Greetings, and welcome to EPAM Systems Second Quarter 2018 Earnings Call. [Operator Instructions] As a reminder, this conference is being recorded. I would now like to turn the conference over to your host, David Straube, Head of Investor Relations.

Thank you, operator, and good morning, everyone. By now, you should have received your copy of the earnings release for the company’s second quarter 2018 results. If you have not, a copy is available at epam.com in the Investors section. With me today are Arkadiy Dobkin, CEO and President; and Jason Peterson, Chief Financial Officer. Before we begin, I’d like to remind you that some of the 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 GAAP and are available in our Q2 earnings materials located in the Investor section of our website. With that said, I will now turn the call over to Ark.

Thank you, David, and good morning, everyone. Thanks for joining us. Let me begin with a few financial highlights. We delivered a strong second quarter with revenues of $445.6 million, reflecting 27.7% year-over-year growth or 27.1% in constant currency terms. Our revenue growth was broad-based, both geographically and across all of our industry verticals. In addition, we delivered strong non-GAAP earnings per share of $1.01, which represents 26% growth from Q2 of 2017. Let me provide you with a brief update across the key dimensions of our business. Looking at our capabilities and offerings. Last quarter, we talked about enriching our offerings across digital transformation programs and connected digital platforms, which continues to be our key areas of focus with accelerated development of capabilities in intelligent automation, RPA, machine learning and IoT. Additionally, we also talked about expanding our horizons with new offerings around physical product innovation with close connectivity into software-controlled ecosystems as well as strengthening our design thinking and business consultancy skills. Finally, we talked about our aspiration to integrate, at different levels, EPAM consulting capabilities across business, experience and technology disciplines into our mainstream delivery offerings, and as a result, to significantly elevate the overall value of the solutions we build for our clients. In Q2, we continued to focus on those areas and are starting to see some results triggered by our new cross-functional initiatives in a number of potentially large engagements as well as in numerous wins of new types of deals because of broader adoption of such an approach. A couple relevant highlights to illustrate. While we were involved for sometime in many proof-of-concept-type efforts based on RPA technologies, some of those projects have evolved into much more complex and sizable intelligent automation engagements across several industries. As in the case of any organization,…

Thank you, Ark, and good morning, everyone. I’ll start with some financial highlights and talk about profitability, cash flow and then end on guidance for fiscal 2018 and Q3. In the second quarter, we delivered very strong top line performance, exceeded our profitability expectations and grew earnings per share. Here are a few key highlights from the quarter. Revenue closed at $445.6 million, reflecting a 27.7% year-over-year growth rate or 27.1% growth in constant currency terms. In the quarter, revenue reflected a foreign exchange benefit of less than 1%, lower than the approximately 2% favorable currency impact we expected when we set our Q2 guidance in May. Applying the same foreign exchange rates to non-USD revenues as those used in our Q2 guidance, reported revenue would have been approximately $2 million higher this quarter. From a geographic perspective, North America, our largest region, representing 59.3% of our Q2 revenues, grew 28% year-over-year in constant currency. Europe, representing 33.6% of our Q2 revenues, grew 23.6% year-over-year or 21.3% in constant currency. CIS, representing 4.4% of our Q2 revenues, grew 31.4% year-over-year or 42.5% in constant currency. And finally, APAC grew 66.5% in constant currency and now represents 2.7% of our revenues. We move down the income statement, our GAAP gross margin for the quarter was 35.1% compared to 36.9% in Q2 of last year. Non-GAAP gross margin for the quarter was 36.7% compared to 38.1% for the same quarter last year. The decline in gross margin was driven primarily by the impact of lower utilization and a higher level of accrued variable compensation compared to Q2 of last year. GAAP SG&A was 20.6% of revenue compared to 23% in Q2 of last year, and non-GAAP SG&A came in at 18.8% of revenue compared to 20.4% in the same period last year.…

[Operator Instructions] Our first question is from Maggie Nolan with William Blair. Please proceed.

I was hoping you could talk a little bit more about how you’re pricing some of these intelligent automation solutions, especially the ones that are a little more horizontal in nature? And then should we expect to see changes in your contract-type mix over time as a result of more of these solutions?

So this is still pretty new area for everybody and it’s a mixed pricing between fixed cost and time and material, specifically on engineering part. But at the same time, when we involve each consultant, we’re trying to assess what would be potential return and project that relate to the client. So it’s a – as I said, it’s a mixed approach right now and I think both vendors and clients are winning at this point still. But the hope, actually on headcount, clear headcount cost reduction.

Okay. Great. And then did you say you’re looking to some new markets for labor? And if so, what geographies are you hoping to develop or expand? And then when you do enter new labor markets, what steps are you taking to gain traction there?

So we’re not looking of new markets in the kind of big meaning of this work because we do believe that we are already in the markets in our traditional Eastern Europe locations. We are in India. We are in China. But we expand in the regions of these markets and some of these – as you know, markets pretty large and we’ll – we are always open for new locations which we open in inorganic way as well.

Our next question is from Avishai Kantor with Cowen and Company. Please proceed.

From the consulting practice perspective, are you considering joint ventures or partnerships with extended loan consultants for front-end strategic opportunities? Or you think it’s critical for you to maintain those skills in-house?

On specific project opportunities, we’re clearly open for any type of partnership and – with other firms. At the same time, we do believe that it’s critically important to have these capabilities inside of EPAM because to achieve the level of integration and the benefits of starting to sync for the total solution versus specific consulting or design or engineering parts of this, it is important to build this capability inside of the company.

And then on M&A opportunities going forward, what are your thoughts on adding digital transformation skills versus domain or vertical expertise?

So we were adding digital transformation skills during the last five, six years, and we’re still open to add this in an organic way where it’s important in specific locations. And we’re, again, looking for such additions. The same like in other areas, which you mentioned, I think we still have enough gaps to fill through specific M&As, the same like we grow in this very aggressively organic nature.

Our next question is from David Grossman with Stifel. Please proceed.

Just one clarification. I missed the utilization number, Jason. Could you give that to me, again, please?

Yes. Utilization number is 78% in the quarter.

Okay. So flat sequentially?

A little bit of an improvement from Q1 to Q2, and that’s in part what drove the improvement in the gross margin from Q1 to Q2.

Okay. So just – since you brought up the gross margin, can you – I know you mentioned a couple of items that impacted the margin on a year-over-year basis, and I think it is lower utilization. I think you were close to 80 last year and higher accrued comp. But it was down in the March quarter as well. I’m just curious, these higher utilization rates, I know they’re – maybe you’re down year-over-year, but you’re still at relatively high levels. Is there some other dynamic going on within the gross margin that can maybe driving it down?

I think it’s pretty much on the surface, the utilization numbers in the accrued compensation that we talked about. And so Q2 of last year was an extremely high level of utilization at 79.6%, and so there is a pretty significant decline between Q2 of 2017 and Q2 of 2018. And then we’ve got the variable comp piece, which we’ve talked about. We did improve gross margin between Q1 and Q2 of this year. And what we expect to see is that continued improvement in gross margin in the second half of 2018. So I think you’ll continue to see gross margin improvement. And I’m sure, as you’ve noted, profitability from an adjusted IFO standpoint is actually up if you look at the first half of 2018 versus the first half of 2017. And so we feel like we’re still very much able to manage within the 16% to 17%. And I think what you’ll see is improvement in gross margin throughout the remainder of the year.

And what drives the higher gross margin in the back half of the year?

Yes. So in Q3, you’ll have sort of 2 effects. One will be that you’ve got a seasonal lower utilization level in Q3 just due to vacations and summertime. And so that’s something that you see every year for us. You do have more bill days though so the net impact to that is still up, the positive improvement in – or an improvement in gross margin. And then what you’ll see us do is continue to work on utilization in Q4. At the same time, I think we’ve talked about the pricing environment in the past is that on average across the broad range of customers, we are seeing average rates increase. And then as we’ve talked about, there’s a significant number of customers where we’re actually getting annual rate increases.

Right. And I think Ark mentioned that there’s an increased demand and requirement of the market to be delivering services locally. Is that pressing the margin at all?

Yes. There hasn’t been a significant shift in the onsite/offshore ratio. So it’s just a very modest shift. And so no. At this time, that wouldn’t be any sort of driver. What you’re really seeing is just the delta between the high level of utilization we ran last year and kind of where we are right now. And that was intentional. We talked about taking utilization down to allow us the opportunity to continue to grow rapidly.

Right. And I guess in the past, you’ve given us a number that characterizes how much growth is coming from the existing base versus new clients. Do you happen to have that number?

Yes. We’ve got that. And so – and it would – it’s consistent with that 40%, 60% that we’ve talked about with 40% of it coming from, what we call, new revenants, which are customers that began generating revenue in the last 12 months; and 60% from the existing customer base.

Our next question is from Jamie Friedman with Susquehanna. Please proceed.

Hi, good morning, good quarter here. I just wanted to follow up with David’s. Not to test your patience here, Jason, but the – so the utilization is down a bit year-over-year, but the headcount is growing slower than the revenue. I see the fixed price is up a bit. I’m just trying to get – basically, my question is it looks like pricing is rising. Is that too blunt for a conclusion?

Yes. There’s probably – okay. I – the answer would be yes, and they’re probably – we sort of peeled it back a layer, so there’ll probably be two factors inside that. So as we discussed with David in the last set of questions, is that there’s a slight shift towards on-site and then at the same time, we are seeing an increase in our rates on average across our customer base. A lot of the rate increases do come in, in the first half. And so you’ve got the combination of actual kind of rate increases and then the subtle shift towards on-site, which would also sort of push up the revenue per employee.

Got it. Okay. And then there is a slight increase in fixed price. I know the first question was about how you’re pricing some of the new offerings. Is this that or is it something else? It’s not – I’m just looking at the fact sheet, it’s not a huge difference, but about 100 basis points. But is there any way to read into that?

You’re not seeing a significant shift in fixed price versus T&M. I do think over time and someday we’ll continue to explore. But at this time, we’re still substantially in the time and materials business from a pricing standpoint.

Our next question is from Arvind Ramnani with KeyBanc. Please proceed.

I just wanted to ask about the demand environment. How do you characterize the demand environment today versus kind of what expectations were at the beginning of the year? And how do you also characterize the competitive environment?

Probably, a traditional answer. We’re still seeing very stable and strong demand across all our offerings. Again, it’s difficult for us to assess the whole market because we’re relatively small in comparison to our large competitors. But in our area, it’s very similar demand to what was in the past. There are some changes structurally that’s why we were talking about intelligent, automation and RPAs, specifically on kind of proof of concept, the first engagements, and we see that it’s potentially might grow faster than other parts. So there are probably some other smaller aspects of this change. But in general, again, it’s a – pretty consistent with the past. And from competition, I would say the same things. I don’t – we don’t see any significant changes in competitors’ offerings.

Great. And on these emerging technologies, you touched upon automation, but if you kind of look at automation, AI or like – even some other things such as blockchain, is there like kind of increased appetite or – when you look at – maybe it may not be impacting your revenue, but when you look at your R&D spend or amount of – kind of investments going in the back end to develop the capabilities, is – how is that – what are you expecting for the emerging technologies over the next 12 to 18 months?

As we mentioned before, we are doing these investments pretty consistently in the past. We were talking about our internal [indiscernible] where we’re experimenting. But we also do believe we have some advantage because part of our business, almost 20% of our business, it’s software service systems for technology and software companies. And in many of these cases, we have opportunity to be exposed to new trends and new technologies, including automation and RPAs and artificial intelligent type of applications. And we’re doing this as part of our delivery engagements. And then in many cases, we actually have an opportunity to go together with our clients to their clients for building specific solutions. So we tried to explain it before that we have this type of advantage, and I think it’s helping us right now and we hope will help in the future because we strategically continue to serve this part of the market.

Our next question is from Jason Kupferberg with Bank of America Merrill Lynch.

This is Brandon Avon [ph] on for Jason. Just wanted to get a sense of how financial services was relative to your expectations in the quarter? Is there anything notable to call out? And maybe talk more broadly about what you’re seeing in terms of spending at the large banks?

Yes. So we continue to a very strong growth in our Financial Services practice. So you see, we’re over 30%. We did get a little bit of benefit from our acquisitions. So if we were to strip that out, we’re still sort of approaching 30% in the very high 20s. We continue to drive revenues from – more kind of the digital transformation and our experience in wealth management and other platform technologies has really – may have been beneficial to us. I don’t know, Ark, do you have anything else you want to say about the Financial Services space?

I don’t think there is, again, any specific changes. We’re working with established vendors, but we will – established clients in financial space, but we’re working on more digital transformation or digital type of platform. This is – probably allow us to continue growing. At the same time, we’re involved in some specific fintech applications with the smaller clients. So it’s giving us opportunity to continuously grow as well.

So I don’t know if the demand has changed, but we continue to see quite significant demand in our space.

Great. That’s really helpful. And just as a follow-up. Obviously, FX is – could be a headwind now on the back half, and you called that out from a revenue perspective. I was just curious how big has the – the recent FX headwinds will that be on your EPS in 3Q and 4Q?

That’s a good question. So we’re actually pretty well hedged. And so we’ve got – we’ve always had kind of a natural hedge. In the Ukraine and in Belarus, actually, the salaries are notionally in U.S. dollars and so we don’t see volatility there. We’ve got currencies in Europe, which are primarily sort of expense currencies, the Polish zloty, the Hungarian forint. We’ve got revenues driven between – in the euro and in the pound in which you find that there’s some degree of correlation between those. So when the U.S. dollar strengthens, you may see less revenue from a euro perspective, but you also generally see a decline in costs in some of our Central European delivery centers. And then we’ve also hedged the ruble. And so what you see is that – I – we’re in a position right now where even as the dollar strengthens, what it tends to do is have an impact on reported revenue and reported revenue growth rate, again, a negative impact, but it only has a very modest or slight impact on EPS.

Our next question is from Frank Atkins with SunTrust. Please proceed.

Thank you for taking my question. I wanted to ask first about the Life Science & Healthcare vertical. What’s driving some of the strength there?

Yes. We mentioned before that it’s one of the smallest verticals for us still. And 1 or 2 clients kind of changes might impact specific quarter. I think we’re coming back to normal there. And it’s practically in line with the company growth right now versus before, we have some slowdown in 1 or 2 clients. So we hope it would be growing more in line with the overall growth of EPAM.

Okay. That’s helpful. And then can you talk a little bit about the talent environment? What you’re doing to attract and retain talent? And were there any changes in attrition on a quarter-over-quarter basis?

Attrition, I think in line with last year right now. It’s sequentially up a little bit. In general, again – and this is our probably consistent permanent answer to this question. Environment for hiring talent and keeping talent is very difficult and it was last quarter and last year and three, four years ago as well. So basically, we don’t feel that it’s ever going to be easier. At the same time, we continuously invest in trainings, education, looking for better opportunities inside of the company for people to grow in. And I don’t think there is any magic here. So that’s a continuous effort which we’re really committed to do.

Our next question is from Vladimir Bespalov with VTB Capital. Please proceed.

My first question is on your geographic breakdown of revenues. There is some slowdown in Europe in the second quarter compared to the first quarter. Is it FX driven or like – if there is anything else behind this? And the second question I have on your Hyderabad office. From what I saw in EBIT capacity of this office, I saw – I think the numbers were from 1,000 people to 1,600 people so – but it’s not reflected in your hiring as far as I could see. Maybe you could elaborate a little bit. Are you going to hire more people? Or this is built up on your current presence in India following the acquisition of Alliance Global Services and how this fits your strategy to develop the APAC region, which is still small, but growing pretty good?

Okay. Let me start from different order, like from Hyderabad. We moved to very well built new location. And we’re operating in India for the third year, and it’s clearly was a new experience for us and we learned a lot. And we are bringing engineering culture, which we have in EPAM, to our locations in India. And it was, again, a lot of learning during these several years. The decision to move was actually attributed to our belief that we would be able to grow because for last years, we maintained practically a flat headcount in the region. Now, we’re much more comfortable that we would be able to benefit from our investment. So we’re careful where the significant clients move to the regions because very good review on the quality of the services, which we started to deliver from there. And this location would allow us to grow with the next several years. So on Europe, yes, I’ll pass it to Jason here.

No, I think we’re still very pleased with the demand environment in Europe and also pleased with the growth. I think largely what you did see with the strengthening of the U.S. dollar that does have a negative impact on the growth rates in Europe. And so right now, the environment there tends to have continued strong demand. And so I don’t think there’s anything to take away from the somewhat slower growth rate there.

[Operator Instructions] Our next question is from Joseph Foresi with Cantor Fitzgerald. Please proceed.

This is Mike Reid on for Joe. Just wondering what the impact to the quarter was from Continuum and then maybe a little detail on the integration, how that’s going.

Yes. And so probably, two points. I’ll answer a question that you didn’t ask. So we only had about two weeks of revenue – of Continuum revenue in our Q1 results. And so you do get a bump sort of in sequential growth because they’re having 13 weeks at Continuum. And Continuum is – about 2% of the growth is coming from Continuum and that’s consistent for the full fiscal year. Then Ark, do you want to talk a little bit about integration and just kind of how things are going with the Continuum acquisition?

Sure. Like – clearly, we’re just a little bit of 4 months in this. And it’s probably too early to do any conclusions. It’s usually only – even after plus 12 months, but we do see a number of very interesting opportunities, which we started to go after together. We have already exposure of Continuum services to EPAM client base and opposite a client capabilities presenting and even starting some smaller projects to clients which originally came from Continuum. From this point of view, we’re thinking pretty good growth right now.

Okay. Great. And then are you partnering with providers in the automation implementation? And if so, have you named who you’re working with?

In what implementation?

Automation, RPA or any of the...

We – basically, like in any other engagements, we’re working with some other vendors on the same implementations like on e-commerce or big data, it could be some other vendors. It’s exactly the same story in RPA, but we don’t partner with anybody specifically, with exception of providers of the specific platforms like Automation Anywhere or Blue Prism or WorkFusion.

Our next question is from Avishai Kantor with Cowen and Company. Please proceed.

I have a quick follow-up. I may have missed it, but can you talk about trends within the top 5 clients? If I’m not mistaken, for me, your revenues really have been – accelerated significantly this quarter. Is it from one specific client? Is it a couple of clients?

I mean, I think what you see is that – from a concentration standpoint, we continue to improve. But certainly, we’ve had – our top clients could – many of our top clients continue to grow quite rapidly. And at the same time, it got to the same story, I think, we’ve told you in the past which is that we’re getting a lot of growth from our new customers as well. But certainly, we see some nice growth from our large, established customers in addition to the growth that we’re getting from new logos.

Ladies and gentlemen, we have reached the end of our question-and-answer session. I would like to turn the call back to Arkadiy Dobkin for closing remarks.

Thank you. And thank you, everybody, for participating. We do believe it was strong quarter despite of some FX influences from results, and we do believe that we will be continue growing with – within the promises we shared like before. So thank you very much, and see you next quarter.

Thank you. This concludes today’s conference. You may disconnect your lines at this time, and thank you for your participation.