Virtusa's (VRTU) CEO Krishan Canekeratne on Q4 2016 Results - Earnings Call Transcript

| About: Virtusa Corporation (VRTU)

Virtusa Corporation (NASDAQ:VRTU)

Q4 2016 Earnings Conference Call

May 16, 2016, 08:00 AM ET

Executives

William Maina - Investor Relations, ICR

Krishan Canekeratne - Chairman and Chief Executive Officer

Ranjan Kalia - Executive Vice President and Chief Financial Officer

Analysts

Mike Reed - Cantor Fitzgerald

Puneet Jain - JPMorgan

Brian Kinstlinger - Maxim Group

Moshe Katri - Sterne Agee

Frank Atkins - SunTrust

Bryan Bergin - Cowen and Co.

Anil Doradla - William Blair

Vincent Colicchio - Barrington Research

Operator

Good day and welcome to the Virtusa Corporation fiscal fourth quarter 2016 earnings conference call. Today's conference is being recorded. At this time, I would like to turn the conference over to Will Maina of ICR. Please go ahead, sir.

William Maina

Thank you, Lee Ann. And welcome to Virtusa's fourth quarter and full fiscal year 2016 earnings conference call, where we will be discussing our financial results for Virtusa's fourth quarter and full year ended March 31, 2016. On the call with me are Kris Canekeratne, Chairman and Chief Executive Officer; and Ranjan Kalia, Executive Vice President and Chief Financial Officer.

Certain statements made on this call that are not based on historical information are forward-looking statements which are made pursuant to the Safe Harbor provisions of the Private Securities Litigation Reform Act of 1995. During this call, we may make expressed or implied forward-looking statements relating to, among other things, Virtusa's expectations and assumptions concerning management's forecast of financial performance, the growth of Virtusa's business, Virtusa's ability to realize the intended benefits, revenues and other synergies with the Polaris acquisition, including the ability to integrate Virtusa's employer to the business and operations, the ability of Virtusa's clients to realized benefits from the use of Virtusa's IT services, and management's plans, objectives and strategies.

These statements are neither promises nor guarantees and 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 prospective investors are cautioned not to place undue reliance on these forward-looking statements which speak only as of the date hereof. Virtusa undertakes no obligation to update or revise the information disclosed during this call whether as a result of new information, future events, circumstances or otherwise.

Other statements on this call also include certain non-GAAP financial information as defined by the SEC. We present constant currency revenue to provide a framework for assessing how our revenue performed excluding the effect of foreign currency rate fluctuations. We provide non-GAAP adjusted operating income, non-GAAP adjusted net income and non-GAAP earnings per share, which we believe provide insight into the operational performance of our business.

Reconciliations of non-GAAP to GAAP measures are included in today's earnings press release and data sheet, which can be found on the Investor Relations page of our website. We also present a reconciliation of cash, cash equivalents, short-term and long-term investments that we believe provides insight into our total cash position and overall liquidity. For additional disclosures regarding these and other risks faced by Virtusa, see the disclosures contained in Virtusa's public filings with the Securities and Exchange Commission and our press release.

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

Krishan Canekeratne

Thanks, Will, and thank you for joining us on our fourth quarter and full year fiscal 2016 conference call.

We are pleased with our fourth quarter results, despite we expected sequential headwind we faced in our insurance segment. Our fourth quarter revenue were $171.9 million, an increase of 14% sequentially and 36% year-over-year, including revenue from Polaris. Excluding the partial quarter revenue contribution from Polaris, we posted sequential revenue growth of 1.2% and year-over-year growth of 21% in the fourth quarter.

With respect to the overall demand environment, feedback from the frontline is that clients IT budget were flat in calendar year 2016, with a slower than expected June quarter spending pattern compared with prior years. We attribute this slower spending pattern in our fiscal Q1 to four main factors: first, corporate restructuring at certain clients has caused a delay or reduction in their project renewals; second, delayed program starts at some of Polaris' banking client as well as the expected spend reductions at Citi; third, softness at a few of our insurance segment client; and fourth, typical seasonal revenue decline from our telecom client. These factors are expected to have an adverse impact on our Q1 fiscal year 2017 revenue growth.

Despite the Q1 softness, our new business pipeline is growing and our win rates remain consistent, which gives us comfort that our revenue growth will begin to improve in the fiscal second quarter. Ranjan will provide you with more color on our fiscal 2017 guidance later in the call.

Within the current demand environment, our clients continue to look to reduce the business as usual, cost of their legacy IT environment and to simultaneously reinvest these savings into enabling business transformation. Virtusa's core capability and ongoing areas of investment remain extremely well aligned with this demand. Our value proposition of enabling our clients to run the business more efficiently, secure the business and grow the business is leading Virtusa to increasingly be viewed as a transformational partner of choice.

Turning to our integration of Polaris Consulting & Services. As we previously announced, we closed the first phase of the transaction, then we acquired 51.7% of Polaris' outstanding stock from its founding shareholders and promoters on March 3, 2016.

We then completed phase two of the transaction in April 2016, then we acquired an additional 26% of Polaris from its public shareholders, as part of a mandatory tender offer, taking our ownership in the company to 77.7% of fully diluted shares outstanding. I am pleased to say that we have made good progress and completed our organizational changes to reflect our go-to-market strategy and organization structure.

We have created two growth engines inside Virtusa Polaris; global banking and financial services or BFS, which includes all the banking and financial services operations of Virtusa and Polaris, will be led by Jitin Goyal; and enterprise technology services or ETS, which includes insurance, communications and technology, media, information and other, will be led by Raj Rajgopal.

We have defined roles and put systems in place that are aligned with this go-to-market strategy, and we expect our IT, HR and finance operations will be fully integrated by the end of this calendar year. Our sales and delivery teams have been unified and reorganized around our BFS and ETS business unit, and they have already begun to deliver our plan to drive revenue synergies this fiscal year.

On that note, let me now spend a moment giving you some insight into the early successes we are generating as a combined Virtusa-Polaris. You may recall that when we announced the acquisition in November of 2015, we discussed three key strategic reasons, why we believe Virtusa and Polaris were a strong fit, and why the combination of our two companies would help create a stronger platform to drive our long-term growth and shareholder value.

First, the combination of our two companies creates a unique fully integrated provider of comprehensive solutions and services across the banking and financial services industry. Second, our combination meaningfully expand our addressable market. And third, the transaction enhances our ability to pursue larger consulting and outsourcing contracts across all the industries we operate in.

I am pleased to say that since announcing the deal, we have seen increased development of new large opportunities in our pipeline. And in fact, we have already signed a handful of new synergy win in banking and financial services that illustrate our strategic rationale for the acquisition.

For example, we recently signed a synergy deal with one of the largest banks in northern Europe. This is a new local win for us. The engagement covers the end-to-end lifecycle for delivering the right payments proposition across customer segment in post-PSD2 or Payments Services Directive world.

In this win, we are leveraging Polaris' vast domain expertise in payments transformation as well as upstream business consulting expertise from Virtusa business consulting to deliver strategy and a technology roadmap for a constantly evolving payments business. The program aims at addressing challenges foreseen in a highly competitive $600 million annual addressable revenue opportunity for our client, and has potential to transform how payments will be executed over the next decade.

In another example, we won a synergy deal with an existing Polaris commercial banking client, where we were chosen to provide a set of Virtusa's digital solutions, including data aggregation, data analytics and user experience to this client. These are two recent examples of how our ability to offer a fully integrate set of end-to-end BFS solution is enabling us to both attract and win new clients as well as expand our addressable market opportunity across our combined Virtusa-Polaris client base.

Finally, I would like to point out a recent multimillion dollar win with an existing large Virtusa banking client as a strategic partner to expand resources for the client's consumer banking business. In this case, in addition to our integrated expertise in the required areas of retail and commercial banking and comprehensive proven approach of captive enablement for other clients, a key reason why we were chosen in this competitive process over other larger generation-one vendors, was the expanded scale of Virtusa-Polaris.

As I' a sure you can tell, we are extremely pleased with our progress so far in integrating Polaris and Virtusa. And earlier, as we then suggest that the depth and breadth of our combined BFS solutions are resonating quite effectively in the market and are helping to set us apart from competitors.

Looking forward, we have identified over $100 million of cumulative revenue synergies over the next three fiscal years from the Polaris acquisition, primarily driven by cross-selling of solutions and services into our combined portfolio of banking and financial services plans. We have a detailed plan in place to meet that goal and remain confident in our ability to deliver these results, based on the significant opportunities we see in the market as well as the solid forward progress we have achieved so far.

Now, I would like to provide some additional detail on the current demand environment and how they are helping our clients transform their businesses to achieve their business objective. As I mentioned earlier, our client across industry verticals continue to address the dual mandate they are facing to reduce costs by improving operational efficiencies and reducing risk, while at the same time investing in revenue growth.

In telecom, for example, communication services providers are being challenged to serve their customers more profitably, and not just merely focus on increasing their number of subscribers. They are looking to technology to improve their revenue performance, while at the same time streamline their business operation.

A great example of how they are helping our clients on this front is with a large Europe-based PSP. This client had high operational cost and poor customer experience. Virtusa's consultants work with the company's business operation, field engineers and technology team, and trace its problem to the needs of better diagnostics and analytics of field engineers.

This eventually led to Virtusa designing and implementing a mobile app for field engineers, providing real-time remote testing and diagnostics, historic fault analysis and route optimization capabilities. Our work resulted in the rationalization of capabilities and functionality of eight devices down to one device, significantly reduced operating expenses, provided a far better customer experience and increased up-sell and cross-sell opportunities by 10%.

Across several of our industry segments, we are seeing a strong emerging focus on intelligent automation, specifically Robotic Process Automation or RPA and smart automation via machine learning. The goals of RPA include decreasing manual processes to reduce human effort and error, reduce cost and increase quality of services. RPA also enables business intelligence, analytics and auditing. Gartner is predicting that by 2018, 40% of outsourced services will leverage smart machine technology.

Virtusa has focused considerable effort and investment in the area of RPA and cognitive computing. They are leveraging both our own technology agnostic RPA tool and setup solutions called Centroid RPA. And we are partnering with other RPA vendors such as Arago, Blue Prism, Automation Anywhere and WorkFusion to serve our clients.

On the side of running the business more efficiently, we see an accelerating shift in demand from applying labor arbitrage across to drive cost down to organizations employing automation solution such as RPA to drive higher efficiencies and consequently higher cost savings. We have numerous clients approaching us to help evaluate areas where they can implement RPA, particularly in the banking, financial services and insurance segments, and we believe that it will be a significant area of opportunity for us in the future.

In conclusion, I remain excited about the breadth of growth opportunities available to Virtusa. Our differentiated solutions clearly address the needs of our client's core objectives of growing revenue, improving operating efficiencies, reducing costs and mitigating risks.

While we are seeing some short-term revenue headwinds in the first quarter, our new business pipeline is solid and our win rates remain consistent, and we believe we are well-positioned to deliver on our revenue and earnings growth outlook in fiscal year 2017. We are on track with our integration of Polaris and our strategic plan for acquiring the company is already showing up in terms of pipeline development and early synergy wins in BFS.

In fiscal 2017, our top priorities are clear. We will focus on: dedicating resources towards ensuring a smooth integration of our two firms; executing our growth plan, with an eye towards raising revenue growth back to above-industry rates; demonstrating excellence across our client base to grow and expand our presence, and with particular emphasis at Citi and other large enterprises, where we have an opportunity to leverage our preferred supplier status to expand our partnerships; and hiring and developing the best talent in the industry and providing a high-performance, gamified work environment, that empowers and stimulates innovation.

Now, let me turn the call over to Ranjan, who will provide more details on our results and our fourth quarter and fiscal year 2017 guidance.

Ranjan Kalia

Thanks, Kris, and good morning to everyone. Let me start by summarizing the results of our fourth quarter and fiscal year 2016. I will then provide our current non-GAAP guidance for both the first quarter and fiscal year ending March 31, 2017, before opening the call for questions.

Revenue for our fiscal fourth quarter was $171.9 million, up 14% sequentially and 36% year-over-year. As you are aware, we completed the acquisition of majority interest in Polaris Consulting & Services on March 3, 2016. In the fourth quarter, Polaris contributed approximately $19.4 million of revenue, which was above our prior expectation of approximately $17 million, primarily due to lower anticipated India to U.S. GAAP adjustments.

Excluding the partial fourth quarter revenue contribution from Polaris, revenue increased 1.2% sequentially and 21% year-over-year on a reported basis, and was 2.2% sequentially and 22% year-over-year on a constant currency basis. Our organic sequential revenue growth was in line with our prior guidance range and industry growth trends.

Gross margin in the fourth quarter was 35.1% compared to 35.7% in the prior quarter and 36.7% [technical difficulty].

Folks, this is Ranjan. I will start my prepared remarks from the beginning again.

Thanks, Kris, and good morning to everyone. Let me start by summarizing the results of our fourth quarter and fiscal year 2016. I will then provide our current non-GAAP guidance for both the first quarter and fiscal year ending March 31, 2017, before opening the call for questions.

Revenue for our fiscal fourth quarter was $171.9 million, up 14% sequentially and 36% year-over-year. As you are aware, we completed the acquisition of majority interest in Polaris Consulting & Services on March 3, 2016. In the fourth quarter, Polaris contributed approximately $19.4 million of revenue, which is above our prior expectations of approximately $17 million, primarily due to lower anticipated India to U.S. GAAP adjustments.

Excluding the partial fourth quarter revenue contribution from Polaris, revenue increased 1.2% sequentially and 21% year-over-year on a reported basis, and was 2.2% sequentially and 22% year-over-year on a constant currency basis. Our organic sequential revenue growth was in line with our prior guidance range and industry growth trends.

Gross margin in the fourth quarter was 35.1% compared to 35.7% in the prior quarter and 36.7% in the year-ago period. The sequential change in our gross margin primarily reflects the dilutive impact of the Polaris acquisition, offsetting a modest sequential increase in Virtusa organic gross margin.

Fourth quarter other income was $7.5 million, including a $6.6 million unrealized foreign exchange gain. As disclosed previously, a $200 million term loan was raised to partially fund the Polaris transaction. The transfer of such debt to our Indian subsidiary using an INR denominated inter-company note resulted in a reevaluation gain of $6.6 million. Additionally we incurred approximately $645,000 of interest expense in the quarter on this term loan.

GAAP diluted earnings per share was $0.41 in our fourth quarter versus $0.38 in the prior quarter and $0.39 in the year-ago period. Polaris contributed $0.04 of EPS in the fourth quarter. GAAP EPS was above our guidance range of negative $0.02 to breakeven.

Our EPS outperformance was mainly due to higher than expected Polaris revenue, lower due diligence expenses and a $6.6 million of foreign exchange gain related to the funding of the Polaris acquisition, partially offset by approximately $8.6 million of Polaris transaction-related charges.

Our income tax rate was 4% versus our historical tax rate of approximately 27%, primarily due to the tax benefits related to interest expense, acquisition-related charges and change in geographical mix of profits.

Turning to our non-GAAP results. Non-GAAP operating income was $21.8 million compared with $20.7 million in the prior quarter and $19.2 million in the year-ago period. Fourth quarter non-GAAP operating margin was 12.7% compared to 13.8% in the prior quarter and 15.2% in the year-ago period. The sequential change in our non-GAAP margin primarily reflects 90 basis points of dilutive impact of the Polaris acquisition.

Non-GAAP diluted earnings per share was $0.55 in our fourth quarter of fiscal 2016, which was better than our $0.43 to $0.45 guidance range. This compares to $0.54 in the prior quarter and $0.51 in the year-ago period. Polaris contributed $0.01 of non-GAAP EPS in the fourth quarter compared to negative $0.11 in our guidance, therefore outperforming $0.12.

Turning to the balance sheet. Ending cash at March 31, 2016, was $231.7 million, inclusive of cash equivalents and short-term and long-term investments, including $65 million of cash from Polaris.

Cash flow from operating activities was $5 million in the fourth quarter or 2.9% of revenue, primarily impacted by increase in DSO. Our DSO, including unbilled receivables, was 78 days. Virtusa's standalone DSO was 77 days compared to 70 days in the prior quarter. Capital expenditures were $3.2 million in the March quarter.

Now, I will turn to some additional quarterly financial and operational metrics, beginning with those related to our fourth fiscal quarter 2016 revenue. Please note that all of the numbers I am about to discuss exclude Polaris.

Revenue across our industry groups and geographies was as follows. BFSI revenue increased 10.5% year-over-year and 1.7% sequentially, representing 51.7% of total revenue.

Our BFSI results in the fourth quarter were in line with our expectations, and as expected, reflect meaningful decline in our insurance segment. We are pleased with the performance of our banking segment, which experienced strong sequential growth and outperformed our expectations.

Communications and technology grew 26% year-over-year and 2.6% sequentially, representing 38% of revenue. The performance at our largest telco client was strong in the fiscal fourth quarter, reflecting seasonality that is consistent with the prior years.

Media information and other grew 81% year-over-year, representing the remaining 10.3% of revenue, driven by clients from our Apparatus acquisition. On a sequential basis, this vertical declined 5.6%, which was more than our expectation.

North America revenue grew 24.4% year-over-year and 1.9% sequentially, making up 70.6% of total revenue. Revenue growth was slightly below our expectations.

Europe revenue increased 6.4% year-over-year and declined 1.5% sequentially on a reported basis and was up 11.3% year-over-year and 2.7% sequentially on a constant currency basis. Europe represented 22.2% of total revenue in the quarter.

Rest of world increased 42.6% year-over-year and 3.2% on a sequential basis and accounted for the remaining 7.2% of revenue. Results were driven by growth at our banking clients.

During the March quarter, we commenced work with five new clients, including two in C&T, two in BFSI and one in media information and other. Additionally, we added 40 net new clients from the Polaris acquisition, which excludes 20 common clients already included in Virtusa client count.

We ended the fourth quarter with 9,795 IT professionals, an increase of 3% sequentially. Including Polaris, we ended the quarter with 16,321 IT professionals. Global utilization, excluding trainees, was 81% in our fourth quarter.

I would now like to briefly summarize our financial results for fiscal year 2016 as compared to fiscal year 2015. Revenue was $600.3 million, an increase of 25% year-over-year. Excluding the partial fourth quarter revenue impact from Polaris, fiscal year 2016 revenue increased 21% year-over-year on reported basis and was up 24% on a constant currency basis.

GAAP diluted EPS was $1.49 compared to $1.44 for fiscal year 2015. On a non-GAAP basis, operating profit was $79.5 million, an increase of 16.4% and operating margin was 13.3% compared with 14.3% for fiscal year 2015. Non-GAAP net income was $61.9 million, an increase of 13.8%. Non-GAAP diluted EPS was $2.06 compared to $1.84 for fiscal year 2015.

Before turning to our guidance, I would briefly like to summarize the Polaris transaction. On March 3, 2016, we completed the acquisition of approximately 51.7% of fully diluted outstanding shares of Polaris from founding shareholders, promoters and certain other minority stockholders for $168.3 million.

On March 30, 2016, we successfully tendered and subsequently purchase an additional 26% of fully diluted outstanding shares of Polaris from public shareholders for $86.8 million, which settled on April 6, 2016. So in total, we paid $255.1 million to acquire approximately 77.7% stake in Polaris on a fully diluted basis.

As you may recall, when we announced the Polaris acquisition in November of last year, we estimated the total purchase price for the 51.7% from selling shareholders and 26% from public shareholders would be approximately $270 million.

We attribute approximately $15 million aggregate savings on the purchase price to three factors: first, favorable U.S. dollar to rupee exchange rates at the time of the transactions; second, favorable purchase price of the founding shareholders stake by purchasing those shares on an active trading market; and third, the strong response of the mandatory open offer, which enabled us to conduct that transaction at the original offering price. In addition, we also received approximately $15 million of more cash in Polaris balance sheet than previously contemplated.

As I mentioned we currently own approximately 77.7% of Polaris on a fully diluted basis. However, as we have disclosed under India Takeover rules, we are required to sell within one year of mandatory offer of our Polaris shareholdings in excess of 75%, and we expect to sell these excess shares to be in compliance.

Now, I will provide our current guidance for first quarter and fiscal year ending March 31, 2017. Revenue in the first quarter of fiscal 2017 is expected to be in the range of $202.5 million to $207.5 million. Non-GAAP diluted earnings per share, in the first quarter of fiscal 2017, is expected to be in the range of $0.14 to $0.18. Our Q1 fiscal 2017 earnings per share guidance, anticipates an average share count of approximately 30.1 million.

For the fiscal year ending March 31, 2017, we expect revenue to be in the range of $890 million to $920 million. Non-GAAP diluted earnings per share for fiscal year 2017 is expected to be in the range of $2.10 to $2.30; excluding $35 million of acquisition-related charges, which includes approximately $6 million of Polaris integration related charges and also excluding $24 million of stock compensation expense.

Full fiscal year 2017 EPS anticipates an average share count of approximately 30.3 million. Our current GAAP and non-GAAP guidance is also based on a set of assumptions including tax rates, interest income, foreign exchange rates, capital expenditures and certain non-GAAP metrics that can be found on our datasheet located in the Investor Relations section of our website.

Now, I would like to spend a moment providing you with some additional detail on our first quarter and fiscal year 2017 guidance. As Kris mentioned earlier, we are seeing clients overall budgets are flat year-over-year with a slower Q1 spending pattern versus prior years. BAU spending on legacy IT environments will continue to contract year-over-year, while clients discretionary spend is being funneled to initiatives focused on enabling digital transformation as well as improving operating efficiencies and mitigating risk.

Our first quarter results are being impacted by four primary factors: first, slower spending pattern as evidenced by declines in our renewals at certain large -- as a result of their corporate restructuring; second, delayed start at some Polaris banking clients including the previously expected reductions at Citi; third, softness at few of our insurance clients; and lastly usual seasonal revenue decline from our U.K. based telecom client.

The telecom seasonality and Citi revenue changes were known to us going into the quarter, however, the impacts due to the changes in our pipeline began to materialize in May Q4 and early April. Our first quarter 2017 guidance anticipates Virtusa organic revenue to decline sequentially in the first quarter. This implies a full year organic growth rate below our previous expectations of above industry growth.

Our expectation for Polaris revenue growth for fiscal year 2017 is slightly below our original expectations due to the delayed start at some of its banking clients. We now expect Polaris revenue to grow in the mid-single digits for FY '17 off of the Q4 run rate of approximately $70 million.

Our client's calendar '16 budgeting process took a little bit longer than our previous expectation and this was evident in our slower pipeline build up in the latter part of our Q4. As we exited Q4, our clients have completed their budget allocation process and we saw a corresponding pickup in our pipeline growth.

Our win rates are consistent with prior periods. Pipeline buildup and closure rates provide us comfort that beginning in Q2 we expect Virtusa to generate sequential above industry revenue growth rates for the remainder of year. Sequential revenue growth will be supported by growth in all our industry segments with particular strengths in C&T, BFS and insurance.

We anticipate quarterly revenue growth to accelerate in the fiscal second quarter and for the remainder of FY '17. As seasonal headwinds and our telecom clients begin to unwind, new project starts begin to drive growth in insurance and banking segments and the quarterly run rate of Citi spend reductions are fully absorbed.

We anticipate non-GAAP combined Virtusa Polaris operating margin to be down year-over-year, but in line with our previous expectations. Even after absorbing the impact from Q1 revenue headwinds and incremental investments in Polaris platform, in addition we now expect Polaris to be accretive to our non-GAAP EPS in FY '17, up from our prior expectations of slightly dilutive.

In conclusion, while we will experience a slow start to FY '17, we anticipate accelerated revenue growth above the industry rate and strong margin accretion in the beginning of fiscal second quarter. Our strong second half FY '17 margin trajectory sets us up to deliver EPS growth in excess of revenue growth in FY '18 and beyond.

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

Folks, since we've got a little bit delayed, if it's convenient for everybody, we will go over by 10 minutes, so that we can take everybody's questions. First question please.

Question-and-Answer Session

Operator

[Operator Instructions] And our first question comes from Joseph Foresi with Cantor Fitzgerald.

Mike Reed

This is Mike Reed on for Joe. The first question was on the insurance softness in the first quarter. Is that going to be mainly due to one large client or is that spread out among a few or more?

Krishan Canekeratne

It's actually spread out across a few clients in the insurance segment. Clearly, one of the larger clients in insurance has been going through a restructuring that has had an impact on Virtusa's insurance segment. But beyond that, we've also seen some slowness in a few clients within the insurance segment.

Mike Reed

And then just one more follow-up. There is obviously a slight down tick in revenues for the first quarter, but then it seems like the EPS projections for the first quarter is a little bit further down than the revenue is. Can you kind of talk about what's going on in between the revenue and the EPS and the profit and loss to cause that difference?

Ranjan Kalia

So Mike, there's probably a couple of different reasons. One is seasonal; usually in Q1, we always have an incremental expenditure for the visa cost, which continues to be for this quarter, which is about 60 basis points impact. And then we're really contemplating another almost 700 basis points impact really due to revenue decline, because revenue is going to be coming down, available utilization will probably go.

We're not taking any significant impact to really bring up utilization just in Q1 because of the revenue impact. But continue to hold that, because we believe revenue will pick up in Q2 and therefore, the utilization will pick up too. So those are really the primary reasons why you do see a drop in EPS, because margins would be dropping almost by 900 basis points in Q1, non-GAAP margins.

Operator

And we'll take our next question from Puneet Jain with JPMorgan.

Puneet Jain

So your onsite effort significantly increased in this quarter, is that on period-end basis or average for quarter, which would obviously implied further increase in Q1? And how should we think about long-term onsite offshore mix given Virtusa's typically operated at higher offshore leverage?

Ranjan Kalia

So Puneet, that is average for the quarter. And in the fact sheet that we are looking at, that fact sheet actually shows the onsite for both Polaris and Virtusa. Polaris onsite was actually higher than even Virtusa. And that is really one of the drivers even with regards to why we feel the Citi spend reductions can really transpire both in the favor of the client as well as for Virtusa.

As the onsite reductions happened at Citi, it's beneficial for the client as well as for Virtusa. So you are really seeing those two reasons play out for the increased onsite effort in the quarter. That being said, we do expect that the onsite effort year-over-year for Virtusa will be higher; even on an organic basis will be higher year-over-year.

Puneet Jain

And that guidance implies very high sequential growth rates beyond Q1. And obviously, you talked about like you expect insurance to get better, telecom client to improve, but how much of $100 million synergy targets have you baked in, in estimates for your fiscal '17 guidance?

Ranjan Kalia

So Puneet, when we had talked about the $100 million synergy, which was going to be over a period of three years, you may remember, we always said that the synergy would really happen in the backhand of FY '17. They were never really contemplated early in FY '17.

We still continue to believe, Kris, talked about we've been in a closing lot of synergy deals, but the meaningful revenue impact for those really start to happen in later part, so not a significant piece is included in FY '17. We believe that if we can get the synergy revenue deals ramp rate going in Q4, it really sets up very well for FY '18.

Krishan Canekeratne

And Punit, just to build on what Ranjan just mentioned, so we've also seen that overall that our pipeline has growing year-over-year, although, the momentum during the second half of our Q4, the quarter that we just concluded, was slower than we had expected. And that obviously, also contributed towards a slower Q1. But pipeline momentum has been noticeably stronger, since the start of fiscal year '17, since April. \

Now, even a more specific piece of information is that the growth of the qualified late-stage pipeline or late-stage deal has been greater than any prior period, which is what really gives us confidence that Q2 and the full year will see that the growth rates that we expect.

Puneet Jain

So it is more organic growth that you expect in later half of this year than acquisitions related, that's good.

Krishan Canekeratne

That's right.

Operator

And we'll take our next question from Brian Kinstlinger with Maxim Group.

Brian Kinstlinger

The guidance, as you mentioned, from an earnings perspective the jump is predicated on revenue ramping. So I'm curious what is the visibility to that revenue ramping? Has it already started, because it sounded like, it was the end of the quarter when you started to see some weakness. So we're already pretty much in June almost, so have we begun to see that pick up in demand?

Ranjan Kalia

So I'll give you couple of data points and then Kris can add. So Brian, if you look at it when we construct our full year revenue, when you look at the full year revenue, the backlog and the revenue visibility, which is that the pipeline, the high-end pipeline, that metric looks very similar, maybe even a tad higher than what would have been last year at this time. That's for the full year.

When we look at in quarters, we saw the pipeline build up started to happen, and especially the late-stage pipeline. The late-stage pipeline, actually we saw an abnormal pick up in that late-stage pipeline for Q2 that really gave us comfort that the Q2 sequential growth that would come from the pipeline, the pipeline is in there, and over and above that we have some normal factors that are going to go away, which is the [ph] BT that we always see Q2 being a sequential pick up versus Q1 and then flattening out of more of the Citi spend reductions that are in there.

Brian Kinstlinger

And then given Citi has seen decline in demand and so has your top insurance customer, talk about how you're going to manage utilization? Will you not hire for the next six months, given you have excess capacity right now? How will you handle the hiring trends?

Ranjan Kalia

So just on the utilization, when we had put our financial modules together for the combined organization, we always knew that on the Polaris side regardless of the revenue down tick that we are really seeing in Q1, we will be doing some utilization pruning in any case. So that was a scenario that we were always prepared for coming into.

Now, coming with the shortfall that we had over the revenue in Q1, we're holding the hiring down in Q1 a little bit, so that we can absorb the bench that we would have created for ourselves into Q2, and then after that kind of in mid-Q2 we expect to get back on normalize hiring trends.

Operator

And we'll take our next question from Moshe Katri with Sterne Agee.

Moshe Katri

As a follow-up on Citi, can you remind us how much will Citi impact revenues this year and fiscal year '17? And what sort of growth would you have had without that impact?

Krishan Canekeratne

So if you would look at on a combined basis, Moshe, Citi would have been about $145 million, $146 million client for us last year. And this year, we are expecting that Citi would basically contribute about $120 million as Citi goes through their spend reduction program. And we are really implementing that spend reduction through what we call an efficiency improvement plan.

So even though the revenue comes down, I think Ranjan alluded to this earlier, as an example, there will be resizing the pyramid, making sure that on-site offshore ratios are more optimal, so we can actually ingest that spend reduction without having a consequential margin impact to Virtusa. If you just take a look at that one account, revenue has come down by approximately $26 million full year.

Moshe Katri

And then you provided us with the revise organic growth for Polaris, you said mid-single digits. What would be the organic growth for Virtusa in fiscal year 2017?

Ranjan Kalia

It's going to be very similar. It's going to be in the mid-single digits, primarily because of -- obviously, it's a disappointing Q1 for all of us over here, so it's really the disappointing Q1, but then the sequential growth rates that the guidance calls for starting in Q2 continue to be very strong. So overall it would be a mid-single digit year.

Moshe Katri

And then the final question here, and obviously I'm assuming the market, looked at the transaction late last year, stock has definitely been penalized versus the group in terms of fee multiples, and I think there is a lot of uncertainty about the acquisition and the integration pace, and also probably about the quality of the business that came on board. If you looked at the combined entity in terms of Virtusa and Polaris, which part of your services mix today is considered in your view digital anything that's related to smack? And which part has related to legacy, which is having some issue these days?

Krishan Canekeratne

Moshe, a couple of questions that I'd like address, so first and foremost, I think we also as we started looking at this fiscal year and we saw some slow down in the pipeline, some of our clients have been restructuring, basically out slowing down their renewals, et cetera, we couldn't help, but asks ourselves, that the acquisition itself might have cause some of the changes to our business momentum.

And actually, as we looked into it deeper, it became and clear and clear to us that what was really going on in terms of business slow down had little or nothing to do with the Polaris acquisition outside of the fact that we knew that Citi was going to post some headwinds for us this year. But very specifically as we looked into this deeper and deeper, there were four things that really stood out as to why we would have a slow Q1 and from there resume the growth.

The first was that that we saw renewals decline as a result of few of our large clients going through a restructuring. We saw a delayed start at some of Polaris' banking clients, including the previously expected spin reduction at Citi, which we had fully contemplated. We saw softness at a few of our insurance clients. And finally, the customary seasonal revenue decline that we've always seen during our first quarter, because of telco clients in the U.K. So these are the four reasons that really led to the slow down in Q1.

Specifically in terms of your second question with respect to digital, there are two areas we focused on with our clients. On the one side, we are helping them streamline, rationalize and consolidate their business as usual operation. And I would say much of that work is longer-term recurring in nature. And on the other side, we are helping them expand their addressable market specifically by helping them reimagine their digital store front.

And I would tell you that that piece of business that we do is hard for us to quantify specifically, whether its all of the business we do or some of the business we do, because almost all the work that both companies does is very transformational in nature and either is directly helping our clients to reimagine their digital store fronts or indirectly creating an IT infrastructure and straight through processing that then can be leveraged to provide a much better end-consumer experience.

But generally speaking, I'll tell you that Virtusa Polaris both spent a great deal of time in terms of helping our clients on their strategic platform and much of this is used for digital enablement of their customers and their consumers.

Ranjan Kalia

Maybe two data points on the financials for the Polaris that you talked about. One in my prepared remarks, I talked about that for FY '17 our guidance is that Polaris versus our previous expectations are being slightly dilutive, this is going to be an accretive transaction in FY '17 for us.

Operator

And we'll take next question from Frank Atkins with SunTrust.

Frank Atkins

Wanted to ask, in your prepared remarks I believe you mentioned signing a large European bank, which is a new customer. Do you see that as evidence of the strategic rationale in terms of kind of breadths of capabilities? And then secondly, as you look at the pipeline, are you seeing evidence of inclusion for larger deals or being considered in that large deal size scope?

Krishan Canekeratne

We signed a great client here in Europe. It has to do a bit of world banking regulation called PSD2 also known as API Banking. We believe that we had some very significant thought leadership in payments and payments processing that actually going to transform the banking industry, especially with respect to some of the FinTech disruption that's taking place.

And this is perhaps a bank that's already seeing the fairly dramatic changes that are coming down to pike and have engaged Virtusa Polaris to be able to execute some very transformational payments related work to not just adhere to PSD2, but to actually take advantage of it, so they can become potentially a PSP or a player in this rapidly emerging payment space.

Now, having said that, this is a clear example of Virtusa's strength in banking and financial services and Polaris' strength in banking and financial services coming together to enable us to be able to pursue this opportunity, win the opportunity, and we believe that following the initial conceptualization of the work that we are doing today, that there is fairly significant downstream work.

We also believe that this same idea whether it'd be PSP or whether it'd be PSD2 or whether it'd be regulatory incompliance initiatives or whether it'd be blockchain and the disruption that blockchain will have in banking and financial service, we believe that the combine companies provide tremendous expertise to be able to go in front of larger engagements, pursue these engagements, demonstrate depth and thought leadership and win these engagements. Actually, we've seen a noticeable expansion of our late-stage large deal pipeline specifically as it has to do with business in those areas where we have industry-leading expertise.

Frank Atkins

And can you give us a little color in terms of SG&A. Kind of what's baked into the guidance, as well as the trajectory you see over the course of the year?

Ranjan Kalia

Frank, on the SG&A, our model, especially if you look at it even with the Q1 decline in revenue, our margin expectations from our prior expectation stay consistent, which is primarily due to our SG&A model of trying to have SG&A growth at a half of revenue growth. So we continue to bake that into our model, both at the Polaris side as well as the Virtusa side. Barring at some of the line items were in S&M, we're continuing to have very similar investments on S&M as prior years.

Operator

And we'll take our next question from Bryan Bergin with Cowen and Co.

Bryan Bergin

Within Citi, can you kind of talk about your early views now into winning larger engagements there?

Krishan Canekeratne

So clearly, the first part of the business that we have to do is to basically ingest the spend reduction at Citi. And I think we are making great progress.

And we took probably a road less travelled, where we spent a great deal of time with Citi upfront, sharing with them that we will implement their spend reduction through an efficiency improvement plan or essentially demonstrate very strong execution, demonstrate our software platforming heritage and expertise through which we can improve productivity, demonstrate better efficiencies around onsite offshore ratios, and demonstrate better efficiencies in terms of how we can leverage fixed price work to be able to meet their needs.

And that was very important for us, because our belief was that to the extent we use this as an opportunity, although we would have some revenue headwinds to be able to demonstrate that we can do the same work with less effort or through effort compression, we thought that that would be a great example of work that we can then do across other parts of Citi now that we have a strategic preferred partnership with Citi.

So we believe that this year we will make great progress in terms of the efficiency improvement program. We will demonstrate examples of how we can effectively change Citi spend. And once we do that, we also believe that we are in a great position to be able to look for new and additional opportunities at Citi, which we've already started.

And we expect that as we get towards the third and the fourth quarter of this year, that the reduction in spend will stabilize and that we will be in a much stronger position to pursue and win new work, so that hopefully, we'll see a growth account at Citi next year on the heels of excellent service execution, productivity and efficiency improvement, and building very strong relationships with buyers at Citi across a much larger estate.

Bryan Bergin

And then just on operating margin. Can you just remind us what our long-term expectation is on operating margin and really the leverage you were going to use to manage that?

Ranjan Kalia

So Bryan, this year combined margins is going to be in the low-double digits, and what our expectation is that over the next three to five years we take the combined company margins into the mid-teens on a non-GAAP basis. And if that continues to happen, what we are really excited about is that the EPS growth will be continue to be higher than revenue growth.

Krishan Canekeratne

Operator, can we go back to Anil?

Operator

Yes. We'll take our next question from Anil Doradla with William Blair.

Anil Doradla

So I know a lot of moving parts as we go through in this quarter, next quarter, and maybe in next several months. But Ranjan and Kris, when I look into fiscal '18, can you talk about how should we be looking at the company's growth rate? I know you're not guiding, but conceptually we've got a lot of moving parts and you're talking about maybe sub-par growth for core Virtusa business in the near term. But as you go into 2018, how should we be looking at the kind of the growth composition of the company?

Krishan Canekeratne

Really, we want to be very clear about this, right. So in the first quarter, because of the reasons we've already mentioned, we've seen a certain slowdown in revenue. Now, beyond that, starting in Q2, we expect to see strong industry-leading growth in ensuing quarters of this fiscal year to really set the stage and the platform for a strong Europe growth in fiscal year '18.

So really what's happened here is that because of some side click reasons, specifically in telco accounts, some of the restructuring that's going on in a few of our large accounts, one being in insurance and another being in technology, that non-headwinds that we were aware from Citi perspective, that's all come together to create a slower Q1 than we expected.

But from a pipeline perspective, we have seen tremendous progress, especially since the start of this year. The large deal segment of our pipeline is stronger than at any prior time that we can recall. We have very significant opportunities that we are pursuing, both within our existing account base and across new account. And we believe that that's what's going to provide us with the growth that we expect in Q2, Q3 and Q4, but then also industry- leading growth in fiscal year '18.

Anil Doradla

Now, I know you guided for about $890 million to $920 million for the full year. And in terms of how much your booked and visibility clearly qualitatively, Kris, you're suggesting, your visibility and kind of for bookings is very strong as the year goes by. But can you quantify that? I mean, at the midpoint are you 75% booked, 80% booked? And can you remind us, how is that with respect to perhaps historical numbers, now that given that you've got two different businesses with different dynamics, right, Polaris as well as core Virtusa [technical difficulty].

Operator

And we have reconnected. I still have Anil on the line.

Anil Doradla

Sorry about that.

Ranjan Kalia

Was I able to answer your question, Anil?

Anil Doradla

So, no, I had a follow-up, but I think we got disconnected, well, either when I was asking, but we didn't here you answer on the follow-up. So let me repeat the follow-up question.

So obviously, you've talked about qualitatively you've been very positive on the outlook, the pipeline and so forth. But I think I wanted to understand the visibility in terms of your bookings. Can you remind us typically at the midpoint, is it what 75%, 80% visibility into your bookings versus is it in line with historical rates, given that now you've got Polaris, which has its own dynamics and core Virtusa. So I just wanted to kind of quantify some of the metrics there?

Ranjan Kalia

So Anil, the way we look at the revenue visibility, we look at the revenue visibility as pipeline as well as the weighted pipeline going into the revenue visibility. Both of those metrics this year are consistent for both organizations that we've tried to reconcile and made them consistent.

To give you even a more data point, our backlog historically has been in the high 60s and that's what at the midpoint, and that sort of continues to be this year. And obviously that's for the full year, so the earlier on in the quarter that percentage is a lot higher.

Anil Doradla

And what you're also suggesting is that the dynamics at Polaris is very similar to the dynamics at Virtusa in terms of the visibility, they're high-60 percentage points, right?

Ranjan Kalia

Yes. The business models are very similar.

Operator

And we'll take our next question from Vincent Colicchio with Barrington Research.

Vincent Colicchio

I was curious. Has there been any loss of key people at Polaris and is that something we should be concerned about?

Krishan Canekeratne

Actually, Vince, there hasn't been anything that's significant. We have not had any significant changes in terms of attrition, and nor have we had any significant losses that we were not expecting or that referred as a combined entity that there would be an opportunity to take advantage of some of the overlaps. So we've actually been very pleased with the progress that we have made on the integration tracks, and especially around things like attrition and leadership changes.

Vincent Colicchio

And Ranjan, what was the contribution of Apparatus and Agora in the quarter?

Ranjan Kalia

Both of them will be about $8 million in revenue, but sequentially that's -- actually they grew sequentially slightly, but nothing unusual. So they both performed based on expectations.

Operator

And at this time, I'd like to turn things back over to Kris Canekeratne for any closing or additional remarks.

End of Q&A

Krishan Canekeratne

Thank you. And thank you all for joining our Q4 and full fiscal year '16 earnings call. I want to thank our Virtusa-Polaris team members for their dedication and servicing our clients. Thank you all.

Operator

And that does conclude today's conference. Thank you for your participation. You may now disconnect.

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