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VRTU > SEC Filings for VRTU > Form 10-Q on 2-Nov-2012All Recent SEC Filings

Show all filings for VIRTUSA CORP

Form 10-Q for VIRTUSA CORP


2-Nov-2012

Quarterly Report


Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations

The following discussion of the financial condition and results of operations of Virtusa Corporation should be read in conjunction with the consolidated financial statements and the related notes thereto included elsewhere in this Quarterly Report on Form 10-Q and the audited financial statements and notes thereto and Management's Discussion and Analysis of Financial Condition and Results of Operations included in our Annual Report on Form 10-K for the year ended March 31, 2012 (the "Annual Report"), which has been filed with the Securities and Exchange Commission, or SEC.

Forward looking statements

The statements contained in this Quarterly Report on Form 10-Q that are not historical facts are forward-looking statements (within the meaning of
Section 21E of the Securities Exchange Act of 1934, as amended) that involve risks and uncertainties. Such forward-looking statements may be identified by, among other things, the use of forward-looking terminology such as "believes," "expects," "may," "will," "should" or "anticipates" or the negative thereof or other variations thereon or comparable terminology, or by discussions of strategy that involve risks and uncertainties. These forward-looking statements, such as statements regarding anticipated future revenue, contract percentage completions, capital expenditures, management's plans and objectives and other statements regarding matters that are not historical facts, involve predictions. Our actual results, performance or achievements could differ materially from the results expressed in, or implied by, these forward-looking statements. There are a number of important factors that could cause our results to differ materially from those indicated by such forward-looking statements, including those factors set forth in Item 1A. "Risk Factors" in the Annual Report on Form 10-K for the fiscal year ended March 31, 2012. We urge you to consider those risks and uncertainties in evaluating our forward-looking statements. We caution readers not to place undue reliance upon any such forward-looking statements, which speak only as of the date made. Except as otherwise required by the federal securities laws, we disclaim any obligation or undertaking to publicly release any updates or revisions to any forward-looking statement contained herein (or elsewhere) to reflect any change in our expectations with regard thereto or any change in events, conditions or circumstances on which any such statement is based.

Business overview

Virtusa Corporation (the "Company", "Virtusa", "we", "us" or "our") is a global information technology services company. We use an offshore delivery model to provide a broad range of information technology ("IT") services, including IT consulting, technology implementation and application outsourcing. Using our enhanced global delivery model, innovative platforming approach and industry expertise, we provide cost-effective services that enable our clients to use IT to enhance business performance, accelerate time-to-market, increase productivity and improve customer experience. We manage to a targeted 25% to 75% onsite-to-offshore service delivery mix, although such delivery mix may be impacted by several factors, including our new and existing client delivery requirements as well as the impact of any acquisitions. Headquartered in Massachusetts, we have offices in the United States, the United Kingdom, the Netherlands, Germany and Singapore and global delivery centers in Hyderabad, Chennai and Bangalore, India, Colombo, Sri Lanka and Budapest, Hungary. At September 30, 2012, we had 6,084 employees, or team members.

In the three months ended September 30, 2012, our revenue increased by 15% to $80.5 million, compared to $70.3 million in the three months ended September 30, 2011. In the six months ended September 30, 2012, our revenue increased by 19% to $156.8 million, compared to $131.4 million in the six months ended September 30, 2011.

In the three months ended September 30, 2012, net income increased by 23% to $5.8 million, as compared to $4.7 million in the three months ended September 30, 2011. Net income increased by 38% to $11.9 million in the six months ended September 30, 2012, as compared to $8.6 million in the six months ended September 30, 2011.

The increase in revenue for the three and six months ended September 30, 2012, as compared to the three and six months ended September 30, 2011, primarily resulted from:

Higher revenue contribution from our clients existing as of September 30, 2011, including our top ten clients collectively and, for the six months ended September 30, 2012, clients obtained in connection with the acquisition of ALaS Consulting LLC ("ALaS") in July 2011

Broad based revenue growth from all of our industry groups, led by clients in our banking, financial services and insurance ("BFSI") industry group


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The key drivers of the increase in our net income for the three and six months ended September 30, 2012, as compared to the three and six months ended September 30, 2011, were as follows:

Higher revenue contribution from new and existing clients

Increase in operating profit due to increased operating efficiencies, partially offset by increased costs related to a higher percentage of our services performed onsite, annual compensation increases, increased use of subcontractors, as well as foreign currency transaction losses related to our hedging program

High repeat business and client concentration are common in our industry. During the three months ended September 30, 2012, 89% of our revenue was derived from clients who had been using our services for more than one year as compared to 90% for the three months ended September 30, 2011. During the six months ended September 30, 2012 and 2011, 90% of our revenue was derived from clients who had been using our services for more than one year. Accordingly, our global account management and service delivery teams focus on expanding client relationships and converting new engagements to long-term relationships to generate repeat revenue and expand revenue streams from existing clients.

We derive our revenue from two types of service offerings; application outsourcing, which is recurring in nature, and consulting, including technology implementation, which is non-recurring in nature. For the three months ended September 30, 2012, our application outsourcing and consulting revenue represented 57% and 43%, respectively, of our total revenue as compared to 52% and 48%, respectively, for the three months ended September 30, 2011. For the six months ended September 30, 2012, our application outsourcing and consulting revenue represented 57% and 43%, respectively, of our total revenue as compared to 53% and 47%, respectively, for the six months ended September 30, 2011.

In the three months ended September 30, 2012, our European revenue increased by 21%, or $2.4 million, to $13.8 million, or 17% of total revenue, from $11.3 million, or 16% of total revenue in the three months ended September 30, 2011. In the six months ended September 30, 2012, our European revenue increased by 18%, or $4.2 million, to $27.2 million, or 17% of total revenue, from $23.0 million, or 18% of total revenue, in the six months ended September 30, 2011.

Our gross profit increased by $2.7 million to $27.6 million for the three months ended September 30, 2012, as compared to $24.9 million in the three months ended September 30, 2011. Our gross profit increased by $6.3 million to $54.3 million for the six months ended September 30, 2012 as compared to $48.0 million in the six months ended September 30, 2011. The increase in gross profit during the three and six months ended September 30, 2012, as compared to the three and six months ended September 30, 2011, was primarily due to higher revenue, partially offset by increased cost of revenue, which includes increases in the number of IT professionals, annual compensation increases, higher costs related to an increased percentage of onsite work, an increased use of subcontractors, as well as foreign currency transaction losses related to our hedging program. As a percentage of revenue, gross margin was 34.3% and 35.4% in the three months ended September 30, 2012 and 2011, respectively. During the six months ended September 30, 2012 and 2011, gross margin, as a percentage of revenue, was 34.6% and 36.5%, respectively. The decrease in gross margin for the three and six months ended September 30, 2012 was primarily due to higher costs related to an increased percentage of onsite work, an increased use of subcontractors, as well as foreign currency transaction losses related to our hedging program.

We perform our services under both time-and-materials and fixed-price contracts. Revenue from fixed-price contracts represented 17% and 15% respectively of total revenue in the three and six months ended September 30, 2012, respectively, as compared to 17% and 19% of total revenue for the three and six months ended September 30, 2011, respectively. The revenue earned from fixed-price contracts in the three and six months ended September 30, 2012 primarily reflects our client preferences.

Over the last few fiscal years, we have also supplemented organic revenue growth with acquisitions. These acquisitions have focused on adding domain expertise, expanding our professional services teams and expanding our client base. We expect that for our long-term growth, we will continue to seek evolving market opportunities through a combination of organic growth and acquisitions. We believe we can fund future acquisitions with our internally available cash, cash equivalents and marketable securities, cash generated from operations, or through debt or equity financings, although we cannot assure you that any such additional financing will be available at terms favorable to us, or at all.

As an IT services company, our revenue growth is highly dependent on our ability to attract, develop, motivate and retain skilled IT professionals. We monitor our overall attrition rates and patterns to align our people management strategy with our growth objectives. At September 30, 2012, our attrition rate for the trailing 12 months, which reflects voluntary and involuntary attrition, was 18.2%. Our attrition rate at September 30, 2012 reflects a lower rate of voluntary attrition as compared to the corresponding prior year period and is approaching our long-term goal. Although we remain committed to continuing to improve our attrition levels, there is intense competition for IT professionals with the specific domain skills necessary to provide the type of services we offer. If our attrition rate increases or is sustained at higher levels, our growth may slow and our cost of attracting and retaining IT professionals could increase.


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We engage in a foreign currency hedging strategy using foreign currency forward contracts designed to hedge fluctuation in the Indian rupee and Sri Lankan rupee against the U.S. dollar and U.K. pound sterling, as well as the U.K. pound sterling against the U.S. dollar, to reduce the effect of change in these foreign currency exchange rate changes on our foreign operations and intercompany balances. There is no assurance that these hedging programs or hedging contracts will be effective. Because these foreign currency forward contracts are designed to reduce volatility in the Indian rupee and U.K. pound sterling exchange rates, they not only reduce the negative impact of a stronger Indian rupee and weaker U.K. pound sterling but also could reduce the positive impact of a weaker Indian rupee and stronger U.K. pound sterling on our Indian rupee expenses and U.K. pound sterling denominated revenue. In addition, to the extent that these hedges do not qualify for hedge accounting, we may have to recognize gains or losses on the aggregate amount of hedges placed earlier and in larger amounts than expected.

Application of critical accounting estimates and risks

The preparation of financial statements in conformity with U.S. generally accepted accounting principles ("GAAP") requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, including the recoverability of tangible assets, the disclosure of contingent assets and liabilities at the dates of the financial statements and the reported amounts of revenue and expenses during the reporting periods. On an ongoing basis, we evaluate our estimates and judgments, in particular those related to the recognition of revenue and profits based on the percentage of completion method of accounting for fixed-price contracts, share-based compensation, income taxes, including reserves for uncertain tax positions, deferred taxes and liabilities and valuation of financial instruments including derivative contracts and investments. Actual amounts could differ significantly from these estimates. Our management bases its estimates and judgments on historical experience and various other factors that are believed to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities and the amounts of revenue and expenses that are not readily apparent from other sources. Additional information about these critical accounting policies may be found in the "Management's Discussion and Analysis of Financial Condition and Results of Operations" section included in the Annual Report.

Results of operations

Three months ended September 30, 2012 compared to the three months ended September 30, 2011

The following table presents an overview of our results of operations for the three months ended September 30, 2012 and 2011.

                                     Three Months Ended
                                       September 30,          $        %
(dollars in thousands)                2012         2011     Change   Change
Revenue                            $    80,535   $ 70,311   10,224     14.5 %
Costs of revenue                        52,902     45,395    7,507     16.5 %
Gross profit                            27,633     24,916    2,717     10.9 %
Operating expenses                      20,204     19,449      755      3.9 %
Income from operations                   7,429      5,467    1,962     35.9 %
Other income (expense)                     241        445     (204 )  (45.8 )%
Income before income tax expense         7,670      5,912    1,758     29.7 %
Income tax expense                       1,907      1,224      683     55.8 %
Net income                         $     5,763   $  4,688    1,075     22.9 %

Revenue

Revenue increased by 14.5%, or $10.2 million, from $70.3 million during the three months ended September 30, 2011 to $80.5 million in the three months ended September 30, 2012. The increase in revenue was primarily driven by higher revenue contribution from our clients existing as of September 30, 2011 and also the result of continued broad based revenue growth from all of our industry groups, led by growth in our BFSI industry group. Revenue from North American clients in the three months ended September 30, 2012 increased by $7.4 million, or 13.2%, as compared to the three months ended September 30, 2011, due to expansion of our existing clients including our top ten clients. Revenue from European clients increased by $2.4 million, or 21.3%, as compared to the three months ended September 30, 2011. We had 92 active clients at September 30, 2012, as compared to 86 active clients at September 30, 2011.


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Costs of revenue

Costs of revenue increased from $45.4 million in the three months ended September 30, 2011 to $52.9 million in the three months ended September 30, 2012, an increase of $7.5 million, or 16.5%. The increase in cost of revenue was primarily driven by an increase of $3.2 million in compensation costs for our IT professionals, including annual compensation increases. At September 30, 2012, we had 5,571 IT professionals as compared to 5,113 at September 30, 2011. In addition, we incurred increased subcontractor costs of $1.9 million in the three months ended September 30, 2012, as compared to the three months ended September 30, 2011, primarily due to an increase in onsite work. We also incurred hedging losses of $1.5 million during the three months ended September 30, 2012 compared to a neutral hedging position during the three months ended September 30, 2011.

As a percentage of revenue, cost of revenue increased from 64.6% for the three months ended September 30, 2011 to 65.7% for three months ended September 30, 2012. This was due primarily to a higher percentage of our services performed onsite, offset by a higher utilization rate for our IT professionals of 78% for the three months ended September 30, 2012 compared to a utilization rate of 75% for the three months ended September 30, 2011.

Gross profit

Our gross profit increased by $2.7 million, or 10.9%, to $27.6 million for the three months ended September 30, 2012 as compared to $24.9 million for the three months ended September 30, 2011 due to a higher revenue base, partially offset by increased costs related to a higher percentage of our services being performed onsite and increased subcontractor costs. As a percentage of revenue, our gross profit was 34.3% and 35.4% in the three months ended September 30, 2012 and 2011, respectively.

Operating expenses

Operating expenses increased from $19.4 million in the three months ended September 30, 2011 to $20.2 million in the three months ended September 30, 2012, an increase of $0.8 million, or 3.9%. The increase in our operating expenses in the three months ended September 30, 2012 was primarily due to an increase of $0.8 million in hedging losses, $0.3 million in travel expenses and a $0.1 million increase in professional services, partially offset by a $0.4 million decrease in facility expenses. As a percentage of revenue, our operating expenses decreased to 25.1% in the three months ended September 30, 2012 as compared to 27.7% in the three months ended September 30, 2011. This decrease was primarily due to increased operating efficiencies leveraged over a larger revenue base.

Income from operations

Income from operations increased by 35.9%, from $5.5 million in the three months ended September 30, 2011 to $7.4 million in the three months ended September 30, 2012. As a percentage of revenue, income from operations increased from 7.8% in the three months ended September 30, 2011 to 9.2% in the three months ended September 30, 2012, primarily due to increased operating efficiencies leveraged over a larger revenue base.

Other income (expense)

Other income (expense) decreased from an income of $0.4 million in the three months ended September 30, 2011 to $0.2 million in the three months ended September 30, 2012. This decrease is primarily attributed to an increase of foreign currency transaction losses in the three months ended September 30, 2012 of $0.5 million, as compared to $0.1 million in foreign currency transaction losses in the three months ended September 30, 2011.

Income tax expense

Income tax expense increased by $0.7 million, from $1.2 million in the three months ended September 30, 2011 to $1.9 million in the three months ended September 30, 2012. Our effective tax rate increased from 20.7% for the three months ended September 30, 2011 to 24.9% for the three months ended September 30, 2012. The increase in income tax expense of $0.7 million reflects increased taxable income in the three months ended September 30, 2012 and a higher effective tax rate driven by our geographical mix of profits.


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Net income

Net income increased by 22.9%, from $4.7 million in the three months ended September 30, 2011 to $5.8 million in the three months ended September 30, 2012 due primarily to higher operating profits.

Six months ended September 30, 2012 compared to the six months ended September 30, 2011

The following table presents an overview of our results of operations for the six months ended September 30, 2012 and 2011.

                                     Six Months Ended
                                       September 30,         $        %
(dollars in thousands)               2012        2011      Change   Change
Revenue                            $ 156,752   $ 131,356   25,396     19.3 %
Costs of revenue                     102,496      83,377   19,119     22.9 %
Gross profit                          54,256      47,979    6,277     13.1 %
Operating expenses                    39,958      37,725    2,233      5.9 %
Income from operations                14,298      10,254    4,044     39.4 %
Other income                           1,481         845      636     75.3 %
Income before income tax expense      15,779      11,099    4,680     42.2 %
Income tax expense                     3,877       2,456    1,421     57.9 %
Net income                         $  11,902   $   8,643    3,259     37.7 %

Revenue

Revenue increased by 19.3%, or $25.4 million, from $131.4 million during the six months ended September 30, 2011 to $156.8 million in the six months ended September 30, 2012. The increase in revenue was primarily driven by higher revenue contribution from our clients existing as of September 30, 2011. The increase in revenue was also the result of continued broad based revenue growth from all of our industry groups, led by growth in our BFSI industry group. Revenue from North American clients increased 20.1%, or $20.7 million, in the six months ended September 30, 2012, as compared to the six months ended September 30, 2011 due to higher revenue contribution from our clients existing at September 30, 2011, including our top ten clients collectively and clients obtained in connection with the acquisition of ALaS in July 2011. Revenue from European clients increased 18.1%, or $4.2 million, in the six months ended September 30, 2012, as compared to the six months ended September 30, 2011, primarily due to revenue contribution from clients added in the twelve months ended September 30, 2012. We had 92 active clients at September 30, 2012 as compared to 86 active clients at September 30, 2011.

Costs of revenue

Costs of revenue increased from $83.4 million in the six months ended September 30, 2011 to $102.5 million in the six months ended September 30, 2012, an increase of $19.1 million, or 22.9%. The increase in costs of revenue was primarily driven by an increase of $8.8 million in compensation costs for our IT professionals, including annual compensation increases, as compared to the six months ended September 30, 2011. At September 30, 2012, we had 5,571 IT professionals as compared to 5,113 IT professionals at September 30, 2011. In addition, there were increased travel costs of $1.4 million and increased subcontractor costs of $4.8 million in the six months ended September 30, 2012 as compared to the six months ended September 30, 2011 primarily due to an increase in onsite work. We also incurred hedging losses of $2.7 million during the six months ended September 30, 2012 compared to a hedging gain of $0.6 million during the six months ended September 30, 2011. As a percentage of revenue, cost of revenue increased from 63.5% for the six months ended September 30, 2011 to 65.4% for six months ended September 30, 2012.

Gross profit

Our gross profit increased by $6.3 million, or 13.1%, to $54.3 million for the six months ended September 30, 2012, as compared to $48.0 million in the six months ended September 30, 2011, due to a higher revenue base, partially offset by an increased number of IT professionals, annual compensation increases, increased subcontractor costs and higher costs related to increased onsite work. As a percentage of revenue, gross profit was 34.6% and 36.5% in the six months ended September 30, 2012 and 2011, respectively.


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Operating expenses

Operating expenses increased from $37.7 million in the six months ended September 30, 2011 to $40.0 million in the six months ended September 30, 2012, an increase of $2.3 million, or 5.9%. The increase in our operating expenses in the six months ended September 30, 2012 resulted primarily from an increase of $1.1 million in compensation expenses and a $0.5 million increase in travel expenses. As a percentage of revenue, our operating expenses decreased from 28.7% in the six months ended September 30, 2011 to 25.5% in the six months ended September 30, 2012, due to leveraging operating efficiencies over a higher revenue base.

Income from operations

Income from operations increased by 39.4%, from $10.3 million in the six months ended September 30, 2011 to $14.3 million in the six months ended September 30, 2012. As a percentage of revenue, income from operations increased from 7.8% in the six months ended September 30, 2011 to 9.1% in the six months ended September 30, 2012, primarily due to growth in revenue and increased operating efficiencies.

Other income (expense)

Other income (expense) increased from $0.8 million in the six months ended September 30, 2011 to $1.5 million in the six months ended September 30, 2012. The increase is attributed to foreign currency transaction losses under our hedging program of $0.2 million during the six months ended September 30, 2012 compared to foreign currency gains under our hedging program of $0.3 million during the six months ended September 30, 2011 as well as an increase in interest income of $0.3 million.

Income tax expense

Income tax expense increased by $1.4 million from $2.5 million in the six months ended September 30, 2011 to $3.9 million in the six months ended September 30, 2012. Our effective tax rate increased from 22.1% for the six months ended September 30, 2011 to 24.6% for the six months ended September 30, 2012. The increase in income tax expense of $1.4 million reflects increased taxable income in the six months ended September 30, 2012 and a higher effective tax rate driven by our geographical mix of profits.

Net income

Net income increased by 37.7%, or $3.3 million, from $8.6 million in the six months ended September 30, 2011 to $11.9 million in the six months ended September 30, 2012 due primarily to higher operating profits and increases in other income.

Liquidity and capital resources

We have financed our operations from sales of shares of equity securities, including common stock, and from cash from operations. We have not borrowed against our existing or preceding credit facilities.

In May 2012, our board of directors authorized a share repurchase program of up to $15.0 million of our common stock over a 12 month period from the approval date, subject to certain price and other trading restrictions. During the three months ended September 30, 2012, we did not purchase any shares of our common stock. During the six months ended September 30, 2012, we purchased 97,315 shares of our common stock for an aggregate purchase price of approximately $1,406 (excluding commissions). (See Part II, Item 2 of this Quarterly Report on Form 10-Q). As of October 15, 2012, our board of directors suspended the share repurchase program.

On July 1, 2011, we acquired substantially all of the assets of ALaS for the purchase price of approximately $27.8 million in cash, 10% of which was held back by us for a period of 12 months as security for the indemnification obligations of ALaS and its members. In July 2012, we released $2.8 million to . . .

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