The EPAM Systems Second Quarter 2023 Earnings Conference Call has begun and David Straube, Head of Investor Relations, is introducing Arkadiy Dobkin, CEO and President, and Jason Peterson, Chief Financial Officer. Straube reminds listeners that some of their comments may contain forward-looking statements and all references to non-GAAP measures have been reconciled to the comparable GAAP measures. Dobkin then mentions their mid-quarter update in June, which was caused by the broader concerns over the economy and the geopolitical impact on their delivery centers.

The technology vertical has been greatly impacted by a pull-back in spending due to economic conditions, leading to a high percentage of shortfall in the first half of 2023. Despite the difficult period, the company is taking pragmatic action plans to prepare for a strong rebound position, focusing on digital product and data engineering services, digital consulting, agency, design, content, and digital marketing services.

EPAM is looking to capitalize on its core capabilities in the IT sector by focusing on cloud data and engineering, and is optimistic about the transformation opportunities that AI-led transformation will bring. They are investing in AI-led transformation, which will result in a more complex application stack and close integration with new classes of AI platforms.

EPAM is working to diversify and stabilize their global delivery platform, and allocate their talent more optimally across the world. During the first half of 2023, they have driven new logo activity at higher levels than in 2021 and 2022. Some of their new Q2 clients include a B2B travel platform, a European-based multi-national resilient marketplace, a molecular diagnostic company, a global insurance provider, and global infrastructure services companies. EPAM will also be a trusted and proven engineering partner in digital system integrator for Canadian Tire's seven-year strategic partnership with Microsoft.

EPAM has been working to establish strong relationships with hyperscalers, such as Google Cloud, Microsoft, and AWS, which has been successful. They have also been focusing on verticals such as financial services, consumer economy, entertainment, healthcare, life sciences, energy, and Hi-tech to help customers modernize and transform their businesses. EPAM is confident that they can compete and win in the new demand climate once customers optimize their initiatives and return to growth. Lastly, they are committed to expanding their capabilities and engineering consulting to create a next-generation agency to support AI.

EPAM is investing in R&D and focusing on pragmatic, responsible, and cost-effective solutions. They are building accelerators in IT to help orchestrate transformation programs, expanding their partnerships with cloud providers and research centers, and aligning their consulting and experience in technology. AI services are still at the entry stage of maturity, and EPAM sees it as a large and accelerating opportunity in their primary market segment.

EPAM generated $1.17 billion in revenue in the second quarter, a 2.1% decrease from the year before. This was largely due to reduced spending from clients and their caution when it comes to new projects. EPAM is focusing on activities to learn more about AI-led requirements, which they believe will drive demand for advanced data engineering and other technology-led initiatives. This is expected to be a real engine for future growth. Jason Peterson then gave an update on their Q2 results, which included the exclusion of expenditures related to the Russian invasion of Ukraine.

The decision to exit the Russian market had a negative impact on year-over-year revenue growth, decreasing it by 1.1% and 1.7% excluding Russia revenues. Revenue in the travel, consumer, financial services, business information and media, software and hi-tech, and life sciences and healthcare verticals all saw decreases in the quarter, with the largest decrease in life sciences and healthcare. In terms of geography, the Americas region saw the largest decrease of 5.9%, while the EMEA region saw an 8.5% increase.

In Q2 2023, CEE represented 1% of EPAM's revenues and contracted 61.1% year-over-year, while APAC declined 19.7%. Gross margin for the quarter was 30.9% (GAAP) and 32.6% (non-GAAP), while SG&A was 16.7% (GAAP) and 14.8% (non-GAAP). EPAM incurred $5 million in severance-related expenses and had an income from operations of $144 million (GAAP) and $191 million (non-GAAP).

In Q2, GAAP effective tax rate was 20%, non-GAAP was 23.3%, diluted earnings per share on a GAAP basis was $2.03, and non-GAAP was $2.64. Cash flow from operations was $89 million and free cash flow was $82 million. DSO was 71 days. Share repurchases were approximately 195,000 shares for $41.4 million at an average price of $212.77. Headcount was more than 49,350 consultants, designers, engineers, trainers and architects, while total headcount was more than 55,600. Utilization was 75.1%. However, revenue generated is not enough to offset further expected reductions in client budgets.

The company is expecting a decline in demand in the third quarter, and flat or further sequential decline in the fourth quarter. The company is continuing to deliver from Ukraine and is managing expenses and headcount levels. The sale of the Russian business will result in a decline in Russian revenues and a loss of $18.4 million, which will impact the third quarter and full year results. The company expects full year revenue to be in the range of $4.65 billion to $4.70 billion, with a year-over-year decline of 3%. The non-GAAP income from operations is expected to be in the range of 15% to 16%.

For Q3 2023, the company expects revenues to decline by 6-7%, or 8.5-9.5% excluding the impact of the exit in Russia. The GAAP income from operations is expected to be 10-11%, with non-GAAP income from operations at 15.5-16.5%. The GAAP and non-GAAP effective tax rates are expected to be 24% and 23%, respectively. GAAP and non-GAAP diluted EPS are expected to be $1.62-1.70 and $2.52-2.60, respectively, with a weighted average share count of 59.1 million. Stock-based compensation expense, amortization of intangibles, and foreign exchange are expected to be $39 million, $5.5 million, and $1.5 million gain, respectively, and the tax effect of non-GAAP adjustments is expected to be $11.7 million for Q3 and $9.3 million for Q4.

Arkadiy Dobkin reports that visibility and predictability are better than they were a couple of quarters ago, though there is still a slowdown and elements of unknown. He also noted that excess tax benefits are estimated to be around $2.7 million for Q3 and $1.8 million for Q4, and interest and other income is expected to be $11.7 million for each of the remaining quarters. He thanked the employees for their dedication and opened the call for questions.

Ark and Jason discussed the workforce diversification and operating footprint of the company. They revealed that the CIS region accounts for less than 30% of the company's delivery locations, with India being a significant part of their delivery footprint. Latin America is also a significant part of their expected current and future delivery footprint. They also discussed operating margins and their hope for growth in the coming quarters.

Jason Peterson discussed how the company is trying to be cautious with spending while still making investments in sales channels and partner programs, and AI capabilities. This is being done by tuning different delivery locations, lower hiring, and offsetting attrition with net reductions in headcount. There is also a variable compensation element that is funded by performance, which has resulted in some benefit in Q2 and will have lesser, but some benefit in the remainder of the year. Q3 is expected to have lower utilization, so there will likely be no improvement or even a slight decline in profitability.

Jason Peterson provides an overview of the demand environment across the company's total client base for the second half of the year. He predicts that there will be a sequential decline across a large number of verticals, but growth in the energy manufacturing, healthcare and life sciences sectors. He also notes that customer decisions to reduce spending in Q2 may also have an impact.

David Grossman is asking when the sequential revenue headwinds will diminish if the customer dynamics stabilize. Arkadiy Dobkin responds that a sequential decline is expected in Q2 to Q3, and that it is possible for there to be a little bit of growth in Q3 to Q4, though there is a lower bill day impact that makes it difficult.

Arkadiy Dobkin discussed the difficulty of predicting when the market will recover and how they have already seen some positive signs. He also mentioned that they have been working to geographically diversify and David Grossman asked for some high-level dashboard items that would give insight into their progress. Arkadiy Dobkin mentioned that they can provide more information about their progress in the next two to four quarters.

This paragraph discusses the progress being made in India, Latin America, Central Western Asia, and Central Eastern Europe in terms of production capacity, quality, and engineering. India and Latin America are expected to reach 18-20% of total capacity by the end of the year, while Central Western Asia has a strong potential for growth due to its demographics and Central Eastern Europe is a high quality engineering location with a high demand for talent. The demand is expected to increase in all locations with the return of demand.

Arkadiy Dobkin and Jason Peterson discussed how they are looking to improve their gross margins by reallocating focus across different delivery locations, but they are not yet ready to discuss specifics or ranges for 2024. They are looking to balance the higher cost geographies, including traditional on-site markets, to help improve their gross margins.

Maggie Nolan and Ramsey El-Assal asked questions about the ability to keep the sales force intact during the transformation and the progress on new logos converting to revenue. Arkadiy Dobkin and Jason Peterson responded that the direction is positive and that the focus is now on external opportunities and driving incremental growth.

EPAM has a reputation for being able to deliver complex modernization and innovation projects, which is why they have been named Microsoft's Partner of the Year. EPAM is working to strengthen their relationships with hyperscalers, and they anticipate upcoming announcements that will further improve their partnership levels. This will be key for when demand picks up again, as there is a lot of pressure to finish cloud and data modernization projects, as well as AI components, that will require data engineering.

Jason Peterson and Arkadiy Dobkin discussed the difference in demand between Europe and North America. North America is seeing larger budget reductions and more conservatism while Europe is seeing more traction in the consumer and retail side. They also discussed the bill rates that are being sold through the delivery centers, including India, and confirmed that they are getting the same bill rates as they are getting in Eastern Europe.

Jason Peterson and Moshe Katri discuss how to mitigate the lower margins that may come with new logos and how India has lower price points than some other geographies. Arkadiy Dobkin then talks about how India is important for getting new logos onboard and accelerating growth in the future.

Arkadiy Dobkin is uncertain whether clients will invest in CapEx to modernize or re-platform their core systems in Q4 of 2021 or if it will be part of their budget for the next year. He notes that EPAM is aiming to build a balanced global delivery network and that they have five development centers, with Hyderabad being the largest.

Arkadiy Dobkin explains that new clients are coming from two categories: those who are taking advantage of the current situation to invest and gain a competitive advantage, and those in industries such as oil and gas that are in better shape. He believes that when these clients show results, it will trigger a faster market recovery and an increase in build and transformative programs.

Arkadiy Dobkin is discussing two categories of clients EPAM works with. The first is focused on transformative programs, while the second is focused on building relationships with vendors for future returns and being prepared for the future. Dobkin provides examples of the different types of clients EPAM works with and suggests that if they see better trends, it could be a sign of a market change. Arvind Ramnani asks Dobkin about the client relationships and how they typically start small and ramp over time.

Arkadiy Dobkin reported that in Ukraine, clients who stayed are more comfortable and some are returning, proving that there has been no impact on production activities. In Belarus, there is a slowdown and some clients are exiting, resulting in a decrease in headcount. Overall, the situation is more stable and predictable than the quarter before.

This summary was generated with AI and may contain some inaccuracies.