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VRTU > SEC Filings for VRTU > Form 10-Q on 2-Aug-2013All Recent SEC Filings

Show all filings for VIRTUSA CORP

Form 10-Q for VIRTUSA CORP


2-Aug-2013

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 fiscal year ended March 31, 2013 (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, 2013. 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, Austria and Singapore and global delivery centers in Hyderabad, Chennai and Bangalore, India, Colombo, Sri Lanka, Kuala Lumpur, Malaysia and Budapest, Hungary. At June 30, 2013, we had 6,877 employees, or team members.

In the three months ended June 30, 2013, our revenue increased by 19% to $90.5 million, compared to $76.2 million in the three months ended June 30, 2012.

In the three months ended June 30, 2013, net income increased by 23% to $7.5 million, as compared to $6.1 million in the three months ended June 30, 2012.

The increase in revenue for the three months ended June 30, 2013, as compared to the three months ended June 30, 2012, primarily resulted from:

Broad based revenue growth among our clients existing at June 30, 2012, particularly our top ten clients collectively

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

Broad based growth in all geographies, led by North America and Europe

The key drivers of the increase in our net income for the three months ended June 30, 2013, as compared to the three months ended June 30, 2012, were as follows:


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Higher revenue contribution from new and existing clients

Increase in gross profit, partially offset by higher operating costs including an increased investment in our sales and business development organization and facilities to support our growth

High repeat business and client concentration are common in our industry. During the three months ended June 30, 2013 and 2012, 92% and 91%, respectively, 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 June 30, 2013, our application outsourcing and consulting revenue represented 57% and 43%, respectively, of our total revenue as compared to 58% and 42%, respectively, for the three months ended June 30, 2012.

In the three months ended June 30, 2013, our European revenue increased by 37%, or $4.9 million, to $18.3 million, or 20% of total revenue, from $13.4 million, or 18% of total revenue in the three months ended June 30, 2012. The increase for the three months ended June 30, 2013 is primarily due to the strength of two of our largest clients in Europe.

Our gross profit increased by $6.1 million to $32.7 million for the three months ended June 30, 2013, as compared to $26.6 million in the three months ended June 30, 2012. The increase in gross profit during the three months ended June 30, 2013, as compared to the three months ended June 30, 2012, was primarily due to higher revenue and increased utilization, partially offset by increased cost of revenue, which includes increases in the number of IT professionals. As a percentage of revenue, gross margin was 36.1% and 34.9% in the three months ended June 30, 2013 and 2012, respectively. The increase in gross margin for the three months ended June 30, 2013 was primarily due to higher revenue and depreciation in the Indian rupee, partially offset by increased compensation costs related to an increase in the number of IT professionals.

We perform our services under both time-and-materials and fixed-price contracts. Revenue from fixed-price contracts represented 21% and 14% of total revenue and revenue from time-and-materials contracts represented 79% and 86% for the three months ended June 30, 2013 and 2012, respectively. The increase in revenue earned from fixed-price contracts in the three months ended June 30, 2013 primarily reflects our client preferences.

From time to time, 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 June 30, 2013, our attrition rate for the trailing 12 months, which reflects voluntary and involuntary attrition, was approximately 18.5%. Our attrition rate at June 30, 2013 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.

We engage in a foreign currency hedging strategy using foreign currency forward contracts designed to hedge fluctuations 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 or 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.


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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 June 30, 2013 compared to the three months ended June 30, 2012

The following table presents an overview of our results of operations for the three months ended June 30, 2013 and 2012:

                                     Three Months Ended
                                          June 30,             $         %
(dollars in thousands)                2013         2012      Change    Change
Revenue                            $    90,489   $ 76,217   $ 14,272     18.7 %
Costs of revenue                        57,802     49,594      8,208     16.6 %
Gross profit                            32,687     26,623      6,064     22.8 %
Operating expenses                      23,758     19,754      4,004     20.3 %
Income from operations                   8,929      6,869      2,060     30.0 %
Other income (expense)                   1,136      1,240       (104 )   (8.4 )%
Income before income tax expense        10,065      8,109      1,956     24.1 %
Income tax expense                       2,543      1,970        573     29.1 %
Net income                         $     7,522   $  6,139   $  1,383     22.5 %

Revenue

Revenue increased by 18.7%, or $14.3 million, from $76.2 million during the three months ended June 30, 2012 to $90.5 million in the three months ended June 30, 2013. The increase in revenue was primarily driven by higher revenue contribution from our clients existing as of June 30, 2012 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 June 30, 2013 increased by $7.5 million, or 12.5%, as compared to the three months ended June 30, 2012, due to expansion of our existing clients including our top ten clients. Revenue from European clients increased by $4.9 million, or 36.5%, as compared to the three months ended June 30, 2012, led by growth in our two largest European clients. We had 95 active clients at June 30, 2013, as compared to 91 active clients at June 30, 2012.

Costs of revenue

Costs of revenue increased from $49.6 million in the three months ended June 30, 2012 to $57.8 million in the three months ended June 30, 2013, an increase of $8.2 million, or 16.6%. The increase in cost of revenue was primarily driven by an increase of $7.9 million in compensation costs for our IT professionals. At June 30, 2013, we had 6,279 IT professionals as compared to 5,348 at June 30, 2012.

As a percentage of revenue, cost of revenue decreased from 65.1% for the three months ended June 30, 2012 to 63.9% for three months ended June 30, 2013. This was due primarily to a higher utilization rate for our IT professionals, depreciation


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of the Indian rupee and a decrease in the percentage of work performed onsite for the three months ended June 30, 2013 as compared to the three months ended June 30, 2012.

Gross profit

Our gross profit increased by $6.1 million, or 22.8 %, to $32.7 million for the three months ended June 30, 2013 as compared to $26.6 million for the three months ended June 30, 2012 due to a higher revenue base and increased utilization, depreciation of the Indian rupee and a decrease in percentage of work performed onsite. As a percentage of revenue, our gross profit was 36.1% and 34.9% in the three months ended June 30, 2013 and 2012, respectively.

Operating expenses

Operating expenses increased from $19.8 million in the three months ended June 30, 2012 to $23.8 million in the three months ended June 30, 2013, an increase of $4.0 million, or 20.3%. The increase in our operating expenses in the three months ended June 30, 2013 was primarily due to an increase of $1.7 million in compensation expense related to the impact of the timing of annual compensation increases and an increased number of sales and business development personnel, a $1.6 million increase in facility expenses and a $0.3 million increase in professional expenses. As a percentage of revenue, our operating expenses increased to 26.3% in the three months ended June 30, 2013 as compared to 25.9% in the three months ended June 30, 2012.

Income from operations

Income from operations increased by 30.0%, from $6.9 million in the three months ended June 30, 2012 to $8.9 million in the three months ended June 30, 2013. As a percentage of revenue, income from operations increased from 9.0% in the three months ended June 30, 2012 to 9.9% in the three months ended June 30, 2013, primarily due to higher gross margins.

Other income (expense)

Other income (expense) decreased from $1.2 million in the three months ended June 30, 2012 to $1.1 million in the three months ended June 30, 2013. This decrease is primarily attributed to an increase of foreign currency transaction losses in the three months ended June 30, 2013 compared to the three months ended June 30, 2012.

Income tax expense

Income tax expense increased by $0.5 million, from $2.0 million in the three months ended June 30, 2012 to $2.5 million in the three months ended June 30, 2013. Our effective tax rate increased from 24.3% for the three months ended June 30, 2012 to 25.3% for the three months ended June 30, 2013. The increase in the effective tax rate was primarily driven by the partial expiration of certain SEZ tax holidays in India, partially offset by new SEZ holiday benefits. The increase in income tax expense of $0.5 million reflects increased taxable income and an increase in the effective tax rate in the three months ended June 30, 2013.

Net income

Net income increased by 22.5%, from $6.1 million in the three months ended June 30, 2012 to $7.5 million in the three months ended June 30, 2013 due primarily to higher operating profits.

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.

On July 30, 2010, we entered into a $3.0 million credit agreement with J.P. Morgan Chase Bank, N.A. ("JPMC") which had an expiration date of July 31, 2013. The primary purpose of this credit agreement is to support our foreign currency hedging programs. The credit agreement is secured by a grant of a security interest in our U.S. assets in favor of JPMC as well as other collateral. The agreement contains financial and reporting covenants and limitations. At June 30, 2013, there were no amounts outstanding under this credit agreement and we are in compliance with all covenants. On July 31, 2013, the Company entered into an amendment to its $3,000 credit agreement with JPMC to extend the expiration date until July 31, 2016 (See Note 12 to the notes to our consolidated financial statements included in this Quarterly Report).


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At June 30, 2013, a significant portion of our cash and short-term investments was held by our foreign subsidiaries. We continually monitor our cash needs and employ tax planning and financing strategies to ensure cash is available in the appropriate jurisdictions to meet operating needs. The cash held by our foreign subsidiaries is considered indefinitely reinvested in local operations. If required, it could be repatriated to the United States. However, under current law, any repatriation would be subject to United States federal income tax less applicable foreign tax credits.

Beginning in fiscal 2009, our U.K. subsidiary entered into an agreement with an unrelated financial institution to sell, without recourse, certain of its Europe-based accounts receivable balances from one client to the financial institution. During the three months ended June 30, 2013, we sold $5.8 million of receivables under the terms of the financing agreement. Fees paid pursuant to this agreement were not material during the three months ended June 30, 2013. No amounts were due under the financing agreement at June 30, 2013, but we may elect to use this program again in future periods. However, we cannot provide any assurances that this or any other financing facilities will be available or utilized in the future.

Cash flows

The following table summarizes our cash flows for the periods presented:

                                                        Three Months Ended
                                                             June 30,
(in thousands)                                           2013         2012
Net cash (used in) provided by operating activities   $    (1,783 ) $  2,374
Net cash used for investing activities                     (4,536 )   (7,505 )
Net cash provided by (used in) financing activities         3,071     (2,294 )
Effect of exchange rate changes on cash                    (2,983 )   (2,501 )
Net decrease in cash and cash equivalents                  (6,231 )   (9,926 )
Cash and cash equivalents, beginning of period             57,199     58,105
Cash and cash equivalents, end of period              $    50,968   $ 48,179

Operating activities

Net cash used in operating activities was $1.8 million during the three months ended June 30, 2013 as compared to $2.4 million provided by operating activities during the three months ended June 30, 2012. This decrease was primarily attributable to an increase in working capital of $4.6 million, primarily driven by an increase in days sales outstanding from 77 days at June 30, 2012 to 91 days at June 30, 2013 or $7.1 million, a decreased change in other long-term assets and liabilities of $0.2 million and excess tax benefits from stock option exercises of $1.8 million. These were partially offset by an increase in net income of $1.4 million, an increased change in income tax payable of $0.3 million, an increased change in prepaid and other current assets of $1.4 million, an increased change in depreciation and share based compensation of $1.0 million.

Investing activities

Net cash used in investing activities was $4.5 million during the three months ended June 30, 2013 as compared to $7.5 million during the three months ended June 30, 2012. The change was primarily due to the net increases in the proceeds of investments of $1.3 million and a decrease in the purchase of property and equipment of $1.4 million.

Financing activities

Net cash provided by financing activities was $3.1 million during the three months ended June 30, 2013 as compared to cash used in financing activities of $2.3 million during the three months ended June 30, 2012. The increase in cash provided is primarily due to an increase in excess tax benefits from the stock options exercises of $1.8 million, an increase in proceeds from the exercise of common stock options of $1.2 million, a decrease in principal payments on capital lease obligations of $1.0 million and a decrease in the purchase of common stock of $1.4 million.

Off-balance sheet arrangements

We do not have investments in special purpose entities or undisclosed borrowings or debt.


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We have a foreign currency cash flow hedging program designed to mitigate the risks of volatility in the Indian rupee against the U.S. dollar and U.K. pound sterling as described below in "Qualitative and Quantitative Disclosures about Market Risk." The program contemplates a partially hedged position of the Indian rupee for a rolling twelve-quarter period. From time to time, we may also purchase multiple foreign currency forward contracts designed to hedge fluctuation in foreign currencies, such as the U.K. pound sterling against the U.S. dollar, and multiple foreign currency hedges designed to hedge foreign currency transaction gains and losses on our intercompany balances. Other than these foreign currency derivative contracts, we have not entered into off-balance sheet transactions, arrangements or other relationships with unconsolidated entities or other persons that are likely to affect liquidity or the availability of or requirements for capital resources.

Recent accounting pronouncements

In February 2013, the Financial Accounting Standards Board, or FASB, issued additional guidance related to accumulated other comprehensive income, requiring the presentation of significant amounts reclassified out of accumulated other comprehensive income to the respective line items in the statement of operations. For those amounts required by U.S. GAAP to be reclassified to earnings in their entirety in the same reporting period, this presentation is required either on the statement of operations or in a single footnote. For items that are not required to be reclassified in their entirety to earnings, the presentation requirement can be met by cross-referencing disclosures elsewhere in the footnotes. We adopted this standard on April 1, 2013. The adoption of this standard affects financial statement presentation only and has no effect on our financial condition or consolidated results of operations.

In July 2013, the Financial Accounting Standards Board ("FASB") issued Accounting Standards Update ("ASU") 2013-11 "Income Taxes-Presentation of an Unrecognized Tax Benefit When a Net Operating Loss Carryforward, a Similar Tax Loss, or a Tax Credit Carryforward Exists" which is part of Accounting Standards Codification ("ASC") 740: Income Taxes. The new guidance requires an entity to present an unrecognized tax benefit and an NOL carryforward, a similar tax loss, or a tax credit carryforward on a net basis as part of a deferred tax asset, unless the unrecognized tax benefit is not available to reduce the deferred tax asset component or would not be utilized for that purpose, then a liability would be recognized. The updated accounting guidance is effective for fiscal years beginning after December 15, 2013. We do not expect the adoption of this guidance to have a material impact on the Company's consolidated financial position.

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