EPAM Systems Q2 2023 Earnings Call Transcript

Quartr
Provided by Quartr
August 3, 2023

There are 12 speakers on the call.

Operator

Welcome to the EPAM Systems Second Quarter 2023 Earnings Conference Call. At this time, all participants are in a listen only mode. After the speakers' presentation, there will be a question and answer Please be advised that today's conference is being recorded. And I would now like to hand the conference over to your speaker today, David Straube, Head of Investor Relations. Sir, please go ahead.

Speaker 1

Thank you, operator, and good morning, everyone. By now, you should have received your copy of the earnings release for the company's Q2 2023 results. If you have not, a copy is available at epam.com in the Investors section. With me on today's call are Arkadiy Dobkin, CEO and President and Jason Peterson, Chief Financial Officer. I'd like to remind those listening that some of our comments made on today's call may contain forward looking statements.

Speaker 1

These statements are subject to risks and uncertainties as described in the company's earnings release and SEC filings. Additionally, all references to reported results that are non GAAP measures have been reconciled to the comparable GAAP measures and are available on our quarterly earnings materials located in the Investors section of our website. With that said, I'll now turn

Speaker 2

the call over to Ark. Thank you, Dave, and good morning, everyone. Before I get into results of our Q2, I would like to spend a few minutes on the mid quarter update we provided in June. As I shared in my prepared remarks, The broader concerns over the economy led to a shift in demand dynamics for our sector. For Yifan, the shift has been much more pronounced Due to the geopolitical impact on our delivery centers and our focus on the build and digital product engineering segments of the market, which represents about 80%, 85% of our engagement portfolio.

Speaker 2

This was especially evident in the technology vertical, which continues to be impacted by the pullback in spend after years of strong investments Digital and product development efforts, while being spread broader across other industry segments as well. Over the last quarters, we have also seen this impact in some of our largest clients as they have paid back or directed spending From newbuild programs to the economic conditions and caution in their businesses. This factor has contributed to a high percentage of our shortfall for the first half of twenty twenty three. Now switch to Q3 and the rest of 2023. Well, we are starting to see a few encouraging signs.

Speaker 2

We'll share more on that in a minute. Today, I would state that we expect still based on the current level of unpredictability, a negative dynamic to continue into the second half of twenty twenty three, but at a lower level than we saw in the first half of this year. With that, we'd like to state That while we do understand that this is a difficult period for us and for the sector more broadly based on insight From the past several years and past several quarters especially, we are turning that experience into pragmatic action plan, which we will be applying to our business throughout the remainder of this year and further into the future and consider this time an opportunity, Which as we all know, any crisis presents to transforming ourselves. Some of our current plans and actions are focusing on making real time adjustment to our offerings, go to market planning, customer engagement programs and Global Delivery Thailand Platform Stabilization. These key investments help us to prep ourselves for a strong rebound position.

Speaker 2

What is important also to note is that our primary focus on digital product and data engineering services combined with digital consulting agency, design content and digital marketing services will remain. In other words, the primary services and market segments, which allow us to double company in the previous 3 years, are staying intact. Well, we continue to tune our capabilities in line with the growing market demands. Our point is simple. The entire IT sector is undergoing what we believe is an evolution of the services market moving from the core IT To digitalization even more broadly and with significant acceleration And to consider new digitally native businesses faster to reinvent entire models and ways of working and now is the promise of Generative AI capabilities empowerment at the core.

Speaker 2

We have been at the forefront of similar trends before As a result, to be underpinned and even more driven exactly by our traditionally strong product platform engineering, data analytics And machine learning capabilities, but now in combination with what generative.ai promises. So our thesis has been and continues to be that our core services profile will benefit In the medium and longer term, from a pump higher concentration on cloud data and engineering. And we will capitalize strongly on our core capabilities By encapsulating not just currently available elements of Gena AI and a very visible needs for trust, Reliability and security management of AI, but also by closely integrating these new classes of composite and adaptive AI platforms as well as with foundational models and specific industry cloud platforms. In short, We are optimistic about the transformative opportunities to the whole application stack coming from AI led transformation, which is also well illustrated by our latest announcements. That is one of the key areas of our investments.

Speaker 2

The second critical part is the further diversification and stabilization of our global delivery platform, including the allocation of our talent More optimally across the world, while at the same time enabling our strong engineering quality standards across all of our locations. This rebalancing effort will be performed over the next 3 to 4 quarters in part to drive higher levels of gross margin performance. Our other plans and actions today are focused on our immediate demand generation and new logo acquisitions. During the first half of twenty twenty three and specifically in Q2, we drove new log activity at higher levels Then when compared to 2021 and 2022, we see this as a positive sign of our return to demand. We should accelerate the recovery and allow us to return to growth as soon as the current client base stimulates.

Speaker 2

A few examples of our new Q2 clients include 1 of the world's leading B2B travel platforms, Reliance European based multinational ocellent marketplace, organizing for trading of shares and other securities, A multibillion dollar molecular diagnostic company specialized in detection of early stage cancers, a leading global insurance provider of financial protection, Absence Management and Supplemental Health Benefit Solutions and Global Infrastructure Services Company in the energy space. In these new programs, we are starting to include a more diverse stack of our capabilities from consulting to different types of implementation efforts. Some of those clients we expect will support our next growth journey. In addition, we also see some programs with existing clients who have started ramping up. Recently, Canadian Tire Announced a 7 year strategic partnership with Microsoft to accelerate their modernization and drive retail innovation across the Canadian markets.

Speaker 2

Leveraging our decade long relationship with Canadian Tire, Yipang will be trusted in proven engineering partner in digital system integrator to lead the effort. So there are some signs indeed that the overall demand environment is coming to more normal terms for us. We probably will be able to share more next quarter of how strong those signs are going to be. But In any way, it also confirms that the pump continues to remain very relevant and competitive even in current markets of low demand for the build function, Which is a good entry point to share some of our go to market progress, especially in relationship with In June, we announced a global strategic partnership with Google Cloud across our global markets, Cloud solutions and focusing on specific efforts in our larger verticals, including financial services, consumer, teleco, media, entertainment, Healthcare Life Sciences, Energy and High-tech to help our customers to modernize and transform their businesses. We also are encouraged and energized by the momentum we are seeing with our other major cloud partners, Microsoft And AWS.

Speaker 2

More to come on these directions very soon, but just as a preview, you might have seen that we We recently made Microsoft Migrate Partner of the Year for 2023 with couple other honorable recognitions with Microsoft Partner Network. In overall, we made very strong progress in establishing a real 360 degree relationship with all 3 major players and plan to be sharing more over the course of the next few weeks publicly. Two final points. First, I just want to reiterate our view that there is a tremendous amount of work to be done in continued modernization, application development and integration And in considering and designing the models and strategies for business change. Our commitment to our expanding Once customers gain confidence in their optimization initiatives and return their attention to growth.

Speaker 2

2nd, I wanted to touch on AI one more time. As it is obviously On everyone's mind these days. So how do we see its impact to our business and more critically to our customers And the industry at large. And of course, what are we doing to position EPAM for long term success. EPAM has a long history of investing in R and D and our call to action over the years Has been to make the promises of technology real.

Speaker 2

So rather than sharing any specific dollar amount we plan to spend on AI, which is very difficult to estimate within current speed of change. We can instead share how we are thinking about directional investments today. Currently, we seek investments with 2 principles in mind. Whatever we do has to be pragmatic To EPAM in terms of relevancy and deliverability for our clients And second, it has to be responsible and cost effective. This translates to 2 broad categories of things we are working on And you probably already saw some of this being announced.

Speaker 2

We are building accelerators in IP that help to orchestrate Full transformation program using the best available capabilities of large language models and related frameworks and tools. A significant portion of this is the work we are doing to change how we ourselves work from how we build code to how we position and operate our company. We are working across 1,000 of use cases to focus, First of all, on responsible and very importantly, cost effective solutions. Otherwise, future real progress will be difficult. To do so, we are focused on expanding our partnership, including with cloud providers and leading research centers To ensure those critical aspects and also focus ourselves on aligning internally across consulting experience in technology to address that.

Speaker 2

The reality is that the production ready AI services application landscape is still very much at the entry stage of maturity today. Well, we see it is a very large and accelerating opportunity for us, specifically in our Primary Market segment. We are currently focusing on all type of activities to learn and experiment more from proof of concepts to real scaled pilots and some scaled production initiatives. So just like advances to our cloud over a decade ago drove demand for advanced engineering, next generation architecture and hybrid and distributed delivery models. We are confident that this wave of AI led requirements will drive more demand for advanced data engineering and cloud computing, content creation and the artificial intelligence native application as well as the new UX and UI paradigms.

Speaker 2

Our clients, who themselves make up a significant segment of technology companies and technology led enterprises, I am in the midst of already started AM arms race, which we believe will be a real engine for the future growth. Some of that we are already starting to see within our demand pipeline. With that, I would like to pass to Jason to share more details and numbers for Q2 And for an update for our business outlook for the remainder of 2023.

Speaker 3

Thank you, Ark, and good morning, everyone. Before covering our Q2 results, I wanted to remind you that in addition to our customary non GAAP adjustments, expenditures Resulting from Russia's invasion of Ukraine, including APM's humanitarian commitment to Ukraine, business continuity resources and accelerated employee relocations have been In the Q2, EPAM generated revenue of $1,170,000,000 a year over year decrease of 2.1% on a reported basis and a decrease of 2.4% in constant currency terms, reflecting favorable foreign exchange impact of 30 basis points. Revenue in the quarter was impacted by reductions in program spending across a number of our clients as well as ongoing client caution related to new project starts. The reduction in Russian customer revenues resulting from our decision to exit the market had a 100 basis point negative impact on year over year revenue growth. Excluding Russia revenues, year over year revenue for reported in constant currency would have decreased by 1.1% and 1.7% respectively.

Speaker 3

Beginning with our industry verticals, on a year over year basis, travel and consumer declined 1%, primarily due to declines in retail, partially offset by solid growth in travel and hospitality. Financial Services grew 3.2% with growth coming from Asset Management and Insurance Services. Business Information and Media decreased 4.1% in the quarter. Revenue in the quarter was impacted by a reduction in spend at a number of large clients based on uncertainty in their end markets, particularly in the mortgage data space. Software and high-tech contracted 10.3%.

Speaker 3

The decline in the quarter reflected a reduction in revenue from a former top 20 customer We mentioned during our previous earnings calls and generally slower growth in revenue across a range of customers in the vertical. Life Sciences and Healthcare declined 10.9%. Revenue in the quarter was impacted by the ramp down of a large transformational program mentioned during our On a sequential basis, growth in life sciences and healthcare actually was a positive 2.9%, driven by new work at both existing and new logos. And finally, our emerging verticals delivered solid growth of 8.6%, driven by clients in Energy, Manufacturing and Automotive. From a geographic perspective, Americas, our largest region representing 58% of Q2 revenues declined 5.9% year over year or 5.7% in constant currency.

Speaker 3

The growth rate in the quarter was impacted in part The ramp down of life sciences and healthcare customer we mentioned during our previous earnings calls. EMEA, representing 39% of our Q2 revenues, Grew 8.5% year over year or 6.5% in constant currency. TEE representing 1% of our Q2 revenues Contracted 61.1 percent year over year or 45.8 percent in constant currency. Revenue in the quarter was impacted by our decision to exit our Russia Operations and the resulting ramp down of services to Russia customers. And finally, APAC declined 19.7 year over year or 18.6% in constant currency terms and now represents 2% of our revenues.

Speaker 3

Revenue in the quarter was impacted primarily by the ramp down of work within our financial services vertical. In Q2, revenues from our top 20 customers declined 2.4% year over year, while revenues from clients outside our top 20 declined 1.9%. Moving down the income statement. Our GAAP gross margin for the quarter was 30.9% compared to 29.2% in the Q2 of last year. Non GAAP gross margin for the quarter was 32.6% compared to 31.5% for the same quarter last year.

Speaker 3

Gross margin in Q2 2023 reflects a lower level of variable compensation expense, partially offset by the negative impact of lower utilization. GAAP SG and A was 16.7% of revenue compared to 19.5% in Q2 of last year. SG and A in Q2 2022 included a more significant level of expenses resulting from Russia's invasion of Ukraine. Non GAAP SG and A in Q2 2023 came in at 14.8% of revenue compared to 15.2% in the same period last year. Reductions in both cost of revenue and SG and A during the quarter reflect the company's ongoing focus on managing its cost base as well as reduced variable compensation expense due to the lower level of financial performance expected for the year.

Speaker 3

In Q2, EPAM incurred $5,000,000 in severance related expense included in both GAAP and non GAAP SG and A as the company works to better align its cost structure with the current demand environment. GAAP income from operations was 144,000,000 12.3% of revenue in the quarter compared to $93,000,000 or 7.8 percent of revenue in Q2 of last year. Non GAAP income from operations was $191,000,000 or 16.3 percent of revenue in the quarter compared to $177,000,000 or 14.9 percent of revenue in Q2 of last year. Our GAAP effective tax rate for the quarter came in at 20%. Non GAAP effective tax rate was 23.3%.

Speaker 3

Diluted earnings per share on a GAAP basis was $2.03 Our non GAAP diluted EPS was $2.64 reflecting a $0.26 increase compared to the same quarter in 2022. In Q2, there were approximately 59,200,000 diluted shares outstanding. Turning to our cash flow and balance sheet. Cash flow from operations for Q2 was $89,000,000 compared to $78,000,000 in the same quarter of 2022. Free cash flow was $82,000,000 compared to free cash flow of $59,000,000 in the same quarter last year.

Speaker 3

At the end of Q2, DSO was 71 days It compares to 69 days for Q1 2023 and 71 days for the same quarter last year. Looking ahead, we expect DSO will remain steady throughout 20 Share repurchases in the 2nd quarter were approximately 195,000 shares for $41,400,000 at an average price of $212.77 per share. As of June 30, we had approximately $450,000,000 of share We ended the quarter with approximately $1,800,000,000 in cash and cash equivalents. Moving on to a few operational metrics. We ended Q2 with more than 49,350 consultants, designers, engineers, trainers and architects.

Speaker 3

Production headcount declined 10% compared to Q2 2022, the result of lower levels of hiring combined with voluntary and involuntary attrition as we continue to balance supply and demand. Our total headcount for the quarter was more than 55,600 employees. Utilization was 75.1% compared to 78% in Q2 of last year and 74.9% in Q1 2023. Now let's turn to our business outlook. As Art mentioned, we've seen a higher level of new logo acquisitions and revenue from our focused efforts on demand generation.

Speaker 3

While this progress is encouraging, the level of revenue generated is not enough to offset further expected reductions in client budgets, Ramp downs and delays in new program starts. With the range of outcomes we outlined on our June 5 call, we are maintaining our expectations for a muted demand environment with sequential decline in Q3 and further sequential or flat revenue growth in Q4. Our Ukrainian delivery organization continues to operate efficiently and our teams remain highly focused on maintaining uninterrupted production. Our guidance assumes that we will continue to be able to deliver from Ukraine at productivity levels at or somewhat lower than those achieved in 2022. Consistent with previous cycles, we will continue to thoughtfully calibrate our expense levels, while investing in our capabilities and focusing on the preservation of our talent in preparation for a return to higher levels of demand.

Speaker 3

We expect headcount will continue to decline modestly in Q3 due to in Q3 due to limited hiring and more typical attrition and we will continue to limit hiring until we see improving demand. We expect utilization to decline slightly in the second half of the year, primarily driven by higher level of expected vacations. Lastly, at the end of July, we completed the sale of our Russian business, which will result in a decline in Russian revenues from Q2 to Q3. We will also recognize an estimated loss on sale of $18,400,000 which will impact our Q3 and full year GAAP results. Additionally, this will drive a further modest reduction in headcount.

Speaker 3

Moving on to our full year outlook, we now expect revenue to be in the range of 4 point $65,000,000,000 to $4,701,000,000 reflecting a year over year decline of approximately 3%. On an organic constant currency basis, excluding the impact of the exit from Russia, we expect revenue decline to also be approximately 3%, both at the midpoint of the range. We expect GAAP income from operations to now be in the range of 10.5% to 11.5%, which includes the loss associated with the sale of our Russian business and non GAAP income from operations to continue to be in the range of 15% to 16%. We expect our GAAP effective tax rate to continue to be approximately 22%. Our non GAAP effective tax rate, which Excludes excess tax benefits related to stock based compensation is expected to continue to be 23%.

Speaker 3

For earnings per share, we expect that GAAP diluted EPS will now be in the range of $7 to $7.20 for the full year And non GAAP diluted EPS will now be in the range of $9.90 to $10.10 for the full year. We now expect weighted average share count of 59,100,000 fully diluted shares outstanding. Moving to our Q3 2023 outlook, expect revenues to be in the range of $1,140,000,000 to $1,150,000,000 producing a year over year decline of 6% to 7%. On an organic constant currency basis, excluding the impact of the ex of Russia, we expect revenue to decline by 8.5% to 9.5%. For the Q3, we expect GAAP income from operations to be in the range of 10% to 11% and non GAAP income from operations to be in the range of 15.5 percent to 16.5%.

Speaker 3

We expect our GAAP effective tax rate to be approximately 24% Our non GAAP effective tax rate, which excludes excess tax benefits related to stock based compensation to be approximately 23%. For earnings per share, we expect GAAP diluted EPS to be in the range of $1.62 to $1.70 for the quarter And non GAAP diluted EPS to be in the range of $2.52 to $2.60 for the quarter. We expect a weighted average share count of 59,100,000 diluted shares outstanding. Finally, a few key assumptions that support our GAAP to non GAAP measurements in the 3rd And the remainder of the year. Stock based compensation expenses are expected to be approximately $39,000,000 for each of the remaining quarters.

Speaker 3

Amortization of intangibles is expected to be approximately $5,500,000 for each of the remaining quarters. The impact of foreign exchange is $2,700,000 for Q3 to $1,800,000 for Q4. In addition to these customary GAAP to non GAAP adjustments Consistent with the prior quarters in 2023, we expect to have ongoing non GAAP adjustments in 2023 resulting from Russia's invasion of Ukraine. Please see our Q2 earnings release for a detailed reconciliation of our GAAP to non GAAP guidance. Finally, one more assumption outside of our GAAP to non GAAP items.

Speaker 3

With our significant cash position, we are now generating healthy level of interest income and are now expecting interest and other income to be $11,700,000 for each of the remaining Lastly, I'd like to thank our employees for their continued dedication and focus on our customers. Operator, let's open the call up for questions.

Operator

Thank One moment please for our first question. Our first question will come from Brian Bergin of TD Cowen. Your line is open.

Speaker 4

Hi, good morning guys. Thank you. I wanted to just kick off with large client visibility and I guess existing base stability. Can you talk about the conversations you're having among your top 10 or top 20 clients, are you getting closer to stability in this space? And I'm curious just as we Look at the implied sequential decline in 3Q and perhaps 4Q, just trying to understand the attribution to the decline among the large clients still in that base versus the intake of new work coming in at lower dollar levels versus like conversion delays and slower ramps of work?

Speaker 2

Hello. Good morning. I think visibility or Predictability probably better than it was couple of quarters ago. So and we can plan But there is still slowdown which started couple of quarters ago and we Working with this and there is also some asynchronous points between clients when they were making some of the decisions. So there is Elements of unknown still there.

Speaker 2

But again, in general, we feel that it's much more stable. We've also seen in top 20 that some clients started to return in discussion about growth. Again, it's difficult to comment when exactly it happened, but we see some signs that they tried Some additional vendors were not satisfied coming back to us with discussions. So I think in general Feeling about Ukraine despite of situations that were getting even more active period Still from the client perspective and from expectation of the stability from work conditions taken into account during the last 18 months, we didn't have practically one productive day. So people believe that the Clients started to feel that they can't rely on this for those who continue that.

Speaker 2

So I think in general, more stable, Still unknown and the risk still slowed down good, a little bit. So, we hope that it will be stopped like within

Speaker 5

the next couple of quarters.

Speaker 4

Okay. And a follow-up just on the workforce diversification. Can you give us a sense On how the current operating footprint is comprised as of the close of the June quarter, just roughly a mix between billable in Ukraine, Belarus versus Central Europe versus LatAm and APAC? Thanks.

Speaker 3

Yes. So we're Under 30% from a CIS region, so that's primarily as you indicated Ukraine and Belarus. We're continuing to see maybe a little bit of growth in India. So that continues to be a significant delivery location for us. And right now, while we're working through demand, probably we see some stabilization in Latin America, but again, continues to be And part of our expected current and future delivery footprint.

Speaker 4

Okay. Thank you.

Operator

Thank you. One moment please for our next question. Our next question will come from the line of Jason Kupferberg of Bank of America, your line is open.

Speaker 6

Hi. Good morning, Ark and Jason. This is Tyler DuPont on for Jason. Thanks for taking the question. I just wanted to start by asking about operating margins.

Speaker 6

During the quarter, they seemed some pretty strong 130 bps And sort of how you're thinking about margins through the back half of the year, where there's any sort of incremental investment opportunities available or any color there?

Speaker 3

Yes. So clearly with the demand environment that we're seeing, we're trying to make certain that we're cautious about spending, While still making certain that we're making investments in sales channels and partner programs And clearly our AI capabilities that would allow us to return to growth in the future. But we're focused clearly on SG And you're seeing efficiency there and then you're also some caution around what we're doing with headcount. And generally what you're It's a little bit of tuning in different delivery locations and lower hiring, very modest hiring, which has been offset by attrition and has resulted in these net reductions in headcount. The other piece and we did talk about it, I think in the script, There is a variable compensation element.

Speaker 3

It's funded by performance versus our expectations for the full year. With the change in expectations for the full year, we did adjust the expected expense related to variable Station, that shows up as some benefit in Q2 and will have lesser, but some benefit in the remainder of the year. And then again, we were just sort of top ish from our revenue standpoint with the $11.70 in Q2. From a profitability standpoint, Generally, Q3 is a good quarter for us with more build days. I don't necessarily I think you're still going to see somewhat lower Utilization in Q3 and so probably not expecting much improvement or probably maybe even a little bit of If you went to the midpoint of the range, the 15.5% to 16.5% that we've guided to for Q3.

Speaker 3

I think gross margins could end up in a 32% to 3% range in Q3 with lower build days in Q4 maybe somewhat lower and I would definitely expect to See a decline in profitability between Q3 and Q4 due to a lower number of bill days, vacations and all of that, which generally impacts profitability In the last quarter of the year.

Speaker 6

Okay, great. I appreciate that, Jason. Thanks. And then for my follow-up, I just wanted to sort of double click on the demand story here As we look towards the back half of the year, specifically your expectations on the evolution of the demand environment across your total client base. The balance between if you're assuming macro stability or any sort of additional softness in Any of the verticals or geographies you're operating in?

Speaker 6

I know Brian sort of alluded to the sequential declines in the last question in regard to 3Q and potentially 4Q. So just sort of any clarity there helping us frame the demand environment would be appreciated.

Speaker 3

So just I'm going to just give you the numbers, what we're currently seeing from a forecast standpoint for Q3 and then I'll let Art comment on maybe provide more color. From a sequential standpoint, I think with some of the budget reductions that you've seen in major customers, you're likely to continue to see sequential decline across a fairly large number of our verticals. I think you could see sequential growth In the emerging, which has got a significant energy manufacturing footprint, I think you could continue to see or likely to see Sequential growth in the Healthcare and Life Sciences, where we're making good traction here in fiscal year 2023. So that's kind of what I'm seeing from that standpoint. I think you still have a little bit of impact from customer decisions to reduce spend in Q2.

Speaker 3

And I think as Ark has indicated that we're more hopeful that clients are beginning to sort of stabilize their spend and could even see some increase later in the Yes,

Speaker 2

I think that's in line with what I shared at the beginning of the first question. It's still soft, it's still unpredictable, it's still slightly going down. At the same time, we've seen Different conversations started to happen. There are more activities with new logos and that's what we shared to you in the Our thought is at the beginning, but also with existing clients, different tone of conversations that we saw Couple months, couple of quarters ago. Again, still difficult to predict.

Speaker 2

We reacted and we are forecasting based on what We really can't see right now.

Speaker 6

Great. Thank you both.

Speaker 7

Thank you.

Operator

Thank you. One moment please for our next question. The next question will come from David Grossman of Stifel. Your line is open.

Speaker 5

Thank you. Good morning. I wonder if I could just a couple of quick follow ups to some of the questions that have been asked. I mean, the first is, Just getting back to the customer dynamics and their own desire to kind of diversify risk geographically. If things stabilize from here, when would the sequential revenue headwinds begin to diminish, if things just Stabilized from here going forward?

Speaker 3

Yes. So clearly, we would expect Sequential decline in Q2 to Q3 to when would the sequential stabilize. And then David, I think you're aware of this, if Q3 to Q4 is just you've got a build impact. And so you have to have an improvement in demand to stay flat Q3 to Q4. And so we think that That's possible as we talked about in the guidance or maybe you could see a little bit of growth Q3 to Q4, but you do have you're walking uphill Q3

Speaker 5

No, I just wanted to clarify. So excluding the seasonality, right, if things stabilize from here, Things would be flattish sequentially, right, excluding the seasonal dynamic?

Speaker 2

I think earlier what I would comment that In June, when we talked last time and in May kind of where we were, Clearly felt that situation was that we expected before. We're certainly thinking about 2, 3, 4 quarters. And I think that's the feeling which we still have today, okay, Because it's very difficult to predict like you're asking when. So I do believe that within this Time frame, we will probably will get to the situation when sequential quarterly sequential growth will start to recover. But we clearly will be updating this quarter after quarter.

Speaker 2

So we're definitely feeling slowdown. We definitely Seeing different signs from the clients, but again, some clients when they made some decisions, They would have themselves in some type of inertia, which would take some time. All markets will be Very clearly changed or less satisfaction with some other vendors will be not as high. Okay. Some of this has started to feel.

Speaker 2

That's what given us some level of optimism, but I don't think we can say anything more than another 2, 3 quarters from now, maybe 4.

Speaker 5

Got it. All right. Thanks. I appreciate that. And then just back to your own internal Efforts to geographically diversify, without getting too far into the details, are there some high level dashboard items that you can Share that would provide some insight into recruiting kind of yield utilization attrition, Anything that would give us a sense of kind of how these new geographies are ramping?

Speaker 2

Okay. You're asking about what do you feel about our progress with To find like our global delivery. Is this Correct. Okay. So I think we're actually pretty much satisfied with the progress.

Speaker 2

I think our efforts in India and Latin America definitely started To pay out, India right now is the 2nd largest location we have and that was part of the Blair, which we shared in May 2022, when we met with all of you That's what we're trying to do. So right now, Ukraine and Belarus production Together, it's more like 25%, 26% of the total capacity, Well, India and Latin America, probably by the end of the year, it will be closer to 18%, 20%. The quality and effort which we put in there Definitely improving. We also have very specific programs how to share knowledge between People who stand with the path for a long time and how to raise the bar with recruitment and more questions. I think We're still committed very much to Ukraine.

Speaker 2

We do believe that it will be growth there. Yes, we don't know when, but maybe we'll be very much aligned with sequential growth which we expected in 2, 3, 4 quarters coming back. So besides India and Latin America, which is more Traditionally, we have actually Central Western Asia, which is interesting because it's accumulated significant Now, well, with people who know ZEPAM well, it's fully located during the last 18 months. So, it's a very interesting base And we have potentially very good demographics for the growth of the target in these countries and clients Starting to experience this and getting comfortable. And again, with the demand coming back, I think it will be Good opportunity for us.

Speaker 2

And finally, more traditional for us location Central Eastern Europe mostly inside of EU, sometimes outside of EU, but Hungary, Poland, this is very quality, high quality In the unique location for us clients, we are comfortable there. In good demand environment, it's always very high So it's also becoming Stronger because good amount of talent relocated from our traditional Dev centers, so I think we're going actually to the direction of building Probably the most balanced global delivery platform. And as soon as the rebound will be started, I think we will feel Comfortable to grow. Bill, one of the important things and we mentioned this, we very carefully kind of We're balancing the cost structures because in all of the sectors which I outlined There are different cost structures and we going back to improve our Gross margins by the allocating focuses across these locations. So, if in short question, we will be able to provide quality, which clients expected from us.

Speaker 2

I think we convinced clients that it's actually very much doable.

Speaker 5

Got it. Thanks very much. I really appreciate that color.

Speaker 2

Thank you.

Operator

Thank you. And one moment please for our next question. The next question will come from Maggie Nolan of William Blair. Your line is open.

Speaker 7

Hi, thank you. Just to follow-up on that last question and your last comment there, Ark, around the margins. Can you give us a little bit of a Preliminary thought on what all of this might mean for gross margins into 2024, when we might see things kind of start to pick up and to what Magnitude?

Speaker 3

Yes. I think I'll step in and we're probably not quite ready to talk about the 2024 in terms of, let's say, Specifics or even ranges. But to our point, as we moved into the different delivery locations, obviously, we did so quickly. In some cases, we probably have a little bit more balance in the higher cost geographies, including traditional kind of on-site markets. We will look to kind of rebalance that somewhat.

Speaker 3

And then the other thing that we've talked about over the last couple of quarters is that as we moved into new geographies and particularly as we sort of Either relocated or stood up new geographies quickly, we ended up with a somewhat more sort of senior delivery organization and delivery pyramid And we're working to begin to introduce more juniors later in the year that would then give us a more balanced pyramid and therefore also improve margins. And so that obviously combined with utilization improvement would be

Speaker 2

the things that we're looking to do to

Speaker 3

sort of stabilize and improve gross margins over time.

Speaker 7

Okay. Thank you. And then on the new logo additions, it was good to hear the progress on that this Quarter. Can you talk a little bit about the ability to keep the sales force intact during all this transformation? And then any kind of patterns that you're seeing on those new logos in terms of the time it's taking for them to convert to revenue?

Speaker 2

So I think I will comment on general new logo and new business kind of It is true that while sales force is also in some dynamics, so I think Directionally, it's working through positively right now. I think after Our comments like several quarters ago when we were in the middle of all these allocations points and we have to deal with thousands of people. So It was slowed down right now. So, I mean, yes, so

Speaker 3

very much actively focused on external opportunities And much of the internal things that we had to manage over the last, I'd say, 4th quarters are substantially behind us and there's a Focus with both the account teams, the sales force and the executives on driving incremental revenue.

Speaker 7

Thank you.

Operator

Thank you. And one moment for our next question. Our next question will come from the line of Ramsey El Assal of Barclays. Your line is open.

Speaker 8

Hi, good morning. Thanks for taking my question. I wanted to follow-up Might impact or expand your capabilities or your addressable market? And then also just comment on whether this is part of positioning EPAM for growth once the demand environment picks up again?

Speaker 2

Yes, I think it's a dynamic also in general because of the Market change in comparison like during the year ago. Now we're talking about much closer relationship from both points of view because we definitely Like everybody else, focusing on strong clients, Client perspective where hyperscalers can open additional doors and all Competitors do the same. And this is kind of nothing new. On another side, the partnership becomes stronger because Just migration to the cloud is kind of as is business Becoming also interesting and usually it means very complex modernization efforts. And this is where strengths of ePAM coming And this is why the partnership with hyperscale is becoming more important Not only for us, but for them as well because the bank has a reputation which actually can do complex modernization, complex operation.

Speaker 2

That's what we mentioned, the status of And as we mentioned, we will be following this announcement during the next couple of weeks, which will be confirming And it's definitely very good preparation from our point of view for rebound because when demand will go back, everything which wasn't finished and it's a lot In all categories in cloud and data modernization projects and Huge pressure on demand for data engineering because of AI components. So

Operator

All right.

Speaker 8

Thank you. And a follow-up from me. Can you contrast the demand environment in Europe versus North America, it looks like the growth rates are different in those geographies, although admittedly they don't necessarily have not tabulated the constant currency number, but is it a different environment you're seeing in different geographies or is it very similar trends across the business regardless of geography?

Speaker 3

Yes. So certainly some of what happened in Europe is due to foreign exchange. But what we are seeing is that some of the larger Budget reductions in conservatism is actually showing up more in North American clients. Think about the couple of clients we talked about in healthcare and And tech, those were both North American clients. We've seen less of these types of reductions in spend in Europe.

Speaker 3

At the same time, we've got some pretty good traction also in even in the consumer and retail side in Europe. And so, yes, does seem to be a bit of a divergence, but we'll see what happens as we work through the remainder of the year.

Speaker 8

Fantastic. Thanks a lot.

Speaker 2

In general, it's still pretty similar. I think we're talking about several specific client situations. Mostly it's happened in North America and those situations were independent

Operator

Thank you. One moment for our next question. Our next question will come from Marsh Latvie of Wedbush Securities. Your line is open.

Speaker 9

Thanks. Good morning. A couple of follow ups here. So looking at the new logos, can you confirm that you're actually getting the same bill rates As you're selling via some of the other delivery centers, including India, as you have been getting In Eastern Europe, so are we talking about comparable billability?

Speaker 3

So, what we would usually talk about is an environment where potentially you could get higher bill rates with new engagements. That's probably less likely to In today's demand environment, generally Moshe, if you're trying to get it just kind of what happens as you deliver more out of India. India does have somewhat lower price points than some of the geographies in Eastern Europe, maybe not significantly different than A few that geographies in Southwest in Western Asia or the Soviet Central Asia, But we've got that somewhat lower price points than certainly sort of central Europe.

Speaker 9

Okay. So would you say that the new logos that are coming on board Are more dilutive to margins versus what you were accustomed to? Or is there any way to mitigate that?

Speaker 3

Yes. So, if you can have different bill rates in different geographies and still have the same margin percent, Right. You've got different cost structures, you've got different cost of benefits and that type of thing. And so lower Price or higher price even doesn't necessarily mean lower or higher margin. Again, so I would say, yes, we can kind of mitigate.

Speaker 3

And no, I don't expect that new business is being taken that's super impressive. Margins, we're working to kind of sharpen our pencils, but be appropriate in our pricing.

Speaker 9

That makes sense. And then last one here. So we visited your center in Hyderabad and I remember you have a Significant capacity to kind of expand there. Can you talk a bit about your future plans in terms of How important India or critical India is going to be to be able to continue to get those new logos on board and

Speaker 2

Yes, still I know like we're answering a little bit kind of in gray area, but in general, Need to understand that current market environment is not what was and everybody knows it like 18 months ago or 2 years ago. The whole rate structure for everyone, not only for us, is different for new deals as well. So the only things which could change is actually Demand coming to more normal scale and demand for complexity for build stuff will go up. Then correction will be happening in other side. So there is nothing magical here.

Speaker 2

So new deals coming today in very different environment as it was Again, 18, 24 months ago. It's number 1. Number 2 about India. Now, I don't know when you visited. I don't remember when you visited Hyderabad, but right now we've got 5 development centers.

Speaker 2

We Hyderabad is still is the biggest one, but we have 2 others which Going very strongly and few others which we started recently going strongly as well. So that's a definitely important part of Our future, but it's one of the parts. It's not like we're going to switch a fleet. That's what I mentioned before. We're really

Speaker 5

Thanks.

Operator

Thank you. And one moment for our next question. Our next question will come from Puneet Jain of JPMorgan. Your line is open.

Speaker 10

Hey, thanks for taking my question. I also wanted to ask about demand. Do you expect like clients to spend on CapEx investments to modernize or replatform their core systems sometime this year, Maybe in 4Q or is that type of work is something that could come through Under next year's budgets, meaning that it might not come in anytime this year.

Speaker 2

Do you expect to see modernization

Speaker 3

in spend occurring in Q4 or more likely to see a return to budget Growth in first half of twenty twenty four.

Speaker 2

It's difficult to I think we answered this question already in another way couple of times. We don't know it though. There is no so much visibility. That's difficult. Some of them who knows it's sometimes unexpected happening in Q4 will be the quarter when

Speaker 10

Got it. And are you seeing any pricing pressure on like to like basis?

Speaker 3

Well, the pricing pressure on like like basis. So I think Art obviously picked it up in a more pronounced way than I did earlier. So This is definitely an environment where you need to sharpen your pencil. And so, clearly, we're being thoughtful, but it is an environment where clients are Particularly cost sensitive, and that is showing up in pricing. And to Moshe's question earlier, It's traditionally in certain newer engagements, it's an opportunity to sort of improve price and that's less the case in this fiscal year.

Speaker 3

Got it. Thank you.

Operator

Thank you. And one moment please for our next question. The next question will come from Arvind Ramnani of Piper Sandler.

Speaker 6

Hi. Thanks for taking my question. I wanted to ask

Speaker 11

you about your new clients. Are they coming from specific industries and geos? Or maybe are you able to provide some color on the nature of work On your new clients?

Speaker 2

I think at this specific time, Yes, there are some indices like, let's say oil and gas, which is in pretty good shape. Okay. Well, this is more an exception today. The rest of the new clients in our view coming from 2 kind of categories. Some clients who's actually trying to utilize this time as an opportunity and decided to go and invest Instead of like and get some competitive advantage.

Speaker 2

And that's exactly what we were called before saying that as soon as This type of clients will demonstrate some results. It will trigger faster recovery on the market for build and Kind of transformative programs. Okay. And the second category, I think it's a client's reach is at this point not trying just to do transformative programs, but Trying to utilize this time to build relationship with the stronger vendors for the future return and be prepared for this because In our view, demand for talent when market will We will be very, very strong with everything what's happening right now in technology, in technical debt, It seems which we have not done or not finished and with everything was triggered by It seems like everybody is trying to talk about the refi, so no questions, but it's still there and it will change actually landscape. So And press will put pressure on the talent demand as well.

Speaker 2

Well, a lot of people speculating that it would Replace companies like you, Barclays. Okay.

Speaker 11

Yes, that's helpful. And I mean, I know typically when you start your client relationships, they start small And then they kind of ramp over time. Is this kind of a similar dynamic that you have with these new clients?

Speaker 2

So there are few, for example, we kind of give, I think, Five, six examples across different industries. There are few of them which is pretty large And that's why we mentioned that it might be that they will be driving our growth for the next years. There are some of them which is more framework contracts, which we won and just started and there is a specific place how it's happening. So it might Start to read results like closer to the end of the year, maybe beginning of the next year, visible results. And there are some which is very, very specific programs, but not big but very interested from the new technology standpoint.

Speaker 2

So it's kind of a variety of this. If we will see better trends that would be that it's actually the market change.

Speaker 11

Terrific. And just last question for me. Just I did want to ask about Belarus. Can you share some sort of headcount trends and utilization in Belarus? And are you also seeing any pushback With sort of your exposure to Belarus?

Speaker 2

I think I would grasp Ukraine and Belarus here. I think with Ukraine clients who stayed with Ukraine much more comfortable right now. We see some clients coming back. Again, the proof that nothing was happening from the quality of delivery What kind of impact on any production activities during the last 18 months Making clients more comfortable. Yes, it's kind of new normal, but the normal is a key Part 2 of this.

Speaker 2

With Belarus, it's a slowdown. We still have clients which operate there and we have some clients who exited there. So Belarus is From headcount point to view kind of sliding faster than Anything else?

Speaker 11

Terrific. Thank you very much.

Operator

Thank you. I am seeing no further questions in the queue. I would now like to turn the conference back to Arkadiy Dovkin for closing remarks.

Speaker 2

Thank you. Thank you, everybody. I think We will update you in 3 months. But in general, feeling that we get in little unpredictability, we feel it's So thank you very much and talk to you in 3 months.

Operator

This concludes today's conference call. Thank you all for participating. You may now disconnect and have a pleasant day.

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Earnings Conference Call
EPAM Systems Q2 2023
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