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spk07: 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 followed by the number one on your telephone keypad. If you would like to withdraw your question please press star one again. For operator assistance throughout the call please press star zero and finally I would like to advise all participants that this call is being recorded. Thank you. I'd now like to welcome Mike Reschandle, Head of Investor Relations, to begin the conference. Mike, over to you.
spk01: Good morning, everyone, and thank you for joining us today. As the operator just mentioned, I'm Mike Reschandle, Head of Investor Relations. By now, you should have received your copy of the earnings release for the company's second quarter 2024 results. If you have not, the copy is available on epam.com in the Investors section. With me on today's call are Akati Dopkin, CEO and President, and Jason Peterson, Chief Financial Officer. I would like to remind those listening that some of the comments made on today's call may contain forward-looking statements. These statements are subject to 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 will now turn the call over to Ark.
spk11: Thank you, Mike. Good morning everyone. Thank you for joining us today. First, I would like to start off with our second quarter results, which came generally in line with our expectations. We believe our performance in the second quarter of 2024 reflects our continuous strong execution and adaptability amidst a still complex demand environment. Let me share some current highlights of our business from Q2 up to today. Our underlying business continues to show signs of stabilization. In the second quarter, we delivered very strong growth in our healthcare and life sciences vertical and strong growth in our emerging verticals. But we also saw some slight sequential improvements in financial services. In some of the verticals, namely business information and media, we continue to work through the impact of the rubdowns from the few large clients we have mentioned before. On the demand environment, we do see broad-based signs of stabilization as well across both EMEA and North America. At the same time, clients are still cautious with larger programs, and our visibility towards significant increase continues to be constrained by a mix of clients' cost saving priorities, delays in program starts, and clients' own business changes. As a result of this complex environment, we are currently assuming no net improvements in overall demand for the remainder of the year. Jason will provide more details of our updated outlook for 2024. Notwithstanding the overall demand picture, we are optimistic about certain sectors of our target market and our current portfolio returning to modest growth story in the next two-three quarters, as we see it now. In overall, while we adjust our offerings and our delivery mix to suit the parameters of the current demand environment, we continue to see significant traction in our data and analytics, core engineering, and digital engagement offerings. especially through the broad transformation of each with AI, as well as increasing evidence that our consulting and advanced technology capabilities are driving new types of the final opportunities for us. So, meanwhile, we remain focused on responsibly managing our business in this part of the cycle, building on our strong fundamentals and ensuring that EPAM continues to be the partners of choice once the demand environment improves. Turning now to our global delivery strategy. In Europe, our differentiated capabilities continue to create significant opportunities for our clients to leverage the top talent on their most complex business and technical challenges. We believe this traditional EPAM advantage will continue to serve our clients well, especially as they turn from mostly cost-driven considerations back toward driving growth and innovation through the use of advanced technologies for their complex transformation and modernization efforts. We are also continuously investing in our more recently established delivery hubs across Western and Central Asia, which are emerging talent markets and where we are enabling strong and experienced tech talent to responsibly lead our future growth in the region. India remains a priority and is on track to becoming our largest delivery location by the end of the year. We have built skilled centers of excellence in data and analytics, digital marketing, commerce, Salesforce, SAP, and other key horizontal and vertical service lines. Our primary focus is on building at scale EPAM great quality engineering, while blending in with many unique enterprise-level capabilities present in India and not available in most of other EPAM locations around the globe. We believe this approach will differentiate EPAM-India for our clients and create strong growth opportunities for our people. We also continue to expand our core engineering capabilities in LATAM. In addition to Mexico and Colombia, we now have a third delivery hub in Argentina. We will continue assessing and developing new local talent across the region. In each of these years, we are investing in our existing and new technical capabilities, crucial for the future GenAI data, ML, and predictive AI, and in corresponding IP development. In short, we are building full-service GenAI delivery practices through a network of GenAI X labs across major dev centers to enable and scale GenAI-enabled client production activities. In addition, both in India and LATAM, we are evolving into a strategy that includes not only differentiated delivery capabilities, but also being able to offer compelling in-market presence and solutions, particularly as we seek to serve our global clients in a more complete and strategic manner, which means building locally a much stronger partner ecosystem as well. Finally, in all our locations, and specifically in our major client markets, we continue to focus on our client engagement programs and to improve our consulting and domain industry capabilities across our service offerings. Now, let's turn in a bit more details on our GNI approach. For the last decade, and despite all challenges during the last several years, we are continuously a recognized leader in advanced technology, digital engineering, and complex data transformation programs. This naturally extends to EPAM being regarded as a company who understands the complexities of AI transformation something we are doing for ourselves, our partners, and our clients for some time now. Today, I would like to highlight our up-to-date progress in that area and how ePAM is helping clients pragmatically initiate and then move use cases beyond pilots into production deployments. Our current approach to AI transformation is three-dimensional. Dimension one, ePAM internal transformation and GenAI enablement investment. We set an ambition goal for ourselves to upskill and effectively train an absolute majority of the company on the usage of GenAI fundamentals, and to do so both responsibly and with the PAM level technical depth. An educated program was established to execute this, and today, with the help of our educational platforms, internal specialized tools, and our global mentoring community, close to 100% of the PAMers have gone through training and are applying AI in their daily work activities. While most of the companies are announcing similar programs, we believe that during the last 24 months, our early and highly focused efforts across a broad range of ePAMRs allow us to better understand future opportunities and to invest in differentiated IP and accelerators around GNI-enabled engineering and solutioning. Our combination of training, IP, and open source style internal initiatives have now become drivers of scaling our advanced GNI practitioner communities across all EPAM organizational units and practices. We assume that well over 10% of EPAMers are now advanced GNI technical practitioners, while over 1,000 are becoming strong internal AI champions with ability to lead GNI-enabled business solutions. We believe all that have enabled our dimension to client transformation opportunities. Our AI client project today has evolved from exploratory pilots and proof of concept late last year to now, upon being selected by clients as a primary AI partner with involvement into hundreds of GenAI-led engagements. We are helping to change the full value chain of HDLC from one side and enabling implementation of real GenAI-driven business use cases from another. Let me briefly highlight just a few IP investments. ePumpDial is a unified GNI orchestration platform, helping enterprises speed their experimentation and innovation efforts to implement real business use cases. And GNI enables solutions by connecting into meaningful workflow and load balancing a set of public and proprietary LLMs and SLMs together with different type of internal, external data sources. AI-native applications and custom add-ons. ePAM AI Run is a gen-AI-powered delivery framework that accelerates the entire software development lifecycle and helps clients recognize ROI of their AI investments by improving time-to-market speed up to 30%. ePAM Aelita is a comprehensive collaboration platform for teams that streamline the development, accessibility, and management of large-language model assets, including prompts, templates, and agents. Now, a few specific examples for the clients, which operate across completely different user environments. For Unity, the world-leading platform of gaming tools for creators to build and grow real-time games, apps, and experiences across multiple platforms. We helped build Unity Muse. From a multi-cloud migration to Microsoft Azure, to adding generic capabilities to make game creation faster and easier for over a million developers by using natural language prompts to generate sprites, textures, and animations, and also providing chat-based assistance and troubleshooting, as well as the ability to easily create behavior trees. For Xalius, a leader in healthcare system purpose-built solutions and industry-leading AI, we helped to develop an air generation AI platform on AWS enhancing Dragonfly, Xalius flagship product. The platform provides real-time data and predictive analytics to nurses, case managers, physician advisors, utilization management, and revenue cycle leaders across 500 hospitals and health systems with more than 500 players connections. Finally, for the IMF, as a part of modernization of their data platform, we built StatGPT, which is SDMX-driven GNI application for statistical organizations relying on their users, economists, and statisticians to query, transform, analyze, visualize, and interpret statistical data using a natural language interface via proprietary talk-to-you-data framework powered by EPUM Dial and EPUM QuantHub accelerators. Initial results showed a 50% increase in research productivity and 35% increase in research accuracy. In overall, we are seeing a significant rise of GenAI-led engagements across every vertical and a very broad set of use cases. And this is now driving transformation in both front-end customer experiences as well as significant back-office and process-related use cases. All that in turn allows us to enable dimension three for AI transformation, extended partner network. First of all, because they saw that we are very practical in our approach. Our technology and AI transformation program are much larger and more complex today than where we started just a few quarters ago. And encompasses both consulting and engineering services as well as a broader range of partnerships. With more than 150 strategic partners, we are accelerating modernization, adapting cloud-native architecture, and leveraging AI and advanced analytics, particularly when our clients' projects have a high degree of technical and business complexity. We are our partner's partner of choice for making corporate engagement real. In fact, just very recently, we've been named Partner of the Year by several of our cloud data and digital partners. including Databricks Disruption Partner of the Year, recognized for the industry-leading design and implementation of GNI-powered conversational interfaces, state-of-the-art machine learning, and large language model frameworks. By the way, as an elite-level partner, we are one of only five companies with a dedicated Databricks Center of Excellence. Google Cloud Talent Development Partner of the Year, A word recognized for our commitment to training, upskilling, and reskilling our team's cloud and AI skills. Microsoft Gaming Partner of the Year, recognized for pushing the boundaries of creativity and technology. Mac and Commerce Tools, recognized for delivering best-in-class modern commerce experience for our clients. It's easy to assume the next question. What is the revenue impact of these programs? I guess the answer is probably predictable as well. We are still in early days of the AI wave. But at the same time, we are very optimistic about the accelerating pipeline opportunities coming from AI-led transformation and what that can bring downstream for us as a highly trusted and valued partner. We remain focused expanding our efforts to drive demand, remaining relevant to our clients and what they need, and proactively expanding our global market share. We also remain committed to managing our delivery footprint, expanding to cost-efficient locations, and generally optimizing our ways of working so we can continue to provide premium service at attractive value to our global client base. I firmly believe EPAM continues to be well-positioned to capture rebounding market demand, driven by long-term pressures for legacy modernization, but needs for advanced customer-centric solution, and by significant interest to understand how to apply GenAI and GenAI capabilities to build new platform and solutions. With this, I would like to pass to Jason to provide additional details on our results in Q2 and our future performance.
spk04: Thank you, Ark, and good morning, everyone. In the second quarter, EPM generated revenue of $1.147 billion, a year-over-year decrease of 2% on a reported basis, or 1.7% in constant currency terms, reflecting a negative foreign exchange impact of 30 basis points. Due to our exit from the Russian market, we no longer generate revenue from Russian clients. The impact of this exit had an approximate 50 basis point negative impact on year-over-year revenue growth. Excluding Russia revenues, year-over-year revenue for reported and constant currency would have decreased by 1.5% and 1.2%, respectively. Moving to our vertical performance, life sciences and healthcare delivered very strong year-over-year growth of 22.4%. Growth in the quarter was driven by clients in both life sciences and healthcare. Consumer goods, retail, and travel decreased 7.7% on a year-over-year basis, largely due to declines in retail. partially offset by solid growth in travel. Financial services decreased 5.6% year-over-year, driven by softness in asset management, banking, and payments. In the quarter, the vertical delivered slight sequential growth, indicating stabilizing demand. Software and high-tech contract 3.7% year-over-year. Business information media declined 12.6% compared to Q2 2023. Revenue in the quarter was substantially impacted by the previously discussed ramp down of a top 20 client. And finally, our emerging verticals delivered solid year-over-year growth of 10.6%, driven by clients in energy and telecom. From a geographic perspective, America is our largest region, representing 60% of our Q2 revenues, grew 1.8% year-over-year on a reported basis, and 2% in constant currency terms. AMEA, representing 38% of our Q2 revenues, contracted 6% year-over-year and a 5.6% in constant currency. And finally, APEC declined 0.6% year-over-year or 0.2% in constant currency terms and now represents 2% of our revenues. In Q2, revenues from our top 20 clients declined 3.7% year-over-year. While revenues from clients outside our top 20 declined 1.1%, the relatively stronger performance of this latter group was driven by both new client and inorganic revenue contributions. Moving down the income statement, our gap gross margin for the quarter was 29.3% compared to 30.9% in Q2 of last year. Non-gap gross margin for the quarter was 30.8% compared to 32.6% for the same quarter last year. Relative to Q2 2023, gross margin in Q2 2024 was negatively impacted by the strengthening of currencies associated with certain delivery locations, as well as the impact of compensation increases, including those resulting from our recent promotion campaign, which we were not able to offset through pricing. The negative impact of foreign exchange and compensation increases exceeded the benefit of improved utilization. GAAP SG&A was 16.9% of revenue compared to 16.7% in the Q2 of last year. Non-GAAP SG&A in Q2 2024 came in at 14.3% of revenue compared to 14.8% in the same period last year. SG&A improvement in the quarter is the result of our ongoing focus on managing our cost base and increased efficiency in our spend. GAAP income from operations was $121 million, or 10.5% of revenue in the quarter. compared to $144 million or 12.3% of revenue in Q2 of last year. Non-GAAP income from operations was $175 million or 15.2% of revenue in the quarter compared to $191 million or 16.3% of revenue in Q2 of last year. Our GAAP effective tax rate for the quarter came in at 26.3% and our non-GAAP effective tax rate was 24.3%. Diluted earnings per share on a GAAP basis was $1.70 Our non-GAAP diluted EPS was $2.45 compared to $2.64 in Q2 of last year, reflecting a 19-cent decrease year-over-year. EPS was positively impacted by a Serbian government investment incentive received and recognized in the quarter, which improved Q2 diluted EPS by 6 cents. Though the benefit from this incentive was contemplated in full-year guidance communicated during our Q1 earnings call, At that time, we had expected to receive the incentive and recognize the benefit in Q3. In Q2, there were approximately 58.1 million deleted shares outstanding. Turning to our cash flow and balance sheet, cash flow from operations for Q2 was 57 million compared to 89 million in the same quarter of 2023. Free cash flow was 52 million compared to free cash flow of 82 million in the same quarter last year. At the end of Q2, DSO was 76 days. and compares to 73 days for Q1 2024 and 71 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 few days of the quarter falling on a weekend. Share repurchases in the second quarter were approximately 1.16 million shares for 214 million at an average price of $184.97 per share. In June 2024, EPAM completed the share repurchase program authorized on February 13, 2023. Over a period of 16 months, 2.24 million shares were repurchased at an average share price of $222.90. On August 1, 2024, the Board of Directors approved a new share repurchase program with authorization to purchase up to another 500 million of EPAM common stock over a term of 24 months. We ended the quarter with approximately $1.8 billion in cash and cash equivalents. Moving on to a few operational metrics, we ended Q2 with more than 47,000 consultants, designers, engineers, and architects, a decline of 4.8% compared to Q2 2023. Sequentially, production headcount remained unchanged as the company reduced headcount in certain onsite locations while continuing to hire in India. Our total headcount for the quarter was more than 52,650 employees. Utilization was 77.5% compared to 75.1% in Q2 of last year, and 76.8% in Q1 2024. However, onsite utilization remains below targeted levels, and the company will continue to take actions to optimize onsite resource levels to improve utilization. Now let's turn to our business outlook. Although client demand has stabilized, we continue to see very little improvement in the near-term demand environment. We're experiencing growth in certain verticals, seeing relatively high levels of new logo activity and working with clients to bring GenAI programs into production. We're also beginning to see some constructive improvement in client discussions with regards to future programs. But decision making continues to be relatively cautious as some clients continue to have challenges with their own end markets and revenue generated by individual new logo accounts is on average less than that generated in prior years. Although we believe clients are beginning to more actively engage around new initiatives, Our guidance assumes macroeconomic stability with no improvement in the aggregate demand environment for the remainder of the year. We are hopeful that change in the tone of client conversations will result in an improved demand environment in 2025. For the remainder of 2024, we are expecting a slight increase in Q3 revenue relative to Q2 driven by greater bill days in the quarter, substantially offset by higher vacation levels. We are expecting a modest sequential decline in Q4 revenues driven largely by some of the seasonal factors mentioned previously. We are maintaining our focus on demand generation and will continue to prioritize revenue growth for the remainder of 2024. At the same time, we are taking steps to improve cost efficiency and on-site utilization and now expect to operate at a higher level of profitability in the fiscal year. Finally, our operations in Ukraine continue to run at high levels of utilization, a testament to our team's dedication and focus on maintaining uninterrupted quality of delivery. Our guidance assumes that we will continue to be able to deliver from our Ukraine delivery centers at productivity levels similar to levels achieved in 2023. Moving to our full year outlook, revenue is now expected to be in the range of 4.590 to 4.625 billion, a negative growth rate of 1.8% in the midpoint of the range. The impact of foreign exchange on growth is expected to have a positive impact of approximately 10 basis points. At this time, we expect approximately 1% of revenue contribution from already completed acquisitions. We expect gap income from operations to now be in the range of 10.5% to 11%, and non-gap income from operations to now be in the range of 15.5% to 16%. We expect our gap effective tax rate to now be 21%. Our non-gap effective tax rate, which excludes excess tax benefits related to stock-based compensation, will continue to be 24%. For earnings per share, we expect the GAAP diluted EPS will now be in the range of $7.18 to $7.38 for the full year. And non-GAAP diluted EPS will now be in the range of $10.20 to $10.40 for the full year. We now expect weighted average share count of 57.9 million fully diluted shares outstanding. Moving to our Q3 2024 outlook, we expect revenue to be in the range of 1.145 to 1.155 billion. producing a year-over-year decline of 0.2% at the midpoint of the range. And on a constant currency basis, we expect Q3 revenue to be flat year-over-year. For the third quarter, we expect gap income from operations to be in the range of 10% to 11%, and non-gap income from operations to be in the range of 16% to 17%. We expect our gap effective tax rate to be approximately 24%, and our non-gap effective tax rate to be approximately 24%. For earnings per share, we expect GAAP diluted EPS to be in the range of $1.75 to $1.83 for the quarter, and non-GAAP diluted EPS to be in the range of $2.65 to $2.73 for the quarter. We expect a weighted average share count of 57.4 million diluted shares outstanding. Finally, a few key assumptions that support our GAAP to non-GAAP measurements for the remainder of the year. Stock-based compensation expense is expected to be approximately $45 million for each of the next two quarters. Amortization of intangibles is expected to be approximately 6 million for each of the remaining quarters. The impact of foreign exchange is expected to be a $1 million loss for each of the remaining quarters. Tax effective non-GAAP adjustments is expected to be around 13 million for each of the remaining quarters. We expect excess tax benefits to be around 1 million for each of the remaining quarters. severance driven by our cost optimization program is expected to be around 10 million for each of the remaining quarters finally one more assumption outside of our gap to non-gap items with our significant cash position we are generating a healthy level of interest income and are now expecting interest in other income to be approximately 13 million for each of the remaining quarters while we work our way through this cycle of lower demand we will continue to run epam efficiently positioning the company to capitalize on a more normalized demand environment Lastly, my continued thanks to all our employees for their dedication and focus on serving our clients and driving results for EPAM. Operator, let's open the call for questions.
spk07: If you wish to ask a question, please press star followed by one on your telephone and wait for your name to be announced. We ask that you limit your questions to one and one follow-up so we are able to take as many questions as possible. Your first question comes from the line of Maggie Nolan of William Blair. Your line is open.
spk09: Thank you. I wanted to dig into the utilization and the dynamics between onsite and offshore. So first of all, what percentage of the workforce is considered to be onsite this quarter? And then is offshore utilization running higher? than what you view as sustainable to offset some of that weakness on-site because you're not too far off from your historical range here?
spk04: Yeah. I think we feel that the offshore utilization is actually quite healthy. And I'm struggling right now to remember exactly what our on-site percentage is from a total headcount. But from a utilization standpoint, it's definitely lower than we would traditionally run at. And it continues to be the area that I think we find ourselves somewhat challenged in. And so it probably is also contributing somewhat to revenue growth for the remainder of the year, where we continue to see more demand for offshore and incrementally more demand for India. And again, continue to run at somewhat lower levels of utilization on site. And that's something that we are working to address both through demand generation and also through taking some actions, as I referred to in my prepared remarks.
spk09: Got it. And then somewhat related, just building on that, the improvement in the margin outlook, is that primarily related to those actions that you want to take on utilization? Are there other levers you're pulling? And have you already seen some progress here in the third quarter to fuel that optimism in the increased number that you gave?
spk04: No, absolutely. And so the focus has been on sort of cost optimization after we, you know, reset our expectations for revenue growth. So we've been more efficient in corporate functions and SG&A. We've been working on utilization. And so, yeah, the actions that we intended to take are underway and, you know, it is beginning to show up probably even in a little bit of the benefit that we saw in profitability in Q2.
spk09: Got it. Thanks, Jason.
spk07: Your next question comes from the line of Brian Bergen from TD Con. Your line is open.
spk05: Hi, guys. Good morning. Thank you. I hear you on the overall complex demand environment. I wanted to dig in on the demand progression in the top accounts that you saw over the last three months, as well as just how you see the top clients, particularly the top five to ten, performing in the second half and as you exit this year.
spk10: I think despite the opticality of the client for the top five, there is only one client which is declining, and this is basically a continuation of the trend which we saw before. And even this client declined, kind of getting less and getting more stable environment right now. So, but in general, it's exactly like we commented before. It is pretty stable.
spk04: Yeah, and that top five client is the one that we talked about in the past, which is a European business information and media client.
spk05: Okay. All right. That's helpful. And then on the Gen-AI front, can you dig in a little bit more on the progression of Gen-AI-related work as far as just maybe any rough quantification on the size of some of these programs and the mix of really the POCs that are moving into production?
spk10: So it is a pretty challenging question when we're thinking that we're trying to understand how some of our 20 finds this, and it's very much all around the web. So that's why for our even internal understanding and progression, we have kind of pure related projects and some influence, revenue, and so on and so on. So from this pure type of stuff, There are a lot of small QAC now approaching high hundreds of thousands or low millions of dollars. This is already starting to happen. And this is dozens in our case. And again, it's very difficult to compare Apple to Apple when we're hearing some numbers from competition. At the same time, from the influence point of view, it started to go already to tens and approaching hundreds of millions as well. So very different even from six, nine months ago.
spk05: Okay, understood. Thank you.
spk10: Still, if you think about it, it's a very small portion of our revenue. And I think general trend is when During the POC, there is a confirmation of potential ROI and excitement. Then it's coming back to the technical debt, which we were talking about during the last quarter. And companies realize that to actually get the benefit of this, it requires real, real investments and go to some data modernization programs, which is much bigger and require much more. And that's actually one of the showstoppers to real progression because they're not ready yet.
spk07: Got it. Thank you. Your next question comes from from Wolf Research. Your line is open.
spk02: Hey, guys. Thanks. Can we just touch for a minute on the sequential math? Looking at the guide, it looks like the dollars of revenue expected is pretty much exactly flat or almost exactly flat going from second through the end of the year. And I know you're trying not to embed any type of upside or inflection. I know there's also some seasonality typically in Q4, although things like budget flush have been tougher lately. But Maybe just touch on that for a minute in terms of your expectations on a per quarter basis and then really just go back to the overall demand environment where you're seeing clients spend what you think you can do that maybe must be a little bit less related to the macro and more idiosyncratic because we've been seeing more and more IT services companies trying to really address current needs as much as possible. So anything more you can just comment on where the demand is today, especially if the macro holds at a slower level for a while. what you think you're doing that's resonating the most.
spk04: Yes, I'll just start with a more tactical, I guess, and I'll leave our chance for maybe the harder questions. And so from a Q2 to Q3, you'd have higher vacation and more bill days. And so you get a, you know, you should see a somewhat modest improvement, but you should see some improvement in revenues just based on what you call kind of technical or seasonal factors. And then In Q4, you know, it'll depend on what type of vacation levels we see, but usually you would see even a little bit higher levels of vacation in Q4, lower bill days, and then, of course, the question is going to be what type of furlough activity we see. So, you know, generally there is, you know, a somewhat significant impact just due to seasonality. And so that's kind of what we're modeling at this time is, again, is generally a very modest improvement from Q2 to Q3 based on seasonal factors. and then some degree of decline unless, as you said, we see some type of budget flush or, again, we're able to influence the level of vacations that employees take.
spk10: Mark, do you want to talk about the best overall demand or where we're seeing? I think our comment is very much in line with the last quarter. So as we mentioned last time, we don't think we can project the market in current situation. So I think it's very much similar. And if a quarter ago our projection range was much broader than today, it's just saying that our expectation of good news were not confirmed, and our expectation for the bad news actually didn't happen as well so we're narrowing and it's a reflection of the type of projects in play right now there is no big modernization stuff there are conversations about it but it's not turning to real things there are a lot of noise around gen ai which not converting to big revenue revenue as well but uh run the business, keeping the status quo on production systems. That's what we're focusing, improving, and again, looking for kind of one-off modernization play where we can really bring the value, but it's very competitive and again, not necessarily decisive on the client side. I don't know if I'm giving you
spk04: I would just add that we're working to change the trajectory in Europe, and we are beginning to see some better conversations and opportunities kind of appear there again. You know, so that's an area where we're looking to sort of, let's say, change the picture. The other thing I think you see in our fixed fee, which continues to go up, we're continuing to sort of explore and work with clients to have more of a committed kind of model around what we'll deliver for a fixed fee. or a fixed monthly fee, and that's a reflection of what we're trying to do to respond to customer needs and win more business.
spk02: Okay, thanks. Actually, one quick one just on hiring is just on, I mean, do you anticipate needing, if utilization stays in these ranges, do you anticipate needing to hire more or, I mean, maybe AI or other types of efficiencies can help maintain?
spk04: You know, there's certainly some programs where we're clearly working to include AI productivity improvements. But no, we would continue to hire. And I think you'll continue to see hiring in the types of geographies we've been talking about, which is more kind of offshore and certainly with somewhat more to the inland America.
spk02: Got it. Thanks, guys. Appreciate it.
spk07: Thank you. Your next question comes from the line of Jim Schneider from Goldman Sachs. Your line is open.
spk12: Good morning. Thanks for taking my question. First of all, on the discretionary demand environment, it's not surprising to hear the constraints given what the environment is out there, but what are your clients telling you about the conditions under which they would start to release more spending or be more aggressive with new projects in 2025? Is that tied to macro? Is that tied to more certainty around their AI strategy or other priorities they have internally in terms of IT spending?
spk10: We do believe that the majority of the decision-making is PACRA-related right now. Because as soon as the situation would be a little bit better, I think investment in general data infrastructure and cloud infrastructure, which was delayed, will be triggered because everybody understands the impact of GNA. And without fixing first this, it would be very difficult to move forward. So I think the market is holding right now.
spk12: Thank you. And then maybe just in terms of the margins, obviously delivered good growth and operating margin leverage in the core. That was good to see. Was that mostly driven by the mix of headcount shifting to India or there are other factors there besides the SG&A line? And then I guess Going into 2025 as we exit this year, what kind of further growth margin leverage do you expect to deliver or is sustainable from here?
spk04: Yes, we're continuing to work on utilization. So the improvement in Q2 was probably a combination of efficiency with SG&A and continuing to focus on improving utilization. I think what we talked about over the last couple of quarters is that we continue to have an opportunity is we've got a fairly heavy pyramid still, including in India. And so what we need to do is make sure that we're introducing more juniors into the mix, which generally has a broader sort of pyramid improves profitability overall, also can allow you to be a little bit sharper with pricing. But the Q2 improvement of profitability was not driven by a shift in India. Again, it was more kind of these operational kind of efficiency factors that we're continuing to work on throughout the remainder of the year.
spk12: And in terms of the forward improvement there?
spk04: Forward improvement, again, is the work that we're doing on utilization improvement, reducing the bench, and ongoing efficiency in SG&A. So, again, it's just a focus on certain areas of our operations. that we think we can see some further sort of reduction in spend, certainly as a percentage of revenue.
spk07: Thank you.
spk10: You're welcome.
spk07: Your next question comes from Jonathan Lee from Guggenheim Securities. Your line is open.
spk14: Great. Thanks for taking our questions. I want to get a better sense of how India is progressing. Can you help unpack the type of volumes you're seeing there and whether expanded presence has had any sort of influence on new types of demand or types of contract structures being utilized, especially if you think about the revenue and margin dynamics that are contemplated in the outlook?
spk04: Yeah, so I'll let Art talk a little bit more about either the type of work or progress. What I would say is that from the last time we spoke with you, Jonathan, is that India is likely to make up a somewhat, a very slightly greater percentage of headcount by the end of the year. So last time, Art and I were talking about something approaching 20%. We now think that India will be slightly above 20% by the end of the year. And what you are seeing is a modest pressure on average bill rates as a result. And that probably is also sort of shaping how we look at the second half. So it's not super significant, but I think last time sometimes we would utter the word 19.5%. And right now we think that India is going to account for just over 20% of our headcount by the end of the year. So we continue to see a modest gradual shift there, while at the same time we are seeing, you know, improved utilization in our other areas of operation in Europe and Western Central Asia. So it's not as if all the demand is shifting to India, but we are seeing, you know, ongoing kind of implement in India. I heard you want to talk about worker.
spk10: The type of work, like, I think that's what we said already today. We consider, like, there is shift to India. There is a price and pressure. So this is definitely a very objective kind of components. At the same time, the type of work which we do is not changing much from location to location. And as we said before, NIPAM has a kind of reputation for more complex quality engineering solutions. And as we said, We build it actually in the very strong data engineering competency. We bring in, like, everything what we do around GNI, productivity improvement for a DLC. We build in digital engagement practice. So it's very much in line with the Rode EPUM. And the type of work is, again, very, very similar. Overall perspective, it's also creating different profile of our grid in India because when we started to move work there, we have to bring much more proportionally experienced teams there. And only after this, we will be able to scale to the different pyramid. And that's what's happening for us simultaneously. Some movement of the work, rebuilding the pyramid, and still invested in quality to be exactly in line with client expectations because they expect from ePump, independently from location, similar type of service.
spk14: Thanks for the detail there. Can you unpack your comments on the lack of improvement contemplating the outlook? I want to understand what that means for deals that have been signed but perhaps not yet launched or ramped. And how much go-get or pipeline conversion is still required to achieve your outlook at both the high end and the low end?
spk04: Yeah, so the last time we guided Jonathan, we did talk about still expecting a very modest improvement in demand. And what we're now saying is we don't see that improvement in demand. And so we try to be quite prudent with our guide, clearly within this quarter and clearly how we set the full year guide, which obviously is how we're thinking about Q4. You know, it does very much, particularly if you take the full guide of 4590 to 4625, it does encompass, you know, even things like some potential reductions in demand due to cost reduction efforts at clients or that type of thing. And so I think we feel pretty confident that, again, we have a little bit of sort of downside as clients continue to be sort of cost sensitive. And then The upside probably would be a little bit more in the lighter furloughs, maybe just a little bit of kind of budget openness in the remainder of the year. And again, our ability to probably influence the level of vacation taken by employees to, again, give us a little bit more capacity in Q4.
spk07: Your next question comes from the line of Ramsey LFL from Barclays. Your line is open.
spk13: Hi. Thanks for taking my question. It looks like your percentage of fixed price contracts has been trending up and it's a little higher now than it's been, at least going back quite a ways in our model. What is driving that mix shift sort of away from time and materials work toward fixed price work? Is it geographic? Is it AI related? And I guess, are there any implications for margins when it comes to fixed price versus time and materials work.
spk04: Yeah, and so you're correct that it has been trending up and probably will continue to trend up somewhat. And so it's a mix of what would be called, you know, percentage of completion and what is sort of a fixed monthly fee. And so it probably does reflect, you know, the fact that we're beginning to, you know, try to address clients' needs in a, you know, in a way that's a little bit non-traditional for EPAM where we have traditionally been you know, kind of more leading edge complex projects where it was difficult to estimate. We clearly have, you know, that type of work, but we are trying to be able to sit with our clients and say, we can do this for a fixed amount of money or fixed amount of money on a monthly basis. The other thing I think you are probably seeing is some opportunity with Gen AI to introduce not only a traditional sort of productivity improvement, but productivity improvement with Gen AI. and commit to a series of savings over a period of time. And so you are seeing us also enter into engagements with clients that may be more multi-quarter or in some cases even multi-year that do reflect what we believe is a productivity improvement that we can achieve over time. And that could go either way, right? It can be net positive to margins. If obviously we've mis-estimated or sort of delivered poorly, it can be negative. But, you know, generally with fixed fee, you do have the opportunity to improve profitability relative to time and materials because it just gives you more flexibility in how you deliver.
spk13: Okay. And a follow-up from me on M&A. I guess given the buybacks in the quarter and the additional share of purchases authorization, is larger scale M&A off the table? Assuming you're still in the market for tuck-ins to plug capability gaps, what types of assets might you be looking to bring into EPAM?
spk10: I think nothing at all off the table. So as always in the past, we constantly have conversations and opportunities for different sides of acquisitions. But buying shares back is actually very much functions of if it's going to happen or not. So it's not must. Condition, it's a direction which we will be executing only if we think that it will grow up with any other aspect of the business. So when that would be happening, we will be adjusting the numbers if necessary.
spk04: Yeah, so we'll do both. But, you know, clearly our bias would be towards acquisitions. And as Eric said, you know, doing something somewhat larger is certainly not off the tip.
spk06: Got it. Thank you very much. Thank you. Your next question comes from the line of Sir Inder Thind of Jefferies. Your line is open.
spk03: Thank you. Just a question around the global delivery footprint. As you look ahead, if revenues was to remain stable, at what point do you think you'll get to your target delivery footprint?
spk06: When you say the revenue will be stable, what do you mean?
spk03: I think there was commentary on the call about on-site utilization being a little bit below expectations and so there's continued shift for the requirement of resources in lower cost regions. I think there's previous commentary around you know, maybe not as much demand in near shore or, you know, Western Europe, shifting some of those resources through natural attrition to other parts of the world. So that was the, what I was trying to get at.
spk06: I think, let me try to answer slightly differently.
spk10: First of all, we definitely, moving to global diversification from this mitigation stability and 24 by 7 on the growing global client base. And from this point of view, we would be much more diversified than in the past and right now it's also. As we mentioned, probably would be the most balanced global direct company. That's a direction. What exactly proportion of this? a much more difficult question to answer because it would be a function of general demand. When you say, like, for example, near-shore in Europe is not so much in demand, it's in many ways subject to the type of work, number one, and the cost pressure, number two. As soon as the market will start to come back to kind of fixing the technical debt which we're talking about, that modernization cloud and data program will accelerate to, again, make the promise of GNI transformation much more real. The demand will come back for practically any region. And because of complexity and creativity of this type of engagements, proximity will become much more important. And pricing component will become less important. So it would influence the structure as well. So again, number one, we will be much more diversified in there. And a lot of time, it will be bigger proportion of the total. But exactly proportion to identify it right now, very difficult. So we're watching this quarterly how to proceed.
spk03: That's helpful. And then related to that, when you think about all of the new talent that you're hiring, how do you differentiate or attract that talent in the sense that others obviously have large delivery operations out of India? They have well-established connections to the local universities, whereas I would argue you are newer to that region. I realize you've been there since 2015. just on a relative basis?
spk10: So if we're talking about India specifically, I think a couple of factors need to be taken. We have an image of different type of services company. We have an image of much more quality engineering company and much more closer to what people would think about software tech companies and from some time point to you we compete with this type of company the same like with some captives which trying to build a high-end tech offices in in India so the image is there already so at the same time we also kind of underdog in India which means that we have opportunity to play differently and in specific spots of the market, including like breeding our training capabilities and different type of work. I think while there are very large companies, for us it's relatively clear how to differentiate us for the labor market, for the talent. And if you're saying that we're growing much, much... Like, our... You said, like, our India is growing pretty strongly in this situation.
spk07: Thank you. Your next question comes from the line of David Grossman. Your line is open.
spk15: Good morning. Thanks. just quick a couple of quick follow-ups uh i if i recall you said the headwind from india the makeshift to india was going to be about 200 basis points this year uh on revenue is is that still a fair assumption and give any initial thoughts on whether or the magnitude of the headwinds would be in 2025. yeah i would say that you know two percent is generally correct
spk04: You know, it probably has gone up slightly for when we guided at the end of the Q1 call. And then I would say for next year, my guess is the headwind from India might be greater than 2%. So I guess that's how I'd respond to that date.
spk15: And that's just because of the ramp of headcount? Is that why it's higher than 25%?
spk04: Yeah, probably a little bit higher in billable India and a little bit lower in billable on-site. Those two things are kind of producing what is probably a modestly lower average bill rate for the company.
spk15: Got it. And similarly, I know you've talked quite a bit about the LOSC client. I think one was M&A and one was something else. I'm just trying to remember whether you've quantified that headwind this year and next, and when we comp out against that headwind.
spk04: Yeah. So, the one that is kind of the M&A-like exit, which is the one I usually refer to, I think we comp out at the end of the year. And then, you know, it was double-digit revenue. Like, it was, you know, over $10 million a quarter. So, it was a significant number. And then the other one is the one that has been, you know, sort of slowly reducing their demand for services. And that continues to be an ongoing trend. And that was a little bit related to their hesitation around our Ukrainian footprint. And then I think they're also just doing a little bit of work around, you know, bringing some positions in-house. But, you know, we still, again, have demand from them, but just there's And I think you'll continue to see that for the next couple of quarters.
spk15: Got it. And just one last thing. Just on the DSO, Jason, I know it was up last quarter and it was up again sequentially. Should we see that or view that as maybe a macro dynamic that's affecting all your accounts or is this another way of providing better terms to remain more competitive or is it something else going on?
spk04: Yeah, I would say that the 76 was definitely a result of just the last couple days being on a weekend, and so we saw a significant amount of cash come in on the Monday and Tuesday, but that was here in Q3. But, David, I would say that as we move towards more fixed fee, that is having an impact on DSO because it does kind of impact the invoicing, and I do think that you're likely to see something closer to 74% for the second half of the year. And again, that's due to the shipping and the type of contracting we've been doing.
spk06: So then I guess with that, maybe we're... Operator, we have time for one more question. Thank you, Dave.
spk07: The final question comes from the line of Jamie Freedman from Susquehanna.
spk08: Your line is open. Hi. Thanks for squeaking me in here. With regard to your last answer, Jason, that was real interesting about the fixed price to DSL. I'm just wondering, also just related to that, is the growth in fixed price related to generative AI or outcomes-based pricing? That's my first one. And then my second one, I'll just ask them up front, is... Art, could you call out what's going on in life science? I know Jason mentioned it's a combination of both health care and life science in his prepared remarks. It was a featured topic at the Analyst Day a couple of years ago. It seems like it's working now. So any high-level stuff, first on fixed price, second on life science. Thank you.
spk04: So fixed fee, certainly there's, I would say, some experimentation with sort of fixed fee with productivity that's Gen AI driven. I don't think that's showing up in the numbers right now, but, you know, may continue to sort of show up in increased fixed fee. I would say more so, you know, again, clients are looking for us to step in and say we can deliver a certain program for a fixed amount of money or we can deliver a certain amount of story points for a fixed amount of money on a monthly basis. And, again, it allows us to be a little bit more competitive. And then we are doing a little bit more business in the Middle East. And that market tends to be more fixed fee oriented as well. And so those would be the two things on that. And then growth in life sciences and health care.
spk10: Yeah, I think we were talking about it. We were talking about building more industry expertise in this area. And in general, from our conversation several years back, it was positive growth, while it was a couple of things when client situation was actually changing. Right now, it's pretty positive. I think concentration of data programs in our life science and health care business is actually very high, which still in demand today. And again, combination of industry expertise, which we invested in, some level of consultancy, and again, data program proportion making this a benefit for us. And that's how we look into some other industries, how we can change the trend similar to what's happening here.
spk06: Thank you. So, I think time is over.
spk10: As usual, thank you for joining us today. So, I think we're trying to communicate that while the situation as it is right now, we do believe that Repalm is all focused on cloud data engineering, and we're pretty well positioned for the future growth when the market comes back. So, I know we're repeating this each time, but it's actually We very much believe in it. And we will be ready for comeback and participation. We'll see how many quarters we will have to still wait for this.
spk06: But again, thank you, and let's talk in three months.
spk07: That does conclude our conference for today. Thank you for participating. You may now disconnect.
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