Epam Systems Inc (EPAM) 2012 Q1 法說會逐字稿

Good morning and welcome to EPAM's fiscal first-quarter 2012 earnings conference call. Today's call is being recorded, and we have allocated an hour for prepared remarks and Q&A. (Operator Instructions)

At this time I would like to turn the call over to call over to Jeff Grossman, Investor Relations at EPAM. Please go ahead, sir.

Thank you, operator. Good morning, everyone. By now you should have received a copy of the earnings release for the Company's first-quarter 2012 results. If you have not, a copy is available on our website, www.EPAM.com.

The speakers we have on today's call are Arkadiy Dobkin, CEO and President, and Ilya Cantor, Chief Financial Officer. Before I begin I would like to remind you that some of the comments made on today's call and some of the responses to your questions may contain forward-looking statements. These statements are subject to the risks and uncertainties as described in the Company's earnings release and other filings with the SEC.

I would now like to turn the call over to Arkadiy Dobkin.

Thank you very much. Good morning, everyone, and thank you for joining us today for our first-quarter 2012 earnings call. We are pleased with our performance, as we reported quarterly results that were ahead of our expectations, delivering strong growth in Europe and the US as well as in most of our key verticals and primary service areas.

During the first quarter, total revenue grew 30% to $94.4 million year-over-year. Adjusted income from operations grew 27% to $16.1 million year-over-year. And we delivered non-GAAP diluted EPS of $0.31 per share for the quarter.

Our first-quarter results were driven by our growing, diverse client base where Europe plays a significant role. Compared to the first quarter of last year, revenue from clients located in Europe expanded 62%.

As we have pointed out before, the European landscape has changed over the last few years and has opened up for high-quality services delivery in near-shoring or off-shoring mode. We have certainly benefited from this trend and expect that it will continue in 2012.

Within North America, which represents our largest market, we also had good traction and increased revenue by 26%, driven by both existing and new clients. In the CEE region, revenue declined by 12% or $1.5 million, due to timing of delivering a certain fixed-fee projects and some pressure on financial services clients in the region.

Similar to last quarter, we saw strong growth from all our primary services lines. Software development revenue increased 31% to $63 million; application test and services increased to 32% to $19 million; and application, maintenance, and support revenues increased 24% to $8 million.

We saw continued growth across most of our verticals. Retail and consumer, which grew 112% as a result of increased demand for our strong expertise in the commerce and SAP technology solutions; travel and hospitality, which grew 50% as a result of several new clients and now our ability to leverage our extensive content management and portal solutions, eCommerce, business intelligence, and mobile expertise; banking and financial services, which grew 38% as a result of continuing penetration of strategic accounts within the investment banking industry; and ISVs, or independent software vendors, and technology grew 21% in line with our intention to have significant portion of our business within that segment, to continually improve our software engineering skills and understanding of the emerging technology trends based on real-life hands-on experience serving the best technology companies in the world. We believe that during this quarter we have captured additional market share across those verticals.

Revenue growth in our business information and media vertical was up only 2% year-over-year, mostly due to completion of the number of large projects for Thomson Reuters, as well as the Thomson decision to use their own internal resources for 30 new projects. This decision was expected; and although the overall revenue is currently declining, our relationship with Thomson Reuters remains strong. We continue to see additional growth opportunities throughout the organization and a number of new potential projects are becoming invisible.

As in the past, we saw strong growth within existing clients, with average of 81% and 65% of our revenues during the first quarter of 2012 coming from the clients that had used our services for at least two and three years, respectively. This confirms the high quality of our services and the loyal measure of our customer base. In addition, we added a number of key new clients during this quarter.

Revenues from our top 10 clients increase $12 million in the first quarter of 2012 as comparing to the first quarter of 2011. This represented 42.5% over the increase in revenue in the first quarter of 2012. Overall, we believe we have a high growth potential over the next few years with most of our top accounts.

In regards to our delivery capacity, as I indicated last quarter, one of our main near-term priorities is to invest more in our core existing competencies across both technology platforms and industry segments. We have to identify and hire new talent with the skills in order to expand our strategic vertical segments farther. During Q1 we increased the number of such professionals in both US and Europe.

We also need to increase scale across our delivery centers. Through our close relationships with universities in Central and Eastern Europe we are able to identify and attract the top new talent without materially impacting utilization or attrition rates.

Relative to the first quarter of 2011 we had a net increase of 1,580 professionals over the past year and ended the quarter with approximately 7,300 engineers, with one of the lowest attrition rates in the industry. We remain on track to expand our headcount by 20% or 22% this year. We also will continue to identify and evaluate potential acquisitions to expand our geographic footprint and complement our global delivery capabilities.

As we move through 2012, we are paying close attention to the broader market economic trends and general levels of IT spend. Thus far we believe that budgets are in line with previous year. However, as you know, there is volatility in the overall market economic environment and in the competitive landscape.

So for the full year 2012, we are maintaining our guidance for revenue and earnings growth. With that I would like to turn the call over to Ilya, who will walk you through the financials. Ilya?

Thank you, Ark, and good morning, everyone. After my comments we will open the call to questions.

As detailed in our press release we had another solid quarter, growing revenues 30% to $94.4 million while maintaining stable margins and a healthy balance sheet. Starting with revenues from a vertical perspective, ISVs and technology comprised 26% of revenues, down slightly from 27% last year, which was in line with our expectations. As we have stated in the past we intend to maintain a substantial part of our business with ISV and tech clients, as they are a part of the foundation of EPAM; and these relationships provide us the necessary means to stay in front of the general and the emerging technology trends.

Banking and financial services increased to 24% of total revenues from 22% last year, as we continued to benefit from the growing trend of outsourcing by financial institutions. Our business information and media vertical accounted for 16% of revenues compared to the 21% last year. Travel and hospitality, 12% versus 11% same time last year. And retail and consumer was 13% of revenues compared to 8% last year.

Our vertical growth was led by retail and consumer, and banking and financial services, which grew 112% and 38%, respectively. As Ark mentioned, we recorded an increase in revenues from our top 10 clients of $12 million, as we continued to grow the size of our key existing accounts. Our top five and top 10 clients accounted for 35% and 48% of total revenues in the quarter.

Time and material contracts continued to increase as a percent of revenues, with 89% versus 87% same time last year. Fixed-fee contracts represented 9% of total revenue this quarter versus 11% in the first quarter of 2011.

Turning to our costs, cost of revenues excluding depreciation and amortization in the first quarter was $60.2 million, representing an increase of 32.2% from $45.5 million in the first quarter of 2011. This increase was primarily due to a net increase of 1,500 IT professionals to support the growth in demand for our services.

SG&A in the first quarter was 18.7% of revenues, down from 18.9% in the first quarter of 2011. Depreciation and amortization expense was $2.2 million, a slight increase from the $1.8 million reported in the same quarter of last year.

GAAP income from operations in the first quarter of 2012 was $13.8 million, an increase of 17% over the first quarter of 2011. Operating margins were 14.6% for the first quarter, compared to 16.3% same quarter last year. The decline in margins were primarily driven by stock compensation and certain nonrecurring charges.

Non-GAAP income from operations in the first quarter of 2012 was $16.1 million, an increase of 27% over the first quarter of 2011. Non-GAAP operating margins were 17.1% for the first quarter compared to 17.5% in the same quarter last year.

Interest income was $0.5 million. We also reported a small net foreign exchange gain of less than $100,000 for the quarter.

Net income for the quarter was $12.1 million, which is a year-over-year increase of 24%. Non-GAAP net income for the first quarter was $14.4 million or a diluted EPS of $0.31 per share; this represents a 29.2% increase compared to the first quarter of 2011. Our non-GAAP diluted share count used for the first quarter of 2012 was 46 million shares computed as if -- converted method as though the initial public offering had occurred as of the beginning of the quarter.

Turning to our balance sheet, as of March 31 we had $112.7 million cash. Accounts receivable decreased to $54.2 million from $59.5 million at the end of 2011. We finished the quarter with a DSO of 53 days compared to 52 days in the first quarter of last year.

Deferred revenues were $5.5 million, a sequential decline from $6.9 million. Unbilled receivables were approximately $42 million compared to $24.5 million at the end of 2011.

During the quarter, net cash used in operations was $4.7 million compared to $0.4 million of net cash provided by operations in the first quarter of 2011. The cash used in operations for the quarter was primarily due to higher bonus payments relating to 2011 performance as well as normal seasonal slowdown in billings at some of our larger clients during the quarter.

Finally, I would like to provide you guidance for our second quarter and update our full-year 2012 expectations. We expect Q2 revenues of between $100 million and $102 million, representing year-on-year growth of 25% to 27%. We expect non-GAAP diluted earnings per share to be in the range of $0.30 to $0.32 for Q2, with an expected share count of approximately $46.3 million and a tax rate of roughly 17%.

For the full year we continue to expect revenues between $411 million and $418 million, which represents growth between 23% to 25% over 2011 results. On a full-year basis we expect earnings growth on a non-GAAP basis to be in the range of 10% to 12% with a tax rate of approximately 17%.

We will now open the call for a question-and-answer session. Operator?

(Operator Instructions) Moshe Katri, Cowen.

Nice quarter. So you have exceeded expectations, raised guidance for Q2, and then you maintain your guidance for the year. I just want to confirm what you are saying during the call, that we are doing this just because we're trying to be conservative; am I correct here?

Hi, Moshe. This is Ilya. Look, we have pretty good visibility into Q2. But as you know there is also a challenging market environment and a competitive landscape. We have less visibility into the second half of the year than we do into Q2. So we are comfortable with $411 million to $418 million in revenues.

So, I mean there is a little bit of a degree of conservativism. But truly we don't want to be out ahead of the market right now.

Understood. Arkadiy, you said something in the opening remarks about weakness in financial services. Maybe you can repeat what you said. I missed it.

No, I was referring to our financial services in CIS region, not in general. So this is related only to our portion of the business in former Soviet Union.

Okay, great. Then can you just repeat some of the revenue metrics I think by service lines in terms of the growth rates? I think you went through it kind of quickly.

Sure. Okay. Starting with software development in the first quarter, grew 31% compared to the same quarter last year. Testing 32% growth; maintenance and support, 24% growth; and infrastructure services, 33.7%. And those are the main components.

Great, and lastly, Thomson Reuters is roughly 9% of revenues for the quarter?

Roughly.

Okay, great. Thank you.

A little bit less than.

Thanks.

Ashwin Shirvaikar, Citibank.

Thanks. Congratulations, guys, on the good quarter. I guess my first question is, as you roll out some of these verticals and they get to scale, especially with the application development and services like that, are you finding a need for different or higher-level of training? Or I mean do the new people have to be trained differently as you hire them? Can you comment a little bit on that?

We're definitely, as we mentioned before, planning to bring different caliber of people specifically for developing our competency or expanding our competencies and to perform different roles onsite in client-facing situations. For this there are special training efforts we put in together. It's the same as the special recruitment efforts as well.

In general, the services which we provide are in line with what we were doing before. So training was in our focus for a long time. It is not something really new -- effort which we're establishing right now. So, again, for some special roles there is a difference and we are paying attention to this.

Okay. One question on client ramps, which I think a few of your competitors have had potential issues with in the last few months. The clients that you signed already, as you ramp those clients, are you finding any hesitancy on their part? Or are they pretty much proceeding as planned in terms of those bookings rolling into revenues?

Okay. First of all, I would like to point out that it is difficult to compare the business and type of clients we have with some of the very large outsourcing firms which you are referring to. Okay? So, it is probably not exactly apple-to-apple comparisons in behavior of the clients.

At the same time, there are some changes; but I don't think it is something unusual happening. I think it is pretty much in line with normal business wins.

Some clients expect some level of ramp up and then change it, or some of them ramping up actually faster than they expected as well. So you have and are seeing both directions right now. We have seen some people were trying to stay flat and then changing plans to increase the team very, very quickly.

Sure; no, that's fair. I was asking on an average level; on an average level it's not so changed. So that's really (multiple speakers).

On average, we feel that it is very similar to previous periods right now, at least in our type of clients.

Great, great. Thank you, guys.

(Operator Instructions) Darrin Peller, Barclays.

Thanks, just one question first. On hiring plans, during the IPO process I know you mentioned you were planning on making more investments in certain personnel, especially around SAP work and other kinds of work, to build out. Is that laying out as -- playing out as expected?

Are clients doing more business with EPAM in those areas, beyond the traditional areas that you have worked on in the past? Maybe just start there.

During the IPO, after this we were pointing out some competencies which we develop -- and SAP just one of them -- were very critical for us to enter our relationships with accounts. Because again with our size and with our profile of the Company, we are opening doors differently than very large, 10 times bigger than us providers.

So this has actually worked for us. We increased the number of people who capable, present our special skills in these area of competencies. So this is happening according to our plans right now.

Good. Then would you say that your hiring plans overall are continuing to run at the same rate relative to the revenue growth you had expected when you first had the IPO also? Has anything changed on the overall big-picture hiring plans?

No, based on what we are seeing right now, it is exactly in line with our projections.

Okay. Then just last question for me, on your guidance you have obviously done well in the first quarters out of the gate. You have maintained guidance right now. Can you give us a sense of your confidence?

If you are not changing the guidance, can you just give us a sense in your confidence level around it? I mean given the environment obviously there is clearly some questions, as was brought up earlier, on the macro and some of your competitors. I know it is not easy to compare. But if you give us a little color on your confidence in your guidance maybe it would go a long way.

Yes, well, I will let Ilya to start answering and then I add what I think.

Hi, Darrin. Yes, again, we have very good visibility into Q2. We have less visibility into Q3 and Q4 as we do in Q2; but the visibility is not outside of what we normally have at this point in time.

What gives us a little bit of pause is, again as you mentioned, the macroeconomic environment. You know, some of the things the peers were saying.

However, we are fairly confident in getting to $411 million to $418 million revenues. We are much less so confident in hitting numbers beyond that range at this time; but certainly we will have more information for you at our next earnings call.

Okay. Maybe just -- go ahead, Ark, were you going to say something?

Again, I would point out the difference between like -- clearly very carefully listen here to the Cognizant call for example. And again, our client base is different and you understand this. So predictability like of our agreements is also a little bit different.

We are getting to the clients with tens of millions, but the number of these clients relatively small yet. Basically the plans which they are sharing with us is also limited. I mean if it is talking about clients between $1 million and $5 million, for example.

So that is why we -- to understand the Ilya answer, we very well and very comfortable with our Q2, but we don't have in our visibility in Q3 or Q4 to go beyond what we are projecting right now.

Okay, all right. I will leave it there then. Thanks, guys.

(Operator Instructions) David Grossman, Stifel Nicolaus.

Thank you. Ark, could you maybe just share with us a little more on the new client activity in the quarter? I may have missed it; I'm sorry if I did. Just how many new clients you signed, and if you could give us a sense for the size of those clients, as well as what your pipeline looks like now versus what it looked like three months ago, or I guess maybe a couple of months ago.

Well, in general pipeline, again we exactly in line with our guideline guidance for revenue, $411 million, $418 million. So basically the probability is increasing for Q3 and Q4.

And based on the new clients like in Q1, we increased number of clients probably by a dozen. But if you are talking about clients which we are considering can bring within next 12 months significant revenue, we think we have around five clients of this size.

Also, coming a little bit back, we were talking or sharing some information about new clients in the past, and these clients are actually growing nicely with us. We have now both clients which are coming from $1 million range to $5 million range and from $5 million range to $10 million range. This is happening, so we are increasing number of large clients in our portfolio right now.

Okay. I guess just getting back to some of the earlier comment about the tone from your existing customers; and I think I appreciate your scale relative to some of the others that have reported issues. But that said, it sounds like the ramp within your installed base of clients is pretty consistent with what your expectations were and the ramp that you were seeing three months ago. Is that a fair comment?

That's true. That is a fair comment. That is exactly what we would like you to understand.

Then in terms of just looking at the competitive landscape, I have seen some activity from some of the larger players in the region. Is there any real change there? Or is it pretty much what it has been historically?

We believe it is very much in line with historical situation. When you are saying locally, you mean exactly compitition for revenue in our regions, or competition for resources, or for --?

For resources, ramping headcount.

Again, it is not easy, as we mentioned many times before; but it is pretty much in line with what we expected so far.

Yes, and I'm sorry. Maybe you mentioned this, but what is your updated expectations for wage increases this year?

Like what we were communicating before was around 12%; and this is approximately what we expect. Maybe a little bit lower, but we will see much better closer to the mid of the year.

Okay, and any update in terms of expanding the capacity in Minsk? Is that pretty much on track?

Expanding capacity in Minsk?

You mean the Minsk building?

Yes, exactly.

Yes, it is in construction right now, yes. Under construction.

All right, then maybe just a couple of quick questions for you, Ilya. In terms of the balance sheet, if I'm looking at this right it looks like you had a pretty big increase in unbilled receivables.

Is that just maybe one or two particular contracts in timing? Or is there a difference in terms of the amount of percentage of completion underway? Or is it something else that drove that up sequentially?

Right, so Q1 seasonally sees a buildup in unbilled revenues as paperwork gets completed, as purchase orders get finalized. So this is not an unusual trend.

We did have a little bit more in terms of unbilled receivable specific to a top five account, which has been resolved at this time. So this is definitely not anything out of the ordinary; and as the business gets bigger, the unbilled receivables get bigger as well.

Should we expect that to be down then sequentially in the June quarter?

Absolutely.

Okay. In terms of the pro forma adjustments I am sure the stock comp number went up with the stock price. But can you help us perhaps with a sense of where those pro forma adjustments are? How we should be modeling those pro forma adjustments for the year now? Both stock comp and intangibles.

And perhaps you could share with us what the one-time charges were in the quarter.

Yes, okay. So in the first quarter, we had one stock compensation charge relevant to a restricted stock grant given to a named executive officer. That will not recur, but it is pushing out stock comp in the first quarter by about $700,000.

Also in the first quarter, we had initiated our long-term equity incentive plan with an initial set of grants to a fairly deep swath of our senior managers, call it about 300 to 400 people. That didn't impact Q1 that much, because it was granted late in March; but it will continue to impact the outer quarters.

So, that said, stock comp will be around or was around $1.5 million in the first quarter because of the combination of the stuff that is coming forward from last year plus the one-off grant to a Section 16. But the outer quarters will look about the same, about $1.5 million, $1.6 million, because they will have the impact of the initiation of the long-term equity incentive plan. So also about $1.6 million across the year.

Okay; and the one-time items in the quarter?

So, the other item of significance that is a one-time item is around about a $600,000 charge that shows up in other expenses. That is related to purchase accounting relevant to an acquisition we did in 2010 that had a trigger on requiring us to issue 53,000 shares of stock once we go public. Obviously we went public, so we issue that stock, so we took that charge; and that is a nonrecurring charge.

I see. Then the amortization of intangibles should stay at the level we're at in the first quarter as well?

Yes, it's about $150 million, $160 million. That will be consistent -- unless of course we make an acquisition.

Right, right. Then, I didn't catch the actual headcount number, the billable headcount number. Do you mind repeating that real quickly, where you were at the end of March?

Sure, 7,300.

Got it. Okay. That's it for me. Thanks very much.

Thank you. And with that I would like to turn the call back to management for any closing remarks.

Thank you, everyone, and have a good day.

Ladies and gentlemen, that does conclude our conference call for today. You may now disconnect.