EPAM Systems, Inc.

Thank you, operator, and good morning, everyone. By now, you should have received your copy of the earnings release for the company's second quarter 2022 results. If you have not, a copy is available on epam.com in the investor section. With me on today's call are Akati Dobkin, CEO and President, and Jason Peterson, Chief Financial Officer. I'd 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 risk and uncertainties as described in the company's earnings release and SEC filings. Additionally, all references to reported results that are non-GAAP measures have been reconciled to the comparable GAAP measures and are available in our quarterly earnings materials located in the investor section of our website. With that said, I'll now turn the call over to ARC.

Thank you, David. Good morning, everyone. Thank you for joining us today. I want to start by reminding you of our earnings call three months ago and then our investors and analysts day on May 19th, when we shared our approach and high-level plan for the following months. At that time, we said that we didn't expect the war to end quickly. And as a result, our plans for adopting the company were developing based on a series of overlapping efforts and phases. Today we are still very much in the wartime, and we don't fully see a definitive conclusion of it in the near term. And that means that, as we expected, we are continually adjusting our operations, our delivery organization, and ways of working to what is our new normal now. So let's go quickly via the progress we are making across those phases. The first phase is a focus on the safety of our employees and stabilization of our operations in Ukraine. At this time, all our employees are in safe locations, either within the country or in neighboring countries, and our teams continue to work, supporting our customers at levels of productivity very much in line with what we experienced before the war, or even higher. In addition, in this new normal, We continue to support our Ukrainian employees and their families, as well as the Ukrainian people, by providing various forms of humanitarian relief with the NIPAM Ukraine Assistance Fund and our $100 million assistance commitment, which we announced back in March. I would just add that we are constantly moved by the resilience and morale of our Ukrainian employees, and we want to take one more opportunity to thank them for their incredible commitment and level of efforts they demonstrate. And yes, this includes, first of all, geographical diversification of our delivery platform. The second phase of our framework is acceleration of our global diversification efforts and continued growth of our diverse capabilities. And yes, this includes, first of all, geographical diversification of our delivery platform. But it also includes many other critical aspects of our operations and several key investment efforts, which ensure the quality of our delivery while we are expanding rapidly across multiple geos. We are scaling in already existing delivery locations in India, Latin America, and Central Asia, as well as establishing several newly created delivery hubs and expanding many existing sites across Central and Eastern Europe and Western and Central Asia as well. This is also supported by the active redeployment of many of our current employees who decided to explore opportunities outside of their home countries and simultaneously establishing a strong IPAM cultural foundation in those locations to further develop the local talent market in fast-growing IPAM hubs. Looking at our global footprint... IPAM now serves customers from more than 50 countries around the world, which means we just doubled our country count in the last three years, and as a result, rebalanced our delivery platform across now four major geographies, which include Central and Eastern Europe, India, Western and Central Asia, and Latin America. two of which almost didn't exist for us just a few years back. To date, with those efforts and accelerated growth outside of impacted regions, we have reduced our delivery capacity there from roughly 60% in February of 2022 to 40% now, and we expect to reach a level close to 30% during the second half of 2022. As part of this process, we are well underway in our commitment of exiting our operations in Russia. While we move quickly and anticipate completing the process shortly, we are still working through a number of regulatory requirements in the country, which means that the timing of full transition is still difficult to predict precisely. With that said, we can share that our local footprint went from over 9,000 people at the end of Q1 to just under 1,000 today. With that, I would like to say a big thank you to many people within NIPAM Global Delivery and Talent Management and financial organizations. at very different seniority levels, who are enabling this massive talent transformation effort across dozens of countries simultaneously and under very challenging timelines. Thank you. Moving to our third phase in the framework, continuing to serve and expand demand for our services for our growing global customer portfolio. Over the last five months, we have repositioned absolutely majority of our client projects who requested their work to be relocated based on their sense of risk mitigation factors. And we also know that such requests will continue to happen in the future, depending on the different fast-developing external factors. We just feel at this point that we are much better prepared now to address such future needs. With that, I would like to state that while we continue to be extremely open and responsive to our customer needs and their preferences, We are seeing today some new incoming demand into the region and expect a significant proportion of our client portfolio, even with increased global diversification, to be continuously served from Ukraine and Belarus. Another indication of our success in our third phase could be expressed by the growth of our top 20 and top 50 client portfolio. Most of them have been with us and stayed with us through multiple phases of change and growth, and thanks to their support today during such a huge and terrible disruption as the current war in Ukraine. Finally, the last element of our framework is the focus on profitability, or Phase 4. As work has been repositioned to new geographies, we have begun the effort to align rate structures and optimize the performance of new delivery locations, which will continue throughout this year and into 2023. While still too early to provide specifics on our progress on this phase, we believe we will return to profit levels, approaching EPAM historical ranges during the first half of 2023. In addition to all of that, we continue to progress our investment agenda across several key for us areas. EPAM Continuum is now a consulting brand, recognized by leading analysts and strongly supporting our growing focus on more complex and advisory-led projects. Our cloud and data offerings are progressing fast into large modernization programs, enabled by our strengthening relationship with key partners in that space. And we continue to see traction with the PAM efforts in our IP and educational initiatives, as well as with our advanced remote supply model, enabled by our continuously invented digital platforms. In short, we feel good right now about our progress to date, of rebalancing our global delivery and moving forward with all other additional initiatives, which should allow us to maintain a sequential constant currency revenue growth rate, despite the massive disruption we have encountered. With that, I would like to provide some comments on the current demand environment, or at least how we see it from our side. While we really are doing better today than we expected, we, like our competitors and all of you, see a growing number of mixed economic indicators and caution in the market. At the same time, we still believe the near-term demand environment remains intact. We also believe the medium-term broad-based demand trends, which have driven activity in our industry in the past, will continue to support our ability to drive strong organic growth at or above our old normal 20% target. So, while we are not immune to the impact of global economic events, we feel we are in a much better position today than in the past to address any future shifts. And we also believe EPAM remains well-positioned for long-term growth and value creation opportunities for our people, for our clients, and for our investors. To summarize, our priority remains to contain as much as possible the impact of the current disruption of the war within 2022. We have made significant progress in this area over the last five months. And, in addition, we are significantly accelerating key elements of our overall strategy. Because to a big extent, other than the closing of our operation in Russia, what is happening right now and what we now call our new normal is very much the accelerated effort towards several strategic directions which have been part of our medium to longer term plans. The resilience of our people, customers, and operations have effectively created exactly this new normal for EPAM, an entirely different level of diversification, productivity, and agility of the business to ensure future growth in this constantly changing market environment. So overall, these challenging times are helping us to build better and more adaptive IPAM and faster. And in closing, as I mentioned on our Q1 earnings call, and it's worth repeating, IPAM as a company fully stands with Ukraine. Since the beginning of the war, our absolute top priority has been and continues to be the safety and well-being of our employees and their families. And one more time, thank you to all of our employees for this effort and their loyalty during these not at all easy times. Now, let me turn the call over to Jason, who will talk about our Q2 results and additional perspective as we look at Q3 and beyond.

Thank you, Ark, and good morning, everyone. In the second quarter, EPM delivered another set of strong results, including a sooner-than-anticipated return to sequential revenue growth. These results were produced at a time when the company was experiencing unprecedented disruptions across all of EPM's major delivery locations. As we mentioned during our Q1 earnings call, in addition to our customary non-GAAP adjustments, expenditures related to EPM's humanitarian commitment to Ukraine, the exit of our Russian operations, and costs associated with accelerated employee relocations have been excluded from non-GAAP financial results. We have included additional disclosures specific to these and other related items in our Q2 earnings release. During Q2, EPM generated revenues of $1.19 billion, a year-over-year increase of 35.6% on a reported basis and 40.1% in constant currency terms, reflecting a negative foreign exchange impact of 450 basis points. Looking at the performance of our industry verticals in geographic regions in the quarter, growth was negatively impacted by the ongoing accident of our Russia operations and the effect of foreign exchange on our U.S. dollar reported results. Where helpful, I will provide an adjusted year-over-year comparison. Beginning with our industry verticals, travel and consumer grew 61.1%, driven by strong organic growth, primarily from our retail customers, as well as revenue contributions from recent acquisitions. Life sciences and healthcare grew 40.1%, with strong growth coming from the healthcare industry, in addition to growth in life sciences. Financial services grew 29.4%, with growth coming from asset management, payments, and banking. Excluding our Russia customers, growth was 41.5%, or 45.7%, in constant currency. Business information and media delivered 25.4% growth in the quarter, driven primarily by customers in the business information industry. Software and high tech grew 22.7% in the quarter. And finally, our emerging verticals delivered 36.1% growth driven by clients in telecommunications, energy, manufacturing, and automotive. Excluding our Russia customers, growth was 40.6% or 49.1% in constant currency. From a geographic perspective, Americas, our largest region representing 60% of our Q2 revenues, grew 36.8% year-over-year or 37.9% in constant currency. EMEA, representing 35% of our Q2 revenues, grew 45.2% year-over-year, or 58% in constant currency. EMEA performance was driven by strong organic growth combined with an incremental contribution from recent acquisitions. CEE, representing 2% of our Q2 revenues, contracted 46.7% year-over-year, or 58.2% in constant currency. Revenue growth in the quarter was impacted by the ramp down of services to our Russian customers. And finally, APAC grew 20.8% year-over-year, or 25% in constant currency terms, and now represents 3% of our revenues. In Q2, revenues from our top 20 clients grew 27% year-over-year, while revenues from clients outside our top 20 grew 41%. Moving down the income statement, our gap gross margin for the quarter was 29.2% compared to 33.8% in Q2 of last year. Non-gap gross margin for the quarter was 31.5% compared to 35% for the same quarter last year. Compared to Q2 2021, Gross margin in Q2 2022 was negatively impacted by the ongoing transition of customer work to higher-cost geographies, as well as lower utilization in Russia. GAAP SG&A was 19.5% of revenue compared to 17.2% in Q2 of last year, and non-GAAP SG&A came in at 15.2% of revenue compared to 15.6% in the same period last year. Gap income from operations was $93 million, or 7.8% of revenue in the quarter compared to $125 million, or 14.2% of revenue in Q2 of last year. The lower level of profitability was primarily driven by costs associated with the exit of our Russia operations, relocation of our employees, and humanitarian expenditures in support of our Ukrainian employees. Non-gap income from operations was $177 million. or 14.9% of revenue in the quarter compared to $155 million, or 17.6% of revenue in Q2 of last year. We are pleased with our operating profit in a quarter when the company was also executing a significant geographic transformation. Our gap effective tax rate for the quarter was negative 114.9%, primarily driven by excess tax benefits related to stock-based compensation, as well as a one-time deferred tax benefit associated with tax planning. Our non-GAAP effective tax rate, which excludes excess tax benefits as well as the one-time benefit from tax planning, was 22.9%. Diluted earnings per share on a GAAP basis was $0.32, reflecting a negative $1.62 or 83.5% decrease year-over-year. GAAP EPS includes the impact of Ukraine humanitarian expenditures, expenses related to accelerated staff relocations, costs related to the planned exit of our Russian operations, and the FX impact of Russian ruble appreciation on intercompany payables denominated in rubles and U.S. dollar denominated assets held by our Russia entity. Our non-GAAP diluted EPS was $2.38, reflecting a 33-cent increase or 16.1% growth over the same quarter in 2021. In Q2, there were approximately 59 million diluted shares outstanding. Turning to our cash flow and balance sheet, cash flow from operations for Q2 was 78 million, compared to 69 million in the same quarter of 2021. Free cash flow was 59 million, compared to free cash flow of 46 million in the same quarter last year. We ended the quarter with approximately $1.3 billion in cash and cash equivalents. At the end of Q2, DSO was 71 days and compared to 69 days for Q1 2022 and 70 days for the same quarter last year. We expect to maintain DSO in and around this level throughout 2022. Now moving on to a few operational metrics. We ended the quarter with more than 54,850 consultants, designers, and engineers, a year-over-year increase of 28.1%. Our total headcount for Q2 was around 61,300 employees. Compared to Q1, we saw a net decrease of approximately 300 headcount. Significant additions in India, Central Europe, and Latin America were offset by the reduction of headcount in Russia. Utilization was 78% compared to 80.2% in Q2 of last year and 78.4% in Q1 2022. Our Q2 utilization includes those employees who have been assigned in a backup capacity to support projects substantially delivered from Ukraine. Although these employees were counted as utilized for the purpose of our utilization calculations, this work was largely unbilled. Additionally, during the quarter, utilization in Russia was significantly lower compared to the same quarter in 2021. Utilization in Ukraine remains steady and at levels similar to, but somewhat lower than, 2021. Now let's turn to our business outlook. As a reminder, on February 28th, we withdrew our full-year business outlook due to the uncertainties related to Russia's invasion of Ukraine. For the remainder of this year, we plan to provide guidance for the next quarter only and expect to resume our full-year guidance at the beginning of the 2023 year. However, I will provide some additional insights and assumptions, which will help frame our Q3 guidance and expectations for the second half of 2022. At this time, we continue to see a stable demand environment, which combined with the progress in repositioning our workforce and portfolio, we expect will drive continued sequential revenue growth throughout the second half of 2022. However, with our reduced Russian customer revenue, we expect to see the impact of tougher year-over-year revenue comparisons in both Q3 and Q4. We will continue to provide color regarding the impact the Russia exit has on EPAM's growth rates. We continue to see relatively high levels of productivity from our Ukrainian staff, who are substantially located in safer portions of the country. Our Q3 guidance assumes that we will maintain Ukrainian utilization levels only slightly lower than pre-war levels. For those Russian employees who wanted to relocate, we have relocated the majority of that population during the second quarter. Therefore, we expect a lower level of employee relocations in Q3. In parallel with the repositioning of our people, we are working through the process to align our cost and rate structures to reflect the prevailing economics in the geographies to which demand has been redirected. In many cases, the result will be increased billing rates to reflect higher costs, although we expect some lag in the establishment of these higher bill rates. With the movement of customer projects and people, we expect some short-term inefficiencies, including a higher level of bench and therefore somewhat lower utilization as we scale new and existing delivery locations. The combination of these factors will continue to weigh on our profitability. However, we expect to see an improvement in profitability between Q2 and Q3 and are currently forecasting profitability in Q4 levels similar to those we expect to achieve in Q3. And finally, to date, EPAM has spent over $34 million as part of the company's $100 million humanitarian commitment to our Ukrainian employees and their families. We expect further humanitarian expenditures will be made throughout 2022 and into 2023. Now moving to our Q3 2022 outlook. We expect revenues to be at least $1.210 billion, producing a year-over-year growth rate of at least 22%. In constant currency terms, revenue growth is expected to be at least 26%. Included in these growth rates is approximately 400 basis points of revenue contribution from acquisitions closed over the last 12 months. I will also point out that we expect customers based in Russia to contribute less than $10 million in revenues in the quarter, compared with the $44 million in Russia-based customer revenues generated in Q3 of 2021. For the third quarter, we expect gap income from operations to be in the range of 9.5% to 10.5%. and non-GAAP income from operations to be in the range of 15% to 16%. We expect our GAAP effective tax rate to be approximately 19% and non-GAAP effective tax rate, which excludes excess tax benefits related to stock-based compensation, to be approximately 22%. For earnings per share, we expect GAAP diluted EPS to be at least $1.65 for the quarter and non-GAAP diluted EPS to be at least $2.48 for the quarter. We expect a weighted average share count of 59.4 million diluted shares outstanding. Finally, a few key assumptions that support our GAAP to non-GAAP measurements in the third quarter. Stock-based compensation expense is expected to be approximately $38 million. Amortization of intangibles is expected to be approximately $5.7 million. The impact of foreign exchange is expected to be negligible. Tax effective non-GAAP adjustments is expected to be around $13.6 million. And finally, we expect excess tax benefits to be around $5.9 million in the quarter. In addition to these customary gap to non-gap adjustments, inconsistent with Q2, we expect to have ongoing non-gap adjustments in Q3, resulting from Russia's invasion of Ukraine. Please see our Q2 earnings release for a detailed reconciliation of our gap to non-gap guidance. We are pleased with our Q2 performance, which is a result of a lot of hard work by our employees around the globe, whom I want to thank for their dedication and the world-class service they provide to our customers. Operator, let's open the call for questions.

Our first question comes from Brian Bergen of Cali. Your line is open.

Hi, good morning. Thank you. I wanted to start with a growth composition question. So can you comment on how the attribution of growth between new clients versus existing clients turned out in 2Q and how you see that progressing over the course of the second half? Just trying to understand if you're seeing a return to new client inflow versus servicing that existing base amid all of this global transition. And really just trying to understand how you're thinking about the recovery of new logo flow if you haven't gotten back to it already.

Yeah. Hey, Brian. So this is Jason, and thanks for the question. You know, from a demand standpoint in revenue growth, you know, we continue to see, you know, solid growth in the existing customers and probably with a little bit of a slowdown in new customers in Q2 because I think you'll remember that our focus certainly in March, probably April and May was really focused more on retaining existing customers. So we continued to grow significantly with the existing customers, as you can see by our revenue beat. And then probably by the time you got to the second half of Q2, we began to focus again on new logo activity. And so right now you've got quite a bit of new logo driven demand that we expect to come in the second half. But again, I think that probably just as a top line, I'd say that we continue to see growth in both our new and our existing customers.

Okay, that makes sense. And then just on the workforce, if you excluded the workforce attrition from Russia, can you give us a sense of how the sequential billable headcount landed in the second quarter? And really, just how you're thinking about your ability to return to the pre-war quarter of a quarter headcount levels across the broader global footprint as you go through the second half?

I'm going to let Art talk about headcount, but let me just mention attrition. So if we exclude Russia, where we've had higher both voluntary and involuntary attrition, Our attrition rates have remained very consistent, you know, Q4, Q1, Q2. Mark, do you want to talk about that?

Yes. And on headcount, I think definitely the total numbers impacted by exiting in Russia right now. But in general, just to understand, we're pretty comfortable that we will pre-war situation. I think it's difficult to compare this with 2021, which was a special year for everybody from the growth perspective, where sometimes we were growing in headcount against 2022, like in 30 plus, sometimes 40% per quarter on an annual basis. So I don't think anybody will be coming back to this, but definitely to what we were experiencing in water by quarter and on annual growth in 19, for example, or 18, we will be coming back to the same speed. And we're comfortable with this based on what we were sharing during our analyst day, how we position ourselves outside of this traditional Eastern European landscape, which we have in Latin America, in Western Central Asia, and India as well. making us pretty comfortable that we will be able to address the demand.

Okay, thank you very much.

Thank you. Our next question comes from Darren Peller of Wolf Research. Your line is open.

Thanks, guys. It's good to see the execution, and I really just want to hone in on the actual headcount changes that you've been making over the last couple of quarters and how it's playing out in the new markets. with the new delivery centers now and really just give us a quick update on, you know, what kind of performance you're seeing out of those newer locations, whether it's where you move people or you've been really growing new head. So our increase was between 25 and 1,300 people in Q2. And all of this clearly was outside of Ukraine, Belarus, and Russia. So which...

If you think and compare this with the past, that explains why we feel comfortable right now, that we will be able to continuously grow in the future as well with similar rates which we experienced before.

Okay, and so when we think about the execution and the utilization of those

Where do you see in terms of timeframe them being at more of a full run rate so they can actually produce the same types of revenue? And as a quick follow-up, I mean, the newer regions you were talking about at your investor day, some in the Latin American areas and some in further and incremental areas, even in Eastern Europe. If you could just give us a quick update on how it's progressed.

So from a utilization standpoint, if I talk about Q2, what we saw, as you would expect, is quite low utilization in Russia. But one of the reasons we had the revenue beat that we had is our utilization was quite a bit higher in the rest of the world than we had originally expected. So utilization levels have remained pretty solid, and particularly quite solid in Ukraine, considering everything that's going on there. We are expecting, as we go from Q2 to Q3, that we may see somewhat lower levels of utilization, because as you transition work from one country to another, you might end up with a somewhat larger bench in, let's say, the donating country, and then we're building up capacity in these newer countries. And again, you have a little bit more bench there. But as Arg said, I think we feel really good about our ability to add headcount to support demand. We've made really good progress in both transitioning resources to some of these newer geographies and adding resources in these geographies. As Arg said, we're around 40% of our delivery capacity in the traditional CIS region. So I think we feel good about not only our execution in Q2, but our ability to support ongoing demand in Q3 and Q4.

All right. Thanks, guys.

Thank you. Our next question comes from Maggie Nolan of William Blair. Your line is open.

Thank you. I wanted to check in on how the conversations regarding those adjusting those rate cards to the new delivery locations are going as well as obviously wage inflation is probably complicating this. And then on the kind of new delivery locations aspect of it, do you expect resolution by 2023 or will there be an impact of that kind of adjustment phase that persists into the next year?

Yeah, maybe all that are common on customers, but just in terms of the algebra, What we see as we transition resources to new geographies is that, you know, you have a change in compensation almost immediately, and then there's a lag, as you know, Maggie, in terms of our ability to get rate increases. And so we have some customers where the rate increases are immediate, some customers where there might be a quarter lag, and some customers where we might not see rate increases until, you know, as we enter 2023. You know, traditional to EPAM operating structure, collect data on all of this, which is updated on a daily basis. We run dashboards. And so we can see that we're making good progress both in terms of the conversations. In some cases, we actually already have the rate changes in place. In other cases, we have agreement to have the rate changes in place later in the year. So Maggie, I think we're making really good progress. And I would expect, you know, let's say the vast majority of those conversations to be completed with higher rates. as we enter Q1 of 2023. And Art, do you want to talk about conversations with clients? I think exactly like Jason said, we're still in the process. Great. And Art, do you want to talk about conversations with clients? I think exactly like Jason said, we're still in the process. And right now, the field is pretty optimistic from the result of this process. We know

Significant number of clients already agreed on rate adjustments. Some of this delayed for the next month, two or three. So as this would be mentioned already today that we expect approaching the profitability rate similar to pre-war conditions in 2023. Again, approaching this. There are too many moving parts. Some of them not even related to these events because if you think about what's happening with foreign exchange, for example, and sometimes it's an important situation as well between euro and U.S. dollars and what currencies we pay. Compensation is official, so it's more difficult conversation.

But rate adjustments on the way, and we are optimistic in this sense.

Thank you. That's helpful. Jason, how does the cash you generated this quarter compare with your expectations going into the quarter, just given all the atypical expenditures you've had of late? And then what's the expectation for how cash flow should trend from here?

Yeah, I would say that, you know, cash flow was pretty good. I think we tried to hold DSO to 70, and it did end up at 71, and so that may have had a modestly negative impact, and we're trying to sort of keep DSO in and around or maybe slightly lower than 71 on a go-forward basis. You know, we do expect cash flow conversion to be over 100% in Q3, which is kind of, you know, more consistent with sort of historical patterns.

And right now, you know, both our cash position and our ability to generate cash is pretty encouraging. Thank you both.

Thank you.

Thank you. Our next question comes from Jason Coffenberg of Bakesville America. Your line is open.

Good morning, everyone. This is Tyler DuPont on for Jason. Last quarter, you had suggested that you could be back to pre-war normalized growth and margins by the first part 23. But based on the two Q results and the three Q guidance so far, do you feel this could happen even sooner? And can you just quantify what your benchmarks are for those pre-war levels?

I think when we, you know, so we're guiding to a 15% to 16% in Q3. And what I said, just in case it wasn't clear in the fixed portion of the call here today, is that we expected that we could see profitability in a similar level in Q4. So that's already trending back towards that traditional sort of 16% to 17% range. And when we kind of talk about our historical range, that's more what we mean rather than the elevated profitability that we would have seen during very, very high demand periods last year. But again, I feel that, you know, the progress to date I think is pretty good, as you can see by the guide. And as Art said, we're continuing to work through the pricing and the other adjustments, but it's still a little too early to sort of communicate exactly where we expect 2023 to end up.

Okay, perfect. Thank you. And just one more. As you continue on your path for headcount diversification, Can you maybe discuss some of the regions that have been relatively easier to build out versus the ones that have been a bit more challenging? And on that line, do you feel that you are past the riskiest phase of your headcount diversification efforts?

Yeah, from the standpoint of the ability to add headcount, you know, we feel that we've actually, you know, we're ahead of our own goals in terms of, you know, building out Latin America and we've seen strong growth in India. seen very strong growth in Central Europe. And so, yeah, I mean, the market continues to be a bit of a challenge, but I don't think we've had any real difficulty hiring to meet demand and to create the capacity that we want to have outside of what we call the impacted region. And so, not to say that things couldn't change in the future, but right now I think we feel pretty good about our ability to build out capacity outside of the region. through both relocations and through the addition of headcount, effectively hiring in the region.

All right, perfect. Thank you very much.

Thank you. Our next question comes from James Fawcett of Morgan Stanley. Your line is open. Mr. Fawcett, your line is open.

Oh, thanks. The operator cut out at the exact moment that she was pronouncing the name. Thanks for taking a few minutes here. I wanted to dig in again on demand and client relationships. Obviously, the client retention has been quite good, et cetera. But as you're moving resources around, are you still having customers decide and indicate that they want to change delivery locations? And what are the trends around that? And how quickly do you expect to customers if they are doing that to get settled on their preferred delivery regions?

I think it's a very right question, and I think there is no simple answer which would be addressed. Everybody kind of approached that. There are some groups of clients which are really trying to mitigate risk and move out of the region in danger. There are some clients which is continuously working almost in kind of pre-war scenarios. And there are some new clients coming there as well. So, but again, as you probably understand too, it's all a little bit moving target. We working month by month, day by day, and sometimes seeing something unexpected, but In general, I think we share exactly the numbers which we kind of aggregating what we understand going to happen. We're clearly not in business as usual in general situation. So when we have to move thousands of people and based on our business continuity approach And if we assign a lot of delivery capacity, it's nothing as business as usual. But if you think that we're still growing, and especially if you think how growth is happening without Russia, because this is where we disconnected our organic constant currency growth outside of Russia in Q2 was like 37%. So which means that there is normal demand if you take into account that we are exiting there. So I know I'm not giving you a precise answer, but there is no precise answer. There are clients which is trying to completely change approaches. There are clients which are picking up on this capacity which is released from them. And in some respect, a little bit similar to what

Got it, got it. That's really helpful though. And then, you know, on top of everything else, what have been the macro-related conversations with your clients, both in terms of existing and potential? And are you seeing any indications of softening, whether it be lengthening sales cycles or having clients approach you and say, hey, these are projects that we'd like to put off because we're a little uncertain? And are you having those conversations at all? And how is macro contemplated in your outlook, if at all?

Are you relating to situations in Eastern Europe? Or just the economy more generally? I think, first of all, for us, sometimes it's difficult to distinguish one to another because it's not necessary. clients said exactly why this conversation might happen. So this conversation are happening, but again, they were happening like 12 months ago, they were happening 24 months ago. If it's a little bit more often, maybe, but it's still difficult because it's even volatile by quarter by quarter. And the reasoning for this could be that the situation where majority of our resources are, or economy. So it's very difficult to distinguish for us.

Yeah, that's understandable. Thanks for that, Mark. Appreciate it.

Thank you. Again, ladies and gentlemen, if you'd like to ask a question, please press star then one on your touchtone telephone. Again, please press star one one on your touchtone telephone. Our next question comes from the end of Jeffrey. Your line is open.

Thank you. Following up on the earlier question about just the client's desire for the delivery model, are the client conversations continuing to evolve in the sense that there were clients last quarter that requested a change in where delivery is from, and this quarter there's new sets of clients that are asking for delivery changes, or how should we think about the potential for your year-end targets to kind of evolve? Like, I realize you kind of said that it's fluid, but I just wanted to make sure I understand all the push-pull factors here.

Oh, I think, again, I think we're repeating ourselves, but everything is a little bit moving. Some clients were asking last quarter and then settled. Some clients might be asking today and will be asking tomorrow as well. So at the same time, if you aggregate everything, we see the picture where demand independently from locations still pretty strong. And that's what I mentioned, which is not exactly right comparison, but in some sense similar to what we experienced eight years ago when some clients were completely leaving the region and some other clients were picking up. And we see this trend as well. What would be bigger, we will see probably in two It's also dependent on what would be happening. What would be actually happening in the region and what would be results of the current war as well. But on top of this, and that's what we're communicating, we're pretty comfortable with a bit of growth outside of the region. When we're talking about Latin America and India and Western Central Asia, we're pretty comfortable that we would be able to grow from applied point of view. in line with what we need.

Understood. And then in terms of just clarification on Russia, it sounds like all of the individuals that you wanted to relocate or have requested relocation are done. So what is left in Russia at this point? Is it assumed that all of that work will be transitioned within the next quarter or two? Any color there or any additional color there?

Yeah, what left? We finalized in finalizing the conditions, how we exit in Russia completely. And I mentioned today that there are some regulatory requirements, and we're going through this right now, which might take another month or so. And after this, the rest of headcount, which we have in Russia today, will be outside of IBAN, which is currently already less than 1,000 people.

Thank you.

Thank you. Our next question comes from Ramsey Elisal of Barclays. Your line is open.

I was wondering if you could update us on your thinking around M&A and the degree to which potentially you could leverage M&A to help fill in some of the gaps or address some of the challenges that have come out of the geopolitical situation you find yourselves in.

I think the approach for M&A didn't change for us much. Very similar like in the past, M&A for us is additional capabilities. sometimes beginning of the growth and sub-vision, but from the point of the current delivery platform and delivery locations, we already feel pretty comfortable with all foundations which we have. I don't think M&A will be specifically important for this part. So, versus, again, traditional editing capabilities in consulting and market and industry expertise, and maybe sometimes in new locations, but again, it's not critical for us because we already established pretty good footprint for growth.

And then my follow-up is just on a question around sort of the macro resilience of the business. And again, I'm not referring to Eastern Europe and the military conflict there. I'm referring more to just the you know, the economic environment more broadly. Can you talk about how you think about EPAM in the context of dealing with cyclical pressures, recessionary pressures? I think, you know, typically, historically, IT services have been somewhat cyclical. I think some of the digital tailwinds today may provide sort of a secular, you know, tailwind that might help quite a bit through a recessionary period. But I'm just curious, Ark, your view about how the business fares during a hypothetical recession.

So I think we do have experience in the past It's always difficult to predict how experience from the past is applicable for the future and how different the next recession is going to be. But in the past, we usually were practically flat for two, three quarters and then started to grow again. I think in general, that's what we were mentioning as well. In our industry, with all what's happening, I think we will be able to kind of tune headcount for a couple quarters and all kind of challenges in 2020 2021 and specifically 2022 make us actually much more resilient and much more adaptive to address potentially necessary adjustments so i think and again we already talked about it today about it we feel ourselves much more comfortable much more prepared for some elements of unknown and we probably during this last couple years and we talked about it Belarus during the last couple of years are trained and prepared better than anybody else on the market right now for recession as well, if it would be happening.

That makes a lot of sense. You guys do have a lot of practice with crisis management at this point and pivoting the business successfully. So thanks for your answer. Appreciate it. Thank you.

Thank you. Our next question comes from Puneet Jain of JP Morgan. Your line is open.

Thanks for taking my question. Good quarter, guys. I have like a question on gross margins. Given that your delivery profile is changing, can gross margins go back to the prior pre-war 35%, 36% levels? Or maybe like the new locations, the pricing dynamics, labor dynamics there might result in like a different gross margin profile over the medium term compared to what it used to be before this invasion.

Yeah, so this is Jason. From the standpoint of gross margin, I think gross margin in Q2 came in somewhat better than we had expected due to our ability to continue to deliver at certain locations and just kind of manage demand. We are expecting a bit of an improvement in gross margin between Q2 and Q3. And as we've talked about, we think there's a temporary impact as we shift people into new geographies, some of which are more expensive than the geographies in which they're leaving. And so there would be a temporary impact that we expect to largely address by the time we enter 2023. But there could be a little bit of compression on margin relative to the very high levels that we were running at. when we were running at 18% IFO or something, right? And so when we talk about kind of our return to profitability, we are really sort of thinking more about the traditional 16% to 17% range. We continue to see good efficiency from an SG&A standpoint. And so, again, I think I probably would sort of guide us towards the adjusted IFO and just assume that we'll kind of manage it between the two components. But, again, feel good about our ability to head back towards the higher levels of gross margins. but they could be slightly lower than they've been during the particularly hot course of 2021.

Understood. And then obviously you mentioned macro remains healthy and all the good comments there. Has there been any change in client priority in terms of the type of projects they execute? Like, have you seen any changes in type of projects or any changes in sales cycles or the speed at which they award new projects at all?

You know, I know that some people are talking about maybe an eventual shift towards efficiency or cost efficiency. We have not seen that at this time. So we still see the traditional drivers... you know, application modernization, cloud migration, data, and then all the platform engineering that EPAM is well known for. And so we still see those as underlying drivers, and part of the reason why I think we feel comfortable guiding towards, you know, sequential growth, both in Q3 and as we talked about, it's unexpected in Q4 as well. But does that answer that question?

Yes, it does. It does. Thank you. Our next question comes from Arvind Ramnani. of Piper Stanley and Linus Open.

Thank you for taking my question. I just wanted to ask about your, you've had roughly maybe six months looking at these newer geos and taking a closer look at scaling operations and input geos across the globe. As you digest what you've looked at in terms of local talent in markets, which geos outside Belarus and Ukraine and Russia are looking promising to scale up as you look out over the next couple of years?

I think it's difficult to add something substantial in a couple of minutes' answer versus what we shared already during our analysis day in May. And I think what we, when we went, actually, to some level of details. And I can only repeat that, for example, what's happening during the last six months, in some respects, was prepared during the previous, like, years. And we were specifically talking about how we were growing in India. And during the last couple of years, it's become one of the fastest talent growing market for us, and we continue to do this. We were starting to focus in on Latin America before war happened, and we pretty impressed with the level of talent there. And a number of countries across Western Central Asia, which we started to focus in 2020, 2021, and some of them, like, after the war, we see there's a good potential as well. That's why, again, Already was answering several times today. We're pretty comfortable that we will be able to scale with the talent outside of our traditional locations. And don't forget that we're still growing pretty significantly in Central Eastern Europe, which we have very strong experience and complement all of these locations. of EPUB DNA and EPUB experience in new apps for us.

Perfect. And just one quick follow-up. Just in terms of your gross margin, clearly it's been impacted by this transition. Are you able to provide some color of how much of the impact was due to utilization in Russia versus the transition to higher-cost geos?

Let me think. Whenever we give you a description of the impact, there's a whole series of different things that are impacting profitability. I don't know. The change into the new geographies is probably having at least the impact or more so than the Russian utilization. We're going to continue to move people into new geographies. We did that in Q2. We're going to do that in Q3. And so you're going to see some accumulation of people who are still sort of in a holding pattern waiting to get rate increases even though their costs have gone up. So that's why I think that you'll see profitability in Q3 and Q4 be more similar rather than an increase in profitability between Q3 and Q4. But again, we're working through it, Arvind. And again, I think we feel relatively comfortable that we're making good progress with clients around Q3. you know, appropriate rates for the geographies. And then we continue to have the same menu of options we've always had in that we also have relatively, you know, lower cost centers in Central and Western Asia, India, other. And so we offer, you know, a full range of opportunities for clients.

Perfect. Thank you very much and good luck for the rest of the year.

Thank you. Our next question comes from David Grossman of Stiefel. Your line is open.

Thank you. Good morning. I just wanted to follow up a couple things you said earlier on the call. The first was, I think you said you expect about 30% of your delivery capacity to come from the impacted regions in the back half of the year, and that's down from 60%, I believe, at the end of last year. So when you look at that change, is that the way to think about the distribution of work and Secondly, it seems about half of that decline came from closing down Russia. I just want to make sure that I got those numbers right.

Yes. At the beginning of this year, we were a little bit under 60% in three countries. Right now, we're at about 40%. By the end of the year, we expect to be closer to 30%. And this is approximately present distribution of work as well. Yes.

Okay. Well, it looks like about half of that decline of that 30% change, 15% of that was shutting down Russia. It seems like the math works that way.

That's right.

Okay. And then the second question I had was just about the new geographies that you opened. or your opening, is the percentage of employees that are being paid in U.S. dollars, is that changing at all with the opening and expansion of the new geography?

So it's a mix, and we still will have a number of geographies which will be denominated in U.S. USDs, which making clearly the whole story a little bit complicated when you try to calculate. We enter it specifically in Western Central Asia. We will be paying salaries in USDT calculation.

Yeah, David, so it's mixed, but the Russian employees were paid in rubles, and some of them are going to end up in countries that are paid in local currency, and some of them are going to end up in countries where we are using a U.S. dollar as the currency for compensation.

Any idea of just of your cost of goods, what percentage is in USD?

I can't do that off the top of my head, David. It would also be hard for me to do it, but let me see what we can do to provide information to the market. But I think we've historically talked about – actually, I want to say there's some – I can't do that off the top of my head, so let me try to provide some information on that later.

Okay, that's fine. Yeah, we can take that offline. Great. Thank you very much.

I'm showing no further questions at this time. I'd like to turn the call back over to Arkady Dovkin, President and CEO, for any closing remarks.

Thank you, operator, and thank you, everybody who joined us today. As always, if you have any questions, David is available to help. And in general, I think we do it better than we would expect, like, four or five months ago. And we're still in challenging time, but, again, we... we see that we're kind of stabilizing, and now we're much more comfortable to say that we know how to redesign our delivery platform, and it works.

Thank you. Valerie, before we close out the call, I'd like to acknowledge we experienced some auto quality issues with the management commentary portion of the call. We have posted a copy of our prepared remarks in the Q2 quarterly earnings section of our investor relations site on ePAM.com. So please go there if you need further clarifications on our prepared remarks.

Ladies and gentlemen, this does conclude today's conference. Thank you all for participating. You may now disconnect.