EPAM Systems, Inc.

Good day, and thank you for standing by. Welcome to the ePAM Systems second quarter 2023 earnings conference call. At this time, all participants are in a listen-only mode. After the speaker's presentation, there will be a question and answer session. To ask a question during that session, you will need to press star 1 1 on your phone. You will then hear an automated message advising your hand is raised. To withdraw your question, please press star 1 1 again. Please be advised that today's conference is being recorded. And I would now like to hand the conference over to your speaker today, David Straube, Head of Investor Relations. Sir, please go ahead.

Thank you, Operator. Good morning, everyone. By now, you should have received your copy of the earnings release for the company's second quarter 2023 results. If you have not, the 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 our 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 on 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, and good morning, everyone. Before I get into results of our second quarter, I would like to spend a few minutes on the mid-quarter update we provided in June. As I shared in my prepared remarks, The broader concerns over the economy led to a shift in demand dynamics for our sector. For EPAM, the shift has been much more pronounced due to the geopolitical impact on our delivery centers and our focus on the built and digital product engineering segments of the market, which represents about 80-85% of our engagement portfolio. This was especially evident in the technology vertical. which continues to be impacted by the pullback and spend after years of strong investments in digital and product development efforts, while being spread broader across other industry segments as well. Over the last quarters, we have also seen this impact in some of our largest clients, as they have pared back for redirected spending from new build programs to the economic conditions and caution in their business. This factor has contributed to a high percentage of our shortfall over the first half of 2023. Now switch to Q3 and the rest of 2023. While we are starting to see a few encouraging signs, we'll share more on that in a minute, today I would state that we expect still, based on the current level of unpredictability, a negative dynamic to continue into the second half of 2023, but at a lower level than we saw in the first half of this year. With that, I would like to state that while we do understand that this is a difficult period for us and for the sector more broadly, based on insight from the past several years and past several quarters especially, we are turning that experience into a pragmatic action plan which we will be applying to our business throughout the remainder of this year and further into the future, and consider this time an opportunity which, as we all know, any crisis presents to transforming ourselves. Some of our current plans and actions are focusing on making real-time adjustment to our offerings, go-to-market planning, customer engagement programs, and global delivery talent platform stabilization. These key investments help us to prep ourselves for a strong rebound position. What is important also to note is that our primary focus on digital product and data engineering services combined with digital consulting agency, design content, and digital marketing services will remain. In other words, the primary services and market segments which allow us to double company in the previous three years are staying intact. while we continue to tune our capabilities in line with the market demands. Our point is simple. The entire IT sector is undergoing what we believe is an evolution of the services market moving from the core IT to digitalization even more broadly and with significant acceleration. and to considering new digitally native businesses faster to reinvent entire models and ways of working and now is a promise of generative AI capabilities empowerment at the core. We have been at the forefront of similar trends before and once again are looking to put IPAM at the center of new wave of transformative services. We fully expect as a result to be underpinned and even more driven exactly by our traditionally strong product platform engineering, data analytics and machine learning capabilities. But now in combination with what generative AI promises. So our thesis has been and continues to be that our core services profile will benefit in the medium and longer term from a pump high concentration on cloud data and engineering. And we will capitalize strongly on our core capabilities once the general situation in our segment rebounds. The AI impact will become even more real in terms of complexity of future applications and platforms by encapsulating not just currently available elements of general AI and the very visible needs for trust, reliability, and security management of AI, but also by closely integrating with new classes composite and adaptive AI platforms, as well as these foundational models and specific industry cloud platforms. In short, we are optimistic about the transformative opportunities to the whole application stack coming from AI-led transformation, which is also well illustrated by our latest announcements. That is one of the key areas of our investments. critical part is the further diversification and stabilization of our global delivery platform, including the allocation of our talent more optimally across the world, while at the same time enabling our strong engineering quality standards across all IPAM locations. This rebalancing effort will be performed over the next three to four quarters, in part to drive higher levels of gross margin performance. Our other plans and actions today are focused on our immediate demand generation and new log acquisitions. During the first half of 2023, and specifically in Q2, we drove new log activity at higher levels than when compared to 2021 and 2022. We see this as a positive sign of our return to demand. We should accelerate the recovery and allow us to return to growth as soon as the current client base stabilizes. A few examples of our new Q2 clients include one of the world's leading B2B travel platforms, a large European-based multinational offering marketplace organizing for trading of shares and other securities, a multi-billion dollar molecular diagnostic company specialized in detection of early stage cancers, a leading global insurance provider of financial protection absence management and supplemental health benefit solutions, and global infrastructure services companies in the energy space. In these new programs, we are starting to include a more diverse stack of our capabilities from consulting to different types of implementation efforts. Some of those clients we expect will support our next growth journey. In addition, we also see some programs with existing clients who have started ramping up. Recently, Canadian Tire announced their seven-year strategic partnership with Microsoft to accelerate their modernization and drive retail innovation across their Canadian markets. Leveraging our decade-long relationship with Canadian Tires, EPAN will be trusted and prove an engineering partner and digital system integrator to lead the effort. So, there are some signs indeed. that the overall demand environment is coming to more normal terms for us. We probably will be able to share more next quarter of how strong those signs are going to be. But in any way, it also confirms that EPAM continues to remain very relevant and competitive, even in current markets of low demand for the build function. which is a good entry point to share some of our go-to-market progress, especially in relationship with hyperscalers. In June, we announced a global strategic partnership with Google Cloud across our global markets, cloud solutions, and focusing on specific efforts in our larger verticals, including financial services, consumer, telecom, media, entertainment, healthcare, life sciences, energy, and high tech, to help our customers to modernize and transform their business. We also encourage and energize with the momentum we are seeing with our other major cloud partners, Microsoft and AWS. More to come on these directions very soon, but just as a preview, you might have seen that we were recently named Microsoft Migrate Partner of the Year for 2023, with a couple of other honorable recognitions with Microsoft Partner Network. In overall, we made very strong progress in establishing a real 360-degree relationship with all three major players and plan to be sharing more over the course of the next few weeks publicly. Two final points. First, I just want to reiterate our view that there is a tremendous amount of work to be done in continued modernization, application development and integration, and in considering and designing the models and strategies for business change. Our commitment to our expanding capabilities in engineering, consulting, and our work to create a next generation agency will help us to compete and win a new demand climate once customers gain confidence in their optimization initiatives and return their attention to growth. Second, I wanted to touch on AI one more time. As it is obviously on everyone's mind these days. So how do we see its impact to our business and more critically to our customers in the industry at large? And of course, what are we doing to position EPAM for long-term success? EPAM has a long history of investing in R&D, and our call to action over the years has been to make the promises of technology real. So rather than sharing any specific dollar amount we plan to spend on AI, which is very difficult to estimate with the current speed of change, we can instead share how we are thinking about directional investments today. Currently, we pick investments with two principles in mind. Whatever we do has to be pragmatic to EPAM in terms of relevancy and deliverability for our clients. And second, it has to be responsible and cost-effective. This translates to two broad categories of things we are working on, and you probably already saw some of this being announced. We are building accelerators in IP that help to orchestrate full transformation program using the best available capabilities of large language models and related frameworks and tools. A significant portion of this is the work we are doing to change how we ourselves work, from how we build code to how we position and operate our company. We are working across thousands of use cases to focus, first of all, on responsible and very importantly, cost-effective solutions. Otherwise, future real progress will be difficult. To do so, we are focused on expanding our partnership, including with cloud providers and leading research centers to ensure those critical aspects and also focus ourselves on aligning internally across consulting experience and technology to address that. The reality is that the production-ready AI services application landscape is still very much at the entry stage of maturity today. Well, we see it as a very large and accelerating opportunity for us, specifically in our primary market segment. We are currently focusing on all type of activities to learn and experiment more, from proof of concepts to real scaled pilots and some scaled production initiatives. So, just like advances toward cloud over a decade ago drove demand for advanced engineering, new generation architecture, and hybrid and distributed delivery models, We are confident that this wave of AI-led requirements will drive more demand for advanced data engineering and cloud computing, content creation, and the artificial intelligence native application, as well as the new UX and UI paradigms. Our clients, who themselves make up a significant segment of technology companies and technology-led enterprises, are in the mid-set of already started AM arms race, which we believe will be a real engine for the future growth. Some of that we're already starting to see within our demand pipeline. With that, I would like to pass to Jason to share more details and numbers for Q2 and for an update for our business outlook for the remainder of 2023.