EPAM Systems, Inc.

Hello, and thank you for standing by. My name is Regina, and I will be your conference operator today. At this time, I would like to welcome everyone to EPAM's third quarter 2023 earnings conference call. All lines have been placed on mute to prevent any background noise. After the speaker's remarks, there will be a question and answer session. If you would like to ask a question during this time, simply press star, then the number one on your telephone keypad. If you'd like to withdraw your question, please press star one again. I'd now like to turn the conference over to David Straube, head of investor relations. 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 third quarter 2023 results. If you have not, copies available on epam.com in the investors 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 comparable GAAP measures and are available in our quarterly earnings materials located on 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 the results of our third quarter, I would like to recap what was said in regards to our expectations for Q3 and full year outlook three months ago during our last call. We stated that while the current business environment is more focused on cost optimization versus our differentiated build and deploy offerings, we do believe the demand for transformation services will come back and that the services market will be moving from core IT to accelerated digitization to reinvent entire business models and ways of working with generative AI at the core of the transformation. And that we expect this new demand to be underpinned and even more driven exactly by our traditionally strong product platform engineering, data analytics, and AI ML capabilities. At the same time, we said we still expect the negative dynamic to continue in the second part of 2023. even as the outlook begins to normalize. We stated that we are focusing on turning the experience from very challenging past quarters into pragmatic plans and action items, which will be applied to our business throughout the rest of 2023 and into 2024. These changes are transformational for us and already better positioning us in preparation for the return of stronger market demands. That was the first part of our premise. The second critical part was about our efforts to further globalize and stabilize our delivery ecosystem, propagate the power engineering quality standards, and optimize operationally our talent allocations while closely focusing on our growth margins improvement efforts. All that to continue throughout the remainder of this year, and I expect it to go throughout 2024. So, with that reminder, let's talk about three key topics to address our demand environment, global capabilities, and key investments. Demand. We believe that while the demand for the new build for platform application remains lower than historic levels, and the impact of rundowns and deferrals continue to work through specific client portfolios, our Q3 results point to sign of stabilization in our business. Both in new logos and in retained and expanded programs in our existing portfolio, we are seeing signs of renewed interest, particularly in our life science and health care verticals, also in insurance and energy, and not only that. What is important to highlight, in today's business environment, we are putting all possible efforts to address our client current priorities, including adjusting a mix of engagement models cost takeouts, and consolidation initiatives while protecting our share of wallet and long-term relationships. While these factors are leading sometimes to like the low short-term profitability metrics, we are seeing signs that clients are returning to a balance between cost and quality, and the pump continues to be well positioned there. Also, it's required today an increased focus on demand-led sales and go-to-market motions and investments in global partnerships to winning and quickly growing new business. Over the last quarter, our global field organizations and our specialized practice teams have focused on developing new offerings in key verticals and horizontals, expanding to new engaging models, and extending our client portfolio to include new logos across a broader spectrum of brands. from large enterprises to mid-market players to new and exciting startups in key for us verticals. And more and more often, we are engaging with clients at the C-level of both IT and business functions. One of the examples of those relatively new for us ways to engage is transitioning our partnerships, which have taken on a greater momentum recently with key collaborations driving net new go-to-market propositions new IP, and new client links. Last quarter, we started our global partnership with Google Cloud to help our clients fast-track the development of artificial intelligence, machine learning, and data solutions to help them accelerate their transformations into AI-enabled business. Earlier this week, we announced and signed a strategic collaboration agreement with AWS. This will aim to accelerate modernization, adapt cloud native architecture, and leverage artificial intelligence and advanced analytics to create customer value in key industries such as healthcare, life science, financial services, insurance, energy, and gaming. Furthermore, we expanded our partnership with Microsoft, becoming a globally managed enterprise system integrator. The enhanced partner status and APAM Advanced Cloud Native AI and data expertise will enable us to help our clients modernize, transform, and simplify complex enterprise platform application and processes to accelerate business growth powered by Azure Open AI Service. Current results of these efforts are showing up an increasing number of conversations with clients and growing numbers of opportunities. And while it's still too early to say when we can so significantly result in revenue growth, our production load is starting to come back to the level comparable with our Q1. And we hope to see this trend take shape during the next quarters. Still, despite signs of improving demand conditions, the global macroeconomic environment remains volatile. And we see certain trends reflecting in our own business, notably in Europe, where the construction in the third quarter is likely to take a few quarters to reverse. Now moving on to global capabilities. India and Latam for us are key growth delivery regions, while Central Eastern Europe and Central Western Asia are areas of stabilization after our massive relocation efforts. And we think future growth opportunities. Part of the effort regarding globalization and stabilization of delivery is the right sizing and cost optimization across multiple locations. based on current and future demand outlook and specific location capabilities, seniority of pyramids and office infrastructures. Some identical efforts are also relevant in several locations in Western Europe and North America. While we are optimizing some locations, we continue to reinvest in new talent in key initiatives to expand our engineering DNA across all strategic global delivery locations with continuous harmonization and upskilling efforts, enabled by our own use of AI and EPUM productivity platforms. Those efforts are on the way as we speak, and we've already seen first results and expect to have additional benefits to materializing in 2024. This brings us to the topic of additional investments, which we mentioned in the past multiple times. We are continuously investing in our strategic priorities, such as expansion of differentiated consulting agency, data, ML, AI, and cloud capabilities with focus on vertical expertise. Development of go-to-market offerings and solutions, which now include propositions related to use of responsible AI across a broad range of business and technology use cases. Strong cloud engineering. data and ML core services profile should position the pump to benefit in the medium and long term from the impact of both current demand for modernization and also from the fundamental skills shortage in complex technological transformations which still persist today. The impact will become even more real in terms of complexity of future applications and platforms by encapsulating not just currently available elements GenAI and requirements for trust, reliability, and security management of AI, but also by closely integrated with new classes of composite and adaptive AI platforms, as well as with foundational models and specific industry cloud platforms. One of the key propositions offered by APAM is our ability to make AI real. As part of this focus, a number of our labs and centers of excellence have created IP that we are using to productize our learnings and to share them with our clients through our own open source initiatives. We mentioned our work with DIAL, our AI orchestration workbench, in our previous call. And today we see a number of extensions of this platform into specific use cases and specific industries based on real-life problems, which we are addressing with a growing variety of integrated AI tools and data sources. One of our most significant investments related to AI is the development and internal rollout of IPAM-responsible AI framework and a broad employee training to adapt it. Today, we are confident that IPAM has the necessary capabilities and talent to help our clients to evolve in the general adoption of AI and also in modernization of applications and proper data engineering efforts to drive the value AI promised to bring. Conversations with our clients are evolving as it becomes generally understood that fundamental capabilities and readiness in cloud engineering and data are necessary prerequisites for success. Still, the level of interest continues to indicate the demand for AI-related services will build momentum into 2024 and beyond. I believe that provides good level of an overview of current state and our key areas of focus. To summarize, I would like to say that with the exciting opportunities in front of us, we are still facing a complex demand environment. We are working to invest for the future while balancing supply and demand for skills and capabilities across a much more diverse delivery footprint. This challenge continues as the war in Ukraine extends into the third year, as well as the new disruptions since the Middle East escalation. requires to continuously adapt the company in appropriate manner. Good thing, at this point, we feel being well-trained to manage all of this better. So with that, I would like to pass to Jason to share more details and numbers for Q3 and for an update for our business outlook for the remainder of 2023.

Thank you, Art, and good morning, everyone. In the third quarter, EPM generated revenue of over $1.15 billion, a year-over-year decrease at 6.1% on a reported basis, or 8% in constant currency terms, reflecting a favorable foreign exchange impact of 190 basis points. Revenue in the quarter continued to be impacted by reduced program spending across a number of our clients, as well as ongoing client caution related to new project starts. The reduction in Russian customer revenues resulting from our exit from the market 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 5.6 percent and 7.6 percent, respectively. Beginning with our industry verticals on a year-over-year basis, financial services decreased 3.3 percent, driven by declines predominantly in banking, partially offset by growth in asset management. Consumer decreased by 6.2%, primarily due to declines in consumer goods, partially offset by solid growth in travel and hospitality. Life sciences and healthcare declined 4.2%. The year-over-year growth rate was negatively impacted by the ramp down of a large transformational program in late 2022, which we have mentioned during our previous earnings call. On a sequential basis, growth in life sciences and healthcare was a positive 8.6%, and we expect to return to positive year-over-year growth next quarter. Business information media declined 12% in the quarter. Revenue in the quarter was impacted by a reduction in spend across a number of large clients based on uncertainty in their end markets, particularly in the mortgage data space. Software and high-tech contracted 15.1%. The year-over-year growth rate was negatively impacted by the reduction in revenue from a former top 20 customer we mentioned during our previous earnings calls and generally slower growth in revenue across a range of customers in the vertical. And finally, our emerging verticals delivered solid growth of 8.5%, driven by clients in energy, manufacturing, and automotive. From a geographic perspective, Americas, our largest region, representing 59% of our Q3 revenues, declined 9.3% year-over-year, or 9.5% in constant currency. On a sequential basis, growth in the Americas was relatively flat and improvement from the declines in previous quarters in 2023. EMEA representing 39% of our Q3 revenues grew 1.8% year-over-year and decreased 3.5% in constant currency. CEE representing less than 1% of our Q3 revenues contracted 66.4% year-over-year or 58.8% in constant currency. Revenue in the quarter was impacted by EPM's exit of its Russian operations. And finally, APAC declined 20.2% year-over-year, or 19.8% 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 Q3, revenues from our top 20 clients declined 8.3% year-over-year, while revenues from clients outside our top 20 declined 4.9%. Moving down the income statement, our GAAP gross margin for the quarter was 31.1% compared to 32.6% in Q3 of last year. Non-GAAP gross margin for the quarter was 32.9% compared to 34.4% for the same quarter last year. Gross margin in Q3 2023 reflects the negative impact of pricing pressure and lower utilization, partially offset by a lower level of variable compensation expenses. GAAP SG&A was 16.9% of revenue compared to 16.1% in Q3 of last year. Non-GAAP SG&A in Q3 2023 came in at 14.4% of revenue compared to 14.1% in the same period last year. GAAP income from operations was $114 million, or 9.9% of revenue in the quarter compared to $180 million, or 14.7% of revenue in Q3 of last year. Included in our GAAP results in the quarter is the $25.9 million loss from a sale of the company's remaining holdings in Russia and $8.4 million in severance as we take steps to reduce our cost structure to better align with demand. Non-GAAP income from operations was $196 million or 17% of revenue in the quarter compared to $232 million or 18.9% of revenue in Q3 of last year. Our GAAP effective tax rate for the quarter came in at 26.3%. which includes a one-time tax charge connected to the disposal holdings in Russia, and lower than expected excess tax benefits related to stock-based compensation. Non-GAAP effective tax rate was 23.2%. Diluted earnings per share on a GAAP basis was $1.65. Our non-GAAP diluted EPS was $2.73, reflecting a 37-cent decrease compared to the same quarter in 2022. In Q3, there were approximately 58.9 million diluted shares outstanding. Turning to our cash flow and balance sheet, cash flow from operations for Q3 was 215 million compared to 252 million in the same quarter of 2022. Free cash flow was 211 million compared to free cash flow of 234 million in the same quarter last year. At the end of Q3, DSO was 73 days and compares to 71 days for Q2 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, combined with the last day of the quarter falling on a weekend. Share repurchases in the third quarter were approximately 318,000 shares for 78.5 million at an average price of $246.44 per share. As of September 30th, we had approximately 372 million of share repurchase authority remaining. We ended the quarter with approximately $1.9 billion in cash and cash equivalents. Moving on to a few operational metrics, we ended Q3 with more than 48,500 consultants, designers, engineers, trainers, and architects. Including the impact of our exit from Russia, production headcount has declined 10% compared to Q3 2022. 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 54,600 employees. Utilization was 72.7% compared to 73.5% in Q3 of last year and 75.1% in Q2 2023. Now let's turn to our business outlook. We are encouraged by the results of our demand generation efforts and new customer revenues resulting from these efforts. However, the level of new customer revenues being generated is still not enough to offset the impact from existing project ramp downs and reduce spending from our top 20 clients. We are beginning to see a degree of demand stability emerging in our North American portfolio, but we are also expecting an impact from planned ramp downs at several of our European customers. Although there are encouraging signs, demand remains somewhat uncertain. In addition to the negative impact that Q4 seasonality usually has on revenue, We've also had a large number of employees relocate to countries that celebrate December holidays. In Q4, we are also expecting unfavorable foreign exchange headwinds in comparison with Q3. These factors are producing a sequential decline in Q4 revenue, despite the stabilizing demand environment. Our Ukrainian delivery organization continues to operate efficiently, and our teams remain highly focused on maintaining uninterrupted production. Our guidance assumes that we will continue to deliver from Ukraine at productivity levels consistent with previous levels throughout 2023. During the third quarter, we elevated our focus on aligning our cost structure with the near-term demand environment, initiating a cost optimization program designed to reduce operating costs by 2.5 to 3%. This effort is clearly more intentional than our previous supply and demand balancing efforts. We think it is necessary to take this action in part to allow for further investment across our strategic initiatives, demand generation efforts, and people programs. As I mentioned earlier, we had $8.4 million in severance-related costs in Q3, of which $7.1 million related to the cost optimization program. In Q4, we expect to recognize a further $15 million in expenses as a result of this cost optimization program. We expect headcount will continue to decline in Q4 due to limited hiring and managed attrition, which will drive utilization slightly higher in the quarter. Moving to our full-year outlook, we now expect revenue to be in the range of $4,663,000,000 to $4,673,000,000, reflecting a year-over-year decline of approximately 3%. On an organic constant currency basis, excluding the impact of the exit from Russia, we expect revenue to also decline by 3%. We expect gap income from operations to now be in the range of 10% to 11%, and non-gap income from operations to continue to be in the range of 15% to 16%. We expect our gap effective tax rate to continue to be approximately 22%. Our non-gap effective tax rate, which includes excess tax benefits related to stock-based compensation, is expected to continue to be 23%. For earnings per share, we expect the GAAP diluted EPS will now be in the range of $7.07 to $7.15 for the full year. And non-GAAP diluted EPS will now be in the range of $10.31 to $10.39 for the full year. We now expect weighted average share count at 59.1 million fully diluted shares outstanding. Moving to our Q4 2023 outlook, we expect revenue to be in the range of 1.13 to 1.14 billion. producing a year-over-year decline of 8%. On an organic constant currency basis, excluding the impact of the exit from Russia, we expect revenue to also decline by approximately 8%. For the fourth quarter, we expect GAAP income from operations to be in the range of 10% to 11%, 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 24%, and our non-GAAP effective tax rate to be approximately 23%. For earnings per share, we expect GAAP-diluted EPS to be in the range of $1.67 to $1.75 for the quarter, and non-GAAP-diluted EPS to be in the range of $2.47 to $2.55 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 in the fourth quarter. Stock-based compensation expense is expected to be approximately 36.3 million. Amortization of intangibles is expected to be approximately $5.7 million. The impact of foreign exchange is expected to be minimal. Tax effective non-GAAP adjustments is expected to be around $12 million. We expect excess tax benefits to be around $1.3 million, and we expect to recognize approximately $15 million in expenses related to our cost optimization program. In addition to these customary GAAP to non-GAAP adjustments, inconsistent with the prior quarters in 2023, We expect to have ongoing non-GAAP adjustments in Q4, resulting from Russia's invasion of Ukraine. Please see our Q3 earnings release for a detailed reconciliation of our GAAP to non-GAAP guidance. 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 $14 million in the fourth quarter. Looking beyond 2023, we intend to provide our 2024 business outlook during our fourth quarter earnings call scheduled for February. However, I would like to provide some commentary at this time to help frame our initial thoughts. As Art mentioned, the demand environment remains uneven, and we believe this will persist at least into the first half of 2024. We have been pleased with the progress we're making on demand generation and will continue to prioritize revenue growth into 2024, which in some pursuits includes some degree of discounting. Additionally, in 2024, we expect to incur incremental costs due to more normalized variable compensation, as well as salary increases from our annual compensation cycle, which typically occurs in Q2. Although the cost optimization program will better align our 2024 cost structure, we still expect wage pressure, combined with a limited ability to improve client pricing, to continue to put pressure on margins. While 2023 has been a challenging year for the IT sector and EPAM, We remain confident in our ability to drive historical levels of revenue growth and profitability in a more normalized demand environment. Operator, let's open the call up for questions.

If you'd like to ask a question, press star one on your telephone keypad. We ask that you please limit yourself to one question and one follow-up so that we can take as many questions as time permits. Our first question will come from the line of Brian Bergen with TD Cowan. Please go ahead.

Hi. Good morning, guys. Thank you. I guess let's start on the demand stabilization trends that you highlighted here again. I heard you mention production loads, I think, coming back toward 1Q levels. Can you dig in a bit more there? Is that prevalent across industries, and is it consistent across the large client cohort? And just anything, how that informs early 2024 client tech budget discussions?

Okay. Let's see. I'm waiting for the question. OK, let me clarify what we mean. We're trying to see the trend, what's happening with our production load. It's not about revenue, it's how much work we do. Because there are a lot of different parameters, which is influence revenue from effects to number of days to rates to discounts and everything else. But from the load point of view, the trend is that We're seeing, we're coming back to a number of people who are doing production work getting comparable to what we saw in Q1. That's what it means. It means that, in general, we find kind of the way to stabilize our share of the business, even with some businesses declining with us, but with some new opportunities, growing and some actually clients coming back to us. So from the main environment we have, and this is what we mentioned as well, we've seen more conversation about programs, more opportunities, but exactly as we mentioned earlier this morning, there is no clear timeline of realizations. So it's still difficult to say, but it seems like pressure on some clients to do work. getting bigger. So, when it started to be realized, difficult to say, especially with everything geopolitically moving as it's moving with VC right now. So, more conversations, more opportunities to discuss, pretty tangible, but there is no clear stop dates.

Okay, understood. And then my follow-up on the cost optimization plan. So, Jason, what's the timeframe on achieving that savings target? And can you talk about how you're balancing efficiency here in the near term versus global diversification investments for future growth?

Yeah. So, you know, the program is designed to achieve somewhat over $100 million, or as we talked about in the prepared remarks, 2.5% to 3% of our cost structure. know most of the actions will be taken um by the end of the year um and then i would say there would be some residual actions that would take place early in 2024 with the idea of giving us a effectively 100 plus million dollars in savings to allow us to further invest in in 2024 and so that's in demand generation programs you know things like partnership programs it's in capabilities uh generative ai further consulting And then it also will allow us to effectively fund a more normalized variable compensation and salary campaign next year. And so again, I expect much of the savings to be achieved by the end of this year. And there'll be probably still some actions taken in Q1. Truly, the costs that we talk about in Q3 and Q4 truly are incremental costs related to either severance payouts in different countries, facilities, lease exits, you know, other costs that are incremental and, again, allow us to achieve a certain amount of savings as we enter 2024.

Thank you.

Your next question will come from the line of Moshe Khatri with Wedbush Securities. Please go ahead.

Okay, thanks. Thanks for taking my question. I want to focus a bit about your selling efforts And using India as one of those, I guess, the liberty centers to be able to kind of pitch those new engagements. Maybe you can talk about some of their successes here. And on top of that, how does that differ in terms of your ability to generate, you know, profitability compared to what you have pre, I guess, hostilities in Eastern Europe? Maybe you can talk a bit about that.

So I think, as we mentioned multiple times, India is growing for us.

India is still the area of investment for us as well, from the investment to uplift the capabilities which we have there, because it's a relatively new location, even if it's fastest growing for the last probably three years. So we're building. purposely the same type of practices as we have globally from digital engagement to significant data practices and cloud practices. Profitability question is a difficult one in general in this environment because of pressure everywhere from any locations which we have. I think we see definitely opportunity to uplift there is a market demand coming back, and we are accumulating a lot of experience. Now we have very sizable programs there. So we also understand that we can hire people and hire them with the with a comparable quality through additional investments. So I think we're pretty optimistic about this, and with everything that's happened, as we mentioned several times, I think it will become a proportionally much bigger part of EPUB deliveries.

Yeah, and I'll just follow in on the profitability. So as we talked about in the last call, and again we'll continue to talk about here today, is that we continue to have some characteristics with EPUB, heavier pyramid than we had traditionally operated with the ongoing kind of pressures on pricing and then some amount of wage inflation. And so it's hard to sort of return to more typical profitability as we enter the next handful of quarters or maybe through most of 2024. But when we look at India, given some time and particularly more demand We think the ability to sort of run that geography at levels of profitability consistent with what we did in Eastern Europe is certainly possible and more than possible I would say it's likely. So it's just right now we're still working through, as Arik said, some of the imbalances on pricing and, again, a heavier delivery pyramid.

Understood. And then in that context, can you just remind us your headcount mix by Eastern Europe, Latin America, and then India? Where are we today? You know, what sort of mix do we want to get to down the road?

So we're, you know, we're clearly less than 30% in Eastern Europe and, you know, heading towards kind of low 20s. India is currently... We're about 26, 27% between Ukraine and Belarus.

Okay. Eastern Europe or Central Europe, it's different because we're pretty significantly present in Poland and Hungary and all of this. And India is becoming right around 13%. Second largest delivery location. Right now it's second largest after Ukraine.

All right. Thank you.

Your next question comes from the line of Ashwin Sriviker with Citigroup. Please go ahead.

Thank you. Ashwin, you may be on mute. Can you hear me now? We can.

Okay. So I guess the question is when I look at your, when I look at the results, either by geography or by vertical, And on a sequential basis, I kind of compared the growth rates, what they were to Q versus the growth rate in pre-Q. Almost everything is either de-cell or relatively unchanged. You have, obviously, the very idiosyncratic thing going on with life sciences. And I'm kind of wondering, trying to dive back with what I sense is a little bit more positivity in terms of commentary because of stabilization. So can you comment on how the environment and the conversations with clients have evolved over the course of the quarter? Was September radically different than July? How are things evolving in October? a little bit more color of where we are going in terms of what seems to be stabilization in more areas. That would be useful.

Okay.

I think I... Again, the general numbers and optics of this is declining from the amount of work which we're doing right now. It's definitely stabilizing.

Because if

And it's difficult to have an apple-to-apple comparison, but with all our attempts, it's actually getting a lot. There are still big programs in which we continue to decline based on the decline decisions done even during the last year. you see in some big clients. On another side, after this period, why there is a positivity, we see that for some more complex programs, clients coming back to us and started conversation or even some decisions when programs starting to come back to us. New opportunities, a lot of new opportunities, but that's what I commented in the very beginning. Some of them sizable. means that clients start to seriously consider that they need to do it. And unfortunately, some of the clients delay them so much while there are very specific deadlines they have ahead of them, and they will have to start making decisions. So this conversation happened, but they're still not making calls. But the level of conversation is a different level. That's a positivity as well. And there are a lot of small new business where we enter in, which is historically for us, it wasn't very normal because the farm never was going to be programmed from day one. It's usually where entry point and then reputationally we were proving that we can do more complex, better quality work, and then it was growing. So we have a lot of seeds right now. for the future. So, but actually the main point that we definitely see is that production load is getting more stable.

Yeah. I think, Ashwin, also, if you look, you know, clearly on a year-over-year basis, the numbers still don't look sequentially, despite the fact that we still saw a decline between Q2 and Q3. That decline was less than the decline we had in Q2. And we look ahead to Q4. We still have a modest decline, but I would say that's largely sort of foreign exchange to a certain extent as we talk about the billability or the available bill days in Q4. And so if you adjust for that, it does feel like our demand is stabilizing, particularly in North America, as we talked about during our prepared remarks.

And something to mention, like I know that there are a lot of concerns if we would be able to deliver quality from new locations. That looks more positive as well for us because we're getting more and more experience and more and more scales outside our traditional strengths in Eastern Europe. While again, in Eastern Europe and Western Central Asia, we're also stabilizing a little bit. While in general, geopolitical environment is still very, very complex.

That last point is really good to hear. In terms of pricing, because when you kind of talk about transaction load and volume versus results, that implies soft pricing environment. And if you could break that down into how much of that is a geomix type of an issue as opposed to apples-to-apples price crunching, and then Over the last few quarters, you have mentioned, obviously, that because of the war in Ukraine, you had to move people to newer geographies, and there was a pricing impact that clients needed to absorb because of that. Are we past the impact of that on client decision-making?

Yeah, so let me quickly do, on a year-over-year basis, you would have had the impact of those movements if we took people from Russia and Belarus and Ukraine and moved them to higher-cost geographies. But if you begin to look at what's happening here in Q3 and what we think we see in Q4, is that you've got both the facts, and unfortunately I can't give you the exact percentage, But certainly one of the effects is that we are seeing more demand for India-based resources where the rates are lower. So that would speak to the mixed shift that you talked about. And then the other thing, as Arik has indicated and, you know, I mentioned as well, is the pricing environment still is, you know, it's somewhat challenging with, you know, in some cases concessions provided to existing customers and then with newer engagements also starting with a sharper pencil. And so you've got both impacts, and I think that you'll see them show up more so in Q4 and probably in the first half of 2024, which, again, is part of the discussion around, you know, what we see for profitability in coming quarters.

Understood, and that's what you're adjusting for then. Okay, I got it. Thanks.

Your next question will come from the line of David Grossman with Stifel. Please go ahead.

Thank you. I was wondering if I could just follow up a couple of points that were just made in the last question. You know, I guess I'm just trying to reconcile. You've given us a lot of good information about production, about, you know, headwinds from customer losses, some of the larger customers that you've been talking about over the last several quarters and other dynamics. So I guess I'm just trying to reconcile that. all of that, because I think, Jason, you said that when you back out FX and seasonal, you know, kind of work days or work hours that, you know, it feels flattish. So it sounds like the newer work that's coming on is offsetting those headwinds. Is that a reasonable way to think about things as we kind of move into 2024? I know you don't want to get guidance, but, you know, does it feel like those headwinds that you've been experiencing in the last couple of quarters that have been driving sequential declines in revenues should pretty much abate by the end of this year.

Yeah, you know, obviously the world is a very complicated place at this time. And so I want to be careful not to make it, you know, an absolute assertion. But certainly at this time, you know, we are seeing more stability in customer programs and budgets. And so, you know, particularly as we look at North America, you know, it does feel like we've achieved some degree of stability, less of these unexpected sort of surprises and ramps down. And we believe that we're seeing similar as we enter Q4. As I did mention in my prepared remarks, we do have a couple of customers in Europe who've already notified us, and we've been aware of it for a little while, that we'll see some ramp downs there. But again, it feels right now that we're, you know, we're seeing less of these sort of unexpected surprises that drove both the miss in Q2 and has, you know, resulted in, you know, sequential declines. And so, you know, absolutely, if you adjusted out that bill day impact, you'd have, you know, flat revenue as you go from Q3 to Q4.

And maybe a similar question, you know, on the margins in terms of, you know, it looks like your utilization went down again sequentially. And you've got, again, the wage pricing dynamic, which sounds like the timing may be extending into, you know, calendar 24. So, you know, and then you factor in, you've taken some cost-cutting action. So when you roll up all those different elements, is it reasonable to think that know you're still targeting your historical range as we go into 2024 that that's you know kind of what the objective is based on the actions he's taken thus far in 24 uh 2023 so i think with some of the actions we're taking and some of the stabilizing stabilization and demand i think that you'll see better utilization in q4 and we clearly hope to improve utilization in the first half of of 2024.

However, with the lower bill days, you'll still have some compressed gross margin in Q4, which is why we've sort of guided the way we have with the 15% to 60%. What I do think as we enter 2024 is there is still an imbalance between customer pricing and wage inflation. And, you know, as I think you've noted before, David, we do, you know, we do expect to return to a more normalized variable compensation. And so, you know, I think as we enter 2024, and we haven't done all the work on this yet, we don't quite know what wage pressures are going to be next year. And again, we're still trying to assess what happens with some of the deals we close here in Q4 and how that will impact future pricing as we enter 2024. But, you know, the sense is that it's possible that we could see profitability decline somewhat as we move from 2023 to 2024. And then, as I've been talking about over the last couple earnings calls, we view 2024 as a transitional year where we get the opportunity to work through a few things. We expect at some point more rational sort of supply-demand, and then that'll give us opportunities on both pricing and with a return to more traditional profitability more likely in 2025.

Great. Thanks for that. Just one quick follow-up to those. So the kind of wage pricing dynamic, is that the biggest headwind to gross margins as we go into next year, just letting that play out?

Yeah, I would say that that continues to be the wage pricing dynamic. It's the uncertain element, which is why it's harder for me to sort of comment on it right now, but I will be able to the next time we talk. But, yeah, I would say that the ongoing imbalance between sort of customer pricing and wage.

Got it. Great. Thanks very much. Appreciate that.

Your next question comes from the line of Ramsey Ellisall with Barclays. Please go ahead.

Thanks so much for taking my question. I wanted to ask about booking conversion trends, and if you could just comment on things like how average portfolio duration is trending or timeline to convert bookings to revenue or pipeline erosion trends. I'm just kind of curious, are you seeing consistency and stability when it comes to conversion, or is it more of a moving target still kind of in this tough environment?

I think it's still second.

At the same time, if you're talking about length of the relationship, I think that's exactly what you said, that it's very much stabilizing and we don't see the same kind of... That's the main difference, like, versus Q1 situation and now. Okay. I think it's much more manageable.

I think much more transparency in situation.

Okay. Thank you. And a quick follow-up from me. I wanted to ask about a follow-up on a prior question about the headcount numbers globally. And in particular, I'm just curious that the absolute headcount numbers in Ukraine and Belarus, should we think about those as relatively stable at this point, or do you have plans to further draw down i'm thinking particularly in in belarus uh especially given kind of the way russia uh kind of ended this quarter officially um i'm just curious whether we should think about the absolute numbers as the sort of watermark that's going to be uh persistent or whether we could see more declines uh on an absolute basis in the region i think the answer is is is very simple like

We believe that Ukraine would be more stable and Belarus less stable just based on the situation of supply and demand ratio. And in absolute numbers and relative numbers, Belarus declined during the last several years much, much, much more significantly than Ukraine. And I think this trend might be

They're dependent on geopolitics and client reactions. Okay. Thank you very much.

Your next question comes from the line of Jason Kupferberg with Bank of America. Please go ahead.

Good morning, guys. I just wanted to come back to some of the commentary around quarter-over-quarter growth rates. I know that's what you guys have been watching most closely just to assess. demand, and you've talked about the stabilization here. Just looking ahead to the first quarter of 24, do you think we get back to positive quarter-over-quarter revenue growth then? I think the street's looking for about 3% growth. So just wanted to get your take on that. I mean, putting any potential moves in FX on the side, given some of the stabilization in parts of the business, do you think we're back in positive territory in the first quarter?

I think you should expect Our assessor will tell you this exactly in three months.

But again, we're seeing positivity right now, but we'll check in three months.

Right. Okay. And just to follow up, Jason, on some of your margin commentary, I want to make sure we've got the messaging right there, because it sounds like most of the cost optimization is going reinvested. So it sounds like what you're suggesting is in 2024, non-GAAP margins are perhaps down versus 2023. And then 25, you're kind of back to, you know, a quote unquote normal range, like 16 or 17%. Is that directionally? Yeah.

So we still, we haven't worked through pricing. We haven't worked, you know, we haven't struggled through what we think is going to happen from it. The wage environment, I think in certain markets is, you know, pressures are not as pronounced, but then there's other markets where there's very, very high cost of living inflation. And so what I'm saying is, you know, we haven't worked through it yet, but I think it's certainly possible that you could see us talk about 2024 with lower profitability. And that was just in response to the question around, you know, do we think that we'll maintain profitability in 2024? I just want to make certain that there's an indication that we could be, you know, lower as we enter fiscal year, and again, working to get ourselves back into a position where we could operate in the 16% to 17% range in 2025.

Very helpful. Thank you.

Your next question comes from the line of Maggie Nolan with William Blair.

Please go ahead.

Hi, good morning. This is Jesse Owen for Maggie. Thanks for taking our questions. So first, how do you feel EPM is performing compared to the market? Do you think that you're starting to take share?

I think we're starting to return to taking some share.

I think in existing clients, we stabilize while, again, there are some longer-term calls which some clients make, and they have a plan, and they will be executing according to the plan. Jason mentioned that there are several clients in Europe which we know was going to happen. So on another side, in existing clients, I think we stabilized, and then some of the clients we started to take care of back.

Got it. Thanks, Art. And then were you going to say something else? No. Go ahead.

Okay. And then for my follow up, Europe appeared to be a bright spot. But Jason, you mentioned the incremental ramp downs there. Have you seen any changing behaviors or sentiment from clients in that geo? Or are there just some client specific challenges that cause those ramp downs?

We saw Europe actually decline somewhat sequentially between Q2 and Q3. And so we are seeing, you know, Europe's a little bit more mixed, but, you know, generally it has been positive relative to North America. And then we've got a couple of these customers that we talked about. So it's not what I would call broad-based, and I would call it more customer-specific.

I think we're looking at this almost year-to-year comparison becoming less meaningful at this environment because there is so big change between these two years. So right now, the quarter-by-quarter comparison really shows what's happening.

And from this point of view... Got it. Got it. Thank you both. Yes, you're welcome. Thank you.

Your next question will come from the line of Jamie Friedman with Susquehanna. Please go ahead.

Hi. I had a slightly longer-term question, Arik. I was wondering how would you compare the relevance and the mind share of some of the key services that you're known for, especially application development, In terms of the tech stack, is application development more or less meaningful, relevant in today's technology architecture? How do you see that evolving, if at all?

I think this is, we will try to predict the future.

And from this future point of view, I think application development and build function will become even more important with everything that was happening.

So it's very easy to optimize yourself to in-time environment.

The whole point and that would happen quarters from now or a couple years from now. And from this point of view, we still believe that this is what we started. this conversation this morning that we still believe that differentiations which we build and will function and strong engineering capabilities would be extremely critical with all tech stack, which is changing on our eyes. We don't know when all this will be impacted, but even I mentioned multiple times, I do believe that there is a huge technical debt on data in cloud environment in the world and right now it's taken kind of second priority in this environment but it couldn't be done for too long because then some some companies which not in western will be there so i think it will come back and everything what's happening with ai will be changing the whole application infrastructure new opportunities will have to be rebuilt again. So that's why I think it's for us still priority how to maintain this advantage.

Got it. Thanks for that. I'll drop back in the queue, give someone else a chance. Thank you.

Your next question will come from the line of James Fawcett with Morgan Stanley. Please go ahead.

Great. Thank you very much. I wanted to ask quickly a couple questions. First on pricing, Jason, you mentioned a little bit of discounting. Can you help us think through kind of the longer-term implications? I know you've alluded to it in terms of, you know, at some point being able to recover that, but can you just help us think through what that mechanism typically would look like and what would make sense over the medium to long run?

Yeah, and this is one we're probably using ARC's, you know, response of, you know, it would vary or it depends is probably, you know, appropriate, but I'll just give you, you know, some versions of it. Certainly, as people wanted to be more cost efficient, India has been a more attractive play. We do think that India will continue to be an important delivery location for us, but that you'll also see more demand over time in our other geographies. And so what you may see in the next couple of quarters is still a more pronounced mix of Indian delivery, but we don't think that that's necessarily permanent. At the same time, from a pricing standpoint, oftentimes it does take probably a year to reset. And so it's hard to kind of go, demand is higher tomorrow and now your price is higher. Oftentimes the relationships are sort of set over a year. And so that's why in some of the earlier calls I've said, I think you're going to enter 2024 with an environment where it's difficult to take up price. And then we'll probably end up somewhat locked in during 2024, okay, not in all clients and not in all roles. And then we've got more opportunity to adjust price probably later in the year. And, of course, we'll be exposed to wage inflation during our traditional compensation campaign in Q2.

Great. I appreciate that, Jason. And then my second question was just how do you think about, and this is for Arc and or Jason, obviously, but How do you think about any changes that you need to adjust to long term if we're in a higher interest rate for longer environment, I guess i'm just thinking that. Historically EPAM has been really good at doing acquisitions and acquiring new technologies to stay at kind of leading edge, but you know with the cost of capital now being higher. Do you have to adjust how you think about the importance and role of acquisitions in future strategy and capability development? Thanks.

I think, you know, we would still continue with the same strategy that we've had with doing acquisitions that allow us to expand capabilities and then sort of help further our opportunity to grow organically. And so certainly we'll be careful as we have been, but I think that you'll still see a significant focus on acquisitions that are probably more in that sort of small to mid-sized token.

And I guess that's an advantage we have from our financial position. We have a very strong cash position to not rely on the outside market to do exactly what we were doing in the past because it was relatively small acquisitions. targeted for specific capital series or very specific geographies. And we are in very good shape to continue doing this.

I think that's not much change. Great. Appreciate those comments. Absolutely. Thank you.

Your next question will come from the line of Puneet Jain with J.P. Morgan. Please go ahead.

Hi. Thanks for taking my question. I wanted to ask on financial services, some of your peers have talked about seeing some weakness there, and you also mentioned banking within financial services as weak. So can you double-click on what you are seeing there? Like, are the headwinds broad-based within banking, or are they client-specific?

Yeah.

For us, you know, clearly we have one large client where it's probably client-specific, and we have seen some, I guess, some reduction in revenues there. And then there's a number of other banks that we would work with where we've also seen declines. I would say it's probably relatively broad for banking, but other elements of the financial services practices are also seeing growth. So banking is certainly somewhat soft, but with opportunities in asset management and other areas in financial services, including insurance.

That's great. And then, like, it was nice to hear that some of the programs, some of the projects, clients are coming back. Is that incremental work driven by clients need to modernize their core systems, maybe because of generative AI? Or are these still more cost optimization type of deals?

I think, well, they don't happen. Usually, it's a program that does this. It's a program where some clients don't use the level of technology and engineering, but they can do it with somebody else. And that's usually the trigger for the return, but then it's actually triggering opening new opportunities with us as well. So we have already several situations during the last several quarters when it's happening. We talked about it. We still think that the direct impact on revenue is not going to be exactly there yet, but there are a lot of activities. And with all investments which we do in R&D right now, and definitely differentiating ourselves, we see the client reaction of what we're showing. So it's starting to create But, yes, the size of them is still relatively small.

So, I think we will see how it's going to be developed in the next quarter soon.

Got it. Thank you.

With that, I'll turn the call back over to Mr. Dobkin, CEO and President, for any closing remarks.

Again, thank you for joining today. We're still looking more positive to the situation than several quarters ago.

Unfortunately, the world still continues to be a very unpredictable place, and that's why it's difficult to make more clear statements sometimes. Let's meet in three months and see what we will be able to share. Thank you very much.

That will conclude today's call. We thank you all for joining. You may now disconnect.