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VRTU > SEC Filings for VRTU > Form 10-Q on 31-Jan-2014All Recent SEC Filings

Show all filings for VIRTUSA CORP

Form 10-Q for VIRTUSA CORP


31-Jan-2014

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 enhanced global delivery model to provide end-to-end information technology ("IT") services to Global 2000 companies. These services, which include IT and business consulting, technology implementation, application support and maintenance, development, systems integration and managed services, leverage our unique platforming methodology that transforms our clients' businesses through IT rationalization. Our services enable our clients to accelerate business outcomes by consolidating, rationalizing, and modernizing our clients' core customer-facing processes into one or more core systems. We deliver cost-effective solutions through a global delivery model, applying advanced methods such as Agile, an industry standard technique designed to accelerate application development, and our consulting methodology, Accelerated Solution Design ("ASD"), which is a collaborative decision-making and design process that ensures our solutions meet the clients' specifications and requirements. We have targeted our solution offerings to help our clients improve the efficiency of running their business and to enable them to grow their business. 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, Sweden, Germany, Austria, and Singapore and global delivery centers in Hyderabad, Chennai, Bangalore and Pune, India, Colombo, Sri Lanka, Budapest, Hungary, Kuala Lumpur, Malaysia and Manila, Philippines. At December 31, 2013, we had 7,527 employees, or team members.

In the three months ended December 31, 2013, our revenue increased by 17% to $101.0 million, compared to $86.5 million in the three months ended December 31, 2012. In the nine months ended December 31, 2013, our revenue increased by 18% to $285.8 million, compared to $243.2 million in the nine months ended December 31, 2012.

In the three months ended December 31, 2013, net income increased by 26% to $9.3 million, as compared to $7.4 million in the three months ended December 31, 2012. Net income increased by 26% to $24.3 million in the nine months ended December 31, 2013, as compared to $19.3 million in the nine months ended December 31, 2012.

The increase in revenue for the three and nine months ended December 31, 2013, as compared to the three and nine months ended December 31, 2012, primarily resulted from:

Broad based revenue growth among our clients existing at December 31, 2012


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Broad based revenue growth from our financial services and insurance and communication and technology industry groups

Increased revenue growth from our non-top ten clients

Broad based growth in all geographies, led by Europe

The key drivers of the increase in our net income for the three and nine months ended December 31, 2013, as compared to the three and nine months ended December 31, 2012, were as follows:

Higher revenue contribution from existing clients

Increase in gross profit, which also reflects lower costs due to the depreciation of the Indian rupee, partially offset by higher operating costs including an increased investment in our sales and business development organization and facilities to support our growth, amortization and increased professional services related to acquisitions

Partially offset by increased income tax expense related to higher taxable profits

High repeat business and client concentration are common in our industry. During the three months ended December 31, 2013 and 2012, 89% of our revenue was derived from clients who had been using our services for more than one year. During the nine months ended December 31, 2013 and 2012, 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 December 31, 2013, our application outsourcing and consulting revenue represented 55% and 45% respectively, of our total revenue as compared to 58% and 42%, respectively, for the three months ended December 31, 2012. For the nine months ended December 31, 2013, our application outsourcing and consulting revenue represented 56% and 44%, respectively, of our total revenue as compared to 58% and 42%, respectively, for the nine months ended December 31, 2012.

In the three months ended December 31, 2013, our European revenue increased by 48%, or $8.0 million, to $24.9 million, or 25% of total revenue, from $16.9 million, or 20% of total revenue in the three months ended December 31, 2012. In the nine months ended December 31, 2013, our European revenue increased by 47%, or $20.6 million, to $64.7 million, or 23% of total revenue, from $44.1 million, or 18% of total revenue, in the nine months ended December 31, 2012. The increase for the three and nine months ended December 31, 2013 is primarily due to broad based growth in our clients existing as of December 31, 2012, particularly in our communications industry group lead by our largest European client.

Our gross profit increased by $6.4 million to $37.2 million for the three months ended December 31, 2013, as compared to $30.8 million in the three months ended December 31, 2012. Our gross profit increased by $18.7 million to $103.7 million for the nine months ended December 31, 2013 as compared to $85.0 million in the nine months ended December 31, 2012. The increase in gross profit during the three and nine months ended December 31, 2013, as compared to the three and nine months ended December 31, 2012 was primarily due to higher revenue, partially offset by increased cost of revenue related to the growth in the number of IT professionals, which also reflects lower costs due to the depreciation of the Indian rupee. As a percentage of revenue, gross margin was 36.8% and 35.6% in the three months ended December 31, 2013 and 2012, respectively. During the nine months ended December 31, 2013 and 2012, gross margin, as a percentage of revenue, was 36.3% and 35.0%, respectively. The increase in gross margin for the three and nine months ended December 31, 2013 was primarily due to higher utilization and depreciation of the Indian rupee.

We perform our services under both time-and-materials and fixed-price contracts. Revenue from fixed-price contracts represented 31% and 19% of total revenue and revenue from time-and-materials contracts represented 69% and 81% for the three months ended December 31, 2013 and 2012, respectively. Revenue from fixed-price contracts represented 27% and 17% of total revenue and revenue from time-and-materials contracts represented 73% and 83% for the nine months ended December 31, 2013 and 2012, respectively. The increase in revenue earned from fixed-price contracts in the three and nine months ended December 31, 2013 primarily reflects our client preferences as well as our strategic effort to perform large application outsourcing services on a fixed price basis.

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. For instance, we acquired the business and assets of OSB Consulting LLC, a New Jersey limited liability company ("OSB") on November 1, 2013 to extend our service offerings to include a broader set of finance transformation services in the financial services and insurance domains, to existing and new clients. On January 2, 2014, we acquired TradeTech Consulting Scandinavia AB and its subsidiaries ("TradeTech") to expand our position within the banking, financial services


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and insurance industries by increasing our asset management and treasury services domain and technology expertise, as well as expanding our global presence into the Nordics. 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. For instance, on December 31, 2013, we entered into an amended and restated credit agreement with JPM which provided for a $25.0 million secured credit facility. We borrowed $20.0 million from this facility to fund our acquisition of TradeTech which closed on January 2, 2014. Then, on January 14, 2014, we completed our underwritten public offering of 2,645,000 shares of our common stock for net proceeds of approximately $86.2 million, which included an additional 345,000 shares sold upon the exercise of a 30-day over-allotment option which we had granted to the underwriters. We used a portion of these proceeds to repay outstanding borrowings of $20.0 million under our secured credit facility with JPM. The remaining proceeds from our offering will be used for general corporate purposes, which may include, among other things, financing of possible acquisitions, working capital and/or capital expenditures, including facilities expansion.

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 December 31, 2013, our attrition rate for the trailing 12 months, which reflects voluntary and involuntary attrition, was approximately 19.4%. Our attrition rate at December 31, 2013 reflects a slightly higher rate of voluntary attrition as compared to the corresponding prior year period and is slightly above 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.

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 December 31, 2013 compared to the three months ended December 31, 2012

The following table presents an overview of our results of operations for the three months ended December 31, 2013 and 2012:

                                     Three Months Ended
                                        December 31,           $         %
(dollars in thousands)                2013         2012      Change    Change
Revenue                            $   101,043   $ 86,474   $ 14,569     16.8 %
Costs of revenue                        63,821     55,698      8,123     14.6 %
Gross profit                            37,222     30,776      6,446     20.9 %
Operating expenses                      26,026     21,634      4,392     20.3 %
Income from operations                  11,196      9,142      2,054     22.5 %
Other income (expense)                   1,155        574        581    101.2 %
Income before income tax expense        12,351      9,716      2,635     27.1 %
Income tax expense                       3,023      2,312        711     30.8 %
Net income                         $     9,328   $  7,404   $  1,924     26.0 %


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Revenue

Revenue increased by 16.8%, or $14.5 million, from $86.5 million during the three months ended December 31, 2012 to $101.0 million in the three months ended December 31, 2013. The increase in revenue was primarily driven by higher revenue contribution from our clients existing as of December 31, 2012 as well as the result of continued broad based revenue growth led by clients in our financial services and insurance, and communication and technology, industry groups. Revenue from North American clients in the three months ended December 31, 2013 increased by $5.5 million, or 8.4%, as compared to the three months ended December 31, 2012, due to expansion of our existing clients. Revenue from European clients increased by $8.0 million, or 47.6%, as compared to the three months ended December 31, 2012, led by growth in our largest European client. We had 95 active clients at December 31, 2013, as compared to 92 active clients at December 31, 2012.

Costs of revenue

Costs of revenue increased from $55.7 million in the three months ended December 31, 2012 to $63.8 million in the three months ended December 31, 2013, an increase of $8.1 million, or 14.6%, which reflects a benefit of $2.4 million due to the depreciation of the Indian rupee. The increase in costs of revenue was primarily driven by an increase of $8.1 million in compensation costs for our IT professionals, which reflects in part annual compensation increases and an increase in travel expense of $0.5 million. This was partially offset by a decrease in sub-contractor costs of $1.2 million. At December 31, 2013, we had 6,817 IT professionals as compared to 5,999 at December 31, 2012.

As a percentage of revenue, costs of revenue decreased from 64.4% for the three months ended December 31, 2012 to 63.2% for three months ended December 31, 2013. This was due primarily to a higher utilization rate for our IT professionals for the three months ended December 31, 2013 as compared to the three months ended December 31, 2012.

Gross profit

Our gross profit increased by $6.4 million, or 20.9%, to $37.2 million for the three months ended December 31, 2013 as compared to $30.8 million for the three months ended December 31, 2012 due to higher revenue, partially offset by increased cost of revenue related to the growth in the number of IT professionals, which also reflects lower costs due to the depreciation of the Indian rupee. As a percentage of revenue, our gross profit was 36.8% and 35.6% in the three months ended December 31, 2013 and 2012, respectively.

Operating expenses

Operating expenses increased from $21.6 million in the three months ended December 31, 2012 to $26.0 million in the three months ended December 31, 2013, an increase of $4.4 million, or 20.3%, which also reflects a foreign currency benefit of $1.3 million due to the depreciation of the Indian rupee. The increase in our operating expenses in the three months ended December 31, 2013 was primarily due to an increase of $2.4 million in compensation expense related to an increase in the number of our team members, including an increased number of sales and business development personnel, a $0.7 million increase in facility expenses and a $0.7 million increase in professional fees. As a percentage of revenue, our operating expenses increased to 25.8% in the three months ended December 31, 2013 as compared to 25.0% in the three months ended December 31, 2012.

Income from operations

Income from operations increased by 22.5%, from $9.1 million in the three months ended December 31, 2012 to $11.2 million in the three months ended December 31, 2013. As a percentage of revenue, income from operations increased from 10.6% in the three months ended December 31, 2012 to 11.1% in the three months ended December 31, 2013.


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Other income (expense)

Other income (expense) increased from $0.6 million in the three months ended December 31, 2012 to $1.2 million in the three months ended December 31, 2013. This increase is primarily attributed $0.2 million of interest income reflecting an increase in cash collections and reduction in days sales outstanding and an increase of foreign currency transaction gains of $0.3 million during the three months ended December 31, 2013 compared to the three months ended December 31, 2012.

Income tax expense

Income tax expense increased by $0.7 million, from $2.3 million in the three months ended December 31, 2012 to $3.0 million in the three months ended December 31, 2013. Our effective tax rate increased from 23.8% for the three months ended December 31, 2012 to 24.5% for the three months ended December 31, 2013. The increase in the effective tax rate was primarily driven by partial expiration of certain special economic zone ("SEZ") benefits in India partly offset by a discrete tax benefit in the United Kingdom recognized in the three month period ended December 31, 2013. The increase in income tax expense of $0.7 million reflects increased taxable income and changes in geographical mix of income in the three months ended December 31, 2013.

Net income

Net income increased by 26.0%, from $7.4 million in the three months ended December 31, 2012 to $9.3 million in the three months ended December 31, 2013 due primarily to increased revenue and operating efficiencies.

Nine months ended December 31, 2013 compared to the nine months ended December 31, 2012

The following table presents an overview of our results of operations for the nine months ended December 31, 2013 and 2012:

                                     Nine Months Ended
                                       December 31,           $         %
(dollars in thousands)               2013        2012       Change    Change
Revenue                            $ 285,833   $ 243,226   $ 42,607     17.5 %
Costs of revenue                     182,126     158,194     23,932     15.1 %
Gross profit                         103,707      85,032     18,675     22.0 %
Operating expenses                    73,806      61,593     12,213     19.8 %
Income from operations                29,901      23,439      6,462     27.6 %
Other income (expense)                 2,396       2,057        339     16.5 %
Income before income tax expense      32,297      25,496      6,801     26.7 %
Income tax expense                     7,969       6,189      1,780     28.8 %
Net income                         $  24,328   $  19,307   $  5,021     26.0 %

Revenue

Revenue increased by 17.5%, or $42.6 million, from $243.2 million during the nine months ended December 31, 2012 to $285.8 million in the nine months ended December 31, 2013. The increase in revenue was primarily driven by higher revenue contribution from our clients existing as of December 31, 2012 as well as the result of continued broad based revenue growth led by clients in our financial services and insurance and communication and technology industry groups. Revenue from North American clients in the nine months ended December 31, 2013 increased by $17.4 million, or 9.2%, as compared to the nine months ended December 31, 2012, due to expansion of our existing clients. Revenue from European clients increased by $20.6 million, or 46.8%, as compared to the nine months ended December 31, 2012, led by growth in our largest European client. We had 95 active clients at December 31, 2013, as compared to 92 active clients at December 31, 2012.

Costs of revenue

Costs of revenue increased from $158.2 million in the nine months ended December 31, 2012 to $182.1 million in the nine months ended December 31, 2013, an increase of $23.9 million, or 15.1%, which also reflects a foreign currency benefit of $5.4 million due to the depreciation of the Indian rupee. The increase in costs of revenue was primarily driven by an increase of $23.4 million in compensation costs for our IT professional which reflects in part annual compensation increases, an increase in recruiting costs of $0.9 million, an increase in travel costs of $0.6 million, and an increase in client related infrastructure costs of $0.5 million. This was partially offset by a decrease in the costs of subcontractors of $1.9 million. At December 31, 2012, we had 5,999 IT professionals as compared to 6,817 at December 31, 2013.


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As a percentage of revenue, costs of revenue decreased from 65.0% for the nine months ended December 31, 2012 to 63.7% for the nine months ended December 31, 2013. This was due primarily to a higher utilization of our IT professionals and depreciation of the Indian rupee for the nine months ended December 31, 2013 as compared to the nine months ended December 31, 2012.

Gross profit

Our gross profit increased by $18.7 million, or 22.0 %, to $103.7 million for the nine months ended December 31, 2013 as compared to $85.0 million for the nine months ended December 31, 2012 due to higher revenue, partially offset by increased cost of revenue related to the growth in the number of IT professionals, which also reflects lower costs due to the depreciation of the Indian rupee. As a percentage of revenue, our gross profit was 36.3% and 35.0% in the nine months ended December 31, 2013 and 2012, respectively.

Operating expenses

Operating expenses increased from $61.6 million in the nine months ended December 31, 2012 to $73.8 million in the nine months ended December 31, 2013, an increase of $12.2 million, or 19.8%, which also reflects a foreign currency benefit of $3.1 million due to the depreciation of the Indian rupee. The increase in our operating expenses in the nine months ended December 31, 2013 was primarily due to an increase of $5.9 million in compensation expense related in part to annual compensation increases and an increase in our team members, including an increased number of sales and business development personnel, a $3.4 million increase in facility expenses and a $1.5 million increase in professional services. As a percentage of revenue, our operating expenses increased to 25.8% in the nine months ended December 31, 2013 as compared to 25.3% in the nine months ended December 31, 2012.

Income from operations

Income from operations increased by 27.6%, from $23.4 million in the nine months ended December 31, 2012 to $29.9 million in the nine months ended December 31, . . .

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