Good day and thank you for standing by. 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 session. [Operator Instructions] 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.

Thank you, Operator. Good morning, everyone. By now you should have received your copy of the earnings release for the company’s second quarter 2023 results. If you have not, the copy is available on 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. 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 quarterly earnings materials located in the Investors section of our website. With that said, I will now turn the call over to Ark.

Thank you, David, and good morning, everyone. Before I get into the results of our second quarter, I would like to spend a few minutes on the mid-quarter update we provided in June. As I said in my prepared remarks, the broader concerns over the economy led to a shift in demand dynamics for our sector. So we found 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 in the first quarter. This was especially evident in the technology vertical, which continues to be impacted by the pull-back in spend after years of strong investments in 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 held back for the direct spending from new build programs to the economic conditions and caution in their businesses. This factor has contributed to a high percentage of our shortfall over the first half of 2023. Now I will switch to Q3 and the rest of 2023. While we are starting to see a few encouraging signs, we will 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 2023, but at the lower level than we saw in the first half of this year. With that, I would like to state that while we do understand that this is a difficult period for us and for those sector more broadly, based on insight from the past several years…

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 EPAM’s humanitarian commitment to Ukraine, business continuity resources and accelerated employee relocations have been excluded from non-GAAP financial results. We have included additional disclosures specific to these and other related items in our Q2 earnings release. In the second quarter, EPAM generated revenue of $1.17 billion, a year-over-year decrease of 2.1% on a reported basis and a decrease of 2.4% in constant currency terms, reflecting a 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 100-basis-point negative impact on year-over-year revenue growth. Excluding the Russia revenues, year-over-year revenue for reported and constant currency would have decreased by 1.1% and 1.7%, respectively. 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 Hi-tech contracted 10.3%. The decline in the quarter reflected a reduction in revenue from the former top 20 customer we mentioned during our previous earnings call and generally slower growth in revenue across a range of customers in the vertical. Life…

Thank you. [Operator Instructions] Our first question will come from Bryan Bergin of TD Cowen. Your line is open.

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 are having among your top 10 or top 20 clients? Are you getting closer to stability in this space, and I am 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?

Hello. Good morning. I think visibility or predictability is probably better than it was a couple of quarters ago. So and we can plan better. But there is still a slowdown which started a couple of quarters ago and we are working with it. 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. But again, in general, we feel it is much more stable. We also see in top 20 that some clients starting 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 who were not satisfied coming back to us with discussions. So, I think, in general, feeling about Ukraine, despite of situations that would get deliberately more active period still from the client perspective, but from expectation of the stability from work conditions, taking in account during the last 18 months, we didn’t have particularly one unproductive day. So, people believe that the clients starting to feel the link, why don’t this [ph] -- for those who continue that. So, I think, in general, more stable, still unknown and there is still slowdown going a little bit. So we hope that it will be start like in the next couple of quarters.

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.

Yeah. So we are under 30% from a CIS region. So that’s primarily, as you indicated, Ukraine and Belarus. We are 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 are working through demand, probably, we see some stabilization in Latin America, but again, continues to be a significant part of our expected current and future delivery footprint.

Okay. Thank you.

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.

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. During the quarter, they have seen some pretty strong, 130 bps greater than the top end of the guidance range. Can you just spend a minute or two parsing out sort of what led to that outperformance and sort of how you are thinking about margins through the back half of the year, where there is any sort of incremental investment opportunities available, or any color there?

Yeah. So, clearly, with the demand environment that we are seeing, we are trying to make certain that we are cautious about spending, while still making certain that we are making investments in sales channels and partner programs, and clearly, our AI capabilities that would allow us to return to significant growth in the future. But we are focused clearly on SG&A and you are seeing efficiency there. And then, you are also -- some caution around what we are doing with headcount, and generally, what you are seeing is it’s a little bit of tuning in different delivery locations and lower hiring, very modest hiring, which is then 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, is -- there is a variable compensation element. 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 compensation. That shows up as some benefit in Q2 and we will have lesser, but some benefit in the remainder of the year. And then, again, we were just sort of toppish from a revenue standpoint with the $1.170 billion in Q2. From a profitability standpoint, generally, Q3 is a good quarter for us with more bill days. I don’t -- I think you are still going to see somewhat lower utilization in Q3 and so probably not expecting much improvement or probably maybe even a little bit of decline if you went to the midpoint of the range, the 15.5% to 16.5% that we have guided to for the Q3. I think gross margins could end up in a 32% to 33% range in Q3 with lower bill days in Q4, may be 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.

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 are assuming macro stability or any sort of additional softness in any of the verticals or geographies you are operating in? I know Bryan sort of alluded to the sequential declines and 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?

So just -- I am going to give you the numbers, what we are currently seeing from a forecast standpoint for Q3 and then I will let Ark comment and maybe provide more color. From a sequential standpoint, I think, with some of the budget reductions that you have seen in major customers, you are 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 -- are likely to see a sequential growth in the healthcare and life sciences, where we are making good traction here in fiscal year 2023. So that’s kind of what I am seeing from that standpoint. I think you still have a little bit of impact from customer decisions to reduce spend in Q2. And I think as Ark has indicated, that we are more hopeful that clients are beginning to sort of stabilize their spend and could even see some increase later in the year, but.

Yeah. I think that’s right 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 see different conversations starting to happen. There are more activities with new logos and that’s what we shared during our thought at the beginning. But also existing clients, different sort of conversations that we saw a couple of months, a couple of quarters ago. Again, it’s still difficult to predict, we reacted and we forecasted based on what we really kind of see right now.

Great. Thank you, both.

Thank you.

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

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?

Yeah. Yes. So, clearly, we would expect a sequential decline in Q2 to Q3, so when would the sequential stabilize. And then, David, I think, you are aware of this Q3 to Q4 is just you have got to bill day 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 are walking uphill Q3 to Q4 with the lower bill days.

Right. So excluding…

Yeah, David. Yeah. Go ahead.

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

I think earlier what I would commented, in June when we talked last time and in May kind of when we were clearly felt that situation worse than we expected before. We said that we are thinking about two quarters, three quarters, four quarters. And I think that’s the feeling which we still have today, okay? Because it’s very difficult to predict like you are asking when. So I do believe that within this timeframe, we will probably will get to the situation when sequential -- quarterly sequential growth will start to recover. But we clearly -- we will be updating this quarter-after-quarter. So we definitely see it slow down. We are definitely seeing different signs from the clients. But again, some clients when they made some decisions, they within themselves have some type of inertia, which would take some time. All market will be very clearly changed or less satisfaction with some other matters will be not as high, okay? Some of this has started to feel, that’s what given us some level of opportunities. But I don’t think we can say anything more than another two some level, three quarters from now, maybe four some level.

Got it. All right. Thanks. I appreciate that. And then just back to your own internal efforts to geographically diversify. And 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?

Okay. You are asking about what we feel about our progress with diversifying like our global delivery, is this...

Correct.

Okay.

Correct.

Okay. So, I think, we are actually pretty much satisfied with the progress. I think our efforts in India and Latin America definitely starting to pay out. India, right now the second largest location we have built and that was part of the lab, which we started in May 2022, where we at least all of you had said, [inaudible] what we are planning to do. So right now, Ukraine and Belarus production together, it’s more like 25%, 26% for the total capacity. Where India -- Latin America caveat, probably, by the end of the year, it will be closer to 18%, 20%. The quality and the effort which we put in there are definitely improving. We also have very specific programs how to share knowledge between people who stay and depart for a long time and how to raise the bar with improvement and operations. I think we still committed very much to Ukraine. We do believe that it will be growth there. Yes, we don’t know when, but maybe we will be very much aligned with the sequential growth, which we are expecting in two quarters, three quarters, four quarters coming back. So besides India and Latin America, which is more traditional, we have actually Central Western Asia, which is interesting, because it’s, I call it, a significant number of people who knows how well it could be located during the last 18 months. So, we have very interesting ways and we have potentially a very good demographics for the growth of the target in these countries and clients started to experience this and getting comfortable. And again, with the demand coming back, I think, it will be a good opportunity for us. And finally, more traditional fast location, Central Eastern Europe, mostly inside of EU, sometimes outside of EU, what, Hungary, Poland, this is very quality -- high quality engineering location for us. Clients very comfortable there. In good demand environment, it’s always very high demand. So it’s also becoming stronger because good level of talents located from our traditional data centers. So I think we go in actually to the direction of building probably the most balanced global delivery platform. And as soon as the rebound will be started, we will feel comfortable to grow. One of the important things and we mentioned this, we very carefully kind of balance in the cost structure is because in all of the sectors which I outlined, there are different cost structures and we are going back to improve our gross margins by reallocating focuses across these locations. So if it’s a short question, we will be able to provide quality which clients expected from us, it’s simply kind of recent clients, but it’s actually very much minimum.

Got it. Thanks very much. Really appreciate that color.

Thank you.

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.

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?

Yeah. I think I will step in. And we are probably not quite ready to talk about the 2024 in terms of, let’s say, specifics or even ranges. But Ark explained, 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 would look to kind of rebalance that somewhat. And then the other thing as we have talked about over the last couple of quarters is that, as we move 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 are 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 the things that we are looking to do to sort of stabilize and improve gross margins over time

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 are seeing on those new logos in terms of the time it’s taking for them to convert to revenue?

So, I think, I will comment on new logo and new business is kind of illustrated that while sales force is also 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 will slow down. Right now, it’s all coming…

Yeah. So very much actively focused on external opportunities and much of the internal things that we had to manage over the last, say, four quarters are substantially behind us and there’s a focus with both the account teams, the sales force and the executives on driving incremental growth.

Thank you.

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.

Hi. Good morning. Thanks for taking my question. I wanted to follow-up with your mentioning kind of tighter integrations and partnerships with the hyperscalers. Can you talk about the strategy, how these relationships might act 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?

Yeah. I think it’s dynamic also in general because of the market change in comparison like during a year ago. And now we are talking about much closer relationship from both point of view, because we definitely, like everybody else, focusing on client’s perspective where hyperscalers can open additional doors and all competitors doing the same and this is kind of nothing new. On another side, the partner should become stronger because just migration to the cloud is kind of as is business becoming not so interesting as usually. It means very complex modernization efforts and this is where strength of EPAM come in from. This is why the partnership with hyperscalers become more important, not only for us, but for them as well, because EPAM has a reputation, which actually can do complex modernization -- complex innovation. That’s what we mentioned based on the status of partner of the year in this category with Microsoft. That’s exactly a confirmation on this. And as we mentioned, we will be following this some announcement during the next couple of weeks, which will be confirming improved partnership levels, specifically because of our ability to deliver complexity. And it’s definitely a very good preparation from our point of view for rebound, because when demand will be back, everything which wasn’t finished, and it’s a lot, in all categories, in cloud and data modernization projects add huge pressure on demand for data engineering because of the AI components. So the hyperscalers relationship will be very critical.

All right. Thank you. And a follow-up for 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 are seeing in different geographies or is it very similar trends across the business regardless of geography?

Yeah. So, certainly, some of what happened in Europe is due to foreign exchange. But what we are seeing is that some of the larger kind of budget reductions and conservatism is actually showing up more in North American clients. Think about the couple of clients we have talked about in healthcare and tech. Those were both North American clients. We have seen less of these types of reductions in spend in Europe. At the same time, we have got some pretty good traction also even in the consumer and retail side in Europe. And so, yes, there does seem to be a bit of a divergence, but we will see what happens as we work through the remainder of the year.

Fantastic. Thanks a lot.

Thank you.

In general, it’s still benefitting, but it is still, all I assume [ph], what we are talking about several specific client situations. Mostly it’s happened in…

North America.

…in North America and those situations were independent from general economic environment.

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

Hey. Thanks. Good morning. A couple of follow-ups here. So do you -- looking at the new logos, can you confirm that you are actually getting the same bill rates as you are 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?

So what we usually talk about is an environment where potentially you can get higher bill rates with new engagements. That’s probably less likely to occur in today’s demand environment. And generally, Moshe, if you are 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 of the geographies in Southwest, in Western Asia or Soviet Central Asia. But we get somewhat lower price points than certainly sort of Central Europe.

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?

Yeah. So if you -- you can have different bill rates in different geographies and still have the same margin percent, right? You have got different cost structures, you 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, and no, I don’t expect that new business is being attained in super expressive margins. We are working to kind of sharpen our pencils but be appropriate in our pricing.

All right. That makes sense. And last…

Absolutely.

Sorry. 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 able to continue to get those new logos onboard and actually to be able to accelerate growth down the road? Thanks.

Yeah. Still, I know like we answered it a little bit in grey area. But in general, you need to understand the current market environment is not what it was and everybody knows it like 18 months ago or two years ago. The whole rate structure for everyone, not only for us, is different for new deals as well. So the other things which could change it is actually the demand turning into more normal scale and the demand for complexity for build stuff will go up, then correction will be happening in other side. So, there is nothing magical here. So the new deals coming today is very different environment if it was, again, 18 months, 24 months ago. It’s number one. Number two about India, now I don’t know when you visited. I don’t remember when we visited Hyderabad, but right now, we have five development centers. We -- Hyderabad is still -- is the biggest one, but we have two others, which are growing very strongly and a few others which we started recently to growing strongly as well. So that’s definitely an important part of our future, but it’s one of the parts. It’s not like we are going to switch completely. That’s what I mentioned before. We are really looking how to build very balanced global delivery network for EPAM.

Thanks.

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

Hi. 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 re-platform their core systems sometime this year, maybe in 4Q or is that type of work is something that could come through on their next year’s budget, meaning that it might not come in anytime this year?

Do you expect to see modernization and spend occurring in Q4 or more likely to see a return to budget growth in the first half of 2024?

It’s difficult to answer that. I think we answered this question already in another way a couple of times. We don’t know right now. There is not so much visibility. That’s difficult. Some of them, who knows, it’s sometimes unexpected happening in Q4 will be the quarter when clients will really start spending. But let’s see, so.

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

The pricing pressure on a like-for-like basis, so I think Ark 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 really, we are being thoughtful, but it is in an environment where clients are particularly cost sensitive and that is showing up in pricing. And to Moshe’s question earlier, is that traditionally in certain newer engagements, it’s an opportunity to sort of improve price and that’s less the case in this fiscal year.

Got it. Thank you.

Thank you. And one moment please for our next question. Next question will come from Arvind Ramnani of Piper Sandler. Your line is open.

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

I think at this specific time, again, there are some industries like, let’s say, oil and gas, which is in pretty good shape, okay? But this is more an exception today. The rest of the new clients, in our view, happens from two kind of categories. Some clients who actually try to utilize this time as an opportunity and decided to go and invest instead of like and get some competitive advantage and that’s exactly what you recall before say, as soon as these type of clients will demonstrate some results, it will trigger a faster recovery of the market for build and kind of transformative programs, okay? And the second category, I think, it’s a client which is, at this point, not trying just to do transformative programs, but trying to utilize this time to build relations with stronger vendors for the future return and be prepared for this. Because, in our view, demand for talent when market will rebound will be very, very strong with everything what’s happening right now in technology, in technical debt and since which we have not done or not finished and with everything was triggered by, it seems like everybody is trying to talk about generative AI on the operations, but it’s still there and it will change actually the landscape. So that will put pressure on the talent demand as well. Well, a lot of people speculation that it would replace companies like EPAM very soon [ph], okay.

Yeah. 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 that kind of a similar dynamic that you have with these new clients?

So there are a few example on -- we kind of give, I think, five, six examples across different vendors. 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 to 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 bring 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 interesting from the new technology standpoint. So it’s kind of a variety of this. If we will see better trends, that would mean that it’s actually the market change.

Perfect. And just last question from me. I 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?

I think I have answered for kind of Ukraine and Belarus here. I think with Ukraine clients who stayed with Ukraine are much more comfortable right now. We see some clients coming back. Again, it proves that nothing was happening from the quality of delivery or 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 of this. With Belarus, it’s a slowdown. We still have clients which operate there and we have some clients who are exiting there. So, Belarus is, from headcount point of view, kind of slightly faster than as of anything else.

Perfect. Thank you very much.

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

Yeah. Thank you. Thank you, everybody. I think we will update you in three months. But in general, that we get in with all unpredictability, we feel a little bit more stable and predictable than the quarter ago. So thank you very much and talk to you in three months.

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