Yahoo Finance EPAM Systems, Inc. (NYSE:EPAM) Q1 2024 Earnings Call Transcript
EPAM Systems, Inc. (NYSE:EPAM) Q1 2024 Earnings Call Transcript May 9, 2024
EPAM Systems, Inc. isn’t one of the 30 most popular stocks among hedge funds at the end of the third quarter (see the details here).
Operator: Thank you for standing by. My name is Eric and I will be your conference operator today. At this time, I would like to welcome everyone to the First Quarter 2024 EPAM Systems Earnings Conference Call. All lines have been placed on mute to prevent any background noise. After the speakers' remarks, there will be a question-and-answer session. [Operator Instructions] Thank you. I would now like to turn the call over to David Straube, Head of Investor Relations. Please go ahead.
David Straube: Thank you operator. Good morning everyone. By now, you should have received your copy of the earnings release for the company's first quarter 2024 results. If you have not, a copy is available on epam.com in the Investors section. With me on today's call are Arkadiy Dobkin, CEO and President; and Jason Peterson, Chief Financial Officer. I would like to remind those listening that some of the comments made on today's call may contain forward-looking statements. These statements are subject to risks and uncertainties as described in the company's earnings release and SEC filings. Additionally, all references to reported results that are non-GAAP measures have been reconciled to the comparable GAAP measures and are available in our quarterly earnings materials located in the Investors section of our website. With that said, I'd like to now turn the call over to Ark.
Arkadiy Dobkin: Thank you, David. Good morning everyone. Thank you for joining us today. First, about our guidance change. As you saw from our press release, we are seeing some continuing volatility in our global demand environment. And while there are encouraging signs of new deals and new types of very different domain specific demands than even in cyclical nature of 2023 follow us well in 2024, which now leads us to adjust our thinking for both Q2 and for whole full year outlook. As I mentioned during our fourth quarter earnings call, our initial view was the 2024 environment will be, at least for the first half of the year, a continuation of second part of 2023's trends, with a potential demand upturn right after. And that would take us into sequential growth for 2024.
This view, which we now believe was optimistic, was supported by broadly anticipated more positive macro assumptions and now active interactions with the clients during the very end of 2023 and the beginning of 2024. That was directing our belief that clients will more quickly come back to growth in their prioritization for the remainder of 2024. We also believed that once we entered into Q2, we would have much more measurable indicators for the improvements of the demand environment for digital engineering, data, cloud and AI, and from which we can build further our 2024 revenue scenarios and plans. What we now understand is that the macroeconomic and geopolitical factors that continue to drive volatility in overall markets and specifically in the IT services and digital transformation sectors are still with us throughout the reminder of the year.
While the programs we anticipated to start by now are still in place and some are in active discussions, many of them have been postponed to future periods or decided to be implemented in much more modest scopes. In addition, we need for rebalancing our delivery platform to lower cost locations, force some level of slowdown and our revenue grows too. And so our expectation for considerably high level of accelerated revenue trends in second part of the year will not be materializing as we anticipated, at least as we see it now. Jason will provide more details in our updated outlook for 2024, but let me share some current highlights of our business from Q1 up to today. Throughout the last quarter and continuing into now, we've been making progress across all critically important areas for us, which we have discussed in depth during our previous call.
We are strengthening and repositioning our talent delivery platform as well as the cost effectiveness of our offerings by rebalancing our talent distribution from more expensive locations to less expensive ones, while maintaining our commitment to our traditionally strong geos. India, our second largest delivery location, is growing rapidly, not only in terms of headcount, but also by creating new capability centers in data cloud, digital transformation and AI-enabled managed services. We recently opened our Gurgaon office and plan to open additional locations to support our client growing needs. LatAm is another of our stated priorities in overall rebalancing. As we refine and expand our locations there, we are expanding our key Engineering DNA capabilities in the region.
In the first quarter, we announced the acquisition of Vates, a multi-award winning software development company with offices in Argentina and Chile. We are continuously investing in our existing and new technical capabilities, including crucial for the future Gen AI data and ML and predictive AI and in correspondent IP development. We also continue to improve our domain industry capabilities and consulting and advisory services. During the beginning of 2024, we have seen encouraging signs of more balanced demand environment across our business with both new and existing logos equally weighted between cost takeout and business change and modernization. This portfolio wide perspective combined with our efforts to establish domain specific and relevant approaches for go-to-market both independently and with our partners, leads us to believe that our ongoing reinvestment in consulting to experience cloud data, AI and vertical edge solutions will provide the unique age we need to secure long-term growth.
Couple short stories to illustrate above. EPAM recently came up with AWS [indiscernible] a leading energy company in the UK to transform its customer experience, responding to a market that is characterized by the need for enhanced customer expectations, emerging competitors, regulatory demands, smart metering, adoption and sustainability goals. Our engagement was built around key transformations of payment channels, customer service frameworks and shift to agile processes to ensure service flexibility. For [indiscernible], one of the world's best known global car [indiscernible] brands, we are helping to redesign a critical data platform that will enhance intelligent real-time pricing capabilities and drive better experiences for customers and further increasing their pricing market leadership.
We believe it is the next iteration of platform engineering into a truly intelligent application empowered by AI that will drive the future of our demand. Finally, in another encouraging sign, our long-term clients are also returning to us with newer streams related to modernization and next gen support, which now include much expanded engagement footprint with larger shares of India and Latin America, including net new delivery locations in Argentina and Brazil. In general, our focus on domain led propositions is the reason why we believe we saw much stronger growth in some verticals this past quarter. For example, in our healthcare and life science portfolio, we are part of a number of strategic programs helping clients in areas of cloud, data platform, physical and digital product development and engineering, as well as a new GenAI driven initiatives.
On another side in some of our vehicles, namely business information and media, we continue to work through the impact of ramp downs from a few large clients initiated previously. And while we aren't able yet to offset this with revenue coming from new opportunities, we are still seeing a more balanced picture emerging over the course of the next quarters. Across all our verticals and geos, we are seeing more interesting and higher level of program starts related to generative AI. In Q1, a number of our key clients formerly selected EPAM as strategic partner for their AI transformation journeys, where EPAM will help to scale AI, including GenAI, to unlock the power of data and to establish valuable insights. These engagements are often starting today from advisory and from the use of our differentiating IP and then ramping up to specific use cases.
We believe that will lead us to new level of engagement with our buyers by allowing to drive meaningful business breakthroughs with our tools and in combination with our consulting and scale delivery capabilities. And while the revenue impact of these programs is still limited today, we see it's a very visible progression of the AI-enabled services market for us. To summarize, while in Q1, across our core business, we were seeing a more balanced demand outlook than in the most part of 2023 and a gradual return to modernization and business change programs, as well as ramping up GenAI-related opportunities. As mentioned already today, by the end of Q1, we realized that the speed and scale of those changes were not in line with our early expectations.
Moving to how we are managing our business in this part of the cycle. As we focus on driving new demand and proactively converting and expanding our wallet share with clients, we are also looking for opportunities to drive efficiency and focus throughout the organization. We have shared our ongoing efforts to rebalance the business from a geographical perspective over the course of last year, and that program is ongoing. Our attention now is turning toward a more finely tuned approach to both geographic investment as well as our areas of capability in market, particularly around our status in market segments; AI Cloud data experienced a domain-led consulting. We've gone to market in much more intentional way with key proposition and strategic partners and are now looking to refine some of those propositions and investments as we look to balance near-term and long-term demand with our investment.
Throughout the remainder of this year, we will be focusing on driving enhanced efficiency and further rebalancing of our geographical footprint, resizing portions of our in market and some other teams, enhancing operational efficiencies and engineering productivity through application of AI and automation internally at EPAM, and driving a singular focus on client centricity for the entire company. Those continual efforts are critically important as we navigate the current environment, while taking the necessary steps for the eventual return for build and transform programs, which have been slowed down during the last two years. Our fundamentals are strong and we are firmly confident that EPAM will be in a lead position in this rebound enabled by our significantly diversified global delivery platform and driven by long-term pressures for legacy modernization, needs for advanced customer centric solutions, and a significant interest in applying and integrating Gen AI and general AI capabilities into new and existing enterprise platforms, innovative intelligent applications and new transformative business models.
With that, let me pass to Jason to provide details on our Q1 results and our guidance for 2024.
Jason Peterson: Thank you, Ark. And good morning everyone. In the first quarter, EPAM generated revenue of $1.165 billion, a year-over-year decrease of 3.8% on a reported basis or 4.3% in constant currency terms, reflecting a favorable foreign exchange impact of 50 basis points. Due to our exit from the Russian market, we will longer generate revenue from Russian clients. The impact of this exit had an approximate 50 basis point negative impact on year-over-year revenue growth. Excluding Russia revenues, year-over-year revenue for reported and constant currency would have decreased by 3.3% and 3.8%, respectively. Moving to our vertical performance, life sciences and healthcare delivered very strong year-over-year growth of 26%.
Growth in the quarter was driven by clients in both life sciences and healthcare. To reflect a more diverse end market, our travel and consumer vertical has been renamed consumer goods, retail and travel. On a year-over-year basis, the vertical decreased 6.9%, largely due to declines in retail, partially offset by solid growth in travel. Sequentially, the vertical grew modestly driven by solid sequential growth in the travel portion of the portfolio. Software and hi-tech contracted 8.3% year-over-year and grew 2.6% on a sequential basis, suggesting some level of stability in the vertical. Financial services decreased 10.3% year-over-year, driven by declines in banking, asset management and the payment sector. Business information and media declined 15.8% compared to Q1 in 2023.
Revenue in the quarter was substantially impacted by the previously discussed ramp down of the top 20 client. And finally, our emerging verticals delivered solid year-over-year growth of 12.9%, driven by clients in energy and telecom. From a geographic perspective, Americas, our largest region, representing 59% of our Q1 revenues, declined 2.4% year-over-year on a reported and constant currency basis. Sequentially, growth was 2.4%, reflecting ongoing signs of stabilization in the geography. EMEA representing 39% of our Q1 revenues contracted 3.2% year-over-year and 4.8% in constant currency. And finally, APAC declined 13.1% year-over-year or 11.5% in constant currency terms and now represents 2% of our revenues. Revenue in the quarter was impacted primarily by the ramp down of work within our financial services vertical.
In Q1, revenues from our top 20 clients declined 8.6% year-over-year, while revenues from clients outside our top 20 declined 1%. The relatively stronger performance of this latter group was driven by both new logo revenue and inorganic revenue contributions. Moving down the income statement. Our GAAP gross margin for the quarter was 28.4%, compared to 29.3% in Q1 of last year. Non-GAAP gross margin for the quarter was 30.4% compared to 31.5% for the same quarter last year. Gross margin in Q1 2024 was negatively impacted by foreign exchange due to strengthening of currencies in certain of our delivery locations. Additionally, the inability to adjust prices after EPAM's Q2 2023 promotion campaign continues to have a negative impact on profitability.
GAAP SG&A was 17% of revenue compared to 17.5% in Q1 of last year. Non-GAAP SG&A in Q1 2024 came in at 14.1% of revenue compared to 15.3% in the same period last year. SG&A improvement in the quarter is a result of our ongoing focus on managing our cost base and increasing efficiency in our spend. GAAP income from operations was $111 million or 9.5% of revenue in the quarter compared to $120 million or 9.9% of revenue in Q1 of last year. Non-GAAP income from operations was $174 million or 14.9% of revenue in the quarter, compared to $178 million or 14.7% of revenue in Q1 of last year. Our GAAP effective tax rate for the quarter came in at 6%, which included a higher level of excess tax benefits related to stock-based compensation. Non-GAAP effective tax rate was 23.4%.
Diluted earnings per share on a GAAP basis was $1.97. Our non-GAAP diluted EPS was $2.46 compared to $2.47 in Q1 of last year, reflecting a $0.01 decrease year-over-year. In Q1, there were approximately 58.9 million diluted shares outstanding. Turning to our cash flow and balance sheet. Cash flow from operations for Q1 was $130 million compared to $87 million in the same quarter of 2023. Cash flow from operations in the quarter reflected a lower level of variable compensation payout related to 2023. Free cash flow was $123 million compared to free cash flow of $79 million in the same quarter last year. At the end of Q1, DSO was 73 days and compares to 71 days for Q4 2023 and 69 days for the same quarter last year. The uptick in DSO reflects an increase in the time some clients are taking in the review and approval of payments.
Share repurchases in the first quarter were approximately 396,000 shares for $121 million at an average price of $304.21 per share. As of March 31, we had approximately $214 million of share repurchase authority remaining. We ended the quarter with approximately $2 billion in cash and cash equivalents. Moving on to a few operational metrics. We ended Q1 with more than 47,050 consultants, designers, engineers and architects, a decline of 8% compared to Q1 2023. This is the result of lower levels of hiring, combined with both voluntary and involuntary attrition as we continue to balance supply and demand. Our total headcount for the quarter was more than 52,800 employees. Utilization was 76.8% compared to 74.9% in Q1 of last year, and 74.4% in Q4 2023.
Now let's turn to our business outlook. We are continuing to see a modest improvement in demand. However, client decision-making continues to be cautious and demand is not improving to the degree expected when we set our original 2024 guidance. At that time, based on the modest sequential growth achieved in Q4 2023 and our forecast of modest growth in Q1, we expected Q2 to show flat to modest sequential improvement, followed by solid sequential growth averaging at least 3% for Q3 and Q4. As a reminder, based on the sequential declines in 2023 quarterly revenue, we needed to generate regular sequential growth in 2024 to produce year-over-year growth. For the remainder of the year, with limited demand improvement, we now expect seasonal factors to have a more pronounced impact on sequential revenue growth, with Q2 showing a modest decline, Q3 improving followed by flat to a possible modest decline in revenues in Q4.
Additionally, although we are seeing some modest incremental contribution to revenue from recently completed acquisitions, that contribution is largely offset by foreign exchange headwinds, resulting from the ongoing strength of the U.S. dollar. We're maintaining our focus on demand generation and will continue to prioritize revenue growth throughout 2024. In 2024, we will incur incremental costs related to compensation. Additionally, lower utilization for EPAM's end market resources and some ongoing pricing pressure will continue to negatively impact gross margins. However, we are committed to running the business at a profitability level of at least 15% for non-GAAP adjusted IFO. We are planning to initiate additional cost savings measures to ensure that we can achieve our profit objectives while still focusing on long-term growth.
Finally, our operations in Ukraine continue to run at high levels of utilization, a testament to our team’s dedication and focus on maintaining uninterrupted quality of delivery. Our guidance assumes that we will continue to be able to deliver from our Ukraine delivery centers at productivity levels similar to levels achieved in 2023. Moving to our full year outlook. Revenue is now expected to be in the range of $4.575 billion to $4.675 billion, a negative growth rate of 1.4% at the mid-point of the range. The impact of foreign exchange on growth is now expected to have a negative impact of approximately 30 basis points. At this time, we expect approximately 1% of revenue contribution from already completed acquisitions. We expect GAAP income from operations will now be in the range of 10% to 10.5% and non-GAAP income from operations will now be in the range of 15% to 15.5%.
We expect our GAAP effective tax rate will now be 20%. Our non-GAAP effective tax rate, which excludes excess tax benefits related to stock-based compensation, will continue to be 24%. Earnings per share, we expect the GAAP diluted EPS will now be in the range of $7.34 to $7.64 for the full year, and we are focused on maintaining non-GAAP diluted EPS, so as to remain in the range of $10 to $10.03 for the full year. We now expect weighted average share count of 58.7 million fully diluted shares outstanding. Moving to our Q2 2024 outlook. We expect revenue to be in the range of $1.135 billion to $1.145 billion, producing a year-over-year decline of 2.6% at the mid-point of the range with the expected impact of foreign exchange to be negative 0.6%.
For the second quarter, we expect GAAP income from operations to be in the range of 9% to 10% and non-GAAP income from operations to be in the range of 13.5% to 14.5%. We expect GAAP effective tax rate to be approximately 25% and our non-GAAP effective tax rate to be approximately 24%. Earnings per share, we expect GAAP diluted EPS to be in the range of $1.52 to $1.60 for the quarter, and non-GAAP diluted EPS to be in the range of $2.21 to $2.29 for the quarter. We expect a weighted average share count of 58.8 million diluted shares outstanding. Finally, a few key assumptions that support our GAAP to non-GAAP measurements for the remainder of the year. Stock-based compensation expense is expected to be approximately $38 million for Q2, $46 million for Q3, and $47 million for Q4.
Amortization of intangibles is expected to be approximately $6 million for each of the remaining quarters. The impact of foreign exchange is expected to be a $1 million loss for each of the remaining quarters. Tax effective non-GAAP adjustments is expected to be around $10 million for Q2 and $11 million for each of the remaining quarters. We expect excess tax benefits to be around $1 million for Q2, and $1.7 million for each of the remaining quarters. We expect incremental restructuring charges in the second half of 2024 and at this time, cannot estimate the amounts with reasonable certainty. We expect to provide detailed estimates during our Q2 call. Incremental restructuring charges are currently not included in our guidance. However, these charges will not impact our non-GAAP results.
Finally, one more assumption outside of our GAAP to non-GAAP items. With our significant cash position, we are generating a healthy level of interest income and are now expecting interest and other income to be approximately $15 million for Q2, $20 million for Q3, and $15 million for Q4. While we work our way through the cycle of lower demand, we will continue to run EPAM efficiently, positioning the company to capitalize on a more normalized demand environment. Lastly, my continued thanks to all of our employees for their dedication and focus on serving our clients and driving results for EPAM. Operator, let’s open the call up for questions.
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