As filed with the Securities and Exchange Commission on July 3, 2007

Registration No. 333-141952

UNITED STATES SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, DC 20549

 

 

Amendment No. 3

to

FORM S-1

 

 

 

2000 West Park Drive

Westborough, Massachusetts 01581

(508) 389-7300

(Address, Including Zip Code, and Telephone Number,

Including Area Code, of Registrant’s Principal Executive Offices)

 

 

 

 

 

Approximate date of commencement of proposed sale to the public:  As soon as practicable after this registration statement becomes effective.

 

If any of the securities being registered on this Form are to be offered on a delayed or continuous basis pursuant to Rule 415 under the Securities Act of 1933, check the following box.   o

 

If this Form is filed to register additional securities for an offering pursuant to Rule 462(b) under the Securities Act, check the following box and list the Securities Act registration statement number of the earlier effective registration statement for the same offering.   o

 

If this Form is a post-effective amendment filed pursuant to Rule 462(c) under the Securities Act, check the following box and list the Securities Act registration statement number of the earlier effective registration statement for the same offering.   o

 

If this Form is a post-effective amendment filed pursuant to Rule 462(d) under the Securities Act, check the following box and list the Securities Act registration statement number of the earlier effective registration statement for the same offering.   o

 

 

The Registrant hereby amends this Registration Statement on such date or dates as may be necessary to delay its effective date until the Registrant shall file a further amendment which specifically states that this Registration Statement shall thereafter become effective in accordance with Section 8(a) of the Securities Act of 1933, as amended, or until the Registration Statement shall become effective on such date as the Securities and Exchange Commission, acting pursuant to said Section 8(a), shall determine.

 

 

Subject to completion, dated July 3, 2007

 

Prospectus

 

           shares

 

 

Common stock

 

 

This is an initial public offering of common stock by Virtusa Corporation. No public market currently exists for our common stock. We are selling           shares of common stock. The estimated initial public offering price is between $           and $      per share.

 

We have applied to have our common stock listed on the NASDAQ Global Market under the symbol “VRTU.”

 

 

 

We and certain of our existing stockholders have granted the underwriters an option for a period of 30 days to purchase up to           additional shares and           additional shares, respectively, of our common stock to cover over-allotments. We will not receive any proceeds from the sale of shares of our common stock by the selling stockholders.

 

 

Investing in our common stock involves a high degree of risk. See “Risk factors” beginning on page 7.

 

 

Neither the Securities and Exchange Commission nor any state securities commission has approved or disapproved of these securities or passed on the adequacy or accuracy of this prospectus. Any representation to the contrary is a criminal offense.

 

 

The underwriters expect to deliver shares on or about          , 2007.

 

        , 2007

 

 

Table of contents

 

 

The names Virtusa and Productization and our logo are trademarks or service marks of Virtusa Corporation. Other trademarks, trade names or service marks in this prospectus are the property of their respective owners.

 

Prospectus summary

•	our revenue is highly dependent on a small number of clients and the loss of any one of our major clients could significantly harm our results of operations and financial condition
•	the IT services market is highly competitive and our competitors may have advantages that may allow them to compete more effectively than we do to secure client contracts and attract skilled IT professionals
•	if we cannot attract and retain highly-skilled IT professionals, our ability to obtain, manage and staff new projects and continue to expand existing projects may result in loss of revenue and an inability to expand our business
•	our quarterly financial position, revenue, operating results and profitability are difficult to predict and may vary from quarter to quarter, which could cause our share price to decline significantly

The offering

 

 

 

 

The number of shares of our common stock to be outstanding after this offering is based on 57,676,390 shares outstanding as of March 31, 2007 and excludes:

 

 

Unless otherwise noted, all information in this prospectus reflects and assumes:

 

 

		Fiscal year ended March 31,
(In thousands, except share and per share amounts)		2005				2006				2007
Revenue		$	60,484			$	76,935				$124,660
Costs of revenue			31,813				43,417				68,031
Gross profit			28,671				33,518				56,629
Operating expenses			27,838				32,925				42,478
Income from operations			833				593				14,151
Other income			376				1,564				1,209
Income before income tax expense			1,209				2,157				15,360
Income tax expense (benefit)			99				176				(3,630	)
Net income		$	1,110			$	1,981				$ 18,990
Net income per share of common stock
Basic		$	0.02			$	0.04				$    0.35
Diluted		$	0.02			$	0.04				$    0.33
Pro forma net income per share of common stock(1)
Basic											$    0.35
Diluted											$    0.33
Pro forma weighted average number of common shares outstanding(1)
Basic											54,560,588
Diluted											57,442,177

(1)		On a pro forma basis to give effect to the conversion of all of our shares of preferred stock outstanding as of March 31, 2007 into 35,762,836 shares of common stock upon the completion of this offering

		March 31, 2007
								Pro forma
(In thousands)		Actual			Pro forma(1)			as adjusted(2)
Cash and cash equivalents		$	45,079		$	45,079		$
Working capital			67,082			67,082
Total assets			99,319			99,319
Redeemable convertible preferred stock			60,862			—
Total stockholders’ equity			19,259			80,121

(1)		On a pro forma basis to give effect to the conversion of all of our shares of preferred stock outstanding as of March 31, 2007 into 35,762,836 shares of common stock upon the completion of this offering
(2)		On a pro forma as adjusted basis to give effect to the sale of shares of common stock in this offering at an assumed public offering price of $      per share, the midpoint of the expected price range, after deducting estimated underwriting discounts and commissions and our estimated offering expenses.

 

You should carefully consider the risks described below and all other information contained in this prospectus before making an investment decision. If any of the following risks actually occur, our business, financial condition and results of operations could be materially and adversely affected. In that event, the trading price of our shares could decline and you may lose part or all of your investment.

 

Risks relating to our business

 

Our revenue is highly dependent on a small number of clients and the loss of any one of our major clients could significantly harm our results of operations and financial condition.

 

We have historically earned and believe that over the next few years we will continue to earn, a significant portion of our revenue from a limited number of clients. For instance, we generated approximately 45%, 43% and 49% of our revenue in our fiscal years ended March 31, 2005, 2006 and 2007, respectively, from our top five clients during those periods. For the fiscal year ended March 31, 2007, British Telecommunications plc, or BT, our largest client, accounted for 23% of our revenue; no other customer accounted for 10% of our revenue in that year. During the fiscal years ended March 31, 2006 and 2007, 91% and 97% of our revenue, respectively came from clients to whom we had been providing services for at least one year and 68% and 84%, respectively, came from clients to whom we had been providing services for at least two years. The loss of any one of our major clients could reduce our revenue or delay our recognition of revenue, harm our reputation in the industry and reduce our ability to accurately predict cash flow. For example, a major client terminated our service engagements within the fourth quarter of fiscal year 2005, and that termination negatively affected our results of operations for the fourth quarter of fiscal year 2005 and the first quarter of fiscal year 2006. The loss of any one of our major clients could also adversely affect our gross profit and utilization as we seek to redeploy resources previously dedicated to that client. Further, the loss of any one of our major clients has required, and could in the future require, us to initiate involuntary attrition. This could have a material adverse effect on our attrition rate and make it more difficult for us to attract and retain IT professionals in the future. We may not be able to maintain our client relationships and our clients may not renew their agreements with us, in which case, our business, financial condition and results of operations would be adversely affected. In addition, although we have recently entered into a five-year IT services agreement with BT that is premised upon minimum aggregate expenditures by BT of approximately $200 million over the term of the agreement, there can be no assurance that we will realize the full amount of those expenditures or that the agreement will not be terminated prior to the end of its term.

 

In addition, this client concentration may subject us to perceived or actual leverage that our clients may have given their relative size and importance to us. If our clients seek to negotiate their agreements on terms less favorable to us and we accept such unfavorable terms, such unfavorable terms may have a material adverse effect on our business, financial condition and results of operations. Accordingly, unless and until we diversify and expand our client base, our future success will significantly depend upon the timing and volume of business from our largest clients and the financial and operational success of these clients. If we were to lose one of our major clients or have a major client cancel substantial projects or otherwise significantly reduce its volume of business with us, our revenue and profitability would be materially reduced and our business would be seriously harmed.

 

The IT services market is highly competitive and our competitors may have advantages that may allow them to compete more effectively than we do to secure client contracts and attract skilled IT professionals.

 

The IT services market in which we operate includes a large number of participants and is highly competitive. Our primary competitors include:

 

 

We also occasionally compete with in-house IT departments, smaller vertically-focused IT service providers and local IT service providers based in the geographic areas where we compete. We expect additional competition from offshore IT outsourcing firms in emerging locations such as Eastern Europe, Latin America and China, as well as offshore IT service providers with facilities in less expensive geographies within India.

 

The IT services industry in which we compete is experiencing rapid changes in its competitive landscape. Some of the large consulting firms and offshore IT service providers that we compete with have significant resources and financial capabilities combined with a greater number of IT professionals. Many of our competitors are significantly larger and some have gained access to public and private capital or have merged or consolidated with better capitalized partners, which has created and may in the future create, larger and better capitalized competitors. These competitors may have superior abilities to compete for market share and for our existing and prospective clients. Our competitors may be better able to use significant economic incentives, such as lower billing rates, to secure contracts with our existing and prospective clients. These competitors may also be better able to compete for and retain skilled professionals by offering them more attractive compensation or other incentives. These factors may allow these competitors to have advantages over us to meet client demands in an engagement for large numbers and varied types of resources with specific experience or skill-sets that we may not have readily available in the short- or long-term. We cannot assure you that we can maintain or enhance our competitive position against current and future competitors. Our failure to compete effectively could have a material adverse effect on our business, financial condition or results of operations.

 

If we cannot attract and retain highly-skilled IT professionals, our ability to obtain, manage and staff new projects and continue to expand existing projects may result in loss of revenue and an inability to expand our business.

 

Our ability to execute and expand existing projects and obtain new clients depends largely on our ability to hire, train and retain highly-skilled IT professionals, particularly project managers, IT engineers and other senior technical personnel. If we cannot hire and retain such additional qualified personnel, our ability to obtain, manage and staff new projects and to expand, manage and staff existing projects, may be impaired. We may then lose revenue and our ability to expand our business may be harmed. There is intense worldwide competition for IT professionals with the skills necessary to perform the services we offer. We and the industry in which we operate generally experience high employee attrition. According to a survey of Indian companies conducted by Hewitt Associates, a human resources consulting firm, the attrition rate in 2006 for respondents was approximately 19.0%. Given our recent significant growth and strong demand for IT professionals from our competitors, we cannot assure you that we will be able to hire or retain the number of technical personnel necessary to satisfy our current and

future client needs. We also may not be able to hire and retain enough skilled and experienced IT professionals to replace those who leave. Additionally, if we have to replace personnel who have left our company, we will incur increased costs not only in hiring replacements but also in training such replacements until they can become productive and billable to our clients. In addition, we may not be able to redeploy and retrain our IT professionals in anticipation of continuing changes in technology, evolving standards and changing client preferences. Our inability to attract and retain IT professionals could have a material adverse effect on our business, operating results and financial condition.

 

Our quarterly financial position, revenue, operating results and profitability are difficult to predict and may vary from quarter to quarter, which could cause our share price to decline significantly.

 

Our quarterly revenue, operating results and profitability have varied in the past and are likely to vary significantly from quarter to quarter in the future. For example, our quarterly results ranged from an operating loss of $0.6 million for the quarter ended September 30, 2005 to operating income of $1.3 million for the quarter ended December 31, 2005. The factors that are likely to cause these variations include:

 

 

 

As a result, our revenue and our operating results for a particular period are difficult to predict and may decline in comparison to corresponding prior periods regardless of the strength of our business. Our future revenue is also difficult to predict because we derive a substantial portion of our revenue from fees for services generated from short-term contracts that may be terminated or delayed by our clients without penalty. In addition, a high percentage of our operating expenses, particularly related to personnel and facilities, are relatively fixed in advance of any particular quarter and are based, in part, on our expectations as to future revenue. If we are unable to predict the timing or amounts of future revenue accurately, we may be unable to adjust spending in a timely manner to compensate for any unexpected revenue shortfall and fail to meet our forecasts. Unexpected revenue shortfalls may also decrease our gross margins and could cause significant changes in our operating results from quarter to quarter. As a result, and in addition to the factors listed above, any of the following factors could have a significant and adverse impact on our operating results, could result in a shortfall of revenue and could result in losses to us:

 

 

Due to the foregoing factors, it is possible that in some future periods our revenue and operating results may not meet the expectations of securities analysts or investors. If this occurs, the trading price of our common stock could fall substantially either suddenly or over time and our business, financial condition and results of operations would be adversely affected.

 

The loss of key members of our senior management team may prevent us from executing our business strategy.

 

Our future success depends to a significant extent on the continued service and performance of key members of our senior management team. Our growth and success depends to a significant extent on our ability to retain Kris Canekeratne, our chief executive officer, who is a founder of our company and has led the growth, operation, culture and strategic direction of our business since its inception. The loss of his services or the services of other key members of our senior management could seriously harm our ability to execute our business strategy. Although we have entered into agreements with our executive officers providing for severance and change in control benefits to them, our executive officers or other key employees could terminate their employment with us at any time. We also may have to incur significant costs in identifying, hiring, training and retaining replacements for key employees. The loss of any member of our

senior management team might significantly delay or prevent the achievement of our business or development objectives and could materially harm our business. We do not maintain key man life insurance on any of our employees other than Kris Canekeratne.

 

We may lose revenue if our clients terminate or delay their contracts with us.

 

Our clients typically retain us on a non-exclusive, engagement-by-engagement basis, rather than under exclusive long-term contracts. Many of our contracts for services have terms of less than 12 months and permit our clients to terminate our engagement on prior written notice of 90 days or less for convenience, and without termination-related penalties. Further, many large client projects typically involve multiple independently defined stages, and clients may choose not to retain us for additional stages of a project or cancel or delay their start dates. These terminations, cancellations or delays could result from factors unrelated to our work product or the progress of the project, including:

 

 

If our contracts were terminated early or materially delayed, our business and operating results could be materially harmed and the value of our common stock could be impaired. Unexpected terminations, cancellation or delays in our client engagements could also result in increased operating expenses as we transition our employees to other engagements.

 

We may incur liability as a result of our failure to register under the Securities Exchange Act of 1934 between 2003 and 2005 when we had more than 500 option holders.

 

Our historical policy was generally to grant stock options to all of our team members worldwide. Section 12(g) of the Securities Exchange Act of 1934, or the Exchange Act, requires that companies with more than $10 million in assets and 500 or more equity security holders at any fiscal year-end register as a reporting company. During our fiscal year ended March 31, 2003, we experienced significant growth in our team member headcount and, as a result, we had granted stock options to more than 500 persons as of March 31, 2003. Accordingly, we may have been required to file a registration statement on Form 10 by July 29, 2003. We did not discover that we may have been obligated to file a Form 10 under Section 12(g) of the Exchange Act until February 2004 as part of the due diligence activities conducted in connection with our Series D convertible participating preferred stock financing. As a result, we did not register our options on Form 10 by July 29, 2003. In July 2005, after conducting extensive research regarding our potential alternatives, we unilaterally terminated certain of our stock options to reduce the number of our option holders to fewer than 300, which would have permitted us to terminate any Section 12(g) registration. Although we will register as a reporting company under the Exchange Act in connection with this offering, our failure to register under Section 12(g) of the Exchange Act as a result of having 500 or more option holders between 2003 and 2005 could subject us and our officers and directors to an enforcement action brought by the Securities and Exchange Commission and to fines and

penalties. In addition, the SEC could require us to prepare and file a registration statement on Form 10 and all periodic reports that we would have been required to file as a reporting company had we registered in fiscal 2004. Preparing and filing these reports at this time would be costly and time-consuming and could distract our management from our operations, which could negatively affect our business. It could also cause us to be perceived adversely by the investment community and cause our stock price to decline. In addition, our failure to file required Exchange Act reports could give rise to actions by federal regulators, or to potential claims by current or former option holders and stockholders based on the assertion that such holders were harmed by the absence of such public reports. If any such claim or action is asserted, we could incur expenses and management’s attention would be diverted in defending the claim or action.

 

We may incur liability to certain option holders as a result of our failure to register under the Exchange Act.

 

We may have been required to register as a reporting company under the Exchange Act as a result of having more than 500 option holders as of March 31, 2003, which would have required us to file a registration statement on Form 10 by July 29, 2003. Upon the effectiveness of such Form 10 registration statement, we would have been required to file periodic reports with the Securities and Exchange Commission. We reduced the number of our option holders to fewer than 300 in July 2005, which would have permitted us to terminate any such registration. The exemption from registration under Rule 701 of the Securities Act may not have been available during the intervening period, and grants of certain options under our stock option plan between August 12, 2003 and December 28, 2004 may not have been otherwise exempt from registration or qualification under federal and state securities laws. In particular, grants to 15 newly-hired, U.S.-based employees of stock options for an aggregate of 318,500 shares of common stock with an aggregate exercise price of $462,250 and a weighted average exercise price of $1.45 per share may not have been exempt from registration or qualification under federal and state securities laws. Although we believe that those option grants were made pursuant to valid exemptions from the registration requirements of the Securities Act of 1933, or the Securities Act, the holders of those options could nonetheless assert that they have rescission rights. If we are required, or elect, to make rescission offers to the holders of those options and such offers are accepted, we could be required to make payments to those holders equal to the value of the options plus statutory interest. Moreover, our financial exposure could be higher if so determined by the courts or regulators.

 

We may face damage to our professional reputation if our services do not meet our clients’ expectations.

 

Many of our projects involve technology applications or systems that are critical to the operations of our clients’ businesses and handle very large volumes of transactions. If we fail to perform our services correctly, we may be unable to deliver applications or systems to our clients with the promised functionality or within the promised time frame, or to satisfy the required service levels for support and maintenance. If a client is not satisfied with our services or products, including those of subcontractors we employ, our business may suffer. Moreover, if we fail to meet our contractual obligations, our clients may terminate their contracts and we could face legal liabilities and increased costs, including warranty claims against us. Any failure in a client’s project could result in a claim for substantial damages, non-payment of outstanding invoices, loss of future business with such client and increased costs due to non-billable time of

our resources dedicated to address any performance or client satisfaction issues, regardless of our responsibility for such failure.

 

We may not be able to continue to maintain or increase our profitability and our recent growth rates may not be indicative of our future growth.

 

We have been consistently profitable only since the quarter ended December 31, 2005. We may not succeed in maintaining our profitability and could incur losses in future periods. We expect to incur additional operating expenses associated with being a public company and we intend to continue to increase our operating expenses, including stock-based compensation, in all areas as we grow our business. If we experience declines in demand or declines in pricing for our services, or if wages in India or Sri Lanka increase at a faster rate than in the United States and the United Kingdom, we will be faced with continued growing costs for our IT professionals, including wage increases. We also expect to continue to make investments in infrastructure, facilities, sales and marketing and other resources as we expand our operations, thus incurring additional costs. If our revenue does not increase to offset these increases in costs or operating expenses, our operating results would be negatively affected. In fact, in future quarters we may not have any revenue growth and our revenue and net income could decline. You should not consider our historic revenue and net income growth rates as indicative of future growth rates. Accordingly, we cannot assure you that we will be able to maintain or increase our profitability in the future.

 

A significant or prolonged economic downturn in the IT services industry may result in our clients reducing or postponing spending on the services we offer.

 

Our revenue is dependent on entering into large contracts for our services with a limited number of clients each year. Because we are not the exclusive IT service provider for our clients, the volume of work that we perform for any specific client is likely to vary from year to year. There are a number of factors, other than our performance, that could affect the size, frequency and renewal rates of our client contracts. For instance, if economic conditions weaken in the IT services industry, our clients may reduce or postpone their IT spending significantly which may, in turn, lower the demand for our services and negatively affect our revenue and profitability. As a way of dealing with a challenging economic environment, clients may change their outsourcing strategy by performing more work in-house or replacing their existing software with packaged software supported by the licensor. The loss of, or any significant decline in business from, one or more of our major clients likely would lead to a significant decline in our revenue and operating margins, particularly if we are unable to make corresponding reductions in our expenses in the event of any such loss or decline. Moreover, a significant change in the liquidity or financial position of any of these clients could have a material adverse effect on the collectability of our accounts receivable, liquidity and future operating results.

 

Restrictions on immigration may affect our ability to compete for and provide services to clients in the United States or the United Kingdom, which could result in lost revenue and delays in client engagements and otherwise adversely affect our ability to meet our growth and revenue projections.

 

The vast majority of our employees are Indian and Sri Lankan nationals. The ability of our IT professionals to work in the United States, the United Kingdom and other countries depends on the ability to obtain the necessary visas and entry permits. In recent years, the United States has

increased the level of scrutiny in granting H-1B, L-1 and ordinary business visas. In response to terrorist attacks and global unrest, U.S. and U.K. immigration authorities, as well as other countries, have not only increased the level of scrutiny in granting visas, but have also introduced new security procedures, which include extensive background checks, personal interviews and the use of biometrics, as conditions to granting visas and work permits. A number of European countries are considering changes in immigration policies as well. The inability of key project personnel to obtain necessary visas or work permits could delay or prevent our fulfillment of client projects, which could hamper our growth and cause our revenue to decline. These restrictions and additional procedures may delay, or even prevent, the issuance of a visa or work permit to our IT professionals and affect our ability to staff projects in a timely manner. Any delays in staffing a project can result in project postponement, delays or cancellation, which could result in lost revenue and decreased profitability and have a material adverse effect on our business, revenue, profitability and utilization rates.

 

Immigration laws in countries in which we seek to obtain visas or work permits may require us to meet certain other legal requirements as conditions to obtaining or maintaining entry visas. These immigration laws are subject to legislative change and varying standards of application and enforcement due to political forces, economic conditions or other events, including terrorist attacks. We cannot predict the political or economic events that could affect immigration laws, or any restrictive impact those events could have on obtaining or monitoring entry visas for our personnel. Our reliance on work visas and work permits for a significant number of our IT professionals makes us particularly vulnerable to such changes and variations, particularly in the United States and the United Kingdom, because these immigration and legislative changes affect our ability to staff projects with IT professionals who are not citizens of the country where the onsite work is to be performed. We may not be able to obtain a sufficient number of visas for our IT professionals or may encounter delays or additional costs in obtaining or maintaining such visas. To the extent we experience delays due to such immigration restrictions, we may encounter client dissatisfaction, project and staffing delays in new and existing engagements, project cancellations, higher project costs and loss of revenue, resulting in decreases in profits and a material adverse effect on our business, results of operations, financial condition and cash flows.

 

Our management has limited experience managing a public company, and regulatory compliance may divert its attention from the day-to-day management of our business.

 

We have never operated as a public company. The individuals who constitute our management team have limited experience managing a publicly traded company and limited experience complying with the increasingly complex laws pertaining to public companies. We may need to hire a number of additional employees with public accounting and disclosure experience in order to meet our ongoing obligations as a public company. Our management team and other personnel will need to devote a substantial amount of time to these new compliance initiatives and we may not successfully or efficiently manage our transition into a public company. In particular, these new obligations will require substantial attention from our senior management and divert its attention away from the day-to-day management of our business, which could materially and adversely affect our business operations.

 

In addition, the Sarbanes-Oxley Act of 2002 requires, among other things, that we maintain effective internal control over financial reporting and disclosure controls and procedures. In particular, we must perform system and process evaluation and testing of our internal control over financial reporting to allow management and our independent registered public

accounting firm to report on the effectiveness of our internal control over financial reporting, which report is first required in our Annual Report on Form 10-K for the fiscal year ending March 31, 2009, as required by Section 404 of the Sarbanes-Oxley Act. Our testing, or the subsequent testing by our independent registered public accounting firm, may reveal deficiencies in our internal control over financial reporting that are deemed to be material weaknesses. To comply with Section 404, we will incur substantial accounting expense and expend significant management time. Compared to many newly-public companies, the scale of our organization and our significant foreign operations may make it more difficult to comply with Section 404 in a timely manner. We may not be able to successfully complete the procedures and certification and attestation requirements of Section 404 by the time we will be required to do so. If we are not able to comply with the requirements of Section 404 in a timely manner, or if we or our independent registered public accounting firm identifies deficiencies in our internal control over financial reporting that are deemed to be material weaknesses, we could be subject to sanctions or investigations by the NASDAQ Global Market, the Securities and Exchange Commission or other regulatory authorities, which would require additional financial and management resources. In addition, because effective internal controls are necessary for us to produce reliable financial reports and prevent fraud, our failure to satisfy the requirements of Section 404 could harm investor confidence in the reliability of our financial statements, which could harm our business and the trading price of our common stock.

 

We may be required to spend substantial time and expense before we can recognize revenue, if any, from a client contract.

 

The period between our initial contact with a potential client and the execution of a client contract for our services is lengthy, and can extend over one or more fiscal quarters. To sell our services successfully and obtain an executed client contract, we generally have to educate our potential clients about the use and benefits of our services, which can require significant time, expense and capital without the ability to realize revenue, if any. If our sales cycle unexpectedly lengthens for one or more large projects, it would negatively affect the timing of our revenue, and hinder our revenue growth. Furthermore, a delay in our ability to obtain a signed agreement or other persuasive evidence of an arrangement or to complete certain contract requirements in a particular quarter, could reduce our revenue in that quarter. These delays or failures can cause our gross margin and profitability to fluctuate significantly from quarter to quarter. Overall, any significant failure to generate revenue or delays in recognizing revenue after incurring costs related to our sales or services process could have a material adverse effect on our business, financial condition and results of operations.

 

We are investing substantial cash in new facilities and our profitability could be reduced if our business does not grow proportionately.

 

We currently plan to spend approximately $30 million of the net proceeds of this offering over the next three fiscal years in connection with the construction and build-out of a facility on our planned campus in Hyderabad, India. We also intend to make increased investments to expand our existing global delivery centers or procure additional capacity and facilities in Chennai, India and Colombo, Sri Lanka. We may face cost overruns and project delays in connection with these facilities or other facilities we may construct or seek to lease in the future. Such delays may also cause us to incur additional leasing costs to extend the terms of existing facility leases or to enter into new short-term leases if we cannot move into the new facilities in a timely manner. Such expansion may also significantly increase our fixed costs. If we are unable to expand our business and revenue proportionately, our profitability will be reduced.

 

We may not be able to recognize revenue in the period in which our services are performed, which may cause our margins to fluctuate.

 

Our services are performed under both time-and-material and fixed-price arrangements. All revenue is recognized pursuant to applicable accounting standards. These standards require us to recognize revenue once evidence of an arrangement has been obtained, services are delivered, fees are fixed or determinable and collectability is reasonably assured. If we perform our services prior to the time when we are able to recognize the associated revenue, our margins may fluctuate significantly from quarter to quarter.

 

Additionally, payment of our fees on fixed-price contracts are based on our ability to provide deliverables on certain dates or meet certain defined milestones. Our failure to produce the deliverables or meet the project milestones in accordance with agreed upon specifications or timelines, or otherwise meet a client’s expectations, may result in our having to record the cost related to the performance of services in the period that services were rendered, but delay the timing of revenue recognition to a future period in which the milestone is met.

 

Our inability to manage to a desired onsite-to-offshore service delivery mix may negatively affect our gross margins and costs and our ability to offer competitive pricing.

 

We may not succeed in maintaining or increasing our profitability and could incur losses in future periods if we are not able to manage to a desired onsite-to-offshore service delivery mix. To the extent that our engagements involve an increasing number of consulting, production support, software package implementation or other services typically requiring a higher percentage of onsite resources, we may not be able to manage to our desired service delivery mix. Additionally, other factors like client constraint or preferences or our inability to manage engagements effectively with limited resources onsite may result in a higher percentage of onsite resources than our desired service delivery mix. Accordingly, we cannot assure you that we will be able to manage to our desired onsite-to-offshore service delivery mix. If we are unable to manage to our targeted service delivery mix, our gross margins may decline and our profitability may be reduced. Additionally, our costs will increase and we may not be able to offer competitive pricing to our clients.

 

The international nature of our business exposes us to several risks, such as significant currency fluctuations and unexpected changes in the regulatory requirements of multiple jurisdictions.

 

We have operations in India, Sri Lanka and the United Kingdom and we serve clients across Europe, North America and Asia. For the fiscal years ended March 31, 2006 and 2007, revenue generated outside of the United States accounted for 14% and 26% of total revenue, respectively. Our corporate structure also spans multiple jurisdictions, with our parent company incorporated in Delaware and operating subsidiaries organized in India, Sri Lanka and the United Kingdom. As a result, our international revenue and operations are exposed to risks typically associated with conducting business internationally, many of which are beyond our control. These risks include:

 

 

 

Negative developments in any of these areas in one or more countries could result in a reduction in demand for our services, the cancellation or delay of client contracts, threats to our intellectual property, difficulty in collecting receivables and a higher cost of doing business, any of which could negatively affect our business, financial condition or results of operations.

 

If we fail to manage our rapid growth effectively, we may not be able to obtain, develop or implement new systems, infrastructure, procedures and controls that are required to support our operations, maintain cost controls, market our services and manage our relationships with our clients.

 

We have experienced rapid growth in recent periods. From March 31, 2004 to March 31, 2007, the number of our team members increased from 1,785 to 3,575. We expect that we will continue to grow and our anticipated growth could place a significant strain on our ability to:

 

 

 

To manage this anticipated future growth effectively, we must continue to maintain and may need to enhance, our IT infrastructure, financial and accounting systems and controls and manage expanded operations in several locations. We also must attract, integrate, train and retain qualified personnel, especially in the areas of accounting, internal audit and financial disclosure. Further, we will need to manage our relationships with various clients, vendors and other third parties. We may not be able to develop and implement, on a timely basis, if at all, the systems, infrastructure procedures and controls required to support our operations. Additionally some factors, like changes in immigration laws or visa processing restrictions that limit our ability to engage offshore resources at client locations in the United States or the United Kingdom, are outside of our control. Our future operating results will also depend on our ability to develop and maintain a successful sales organization despite our rapid growth. If we are unable to manage our growth, our operating results could fluctuate from quarter to quarter and our financial condition could be materially adversely affected.

 

Unexpected costs or delays could make our contracts unprofitable.

 

When making proposals for engagements, we estimate the costs and timing for completion of the projects. These estimates reflect our best judgment regarding the efficiencies of our methodologies, staffing of resources, complexities of the engagement and costs. The profitability of our engagements, and in particular our fixed-price contracts, are adversely affected by increased or unexpected costs or unanticipated delays in connection with the performance of these engagements, including delays caused by factors outside our control, which could make these contracts less profitable or unprofitable. The occurrence of any of these costs or delays could result in an unprofitable engagement or litigation.

 

Currency exchange rate fluctuations may negatively affect our operating results.

 

The exchange rates among the Indian and Sri Lankan rupees and the U.S. dollar and the U.K. pound sterling have changed substantially in recent years and may fluctuate substantially in the future. We expect that a majority of our revenue will continue to be generated in the U.S. dollar and U.K. pound sterling for the foreseeable future and that a significant portion of our expenses, including personnel costs, as well as capital and operating expenditures, will continue to be denominated in Indian and Sri Lankan rupees. Accordingly, any material appreciation of the Indian rupee or the Sri Lankan rupee against the U.S. dollar or U.K. pound sterling could have a material adverse effect on our cost of services, gross margin and net income, which may in turn have a negative impact on our business, operating results and financial condition.

 

We may face liability if we inappropriately disclose confidential client information.

 

In the course of providing services to our clients, we may have access to confidential client information. We are bound by certain agreements to use and disclose this information in a manner consistent with the privacy standards under regulations applicable to our clients. Although these privacy standards may not apply directly to us, if any person, including an employee of ours, misappropriates client confidential information, or if client confidential information is inappropriately disclosed due to a breach of our computer systems, system failures or otherwise, we may have substantial liabilities to our clients or our clients’ customers. In addition, in the event of any breach or alleged breach of our confidentiality agreements with

our clients, these clients may terminate their engagements with us or sue us for breach of contract, resulting in the associated loss of revenue and increased costs. We may also be subject to civil or criminal liability if we are deemed to have violated applicable regulations. We cannot assure you that we will adequately address the risks created by the regulations to which we may be contractually obligated to abide.

 

We will incur significant increased costs as a result of being a public company.

 

We will face increased legal, accounting, administrative and other costs and expenses as a public company that we do not incur as a private company. The Sarbanes-Oxley Act, as well as rules subsequently implemented by the Securities and Exchange Commission, the Public Company Accounting Oversight Board and the NASDAQ Stock Market, has imposed various requirements on public companies, including changes in the corporate governance practices of public companies. We expect these rules and regulations to increase our legal and financial compliance costs and to make legal, accounting and administrative activities more time-consuming and costly. We also expect to incur substantially higher costs to obtain directors and officers insurance.

 

Our failure to anticipate rapid changes in technology may negatively affect demand for our services in the marketplace.

 

Our success will depend, in part, on our ability to develop and implement business and technology solutions that anticipate rapid and continuing changes in technology, industry standards and client preferences. We may not be successful in anticipating or responding to these developments on a timely basis, which may negatively affect demand for our solutions in the marketplace. Also, if our competitors respond faster than we do to changes in technology, industry standards and client preferences, we may lose business and our services may become less competitive or obsolete. Any one or a combination of these circumstances could have a material adverse effect on our ability to obtain and successfully complete client engagements.

 

Interruptions or delays in service from our third-party providers could impair our global delivery model, which could result in client dissatisfaction and a reduction of our revenue.

 

We depend upon third parties to provide a high speed network of active voice and data communications 24 hours per day and various satellite and optical links between our global delivery centers and our clients. Consequently, the occurrence of a natural disaster or other unanticipated problems with the equipment or at the facilities of these third-party providers could result in unanticipated interruptions in the delivery of our services. For example, we may not be able to maintain active voice and data communications between our global delivery centers and our clients’ sites at all times due to disruptions in these networks, system failures or virus attacks. Any significant loss in our ability to communicate or any impediments to any IT professional’s ability to provide services to our clients could result in a disruption to our business, which could hinder our performance or our ability to complete client projects in a timely manner. This, in turn, could lead to substantial liability to our clients, client dissatisfaction, loss of revenue and a material adverse effect on our business, our operating results and financial condition. We cannot assure you that our business interruption insurance will adequately compensate our clients or us for losses that may occur. Even if covered by insurance, any failure or breach of security of our systems could damage our reputation and cause us to lose clients.

 

Our services may infringe on the intellectual property rights of others, which may subject us to legal liability, harm our reputation, prevent us from offering some services to our clients or distract management.

 

We cannot be sure that our services or the deliverables that we develop and create for our clients do not infringe the intellectual property rights of third parties and infringement claims may be asserted against us or our clients. These claims may harm our reputation, distract management, cost us money and prevent us from offering some services to our clients. Historically, we have generally agreed to indemnify our clients for all expenses and liabilities resulting from infringement of intellectual property rights of third parties based on the services and deliverables that we have performed and provided to our clients. In some instances, the amount of these indemnities may be greater than the revenue we receive from the client. In addition, as a result of intellectual property litigation, we may be required to stop selling, incorporating or using products that use or incorporate the infringed intellectual property. We may be required to obtain a license or pay a royalty to make, sell or use the relevant technology from the owner of the infringed intellectual property. Such licenses or royalties may not be available on commercially reasonable terms, or at all. We may also be required to redesign our services or change our methodologies so as not to use the infringed intellectual property, which may not be technically or commercially feasible and may cause us to expend significant resources. Subject to certain limitations, under our indemnification obligations to our clients, we may also have to provide refunds to our clients to the extent that we must require them to cease using an infringing deliverable if we are unable to provide a work around or acquire a license to permit use of the infringing deliverable that we had provided to them as part of a service engagement. If we are obligated to make any such refunds or dedicate time to provide alternatives or acquire a license to the infringing intellectual property, our business and financial condition could be materially adversely affected.

 

Any claims or litigation involving intellectual property, whether we ultimately win or lose, could be extremely time-consuming, costly and injure our reputation.

 

As the number of patents, copyrights and other intellectual property rights in our industry increases, we believe that companies in our industry will face more frequent infringement claims. Defending against these claims, even if the claims have no merit, may not be covered by or could exceed the protection offered by our insurance and could divert management’s attention and resources from operating our company.

 

Our ability to raise capital in the future may be limited and our failure to raise capital when needed could prevent us from growing.

 

We anticipate that our current cash and cash equivalents, together with the net proceeds of this offering, will be sufficient to meet our current needs for general corporate purposes for the foreseeable future. We may also need additional financing to execute our current or future business strategies, including to:

 

 

 

If we raise additional funds through the issuance of equity or convertible debt securities, the percentage ownership of our stockholders could be significantly diluted and these newly issued securities may have rights, preferences or privileges senior to those of existing stockholders. If we incur additional debt financing, a substantial portion of our operating cash flow may be dedicated to the payment of principal and interest on such indebtedness, thus limiting funds available for our business activities. Any such debt financing could require us to comply with restrictive financial and operating covenants, which could have a material adverse impact on our business, results of operations or financial condition. We cannot assure you that additional financing will be available on terms favorable to us, or at all. If adequate funds are not available or are not available on acceptable terms, when we desire them, our ability to fund our operations and growth, take advantage of unanticipated opportunities or otherwise respond to competitive pressures may be significantly limited.

 

Potential future acquisitions, strategic investments, partnerships or alliances could be difficult to identify and integrate, divert the attention of key management personnel, disrupt our business, dilute stockholder value and adversely affect our financial results.

 

We may acquire or make strategic investments in complementary businesses, technologies or services or enter into strategic partnerships or alliances with third parties to enhance our business. If we do identify suitable candidates, we may not be able to complete transactions on terms commercially acceptable to us, if at all. These types of transactions involve numerous risks, including:

 

 

We may finance future transactions through debt financing or the issuance of our equity securities or a combination of the foregoing. Acquisitions financed with the issuance of our equity securities could be dilutive, which could affect the market price of our stock. Acquisitions financed with debt could require us to dedicate a substantial portion of our cash flow to principal and interest payments and could subject us to restrictive covenants. Acquisitions also frequently result in the recording of goodwill and other intangible assets that are subject to potential impairments in the future that could harm our financial results. It is possible that we may not identify suitable acquisition, strategic investment or partnership or alliance candidates. Our inability to identify suitable acquisition targets, strategic investments, partners or alliances, or our inability to complete such transactions, may negatively affect our competitiveness and growth prospects. Moreover, if we fail to properly evaluate acquisitions, alliances or

investments, we may not achieve the anticipated benefits of any such transaction and we may incur costs in excess of what we anticipate.

 

Our profitability is dependent on our billing and utilization rates, which may be negatively affected by various factors.

 

Our profit margin is largely a function of the rates we are able to charge for our services and the utilization rate of our IT professionals. The rates we are able to charge for our services are affected by a number of factors, including:

 

 

A number of factors affect our utilization rate, including:

 

 

If we are not able to maintain the rates we charge for our services or maintain an appropriate utilization rate for our IT professionals, our revenue will decline, our costs will increase and we will not be able to sustain our profit margin, any of which will have a material adverse effect on our profitability.

 

We depend on clients primarily located in the United States and the United Kingdom, as well as clients concentrated in specific industries, and are therefore subject to risks relating to developments affecting these clients that may cause them to reduce or postpone their IT spending.

 

For the fiscal year ended March 31, 2007, we derived substantially all of our revenue from clients located in the United States and the United Kingdom, as well as clients concentrated in certain industries. During the fiscal year ended March 31, 2007, we generated 74% of our revenue in the United States and 26% of our revenue in the United Kingdom. For the same fiscal year, we derived substantially all of our revenue from three industries: communications

and technology; banking, financial services and insurance; and media and information. If economic conditions weaken, particularly in the United States, the United Kingdom or any of these industries, our clients may significantly reduce or postpone their IT spending. Reductions in IT budgets, increased consolidation or decreased competition in these geographic locations or industries could result in an erosion of our client base and a reduction in our target market. Any reductions in the IT spending of companies in any one of these industries may reduce the demand for our services and negatively affect our revenue and profitability.

 

Some of our client contracts contain restrictions or penalty provisions that, if triggered, could result in lower future revenue and decrease our profitability.

 

We have entered in the past, and may in the future enter, into contracts that contain restrictions or penalty provisions that, if triggered, may adversely affect our operating results. For instance, some of our client contracts provide that, during the term of the contract and for a certain period thereafter ranging from six to 12 months, we may not use the same personnel to provide similar services to any of the client’s competitors. This restriction may hamper our ability to compete for and provide services to clients in the same industry. In addition, some contracts contain provisions that would require us to pay penalties to our clients if we do not meet pre-agreed service level requirements. If any of the foregoing were to occur, our future revenue and profitability under these contracts could be materially harmed.

 

Negative public perception in the United States and the United Kingdom regarding offshore IT service providers and proposed legislation may adversely affect demand for our services.

 

We have based our growth strategy on certain assumptions regarding our industry, services and future demand in the market for such services. However, the trend to outsource IT services may not continue and could reverse. Offshore outsourcing is a politically sensitive topic in the United States and the United Kingdom. For example, many organizations and public figures in the United States and the United Kingdom have publicly expressed concern about a perceived association between offshore outsourcing providers and the loss of jobs in their home countries. In addition, there has been recent publicity about the negative experience of certain companies that use offshore outsourcing, particularly in India. Current or prospective clients may elect to perform such services themselves or may be discouraged from transferring these services from onshore to offshore providers to avoid negative perceptions that may be associated with using an offshore provider. Any slowdown or reversal of existing industry trends towards offshore outsourcing would seriously harm our ability to compete effectively with competitors that operate out of facilities located in the United States or the United Kingdom.

 

Legislation in the United States or the United Kingdom may be enacted that is intended to discourage or restrict outsourcing. In the United States, a variety of federal and state legislation has been proposed that, if enacted, could restrict or discourage U.S. companies from outsourcing their services to companies outside the United States. For example, legislation has been proposed that would require offshore providers to identify where they are located. In addition, it is possible that legislation could be adopted that would restrict U.S. private sector companies that have federal or state government contracts from outsourcing their services to offshore service providers. We do not currently have any contracts with U.S. federal or state government entities. However, there can be no assurance that these restrictions will not extend to or be adopted by private companies, including our clients. Recent legislation introduced in the United Kingdom has also been introduced to restrict or discourage companies from outsourcing their services, including IT services. Any changes to existing laws or the enactment

of new legislation restricting offshore outsourcing in the United States or the United Kingdom may adversely affect our ability to do business in the United States or in the United Kingdom, particularly if these changes are widespread, and could have a material adverse effect on our business, results of operations, financial condition and cash flows.

 

Risks related to our Indian and Sri Lankan operations

 

Political instability or changes in the government in India could result in the change of several policies relating to foreign direct investment and repatriation of capital and dividends. Further, changes in the economic policies could adversely affect economic conditions in India generally and our business in particular.

 

We have a subsidiary in India and a significant portion of our business, fixed assets and human resources are located in India. As a result, our business is affected by foreign exchange rates and controls, interest rates, changes in government policy, taxation, social and civil unrest and other political, economic or other developments in or affecting India.

 

Since 1991, successive Indian governments have pursued policies of economic liberalization, including significantly relaxing restrictions on foreign direct investment into India with repatriation benefits. Nevertheless, the roles of the Indian central and state governments in the Indian economy as producers, consumers and regulators have remained significant. The rate of economic liberalization could change and specific laws and policies affecting software companies, foreign investment, currency exchange and other matters affecting investment in our securities could change as well. A significant change in India’s economic liberalization and deregulation policies could adversely affect business and economic conditions in India generally and our business in particular, if new restrictions on the private sector are introduced or if existing restrictions are increased.

 

Changes in the policies of the government of Sri Lanka or political instability could delay the further liberalization of the Sri Lankan economy and adversely affect economic conditions in Sri Lanka, which could adversely affect our business.

 

Our subsidiary in Sri Lanka has been approved as an export computer software developer by the Board of Investment in Sri Lanka, which is a statutory body organized to facilitate foreign investment into Sri Lanka and grant concessions and benefits to entities with which it has entered into agreements. Pursuant to our agreement with the Board of Investment, our subsidiary is entitled to exemptions from taxation on income for a period of 12 years expiring on March 31, 2019. Our subsidiary is also exempt from exchange control regulations which will enable our subsidiary to repatriate dividends abroad. Nevertheless, government policies relating to taxation other than on income would have an impact on the subsidiary, and the political, economic or social factors in Sri Lanka may affect these policies. Historically, past incumbent governments have followed policies of economic liberalization. However, we cannot assure you that the current government or future governments will continue these liberal policies.

 

Regional conflicts or terrorist attacks and other acts of violence or war in India, Sri Lanka, the United States or other regions could adversely affect financial markets, resulting in loss of client confidence and our ability to serve our clients which, in turn, could adversely affect our business, results of operations and financial condition.

 

The Asian region has from time to time experienced instances of civil unrest and hostilities among neighboring countries, including between India and Pakistan. Since May 1999, military confrontations between India and Pakistan have occurred in Kashmir. Also, there have been military hostilities and civil unrest in Iraq. Terrorist attacks, such as the ones that occurred in New York and Washington, D.C., on September 11, 2001, New Delhi on December 13, 2001, Bali on October 12, 2002, civil or political unrest in Sri Lanka and other acts of violence or war, including those involving India, Sri Lanka, the United States, the United Kingdom or other countries, may adversely affect U.S., U.K. and worldwide financial markets. Prospective clients may wish to visit several of our facilities, including our global delivery centers in India and Sri Lanka, prior to reaching a decision on vendor selection. Terrorist threats, attacks and international conflicts could make travel more difficult and cause potential clients to delay, postpone or cancel decisions to use our services. In addition, such attacks may have an adverse impact on our ability to operate effectively and interrupt lines of communication and restrict our offshore resources from traveling onsite to client locations, effectively curtailing our ability to deliver our services to our clients. These obstacles may increase our expenses and negatively affect our operating results. In addition, military activity, terrorist attacks, political tensions between India and Pakistan and conflicts within Sri Lanka could create a greater perception that the acquisition of services from companies with significant Indian or Sri Lankan operations involves a higher degree of risk that could adversely affect client confidence in India or Sri Lanka as a software development center, each of which would have a material adverse effect on our business.

 

Our net income may decrease if the governments of the United Kingdom, the United States, India or Sri Lanka adjust the amount of our taxable income by challenging our transfer pricing policies.

 

Our subsidiaries conduct intercompany transactions among themselves and with the U.S. parent company on an arm’s-length basis in accordance with U.S. and local country transfer pricing regulations. The jurisdictions in which we pay income taxes could challenge our determination of arm’s-length profit and issue tax assessments. Although the United States has income tax treaties with all countries in which we have operations, which mitigates the risk of double taxation, the costs to appeal any such tax assessment and potential interest and penalties could decrease our earnings and cash flows.

 

The Indian taxing authorities recently issued an assessment order with respect to their examination of the tax return for the fiscal year ended March 31, 2004 of our Indian subsidiary, Virtusa (India) Private Ltd., or Virtusa India. At issue were several matters, the most significant of which was the re-determination of the arm’s-length profit which should be recorded by Virtusa India on the intercompany transactions with its affiliates. We are contesting the assessment and have filed appeals with both the appropriate Indian tax authorities and the U.S. Competent Authority. During the fiscal year ended March 31, 2007, we recorded a $0.4 million reserve related to this matter. In addition, the Indian tax authorities are conducting an audit of our fiscal year ended March 31, 2005. Although no assessments have been issued to date, we may receive assessments in the future related to our intercompany pricing arrangements. Any failure

of our appeals with India or audit assessments from India, Sri Lanka, the United Kingdom or the United States could reduce our earnings and cash flows.

 

Our net income may decrease if the governments of India or Sri Lanka reduce or withdraw tax benefits and other incentives provided to us or levy new taxes.

 

Our Indian subsidiary, Virtusa India, is an export-oriented company under the Indian Income Tax Act of 1961 and is entitled to claim tax exemption for each Software Technology Park, or STP, which it operates. Virtusa India currently operates two STPs, in Chennai and in Hyderabad. Substantially all of the earnings of both STPs qualify as tax-exempt export profits. These holidays will be completely phased out by March 2009, and at that time any profits would be fully taxable at the Indian statutory rate, which is currently 34.0%. Although we believe we have complied with and are eligible for the STP holiday, the government of India may deem us ineligible for the STP holiday or make adjustments to the profit level resulting in an overall increase in our effective tax rate. In anticipation of the phase-out of the STP holidays, we intend to locate at least a portion of our Indian operations in areas designated as a Special Economic Zone, or SEZ, under the SEZ Act of 2005. In particular, we intend to build a campus on a 6.3 acre parcel of land in Hyderabad, India that has been designated as an SEZ and we intend to seek SEZ designation in other locations. Although our profits from the SEZ operations would be entitled to certain income tax incentives for a period up to 15 years, there is no guarantee that we will secure SEZ status for any other location in India. Additionally, the government of India may deem us ineligible for an SEZ holiday or make adjustments to the transfer pricing profit levels resulting in an overall increase in our effective tax rate.

 

In addition, our Sri Lankan subsidiary, Virtusa Private Ltd., or Virtusa SL, was approved as an export computer software developer by the Sri Lanka Board of Investment in 1998 and has negotiated multiple extensions of the original holiday period in exchange for further capital investments in Sri Lanka facilities. The most recent 12-year agreement, which is set to expire on March 31, 2019, requires that we meet certain new job creation and investment criteria. Any inability to meet the agreed upon timetable for new job creation and investment would jeopardize the new holiday arrangement.

 

Newly-enacted legislation in India could harm our results of operations and ability to attract, hire and retain qualified personnel.

 

In May 2007, the Parliament of India enacted the Finance Act, 2007, which, among other things, imposes a fringe benefit tax at the applicable Indian tax rate (currently 34.0%) on certain stock compensation and equity awards paid or issued to team members of our Indian subsidiary, Virtusa India. Specifically, the fringe benefit tax, which is payable upon the exercise of such equity awards, is based on the difference between the exercise price of the equity award and the fair market value of the equity award upon vesting. Because our potential tax liability is dependent on the fair market value of our common stock at the time of vesting of such equity awards, which could span over the next several years, and whether the equity awards are ultimately exercised, it is difficult to accurately forecast and could represent a significant liability and expense to us. While we may pursue strategies to reduce the impact of this tax obligation on us, such as passing the cost of the fringe benefit tax on to our Virtusa India team members, such alternatives may not eliminate the negative impact of the tax liability on our statements of operations and could result in significant non-cash compensation expense, which would harm our gross margin, operating profit margin and net income. In addition, if we pass on the cost of

the fringe benefit tax to our Virtusa India team members, it could significantly decrease the desirability of these equity awards to these team members, which could harm our ability to attract, hire and retain qualified personnel.

 

Wage pressures and increases in government mandated benefits in India and Sri Lanka may reduce our profit margins.

 

Wage costs in India and Sri Lanka have historically been significantly lower than wage costs in the United States and Europe for comparably-skilled professionals. However, wages in India and Sri Lanka are increasing, 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 employee 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.

 

In addition, we contribute to benefit funds covering our employees in India and Sri Lanka as mandated by the Indian and Sri Lankan governments. Benefits are based on the employee’s years of service and compensation. If the governments of India and/or Sri Lanka were to legislate increases to the benefits required under these plans or mandate additional benefits, our profitability and cash flows would be reduced.

 

Our facilities are at risk of damage by earthquakes, tsunamis and other natural disasters.

 

In December 2004, Sri Lanka and India were struck by multiple tsunamis that devastated certain areas of both countries. Our Indian and Sri Lankan facilities are located in regions that are susceptible to tsunamis and other natural disasters, which may increase the risk of disruption of information systems and telephone service for sustained periods. Damage or destruction that interrupts our ability to deliver our services could damage our relationships with our clients and may cause us to incur substantial additional expense to repair or replace damaged equipment or facilities. Our insurance coverage may not be sufficient to cover all such expenses. Furthermore, we may be unable to secure such insurance coverage or to secure such insurance coverage at premiums acceptable to us in the future. Prolonged disruption of our services as a result of natural disasters may cause our clients to terminate their contracts with us and may result in project delays, project cancellations and loss of substantial revenue to us. Prolonged disruptions may also harm our team members or cause them to relocate, which could have a material adverse effect on our business.

 

The laws of India and Sri Lanka do not protect intellectual property rights to the same extent as those of the United States and we may be unsuccessful in protecting our intellectual property rights. Unauthorized use of our intellectual property rights may result in loss of clients and increased competition.

 

Our success depends, in part, upon our ability to protect our proprietary methodologies, trade secrets and other intellectual property. We rely upon a combination of trade secrets, confidentiality policies, non-disclosure agreements, other contractual arrangements and copyright and trademark laws to protect our intellectual property rights. However, existing laws of India and Sri Lanka do not provide protection of intellectual property rights to the same extent as provided in the United States. The steps we take to protect our intellectual property may not be adequate to prevent or deter infringement or other unauthorized use of our

intellectual property. Thus, we may not be able to detect unauthorized use or take appropriate and timely steps to enforce our intellectual property rights. Our competitors may be able to imitate or duplicate our services or methodologies. The unauthorized use or duplication of our intellectual property could disrupt our ongoing business, distract our management and employees, reduce our revenue and increase our costs and expenses. We may need to litigate to enforce our intellectual property rights or to determine the validity and scope of the proprietary rights of others. Any such litigation could be extremely time-consuming and costly and could materially adversely impact our business.

 

Risks relating to this offering and our stock

 

If you purchase shares of common stock in this offering, you will suffer immediate and substantial dilution of your investment and may experience additional dilution in the future.

 

If you purchase common stock in this offering, you will pay more for your shares than the amounts paid by existing stockholders for their shares. As a result, you will incur immediate and substantial dilution of $      per share, representing the difference between our adjusted net tangible book value per share after giving effect to this offering and an assumed initial public offering price of $      per share. Purchasers of shares of our common stock in this offering will have contributed approximately  % of the aggregate price paid by all purchasers of our common stock, but will own only approximately  % of the shares of our common stock outstanding after this offering. Moreover, we issued options in the past to acquire common stock at prices significantly below the initial public offering price. As of March 31, 2007, there were 116,882 shares of common stock issuable upon the exercise of warrants at an exercise price of $1.75 per share, 10,052,476 shares subject to outstanding options at a weighted average exercise price of $1.13 per share and 614,235 shares of common stock issuable after this offering under stock appreciation rights, or SARs, reduced by the weighted average exercise price of $1.29 per SAR. To the extent that these outstanding warrants, options or SARs are ultimately exercised, you will incur further dilution. In the future, we may also acquire other companies or assets, raise additional needed capital or finance strategic alliances by issuing equity, which may result in additional dilution to you.

 

A significant portion of our total outstanding shares may be sold into the public market in the near future, which could cause the market price of our common stock to drop significantly, even if our business is doing well.

 

Sales of a substantial number of shares of our common stock in the public market could occur at any time after the expiration of the lock-up agreements described in “Underwriting.” These sales, or the market perception that the holders of a large number of shares intend to sell shares, could reduce the market price of our common stock. After the close of this offering, we will have           shares of common stock outstanding based on the number of shares outstanding as of March 31, 2007. This includes the           shares that we are selling in this offering, which may be resold in the public market immediately. The remaining 57,676,390 shares, or  % of our outstanding shares after this offering, will be able to be sold, subject to any applicable volume limitations under federal securities laws, in the near future as set forth below.

 

 

In addition, as of March 31, 2007, there were 116,882 shares subject to outstanding warrants, 10,052,476 shares subject to outstanding options and an additional 1,307,373 shares reserved for future issuance under our stock option plan that will become eligible for sale in the public market to the extent permitted by any applicable vesting requirements, the lock-up agreements and Rules 144, 144(k) and 701 under the Securities Act. We also maintain a stock appreciation rights plan for the benefit of our non-U.S. employees, which plan, following this offering, will require us to settle all exercises of SARs in shares of our common stock. We have reserved 614,235 shares of common stock for issuance after this offering upon the exercise of SARs outstanding as of March 31, 2007, although this number will be reduced by the exercise price of these SARs. Moreover, after this offering, holders of an aggregate of approximately 56,340,077 shares of our common stock as of March 31, 2007, will have rights, subject to some conditions, to require us to file registration statements covering their shares or to include their shares in registration statements that we may file for ourselves or other stockholders. We also intend to register all shares of common stock that we may issue under our employee incentive plans. Once we register these shares, they can be freely sold in the public market upon issuance, subject to the lock-up agreements and the restrictions imposed on our affiliates under Rule 144.

 

We do not currently intend to pay dividends on our common stock and, consequently, your ability to achieve a return on your investment will depend on appreciation in the price of our common stock.

 

We have never declared or paid any cash dividends on our common stock and do not currently intend to do so for the foreseeable future. We currently intend to invest our future earnings, if any, to fund our growth. In addition, the terms of our credit facility prohibit us from paying cash dividends. Therefore, you are not likely to receive any dividends on your common stock for the foreseeable future and the success of an investment in shares of our common stock will depend upon any future appreciation in its value. There is no guarantee that shares of our common stock will appreciate in value or even maintain the price at which our stockholders have purchased their shares.

 

Provisions in our charter documents and under Delaware law may prevent or delay a change of control of us and could also limit the market price of our common stock.

 

Certain provisions of Delaware law and of our certificate of incorporation and by-laws to be effective upon the closing of this offering could have the effect of making it more difficult for a

third party to acquire, or of discouraging a third party from attempting to acquire, control of us, even if such a change in control would be beneficial to our stockholders or result in a premium for your shares of our common stock. These provisions may also prevent or frustrate attempts by our stockholders to replace or remove our management. These provisions include:

 

 

The affirmative vote of the holders of at least 75% of our shares of capital stock entitled to vote is necessary to amend or repeal the above provisions that are contained in our certificate of incorporation. In addition, our board of directors has the ability to designate the terms of and issue new series of preferred stock without stockholder approval. Also, absent approval of our board of directors, our by-laws may only be amended or repealed by the affirmative vote of the holders of at least 75% of our shares of capital stock entitled to vote.

 

In addition, upon the closing of this offering, we will be subject to the provisions of Section 203 of the Delaware General Corporation Law, which limits business combination transactions with stockholders of 15% or more of our outstanding voting stock that our board of directors has not approved. These provisions and other similar provisions make it more difficult for stockholders or potential acquirers to acquire us without negotiation. These provisions may apply even if some stockholders may consider the transaction beneficial to them.

 

These provisions could limit the price that investors are willing to pay in the future for shares of our common stock. These provisions might also discourage a potential acquisition proposal or tender offer, even if the acquisition proposal or tender offer is at a premium over the then current market price for our common stock.

 

Because our common stock price is likely to be highly volatile, the market price of our common stock could drop unexpectedly.

 

Prior to this offering, there has been no public market for our common stock. The initial public offering price for our common stock will be determined through negotiations with the underwriters. This initial public offering price may vary from the market price of our common stock after the offering. We cannot guarantee that an active trading market will develop or be sustained or that the market price of our common stock will not decline. Even if an active market for our stock develops and continues, our stock price nevertheless may be volatile. Some of the factors that may cause the market price of our common stock to fluctuate include:

 

 

 

Many of these factors are beyond our control. In addition, the stock markets, especially the NASDAQ Global Market, have experienced significant price and volume fluctuations that have affected the market prices of equity securities of many technology companies. These fluctuations have often been unrelated or disproportionate to operating performance. If any of the foregoing occurs, it could cause our stock price to fall and may expose us to securities class action litigation. Any securities class action litigation could result in substantial costs and the diversion of management’s attention and resources.

 

Because we will have broad discretion in using the net proceeds of this offering, the benefits from our use of the proceeds may not meet investors’ expectations.

 

Our management will have broad discretion over the allocation of the net proceeds from this offering as well as over the timing of their expenditure without stockholder approval. Other than the use of approximately $30 million of the net proceeds from this offering during the next three fiscal years to construct and build out a new facility on our planned campus in Hyderabad, India, we have not yet determined the specific amounts of the balance of the net proceeds to be used for working capital and other general corporate purposes, including possible acquisitions of complementary technologies or businesses. As a result, investors will be relying upon management’s judgment with only limited information about our specific intentions for the use of the balance of the net proceeds of this offering. Our failure to apply these proceeds effectively could cause our business to suffer. Pending their use, we may invest the net proceeds from this offering in a manner that does not produce income or that loses value.

 

Our existing stockholders and management control a substantial interest in us and thus may influence certain actions requiring stockholder vote.

 

Upon the closing of this offering, our officers, directors and stockholders affiliated with our directors will beneficially own, in the aggregate, shares representing approximately  % of our outstanding capital stock. Although we are not aware of any voting arrangements that will be in place among these stockholders following this offering, if these stockholders were to choose to act together, as a result of their stock ownership, they would be able to control all matters submitted to our stockholders for approval, including the election of directors and approval of any merger, consolidation or sale of all or substantially all of our assets. This concentration of voting power could delay or prevent an acquisition of our company on terms that other stockholders may desire.

 

An active trading market for our common stock may not develop and you may not be able to sell your shares of common stock at or above the initial public offering price or at a time that is acceptable to you.

 

Prior to this offering, there has been no public market for our common stock. Although we have applied to have our common stock listed on the NASDAQ Global Market, an active trading market for shares of our common stock may never develop or be sustained following this offering. If no trading market develops, securities analysts may not initiate or maintain research coverage of our company, which could further depress the market for our common stock. As a result, investors may not be able to sell their common stock at or above the initial public offering price or at the time that they would like to sell.

 

If equity research analysts do not publish research or reports about our business or if they issue unfavorable commentary or downgrade our common stock, the price of our common stock could decline.

 

The trading market for our common stock will rely in part on the research and reports that equity research analysts publish about us and our business. We do not control these analysts. The price of our stock could decline if one or more equity analysts downgrade our stock or if those analysts issue other unfavorable commentary or cease publishing reports about us or our business.

 

This prospectus contains forward-looking statements that are based on our current expectations, assumptions, estimates and projections about our company and our industry. The forward-looking statements are subject to various risks and uncertainties. Generally, these forward-looking statements can be identified by the use of forward-looking terminology such as “anticipate,” “believe,” “estimate,” “expect,” “intend,” “will,” “project,” “seek,” “should, ” “may,” “could,” “would,” “plans,” “predicts,” “potential,” and similar expressions (as well as other words or expressions referencing future events, conditions, or circumstances). Those statements include, among other things, the discussions of our business strategy and expectations concerning our market position, future operations, financial position, revenue, costs, prospects, margins, profitability, liquidity and capital resources, as well as management’s plans and objectives. We caution you that reliance on any forward-looking statement involves risks and uncertainties and that although we believe that the assumptions on which our forward-looking statements are based are reasonable, any of those assumptions could prove to be inaccurate, and, as a result, the forward-looking statements based on those assumptions could be materially incorrect. These factors include but are not limited to:

 

 

These and other factors are more fully discussed in “Risk factors,” “Management’s discussion and analysis of financial condition and results of operations” and elsewhere in this prospectus. In light of these and other uncertainties, you should not conclude that we will necessarily achieve any plans, objectives or projected financial results referred to in any of the forward-looking statements. Except as required by law, we do not intend to update any of these forward-looking statements to reflect future events or circumstances.

 

Unless otherwise indicated, information contained in this prospectus concerning our industry and the markets in which we operate, including our general expectations and market position, market opportunity and market share, is based on information from various sources (including industry publications, surveys and forecasts and our internal research), on assumptions that we have made, which we believe are reasonable, based on those data and other similar sources and on our knowledge of the markets for our services. Our internal research has not been verified by any independent source and we have not independently verified any third-party information. The projections, assumptions and estimates of our future performance and the future performance of the industry in which we operate are necessarily subject to a high degree of uncertainty and risk due to a variety of factors, including those described in “Risk factors” and elsewhere in this prospectus. These and other factors could cause results to differ materially from those expressed in the estimates included in this prospectus.

 

We estimate that our net proceeds from this offering will be approximately $      million, assuming an initial public offering price of $      per share, which is the midpoint of the range listed on the cover page of this prospectus and after deducting estimated underwriting discounts and commissions and estimated offering expenses that we must pay. A $1.00 increase (decrease) in the assumed initial public offering price of $      per share would increase (decrease) the net proceeds to us from this offering by approximately $      million, assuming the number of shares offered by us, as set forth on the cover page of this prospectus, remains the same and after deducting estimated underwriting discounts and commissions and estimated offering expenses payable by us. If the underwriters exercise their over-allotment option in full, we estimate that our net proceeds from this offering will be approximately $      million. We will not receive any proceeds from the sale of shares of our common stock by the selling stockholders as part of the over-allotment option.

 

If we fund the following solely with our net proceeds from this offering without allocation of funds from other sources, we currently estimate that we will use:

 

 

We may use a portion of our net proceeds to expand our business into new geographic locations. We may also use a portion of these net proceeds to expand our current business through strategic alliances involving, or acquisitions of, other complementary businesses or technologies. We have no agreements or commitments for any specific acquisitions at this time. Pending use of our net proceeds of this offering, as described above, we plan to invest the net proceeds in a variety of capital preservation investments, including investment-grade, short-term, interest-bearing securities.

 

This expected use of our net proceeds of this offering represents our current intentions based upon our present plans and business condition. The amounts and timing of our actual expenditures will depend upon numerous factors, including cash flows from operations and the anticipated growth of our business. We will retain broad discretion in the allocation and use of our net proceeds.

 

We have never declared or paid cash dividends on our common stock and do not expect to pay dividends in the foreseeable future. We currently intend to retain all of our future earnings to fund the operation, development and expansion of our business. In addition, the terms of our credit facility prohibit us from paying cash dividends. Any future determination to pay dividends will be at the discretion of our board of directors and will depend upon a number of factors, including our results of operations, financial condition, future prospects, contractual restrictions and other factors that our board of directors deems relevant.

 

The following table sets forth our cash and cash equivalents and capitalization as of March 31, 2007:

You should read this table together with “Management’s discussion and analysis of financial condition and results of operations,” “Description of capital stock,” and our consolidated financial statements and related notes appearing elsewhere in this prospectus.

 

 

A $1.00 increase (decrease) in the assumed initial public offering price of $      per share would increase (decrease) the pro forma as adjusted amount of each of cash and cash equivalents, additional paid-in capital, total stockholders’ equity, total redeemable convertible preferred stock and stockholders’ equity and total capitalization by approximately $      million, assuming that the number of shares offered by us, as set forth on the cover page of this prospectus, remains the same and after deducting estimated underwriting discounts and commissions and estimated offering expenses.

 

The table above does not include:

 

 

If you invest in our common stock, your interest will be diluted immediately to the extent of the difference between the assumed initial public offering price of $      per share, the midpoint of the price range set forth on the cover page of this prospectus, and the adjusted net tangible book value per share of our common stock after this offering.

 

At March 31, 2007, the net tangible book value of our common stock, after giving effect to the conversion of our series A, B, C and D preferred stock upon the closing of this offering, was approximately $      million, or approximately $      per share. We calculate our net tangible book value per share as total assets less intangible assets and total liabilities, divided by the number of shares of our common stock outstanding on March 31, 2007.

 

After giving effect to the sale of           shares of our common stock offered by us at the assumed initial public offering price of $      per share, the midpoint of the price range set forth on the cover page of this prospectus, and after deducting the estimated underwriting discounts, commissions and offering expenses, our adjusted net tangible book value at March 31, 2007 would have been approximately $      million, or approximately $      per share. This amount represents an immediate increase in net tangible book value of approximately $      per share to our existing stockholders and an immediate dilution in net tangible book value of $      per share to new investors purchasing shares of our common stock in this offering.

 

The following table illustrates this dilution without giving effect to the over-allotment option granted to the underwriters.

 

 

A $1.00 increase (decrease) in the assumed initial public offering price of $      per share would increase (decrease) the adjusted net tangible book value per share after this offering by approximately $      , and dilution in net tangible book value per share to new investors by approximately $     , assuming that the number of shares offered by us, as set forth on the cover page of this prospectus, remains the same and after deducting estimated underwriting discounts and commissions and estimated offering expenses.

 

The following table sets forth as of March 31, 2007, the differences between the number of shares of common stock purchased from us, the total consideration paid and the average price per share paid by existing stockholders and new investors purchasing shares of our common stock in this offering, before deducting estimated underwriting discounts, commissions and offering expenses payable by us at an assumed initial public offering price of $      per share, the midpoint of the price range set forth on the cover page of this prospectus.

 

 

The number of shares of our common stock to be outstanding following this offering is based on 57,676,390 shares of our common stock outstanding as of March 31, 2007 and excludes:

 

 

To the extent any of these outstanding options, SARs or warrants is exercised, there will be further dilution to new investors. To the extent all of such outstanding options, SARs and warrants had been exercised as of March 31, 2007, the adjusted net tangible book value per share after this offering would be $           and total dilution per share to new investors would be $     .

 

If the underwriters exercise their over-allotment option in full:

 

 

You should read the following selected consolidated financial data together with our financial statements and the related notes thereto and “Management’s discussion and analysis of financial condition and results of operations” appearing elsewhere in this prospectus. The selected consolidated statement of operations data for the fiscal years ended March 31, 2005, 2006 and 2007 and the selected consolidated balance sheet data as of March 31, 2006 and 2007 are derived from our audited consolidated financial statements included elsewhere in this prospectus. The selected consolidated statement of operations data for the fiscal years ended March 31, 2003 and 2004 and the selected consolidated balance sheet data as of March 31, 2003, 2004 and 2005 are derived from our consolidated financial statements not included in this prospectus. These financial statements have been prepared in accordance with U.S. generally accepted accounting principles. Our historical results may not be indicative of the operating results to be expected in any future periods.

 

Consolidated statement of operations data

 

 

 

Consolidated balance sheet data

 

 

You should read the following discussion and analysis together with our consolidated financial statements and the related notes appearing elsewhere in this prospectus. This discussion contains forward-looking statements that involve risks and uncertainties. Our actual results could differ materially from the results described in or implied by these forward-looking statements as a result of various factors, including those discussed below and elsewhere in this prospectus, particularly under the heading “Risk factors.”

 

Business overview

 

We are a global information technology services company. We use an offshore delivery model to provide a broad range of IT services, including IT consulting, technology implementation and application outsourcing. Using our enhanced global delivery model, innovative platforming approach and industry expertise, we provide cost-effective services that enable our clients to use IT to enhance business performance, accelerate time-to-market, increase productivity and improve customer service. Headquartered in Massachusetts, we have offices in the United States and the United Kingdom and global delivery centers in Hyderabad and Chennai, India and Colombo, Sri Lanka. We have experienced compounded annual revenue growth of 50% over the five-year period ended March 31, 2007. At March 31, 2007, we had 3,575 employees, or team members, and for the fiscal year ended March 31, 2007, we had revenue of $124.7 million and income from operations of $14.2 million.

 

We provide our IT services primarily to enterprises in the following industries: communications and technology, BFSI and media and information. Our current clients include leading global enterprises such as Aetna Life Insurance Company, British Telecommunications plc, or BT, ING North America Insurance Corporation, International Business Machines Corporation, Iron Mountain Information Management, Inc., JPMorgan Chase Bank, N.A. and Thomson Healthcare Inc., and leading enterprise software developers such as Pegasystems Inc. and Vignette Corporation.

 

We have a high level of repeat business among our clients and a significant portion of our revenue comes from a limited number of clients. For instance, during the fiscal years ended March 31, 2006 and 2007, 91% and 97% of our revenue, respectively, came from clients to whom we had been providing services for at least one year, and 68% and 84%, respectively, came from clients to whom we had been providing services for at least two years. Our ten largest clients accounted for 62% and 72% of our revenue for fiscal years ended March 31, 2006 and 2007, respectively. We expect to continue to realize high levels of repeat business. Client concentration is expected to decline as we grow, but will remain high as a percentage of our revenue.

 

High repeat business and client concentration is common in our industry. 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.

We expanded operations into the United Kingdom to provide revenue diversification and reduce the risks associated with operating in a single country. As a result of this initiative, U. K. revenue increased from $10.6 million, or 14% of total revenue, to 31.9 million, or 26% of total revenue, for the fiscal years ended March 31, 2006 and 2007, respectively. While we expect our U.K. business to continue to grow, we do not expect the U.K. revenue, as a percentage of our total revenue, to continue to increase.

 

We perform our services under both time-and-materials and fixed-price contracts. Revenue from fixed-price contracts has been 5%, 5% and 14% for the fiscal years ended March 31, 2005, 2006 and 2007, respectively. The increased revenue earned from fixed-price contracts reflects our clients’ preferences. We strive to manage both fixed-price and time-and-materials engagements to a highly-efficient 20/80 onsite-to-offshore service delivery team mix.

 

As an IT services company, our revenue growth has and will continue to be highly dependent on our ability to attract, develop, motivate and retain skilled IT professionals. We closely monitor our overall attrition rates and patterns to ensure our people management strategy aligns with our growth objectives. For the fiscal year ended March 31, 2007, our attrition rate was 16.1%, which is within our targeted range and compares well with the industry. There is intense competition for IT professionals with the skills necessary to provide the type of services we offer. If our attrition rate increases and is sustained at higher levels, our growth may slow and our cost of attracting and retaining IT professionals could increase.

 

We have been profitable for the past six consecutive quarters. We continually monitor and manage a number of operating metrics to ensure quality and avoid volatility in our earnings, including:

 

 

 

 

 

 

 

 

 

Sources of revenue

 

We generate revenue by providing IT services to our clients located primarily in the United States and the United Kingdom. We have historically earned and believe that over the next few years we will continue to earn, a significant portion of our revenue from a limited number of clients. For the fiscal year ended March 31, 2007, our five largest and ten largest clients accounted for 49% and 72% of our revenue, respectively. Our largest client, BT, accounted for 23% of our revenue for the same period. Although no other client accounted for 10% or more of our revenue during our fiscal year ended March 31, 2007, the loss of any one of our major clients could reduce our revenue or delay our recognition of revenue, harm our reputation in the industry and reduce our ability to accurately predict cash flow. During the fiscal year ended March 31, 2007, 74% of our revenue was generated in the United States and 26% in the United Kingdom. We provide IT services on either a time-and-materials or a fixed-price basis. For the fiscal year ended March 31, 2007, the percentage of revenue from time-and-materials and fixed-price contracts was 86% and 14%, respectively.

 

Revenue from services provided on a time-and-materials basis is derived from the number of billable hours in a period multiplied by the rates at which we bill our clients. Revenue from services provided on a fixed-price basis is recognized as efforts are expended pursuant to the percentage-of-completion 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.

 

We have found there is a wide range in unit pricing from one client to another and from one engagement to another, 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 may, on occasion, offer volume discounts. We manage our business carefully to protect our account margins and our overall profit margins. We have not experienced significant pressure from clients to reduce rates beyond what we consider to be our normal negotiation process. We find that our clients generally purchase on the basis of total value, rather than 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. As a result, we do not see strong pricing pressure from competitors 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. On average, our unit pricing, for both onsite and offshore resources, has increased in each of the last three fiscal years.

 

In March 2007, we entered into a five-year IT services agreement with BT that is premised upon BT making minimum aggregate expenditures of approximately $200 million over the term of the agreement. In the event that BT fails to meet any of the annual minimum expenditure targets, BT will lose any discounts under the agreement for the applicable annual period. In such event, BT is also obligated to pay an increasing percentage of any expenditure shortfall to us as liquidated damages. BT is entitled to increasing discounts for expenditures above the annual minimum expenditure targets. As part of this IT services agreement, we are now eligible to bid on work across all divisions within BT. In March 2007, BT, through a wholly-owned subsidiary, also made an equity investment in Virtusa and acquired 2,875,869 shares of our common stock for an aggregate purchase price of approximately $11.3 million.

 

In addition, in December 2004, we entered into a master services agreement with JPMorgan Chase Bank, N.A., or JPMC, pursuant to which we provide, and are able to bid on future, IT services with respect to JPMC and its affiliates. The agreement has a ten-year term, but may be terminated by JPMC for convenience at any time without penalty on 30, 60, or 90 days written notice, depending on the time of termination. The agreement contains negotiated rates but has no minimum expenditure targets or commitments, and generally has other customary terms and conditions of an IT services agreement. JPMC and its affiliates represented 11% and 7% of our revenue for the fiscal years ended March 31, 2006 and 2007, respectively.

 

The proportion of work performed at our offshore facilities and at client locations varies from period-to-period. Effort, in terms of the percentage of hours billed to clients by onsite resources, was 17% of total hours billed in each of the fiscal years ended March 31, 2006 and 2007, respectively, while the revenue from onsite and offshore resources accounted for 40% and 60% and 47% and 53%, during the fiscal years ended March 31, 2006 and 2007, respectively. We charge higher rates and incur higher compensation and other expenses for work performed at client locations in the United States and the United Kingdom than for work performed at our global delivery centers in India and Sri Lanka. Services performed at client locations or at our offices in the United States or the United Kingdom generate higher revenue per-capita at lower gross margins than similar services performed at our global delivery centers in India and Sri Lanka. We manage to a 20/80 onsite-to-offshore service delivery mix and intend to manage to an efficient onsite-to-offshore service delivery ratio for the foreseeable future.

 

Costs of revenue and gross profit

 

Costs of revenue consist principally of payroll and related fringe benefits, reimbursable and non-reimbursable travel 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 in India and Sri Lanka have historically been significantly lower than wage costs in the United States and Europe for comparably-skilled IT professionals. However, wages in India and Sri Lanka are increasing, 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 employee 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.

 

Our revenue and gross profit are also affected by our ability to efficiently manage and utilize our IT professionals. 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 of a significant project could cause us to experience a higher than expected number of unassigned IT professionals, thereby lowering our utilization rate.

 

Operating expenses

 

Operating expenses consist primarily of payroll and related fringe benefits, commissions, share-based compensation and non-reimbursable travel costs, as well as promotion, communications, management, finance, administrative, occupancy, marketing and depreciation and amortization expenses. In the fiscal years ended March 31, 2006 and 2007, we invested in all aspects of our business, including sales, marketing, IT infrastructure, human resources programs and financial operations.

 

Other income (expense)

 

Other income (expense) includes interest income, interest expense, investment gains and losses and foreign currency transaction gains and losses. The functional currencies of our subsidiaries are their local currencies. Foreign currency gains and losses are generated primarily by fluctuations of the Indian rupee, Sri Lankan rupee and U.K. pound sterling against the U.S. dollar on inter-company transactions.

 

In past periods, we have realized investment gains and losses from equity holdings in private and public companies. We have not made any new equity investments in private or public companies in the past five years.

 

Income tax expense (benefit)

 

Our net income is subject to income tax in those countries in which we perform services and have operations, including India, Sri Lanka, the United Kingdom and the United States. In previous years, we accumulated net operating loss carry-forwards which will be available to offset U.S. taxable income into fiscal 2008. We have benefited from long-term income tax holiday arrangements in both India and Sri Lanka that are offered to certain export-oriented IT services firms. As a result of these net operating losses and 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 operate. The effect of the income tax holidays

increased our net income in the fiscal years ended March 31, 2006 and 2007 by $1.2 million and $2.4 million, respectively.

 

Our effective tax rates were 8.1% and (23.6%) for the fiscal years ended March 31, 2006 and 2007, respectively. At December 31, 2006, we determined that it was more likely than not that our deferred tax assets would be realized based upon our positive cumulative operating results and our assessment of our expected future results. As a result, we released our valuation allowance and recognized a discrete income tax benefit of $5.0 million in our statement of operations for the fiscal year ended March 31, 2007. Our effective tax rate in future periods will be affected by the geographic distribution of our earnings, as well as the availability of tax holidays in India and Sri Lanka.

 

Indian tax proposals

 

In May 2007, the Parliament of India enacted the Finance Act, 2007, which makes several changes to the tax regime in India. The changes introduced by the new statute include a service tax on rental property income, minimum alternative income tax and fringe benefit taxes, and increases in the corporate income and dividend distribution tax rates. The most significant change is the imposition of the fringe benefit tax on stock compensation paid to our Indian employees. We are still in the process of evaluating the potential impact of these changes, which may adversely affect our earnings and cash flow.

 

Application of critical accounting estimates and risks

 

Our consolidated financial statements have been prepared in accordance with United States generally accepted accounting principles, or 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 financial statements when both of the following are present:

 

 

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

 

Our revenue is derived from a variety of IT consulting, technology implementation and application outsourcing services. Our services are performed under both time-and-material and fixed-price arrangements. All revenue is recognized pursuant to GAAP. Revenue is recognized as work is performed and amounts are earned in accordance with the SEC Staff Accounting Bulletin, or SAB, No. 101, Revenue Recognition in Financial Statements, as amended by SAB No. 104, Revenue Recognition.  We consider amounts to be earned once evidence of an arrangement has been obtained, services are delivered, fees are fixed or determinable and collectability is reasonably assured. For contracts with fees billed on a time-and-materials basis, we generally recognize revenue over the period of performance.

 

Fixed-price engagements are accounted for under the percentage-of-completion method in accordance with the American Institute of Certified Public Accountants Statement of Position, or SOP, 81-1, Accounting for Performance of Construction-Type and Certain Production-Type Contracts. Under the percentage-of-completion method, we estimate the percentage-of-completion by comparing the actual number of work days performed to date to the estimated total number of days required to complete each engagement. The use of the percentage-of-completion method requires significant judgment relative to estimating total contract revenue and costs to completion, including assumptions and estimates relative to the length of time to complete the project, the nature and complexity of the work to be performed and anticipated changes in other engagement-related costs. Estimates of total contract revenue and costs to completion are continually monitored during the term of the contract and are subject to revision as the contract progresses. Unforeseen circumstances may arise during an engagement requiring us to revise our original estimates and may cause the estimated profitability to decrease. When revisions in estimated contract revenue and efforts are determined, such adjustments are recorded in the period in which they are first identified. Depending on the specific contractual provisions and nature of the deliverable, revenue may be recognized as milestones are achieved or when final deliverables have been accepted.

 

Income taxes

 

The calculation of our tax liabilities involves dealing with uncertainties in the application of complex tax regulations in multiple jurisdictions. We record liabilities for estimated tax obligations in the 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, including India, Sri Lanka, the United States and the United Kingdom, and this can involve complex issues which require an extended period of time to resolve. In the 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 changes in the geographic mix or estimated level of annual pretax income, 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 an appropriate arm’s-length price and use such estimate for our intercompany transactions.

 

On an ongoing basis, 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 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). At December 31, 2006, we determined that it was more likely than not that our deferred tax assets would be realized based upon our positive cumulative operating results and our assessment of our expected future results. As a result, we released our valuation allowance and recognized a discrete income tax benefit of $5.0 million in our statement of operations for the fiscal year ended March 31, 2007.

 

We have benefited from long-term income tax holiday arrangements in both India and Sri Lanka. Our Indian subsidiary is an export-oriented company that is entitled to claim a tax exemption for a period of ten years for each Software Technology Park, or STP, it operates. All STP holidays will be completely phased out by March 2009 and, at that time, any profits could be fully taxable at the Indian statutory rate, which is currently 34.0%. Although we believe we have complied with and are eligible for the STP holiday, it is possible that upon examination the government of India may deem us ineligible for the STP holiday or make adjustments to the profit level. In anticipation of the phase-out of the STP holidays, we intend to locate at least a portion of our Indian operations in areas designated as SEZs to secure additional tax exemptions for a period of ten years, which could extend to 15 years if we meet certain reinvestment requirements. Our Sri Lankan subsidiary has been granted an income tax holiday by the Sri Lanka Board of Investment which expires on March 31, 2019. The tax holiday is contingent upon a certain level of job creation during a given timetable. Any inability to meet the agreed upon level or timetable for new job creation would jeopardize this holiday arrangement. Primarily as a result of these tax holiday arrangements, our worldwide profit has been subject to a relatively low effective tax rate, and the loss of any of these arrangements would increase our overall effective tax rate.

 

It is our intent to reinvest all accumulated earnings from India and Sri Lanka back into their respective operations to fund growth. As a component of this strategy, pursuant to Accounting Principles Board Opinion No. 23, Accounting for Income Taxes-Special Areas, we do not accrue incremental U.S. taxes on Indian or Sri Lanka earnings as these earnings are considered to be permanently or indefinitely reinvested outside of the 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.

 

Share-based compensation

 

Prior to April 1, 2005, we accounted for share-based compensation using the intrinsic value method prescribed in Accounting Principles Board Opinion No. 25, Accounting for Stock Issued to Employees , and related interpretations. Accordingly, compensation cost for stock options generally was measured as the excess, if any, of the estimated fair market value of our common stock over the amount an employee must pay to acquire the common stock on the date that both the exercise price and the number of shares to be acquired pursuant to the option are fixed. We had adopted the disclosure-only provisions of SFAS No. 123, Accounting for Stock-Based Compensation, or SFAS 123, and SFAS No. 148, Accounting for Stock-Based Compensation—Transition and Disclosure , which was released in December 2002 as an amendment to SFAS 123 and used the Black-Scholes method of valuing stock options as allowed for non-public companies.

 

Effective April 1, 2005, we adopted SFAS No. 123R, Share-Based Payment , or SFAS 123R, using the modified prospective method, which requires the measurement and recognition of compensation expense for all share-based payment awards made to employees, certain non-employee consultants and directors based on estimated fair values. Accordingly, the statements of operations for the fiscal years ended March 31, 2006 and 2007 include the expensing of the compensation cost related to newly granted stock option awards, as well as for those issued in prior years that vest after the adoption date. In connection with our adoption of SFAS 123R, we recorded share-based compensation expense for the fiscal year ended March 31, 2006 related to share-based payments granted prior to April 1, 2005 and unvested as of that date of

approximately $1.6 million, calculated in accordance with SFAS 123. Under SFAS 123R, we estimate the fair value of stock options and cash-settled stock appreciation rights, or SARs, granted using the Black-Scholes option-pricing model and a single option award approach. This fair value is then amortized on a straight-line basis over the requisite service periods of the awards, which is generally the vesting period. The fair value of cash-settled SARS are marked-to-market and recorded as a liability on a quarterly basis. This model also utilizes the estimated fair value of our common stock as determined by our board of directors and requires that, at the date of grant, we estimate the expected term of the share-based award, the expected volatility of the price of our common stock over the expected term, risk-free interest rates and expected dividend yield of our common stock to determine the estimated fair value.

 

The fair value of our options issued during the fiscal years ended March 31, 2006 and 2007 was determined using the Black-Scholes model with the following range of assumptions:

 

 

The expected term represents the weighted-average period that our stock options are expected to be outstanding. The expected term assumption is based on the simplified or “safe-haven” method outlined in the Securities and Exchange Commission’s Staff Accounting Bulletin, or SAB, No. 107 since we are a privately-held company with share-based compensation plans that are relatively new and, accordingly, we have relatively little experience or history to be able to determine the expected period or term over which our awards will be held before exercise. As we have been operating as a private company since inception with no active market for our stock or traded options, it is not possible to use actual price volatility data. Therefore, we estimated the volatility of our common stock based on a composite six-year, historical volatility of peer group companies which approximates our expected term of option awards as determined using the simplified method as stated in SAB 107. Using an expected volatility based on the average historical volatility of other entities may result in variability when compared to actual historical volatility once we have a public market for our common stock. We base the risk-free interest rate that we use in the option pricing model on U.S. Treasury issues with terms equal to the expected lives of the stock options. We have never and do not anticipate paying any cash dividends in the foreseeable future and therefore use an expected dividend yield of zero in our option pricing model. We determined the amount of share-based compensation expense for the fiscal years ended March 31, 2006 and 2007, based on awards that we ultimately expected to vest, taking into account estimated forfeitures. SFAS 123R requires forfeitures to be estimated at the time of grant and revised, if necessary, in subsequent periods if actual forfeitures differ from those estimates. To properly attribute compensation expense, we are required to estimate pre-vesting forfeitures at the time of grant and revise those estimates in subsequent periods if actual forfeitures differ from those estimates. We use historical data to estimate pre-vesting forfeitures and record stock-based compensation expense only for those awards that are expected to vest. If the actual forfeiture rate is materially different from the estimate, stock-based compensation expense could be significantly different from what has been recorded. Share-based awards are allocated to expense on a straight-line basis over the requisite service period.

 

We believe there is a high degree of subjectivity involved when using option-pricing models to estimate share-based compensation under SFAS 123R. Option-pricing models were developed

for use in estimating the value of traded options that have no vesting or hedging restrictions, are fully transferable and do not cause dilution. Because our share-based payments have characteristics different from those of freely traded options and because changes in the subjective input assumptions can materially affect our estimates of fair values (such as attrition), in our opinion, existing valuation models, including Black-Scholes, may not provide reliable measures of the fair values of our share-based compensation. Consequently, there is a risk that our estimates of the fair values of our share-based compensation awards on the grant dates may bear little resemblance to the actual values realized upon the exercise, expiration, early termination or forfeiture of those share-based payments in the future. Certain share-based payments, such as employee stock options, may expire worthless or otherwise result in zero intrinsic value as compared to the fair values originally estimated on the grant date and reported in our financial statements. Alternatively, value may be realized from these instruments that are significantly in excess of the fair values originally estimated on the grant date and reported in our financial statements. There is currently no market-based mechanism or other practical application to verify the reliability and accuracy of the estimates stemming from these valuation models, nor is there a means to compare and adjust the estimates to actual values. Although the fair value of employee share-based awards is determined in accordance with SFAS 123R using an option-pricing model, that value may not be indicative of the fair value observed in a market transaction between a willing buyer and willing seller. If factors change and we employ different assumptions in the application of SFAS 123R in future periods than those currently applied under SFAS 123R and those previously applied under SFAS 123 in determining our pro forma amounts, the compensation expense that we record in the future under SFAS 123R may differ significantly from what we have reported during the fiscal year ended March 31, 2007 and what we have reported as our pro forma expense during the period prior to adoption of SFAS 123R.

 

Because there has been no public market for our common stock, our board of directors determined the fair value of our common stock by considering a number of relevant factors including our operating and financial performance and corporate milestones, the prices at which we sold shares of our redeemable convertible preferred stock in arms-length transactions, the composition of and changes to our management team, the superior rights and preferences of securities senior to our common stock at the time of each grant and the likelihood of achieving a liquidity event for the shares of common stock underlying stock options. Our board of directors also obtained retrospective valuations for stock options granted prior to June 30, 2004, and contemporaneous valuations for those equity awards granted on or after June 30, 2004.

 

With the exception of stock appreciation rights, or SARs, grants made in August and November 2005, all stock options and SARs issued since then have been granted with exercise prices equal to or in excess of the fair value of our common stock as determined by our board of directors. In August 2005, the board of directors granted 218,295 SARs with an exercise price of $0.50 per SAR. At that time, the board of directors had determined that the fair value of our common stock was $0.68 per share. In determining such fair value, the board of directors considered the factors described above and the board of directors’ assessment of the uncertainties regarding our results of operations and financial condition for the then current quarter. In November 2005, the board of directors granted 52,024 SARs with an exercise price of $0.50 per SAR. At that time, the board of directors had determined that the fair value of our common stock was $0.76 per share based on the foregoing factors. Our board of directors also obtained contemporaneous valuations of our common stock in connection with the August 2005 and November 2005 SARs grants.

 

In determining the fair value of our common stock since March 31, 2006, our enterprise value was estimated based on the income approach, which was validated through comparison to the enterprise value estimated using the market approach. The income approach involves applying appropriate discount rates to estimate cash flows that are based on forecasts of revenue and costs. Key assumptions associated with the income approach includes projected revenue, profit and cash flows which reflect management’s best estimates of our future operations; a terminal value, which attributes value to cash flows for the years beyond the projection period; and a discount rate which reflects the illiquid nature of the company and the risks associated with the business. Our revenue and cost forecasts extended out six to seven years and were consistent with the plans and estimates that we use to manage the business. The risks associated with achieving our forecasts were assessed in selecting the appropriate discount rates to reflect both the relative risk of achieving the cash flows and the time value of money, which ranged from 19% to 15% during the period from March 31, 2006 through March 31, 2007. If different discount rates had been used, the valuations would have been different. An enterprise value was calculated by capitalizing expected cash flows at the end of the forecast period. Adjustments related to the equity interest to be valued were then applied ranging from 16% to 2.7% during the period from March 31, 2006 through March 31, 2007. These adjustments related primarily to lack of marketability of the equity interest and, accordingly, decreased significantly over the period as our prospects for an initial public offering increased.

 

The market approach provides an indication of our value by comparison to long-term growth rates, margins and revenue multiples of similar publicly-traded companies and transactions in our industry. Using the resulting enterprise value, the fair value of our common stock was then estimated using the option-pricing method. The option-pricing method involves making estimates of the anticipated timing of a potential liquidity event and estimates of the volatility of our equity securities. The anticipated timing of a liquidity event was based on our plans of an initial public offering and our board of directors’ judgment. Estimating the volatility of the share price of a privately-held company is subjective because there is no readily available market for its shares. We believe that we have used reasonable methodologies, approaches and assumptions consistent with the AICPA’s Practice Aid Valuation of Privately-Held Company Equity Securities Issued as Compensation to determine the fair value of our common stock.

 

Although it is reasonable to expect the completion of this offering will add value to the shares because they will have increased liquidity and marketability, the amount of additional value can be measured with neither precision nor certainty.

 

Long-lived assets

 

Our long-lived assets include property and equipment, long-term investments and capitalized software development costs. We evaluate the recoverability of our long-lived assets whenever events or changes in circumstances indicate that their carrying amounts may not be recoverable. Such circumstances would include a significant decrease in the market price of a long-lived asset, a significant adverse change to the manner in which the asset is being used or its physical condition, or a history of operating or cash flow losses associated with the use of the asset. In addition, changes to the expected useful lives of these long-lived assets may also be an indicator of impairment. Recoverability of assets to be held and used is measured by a comparison of the carrying amount of an asset to future undiscounted net cash flows expected to be generated by the asset. If such assets are considered to be impaired, the impairment to be recognized is measured by the amount by which the carrying value of the assets exceeds the fair value of the assets and the resulting losses are included in the statement of operations.

 

Results of operations

 

Fiscal year ended March 31, 2006 compared to fiscal year ended March 31, 2007

 

The following table presents an overview of our results of operations for the fiscal years ended March 31, 2006 and 2007.

 

 

Revenue

 

Revenue increased from $76.9 million in the fiscal year ended March 31, 2006 to $124.7 million in the fiscal year ended March 31, 2007, representing an increase of $47.7 million, or 62.0%. Billable time was the primary reason for the revenue growth, accounting for 83.8% of the total revenue increase. Increased average billing rates for IT professionals, reimbursable expenses and the strengthening of the U.K. pound sterling accounted for 6.9%, 3.2% and 6.1% of the total revenue increase, respectively. These increases were supported by strategic initiatives including hiring of key personnel and alignment with client markets. Our top five clients in the fiscal years ended March 31, 2006 and 2007 accounted for 42.6% and 49.0% of our revenue, respectively. Our top ten clients in the fiscal years ended March 31, 2006 and 2007 accounted for 61.8% and 72.0% of our revenue, respectively. U.S. revenue increased 39.9% from $66.0 million in the fiscal year ended March 31, 2006 to $92.4 million in the fiscal year ended March 31, 2007. U.K. revenue increased 200.0% from $10.6 million in the fiscal year ended March 31, 2006 to $31.9 million in the fiscal year ended March 31, 2007, due to growth in revenue from one of our significant clients and we also experienced a $2.9 million increase in revenue attributable to the strengthening of the U.K. pound sterling as compared to the U.S. dollar during the fiscal year ended March 31, 2007. We do not expect our U.K. revenue to continue to grow as a percentage of our total revenue. Revenue from onsite and offshore resources accounted for 40% and 60%, and 47% and 53%, during the fiscal years ended March 31, 2006 and 2007, respectively.

 

Costs of revenue

 

Costs of revenue increased from $43.4 million in the fiscal year ended March 31, 2006 to $68.0 million in the fiscal year ended March 31, 2007, an increase of $24.6 million, or 56.7%. A significant portion of the increase was attributable to an increase in the number of IT

professionals to support revenue growth, from 2,113 as of March 31, 2006 to 3,312 as of March 31, 2007, resulting in additional costs of $21.1 million. We also incurred $2.5 million of additional costs related to subcontractors working on client engagements for the fiscal year ended March 31, 2007 as compared to the fiscal year ended March 31, 2006. Salary increases in India and Sri Lanka during the fiscal year ended March 31, 2007 added $0.4 million to our costs of revenue. Share-based compensation expense rose from $0.5 million in the fiscal year ended March 31, 2006 to $1.2 million in the fiscal year ended March 31, 2007. The increases were offset by the effects of a stronger U.S. dollar against the Indian rupee during the fiscal year ended March 31, 2007, decreasing our costs of revenue by approximately $0.3 million. We entered into foreign currency forward contracts which offset the impact of foreign currency exposure by $0.2 million.

 

Gross profit

 

Our gross profit increased from $33.5 million in the fiscal year ended March 31, 2006 to $56.6 million in the fiscal year ended March 31, 2007, an increase of $23.1 million, or 69.0%, due to increases in our revenue. Our gross margin increased from 43.6% in the fiscal year ended March 31, 2006 to 45.4% in the fiscal year ended March 31, 2007. The gross margin improvement resulted primarily from higher utilization of IT professionals in the United Kingdom, due in large part to our efforts to establish our U.K. delivery organization in prior periods in advance of anticipated revenue.

 

Operating expenses

 

Operating expenses increased from $32.9 million in the fiscal year ended March 31, 2006 to $42.5 million in the fiscal year ended March 31, 2007, an increase of $9.6 million, or 29.0%. Of the increase, $2.6 million was attributable to facilities expenses to accommodate the increase in the number of team members in India, Sri Lanka and the United Kingdom; $0.7 million was attributable to marketing programs, including branding and business development programs; and $0.6 million was attributable to recruiting and training of additional sales and administrative staff to support our growth. In addition, we invested $3.7 million in professional services and travel expenses to establish a financial shared-services center in India to provide back-office transactional support to our Indian, U.K. and U.S. finance organizations and to formalize our internal control framework in anticipation of meeting the standards set forth by the Sarbanes-Oxley Act of 2002. The increase was also attributable to increased salary and benefit costs of $2.8 million and share-based compensation expense of $0.4 million. There was also an increase in supply costs of $0.2 million. These increases were partially offset by reductions of approximately $1.4 million in other expenses and fees. Effects of foreign currency exchange rates were not material during the fiscal year ended March 31, 2007.

 

In the fiscal years ended March 31, 2006 and 2007, we invested in sales, marketing, IT infrastructure, human resource programs and financial operations. Our investments in our infrastructure, principally in staff and systems, provided us with higher economies of scale and supported our revenue growth. As a result, our operating expenses as a percentage of revenue decreased from 42.8% in the fiscal year ended March 31, 2006 to 34.1% in the fiscal year ended March 31, 2007.

 

Income from operations

 

Income from operations increased from $0.6 million in the fiscal year ended March 31, 2006 to $14.2 million in the fiscal year ended March 31, 2007, an increase of $13.6 million. This improvement resulted from higher gross profit and lower operating expenses as a percentage of revenue. As a percentage of revenue, income from operations increased from 0.8% in the fiscal year ended March 31, 2006 to 11.4% in the fiscal year ended March 31, 2007.

 

Other income (expense)

 

Other income decreased from $1.6 million in the fiscal year ended March 31, 2006 to $1.2 million in the fiscal year ended March 31, 2007. The decrease is primarily attributable to the absence of investment gains of $0.9 million, partially offset by an increase in interest income by $0.4 million in the fiscal year ended March 31, 2007 due to a higher average cash balance.

 

Income tax expense (benefit)

 

We had income tax expense of $0.2 million in the fiscal year ended March 31, 2006 compared to an income tax benefit of $3.6 million in the fiscal year ended March 31, 2007. This decrease in tax expense is largely related to the recognition of a discrete income tax benefit of $5.0 million due to the reversal of our deferred tax asset valuation allowance in our statement of operations during the fiscal year ended March 31, 2007. This was partially offset by the provision of $1.4 million in taxes in the fiscal year ended March 31, 2007. Also reflected in the provision are higher U.S. federal and state income taxes due to higher U.S. profit levels. Our effective tax rate was 8.1% for the fiscal year ended March 31, 2006 as compared to an income tax benefit rate of 23.6% for the fiscal year ended March 31, 2007.

 

Net income

 

Net income increased from $2.0 million in the fiscal year ended March 31, 2006 to $19.0 million in the fiscal year ended March 31, 2007, an increase of $17.0 million. The increase in revenue, offset by comparatively smaller increases in costs of revenue and operating expenses and the recognition of a discrete income tax benefit of $5.0 million due to the reversal of our deferred tax valuation allowance were the primary contributors to this positive growth in net income.

 

Fiscal year ended March 31, 2005 compared to fiscal year ended March 31, 2006

 

The following table presents an overview of our results of operations for the fiscal years ended March 31, 2005 and 2006.

 

 

Revenue

 

Revenue increased from $60.5 million in the fiscal year ended March 31, 2005 to $76.9 million in the fiscal year ended March 31, 2006, representing an increase of $16.5 million, or 27.2%. The increase in billable time and average billing rates represented 108.3% and 1.2% of the total revenue increase, respectively. These revenue increases were partially offset by decreases in reimbursable expenses and the weakening of the U.K. pound sterling, which lowered the total revenue increase by 4.7% and 4.9%, respectively. The loss of a significant consulting engagement during the fourth quarter of the fiscal year ended March 31, 2005 along with delays in the anticipated start of new projects constrained our revenue growth during the fiscal year ended March 31, 2006. Our top five clients accounted for $26.9 million and $32.8 million, or 44.5% and 42.6%, of total revenue for the fiscal years ended March 31, 2005 and 2006, respectively. Our top ten clients accounted for $39.5 million and $47.6 million, or 65.3% and 61.8%, of total revenue for the fiscal years ended March 31, 2005 and 2006, respectively. U.K. revenue grew to $10.6 million in the fiscal year ended March 31, 2006 from $1.9 million in the fiscal year ended March 31, 2005, an increase of over 450% due to growth in revenue from one of our significant clients. Increases in U.K. revenue were offset by $0.8 million as a result of the weakening of the U.K. pound sterling as compared to the U.S. dollar during the fiscal year ended March 31, 2006. Revenue from onsite and offshore resources accounted for 44% and 56% and 40% and 60%, during the fiscal years ended March 31, 2005 and 2006, respectively.

 

Costs of revenue

 

Costs of revenue increased from $31.8 million in the fiscal year ended March 31, 2005 to $43.4 million in the fiscal year ended March 31, 2006, an increase of $11.6 million, or 36.5%. As a percentage of revenue, costs of revenue increased from 52.6% to 56.4%. The number of our IT professionals grew from 1,976 as of March 31, 2005 to 2,113 as of March 31, 2006, resulting in additional costs of $6.6 million, while salary increases in India and Sri Lanka in 2006 added $0.9 million to our costs of revenue. We incurred $0.8 million of additional costs related to

subcontractors working on client engagements and we incurred share-based compensation expense of $0.5 million as a result of adopting SFAS 123R as of April 1, 2005. We also incurred additional costs of $2.6 million related to the deployment of onsite teams for our U.K.-based clients. Effects of a stronger U.S. dollar against the Indian rupee in the fiscal year ended March 31, 2006 resulted in a decrease of approximately $0.2 million in our costs of revenue. We used foreign currency forward contracts which offset this currency exposure by $0.1 million.

 

Gross profit

 

Our gross profit increased from $28.7 million in the fiscal year ended March 31, 2005 to $33.5 million in the fiscal year ended March 31, 2006, an increase of $4.8 million, or 16.9%, due to increases in our revenue. Our gross margin decreased from 47.4% in the fiscal year ended March 31, 2005 to 43.6% in the fiscal year ended March 31, 2006.

 

The decrease in gross margin resulted from lower utilization of our IT professionals during the first half of the fiscal year ended March 31, 2006 resulting in part from the loss of a significant consulting engagement in the fourth quarter of the fiscal year ended March 31, 2005. As our revenue strengthened during the second, third and fourth quarters of the fiscal year ended March 31, 2006, our utilization rates improved. In addition, we experienced lower gross margins on U.K. revenue than those achieved historically in the United States due primarily to our efforts to build our U.K. delivery organization in advance of anticipated revenue.

 

Operating expenses

 

Operating expenses increased from $27.8 million in the fiscal year ended March 31, 2005 to $32.9 million in the fiscal year ended March 31, 2006, an increase of $5.1 million, or 18.3%. Compensation cost increased $3.4 million resulting from increased salary and benefit costs of $0.8 million, increased bonus and commission expense of $1.3 million and $1.3 million of incremental cost relating to the adoption of SFAS 123R on April 1, 2005. Facilities expense and spending on marketing, branding and business development programs increased by $1.2 million and $0.3 million, respectively, primarily as a result of our efforts to acquire new clients with a focus on supporting our expanding U.K. business. During the fiscal year ended March 31, 2006, we had expense of $0.2 million related to terminated internally-developed software projects. Effects of foreign currency exchange rates were not material during the fiscal year ended March 31, 2006.

 

Our operating expenses as a percentage of revenue decreased from 46.0% in the fiscal year ended March 31, 2005 to 42.8% in the fiscal year ended March 31, 2006. The decrease resulted primarily from our investment in infrastructure, principally staff and systems, which provided us with higher economies of scale and supported our revenue growth.

 

Income from operations

 

Income from operations decreased from $0.8 million in the fiscal year ended March 31, 2005 to $0.6 million in the fiscal year ended March 31, 2006, a decrease of $0.2 million. This decrease is due to lower gross margin in the fiscal year ended March 31, 2006, resulting from a lower utilization rate in the first half of the fiscal year ended March 31, 2006 and an increase in operating expenses greater than the increase in gross profit. As a percentage of revenue, income from operations decreased from 1.4% in the fiscal year ended March 31, 2005 to 0.8% in the fiscal year ended March 31, 2006.

 

Other income (expense)

 

Other income increased from $0.4 million in the fiscal year ended March 31, 2005 to $1.6 million in the fiscal year ended March 31, 2006. The increase was primarily attributable to an increase in gain on sale of investments of $0.8 million and an increase in interest income of $0.4 million due to higher average cash balances.

 

Income tax expense (benefit)

 

Our income tax expense increased from $0.1 million in the fiscal year ended March 31, 2005 to $0.2 million in the fiscal year ended March 31, 2006. Our effective tax rates were 8.2% and 8.1% for the fiscal years ended March 31, 2005 and 2006, respectively. Our income tax expense related primarily to U.S. income taxes and foreign income taxes of our foreign subsidiaries.

 

Net income

 

Net income increased from $1.1 million in the fiscal year ended March 31, 2005 to $2.0 million in the fiscal year ended March 31, 2006, an increase of $0.9 million. As a percentage of revenue, net income increased from 1.8% in the fiscal year ended March 31, 2005 to 2.6% in the fiscal year ended March 31, 2006. The growth in net income was primarily due to an increase in revenue offset by comparatively smaller increases in operating expenses.

 

Quarterly results of operations

 

The following tables present our unaudited consolidated statements of operations data in U.S. dollars and as a percentage of revenue for the eight fiscal quarters in the two-year period ended March 31, 2007. You should read the following tables together with the consolidated financial statements and related notes contained elsewhere in this prospectus. We have prepared the unaudited statements of operations data on the same basis as our audited consolidated financial statements. These tables include normal recurring adjustments that we consider necessary for a fair presentation of our operating results for the quarters presented. Operating results for any quarter are not necessarily indicative of results for any future quarters or for a full year.

 

 

 

We experience some level of seasonality because many of our clients undergo their budget approval process during the first quarter of the calendar year, which corresponds to our fourth quarter ending March 31. This process may delay project approvals and could cause revenue to be deferred from our fourth fiscal quarter to our first fiscal quarter of the following year.

 

Our annual review and promotion cycle and the corresponding pay increases generally become effective as of April 1 at our global delivery centers. This factor generally results in an increase in our costs of revenue and has a negative effect on gross margin during our first fiscal quarter.

 

Liquidity and capital resources

 

We have financed our operations primarily from sales of shares of equity securities, including preferred and common stock and from cash from operations. We have not borrowed against our existing or preceding credit facilities.

 

As of March 31, 2007, we had cash and cash equivalents of $45.1 million, of which $5.5 million was held outside the United States. We have a $3.0 million revolving line of credit with a bank. This facility provides a $1.5 million sub-limit for letters of credit. The revolving line of credit also includes a foreign exchange line of credit requiring 15% of foreign exchange contracts to be supported by our borrowing base which does not support any foreign currency contracts at March 31, 2007. Advances under our credit facility accrue interest at an annual rate equal to the prime rate minus 0.25%. Our credit facility is secured by the grant of a security interest in all of our U.S. assets in favor of the bank and contains financial and reporting covenants and limitations. We are currently in compliance with all covenants contained in our credit facility and believe that our credit facility provides sufficient flexibility so that we will remain in compliance with its terms. Our credit facility expires on September 30, 2007. We intend to renew this line prior to its expiration. As of March 31, 2007, we had no amounts outstanding under this credit facility.

 

The funds held at locations outside of the United States are for future operating expenses and we have no intention of repatriating those funds. We are not, however, restricted in repatriating those funds back to the United States, if necessary. If we decide to remit funds from India to the United States in the form of dividends, they would be subject to Indian dividend distribution tax, which is currently at a rate of approximately 14%, as well as U.S. corporate income tax on the dividends.

 

We believe that our available cash and cash equivalents, cash flows expected to be generated from operations and net proceeds from this offering will be adequate to satisfy our current and

planned operations for the foreseeable future. Our ability to expand and grow our business in accordance with current plans and to meet our long-term capital requirements will depend on many factors, including the rate, if any, at which our cash flow increases, our continued intent not to repatriate earnings from India and Sri Lanka and the availability of public and private debt and equity financing. Although we currently have no specific plans to do so, to the extent we decide to pursue one or more significant strategic acquisitions, we may incur debt or sell additional equity to finance those acquisitions.

 

Anticipated capital expenditures

 

We are beginning the work to build a facility as part of a planned campus on a 6.3 acre site in Hyderabad, India. We expect to construct and build out this facility, which will be approximately 340,000 square feet, over the next three fiscal years at a total estimated cost of $30.0 million, of which we anticipate spending between $10.0 million and $12.0 million during the fiscal year ending March 31, 2008. We plan to fund the construction and build-out of this facility with a portion of the net proceeds of this offering. We expect other capital expenditures in the normal course for fiscal 2008 to be approximately $8.0 million, primarily for leasehold improvements, capital equipment and purchased software.

 

Cash flows

 

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

 

 

Net cash provided by (used for) operating activities

 

Net cash of $1.9 million was provided by operations during the fiscal year ended March 31, 2006 as compared to $11.1 million during the fiscal year ended March 31, 2007. This increase was directly attributable to our increase in net income of $17.0 million in the fiscal year ended March 31, 2007 as compared to the fiscal year ended March 31, 2006. Changes in non-cash items impacting net income from the fiscal year ended March 31, 2006 to the fiscal year ended March 31, 2007 were $1.1 million of increased share-based compensation expense and a $0.9 million reduction on the gain on sale of equity investment, offset by a $5.0 million decrease in our deferred tax asset valuation allowance. Working Capital changes from the prior period related to accounts receivable and deferred revenue of $6.1 million and $0.7 million, respectively, reduced cash provided by operations and were offset by an increase in accounts payable of $2.0 million.

 

Net cash of $0.3 million was used for operations during the fiscal year ended March 31, 2005 as compared to net cash of $1.9 million provided from operations during the fiscal year ended March 31, 2006. This increase was directly attributable to our increased revenue during the fiscal year ended March 31, 2006 as compared to the fiscal year ended March 31, 2005 providing an increase in net income for the comparative period of $0.9 million. In addition, cash provided from operations was improved from increases in accrued compensation and expenses of $3.5 million, deferred revenue of $0.8 million and income taxes payable of $0.4 million, partially offset by an increase in our accounts receivable balance of $4.2 million and gain on sale of equity of $0.8 million. There were increases in non-cash charges for share-based compensation expense of $1.5 million in the fiscal year ended March 31, 2006, as compared to the fiscal year ended March 31, 2005.

 

Net cash used for investing activities

 

Net cash used for investing activities was $0.9 million during the fiscal year ended March 31, 2006 as compared to $5.5 million during the fiscal year ended March 31, 2007. During the fiscal year ended March 31, 2007, we invested $4.8 million in facilities and equipment at our global delivery centers in India and Sri Lanka to support our revenue growth. We contained our facilities and equipment spending and made an effort to redeploy existing equipment during the fiscal year ended March 31, 2006 due to lower utilization at our global delivery centers in India and Sri Lanka, particularly during the first half of the fiscal year ended March 31, 2006.

 

Net cash used for investing activities was $3.1 million in the fiscal year ended March 31, 2005 as compared to $0.9 million in the fiscal year ended March 31, 2006. Our efforts to contain facilities and equipment spending through redeployment of existing equipment led to a decrease in cash used during the fiscal year ended March 31, 2006. During the fiscal years ended March 31, 2005 and 2006, we received cash from sales of equity investments of $0.4 million and $0.5 million, respectively.

 

Net cash provided by (used for) financing activities

 

Net cash of $0.7 million was provided by financing activities during the fiscal year ended March 31, 2006 as compared to net cash of $9.0 million provided by financing activities during the fiscal year ended March 31, 2007. The increase was due to proceeds of $11.0 million, net of expenses, on the sale of common stock to a wholly-owned subsidiary of BT in addition to $0.5 million in cash provided by other stock sales and option exercises during the fiscal year ended March 31, 2007 as compared to proceeds from sales of common stock and option exercises of $0.9 million in the fiscal year ended March 31, 2006. Restricted cash increased by $0.9 million, year-over-year, and payments on capital leases decreased by $0.2 million in the fiscal year ended March 31, 2007 as compared to the fiscal year ended March 31, 2006 due to our efforts to end these arrangements. In the fiscal year ended March 31, 2007, we incurred $1.8 million of costs attributable to this offering.

 

Net cash of $1.4 million was provided by financing activities during the fiscal year ended March 31, 2005 as compared to $0.7 million during the fiscal year ended March 31, 2006. The decrease was primarily due to proceeds from the sale of common stock of $1.5 million in the fiscal year ended March 31, 2005 as compared to proceeds from sales of common stock of $0.8 million and exercises of employee stock options of $0.1 million in the fiscal year ended March 31, 2006. Capital lease payments were $0.1 million and $0.2 million in the fiscal years ended March 31, 2005 and 2006, respectively.

 

Contractual obligations

 

We have no long-term debt and have various contractual obligations and commercial commitments. The following table sets forth our future contractual obligations and commercial commitments as of March 31, 2007.

 

 

 

Off-balance sheet arrangements

 

We do not have any investments in special purpose entities or undisclosed borrowings or debt. We have cash-secured letters of credit totaling approximately $1.6 million at March 31, 2007.

 

We have entered into derivative foreign currency forward contracts with the objective of limiting our exposure to changes in the Indian rupee described below in “Qualitative and quantitative disclosures about market risk.” The changes in fair value of these derivative instruments of $12,000, $133,000 and $202,000 were taken into account in the statement of operations for the fiscal years ended March 31, 2005, 2006 and 2007, respectively. We use quoted market prices from published sources or brokers to value these contracts.

 

Other than these foreign currency forward 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.

 

Reconciliation of non-GAAP financial measures

 

The following table includes certain non-GAAP financial measures, namely adjusted net income and adjusted net income per share, which exclude the impact of a one-time tax benefit related to the release of our deferred tax asset valuation allowance. This table also includes reconciliations of net income presented in accordance with GAAP to these non-GAAP financial measures. Internally, we use financial statements that exclude the benefit related to the release of our deferred tax asset valuation allowance for the following purposes: financial and operational decision making, evaluating period-to-period comparisons and making comparisons of our operating results to that of our competitors. Further, we believe that the presentation of these non-GAAP financial measures provides useful information to investors because our consolidated statements of operations for the fiscal years ended March 31, 2005 and 2006 do not reflect the impact of a one-time tax benefit, and, therefore, the presentation of the non-GAAP financial measures enhances an investor’s ability to make period-to-period comparisons of our operating results. Although we believe the non-GAAP financial measures presented in this

prospectus enhance an investor’s understanding of our performance, these non-GAAP financial measures should not be considered a substitute for GAAP financial measures.

 

 

Recent accounting pronouncements

 

In July 2005, the Financial Accounting Standards Board, or FASB, issued FASB Staff Position, or FSP, 150-5, Accounting Under SFAS 150 for Freestanding Warrants and Other Similar Instruments on Redeemable Shares. FSP 150-5 clarifies that warrants on shares that are redeemable or puttable immediately upon exercise and warrants on shares that are redeemable or puttable in the future qualify as liabilities under SFAS 150, regardless of the redemption feature or redemption price. FSP 150-5 was effective for the first reporting period beginning after June 30, 2005, with resulting changes to prior period statements reported as a cumulative effect of an accounting change in accordance with the transition provisions of SFAS 150. The adoption of FSP 150-5 did not have a material impact on our financial position or results of operations.

 

In February 2006, the FASB issued SFAS No. 155, Accounting for Certain Hybrid Instruments , or SFAS No. 155, which is an amendment to SFAS No. 133 and SFAS No. 140 and allows financial instruments that have embedded derivatives to be accounted for as a whole (eliminating the need to bifurcate the derivative from its host) if the holder elects to account for the whole instrument on a fair value basis. SFAS No. 155 is effective for an entity’s first fiscal year that begins after September 15, 2006. We do not expect SFAS No. 155 to have a material impact on our financial position or results of operations.

 

In June 2006, the FASB issued Accounting for Uncertainty in Income Taxes, an Interpretation of FASB Statement No. 109, or FIN 48, which clarifies the accounting for uncertainty in income taxes recognized in a company’s financial statements and prescribes a recognition threshold and measurement attribute for the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return. FIN 48 also provides guidance on description, classification, interest and penalties, accounting in interim periods, disclosure and transition. FIN 48 is effective for fiscal years beginning after December 15, 2006. We are currently in the process of assessing the impact that FIN 48 will have on our financial position or results of operations.

 

In September 2006, the FASB issued SFAS No. 157, Fair Value Measurements. SFAS No. 157 defines fair value, establishes a framework for measuring fair value and expands disclosures about fair value measurements. SFAS No. 157 is effective for financial statements issued for fiscal years beginning after November 15, 2007 and interim periods within those fiscal years. We are currently evaluating the impact that SFAS No. 157 will have on our financial position or results of operations.

 

In September 2006, the FASB issued SFAS No. 158, Employers’ Accounting for Defined Benefit Pension and Other Post-Retirement Plans—an Amendment of FASB Statements No. 87, 88, 106 and 132(R). This standard requires recognition of the funded status of benefit plans in statements of financial position. The standard also requires recognition in other comprehensive income of certain gains and losses that arise during the period but are deferred under pension accounting rules and modifies the timing of reporting and adds certain disclosures. The recognition and disclosure elements of SFAS No. 158 are effective for fiscal years ending after December 15, 2006, and the measurement elements are effective for fiscal years ending after December 15, 2008. We adopted the recognition and disclosure requirements of SFAS No. 158 for the fiscal year ending March 31, 2007. This adoption did not have a material impact on our financial position or results of operations.

 

In February 2007, the FASB released SFAS 159, The Fair Value Option for Financial Assets and Financial Liability . SFAS 159 allows entities to measure many financial instruments and certain other items at their fair value. The objective is to improve financial reporting by providing entities with the opportunity to mitigate volatility in reported earnings caused by measuring related assets and liabilities differently without having to apply complex hedge accounting provisions. We will adopt SFAS 159 in our fiscal year beginning on April 1, 2008. We are currently evaluating the requirements of SFAS 159 and have not yet determined its impact on our financial position or results of operations.

 

Quantitative and qualitative disclosures about market risk

 

Exchange rate risk

 

We are exposed to foreign currency exchange rate risk in the ordinary course of doing business as we transact business in foreign currencies. We have historically entered into, and in the future we may enter into, foreign currency derivative contracts to provide an economic hedge of non-U.S. dollar currency exchange exposures. The purpose of this foreign exchange policy is to protect us from the risk that the eventual cash flows from Indian rupee denominated expenses might be adversely affected by changes in exchange rates. At March 31, 2006, we had outstanding contracts of $10.5 million to offset the exposure of the Indian rupee. These contracts did not qualify for hedge accounting under SFAS 133: Accounting for Derivative Instruments and Hedging Activities , or SFAS 133. We had no outstanding foreign currency derivative contracts at March 31, 2007.

 

We are in the process of evaluating our foreign exchange policy to address foreign exchange exposures on our balance sheet and operating cash flows from U.K. pounds sterling and Indian rupees. We are considering a program to mitigate the effect of the fluctuations of these currencies in relation to our reporting currency.

 

Sensitivity analysis is used as a primary tool in evaluating the effects of changes in foreign currency exchange rates, interest rates and commodity prices on our business operations. The analysis quantifies the impact of potential changes in these rates and prices on our earnings,

cash flows and fair values of assets and liabilities during the forecast period, most commonly within a one-year period. The ranges of changes used for the purpose of this analysis reflect our view of changes that are reasonably possible over the forecast period. Fair values are the present value of projected future cash flows based on market rates and chosen prices.

 

Interest rate risk

 

We do not believe we are exposed to material direct risks associated with changes in interest rates. As of March 31, 2007, we had $45.1 million in cash and cash equivalents and short-term investments, the interest income from which is affected by changes in short-term interest rates. We had no debt outstanding as of March 31, 2007.

 

Concentration of credit risk

 

Financial instruments which potentially expose us to concentrations of credit risk primarily consist of cash and cash equivalents, accounts receivable and unbilled accounts receivable. We place our temporary cash in liquid investments at highly-rated financial institutions. We believe that our credit policies reflect normal industry terms and business risk. We do not anticipate non-performance by the counterparties and, accordingly, do not require collateral. Credit losses and write-offs of accounts receivable balances have historically not been material to our financial statements and have not exceeded our expectations.

 

Overview

 

We are a global information technology services company. We use an offshore delivery model to provide a broad range of IT services, including IT consulting, technology implementation and application outsourcing. Using our enhanced global delivery model, innovative platforming approach and industry expertise, we provide cost-effective services that enable our clients to use IT to enhance business performance, accelerate time-to-market, increase productivity and improve customer service. Headquartered in Massachusetts, we have offices in the United States and the United Kingdom and global delivery centers in Hyderabad and Chennai, India and Colombo, Sri Lanka. We have experienced compounded annual revenue growth of 50% over the five-year period ended March 31, 2007.

 

Our enhanced global delivery model leverages a highly-efficient onsite-to-offshore service delivery mix and proprietary tools and processes to manage and accelerate delivery, foster innovation and promote continual improvement. Our global service delivery teams work seamlessly at our client locations and at our global delivery centers in India and Sri Lanka to provide value-added services rapidly and cost-effectively. They do this by using our enhanced global delivery model, which we manage to a 20/80 onsite-to-offshore service delivery mix.

 

We apply our innovative platforming approach across all of our services. We help our clients combine common business processes and rules, technology frameworks and data into reusable application platforms that can be leveraged across the enterprise to build, enhance and maintain existing and future applications. Our platforming approach enables our clients to continually improve their software platforms and applications in response to changing business needs and evolving technologies while also realizing long-term and ongoing cost savings.

 

We provide our IT services primarily to enterprises engaged in the following industries: communications and technology; banking, financial services and insurance; and media and information. Our current clients include leading global enterprises such as Aetna Life Insurance Company, British Telecommunications plc, ING North America Insurance Corporation, International Business Machines Corporation, Iron Mountain Information Management, Inc., JPMorgan Chase Bank, N.A. and Thomson Healthcare Inc., and leading enterprise software developers such as Pegasystems Inc. and Vignette Corporation. We have a high level of repeat business among our clients. For instance, during the fiscal year ended March 31, 2007, 97% of our revenue came from clients to whom we had been providing services for at least one year and 84% came from clients to whom we had been providing services for at least two years. Our top ten clients accounted for approximately 65%, 62% and 72% of our total revenue in the fiscal years ended March 31, 2005, 2006 and 2007, respectively.

 

Industry background

 

The role of IT in enterprises has grown far beyond operational support to become a source of competitive advantage. Enterprises are using Internet-based IT applications to facilitate critical interactions with customers, vendors and partners to compete in a global, real-time environment. At the same time, enterprises are using IT applications and data to address regulatory changes, meet market demands and improve business efficiency. As a result, leading enterprises are using IT to accelerate time-to-market, increase productivity and improve customer service.

 

While enterprises expect IT to play a key role in driving business growth and productivity, they are under increasing pressure to control costs. According to an October 2006 Gartner report, annual IT budgets increased less than 3% for the fourth year in a row while a February 2007 Gartner press release forecasts an average growth rate of 3% for 2007. As a result, business and technology leaders are expected to address IT challenges of increasing scope and complexity with limited resources under rigorous time constraints.

 

Many enterprises increasingly manage their technology costs and shortage of locally-available IT professionals by outsourcing IT services offshore. According to a 2006 IDC report, 20.8% of U.S. IT services, including application management, custom application development, IT consulting, information systems outsourcing, systems integration and other related activities, will move to offshore players by 2010. Using a global delivery model, IT service providers employ skilled labor in lower-cost geographies in order to cost-effectively deliver high quality services to their clients. According to IDC, in 2005, the largest markets for these offshore IT services were concentrated in the United States and in Europe, the Middle East and Africa with market shares of 79.6% and 17.4%, respectively.

 

A 2005 NASSCOM-McKinsey report estimates that global offshore IT services adoption will increase at a compounded annual growth rate of 24.4% from $18.4 billion for the 12 months ended March 31, 2005 to $55.0 billion for the 12 months ending March 31, 2010. This exceeds the estimate in IDC’s 2007 Worldwide IT Spending 2006-2010 Forecast Update by Vertical Market of 5.8% compounded annual growth rate for the overall IT services industry from calendar year 2005 to calendar year 2010.

 

Engaging offshore IT service providers to improve business performance, beyond reducing costs, can be challenging. The rate of technological change, the impact of mergers and acquisitions and a historical approach to building and managing stand-alone, legacy IT systems and applications have led to fragmented IT environments. Enterprises often support multiple IT applications that vary in capabilities and cannot interoperate effectively, creating IT application silos. These fragmented IT environments are complex, inefficient and costly to maintain and operate. They limit an enterprise’s ability to leverage valuable corporate IT assets, including business processes and rules, technology frameworks and data. We believe enterprises seek service providers that can cost-effectively address this range of complex challenges.

 

Our solution

 

We deliver a broad range of IT services using an enhanced global delivery model and an innovative platforming approach. We have significant domain expertise in IT-intensive industries, including communications and technology, BFSI and media and information. We enable our clients to leverage IT to improve business performance, use IT assets more effectively and reduce IT costs.

 

Broad range of IT services.  We provide a broad range of IT services, either individually or as part of an end-to-end solution, from IT consulting and technology implementation to application outsourcing. Our IT consulting services include strategic activities such as defining technology roadmaps, providing architecture services and assessing application portfolios. Our technology implementation services include application development, systems integration and legacy system conversion and enablement. Our application outsourcing services include application enhancement and maintenance and infrastructure management.

 

Enhanced global delivery model.  We believe we have an enhanced and integrated global delivery model. Our enhanced global delivery model leverages a highly-efficient onsite-to-offshore service delivery mix and proprietary tools and processes to manage and accelerate delivery, foster innovation and promote continual improvement. We manage to a 20/80 onsite-to-offshore service delivery mix, which allows us to provide value-added services rapidly and cost-effectively. During the past three fiscal years, we performed more than 80% of our total billable hours at our offshore global delivery centers. Our onsite client service teams comprise senior technical and industry experts, who work on an integrated basis with our offshore teams in India and Sri Lanka. We leverage our global delivery model across all of our service offerings.

 

Platforming approach.  We apply an innovative platforming approach across our IT consulting, technology implementation and application outsourcing services to reduce costs, increase productivity and improve the efficiency and effectiveness of our clients’ IT application environments. As part of our platforming approach, we assess our clients’ application environments to identify common elements, such as business processes and rules, technology frameworks and data. We incorporate those common elements into one or more application platforms that can be leveraged across the enterprise to build, enhance and maintain existing and future applications. Our platforming approach enables our clients to continually improve their software platforms and applications in response to changing business needs and evolving technologies while also realizing long-term and ongoing cost savings.

 

We enable our clients to use IT to accelerate time-to-market, increase productivity and improve customer service. We are able to reduce costs through our enhanced global delivery model. We also reduce the effort and costs required to maintain and develop IT applications by streamlining and consolidating our clients’ applications on an ongoing basis. We believe that our solution provides our clients with the consultative and high-value services associated with large consulting and systems integration firms, the cost-effectiveness associated with offshore IT outsourcing firms and ongoing benefits of our innovative platforming approach.

 

Our growth strategy

 

Key elements of our growth strategy include:

 

Deepen and grow our client base.  We seek to deepen and broaden our existing client relationships and grow our client base. Our global account management and service delivery teams focus on expanding existing client relationships and converting new engagements to long-term relationships. We intend to leverage our executive-level relationships and preferred vendor status with many of our clients to extend our service offerings across those enterprises. For example, in March 2007, BT entered into a five-year IT services agreement with us and also purchased, through a wholly-owned subsidiary, 2,875,869 shares of our common stock. We also have a dedicated business development team focused on generating engagements with new clients. Our software company clients provide an additional channel for establishing new client relationships. We plan to expand our domestic and international presence, either directly or through strategic alliances, to pursue new market opportunities.

 

Expand our service offerings.  We seek to create new and innovative service offerings by analyzing emerging technologies and industry trends and changing client needs. Our industry solution teams work closely with our marketing group, industry and technology practice groups and research and development teams to develop new, highly-differentiated services. We then

test and refine these new services based on feedback from our clients, strategic alliances and industry analysts.

 

Deepen and expand our industry expertise.  We seek to deepen our existing industry expertise and develop expertise in new vertically-oriented industries. Our experience in the communications and technology, BFSI and media and information services industries has enabled us to deliver increased value to our clients in these sectors. We also plan to extend our domain expertise to adjacent industries, where we can directly leverage existing in-house skills, experience and client relationships. We also may make acquisitions to deepen or expand our industry expertise.

 

Strengthen our brand.  We seek to enhance our profile and brand equity to help us acquire new clients, enhance our existing client relationships and attract and retain talented team members. We believe our platforming approach to IT services positions us as a thought leader with clients and enables us to attract and retain talented team members. We promote our brand through a range of marketing and communications activities.

 

Develop new strategic alliances.  We seek to strengthen our existing strategic alliances and build new ones. We intend to leverage our strategic alliances with software companies to win new clients, extend our services to existing clients and enter new geographic or industry markets. Some of these alliances are with software companies who are our clients. We believe these alliances provide us with an opportunity to access new markets and new clients. In addition, our strategic alliances with software companies allow us to share sales leads, develop joint account plans and engage in joint marketing activities. We believe that some of these alliances with software company clients enable us to compete more effectively for the technology implementation and support services required by our clients’ customers.

 

Services

 

We provide a broad range of IT consulting, technology implementation and application outsourcing services to our clients, either individually or as part of an end-to-end solution.

 

IT consulting services

 

We provide IT consulting services to assist our clients with their continually-changing IT environments. Our goal is to help them to continually improve the effectiveness and efficiency of their IT application environments by adopting and evolving towards re-useable software platforms. We help clients analyze business and/or technology problems and identify and design platform-based solutions. We also assist our clients in planning their IT initiatives and transition plans.

 

Our IT consulting services include the following assessment and planning, architecture and design and governance-related services:

 

 

During our consulting engagements, we often leverage proprietary frameworks and tools to differentiate our services and to accelerate delivery. Examples of these frameworks and tools include our Strategic Enterprise Information Roadmap framework and our Business Process Visualization tools. We believe that our consulting services are also differentiated in that we are typically able to leverage our global delivery model for our engagements. Our onsite teams work directly with our clients to understand and analyze the current-state problems and to design the conceptual solutions. Our offshore teams work seamlessly with our onsite teams to design and expand the conceptual solution, research alternatives, perform detailed analyses, develop prototypes and proofs-of-concept and produce detailed reports. We believe that this approach reduces cost, allows us to explore more alternatives in the same amount of time and improves the quality of our deliverables.

 

Technology implementation services

 

Our technology implementation services involve building, testing and deploying IT applications, and consolidating and rationalizing our clients’ existing IT applications and IT environments into platforms.

 

Our technology implementation services include the following development, legacy asset management, data warehousing and testing services: