Good day and welcome to the Second Quarter 2024 EPAM Systems Earnings Conference Call. All lines have been placed on mute to prevent any background noise. After the speakers' remarks, there will be a question-and-answer session. [Operator Instructions] And finally, I would like to advise all participants that this call is being recorded. Thank you. I'd now like to welcome Mike Rowshandel, Head of Investor Relations to begin the conference. Mike, over to you.

Good morning, everyone and thank you for joining us today. As the operator just mentioned, I'm Mike Rowshandel, Head of Investor Relations. By now, you should have received your copy of the earnings release for the company's second quarter 2024 results. If you have not, a 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 would like to remind those listening 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 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, Mike. Good morning, everyone. Thank you for joining us today. First, I would like to start off with our second quarter results which came generally in line with our expectations. We believe our performance in the second quarter of 2024 reflects our continued strong execution and adaptability amidst a still complex demand environment. Let me share some current highlights of our business from Q2 up to today. Our underlying business continues to show signs of stabilization. In the second quarter, we delivered very strong growth in our healthcare and life sciences vertical and strong growth in our emerging verticals, where we also saw some slight sequential improvements in financial services. In some of the verticals, namely business information and media, we continue to work through the impact of the ramp downs from the few large clients we have mentioned before. On the demand environment, we do see broad-based signs of stabilization as well across both EMEA and North America. At the same time, clients are still cautious with larger programs and our visibility to a significant increase continues to be constrained by a mix of clients, cost-saving priorities, delays in program starts and clients' own business changes. As a result of this complex environment, we are currently assuming no net improvements in overall demand for the remainder of the year. Jason will provide more details of our updated outlook for 2024. To be clear, notwithstanding the overall demand picture, we are optimistic about certain sectors of our target market and our current portfolio returning to modest growth story in the next 2, 3 quarters as we see it now. In overall, while we adjust our offerings and our delivery mix to see the parameters of the current demand environment, we continue to see significant traction in our data…

Thank you, Ark and good morning, everyone. In the second quarter, EPAM generated revenue of $1.147 billion, a year-over-year decrease of 2% on a reported basis or 1.7% in constant currency terms, reflecting a negative foreign exchange impact of 30 basis points. Due to our exit from the Russian market, we no longer generate revenue from Russian clients. The impact of this exit had an approximate 50 basis point negative impact on year-over-year revenue growth. Excluding Russia revenues, year-over-year revenue for reported and constant currency would have decreased by 1.5% and 1.2%, respectively. Moving to our vertical performance. Life sciences & healthcare delivered very strong year-over-year growth of 22.4%. Growth in the quarter was driven by clients in both life sciences & healthcare. Consumer goods, retail and travel decreased 7.7% on a year-over-year basis, largely due to the declines in retail, partially offset by solid growth in travel. Financial services decreased 5.6% year-over-year, driven by softness in asset management, banking and payments. In the quarter, the vertical delivered slight sequential growth, indicating stabilizing demand. Software and hi-tech contracted 3.7% year-over-year. Business information and media declined 12.6% compared to Q2 2023. Revenue in the quarter was substantially impacted by the previously discussed ramp down of a top 20 client. And finally, our emerging verticals delivered solid year-over-year growth of 10.6%, driven by clients in energy and telecom. From a geographic perspective, Americas, our largest region, representing 60% of our Q2 revenues, grew 1.8% year-over-year on a reported basis and 2% in constant currency terms. EMEA representing 38% of our Q2 revenues, contracted 6% year-over-year and 5.6% in constant currency. And finally, APAC declined 0.6% year-over-year or 0.2% in constant currency terms and now represents 2% of our revenues. In Q2 revenues from our Top 20 clients declined 3.7% year-over-year, while revenues…

[Operator Instructions] Your first question comes from the line of Maggie Nolan of William Blair.

I wanted to dig into the utilization and the dynamics between on-site and offshore. So first of all, what percentage of the workforce is considered to be on site this quarter? And then is offshore utilization running higher than what you view as sustainable to offset some of that weakness on on-site because you're not too far off from your historical range here?

Yes. The -- I think we feel that the offshore utilization is actually quite healthy. And I'm struggling right now to remember exactly what our on-site percentage is but from a total head count -- but from a utilization standpoint, it's definitely lower than we would traditionally run at. And it continues to be the area that I think we find ourselves somewhat challenged in. And so it probably is also contributing somewhat to revenue growth for the remainder of the year, where we continue to see more demand for offshore and incrementally more demand for India and again, continue to run at somewhat lower levels of utilization on site. And that's something that we are working to address, pull-through demand generation and also through taking some actions, as I referred to in my prepared remarks.

Got it. And then somewhat related, just building on that, the improvement in the margin outlook, is that primarily related to those actions that you want to take on utilization? Are there other levers you're pulling? And have you already seen some progress here in the third quarter to fuel that optimism in the increased number that you gave?

No, absolutely. And so the focus has been on sort of cost optimization after we reset our expectations for revenue growth. So we've been more efficient in corporate functions and SG&A. We've been working on utilization. And so yes, the actions that we intended to take are underway and it is beginning to show up probably even in a little bit of the benefit that we saw in profitability in Q2.

Your next question comes from the line of Bryan Bergin from TD Cowen.

I hear you on the overall complex demand environment. I wanted to dig in on the demand progression in the top accounts. that you saw over the last 3 months as well as just how you see the top clients, particularly the top 5 to 10 performing in the second half and as you exit this year.

So I think despite of the opticality of the clients for the top 5, there is only one client which is declining and this is basically a continuation of the trend which we saw before. And even this client decline, kind of getting less and getting to a more stable environment right now. So but in general, it's exactly like we commented before. It is pretty stable.

Yes. And that top 5 client, this is the one that we talked about in the past which is a European business information and media client.

Okay. All right. That's helpful. And then just on the GenAI front, can you dig in a little bit more on the progression of GenAI-related work as far as just maybe any rough quantification on the size of some of these programs and the mix of really the POCs that are moving into production?

So it is pretty challenging, especially when we're thinking that -- we're trying to understand how some of our talents quantifying this. And it's very much all around the well. So that's why for our internal understanding and integration, we have kind of fewer GenAI-related projects and some influence revenue and so on and so on. So from this pure type of stuff, a lot of small POC now approaching high hundreds of thousand or low millions of dollars. This is already starting to happen. So -- and this is dozens in our case. And again, it's very difficult to compare apple to apple when we're hitting some numbers for competition. At the same time, from influence point of view, we started to go already to tens and upwards of hundreds of millions as well. So very different even from 6, 9 months ago.

Okay. Understood.

Still, if you think about it, it's a very small portion of our revenue. And I think general trend that -- when during the POC, there is a confirmation, the potential ROI and excitement, then it's coming back to the technical debt which we were talking about during the last quarter. And companies realize that to actually get the benefit of this, it requires really investments and go to some data modernization program which is much needed and require much more depth. And that's actually one of the showstoppers to real progression, because they are not ready yet.

Your next question comes from the line of Darrin Peller from Wolfe Research.

Could we just touch for a minute on the sequential math? Looking at the guide, it looks like the dollars of revenue expected is pretty much exactly flat or almost exactly flat going from second through the end of the year. And I know you're trying not to embed any type of upside or inflection. Just -- I know there's also some seasonality typically in Q4, although things like budget flows have been tougher lately. But maybe just touch on that for a minute in terms of your expectations on a per quarter basis. And then really just go back to the overall demand environment, where you're seeing clients spend what you think you can do that maybe must -- a little bit less related to the macro and more idiosyncratic as we've been seeing more and more IT services companies trying to really address current needs as much as possible. So anything more you can just comment on where the demand is today, especially if the macro holds at a slower level for a while, what you think you're doing that's resonating the most.

Yes. So I'll just start with the more technical, I guess and I'll leave Ark to answer maybe the harder questions. And so from a Q2 to Q3, you'd have higher vacation and more build days. And so you get a -- you should see a somewhat modest improvement but you should see some improvement in revenues just based on what you can call kind of technical or seasonal factors. And then in Q4, it will depend on what type of vacation levels we see. But usually, you would see even a little bit higher levels of vacation in Q4, lower build days. And then, of course, the question is going to be what type of furlough activity we see. So generally, there is a somewhat significant impact just due to seasonality. And so that's kind of what we're modeling at this time, again, is that generally, a very modest improvement up from Q2 to Q3 based on seasonal factors. And then some degree, a decline unless, as you said, we see some type of budget flush or again, we're able to influence the level of vacations that employees take. Ark, do you want to talk a little bit about overall demand or where we're seeing [ph].

I think our equipment, very much in line with the last quarter. So we -- as we mentioned last time that we don't -- we don't think we can project the market in current situation. So I think it's very much similar. And if quarter ago, our projection range was much broader than today, in just saying that our expectation of good news, we are not confirmed. And our expectation for the great news actually didn't happen as well. So we're narrowing and it's a reflection of the type of projects in play right now. There is no big modernization talk. There are conversations about it but it's not turning into reality. There are a lot of noise around GenAI which is not converting to big revenue as well. But around the business, keeping the status quo on production systems, that's what we're focusing, improving. And again, looking for kind of one-off modernization play where we can really bring the value but it's very competitive and again, not necessarily decided for the client right now. I don't know if I'm giving you answer that you want but...

And I would just add that we're working to change the trajectory in Europe and we are beginning to see some better conversations and opportunities kind of appear there. Again, so that's an area where we're looking to sort of, let's say, change the picture. The other thing I think you see in our fixed fee which continues to go up, we're continuing to sort of explore and work with clients to have more of a committed kind of model around what we'll deliver for a fixed fee or a fixed monthly fee and that's a reflection of what we're trying to do to respond to customer needs and win more business.

Okay. Actually one quick one just on hiring, is just on -- I mean do you anticipate -- if utilization stays in these ranges, do you anticipate needing to hire more? Or I mean, maybe AI or other types of efficiencies can help maintain?

There's certainly some programs where we're clearly working to include AI productivity improvements. But no, we would continue to hire and I think you'll continue to see hiring in the types of geographies we've been talking about which is more kind of offshore certainly with someone [ph] in Latin America.

Your next question comes from the line of Jim Schneider from Goldman Sachs.

First of all, on the discretionary demand environment, it's not surprising to hear of the constraints given what the environment is out there. But what are your clients telling you about the conditions under which they would start to release more spending or more aggressive with new projects in 2025? Is that tied to macro? Is that tied to more certainty around their AI strategy or other priorities they have internally in terms of IT spending?

So we do believe that majority of the kind of decision making, it's environment related right now. Because as soon as kind of situation would be a little bit better, I think investment in general data infrastructure and cloud infrastructure which was delayed will be triggered, because everybody understands the impact of GenAI. And without fixing first this, it would be very difficult know for -- so I think market is holding right now.

And then maybe just in terms of the margins, obviously you delivered good growth and operating margin leverage in the quarter. That was good to see. Was that mostly driven by the mix of head count shifting to India? Or are there other factors there besides the SG&A line? And then, I guess, going into '25, as we exit this year, what kind of further gross margin leverage do you expect to deliver or is this sustainable from here?

Yes. So we're continuing to work on utilization. And the improvement in Q2 was probably a combination of efficiency with SG&A and continued to focus on improving utilization. I think what we've talked about over the last couple of quarters is that we continue to have an opportunity because we've got a fairly heavy pyramid still including in India. And so what we need to do is make sure that we're introducing more juniors into the mix which generally has a broader sort of pyramid, it improves profitability overall, also can allow you to be a little bit sharper with pricing. But the Q2 improvement in profitability was not driven by a shift in India. Again, it was more kind of these operational kind of efficiency factors that we're continuing to work on throughout the remainder of the year.

And in terms of the forward improvement there?

Forward improvement, again, is the work that we're doing on utilization improvement, reducing the bench and ongoing efficiency in SG&A. So again, it's just a focus on certain areas of our operations that we think we can see some further sort of reduction in spend certainly as a percentage of revenue.

Your next question comes from the line of Jonathan Lee from Guggenheim Securities.

I want to get a better sense of how India is progressing. Can you help unpack the type of volumes you're seeing there and whether expanded presence has had any sort of influence on new types of demand or types of contract structures being utilized, especially if you think about the revenue and margin dynamics that are contemplating the outlook?

Yes. So I'll let Ark talk a little bit more about the type of work in progress. What I would say is that from the last time we spoke with you, Jonathan, is that India is likely to make a somewhat -- a very slightly greater percentage of head count by the end of the year. So last time, Ark and I were talking about something approaching 20%. We now think that India will be slightly above 20% by the end of the year. And what you are seeing is a modest pressure on average bill rates as a result. And that probably is also sort of shaping how we look at the second half. So it's not super significant. But I think last time -- sometimes we would utter the word, 19.5% and right now, we think that India is going to account for just over 20% of our head count by the end of the year. So we continue to see a modest gradual shift there, while at the same time, we are seeing improved utilization in our other areas of operation, in Europe and Western and Central Asia. So it's not as if all the demand is shifting to India but we are seeing ongoing kind of increment in India. Ark do you want to talk about type of work or...

Type of work, like I think that's what we shared already today. We consider like this into India, there is a pricing pressure. So this is definitely a very objective kind of component. At the same time, the type of work which we do, not changing much from location to location. And as we said before, EPAM has a kind of reputation for more complex quality engineering solutions. And as we said, we're building actually in the very strong data renewing occupancy. We're bringing like everything that we do around GenAI, productivity improvement for SLDC. We built a digital engagement practice. So it's very much in line with the broad EPAM and the type of work is, again, very, very similar. So from overall perspective, it's also creating different profile of our breadth in India. Because when we started to move work there, we have to bring much more proportionally experienced teams there. And only after this, we will be able to scale to the different pyramid. That's what's happening for us in multi-nesting, some movement of the work, rebuilding the pyramid and still investing in -- wanting to be exactly in line with client expectations because they expect from EPAM independently from location, similar type of service.

Thanks for the detail there. Can you unpack your comments on the lack of improvement contemplated in the outlook? I want to understand what that means for deals that have been signed but perhaps not yet launched or ramped. How much go-get or pipeline conversion is still required to achieve your outlook at both the high end and the low end?

Yes. And the last time we guided, Jonathan, we did talk about still expecting a very modest improvement in demand and what we're now saying is we don't see that improvement in demand. And so we try to be quite prudent with our guide. Clearly within this quarter and clearly, having set the full year guide which obviously is how we're thinking about Q4, it does very much -- particularly if you take the full guide of $4.590 billion to $4.625 billion, it does encompass even things like some potential reductions in demand due to cost reduction efforts at clients or that type of thing. And so I think we feel pretty confident that, again, we have a little bit of sort of downside as clients continue to be sort of cost sensitive. And then the upside probably would be a little bit more in the lighter furloughs, maybe just a little bit of kind of budget openness in the remainder of the year. And again, our ability to probably influence the level of vacation taken by employees to again, give us a little bit more capacity in Q4.

Your next question comes from the line of Ramsey El-Assal from Barclays.

It looks like your percentage of fixed-price contracts has been trending up and it's a little higher now than it's been at least going back quite a ways in our model. What is driving that mix shift sort of away from time and materials work towards fixed price work? Is it geographic? Is it GenAI related? And I guess, are there any implications for margins when it comes to fixed price versus time and materials work?

Yes. So you're correct that it has been trending up and probably will continue to trend up somewhat. And so it's a mix of what would we call percentage of completion and what is sort of a fixed monthly fee. And so it probably does reflect the fact that we're beginning to try to address clients' needs in a way that's a little bit on traditional prepay where we have traditionally been kind of more bleeding-edge complex projects where it was difficult to estimate. We clearly have that type of work but we are trying to be able to sit with our clients and say we can do this for a fixed amount of money or fixed amount of money on a monthly basis. The other thing I think you are probably seeing is some opportunity with GenAI to introduce not only traditional sort of productivity improvement or productivity improvement from GenAI and commit to a series of savings over a period of time. And so you are seeing us also enter into engagements with clients. It may be more a multi-quarter or in some cases, even multiyear that do reflect what we believe is a productivity improvement that we can achieve over time. And that could go either way, right? It can be net positive to margins. If obviously, we've misestimated or sort of delivered poorly, it could be negative. But generally, with fixed fee, you do have the opportunity to improve profitability relative to time and materials because it just gives you more flexibility in how you deliver.

Okay. And a follow-up for me on M&A. I guess, given the buybacks in the quarter and the additional share repurchase authorization, is larger scale M&A off the table? Assuming you're still in the market for tuck-ins to plug capability gaps, what types of assets might you be looking to bring into EPAM?

I think nothing is off the table. So as always in the past, we constantly have conversations and opportunities for different sizes of acquisitions. And -- by insurance back is actually very much functions of if it's going to happen or not. So it's not must condition, it's a direction which we will be executing only if we think that we will ramp up with any other aspects of the business. So if the M&As will be happening, we will be adjusting the numbers, if necessary.

Yes. So we'll do both. But clearly, our bias would be towards acquisitions. And as Ark said, doing something somewhat larger, certainly not off the table.

Your next question comes from line of Surinder Thind of Jefferies.

Just a question around the global delivery footprint. As you look ahead, if revenues was to remain stable, at what point do you think you'll get to your target delivery footprint?

When you say it will be stable, what do you mean? So...

Assuming -- I think there was commentary on the call about on-site utilization being a little bit below expectations. And so there's continued shift for the requirement of resources in lower-cost regions. I think there's previous commentary around maybe not as much demand in nearshore or Western Europe shifting some of those resources through natural attrition to other parts of the world. So that was the -- what I was trying to get at.

I think -- let me try to answer slightly differently. First of all, we definitely move into global diversification from indications of stability and 24/7 on the growing global climate. And from this point of view, we will be much more diversified than in the past. And right now, it's also -- as we mentioned, probably will be the most balanced global direct company. That's a direction. What exactly proportion of this, it's much more difficult question to answer because it would be a function of general demand. When you say like, for example, the assurance in Europe is not so much in demand, it's in many ways, subject to the type of work, number one and the cost pressure, number two. As soon as the market will start to come back to kind of fix the technical debt which we're talking about, that modernization cloud and data program will accelerate to again, make the progress of GenAI transformation much more real. The demand will come back for practically any region. And because of complexity and creativity of these type of engagements proximity will become much more important and pricing component will become less important. So it would influence the structure as well. So again, number one, we will be much more diversified in India and LatAm, it will be a bit the proportion of the total but exactly proportion, we identify it right now.

That's helpful. And then related to that, when you think about all of the new talent that you're hiring, how do you differentiate or attract that talent in the sense that others obviously have large delivery operations out of India. They have well-established connections to the local universities, whereas I would argue you're newer to that region. I realize you've been there since 2015 but just on a relative basis.

So if we're talking about India specifically, I think a couple of factors need to be acknowledged. We have an image of different type of services company, we have an image of much more quality engineering companies and much more closer to what people would think about software tech companies. And from some talent point of view, we compete with these type of companies, the same like with some captives which are trying to build a high-end tech purchases in India. So the image is there already. So at the same time, we are also kind of an underdog in India which means that we have opportunity to play differently and in specific parts of the market, including like bringing our training capabilities and different type of work. I think while there are very large companies, it's -- for us, it's relatively clear how to differentiate us for the labor market, for the type of market. And if you say that we're growing much, much -- like how -- you see it like how India is growing pretty strongly in this situation.

Your next question comes from the line of David Grossman [ph].

Just quick -- a couple of quick follow-ups. If I recall, you said the headwind from India, the mix shift in India was going to be about 200 basis points this year on revenue. Is that still a fair assumption? And do you have any initial thoughts on whether -- or the magnitude of the headwinds would be in 2025?

Yes. I would say that 2% is generally correct. It probably has gone up slightly from when we guided at the end of the Q1 call. And then I would say for next year, my guess is the headwind from India might be greater than 2%. So I guess that's how I'd respond to that, David.

And that's just because of the ramp of headcount? Is that why it's higher in '25?

Yes, it's probably a little bit higher in billable India and a little bit lower in billable on site. And those 2 things are kind of producing what is probably a modest -- modestly lower average bill rate for the company.

Got it. And similarly, I know you've talked quite a bit about the lost clients, I think one was M&A and one was something else. And I'm just trying to remember whether you quantified that headwind this year and next and when we come out against that headwind?

Yes. So the one that is kind of the M&A like exit which is the one I usually refer to, I think we called out at the end of the year. And then it was double-digit revenue, like it was over $10 million a quarter. So it was a significant number. And then the other one is the one that has been sort of slowly reducing their demand for our services and that continues to be an ongoing trend. And that was a little bit related to their hesitation around our Ukrainian footprint. And then I think they're also just doing a little bit of work around bringing some positions in-house. But we still, again, have demand from them but just there's been a gradual decline over time. And I think you'll continue to see that for the next couple of quarters.

Got it. And just one last thing. Just on the DSO, Jason, I know it was up last quarter and it was up again sequentially. Should we see that or do that as maybe a macro dynamic that's affecting all your accounts? Or is this another way of providing better terms to remain more competitive? Or is there something else going on?

Yes. I would say that on the 76 was definitely a result of just the last couple of days being on a weekend and so we saw a significant amount of cash coming on the Monday and Tuesday but that was here in Q3. But David, I would say that as we've moved towards more fixed fee, that is having an impact on DSO, because it does kind of impact the invoicing. And I do think that you're likely to see something closer to 74 for the second half of the year. And again, that's due to the shifting in the type of contracting we've been doing. So then I guess with that, maybe we're...

Operator, we have time for one more question.

The final question comes from the line of Jamie Friedman from Susquehanna.

So with regard to your last answer, Jason, that was really interesting about the fixed price to DSO. I'm just wondering also just related to that, is fixed -- is the growth in fixed price related to generative AI or outcomes-based pricing? That's my first one. And then my second one, I'll just ask it upfront, is Ark, could you call out what's going on in life science? I know Jason mentioned it's a combination of both healthcare and life sciences in his prepared remarks. It was a featured topic at the Analyst Day a couple of years ago. It seems like it's working now. So any high-level stuff, first, on fixed price; and second, on life science?

Fix fees, certainly, there's, I would say, some experimentation with sort of fixed fee with productivity that's GenAI driven. I don't think that's showing up in the numbers right now but it may continue to sort of show up in increased fixed fee. I would say more so, again, clients are looking for us to step in and say, we can deliver a certain program for a fixed amount of money or we can deliver a certain amount of story points for a fixed amount on a monthly basis. And again, it is -- it allows us to be a little bit more competitive. And then we are doing a little bit more business in the Middle East and that market tends to be more fixed fee oriented as well. And so those would be the two things on that. And then growth in life sciences & healthcare, Ark?

Yes. I think we were talking about it. We were talking about building more industry expertise in this area. And in general, from our conversation several years back, it was positive growth, while it was a couple of things when client situation was actually changed. Right now, it's pretty positive. I think concentration of data programs in our life sciences & healthcare business is actually very high which is still in demand today. And again, combination of industry expertise which we invested in some level of consultancy and again data program proportion makes this a benefit for us. And that's with how we look into some other industries, how we can change the trend similar to what is happening here. I think time is over. And as usual, thank you for joining us today. So I think we're trying to communicate that while situation as it is right now, we do believe that EPAM is all focused on cloud data engineering and with GenAI, pretty well positioned for the future growth when markets come back. So I know we repeated this each time but it's actually -- we very much believe it. And we will be ready for a comeback and anticipation. We'll see how many quarters we will have to still wait for this. But again, thank you and let's talk in 3 months.

That does conclude our conference for today. Thank you for participating. You may now all disconnect.