Operator:
Good day and welcome to the Virtusa Corporation VRTU Fiscal Fourth Quarter 2016 Earnings Conference Call. Today’s conference is being recorded. At this time, I would like to turn the conference over to Will Maina, of ICR. Please go ahead sir.
Will Maina: Investor Relations-ICR:
Thank you, Lee-Ann, and welcome to Virtusa’s fourth quarter and full fiscal year 2016 earnings conference call where we will be discussing our financial results for Virtusa’s fourth quarter and full year ended March 31, 2016. On the call with me is Kris Canekeratne, Chairman and Chief Executive Officer; and Ranjan Kalia, Executive Vice President & Chief Financial Officer.
Certain statements made on this call that are not based on historical information are forward-looking statements which are made pursuant to the Safe Harbor Provisions of the Private Securities Litigation Reform Act for 1995. During this call, we may make expressed or implied forward-looking statements relating to, among other things, Virtusa’s expectations and assumptions concerning Management’s forecast of financial performance, the growth of Virtusa’s business, Virtusa’s ability to realize the intended benefits, revenues, and other synergies of the Polaris acquisition, including the ability to integrate Virtusa and Polaris’s business and operations, the ability of Virtusa’s clients to realize benefits from the use of Virtusa’s IT services and Management’s plans, objectives, and strategies. These statements are neither promises nor guarantees and are subject to a variety of risks and certainties, many of which are beyond Virtusa’s control which could cause actual results to differ materially from those contemplated in these forward-looking statements. Existing and prospective investors are cautioned not to place undue reliance on these forward-looking statements, which speaks only as of the date hereof. Virtusa undertakes no obligation to update or revise the information disclosed during this call whether as a result of new information, future events, circumstances, or otherwise.
Other statements on this call also include certain non-GAAP financial information as defined by the SEC. We present constant currency revenue to provide a framework for assessing how our revenue performed excluding the effect of foreign currency rate fluctuations. We provide non-GAAP adjusted operating income, non-GAAP adjusted net income, and non-GAAP earnings per share, which we believe provide insight into the operational performance of our business. Reconciliations of non-GAAP to GAAP measures are included in today’s earnings press release and data sheet which can be found on the Investor Relations page of our website. We also present the reconciliation of cash, cash equivalents short-term and long-term investments, that we believe provides insight into our total cash position and overall liquidity. For additional disclosure regarding these and other risks faced by Virtusa, see the disclosures contained in Virtusa’s public filings with the Securities and Exchange Commission and our press release.
With that I would like to turn the call over to Kris.
Kris Canekeratne:Chairman and Chief Executive Officer:
Thanks Will and thank you for joining us on our fourth quarter and full-year fiscal 2016 conference call. We are pleased with our fourth quarter results, despite the expected sequential headwinds we faced in our insurance segment. Our fourth quarter revenue were $171.9 million an increase of 14% sequentially and 36% year-over-year including revenue from Polaris. Excluding the partial quarter revenue contribution from Polaris, we posted sequential revenue growth of 1.2% and year-over-year growth of 21% in the fourth quarter.
With respect to the overall demand environment feedback from the frontline is that clients IT budgets are flat in calendar year 2016 with a slower than expected June quarter spending pattern compared with prior year. We attribute this slower spending pattern in our fiscal Q1 to four main sectors. First corporate restructuring at certain clients has caused a delay or reduction in the project renewal.
Second, delayed program starts at some of Polaris’s banking clients as well as the expected spend reductions at Citi. Third; softness at a few of our insurance segment side and fourth typical seasonal revenue declined from our telecom side. These factors are expected to have an adverse impact on our Q1 fiscal year 2017 revenue growth.
Despite the Q1 softness, our new business pipeline is growing and our win rates remain consistent, which gives us comfort that our revenue growth will began to improve in the fiscal second quarter. Ranjan will provide you with more color on our fiscal 2017 guidance later in the call.
Within the current demand environment, our clients continue to look to reduce the businesses usual costs of their legacy IT environment and to stimulate and simultaneously reinvest these savings into enabling business transformation. Virtusa’s core capabilities and ongoing areas of investments remain extremely well aligned with this demand. Our value proposition of enabling our clients to run the business more efficiently secure the business and grow the business is leading Virtusa to increasingly be viewed as a transformational partner of choice.
Turning to our integration of Polaris Consulting and Services. As we previously announced, to be close the first phase of the transaction, then we acquired 51.7% of Polaris’s outstanding stock from its founding shareholders and promoters on March 3, 2016. We then completed phase two of the transaction in April 2016, when we acquired an additional 26% of Polaris from its public shareholders as part of a mandatory tender offer taking our ownership in the Company to 77.7% of fully diluted shares outstanding.
I am pleased to say, that we have made good progress and completed our organizational changes to reflect our go-to-market strategy and organizational structure. We have created to growth engines inside Virtusa, Polaris, global banking and financial services or BFS which includes all the banking and financial services, operations of Virtusa and Polaris will be led by Jitin Goyal and enterprise technology services or ETS, which includes insurance, communications and technology, media, information and other will be lead by Raj Rajgopal.
We have defined roles and put systems in place that are aligned with this go-to-market strategy and we expect our IT, HR and finance operations will be fully integrated by the end of this calendar year. Our sales and delivery team have been unified and reorganized around of a BFS and ETS business units and they have already begun to deliver our plans to drive revenue synergies this fiscal year.
On that note, let me now spend a moment giving you some insight into the early successes we are generating as a combined Virtusa, Polaris. You may recall that when we announced the acquisition in November of 2015, we discussed three key strategic reasons why we believe Virtusa and Polaris were a strong fit and why the combination of our two companies would help create a stronger platform to drive our long-term growth and shareholder value.
First, the combination of our two companies creates a unique fully integrated provider of comprehensive solutions and services across the banking and financial services industry. Second, our combination meaningfully expands of a addressable market. And third, the transaction enhances our ability to pursue larger consulting outsourcing contracts across all the industries we operate in.
I am pleased to say that since announcing the deal we have seen increased development of new large opportunities in our pipeline and in fact we have already signed a handful of new synergy win in banking and financial services that illustrate our strategic rationale for the acquisition. For example, we recently signed a synergy deal with one of the largest bank in the Northern Europe. This is a new logo win for us. The engagement covers the end-to-end to lifecycle for delivering the right payment proposition across customers segments in a post CSD2 of payments, services, directive warrants.
In this win , we are leveraging Polaris vast domain expertise in payments transformation as well as upstream business consulting expertise from Virtusa business consulting to deliver strategy and a technology roadmap for a constantly evolving payments business. The program is at addressing challengers foreseen in a highly comparative $600 million annual addressable revenue opportunity for our clients and has potential to transform how payments will be executed over the next decade.
In another example, we want to a deal with an existing Polaris commercial banking clients that we have chosen to provide a set of Virtusa’s digital solution including data aggregation, data analytics and user experience to these clients. These are two recent examples of how our ability to offer a fully integrated set of end-to-end BSF solution is enabling us to both attract and win new clients as well as expand our addressable market opportunity across our combined of Virtusa Polaris client base.
Finally I would like to point out a recent multimillion dollar win, with an existing large Virtusa banking client as a strategic partner to expand resources for the client’s consumer banking business. In this case in addition to our integrated expertise in the required areas of retail and commercial banking and comprehensive proven approach of captive enablement for other clients. A key reason by we were chosen in this competitive process over other larger generation one vendors was the expanded scale of Virtusa, Polaris. As I am sure you can tell , we are extremely pleased with our progress so far in integrating Polaris and Virtusa.
An early evidence suggests that the depth and breadth of our combined BFS solutions are resonating quite effectively in the market and are helping to set us apart from competitors.
Looking forward, we have identify over $100 million of cumulative revenue synergies over the next three fiscal years from the Polaris acquisition primarily driven by cross-selling of solutions and services into our combined portfolio of banking and financial services plan. We have a detailed planning place to meet that goal and remained confident in our ability to deliver these results based on the significant opportunities we see in the market as well as the solid forward progress we have achieved so far.
Now I would like to provide some additional details on the current demand environment and how they are helping our clients, transform their businesses to achieve their business objectives. As I mentioned earlier our clients across industry verticals continued to address the dual man based they are facing to reduced costs by improving operational efficiencies and reducing risks while at the same time investing in revenue growth. In telecoms example, communication services providers are being challenged to serve their customers more profitably and not just nearly focused on increasing their number of subscribers. They are looking to technologically improve their revenue performance while at the same time streamline their business operation.
A great example of how we are helping our clients on the front, is with a large Europe based BSP. This time had high operational cost and poor customer experience. Virtusa’s consultants work with the company’s business operation, field engineers and technology teams and creates problems the need for better diagnostics and analytics of field engineers. This eventually led to Virtusa designing and implementing in mobile App for field engineers providing real time remote testing and diagnostics historic fault analysis and route optimization capabilities.
Our work resulted in the rationalization of capabilities and functionalities of eight devices down to one device significantly reduced their operating expenses provides a far better customer experience and increased up-sell and cross-sell opportunities by 10%.
Across several of our industry segments we are seeing is strong emerging focus on intelligent, automation, specifically, robotic process automation or RPA and smart automation via machine learning. The goals of RPA include decreasing manual processes to reduce human efforts and error, reduced costs and increase quality of services. RPA also enables business intelligence, analytics, and auditing. Gartner is predicting that by 2018, 40% of outsourced services will liberate smart machine technology.
Virtusa has focused considerable effort and investment in the area of RPA and cognitive computing. We are leveraging both our owned agnostic RPA tool and setup solutions called Centroid RPA and we are partnering with other RPA vendors such as Arago, Blue Prism, automation anywhere and work fusion to serve our clients. On the side of running the business more efficiently, we see and accelerating shift in demand from applying labor arbitrage to drive costs down to organizations employing automation solution such as RPA to drive higher efficiencies and consequently higher costs savings. We have numerous clients approaching us to help evaluate areas where they can implement RPA particularly in the banking financial services and insurance segments and we believe that it will be a significant area of opportunity for us in the future.
In conclusion, I remain excited about the breadth of growth opportunities available to Virtusa. Our differentiated solutions clearly address the needs of our clients’ co-objective of growing revenue improving operating efficiencies, reducing costs and mitigating risks. While we are seeing some short-term revenue headwinds in the first quarter, our new business pipeline is solid and our win rates remain consistent and we believe we are well positioned to deliver on our revenue and earnings growth outlook in fiscal year 2017.
We are on track with our integration Polaris and our strategic plan for acquiring the company is already showing up in terms of pipeline development and early synergy win in BFS. in fiscal 2017, our top priorities are clear, we will focus on dedicating resources towards ensuring a smooth integration of our two firms executing our growth plan within eye towards raising revenue growth back to above industry rates demonstrating excellence across our plan base to grow and expand our presence and with particular emphasis at Citi and other large enterprisers where we have an opportunity to leverage our proffered supplier status to expand our partnerships and hiring and developing the best talent in the industry and providing a high performance ramified work environment that empowers and stimulates innovation.
Now let me turn the call over to Ranjan who will provide more details on our results and our fourth quarter and fiscal year 2017 guidance.
Ranjan Kalia:Executive Vice President & Chief Financial Officer:
Thanks Kris and good morning to everyone. Let me start by summarizing the results of our fourth quarter and fiscal year 2016. I will then provide our current non-GAAP guidance for both the first quarter and fiscal year ending March 31, 2017 before opening the call for questions.
Revenue for our fiscal fourth quarter was $171.9 million up 14% sequentially and 36% year-over-year. As you are aware we completed the acquisition of a majority interest in Polaris consulting in services on March 3, 2016. In the fourth quarter Polaris contributed approximately $19.4 million of revenue which was above our prior expectations of approximately $17 million, primarily due to lower anticipated India to U.S. GAAP adjustments.
Excluding the partial fourth quarter revenue contribution from Polaris, revenue increased 1.2% sequentially and 21% year-over-year on a reported basis and was 2.2% sequentially and 22% year-over-year on a constant currency basis. Our organic sequential revenue growth was in line with our prior guidance range and industry growth trends. Gross margin in the fourth quarter was 35.1% compared to 35.7% in the prior quarter and 36.7%...
Operator:
Please stand by while we reconnect. And we are now reconnected.
Ranjan Kalia:
This is Ranjan. I will start my prepared remarks from the beginning again. Thanks Kris, and good morning to everyone. Let me start by summarizing the results of our fourth quarter and fiscal year 2016.
I would then provide our current non-GAAP guidance for both the first quarter and fiscal year ending March 31, 2017, before opening the call for questions. Revenue for our fiscal fourth quarter was $171.9 million up 14% sequentially and 36% year-over-year. As you are aware we completed the acquisition of majority interest in Polaris Consulting and Services on March 3, 2016.
In the fourth quarter Polaris contributed approximately $19.4 million of revenue which is above our prior expectations of approximately $17 million, primarily due to lower anticipated India to U.S. GAAP adjustments. Excluding the partial fourth quarter revenue contribution from Polaris, revenue increased 1.2% sequentially and 21% year-over-year on a reported basis and was up 2.2% sequentially and 22% year-over-year on a constant currency basis. Our organic sequential revenue growth was in line with our prior guidance range and industry growth trends.
Gross margin in the fourth quarter was 35.1% compared to 35.7% in the prior quarter and 36.7% in the year-ago period. The sequential change in our gross margin primarily reflects the diluted impact of the Polaris acquisition offsetting a moderate sequential increase in Virtusa organic gross margin. Fourth quarter other income was $7.5 million including a $6.6 million unrealized foreign exchange gain.
As we disclosed previously, our $200 million term loan was raised to partially fund the Polaris transaction. The transfer of such dept to our Indian subsidiary using an INR denominated inter-company note resulted in a revaluation gain of $6.6 million. Additionally, we incurred approximately $645,000 of interest expense in the quarter on this term loan. GAAP diluted earnings per share was $0.41 in our fourth quarter versus $0.38 in the prior quarter and $0.39 in the year-ago period.
Polaris contributed $0.04 of EPS in the fourth quarter. GAAP EPS was above our guidance range of negative $0.02 to break even.
Our EPS out performance was mainly due to higher than expected Polaris revenue, lower due diligence expenses and the $6.6 million of foreign exchange gain related to the funding of the Polaris acquisition partially offset by approximately $8.6 million of Polaris transaction related charges. Our income tax rate was 4% versus our historical tax rate of approximately 27% primarily due to the tax benefits related to interest expense, acquisition related charges, and change in geographical mixed of profits.
Turning to our non-GAAP results, non-GAAP operating income was $21.8 million compared with $20.7 million in the prior quarter and $19.2 million in the year-ago period. Fourth quarter non-GAAP operating margin was 12.7% compared to 13.8% in the prior quarter and 15.2% in the year-ago period. The sequential change in our non-GAAP margin primarily reflects 90 basis points of diluted impact of the Polaris acquisition. Non-GAAP diluted earnings per share was $0.55 in our fourth quarter of fiscal 2016 which was better than our $0.43 to $0.45 guidance range.
This compares to $0.54 in the prior quarter and $0.51 in the year-ago period. Polaris contributed $0.01 of non-GAAP EPS in the fourth quarter compared to negative $0.11 in our guidance. Therefore, outperforming $0.12.
Turning to the balance sheet, ending cash at March 31, 2016 was $231.7 million inclusive of cash equivalents and short term and long term investments including $65 million of cash from Polaris. Cash flow from operating activities was $5 million in the fourth quarter or 2.9% of revenue primarily impacted by increasing DSO. Our DSO including unbilled receivables was 78 days. Virtusa standalone DOS was 77 days compared to 70 days in the prior quarter.
Capital expenditures were $3.2 million in the March quarter.
Now, I will turn to some additional quarterly financial and operational metrics beginning with those related to our fourth fiscal quarter 2016 revenue. Please note that all of the numbers I am about to discuss exclude Polaris. Revenue across our industry groups and geographies was as follows. BFSI revenue increased 10.5% year-over-year and 1.7% sequentially representing 51.7% of total revenue.
Our BFSI results in the fourth quarter were in line with our expectations and as expected reflects meaningful declines in our insurance segments. We are pleased with the performance of our banking segment which experienced strong sequential growth and outperformed our expectations. Communications and technology grew 26% year-over-year and 2.6% sequentially representing 38% of revenue. The performance at our largest Telco clients was strong in the fiscal fourth quarter seasonality that is consistent with the prior years.
Media information and other grew 81% year-over-year, representing the remaining 10.3% of revenue driven by clients from our Apparatus acquisition. On a sequential basis this vertical declined 5.6% which was more than our expectations.
North America revenue grew 24.4% year-over-year and 1.9% sequentially, making up 70.6% of total revenue. Revenue growth was slightly below our expectations. Europe revenue increased 6.4% year-over-year and declined 1.5% sequentially on a reported basis and was up 11.3% year-over-year and 2.7% sequentially on a constant currency basis. Europe represented 22.2% of total revenue in the quarter.
Rest of world increased 42.6% year-over-year and 3.2% on a sequential basis and accounted for the remaining 7.2% of revenue. Results were driven by growth and our banking clients.
During the March quarter, we commenced works with five new clients including two in C&T, two in BFSI and one in media information and other. Additionally we added 40 net new clients from the Polaris acquisition, which excludes 20 common clients already included in Virtusa client ---. We ended the fourth quarter with 9,795 IT professionals an increase of 3% sequentially. Including Polaris, we ended the quarter with 16,321 IT professionals.
Global utilization excluding trainees, was 81% in our fourth quarter. I will now like to briefly summarize our financial results for fiscal year 2016 as compared to fiscal year 2015. Revenue was $600.3 million an increase of 25% year-over-year excluding the partial fourth quarter revenue impact from Polaris. Fiscal year 2016 revenue increased 21% year-over-year on reported basis and was up 24% on a constant currency basis.
GAAP diluted EPS was $1.49 compared to $1.44 for fiscal year 2015.
On a non-GAAP basis operating profit was $79.5 million an increase of 16.4% and operating margin was 13.3% compared with 14.3% for fiscal year 2015. Non-GAAP net income was $61.9 million an increase of 13.8% . Non-GAAP diluted EPS was $2.06 compared to $1.84 for fiscal year 2015.
Before turning to our guidance, I would briefly like to summarize the Polaris transaction. On March 3, 2016, we completed the acquisition of approximately 51.7% of fully diluted outstanding shares of Polaris from founding shareholders, promoters and certain others minority stockholders for $168.3 million. On March 30, 2016, we successfully tendered and subsequently purchased an additional 26% of fully diluted outstanding shares of Polaris from public shareholders for $86.8 million which settled on April 6, 2016. So in total, we paid $255.1 million to acquire approximately 77.7% stake and Polaris on a fully diluted basis.
As you made a call when we announced the Polaris acquisition in November of last year, we estimated the total purchase price for the 51.7% from selling shareholders and 26% from public shareholders would be approximately $270 million.
We attributed approximately $15 million aggregate saving on the purchase price to three factors. First favorable US dollar to rupee exchange rate at the time of the transaction. Second, favorable purchase price of the founding shareholders stake by purchasing those shares on an active trading market and third the strong response of the mandatory open offer which enabled us to conduct that transaction at the original offering price. In addition, we also received approximately $15 million of more cash and Polaris balance-sheet then previously contemplated.
As I mentioned we currently owned approximately 77.7% of Polaris on a fully diluted basis. However, as we have disclosed under India takeover rules we are required to sale within one year of mandatory offer of our Polaris share holdings in excess of 75% and we expect to sale these excess shares to be incompliant.
Now, I will provide our current guidance for first quarter and fiscal year ending March 31, 2017. Revenue in the first quarter of fiscal 2017 is expected to be in the range of $202.5 million to . Non-GAAP diluted earnings per share in the first quarter of fiscal 2017 is expected to be in the range of $0.14 to $0.18. Our Q1 fiscal 2017 earnings per share guidance anticipates an average share count of approximately $30.1 million.
For the fiscal year ending March 31, 2017, we expect revenue to be in the range of $890 million to $920 million. Non-GAAP diluted earnings per share for fiscal year 2017 is expected to be in the range of $2.10 to $2.30 excluding $35 million of acquisition related charges which includes approximately $6 million of Polaris integration related charges and also excluding $24 million of stock compensation expenses.
Full fiscal year 2017 EPS anticipates an average share count of approximately $30.3 million. Our current GAAP and non-GAAP guidance is also based on the set of assumptions including tax rate, interest income, foreign exchange rates, capital expenditures and certain non-GAAP metrics that can be found on our data sheet located in the Investor Relations section of our website.
Now I would like to spend a moment providing you with some additional details on our first quarter and fiscal year 2017 guidance. As Kris mentioned earlier we are seeing clients overall budgets are flat year-over-year with a slower Q1 spending pattern versus prior years. BAU spending on legacy IP environment will continue to contract year-over-year while client discretionary spend is being funnel to initiatives focused on enabling digital transformation, information as well as improving operating efficiencies and mitigating risks.
Our first quarter results are being impacted by four primary factors. First slower spending pattern as evidence by declines in our renewals at certain large -- as a result of their corporate restructuring. Second, delayed start at some Polaris banking clients including the previously expected reduction at Citi. Third softness at few of our insurance clients and lastly usual seasonal revenue declined from our UK based telecoms clients.
The telecom seasonality and Citi revenue changes were know to us going into the quarter. However the impacts due to the changes in our pipeline began to materialize in late Q4 and early April. Our first quarter 2017 guidance anticipates Virtusa organic revenue to decline sequentially in the first quarter. This implies of full year organic growth rate below our previous expectations of above industry growth.
Our expectations for Polaris revenue growth for fiscal year 2017 is slightly below our original expectations due to the delayed start at some of our banking clients.
We now expect Polaris revenue to grow in the mid single-digits for FY ‘17 of to Q4 run-rate of approximately $70 million. Our clients’ calendar ‘16 budgeting process took a little bit longer then our previous expectations and this was evident in our slower pipeline buildup in the later part of our Q4. As we exited Q4 our clients have completed their budget allocation process and we saw a corresponding pickup in our pipeline growth. Our win rate are consistent with prior periods, pipeline built up and closure rates provide a comfort that beginning in Q2, we expect Virtusa to generate sequential above industry revenue growth rates for the remainder of fiscal year.
Sequential revenue growth will be supported by growth in all our industry segments with particular strength in C&T, BFS and insurance.
We anticipate quarterly revenue growth to accelerate in the fiscal second quarter and for the remainder of FY ‘17. As seasonal headwinds at our telecoms clients begin to unwind. New projects starts begin to drive growth in insurance and banking segments and the quarterly rounded of Citi spend reductions are fully absorbed. We anticipate, non-GAAP combined Virtusa Polaris operating margin to be down year-over-year but in line with our previous expectations.
Even after absorbing the impact from Q1 revenue headwinds and incremental investments in Polaris platform, in addition we now expect Polaris to be accretive to our non-GAAP EPS in FY ‘17 up from our prior expectations of slightly diluted.
In conclusion, while we will experience a slow start to FY ‘17 we anticipate accelerated revenue growth above the industry rate and strong margin accretion in the beginning of fiscal second quarter. A strong second half FY ‘17 margin trajectory sets up to deliver EPS growth in excess of revenue growth in FY ‘18 and beyond.
I will now turn the call over to the Operator to begin Q&A. Thank you.
Question & Answer
Operator:
Thank you. If you would like to ask a question, please signal by pressing star, one on your telephone keypad. If you are using a speaker phone, please make sure your mute function is turned off to allow your signal to reach our equipment. To allow everyone to ask a question we ask that you limit yourself to one question and one follow up question. Again press star, one to ask a question. And we will take our first question.
Ranjan Kalia:
Since we got a late bit delayed if it is communed by everybody we will go over 5-10 minutes. So that we can take everybody’s questions. First question please.
Operator:
And our first question comes from Joseph Foresi with Cantor Fitzgerald.
Michael Reid:Cantor Fitzgerald:
Hi guys, this is Mike Reid on for Joe thanks for taking my call. The first question was on the insurance softness in the first quarter. Is that going to make mainly due to one large client or is that spread out among a few or more?
Kris Canekeratne:
Its actually spread out across our few clients in the insurance segment. Clearly one of the larger clients in insurance has been going to a restructuring that has had an impact on Virtusa’s insurance segment. But beyond that it we have also seen some slowness in our few client within the insurance segment.
Michael Reid:
Okay. Thanks. And then I just one more follow up with the there is a obviously see a slight down tick in revenues for the first quarter but then its seems like the EPS projections for the first quarter is a little bit further down than the revenue is, can you kind of talk about what’s going on in between the revenue and EPS and the profit and loss that caused that difference?
Ranjan Kalia:
Sure. So Mike. A couple of different reasons one is in a seasonal usually in Q1 we always have an incremental expenditure for the visa cost which continues to be for this quarter which is about as 60 basis points impact and then we are really contemplated contemplating another almost 700 basis point impact really due to revenue decline, because revenue is going to be coming down, billable utilization will probably go we are not taking any significant impacts to really bring up utilization just in Q1 because of the revenue impact but continue to all hold that because we believe revenue will pick up in Q2 and therefore and utilization will pick up too. So those are really the primary reasons why you do see a drop in EPS, because margins would be dropping almost by 900 basis points in Q1.
Michael Reid:
Okay. All right thanks guys.
Operator:
And we’ll take our next question from Puneet Jain with JPMorgan.
Puneet Jain:JPMorgan:
Thanks for taking my question. So you are onsite efforts significantly increased in this quarter, is that on period end basis or average for the quarter which would obviously implied further increase in Q1 and how should we think about long-term onsite offshore mix given Virtusa is typically operated at higher offshore leverage.
Kris Canekeratne:
So that is average for the quarter and that’s end of fact sheet that you are looking at that fact sheet actually shows the onsite for both Polaris and Virtusa. Polaris onsite what actually higher than even Virtusa and that is really one of the drivers even with regards to as we feel the city spend reductions can really transpired both in the favor of the clients as well as for Virtusa and as the onsite reductions happened at city, it’s beneficial for the client as well as for Virtusa. So its you’re really seeing those two reasons play out for the increased onsite ending the quarter. That being said, we do expect that onsite effort year-over-year for Virtusa will be high even on an organic basis will be higher year-over-year.
Puneet Jain:
Understood. And that guidance implies very high sequential growth rates beyond Q1 and obviously you talked about like you expect insurance to get better, telecom clients to improve but how much of $100 million synergy targets have you baked and estimates for your fiscal ‘17 guidance.
Ranjan Kalia:
When we had talked about the $100 million synergy which was over a period of three years, you may remember we always said that the synergy would really happen in the backend of FY ‘17 there were never really contemplated early in FY ‘17. We still continue to believe as Kris talked about we being in a closing lot of synergy deals but the meaningful revenue impact for those really start to happen in later part. So not a significant piece is included in FY ‘17 we believe that if we can get that synergy revenue deals ramp rate going in Q4 it really sets us up very well for FY ‘18.
Kris Canekeratne:
And Puneet just to build on what Ranjan just mentioned, we have also seen that overall that our pipeline has growing year-over-year although the momentum during the second half of our Q4 the quarter that we just concluded was slower than we had expected and that obviously also contributed towards a lower slower Q1. But pipeline momentum has been noticeably stronger since the start of fiscal year ‘17 since April.
Puneet Jain:
Understood.
Kris Canekeratne:
Now even a more specific piece of information is that the growth of the qualified late stage pipeline or late stage deals has been greater than any prior period which is what really gives us confidence that Q2 and the full year will see the growth rates that we expect .
Puneet Jain:
Understood. So it is more organic growth that you expected in later half of this year then acquisition related that’s good. Thanks a lot.
Kris Canekeratne:
That’s right.
Operator:
And we will take our next question from Brian Kinstlinger with Maxim group.
Brian Kinstlinger:Maxim group:
Great. Thank you so much. The guidance as you mentioned from earnings perspective the jump is predicated on revenue ramping. So I am curious, what is the visibility to that revenue ramping, has it already started because it sounds that like it was the end of the quarter when you started to see some weakness, so or already pretty much in June almost to have, have we begun to see that pickup in demand?
Ranjan Kalia:
So, I’ll give you couple of data points and then Kris can add So Brian if you look at it when we construct our full year revenue. When you look at the full year revenue the backlog and the revenue visibility which is either the pipeline the high-end pipeline, that metric looks very similar maybe even a ted higher than what would have been last year at this time. That’s for the full-year.
When we look at in quarters we saw the pipeline build up started to happen and especially the late stage pipeline. The late stage pipeline actually we saw an abnormal pick up in that late stage pipeline for Q2 that really gave us comfort that the Q2 sequential growth that would come from the pipeline. The pipeline is in there and over and above that we have some in a normal factors that are going to go away which is the BT that we are always see Q2 being a sequential pick up versus Q1 and then flattening out of more of the Citi spend reduction that are in there.
Brian Kinstlinger:
Okay and then even Citi has seen declined demand and so has your ---- insurance customer, talk about how you’re going to manage your utilization will you not hire for next six months given you have excess capacity right now. How you would handle the hiring fronts?
Kris Canekeratne:
So, just on the utilization, as we, when we had put our financial models together for the combined organization, we always knew that on the Polaris side regardless of the revenue down, that we are really seeing in Q1. We will be doing some utilization pruning in any case. So that was the scenario that we were always prepared for coming into. Now coming with the short fall that we had in the revenue in Q1, in a way we are holding the hiring down in Q1 a little bit so that we can absorb the bench that we would have created for ourselves into Q2 and then after that, that in the mid Q2 we expect to get back on normalize hiring trends.
Brian Kinstlinger:
Great. Thank you.
Operator:
And we will take our next question from Moshe Katri with Sterne Agee.
Moshe Katri:Sterne Agee:
Thanks. Good morning guys. Can you, as a follow up on Citi, can you remind us, how much will Citi impact revenues this year in fiscal ‘17 and what sort of growth would you have had with that impact.
Kris Canekeratne:
So if you look at on a combined basis Moshe, Citi would have been about a $145, $146 million clients for us last year and this year we are expecting that Citi would basically contribute about $120 million as Citi grows though their spend reduction program and we are really implementing that’s spend reduction through what we call an efficiency improvement plan so even though the revenue comes down I think, Ranjan eluded to this earlier as an example there will be resizing the pyramid , making sure that onsite offshore ratio’s are more optimal. So we can actually ingest that spent reduction with already having a consequential margin impact to Virtusa.
Just take a look at that one revenue has come down by approximately $26 million.
Moshe Katri:
Okay. And then you provided us with the revised organic growth for Polaris’s had mid single-digits. What would be the organic growth for Virtusa in fiscal year 2017.
Ranjan Kalia:
It’s going to be very similar it’s going to be in the mid single-digit, primarily because of a very unsafe, as a disappointing Q1 for all of our. That’s really the disappointing Q1 but then in the sequential growth rates that the guidance for starting Q2 are continually very strong. So overall it be a mid single-digit this year.
Moshe Katri:
Yes and then a follow-up question here and obviously when we see in the market look for the transaction late last year, stock is definitely been penalize versus the group in terms of P multiples and I think there is a lot of uncertainty about the acquisition, the integration pace, and also probably about the quality of the business that came on board. If you looked at the combined entity in terms of Virtusa and Polaris which part of your services mix today is considered in your view digital, anything that’s related to smack and which part is related to legacy which is having some issues?
Kris Canekeratne:
Yes Moshe, the couple of questions that I would like to address. So, first and foremost I think, we also as we started looking at this fiscal year and we saw some slowdown in the pipeline, some of our clients that the restructuring basically of slowing down their renewals et cetera. We couldn’t help but extra sales whether the acquisition itself might have cause some of the changes to our business momentum and actually as we looked into a deeper it became clear and clear to us that what was really going on in the business was in terms of business slowdown had little or nothing to do with the Polaris acquisition outside of the fact that we knew that city was going to some headwinds for us this year. But very specifically as we looked into this deeper and deeper that will four things that really stood out as to why we would have a slow Q1 and from that resume the growth.
The first was that, we saw renewals declined as a result of few of our large clients going through a restructuring. We saw delayed starts at some of Polaris’ banking clients including the previously expected spend reduction at city which could fully contemplated. We saw softness at a few of our insurance clients and finally, the customary seasonal revenue declined that we’ve always seeing during our first quarter because our telecom clients in the UK. So these are the four reasons that really met to the slowdown in Q1.
Specifically in terms of your second question with respect to digital, there are two areas we focused on with our clients on the side we are helping them, streamline, rationalize and consolidate their businesses usual operations and I would say much of that work is longer-term recurring in nature. And on the other side they are helping them expand the addressable markets specifically by helping them re-imagine their digital store front. And I would tell you that, that piece of business that we do is hard for us to quantify specifically whether it is all of the business we do or some of the business we do, because almost all the work that both companies does is very transformational in nature and either is directly helping our clients, re-imagine their digital store price or indirectly creating an It infrastructure and straight through processing that then can be leveraged to provide a much better and consumer experience. But generally speaking I tell you that Virtusa, Polaris both spends a great deal of time in terms of helping our clients on their strategic platform much of which is used for digital enablement of their customers and their consumers.
Ranjan Kalia:
And may be two data points on the financials for the Polaris that you talked about, one in my prepared remarks I talked about that as FY ‘17 our guided was that Polaris versus our previous expectations are being slightly diluted this is going to be an accretive transaction in FY ‘17 for us.
Moshe Katri:
Thanks, guys.
Operator:
And we’ll take our next question from Anil Doradla with William Blair.
Kris Canekeratne:
Hey Anil, we can’t here you. Operator can we go to the next and then may be come back to Anil at the end.
Operator:
Yes. We’ll take our next question from Frank Atkins with SunTrust.
Frank Atkins:SunTrust:
Thanks for taking my question. I wanted to ask, in you prepared remarks I believe you mentioned signing a large European bank which is a new customer. Do you see that is evidence of the strategic rationale in terms of kind of breadth of capability and then secondly, as you look at the pipeline are you seeing evidence of inclusion for a larger deals or being considered in that larger deal size to Yes, so great question. We signed a great client here in Europe.
It has to do with of world banking regulation for MiFID II also known as API banking. We believe that we have some very significant thought leadership in payments and payment processing that actually going to transform the banking industry especially with respect to some of the -- disruption that’s taking place and this is perhaps a bank that’s already being the fairly dramatic changes that are coming down the pick and have engaged Virtusa Polaris to be able to execute some very transformational payment traded work so not just adhere to PSD2, but to actually take advantage of it. So they can become potentially a PSD or a player in this rapidly emerging payment space.
Now having said that, this is a clear example of Virtusa’s strength in banking and finance services and Polaris’s strength in banking and financial services coming together to enable us to be able to pursue this opportunity, win the opportunity, and we believe that following the initial conceptualization of the work that we are doing today that they solid significant downstream work. We also believe that this same idea whether it be PSD or whether it be PSD2 or whether it regulatory and compliance initiatives or whether it be block chain and the disruption that block chain will have in banking and financial services we believe that the combined companies provides tremendous expertise to be able to go in front of larger engagement, pursue these engagements, demonstrates depth and thought leadership and win these engagements. Actually we seeing a noticeable expansion of our late stage large deals pipeline specifically as it has to do with business in those areas that we have industry leading expertise.
Frank Atkins:
Okay great that’s helpful and can you give us a little color in terms of SG&A kind of what’s backed into the guidance as well as the trajectory you see over the course of the year?
Ranjan Kalia:
So the Frank on the SG&A our model especially you look at it even with the Q1 a decline in revenue our margin expectation from our prior expectations there consistent which is primarily due to our SG&A model of prior to have SG&A growth and a half of revenue growth. So we continue to bake that into our model both at the Polaris side as well as the Virtusa side bodying at some of the line items were in S&M we are continue to have very similar investment on a S&M as prior years.
Frank Atkins:
Okay, great. Thank you.
Operator:
And we will take our next question from Brian Burgin with Cowen and Company.
Brian Burgin: Cowen and Company:
Hi thanks for taking my question. Within city can you kind of talk about your early views now into wining some later engagements there?
Kris Canekeratne:
Yes. So clearly the first part of the business that we have to do is to basically invest the spend reduction at city and I think they are making great progress and we took probably a road less travelled were we spend a great deal of time with city upfront sharing with them that we will implement their spend reduction through an efficiently improvement plan or potentially demonstrate very strong execution, demonstrate our software plat forming heritage and expertise through which we can improve productivity, demonstrate better efficiencies around onsite offshore ratio and demonstrate better efficiencies in terms of how we can leverage fixed price work to be able to meet their needs and that was very important for us because, our belief was that to be extensively use this as an opportunity although we would have some revenue headwinds to be able to demonstrate that we can do the same work with less efforts or through efforts compression we thought that would be a great example of work that we can then do across other parts of Citi. Now that we have a strategic preferred partnership with the Citi.
So, we believe that this year we will make great progress in terms of the efficiency improvement program. We will demonstrate examples of how we can effectively change the spend and once we do that we also believe that we are in a great position to be able to look for new and additional opportunity that’s the deal which we have already started and we expect that as we get towards the third and the fourth quarter of this year that’s the reduction in spend will stabilize and that we will be in a much stronger position to pursue and win new work, so that hopefully we will see a growth account at Citi next year on the hills of excellent service execution productivity and efficiency improvement and building very strong relationships with buyers at Citi across a much larger ----.
Brian Burgin:
Okay. Thank you. Just on operating margin, can you just remind us what our long-term expectation as on operating margin and really the leverage you used to manage that?
Kris Canekeratne:
Yes, this year our margins is combined margins it’s going to be in the low double-digit and what our expectation is that over the next three to five years we take the combined company margins into the mid teens on a non-GAAP basis and that continues to happen. What we are really excited about is that the EPS growth will be continue to be higher than revenue growth.
Brian Burgin:
Okay. Thank you.
Kris Canekeratne:
Thanks Frank. Operator can we go back to Anil.
Operator:
Yes we will take our next question from Anil Doradla with William Blair.
Anil Doradla: William Blair:
Hey Guys can you hear me now.
Kris Canekeratne:
Yes, we can Anil.
Anil Doradla:
Okay sorry about the confusion earlier. So I know lot of moving parts as we go through in this quarter, next quarter and maybe next several months. Ranjan and Kris when I look into fiscal ‘18 can you talk about, how should we looking at the Company’s growth rate, I know you are not guiding but conceptually we have got lot of moving parts and you are talking about, maybe ---- par growth for core Virtusa business in the near term. But as we go into 2018 how should we looking at the kind of growth composition of the Company.
Kris Canekeratne:
So Anil. Let’s be really, as we want to be very clear about this right. During the first quarter because of the reasons we have already mentioned, we have seen a certain slowdown in revenue. Now beyond that starting in Q2 we expect to see strong industrial leading growth in --- quarters of this fiscal year to really set the stage and the platform for a strong Europe growth in fiscal year ‘18.
So really what’s happened here is that because of some ---- reasons specifically in Telco accounts, some of the restructuring that’s going on in a few of our larger account, one being in insurance and another being in technology this known headwinds that we were aware of from a Citi perspective. That’s all come together to create a slower Q1 that we expected. But from a pipeline perspective we have seen tremendous progress especially since the start of this year. We have the large deal segment of our pipeline. Is stronger than at any prior time that we can recall.
We have very significant opportunities that we are pursuing both within our existing account base and across new account and we believe that what’s going to provide us with the growth that we expect in Q2, Q3 and Q4 but then also industry leading growth in fiscal year ‘18.
Anil Doradla:
Very good. Now, I know you guided for what 890 to 920 for the full year and in terms of how much your booked and visibility clearly qualitatively Kris you are suggesting, your visibility and kind of bookings as very strong as the year goes by. But can you quantify that I mean at the midpoint are you 75% booked 80% booked and can you remind us how is that with respect to perhaps a historical numbers. Now that given that you got two different businesses with different brands straight Polaris as well as core Virtusa?
Kris Canekeratne:
Hello.
Operator:
Please stand by. And we are reconnected, Anil still you have on the line.
Anil Doradla:
Yes sorry for that.
Kris Canekeratne:
Was I able to answer your question Anil.
Anil Doradla:
I had a follow up but I don’t think, I think we got disconnected well either when I was asking but we didn’t here you answer on the follow-up. So let me repeat the follow-up question. So obviously you’ve talked about, qualitatively that you have been very positive on the outlook the pipeline and so forth. But I think I wanted to understand the visibility in terms of bookings can you remind us, as you know typically at the midpoint is it what 75%, 80% visibility to your bookings versus, is it in line with historical rates given that now you have got Polaris which has its own dynamics and core Virtusa.
So we just wanted I just wanted to kind of quantify one of the metrics there?
Ranjan Kalia:
So Anil both the way we look at the revenue visibility we look at the revenue visibility as pipeline as well as the weighted pipeline going into the revenue visibility. Both those metrics this year are consistent for both the organizations that we’ve tried to reconcile and made them consistent to give you even a more data points. Our backlogs historically has been in the high 60s and that’s what is at the midpoint and that’s what it continues to be this year.
Anil Doradla:
Okay. So high 60s
Ranjan Kalia:
That’s for the full year, so the earlier on in the quarter that percentage is not higher.
Anil Doradla:
Right and what’s you are also suggesting is that the dynamics at Polaris is very similar to the dynamics that Virtusa in terms of the visibility there high 60 percentage points right.
Ranjan Kalia:
Yes. The business models are very similar.
Anil Doradla:
Okay, very good. Alright. Thank you very much guys.
Operator:
And we will take our next question from Vincent Colicchio with Barrington Research.
Vincent Colicchio:Barrington Research:
Yes I was just curious as there been any loss of key people at Polaris and is that something we should be concerned about.
Kris Canekeratne:
Actually been there hasn’t been anything that’s significant. We have not had any significant changes in terms of attrition and now have we had any significant losses that we were not expecting all of that we thought as a combined entity that there would been an opportunity to take advantage of some of the overlaps. So we have actually been very pleased with the progress that we have made on the integration tracks and expressly around thinks like attrition and leadership changes.
Vincent Colicchio:
Okay, very good and Ranjan what was the contribution of Apparatus and Agora in the quarter?
Ranjan Kalia:
Apparatus both of them would be about $8 million in revenue. But that’s sequentially that’s the actually they grew sequentially slightly. But nothing unusual and though both were, so they both performed based on our expectations.
Vincent Colicchio:
Thank you guys.
Ranjan Kalia:
Thanks, Vin.
Operator:
And at this time I would like to turn the things back over to Kris Canekeratne for any closing or additional remarks.
Kris Canekeratne:
Thank you and thank you all for joining of our Q4 and full year fiscal year ‘16 earnings call. I want to thank of our to Polaris team members for their dedication and servicing our clients. Thank you all.
Operator:
And that does conclude today’s conference. Thank you for your participation. You may now disconnect.
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