The following discussion and analysis of our financial condition and results of our operations should be read together with our consolidated financial statements and related notes to consolidated financial statements included elsewhere in this Annual Report on Form 10-K. The following discussion contains forward-looking statements. Actual results may differ significantly from those projected in the forward-looking statements. Factors that might cause future results to differ materially from those projected in the forward-looking statements include, but are not limited to, those discussed in "Risk Factors" and elsewhere in this Annual Report. For a discussion of our results of operations for the fiscal year endedMarch 31, 2019 , including a year-to-year comparison between fiscal year endedMarch 31, 2019 and 2018 refer to Part II, Item 7, "Management's Discussion and Analysis of Financial Condition and Results of Operations" in our Annual Report Form 10-K for the fiscal year endedMarch 31, 2019 .
Business overview
Virtusa Corporation (the "Company", "Virtusa", "we", "us" or "our") is a global provider of digital engineering and information technology ("IT") outsourcing services that accelerate business outcomes for its clients. We support Forbes Global 2000 clients across large, consumer-facing industries like banking, financial services, insurance, healthcare, communications, technology, and media and entertainment, as these clients seek to improve their business performance through accelerating revenue growth, delivering compelling consumer experiences, improving operational efficiencies, and lowering overall IT costs. We provide services across the entire spectrum of the IT services lifecycle, from consulting, to technology and user experience ("UX") design, development of IT applications, systems integration, digital engineering, testing and business assurance, and maintenance and support services, including cloud, infrastructure and managed services. We help our clients solve critical business problems by leveraging a combination of our distinctive consulting approach, unique platforming methodology, and deep domain and technology expertise. Our services enable our clients to accelerate business outcomes by consolidating, rationalizing and modernizing their core customer facing processes into one or more core systems. We help organizations realize the benefits of digital transformation ("DT") and cloud transformation ("CT") by bringing together digital infrastructure, analytics and intelligence and customer experience by engineering the digital enterprise of tomorrow on the cloud. We deliver cost effective solutions through a global delivery model, applying advanced methods such as Agile, an industry standard technique designed to accelerate application development. We use ourDigital Transformation Studio (DTS), which is built byVirtusa's engineering teams that have decades of industry knowledge and experience. These teams are certified and leverageVirtusa's industry leading tools and assets, providing speed and transparency. DTS engineering tools drive software development lifecycle (SDLC) automation to improve quality, enabling speed and increasing productivity. Headquartered inMassachusetts , we have offices throughout theAmericas ,Europe ,Middle East andAsia , with global delivery centers inthe United States ,India ,Sri Lanka ,Hungary ,Singapore ,Poland ,Mexico andMalaysia . We also have many employees who work with our clients either onsite or virtually, which offers flexibility for both clients and employees. AtMarch 31, 2020 , we had 22,830 employees, or team members. In fiscal year 2020, we initiated a multi-year strategy to increase our revenue growth, operating margin accretion, and earnings per share growth. Our strategy focuses on three fundamental pillars: increasing profitable revenue growth by targeting large digital and cloud transformation engagements, achieving greater revenue diversification, categorized by geography, industry and client, and increasing gross and operating margins through pyramid efficiencies, project profitability and general and administrative ("G&A") expense leverage. While we began to implement these three pillars in fiscal year 2020, we faced significant headwinds, which masked our progress. These headwinds were primarily related to a decline in revenue from a large European banking client, negotiated productivity savings which affected growth at our largest client, and adverse impacts on our clients' spend in the fiscal fourth quarter of 2020 due to the onset of the COVID-19 pandemic and related negative impact on our client budgets and the economy as a whole. 49 Table of Contents The significant negative impact of COVID-19 on the global economy has created near-term challenges for us and the entire IT services industry. Simultaneously, the global pandemic has revealed unique opportunities for us to strengthen and advance our three-pillar plan. As a result, in late fiscal year 2020 and early fiscal year 2021, we launched several new initiatives under our three-pillar strategy designed to enable us to navigate the pandemic's near-term economic impacts, and strengthen our overall market, financial and operational positioning going forward. Our fiscal year 2021 plan builds on and strengthens our three-pillar strategy of increased profitable revenue growth, revenue and client diversification, and margin expansion. On the first pillar, we are increasing our efforts to capture new opportunities created by a change in Global 2000 enterprises' buying behaviors during the COVID-19 pandemic. For example, in late fiscal year 2020, we launched several go-to-market campaigns targeting remote workforce enablement, cost reduction and efficiency programs, and end-to-end deep digital transformation. In addition to our COVID-19 specific actions, we are also sharpening our sales and marketing efforts in fiscal year 2021 to target an increasing number of large, recurring, high-margin, and faster growing digital and cloud transformation engagements. On the second pillar of revenue and client diversification, our efforts to increase our geographic diversification were strengthened in fiscal year 2020 when we realigned our senior executives to improve regional supervision, and made key local leadership hires inEurope and theMiddle East . We expect these, and other changes being formulated, will help to expand our EMEA client base and enable closer client relationships, resulting in stronger revenue growth in EMEA. With respect to industry group diversification, our increased investments in attractive high-growth verticals, and strategic M&A, resulted in 46% year-over-year growth in healthcare client revenue and 25% growth inCommunications and Technology (C&T) industry group revenue in fiscal year 2020. In fiscal year 2020, our C&T industry group represented 34% of our revenue, up from 29% in fiscal year 2019, while Banking, Financial Services and Insurance (BFSI) revenue declined from 62% to 58% over the same time. Given the significant opportunity we have to continue expanding our presence in high-growth sectors such as High-Tech and Healthcare, in fiscal year 2021 we will increase our investments in our domain expertise, skills, and sales and marketing programs in these sectors. We believe our actions will enable us to grow our revenue in these attractive industries faster than the company average, and simultaneously reduce our concentration in the Banking and Financial services segment. Regarding client level diversification, we recognize the importance over the long-term to reduce revenue concentration at our largest accounts and capture increasing organic growth opportunities across the remainder of our account base. To do so, in fiscal year 2021, we will direct more of our sales and marketing efforts toward smaller accounts that have the ability to expand significantly with us. We have had success with this strategy at our strategic clients. We will apply these same techniques to grow high potential accounts faster than our total company in order to accelerate account diversification. Finally, with respect toVirtusa's third pillar, margin expansion, our fiscal year 2021 plan also includes several strategies underway to improve our gross and operating margins by reducing our costs and creating operating efficiencies. Specifically, our fiscal year 2021 plan will include actions to improve pyramid efficiencies, reduce the use of sub-contractors, increase utilization, and reduce general and administrative expenses as a percentage of revenue.
Recent developments
OnMarch 3, 2016 , our Indian subsidiary,Virtusa Consulting Services Private Limited ("Virtusa India") acquired approximately 51.7% of the fully diluted shares ofPolaris Consulting & Services Limited ("Polaris") for approximately$168.3 million in cash (the "Polaris Transaction") pursuant to a share purchase agreement dated as ofNovember 5, 2015 , by and among Virtusa India, Polaris and the promoter sellers named therein. Through a series of transactions,Virtusa increased its ownership to 100% for an additional aggregate consideration for$289.4 million , with$21.2 million being paid during the fiscal year endedMarch 31, 2020 . During the three months endedMarch 31, 2020 , Polaris merged with and into Virtusa India, with Virtusa India being the surviving entity. In connection with the Polaris Transaction, we entered into an amendment withCitigroup Technology, Inc. ("Citi"), which became effective upon the closing of the Polaris Transaction, pursuant to whichVirtusa was added as a party to the master services agreement with Citi and was appointed as a preferred vendor. 50 Table of Contents
OnDecember 31, 2019 , in connection with a request for proposal ("RFP") and vendor consolidation process conducted by Citi, and as part of the Company being one of the vendors selected to continue preferred vendor status at Citi and have the opportunity to compete for additional vendor consolidation work, the Company and Citi entered into Amendment No. 5 to the Master Professional Services Agreement, by and between the Company and Citi, dated as ofJuly 1, 2015 , as amended (the "Amendment"). Pursuant to the Amendment, (i) Citi agreed to maintain the Company as a preferred vendor under theResource Management Organization ("RMO") for the provision of IT services to Citi on an enterprise wide basis, (ii) the Company agreed to provide certain savings to Citi for the period fromApril 1, 2020 toDecember 31, 2020 ("Savings Period"), which savings can be achieved through productivity and efficiency measures and associated reduced spend; provided that if these productivity and efficiency measures do not achieve the projected savings amounts, the Company is required to provide certain discounts to Citi for the Savings Period to achieve the savings commitments; and (iii) to the extent that Citi awards the Company additional or new work in addition to the services covered by the RFP, the Company agreed to provide Citi with a certain percentage of savings (whether achieved through productivity measures, efficiencies, discounts or otherwise) as a condition to performing such services. OnDecember 22, 2017 , theU.S. government enacted comprehensive tax legislation commonly referred to as the Tax Cuts and Jobs Acts (the "Tax Act"). The Tax Act contains several key tax provisions that impacted the Company, including the reduction of the corporate income tax rate to 21% effectiveJanuary 1, 2018 . The Tax Act also includes a variety of other changes, such as a one-time repatriation tax on accumulated foreign earnings, a limitation on the tax deductibility of interest expense, acceleration of business asset expensing, and reduction in the amount of executive pay that could qualify as a tax deduction, among others. During the fiscal year endedMarch 31, 2019 , the Company elected to treat several foreign entities as disregarded entities. The earnings of these subsidiaries will be subject to US taxation as well as local taxation with a corresponding foreign tax credit. (See Note 17 to the consolidated financial statements for further information). In response to the COVID-19 pandemic, the Coronavirus Aid, Relief, and Economic Security Act ("CARES Act") was enacted onMarch 27, 2020 in theU.S. The Act includes both tax and nontax measures. The act restores the five-year net operating loss (NOL) carryback for losses arising in any taxable year beginning after 2017, but before 2021. Employers can defer payment for the employer portion of payroll taxes incurred between the date the CARES Act is enacted throughDecember 31, 2020 . The CARES Act increases the interest deduction limitation from 30% to 50% of adjusted taxable income (ATI) for tax years beginning in 2019 or 2020. (See Note 17 to the consolidated financial statements for further information).
COVID-19 and factors impacting our business and operating results
During the fourth quarter of fiscal 2020, the global pandemic related to COVID-19 presented significant challenges and adversely impacted our business and operating results. Our fiscal fourth quarter results were impacted by pandemic-related business interruptions and project delays, as well as elongated client decision making cycles. We are unable at this time to predict the full impact of COVID-19 on our operations, liquidity and financial results, and, depending on the magnitude and duration of the COVID-19 pandemic, such impact may be material. We expect to see an adverse impact to our revenue, earnings and cash flows due to the COVID-19 pandemic in the first quarter of fiscal 2021, which may also continue into the second quarter or beyond. Accordingly, current results and financial condition discussed herein may not be indicative of future operating results and trends. Refer to "Risk Factors" for further discussion of the impact of the COVID-19 pandemic on our business. In response to the COVID-19 pandemic,Virtusa quickly initiated a rigorous plan to protect the health and safety of its global team members, while continuing to serve clients in a safe and sustainable manner. As the world faces unprecedented challenges caused by COVID-19,Virtusa is committed to doing everything possible to help our team members and clients manage through these turbulent times. Recent actions include:
? Enacted a Work-From-Home policy starting
global billable team members are enabled to work from home.
? Daily sessions between
teams to ensure employee safety and consistent client delivery. 51 Table of Contents
Proactively launched a series of new services and solutions tailored to help
? clients address the challenges created by COVID-19, including Hyper Distributed
Agile Services, Agile Squads, and Release Assurance.
? Implemented a comprehensive cost reduction and efficiency plan across delivery,
shared services and professional services.
Proactively increased readily available cash by drawing down
? under its credit facility and moving
U.S. without tax implications.
For the fiscal year ending
? Demand from our clients, particularly for our digital transformation (DT) and
cloud transformational (CT) solutions and outsourcing services
Demand from our clients for solutions and services that drive cost efficiencies
? including cloud transformation, intelligent automation, and offshoring
development.
? Ability to leverage our deep domain expertise to provide digital
transformational solutions across our industry groups
? Adverse impacts on our clients' IT services spend from the economic impact of
COVID-19
? Discretionary spending by our clients may be negatively affected by COVID-19
and related macroeconomic factors
? Uncertainty regarding regulatory changes, including potential regulatory
changes with respect to immigration and taxes;
? Foreign currency volatility
? Impact of the COVID-19 pandemic and related economic conditions on our business
and operations
For the fiscal year ending
? Execute our three-pillar plan for increased profitable revenue growth, revenue
and client diversification, and gross and operating margin expansion
? Invest in and develop intellectual property-based solutions to provide to our
clients and increase non-linear revenue
? Continued revenue diversification by focusing on vertical, geographical and
client portfolio diversification
? Align our practices to provide digital transformation services across our core
industry groups such as BFSI, C&T and Media, Information and others ("M&I")
? Leverage our core engineering and domain expertise to delivery digital and
cloud solutions to our clients
Invest in domain led digital and cloud transformational solutions within core
? verticals like banking, healthcare, high-tech, insurance, media and
telecommunications
? Continue our focus on client acquisition and expansion of revenue gained from
existing clients, particularly with high-potential accounts
Deepen our domain expertise in our service offerings related to enterprise
? mobile applications, social media, gamification, big data analytics, robotics
process automation, and cloud computing
Continue to invest in our talent base, including new onsite campus recruitment
? programs, training and talent engagement programs, with a focus on re-skilling and digital technologies 52 Table of Contents
Implement efficiency initiatives focused on improving pyramid efficiencies;
? reducing use of sub-contractors; increasing utilization; enhancing project
profitability; and G&A cost leverage
Deepen our solution and service offerings across the software development
? lifecycle, including application support and maintenance and independent
software quality-assurance
? Focus on growing our business in
are opportunities to gain market share
? Pursue opportunistic acquisitions that would improve or broaden our overall
service delivery capabilities, domain expertise, and/or service offerings
Historically, we have also supplemented organic revenue growth with acquisitions. These acquisitions have focused on adding domain expertise, augmenting our geographic footprint, expanding our professional services teams and expanding our client base. For instance, during fiscal year endedMarch 31, 2020 , we completed several tuck-in asset and business acquisitions, which expanded our relationship with our existing clients or supplemented existing service offerings. During the fiscal year endedMarch 31, 2018 , we completed the acquisition of eTouch, which expands our digital solution offerings. During the fiscal year endedMarch 31, 2016 , we acquired Polaris, which expanded our banking and financial services offerings and domain expertise as described above.
Financial overview
AtMarch 31, 2020 , we had 22,830 employees, or team members, an increase from 21,745 atMarch 31, 2019 . For the fiscal year endedMarch 31, 2020 , we had revenue of$1,312.3 million , and income from operations of$80.2 million . In our fiscal year endedMarch 31, 2020 , our revenue increased by$64.4 million , or 5.2%, to$1,312.3 million , as compared to$1,247.9 million in our fiscal year endedMarch 31, 2019 . Our net income increased from$11.8 million in our fiscal year endedMarch 31, 2019 to$43.6 million in our fiscal year endedMarch 31, 2020 .
The key drivers of the increase in revenue in our fiscal year ended
? Growth, led by several of our top ten clients, primarily in our C&T industry
group, including revenue from several tuck-in asset and business acquisitions
? Revenue growth in
partially offset by:
? Decline in revenue from
banking clients
? Decrease in revenue in our banking and insurance industry group
The key drivers of our increase in net income in our fiscal year ended
Higher revenue, particularly in our top ten clients, primarily in our C&T
? industry group, including revenue from several tuck-in asset and business
acquisitions
? Decrease in operating expense as a percentage of revenue, reflecting a larger
revenue base and cost reduction initiatives
? Decrease in impairment related to land in
? Significant non-recurring tax benefit related to our merger of Polaris with and intoVirtusa 53 Table of Contents partially offset by:
Substantial increase in foreign currency transaction losses, primarily related
? to the revaluation of Indian rupee denominated intercompany note, primarily due
to substantial depreciation of the Indian rupee against the
? Increase in interest expense related to an increase in our outstanding debt
under our credit facility
High repeat business and client concentration are common in our industry. During the fiscal year endedMarch 31, 2020 , 2019 and 2018, 97%, 91% and 96%, respectively, of our revenue was derived from clients who had been using our services for more than one year, including clients acquired from eTouchSystems Corp. inMarch 2018 . Accordingly, our global account management and service delivery teams focus on expanding client relationships and converting new engagements to long-term relationships to generate repeat revenue and expand revenue streams from existing clients. We also have a dedicated business development team focused on generating engagements with new clients to continue to expand our client base and, over time, reduce client concentration. For the fiscal years endedMarch 31, 2020 , 2019 and 2018, we generated 56%, 54%, and 56%, respectively, of revenue from application outsourcing and 44%, 46% and 44%, respectively, of revenue from consulting services. We perform our services under both time-and-materials and fixed-price contracts. Revenue from fixed-price contracts remained unchanged at 41% of total revenue for the fiscal years endedMarch 31, 2020 , 2019 and 2018. The revenue earned from fixed-price contracts reflects our clients' preferences. AtMarch 31, 2020 , we had cash and cash equivalents, short-term and long-term investments, which is a non-GAAP measure, of$300.6 million , which includes a draw-down of$84.0 million inMarch 2020 from our line of credit to supplement our liquidity and working capital. AtMarch 31, 2019 , we had cash and cash equivalents, short-term and long-term investments, which is a non-GAAP measure, of$223.1 million . As an IT services company, our revenue growth has been, and will continue to be, highly dependent on our ability to attract, develop, motivate and retain skilled IT professionals. For the fiscal year endedMarch 31, 2020 , we finished the fiscal year with a total headcount of 22,830 as compared with a total headcount of 21,745 for the fiscal year endedMarch 31, 2019 , which reflects voluntary and involuntary attrition. There is intense competition for IT professionals with the skills necessary to provide the type of services we offer. We closely monitor our overall attrition rates and patterns to ensure our people management strategy aligns with our growth objectives. For the last twelve months endedMarch 31, 2020 , our attrition rate reflects voluntary attrition of 16.2% and involuntary attrition of 9.3%. The majority of our attrition occurs inIndia andSri Lanka , and is weighted towards the more junior members of our staff. In response to higher attrition and as part of our retention strategies, we have experienced increases in compensation and benefit costs, which may continue in the future. However, we try to absorb such cost increases through price increases or cost management strategies such as managing discretionary costs, the mix of professional staff and utilization levels and achieving other operating efficiencies. If our attrition rate increases or is sustained at higher levels, our growth may slow and our cost of attracting and retaining IT professionals could increase. We maintain an 18 month rolling and layering hedging program, which we believe has been effective since inception at reducing the impact of fluctuations in the Indian rupee on our operating results and there is no assurance that this hedging program will continue to be effective. These hedges may also cause us to forego benefits of a positive currency fluctuation, especially given the volatility of the Indian rupee . In addition, to the extent that these hedges cease to qualify for hedge accounting, any gains or losses associated with those hedges would be recorded in other comprehensive income until the occurrence of the underlying transaction and at that time the gains or losses would be recognized in the consolidated statement of income in other income (expense).
We monitor a number of operating metrics to manage and assess our earnings, including:
Days sales outstanding ("DSO") is a measure of the number of days our accounts
receivable are outstanding based upon the last 90 days of revenue activity,
? which indicates the timeliness of our cash collection from clients and our
overall credit terms to our clients. AtMarch 31, 2020 , our DSO was 78 days compared to 54 Table of Contents
76 days at
delaying payments and/or requesting longer payment terms in our fiscal year
ending
Realized billing rates are the rates we charge our clients for our services,
which reflect the value our clients place on our services, market competition
and the geographic location in which we perform our services. Our realized
billing rates have remained relatively consistent subject to foreign currency
exchange fluctuation for our fiscal year ended
? our fiscal year ended
a result of our ability to successfully preserve or increase our billing rates
with existing and/or new clients. In connection with the COVID-19 pandemic, our
clients are increasingly requesting discounts to our rates and other pricing
concessions for the fiscal year ending
lower realized billing rates in the future.
Average cost per IT professional is the sum of team member salaries, including
variable compensation, and fringe benefits, divided by the average number of IT
? professionals during the period. We experienced an increase in our average cost
per IT professional in our fiscal year ended
fiscal year ended
resources.
Utilization rate indicates the efficiency of our billable IT resources. Our
utilization rate is defined as the number of billable hours in a given period
divided by the total number of available hours of our IT professionals in a
given period, excluding trainees. We track our utilization rates to measure
revenue potential and gross profit margins. Management's target for the
utilization rate is in the low 80% range. Our utilization rates were 81%, 83%
? and 83% for the fiscal years ended
The utilization rate is affected by the rate of quarterly sequential revenue
growth, as well as ability to staff existing IT professionals on billable
engagements. In growth periods, utilization tends to rise as more resources are
deployed to meet rising demand. Utilization rates above the targeted range may
also indicate that there are insufficient IT professionals to staff existing or
future engagements, which may result in loss of revenue or inability to service
client engagements. Attrition rate is the ratio of terminated team members during the latest
twelve months to the total number of team members at the end of such period,
which measures team member turnover. Increased voluntary attrition rates result
in increased hiring, training and on-boarding costs and productivity losses,
? which may adversely affect our revenue, gross margin and operating profit
margin. For the last twelve months ended
25.5%, which reflects voluntary attrition of 16.2% and involuntary attrition of
9.3%. Our attrition rate for the fiscal year ended
which reflects voluntary attrition of 16.4% and involuntary attrition of 9.1%.
Operating expense efficiency is a measure of operating expenses as a percentage
of revenue. If we continue to successfully grow our revenue, we anticipate that
? operating expenses will decrease as a percentage of revenue as such expenses
are absorbed across a larger revenue base. In the near term, however, any
operating expense efficiency may decline if our revenue declines. Effective tax rate is our worldwide tax expense as a percentage of our
consolidated net income before tax, which measures the impact of income taxes
worldwide on our operations and net income. We monitor and assess our effective
tax rate to evaluate whether our tax structure is competitive as compared to
our industry. Our effective tax rate was 0.6% and 53.6% for the fiscal years
ended
? primarily due to the merger of our Indian operations. The merger permits
previous nondeductible items to be deducted in computing taxable income. As a
result of the merger, the Company filed a refund claim of
fiscal year ended
tax credits of
valuation allowance and increased income from operations during the fiscal year
ended
tax rate will also have a negative effect on our earnings in future periods.
55 Table of Contents
Onsite-to-offshore mix is the measurement of hours billed by resources located
offshore to hours billed by our team members onsite over a defined period. We
strive to manage both fixed-price contracts and time-and-materials engagements
? to a targeted 30% to 70% onsite- to-offshore service delivery team mix,
although such delivery mix may be impacted by several factors including our new
and existing client delivery requirements as well as the impact of any
acquisitions. Sources of revenue We generate revenue by providing IT services to our clients located primarily inNorth America andEurope . We have historically earned, and believe that over the next few fiscal years we will continue to earn a significant portion of our revenue from a limited number of clients. For the fiscal year endedMarch 31, 2020 , collectively, our five largest and ten largest clients accounted for 41% and 56% of our revenue, respectively. Our largest client accounted for 16% of our revenue for the fiscal year endedMarch 31, 2020 . The loss of any one of our major clients could reduce our revenue and operating profit and harm our reputation in the industry. During the fiscal year endedMarch 31, 2020 , 74% of our revenue was generated inNorth America , 17% inEurope and 9% in rest of the world. We provide IT services on either a time-and-materials or a fixed-price basis. For the fiscal year endedMarch 31, 2020 , the percentage of revenue from time-and-materials and fixed-price contracts was 59% and 41%, respectively. OurNorth America revenue for the fiscal year endedMarch 31, 2020 increased by 9.5%, or$84.0 million , to$968.1 million , or 74% of total revenue, from$884.1 million , or 71% of total revenue in the fiscal year endedMarch 31, 2019 . The increase inNorth America revenue for the fiscal year endedMarch 31, 2020 was primarily due to the increase in revenue from clients in the C&T industry group, including revenue from several tuck-in asset and business acquisitions. Our European revenue for the fiscal year endedMarch 31, 2020 decreased by 11.8%, or$31.0 million , to$231.0 million , or 17% of total revenue, from$262.0 million , or 21% of total revenue in the fiscal year endedMarch 31, 2019 . The decrease in European revenue for the fiscal year endedMarch 31, 2020 was primarily due to a decline in revenue from one of our large banking clients. Revenue from services provided on a time-and-materials basis is derived from the number of billable hours in a period multiplied by the contractual rates at which we bill our clients. Revenue from services provided on a fixed-price basis is recognized as efforts are expended generally on an input method. Revenue also includes reimbursements of travel and out-of-pocket expenses with equivalent amounts of expense recorded in costs of revenue. Most of our client contracts, including those that are on a fixed-price basis, can be terminated by our clients with or without cause on 30 to 90 days prior written notice. All fees for services provided by us through the date of cancellation are generally due and payable under the contract terms. Our unit pricing is driven by business need, delivery timeframes, complexity of the engagement, operating differences (such as onsite/offshore ratio), competitive environment and engagement size or volume. As a pricing strategy to encourage clients to increase the volume of services that we provide to them, we, on occasion may offer volume discounts or longer payment terms. We manage our business carefully to protect our account margins and our overall profit margins. We find that our clients generally purchase on the basis of total value, rather than on minimum cost, considering all of the factors listed above. While we are subject to the effects of overall market pricing pressure, we believe that there is a fairly broad range of pricing offered by different competitors for each service we provide. We believe that no one competitor, or set of competitors, sets pricing in our industry. We find that our unit pricing, as a result of our global delivery model, is generally competitive with other firms who operate with a predominately offshore operating model. The proportion of work performed at our offshore facilities and at onsite client locations varies from period-to-period. Effort, in terms of the percentage of hours billed to clients by onsite resources, was 28% of total hours billed in each of the fiscal years endedMarch 31, 2020 and 2019, while the revenue from resources located onsite and offshore accounted for 60% and 40% respectively in the fiscal year endedMarch 31, 2020 and 59% and 41% respectively during the fiscal year endedMarch 31, 2019 . We charge higher rates and incur higher compensation costs and other expenses for work performed at client locations inthe United States , theUnited Kingdom andEurope as compared to work performed at our global delivery centers inAsia , particularly our largest centers inIndia andSri Lanka . Services performed 56
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at client locations or at our offices inthe United States or theUnited Kingdom generate higher revenue per-capita at lower gross margins than similar services performed at our global delivery centers inAsia , particularly our largest centers inIndia andSri Lanka . We manage to a targeted 30% to 70% onsite-to-offshore service delivery mix, although such delivery mix may be impacted by several factors including our new and existing client delivery requirements as well as the impact of any acquisitions.
Costs of revenue and gross profit
Costs of revenue consist principally of payroll and related fringe benefits, reimbursable and non-reimbursable costs, immigration-related expenses, fees for subcontractors working on client engagements and share-based compensation expense for IT professionals including account management personnel. Wage costs inIndia andSri Lanka have historically been significantly lower than wage costs inthe United States ,Europe and rest of the world for comparably-skilled IT professionals. However, wages inIndia andSri Lanka are increasing in local currency, which will result in increased costs for IT professionals, particularly project managers and other mid-level professionals. We may need to increase the levels of our team member compensation more rapidly than in the past to remain competitive without the ability to make corresponding increases to our billing rates. Compensation increases may reduce our profit margins, make us less competitive in pricing potential projects against those companies with lower cost resources and otherwise harm our business, operating results and financial condition. We deploy a campus hiring philosophy and encourage internal promotions to minimize the effects of wage inflation pressure and recruiting costs. Additionally, any material appreciation in the Indian rupee or Sri Lankan rupee against theU.S. dollar orU.K. pound sterling could have a material adverse impact on our cost of services. Our revenue and gross profit are also affected by our ability to efficiently manage and utilize our IT professionals and fluctuations in foreign currency exchange rates. We define utilization rate as the total number of days billed in a given period divided by the total available days of our IT professionals during that same period, excluding trainees. We manage employee utilization by continually monitoring project requirements and timetables to efficiently staff our projects and meet our clients' needs. The number of IT professionals assigned to a project will vary according to the size, complexity, duration and demands of the project. An unanticipated termination or reduction of a significant project could cause us to experience a higher than expected number of unassigned IT professionals, thereby lowering our utilization rate. Although we have adopted a cash flow hedging program to minimize the effect of the Indian rupee movement on our financial condition, particularly our costs of revenue, these hedges may not be effective or may cause us to forego benefits, especially given the volatility of these currencies. In addition, to the extent that these hedges do not qualify for hedge accounting, any gains or losses associated with those hedges would be recorded in other comprehensive income until the occurrence of the underlying transaction and at that time the gains or losses would be recognized in the consolidated statement of income in other income (expense).
Operating expenses
Operating expenses consist primarily of payroll and related fringe benefits, commissions, selling and marketing as well as promotion, communications, management, finance, administrative, occupancy, share-based compensation and depreciation and amortization expenses. In the fiscal years endedMarch 31, 2020 , 2019, and 2018, we invested in all aspects of our business, including sales, marketing, IT infrastructure, facilities, human resources programs and financial operations. Additionally, any material appreciation in the Indian rupee or Sri Lankan rupee against theU.S. dollar orU.K. pound sterling could have a material adverse impact on our cost of operating expenses.
Other income (expense)
Other income (expense) includes interest income, interest expense, investment gains and losses, foreign currency transaction gains and losses and disposal of fixed assets. We generate interest income by investing in time deposits, money market instruments, short-term investments and long-term investments. We incur interest expense primarily from our long-term debt and amortization of our debt issuance cost. The functional currencies of our subsidiaries are their local currencies, except forHungary which operates in the euro and certainNetherlands entities which operate in theU.S. dollar. Foreign currency gains and losses are generated primarily by fluctuations of the Indian rupee, Sri
Lankan rupee, Swedish 57 Table of Contents
Krona ("SEK"), euro,U.K. pound sterling and theSingapore dollar, against theU.S. dollar on intercompany transactions. This includes fluctuations on an Indian rupee denominated intercompany note in aU.S. dollar functional currency entity inthe Netherlands that was put in place as part of the structuring of the Polaris Transaction. AtMarch 31, 2020 , the approximate value of the intercompany note was$267.3 million (Indian rupee 20,000 million ). We place our cash in liquid investments at highly-rated financial institutions, as well as in money market funds, fixed income securities, U. S. dollar denominated corporate bonds, agency bonds and government bonds based on our investment policy approved by our audit committee and board of directors. We believe that our credit policies reflect normal industry terms and business risk.
Income tax expense
Our net income is subject to income tax in those countries in which we perform services and have operations, includingthe United States , theUnited Kingdom ,the Netherlands ,India ,Sri Lanka ,Germany ,Singapore ,Austria ,Hungary ,Malaysia andSweden . In the fiscal year endedMarch 31, 2020 , our effective tax rate was impacted by the Tax Act, the mix of income by jurisdiction, the impact of adopting the new tax regime offered by the Indian government and certain deductions granted to large IT service providers inSri Lanka and the CARES Act. Historically, we have benefited from long-term income tax holiday arrangements in bothIndia andSri Lanka that are offered to certain export-oriented IT services firms. As a result of these tax holiday arrangements, our worldwide profit has been subject to a relatively low effective tax rate as compared to the statutory rates in the countries in which we generate the substantial portion of our revenue. The effect of the income tax holidays inIndia andSri Lanka decreased our income tax expense in the fiscal years endedMarch 31, 2020 and 2019 by$0.1 million and$5.8 million , respectively. Our tax expense decreased by$20.2 million in the fiscal year endedMarch 31, 2020 compared to our tax expense for our fiscal year endedMarch 31, 2019 . The decrease in the tax expense and effective tax rate for the fiscal year endedMarch 31, 2020 was primarily due to non-recurring tax benefits resulting from merger of our Indian operations during the fiscal year endedMarch 31, 2020 . Our effective tax rate was 0.6% and 53.6% for each of the fiscal years endedMarch 31, 2020 and 2019 respectively. Our effective tax rate in future periods will be affected by the Tax Act, CARES Act, the geographic distribution of our earnings and increasedU.S. taxable income due to restricting activities and the availability of foreign tax credits to offsetU.S. tax expense. (See Note 17 to the consolidated financial statements for further information). 58 Table of Contents Results of operations
Fiscal year ended
The following table presents an overview of our results of operations for the
fiscal years ended
Fiscal Year Ended March 31, 2020 2019 $ Change % Change (Dollars in thousands) Revenue$ 1,312,283 $ 1,247,863 $ 64,420 5.2 % Costs of revenue 959,143 884,652 74,491 8.4 % Gross profit 353,140 363,211 (10,071) (2.8) % Operating expenses 272,928 292,943 (20,015) (6.8) % Income from operations 80,212 70,268 9,944 14.2 % Other income (expense) (31,551) (32,104) 553 (1.7) %
Income before income tax expense 48,661 38,164
10,497 27.5 % Income tax expense 309 20,473 (20,164) (98.5) % Net income 48,352 17,691 30,661 173.3 % Less: net income attributable to noncontrolling interests, net of tax 450 1,545 (1,095) (70.9) % Net income available toVirtusa stockholders 47,902 16,146 31,756 196.7 % Less: Series A Convertible Preferred Stock dividends and accretion 4,350 4,350 - - % Net income attributable toVirtusa common stockholders$ 43,552 $ 11,796 $ 31,756 269.2 % Revenue Revenue increased by 5.2%, or$64.4 million , from$1,247.9 million during the fiscal year endedMarch 31, 2019 to$1,312.3 million in the fiscal year endedMarch 31, 2020 . The increase in revenue was primarily driven by an increase in revenue from several of our top ten clients, including revenue from several tuck-in asset and business acquisitions of$45.4 million , partially offset by a decline in our banking and insurance industry, including one of our large European banking clients. Revenue from North American clients in the fiscal year endedMarch 31, 2020 increased by$84.0 million , or 9.5%, as compared to the fiscal year endedMarch 31, 2019 , particularly due to the increase in revenue from clients in the C&T industry group, including revenue from several tuck-in asset and business acquisitions. Revenue from European clients in the fiscal year endedMarch 31, 2020 decreased by$31.0 million , or 11.8%, as compared to the fiscal year endedMarch 31, 2019 , primarily due to a decline in revenue from one of our large banking clients. We had 221 active clients atMarch 31, 2020 , as compared to 216 active clients atMarch 31, 2019 .
Costs of revenue
Costs of revenue increased from$884.7 million in the fiscal year endedMarch 31, 2019 to$959.1 million in the fiscal year endedMarch 31, 2020 , an increase of$74.5 million , 8.4%. The increase in cost of revenue was primarily due to an increase in the number of IT professionals and related compensation and benefit costs of$23.8 million . The increased costs of revenue were also due to an increase in subcontractor costs of$57.5 million partially offset by decrease in travel costs of$8.0 million . AtMarch 31, 2020 , we had 20,606 IT professionals as compared to 19,502 atMarch 31, 2019 . As a percentage of revenue, cost of revenue increased from 70.9% for the fiscal year endedMarch 31, 2019 to 73.1% for fiscal year endedMarch 31, 2020 .
Gross profit
Our gross profit decreased by$10.1 million or 2.8%, to$353.1 million for the fiscal year endedMarch 31, 2020 as compared to$363.2 million in the fiscal year endedMarch 31, 2019 , primarily due to increase in subcontractor costs 59 Table of Contents and higher onsite effort, partially offset by higher revenue. As a percentage of revenue, for the fiscal year endedMarch 31, 2020 compared to the fiscal year endedMarch 31, 2019 , gross margin decreased from 29.1% to 26.9% primarily due to higher onsite effort and subcontractor costs partially offset by higher revenue.
Operating expenses
Operating expenses decreased from$292.9 million in the fiscal year endedMarch 31, 2019 to$272.9 million in the fiscal year endedMarch 31, 2020 , a decrease of$20.0 million , or 6.8%. The decrease in operating expenses was primarily due to a decrease of$23.7 million in compensation expenses, including stock and variable compensation expense. The decrease in operating costs was also due to a decrease in travel costs of$3.5 million . The decrease is partially offset by increase in acquisition related expense of$3.5 million and an increase in facilities cost of$3.1 million . As a percentage of revenue, our operating expenses decreased from 23.5% in the fiscal year endedMarch 31, 2019 to 20.8% in the fiscal year endedMarch 31, 2020 .
Income from operations
Income from operations increased by$9.9 million or 14.2%, from$70.3 million in the fiscal year endedMarch 31, 2019 to$80.2 million in the fiscal year endedMarch 31, 2020 . As a percentage of revenue, income from operations increased from 5.6% in the fiscal year endedMarch 31, 2019 to 6.1% in the fiscal year endedMarch 31, 2020 , primarily due to higher revenue and decrease in operating expense partially offset by higher onsite effort and subcontractor costs.
Other (income) expense
Other expense decreased by$0.6 million , from$32.1 million in the fiscal year endedMarch 31, 2019 to$31.5 million in the fiscal year endedMarch 31, 2020 , primarily due to an impairment related to land inIndia , which was recorded in the fiscal year endedMarch 31, 2019 , partially offset by an increase in net foreign currency transaction losses related to the revaluation of a$267.3 million Indian rupee denominated intercompany note, primarily due to a substantial depreciation of the Indian rupee against theU.S. dollar and an increase in interest expense related to our credit facility.
Income tax expense
Income tax expense decreased by$20.2 million , from$20.5 million in the fiscal year endedMarch 31, 2019 to$0.3 million in the fiscal year endedMarch 31, 2020 . Our effective tax rate decreased from 53.6% for the fiscal year endedMarch 31, 2019 to 0.6% for the fiscal year endedMarch 31, 2020 . The decrease in tax expense and effective tax rate for the fiscal year endedMarch 31, 2020 , was primarily due to the merger of our Indian operations. The merger permits previous nondeductible items to be deducted in computing taxable income. As a result of the merger, the Company filed a refund claim of$11.4 million for the fiscal year endedMarch 31, 2019 and realized a benefit in theU.S. for foreign tax credits of$14.3 million . The tax benefit is offset by an increase in the valuation allowance and increased income from operations during the fiscal
year endedMarch 31, 2020 . Noncontrolling interests In connection with thePolaris Consulting & Services Limited ("Polaris") acquisition, for the fiscal year endedMarch 31, 2020 , we recorded a noncontrolling interest of$0.5 million representing a 2.3% share of profits of Polaris held by parties other thanVirtusa . As ofMarch 31, 2020 , we own 100% of Polaris shares.
Net income available to
Net income available toVirtusa stockholders increased by 196.7%, from a net income of$16.1 million in the fiscal year endedMarch 31, 2019 to net income of$47.9 million in the fiscal year endedMarch 31, 2020 . The increase in net income in the fiscal year endedMarch 31, 2020 was primarily due to higher revenue, an increase in income from operations and a decrease in income tax
expense. 60 Table of Contents
Series A Convertible Preferred Stock dividends and accretion
In connection with the preferred stock financing transaction with theOrogen Group , we accrued dividends and accreted issuance costs of$4.4 million at a rate of 3.875% per annum during the fiscal year endedMarch 31, 2020 .
Net income attributable to
Net income available toVirtusa common stockholders increased by 269.2%, from a net income of$11.8 million in fiscal year endedMarch 31, 2019 to a net income of$43.6 million in the fiscal year endedMarch 31, 2020 . The increase in net income in the fiscal year endedMarch 31, 2020 was primarily due to higher revenue, an increase in income from operations and a decrease in income tax expense.
Non-GAAP Measures
We include certain non-GAAP financial measures as defined by Regulation G by theSecurities and Exchange Commission . These non-GAAP financial measures are not based on any comprehensive set of accounting rules or principles and should not be considered a substitute for, or superior to, financial measures calculated in accordance with GAAP, and may be different from non-GAAP measures used by other companies. In addition, these non-GAAP measures should be read in conjunction with our financial statements prepared in accordance with GAAP. We consider the total measure of cash, cash equivalents, short-term and long-term investments to be an important indicator of our overall liquidity. All of our investments are classified as either equity or available-for-sale debt securities, including our long-term investments which consist of fixed income securities, including government agency bonds and corporate bonds, which meet the credit rating and diversification requirements of our investment policy as approved by our audit committee and board of directors. The following table provides the reconciliation from cash and cash equivalents to total cash and cash equivalents, short-term investments and long-term investments: At March 31, At March 31, At March 31, 2020 2019 2018
Cash and cash equivalents$ 290,837 $ 189,676 $ 194,897 Short-term investments 9,785 33,138 45,900 Long-term investments 4 322 4,140 Total cash and cash equivalents, short-term and long-term investments$ 300,626 $ 223,136 $ 244,937
We believe the following financial measures will provide additional insights to measure the operational performance of our business.
We present consolidated statements of income measures that exclude, when
applicable, stock-based compensation expense, acquisition-related charges,
restructuring charges, foreign currency transaction gains and losses,
impairment of investments, impairment of long-lived assets, non-recurring third
? party financing costs, the tax impact of dividends received from foreign
subsidiaries, the initial impact of our election to treat certain subsidiaries
as disregarded entities for
government enacted comprehensive tax legislation ("Tax Act") and other
non-recurring tax items to provide further insights into the comparison of our
operating results among periods. 61 Table of Contents
The following table presents a reconciliation of each non-GAAP financial measure
to the most comparable GAAP measure for the years ended
Fiscal Year Ended March 31, 2020 2019 2018 (in thousands, except share and per share amounts) GAAP income from operations$ 80,212 $ 70,268 $ 46,387 Add: Stock-based compensation expense 15,716 29,056 27,411 Add: Acquisition-related charges and restructuring charges (1) 17,915 23,904 13,278 Non-GAAP income from operations$ 113,843 $ 123,228 $ 87,076 GAAP operating margin 6.1 % 5.6 % 4.5 % Effect of above adjustments to income from operations 2.6 % 4.3 % 4.0 % NonGAAP operating margin 8.7 % 9.9 % 8.5 % GAAP net income (loss) available toVirtusa common stockholders$ 43,552 $ 11,796 $ (2,709) Add: Stock-based compensation expense 15,716 29,056 27,411 Add: Acquisition-related charges and restructuring charges (1) 18,182 25,710 13,346 Add: Non-recurring third party financing costs (9) - - 701 Add: Impairment of investment (10) 184 1,411 - Add: Other impairment charge (11) - 3,955 - Add: Foreign currency transaction losses (2) 15,999 13,130 3,543 Add: Impact from the Tax Act (8) - (1,628) 22,724 Tax adjustments (3) (26,080) (16,365) (14,037) Less: Noncontrolling interest, net of taxes (4) (44) (68) (1,469) Non-GAAP net income available toVirtusa common stockholders$ 67,509 $ 66,997 $ 49,510 GAAP diluted earnings (loss) per share (6)$ 1.42 $ 0.38 $ (0.09) Effect of stock-based compensation expense (7) 0.47 0.86 0.85 Effect of acquisition-related charges and restructuring charges (1) (7) 0.54 0.77 0.41 Effect of non-recurring third party financing costs (9) (7) - - 0.02 Effect of impairment of investment (10) (7) - 0.04 - Effect of other impairment charge (11) (7) - 0.12 - Effect of foreign currency transaction losses (2) (7) 0.48 0.39 0.11 Effect of impact from the Tax Act (7) (8) - (0.05) 0.70 Tax adjustments (3) (7) (0.77) (0.49) (0.43) Effect of noncontrolling interest (4) (7) - - (0.05) Effect of dividend on Series A Convertible Preferred Stock (6) (7) 0.13 0.13 0.10 Effect of change in dilutive shares for non-GAAP (6) (0.13) (0.03) 0.01 Non-GAAP diluted earnings per share (5) (7)$ 2.14 $
2.12
Acquisition-related charges include, when applicable, amortization of
purchased intangibles, external deal costs, transaction-related professional
fees, acquisition-related retention bonuses, changes in the fair value of
contingent consideration liabilities, accreted interest related to deferred
acquisition payments, charges for impairment of acquired intangible assets (1) and other acquisition-related costs including integration expenses consisting
of outside professional and consulting services and direct and incremental
travel costs. Restructuring charges, when applicable, include termination
benefits, facility exit costs as well as certain professional fees related to
restructuring. The following table provides the details of the acquisition-related charges and restructuring charges: 62 Table of Contents Fiscal Year EndedMarch 31, 2020 2019
2018
Amortization of intangible assets$ 14,675 $ 11,394 $ 10,089 Acquisition and integration costs 3,240 12,101 1,821 Restructuring charges - 409 1,368 Acquisition-related charges included in costs of revenue and operating expense 17,915 23,904 13,278 Accreted interest related to deferred acquisition payments 267 1,806 68 Total acquisition-related charges and restructuring charges$ 18,182 $ 25,710 $ 13,346
Foreign currency transaction gains and losses are inclusive of gains and (2) losses on related foreign exchange forward contracts not designated as
hedging instruments for accounting purposes.
Tax adjustments reflect the tax effect of the non-GAAP adjustments using the
tax rates at which these adjustments are expected to be realized for the (3) respective periods, excluding the initial impact of our election to treat
certain subsidiaries as disregarded entities for
adjustments also assumes application of foreign tax credit benefits in the
(4) Noncontrolling interest represents the minority shareholders interest of
Polaris.
(5) Non-GAAP diluted earnings per share is subject to rounding.
During the fiscal year ended
calculations of GAAP diluted earnings per share as their effect would have
been anti-dilutive using the if-converted method.
The following table provides the non-GAAP net income available toVirtusa common stockholders and non-GAAP dilutive weighted average shares outstanding using if-converted method to calculate the non-GAAP diluted earnings per share for the fiscal year endedMarch 31, 2020 , 2019 and 2018: Fiscal Year Ended March 31, 2020 2019 2018 Non-GAAP net income available toVirtusa common stockholders$ 67,509 $ 66,997 $ 49,510 Add: Dividends and accretion on Series A Convertible Preferred Stock 4,350 4,350 3,262 Non-GAAP net income available toVirtusa common stockholders and assumed conversion$ 71,859 $ 71,347 $ 52,772 GAAP dilutive weighted average shares outstanding 30,654,527 30,659,654 29,397,350 Add: Incremental dilutive effect of employee stock options and unvested restricted stock awards and restricted stock units - - 728,820 Add: Incremental effect of Series A Convertible Preferred Stock as converted 3,000,000 3,000,000 2,250,000 Non-GAAP dilutive weighted average shares outstanding 33,654,527 33,659,654 32,376,170
To the extent the Series A Convertible Preferred Stock is dilutive using the (7) if-converted method, the Series A Convertible Preferred Stock is included in
the weighted average shares outstanding to determine non-GAAP diluted
earnings per share.
(8) Impact from the
Act").
(9) Non-recurring third party financing costs related to the new credit facility.
63 Table of Contents
(10) Other-than-temporary impairment of available-for-sale securities recognized
in earnings.
(11) Impairment related to a long-lived asset
Liquidity and capital resources
We have financed our operations primarily from sales of shares of common stock, cash from operations, debt financing and from sales of shares of Series A Convertible Preferred Stock. Our ability to expand and grow our business to execute our strategic objectives will depend on many factors, including our willingness to make opportunistic acquisitions, strategic investments and partnerships.
In response to the COVID-19 outbreak, which had and is having a negative business impact on our operations, inMarch 2020 , we drew down approximately$84.0 million dollars from our revolving credit facility to supplement our liquidity and working capital in light of the impact of the COVID-19 pandemic on our clients and our results of operations. For additional liquidity, onMay 27, 2020 , we entered into Amendment No. 3 to Amended and Restated Credit Agreement withJPMorgan Chase Bank, N.A . (the " Administrative Agent" ) and the lenders party thereto (the " Third Credit Agreement Amendment" ), which amends the Company's Amended and Restated Credit Agreement, dated as ofFebruary 6, 2018 , with such parties (as amended, "Credit Agreement" ) to, among other things, (i) provide for$62.5 million in incremental 364-day delayed draw term loans (the "New Delayed Draw Term Loans" ), which can be drawn down up to three times on or beforeSeptember 27, 2020 and (ii) extend out the debt to EBITDA ratio covenant step down by two quarters such that the leverage covenant remains at 3.25:1.00 throughDecember 31, 2020 . The Company can use the proceeds of the New Delayed Draw Term Loans to fund general working capital and refinance existing indebtedness under the credit facility. OnMay 27, 2020 , the Company prepaid$55.0 million on its existing revolving facility as a condition to closing the Third Credit Agreement Amendment. AtMarch 31, 2020 , we had approximately$300.6 million of cash, cash equivalents, short term investments and long term investments, of which we hold approximately$194.8 million of cash, cash equivalents, short term investments and long-term investments in non-U.S. locations, particularly inIndia ,Sri Lanka and theUnited Kingdom . Cash in these non-U.S. locations may not otherwise be available for potential investments or operations inthe United States or certain other geographies where needed, as we have stated that this cash is indefinitely reinvested in these non-U.S. locations. If our intent were to change and we elected to repatriate this cash back tothe United States , or this cash was deemed no longer permanently invested, this cash could be subject to additional taxes and the change in such intent could have an adverse effect on our cash balances as well as our overall statement of income. Notwithstanding these limitations, inApril 2020 , we were able to move$25.0 million of cash from ourIndia entity to ourU.S. entity, without tax implication, to support ourU.S. legal entity's liquidity needs. Due to various methods by which cash could be repatriated tothe United States in the future, the amount of taxes attributable to the cash is dependent on circumstances existing if and when remittance occurs. In addition, some countries could have restrictions on the movement and exchange of foreign currencies which could further limit our ability to use such funds for global operations or capital or other strategic investments. Due to the various methods by which such earnings could be repatriated in the future, it is not practicable to determine the amount of applicable taxes that would result from such repatriation. We believe that our sources of funding will be sufficient to satisfy our currently anticipated cash requirements including capital expenditures, working capital requirements, potential acquisitions, strategic investments and other liquidity requirements through at least the next 12 months. To the extent that existing cash from operations is insufficient to fund our working capital needs and other cash obligations, we may raise additional funds through debt or equity financing. We cannot give any assurance that additional financing, if required, will be available on favorable terms or at all. We do not believe the deemed repatriation tax on accumulated foreign earnings related to the Tax Act will have a significant impact on our cash flows in any individual fiscal year. During the fiscal year endedMarch 31, 2020 , we completed multiple tuck-in asset and business acquisitions for an aggregate purchase price consideration of$49.6 million , with an additional earn-out consideration of$38.7 million , 64
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which, if earned, would be payable over the next two fiscal years. During the fiscal year endedMarch 31, 2020 , we paid$38.7 million in purchase price and$3.8 million in earn-out consideration related to these tuck-in acquisitions. OnOctober 15, 2019 , we entered into Amendment No. 2 to Amended and Restated Credit Agreement withJPMorgan Chase Bank, N.A . (the "Administrative Agent") and the lenders party thereto (the "Second Credit Agreement Amendment"), which amends the Company's Amended and Restated Credit Agreement, dated as ofFebruary 6, 2018 , with such parties (as amended the "Credit Agreement") to, among other things, increase the revolving commitments available to us under the Credit Agreement from$200.0 million to$275.0 million , reduce the interest rate margins applicable to term loans and revolving loans outstanding under the Credit Agreement from time to time and reduce the commitment fee payable by us to the lenders in respect of unused revolving commitments under the Credit Agreement. We executed the Second Credit Agreement Amendment to provide additional lending capacity which we used to fund the completion of the Polaris delisting transaction, as well as to provide excess lending capacity in the event of future opportunistic, strategic, investment opportunities. The Second Credit Agreement Amendment contains customary terms for amendments of this type, including representations, warranties and covenants. Interest under the credit facility accrues at a rate per annum of LIBOR plus 2.75%, subject to step-downs based on the Company's ratio of debt to EBITDA. For the fiscal year endingMarch 31, 2021 , the Company is required to make principal payments of$4.3 million per quarter. The term of the Credit Agreement is five years endingFebruary 6, 2023 . During the fiscal year endedMarch 31, 2020 , the Company drew down$145.0 million from the credit facility, inclusive of$84.0 million drawn in the three months endedMarch 31, 2020 to supplement our liquidity and working capital in light of the uncertainty resulting from the COVID-19 pandemic. Earlier draws in the fiscal yearMarch 31, 2020 were used to fund the eTouch 18-month anniversary payment of$17.5 million and to fund opportunistic, strategic, investment opportunities. As ofMarch 31, 2020 , the total outstanding amount under the Credit Agreement was$500.0 million . AtMarch 31, 2020 , the weighted average interest rate on the term loan and revolving line of credit was 3.18%. The Credit Facility is secured by substantially all of the Company's assets, including all intellectual property and all securities in domestic subsidiaries (other than certain domestic subsidiaries where the material assets of such subsidiaries are equity in foreign subsidiaries), subject to customary exceptions and exclusions from the collateral. All obligations under the Credit Agreement are unconditionally guaranteed by substantially all of the Company's material direct and indirect domestic subsidiaries, with certain exceptions. These guarantees are secured by substantially all of the present and future property and assets of the guarantors, with certain exclusions. AtMarch 31, 2020 , we were in compliance with all covenants set forth in our Credit Agreement. Based upon our current plans, we expect our operating cash flows, together with our cash and short-term investment balances, to be sufficient to meet our operating requirements and service our debt for the foreseeable future. However, given the dynamic nature of the COVID-19 pandemic, there can be no assurances that its future impact will not have a material adverse effect on our ongoing business, results of operations, liquidity needs, debt covenant compliance or overall financial performance. OnAugust 5, 2019 , our board of directors authorized a share repurchase program of up to$30.0 million of our common stock over 12 months from the approval date, subject to certain price and other trading restrictions as established by the Company. During the fiscal year endedMarch 31, 2020 , we repurchased 505,565 shares of the Company's common stock at a weighted average price of$36.93 per share for an aggregate purchase price of$18.7 million . As ofMarch 31, 2020 , the share repurchase program has been suspended due to the COVID-19 pandemic. To strengthen our digital engineering capabilities and establish a solid base inSilicon Valley , onMarch 12, 2018 , we acquired all of the outstanding shares of eTouchSystems Corp ("eTouch US"), and its Indian subsidiary, eTouchSystems (India) Pvt. Ltd ("eTouchIndia ," together with eTouch US, "eTouch") for approximately$140.0 million in cash, subject to certain adjustments. As part of the acquisition, we set aside up to an additional$15.0 million for retention bonuses to be paid to eTouch management and key employees, in equal installments on the first and second anniversary of the transaction. We agreed to pay the purchase price in three tranches, with$80.0 million paid at closing,$42.5 million on the 12-month anniversary of the close of the transaction, and$17.5 million on the 18-month anniversary of the close of the transaction, subject in each case to certain adjustments. During the three months endedMarch 31, 2019 , we paid the 12-month anniversary purchase price payment of$42.5 million and the retention bonus amount of$7.0 million to the eTouch management and key employees. During the fiscal year endedMarch 31, 2020 , we paid the 18-month anniversary purchase price payment of$17.5 million and the remaining retention bonus related to the employees. 65
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OnMarch 3, 2016 , our Indian subsidiary,Virtusa Consulting Services Private Limited ("Virtusa India") acquired approximately 51.7% of the fully diluted shares ofPolaris Consulting & Services Limited ("Polaris") for approximately$168.3 million in cash (the "Polaris Transaction") pursuant to a share purchase agreement dated as ofNovember 5, 2015 , by and among Virtusa India, Polaris and the promoter sellers named therein. Through a series of transactions,Virtusa increased its ownership to 100% for an additional aggregate consideration of$289.4 million , with$21.2 million being paid to former shareholders of Polaris during the fiscal year endedMarch 31, 2020 . During the three months endedMarch 31, 2020 , Polaris merged with and into Virtusa India, with Virtusa India being the surviving entity. In connection with the Polaris Transaction, we entered into an amendment withCitigroup Technology, Inc. ("Citi"), which became effective upon the closing of the Polaris Transaction, pursuant to whichVirtusa was added as a party to the master services agreement with Citi and was appointed as a preferred vendor. OnDecember 31, 2019 , in connection with a request for proposal ("RFP") and vendor consolidation process conducted by Citi, and as part of the Company being one of the vendors selected to continue preferred vendor status at Citi and have the opportunity to compete for additional vendor consolidation work, the Company and Citi entered into Amendment No. 5 to the Master Professional Services Agreement, by and between the Company and Citi, dated as ofJuly 1, 2015 , as amended (the "Amendment"). Pursuant to the Amendment, (i) Citi agreed to maintain the Company as a preferred vendor under theResource Management Organization ("RMO") for the provision of IT services to Citi on an enterprise wide basis, (ii) the Company agreed to provide certain savings to Citi for the period fromApril 1, 2020 toDecember 31, 2020 ("Savings Period"), which savings can be achieved through productivity and efficiency measures and associated reduced spend; provided that if these productivity and efficiency measures do not achieve the projected savings amounts, the Company is required to provide certain discounts to Citi for the Savings Period to achieve the savings commitments; and (iii) to the extent that Citi awards the Company additional or new work in addition to the services covered by the RFP, the Company agreed to provide Citi with a certain percentage of savings (whether achieved through productivity measures, efficiencies, discounts or otherwise) as a condition to performing such services. OnMay 3, 2017 , we entered into an investment agreement withThe Orogen Group ("Orogen") pursuant to which Orogen purchased 108,000 shares of the Company's newly issued Series A Convertible Preferred Stock, initially convertible into 3,000,000 shares of common stock, for an aggregate purchase price of$108.0 million with an initial conversion price of$36.00 (the "Orogen Preferred Stock Financing"). In connection with the investment,Vikram S. Pandit , the former CEO of Citigroup, was appointed toVirtusa's Board of Directors. Orogen is an operating company that was created byVikram Pandit andAtairos Group, Inc. , an independent private company focused on supporting growth-oriented businesses, to leverage the opportunities created by the evolution of the financial services landscape and to identify and invest in financial services companies and related businesses with proven business models. Under the terms of the investment, the Series A Convertible Preferred Stock has a 3.875% dividend per annum, payable quarterly in additional shares of common stock and/or cash at our option. If any shares of Series A Convertible Preferred Stock have not been converted into common stock prior toMay 3, 2024 , the Company will be required to repurchase such shares at a repurchase price equal to the liquidation preference of the repurchased shares plus the amount of accumulated and unpaid dividends thereon. If we fail to effect such repurchase, the dividend rate on the Series A Convertible Preferred Stock will increase by 1% per annum and an additional 1% per annum on each anniversary ofMay 3, 2024 during the period in which such failure to effect the repurchase is continuing, except that the dividend rate will not increase to more than 6.875% per annum. During the fiscal year endedMarch 31, 2020 , the Company has$4.2 million as a cash dividend on its Series A Convertible Preferred Stock. The Company also uses interest rate swaps to mitigate the Company's interest rate risk on the Company's variable rate debt. The Company's objective is to limit the variability of cash flows associated with changes in LIBOR interest rate payments due on the Credit Agreement (See Note 14 to the consolidated financial statements), by using pay-fixed, receive-variable interest rate swaps to offset the future variable rate interest payments. The Company purchased interest rate swaps inJuly 2016 with an effective date ofJuly 2017 andNovember 2018 . TheJuly 2016 interest rate swaps are at a blended weighted average of 1.025% and the Company will receive 1-month LIBOR on the same notional amounts. TheNovember 2018 interest rate swaps are at a fixed rate of 2.85% and are designed to maintain a 50% coverage of our LIBOR debt, therefore the notional amount changes over the life of the swap to retain the 50% coverage target. 66 Table of Contents The counterparties to the Interest Rate Swap Agreements could demand an early termination of theJune 2016 andNovember 2018 Swap Agreements if we are in default under the Credit Agreement, or any agreement that amends or replaces the Credit Agreement in which the counterparty is a member, and we are unable to cure the default. An event of default under the Credit Agreement includes customary events of default and failure to comply with financial covenants, including a maximum consolidated leverage ratio commencing onDecember 31, 2018 , of not more than 3.50 to 1.00 for periods ending prior toMarch 31, 2020 , of not more than 3.25 to 1.00 commencingMarch 31, 2020 and for periods ending prior toSeptember 30, 2020 , and 3.00 to 1.00 thereafter and a minimum consolidated fixed charge coverage ratio of 1.25 to 1.00. As ofMarch 31, 2020 , we were in compliance with these covenants. The net unrealized loss associated with Interest Rate Swap Agreement was$11.1 million as ofMarch 31, 2020 , which represents the estimated amount that we would pay to the counterparties in the event of an early termination. From time to time, the Company enters into arrangements to deliver IT services that include upfront payments to our clients. As ofMarch 31, 2020 , the total unamortized upfront payments related to these services were$32.2 million and are expected to be amortized as a reduction to revenue over a benefit period of 5 years. Beginning in fiscal 2009, ourU.K. subsidiary entered into an agreement with an unrelated financial institution to sell, without recourse, certain of itsEurope -based accounts receivable balances from one client to the financial institution. During the fiscal year endedMarch 31, 2020 , we sold$30.7 million of receivables under the terms of the financing agreement. Fees paid pursuant to this agreement were not material during the fiscal year endedMarch 31, 2020 . No amounts were due under the financing agreement atMarch 31, 2020 , but we may elect to use this program again in future periods. However, we cannot provide any assurances that this or any other financing facilities will be available or utilized in the future. During the three months endedMarch 31, 2019 , we recorded an impairment loss of$4.0 million relating to the reclassification of land acquired in the Polaris Transaction to held for sale. The decision to sell this land was made during the three months endedMarch 31, 2019 as part of our annual planning process where we evaluated strategic alternatives to maximize return on our cash and assets. As part of the assessment process, we considered projected headcount growth in this region, as well as ongoing compliance costs associated with holding the land, and concluded that our cash, including cash from the sale of this asset, would generate a higher return elsewhere. The reclassification to held for sale triggered a reduction in value to$8.3 million , which represents the lower of net book value and market value atMarch 31, 2020 . We are actively marketing this land for sale and expect to complete a transaction over the next 12 months. OnFebruary 28, 2019 , theSupreme Court of India issued a ruling interpreting certain statutory defined contribution obligations of employees and employers, which altered historical understandings of such obligations, extending them to cover additional portions of employee income. As a result, contributions by our employees and the Company will increase in future periods. There is uncertainty as to whether the Indian government will apply theSupreme Court's ruling on a retroactive basis and if so, how this liability should be calculated as it is impacted by multiple variables, including the period of assessment, the application with respect to certain current and former employees and whether interest and penalties may be assessed. As such, the ultimate amount of our obligation is difficult to quantify. If the Indian Government were to apply the Supreme Court ruling retroactively, without assessing interest and penalties, the impact would be a charge of approximately$7.5 million to our income from operations and cash flows.
We expect capital expenditures made in the normal course of business during the
fiscal year ended
67 Table of Contents Cash flows
The following table summarizes our cash flows for the periods presented:
Fiscal Year Ended March 31, 2020 2019 2018 (In thousands)
Net cash provided by operating activities$ 79,894 $ 68,619 $ 62,699 Net cash used in investing activities (47,019) (74,708) (52,669) Net cash provided by financing activities 75,383 14,749 37,442 Effect of exchange rate changes on cash, cash equivalents and restricted cash (6,770)
(13,782) 2,677 Net increase (decrease) in cash and cash equivalents and restricted cash
101,488
(5,122) 50,149 Cash, cash equivalents and restricted cash, beginning of year
190,113 195,235 145,086 Cash, cash equivalents and restricted cash, end of year$ 291,601 $ 190,113 $ 195,235
Net cash provided by operating activities
Net cash provided by operating activities increased in the fiscal year endedMarch 31, 2020 compared to the fiscal year endedMarch 31, 2019 , primarily due to an increase in the net income adjusted for non-cash expenses, primarily related to a decrease in stock-based compensation as a result of performance stock awards and partially offset by an increase in long-term liabilities and income tax payable during the fiscal year endedMarch 31, 2020 . Net cash provided by operating activities increased in the fiscal year endedMarch 31, 2019 compared to the fiscal year endedMarch 31, 2018 , primarily due to an increase in the net income adjusted for non-cash expenses and a decrease in the working capital, partially offset by a decrease in long-term assets and long-term liabilities during the fiscal year endedMarch 31, 2019 .
Net cash used for investing activities
Net cash used in investing activities decreased in the fiscal year endedMarch 31, 2020 compared to fiscal year endedMarch 31, 2019 . The decrease in net cash used in investing activities is primarily due to decrease in payment for deferred consideration related to the acquisition of eTouch, decrease in the purchase of property and equipment and a net decrease in the purchase of investments partially offset by payments for business combination and asset acquisitions. Net cash used in investing activities increased in the fiscal year endedMarch 31, 2019 compared to fiscal year endedMarch 31, 2018 . The increase in net cash used in investing activities is primarily due to the increase in the purchase of property and equipment and a net decrease in the proceeds from sale of investments during the fiscal year endedMarch 31, 2019 offset by a decrease in business acquisition payments.
Net cash provided by financing activities
Net cash provided by financing activities increased in the fiscal year endedMarch 31, 2020 compared to fiscal year endedMarch 31, 2019 . The increase in net cash provided by financing activities in the fiscal year endedMarch 31, 2020 was primarily due to an increase in proceeds from debt and a decrease in payment of noncontrolling interest, partially offset by repurchases of common stock. Net cash provided by financing activities decreased in the fiscal year endedMarch 31, 2019 compared to fiscal year endedMarch 31, 2018 . The decrease in net cash provided by financing activities during the fiscal year endedMarch 31, 2019 is primarily due to a net decrease in the proceeds from the credit facility, an increase in payment of withholding taxes related to net share settlements of restricted stock, and an increase in payment of dividend on Series A Convertible Preferred Stock, partially offset by a net decrease in the acquisition of a noncontrolling interest. 68 Table of Contents Contractual obligations
The following table sets forth our future contractual obligations and commercial
commitments at
Payments Due by Period Less Than Total 1 Year 1 - 3 Years 3 - 5 Years 5+ Years (In thousands)
Longterm debt obligation (1)$ 499,969 $ 17,344 $ 482,625 $ - $ - Interest on longterm debt (2) 53,274 19,472 33,802 - - Operating lease obligations (3) 64,415 15,103 24,905 12,176 12,231 Defined benefit plans (4) 26,472 2,047 3,707 5,319 15,399 Capital and other purchase commitments (5) 31,758 10,324 10,115 11,319 - Cumulative preferred stock dividends (6) 686 686 - - - Deferred acquisition payments and contingent consideration (7) 39,276 29,523
9,753 - - Total$ 715,850 $ 94,499 $ 564,907 $ 28,814 $ 27,630
(1) Our obligations towards repayments of our long-term debt, please see Note 14
to the consolidated financial statements for further information.
(2) Interest on long-term debt of 3.18% was calculated using weighted average of
interest rates effective as of
(3) Our obligations under our operating leases consist of future payments
primarily related to our real estate leases.
We accrue and contribute to benefit funds covering our employees in
benefit payments beyond ten years with any certainty. We make periodic
contributions to the plans such that the unfunded amounts are immaterial.
(5) Relates to build-out of various facilities in
subscriptions and other purchase commitments, net of advances.
(6) Relates to our Series A Convertible Preferred Stock, which is payable
quarterly.
(7) Relates to deferred acquisition payments and contingent consideration of
asset and business acquisitions during the fiscal year 2020.
AtMarch 31, 2020 , we had$6.6 million of unrecognized tax benefits. This represents the tax benefits associated with tax positions on our domestic and international tax returns that have not been recognized on our financial statements due to uncertainty regarding their resolution. Resolution of the related tax positions with the relevant tax authorities may take years to complete, since such timing is not entirely within our control. It is reasonably possible that within the next 12 months certain positions will be resolved, which could result in a decrease in unrecognized tax benefits. These decreases may be offset by increases to unrecognized tax benefits if new positions are identified. The resolution or settlement of positions with the relevant taxing authorities is at various stages and therefore it is not practical to estimate the eventual cash flows by period that may be required to settle these matters. 69 Table of Contents Commitments and Contingencies
See Note 23 to our consolidated financial statements for additional information.
Application of critical accounting estimates and risks
Our consolidated financial statements have been prepared in accordance withUnited States generally accepted accounting principles, orU.S. GAAP. Preparation of these financial statements requires us to make estimates and assumptions that affect the reported amount of revenue and expenses, assets and liabilities and the disclosure of contingent assets and liabilities. We consider an accounting estimate to be critical to the preparation of our consolidated financial statements when both of the following are present:
? the estimate is complex in nature or requires a high degree of judgment; and
? the use of different estimates and assumptions could have a material impact on
the consolidated financial statements.
We have discussed the development and selection of our critical accounting estimates and related disclosures with the audit committee of our board of directors. Those estimates critical to the preparation of our consolidated financial statements are listed below.
Revenue recognition
We account for a contract when it has approval and commitment from both parties, the rights of the parties are identified, payment terms are identified, the contract has commercial substance and collectability of consideration is probable.
Revenues are recognized when control of the promised services is transferred to our customers in an amount that reflects the consideration we expect to be entitled to in exchange for those services.
We generally recognize revenue for services over time as our performance creates or enhances an asset that the customer controls from fixed price contracts related to complex design, development and customization. For these contracts, we measures the progress and recognize revenue using effort-based input methods, as we perform, based on actual efforts spent compared to the total expected efforts for the contract. The use of the effort based input method requires significant judgment relative to estimating total efforts, including assumptions relative to the length of time to complete the project and the nature and complexity of the work to be performed. Estimates of total efforts are continuously monitored during the term of the contract and are subject to revision as the contract progresses. When revisions in estimated contract revenue and efforts are determined, such adjustments are recorded in the period in which they are first identified. An input method is used to recognize revenue as the value of services provided to the customer is best represented by the hours expended to deliver those services. We generally recognize revenue for services over time where the Company performance does not create an asset with an alternative use to the Company and the Company has an enforceable right to payment for performance completed to date for fixed-price contracts related to consulting or other IT services. For these contracts, we measure the progress and recognize revenue using effort-based input methods as we perform based on actual efforts spent compared to the total expected efforts for the contract. The cumulative impact of any change in estimates of the contract revenue is reflected in the period in which the changes become known.
We generally recognize revenue for time and material contracts over time as the customer simultaneously receives and consumes the benefits as the Company performs services. We either apply the as-invoiced practical expedient to recognize revenues for services rendered on time and material basis, or a method that is otherwise consistent with the way in which value is delivered to the customer. 70 Table of Contents We generally recognize revenue from fixed-price applications management, maintenance, or support engagements over time as customers receive and consume the benefits of such services and have applied the as-invoiced practical expedient to recognize revenue for services we render to customers based on the amount we have a right to invoice, which is representative of the value being delivered. If our invoicing is not consistent with value delivered, revenues are recognized on a straight-line basis unless revenues are earned and obligations are fulfilled in a different pattern. Contracts are often modified to account for changes in contract specification and requirements. We consider a contract modification when the modification either creates new or changes the existing enforceable rights and obligations. The accounting for modifications involves assessing whether the services added to an existing contract are distinct and whether the pricing is at the standalone selling price. Services added that are not distinct are accounted for on a cumulative catch up basis, while those that are distinct are accounted for prospectively, either as a separate contract if the additional services are priced at the standalone selling price, or as a termination of the existing contract and creation of a new contract if not priced at the standalone selling price. Certain customers may receive discounts, incentive payments or service level credits. A portion of the revenues relating to such arrangements are accounted for as variable consideration when the amount of revenue to be recognized can be estimated to the extent that it is probable that a significant reversal of any revenue will not occur. We estimate these amounts based on the expected amount to be provided to customers and adjusts revenues recognized. We estimate the amount of variable consideration and determination of whether to include estimated amounts in the transaction price may involve judgment and are based largely on an assessment of our anticipated performance and all information that is reasonably available to us. From time to time, we may enter into contracts with customers that include multiple performance obligations. For such arrangements, we allocate revenue to each performance obligation based on its relative standalone selling price. We generally determine standalone selling prices based on an expected cost plus a margin approach.
Our warranties generally provide a customer with assurance that the related deliverable will function as the parties intended because it complies with agreed-upon specifications and is therefore not considered as an additional performance obligation in the contract.
When we receive consideration from a customer prior to transferring services to the customer under the terms of a contract, we record deferred revenue, which represents a contract liability. We recognize deferred revenue as revenue after we have transferred control of the services to the customer and all revenue recognition criteria are met. Our payment terms vary by the type and location of its customers. The term between invoicing and when payment is due is not significant. As a practical expedient, we have not assessed the existence of a significant financing component when the difference between payment and transfer of deliverables
is one year or less.
We report gross reimbursable "out-of-pocket" expenses incurred as both revenues and cost of revenues.
Any tax assessed by a governmental authority that is incurred as a result of a revenue transaction (e.g. sales tax) is excluded from our assessment of transaction prices.
Leases
Our leased assets primarily consist of operating leases for office space, equipment and vehicles. At the inception of a contract, we determine whether a contract contains a lease, and if a lease is identified, whether it is an operating or finance lease. In determining whether a contract contains a lease, we consider whether (1) it has the right to obtain substantially all of the economic benefits from the use of the asset throughout the term of the contract, (2) it has the right to direct how and for what purpose the asset is used throughout the term of the contract and (3) it has the right to operate the asset throughout the term of the contract without the lessor having the right to change the terms of the contract. We lease vehicles in certain locations primarily as an employee benefit and these leases are classified as either operating or finance leases. We do not have finance leases that are material to our consolidated financial statements. Some of our lease 71
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agreements contain both lease and non-lease components. We separate lease components from non-lease components for all our lease assets. The consideration in the lease contract is allocated to the lease and non-lease components based on the estimated standalone prices. Our lease agreements, mainly for office space, may include options to extend or terminate the lease before the expiration date. We include such options when determining the lease term when it is reasonably certain that we will exercise that option. A portion of the leases for office space contain certain charges for additional rent expenses that are variable. Due to this variability, the cash flows associated with these charges are not included in the minimum lease payments used in determining the right-of-use ("ROU") lease assets and associated lease liabilities.
Our ROU lease assets represent our right to use an underlying asset for the lease term and may include any advance lease payments made and any initial direct costs and exclude lease incentives. Our lease liabilities represent our obligation to make lease payments arising from the contractual terms of the lease. ROU lease assets and lease liabilities are recognized at the commencement of the lease and are calculated using the present value of lease payments over the lease term. Our operating lease agreements do not provide enough information to arrive at an implicit interest rate. Therefore, we use our estimated incremental borrowing rate based on information available at the commencement date of the lease to calculate the present value of the lease payments. We determine the incremental borrowing rate on a lease-by-lease basis by developing an estimated borrowing rate of the Company for a fully collateralized obligation with a term similar to the lease term, and adjusts the rate to reflect the incremental risk associated with the currency in which the lease is denominated.
Derivative instruments and hedging activities
We enter into forward foreign exchange contracts to mitigate the risk of changes in foreign exchange rates on forecasted transactions denominated in foreign currencies. The Company also enters into interest rate swaps to mitigate interest rate risk on the Company's variable rate debt. Certain of these transactions meet the criteria for hedge accounting as cash flow hedges under accounting standards codification. Changes in the fair values of these hedges are deferred and recorded as a component of accumulated other comprehensive income (loss), net of tax, until the hedged transactions occur and are then recognized in the consolidated statements of income in the same line item as the item being hedged. The Company measures the effectiveness of these hedges at the time of inception, as well as on an ongoing basis. If any portion of the hedges is deemed ineffective, the respective portion is recorded in accumulated other comprehensive income until the occurrence of the hedged transaction and at that time, the gains or losses are recognized in the consolidated statement of income in other income (expense). For derivative contracts that are not designated as cash flow hedges, at maturity changes in the fair value, if any, are recognized in the same line item as the underlying exposure being hedged in the statements of income. We value our derivatives based on market observable inputs including both forward and spot prices for currencies. Any significant change in the forward or spot prices for currencies would have a significant impact on the value of our derivatives.
We account for our business combinations under the acquisition method of accounting. We allocate the cost of an acquired entity to the assets acquired and liabilities assumed, including any contingent consideration based on their estimated fair values at the date of acquisition. The excess of the purchase price for acquisitions over the fair value of the net assets acquired, including other intangible assets, is recorded as goodwill.Goodwill is not amortized but is tested for impairment at the reporting unit level, defined at the Company level, in the fourth quarter of each fiscal year or more frequently when events or circumstances occur that indicate that it is more likely than not that an impairment has occurred. In assessing goodwill for impairment, an entity has the option to assess qualitative factors to determine whether events or circumstances indicate that it is not more likely than not that fair value of a reporting unit is less than its carry amount. If this is the case, then performing the quantitative two-step goodwill impairment test is unnecessary. An entity can choose not to perform a qualitative assessment for any or all of its reporting units, and proceed directly to the use of the two-step impairment test. The two-step process begins with an estimation of the fair value of a reporting unit.Goodwill impairment exists when a reporting unit's carrying value of goodwill exceeds its implied fair value. Significant judgment is applied when goodwill is assessed for impairment. 72
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For our goodwill impairment analysis, we operate under one reporting unit. Any impairment would be measured based upon the fair value of the related assets. In performing the first step of the goodwill impairment testing and measurement process, we compare our entity-wide estimated fair value to net book value to identify potential impairment. Management estimates the entity-wide fair value utilizing our market capitalization, plus an appropriate control premium. Market capitalization is determined by multiplying the shares outstanding on the assessment date by the market price of our common stock. If the fair value of the reporting unit is less than the book value, the second step is performed to determine if goodwill is impaired. If we determine through the impairment evaluation process that goodwill has been impaired, an impairment charge would be recorded in the consolidated statement of income. We completed the annual impairment test required during the fourth quarter of the fiscal year endedMarch 31, 2020 and determined that there was no impairment. We continue to closely monitor our market capitalization. If our market capitalization, plus an estimated control premium, is below its carrying value for a period considered to be other- than-temporary, it is possible that we may be required to record an impairment of goodwill either as a result of the annual assessment that we conduct in the fourth quarter of each fiscal year, or in a future quarter if an indication of potential impairment is evident. The estimated fair value of the reporting unit on the assessment date significantly exceeded the carrying book value. Other intangible assets acquired in a business combination are recognized at fair value using generally accepted valuation methods appropriate for the type of intangible asset and reported separately from goodwill. Intangible assets with definite lives are amortized over the estimated useful lives and tested for impairment when events or circumstances occur that indicate that it is more likely than not that an impairment has occurred. We test other intangible assets with definite lives for impairment by comparing the carrying amount to the sum of the net undiscounted cash flows expected to be generated by the asset whenever events or changes in circumstances indicate that the carrying amount of the asset may not be recoverable. If the carrying amount of the asset exceeds its net undiscounted cash flows, then an impairment loss is recognized for the amount by which the carrying amount exceeds its fair value.
Income taxes
The calculation of our tax liabilities involves dealing with uncertainties in the application of complex tax regulations in multiple jurisdictions where we have operations. We record liabilities for estimated tax obligations inthe United States and other tax jurisdictions. Determining the consolidated provision for income tax expense, tax reserves, deferred tax assets and liabilities and related valuation allowance, if any, involves judgment. We calculate and provide for income taxes in each of the jurisdictions in which we operate, and these calculations and determinations can involve complex issues which require an extended time to resolve. In the fiscal year of any such resolution, additional adjustments may need to be recorded that result in increases or decreases to income. Our overall effective tax rate fluctuates due to a variety of factors, including arm's-length prices for our intercompany transactions, changes in the geographic mix, as well as newly enacted tax legislation in each of the jurisdictions in which we operate. Applicable transfer pricing regulations require that transactions between and among our subsidiaries be conducted at an arm's-length price. On an ongoing basis, we estimate appropriate arm's-length prices and use such estimates for our intercompany transactions. At each financial statement date, we evaluate whether a valuation allowance is needed to reduce our deferred tax assets to the amount that is more likely than not to be realized. This evaluation considers the weight of all available evidence, including both future taxable income and ongoing prudent and feasible tax planning strategies. In the event that we determine that we will not be able to realize a recognized deferred tax asset in the future, an adjustment to the valuation allowance would be made, resulting in a decrease in income (or equity in the case of excess stock option tax benefits) in the period such determination was made. Likewise, should we determine that we will be able to realize all or part of an unrecognized deferred tax asset in the future, an adjustment to the valuation allowance would be made, resulting in an increase to income (or equity in the case of excess stock option tax benefits). We currently have net operating loss carry forwards in theU.S. ,Sweden and theUnited Kingdom , some of which realization of benefits is no longer considered more likely than not of materializing. A valuation allowance has been recorded in current period results to reflect this. The CARES Act provided for NOLs arising in tax years beginning afterDecember 31, 2017 , and beforeJanuary 1, 2021 , may be carried back to each of the five tax years preceding the tax year of such loss. The CARES Act also provided a correction to the Tax Act providing a two-year carryback for our NOL in the fiscal year endedMarch 31, 2018 . The Company intends to file an immediate carry back claim in theU.S. Net operating losses have an unlimited carry forward period, although there are annual limitations on their use suspended for certain years as result of CARES Act. 73 Table of Contents OnSeptember 20, 2019 , the Indian government issued Ordinance 2019 making certain amendments in the Income-tax Act 1961, which substantially reduces tax rates. The effective rate of tax onIndia -based companies was reduced from 34.9% to 25.17%, effective for fiscal years beginningApril 1, 2019 . We adopted the new ordinance for the fiscal year beginningApril 1, 2019 . The new rates require the surrendering of any tax holidays and other attributes of which the Company historically was taking advantage of and favorably impacting our tax rate. In the past, we have benefited from long-term income tax holiday arrangements in bothIndia andSri Lanka . We have located development centers in areas designated as Special Economic Zones ("SEZ") to secure tax exemptions for these operations for a period of ten years, which extend to 15 years if we meet certain reinvestment requirements. During the fiscal year endedMarch 31, 2013 , we elected the tax holiday for our SEZ Co-developer located inHyderabad, India for a period of 10 years. OurIndia profits ineligible for SEZ benefits were subject to corporate income tax at the current rate of 34.94%. OurSri Lanka subsidiary has been granted an income tax holiday by theSri Lanka Board of Investment ("BOI") which expired onMarch 31, 2019 . The tax holiday is contingent upon a certain level of job creation by us during a given timetable. Although we believe we have met the job creation requirements, if theBOI concludes otherwise, this would jeopardize the maximum benefits from this holiday arrangement. As a result of these tax holiday arrangements, our worldwide profit has been subject to a relatively low effective tax rate. It is our intent to reinvest all accumulated earnings from foreign operations back into their respective businesses to fund growth. As a component of this strategy, we do not accrue incremental taxes on foreign earnings as these earnings are considered to be indefinitely reinvested outside ofthe United States . If such earnings were to be repatriated in the future or are no longer deemed to be indefinitely reinvested, we will accrue the applicable amount of taxes associated with such earnings, which would increase our overall effective tax rate.
Off-balance sheet arrangements
We do not have any investments in special purpose entities or undisclosed borrowings or debt.
We have entered into foreign currency derivative contracts with the objective of limiting our exposure to changes in the Indian rupee, theU.K. pound sterling, the euro, the Canadian dollar, the Australian dollar and the Swedish Krona as described below and in "Quantitative and Qualitative Disclosures about Market Risk." We maintain a foreign currency cash flow hedging program designed to further mitigate the risks of volatility in the Indian rupee against theU.S. dollar andU.K. pound sterling as described below in "Quantitative and Qualitative Disclosures about Market Risk." From time to time, we may also purchase multiple foreign currency forward contracts designed to hedge fluctuation in foreign currencies, such as theU.K. pound sterling, euro, the Canadian dollar, the Australian dollar and Swedish Krona against theU.S. dollar to minimize the impact of foreign currency fluctuations on foreign currency denominated revenue and expenses. Other than these foreign currency derivative contracts, we have not entered into off-balance sheet transactions, arrangements or other relationships with unconsolidated entities or other persons that are likely to affect liquidity or the availability of or requirements for capital resources.
Recent accounting pronouncements
See Note 2 to our consolidated financial statements for additional information.
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