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Virtusa Corp  (NASDAQ:VRTU)
Q3 2019 Earnings Conference Call
Feb. 07, 2019, 5:00 p.m. ET

Contents:

  • Prepared Remarks
  • Questions and Answers
  • Call Participants

Prepared Remarks:

Operator

Welcome to the Virtusa Corporation Third Quarter Fiscal 2019 Earnings Conference Call. All participants will be in listen-only mode. (Operator Instructions) After today's presentation, there will be an opportunity to ask questions. (Operator Instructions) Please note this event is being recorded.

I would now like to turn the conference over to William Maina, Investor Relations. Please go ahead.

William Maina -- Senior Vice President

Thank you, Andrea, and welcome to Virtusa's third quarter fiscal year 2019 earnings conference call, where we'll be discussing our financial results for Virtusa's third quarter ended December 31, 2018. On the call with me are Kris Canekeratne, Chairman and Chief Executive Officer; and Ranjan Kalia, Executive Vice President and Chief Financial Officer.

Certain statements made on this call that are not based on historical information are forward-looking statements, which are made pursuant to the safe harbor provisions of the Private Securities Litigation Reform Act of 1995. During this call, we may make, express or imply forward-looking statements relating to, among other things, Virtusa's expectations and assumptions concerning management's forecast of financial performance, the growth of Virtusa's business, Virtusa's ability to realize intended benefits, revenues and other synergies of acquisitions; the ability of Virtusa's clients to realize benefits from the use of Virtusa's IT services and management's plans, objectives and strategies.

These statements are neither promises nor guarantees and are subject to a variety of risks and uncertainties, many of which are beyond Virtusa's control, which could cause actual results to differ materially from those contemplated in these forward-looking statements. Existing and prospective investors are cautioned not to place undue reliance on these forward-looking statements, which speak only as of the date hereof. Virtusa undertakes no obligation to update or revise the information disclosed during this call, whether as a result of new information, future events or circumstances or otherwise.

Other statements on this call also include certain non-GAAP financial information as defined by the SEC. We present constant currency revenue to provide a framework for assessing how our revenue performed, excluding the effect of foreign currency rate fluctuations. We provide non-GAAP operating income, non-GAAP adjusted net income and non-GAAP earnings per share, which we believe provide insight into the operational performance of our business.

Reconciliations on the non-GAAP to GAAP measures are included in today's earnings press release and data sheet, which can be found on the Investor Relations page of our website.

We also present a reconciliation of cash, cash equivalents, short-term and long-term investments that we believe provides insight to our total cash position and overall liquidity.

Please note that a supplemental data presentation to our fiscal third quarter results has also been posted on our Investor Relations website. For additional disclosure regarding these and other risk factors faced by Virtusa, see the disclosures contained in Virtusa's public filings with the Securities and Exchange Commission and in our earnings press release.

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

Kris Canekeratne -- Chairman and Chief Executive Officer

Thank you, Will. Good evening, everyone, and thank you for joining our call. We delivered strong fiscal third quarter 2019 results. Total revenue was $314.7 million representing 3% sequential and 19% year-over-year growth. We generated revenue growth across all of our industry groups, driven by our digital and non-digital engineering solutions which continue to grow at a strong pace. Our non-GAAP operating margin was 10.4%, up 50 basis points year-over-year. And we remain on track to achieve our fiscal 2019 operating margin expansion targets on above industry revenue growth.

Finally, we delivered non-GAAP EPS of $0.61 which was at the high end of our guidance and up 30% year-over-year. Our solid results through the first three quarters of fiscal 2019 reflects strong execution across our business. Equally as important, our consistently strong performance validates Virtusa's leading position in the digital engineering space, made possible by our targeted solutions, deep domain expertise and dedicated global team that enable our clients to capture the top and bottom line benefits of deep digital transformation.

Our emergence as a leader in the burgeoning digital engineering and transformation space is testimony to both market forces and Virtusa's core strength. The Virtusa organization brings a unique set of skills that harness deep industry knowledge and digital engineering competency that are inextricably linked and required for transformation. But to has that, requires the ability to both rethink and rebuild IT infrastructures, platforms and interfaces but today's hyper-speed digital world.

Hi-tech Internet platform companies such as Google, Facebook, Airbnb and Uber are effectively the standard-bearer but Digital 2.0 businesses. They are the drivers of the digital economy, focused on the end-to-end digitization and integration of all vertical and horizontal value chains, product and service offerings, business models and customer access points. These industry 4.0 companies unencumbered by legacy business processes and rigid monolithic IT architectures are able to innovate and deploy new digital-only business models by taking full advantage of deep digital technologies. More and more of these companies are providing services that blur the line between hi-tech and traditional enterprises, further intensifying the competitive environment, but traditional businesses with legacy business models.

Fundamentally, the digital economy is disrupting the long-standing conventional beliefs about how businesses are structured and how business model function, while profoundly changing the way consumers access information, goods and services. Digital is all about speed, convenience and engagement. Digital businesses eliminate complexity and simplify on the access of speed to market, speed to customer and speed to value. Speed and velocity is the new currency in the business. Virtually every major player in every major industry is faced with the question of how to move faster while holding on to their core business. How to leverage digital technologies to differentiate, remain competitive and expand addressable markets while at the same time take advantage of the cost efficiency gains and end-to-end engagement value of deep digital.

It is a digital war in the market and the tasks ahead is akin to king a lumbering battleship moving forward while concurrently turning it into a stealth bomber. That deep digital transformative capacity is exactly what Virtusa's core strength is.

Digital 2.0 transformation is a multi-year evolution that enterprises must rethink, must reimagine and reengineer the boundaries and bridges of their interactions with other companies and their end customers, from applications and platforms to infrastructure and interfaces. We believe, we are at the early stages of this evolution which represents significant long-term opportunity for Virtusa. Today, we are seeing our plans progress along the Digital 2.0 journeys in a couple of significant ways.

The first trend we are seeing is traditional enterprises realizing the need to invest more deeply in digitizing their legacy business models and business processes through technology such as cloud native adoption, artificial intelligence, machine learning, open APIs, microservices, and platform modernization. At the heart of this deep digital transformation is data, from its architecture and management to flow and analysis. Data is the lifeblood that speeds and circulates through an organization systems, be it customer data, ERPs, applications, distribution centers or data centers. These data assets all need to be unified, synchronized, standardized and made universally available on agile cloud native platforms to effectively and efficiently support deep digital transformation.

Even more critical is the ability to leverage AIML technologies to turn these data and application assets into systems of intelligence to deliver a true digital consumer experience. AIML technologies are now powering innovations such as virtual agents, identity analytics, and recommendation systems, which are transforming the way companies engage with their customers and consumers, resulting in predictive capacity, higher customer retention, improved margins, and more fundamentally creating significant competitive advantage.

The second trend we are seeing and this is predominantly happening within industries that tend to be more innovative if enterprises investing in building digital native business models that are adjacent to their traditional businesses. These enterprises are investing in alternative digital-only business model, independent of the ongoing incremental digitization of their legacy businesses to be able to not only expand their addressable market opportunity and attract new digital customers, but also to advance their learning of what types of digital products and services work best.

Our proven experience modernizing legacy IT estates, our ability to design and build effective and immersive digital experiences, the depth and breadth of our engineering capacity, and our deep domain expertise result in Virtusa being extremely well positioned to capitalize on these ongoing areas of demand. Today, Virtusa is working with some of the most venerable companies in the world across banking and financial services, media, telecom, insurance, and healthcare to deliver deep digital transformation in their businesses. In addition, we work with many blue chip clients in hi-tech internet space that are investing in leveraging their digital native platforms to further expand into adjacent markets and provide new or improved services to end consumers.

Let me now provide you with some examples that illustrate these industry trends. For a top five US Fortune 500 insurance company, Virtusa was recently selected to engage, to lead a large scale digital transformation program aimed at transforming our client's entire customer experience across all customer touch points. For this engagement, Virtusa developed a robust microservices based middleware architecture supporting deep digital experiences across their digital front end, agents and service center. This engagement yielded immediate and tangible results for our client in the form of best improvements in business KPIs, operating efficiencies, and brand perception.

Turning to another example, Virtusa was chosen to lead a global effort in creating a bold innovation, the API Exchange or APIX, the world's first cross-border open architecture financial services platform. The goal of the APIX platform is to greatly increase financial inclusion and service innovation by connecting banks that must embrace digital transformation with hundreds of FinTechs that offer ready for market capabilities. The API Exchange is built on top of Virtusa's cloud native, open innovation platform that exposes banking interfaces through microservices and provides a synthetic data sandbox to rapidly discover design and deploy digital banking products and services. We are very proud to have led this first of its kind partnership and believe the API Exchange enables financial institutions to quickly identify FinTechs and deploy digital banking journeys, greatly increasing financial inclusion across ASEAN and other geographies.

Third, Virtusa was recently engaged by a top US bank to lead an end-to-end transformation of their open banking platform. We reengineered their legacy middleware into a Digital 2.0 infrastructure, enabling scalable and rapid modernization by leveraging microservices, containers, cloud native principles, and self-healing self-adaptive architectures. We have also completely redesigned that legacy release process leveraging DevOps and CICD for regular and rapid deployments.

Finally, a pharmaceutical company recently chose Virtusa for a two-fold engagement. The first includes the development of a digital health platform for patients and healthcare providers for pre and post-operative care. And the second, is to build a data science solutions leveraging Virtusa's AIML assets as well as data APIs. Both are examples of Virtusa's unique ability to build digital first front-ends enabled by a robust back-ends. While we are enabling our clients to reimagine and disrupt their own business models through investments in deep digital transformation, we are also continuously investing in our own business, in our people and in strengthening our solutions, capabilities, and partnerships to stay ahead of new technological wins (ph) and deliver even greater value to our clients.

For example, in November, we announced a strategic collaboration agreement with Amazon Web Services where together we will build solutions that help clients drive their digital transformation and cloud adoption at a much faster pace and develop a greater talent pool through extensive training and certification of Virtusa team members on AWS. We believe cloud (ph) and AIML technologies are the critical skills needed for deep digital transformation. At Virtusa, we are making significant investments in enabling all of our disciplines to think and embrace AI and cloud-first.

In conclusion, we are pleased with our strong third quarter performance and believe we are well positioned for above industry revenue growth and margin accretion. As a leading digital engineering services company, Virtusa has the solutions, capabilities and deep industry domain expertise to deliver large scale Digital 2.0 transformation programs that yield lasting results for our clients. In addition, our investments in attracting and developing the best talent, being an employer of choice and expanding our digital capabilities will enable us to remain ahead of emerging technologies and increase the value we deliver to our clients. Our consistently solid fiscal 2019 financial results are proof positive of our successful strategy and competitive advantage.

Now I'd like to turn the call over to Ranjan, who will provide more details on our results as well as our fourth quarter and fiscal year 2019 guidance. Ranjan?

Ranjan Kalia -- Executive Vice President and Chief Financial Officer

Thanks, Kris. And good evening to everyone. Let me start by summarizing the results of our fiscal third quarter 2019. I will then provide our current guidance for both fiscal fourth quarter and fiscal year ending March 31, 2019 before opening the call for questions. Revenue for the third quarter was $314.7 million toward the high end of our guidance and growing 3% sequentially in reported currency and 3.3% in constant currency. Our sequential revenue growth reflects strong performance at our top 10 client portfolio. Year-over-year, our third quarter revenue increased 19.3% in reported currency and 20.1% in constant currency.

Gross margin in the third quarter was 29.6%, up 40 basis points sequentially, primarily driven by high utilization and higher realized pricing, partially offset by higher subcontractor expense. GAAP operating income for the third quarter was $19.3 million, up from $14 million in the prior quarter and $13.7 million in the year ago period. GAAP operating income was at the high end of our expectation, reflecting solid revenue performance and stronger SG&A leverage. Third quarter other income was $3.9 million. This includes $8.3 million of net foreign exchange gain, $4 million of net interest expense and $400,000 of other expense. Please note, other expense includes $900,000 of impairment charge from the writedown of an available for sale security acquired through the Polaris acquisition.

GAAP earnings per diluted share was $0.37 in the third quarter. This compares to GAAP EPS of $0.01 in the prior quarter and a loss of $0.38 per share in the year ago period. Our Q3 2019 GAAP EPS includes $8.3 million or $0.15 of net unrealized foreign exchange gain on an after-tax basis. This item was not included in our prior guidance.

Now turning to our non-GAAP results. Non-GAAP operating income was $32.7 million in the third quarter compared to $29 million in the prior quarter and $26 million in the year ago period. Third quarter non-GAAP operating margin was 10.4%, an increase of 90 basis points sequentially and 50 basis points from the year ago period. Non-GAAP diluted earnings per share was $0.61 in the third quarter, $0.02 above the midpoint of our prior guidance. This is compared to $0.54 in the prior quarter and $0.47 in the year ago period.

Turning to the balance sheet. Ending cash at December 31, 2018 was $253.1 million, inclusive of cash and cash equivalents, short-term and long-term investments. Cash provided by operating activities was $36.5 million in the third quarter, representing 11.6% of revenue. Our DSO for the third quarter was 71 days, an improvement of 5 days from the prior quarter.

Now I will turn to a more detailed discussion of our third quarter revenue performance by industry group. Revenue across our industry groups was as follows. BFSI revenue increased 2.7% sequentially and 9% year-over-year representing 63% of revenue. Our BFSI growth was primarily driven by our banking clients including growth at our largest client. Communication and technology revenue increased 4.5% sequentially and 51.7% year-over-year, representing 28% of revenue. C&T results were above our expectations, reflecting strong growth at our large Internet and technology client. Media information and other was up slightly quarter-over-quarter and 17.9% year-over-year representing the remaining 9% of revenue. M&I performance was in line with our expectations. With respect to our geographical performance, as expected, our sequential revenue growth was led by Europe, which grew 7.7%, and North America, which was up 2.7%.

I will now provide our current guidance for fiscal fourth quarter and year ending March 31, 2019. Revenue in the fourth quarter of '19 is expected to be in the range of $326 million to $334 million. Non-GAAP diluted earnings per share in the fourth quarter of 2019 is expected to be in the range of $0.59 to $0.65. For the fiscal year ending March 31, 2019, we expect revenue to be in the range of $1.246 billion to $1.254 billion. Non-GAAP diluted earnings per share for fiscal year 2019 is expected to be in the range of $2.25 to $2.31. Our non-GAAP guidance excludes $29.2 million of stock compensation expense and $25.4 million of acquisition related charges.

Our fourth quarter and fiscal year 2019 non-GAAP EPS guidance anticipates an average share count of approximately 33.9 million and 33.7 million respectively. Our current GAAP and non-GAAP guidance is based on a set of assumptions that can be found on our data sheet located in the Investor Relations section of our website. Our fiscal fourth quarter pipeline increased both sequentially and year-over-year at a strong pace even with the seasonal holiday impact to December's pipeline injection. We continue to see strong momentum for digital transformation and cloud migration initiatives across our client portfolio.

In addition, we are seeing growing interest for projects that result in cost takeout and increased efficiency, which in turn is driving demand for automation and AI. We are seeing a rise in the requirement for full stack engineers will help to mitigate skill set shortages. Full stack engineers have specialized knowledge in all stages of software development and have the functional knowledge to translate concepts into outcomes. They understand the software development process end-to-end, and can anticipate problems accordingly. We have been gearing for this trend over the past several quarters by increasing training of our engineers to maintain a wide variety of skill sets allowing to maintain a highly billable resource pool.

Our clients' calendar 2019 budgeting process appears to be consistent with prior years. Digital transformation programs will continue to have strong funding. In addition, current economic uncertainty will continue to present opportunities for agile and innovative IT service vendors that focus on effort compression as a means of reduced costs. Finally, we expect increased funding for Brexit related IT projects such as cloud migrations as our European clients are preparing themselves for a more complex regulatory environment. At the midpoint of our Q4 guidance, we expect revenue to grow 4.9% sequentially. Our strong sequential revenue growth expectation in the fourth quarter reflects growth across our industry groups and especially within our BFS, telco, hi-tech and healthcare client portfolios.

Within our banking client portfolio, we expect growth at most of our large clients. Following strong fiscal Q2 and Q3 growth with our largest banking client, the midpoint of our guidance anticipates our revenue will decline sequentially with this client in Q4 due to expected contract completions and the timing of new project start-ups, but revenue will still be up year-over-year. At the high end of our guidance, we contemplate growth with our largest account primarily due to new project starts or pipeline conversions in line with historical timelines. For fiscal year 2019 at the midpoint of our guidance range, we continue to expect revenue growth at 22.5%. Since providing our initial FY19 guidance last May, we have faced approximately $20 million of increased FX headwinds.

However, our underlining business momentum has allowed us to absorb these headwinds and maintain the midpoint of our original fiscal 2019 guidance. We also expect our non-GAAP operating margin to expand approximately 140 basis points year-over-year. Our non-GAAP effective tax rate is expected to be 30.1% for fiscal year 2019 consistent with our prior guidance. Our current non-GAAP guidance anticipates a minority interest of $1.6 million, unchanged from our prior guidance. Our net interest expense guidance is $11.4 million and includes $16.4 million of interest expense and $5 million of interest income.

Finally, we are on track with executing against our cost savings initiatives discussed on our last call. We continue to expect this initiative will yield approximately $15 million of annual cost savings. As a reminder, these savings will enable us to achieve our FY20 profitability objectives of 100 basis points to 150 basis points margin accretion, while continuing to invest for above industry revenue growth.

In conclusion, we delivered strong third quarter revenue and EPS growth toward the high end of our guidance and generated solid operating cash flow. We also continue to execute against our margin expansion goals, generating solid sequential and year-over-year operating margin accretion and achieving double-digit non-GAAP operating income margins. We expect our momentum to continue in the fiscal fourth quarter and are maintaining the midpoint of our fiscal 2019 revenue guidance range despite significant FX headwinds throughout the year. We are well positioned to continue to drive above industry organic revenue growth and incremental annual margin expansion in line with our stated objectives.

Operator, you may begin the Q&A session.

Questions and Answers:

Operator

We will now begin the question-and-answer session. (Operator Instructions) And our first question comes from Mayank Tandon of Needham & Company. Please go ahead.

Mayank Tandon -- Needham & Company -- Analyst

Thank you. Good evening. Kris, and Ranjan, clearly it sounds like the demand climate is very healthy, despite some of the broader global economic concerns. Could you talk about booking strength? I think you've mentioned that in the past, sorry if I missed it, but just in terms of what the sequential change was and also maybe on a year-over-year basis. And also in that vein, if you could talk about the strong new client wins, maybe the nature of those wins by vertical and by service line, that would be helpful.

Kris Canekeratne -- Chairman and Chief Executive Officer

Hey, Mayank, this is Kris. So before I get into specific details about the pipeline, maybe I'll provide a little context specifically around Virtusa's positioning. So, Virtusa has been nominally well positioned to intersect both the digital as well as the BAU spend at our clients. Despite the general BAU compression, what we are really seeing is that, Virtusa's ability to not just help on the digital transformation side, but also to be able to provide deep digital solutions that leverage some of the existing legacy assets while also converting much of the legacy through effort compression to a much nimbler more agile state to provide end-to-end seamless digital access for consumers and customers.

So because of this, not only are we seeing growth in terms of digital pipeline activity, but we are also seeing growth in the non-digital pipeline resulting in the entire platform growing for us. With that said, overall pipeline grew approximately 30% year-over-year, digital pipeline was up close to 40% year-over-year. Our main time to close and win rates, but very consistent with the past, average deal sizes for all stages in the pipeline increased year-over-year, as did deal tenure. So this is -- the fact that Virtusa is -- extremely well positioned both in terms of expanding market share around digital spend as well as despite a compression in BAU, we are extremely well positioned to pickup BAU work, specifically because of our platforming expertise and our ability to deploy work compression as opposed to simply cost arbitrage.

Mayank Tandon -- Needham & Company -- Analyst

That's very helpful. Thank you for the perspective. If I can just squeeze one more in, maybe for Ranjan in terms of margins. How much more room, Ranjan, is there on the utilization front? It seems like it's already running at the upper end of the historical range. And also I would love to get some perspective on how much more leverage you have on the pyramid side? And then I guess the question really on, what I'm getting at is, should we expect more of the margin expansion going forward in fiscal '20 and beyond to be SG&A driven versus on the gross margin line?

Ranjan Kalia -- Executive Vice President and Chief Financial Officer

Sure. So, Mayank, at a high level, we believe that our margin accretion annually will come both from gross margin as well as from SG&A, I mean, that's been our stated goal and we believe we can continue to execute against that. It's -- being 100 basis points to 150 basis points, we're really talking 50 basis points to 70 basis points from gross margin, 50 basis points to 75 basis points from SG&A. If you look at the levers inside gross margin, the levels of utilization will continue to be there. Yeah, we ended at about 84% utilization in Q3. We still believe we have much opportunity from that especially what we talked about in our prepared remarks this whole piece as the mix of the full stack engineers that is increasing. That mix of full stack engineers increasing and some of the non-linear initiatives that Kris talked about in the last call, the whole APN piece. We believe those things are going to continue to drive utilization, that's going to add to that margin level over and above like you said our pyramid is still a lot below industry standard. So we believe that especially is our bottom tier of the pyramid, we will continue to expand that. I mean, our one to -- our less than one year pyramid is running less than 30% right now.

Kris Canekeratne -- Chairman and Chief Executive Officer

And Mayank, I think you had a second question about new wins. We had seven new enterprise wins. Our overall active client list expanded to 216 active clients in the quarter.

Mayank Tandon -- Needham & Company -- Analyst

Great. Thank you. Congrats on the numbers.

Ranjan Kalia -- Executive Vice President and Chief Financial Officer

Thank you.

Operator

Our next question comes from Maggie Nolan of William Blair. Please go ahead.

Ted Starck-King -- William Blair -- Analyst

Hi, this is Ted (ph) on from Maggie. Thanks for taking my questions. So as we head into fiscal 2020, how are you guys thinking about normalized growth rates?

Kris Canekeratne -- Chairman and Chief Executive Officer

So, it's a little early to tell in terms of exactly what clients' spend patterns will be and budgets will be. Having said that, of course, we expect and we are seeing digital investments expanding and the BAU environment compressing. As I mentioned earlier, even though the BAU environment is compressing, Virtusa's services, specifically around effort compression and engineering arbitrage are playing really well in our ability to expand market share both on the digital spend side as well as on the non-digital spend side. Having said that, we expect that we will have a lot more color about budgets as the year gets going. And in general, once again, we expect that digital investments will increase and BAU spend will compress.

Ranjan Kalia -- Executive Vice President and Chief Financial Officer

Some of the things that we've talked at prior calls, if you look at it, our run rate trajectory, Q4 being really strong. And if you look at, our Q3 being really strong, you look if -- we execute against our Q4 guidance that we put for ourselves and you annualize that. You really are expecting very reasonable in quarter ramp rates to aspire to be a double-digits revenue growth company year-over-year. And that's where we continue to build our financial models around. That being said, we are going to go through the budgeting cycle with our clients, over the next quarter, we'll roll it up and we'll walk you through that.

Ted Starck-King -- William Blair -- Analyst

Understood. And then on the growth clients outside the top 10, I wanted to take a look at a multi-year perspective, those relationships. Could you provide some additional color regarding the opportunities and the focus to grow these accounts?

Ranjan Kalia -- Executive Vice President and Chief Financial Officer

Yeah. So actually, we're really pleased with that actually in the non-top 10. When we compare our non-top 10 last year with this year, there are three clients that were in the non-top 10 category that have actually jumped into the top 10 category. So, which means that our non-top 10 crop continues to be a very strategic crop that continues to grow very rapidly. And you could -- it's also demonstrated, if you look at that on the data sheet and you look at the data that's provided on the trailing 12 months count, you pretty much look at most of the revenue trailing 12 months count that we have provided have been growing. So which shows you that the non-top 10 portfolio is also doing well. Because it has $1 million trailing, it has $5 million trailing in there, it has $10 million trailing that a lot of those will find homes in the non-top 10.

Kris Canekeratne -- Chairman and Chief Executive Officer

I think, Ted, what we are seeing -- this is Kris by the way. What we are seeing specifically on that front, especially given our size and scale and the knowledge and expertise we have both in the industries that we serve and very deep digital engineering expertise is that the combination of the industry knowledge and the deep digital together with our scale now that we are well beyond a $1 billion -- $1 billion in revenue, that now starting to get the benefit of economies of scale, not just within the enterprises that we serve today, which you can see, are all expanding with us. But also in the industries that we work in, we provide highly differentiated services. And to the extent that clients don't use us, they could see some disadvantages. And I think that's bearing out, whether it be in our pipeline or whether it be in our execution or whether it be in the results or the momentum and the opportunity ahead of Virtusa.

Ted Starck-King -- William Blair -- Analyst

Thank you.

Operator

Our next question comes from Puneet Jain of JPMorgan. Please go ahead.

Puneet Jain -- JPMorgan -- Analyst

Hi, thanks for taking my question. So, Kris, I think you mentioned that you are doing some works around Brexit. Is it mostly consulting or advisory work or are clients actually spending on actual development to prepare themselves for Brexit? And was any of that work in December quarter revenue as well or do you expect such work into 4Q?

Kris Canekeratne -- Chairman and Chief Executive Officer

So, I'll start and I'll turn to Ranjan very quickly. So basically, we have been and continue to prepare for a post-Brexit world, specifically in terms of making sure that we are aligned with our clients so that we can service them, whether they be in the UK and now migrating to parts of Europe or whether they are in Europe, and they're coming into the UK. Specifically, our solutions around software platforming, our ability to cloudify and move infrastructures from existing co-mingled systems to separate platforms and systems is a key area of strength of Virtusa, that we believe is going to play an inextricably important role in the post-Brexit world. Ranjan?

Ranjan Kalia -- Executive Vice President and Chief Financial Officer

So, Puneet, we had talked about in the prepared remarks, if you look at both our revenue and our pipeline for Europe, there are lot of cloud migration related projects that are there. And we understand lot of those cloud migration projects that are there, really clients trying to set themselves up in the post-Brexit era.

Puneet Jain -- JPMorgan -- Analyst

Got it, got it. And was there any pull forward of revenue from 4Q into 3Q?

Ranjan Kalia -- Executive Vice President and Chief Financial Officer

No, we don't -- nothing really, I mean Q3, it was a very strong Q3 that we had -- we performed at the high end of our guidance range and Q4 also continues to be a very strong quarter with about 4.9% sequential growth rate.

Puneet Jain -- JPMorgan -- Analyst

And last one quickly. Last quarter you talked about potential restructuring in -- expense in Q3 or Q4. Can you remind us and update us on that?

Kris Canekeratne -- Chairman and Chief Executive Officer

Yeah, sure.

Ranjan Kalia -- Executive Vice President and Chief Financial Officer

Puneet, I talked about in my prepared remarks. So the -- our target was a $15 million annualized cost reduction plan. We are continuing to execute -- we significantly executed that in Q3. In fact, if you look at in our Q3 financials, we're carrying severance costs for those in Q3 as well as in Q4 and most of those are expected to be done pretty much by middle to little bit latter part in Q4. So we are expecting annualized cost benefit starting from April 1 for $15 million and that sets up our cost basis to reach at least the 100 basis points to 150 basis points margin accretion.

Puneet Jain -- JPMorgan -- Analyst

That's great. Thanks a lot.

Kris Canekeratne -- Chairman and Chief Executive Officer

Thank you, Puneet.

Operator

Our next question comes from Frank Atkins of SunTrust. Please go ahead.

Nick -- SunTrust -- Analyst

Hi guys, this is actually Nick (ph) on for Frank. Thank you for taking the questions. So I was actually just wondering if you guys saw any changes in the pricing environment? I know you guys pointed to an increase in the realized pricing, driving the sequential gross margin improvements. Just wanted to see if there is any change there?

Ranjan Kalia -- Executive Vice President and Chief Financial Officer

Sure. Nick, as we -- throughout the year, there are always price rate card negotiations that happen with our clients and the slight rate card increases our drive. But the significant realized pricing gross margin impact that we talked in our prepared remarks were more so mix related that happens.

Nick -- SunTrust -- Analyst

Okay, understood. And then I guess could you guys just remind us of the economic sensitivity of margins going into this next year? Thanks.

Ranjan Kalia -- Executive Vice President and Chief Financial Officer

Usually, you will see -- Nick, usually we will see our margins start to expand very significantly in -- from our Q2 quarters and they continue to move up from that. So right now we haven't really put our quarterly guidance for that for next year, but if you look at our margin trajectory for this year and probably even last year, you will see that margins do expand every year, but the significant expansion starts to happen from Q2.

Nick -- SunTrust -- Analyst

Okay. And then just one last one from me. I saw the attrition ticked up a little bit within the quarter. Is there any update on talent environment especially around digital engineering? Thank you.

Kris Canekeratne -- Chairman and Chief Executive Officer

Yes. So, -- actually what you will find Nick is that attrition, unforced attrition actually came down and forced attrition went up directly in line with our cost reduction initiatives that we talked about in Q3. So overall, if you take a look at attrition, although the overall attrition number is higher, if you unpack it, unforced attrition came down by I think 60 basis points or 70 basis points. And -- I'm sorry 40 basis points and obviously the force attrition went up. A large part of the reason for doing this is that we are preparing for more full stack engineers. These are engineers that can walk across the entire software development life cycle from the front end to the microservices, middleware layer, and to the API application and back-end, also engineers that can work in a DevOps environment.

So most of our clients now especially in the hi-tech corridor and now even some of the more progressive enterprises are moving to an environment where they can deploy a new release virtually, instantly. And it requires certain skilling and reskilling, but we have great reputation in across all of our hiring geographies. We're extremely well known for the types of transformational deep digital work that we do for obviously some of the most venerable brands in the world. And that has enabled us to attract and retain some of the best engineering minds in industry across all of the geographies we operate in.

Nick -- SunTrust -- Analyst

Okay, great. Thank you. Congrats on the quarter.

Kris Canekeratne -- Chairman and Chief Executive Officer

Thank you.

Ranjan Kalia -- Executive Vice President and Chief Financial Officer

Thanks.

Operator

(Operator Instructions) And our next question comes from Vincent Colicchio of Barrington Research. Please go ahead.

Vincent Colicchio -- Barrington Research -- Analyst

Yeah. Kris, could you provide an update on the progress you're making at your largest client and some of the newer lines of business we've become active?

Kris Canekeratne -- Chairman and Chief Executive Officer

So, as Ranjan mentioned in his prepared remarks, we are -- we've seen strong sequential growth at our largest clients. As we look at Q4, we expect at the midpoint of our guidance that our largest client will have some decline from a revenue perspective, and at the higher end of our guidance, we'd expect that we will see growth at our largest client. Now a part of the reason for this, is obvious, the fact that it's the new year starting, certain programs come to an end and we are aware of the fact that some programs may actually delay or they may start on time, it's still a little bit difficult to predict. So as a result of that, we have taken into consideration our largest client spend in Q4 as we contemplated guidance.

Having said that, we are extremely well positioned within our largest client. We work now across all areas of our client, which is a significant difference from the time that the acquired Polaris three years ago, which basically means that we work across not just the ICG environment of our largest client, which is the institutional and client organization. We also work now within their global consumer group. And as a result of this, our addressable market has greatly expanded.

Vincent Colicchio -- Barrington Research -- Analyst

Okay. I have a question on eTouch. Is there any cross-selling success outside of the biggest client there that you could -- is there anything there to mention?

Kris Canekeratne -- Chairman and Chief Executive Officer

So, Vince, we are very pleased, just as we saw after the Polaris acquisition, Virtusa's engineering heritage, our customer relationship management enabled us to take in account, which is now our largest account, which was Polaris's largest account, and over a short period of time dramatically expanded that relationship. If you recall, when we first acquired Polaris, our largest client's contribution was approximately $32 million per quarter. And I believe in the most recent quarter, our largest client contributed over $55 million in the quarter. So very significant expansion.

The reason I cite that is because post the eTouch acquisition, we have been able to take their largest client, which is one of the largest hi-tech platform companies in the world and greatly expanded our relationship with that client, enabling us to grow the largest hi-tech client considerably in the last three quarters, and from the point of acquisition. But perhaps even more importantly, we've been able to take a lot of the hi-tech deep digital expertise that's mostly prevalent in hi-tech platform companies and bring that expertise to enterprise clients. And at the same time, take a lot of industry expertise that we have gained by doing significant work in industry to our hi-tech clients. So, we are seeing great synergies in both directions.

Ranjan Kalia -- Executive Vice President and Chief Financial Officer

I just wanted to add there. If you take the hi-tech, the -- our largest client would be 18% of our revenue, which will result in about $56.7 million.

Vincent Colicchio -- Barrington Research -- Analyst

And then, just one last one for Ranjan. What percentage of revenue was digital related in the quarter?

Ranjan Kalia -- Executive Vice President and Chief Financial Officer

It's consistent in about 39% to 40% in that range, in September, in our last quarter.

Vincent Colicchio -- Barrington Research -- Analyst

Thanks. Thank you, guys. Nice quarter.

Ranjan Kalia -- Executive Vice President and Chief Financial Officer

Thanks.

Operator

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

Kris Canekeratne -- Chairman and Chief Executive Officer

Thank you. And I'd like to take this opportunity to thank all of our global team members for their incredible dedication and the outstanding performance to all of our clients. Thank you for joining us and we look forward to updating you at our fourth quarter earnings call.

Operator

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

Duration: 53 minutes

Call participants:

William Maina -- Senior Vice President

Kris Canekeratne -- Chairman and Chief Executive Officer

Ranjan Kalia -- Executive Vice President and Chief Financial Officer

Mayank Tandon -- Needham & Company -- Analyst

Ted Starck-King -- William Blair -- Analyst

Puneet Jain -- JPMorgan -- Analyst

Nick -- SunTrust -- Analyst

Vincent Colicchio -- Barrington Research -- Analyst

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