Epam Systems Inc (EPAM) 2012 Q2 法說會逐字稿

Good morning and welcome to EPAM's second-quarter 2012 earnings conference call. Today's call is being recorded and we have allocated one hour for prepared remarks and question-and-answer.

During today's presentation, all participants will be in a listen-only mode. Following the presentation the conference will be open for questions. (Operator Instructions).

At this time I would like to turn the conference call over to Richard Zubek, Investor Relations. 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 second-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 we 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, Richard. Good morning to everyone and thank you for joining us today for our second-quarter 2012 earnings call. I will discuss highlights from our second quarter, discuss our key achievements, as well as discuss specific challenges we are currently facing. After that, I will turn it over to Ilya for a more in-depth review of the second-quarter financials.

We are pleased to report another strong quarter. Our revenue grew 10% sequentially and nearly 30% year-over-year to $103.8 million. This is an important milestone as this is the first time in our history where we exceeded $100 million in revenues for the quarter and I am particularly happy to see that result.

I am proud of our people and of our accomplishments over the past years that made all this possible. So I want to say thanks to all our people for a job well done.

We are also pleased to report the strong earnings growth and margin expansion. Non-GAAP income from operations increased 40% to a record $19.1 million, and operating margins increased 140 basis points to 18.4% from 17% last year. Finally non-GAAP diluted earnings per share were $0.37 or a 42% increase from last year.

During the quarter we closed on the acquisition of Thoughtcorp, a Toronto-based IT consultancy and software solutions provider. Thoughtcorp has a 17-year history of delivering high-value IT solutions and complex software applications to many of Canada's most recognized companies through [business] telecommunications, financial, and retail sectors.

Thoughtcorp complements our existing global delivery capabilities with its proven expertise in areas important for us such as agile development, enterprise mobility, and business intelligence. We are excited about the possibilities this combination brings.

As in the first quarter, we benefited from a growing trend in Europe who are in difficult times, companies are turning to evaluate strategic partners to help drive efficiencies and reduce their costs. Compared to the second quarter of last year, revenue from clients located in Europe expanded 37%.

Within North America, which continues to be our largest market, we also had good traction and increased revenue by 27%, driven by both existing and new accounts.

[In the CIS] regions, revenue increased by 25% due to recognition of $4.3 million in non-recorded revenue from a large World Bank-sponsored fixed fee project that was completed this quarter. This revenue has been included within our previous guidance and we don't expect any such other nonrecurring items during the rest of the year.

We also saw continuing growth across most of our verticals. ISVs & Technology grew 19% since the software industry drive our clients to demand proven expertise and cutting edge technologies such as Big Data, cloud, and mobility as well as related large replatforming efforts. We are one of the best positioned product development vendors to benefit from such demands.

In this turn, retail and consumer grew 87% as a result of pressure on (inaudible) to improve their online customer experience enabled Web 2.0 Rich Internet Applications, and support mobile [deployments].

Banking and financial services grew 38%. Customers in this industry continue facing many challenges and are looking for higher deployment and reliable vendors to help addressing those challenges. And EPAM proved such a value during the last several years and continues to grow with a number of strategic investment banking accounts.

Our Business Information & Media vertical was essentially flat year-over-year mostly due to continued drawdown at Thomson Reuters. Excluding the impact of these cutbacks, this vertical would have grown 17%.

And in (inaudible) we continue to maintain a very healthy balance of revenues between our industries, geographies, and customs. Since the same quarter last year, we have had a number of new wins which we are particularly excited about. We cannot go into specific names but we have acquired highly strategic accounts in nearly every sector in which we compete. About 20 of new clients are on $1 million plus run rate right now. About half of those would be considered to have potential of becoming $10 million plus accounts within the next 24 months.

We also saw strong growth within our existing accounts with approximate 80% revenues coming from clients that have used our services for at least two years. This again confirms the high quality of our services and the loyal nature of our customer base.

On resources, we had a net increase of about 1,600 IT professionals over the past year for roughly 26% growth and ended the quarter with 7,715 engineers and we continue to maintain one of the lowest attrition rates in the industry.

Turning to the outlook, there are several key issues. First, Thomson Reuters announced further unexpected forecasts and provided services during the last several years. This impacts our outlook for the second half of the year by approximately $2 million to $3 million. We are dealing with this separation by aggressively reallocating the people to a number of other new and existing growing accounts but this will impact results in any case.

Second, currency cost was approximately $1.6 million in Q2 revenue compared to previous guidance and if exchange rates stay in current levels, it would cost another $3 million or so compared to our regional full-year guidance.

Third, based on the conversations we have had with our existing clients, IT budgets are currently in line with previous years but decisions time for initiating new projects are extended in some cases. Based on this, we are taking a more conservative stance and revising our full year revenue outlook to be $412 million to $418 million which represents year-on-year growth of 23% to 25%.

On the positive side, we are increasing our earnings growth expectation to be 16% to 18% for the year versus the previous guidance of 11% to 13%. There are several reasons for this such as continuing focus on cost controls, moderate wage inflation, and a slight benefit from currency.

So to recap, we had another good quarter with solid revenue and earnings growth and margin expansions. We were able to acquire some great new accounts and we had strong growth from existing accounts. We also continue to recruit and retain smart and talented people.

At the same time, we now face some challenges specifically from (inaudible) to Thomson Reuters and headwinds from currency. But fundamentally our business remains strong and we continue to execute according to our plan.

With that, I would like to turn the call over to Ilya, who will walk you through the financial results. Ilya?

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

As Arkadiy highlighted, Q2 was another solid quarter where we grew revenues nearly 30% to a record $103.8 million while expanding margins and maintaining a healthy balance sheet.

I would like to start by providing more details and color around our guidance for the third quarter of the year. As you heard, there are two specific issues that came up very recently that impacted topline outlook.

As Arkadiy noted, Thomson Reuters informed us of additional and unexpected cuts in their services. We expect the impact of their decision to be approximately $2 million to $3 million in the second half of the year. This estimate though does not include any potential upside from reallocation of those resources to other growing or new projects. In other words, our revised full-year guidance assumes 100% hit to utilization, which may or may not be the case over the next several months.

Second, the stronger dollar negatively impacted revenues by approximately $1.6 million in Q2 compared to previous guidance. And if exchange rates stay at the current levels, it would cost another $3 million or so compared to our original full-year guidance. Remember that this is only topline and in fact, we benefited in Q2 slightly at the operating margin level from cost-saving impacts of currency on our expense base.

So these are two specific issues that caused us to slightly decrease full-year revenue guidance. Furthermore, we are raising our earnings growth projections for the year. This is primarily the result of two things.

One is our continuing focus on cost controls. Our SG&A excluding stock compensation (inaudible) as a percent of revenue by 140 basis points compared to last year to 19.1% of revenues. Two, better than the plan wage inflation.

So putting all this together, one, we expect Q3 revenues of between $107 million and $109 million representing year-on-year growth of 24% to 26% and sequential growth of 3% to 5%.

Two, we expect non-GAAP diluted EPS to be in the range of $0.34 to $0.36 per share for Q3 with an expected share count of approximately $45.6 million and a tax rate of approximately 16%.

For the full year, we expect revenues to be between $412 million to $418 million which represents growth of 23% to 25%. On a full-year basis we are raising adjusted earnings growth to be in the range of 16% to 18% with an assumed tax rate of approximately 16%.

So onto the rest of the financials. Starting with revenues from a vertical perspective, ISVs & Technology comprised 24% of revenues down slightly from 26% last year, which was in line with our expectations. Banking & Financial Services increased to 23% of total revenues from 22% last year. Our business Information & Media vertical accounted for 15% of revenues compared to 20% last year, reflecting a continued decline of Thomson Reuters, as previously mentioned.

Travel & Hospitality 10% versus 12% at the same time last year, Retail & Consumer with 12% revenues compared to 8% last year, and finally, Other with of revenues compared to 9% last year, which was driven entirely by the $404.3 million of nonrecurring revenue related to the large World Bank-sponsored project mentioned earlier by Arkadiy.

We reported an increase in revenues from our top 10 clients of $12 million as we continue to grow the size of our key existing accounts. Our top five to top 10 clients accounted for 32% and 47% of total revenue in the quarter compared to 35% and 48% in the preceding quarter respectively, so a slight decline.

We continue to generate a substantial portion of our revenues from our existing client base with approximately 80% of revenues generated by customers who have been with us for at least two years.

Time and material contracts decreased as a percent of revenue with 85% in the second quarter of 2012 versus 87% in the second quarter of 2011. Fixed fee revenues represented 13% of total revenues in the second quarter of 2012 versus 10% in the second quarter of 2011. This shift is again a direct result of the previously mentioned fixed fee project revenue recognition in Q2. Excluding this item, fixed fee revenues would be roughly 9% of our revenues in the quarter and 88% (technical difficulty).

Turning to our costs, cost of revenue excluding depreciation and amortization in the second quarter was $63.8 million, representing an increase of 30.7% from $48.8 million in the second quarter of 2011. This increase was primarily due to a net increase of 26% in IT professional (inaudible).

SG&A in the second quarter was 20% of revenues, down from 21% in the second quarter of 2011. Depreciation and amortization expense was $2.4 million, a slight increase from $2 million reported in the second quarter of 2011.

GAAP income from operations in the second quarter of 2012 was $16.8 million, an increase of 55% over the second quarter of 2011. Operating margins were 16.2% for the second quarter compared to 13.6% same quarter last year. The improvement in operating margin is due largely to the nonrecurring goodwill impairment charge taken in the second quarter of 2011 as well as lower professional fees and continued leverage of our overhead costs.

Non-GAAP income from operations in the second quarter of 2012 was $19.1 million, an increase of 40% over the second quarter of 2011. Non-GAAP operating margins were 18.4% for the second quarter compared to 17% same quarter last year.

Net income for the quarter was $13.3 million, which is a year-over-year increase of 61%. Non-GAAP net income for the second quarter was $16.9 million or a diluted earnings per share of $0.37. This represents 42.3% increase compared to the second quarter of 2011. Our non-GAAP diluted share count used for the second quarter of 2012 was 46.4 million.

Turning to our balance sheet as of June 30, we had $104.9 million in cash. During the quarter, net cash provided by operations was $6.4 million compared to $10.4 million of net cash provided by operations in the second quarter of 2011. Year-to-date cash provided by operations what was $1.6 million compared to $10.8 million last year.

So in conclusion, our business is fundamentally sound. Our pipeline is healthy and we are continuing to execute according to our plan.

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

(Operator Instructions). Moshe Katri, Cowen and Company.

Thanks, guys. Good morning. Arkadiy, you spoke about long sales cycles or decision sales cycles. Can you kind of elaborate a bit more on that? Are we seeing this in a specific region or vertical? Are we being just conservative? And then are we seeing any delays or cancellation in that respect?

I would not say that it's like all across all regions or all our line segments. More related to our relatively small business in CIS region today and probably one or two accounts. So again we see this isn't exactly like we mentioned it in some specific cases but still didn't see it as a complete trend.

Okay, that's fair. Just a follow-up, Thomson Reuters, can you just remind us how many people are kind of deployed at this account right now? How quickly can you redeploy them without incurring the incremental utilization rate hit? And then maybe kind of give us some more details on what happened at Reuters in the past few weeks as you said?

We have around 500 people deployed today. As we mentioned, it would -- was another notification just during the last couple weeks which was in addition to more kind of carefully planned level of run down which we discussed in previous calls. We don't know about specific reasons why it was done but at the same time, we already starting to redeploy on this. We have several very (inaudible) growing accounts with similar skills and we started the redeployment process very, very aggressively right now.

So we do think that in several months we will be able to utilize these people because it's a very experienced team and was working together for a long time. So it's kind of creating additional opportunities for us.

All right, thanks. Good execution.

Ashwin Shirvaikar, Citi.

Good morning, guys. Yes, my first question is also on Thomson Reuters. Just a clarification. The 100% hit to utilization, I'm assuming it's for both revenues and profits that you've assumed in your numbers. And as you redeploy these people, would they be at higher billing rates given what we know about Thomson Reuters' lower rate?

Good morning. The answer to your question is yes to both.

Okay, that was quick. Then on Russia, if you could update us on the situation there, as it was one of the sources of weakness particularly in financial services last time. How is that trending?

As far as Russia is concerned specifically, the region is not growing. We -- in the CIS region, as we mentioned, we had a one-time nonrecurring revenue recognition item of $4.3 million which showed growth for the region -- of $3.1 million or 25% or so. But if you stripped that out, it would be in a slight decline. We don't particularly see sort of additional volatility to this extent from here on out but we also don't count on growth from that region, either. This is as we've talked about in the past, by design.

So it's not a focus for you -- you draw down these revenues?

Yes.

Okay, that's it.

Darrin Peller, Barclays.

Thanks, guys. Can you just first of all comment on the pipeline of what you are seeing, where you are seeing it from, what kinds of business? A little more detail and color would be helpful in terms of new pipeline, new bookings, maybe geographically as well as type of business from a discretionary and how long the contracts are now? I know when you guys first went public on --

Yes, within -- we have a good traction right now in Europe and North America. Both of them growing and we have some exceptions like I mentioned already. Between specific industries, I would say that we have very good opportunities in the ISV sector in United States. We also continue to grow pretty fast on the financial services in Europe.

Another faster growing area is Retail Consumer and Travel & Hospitality for us. So that it's the fastest-growing sector and it's all related to demand to new online experience, commerce-related applications.

So we're seeing a lot of opportunities around this area and we actually are very aggressively building up our focus contingencies and solution practices specifically in this area.

Alexander Vengranovich, Okritie Capital.

Good morning. I have a question regarding your potential cost cutting measures and cost control measures, which you are planning and already started as far as I understand. (inaudible) demands in the company should result in increase in net income. Could you please elaborate on that?

Yes, hi Alexander. We didn't say we were starting a cost-cutting program. We said we were raising earnings growth guidance because we continue to maintain a really sharp focus on cost controls, as we have always done. And this has been slightly ahead of expectations.

There is one of the reasons for raising the earnings growth target. But we are in really good shape. We don't feel we need to sort of have a comprehensive cost-cutting program. It's just business as usual.

Just normal results of our -- we're still growing. We're growing in revenue and growing in headcount and clearly billable headcount and it's clearly a portion of G&A going down. That's what we specifically meant.

Okay, thanks. And second question, could you update us on your M&A plans for this year? Are you still planning to continue M&A activities?

I don't think we can give you any specifics. You saw that we completed our first acquisition this year in Q2 and we have some other opportunities in our pipeline, but I don't think we can give you any specific answer right now.

Okay, thank you.

(Operator Instructions). Darrin Peller, Barclays.

Sorry about that before, guys. I got cut off. I just wanted to follow up with a different question also. Around the expense side, obviously there's been margin improvement going on. Can you just give us a little more color on what we should be expecting in terms of sustainability of that? Just maybe a little more specifics or specificity on what exactly you are doing to really bring out costs in the model and what can go on.

Yes, Darrin. We did have really good margin expansion in this quarter. Part of that was driven by also the one-time revenue recognition item. So kind of full disclosure. So we don't expect sort of aggressive expansion of margins like we saw in Q2 in Q3 and Q4 particularly since our sequential growth we are projecting right now at least in the model to be kind of 3% to 5% in Q3 and flattish in Q4 to Q3. So I would moderate sort of expectations about margin expansion from here.

But as far as the question with regards to taking costs out of the model, again just like I think though you dropped off when we were answering a similar question to Alexander, but we don't have a comprehensive cost-cutting program going on. It's just business as usual where we always keep a sharp focus on costs. Our SG&A continues to drive leverage into the model. We did see slightly better wage inflation results and we moderated those expectations for the year as well, so that helped.

All right. Thanks, guys.

David Grossman, Stifel Nicolaus.

Good morning, thanks. Ilya, could you just review perhaps the flow of FX down the P&L in terms of revenue and margin? Obviously we can see the benefit in terms of the gain or loss from FX but perhaps you could run us through the impact above that.

Okay, so as we mentioned compared to where we were in Q1, Q2 was negatively impacted on a top line basis by about $1.5 million, $1.6 million and this came primarily from the euro and the ruble. I think pound actually has strengthened a little bit.

Net-net, it actually gave us a slight benefit on the bottom line, but nothing sort of material to speak of. But again, if we are extending this trend forward and we are just doing sort of simple dumb math, $1.5 million for in Q3, $1.5 million for Q4 would cause another $3 million in topline headwinds. So this is what we are projecting right now.

Again, our currency mix is such that we are actually neutral on the bottom line and this is what we saw in Q2. We don't expect the situation to change materially from there. Hopefully that answers your question.

When you say neutral to the bottom line, is that including the foreign exchange loss or excluding that?

This is excluding the foreign exchange loss, which on the P&L right now for Q2 really represents a remeasurement of local currency, monetary assets and liabilities to a functional. So that kind of stuff aside, the economic impact to our P&L is neutral and at times even slightly positive.

So the 1.39 is just balance sheet translation, then?

Remeasurement, yes.

Okay and I guess just going back to your change in outlook, I think if you take Thomson Reuters as $2 million to $3 million and then the FX impact of another $3 million that you just outlined, that pretty much accounts for the change for the year. So should we take from that that the balance of the installed base at least and the new business activity that you had actually assumed for the balance of the year is pretty much consistent with where we were three months ago or is that too much of a generalization?

Barring a disaster scenario, yes, it is the answer. We are still in a good place. We still see a healthy pipeline. We still see good client activity. As Arkadiy mentioned, we had really good results from new client acquisition in the past couple of quarters.

So fundamentally the sort of the tweaks to the guidance does relate to those two specific issues. And to the extent that we are taking a somewhat conservative approach and not sort of recognizing the benefits of potential reallocation of Thomson Reuters personnel, that's sort of tempered also by the fact that while we don't know what Thomson Reuters is going to do, what we know is what we know right now. We think we've baked in all the bad news, but that's what we said last time.

Okay, great. Thanks very much.

Moshe Katri, Cowen and Company.

Thanks. Ilya, I guess you mentioned the fact that you are expecting wage inflation to moderate. Can you kind of provide some more details on that in terms of what sort of comp increases are baked into the model now versus what sort of increases were baked before? Thanks.

I think we mentioned before that we were going to have wage inflation around 10% to 12%. We are now seeing it below 10%.

All right. And is there a way kind of to break it down by the various regions or this is kind of across the board?

This is really across the board. It's really across the board.

All right, thanks.

Thank you. At this time, I am showing no further questions. I would like to turn the conference back over to management for any closing remarks.

Okay, thank you, Richard. So what we can confirm that there are some exceptional issues which we will see in this quarter. In general, business is strong and we have a lot of prospects and we have most of our -- practically all of our top 10 accounts except Thomson Reuters in very good shape and most of them growing.

So we are very confident in our current situation in the Company and have actually various opportunities for the future, so I think we internally consider the situation with Thomson Reuters as a good opportunity as well. Thank you.

Thank you, sir. Ladies and gentlemen, this does conclude EPAM's second-quarter 2012 earnings conference call. Thank you very much for your participation. You may now disconnect.