Epam Systems Inc (EPAM) 2023 Q2 法說會逐字稿

Good morning, and thank you for standing by. Welcome to the EPAM Report Second Quarter and Full Year 2023 update. (Operator Instructions) Please be advised that today's conference is being recorded.

I would now like to hand the conference over to your speaker today, David Straube, Head of Investor Relations. Please go ahead.

Thank you, Michelle. I appreciate everybody joining this call on short notice. Earlier today, we issued a press release updating our second quarter and full year 2023 outlook, which Jason and Ark will speak to shortly.

Some of the comments made on today's call may contain forward-looking statements. These statements are subject to risk 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 with comparable GAAP measures and are available in our press release issued earlier today and also located in the Investors section of our website. Lastly, to allow us to get through as many questions as time permits. I would ask you to limit your questions to one per person.

With that, I will now turn the call over to Ark.

Thank you, David. Hello, everybody. And as you know, 1 month ago, we already understood that our initial assumptions for 2023 should be adjusted and today we do so. We realized a number of new opportunities and current client decision framework for new and existing work business are becoming difference versus those which worked for during the last decade.

So we applied revenue -- for the time, understanding to Q2 and 2023 guidance back on the month May (inaudible). However, during the last 4 weeks, we realized that those new assumptions that work for us as well. As we generate from lower probability opportunities to realize revenue turned out to be different versus what we experienced even during Q1 and first months of Q2. So in addition to foreign exchange impact and unexpectedly for us very high number of vacation days in comparison to the last several years.

The rate of dropped opportunities and opportunities move to the next periods increased very significantly. It is something we didn't experience, as I mentioned during the last years and something, which resolved our adjustment to the forecasted approach we did during the last few quarters. We still didn't expect to happen at that extent this time.

As a result, we realized that we must adjust the guidance for Q2 and yet with about 25% impact from FX and vacation plan and the rest approximately equally split between canceled opportunities as those which move to the future. With that new reality, we decided to take a much more conservative approach to the end of the year and to assign to all materialize opportunities at very different probability weight. We also have reestimated more conservatively the situation at some existing accounts.

In the result of this recently (inaudible) recasting approach, we decided to change the annual guidance and bridge is down by about 5% in comparison this previous year set of accounts -- for annual one. Jason will provide more details on the numbers. But before -- question to keep, I would like to share a couple of more thoughts.

While I understand that it's very much not an anticipated change after or it's called just a month ago and not insignificant one as well. I would like to reiterate a couple of few other assumptions we shared with you (inaudible) which we still believe are true. If you think about the cost structure of the revenue in more horizontal way versus industries. Then we can say that about 35%, 40% of fleets associated directly with software product and technology platform companies. And it was always a strong and important depreciation point in our figures. In addition, based on our estimation about 70%, 75% of the remainder of our revenue directly relates to build new included modernization to Cloud data projects, new platforms, et cetera, which is related to all our traditional market segment, build, GeoSoftware and technology. So in total, build for us is a very significant percentage of total business. Practically close to 85%, 90%.

According to Gartner, exactly that portion of the IT market, was experiencing the most significant impact even in 2022 and continue to be under significant pressure in 2023. But -- and that's important. This market segment should recover little strongly later in 2024. At least according to Gartner, almost to the extent of 2021 growth, which even with all discounts will be significant.

So at this point, we have to accept that we underestimated the sharpness of the decline in this specific segment of global IT market, for build and transformational deals. But we also strongly believe in the recovery of this segment, especially with another technology wave, which is going to disrupt the future. And we believe -- we are well-prepared to realize this opportunity in line with how we did it in the past. Our fundamentals are very sound. We continue to run as a strong profitable business still even with lower revenue than we expected several weeks ago.

Our business is operating still as a growth company, which means that we will continue to praise investments and opportunities to develop new capabilities, new markets and new effects and do all possible to prepare a fund for the growth as soon as a growth market will revert. In our view, nothing has changed in terms of the long-term outlook for EPAM even with all distractions, we have to deal with due to the war. And I believe it proves that we can manage this during the last 18 months.

Artificial intelligence triggered and other technology changes will be strong opportunities for us to capitalize. Again, we proved that we can capitalize on previous technology waves well, and I think we prepare it for the next one better than most of us. So in overall, we will be continuously building the foundation for EPAM to return to our historical growth rates when the market demand returns. And we think this time frame is going to be about 2, 4 quarters from now.

To summarize, we still believe very positively that this is a growth business. We are going through some macroeconomic sale packets and dislocations that have cost debt relationship. We plan to continue managing this company as a growth company. However, if the economic situation persists longer than we are anticipating, and we get additional pressure, we will re-evaluate our approach and actions which we would have to take.

With that, I would like to turn to Jason to provide more details on specific adjustments we are sharing with you.

Thank you, Ark, and good morning, everyone. I want to provide some commentary related to the updated guidance provided in our press release. The press release includes both GAAP and non-GAAP figures, but my commentary this morning will focus on our non-GAAP numbers only.

We have reduced our Q2 revenue guidance of $1.195 billion to $1.205 billion by $35 million and our updated revenue guidance is now $1.160 billion to $1.170 billion. We continue to take steps to maintain the profitability of our business even with the lower levels of revenue achievement, we expect to operate in the same 14% to 15% adjusted IFO range that we guided to on May 5.

Regarding our full year guidance, we have lowered our guidance based on our current pipeline visibility. Our pipeline has not converted as expected in Q2 and our updated demand analysis suggests that we will not see a significant improvement in the demand pipeline during the remainder of 2023. We have reduced our 2023 full year guidance to $4.65 billion from $4.8 billion.

Our updated base case assumption for 2023 assumes that overall quarterly demand does not change substantially during the remainder of the year. The higher end of the range requires that known one programs start as expected and that EPAM continues to win some level of new business. The higher end of the range implies a modest degree of sequential growth in the second half.

The lower end of the range includes the possibility that we see further reductions in client budgets, ramp-downs and greater delays in new program starts. This implies modest sequential declines in the second half. Under any of the scenarios, year-over-year growth rates would be negative Q2 through Q4.

For the full year 2023, we are focused on running the business at profitability levels similar to those we previously guided to. We expect to run the business in the range of 15% to 16% adjusted IFO, slightly below the previously guided to 15.5% to 16.5%.

Operator, why don't we open up the call for questions.

(Operator Instructions) The first question comes from Bryan Bergin with Cowen.

I guess mine is going to be just on how broad-based the spending caution is. Can you comment on whether this is a handful of clients or whether this is more prevalent across the entire portfolio? And I'm curious if there is increased caution by a particular industry or region that you attribute this to?

Yes, Bryan, it's hard to sort of look at a single customer even at a handful of customers and sort of say this change in guidance was related to that. It does feel broader-based. We are seeing -- I would say we're expecting sequential declines in revenue across our geographies. Although Europe feels a little bit less impacted. And then from an industry standpoint, we have a few industries that might show sequential growth in the quarter, but generally, the reduction in demand does feel kind of broader based and it's showing up across the industry verticals.

The next question comes from Maggie Nolan with William Blair.

I was hoping you could give us a little more information on pricing dynamics that you're seeing within the existing book of business, the existing contracts that are underway or projects that are underway? Are you seeing any pressure there?

Yes. I think that the market is certainly -- I would think, consistent with what we talked about during the earnings call, which is that it's not a market that allows us to have stronger pricing for new opportunities. And clearly, we have to make sure that we continue to be competitive with existing customers. And so it's -- Yes, it's a market that clearly doesn't allow for a lot of additional sort of price.

I guess the other thing I should probably say is that with sensitivity to cost you might see over time that we're doing more business in lower-cost geographies in the (inaudible) and India regions and those would have lower cost per units associated with.

The next question comes from Jason Kupferberg with Bank of America.

So just wanted to probe into -- just the deterioration here. I mean the magnitude of the slowdown or the weakness in EPAM's numbers, just seems to be a bit more than others. So wondering how you guys separate kind of the pure macro effects that you described around the weaker discretionary spending from perhaps other effects that maybe are more company specific? Just are clients looking at EPAM differently after all of the geographic headcount redistribution last year? Is there evidence of that? And if you can just comment on why the preannouncement so early in the quarter?

So as we mentioned before, it's really difficult to draw the line what's the real cost. And I think even at the beginning of the year, our first earnings call, we were talking about 2 trends and one of them that clients definitely started to execute risk mitigation policies, only one in 2022. And we -- potentially, we are seeing impact of the this late in the year. Assume -- still things which were triggered by that happening today, and we're not excluding the impact of this.

At the same time, I would like to mention that most of the our clients, which were concerned about impact of the war on our performance and the situation in Ukraine, where we have the largest concentration of our talent, by now realizing that it did not impact performance components. And I think this becoming less as important. So we do believe that -- it's again, majority of the issue coming from our high concentration and build transformational deals, while definitely not excluded, there is a component of client risk mitigation policies due to (inaudible) in Eastern Europe.

Yes. I think additionally, as we sort of went through that geographic transformation process, I think it's well known that in some cases, we had to move into more expensive geographies, making it somewhat more expensive than we have been in today's market, which is particularly price sensitive. And so that probably is somewhat specific sort of EPAM factor. And then in response to kind of why we're updating today, I think most people are aware that we've got a series of -- a significant amount of data that we used to run the business. In platforms that allow us to sort of see near real-talent kind of changes. We have an updated pipeline analysis that is updated daily. That translates into a series of forecasting exercises that we do, and we could see very late last week that our pipeline was not converting as we expected, and that resulted in an update to our forecast.

And then -- clearly, this isn't the easiest thing to do, but we thought it was appropriate to come to the market as soon as possible when we get identified based on our insight using our internal data and update our guidance as we now believe that it would be impossible for us to get even low into the previously guided range. And so that's kind of why we've chosen to update at this time.

The next question comes from James Faucette with Morgan Stanley.

This is Jonathan, on for James. What in your client conversations is giving you confidence and in some of your commentary earlier around potential demand improvement in 2 to 4 quarters?

Yes. I think clients probably reacted on this very similar as we do. So there is no 100% confidence or confirmation for clients that they're coming back in 2, 3, 4 quarters with high demand. So they're cautious and they definitely operating in the current environment and situation.

So our confidence or, let's say, expectations that it would happen coming from two things. First of all, as I mentioned, we mentioned multiple times, historical situation that during the last decade, it was only 4, 6 quarters and only 2 years when sequential growth on the market was negative. So basically, during the last 30 years, it's a very short period of time. And usually 1 period was not more than 2, 3 quarters. And then technology were triggering growth again because some customers were in Western and starting to overperform and run ahead and trigger investments from us. So that did happen each time.

So on top of this one, we're analyzing what analysts were saying, like, for example, specifically for build transformational part of the business, which is probably around 20%, 25% of total global IT services market. For example, Gartner, in December was sharing the numbers that in their calculations and multiples interviews with clients. 2022 was practically flat versus 2021. And in December 2022, they were thinking that it will -- this segment will grow maybe 2%, 3%.

I think what we're feeling right now -- that this growth is not happening yet. That is probably more pressure. And if you think that they were predicting practically flat in 2022 in December last year. And we all know that the first half of the 2022 still was a significant growth even with us, we grew 20%, 28% last year. So it means that the negative in the second part and what clients were telling them was kind of predicted. But what Gartner talking about 2024 that it will be practically returned to the rate of 2021 or very close to this. That's where our confidence coming and Gartner talking with clients are talking with customers much more kind of freely and without dependency on the vendor. So I think it's a reliable data.

The next question comes from Surinder Thind with Jefferies.

The question I have here is, how are you guys thinking about visibility today relative to the onset of the pandemic in terms of the uncertainty that you're seeing from clients? And I guess related to that, given how fast things are changing, why even bother to guide at this point?

Yes. So I think with the pandemic, we had a very pronounced V, I think, with a significant input reduction in demand -- at this point, Surinder, what we're seeing is a reduction in demand. And as we've indicated in the full -- the guide for the full year is a potential further reduction in demand. And so I think that the difference probably is that we think that the lower level of demand is going to last for a greater period than a, we originally expected and certainly longer than the sort of the V-shaped recovery that you saw around the time of pandemic.

In terms of the guide, we thought it was more appropriate to provide a broader range, which we've done, which is 150 points between the bottom end and the high end of the range. It is appropriate. And again, I think we've articulated the assumptions and feel comfortable that it's a prudent guide and a better alternative than just a saying that, we can't see. We just figured that -- we do have some degree of visibility and -- but at the same time, with the uncertainty, we thought just a broader range was appropriate.

The next question comes from James Friedman with Susquehanna International Group.

Ark, in the press release, you say, I quote, you're encouraged by the increasing pace of new logo acquisition despite the otherwise weaknesses. I was just wondering if you can give some context about the types of new logos that you may be winning and where those may be coming from?

So I think we're bringing the new business, and I think it creates opportunity for the growth for the future. The difference with new business today, and a new business in the past that is much smaller opportunities than we were having with new logos during the previous several years. So -- but again, it's business happening, and this is exactly to the point which I was trying to make. Some of these companies will invest and will show to the rest of the market that this investment bringing the results and will trigger the kind of the investment from the next layer of the clients. So we really focused on those opportunities to prove exactly that. Somebody who will be (inaudible) right now will be (inaudible) of tomorrow.

So I know it's trivial statement, but it's still -- we believe true and this is exactly how it did work in the past. But again, this new logos happening, but it's initially my single opportunities in comparison to the past.

(Operator Instructions) The next question is from Moshe Katri with Wedbush Securities.

So I appreciate your comments about what do you think your visibility to improve and maybe able to see some sort of a pickup in terms of spending, but some of your peers are talking about the fact that we may not see any funding for new programs during the second half. And this is where the kind of recovery will start, which is probably with the budget for calendar '24 kind of offset. What do you think about that scenario where you're not seeing any funding for any programs this year, but we'll probably start seeing that at the beginning of next year?

About that approximately what we say, we're talking about 2, 4 quarters, which means that potentially recovery can start in Q1 or even Q2 next year.

Yes. So I think what you're saying is fair. Our base case really is that there is not really an increase in sort of programmatic demand throughout the remainder of the year, Q3 and Q4. And so that would be kind of consistent with that of -- with not significant improvement in customer budgets. So it's a yes, I think it's -- and again, there's some comfort level that we will see return to sequential growth in 2024, but I think their question is still valid.

The next question comes from Puneet Jain with JPMorgan.

I just wanted to ask about like visibility on second half of this year. How much of implied revenue for second half stems from ramp-up in some of the newly won customers or some of the new engagements from existing customers?

So there are some visibility, but that's exactly why we had to announce what we announced. We reevaluating visibility criteria from the past to the current market environment. And most of our forecast right now, down based on what we see in existing client base and the trends which you are experiencing during the last months. So I think -- again, we -- as you see, we're more -- much more flattish or even decline in revenue new today. But based on existing client base and some opportunities we share we're still very confident, but moving from previous periods to the future.

Yes. And so clearly, with the tick down in Q2, what we've seen is further reduction in spend at certain clients. And again, it's a broader range and then what we've tried to do is then take that and then sort of extrapolate into a Q3 that really doesn't have improvement and may have some further impact. And at the same time, we've got some very detailed knowledge of programs that we expect to move forward that are relatively modest in size. And we've got less certainty on some of the larger cloud transformation programs that we had talked about earlier in the year, which again, is why you see a lower guided range for the full year.

The next question comes from Thomas Blakey with KeyBanc Capital Markets.

I just was wondering this new kind of like slower for longer -- if I'm mischaracterizing that, please help me, outlook here. What your plans are for headcount growth and investment around there?

So right now, definitely in this market we're not talking about total headcount growth, but we're definitely focused on how to restructure the talent situation, what markets will be requiring more investments. And as we mentioned before, we do think that in general, in a few years, we will be the most balanced global talent platform.

On the market probably and that's why focus on new for us talent markets like India and Latin America will be very important, but we're still going to invest in Eastern Europe. We're going to invest in Central Asia, but total headcount for this year definitely to grow some.

I show no further questions at this time. I would now like to turn the call back to Ark Dobkin for closing remarks.

Thank you for joining. Yes, it's unusual for us all today. Thank you for understanding of the market dynamics as well and difficulties to predict. And so I think, all I can mention that we were thinking about what's happening and look at 2021. At the beginning of 2021, our guidance happened to be wrong by the end of the year, but approximately $500 million. So that's a dynamic of the market when something happening outside of the norm, while we were trying to forecast this based on our margin. I think that's what's kind of happening with us right now because 2021 was a huge growth for us, exactly because our concentration in built and transformation deals, and we overperformed significantly.

This year, again, different terminology. But again, these 2 abnormal years only confirming that in general, this market growing usually around 10%, 15% of the year. And during the last decade, we proved that we have over performing the growth. So that's kind of points why we think we will be back and why we think we need to operate still as a growth company even in this environment and prepare for (inaudible). Okay.

Thank you, again, and talk to you in 2 months.

This concludes today's conference call. Thank you for participating. You may now disconnect.