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VRTU > SEC Filings for VRTU > Form 10-Q on 6-Aug-2014All Recent SEC Filings

Show all filings for VIRTUSA CORP

Form 10-Q for VIRTUSA CORP


6-Aug-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, 2014 (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," "seek," "intends," "plans," "estimates," "projects," "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, the effect of new accounting pronouncements, 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, 2014. 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, Germany, Sweden and Austria, with global delivery centers in India, Sri Lanka, Hungary, Singapore, Malaysia and the Philippines, as well as a near shore delivery center in the United States. At June 30, 2014, we had 8,421 employees, or team members.

In the three months ended June 30, 2014, our revenue increased by 24% to $112.3 million, compared to $90.5 million in the three months ended June 30, 2013.

In the three months ended June 30, 2014, net income increased by 20% to $9.0 million, as compared to $7.5 million in the three months ended June 30, 2013.

The increase in revenue for the three months ended June 30, 2014, as compared to the three months ended June 30, 2013, primarily resulted from:

Broad based revenue growth among our clients existing at June 30, 2013, particularly among our non-top ten clients collectively

Broad based revenue growth within our banking, financial services and insurance ("BFSI") and communication and technology ("C&T") industry groups

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

Revenue generated from clients acquired by us in the acquisition of OSB Consulting LLC, ("OSB") on November 1, 2013 and TradeTech Consulting Scandinavia AB and its subsidiaries ("TradeTech") on January 2, 2014


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The key drivers of the increase in our net income for the three months ended June 30, 2014, as compared to the three months ended June 30, 2013, were as follows:

Higher revenue contribution from existing clients, as well as clients from our OSB and TradeTech acquisitions

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, and acquisition amortization

Lower operating costs related to the reduction of the earn-out consideration previously accrued for in connection with the TradeTech acquisition partially offset by an increase of the earn-out consideration in connection with the OSB acquisition

Reduced 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 June 30, 2014 and 2013, 85% and 92%, 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, 2014, our application outsourcing and consulting revenue represented 55% and 45%, respectively, of our total revenue as compared to 57% and 43%, respectively, for the three months ended June 30, 2013.

In the three months ended June 30, 2014, our European revenue increased by 74%, or $13.6 million, to $31.9 million, or 28% of total revenue, from $18.3 million, or 20% of total revenue in the three months ended June 30, 2013. The increase in revenue for the three months ended June 30, 2014 is primarily due to the broad-based revenue growth in Europe, particularly from two of our largest European clients, as well as clients acquired in our TradeTech acquisition.

Our gross profit increased by $7.0 million to $39.7 million for the three months ended June 30, 2014, as compared to $32.7 million in the three months ended June 30, 2013. The increase in gross profit during the three months ended June 30, 2014, as compared to the three months ended June 30, 2013, was primarily due to higher revenue, partially offset by increased cost of revenue, which includes increases in the number of IT professionals. As a percentage of revenue, gross margin was 35.3% and 36.1% in the three months ended June 30, 2014 and 2013, respectively. The decrease in gross margin for the three months ended June 30, 2014 was primarily due to increased compensation costs related to an increase in the number of IT professionals and higher subcontractor costs partially offset by depreciation in the Indian rupee.

We perform our services under both time-and-materials and fixed-price contracts. Revenue from fixed-price contracts represented 35% and 21% of total revenue, and revenue from time-and-materials contracts represented 65% and 79% of total revenue for the three months ended June 30, 2014 and 2013, respectively. The increase in revenue earned from fixed-price contracts in the three months ended June 30, 2014 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, 2014, our attrition rate for the trailing 12 months, which reflects voluntary and involuntary attrition, was approximately 19.0%. Our attrition rate at June 30, 2014 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.


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We engage in a foreign currency hedging strategy using foreign currency forward contracts designed to hedge fluctuations in the Indian rupee against the U.S. dollar and U.K. pound sterling, the Swedish krona ("SEK") against the U.S. dollar and the U.K. pound sterling against the U.S. dollar, to reduce the effect of change in these foreign currency exchange rates on our foreign operations, when consolidated into U.S. dollars 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, contingent consideration both upon and subsequent to acquisitions 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, 2014 compared to the three months ended June 30, 2013

The following table presents an overview of our results of operations for the three months ended June 30, 2014 and 2013:

                                     Three Months Ended
                                          June 30,             $         %
(dollars in thousands)                2014         2013      Change    Change
Revenue                            $   112,274   $ 90,489   $ 21,785     24.1 %
Costs of revenue                        72,588     57,802     14,786     25.6 %
Gross profit                            39,686     32,687      6,999     21.4 %
Operating expenses                      28,456     23,758      4,698     19.8 %
Income from operations                  11,230      8,929      2,301     25.8 %
Other income (expense)                     994      1,136       (142 )  (12.5 )%
Income before income tax expense        12,224     10,065      2,159     21.5 %
Income tax expense                       3,221      2,543        678     26.7 %
Net income                         $     9,003   $  7,522   $  1,481     19.7 %

Revenue

Revenue increased by 24.1%, or $21.8 million, from $90.5 million during the three months ended June 30, 2013 to $112.3 million in the three months ended June 30, 2014. The increase in revenue was primarily driven by higher revenue contribution from our clients existing as of June 30, 2013, particularly among our non-top ten clients collectively, revenue generated from clients acquired in the acquisition of OSB and TradeTech and broad based revenue growth within our BFSI and C&T industry groups. Revenue from North American clients in the three months ended June 30, 2014 increased by $6.2 million, or 9.2%, as compared to the three months ended June 30, 2013, due to broad based revenue growth, particularly in our insurance group and clients acquired in the last twelve months. Revenue from European clients increased by $13.6 million, or 73.9%, as compared to the three months ended June 30, 2013, primarily due to the broad-based growth in Europe, particularly two of our largest European clients, as well as clients acquired in our TradeTech acquisition. We had 107 active clients at June 30, 2014, as compared to 95 active clients at June 30, 2013.


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Costs of revenue

Costs of revenue increased from $57.8 million in the three months ended June 30, 2013 to $72.6 million in the three months ended June 30, 2014, an increase of $14.8 million, or 25.6%, which reflects a benefit of $1.3 million due to the depreciation of the Indian rupee. The increase in cost of revenue was primarily due to an increase in the number of IT professionals and related compensation and benefit costs of $9.9 million. The increased costs of revenue are also due to an increase of $1.5 million in travel expenses and an increase in subcontractor costs of $3.1 million. At June 30, 2014, we had 7,535 IT professionals as compared to 6,279 at June 30, 2013.

As a percentage of revenue, cost of revenue increased from 63.9% for the three months ended June 30, 2013 to 64.7% for three months ended June 30, 2014.

Gross profit

Our gross profit increased by $7.0 million, or 21.4 %, to $39.7 million for the three months ended June 30, 2014, as compared to $32.7 million for the three months ended June 30, 2013, primarily due to our growth in revenue, partially offset by increased cost of revenue related to the growth in the number of IT professionals, subcontractor costs and immigration related costs. As a percentage of revenue, our gross profit was 35.3% and 36.1% in the three months ended June 30, 2014 and 2013, respectively.

Operating expenses

Operating expenses increased from $23.8 million in the three months ended June 30, 2013 to $28.5 million in the three months ended June 30, 2014, an increase of $4.7 million, or 19.8%, which reflects a benefit of $0.7 million due to the depreciation of the Indian rupee. The increase in operating expenses was primarily due to an increase of $3.5 million in compensation related expenses, $1.5 million in facilities expenses and an increase of $0.7 million in travel expenses, partially offset by a $1.2 million net decrease in earn-out consideration. The $1.2 million net decrease in earn-out consideration was a result of a $1.8 million decrease in earn-out consideration related to the TradeTech acquisition offset by approximately $0.6 million increase in earn-out consideration related to the OSB acquisition. As a percentage of revenue, our operating expenses decreased to 25.3% in the three months ended June 30, 2014 as compared to 26.3% in the three months ended June 30, 2013.

Income from operations

Income from operations increased by 25.8%, from $8.9 million in the three months ended June 30, 2013 to $11.2 million in the three months ended June 30, 2014. As a percentage of revenue, income from operations increased from 9.9% in the three months ended June 30, 2013 to 10.0% in the three months ended June 30, 2014, primarily due to higher gross profit.

Other income (expense)

Other income (expense) decreased from $1.1 million in the three months ended June 30, 2013 to $1.0 million in the three months ended June 30, 2014 primarily due to foreign currency transaction losses.

Income tax expense

Income tax expense increased by $0.7 million, from $2.5 million in the three months ended June 30, 2013 to $3.2 million in the three months ended June 30, 2014. Our effective tax rate increased from 25.3% for the three months ended June 30, 2013 to 26.4% for the three months ended June 30, 2014. The increase in the effective tax rate was primarily due to the geographic mix of profit and an additional tax expense incurred due to increased executive compensation expense not being subject to deduction, partially offset by a tax benefit associated with the reduction in earn-out expense recorded in connection with the Trade Tech earn-out and increased tax benefits realized in certain special economic zones in India.

Net income

Net income increased by 19.7%, from $7.5 million in the three months ended June 30, 2013 to $9.0 million in the three months ended June 30, 2014 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.


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On December 31, 2013, we entered into an amended and restated credit agreement with JPM expiring December 31, 2018. The credit agreement amends and restates our $3.0 million secured revolving credit agreement with JPM and provides for a $25 million secured revolving credit facility, which shall be available to fund working capital and other corporate purposes, as well as to serve as security in support of our foreign currency hedging programs. The credit agreement contains financial and reporting covenants and limitations. At June 30, 2014, there were no borrowings outstanding under the credit facility. (See Note 11 to the notes to our consolidated financial statements included in this Quarterly Report).

At June 30, 2014, 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, 2014, we sold $5.1 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, 2014. No amounts were due under the financing agreement at June 30, 2014, 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.

In connection with the OSB acquisition, the purchase price was subject to adjustment after the closing for up to an additional $6.0 million in earn-out consideration based on the achievement of certain revenue and operating margin targets for the five months ended March 31, 2014, the nine months ending December 31, 2014 and the twelve months ending December 31, 2015. At March 31, 2014, the Company determined that OSB had met 100% of the performance targets for the five months ended March 31, 2014 and $500 earn-out consideration was paid as of June 30, 2014. The fair value of the remaining contingent consideration at June 30, 2014 is $4,205.

In connection with the TradeTech acquisition, the purchase price was subject to adjustment after the closing for up to an additional $4.1 million in earn-out consideration based on the achievement of certain revenue and EBITA targets for the twelve-month period ending December 31, 2014. At June 30, 2014, no earn-out consideration is expected to be paid.

In connection with the OSB acquisition on November 1, 2013 and the TradeTech acquisition on January 1, 2014, 10% or $684 and 12.5% or $2,444 of the purchase price respectively, was held back and placed into escrow for a period of 12 months from the acquisition date as security for indemnification obligations. In connection with the TradeTech acquisition, a working capital adjustment of $468 was released to us from escrow pursuant to the Share Purchase Agreement. At June 30, 2014, the TradeTech holdback was $1,961, inclusive of a foreign currency translation adjustment of $15.

Cash flows

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

                                                        Three Months Ended
                                                             June 30,
(in thousands)                                           2014         2013
Net cash (used in) provided by operating activities   $    (2,500 ) $ (1,783 )
Net cash used for investing activities                     (4,792 )   (4,536 )
Net cash provided by financing activities                   1,458      3,071
Effect of exchange rate changes on cash                        (1 )   (2,983 )
Net decrease in cash and cash equivalents                  (5,835 )   (6,231 )
Cash and cash equivalents, beginning of period             82,761     57,199
Cash and cash equivalents, end of period              $    76,926   $ 50,968

Operating activities

Net cash used in operating activities was $2.5 million during the three months ended June 30, 2014 as compared to $1.8 million used in operating activities during the three months ended June 30, 2013. This change was primarily attributable to an increase in working capital of $3.5 million, primarily driven by a decreased change in accrued employee compensation by $5.2 million and reversal of the contingent consideration of $1.8 million. These were partially offset by an increase in net income of $1.5 million, an increased change in long-term assets and liabilities of $0.3 million, depreciation and share based compensation of $1.8 million and an increased change in excess tax benefits from stock option exercises of $0.3 million.


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Investing activities

Net cash used in investing activities was $4.8 million during the three months ended June 30, 2014 as compared to $4.5 million during the three months ended June 30, 2013. The change was primarily due to the net increases in the proceeds of investments of $2.6 million and an increase in the purchase of property and equipment of $2.8 million, which includes the acquisition of certain intellectual property rights for $1.1 million during the three months ended June 30, 2014.

Financing activities

Net cash provided by financing activities was $1.5 million during the three months ended June 30, 2014 as compared to cash used in financing activities of $3.1 million during the three months ended June 30, 2013. The decrease in cash provided is primarily due to a decrease in excess tax benefits from the stock options exercises of $0.3 million, a decrease in proceeds from the exercise of common stock options of $0.8 million and cash used in the payment of contingent consideration related to the OSB acquisition of $0.4 million.

Off-balance sheet arrangements

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

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 "Quantitative and Qualitative 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 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 . . .

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