EPAM Systems Q4 2023 Earnings Call Transcript

Quartr
Provided by Quartr
February 15, 2024

There are 13 speakers on the call.

Operator

Ladies and gentlemen, thank you for standing by. I would like to welcome everyone to the EPAM Systems Q4 2023 Earnings Conference Call. At this time, all lines have been placed on mute to prevent any background noise. After the speakers' remarks, there will be a question and answer session. Thank you.

Operator

I will now hand the call over to David Straubar, Head of Investor Relations. You may begin your conference.

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 Q4 and full year 2023 results. If you have not, a copy is available on epam.com in the Investors section. With me on today's call are Arkadiy Dobkin, CEO and President Jason Peterson, Chief Financial Officer. I would like to remind those listening that some of the 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 in our earnings materials located in the Investors section of our website. With that said, I'll now turn the call over to Ark.

Speaker 2

Thank you, David. Good morning, everyone. Thank you for joining us today. As usual in Q1, it's time for us to reflect on the past 12 months and share what we think about the next 12. Before I do that, I want to thank our team around the world for their dedication to our clients and hard work throughout last year and for staying committed and engaged in the work ahead of us in 2024.

Speaker 2

Looking back to 2023, I will start from a short summary very much in line with what we shared in today's press release. We believe that if our performance in 2023 reflects our ability to navigate volatile demand Growth simultaneously and simultaneously is the key word here, honored by both geopolitical and macroeconomic conditions. After rebalancing most of our delivery Italian footprint across Europe, Western and Central Asia, India and Latin America and refining our go to market approach to meet current demand, we are now focused primarily on harmonizing our delivery quality, optimizing cost effectiveness and proactively leveraging our extensive advanced technology and growing consulting capabilities to capitalize on Gen AI and AI driven opportunities of the future. In that context, first a few notes on 2023 and their relevance to 2024, And then I can move on aspects of our 2024 outlook. Let me start from geopolitical and economic impacts on the Palm operations.

Speaker 2

In February of 2022, the Russian invasion of Ukraine made it necessary for us to relocate over 13,000 people plus families to new geographies. While most of these relocations completed back in 2022, many adjustments did happen last year. And still today in 2024, we will continue to work on some downstream factors, including seniority pyramid, team composition and cost effectiveness across our traditional and new locations. I want to also especially recognize our team in Ukraine who proved that despite the level of challenges, they accepted a reliable partner for our clients, existing and new ones. A few additional notes on repositioning and stabilization of our Thailand delivery platform.

Speaker 2

As mentioned already, 2023 was a year of significant rebalancing for most of our global delivery. We work on scaling India and LatAm And at the same time, preparing for future growth in development centers across Europe, Investor and Central Asia, our key destination In 2023, India continued to be our fastest growing location, practically since 2021. And while we were growing our capabilities there with accelerated speed, we also worked to ensure that our delivery culture remains focused on quality and client value. India will likely become our largest location by the end of 2024 or at least on March with our current scale in Ukraine. Latin America, specifically our locations in Colombia and Mexico, has been maturing significantly as we scale out our cloud and data capabilities there to be prepared to meet rising demand from North American clients.

Speaker 2

And so we are starting 2024 from significantly refactored geographic delivery platform, much more balanced than ever to bring together the practices, methods and collaborative ways of working and to focus on harmonizing our engineering competencies and critical capabilities in cloud, data and now in AI, to be present now in each of our strategic locations. In 2024, this is one of our key priorities, and we expect these programs to be continuous areas of investment and differentiations for EPAM. As we mentioned in previous calls, there is a growing number of clients who have to slow in their spending with us due to the war. We have started to grow the engagements with us again, but utilizing our much more diverse geographic footprint and advanced delivery capabilities. Supporting this trend will be another key priority As we continue during 2024 to build up our capabilities both geographically and from our services mix perspective.

Speaker 2

To illustrate some relevant specific efforts, I will share several ongoing investments in engineering Capstone's AI learning journeys for all the partners covering standard copilots and other AI assisted engineering productivity tools for all key delivery roles with specific adoption targets being set up for all locations. This tool was released in 2023 with upgrades coming in Q1 and beyond. New upgrades to our digital delivery platform, now BN AI enabled and leveraging a set of composable assets that include EPAM proprietary together with open source components and tools to connect to a variety of other lens for supporting the most critical capabilities, protecting private data and promoting cost effective and reliable consumption for external LLX, the EPAM Dial Platform. Finally, productivity measurement framework, allowing tailoring of engineering and agile best practices for continuous improvements of individual and team productivity in AI assisted development environment. All those efforts should make it possible for us to become the most geographically diverse and broadly AI assisted delivery talent platforms in the industry.

Speaker 2

Now about cost effectiveness. It became obvious at the end of 2022 throughout 2023 But to navigate current economic environment, we must continuously consider post optimization efforts to react properly to oil changes around us. Some targeted optimization efforts were ongoing in 2023 across both in market and global delivery locations. This has improved our utilization in short term and allow us to fund several initiatives in 2023 2024. We will be considering similar efforts as appropriate in the future to ensure our adaptability needs.

Speaker 2

We are also actively working on rebalancing our seniority parameters by engaging and training junior talent, while improving overall seniority in market and across our key global practices. About AI and Ren AI efforts. For years, we have been investing into and scaling our data, ML and predictive AI capabilities. Today, many of our clients are engaging us to do the foundational engineering and data ML work required to help them operate their current businesses, but also to enable them to start their work as generative AI. Since mid of last year, the majority of these are relatively small.

Speaker 2

We engaged in over 400 G and I related projects. Our coverage of use cases is broad, from knowledge management to HCM, from product management to supply chain and service optimization, From advanced business process redesign to new interactive agent development, from engineering productivity enhancements by using Gen AI tools to improving speed and quality of code generation and testing. Last year, we launched DIAL, our enterprise level orchestration platform to accelerate development of Geni Empowering Business Solutions. Recently, we released it for open source. We are encouraged by seeing a high level of interest from our clients expressed in over 60 pursuits with 15 active projects in progress right now and some already in production implementations across Tech, Insurance, Retail, Automotive, Life Science and Business Information vertical segments.

Speaker 2

One of the most interesting deployment was done for major global economic data institution and one of the most rewarding has been our work in Ukraine on famous DEA, a government platform, which now includes NNI and AI capabilities as well. Now let's talk about demand environment. In 2023, we have managed to safeguard many of our programs and clients' portfolios. We also saw some call back in spend last year and expect that this may continue to be a factor into 2024 as our clients execute vendor consolidation exercises to manage their costs. While this trend continues and in some cases To our benefit, we are seeing encouraging signals of general rebound for build based solutions and for traditionally strong Katupama capabilities and advanced tech data experience consulting, NII.

Speaker 2

To capitalize on potential new demand, we are expanding our new business initiative by enhancing our sales strategies and go to market partnerships dedicating resources to create new accelerators, establishing new engaging models and innovating our customer interaction method. In 2023, it was also evident that we brought new clients at a rate higher than in previous years, and we plan to do it again in 2024. Still, in overall, we believe at this point, the 2024 environment will be, at least for the first half of the year, a continuation of 2nd part of 2023 trends with the potential demand after 2nd half. While we have made significant progress on involving our operations and despite the challenges we have faced in 2023, Our work as clients is being increasingly recognized by leading analysts and provide in turn some independent support for the stories we shared. All the reports are very recent, last 2, 3 months and present the up to date use on EPAM.

Speaker 2

About some new capabilities, in November 2023, EPAM was featured in by Gartner and competitive landscape IT service providers to the Global Insurance Industry Report. That is probably one of the first recognition by Gartner of our industry expertise and a result of our efforts to bring Insurance Consultancy and implementation services simultaneously for the clients' benefits. Putting together Insurance Consulting Advisory Practice was of the key efforts for us during the last few years. Similar efforts today are underway in Healthcare and Life Science, Retail and Distribution, Oil and Gas In Q4 2023, EPAM was featured in Forrester Report the cybersecurity consulting services landscape Q4 2023. EPAM was highlighted as one of the top 33 cybersecurity consulting services providers, which is probably a forced recognition of a critical capability we are developing for the last years.

Speaker 2

Now about some established capabilities, which were confirmed recently. In November 2023, EPAM was recognized as a top 3 companies in Magic Quadrant for critical capabilities for customer software development services worldwide by Gartner. Leadership and strengths were specifically highlighted in leveraging the narrative AI, pioneering DevOps and providing superior customer support and unique user experience. In November December 2023, IDC named EPAM as a leader in 3 reports: IDC Marketscape for Worldwide Experience Design Services Vendor Assessment IDC Marketscape for Worldwide Experience Built Services Vendor Assessment, NIDC Marketscape for Worldwide Software Engineering Services Vendor Access. Finally, Ad Age recognized EPAM as the number 6 largest agencies in the United States and number 18 in the world's largest agency companies categories.

Speaker 2

In just 7 years, EPAM has moved from number 130 to number 6 among U. S. Agencies. Before I hand over the call to Jason, I would like to take a moment to share a couple of points on some aspects of our results for 2023 And our outlook for 2024. In 2023, we generated RMB4.69 billion in revenues, reflecting a correction of 2.8% year over year.

Speaker 2

Excluding the impact of exiting our Russian operations, Revenue declined 1.8%. Adjusted income from operations was 16.3% of revenue and above the midpoint of our initial guided range. Also, the current market conditions don't represent at all an ideal demand environment for EPAM. Our 2023 results highlight our commitment to adapting the company to suit the current circumstances while continuously preparing for the more beneficial for us demand environment in the future. What I want to point out as well is that our Q4 results shows a sequential revenue growth, first time after 3 previous quarters of sequential declines.

Speaker 2

About 2024 outlook, Because of our ability to adapt to new client demands and market conditions, we are optimistic about the opportunities ahead of us towards the end of 2024. Demand to build postponed during the last 2 years should rebound, driven by long term pressures for legacy modernizations, by needs for advanced customer centric solutions and by the massive interest to understand how to apply Gen and I and General AI capabilities to build new platforms and solutions. Even while we continue to integrate current economic and geopolitical environment carefully, we will invest in strategic initiatives organically and with support of expanded M and A activities in demand generation efforts and in people programs. This will have some effect on our profitability in 2024, but we believe this has the right actions to ensure long term growth and stronger market position. Let me turn the call over to Jason to provide more details on our Q4 and full year results in addition to our initial view of 2024 expectations.

Speaker 3

Thank you, Ark, and good morning, everyone. In the Q4, EPAM generated revenues of $1,160,000,000 a year over year decrease of 6% on a reported basis and a 7.3% decrease in constant currency terms, reflecting a positive foreign exchange impact of 130 basis points. The reduction in Russian customer revenues resulting from our decision to exit the market had a 70 basis point negative impact on year over year revenue growth. The modest sequential growth in the quarter was the result of stabilizing demand. Revenues in Q4 were higher than we expected when we set Q4 guidance due to both stronger client demand and significant benefit from favorable foreign exchange.

Speaker 3

Beginning with our industry verticals, life sciences and healthcare grew 11.6%. Growth in the quarter was driven primarily by clients in life sciences. Travel and consumer decreased 4.4% with solid growth in travel and hospitality, offset by declines in revenues derived from consumer goods and retail customers. Financial services contracted 7.1% driven by declines in banking, partially offset by work performed for marketplace exchange and finance information and analytics clients. Excluding the impact of the exit of our Russian operations, revenue on a year over year basis declined 5.5%.

Speaker 3

Business Information and Media declined 14.8% in the quarter. Revenues in the quarter continued to be impacted primarily by a reduction in spend across a number of large clients due to uncertainty in their end markets, particularly in the mortgage data space. Software and high-tech declined 16.8% in the quarter. The year over year growth rate was negatively impacted by the reduction in revenue from a former top 20 client. We mentioned during our previous earnings calls and generally slower growth in revenues across the range of customers in the vertical.

Speaker 3

And finally, our emerging verticals delivered growth of 4.2%, driven by clients in energy, manufacturing and education. From a geographic perspective, the Americas, Our largest region representing 58% of our Q4 revenues declined 7.6% year over year or 7.7% in constant currency. On a sequential basis, growth remained relatively flat consistent with the previous quarter. EMEA, representing 39% of our Q4 revenues, was Flat year over year and declined 3.5% in constant currency. APAC declined 10.9% in both reported and constant currency terms and now represents 2% of our revenues.

Speaker 3

And finally, CEE representing 0.1% of our Q4 revenues contracted 91.6% year over year or 91.3% in constant currency. Revenue in the quarter was impacted by the exit of our operations in Russia. Going forward, I will no longer comment on the CE region in our quarterly prepared remarks, given that its revenue contribution is immaterial relative to our total revenues. In Q4, revenues from our top 20 clients declined 5% year over year, while revenues from clients outside our top 20 contracted 7%. Moving down the income statement, our GAAP gross margin for the quarter was 31.1% compared to 32.4% in Q4 of last year.

Speaker 3

Non GAAP gross margin for the quarter was 33% compared to 34.1% for the same quarter last year. Gross margin in Q4 2022 was positively impacted by the timing of year end revenue recognition. GAAP SG and A was 18.5 percent of revenue compared to 16.6% in Q4 of last year. GAAP SG and A in the quarter was impacted by one time charges, including expenses associated with the company's cost optimization program. Non GAAP SG and A came in at 14.2 percent of revenue compared to 14.8% in the same period last year.

Speaker 3

SG and A expense for Q4 2023 reflects some cost efficiencies achieved in the quarter as well as lower variable compensation compared to Q4 2022. GAAP income from operations was $122,000,000 or 10.6 percent of revenue in the quarter compared to 170,000,000 or 13.8 percent of revenue in Q4 of last year. Non GAAP income from operations was $200,000,000 or 17.3 percent of revenue in the quarter, compared to $220,000,000 or 17.8 percent of revenue in Q4 of last year. Our GAAP effective tax rate for the quarter came in at 23.4% versus our Q4 guide of 24%, due to greater than expected excess tax benefits related to stock based compensation, partially offset by higher state taxes and the impact of losses in certain non U. S.

Speaker 3

Acquired subsidiaries. Our non GAAP effective tax rate, which includes the impact of state taxes and subsidiary losses and excludes excess tax benefits was 25.1%. Diluted earnings per share on a GAAP basis was $1.66 Our non GAAP diluted EPS was $2.75 reflecting a decrease of $0.18 or 6.1% compared to the same quarter in 2022. In Q4, there were approximately 58,900,000 diluted shares outstanding. Turning to cash flow and our balance sheet.

Speaker 3

Cash flow from operations for Q4 was $171,000,000 compared to $186,000,000 in the same quarter of 2022. Free cash flow was $161,000,000 compared to free cash flow of $165,000,000 in the same quarter last year. We ended the quarter with approximately $2,000,000,000 in cash and cash equivalents. At the end of Q4, DSO was 71 days and compares to 73 days in Q3 2023 70 days in the same quarter last year. Share repurchases in the 4th quarter were approximately 143,000 shares for $36,500,000 at an average price of $255.96

Speaker 4

per share.

Speaker 3

As of December 31, we had approximately $335,000,000 of share repurchase authority remaining. Now moving on to a few operational metrics for the quarter. We ended Q4 with more than 47,350 consultants, Designers, engineers, trainers and architects, a decline of 10.4% compared to Q4 2022. This is the result of lower levels of hiring combined with both voluntary and involuntary attrition as we continue to balance supply and demand. Our total headcount for the quarter was more than 53,150 employees.

Speaker 3

Utilization was 74.4% compared to 73.6 in Q4 of last year and 72.7 percent in Q3 2023. Turning to our full year results for 2023. Revenues for the year were $4,690,000,000 producing a decline of 2.8% reported and a decline of 3.4% in constant currency terms compared to 2022. Excluding Russia revenues, the reported year over year growth rate would have been negative 1.8% reported and negative 2.4% in constant currency terms. GAAP income from operations was 501,000,000 a decrease of 12.5% year over year and represented 10.7 percent of revenue.

Speaker 3

Our non GAAP income from operations was 765,000,000 a decrease of 6.5% compared to the prior year and represented 16.3% of revenue. Our GAAP effective tax rate for the year was 22.3%. Our non GAAP effective tax rate was 23.7%. Diluted earnings per share on a GAAP basis was $7.06 Non GAAP EPS, which excludes adjustments for stock based compensation, Acquisition related costs and certain other one time items including costs associated with our cost optimization program was $10.59 reflecting a 2.8% decrease over fiscal 2022. In 2023, there were approximately 59,100,000 weighted average diluted shares Outstanding.

Speaker 3

Cash flow from operations was $563,000,000 compared to $464,000,000 for 2022 And free cash flow was $534,000,000 reflecting 85.4% adjusted net income conversion. And finally, share repurchases in 2023 were approximately 686,000 shares for $164,900,000 at an average price of $240.49 per share. Our 2023 results reflects EPAM's ability to manage the business through challenging macro conditions, while positioning the company for the return to a more normalized demand environment. Now let's turn to guidance. Before moving to the specifics of our 2024 and Q1 outlook, I would like to provide some thoughts to help frame our guidance.

Speaker 3

As Ark mentioned, the demand environment remains uneven and we believe this will persist at least on first half of twenty twenty four. We have been pleased with the progress we are making on demand generation and we'll continue to prioritize revenue growth into 2024, which in some pursuits includes some degree of discounting. In 2024, we expect to incur incremental costs due to more normalized variable compensation levels in addition to wage inflation in certain geographies. This higher level of compensation combined with the limited ability to improve client pricing in the near term will continue to put pressures on margins in 2024. Finally, despite the war, our operations in Ukraine have not been materially impacted and our teams remain highly focused on maintaining uninterrupted production.

Speaker 3

Our guidance assumes that we will continue to be able to deliver from our Ukraine delivery centers at productivity levels similar to those achieved in 2023. Now starting with the full year outlook, revenue growth will be in the range of 1% to 4% on both a reported and constant currency basis. The impact of foreign exchange is expected to be negligible. At this time, we expect a nominal revenue contribution from inorganic revenue for 2024. Lastly, we are seeing some improvement of demand, but visibility for the year is still limited.

Speaker 3

Although we are guiding to modest sequential growth in Q1, Increases in demand may not sufficiently offset revenue impacts resulting from seasonality in all quarters in 2024. We expect GAAP income from operations to be in the range of 9.5 percent to 10.5 percent and non GAAP income from operations be in the range of 14.5 percent to 15.5 percent. We expect our GAAP effective tax rate to be approximately 21%. Our non GAAP effective tax rate, which excludes excess tax benefits related to stock based compensation will be 24%. Earnings per share, we expect that GAAP diluted EPS will be in the range of $7.20 to $7.60 for the full year.

Speaker 3

And non GAAP diluted EPS will be in the range of $10 to $10.40 for the full year. We expect weighted average share count 59,300,000 fully diluted shares outstanding. For Q1 of 2024, we expect revenues to be in the range of 1.155 to $1,165,000,000 producing a year over year decline of approximately 4% With the expected impact of FX to be minimal. For the Q1, we expect GAAP income from operations to be in the range of 9% to 10% and non GAAP income from operations to be in the range of 13.5 percent to 14.5 percent. Our Q1 income from operations guide reflects the impact the resetting of social security caps, normalized variable compensation and somewhat higher bench levels, where we expect to see improvement throughout the year.

Speaker 3

We expect our GAAP effective tax rate to be approximately 11% and our non GAAP effective tax rate, which excludes excess tax benefits related to stock based compensation to be approximately 24%. For earnings per share, we expect GAAP diluted EPS to be in the range of $1.79 $1.87 for the quarter and non GAAP diluted EPS to be in the range of $2.26 to $2.34 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 for 2024. Stock based compensation expense is expected to be approximately $198,000,000 with $44,000,000 in Q1, $48,000,000 in Q2 $53,000,000 in each remaining quarter.

Speaker 3

Amortization of intangibles is expected to be approximately $26,000,000 for the year, evenly spread across each quarter. The impact of foreign exchange is expected to be a $1,000,000 loss for each of the quarters. Tax effective non GAAP adjustments is expected to be approximately $46,000,000 for the year, with $11,000,000 in Q1, dollars 11,000,000 in Q2 and $12,000,000 in each remaining quarter. We expect excess tax benefits to be around $28,000,000 for the full year with approximately $17,000,000 in Q1, dollars 5,000,000 in Q2 and $3,000,000 in each remaining quarter. Finally, one more assumption outside of our GAAP to non GAAP items.

Speaker 3

Our growing cash reserves are generating interest income EPAM is receiving governmental incentives from several countries in which we establish delivery operations. As a result, in 2024, we are anticipating an increased level of other income. We expect interest and other income to be around $66,000,000 for the full year, with $16,000,000 in Q1, $20,000,000 in Q2 $15,000,000 in each remaining quarter. My thanks to all the ePAMers who made 2023 a successful year and will help us drive growth throughout 2024. Operator, let's open the call up for questions.

Operator

Thank you. Our first question comes from the line of Ramsey El Assal of Barclays. Please go ahead.

Speaker 5

Hi, thank you for taking my question this morning. I wanted to ask about your view on the second half of twenty twenty four sort of inflection. You sounded incrementally confident, I think, that the demand environment might pivot into a positive direction at that point. Can you just comment further on what's giving you confidence in this visibility, are client conversations changing? Are you seeing a backlog of delayed projects build up?

Speaker 5

What has changed in your forward view That's supporting this sort of incrementally positive sense that the second half is where things may inflect?

Speaker 6

I think it's exactly what you said. We were thinking a lot of activities in Q4 and A lot of conversations still happening today, but decision point delays still. And In our view, how these activities were increased, we do believe that Future delays would be very difficult to kind of hold because the companies will need to address grew in debt. And we've taken at least we think it's a pretty responsible view What might be happening as this type of increase, place of discussion of Many programs and kind of desires which we have during the last months should become to subsidization. So as we kind of laid in and shaped in our activities around it.

Speaker 5

Got it. Okay. Thank you.

Operator

Thank you. Our next question comes from the line of Bryan Bergin of TD Cowen. Please go ahead.

Speaker 7

Hi, good morning. Thank you. I wanted to start on margin here. So good result in the 4Q AUM. Can you talk about maybe what costs and investments now are most notable that I'm back in for 2024 and the cadence considerations.

Speaker 7

I heard some investments in demand gen and go to market, I think, can you flesh that a bit more? And I guess the root of the question is, What do you consider more transitory versus potentially structural cost differences as you go forward?

Speaker 3

Yes. So, we obviously have been very thoughtful around what our cost structure would look like this year and are mindful of the guide here Profitability, the decision we made, Brian, was that we did want to return to a more typical variable compensation. And then we thought a lot about the pricing environment and the wage environment and decided that we would move forward with our traditional salary increases or promo in Q2 of this year. We've got very low voluntary attrition. We want to keep it that way because we do have confidence in return to growth later in the year.

Speaker 3

So I would say the people programs are probably most significant. But then we do have significant investments in AI. And again, we thought about whether or not we would want to scale those back and we thought that that wasn't appropriate some of the traction that we believe that we're getting in AI at this point. And then as you talked about the programs that are primarily focused on sort of demand generation, some of our partnership programs, and then continuing to enhance our domain capabilities. And I don't know, Ark, you have any thoughts about either the AI or the demand generation?

Speaker 6

Yes. As everybody said, it's Still a lot of experimentation, but we highlighted something which we do. And there is a quest to Implementation is happening as we speak. Still the program is not very sizable, but what we

Speaker 4

also see is that a lot

Speaker 6

of proof of concepts Actually proven to the point that it will trigger additional tail of data engineering programs a lot Because while experimentation going well and proof of concept looks good, Usually the data for this type of activities is massaged well enough And as soon as you go into production activities in many cases, it's figured it visibly need to invest in data engineering and different activities to at scale proactively. So that's why also we believe that this figure will happen and amount of work for this type of CHS will be Being some fruits to us as well. Yes.

Speaker 3

We think there will clearly be a return on the AI investment. Then Brian will be working on utilization and our security permits throughout the year. I think you'll see an improvement in gross margin in the second half of twenty twenty four, hopefully setting us up for more better profitability in 2025.

Speaker 7

Okay, thanks. And then follow-up just as it relates to kind of your larger client Award expectations. Are the ramp down that you had thought as you entered 'twenty four progressing as you had expected? And is the second half improvement consistent across your larger clients? I'm thinking about your top 10, your top 20 base.

Speaker 3

We had talked about a known and expected ramp down in Q1 That is upon us and it is obviously part of our Q1 guide. Other than that, you don't see Significant incremental kind of ramp downs and we are feeling like demand is stabilizing. From a customer standpoint, we are seeing good strong Traction in life sciences, we clearly are seeing a lot of opportunities in energy. And I expect that we probably return to sequential growth in a number of our industry verticals here in Q1. So I would say, yes, it's generally the demand is a little broader from at least an industry vertical and customer standpoint.

Speaker 8

Okay. Thank you.

Operator

Thank you. Our next question comes from the line of David Grossman of Stifel. Please go ahead.

Speaker 9

Good morning. Thank you. I'm just looking at the headcount adds and it looks like you're on a year over year basis Pretty much down in most geographies, I think with the exception of a couple or maybe just India. And I guess I'm just trying to understand and juxtapose that dynamic against expectation of Accelerating growth in the back half of the year and perhaps you're targeting a higher utilization rate than you experienced in 'twenty three or other factors at play. And just wondering if you could help flush that out for us and Whether or not the kind of changing how we should think about the changing geographic mix and its Impact on growth given the bill rate differential between India, for example, and Ukraine and Eastern Europe?

Speaker 3

Yes, so good questions. The first that I would say is as you look at that Our fact sheet where you can see obviously the headcount declines across a range of geographies. If we turn to kind of Eric's comments here during, I guess, the fixed portion of today is that we did obviously have to increase headcount across a broad range of countries It's kind of a contingency in case things didn't go as well as they all planned and up going in Ukraine. And so we then afterwards tuned headcount somewhat just because we've Done some amount of access hiring across a broad range of geographies, just as a contingency in case we weren't able to deliver successfully from Ukraine. At this point, you're clearly seeing growth in India.

Speaker 3

You'll continue to see growth in Latin America. We do expect The incremental growth in India is going to put some pressure on revenue per headcount. And that's part of reason for the guide of the 1% to 4% that we've got in there. I think I

Speaker 6

would add to the full add. If you remember our original guide, 1 year ago, at the beginning of 2023. So It was way kind of optimistic and revenue was higher than we guided Today for 2024. So which means that we Prepare it for the growth and number of people that you have back then were corresponding to our source. Then 2023, in this case, become for us an adjustment period when we have to bring Relative numbers to this kind of to reality.

Speaker 6

And on top of this, as we Saying we were just now thinking about market from cost perspective as well. So 2023 was actually 12 months when we were breathing us back to shape to change its condition. From this point of view, it's very much in line with our guidance for this year. We're still keeping The serious kind of investments to be able to start hiring back to trade in big quantities, so we feel Well, it's not where it's pretty comfortable. That actually reflected the reality.

Speaker 9

So if I take those comments and the comments you in a previous question about the margin dynamic for the year, Does that imply that the cadence of margins should improve? Or if we think about margin improvement As 2024 progresses that we'll get back to kind of more of a historical level as we exit 2024?

Speaker 3

Certainly, I expect lower gross margins in the first half, that's both Q1 and Q2 and then a fairly significant improvement in the second half. And that would be both due to the available bill base as well as improvements in utilization and pyramid. So I don't know whether or not that's the same as where we've been kind of historically, but I do expect us to head back towards more typical profitability, as we get closer to the end of the year and as we enter 2025.

Speaker 9

All right. Got it. Thanks very much.

Operator

Thank you. Our next question comes from the line of Puneet Jain from JPMorgan. Please go ahead.

Speaker 10

Hey, thanks for taking my question and good quarter. So, Ark, you mentioned like That there is some like the adjustment of seniority of employees that's ahead of you, probably something you'll do this year. Could you share like if your average experience like running above normal due to maybe low attrition, low hiring right now? And what should we expect for revenue per employee as like if

Speaker 6

I think This adjustment is happening. What I don't believe is the revenue per employee exactly the Kind of the metric which reflects the reality because it depends Very much is how we kind of optimize our delivery locations. India is growing and India, for example, growing not little. I think it's 20% last year. And I think it was even much higher year before, like more than 50%, Okay.

Speaker 6

So which is actually definitely impacted the revenue per employee. It's the same like switch between People moving from Eastern Europe to Central Europe growing in Latin America, that should be taken into account, Not talking about even on-site present. So I said we're not looking to this metric as a physical metric for us.

Speaker 10

Got it. Got it. And your utilization like it improved on sequential basis like what should we normalize utilization given that you are operating under a much more distributed delivery model now?

Speaker 3

Yes. I mean, our goal would be to go back towards more typical, which was the amount of the higher 70s. So I don't think that the distribution is going to have a significant impact on our targeted utilization levels.

Speaker 2

Okay. Thank you.

Operator

Thank you. Our next question comes from the line of Maggie Nolan of William Blair.

Speaker 11

Jason, can you be a little bit more explicit on your commentary about Seasonality versus demand offsets on a quarter by quarter basis and maybe just remind us which quarters are going to be more difficult to overcome Seasonal pressures given that that may be different from historical given your changing geographic footprint and holiday schedules, etcetera?

Speaker 3

Okay, great. Thanks for giving me the chance to clarify that. So Q2 is generally There's less capacity or less sort of available build days. Q3 is usually very strong quarters. Usually we see Quite significant sort of sequential growth Q2 to Q3.

Speaker 3

The comment that I made in my prepared remarks was really that We are seeing what feels like a better demand environment, more stability, Larger number of conversations with clients and some kind of larger deal size opportunities, but Q1 to Q2 definitely has a negative seasonal impact. And so I just wanted to call out that there was some potential that that seasonality could cause us to be sequentially flat to maybe even possibly down. But generally the expectations are that we'd see much growth Q1 to Q2. But again, it will take definitely improving demand environment to get us there.

Speaker 11

Okay. Thank you. And then you've mentioned Pricing for a couple of different quarters now and sharpening your pencils, are you doing anything that you feel will help protect your ability to raise Pricing in future quarters years, and how do you get comfortable with the level that you're setting your rate cards to now versus ability to increase in the future?

Speaker 6

There's probably

Speaker 3

a few things going on. I think we're trying to make certain that we don't have multi year commitments that kind of lock us in. Even when you do have opportunities to come back to clients. So generally Maggie, I would say traditional S and W structure for us are about a year in length. The other thing that we are continuing to do and I think you would see it in the mix of our commercials You're seeing more fixed fee engagements where there's not only is it more sort of consulting led, But also there's a little bit more opportunity for us to take responsibility for delivery and

Speaker 6

that gives

Speaker 3

us an opportunity to improve profitability as well.

Speaker 11

Thanks for all the detail.

Speaker 6

Thank you.

Operator

Thank you. Our next question comes from the line of Tarinder Thind of Jefferies. Please go ahead.

Speaker 8

Thank you. In terms of just as we look at the year ahead, how much of a reshaping of the pyramid do you think you need at this point in terms of having the appropriate skill set for the demand environment evolves? And then I guess related to that, how quickly are you able to hire at this point if There was an increase in demand in terms of how much bench do you need to keep and how quickly can you

Speaker 6

Okay. I think it's an interesting question to address. First of all, because There is a lot of uncertainty even how quickly productivity will be growing and We're watching this very, very carefully. What type of new people will be needed actually in the market And we put in a lot of investment efforts and that's what we shared already, specifically in this activity. What it means that we need to watch practically month by month, quarter by quarter, how productivity improvements would be realized and how Clients will be kind of supporting this because there are a lot of questions about legal aspects of So it's about What actually we'll need like a year from now or later.

Speaker 6

So when ability to hire And again, we invested here, we play as we watch this very, very carefully. So liability to hire, we keep in All our core previous investments in educational training for juniors. And again, it's how and what we're going to trade is changing of the fly. During the last time, We're going to continue changing. So but we're pretty confident that we would be able to accelerate when needed, Especially with the softness of the market, during the last several years, a lot of talent was produced on the market in junior levels, which is Not necessary, we're finding jobs.

Speaker 6

So I think it's building up right now and when markets will be back Is everything what we did before, we feel kind of normal to increase?

Speaker 3

Yes, we continue to have we're flexible. We clearly have been investing to make certain that we can add capacity across a broad range of geographies. So, yes, we'll go about our development that responded demand.

Speaker 8

Got it. I guess just as a clarification. So the idea is that you can hire within a quarter to address needs terms of having the flexibility, the capability, the training, I guess that's kind of what I was trying to get at.

Speaker 3

Yes. I think That would be fair. We've got obviously utilization opportunities 1st and foremost, but then yes, a quarter window would probably be appropriate.

Speaker 6

This is all proportionally. The 1 quarter is the demand will not jump as It's crazy. So it's still going to be spread around the quarters. We still don't seem Right now that demand will be performing kind of in 2021. It would be much more softer.

Speaker 6

So and if you remember 2021 and it was very quickly become hot market, we were performing pretty well.

Speaker 8

That's very helpful. Thank you.

Operator

Thank you. As a reminder, And as we have limited time and a desire to get to as many analysts as possible, we kindly request that questions are limited to 1 per caller. And if time permits, you may poll for a follow-up Thank you. Our next question comes from the line of Moshi Khatri of Wooten Securities. Please go ahead.

Speaker 4

Okay, thanks. Congrats on strong execution. Art, when you started the call, you indicated the clients That moderated spending with EPAM last year coming back.

Speaker 6

Can you talk a bit

Speaker 4

more about that? Is it that they went to some some of your competitors are coming back, they're changing their plans, what's prompting that?

Speaker 6

I think we were talking about it many times during the last year, but At the beginning of the year, we were much more optimistic. We didn't realize that impact of the war raised Risk profile for Evam and uncertainty that we will be able to navigate the war. So a lot of calls clients were doing the middle of 2022, which kind of delayed decision with us or actually going to Just starting to replace, not put a new release to us, but unfortunately, we realized impact of this only kind of at the end of the Q1 2023. And some of these actions make a pretty long Term impact, we still have clients who declining because when decision done and they signed with somebody else, it's happening. So this is was This is very visible impact in 2023.

Speaker 6

Plus economy and that's why I would say the simultaneous impact of these 2, 6 were The most critical for us, which really put us aside from our competitors, which have only one part of this challenges. So when economy started to slow down, then again, competition for rates, cost and everything else pick up. And this was second one. So but it seems which we also mentioned that there are some clients who are coming back to us And some of them growing as well, but definitely this is part of 20 23 and partially will be for us part of 2024. If you think at the same time that how we were bridging some new business To compensate this, that's kind of a positive part of the story.

Speaker 6

Declining in 2024 definitely will be Smaller than declining was at 2023.

Speaker 3

And then we continue to see clients who may have experimented with other vendors, reengaging with us with both discussions and in some cases actually transferring work back to us just based on

Speaker 6

the fact that they didn't

Speaker 3

get as much done with those other banners.

Speaker 4

That makes sense. And is that because they're more comfortable with your execution from places like India or Latin America? Is that kind of It's

Speaker 6

multiple factors. Some of them become much more comfortable with Ukraine because it was any impact of the quality of interaction. So some were thinking we'll believe it and Now it stays there. So it's also we proved that we can deliver from different locations. India was probably one of the kind of major critical components here.

Speaker 6

So and third one, I think that when we're removing Some lot of works to some competitors, the results were not satisfactory and they started to come back to us or waiting when their commitments with new vendors will be kind of expired and it will be possible to So I think it's between all these lines.

Speaker 4

Understood. Thank you.

Operator

Thank you. Our next question comes from the line of Darrin Teller of Wolfe Research. Please go ahead.

Speaker 12

Yes, guys. I want to follow-up a bit on the competitive landscape for a minute. And the main question is really just sort of circling back. You said you're seeing You also talked about adding a ton of new, I think more than usual new customers over the past year and you're seeing that progressing into this year. So Putting that all into context, just there's been a lot of discussion of competitors trying to be more aggressive, taking advantage of what happened in the war in Ukraine.

Speaker 12

What are you seeing competitively? I mean, has anything truly changed? And then maybe dovetailing that into The potential we could see for this year, you said you added a bunch more than usual new customers you've been adding at a run rate. I guess that informs your decision on what you're seeing in terms of guidance

Speaker 3

for the second half of

Speaker 12

the year. Why not a little bit more in the first half it was being added last year. Thanks guys.

Speaker 6

So I think when we're talking about increasing the client It's true the difference with previous year that this is smaller clients, smaller Clients maybe not smaller, but smaller engagements. And overall, it still feel A lot of pressure from both companies and organizations. It's all coming back to our statement that We actually adjusted our behavior during the 2023, okay, and started to use different approaches to kind of protect client base as well. But It was much more visible all the transition between first half and second half of twenty twenty three. We're still seeing that something similar will be continuous for this and next quarter.

Speaker 6

And that's exactly explained all these dynamics and competitive situation. We see that clients Starting the programs, we participated in this bigger programs than they were considering in the first half of twenty twenty three. So we think this acceleration will be happening that second half will give us opportunity To demonstrate it. One point I just Okay. I'll load the points which I was reading maybe later.

Speaker 6

I will add.

Speaker 3

You're right, definitely stronger new logo activity, stronger new customer revenues. Don't forget that we do have the ramp down in Q1 from the one customer. And as Ark said, some kind of slower kind of decision making. But again, generally the demand environment This feels like it's stabilizing and potentially improving.

Operator

Thank you.

Speaker 6

Well, what I wanted to do is actually my our usual remark. Until The full speed what we kind of all expecting from margins and from the real growth, It's still function of right demand. And this right demand, We consider it will start to be realized on second part. At what level, so we put it conservative right now, at least we think that it's conservative or realistic right now. So what would be happening still this year, definitely Less predictable than kind of before what, yes.

Speaker 6

We all know it and it's not about us, it's about the whole IT segment.

Speaker 1

Should we do one last quick call or question and then wrap up?

Operator

Thank you. Our final question comes line of Sean Kandi of Mizuho. Please go ahead.

Speaker 4

Hi, everyone. Good morning and thank you for taking my question. I understand it's still very early on, GenAI, but what specific types of GenAI capabilities are your clients most excited about currently? And you expect those to change as the technology matures?

Speaker 6

So I think still there are at this point a lot of experimentation and a lot of Kind of more straightforward thinking about Gen AI As it's available practically for the end consumers and how this can change interfaces. And again, very straightforward that Everybody is thinking how to have right access to the hybrid Data between general labs, the specific ones and most of the companies experimenting in this area and create some type of copilots. And I'm talking about application areas and just utilizing G and A as a productivity tools for individuals We call it as a subset. I'm talking about like client facing capabilities, New insight, the difficulties of this is it will be changing quarter by quarter. So And I think some exciting things which we've seen right now would become very quickly commodity and much more sophisticated since we'll be happy like 12 months from now.

Speaker 6

Got it. Thank you. Very worried, like you said.

Operator

Thank you. I will now turn the call back over to Arkady Dobkin, Chief Executive Officer and President for concluding remarks.

Speaker 6

Thank you very much as usual for your questions. I think we feel in general this The business is happening. At the same time, we feel that a lot of unknowns ahead of us and some trends which were Driving the market and our performance in 2023 still actually critical for 2024. But Yes, we feel much better after showing that we can stabilize the revenue decline base And even little but some growth versus continuous decline, which was happening during the previous 4 quarters. Thank you very much and talk to you in 3 months.

Speaker 10

Thank you.

Operator

Thank you. This concludes today's conference call. We thank you for participating and you may now disconnect.

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Earnings Conference Call
EPAM Systems Q4 2023
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