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Edited Transcript of VRTU earnings conference call or presentation 7-Nov-19 10:00pm GMT

Q2 2020 Virtusa Corp Earnings Call

Westborough Dec 11, 2019 (Thomson StreetEvents) -- Edited Transcript of Virtusa Corp earnings conference call or presentation Thursday, November 7, 2019 at 10:00:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Krishan Aruna Canekeratne

Virtusa Corporation - Co-Founder, Chairman & CEO

* Ranjan Kalia

Virtusa Corporation - Executive VP of Finance, CFO, Treasurer & Secretary

* William Maina

Virtusa Corporation - Head of IR, ICR

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Conference Call Participants

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* Bryan C. Bergin

Cowen and Company, LLC, Research Division - Director

* Joseph Dean Foresi

Cantor Fitzgerald & Co., Research Division - Analyst

* Kyle David Peterson

Needham & Company, LLC, Research Division - Associate

* Margaret Marie Niesen Nolan

William Blair & Company L.L.C., Research Division - Analyst

* Moshe Katri

Wedbush Securities Inc., Research Division - MD of Equity Research & Senior Equity Research Analyst

* Puneet Jain

JPMorgan Chase & Co, Research Division - Computer Services and IT Consulting Analyst

* Vincent Alexander Colicchio

Barrington Research Associates, Inc., Research Division - MD

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Presentation

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Operator [1]

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Welcome to the Virtusa Corporation Second Quarter Fiscal Year 2020 Earnings Conference Call. (Operator Instructions) Please note, this event is being recorded. I would now like to turn the conference over to William Maina, Investor Relations. Please go ahead.

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William Maina, Virtusa Corporation - Head of IR, ICR [2]

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Thank you, Andrew, and welcome to Virtusa's Second Quarter Fiscal Year 2020 Earnings Conference Call, where we will be discussing our financial results for Virtusa's second quarter ended September 30, 2019. On the call with me are Kris Canekeratne, Chairman and Chief Executive Officer; and Ranjan 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 pursuant to the safe harbor provisions of the Private Securities Litigation Reform Act of 1995. During this call, we may make express 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; 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 uncertainties, 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 speak only as of the date hereof. Virtusa undertakes no obligation to update or revise 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 a reconciliation of cash, cash equivalents, short-term and long-term investments that we believe provides insights into our total cash position and overall liquidity.

Please note that a supplemental data presentation to our second quarter results has also been posted to our Investor Relations website. For additional disclosure regarding these and other risks faced by Virtusa, please see the disclosures contained in Virtusa's public filings with the SEC and in our earnings press release.

With that, I'd like to turn the call over to Kris. Kris?

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Krishan Aruna Canekeratne, Virtusa Corporation - Co-Founder, Chairman & CEO [3]

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Thank you, Will. Good evening, everyone, and thank you for joining us today. We delivered solid fiscal second quarter financial results that exceeded the midpoint of our guidance range. Total revenue was $328.5 million, representing 3% sequential and 7.5% year-over-year growth. We generated sequential revenue growth across all our major industry groups. Our non-GAAP operating margin was 8.9%, up 130 basis points sequentially and in line with our expectations. Our non-GAAP EPS was $0.54.

Our second quarter results reflect strong demand across our industry groups and geographies with digital transformation and cloud transformation, our DT and CT practices areas continuing to be the key drivers of our business. It's an unwavering trajectory that reflects the realization of what has been called the fourth industrial revolution, a profound technology-driven shift from discrete, layered and controlled business model that the user or customer was subject to to ones that are fully distributed, flat and user-empowered. The legacy approaches of the past are being disrupted and, in some cases, destroyed by this new order, placing unrelenting pressure on virtually every company to rethink, reimagine and ultimately transform their businesses in order to remain competitive. Digital transformation and cloud transformation are the cornerstone initiatives to make that happen, and they are the cornerstones of our business.

Digital transformation continues to garner more strategic attention at the highest levels of our clients' organizations and, consequently, more budget as our clients realize its importance to their survival. Of note, a recent IDC study projects global DT spending to top $2 trillion by 2022. This trend is evident in our metrics. Our digital work is increasing. Our digital pipeline grew by more than 30% year-over-year for the second straight quarter. And our digital revenue was 41% of total revenue in fiscal Q2.

As the digital transformation demand continues to grow, we are seeing increased interest from clients across all industries in cloud transformation, and the 2 are inextricably linked. Our cloud transformation engagements range from working with clients who are beginning the journey of moving to the cloud, to developing cloud-native applications and data migration for global organizations with well-established multi-cloud strategies. We believe it is no longer a question of if our enterprise clients are considering cloud adoption but rather when they will begin or at what stage of their cloud journey they are currently in.

In anticipation of this trend, we have been making strategic investments across our business in building a workforce with strong cloud expertise, augmenting our in-house cloud capabilities, creating cloud-native solutions and strengthening our partnerships with industry-leading public cloud service providers. As a result of these investments and our proven leadership in delivering on the promise of cloud transformation, our clients are increasingly turning to Virtusa for cloud solutions to resolve everyday challenges, transform their organizations and create a ready-for-anything scalable digital infrastructure. Let me now give you a few examples of what we are doing in the cloud space.

Virtusa today is leading an enterprise-wide cloud transformation for a multinational telecommunications company. This multiyear engagement extends beyond just application migration to the cloud. Our engagement begins with creating a new application development blueprint for our client utilizing agile approaches and applying this blueprint to several lighthouse application transformation use cases. Our clients will then leverage this new development playbook to facilitate its migration of over 400 applications from disparate data centers to their preferred public cloud provider. Virtusa won this deal competing against multiple generation 1 consulting firms, not only because of our CT capabilities but just as importantly, our creativity and engineering expertise, which will enable increased efficiencies across our clients' global application development ecosystem. With this win, we are now in a leading position to further radiate our presence within this multiyear cloud migration program with a total value in the tens of millions of dollars.

Virtusa was also recently selected by a leading U.S.-based multinational bank for the implementation of a multi-cloud program transforming their legacy debit platform into a cutting-edge cloud-native platform that will be built using our client's proprietary tools. This transformation will enable our client to modernize their debit card platform and achieve scalability at a reduced cost. Virtusa was chosen as the preferred transformation partner after careful client due diligence to ascertain our cloud enablement expertise and experience in delivering large transformation programs for major banks.

In my last example, Virtusa was recently selected by 1 of Europe's largest banks to migrate a set of over 140 applications onto a private cloud infrastructure. This program will enable our client to mediate time-bound requirement for separating its shared data centers with a subsidiary company. Virtusa gained 1 disengagement because of our extensive cloud expertise as well as our deep domain knowledge and engineering heritage.

Our client examples in our digital transformation practice area continue to demonstrate our leadership position. DT initiatives have been and are being undertaken to expand our clients' addressable markets through digital-first and digital-only strategies, increase their speed to market, mitigate risk and reduce their BAU costs. All of these outcomes remain key client priorities across all of our industry groups.

Health care, for example, remains 1 of our fastest-growing industries and is an area where we are seeing substantial demand for our DT solution. Our health care clients are increasingly looking to implement analytics solutions, driven by AI/ML, in order to gain better business insights, facilitate greater engagement between patients and providers and provide better, more advanced care for patients.

For example, Virtusa is currently engaged by a leading health care technology company to modernize their current analytics system. Over the course of this engagement, we will be developing an advanced set of dashboards, which will be highly interactive and will give health care providers access to robust analytics capabilities of medical data. When this engagement is complete, the new system will be able to run advanced AI analytics that provide predictive and prescriptive information to its users, ultimately providing better care to patients.

We also recently announced a collaboration with Cardinal Health, Amazon Web Services and The University of Texas Health Science Center at Houston to use AI and machine learning to advanced medical research. Using Virtusa's cloud-based platform, prebuilt APIs and AI/ML models, medical researchers at UTHealth will seek to find trends that can lead to new treatment strategies and cures for a range of illnesses. We are very proud to be part of this collaboration.

Within banking and financial services, regulatory compliance initiatives remain near the forefront of our clients' DT spending priorities, especially in Europe. We continue to see increased collaboration with banks specifically around Know Your Customer or KYC requirements. In addition, those banks that are KYC-compliant are looking to monetize their early investments by developing APIs with fee-based usage models for customers and partners. Today, we are engaged with multiple European banks in building their KYC platform, benefiting from our earlier investments in building solution accelerators in this area.

Our cloud and digital transformation capabilities continue to be recognized market-wide, and this is leading to even greater opportunities for Virtusa. Our consistent track record is garnering us both attention and reward, with the most recent example involving Virtusa being selected as a major European bank's #1 strategic digital engineering partner after a grueling competitive RFP process against 22 other service providers. The selection gives us the ability to bid on 100% of the client's digital projects beginning in our fiscal fourth quarter and positions us as their partner of choice.

We have already been awarded new work, including engagement to build a digital personal financial coach for their retail banking customers. It's a sizable project, but as importantly, it is an opportunity to expand within a division of the bank with the largest digital budget. We are very pleased to be selected as this client's numbers digital engineering partner and believe it reflects our growing position as a leader in the space known for the integrity of our work and our track record of delivery excellence.

Moving forward, we see demand remaining strong across all of our industry groups and geographies, but we are not standing still. We continue to make revenue diversification a priority and are making solid strides. We are targeting high-growth verticals, including health care and high tech, and increasing our focus on high-growth geographies in EMEA. We are also committed to growing high-potential accounts faster than the company's growth rate to further diversify revenue. We believe these initiatives will reduce revenue concentration risk over time and lead to better-than-industry growth.

In conclusion, we believe that our focus on digital and cloud transformation work across industries and geographies remains the right focus. The task of transformation has become a necessary one for virtually every business in today's world, and the ability to make it happen is our core strength. Our progress and position gives us confidence in our ability to deliver solid, sustainable growth.

Now I'd like to turn the call over to Ranjan, who will provide more details on our results as well as our third quarter and fiscal year 2020 guidance. Ranjan?

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Ranjan Kalia, Virtusa Corporation - Executive VP of Finance, CFO, Treasurer & Secretary [4]

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Thanks, Kris, and good evening to everyone. Let me start by summarizing the results of our fiscal second quarter 2020. I will then provide our current guidance for both fiscal third quarter and fiscal year ending March 31, 2020, before opening the call for questions.

Revenue for fiscal second quarter was $328.5 million, above the midpoint of our guidance and representing 3% sequential growth in reported currency and 3.5% growth in constant currency. Our sequential revenue growth was driven by growth across all of our industry groups. Year-over-year, our second quarter revenue increased 7.5% in reported currency and 8.4% in constant currency.

Gross margin of 27.4% was in line with our expectation and up 100 basis points sequentially, primarily reflecting higher utilization.

GAAP operating income for the second quarter was $19.2 million compared with $13.4 million in the prior quarter and $14 million in the year-ago period. GAAP operating income was slightly above the midpoint of our expectation, reflecting our revenue beat.

Second quarter other expense was $7.2 million. This includes $3.5 million of net foreign exchange loss and $3.7 million of net interest and other expense.

Net interest and other expense includes $4.8 million of interest expense and $1.1 million of interest and other income.

GAAP earnings per share was $0.20 in the second quarter. This compares to $0.15 in the prior quarter and $0.01 in the year-ago period.

Turning to our non-GAAP results. Non-GAAP operating income was $29.4 million in the second quarter compared to $24.2 million in the prior quarter and $29 million in the year-ago period.

Second quarter non-GAAP operating margin was 8.9%, in line with our prior expectations.

Non-GAAP earnings per share was $0.54 in the second quarter, $0.02 above the midpoint of our prior guidance, primarily due to higher operating income and our share repurchases in the quarter. This is compared to $0.41 in the prior quarter and $0.54 in the year-ago period.

Turning to the balance sheet. Ending cash at September 30, 2019, was $198.5 million, inclusive of cash and cash equivalents, short-term and long-term investments. Cash declined approximately $10 million sequentially as we funded our stock buyback program. Cash provided by operating activities was $21.6 million in the second quarter, representing 7% of revenue.

Our DSO for the second quarter was 74 days, an improvement of 1 day sequentially and 2 days from the year-ago period.

In Q2, we repurchased approximately 505,000 shares for $18.7 million under our current share buyback program. As of September 30, 2019, $11.3 million was available under this program.

Now I will turn to some more detailed discussion of our second quarter revenue performance by industry group. Revenue across all industry groups exceeded the midpoint of our prior expectation. BFSI revenue increased 1.8% sequentially and 70 basis points year-over-year, representing 59% of revenue. The sequential increase in BFSI primarily reflects growth with our financial services and banking clients, including growth at our largest client as previously expected.

Communication and technology revenue increased 3.7% sequentially and 27% year-over-year. C&T represents 33% of revenue in Q2, up from 28% a year ago, highlighting our strong growth in this industry group and ongoing focus on revenue diversification.

Media, information and other. Revenue increased 9% quarter-over-quarter and decreased 4.8% year-over-year, representing the remaining 8% of revenue.

With respect to our geographical performance, North America revenue increased 11% year-over-year, followed by rest of world by 8.8%. This was partially offset by Europe, which declined 5.6% in reported currency and 1.1% in constant currency.

I will now provide our current guidance for our fiscal third quarter and year ending March 31, 2020. Revenue in the third quarter of 2020 is expected to be in the range of $332 million to $340 million. Non-GAAP diluted earnings per share in the third quarter of 2020 is expected to be in the range of $0.73 to $0.79. Our Q3 fiscal 2020 non-GAAP EPS guidance anticipates an average share count of approximately 33.4 million.

For the fiscal year ending March 31, 2020, we expect revenue to be in the range of $1.3 billion to $1.35 billion. Non-GAAP diluted EPS for fiscal 2020 is expected to be in the range of $2.51 to $2.65. Our guidance excludes $23.4 million of stock compensation expense and $16.8 million of acquisition-related charges. Full fiscal year 2020 non-GAAP EPS anticipates an average share count of approximately 33.7 million. Our current 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.

As Kris discussed earlier, digital transformation and cloud transformation client initiatives continue to be the key growth driver for Virtusa. Digital transformation primarily involves 3 core business areas: data, integration and CX or customer experience. Data involves the ability to capture, aggregate and analyze massive amounts of data via machine learnings in real time to both measure performance and generate insights that can drive future growth. DT integration opportunities include building scale middleware that can bridge applications with partner ecosystem to improve time to market. DT applied to customer experience is about creating seamless, often mobile-first interfaces that allow customers to engage when and how they want.

As digital transformation demand continues to grow, we are also seeing greater interest from clients across all industries in cloud transformation. As with DT, we believe there is significant runway for growth from cloud transformation services within our banking and financial services, insurance and health care clients as they are earlier in their adoption of cloud versus high-tech clients.

At the midpoint of our fiscal Q3 guidance, revenue is expected to increase 2.3% sequentially, slightly below our prior expectations, impacted primarily by higher-than-anticipated client-mandated holidays. As contemplated in our prior guidance, we expect strong sequential non-GAAP operating margin accretion in Q3.

Looking to fiscal Q4, our guidance contemplates that our strong sequential revenue growth will be supported by the following factors: first, a higher number of billing days versus Q3; second, the resumption of growth at 1 of our large European banking clients, which we discussed with you previously; third, the usual Q4 revenue acceleration at our large European telecom client; and last, organic growth with other clients in line with past performance.

For FY '20, at the midpoint of our guidance range, we continue to expect revenue growth of 7.4% in reported currency and 8.1% in constant currency. In addition, we expect 60 basis points of non-GAAP operating margin accretion in FY '20. Our non-GAAP effective tax rate is expected to be 30.3% for fiscal year 2020 versus 30% previously stated. As a reminder, our ETR does not include any BEAT tax impact as we have been contemplating a reorganization of our Indian legal entities, which continues to be on track. Our current non-GAAP guidance anticipates $18.7 million of interest expense. We continue to expect strong non-GAAP EPS growth of 22% in FY '20 at the midpoint. The $0.03 increase in our non-GAAP EPS guidance is primarily due to our share repurchase activity in Q2.

In conclusion, our second quarter results exceeded the midpoint of our prior guidance. Based on current demand trends, backlog and pipeline, we expect our fiscal second half results to perform in line with our expectations, and we reiterate the midpoint of our fiscal year 2020 revenue guidance and raised our non-GAAP EPS guidance. While our business momentum remains positive, particularly within health care and high tech, we will continue to monitor macroeconomic trends and their potential impact on demand at our banking clients in the U.S. and in U.K. Our focus continues to be on creating long-term shareholder value by delivering strong EPS growth in fiscal 2020 and beyond.

Operator, you may now begin the Q&A session.

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Questions and Answers

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Operator [1]

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(Operator Instructions) The first question comes from Mayank Tandon of Needham & Company.

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Kyle David Peterson, Needham & Company, LLC, Research Division - Associate [2]

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This is actually Kyle Peterson on for Mayank. Just wanted to start on margins, kind of walking through that kind of 60 bps year-on-year expansion. Just between kind of gross margin and SG&A, is there any more room, do you guys think, on whether it's utilization or bill rates that gross margin could kind of see itself walk higher? Or is most of that expansion going to be through SG&A? Just kind of want to see how we should be thinking of that as the year progresses.

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Ranjan Kalia, Virtusa Corporation - Executive VP of Finance, CFO, Treasurer & Secretary [3]

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Well, Kyle, we believe, at the midpoint of our guidance, the OPM accretion is expected to be 60 basis points. If we tend to be at the high end, the OPM accretion can be higher than that. That being said, we believe that our business model and our financial model continues to have many levers that we will continue to extract to walk on our 100 to 150 basis points road map that we've designed for ourselves, which we did meet the last 2 years. I mean this year is an exception because of the big revenue change that we had after our May guidance, but we believe that we continue to be on the road map to growing margins by 100 to 150 basis points annually, which would mean that we will have plenty levers in our gross margin as well as in our SG&A.

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Kyle David Peterson, Needham & Company, LLC, Research Division - Associate [4]

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All right. That's helpful color. And then just a follow-up. We noticed that the number of clients with $25 million plus in revenue took a little leg up. I think there were 3 more in that bucket this quarter. Are these new clients that have been ramping (inaudible) kind of potential to scale and kind of help with the revenue diversification? Or is this new work out of the existing clients? Just any color you might be able to add would be helpful because it's just nice to see the diversification playing out.

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Krishan Aruna Canekeratne, Virtusa Corporation - Co-Founder, Chairman & CEO [5]

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Kyle, this is Kris. And yes, absolutely, we have been focused on our diversification strategy. Our diversification strategy spans multiple areas. We are targeting high-growth verticals, including health care and high tech. We are increasing our focus on high-growth geographies such as the U.K. and Australia. And we're also committed to growing high-potential accounts faster than the company's growth rate, specifically those accounts that have the potential to be greater than $25 million accounts. Now some of those accounts have been accounts that we have actually been working with for some time. We have made the necessary investments. We have proven the differentiation of our service offerings, whether it be in cloud and/or digital transformation. And we are expanding our addressable market across those accounts.

In other instances, we have a crop of new accounts that are rapidly emerging to be able to provide the potential to actually become $25 million plus accounts. So we are seeing it both from the perspective of existing accounts that we've worked with for quite some time, and we're also seeing it from the perspective of newer accounts that we are closing. But I think the large underlying reason for this level of growth, especially in those accounts that have the potential to be accounts that are meaningful and over $25 million, has to do with our expertise and capabilities in digital transformation and cloud transformation.

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Ranjan Kalia, Virtusa Corporation - Executive VP of Finance, CFO, Treasurer & Secretary [6]

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Kyle, I think Kris' remarks were pretty clear. I just want to add 1 more thing, that what you're really seeing is none of -- it's all by design. I mean this was incorporated in our guidance earlier on in the year. We've been working a lot of initiatives that actually translated into showing that our $25 million clients have really grown significantly. So none of this was actually a surprise to us. We've been working on this behind the scenes.

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Operator [7]

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The next question comes from Puneet Jain of JPMorgan.

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Puneet Jain, JPMorgan Chase & Co, Research Division - Computer Services and IT Consulting Analyst [8]

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So your organic growth over the last few quarters is driven by the second telecom vertical, which has offset weakness in other areas. So what's driving high growth in that vertical? Is it the synergies from eTouch deal or any industry trends, maybe in health care, if that revenue goes in there, or telecom that's driving growth in that business?

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Krishan Aruna Canekeratne, Virtusa Corporation - Co-Founder, Chairman & CEO [9]

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So, Puneet, the fundamental areas that's actually driving fairly significant growth for us is our strength and expertise in digital transformation, build a robust layer of micro services to be able to enable our clients to provide seamless journeys to consumers and expand their addressable markets and an increasing volume of activity in cloud transformation.

So about a year ago, what we found was that there were a large number of experiments that are being done around cloud initiatives, and now we are finding that these programs are becoming substantial programs. Specifically in telco and health care and in high tech, we are seeing significant increases in need and adoption of digital transformation and cloud transformation services. And as you probably noticed, our digital revenue mix has increased, and our digital pipeline, now 2 quarters in a row, have grown by over 30%.

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Puneet Jain, JPMorgan Chase & Co, Research Division - Computer Services and IT Consulting Analyst [10]

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Got it. Got it. And with U.K. or Brexit uncertainty likely pushed out into your fourth quarter, how confident you are about seeing the improvement in that U.K.-based banking client? And are -- is that client -- like given where it is in 2Q, is there going to be any further step-down in revenue from Q2 into Q3 at that client?

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Krishan Aruna Canekeratne, Virtusa Corporation - Co-Founder, Chairman & CEO [11]

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So let me just start by sharing some color in terms of our large European banking client. So we do expect that our large European banking client from an expectation standpoint was lower than our forecast, and we've recalibrated that especially in -- going into Q3. We are expecting fairly sharp -- a sharp rise in revenue growth at our large European banking client going into Q4, and that's being driven by us being selected in a very deep and complex pursuit amongst 22 services providers and being selected as the #1 digital engineering services provider. As a result of that selection, the momentum that we have and the pipeline activity that we have, especially as we start calendar year '20, has increased sharply, and we're expecting that some of those programs will drive significant growth in revenue from our large European banking client as we go into our Q4 or the first calendar quarter of '20.

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Ranjan Kalia, Virtusa Corporation - Executive VP of Finance, CFO, Treasurer & Secretary [12]

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So, Puneet, just -- so 1 -- from the large European client, that was always expected that Q3 versus Q2 will still be a decline, whereas our prior guidance expectation continues to be our same expectation where we -- the guidance call for this is probably the last quarter of continued declines in this. We are expecting -- because the March quarter is their first budgeting quarter, we will start to grow that. But the growth is not -- at the client level, the growth should not be thought about as an exponential growth that is somehow going to reverse in 1 quarter. We are expecting growth will happen, but it will happen in a more measured manner. But the big piece that will happen for the company is at least that won't be masking a lot of the growth that happens at the other clients. So the growth that happened at the other clients would also start to show very favorable.

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Operator [13]

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The next question comes from Bryan Bergin of Cowen.

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Bryan C. Bergin, Cowen and Company, LLC, Research Division - Director [14]

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I wanted to ask you on the large health care deal, how that might be progressing. Any early signs of success here that you think potential expansions that you can call out?

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Ranjan Kalia, Virtusa Corporation - Executive VP of Finance, CFO, Treasurer & Secretary [15]

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Yes. So, Bryan, the large health care that we talked about in Q1 continues to do well, it's probably contributing about $5 million to $6 million worth of revenue on a quarterly basis. As you know, how we try to do these things is we don't really go very hard and heavy on synergy play earlier on, and the synergy play is something that we are working on, start to really extract maybe later part in Q4. There are initiatives that are there, but these numbers that I talked about, $5 million to $6 million, do not contemplate synergy revenue in that. And we expect synergy revenue opportunities for Virtusa continues to do that. So the deal has done -- pretty much on track with what -- how we had designed the acquisition model.

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Bryan C. Bergin, Cowen and Company, LLC, Research Division - Director [16]

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Okay. That's helpful. And then with your top client, did that come in line with your expectation? I think it did a little bit better than you expected last quarter. How did that fare here relative to your outlook in this quarter and going forward? Is it still kind of that sequential growth as we move through the back half?

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Ranjan Kalia, Virtusa Corporation - Executive VP of Finance, CFO, Treasurer & Secretary [17]

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Yes. So it sequentially grew, and the sequential growth was slightly better than our expectations, and we are expecting sequential growth again in our Q3. So full year, our expectations for this client is pretty much what we had talked about in our May guidance.

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Operator [18]

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The next question comes from Moshe Katri of Wedbush Securities.

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Moshe Katri, Wedbush Securities Inc., Research Division - MD of Equity Research & Senior Equity Research Analyst [19]

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Just going back to the topic of the European client. Can you just talk a bit more maybe about how this actually gets reflected in the quarterly numbers for the next few quarters? That's number one. And then did you mention what was the digital mix here in the quarter and also the growth rates?

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Krishan Aruna Canekeratne, Virtusa Corporation - Co-Founder, Chairman & CEO [20]

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So with the large European banking client, as we expected, we would see sequential decline going into Q3, and that's exactly what's transpiring. As a matter of fact, the client has performed a little bit below our expectations, offset by other plans that have performed better than our expectations, hence, the guidance being exactly what it was when we guided last quarter.

Now having said that, we have been recently selected by this client as their #1 strategic digital engineering partner after going through a fairly extensive RFP process. Now what that means is that as a result of being selected as their #1 digital engineering partner, we basically get to bid on the entire opportunity set of digital engineering programs, which is quite sizable. And we're also very pleased that we actually competed against pretty much everyone in the space, whether they were generation 1 companies that are India-headquartered, consulting firms that are either Europe- or U.S.-headquartered, digital engineering firms from Eastern Europe and other parts of the world. And we were picked essentially as the #1 strategic partner. And that really talks, clearly, and points to the highly differentiated services that we have in terms of digital and cloud.

Now what's happened, Moshe, since this is that we have been selected for a variety of different engagements, many of them commencing in January or the January quarter of 2020. So we expect that as we go into our fourth quarter, that we will see fairly significant revenue ramp at this client. And then beyond that, the potential is pretty significant because we are now their #1 strategic digital partner.

Now in terms of our overall pipeline, our overall pipeline was up 12% year-over-year. But more importantly, the digital pipeline was up 39% year-over-year. Our average deal sizes for the total pipeline was up close to 20% year-over-year. So overall, we are making great progress across pipeline metrics. And it's directly corroborating the fact that our overall volume of digital engineering work is increasing. We are becoming very well-known as a transformational digital and cloud transformation partner, and I think that's further underscored by going up against perhaps some of the best-known services companies and being selected as the #1 partner in this RFP process that I just described.

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Operator [21]

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The next question comes from Maggie Nolan of William Blair.

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Margaret Marie Niesen Nolan, William Blair & Company L.L.C., Research Division - Analyst [22]

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You've kind of alluded to this a couple of times when talking about the other large clients, but outside of your top 10 -- or outside of the top clients, the top 10 clients actually grew pretty well. So I'm wondering kind of what you expect this group to do, whether these growth levels can continue in kind of these strong double-digit rates. And then what's your visibility into the rest of this group and your confidence level there?

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Krishan Aruna Canekeratne, Virtusa Corporation - Co-Founder, Chairman & CEO [23]

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Maggie, I just want to provide a few data points around this, right? So even though we are clearly seeing that when you take a look at the industries, that health care and communications and technology is growing pretty well for us, if I were to just simply exclude 2 of our large banking clients, the rest of our banking business year-over-year is growing 22%, right? So matched by -- if you include all of the portfolio, banking is growing about 1%. But if you were to exclude the 2 large banking clients or 2 of our large banking clients, the rest of the book of business is growing 22%. And we fully expect, given the pipeline activity that we have and the traction that we are seeing in terms of digital transformation and cloud transformation, for that level of robust growth to continue.

Ranjan, do you want to build on that?

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Ranjan Kalia, Virtusa Corporation - Executive VP of Finance, CFO, Treasurer & Secretary [24]

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Well, Maggie, the other pieces that we're really excited about as we are moving into the back half is really the growth on our non-top 10 client portfolio. As Kris talked about, we as management recognize the importance of revenue diversification, and we actually have been doing a lot of things on revenue diversification that are -- some of it are actually starting to show. You saw a $25 million client. If the guidance plays out the way we've been contemplating, the non-top 10 clients are expected to grow a lot faster than the company average. That will really continue to contribute to the revenue diversification story.

And the [release] sets are Q4 and then FY '21, we believe very well for back growth at what Virtusa aspires to and Virtusa is very used to, which is really growth of a few percentage points faster than industry average.

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Margaret Marie Niesen Nolan, William Blair & Company L.L.C., Research Division - Analyst [25]

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And then in regards to the strong cloud expertise that you've been building, how do you feel you're positioned competitively with some of this cloud transformation work that you're doing? And then where do you think that we are on the maturity curve of this type of cloud work?

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Krishan Aruna Canekeratne, Virtusa Corporation - Co-Founder, Chairman & CEO [26]

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So let me address the second part first. So we are in the very early stages of cloud. So it's -- this is the first year where we are really seeing significant budget dollars being allocated to cloud and cloud transformation. As I had mentioned earlier, in prior years, there was a lot of experimentation, a lot of proof of concepts being done but relatively small engagements. This year, we are seeing very significant engagements, and we're also seeing the maturity level of our clients in terms of cloud adoption going up fairly sharply. So today, it's not about if it's really a question of when people are really going to embrace cloud in the enterprise arena. And a large part of that is driven by virtue of the fact that as they adopt cloud and as they can actually move workloads to the cloud, they don't have to size their data centers anymore for max volume or max load. They can basically size their cloud requirements and scale it as and when they need. So clearly, you can see that there's a significant benefit from an operating perspective once you move to cloud.

Now in that journey, many of the clients are still in the very early stages of basically picking either a private cloud infrastructure and/or maybe 1 cloud services partner to move some of the workloads to. The more advanced clients that we are working with have a multi-cloud strategy. And in the multi-cloud strategy, they could have a private cloud. They could have multiple CSPs or cloud services providers. And they've actually built or we've built for them the ability to move workloads from 1 cloud to another with minimal changes, and that obviously gives them significant flexibility and significant opportunities to continue to drive their price points down.

Now as far as Virtusa's differentiation, we've been working on cloud for over 4 years. We had strategic partnerships, very significant strategic partnerships with all the leading CSPs. And we have executed some of the most transformational cloud programs in industry. So I believe that we are a standout, and we have highly differentiated services no matter whether a client is looking at cloud in the early phases, as in moving to a private cloud or maybe to 1 CSP, or whether they're looking at the possibility of going to a multi-cloud environment and working with us to actually build the layers that are required to be able to move workloads from 1 CSP to another. So we believe that we are extremely well positioned and in a leadership role in terms of working with our clients and bringing industry-leading cloud thought leadership to the table.

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Operator [27]

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Your next question comes from Daniel Reagan of Cantor Fitzgerald.

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Joseph Dean Foresi, Cantor Fitzgerald & Co., Research Division - Analyst [28]

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This is Joe. Let me just ask kind of directly. You've gone through these struggles with a large client. I know you've talked about it quite extensively during the call. Help me understand why you feel like maybe the numbers are derisked now appropriately after seeing demand for a quarter and how comfortable you are that there won't be another revision.

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Ranjan Kalia, Virtusa Corporation - Executive VP of Finance, CFO, Treasurer & Secretary [29]

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Yes. Sure. Fair question, Joe. So if you really look at it 1 -- our guidance forecasting methodology, 1, our forecasting methodology continues to be consistent. We obviously learn from our past learnings and incorporate them, but primarily, the methodology stays consistent. It is a very data-driven methodology, which really shows there's a backlog percentage, which in this quarter's case continues to be at par to what it was in prior times during this period. For full year visibility, it shows backlog rolling forward as well as pipeline to show 100% revenue visibility for the remaining of the year, which means we don't really need to go out and extract any more new pipeline injection to really make our full year number. All we've got to do is continue the backlog forward and continue to close the way the pipelines that are in there. We don't need incremental pipeline, which is very consistent to what we talked at the calls before. This is how our revenue methodology works.

Yes, I mean, sometimes, these black swan events that come in, and they come in in a very short period of time, it has taken us time to absorb it, but we also believe that we've proven that more than once, that this model is so resilient, that it does absorb. It takes a couple of quarters, and it does absorb those hits. In this case, we believe that our large European client will be -- this will be the last quarter of their decline, which is no different than what we had talked about earlier. This is no change in our viewpoint about that. And then they will start to really grow in the March quarter. The growth in the March quarter is being supported by the fact that a big RFP where Virtusa came in as #1, which means Virtusa is going to have access to 100% of digital bidding. But we can choose that work or we may not choose that work because of the margin. But we get the first shot of it versus anybody else. That gives you the comfort.

Over and above that, the pipeline that was there is starting to, once again, resume and starting to grow. That gives us comfort. And then the remaining business always was doing well. We had been talking about the remaining business had been doing -- continues to do well, and that provides us comfort in the overall revenue guidance.

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Joseph Dean Foresi, Cantor Fitzgerald & Co., Research Division - Analyst [30]

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Got it. 2 more from me. From a resourcing perspective, did you have to reassign headcount? Has that process already taken place from the large European client? And are those people now productive again? And should we see utilizations go up? Or did you keep a couple of people on the bench because you're assuming that revenue growth rates are going to reaccelerate at the large European client?

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Krishan Aruna Canekeratne, Virtusa Corporation - Co-Founder, Chairman & CEO [31]

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A little bit of both, right, as you would expect. I mean we basically figured out what we would need to keep back so that we didn't have to go into sort of a yo-yo between letting some people go that we would need just in a short period. And then we looked at skill sets that were somewhat aged and took the opportunity to let some of the people move on. So it's a little bit of both. But from a resourcing and staffing perspective, we are very well positioned to be able to capture this increased demand that we are seeing. As we have indicated, from a pipeline perspective, our digital pipeline continues to outstrip growth of any other type of work that we're doing. And obviously, that includes both digital transformation and cloud transformation, and we are very well positioned to execute against it.

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Ranjan Kalia, Virtusa Corporation - Executive VP of Finance, CFO, Treasurer & Secretary [32]

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Specifically on utilization, we're not expecting a very significant increase in utilization in the back half. Marginal increases but no significant increases. We've really realigned our utilization a lot.

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Joseph Dean Foresi, Cantor Fitzgerald & Co., Research Division - Analyst [33]

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Got it. Okay. And then the last question for me is really sort of a more strategic one. What's the next stage of evolution for the Virtusa model, right? I mean we've known each other a long time. You were a core -- organic core during the Indian offshore days. You did Polaris, which is transformational acquisition. And now we've had a couple of lumpy quarters but really sort of steady growth overall in the digital practices. So I'm just wondering, what are you next focused on? Would it be another transformational acquisition once we get the noise behind us? Is it just continuing to grow the business from a digital perspective? Again, just looking for sort of the overall strategy.

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Krishan Aruna Canekeratne, Virtusa Corporation - Co-Founder, Chairman & CEO [34]

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I mean it's quite simple, Joe. We have an industry leadership position in both digital transformation and cloud transformation. We are highly differentiated. We compete very effectively. And we can -- we've demonstrated that we have a unique and differentiated set of offerings. We're going to double down on those. As we do that, we're going to continue to be mindful of the importance of diversification. We're going to focus a lot of our attention in terms of growing in accounts that we might be scaled in some areas, but we are underpenetrated in other areas. We're going to grow those areas effectively, specifically with these new service offerings and new service lines. And then we're targeting both industries and certain geographies where we believe that we have a significant opportunity to grow our accounts and have them -- that they have potential to be over $25 million in revenue to Virtusa. That's our goal. As we do this, I'm sure we're going to find more opportunities and get back to our growth rates that we have always enjoyed, which is basically growing the business on an organic basis, a couple of points ahead of industry.

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Operator [35]

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(Operator Instructions) The next question comes from Vincent Colicchio of Barrington Research.

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Vincent Alexander Colicchio, Barrington Research Associates, Inc., Research Division - MD [36]

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Yes, Kris, in Europe, should we be concerned more broadly beyond your large banking client in terms of weakness? What are you seeing on the ground?

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Ranjan Kalia, Virtusa Corporation - Executive VP of Finance, CFO, Treasurer & Secretary [37]

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Let me just start with -- because in my prepared remarks, I talked about, look, we do continue to watch the macroeconomic uncertainties that play out, right? We do believe that even with this large European client, some of the spending impact that they faced was as a result of the big Brexit. That plan continues to play out in geo. Over and above that, we are watching macroeconomic uncertainties that play out, whether that will be a trade discussion or whether that could be upcoming election. Any significant events, we continue to watch the impact of those on our financial services clients.

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Krishan Aruna Canekeratne, Virtusa Corporation - Co-Founder, Chairman & CEO [38]

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And assuming that there isn't a significant impact on -- to a situation, right, that we're actually seeing, as an example, that while large enterprises that we're very focused on just the U.K. market may have had some -- certain slowdowns, we're also seeing enterprise clients that are servicing both European customers and U.K. customers needing to double down and do things like data center separation. And as they do data center separation, it's a great opportunity for them to embrace the benefits of cloud. And we're actually seeing a surging of activity. In the U.K. and in Europe, there are enterprises that are servicing consumers and customers beyond just the U.K. actually doubling down and investing in terms of preparing themselves for whatever happens with Brexit.

And 1 thing is very clear, that you can't service European customers with data in the U.K. nor can you service U.K. customers with data in Europe in a post-Brexit environment, and many clients have to prepare for that well ahead of the Brexit. So we're actually seeing some increased activity as a result of Brexit. In the same time, just as Ranjan mentioned, enterprises that are very U.K.-specific may have seen some negative impacts of the Brexit as well.

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Vincent Alexander Colicchio, Barrington Research Associates, Inc., Research Division - MD [39]

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And you spent a lot of time talking about CT versus DT work. I'm curious, how do the margins compare between the 2?

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Ranjan Kalia, Virtusa Corporation - Executive VP of Finance, CFO, Treasurer & Secretary [40]

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Yes. DT and CT [is not necessarily worse]. It continues to be a strong growth driver. What we have seen there on our digital portfolio, which is a mix of 41%, those margins have always been slightly higher than the company margin, and that trend continues to play out.

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Vincent Alexander Colicchio, Barrington Research Associates, Inc., Research Division - MD [41]

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And, Kris, I heard 2 different numbers. Just for clarity, digital pipeline was up. Was it 30% year-over-year or 39%?

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Krishan Aruna Canekeratne, Virtusa Corporation - Co-Founder, Chairman & CEO [42]

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Yes. So in 2 consecutive quarters, our digital pipeline has grown over 30%. In this last quarter, digital pipeline grew 39%.

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Operator [43]

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This concludes our question-and-answer session. I would like to turn the conference back over to Kris Canekeratne for any closing remarks.

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Krishan Aruna Canekeratne, Virtusa Corporation - Co-Founder, Chairman & CEO [44]

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Thank you, Drew. Thank you all for joining us today. I'd like to take this opportunity to thank our global team members for their dedication and commitment to our clients. Thank you. And we look forward to speaking to you on our Q3 earnings call. Thank you.

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Operator [45]

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The conference has now concluded. Thank you for attending today's presentation. You may now disconnect.