David Straube - Senior Director, IR Arkadiy Dobkin - CEO & President Jason Peterson - CFO.

Anil Doradla - William Blair Steve Milunovich - UBS Jason Washburn - KeyBanc Vladimir Bespalov - VTB Capital Avishai Kantor - Cowen & Company Carlos López - Credit Suisse Mitch Mitchell - ECS.

Greetings, and welcome to EPAM Systems Second Quarter 2017 Earnings Call. At this time, all participants are in a listen-only mode. A question-and-answer session will follow the formal presentation. [Operator Instructions]. I'd now like to turn the conference over to your host, David Straube..

Thank you, Operator, and good morning everyone. By now, you should have received your copy of the earnings release for the company's second quarter fiscal 2017 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 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 numbers have been reconciled to GAAP and are available in our investor materials 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. Thanks for joining us. Let us start with a few key highlights on EPAM overall performance in the second quarter.

Our growth was broad based across both geographies and industries, the revenue for Q2 climbing U.S.$649 million, representing 23% year-over-year growth or 23.7% in constant currency growth, from a vertical perspective, with a strong growth across the majority of our industry segments.

In reporting currency, financial services, our legacy vertical continued the quarter with 7.6% growth which reflects the effect of the UBS revenue trends we discussed during our previous earnings call. Excluding the impact of UBS financial services grew 31.6% in Q2.

Demand from financial services is being driven by digitalization, regulatory changes in addition to record improvements. Travel and consumer finished the quarter at 21.7% growth with demand climbing from digital transformation projects as well as day-to-day earnings side programs.

Software and Hi-Tech grew 20.2% for the quarter based on diversified portfolio of software emerging start-ups and technology companies going over digital platform transformations. Media and entertainment grew 52.3% driven by our engagements in digital services, major information providers, publishers, and broadcasters.

Life Sciences and Healthcare grew 3% over the same quarter last year. Year-over-year growth was mostly imparted with retirement at one of our clients' with significant increase in revenue in Q2 of last year. Excluding this effect, year-over-year growth was 21.5% and 6.7% sequentially.

Worth to mention in healthcare, we continue to see demand in patient health management initiatives and major healthcare player and medical hospital managing provider in Q2 to all countries. Emerging verticals at 60.1%, growth was driven mostly by energy and telecommunications.

Revenue expectation across our clients continues to grow outside of the top 20 accounts climbing in at 37% with growth in the top 20 adjust on to 10% or more than 18% excluding the effect of UBS.

And our continued focus in helping our clients to address the challenges of digitally driven changes have led to broad opportunities across the Fortune 2000. In Q2, our growth was broad-based across year-over-year. In constant currency terms, North America grew 27%, Europe growth was 19% year-over-year or 34% excluding the effect of UBS.

This two geographic areas combine representing 94% of our revenues. Additionally our CIS region grew 17% and APAC grew 24% in constant currency terms. Our people. We ended with over 20,480 professionals a 12% increase year-over-year bringing our total in place head count more than 23,200.

Utilization for the quarter was 79.6%, climbing higher than our historical ranges due to tighter management during this period. We do expect utilization in Q3 to be down due to seasonality and natural volatility in supply and demand cycles. And in balanced market that is always is increasingly competitive.

We remain focused on attracting, retaining, and developing the right talent to support the current and future growth needs. In regards to overall market demand, the rate of disruption among our clients continues to offer extremely fast pace creating the challenge of successfully mitigating through important technology and operational confirmations.

We do believe we're still in the early stages of this digital era, this digital platform engineering extending from the consumer to the enterprise driving the need for next generation capabilities in areas such as full stock, engineering, [indiscernible], automation, and cyber security.

We continued to see real strengths in demand across our verticals service lines and geographies and we believe this demand for next generation capabilities and engineering deliver skills will continue for the foreseeable future. So as we will our business to position it for the future.

Our priority will be to continue investing across multiple areas including corporate and people talent infrastructure in line with our growth rate needs to allow us to establish new and growing capabilities with a focus on delivering increasingly sophisticated end-to-end integrated business and technology solution this is initiated by our advanced engineering capabilities.

Our profitability for the first half of this fiscal year reflect this ongoing investment and going forward you should expect this level of investment will continue and at times vary quarter-to-quarter. With that let me turn it over to Jason for a detailed financial update of our Q2 results and our fiscal 2017 guidance..

Thank you, Ark. Good morning everyone. Our service and financial highlights talk about profitability then cash flow and then guidance. As Ark mentioned we delivered strong top-line performance and generated solid free cash flow in the second quarter. Here are a few key highlights from the quarter.

Revenue closed to $349 million, 23% growth over the second quarter of last year and 7.5% sequentially. Year-over-year constant currency growth was 23.7% reflecting a modest headwind of 0.7% which was less than anticipated.

Actual revenues compared to our Q2 guidance benefited from stronger revenue production of $2.9 million and a favorable currency impact of $6.1 million. From a geographic perspective North America our largest region representing 59% of our Q2 revenues, grew 26.6% year-over-year and 26.9% in constant currency.

Europe representing 34.8% of our Q2 revenue grew 16.8% year-over-year and 19.4% in constant currency. Absent the effect of UBS growth in Europe was 34% in constant currency; CIS grew 27.2% year-over-year or 17.1% in constant currency and now represents 4.2% of our revenue.

And lastly APAC grew 21.9% year-over-year and 24.3% in constant currency and now represents 2% of our revenue. So moving down the income statement gross margin for the quarter was 36.9% compared to 36.3% for the same quarter last year.

The 60 basis point year-over-year increase resulted from higher utilization which ended at 79.6% compared to 74.1% in the same quarter last year, and 77.5% in Q1 of fiscal 2017. The increase in utilization was offset by a negative foreign exchange impact, a higher level of payroll tax related to options exercises and employee compensation.

In constant currency terms gross margin was 37.8%. GAAP SG&A was 23% of revenue compared to 22.6% in Q2 fiscal 2016. Included in this quarter's SG&A were higher costs related to an increase in personnel related expenditures including payroll tax associated with the exercise of stock options.

In addition, an increase in investments to continue supporting expansion in our client base in geographies. Non-GAAP SG&A which excludes stock-based compensation expense and certain other items came in at 20.4% compared to 19.6% in the same period last year.

As Ark mentioned, our SG&A reflects the continued investment in our talent acquisition, extension of our global footprint, and building onsite capabilities with a focus on supporting our long-term sustainable growth strategy.

GAAP income from operations was $40.7 million compared to $32.1 million in Q2 last year, representing 11.7% of revenue in the quarter. Non-GAAP income from operations was $55.8 million compared to $47.6 million in Q2 last year representing 16% of revenue. Our GAAP effective tax rate for this quarter came in at 13.2%.

The lower than expected tax rate was a result of the adoption of the recently announced stock-based compensation pronouncement and the generation of the greater than expected tax benefit due to a higher level of exercised options. Our non-GAAP effective tax rate was 22.7%.

For the quarter, we generated $0.68 of GAAP EPS which reflects an FX gain rather than unexpected FX loss lower than expected stock compensation expense in addition to the lower tax rate. Non-GAAP EPS was $0.80 compared with non-GAAP EPS of $0.71 in the second quarter of last year, reflecting a 12.7% increase.

Total shares outstanding for Q2 were approximately 54.8 million higher than the expected level of 54.3 million, largely due to the sizable number of options exercised in the quarter. Turning to our cash flow and balance sheet, cash from operations for Q2 was $27.9 million compared with $38.5 million in the same quarter last year.

The year-over-year decline is primarily due to the impact of a reduction in DSO in Q2 last year, coupled with an increase in DSO in Q2 of this year. Free cash flow came in at $22.2 million compared with $31.1 million in the same quarter last year resulting in a 50.7% conversion of adjusted net income.

Total DSO was 82 days compared to 88 days in the same quarter last year, AR DSO was 54 days and our unbilled DSO was 28 days. Turning now to guidance. Starting with full year fiscal 2017 revenue growth will now be at least 23% and we expect constant currency growth will continue to be at least 23%.

For the full year we now expect the impact of foreign exchange will be flat. We expect GAAP income from operations to now be in the range of 12% to 13% and non-GAAP income from operations will now be in the range of 16% to 17% which reflects our first half performance.

We expect our GAAP effective tax rate will now be approximately 16% and our non-GAAP effective tax rate will now be approximately 22%.

Earnings per share we now expect GAAP diluted EPS will be at least $2.57 for the full year driven primarily by a lower effective tax rate attributed to greater than expected excess income tax benefit from stock-based compensation. Non-GAAP EPS will now be at least $3.29 for the full year.

The updated non-GAAP EPS reflects greater than expected employee stock option exercises driving both higher total share count and greater payroll tax expense. We now expect weighted average share count of 55.2 million fully diluted shares outstanding.

For Q3, revenues will be at least $367 million for the third quarter reflecting a growth rate of at least 23% after 1% currency tailwinds meaning we expect constant currency growth will be at least 22%.

For the third quarter, we expect GAAP income from operations to be in the range of 11.5% to 12.5% and non-GAAP income from operations to be in the range of 15.5% to 16.5%. This range reflects a seasonal impact of utilization in Q3.

We expect our GAAP effective tax rate will now be approximately 16.5% and our non-GAAP effective tax rate will now be approximately 22%. For earnings per share, we expect GAAP diluted EPS will be at least $0.68 and non-GAAP EPS to be at least $0.84 for the quarter.

We expect the weighted average share count of 55.6 million fully diluted shares outstanding. Few key assumptions which support our GAAP to non-GAAP measurements. Stock compensation expense is now expected to be approximately $11.2 million in Q3 and $10.9 million in Q4.

Amortization of intangibles is now expected to be approximately $1.9 million in each remaining quarter. FX losses are now expected to be approximately $2 million for each quarter. Tax effect of non-GAAP adjustments is now expected to be approximately $4 million in each remaining quarter.

Lastly, with the recent adoption of ASU 2016-09, and as a result of moment in our stock price, we expect future volatility in our effective tax rates and GAAP EPS. We expect an excess tax benefit of approximately $2 million for each remaining quarter. Thank you. And let me turn the call back to David..

Thanks, Jason. I'd like to ask that each of you keep to one question and a follow-up to allow as many participants as possible to ask a question.

Operator, would you provide instructions for those on the call, please?.

Thank you. [Operator Instructions]. Our first question is from Anil Doradla with William Blair. Please take your question..

Hey guys good morning and good job on the top-line. So when you look at the top-line and the upper division for the full year was it driven by any particular end market customers or was it kind of more widespread as you saw in the current quarter..

It’s usually again you saw the concentration of clients is kind of becoming better balance or basically it's spread but we definitely have a number of our new large clients which you grow in very faster and creating potential for future grows. So again it's needed but there are very specific, specific engagements which drive into this now..

And in terms of geographic expansion over the next call it 12 months is there any particular geography around the world where you expect to emphasize in terms of headcount growth..

Headcount growth. Headcount growth well for us right now is usual and pretty much balanced around all our main delivery locations. So clearly still Eastern Europe which includes all Hungary, Poland, Belarus, Ukraine, Russia, Israel, we planning to grow in India too..

And don't mind me speaking in one thing the EPS reset was that purely driven by just this option stuff going around or was there any other particular you talked about options and share count but was there anything else or was it just driven by this..

Yes, the $0.09 reduction is just largely driven by the result of the impact of the greater than expected stock option exercises and so as we've said it's basically two impacts, one you've got the additional payroll tax expense and then the second is just the dilution impact and that's broken out by $0.07 by the additional payroll tax expense and $0.02 from the dilution..

Our next question is from Steve Milunovich with UBS. Please state your question..

Thank you very much. You're building pretty significant cash on the balance sheet.

How do you think about the use of the cash over the next couple of years?.

Yes, from a use of the cash standpoint, today we prioritize allocation of capital for our inorganic growth strategy. At the same time we are sensitive to dilution. So, capital allegation is an ongoing topic that we discussed with the board no change at this time but I think what we would update you as we evolve our thinking on that topic..

Okay. And at the Investor Day you spoke about recruiting the right talent to keep moving up the value stack part of that was getting to main experts with more consulting capabilities.

Can you update us on how that initiative is moving and how we should think about the impacts on margin and revenue per engineer going forward?.

So we definitely executing on this plan and we're bringing people. So, how it's going to impact any financial metrics is difficult to predict as this go and so. Clearly it could be little bit volatile because we bring in.

We plan -- we’re bringing and we're planning to bring more consultative people in the market is prior question and probably would be some gap between the time they joined and the time they start to really perform and become billable.

But again there is no specific projection how it’s going to impact; we do believe that we would be able to manage it in normal way of business.

Hello?.

Steve, are you there? Okay. Our next question is from Arvind Ramnani from KeyBanc. Please state your question..

Good morning guys. This is Jason Washburn in for Arvind. I'm just curious what investments are you guys making in AI.

What capabilities do you currently have in AI and how do you expect your business model to change if AI becomes more integral to your offering?.

So we have competence through this specific expertise in this. So we actually involved in multiple implementation of we process automation solutions, so how it's going to impact significantly anything in smaller short-term, I don't think we can judge on this.

But we definitely focus on this area and it's one of the most interesting future service lines for us for sure, we didn’t have traditional BPO services which would be mostly impacted by this. So we do invest in this and we do have some advantage..

Our next question is from Vladimir Bespalov. Please state your question..

Hello, my question is actually on your margins guidance, you lowered the upper balance of the guided ranges for the full year despite previous strong revenue trend, could you elaborate a little bit what is behind this?.

Sure. So we're really narrowing the range from 16% to 18% to 16% to 17% and it’s largely just a reflection of our first half results.

So if you'll remember we had 15.2% in Q1 and 16% in Q2 and so I should remind you that the Q1 performance included the impact of the $1.9 million land tax and so the narrowing I think just kind of reflects kind of our first half performance and I think if you do the math, you will see that we’re expecting improvement in remainder of the year..

[Operator Instructions]. Our next question is from Avishai Kantor with Cowen & Company. Please state your question..

Good morning and thanks for taking my questions.

On pricing, since the last conference call, you said that you were talking about stable pricing environment, is that still the case?.

Yes. We've seen a stable pricing environment and as I think we've talked about in the past, we continue to get angled price increases across a number of our customers and so definitely stable and with the opportunity for some improvement on an annual basis..

And a follow-up, regarding the acquisition in India any changes in how it is factored into the model in the last three to six months on the impact of the India acquisition on the model in last three to six months?.

No, we talked about it pretty extensively I think during the previous calls and I think transition investor days. There is no changes since last periods. We’re improving delivery quality and we kind of bring this to the general EPAM standards, so that's our main focus right now..

Our next question is from Carlos López with Credit Suisse. Please ask your question..

Hi, I wanted to ask about the working capital increase on the cash flow, I think it's driven by the increase in DSO, so could you please little bit elaborate on this, what were the reason for it and shall we expect the further negative cash impact from working capital? Thank you..

Sure.

Yes, so primarily this story is around the DSO and so what you're seeing is actually a substantial improvement in DSO on an year-over-year basis so, I think you'll remember that we were over 90 in Q1 of last year we were flat I think 88 in Q2 of last year and then we're down to 82 which is kind of where we guided but the 82 is an increase over Q1 and so clearly that does has an impact..

Our next question is from Vladimir Bespalov with VTB Capital. Please state your question..

Thank you for taking my follow up question.

I would like to ask you about UBS and outlook if my calculations are correct, they are approaching to the levels stipulated by your long-term agreements in terms of revenue generation a little bit about that level so, do you expect like going forward the impact of UBS on your growth rate to diminish and in general what do you see as the outlook for the coming quarters for this account.

Thank you..

Again, we don't care for any specific update on this. I think our long-term agreement actually indicated a minimum commitment. So and we this and above this how this account going to develop in the future it's a very difficult to predict.

We don't see any specific signs to share, the same like we were talking about it before it is in pretty stable condition to now, yes..

Yes, I just add to that so, UBS is certainly stable it’s performing within our expectations and we continue to see rapid growth in smaller accounts and new accounts within EPAM. So what I do think you'll see is that -- it has a let’s say modest impact on growth rates over time as we continue to grow other accounts..

[Operator Instructions]. Our next question is from Mitch Mitchell with ECS. Please state your question..

I just wanted to ask about the staffing again it seems like you're hiring rates slowed down a little bit this quarter is that -- is that the case or is this just something a little bit may be seasonal. Sort of lumpiness in the hiring process I mean just related to that can you give us an attrition figure for the quarter. Thank you..

I think it’s a little bit different reason because several quarters ago we were talking about our utilization levels which were below what you wanted and some unexpected branch existed due to some changes on UBS side.

And clearly our recruitment cycles where under our very detailed control so and right now we coming back to current exercise of the current 12% increase is much more than it was last quarter so, we just increasing hiring right now but it’s some normal kind of cycling right now..

[Operator Instructions]. Okay, ladies and gentlemen we have reached the end of the question-and-answer session. I'd like to turn the conference call back over to Ark for closing remarks..

As usual thank you very much for joining us today so, I simply have pretty strong quarter on revenue side. We also continue growing. I would share actually one [indiscernible] like we were talking about UBS and our growth outside of UBS right now around 29% which means that the future is stability of the account.

The growth should be -- should be good so and with this so we will see you next quarter. Thank you very much..

Thank you..

Thank you. This concludes today's conference. You may disconnect your lines at this time and thank you for your participation..