EPAM Systems Inc (EPAM) — Q4 2019 Earnings Call Transcript

Thank you, operator, and good morning everyone. By now, you should have received your copy of the earnings release for the company's fourth quarter 2019 results. If you have not, a copy is available at epam.com in the Investors section. With me on today's call are Arkadiy Dobkin, CEO and President, and Jason Peterson, Chief Financial Officer. Before we begin, I'd like to remind you 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 GAAP and are available in our quarterly earnings materials located in the Investor section of our website. With that said, I would now like to turn the call over to Ark.

Thank you, David, and good morning, everyone. Thanks for joining us. With our recent Investor and Analyst Day in November 2019, we spent some time speaking about the challenges our customers face, while improving productivity to speed up business results in an increasingly competitive environment. We talked about the necessity for most of our customers to transform themselves into adaptive enterprises, because the way we see it, adaptiveness is a key puzzle that must be solved in order to compete effectively. And in turn, to be the best partner to our clients and help them solve the challenges. We understand that EPAM needs to be a fast global and highly adaptive organization itself. Well, obviously, most of our competitors have also been talking about transforming into modern players. We try to explain work in November, why recently EPAM is already fully adopting distributed agile delivery models and close collaboration, so I have three teams in product-centric engineering practices that are positioned better than most to be successful in solving the corresponding challenges. Now three months later, we can share our full year financial results as well as revisit several points we talked with you about back in November. We finished 2019 in a strong fiscal position across several dimensions of our business. Financially, we landed at $2.29 billion in revenues reflecting 25% year-over-year constant currency growth. And non-GAAP earnings per share were $5.42, reflecting a 23% increase over fiscal 2018. Additionally, we generated $188 million of free cash flow for the year. On the people front, we added 6,500 to our EPAM headcount across our client-facing teams and corporate functions. We launched EPAM Continuum, our brand that integrates our capabilities in business technology and experienced consulting. EPAM Continuum along with our core product engineering capabilities brings to the market an integrated approach to solving complex problems. We have seen this component-built strategy gain more traction in the market as enterprises start to orient away from few of the shelf models towards more product-centric go-to-market and solution strategies. We believe this intelligent component build capabilities will become even more important beyond 2020 as speed and differentiation pressures continue to push our customers to change the way they look at their technology, business processes, and organizations. With all of these initiatives in mind, in 2020, we will continue to focus our investment into real programs that support our ability to execute our growth strategy. Overall, we are optimistic about 2020 and believe that we can remain relevant to our global and diverse client base through our ability to execute large scale digital transformation programs.

Thank you, Ark, and good morning, everyone. I'll start with our fourth quarter financial highlights. Revenue for Q4 came in at $632.8 million, a year-over-year growth of 25.3% on a reported basis or 24.8% growth in constant currency. We saw higher than expected revenue for Q4 driven substantially by an uptick in demand in the second half of the quarter, as well as stronger performance from a few of our acquired companies. In the FX benefit due to the strengthening Russian ruble. Growth in the quarter was broad-based across our client portfolio. Some of the trends in growth include customer engagement, e-commerce re-platforming, scaling new models to drive clients' future growth, product and platform engineering and application modernization. Looking at our fourth quarter revenue growth across our industry verticals, Software and Hi-Tech grew 24.5%, Financial Services delivered 21.8%, Life Sciences and Healthcare grew 20.3%, and Travel and Consumer grew 15.9%. Rounding out our vertical performance, we saw very strong growth in both business information and media which posted growth of 38%. Our emerging vertical delivered 36.3% growth driven primarily by clients in telecommunications and energy. Moving on the income statement, our GAAP gross margin for the quarter was 35.2% compared to 36.8% in Q4 of last year. Non-GAAP gross margin for the quarter was 36.7%, compared to 37.7% for the same quarter last year. In Q4, both GAAP and non-GAAP tax rates were favorably impacted by one-time adjustments. Diluted earnings per share on GAAP basis was $1.29 and non-GAAP EPS was $1.51, reflecting an 18.9% increase over the same quarter in fiscal 2018. In Q4, cash flow from operations was $124.6 million. We expect revenue growth to be in excess of 22% for both reported and constant currency. We expect GAAP income from operations to be in the range of 13% to 14% and non-GAAP income from operations to be in the range of 16% to 17%. For the first quarter of FY2020, revenues will be at least $642 million, producing a growth rate of at least 23% for both reported and constant currency. We expect GAAP diluted EPS to be at least $1.27 for the quarter and non-GAAP EPS will be at least $1.36.

Thank you. Good morning. Jason, I wanted to follow-up on that last comment about the cadence of the year, the first half versus the second half. What is contributing to that lower utilization and profitability in the first half, and why is it going to improve in the second half of the year?

Sure. The traditional pattern for the company has been higher profitability in the first half and lower profitability in the second half. In 2018, we ran with very high utilization in Q1, which was 80%. We don't expect to run at that level of utilization in Q1. We have fewer available bill days in the first half of the fiscal year than we have in the second half. The other thing is we've got some impacts in Q1 due to payroll taxes kicking back in. We're expecting more bill days and higher utilization in the second half.

Okay, great. Thank you. Arkadiy, you talked about continuing to be adaptive. Is there a risk that certain initiatives could cannibalize other opportunities that you already have? For instance, does the education capabilities and services ever cannibalize your opportunity for other services with clients?

Hopefully when people talk about it, it means that we're trying to improve speed to market. Our educational services do not compete with our core capabilities. When you educate clients, you can eventually work with them more efficiently and improve overall speed.

Thank you, Ark.

Hi Ark. Hi, Jason. Congratulations on the good quarter. I wanted to start with a question on margin. Is the incremental push into consulting also affecting the margin profile this year, or has that become part of the baseline at this point?

I don't think that the consulting business itself has a specific impact on profitability or the model. It's a modest evolution. We're continuing to make investments in the business to grow the company at a rate in excess of 20%.

Got it, that's good to hear. And the cadence of revenue growth, seemed to me that there isn't necessarily a risk. It should continue to be steady, hopefully approaching mid-20's type of growth. Would you agree with that?

Yes, we continue to feel good about the demand environment and expect to grow revenue in excess of 22%.

Hey, thanks for taking my question. I was wondering if you could give a little color on the reacceleration in growth in the Travel and Consumer segment, what are the drivers there?

We had seen a slowdown in that segment across a couple of customers. But we think there is stabilization and we're beginning to see opportunities in the branded consumer goods space.

That's great. And can you give us your general read on the demand environment? Are you seeing impacts from geopolitical issues, such as the Coronavirus?

There is some direct, but very minimal impact we are seeing at this point with the current situation in APAC. We're looking at this optimistically and believe we can exceed 22% growth.

We continue to see strong growth in various sectors, including life sciences and healthcare, and have good opportunities in areas such as neobanks and insurance.

Okay, great. Thanks so much. Super helpful.

Hey, good morning, guys. I wanted to start with a high-level question on the trade-offs between growth and margins. Do you think it’s plausible to have both accelerating top-line growth and margin expansion simultaneously?

Growth for us is a primary goal, but profitability is also an important factor. We will be investing in our business to support growth, even if it results in some volatility in profitability.

Just a quick follow-up, I noticed that growth in the top five customers accelerated. Is there a change in the composition of those top five clients?

There are some changes in the composition of our top five. One of our top clients split in two and both parts continue to grow, which is a positive.

Just a quick question on the NAYA Tech integration. Can you give us some detail there?

It was a little bit stronger than we expected, but it's still too early to analyze the long-term impacts. We anticipate continued good performance.

We've been guiding to an 18% to 19% range on SG&A as a percentage of revenue. This might be an investment year, and we expect some improvements down the line.

Just a quick question on your revenues and guidance. Are there any risks you've accounted for that might impact your guidance?

We don't think our predictions are impacted significantly by elections or geopolitical situations. We are still guiding for strong growth.

We continue to seek opportunities for M&A, but culture and a good fit are always our primary filters for potential targets.

Wanted to home in on account cohorts with regards to the revenue size. How are you seeing the graduation of clients from lower tiers?

It's a combination of things; we continue to grow within existing relationships while also adding new clients. We see strong growth in our existing customers and have new opportunities as well.

Our product engineering background helps us differentiate ourselves and provide value. We're adopting new technologies and we are investing in education to build the right skills.

Can you tell us about the transformation areas customers are most interested in these days?

The answer will be generic, but we are focused on analytics and data, IT and cloud integrations. The need for a system of engagement is strong.

Do you feel like you have the necessary skill sets for the transformations you're undertaking?

There's a gap in market skills and we are developing our talent. Education is key in building necessary skills to adapt to changes in the market. Thank you, everybody. We’re pleased with our 2019 results. We continue to grow, confirming our ability to grow 20%. Thank you for your support and thank you to all of our 36,000 people globally. Let’s talk in three months.