Greetings and welcome to the EPAM Systems Fourth Quarter and Full-Year 2018 Earnings Call. At this time, all participants are in a listen-only mode. A question-and-answer session will follow the formal presentation. [Operator Instructions]. As a reminder, this conference is being recorded. I would now like to turn the conference over to your host, Mr. David Straube, Head of Investor Relations for EPAM Systems. Thank you. You may begin.

Thank you, operator. And good morning, everyone. By now, you should have received your copy of the earnings release for the company's fourth quarter fiscal 2018 results. If you have not, a copy is available at epam.com in the Investors section. With me on today's call are Arkadiy Dobkin, CEO and President, and Jason Peterson, Chief Financial Officer. Before I 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 quarterly earnings material located on 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. We finished this year in a strong position across several dimensions of our business. Financially, we delivered a revenue of $1.84 billion, reflecting 27.1% year-over-year reported growth or 26.9% in constant currency terms. And non-GAAP earnings per share of $4.38 or 26% increase over fiscal 2017. Additionally, we generated free cash flow of $255 million. 2018 was an important year for us. First of all, at the end of December, we celebrated our 25th anniversary. The real significance of that year for us was to prove that, while we have been in business for 25 years, we still act, change, grow and feel like a very young and dynamic company. So, in 2018, we tirelessly continued to expand our capabilities and working to driving deeper connection with clients. And we have done this organically through very selective acquisitions and by growing some of our more strategic partner relationships. As we look across our portfolio of clients, it's clear to see that the types of engagements we are executing today and type of demand we're seeing for the future is broader than pure engineering. This is the change that we have talked about before in terms of how we view our investments and capabilities. 2018 was a remarkable year for us to observe the shift from pure software product development programs to much more complex scale and business critical engagements for our clients. So, today, with all our expanding capabilities, many of which have been recognized by industry analysts as increasingly vital accelerators, we're not longer just a software engineering company as the core, but also a strong design and experience consultancy, growing business and innovation consultancy, as well as emerging training and educational firm. While stating that, I would…

Thank you, Ark. And good morning, everyone. I'll start with 2018 financial highlights, then talk about profitability, cash flow and end on guidance for the 2019 fiscal year and Q1. In the fourth quarter, we delivered very strong topline performance, exceeded our profitability expectations and grew earnings per share. Here are a few key highlights from the quarter. Revenue came in at $504.9 million, a year-over-year growth of 26.5% on a reported basis and 28.9% growth in constant-currency, reflecting a negative foreign exchange impact of 2.4%. Looking at our fourth quarter revenue growth across industry verticals, the drivers of growth remain very consistent, and include digital transformation and increased focus on customer engagement, product development and driving efficiencies and deeper insights through artificial intelligence, machine learning and analytics. Financial services, our largest vertical, delivered 16.9% reported and 21.1% constant currency year-over-year growth. Growth in Q4 was impacted by continued expected ramp down of activity at a few clients outside of our top five, predominantly based in Europe. Travel and consumer grew 17.3% reported and 20.6% in constant currency terms. Growth in Q4 was impacted by slowdown within certain consumer clients in Europe. Software and hi-tech grew 26% in the quarter. Business information and media posted 24% growth in Q4. Life sciences and healthcare grew 71.3%, reflecting broad-based growth across all industries in existing and new client programs. And lastly, our emerging verticals delivered 38.1% growth, driven primarily by clients in energy, telecommunications and automotive. From a geographic perspective, North America, our largest region, representing 61.6% of our Q4 revenues, grew 36.9% year-over-year or 37.5% in constant currency. Europe, representing 31.2% of our Q4 revenues, grew 12.1% year-over-year or 15.2% in constant currency. CIS, representing 4.4% of our Q4 revenues, contracted 4.8% year-over-year and grew 11.3% in constant currency. Growth in…

Thank you. [Operator Instructions]. Our first question comes from the line of Ashwin Shirvaikar with Citi. Please proceed with your question.

Thank you. Good morning, Ark. Good morning, Jason. And congratulations. My first question is, Ark, you started off mentioning a high degree of confidence entering 2019. And I'm wondering how this translates to the financial model. Is there higher visibility? Maybe higher than the normal 80% to 90% range. Or is it the slightly higher starting point for growth? And then, also, how does it factor into your hiring plans?

Hi, Ashwin. Yeah. We have good level of confidence, but it's not coming that it's something unusual, it's more like because it's in line with what you have seen before, which, as you would suspect, giving us a good feel. But after growing pretty highly during the several years before, we're still carrying the same level of visibility and confidence. I think that's the answer to this. And in regards to talent acquisition, you probably would suspect my usual answer. It's very challenging and it was challenging and will be challenging. But we, again, feel confident we would be able to support the necessary level of growth with what we see in the labor market.

Got it. And then, the follow-up there is on the cash flow. Jason, good job there on the cash flow conversion, the DSO level. Would you say ahead for 2019 that DSO level might be sustainable? Is there a target that you can give us with regards to cash flow conversion? Yeah.

Yeah. Certainly, a nice improvement as we went to 73 in Q4. What we usually see in Q1 is a certain – almost a seasonal impact with DSO where people have got to get paperwork and things in place. And our clients doing that actually results in sort of a delay in some of the invoicing processes. So, we usually do see DSO actually creep up somewhat. I am expecting that we'll probably end up something approaching the 80 number. So, it should be below the levels that we saw in 2018, but it's certainly going to be somewhat higher than what we saw as we exited Q4. However, there's a strong focus on DSO, and so we'll kind of keep you posted as we go throughout the year. The other thing I'd just want to remind you of is we do have kind of a seasonal pattern when it comes to cash flow. We usually have strong cash flow in both Q3 and Q4 of the fiscal year. And then, in Q1, we've got that variable compensation element, and that has paid substantially in Q1 and we also have a cash-settled RSU payment that's made. And so, you usually see a much lower level of cash flow generation in Q1. And also, somewhat lower level in Q2 because you also have a little bit of the variable compensation element paid there as well. So, I just want to remind people of that, that, in addition, to having some seasonality on the profitability front, you also see a little bit of seasonality from a cash flow generation standpoint.

Got it. Thank you, guys. Congratulations again.

Thank you.

Our next question comes from the line of Jason Kupferberg with Bank of America Merrill Lynch. Please proceed with your question.

Hi, guys. This is actually Amit Singh. Just quickly wanted to talk about the adjusted operating margins. This quarter was obviously very strong at 18.4%. I guess the strongest since, I think, the second quarter of 2012. So, if you could talk about what led to that strong margins in the quarter? I know utilization has gone up to above 80 [indiscernible]. So, a little bit of color there would be helpful.

Yeah. So, first off, the beat on the revenue clearly helps in other ways, right? It kind of supports the SG&A efficiency and, generally, it leads to higher utilization. So, as you point out, we have the higher utilization, high revenue overall. SG&A was somewhat lower than we had expected, and there was kind of a one-time effect that I don't think that you would see in future quarters. And so, it could be the – the higher utilization, we usually have pretty good sort of calendar day availability or bill days in Q4, and then just the overall SG&A efficiency. If I were to kind of take you forward to Q1, usually, what you see is you see quite a bit lower bill days for EPAM in Q1. And then, the T&M business bill days will impact your adjusted IFO. And that's because you've got a lot more holidays in Russia, Belarus and Ukraine in that time period with kind of the Orthodox Christmas – or Eastern Orthodox Christmas, right? Then, we probably have slightly lower utilization. And then, I do want to make certain that everyone understands that we do expect that SG&A will go back to a rate more on our 18% to 19%. So, as we exited Q4, we were below 18% as a percentage of revenue. And then, I expect in both Q1 and for the remainder of the fiscal year that we'll operate in the 18% to 19% range.

All right. Perfect. So, just a follow-up to this for fiscal 2019 guidance. You're guiding to 16% to 17% when we look at the full year. And you ended this year, for the full year, at the higher end of that range. So, at the midpoint, why should overall margins decline? And then, also, if you are looking at topline, at the beginning of the year, so I understand that you want to be cautious and see how things play out. But you ended the year at around 27% topline growth in constant currency. And the guidance for next year is 23%. So, if you could explain these two, on margins and topline, and also just add to how M&A is contributing sort of next year.

Yes, let me start with the end. And so, first off, with the 27% on the constant currency, we would have had a 2% benefit from M&A, specifically the Think and Continuum acquisitions. In 2019, we expect that there will be a 1% benefit. So, if I were to look at the constant currency growth rate, we're guiding to an at least 22% growth rate for 2019, which is actually consistent with the growth rate that we guided to in 2018. From an overall kind of profitability standpoint, we are going to continue to make the investments that we need to continue to grow the business at greater than 20% a year. Again, we expect that that will mean that we'll return SG&A back to an 18% to 19% range. And we continue to get all of the price increases and wage inflation continues to be kind of within our expectations and kind of within our recent history. And so, we believe we'll continue to manage the business very much in that 16% to 17% range, again, with the idea that we want to be able to make the investments that allow us to continue to grow the business not just in 2019, but into the future. I guess, the only other thing I'm going to point out is just that we do – you did have that very strong exit and it was a great quarter and a great fiscal year in 2018. However, you do have seasonal patterns. And so, generally, what we find is the first half of the year has got a lower level of profitability than the second half of the year, and I expect that you'll see that pattern again in 2019.

All right. Perfect. Thank you very much.

Sure. Thank you.

Thank you. Our next question comes from the line of Maggie Nolan with William Blair. Please proceed with your question.

Good morning. I want to follow-up to that M&A contribution question. I think you said 1% for the full-year 2019. What's the contribution in the first quarter specifically? And what was the contribution in the fourth quarter of 2018 as well?

Yeah, great question. So, in the first quarter, we expect 200 basis points of benefit. And in Q4, it would be 250 basis points of benefit. And so, we would have had Continuum, we acquired on March 15th of Q1 of last year and Think was November of 2018.

Very helpful. Thanks. And then, you've talked about more complex larger scale engagements. Obviously, that's going to get you into competition with some larger and more experienced firms as you engage these new types of opportunities. Can you just kind of comment on the competitive environments? Do you expect to see any increasing competitively bid deals or any changes in terms of your ability to bring on higher pricing or drive higher pricing on new engagements?

Yeah. We, clearly, compete with top firm for some time already and proportion of these deals for us is increasing year by year. And some of them, we've been able to price differently, but I don't think it's impacting the total picture yet. We hope that it would be changing in the future. But as in the past, it's very – my answer is the same. It's very difficult to predict how it would be happening. And again, directionally, there is a chance that we will benefit from this.

Okay. So, you're talking about change in method of pricing or are you talking about the…?

It's actually rates in general because complex projects also require different composition of the teams, including teams with consultant skills and in-market skills, which also changes the pricing. And on top of this, the method of pricing, because when we go into automation projects, there are some opportunities to do it differently. But, again, it's relatively a small portion of the revenue, and I think impact might be seen like later in the game.

Understand. Thank you.

Thank you.

Thank you. Our next question comes from the line of David Grossman with Stifel. Please proceed with your question.

Thank you. Well, good morning. I am wondering, Jason, could you just help us out and maybe deconstruct the revenue guide? I think you said a point from acquisitions in 2019. We're still simmering kind of mid-teens-ish headcount with the balance from pricing and a little from utilization. But I think you had mentioned utilization coming down. So, maybe you could just help us out to deconstruct the top line growth?

Yeah. So, from a reported standpoint, we've got at least 22% guide. We've got a constant currency at 23%. We've got the minus 1% and that's with Think and Continuum only, if we were to do additional acquisitions. So, that would be additive. And so, if you net out the Think and Continuum at 1%, then you end up with a reported growth rate of 21% and a constant currency growth rate of 22%. I think you'll see the same types of patterns that we've seen in the past, David. And I think you are aware of the fact that we've seen a gradual shift towards onsite capabilities. Those onsite capabilities come on with higher revenues. Also, what we'll see is a certain amount of wage inflation, but we're not seeing any significant changes relative to what we've seen in past years. And we also are, as Ark just indicated, able to get price increases with customers. And the environment seemed somewhat more friendly to that just based on sort of the supply constraints in the market. So, I think you'll see fairly consistent patterns to what maybe you saw in 2018. And I suspect that the – the gross margin will now be as high as it was in Q4 where we exceeded 80%, or that's not what we're expecting. But I think that you'll find that gross margin levels will be in or around what we did for the full year of 2018 [indiscernible].

Okay, got it. And then, in terms of just thinking more broadly about the business model, I know you guys have talked in the past about broadening the pyramid, particularly given what's going on with supply. Any updates there in terms of your efforts to kind of create a broader platform at the bottom of the pyramid and perhaps enhance the available supply that you can use?

David, you know for a long time that we're mentioning how much we invest in education and platforms to manage people. We mentioned this today as well. So, I think that's our constant focus and constant investment. And that's why we have good level of confidence that we would be able to stop. You're absolutely right, it's very, very, very challenging and very tough in all markets.

David, our 2019 plan would include slightly elevated level of kind of new grads as we kind of focus on the pyramid in certain geographies in which we operate.

And so, was that at this point, Jason...? Yeah. Go ahead, Ark. I'm sorry.

I just wanted to mention that we also – you know we entered into new markets for talent like India several years ago. And I think we're in much better shape there as well than we were several years ago. So, there are multiple sources now. It's not just Eastern Europe.

Okay, got it. Just one last question. Jason, you mentioned SG&A. There was a one-time benefit in the quarter. Could you just give us a sense of just how large that was?

It was approximately – approaching kind of $1 million. So, yeah, it was somewhat substantial in the quarter. But, again, approaching that level.

Got it. All right. Thanks very much.

Thank you. Our next question comes from the line of Darrin Peller with Wolfe Research. Please proceed with your question.

Thanks, guys. I just want to follow-up on – when I think about the run rate of revenues from fourth quarter, I know you touched on this, but you're guiding on it because you see something in like Financials or in any other vertical? And just [indiscernible] how sustainable is that kind of [indiscernible]. You're breaking up a little bit, Darrin.

You broke up a little bit. So, you're asking about the guide for the quarter or the full year and then it sounds like you specifically asked about healthcare?

Yeah. So, can you hear me now? I was just basically trying to figure out if the healthcare and the financials vertical, how you're thinking about the two of them? Healthcare being very strong at 70% and financials being more of a question given the European side?

From a healthcare standpoint, we're seeing extremely strong trajectory as we exit Q4, and also seeing extremely strong demand as we enter Q1. So, I expect that that's going to continue to be a very high-growth area for us. From a financial services standpoint, little bit as we talked about. A couple of customers in the European space, which have not been generating growth for us, but we actually are seeing good traction across a number of customers. We've got some payments customers that we're beginning to do some work for. We're also beginning to get some entry into the insurance space, which has been a very kind of underpenetrated kind of part of the financial services area for us. And then, I just think we've got a broad range of, what I'll call, kind of growth engines. And you look at what we've done from an industry vertical standpoint. A year ago, I think that healthcare was actually the slowest-growing vertical we had. And here we are, in this quarter, with it being the highest growing vertical. So, we've got a broad range of growth opportunities across a range of different industry verticals.

Okay. Is there anything happening within the financial institutions, the two or three or four that you talked about that we should be keeping an eye on, that could get worse or, potentially – are you embedding the conservatism around those into your guidance, which is partly why you have a deceleration from the fourth quarter run rate?

I wouldn't say that there is anything which we need to worry about from what we mentioned. And I think we are – and I think you might be thinking about our revenues traction not only in terms of verticals, but what type of work we're doing. And that's why, like, volatility between verticals is pretty significant from quarter to quarter, while the growth across the company pretty stable because, like, again, this transformational type of programs digitally led, if you will, they kind of simulate across the verticals as well. And because of the size of the company, when you compare us to the really big guys, we still have higher – much higher volatility across the industries, while general business and the type of business is sometimes similar in these specific portfolios.

Okay, right. Just the last question is, I understand that you guys have seasonality on the margin side, but, I guess, having the margins flattish basically after what we saw year-over-year increase and even – Jason, you talked about last quarter – improved contract profitability. Do you still see that improvement continuing through the year despite the puts and takes on a quarterly basis? And then, were you reinvesting the upside?

Yeah. So, from a contract standpoint, there is a strong focus within the company on account level profitability. There's some opportunity for price increases and maybe a little bit more so this year than in past years. But at the same time, we've got cost increases in wages and we are making investments in certain areas that probably, if I were to specifically talk about investments in account management, which we think is supportive of future revenue growth, but also allows us to sort of manage some of these more complex programs that Arkadiy was referring to. Another example, in 2018, of investments would be in capabilities and you think about the Google cloud capability that we've talked about. And so, it's a combination of investments in the infrastructure that's required to continue to support a business growing at this rate. And then, investment in capabilities that allow us to address sort of different markets or different segments of markets and grow with our customers.

Okay. All right. That's helpful.

Sure.

Thank you. Our next question comes from the line of Arvind Ramnani of KeyBanc Capital Markets. Please proceed with your question.

Hi. Thanks for taking my call. I just kind of wanted to get your sense of the overall sort of demand environment. You certainly sound fairly positive. But can I cast it in comparison to how you felt about the demand environment last year? Have things incrementally improved and what have been the sort of underlying drivers?

Arvind, sorry for boring answer, but again it's very similar. Because the whole company focused on more fast-growing component of the market in comparison to, again, our larger competitors, we've seen relatively strong consistency this year versus last year versus year before. So, there is no much difference in the segment which we play. The demand is pretty good right now still.

Yeah. So, a little bit of color, since we talked about, we've got good growth in life sciences and healthcare. In North American hi-tech, particularly in the Bay Area, we're seeing nice growth and we're being brought into a number of large tech customers there. Financial services, again we've talked a little bit about a couple of those smaller customers in Europe, but we've got good growth opportunities in financial services, including insurance that we talked about. And then, we're also seeing a lot of good growth opportunities in North America in the energy space. So, again, we feel that the demand environment looks really good in Q1. A little less visibility, obviously, if you look through the end of the year, but, as Ark said, the visibility is consistent with probably what we've seen in the past.

Great. And on the last earnings call, you all had talked about automation and some of the work that you are doing with WorkFusion. Can you just give us a little bit more color? And also, are you expanding the kind of vendors you're working with and kind of has some of that work accelerated? Any color on the automation side would be great.

Yeah. We do expand in the number of vendors and this work is growing for us. It's all right. And this is pretty good interesting examples where we're able to green light the call [indiscernible] consulting engagements back to actual realization of the benefits.

Great. Sounds good. Good luck for remainder of the year.

Hey, thank you so much.

Thank you. Our next question comes from the line of Moshe Katri with Wedbush Securities. Please proceed with your question.

Hey, thanks. Good morning. A great quarter. In the past, we spoke a bit about wage inflation. And I think you mentioned it today as well. Can we talk about some of those pockets, where are we seeing those pressures? That's number one. And then, I've also noticed besides the fact that Life Sciences was very strong during the quarter, emerging verticals were also very strong. Maybe you can talk about some of those emerging verticals, where are we seeing that strength? And are we getting to a point where some of those emerging verticals will be reported on a separate basis? Thank you.

Yeah. Regarding emerging verticals, I think we've talked about automotive in the past. As I just talked about with the last question, the energy has been quite strong for us and we've got some more, I guess, telco-related business. And so, those would kind of be the three to kind of, I think, I'd point out. I don't think we are at a point yet where we would sort of separate any of those, but they continue to be very interesting opportunities and high-growth areas for us.

Okay. And then wage inflation, different pockets?

Yeah, wage inflation would be pretty consistent with what we saw over the last couple of years. And it's – we've talked about a number kind of approaching 5%. Certainly, there may be some geographies where it's somewhat higher, including maybe the Bay Area, but we haven't seen elevated wage inflation at this time.

Okay. And then, just final point. You mentioned very favorable environment for pricing. Should we assume what we've assumed in the past, which is kind of low single-digit growth in pricing for the year? Is that a good number to use for modeling?

Yeah. And so, I think I would sort of just make sure. I think I said, as somewhat more favorable environment for pricing. Yeah. And so, I think it would probably be somewhat consistent with what we've seen in the past with maybe a little bit of opportunity.

Great, thanks.

Sure.

Thank you. Our next question comes from the line of Mayank Tandon with Needham & Company. Please proceed with your question.

Hey, good morning. This is actually Kyle Peterson on for Mayank today. I just want to see, if you comment a little bit – I know you mentioned the kind of war on talent remains pretty strong. Is that having any impact on attrition? Or is that kind of just bouncing along historical averages?

Yeah. If I just look at the numbers, it would be just slightly elevated over what we've seen in the past. I could be fair, we're about to payout a variable compensation element. And I think, for any company, you sort of see things change sometimes after that. But, right now, it would just be slightly elevated. Ark, do you have any other thoughts or...?

I don't think there's anything else to add. Slightly higher on attritional rate. But, again, this type of volatility, we saw it before as well. It's nothing new.

Great. And then, my only other question would be on the M&A pipeline. Just kind of – if you describe qualitatively kind of what you guys are seeing or what you might be looking for kind of appetite for future deals?

I think nothing changing here. We are always looking, always talking. And as soon as something happening, clearly communicating and the strategy there is still the same. It's mostly about client engagement and very specific capabilities. And we building our plans on the same size of acquisitions, while if something bigger and interesting will come. So, we will be considering this too.

All right, great. Thanks, guys.

Thank you.

Thank you. Our next question comes from the line of Jamie Friedman of Susquehanna International Group. Please proceed with your question.

Hi. Good morning. I wanted to ask two questions. I'll just get them both in upfront. When I take your headcount from the end of 2017 relative to the end of 2018, it looks like it grew about 17%, but the revenue was up about 27% constant currency. Jason, I know there's other inputs like utilization and fixed price, but that's a 10% delta between revenue and headcount, which seems like a lot of pricing relative to what you've trained us historically. So, I don't want to get – one, can you verify the math? And two, you're qualifying the pricing increases for 2019, was 2018 just an extraordinary year that way?

Yeah. I think the important thing to think about, again, when we talk about pricing, I think we're kind of talking about pricing on a like-for-like basis. And so, for instance, if you've said, resource of a certain level in a certain geography, and so what you're seeing that I think is driving that higher revenue per headcount or whatever language we had used for that is really a generalized kind of drift towards a higher level of in-market resourcing. And so, I think that, if you see early in the fiscal year, we would have been more in the sort of 9% range. And as we exit 2018, I think we're closer to 11% or around that range. And so, obviously, an on-site resource has got a much higher bill rate than an offshore resource, but you don't necessarily – that doesn't translate directly into profitability, right? Because the wages for the onsite are much higher as well. And so, I think what – we're certainly getting some prices I've talked about. But I think a lot of what you see when you do the calculation you're doing is really the shift towards somewhat higher levels of resourcing onsite. And that's relevant for us, as Ark talked about, as we sort of take on more complex engagements with customers. It does help drive larger programs, but it doesn't necessarily drop into a straight improvement in gross margin or adjusted IFO. Does that clarify that?

Yeah. No, that's a great answer. Do you disclose that? I'm looking at the fact sheet. I may be forgetting it, but the onsite/offshore mix?

I think we've talked about it publicly. I'm not certain that we actually sort of put in a fact sheet, but it is something that we update on verbally.

Okay. And then, if I could just ask one more, with the top five – no EPAM conversation would be sufficient without the top five question. So, the top five, my calculation, is it grew by 12%, 12.5%, which is about half the corporate average for the quarter. But, interestingly, it looks like it was down sequentially. I know there's some currency mix in there, but my calc is that it's down 2.5% sequentially. You were up 7.8% sequentially. So, anyway, and I know there can be movement in top five that we can see. But, anyways, does that math sound about right? Any commentary there?

Yeah. Just one of the top five customers, a piece of their business was split out. And so, now it's an independent entity and you might be able to guess which one that was, okay. A piece of revenue that would have been part of that customer is now not part of that customer, that we're still doing revenue with both customers. But what it did is it reduced the level of revenue associated with one of our top five customers. Is that a clear enough answer?

Yeah. Thank you for that. Thank you, guys.

Thank you.

Operator? Operator, are you on the line? So, for those that are remaining on the call that we're not able get through the Q&A, we will follow-up with you after this call. But why don't we go ahead – Ark, go ahead and proceed the closing.

Okay. As usual, thank you, everybody, for being with us. So, I think it was – 2018 was a very good year for us. And we hope to continue growing. Talk to you in the next quarter. And happy Valentine's Day for everyone.

Thank you.