Q1 2020 Earnings Call
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I would now like to turn the conference over to William Maina Investor Relations. Please go ahead.
Thank you and welcome for two to Virtusa is first quarter fiscal year 2020, <unk> earnings conference call well be discussing our financial results for Virtusas first quarter ended June 32019.
On the call with me are Chris Kinda, Craddock, Chairman and Chief Executive Officer, and Roger Kalia Executive Vice President and 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 provision of the private Securities Litigation Reform Act of 995.
During this call we may make expressed or implied forward looking statements relating to among other things virtusas expectations and assumptions concerning management's forecast of financial performance.
The growth of Virtusas business, the ability of virtusas clients to realize benefits from the use of Virtusas IP services and managements plans objectives and strategies. These statements are neither promises or guarantees are subject to a variety of risks and uncertainties. Many of which are beyond virtusas control, which could cause actual results to differ materially from those contemplated these forward looking statements.
Existing and prospective investors are cautioned not to place undue reliance on these forward looking statements, which speak only as of the date hereof.
Virtusa undertakes no obligation to update or revise the information.
Uh huh.
And these forward looking statements Virtusa undertakes no obligation to revise the information disclosed during this call whether as a result of new information future events or circumstances or otherwise.
Other statements on the call on this call also includes certain non-GAAP financial information as defined by the FCC, we present constant currency revenue to provide a framework for assessing how our revenue performed.
During 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. They provide further 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 a reconciliation of cash cash equivalents short term and long term investments that we believe provide insights into our total cash position. Other look overall liquidity. Please note that a supplemental data presentation to our fiscal first quarter results has also been posted to our Investor Relations website.
For additional disclosures regarding these and other risks faced by Virtusa. Please see if disclosures contained in Virtusas public filings with the Securities and Exchange Commission and in our earnings press release with that I'd like to turn the call over to Chris.
Thank you well.
Good evening, everyone and thank you for joining us today.
Overall, our fiscal first quarter results were in line with our expectations.
Total revenue was $319 million, representing 2.6% sequentially, the decline and 6.3% year over year growth.
non-GAAP EPS was 41 cents.
Although the first quarter topline performance reflects continued momentum with double digit engineering and transformation solutions and services across our entire business.
From a profitability perspective, although Q1, non-GAAP operating margin and EPS results tracked in line with our guidance.
Now before discussing the demand environment and some of our recent accomplishments.
I would like to address.
Updated fiscal 2020 guidance.
In July we learned that one of the European banking cotton.
Is reducing does the content spend and accelerating some of their programs with us to offshore.
Although partnership the disguise remained strong and diversified across multiple lines of business and I'm a pipeline of new business with them is robust.
Anticipation of resumed spending growth starting in calendar Q1 2020.
Additionally, as many of you already know roughly 11% of our revenue is denominated in the UK Poland. We just couldn't can you could slip both the daughter largely due to Brexit uncertainty.
Considering these two factors, we have reduced our fisker 2020 revenue guidance and the <unk>.
The reading some of the cost containment programs to partially offset the impact on our profitability.
Notwithstanding this one kind of core business is growing in line, but I wouldn't long term expectations and we continue to see good business momentum across all our industry groups and the majority of our client portfolio.
This includes our largest client which is expected to resume sequential growth in the second quarter as we previously discussed.
Underpinning this momentum is strong demand across all industries, but digital and cloud transformation services.
Two areas. The other two so has strong competencies and you'd be a proven leader.
The engine driving our success, yeah, I wouldn't digital transformation studio a unique platform, which delivers deep digital engineering.
And industry expertise via client specific and integrated agile scrum teams through other proprietary process. These gamified continuous integration continuous deployment toolsets adapters and accelerators.
Oh, but it's still a transformation studio sets us apart you know <unk> ability to deliver effective digital and Coke transformation initiative faster better and more cost effectively.
I would like to know dig a little deeper into the current demand environment and the types of engagements, but <unk> is running.
As we discussed previously digital transformation or DP and cloud transformation.
Oh I see.
Continue to get more strategic attention and budget as clients across industries seek to utilize these technologies to compete more effectively while reducing business as usual or cost.
Virtually every major business today understand that becoming digital first and leveraging efficiencies and economics of coat technology, all essential path with continued business viability.
Accordingly, we believe the demand for DP and C. D. The only grow in the years ahead and that we are perfectly positioned to benefit from this growth.
More specifically, we are seeing increasing client spend on digital and cloud transformation engagements that include the decomposition of monolithic I'd architectures into more nimble and integrated <unk> and micro services architecture.
Devops Monday night vision, and data and application migrations to the cloud.
Digital transformation initiatives, driven by regulatory and compliance requirements.
Well those are behind growing levels of demand.
Yes, its interest in intelligent automation technologies that directly contribute to our kids business as usual cost reduction efforts.
In the banking and financial services sector cloud transformation, a significant driver of I'd spend from many of our Brooklyn, including investment in cloud Native application development application and data migration and infrastructure.
For example, Medusa has been selected by a leading U.S. multinational financial services company for a large scale cloud transformation engagement.
We have been passed.
Evaluating our client's entire application portfolio of over 1400 applications for accounts, the suitability and migration planning.
Disengagement also has the potential for multiple downstream projects, including application re factoring.
The kitchen sunsetting initiatives and for the cloud migration opportunities.
In another example, a very competitive pursuit.
But but to sell but selected by the European banking kind to implement a large cloud transformation.
We were selected because of our industry, leading safety offering.
And the unparalleled speed and cost benefit about digital transformation studio.
This strategic program commences in our second quarter and represents the first phase of the multiyear engagement.
I mentioned before that regulatory compliance requirements are also driving increased demand for other services, including digital transformation.
[noise] European and global Banks for example are increasing their spend with us and regulatory compliance initiative that enabled them to become compliant with the forthcoming P.S.D. to directive that night.
We believe that less than one half of all European and global banks have become B S D to comply and to date.
And the banks that are already completed and are looking to monetize that early investments by developing a p. idea with the fee based usage Martha's hook customers and partners.
We were recently selected by a joint venture of large banks in Europe , and the Middle East as an example to help them monetize depth. The S. D. Two investments by launching an open banking platform, which enables them to accelerate their journey to completion by providing cutting edge digital services to their customers.
As we shared demand for digital and cloud consummation extend beyond the banking and financial services industry, and it's helping to drive our strong results in other communications and technology industry verticals as well as we called what health care.
Increased cloud adoption, including the cold indication of critical business operations and core business applications is becoming increasingly you any buffer among C. N T companies.
In the telecom industry Virtualized networks, and the emergence of fight Gee why those are driving demand for digital engineering partner like but too so that have proven expertise in emerging communication and network technologies.
Okay.
Healthcare clients are increasingly adopting cloud strategies, including a mix of public cloud platforms and open source cloud applications to expand the addressable market and all their maintenance and infrastructure expenses.
Life Sciences gun off focusing on digital transformation initiatives, ranging from rationalizing applications, the migrating to cloud native architectures.
For example, the Tusa Buzz recently engaged by a global health care company specializing in dialysis devices and renal disorders.
Transform the entire renal care business.
We are currently providing our clients with a roadmap for building a HIPAA compliant platform, which will support device to cloud connectivity and beyond developing the capabilities for our clients to manage devices remotely.
In conclusion, I'm pleased with our first quarter results versus guidance and we remain excited about the long term growth opportunity ahead of us.
While we are clearly disappointed with the change in direction at one of our European banking clients. It is important that the work closely and support them in their cost savings objectives.
Continue to build on the grid credibility and execution excellence beyond one quarter and strategically position ourselves the strong future potential.
The 50 million that you will feel prime examples that we have that third account specific downturns.
Strategically strengthened other position during those times and significantly expanded our future revenue and one a share.
We view the impacts of this plan spend reduction and unfavorable FX or now the expected 2020 results as short term factors and we have a clear plan in place to partially offset the impact on our profitability for this fiscal year.
Our long term strategy remains on track.
Demand is robust.
And our client portfolio is as strong as it has ever been.
Deep this stood transformation continues to be a significant part of our times agenda in all industries.
Which fits squarely with our core competency.
Two other digital and cloud cross the emission solution Youre able to help our clients better engage with their end customers.
Established significant competitive advantages and concurrently realize the significant cost reduction and efficiency improvement benefits of D T and CD executed through our industry, leading digital transformations studio.
Excluding the impact of this one client the momentum in our underlying business is strong and in line with our exploration above industry and will grow.
The pipeline activity and the velocity in our district lines of business gives us confidence that our strategy is working and good delivered strong results in the future.
No I'd like to turn the call over run John will then provide more details on our results as well as our second quarter and fiscal Neo 2020 guidance.
Right John .
Thanks, Chris and good evening to everyone.
Let me start by summarizing the results of our fiscal first quarter 2020 I will then provide our current guidance for both fiscal second quarter and fiscal year ending March 31st 2020 before opening the call for questions.
Revenue for fiscal first quarter was $390 million above the midpoint of our guidance and representing 2.6% sequential decline in reported currency and 2.3% decline in constant currency.
Year over year, our first quarter revenue increased 6.3% in reported currency and 7.3% in constant currency.
Our year over year revenue growth was driven by strong growth in our communication and technology industry group.
Gross margin in the fourth quarter was 26.4%.
Primarily reflecting higher onsite effort from the large transformation healthcare deal, we announced on our last earnings call.
GAAP operating income for the first quarter was $30.4 million compared with $23 million in the prior quarter.
And $13.9 million in the year ago Peter.
GAAP operating income was above the midpoint of our expectation, reflecting our topline results and stronger SDN they leverage.
First quarter other expense was $2.7 million. This includes $1.2 million of net foreign exchange gain and $3.9 million of net interest and other expense.
Net interest and other expense includes $4.9 million of interest expense and $1 million of interest and other income.
GAAP earnings per share was 15 cents in the first quarter. This compares to 24 cents in the prior quarter and a loss of 25 cents per share in the year ago period.
Now turning to our non-GAAP results non-GAAP operating income was $24.2 million in the first quarter compared to $34 million in the prior quarter and $27.5 million in the year ago Peter.
First quarter non-GAAP operating margin was 7.6% slightly above the midpoint of our expectation primarily due to our revenue performance and SDN and leverage.
non-GAAP earnings per share was 41 cents in the first quarter, one cents above the midpoint of our prior guidance.
This is compared to 46 cents in the prior quarter and 50 cents and the Unum <unk> Peter.
Turning to the balance sheet.
And then cash at June Thirtyth, 2019 was $208.3 million inclusive of cash and cash equivalents short term and long term investments.
Cash provided by operating activities was $2.2 million in the first quarter.
Our dsos for the first quarter was 75 days, an improvement of one day sequentially and four days from the year ago period.
Now I will turn to a more detailed discussion of our first quarter revenue performance by industry group.
Revenue across our industry groups was as follows.
[noise] B, if aside revenue decreased 4.4% sequentially and increased 70 basis points year over year, representing 60% of revenue.
Our Q1 sequential change in BFS I, primarily reflects a decline in revenue from our largest client, which we discussed on our last earnings call. Excluding our largest client revenue from our banking portfolio grew approximately 2% sequentially.
Communication and technology revenue increased 1% sequentially and 25.9% year over year, representing 32% of revenue.
CMT results, well above our expectations, reflecting strong growth with our technology and healthcare clients.
Media information and other revenue declined 3.2% quarter over quarter, and 30.1% year over year, representing the remaining 8% of revenue.
And then I performance was slightly better than our expectations.
With respect to our geographical performance on a year over year growth was led by North America up 9.9% and rest of world up 7.6%, partially offset by Europe , which declined 5.5% in reported currency and 1.1% in constant currency.
I will now provide our current guidance for fiscal second quarter and year ending March 31st 2020 .
Revenue in second quarter off 2020 is expected to be in the range of 323 million to $331 million.
non-GAAP diluted earnings per share in the second quarter of 2020 is expected to be in the range of 49 cents to 55 cents.
Our Q2 fiscal 2020 non-GAAP EPS guidance anticipates, an average share count of approximately 34 million.
For the fiscal year, ending March 31st 2020 , we expect revenue to be in the range of $1.32 billion.
Two $1.354 billion.
non-GAAP diluted EPS for fiscal year 2020 is expected to be in the range of $2.45.
Two $2.65.
Our guidance excludes $24 million of stock compensation expense and $16.1 million of acquisition related charges.
For fiscal year, 2020 , non-GAAP , EPS anticipates, an average share count of approximately $34.1 million.
I've got in GAAP and non-GAAP guidance is based on a set of assumptions that can be found on our data sheet located in the Investor Relations section of our website.
When we spoke with you in May we mentioned that our fiscal 20 revenue visibility was consistent with prior year would slightly better backlog and qualified pipeline.
However, as Chris discussed in early July one of our European banking clients informed us of spending reductions, which will impact this year's renewal revenue with this account.
Keeping this trend in mind, we have also decided to risk adjust fytwenty pipeline conversions for this client.
Additionally, this client is accelerating their drive to offshore more work with US which will also have an impact on our fytwenty revenue from this account.
All of these factors are impacting current year revenue with this decline by approximately $37 million.
In addition, since we last provided guidance. The UK pound has continued to slide versus the dollar which has created an incremental $7 million or 60 basis point headwind to our fytwenty revenue growth.
Our European banking account revenue change and FX impacting our fytwenty revenue guidance by approximately $44 million, which is partially being offset by incremental growth at our top 10 clients.
As a result of these factors we have adjusted the midpoint of fiscal 20 revenue guidance by $39 million.
As expected the large healthcare transformational deal we mentioned in our fiscal Q4 19 call was consummated during the first quarter.
In addition, when adjusted for the impact of one European banking client discussed earlier, all our industry verticals continue to grow in line or slightly better than our prior expectations on a constant currency basis.
At the midpoint of our fiscal Q2 guidance revenue is expected to increase approximately 2.5% sequentially.
As previously discussed revenue from our largest client is expected to resume sequential growth in Q2.
Sequential non-GAAP operating margin accretion is expected to resume in fiscal Q2 in line with our prior outlook.
[noise] fytwenty at the midpoint of our guidance range. We now expect revenue growth of 7.4% in reported currency and 8.1% in constant currency.
In addition, we now expect 60 basis points of non-GAAP operating margin accretion in EPS by 20 words is 100 basis points previously.
This reflects 70 basis points of margin impact from lower client revenue.
20 basis points of margin impact from incremental FX headwinds, partially offset by accelerating the cost containment programs, we initiated at the start of this year.
Our non-GAAP effective tax rate is expected to be 30% for fiscal 2020 worse is 31.2% previously.
As a reminder, this does not include any be tax impact as we are contemplating a reorganization of our Indian legal entities.
Our current non-GAAP guidance anticipates $18.5 million of interest expense.
Lastly, we are expecting healthy non-GAAP EPS growth of 20% in Fytwenty.
Before closing as you probably noticed in our earnings press release, our board of directors have authorized a new $30 million share repurchase program.
We plan to Opportunistically repurchase our stock using our existing credit for two facility as well as cash on hand, while maintaining ample liquidity to support our growth strategies.
In conclusion, our first quarter results exceeded the midpoint of our prior guidance aside from the revenue impact of one client business continues to grow and largely in line with our expectations.
We have accelerated plans to calibrate our cost structure to enable us to deliver year over year margin expansion and our new share repurchase program will contribute incremental EPS accretion.
The underlying growth drivers of our business remains solid and we are well positioned to deliver revenue growth and margin expansion in fytwenty and beyond.
Operator, you may now begin the Q and a session.
We will now begin the question and answer session.
To ask a question press Star then one on your Touchtone phone.
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Please limit yourself to one question and one follow up if you have further questions you may reenter the question.
At this time, we will pause momentarily to assemble our roster.
And our first question comes from Joseph foresee of Cantor Fitzgerald.
Gerald Please go ahead.
Hi.
Maybe we could just talk about.
The European financial client first.
It's fairly unusual I guess as she budgets opened during the middle of the year.
Maybe you could just give us some more color as to why.
Those.
Cuts were being made to what portion of the business.
Those cuts are being made and what gives you confidence that.
Spending will resume.
Hi, Joe This is Chris So as we said earlier will be launched in July early July that one of our banking and financial services clients in Europe have decided to reduce their spend on IP.
A large part of it this is driven by their desire and objective of becoming a leader in cost income ratio in the banking sector.
Now.
As a result of our goals and objectives.
We have decided to delay the start of some programs.
At end of Q1.
Turning 20.
Not renewing certain program.
And accelerating some of our programs to offshore.
Withstanding.
Our pipeline continues to grow.
Although start dates have been pushed to calendar Q1 2012.
Having said that.
We have an excellent track record with this time.
And it is critically important.
The Beast support.
The second half calendar year, 2019 cost objective and strategically position ourselves for future growth.
Joe just on internal checks.
We believe show us that those.
At this a little bit of a mixed spending issue I think the full year on a full year basis. Their budgets are probably lost their budgets are accelerating year over year, but it was a mixed spending issue first half versus second half. So there's really try to rebalance that spending patterns first half versus second half and thats impacting our second half revenue with them.
Okay, and then secondly, just as far as.
You know the resources and I guess I'll ask this kind of two ways resources and visibility.
From a resource perspective are you going to hold those resources and Thats why you're taking.
70 basis point impact to margins, and then redeploy them or try to use them as efficiently until that business comes back and then secondly, we held the call a couple of months ago, and we talked about there being fairly high visibility, but since the beginning of the year, we heard about a large client and clearly you're right about that that large client has come back but now we're hearing about a European client. So maybe we can just get an update on where you stand from a visibility standpoint, and what you're going to do with those resources. Thanks.
Sure.
Joe in terms of resources, you know it will be a combination of the two that some will be redeployed and some we will have to look at.
Further actions in than that and Thats really what is impacting the margins. In fact, we believe some of the margins will also to relating to severance type of expenditures that are already being absorbed in the margin impact. So in this case, we don't believe all of it will be absorbed back in the growth of the business, partially some will be absorbed some may not be absorbed.
In terms of the revenue visibility we were trying to address it in our prepared remarks, when we look at the revenue visibility at the beginning of the year.
The backlog the pipeline, what we have really the backlog pretty much stays as it is that we have the decline the only piece that the backlog getting impacted is really by the offshoring element. The big piece that has really impacted as daily the renewal, which we always accounted for as a very high percentage of renewal rate because that's really been our historical past practice and if that continues to hold true with all our client base, except for the in decline now so we've readjusted the renewal revenue for this client because we've really significantly the adjusted the renewal revenue we took a prudent to active you adjust the pipeline to for this year and Joe. This is Chris so outside of this one client the rest of our business is growing approximately 5% sequentially.
And above industry growth year over year in line with our long term growth aspirations.
Thank you.
And Joe even in this client would we have seen actually the new pipeline injection still continues so thats hasn't been held back. We're just you know we feel like the patent right now is at a little bit of a readjustment of first half spending versus second half spending so it might not be that prudent for us to use the historical conversion ratios that we use and pipeline for this account. So thats really we adjusted we believe a lot of those pipeline will translate back into revenue when they resumed spending which is now being talked about in this calendar.
20.
Thank you.
Again, if you have a question. Please press Star then one.
And our next question will come from Maggie Nolan of William Blair. Please go ahead.
Hi, a follow up on that.
Large client conversation the large banking client and how much of the impact is related to some of the work being moved offshore.
And it sounds like Thats, an accelerated rate. So was this something that you expected to do with them over time, and it's and it's just hitting all at once and how long would that previous expectation I'm trying to get an understanding of.
How much of this work is still kind of recurring.
And the next year, but its just now happening from offshore.
Yes.
Hi, Mike its Chris so once again.
They are basically delaying the start of some of their programs to calendar Q1 2020.
Not renewing certain programs and accelerating some of our programs to offshore business or a three drivers.
On accelerating the offshoring program, that's approximately about an 11% shift from onshore to offshore and clearly because they have been on a fairly aggressive spend pattern.
In and around transformation.
In the first half of the year.
And they have elected.
To basically cut back on their second half costs. They are essentially doing all of these three things simultaneously.
Now we are very confident and as Ron said earlier.
The pipeline with our large clients in Europe is growing fairly significantly.
However.
We expect that much of that conversion.
The only contribute starting in calendar Q1 20.
Okay and then.
Good color on kind of the rest of the business I'm wondering if you could get a little more granular I'm you know what is the expectation for financial services growth outside of that large client and how is the traction there.
Continuing and then is there an effort to diversify within financial services and potentially decrease.
Some of this client concentration or decrease exposure to banking whatever the efforts may be any color there would be great. Thank you.
So Maggie favorable like this I alluded to.
When we look at our business, we look at the impact of the business had with regards to our largest client a failure in Q1, and then that as you can see the data sheet that we provided.
Recall for that Thats client would start to really resumed spending and in fact, our Q1.
As expected the stations that though the actuals would actually a little bit better than the expectations that we have for the Q1 client and this largest client and they're really starting to show sequential growth rate in Q2, and then we have this other European client issue now if I if I bucket those two if I look at the growth of Virtusa as a company.
Ex the large client or ex this one European client it really in both those cases the shows a double digit low double digit growth if I look at the.
Company growth.
Combining these two events then we're really talking almost a mid teens growth for the company for the rest of the business. So strong growth that we have across the business EBITDA and especially.
When we look at our Cfd business when we look at inside the healthcare segment of the business that has all going very rapidly.
Thank you.
Our next question comes from Tony James of JP Morgan. Please go ahead.
Yes, hi, Thanks for taking my question. So it seems like the time factor. This utopian time was not slated to Brexit.
So can you talk about the extent stress tested your guidance for various Brexit scenarios.
So puneet Thats a great question this is Chris.
We are not certain whether this was brexit related or not.
What we are seeing in general is that there are certain banking and financial services clients in Europe .
That are spending a head up Brexit uncertainty.
And preparing themselves for fairly fairly large transformational programs to operate better enable post Brexit world.
And Im sure. Conversely, there are some banking client that may be more focused just in the UK.
That may be.
Looking at the Brexit uncertainty.
And waiting until the dust settles to determine.
The our direction and course.
Right. So we are seeing.
Across the board in Europe .
A tale of two cities when it comes to Brexit impact.
As a matter of fact, we very recently won.
A very competitive.
Large engagement for another European Bank.
Who is specifically investing in systems separation and Cloudification.
To essentially operate in a post Brexit environment.
Right, so get with seeing both sides of this.
Got it got it and how should we think about margin expansion potential beyond the theaters does surprise.
By the margin guidance given you also had benefits from restructuring you did last year.
So yes was there any underlying change in.
Ill patients delivery.
That's hurting margins this year.
No I think like I provided earlier in the prepared remarks, when you look at a 70 basis points of impact is really happening the margin impact because of the revenue impact that's happening $37 million or the revenue impact. That's just from this one client in the back half that we have.
Another 20 basis points as FX now that is being netted by cost containment program. I mean do you run the math, you'll probably see that the cost containment programs, our daily about adding about 50 basis points in the back half.
And those are the cost containment program.
Always really continue to run really preparing ourselves for the following year.
So you know I mean, you've seen us come out and really talk about the significant cost containment programs that we are announcing for the following year recovered are usually in the Q3 to the reason why we are not able to do that is because we are always working on this what did we do in this case, we significantly accelerated.
Yes, we could not cover the whole 100 basis points impact, but all the all of the 90 basis points to 70 of the revenue in the 20 of FX, we can do that all of it but we were able to.
Partially reduce the impact by 50 basis points.
Only because we have had a lot of these programs that are always in play producer and we believe those will continue to be in place for Medusa and nothing really changes for us from a long term.
Objective, which is continue to be an above industry growth rates revenue company and continue to deliver margins under 250 basis points.
Okay. Thank you.
This concludes our question and answer session I would like to turn the conference back over to Kris Canekeratne for any closing remarks.
Thank you I would like to take this opportunity to thank our global team members for their dedication and hard work.
Thank you for joining us on this call and I look forward to updating you on our Q2 earnings call. Thank you.
The conference has now concluded. Thank you for attending today's presentation you may now disconnect.