The operator introduces the conference call for EPAM's third quarter 2023 earnings and reminds participants of the mute function. David Straube, Head of Investor Relations, introduces the speakers, CEO and President Arkadiy Dobkin and Chief Financial Officer Jason Peterson. He also mentions that some statements may contain forward-looking information and that non-GAAP measures have been reconciled to GAAP measures. Arkadiy Dobkin then recaps the company's expectations for the third quarter and full year outlook from the previous call, stating that they believe demand for transformation services will increase in the future.

In the second paragraph, the speaker discusses the company's plans to reinvent their business models and ways of working through accelerated digitization and generative AI. They also mention their expectation for the negative dynamic to continue in the second part of 2023, but express optimism for a return to stronger market demand in 2024. The company is also focused on globalizing and stabilizing their delivery ecosystem and improving gross margins. In terms of demand, there are signs of stabilization in the business, particularly in the life science, healthcare, insurance, and energy sectors.

In today's business environment, the company is focused on addressing client priorities, such as engagement models and cost reduction, while maintaining long-term relationships. They are also investing in demand-led sales and global partnerships to win new business. The company is expanding into new verticals and horizontals, and engaging with clients in both IT and business functions. They have formed partnerships with companies like Google Cloud and AWS to develop AI and data solutions for clients.

EPAM is focusing on accelerating modernization through cloud-native architecture and leveraging AI and advanced analytics in key industries such as healthcare, life science, financial services, insurance, energy, and gaming. They have expanded their partnership with Microsoft to become a globally managed enterprise system integrator, which will help them modernize and transform complex enterprise platforms and processes. While there are signs of improving demand, the global macroeconomic environment remains volatile. EPAM sees growth opportunities in India and Latin America, while Central Eastern Europe and Central Western Asia are stabilizing after previous efforts. Part of their globalization and stabilization efforts include rightsizing and cost optimization across multiple locations based on demand and capabilities. Similar efforts are also happening in Western Europe and North America.

EPAM is continuously investing in key initiatives to expand its engineering G&A and upskill its talent in strategic locations. This includes investing in differentiated consulting, data, ML, AI, and cloud capabilities, as well as developing cost-effective solutions related to responsible AI. EPAM's strong profile in cloud engineering, data, and ML positions them to benefit from the current demand for modernization and the skills shortage in technological transformations. EPAM is also focused on encapsulating Gen AI, trust, reliability, and security management in future applications and platforms through its labs and centers of excellence, which have created IP that is shared with clients through open-source initiatives. One example of this is EPAM's AI orchestration work bench, Dial.

EPAM has made significant investments in AI and has developed a responsible AI framework to help clients with adoption and modernization efforts. The demand for these services is expected to continue growing in the future. The company is also facing challenges in managing supply and demand for skills and adapting to disruptions in the war in Ukraine and the Middle East. The company remains confident in its ability to manage these challenges and is focused on investing for the future. The upcoming quarter and business outlook for 2023 will be discussed in more detail by Jason Peterson.

In the third quarter, EPAM's revenue decreased by 6.1% on a reported basis, or 8% in constant currency terms. This was due to reduced program spending and client costs, as well as the impact of exiting the Russian market. The financial services, consumer goods, and life sciences & health care industries all experienced declines, while business information & media and software and Hi-Tech saw larger decreases due to reduced spending from clients and slower growth.

In the third quarter, the company's emerging verticals saw growth of 8.5%, driven by clients in energy, manufacturing, and automotive industries. The Americas, which represent the largest region for the company, saw a decline of 9.3% year-over-year. EMEA grew 1.8% year-over-year, while CEE saw a significant decline due to the company's exit from its Russian operations. APAC also saw a decline due to decreased work in the financial services vertical. Revenues from the top 20 clients declined 8.3% year-over-year, while revenues from other clients declined 4.9%. Gross margin and income from operations also saw a decrease compared to the same quarter last year. The company incurred a loss and severance expenses due to cost-cutting measures.

In the third quarter, the company's non-GAAP income from operations was $196 million, representing 17% of revenue. The GAAP effective tax rate was 26.3%, while the non-GAAP effective tax rate was 23.2%. Diluted earnings per share on a GAAP basis was $1.65. Cash flow from operations was $215 million and free cash flow was $211 million. DSO increased to 73 days, and share repurchases totaled $78.5 million. The company ended the quarter with $1.9 billion in cash and cash equivalents. Production headcount has decreased by 10% compared to the same quarter last year, and total headcount was over 54,600 employees.

The company's utilization rate decreased slightly in the third quarter compared to the previous year and quarter. Demand generation efforts have resulted in new customer revenues, but they are not enough to offset the impact of project ramp-downs and reduced spending from top clients. There is some stability in the North American portfolio, but there will be an impact from planned ramp-downs at European customers. The company expects a decline in Q4 revenue due to seasonality, employee relocations, and unfavorable foreign exchange rates. The Ukrainian delivery organization is operating efficiently and there is a focus on cost optimization to align with demand. $8.4 million in severance-related costs were incurred in Q3, with $7.1 million related to the cost optimization program.

The company expects to incur $15 million in expenses in Q4 due to a cost optimization program, leading to a decline in headcount and an increase in utilization. For the full year, they anticipate a 3% decline in revenue and a 10-11% GAAP income from operations. They also expect a 22% GAAP effective tax rate and a 23% non-GAAP effective tax rate. The GAAP diluted EPS is projected to be $7.07-$7.15 for the full year, while the non-GAAP diluted EPS is expected to be $10.31-$10.39. In Q4, they anticipate an 8% decline in revenue and a 10-11% GAAP income from operations. They also expect a 24% GAAP effective tax rate and a 23% non-GAAP effective tax rate, with a GAAP diluted EPS of $1.67-$1.75 and a non-GAAP diluted EPS of $2.47-$2.55.

The company expects a weighted average share count of 58.8 million diluted shares outstanding in the fourth quarter. They also anticipate stock-based compensation expense of $36.3 million, amortization of intangibles of $5.7 million, minimal impact of foreign exchange, and non-GAAP adjustments of $12 million. They expect to recognize $15 million in expenses related to their cost optimization program and have ongoing non-GAAP adjustments due to Russia's invasion of Ukraine. Interest and other income is expected to be $14 million in the fourth quarter. The company plans to provide their 2024 business outlook in their fourth quarter earnings call, but expect the demand environment to remain uneven in the first half of 2024. They will prioritize revenue growth and may incur incremental costs due to variable compensation and salary increases.

The company's cost optimization program will help align their 2024 cost structure, but they still expect wage pressure and limited ability to raise client prices to impact margins. The IT sector has faced challenges in 2023, but the company remains confident in their ability to drive revenue growth and profitability in a more stable demand environment. The operator then opens the call for questions, with the first question asking about demand stabilization trends. The company clarifies that they are seeing a trend of production load returning to levels seen in Q1, indicating a stabilization in their share of business. They have also seen an increase in conversations and opportunities for programs, but there is no clear timeline for realization.

The speaker discusses the increasing pressure on clients to do work and the difficulty in predicting future developments due to geopolitical factors. They mention the cost optimization plan and its goal of achieving $100 million in savings, with most actions to be taken by the end of the year. The remaining savings will be used for investments in demand generation, partnerships, and other capabilities. The speaker expects the majority of the savings to be achieved by the end of the year, with some residual actions in the first quarter of 2024.

The interviewer asks Arkadiy Dobkin about EPAM's selling efforts and the use of India as a delivery center. Dobkin explains that India is still an investment for the company, but they have built practices there for digital engagement, data, and cloud. He also mentions the difficulty of stability in the current environment, but is optimistic about the market demand and EPAM's ability to hire quality employees in India. The interviewer also asks about profitability and Dobkin responds that they are facing challenges with pricing pressures and wage inflation.

The speaker discusses the company's growth in India and Eastern Europe and mentions that they are currently facing some pricing imbalances. They also mention their headcount mix in these regions and note that India is becoming their second largest delivery location. A question is then asked about the company's growth rates in different regions and verticals, and the speaker attributes the deceleration to idiosyncratic factors, particularly in the life sciences sector. They also mention that the company has seen stabilization in client conversations, which may have contributed to a more positive outlook.

In October, EPAM's workload has stabilized and there are signs of improvement in some areas. Some new clients have been acquired and there are conversations with previous clients who are considering returning. There are also new opportunities and potential for future growth. However, there is still a decline in comparison to the previous year.

The decline in Q3 was less than in Q2, and Q4 is expected to have a modest decline due to foreign exchange and availability of builds. The demand is stabilizing in North America and the company is gaining experience and scale in new locations. The geopolitical environment is still complex. There has been a soft pricing environment, but the impact of moving employees to higher-cost geographies is decreasing. The exact percentage of this impact is not available.

The company is seeing a shift in demand for India-based resources due to lower rates. The pricing environment is challenging due to concessions provided to existing customers and new engagements starting with lower rates. This will impact profitability in the coming quarters. The company expects these headwinds to abate by the end of the year, but the situation is complex and they cannot make absolute assertions.

The company is seeing more stability in customer programs and budgets, particularly in North America. They have a couple of customers in Europe who have already notified them of ramp downs, but overall there are less unexpected surprises. If the impact of the build is adjusted out, revenue would be flat from Q3 to Q4. The company is taking cost-cutting actions and hopes to improve utilization in Q4 and the first half of 2024. However, there is still an imbalance between customer pricing and wage inflation, and the company expects to return to a more normalized variable compensation in 2024.

In the paragraph, the speaker discusses the potential for declining profitability in 2024 due to uncertain wage pressures and the need to work through certain issues. They also mention that the wage pricing dynamic is the biggest headwind to gross margins and that booking conversion trends are still uncertain and may be affected by the current tough environment.

The speaker discusses the stabilizing relationship between the company and its clients, which has led to a more manageable and transparent situation. In terms of headcount, there may be further declines in Belarus due to supply-demand ratio, but Ukraine is expected to remain stable. The speaker also mentions that the company is closely monitoring quarter-over-quarter growth rates and believes that by Q1 2024, there could be a return to positive growth.

The speaker asks for the opinion of the listener on the potential moves in FX and the stabilization in the business, and whether they think EPAM is back in positive territory in the first quarter. The listener responds that they will have to wait three months for a definite answer, but there is currently positivity. The listener also clarifies that most of the cost optimization will be reinvested and profitability in 2024 may be lower, but they are working towards being back in the 16-17% range in 2025. The next question asks about EPAM's performance compared to the market and whether they are gaining market share.

The company has stabilized in terms of existing clients, but there are some long-term plans in place that may affect client share. In Europe, there has been a decline but it is mostly customer-specific. Year-to-year comparisons are becoming less meaningful in the current environment. The next question is from a long-term perspective.

Dobkin believes that application development and the build function will become even more important in the future, especially with the changes happening in the industry. He also mentions the technical debt in the cloud environment and how it will eventually need to be addressed. Friedman asks a question about pricing and discounting, but the details of the response were not provided.

Jason Peterson discusses the longer-term implications of the current situation, acknowledging that India has been a more cost-efficient location but that demand may shift to other geographies over time. He also mentions that it typically takes a year to reset pricing, so it may be difficult to raise prices in the near future. In terms of adjusting to a higher interest rate environment, the company may be locked into current pricing for 2024 but will have more opportunity to adjust later in the year.

The speaker is asked about the impact of higher cost of capital on EPAM's acquisition strategy. They state that they will continue with their current strategy of small to mid-sized tuck-in acquisitions to expand capabilities and drive organic growth. They also mention their strong cash position as an advantage. In response to a question about weakness in financial services, they mention one large client and a decline in revenues from other banks, indicating that the weakness is broad-based within the banking sector.

The financial services practices of the company are experiencing growth, particularly in asset management and insurance. The return of clients to projects is driven by a need to modernize core systems and cost optimization. The company is seeing opportunities for generative AI, but the direct impact on revenue is still small. The CEO remains cautiously optimistic about the future due to the unpredictable nature of the world.

The operator ends the call and thanks everyone for joining, giving them permission to hang up.

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