significant contractor on-site presence and that significant contractor's on-site presence is also impacting the gross margin, so the three factors are, if you take four, three were there at the guidance time adding to the fourth is a contract one.

Anil Doradla - William Blair

Great. A quick question, if you look at the telecom industry, it's going through some consolidation we are seeing. Some stuff going on in the cable side, the satellite side. Does that have any impact on your business? Does that offer some potential pause in some of your clients or you are pretty insulated with some of those trends.

Kris Canekeratne

Clearly what we are seeing, Anil, across the communication sector is that, with the clients that we have had strong relationships, and I think this primarily has to do with the types of work and the services we offer specifically around IT, efficiency improvement, rationalization consolidation, improving the consumer experience just in that outlook - continues to grow and expand.

Some of these stuff was as you better know are expanding into areas that were traditionally non-telecom perhaps more media-like. As they launch programs, whether it would be new sports channels or content over that telecommunication infrastructure is, we are actually gaining very strong market share as a preferred partner within those turk holes to actually help them rollout from the new program.

We have seen across the Telco sector, both, the service offering that we have the types of opportunities that we are pursuing as being a growth driver for the company.

Raj Rajgopal

This is Raj. The revenue is fairly diversified. We have businesses across all our geographies and that actually helps us manage any risk that we might have.

Anil Doradla - William Blair

Great. Finally, if I can squeeze one in. Europe continues to do well. Do you are staffed up well in terms of resources or are you limited in terms of ramping up. Thanks a lot.

Kris Canekeratne

As you better know, we are very much a global model. We are well prepared for expansion across all of our geographies. We are seeing some good momentum across Europe as the as the rest of the world, but we are seeing good momentum here in the U.S. as well in terms of running the company and running resources. We are not seeing any issues in terms of ramp-up.

Anil Doradla - William Blair

Thanks a lot, guys.

Operator

Thank you. We will move next to Puneet Jain with JPMorgan.

Puneet Jain - JPMorgan

Hi. Is it better now?

Kris Canekeratne

Much better.

Puneet Jain - JPMorgan

Sorry about that. The question really was about Big Data you talked about today and in the past you talked about capabilities in mobility SoLoMo, so are your capabilities in all of these areas, are they at a stage, where you can go in and win new clients just based on this or do you offer these to your existing customers and win there.

Kris Canekeratne

Let me provide you with a bit of context and then very specifically answer your question. From a contextual standpoint, we are seeing this theme across the majority of our large enterprise especially the industries we serve and those clients that are servicing consumer population.

There is strong demand for work that we do in terms of digital channels and essentially helping then expand their addressable market by very specifically targeting new technology solutions whether it's SoLoMo, whether it's Big Data, to really focus on creating a consumer experience to be able to makes a little more than expected to really focus on creating a consumer next. To be individual reach a focus on creating a consumer experience to be able to reach out to a much broader constituency and reach out to them in a way that's very different. That's clearly driving work for Virtusa; both in terms of existing clients who have a need to expand their offerings through digital channel as well as new clients who want to provide services through digital channels and looking for partners, our best-in-class partners to do so.

As you better know, Puneet, we have been doing this for many, many years. Much of Virtusa's is predicated on what in the past digital online and in the more recent past, very specifically things like mobile first, table first implementations, Big data, Cloud solutions and we find a very robust pipeline of opportunities, both in our existing customer base and new customers.

Puneet Jain - JPMorgan

Understood, can you also talk about your strategy? Obviously you have done 13 acquisitions includes services mix, but how should we think about cash level to run the business maybe to show like a strong balance sheet to your customers?

Kris Canekeratne

For a company our size and scale having that strong cash on the balance sheet really helps us to bid for those larger deal, so it's been a strategic asset for us and really it continues to pay us well from that business perspective.

Like we have done, we will continue to make very selective capability oriented acquisitions. Using those acquisitions to continue to expand our addressable market, lastly like we had talked to you before is, we will also take some of this cash to make expense leverage opportunities for ourselves, where we might convert into some lease hole facilities in into company-owned facilities, so those are the three broad-based uses I can see.

Puneet Jain - JPMorgan

Thank you.

Operator

Thank you. Our next question comes from Brian with Kinstlinger with Maxim Group.

Brian Kinstlinger - Maxim Group

Hi. Good evening, guys.

Ranjan Kalia

Hey, Brian.

Brian Kinstlinger - Maxim Group

The first question I had, what was the effective foreign exchange rate will be to the dollar this quarter versus a year ago. Since I know you have a expensive hedging program, what would you exit fiscal '15, what kind of rate will you be locked in then?

Kris Canekeratne

Q1 was 50 and effective INR was 58.1, last year it was 53.1. Actually, we will have a little bit of a dip in Q3, but we pick up in Q4, so for the full year, we pretty much will end up in the 58.10 range.

Brian Kinstlinger - Maxim Group

58.1, so I guess I am just wondering in the first quarter, the seasonally weak quarter in the margin, but the comp compared to last year is seasonally weak too, so I guess I am just trying to reconcile that huge change in the effective FX rate versus the only 10 bps expansion in the operating margin. Could you, I guess, highlight the year-over-year comparison as opposed to just the seasonally weak quarter?

Kris Canekeratne

I think if you look at it year-over-year, it continues to be an expansion. Like you said, at the midpoint, it is 10 basis points, but it continues to be an expansion. We did invest a lot in the business, because if you look at it there is a very strong sequential revenue growth. In fact that strong sequential revenue growth has even improved the May guidance, so a lot of those investments you have to really start to make that earlier on in the quarters, because there is a time period before those investments incubate and start to really realize you for the revenue and the margin.

Brian Kinstlinger - Maxim Group

Then, can you quantify the pipeline, I guess, of larger, I mean, I think last quarter you talked about $10 million contract value deals and somehow maybe communicated how you are competing more than a year ago, maybe given your size or new MSA agreements. Can you just maybe help us understand how you are positioned for those larger deals better than maybe year or two ago?

Raj Rajgopal

Thanks. This is Raj. On the pipeline, we see extremely strong growth in the pipeline of the last three months especially, which positions us really well for the second half of the year in terms of growth. Especially, if you look at pipeline injections that have happened during these three months that has been pretty substantial.

Now you see this pipeline expansion sort of all around, strong increases in the number of deals, substantial increase in the big deal pipeline that you just talked about and also in the average contract value, the deal value for these big deals. This also cuts across BFSI pipeline, which has grown and is actually very well diversified.

While this pipeline has increased across all the geos, pipelines in Europe and pipelines in Asia have actually grown much faster. For example, in Europe, finding specifically - some of your question was the clients are no longer looking at the large global players the only option. We are looking at companies like Virtusa for disruptive options or their global delivery.

In Asia what we are finding is that pipelines are expanding due to sort of legacy modernization efforts, business transformation initiatives especially catering to a new generation of customers, especially in banking and insurance what we are seeing is that clients are continuing to invest in millennial enablement and consequently in Big Data and Analytics, which are all strong areas for us.

Brian Kinstlinger - Maxim Group

Great. The last question I have, Ranjan, if you could just talk about your largest banking customer. What I am confused about it is, are you actually losing, what did you say from the commoditized work? Is some of the growth are saying and budget for more commoditized work and are you actually generate less revenue year-over-year from them or it's just very slow. I was just confused about the details.

Ranjan Kalia

Brian, just one correction I want to make is, INR rate is actually better than even what I said before. I said 58.1, it's actually 58.8, which you know in case of actually has even margin accretion. Little further, largest client, let me just turn it over to Kris. He will walk you through it.

Kris Canekeratne

Brian, to the best of our understanding, our banking client is going through a categorization of their partners based on size and global reach. However, that does not mean that they won't continue to work with highly differentiated vendors like Virtusa.

Based on our conversations with them, our focus areas going forward will be around our core areas of strength. They are already established and have proven differentiation. While we continue deliver services and pursue business in key investment areas of this plant, we will be limited from bidding on and expanding into more traditional commodity based outsourcing work.

As you will know, much of our work in the past and even today is in value oriented innovation type look. I think I have used this example before jointly with successors, launching things like quick deposit, where people can deposits their checks using their handheld devices without having to step into a branch office.

Work that's innovation, work that's they are highly differentiated, they are very strong. We will continue to bid and work with our client on. At the same time, there will be limited from pursuing work that's more commodity outsourcing work.

Now, these clients spends billions of dollars across many IT services suppliers. Based on our differentiated servicers and the quality of work we expect this client to be a meaningful contributor although at a reduced level.

We are reflecting this impact in our revised guidance for this year, which is by the way being more than offset by the strength out of the pipeline and the diversity of our portfolio. This is essentially enabling us take up a full year guidance and we believe that BFSI has an industry segment. We will continue to grow at the company growth rate.

Brian Kinstlinger - Maxim Group

Thanks for the detail.

Operator

Thank you. Our next question comes from Abhishek Rathore with Cowen & Company.

Abhishek Rathore - Cowen & Company

Yes. Hi. Can you talk a little bit about - you spoke about, but if you could elaborate little bit more on the use of subcontractors going forward. Then average realized pricing environment excluding the large insurance client.

Kris Canekeratne

What we had talked about was in Q1, we were fortunate enough to pick up a very large program of one of our top-10 clients, which meant that the on-site ratio on that large program and we have seen that before in some of these transformation program that the onsite ratio started normally the percentage started heavy, but it started with a contractor base.

The vision of the program is, which is agreed up on with the client that over a period of time, this program becomes from being more on-site-centric t being more offshore centric and we will start to remove the contractor and start to move the work offshore.

That's how that's going to play out. In terms of the pricing, if you look at it, pricing that we have incorporated in our guidance for FY'15, we see pricing slightly up year-over-year. Even Q1 would have been better.

Abhishek Rathore - Cowen & Company

Okay. It sounds like you are gaining some market share from traditional multi-national vendors, especially in Europe and Asia. Can you talk a little bit more about the areas of those large deal opportunities, can you be more specific?

Kris Canekeratne

Certainly, Abhishek. We have opportunities across two areas. We describe as a duality before large enterprise have to focus on investing in terms of offering their service through digital channels to really go after millennial consumer and the superset of millennial consumers. That's the largest application modernization initiative in history and Virtusa is extremely well-positioned to be able to lead our plans to through this transition, so this is specifically around taking large enterprise business to consumer services because and creating and delivering those services through digital handheld devices and create an experience that's very unique and very powerful.

This is a source of opportunities of Virtusa across all geos of operation and across all industries of operation, because of common permitting thread for Virtusa is that all the industries we operate in are very large business to consumer industries that have to transform.

Now on the other side, they have to figure out a way, these large enterprises in terms of how to keep their lights on and how to run their business as usual operation a lot more efficiently. Virtusa has a set of transformational solutions and offerings that are industry-leading in the segments and the industries that we operate in. These are leading to very significant engagements for Virtusa.

I am going to pause for moment and I am going to ask Raj to provide you with some color around the pipeline that we have built specifically the expansion in the pipelines that we have seen across the large deals that the we are pursuing.

Raj Rajgopal

I think, I already mentioned this before, but I will reiterate some other points I mentioned before. Some of the large deal pipeline has grown actually at a faster velocity than the overall pipeline, so we have seen too good traction on that. These are multi-year deals that cut across three to five years in range. Not only has the velocity of this big deal pipeline increase, but also the average contract value for these deals have also increased.

Now, what we are finding in Europe is that because of cost pressures et cetera, there is a preponderance to sort of outsourcing players such as Virtusa work that is what we call the non-discretionary budget support maintenance et cetera, so we are seeing a lot of traction around recurring revenue-type deals, where essentially the client is looking at taking the existing cost base and trying to transform the cost base and put in a lower cost curve and actually funding their digital initiative that Kris talked about.

Abhishek Rathore - Cowen & Company

Thank you very much.

Operator

Thank you. Our next question comes from Vincent Colicchio with Noble Financial.

Vincent Colicchio - Noble Financial

Yes. Kris or Ranjan, what is driving the big increase in fixed price contracts?

Kris Canekeratne

You know, one piece of it is there are customer preferences and also the value proposition that we are making with some of the toolsets that we have now in delivery, I think, the clients are much more open to using those toolsets.

It has been a initiative at Virtusa to drive the fixed pricing and a lot of those things have come together where the fixed price has been moving out. Right now, I would say that more the fixed price increase is still concentrated at a few clients. I would probably will like to see that to get more and more diversified across the portfolio.

Vincent Colicchio - Noble Financial

Should we expect that to continue to increase this year for example?

Kris Canekeratne

I would say probably, it would stay probably stable in this range. I mean, it is much better than what it used to be, not expecting as really a significant spike in it for the remaining of the year.

Vincent Colicchio - Noble Financial

Ranjan, now what are the key drivers that need to happen for you to hit the high end of your guidance for the year?

Ranjan Kalia

Continued performance I would say at our BFSI vertical. BFSI vertical continues to be a strong growth driver. Inside BFSI vertical like we talked about in insurance and financial services, the need for them to continue to be at the growth trajectory that we are seeing in the guidance.

Over and above that communication and technology, which has like I have discussed before is we are very pleased that our communication technology vertical is not really propelling behind a few clients, but that base has also become much and much wider. Those two verticals would really continue to drive the growth.

Vincent Colicchio - Noble Financial

Okay. That's it for me. Thanks, guys. Nice quarter.

Operator

Thank you. Our next question comes from Elizabeth Colley with Needham & Company.

Elizabeth Colley - Needham & Company

Hi. Thank you for taking my question. Has there been any changes in the competitive environment particularly with the larger IT services players and is your win rate consistent with where it's been in previous quarters?

Kris Canekeratne

Yes. Elizabeth, we have not seen any material change outside of the fact that given that Virtusa has continued to grow and grow fast than the industry, we are in a position to go after larger deals, larger engagements. In some cases, head-to-head with some of the larger outsourcing providers and demonstrate the differentiation that we have the fact we are a lot more agile, the fact that they come still specific solutions - that would be in the whole digital actualization space or the transformation space that we are best-in-class. We continue to see that as a growth driver throughout the industries and the geos that we operate in. You want to add anything…

Raj Rajgopal

We are on the competitive side, actually we do track our win rates actually very closely and our win rates have stayed consistent over the last two years.

Elizabeth Colley - Needham & Company

Okay. Thank you. Also, can you give us any additional color on how you are thinking about hiring for the rest of the year specifically around junior hires and U.S. versus offshore hiring?

Kris Canekeratne

Hiring is pretty much a function of about our growth and our forecast. We typically run the company in terms of around 80% utilization. We had good visibility because of the significant part of our revenue comes from our existing accounts, significant part of growth comes from our existing accounts, so we have great visibility and we will continue to hire people in accordance with our hiring strategies, but once again they are commensurate with revenue growth forecast that we see.

Elizabeth Colley - Needham & Company

Okay. That was my last question. Thanks for taking them.

Operator

Thank you. That concludes today's question and answer session. Mr. Kris Canekeratne, at this time, I would like to turn the conference back to you for any additional or closing remarks.

Kris Canekeratne

Thank you. Thank you for joining us on our Q1 fiscal year '15 earnings call. I would like to take this opportunity to thank our global team members for their commitment and dedication and the outstanding quality of the work they performed. Thank you.

Operator

That does conclude today's presentation. We thank you for your participation.

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Source: Virtusa's (VRTU) CEO Kris Canekeratne on Q1 2015 Results - Earnings Call Transcript

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