EPAM Systems, Inc. (EPAM) Earnings Call Transcript & Summary

Good day, and thank you for standing by. Welcome to the EPAM Systems Second Quarter 2023 Earnings Conference Call. [Operator Instructions] Please be advised, this conference is being recorded. And I would now like to hand the conference over to your speaker today, David Straube, Head of Investor Relations. Sir, please go ahead.

Thank you, operator, and good morning, everyone. By now, you should have received a copy of the earnings release for the company's second quarter 2023 results. If you have not, a copy is available on epam.com in the Investors section. With me on today's call are Arkadiy Dobkin, CEO and President; and Jason Peterson, Chief Financial Officer. I'd like to remind those listening to some of our comments made on today's call may contain forward-looking statements. These statements are subject to risks 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 Investors section of our website. With that said, I'll now turn the call over to Ark.

Thank you, David, and good morning, everyone. Before I get into results of our second quarter, I would like to spend a few minutes on the mid-quarter update we provided in June. As I shared it in my prepared remarks, the broader concerns over the economy led to a shift in demand dynamics for our sector. For EPAM, the shift has been much more pronounced due to the geopolitical impact on our delivery centers and our focus on the build and digital product engineering segments of the market, which represents about 80%, 85% of our engagement portfolio. This was especially evident in the technology vertical, which continues to be impacted by the pullback and spend after years of strong investments in digital and product development efforts, while being spread broader across other industry segments as well. Over the last quarters, we have also seen this impact in some of our largest clients, as they have [ held back ] for direct spending from new build programs to the economic conditions and caution in their businesses. This factor has contributed to a high percentage of our shortfall over the first half of 2023. Now I'll switch to Q3 and the rest of 2023. While we are starting to see a few encouraging signs, we'll share more on that in a minute. Today, I would state that we expect still, based on the current level of unpredictability, a negative dynamic to continue into the second half of 2023, but at a lower level than we saw in the first half of this year. With that, I would like to state that while we do understand that this is a difficult period for us and for the sector more broadly, based on insight from the past several years and past several quarters, especially. We are turning that experience into pragmatic action plan, which we will be applying to our business throughout the remainder of this year and further into the future and consider this time an opportunity, which, as we all know, [ any crisis ] presents to transforming ourselves. Some of our current plans and actions are focused on making real-time adjustments to our [ settings ], go-to-market planning, customer engagement programs and global delivery talent platform stabilization. These key investments help us to prep ourselves for a strong rebound position. What is important also to note is that our primary focus on digital products and data engineering services combined with digital consulting agency, design, content and digital marketing services will remain. In other words, the primary services and market segments, which allow us to double the company in the previous 3 years, are staying intact, while we continue to tune our capabilities in line with the volume market demands. Our point is simple. The entire IT sector is undergoing what we believe is an evolution of the services market moving from the core IT to digitalization, even more broadly and with significant acceleration. And to consider new digitally native businesses faster to reinvent entire models and ways of working and now is the promise of generative AI capabilities empowerment at the core. We have been at the forefront of similar trends before and, once again, are looking to put EPAM at center of new wave of transformative services. We fully expect as a result to be underpinned and even more driven excited by our traditionally strong product platform engineering, data analytics and machine learning capabilities, but now in combination with what generative AI promises. So our thesis has been and continues to be that our core services profile will benefit in the medium and longer term from a higher concentration on cloud data and engineering. And we will capitalize strongly on our core capabilities once the general situation in our segment rebounds. The AI impact will become even more real in terms of complexity of future applications and platforms by encapsulating not just currently available elements of Gen AI and a very reasonable needs for trust, reliability and security management of AI, but also by closely integrating with new classes of composite and adaptive AI platforms as well as with foundational models and specific industry cloud platforms. In short, we are optimistic about the transformative opportunities to the whole application stack coming from AI-led transformation, which is also well illustrated by our latest announcements. That is one of the key areas of our investments. The second critical part is a further diversification and stabilization of our global delivery platform, including the allocation of our talent more optimally across the world, while, at the same time, enabling our strong engineering quality standards across all EPAM locations. This rebalancing effort will be performed over the next 3 to 4 quarters, in part, to drive higher levels of gross margin performance. Our other plans and actions today are focused on our immediate demand generation and new logo acquisitions. During the first half of 2023 and specifically in Q2, we drove new logo activity at higher levels than when compared it to 2021 and 2022. We see this as a positive sign of our return to demand. We should accelerate the recovery and allow us to return to growth as soon as the current client base stabilizes. A few examples of our new Q2 clients include one of the world's leading B2B travel platforms, a large European-based multinational resilient marketplace organizing for trading of shares and other securities, a multibillion-dollar molecular diagnostic company specialized in detection of early stage cancers, a leading global insurance provider of financial protection, absence management and supplemental health benefit solutions and global infrastructure services company in [indiscernible]. In these new programs, we are starting to include a more diverse stack of our capabilities from consulting to different types of implementation efforts. Some of those clients, we expect will support our next growth journey. In addition, we also see some programs with existing clients who have started ramping up. Recently, Canadian Tire announced their 7-year strategic partnership with Microsoft to accelerate the modernization and drive retail innovation across the Canadian markets. Leveraging our decade-long relationship with Canadian Tires, EPAM will be trusted to improving engineering partner and digital system integrator to lead the effort. So there are some signs indeed that the overall demand environment is coming to more normal terms for us. We probably will be able to share more next quarter of how strong those signs are going to be. But in anyway, it also confirms that EPAM continues to remain very relevant and competitive even in current market of low demand for the build function, which is a good entry point to share some of our go-to-market progress, especially in relationship with hyperscalers. In June, we announced a global strategic partnership with Google Cloud across our global markets, cloud solutions and focusing on specific efforts in our larger verticals, including financial services, consumer, telecom, media, entertainment, health care, life sciences, energy and hi-tech to help our customers to modernize and transform their businesses. We're also encouraged and energized by the momentum we are seeing with our other major cloud partners, Microsoft and AWS. More to come on this direction very soon. But just as a preview, you might have seen that we were recently named Microsoft's Migrate Partner of the Year for 2023 with couple other vulnerable recognitions with Microsoft Partner Network. In overall, we made very strong progress in establishing a real 360-degree relationship with all 3 major players and plan to be sharing more over the course of the next few weeks publicly. Two final points. First, I just want to reiterate our view that there is a tremendous amount of work to be done in continued modernization, application development and integration and in considering and designing the models and strategies for business change. Our commitment to our expanding capabilities and engineering consulting can now work to create a next generation agency, will help us to compete and win a new demand climate once customers gain confidence in the optimization initiatives and return their attention to growth. Second, I wanted to touch on AI one more time, as it is obviously on everyone's mind these days. So how do we see its impact to our business and more critically to our customers and the industry at large? And of course, what are you doing to position EPAM for long-term success? EPAM has a long history of investing in [ RNG ] and our call to action over the years has been to make the promises of technology real. So rather than sharing any specific dollar amount we plan to spend on AI, which is very difficult to estimate within current speed of change. We can instead share how we are thinking about directional investments today. Currently, we pick investments with 2 principles in mind. Whatever you do, it has to be pragmatic to EPAM in terms of relevancy and deliverability for our clients. And second, it has to be responsible and cost-effective. This translates to 2 broad categories of things we are working on, and you probably already saw some of this being announced. We are building accelerators in IT that help orchestrate full transformation program using the best available capabilities of large language models and related from works and tools. A significant portion of this is the work we are doing to change how we ourselves work from how we will [indiscernible] to how we position and operate our company. We are working across thousands of use cases to focus, first of all, on responsible, and very importantly, cost-effective solutions. Otherwise, future real progress will be difficult. To do so, we are focused on expanding our partnership, including these cloud providers and leading research centers to ensure those critical aspects and also focus ourselves on aligning internally across consulting experience in technology to address that. The reality is that the production ready services application landscape is still very much at the entry stage of maturity today. While we see it is a very large and accelerating opportunity for us, specifically in our primary market segment, we are currently focusing on all type of activities to learn and experiment more from proof of concepts to real scale pilots and some scaled production initiatives. So just like advances to our cloud over a decade ago drove demand for advanced engineering, [ new generation ] architecture and hybrid and distributed delivery models, we are confident that this wave of AI-led requirements will drive more demand for advanced data engineering in cloud computing, content creation and the artificial intelligence native application as well as the new UX and UI paradigms. Our clients, who themselves make up a significant segment of technology companies in technology-led enterprises are in the mindset of already started AM arms race, which we believe will be a real engine for the future growth. Some of that, we're already starting to see within our demand pipeline. With that, I would like to pass to Jason to share more details and numbers for Q2 and for an update for our business outlook for the remainder of 2023.

Thank you, Ark, and good morning, everyone. Before covering our Q2 results, I wanted to remind you that in addition to our customary non-GAAP adjustments, expenditures resulting from Russia's invasion of Ukraine, including EPAM's humanitarian commitment to Ukraine, business continuity resources and accelerated employee relocations have been excluded from non-GAAP financial results. We have included additional disclosures specific to these and other related items in our Q2 earnings release. In the second quarter, EPAM generated revenue of $1.17 billion, a year-over-year decrease of 2.1% on a reported basis and a decrease of 2.4% in constant currency terms, reflecting a favorable foreign exchange impact of 30 basis points. Revenue in the quarter was impacted by reductions in 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 decision to exit the market had a 100 basis point negative impact on year-over-year revenue growth. Excluding the Russia revenues, year-over-year revenue for reported and constant currency would have decreased by 1.1% and 1.7%, respectively. Beginning with our industry verticals. On a year-over-year basis, travel and consumer declined 1%, primarily due to declines in retail, partially offset by solid growth in travel and hospitality. Financial services grew 3.2%, with growth coming from asset management and insurance services. Business information and media decreased 4.1% in the quarter. Revenue in the quarter was impacted by a reduction in spend at a number of large clients based on uncertainty in their end markets, particularly in the mortgage data space. Software and Hi-Tech contracted 10.3%. The decline in the quarter reflected a reduction in revenue from the former top 20 customer we mentioned during our previous earnings call and generally slower growth in revenue across a range of customers in the vertical. Life sciences and health care declined 10.9%. Revenue in the quarter was impacted by the ramp down of a large transformational program mentioned during our previous earnings calls. On a sequential basis, growth in life sciences and healthcare actually was a positive 2.9%, driven by new work at both existing and new logos. And finally, our emerging verticals delivered solid growth of 8.6%, driven by clients in energy, manufacturing and automotive. From a geographic perspective, Americas, our largest region representing 58% of Q2 revenues, declined 5.9% year-over-year or 5.7% in constant currency. The growth rate in the quarter was impacted in part by the ramp down of life sciences and health care customer we mentioned during our previous earnings call. EMEA, representing 39% of our Q2 revenues, grew 8.5% year-over-year or 6.5% in constant currency. CEE represented 1% of our Q2 revenues contracted 61.1% year-over-year or 45.8% in constant currency. Revenue in the quarter was impacted by our decision to exit our Russia operations and the resulting ramp-down of services to Russia customers. And finally, APAC declined 19.7% year-over-year or 18.6% 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 Q2, revenues from our top 20 customers declined 2.4% year-over-year while revenues from clients outside our top 20 declined 1.9%. Moving down the income statement. Our GAAP gross margin for the quarter was 30.9% compared to 29.2% in Q2 of last year. Non-GAAP gross margin for the quarter was 32.6% compared to 31.5% for the same quarter last year. Gross margin in Q2 2023 reflects a lower level of variable compensation expense, partially offset by the negative impact of lower utilization. GAAP SG&A was 16.7% of revenue compared to 19.5% in Q2 of last year. SG&A in Q2 2022 included a more significant level of expenses resulting from Russia's invasion on Ukraine. Non-GAAP SG&A in Q2 2023 came in at 14.8% of revenue compared to 15.2% in the same period last year. Reductions in both cost of revenue and SG&A during the quarter reflect the company's ongoing focus on managing its cost base as well as reduced variable compensation expense due to the lower level of financial performance expected for the year. In Q2, EPAM incurred $5 million in severance-related expense included in both GAAP and non-GAAP SG&A as the company works to better align its cost structure with the current demand environment. GAAP income from operations was $144 million or 12.3% of revenue in the quarter compared to $93 million or 7.8% of revenue in Q2 of last year. Non-GAAP income from operations was $191 million or 16.3% of revenue in the quarter compared to $177 million or 14.9% of revenue in Q2 of last year. Our GAAP effective tax rate for the quarter came in at 20%. Non-GAAP effective tax rate was 23.3%. Diluted earnings per share on a GAAP basis was $2.03. Our non-GAAP diluted EPS was $2.64, reflecting a $0.26 increase compared to the same quarter in 2022. In Q2, there were approximately 59.2 million diluted shares outstanding. Turning to our cash flow and balance sheet. Cash flow from operations for Q2 was $89 million compared to $78 million in the same quarter of 2022. Free cash flow was $82 million compared to free cash flow of $59 million in the same quarter last year. At the end of Q2, DSO was 71 days and compares to 69 days for Q1 2023 and 71 days for the same quarter last year. Looking ahead, we expect DSO will remain steady throughout 2023. Share repurchases in the second quarter were approximately 195,000 shares for $41.4 million at an average price of $212.77 per share. As of June 30, we had approximately $450 million of share repurchase authority remaining. 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 49,350 consultants, designers, engineers, trainers and architects. Production headcount declined 10% compared to Q2 2022, the result of lower levels of hiring, combined with voluntary and involuntary attrition as we continue to balance supply and demand. Our total headcount for the quarter was more than 55,600 employees. Utilization was 75.1% compared to 78% in Q2 of last year and 74.9% in Q1 2023. Now let's turn to our business outlook. As Ark mentioned, we have seen a higher level of new logo acquisitions and revenue from our focused efforts on demand generation. While this progress is encouraging, the level of revenue generated is not enough to offset further expected reductions in client budgets, ramp-downs and delays in new program starts. With the range of outcomes we outlined on our June 5 call, we are maintaining our expectations for a muted demand environment with sequential decline in Q3 and further sequential or flat revenue growth in Q4. 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 be able to deliver from Ukraine in productivity levels at or somewhat lower than those achieved in 2022. Consistent with previous cycles, we will continue to thoughtfully calibrate our expense levels, while investing in our capabilities and focusing on the preservation of our talent in preparation for a return to higher levels of demand. We expect headcount will continue to decline modestly in Q3 due to limited hiring and more typical attrition, and we will continue to limit hiring until we see improving demand. We expect utilization to decline slightly in the second half of the year, primarily driven by a higher level of expected vacations. Lastly, at the end of July, we completed the sale of our Russian business, which will result in a decline in Russian revenues from Q2 to Q3. But we will also recognize an estimated loss on sale of $18.4 million, which will impact our Q3 and full year GAAP results. Additionally, this will drive a further modest reduction in headcount. Moving on to our full year outlook. We now expect revenue to be in the range of $4.65 billion to $4.70 billion, reflecting a year-over-year decline of approximately 3%. On an organic constant currency basis, excluding the impact of the exit in Russia, we expect revenue decline to also be approximately 3%, both at the midpoint of the range. We expect GAAP income from operations to now be in the range of 10.5% to 11.5%, which includes the loss associated with the sale of our Russian business. The non-GAAP income from operations to continue to be in the range of 15% to 16%. We expect our GAAP effective tax rate to continue to be approximately 22%. Our non-GAAP effective tax rate, which excludes excess tax benefits related to stock-based compensation, is expected to continue to be 23%. For earnings per share, we expect that GAAP diluted EPS will now be in the range of $7 to $7.20 for the full year, and non-GAAP diluted EPS will now be in the range of $9.90 to $10.10 for the full year. We now expect weighted average share count of 59.1 million fully diluted shares outstanding. Moving to our Q3 2023 outlook. We expect revenues to be in the range of $1.14 billion to $1.15 billion, producing a year-over-year decline of 6% to 7%. On an organic constant currency basis, excluding the impact of the exit in Russia, we expect revenue to decline by 8.5% to 9.5%. For the third 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 15.5% to 16.5%. We expect our GAAP effective tax rate to be approximately 24% and our non-GAAP effective tax rate, which excludes excess tax benefits, related to stock-based compensation to be approximately 23%. For earnings per share, we expect GAAP diluted EPS to be in the range of $1.62 to $1.70 for the quarter and non-GAAP diluted EPS to be in the range of $2.52 to $2.60 for the quarter. We expect a weighted average share count of 59.1 million diluted shares outstanding. Finally, a few key assumptions that support our GAAP to non-GAAP measurements in the third quarter and the remainder of the year. Stock-based compensation expense is expected to be approximately $39 million for each of the remaining quarters. Amortization of intangibles is expected to be approximately $5.5 million for each of the remaining quarters. The impact of foreign exchange is expected to be a $1.5 million gain for each of the remaining quarters. Tax effect of non-GAAP adjustments is expected to be around $11.7 million for Q3 and $9.3 million for Q4. We expect excess tax benefits to be around $2.7 million for Q3 and $1.8 million for Q4. In addition to these customer GAAP to non-GAAP adjustments and consistent with the prior quarters in 2023, we expect to have ongoing non-GAAP adjustments in 2023 resulting from the Russian invasion of Ukraine. Please see our Q2 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 now generating a healthy level of interest income and are now expecting interest and other income to be $11.7 million for each of the remaining quarters. Lastly, I'd like to thank our employees for their continued dedication and focus on our customers. Operator, let's open the call up for questions.

[Operator Instructions] Our first question will come from Bryan Bergin of TD Calvin.

I wanted to just kick off with large client visibility and, I guess, existing base stability. Can you talk about the conversations you're having among your top 10 or top 20 clients? Are you getting closer to stability in this space? And I'm curious, just as we look at the implied sequential decline in 3Q and perhaps 4Q, just trying to understand the attribution to the decline among the large clients still in that base versus the intake of new work coming in at lower dollar levels versus like conversion delays and slower ramps of work.

I think visibility or predictability is probably better than was a couple of quarters ago. So -- and we can plan better. But there is still a slowdown, which started a couple of quarters ago, and we're working with it. And there is also some synchronous points between clients when they were making some of the decisions. So there is elements of unknown still there. But again, in general, we feel that it's much more stable. We will also see in top 20 that some clients started to return in discussion about growth. Again, it's difficult to comment when exactly it happened. But we see some signs that they tried some additional vendors, we're not satisfied, coming back to us with discussions. So I think in general feeling about Ukraine despite of situations that would get you into a more active period still from the client perspective and from expectation of the stability from work conditions. Taking into account during the last months, we didn't have particularly 1 unproductive day. So people believe that the clients starting to [indiscernible] for those who continue that. So I think, in general, more stable, still unknown, and there is still a slowdown going [indiscernible]. We hope that it will be stopped likely in the next couple of quarters.

Okay. And a follow-up just on the workforce diversification. Can you give us a sense on how the current operating footprint is comprised as of the close of the June quarter? Just roughly a mix between billable in Ukraine, Belarus versus Central Europe versus LatAm and APAC?

Yes. So we're under 30% from a CIS region. So that's primarily, as you indicated, Ukraine and Belarus. We're continuing to see maybe a little bit of growth in India. So that continues to be a significant delivery location for us. And right now, while we're working through demand, probably we see some stabilization in Latin America, but again, continues to be a significant part of our expected current and future delivery footprint.

Our next question will come from the line of Jason Kupferberg of Bank of America.

This is Tyler DuPont, on for Jason. I just wanted to start by asking about operating margins. During the quarter, they've seen some pretty strong 130 bps greater than the top end of the guidance range. Can you just spend a minute or 2 parsing out sort of what led to that outperformance and sort of how you're thinking about margins through the back half of the year, where there's any sort of incremental investment opportunities available? Or any color there?

Yes. So clearly, with the demand environment that we're seeing, we're trying to make certain that we're cautious about spending, while still making certain that we're making investments in sales channels and partner programs, and clearly, our AI capabilities that would allow us to return to significant growth in the future. But we're focused clearly on SG&A, and you're seeing efficiency there. And then you're also -- some caution around what we're doing with headcount. And generally, what you're seeing is it's a little bit of tuning in different delivery locations and lower hiring, very modest hiring, which is then offset by attrition and has resulted in these net reductions in headcount. The other piece, and we did talk about it, I think, in the script, is -- there is a variable compensation element. It's funded by performance versus our expectations for the full year. With the change in expectations for the full year, we did adjust the expected expense related to variable compensation. That shows up as some benefit in Q2, and we'll have lesser, but some benefit in the remainder of the year. And then again, we were just sort of toppish from a revenue standpoint with the $1.170 billion in Q2. From a profitability standpoint, generally, Q3 is a good quarter for us with more [ build-outs ]. I don't -- I think you're still going to see somewhat lower utilization in Q3, and so probably not expecting much improvement or probably maybe even a little bit of decline if you went to the midpoint of the range, the 15.5% to 16.5% that we've guided to for Q3. I think gross margins could end up in a 32% to 33% range in Q3 with lower bill days in Q4, may be somewhat lower. And I would definitely expect to see a decline in profitability between Q3 and Q4 due to a lower number of bill days, vacations and all of that, which generally impacts profitability in the last quarter of the year.

Okay. Great. I appreciate that, Jason. And then for my follow-up, I just wanted to sort of double click on the demand story here as we look towards the back half of the year, specifically your expectations on the evolution of the demand environment across your total client base, the balance between if you're assuming macro stability or any sort of additional softness in any of the verticals or geographies you're operating in? I know Bryan sort of alluded to the sequential declines and the last question in regard to 3Q and potentially 4Q. So just sort of any clarity there helping us frame the demand environment would be appreciated.

So just -- I'm going to give you the numbers, what we're currently seeing from a forecast standpoint for Q3, and then I'll let Ark comment and maybe provide more color. From a sequential standpoint, I think with some of the budget reductions that you've seen in major customers, you're likely to continue to see sequential decline across a fairly large number of our verticals. I think you could see sequential growth in the emerging, which has got a significant energy manufacturing footprint. I think you could continue to see -- are likely to see a sequential growth in the healthcare and life sciences, where we're making good traction here in fiscal year 2023. So that's kind of what I'm seeing from that standpoint. I think you still have a little bit of impact from customer decisions to reduce spend in Q2. And I think as Ark has indicated that we're more hopeful that clients are beginning to sort of stabilize their spend and could even see some increase later in the year. But...

Yes, I think that's in line with what I shared at the beginning of the questions. It's still soft. It's still unpredictable. It's still slightly going down. At the same time, we see different conversations starting to happen. There are more activities with new logos, and that's what we shared during our thought at the beginning, but also existing clients, different tone of conversations that we saw a couple of months, a couple of quarters ago. Again, it's still difficult to predict. We reacted and forecasted based on what we really kind of see right now.

The next question will come from David Grossman of Stifel.

I wonder if I could just -- a couple of quick follow-ups to some of the questions that have been asked. I mean, the first is just getting back to the customer dynamics and their own desire to kind of diversify risk geographically. If things stabilize from here, when would the sequential revenue headwinds begin to diminish if things just stabilized from here going forward?

Yes. So clearly, we would expect a sequential decline in Q2 to Q3, so when would the sequential stabilize. And then, David, I think you're aware of this Q3 to Q4 is just you've got to build an impact. And so you have to have an improvement in demand to stay flat Q3 to Q4. And so we think that, that's possible as we talked about in the guidance or maybe you could see a little bit of growth Q3 to Q4. But you do have -- you're walking uphill Q3 to Q4 with the lower build is.

Right. So including...

Yes, go ahead.

No, I just wanted to clarify, so excluding seasonality, right, if things stabilize from here, things would be flattish sequentially, right, excluding the seasonal dynamic.

I think its earlier what I would comment that in June when we talked last time, I mean in May kind of when we clearly felt that situation worse than we expected before. We [indiscernible] about 2, 3, 4 quarters. And I think that's the feeling, which we still have today, okay? Because it's very difficult to predict. Like you're asking when. So I do believe that within this time frame, we will probably will get to the situation when sequential -- quarterly sequential growth will start to recover. But we clearly we'll be updating this quarter-to-quarter. So we definitely see it slow down. We definitely see different signs from the clients. But again, some clients when they made some decisions, they within themselves have some type of inertia, which would take some time. All market will be very clearly changed or less satisfaction with some other matters will be not as high, okay? Some of this has started to feel, that's what given us some level of [indiscernible]. But I don't think we can say anything more than another 2, 3 quarters from now, maybe 4.

Got it. All right. I appreciate that. And then just back to your own internal efforts to geographically diversify. And without getting too far into the details, are there some high-level dashboard items that you can share that would provide some insight into recruiting kind of yield, utilization, attrition? Anything that would give us a sense of kind of how these new geographies are ramping?

Okay. You're asking about what we feel about our progress with diversifying like our global delivery. Is this...

Correct, correct.

Okay. So I think we're actually pretty much satisfied with the progress. I think our efforts in India and Latin America definitely starting to pay out. India, right now, the second largest location we've built. And that was part of the [indiscernible] which we started in May 2022, when we went with all of you [indiscernible] what we're planning to do. So right now, Ukraine and Belarus production together, it's more like 25%, 26% for the total capacity. Where in the Latin America, probably by the end of the year it will be closer to 18%, 20%. The quality and efforts, which we put in there, are definitely improving. We also have very specific programs, how to share knowledge between people who stay and depart for a long time, and how to raise the bar with improvement and new operations. I think we're still committed very much to Ukraine. We do believe that it will be growth there. Yes, we don't know when, but maybe we'll be very much aligned with the sequential growth, which we are expecting in 2, 3, 4 quarters coming back. So besides India, Latin America, which is more traditional, we have actually Central Western Asia, which is interesting because it's accumulate a significant number of people for those who [indiscernible] located during the last 18 months. So we have very interesting ways, and we have potentially a very good demographics for the growth of the target in these countries and clients started to experience this and getting comfortable. And again, with the demand coming back, I think it will be a good opportunity for us. And finally, more traditional fast location, Central Eastern Europe, mostly inside of EU, sometimes outside of EU, what, Hungary, Poland, this is very quality -- high-quality engineering location for us. Clients very comfortable there and good demand environment. It's always very high demand. So it's also becoming stronger because good [indiscernible] located from our traditional data centers. So I think we go in actually to the direction of building probably the most balanced global delivery platform. And as soon as the rebound will be started, we will feel comfortable to grow. One of the important things that we mentioned this, we very carefully kind of balance in the cost structure is because in all of the sectors which I outlined, there are different cost structures. And we -- going back to improve our gross margins by reallocating focuses across [indiscernible]. So if in a short question, we will be able to provide quality, which clients expected from us. It's simply recent clients that is actually very [indiscernible].

Next question will come from Maggie Nolan of William Blair.

Just to follow up on that last question and your last comment there, Ark, around the margins. Can you give us a little bit of a preliminary thought on what all of this might mean for gross margins into 2024? When we might see things kind of start to pick up and to what magnitude?

Yes. I think I'll step in. And we're probably not quite ready to talk about the 2024 in terms of, let's say, specifics or even ranges. But Ark explained, as we moved into the different delivery locations, obviously we did so quickly. In some cases, we probably have a little bit more balance in the higher-cost geographies, including traditional kind of on-site markets. We would look to kind of rebalance that somewhat. And then the other thing as we've talked about over the last couple of quarters is that as we move into new geographies, and particularly as we sort of either relocated or stood up new geographies quickly, we ended up with a somewhat more sort of senior delivery organization and delivery pyramid. And we're working to begin to introduce more juniors later in the year that would then give us a more balanced pyramid and therefore also improve margins. And so that, obviously combined with utilization improvement, would be the things that we're looking to do to sort of stabilize and improve gross margins over time.

Okay. And then on the new logo additions, it was good to hear the progress on that this quarter. Can you talk a little bit about the ability to keep the sales force intact during all this transformation -- and then any kind of patterns that you're seeing on those new logos in terms of the time it's taking for them to convert to revenue?

So I think our comment on new logo and new business is kind of illustrated that while sales force is also some [indiscernible], I think directionally, it's working through positively right now. I think after our comments like several quarters ago, when we were in the middle of all the allocations, we have to deal with thousands of people, so it will slow down. Right now, it's all [indiscernible]

Yes. So very much actively focused on external opportunities and much of the internal things that we had to manage over the last, say, 4 quarters are substantially behind us. And there's a focus with both the account teams, the sales force and the executives on driving incremental revenue growth.

Next question will come from the line of Ramsey El-Assal of Barclays.

I wanted to follow up with your mentioning kind of tighter integrations and partnerships with the hyperscalers. Can you talk about the strategy, how these relationships might act or expand your capabilities or your addressable market? And then also just comment on whether this is part of positioning EPAM for growth once the demand environment picks up again.

Yes, I think it's dynamic also in general because of the market change in comparison like during a year ago. Now we're talking about much closer relationship from [indiscernible] we definitely, like everybody else, focusing on client perspective, where hyperscalers can open additional doors and all competitors doing the same. And this is kind of nothing new. On another side, the partner should become stronger because just migration to the cloud is kind of as-is business, becoming not so interested and usually, it means very complex modernization efforts. And this is where the strengths of EPAM come in from. And this is why the partnership with hyperscalers has become more important not only for us, but for them as well because EPAM has a reputation, which actually can do complex modernization and complex integration. And that's what we mentioned getting the [indiscernible] status of partner of the year in this category with Microsoft. That's exactly a confirmation on this. And as we mentioned, we will be following this some announcement during the next couple of weeks, which will be confirming improved partnership levels, specifically because of our ability to deliver complexity. And it's definitely a very good preparation, from our point of view, for rebound because when demands will be back, everything which wasn't finished, and it's a lot, in all categories, in cloud and data modernization projects adds huge pressure or demand for data engineering because of the AI components. So the hyperscalers relationship will be very critical.

All right. And a follow-up for me. Can you contrast the demand environment in Europe versus North America? It looks like the growth rates are different in those geographies, although admittedly I don't -- necessarily have not tabulated the constant currency number. But is it a different environment you're seeing in different geographies? Or is it very similar trends across the business regardless of geography?

Yes. So certainly, some of what happened in Europe is due to foreign exchange. But what we are seeing is that some of the larger kind of budget reductions and conservatism is actually showing up more in North American clients. Think about the couple of clients we've talked about in health care and tech. Those were both North American clients. We've seen less of these types of reductions in spend in Europe. At the same time, we've got some pretty good traction also even in the consumer and retail side in Europe. And so yes, there does seem to be a bit of a divergence, but we'll see what happens as we work through the remainder of the year.

In general, it's still [indiscernible] we're talking about several specific client situations. Mostly it's happened in North America, and those situations were independent from general economic environment.

Our next question will come from Moshe Katri of Wedbush Securities.

A couple of follow-ups here. So do you -- looking at the new logos -- can you confirm that you're actually getting the same bill rates as you're selling via some of the other delivery centers, including India, as you have been getting in Eastern Europe? So are we talking about comparable billability?

So what we usually talk about is an environment where potentially you can get higher bill rates with new engagements. That's probably less likely to occur in today's demand environment. And generally, Moshe, if you're trying to get it just kind of what happens as you deliver more out of India. India does have somewhat lower price points than some of the geographies in Eastern Europe, maybe not significantly different than a few of the geographies in Southwest, in Western Asia or Soviet Central Asia. But we does have somewhat lower price points than certainly sort of Central Europe.

Okay. So would you say that the new logos that are coming on board are more dilutive to margins versus what you were accustomed to? Or is there any way to mitigate that?

Yes. So if you -- you can have different bill rates in different geographies and still have the same margin percent, right? You've got different cost structures, you got different cost of benefits and that type of thing. And so lower price, or higher price even, doesn't necessarily mean lower or higher margin. Again -- so I would say, yes, we can kind of mitigate. And no, I don't expect that new business is being attained in super expressive margins. We're working to kind of sharpen our pencils, but be appropriate in our pricing.

All right. That makes sense. And last one here. So we visited your center in Hyderabad. And I remember, you have a significant capacity to kind of expand there. Can you talk a bit about your future plans in terms of how important India or critical India is going to be able to continue to get those new logos onboard and actually to be able to accelerate growth down the road?

Yes. Still, I know like we answered it a little bit in gray area. But in general, you need to understand the current market environment is not what it was. And everybody knows it like 18 months ago or 2 years ago. The whole rate structure for everyone, not only for us, is different for new deals as well. So the other things which could change it is actually the demand come into more normal scale and the demand for complexity for build stuff will go up, then correction will be happening in other side. So there is nothing magical here. So the new deals coming today is very different environment if it was, again, 18, 24 months ago. It's number one. Number two, about India. Now I don't know when you visited -- I don't remember when we visited Hyderabad, but right now we have 5 development centers. We -- Hyderabad still is the biggest one, but we have 2 others, which are going very strongly and a few others which we started recently going strongly as well. So that's definitely an important part of our future, but it's one of the parts. It's not like we're going to switch completely. That's what I mentioned before. We're really looking how to build very balanced global delivery network for EPAM.

Our next question will come from Puneet Jain of JPMorgan.

I also wanted to ask about demand. Do you expect like clients to spend on CapEx investments to modernize or replatform their core systems sometime this year, maybe in 4Q? Or is that type of work is something that could come through under next year's budget, meaning that it might not come in anytime this year?

Do you expect to see modernization and spend occurring in Q4 or more likely to see a return to budget growth in the first half of 2024?

It's difficult to answer that. I think we answered this question already in another way a couple of times. We don't know it. There is not so much visibility. That's difficult. Some of them, who knows, it's sometimes unexpected happened in Q4 will be the quarter when clients will really start spending. But let's see, so...

Got it. And are you seeing any pricing pressure on a like-to-like basis?

The pricing pressure on like-for-like basis. So I think Ark obviously picked it up in a more pronounced way than I did earlier. So this is definitely an environment where you need to sharpen your pencil. And so clearly, we're being thoughtful, but it is in an environment where clients are particularly cost-sensitive. And that is showing up in pricing. And to Moshe's question earlier, is that traditionally in certain newer engagements, it's an opportunity to sort of improve price and that's less the case in this fiscal year.

The next question will come from Arvind Ramnani of Piper Sandler.

I wanted to ask you about your new clients. Are they coming from specific industries and geos? Or maybe are you going to provide some color on the nature of work on your new clients?

I think at this specific time, again, there are some industries like, let's say, oil and gas, which is in pretty good shape, okay? But this is more an exception today. The rest of the new clients, in our view, happens from 2 kind of categories. Some clients who actually try to utilize this time as an opportunity and decided to go and invest instead of like and get some competitive advantage. And that's exactly what you will recall before I said. As soon as these type of clients will demonstrate some results, it will trigger a faster recovery of the market for build and kind of transformative programs, okay? And the second category, I think it's a client which is, at this point, not trying just to do transformative programs, but trying to utilize this time to build relations with stronger vendors for the future return and be prepared for this because, in our view, demand for talent when market will rebound will be very, very strong with everything what's happening right now in technology, in technical debt. And since which we have not done or not finished and with everything was triggered by -- it seems like everybody is trying to talk about generative AI, so no questions, but it's still there and it will change actually and scale. So press will put pressure on the talent demand as well. Well, a lot of people -- speculation that it would replace companies like [indiscernible].

Yes. That's helpful. And I mean, I know typically, when you start your client relationships, they start small and then they kind of ramp over time. Is that kind of a similar dynamic that you have with these new clients?

So there are a few, for example, on -- we kind of give I think, 5, 6 examples across different [ industries ]. There are few of them which is pretty large. And that's why we mentioned that it might be that they will be driving our growth the next years. There are some of them, which is more framework contracts, which we won and just started, and there is a specific place how it's happening. So it might start to bring results like closer to the end of the year, maybe beginning of the next year, visible results. And there are some which is very, very specific programs, but not weak, but very interesting from the new technology standpoint. So it's kind of a variety of this. If we will see better trends, that would mean that it's actually the market change.

Perfect. And just last question for me. Just -- I did want to ask about Belarus. Can you share some sort of headcount trends and utilizing in Belarus? And are you also seeing any pushback with sort of your exposure to Belarus?

I think I would [indiscernible] Ukraine and Belarus here. I think with the Ukraine clients who stay with Ukraine are much more comfortable right now. We see some clients coming back. Again, it proves that nothing was happening from the quality of delivery or kind of impact on any production activities during the last 18 months, making clients more comfortable. Yes, it's kind of new normal, but normal is a key part of this. With Belarus, it's a slowdown. We still have clients which [indiscernible] there, and we have some clients who are exiting there. So Belarus is, from headcount point of view, kind of [ slightly ] faster than as of anything else.

I am seeing no further questions in the queue. I would now like to turn the conference back to Arkadiy Dobkin for closing remarks.

Thank you, everybody. I think we will update you in 3 months. But in general, we get in -- with all unpredictability, we feel a little bit more stable and predictable than the quarter ago. So thank you very much and talk to you in 3 months.

This concludes today's conference call. Thank you all for participating. You may now disconnect, and have a pleasant day.