Epam Systems Inc (EPAM) 2012 Q3 法說會逐字稿

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

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

At this time, I would like to turn the conference call over to Richard Zubeck, Investor Relations. Please go ahead.

Thank you, operator, and good morning, everyone. By now you should have received a copy of the earnings release for the Company's third-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 third-quarter 2012 earnings call. I will discuss highlights from the quarter, our key achievements, and provide an update on our guidance. After this, I will turn it over to Ilya for a more in-depth review of the third-quarter financials.

So, we are pleased to report another strong quarter. Our revenue grew 6% sequentially and over 27% year over year to $110.1 million. Non-GAAP income from operations increased 6% to $19.2 million. And non-GAAP diluted earnings per share were $0.37.

This performance confirms our unique value proposition, which comes from almost 20 years of software product engineering experience, continuing focus on expanding vertical and technology domain knowledge, and our ability to attract and retain the best engineering talent [within the green space].

In Q3, we continued to benefit from growing trend across European companies that are turning to high-value adds [near shore] strategic partners to help drive efficiencies and optimizing their IT spend.

Compared to the third quarter of last year, revenue from clients located in Europe expanded 46%. Banking and financial, and retailer and consumer verticals were the two largest contributors to our growth in Europe.

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 clients. ISVs and technology vertical were the largest contributor to our growth in North America.

In the CIS regions, revenue was down slightly, in line with our expectations for this region.

We also saw continuing growth across most of our verticals. ISV and technology had a strong quarter, growing 33%, which includes the impact of several clients added as a result of Thoughtcorp acquisition, without which the vertical increased by 26%.

In addition to consistent performance from our existing clients, we have had solid new business developments in this sector over the past several quarters.

Banking and financial services performed exceptionally well, with 50% growth. We continue to expand our partnership with several large financial institutions that look to us for both additional IT outsourcing services, as well as the [future emerging] technologies domain as a mobile cloud computing and high-performance real-time [related in] business intelligence.

Within retail and consumer vertical, we continue to outperform the market, which resulted in revenue growth of 55%, while in travel and hospitality, it declined 15%. Still, combined, this consumer-oriented segment grew by 20% for us in Q3.

As you know, this industry segment is moving to a new model where marketing decision makers are dramatically shifting their spending to digital world to create more integrated brand stories and developing differentiated experiences across a variety of connected systems and devices.

Many of the world's leading brands rely on EPAM to build systems that extend their reach through an ever-increasing mix of interactive and social applications. And [three, while our] close exposure to a number of cutting-edge, emerging technologies in result of our product development [port for many regional] ISVs, uniquely positioned to help companies expand and revolutionize the business model.

Our business information and media vertical was down 4% year over year, due to the planned ramp-down at Thomson Reuters. Excluding this single client, this vertical would have grown 24%, primarily through successful new client acquisitions with several big names in the entertainment and media space.

Since the same quarter last year, we have had a number of new wins which we are particularly excited about. While we cannot go into specific names, I would say that we have acquired highly strategic accounts in nearly every sector in which we compete.

We also saw strong growth within our existing client base, with 89% and 76% of revenues coming from clients that have used our services for at least one year or two years, respectively. 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 1600 IT professionals over the past year, or roughly 24% growth, and ended the quarter with over 8100 engineers, while we continue maintaining one of the lowest attrition rates in the industry.

Turning to the outlook, when we spoke last quarter, we anticipated cuts in services from Thomson Reuters and foreign currency headwinds to negatively impact our full-year results by $5 million to $6 million. Thomson Reuters' cuts were almost exactly in line with our expectations. However, we have transferred the people to new and other growing accounts, which in turn are exceeding our [real] expectation for growth in Q4.

On that point, we had better-than-expected performance in several new accounts, as well as better-than-anticipated performance in numerous existing accounts, virtually across every vertical we have. A lot of that we've seen in budgets is a budget flush.

Foreign currency exchange rates improved the result from the last time we spoke, so that benefited our revenue as well by several hundred thousand dollars. Lastly, we've seen better than originally anticipated results in financial sector in CIS region.

Based on this, we are revising our full-year revenue outlook to be $423 million to $426 million, which represents year-on-year growth of approximately 27%. This is an increase from our prior guidance of $412 million to $418 million. We are also raising our earnings growth expectation to 18% to 20% for the year, from 16% to 18% as previously guided.

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

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

In addition to my comments here, we are now providing a supplemental fact sheet on our website with detailed information about our revenues and results of operations, including information about our verticals, geographies, and service offerings.

As Arkadiy highlighted, Q3 was another strong quarter. We grew revenue 6% sequentially and 27% over last year to $110 million, which is above the top end of our guidance of $109 million. Earnings per share was $0.37, also above our prior guidance of $0.36 per share.

On our outlook, during our second-quarter earnings call we identified two areas of concern that caused us to lower our revenue expectations for 2012. First, we had anticipated $2 million to $3 million in additional reductions from Thomson Reuters, and also a potential $3 million impact from currency on our revenues.

While the Thomson Reuters reductions are proceeding as we had expected, currency did not impact revenues by as much as we initially anticipated. But more importantly, as Ark said, we are also seeing very strong momentum across virtually all of our key verticals and target geographies.

With that, we now expect quarter-four revenues of between $115 million to $118 million, which represents year-on-year growth of 21% to 24% and sequential growth of 4% to 7%. We also expect non-GAAP diluted earnings per share to be in the range of $0.35 to $0.37 per share for quarter four, with an expected share count of 47.4 million, and a tax rate of approximately 17%.

For the full year, we expect revenues to be between $423 million to $426 million, which represents growth of approximately 27%. On a full-year basis we are also raising adjusted earnings growth to be in the range of 18% to 20%, with an assumed tax rate of 16% to 17%.

On the rest of the results, we continue to maintain our lower revenue concentration with our top 5 and top 10 clients accounting for 32% and 45% of total revenue in the quarter, respectively, compared to 32% and 44% in the preceding quarter.

Time and material contracts were 85% of revenues in the third quarter versus 87% in the same quarter last year. Fixed fee revenues represented 14% of total revenues in the third quarter versus 10% in Q3 last year.

Turning to our costs, cost of revenue, excluding depreciation and amortization, in the third quarter was $69 million, representing an increase of 34% from $51.6 million in the third quarter of 2011. The increase was primarily attributable to a net increase of nearly 1600 IT professionals from September 30, 2011, to September 30, 2012, or an average growth of 24%.

Gross margins excluding stock compensation of $1 million were 38.2% compared to 40.7% last year, which is within our target range of 36% to 40%.

SG&A in the third quarter was 19% of revenues, up from 18% in the third quarter of 2011, but down from 20% in Q2.

Depreciation and amortization expense was $3 million, up from $2.1 million reported in the third quarter of 2011, which was primarily due to amortization of intangibles from the acquisition of Thoughtcorp in Q2 this year.

GAAP income from operations was $16.7 million, a decrease of 0.9% compared to $16.9 million in the third quarter of 2011, with non-GAAP income from operations of $19.2 million, which was an increase of almost 6% compared to $18.1 million in the third quarter of 2011.

Net income for the quarter was $14.1 million, representing growth of 28% year over year. Non-GAAP net income for the quarter were $17.2 million, a year-over-year decline of 2%.

Non-GAAP diluted earnings per share was $0.37 compared to $0.39 last year. However, the $0.02 decline was due to a higher share count of approximately 1 million shares this quarter and a lower tax rate in the year-ago quarter. Our non-GAAP diluted share count used for the third quarter of 2012 was 46.5 million compared to 45.4 million in the same quarter last year.

Lastly, our balance sheet remains very healthy. As of September 30, we had $106 million in cash. During the quarter, net cash provided by operations was $11.1 million. We finished the quarter with a DSO of 58 days compared to 61 days in the second quarter of this year. During the quarter, we had $14.1 million in capital expenditures, of which approximately $10 million was for progress payments for construction of our new facility in Belarus.

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

(Operator Instructions) Moshe Katri, Cowen.

Nice quarter. Tremendous growth in financial services; I think it will be helpful, Arkadiy, if you just talk about what's driving that growth. Is it new logos? Is it existing logos? And then maybe talk a bit about the nature of the work. And then I have another follow-up. Thanks.

Thank you, Moshe, for questions. So, we have several very strong strategic relationships in financial services. And with all difficulties which this industry is facing right now, we are actually seeing good opportunity for us because of type of services and kind of expertise we can provide.

So the growth relates to several very large accounts which is growing with us. But it also partly relates to kind of recovery of our financial services in the former Soviet Union region, which we mentioned last time that it was kind of a question of us, how successful it's going to be this year.

So, we also have several new accounts, but their contributions at this point are probably not so critical yet. We hope that it will become visible in the next quarter or so.

And then this is for Ilya. I guess when you guys (technical difficulty) like you spoke about the fact that the Company needs to invest in the business, and you did kind of indicate that margins will be down slightly. I think the general kind of guidance was for EBIT margin to be somewhere in the mid-teens.

Is that a level that we're comfortable at going on an ongoing basis at this point? Just talk a bit about the margin trends and, without talking about next year's numbers, but just in general.

Sure. Thanks, Moshe. I think we are within what we consider to be our target operating margin range, so adjusted income from operations this quarter is about 17.4%. I believe we said previously it was anywhere in that, as you said, mid-teens up to upper teens.

We also said previously that we would continue to reinvest some of the margin back into the business, into initiatives such as expanding our on-site presence and strengthening our [competence piece] and competency centers. We have been doing that. It has been -- we've increased our on-site presence by about 100 basis points from the beginning of the year.

It's not exactly where we want to be, but we continue to push forward on that initiative and some others. But, yes, our target operating margin range is from about mid-teens to upper teens.

David Ferguson, Renaissance Capital.

Just two questions, please. Firstly, on the full-year guidance, are you still working on the assumption that sort of the FX impact will be negative of around, I think you said $3 million? So that's the first question -- or what you see as the sort of constant currency guidance for this year?

And then secondly, again, looking into next year, without going too specific into the numbers, maybe you can just give us a sense of sort of the conversations that you're having with clients at the moment. Would you say things are sort of more buoyant or less buoyant than at this point 12 months ago? That's it. Thank you.

Sure. I'll take the first, question. Ark will take the second question.

On the currency question, last quarter we said that Q3 and Q4 would be negatively impacted by currency to the tune of around $3 million, provided that rates stay where they were. The euro, pound and ruble in particular came back, as you guys know, from that time. So the currency -- the negative currency impact on Q3 and Q4 was not as great as we thought. Instead of about $1.5 million per quarter, we were impacted by about $1 million per quarter. And obviously, I'm talking about Q3 as an actual and Q4 as an expectation, assuming that rates stay where they are today.

As far as income of currency on margins, again, we are relatively neutral as far as P&L impact of currency on our margins and our bottom line. Really what you see is swings on the top line are offset by -- well, sorry, offset in expenses. So, that's about the currency.

But a little bit more on Q3 -- compared to last year's Q3, we had a negative impact of about $1.7 million, but compared to prior quarter Q2 this year, it was a positive impact of about a couple hundred thousand dollars.

So, Ark, I believe the second question was what we are hearing from customers.

Over the next year?

To the extent that we can talk about that.

Yes, in comparison with -- if I understand the question correctly, in comparison to what we were knowing at the beginning of the year and what we know right now, I think it was pretty much the communication from the client kind of in line with what were happening during the year. It was some small surprises, negative and positive, but in general it was pretty consistent.

In regards to the 2013, right now we don't think it's the right time to talk [to the client]. It's the beginning of planning period, and probably we will understand much better the situation kind of in the beginning of the year.

Okay, that's great. Thank you very much.

Ashwin Shirvaikar, Citi.

Good morning, Ark; good morning, Ilya -- I guess assuming you guys are in the US.

I guess the first question I had was, as I look at the growth of headcount versus the year-over-year growth rate for revenues, you maintained a positive gap in revenue growth over headcount growth for many quarters.

How long is that sustainable? You know, obviously there are all kinds of positive implications from that trend, so could you go into some detail on that?

Sure. So, we do believe that it will be sustainable. The question -- at what rate was actually the difference between these two growth rates? So, why sustainable? Because as we mentioned, we invested a lot in specific countries and systems. We have vertical expertise. And we are getting in the areas where we hope to get higher rates and eventually better margins.

And yes, you can see it a little bit from now, but it's still our investment time. We are investing in innovation, we are investing in training, investing in a lot of people right now, and some on-site -- increase in on-site presence also. But all of this actually is our effort to kind of distance our revenue growth from our headcount growth.

Okay. No, that's very useful. In terms of I guess the forward or predictive nature of your headcount to revenues, how much -- is there a percentage -- you may have given this out; I apologize if I missed it -- you know, people that are lateral versus, call it hires? Could you give us that delta or that percentage breakout, as well as what's the training period you use and so on?

So, we have a little bit different strategy in our different labor market, because what we're doing in Belarus is different from what we're doing in the Ukraine, or what we're doing in Russia, or what we're doing in Hungary.

In general, I think around 30% of our people come in from universities. And in this case, they spend a pretty significant period of time inside training facilities [at a bow], sometimes from several months, but sometimes up to five or six months.

So in Belarus, this percentage is high; in the Ukraine, it's lower based on the historical kind of situation, [where notice] was started and what actually is their skills pyramid and skills experience we have.

Got it, okay. Great. No, those are the only questions I had. Excellent quarter, guys; congratulations.

Darrin Peller, Barclays.

Could you just give a little more specific color into where you may have been surprised to the upside, just given your improvements? I think you mentioned earlier that improvements or better performance across every vertical is part of the reasons to drive guidance increase I think beyond even the beat from the quarter.

So, you're asking about specific examples of -- or what exactly I'd like to --

I'm looking for specifics on the vertical -- like, which industry verticals, which -- yes, I mean, I guess examples would be nice as well.

From what we were sharing already, clearly financial services and the retail consumer is growing very fast. Also, our IC or product development services expertise allow us to grow as well. So this is three main drivers for our revenue.

On specific cases, we have several strategic accounts which committed to relationships with EPAM, and it's very predictable, kind of the growth. Probably if you look at our top 10 clients this year, there are five of them who are growing above 40%, and we still have very large opportunity practically in each of these clients. Only two clients were declining significantly, like Thomson Reuters and one more around 20% or more, and another three clients practically flat, plus/minus 5% or so. But we have, like, from top 10, five client growing very, very fast.

We're also increasing the number of clients with over $5 million in revenue. Each of them have pretty good potential to become even bigger. And we have several of them, specifically in the retail and consumer services group, and ISV and technology group, which have a potential to grow over $10 million.

Just during this year, or let's say during the last four quarters, we got about -- over 10 clients with $1 million run rate already today, and half of them having potential to become within the next four quarters $10 million in size.

And I'll add to sort of the part of the upside surprise that is causing us to raise guidance, one thing Ark already mentioned earlier, which is what we're seeing is a slight recovery in the financial sector in the former Soviet Union, as well as we were also developing a very good relationship with a very large retailer in Canada, which came about as part of our acquisition of Thoughtcorp earlier this year.

And then there was just broad-based strength across, as we said, most of our verticals. And we're definitely seeing a lot of indications of budget flush in Q4.

That's interesting, because, I mean, it's not -- you're not seeing that across, I would say, broad-based across some of your larger competitors, but that's great to hear. And the type of work -- I mean, just, it seems like your software development work as a percentage of overall has gone up a little bit over the past year -- not a lot, but I guess relatively speaking.

Just tell us a little bit about the stickiness of this revenue in the sense of how much is -- A., is this with existing clients that you've basically harvested for more opportunity and just increasing the percentage of your large top 10 or so? I think you mentioned earlier some of that increasing, but more specifically, I just want to know how much is actually coming from your existing base, and then much of that do you think can last more than -- is it six-month projects versus longer?

So I think I was sharing this during the -- my note, that around 89% of revenue coming from the client who are with us at least for 12 months, and 76% coming with clients who are with us over two years. So, basically, it's a pretty, pretty strong stickiness in our client base.

If you think about software companies, they're usually releasing software in pretty stable cycles, and it's a really very strong relationship. So there are some clients, specifically in several hospitality area, where we might get one-time, big project and it might be finishing after this. Still, we hope that these relationships would be continued, but besides this area, most of our client base is very long term and very stable and recurring revenue stream.

Okay. All right, thanks, guys.

David Grossman, Stifel Nicolaus.

Arkadiy, in your prepared remarks you talked about your digital marketing business. I'm wondering, can you help us understand just how meaningful that business is to you and where the momentum is coming from, whether it be geographic or by vertical?

So, from -- like, if you think about our key industry focus areas, we talked about ISVs a lot, financial services probably the most understandable market in IT outsourcing services. Then, if you look at the business information with the consumer and retailer -- consumer and retailers, and travel and hospitality, all the three segments is very dependent right now on new type of business models. And most of them are driven by digital strategy and clearly Internet, mobility, and cloud deployments.

So, I think all these three industries very much demand this type of skills. And these type of skills, usually very new. So that's what we were trying to explain, that we're accumulating the skills probably faster than most of our competitors because we're working with a lot of technology companies and getting kind of early exposure to these new trends and converting them to the experience which is very much in demand in this segment. So, that's probably kind of explanation of importance and what's driving this.

From the point of view of the geographies, how it's split around, clearly North America and Western Europe providing a lot of demand. But what's interesting is that this experience which we accumulated in this region is actually now driving some success for us in the former Soviet Union region. We even didn't mention that, together with financial services, probably e-commerce type of applications right now is the biggest driver in the region for us, in the former Soviet Union as well.

And how meaningful is this business to you right now, in terms of size?

So, the most of the growth you see in the retail and consumer coming from this. Big portion of the growth in business information media also coming from this type of services.

While you can't use it as a direct proxy, the percent of revenues at retail and consumer and travel and hospitality together are about 20% of our business. And you could say a lot of that -- and business information media is about 14%, right? So --

Just as a proportion of the total business between these three segments, it's more like -- what you mention? 40%, 50%, right?

Yes, yes.

40% to 50% of those verticals?

Yes.

Okay.

(multiple speakers) in financial services, each of them around 25%, 26%, so basically, the rest, it's related to this.

Okay. And then -- I think you mentioned this perhaps on one of the earlier questions, but just if I didn't hear it right, that do we have any sense yet whether the Thomson Reuters base is stabilizing at current levels, or whether it will continue to degrade from what you're I guess estimating for the fourth quarter?

So, there is not any news we can definitively share right now about the future. We hope that it's stabilized. We actually, as I mentioned during the last couple quarters when kind of addressing the Thomson Reuters questions, we have some opportunities outside of the area of where we have decreasing business. But at this point, it's too early to say.

So at the same time, you saw the announcement that we are discussing -- not actually starting some partnerships, which, again, too early to say where it would go, but definitely the relationship is normal. A lot of it depends on the actually business of Thomson Reuters itself. That's why it's very difficult to comment right now. We hope that it's stabilized based on the Q4, kind of the size.

And also, David, just a rough estimate -- the people that we transferred from or that have transferred from Thomson Reuters to other accounts, other new or faster-growing accounts at higher rates, at full run rate, you would generate about $400,000 or $500,000 in internal revenue per quarter, at sort of full run rate.

And where are you in that transfer process, Ilya? Are you 75% done based on current revenue rates, for Thomson Reuters, or how much of that capacity has been absorbed?

Yes, we are mostly done.

Okay, and was that mostly done in the third quarter?

At the end of the third quarter, it was mostly done. This clearly still affected the third-quarter results.

Right. Okay. Great, guys; thanks very much.

(Operator Instructions) Alexander Vengranovich, Otkritie Capital.

I have a question regarding your cash on the balance sheet. So, you're continuing to accumulate cash, and I'm just wondering whether you're actually planning to do some M&A this year, or probably you have any other ways of using that cash this year going forward. Thank you.

So, yes, we do have a good amount of cash on the balance sheet, and our balance sheet in general is healthy. Now, we are looking at a number of M&A opportunities. We obviously cannot talk about the opportunities we're looking at in detail. We are also continuing to invest in facilities, as we talked about before. Our projected investment in total for the new Minsk facility is about $18 million to $20 million, of which we've spent only about half so far. And we're also looking at other facilities in the Ukraine, for instance, which would also generate incremental benefits in terms of reductions of overhead and increase in resource brand awareness in the region.

So, while it may seem like it's a comfortable cushion, you know, if we continue to execute with our M&A strategy as planned and with our facility expansion, then we are utilizing our capital in line with our expectations.

Okay, and in case there is not any further M&As in your landscape, would you consider changing your dividend policy?

Dividend policy? No, we do not anticipate changing our dividend policy in the near future, same as with our peer group.

Okay. Okay, thank you.

Thank you, and I'm showing no further questions at this time. I would like to turn the call back to management for any closing remarks.

Okay, thank you very much. Thank you for taking time to participate in our call today. We appreciate the interest, and we are happy to entertain the call for any follow-up questions. So on this, I would like to conclude this call today. Thank you very much.

Thank you. Ladies and gentlemen, this does conclude today's conference call. Thank you for your participation, and you may now disconnect.