Ladies and gentlemen, thank you for standing by, and welcome to the EPAM Systems' Second Quarter 2020 Earnings Conference Call. At this time, all participant lines are in a listen-only mode. After the speakers’ presentation, there will be a question-and-answer session. [Operator Instructions] Please be advised that today's conference is being recorded.

[Operator Instructions] I would now like to hand the conference over to your speaker today, David Straube, Head of Investor Relations. Thank you. Please go ahead, sir..

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 2020 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.

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 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 GAAP and are available in our quarterly earnings materials located in the Investors section of our website. With that said, I will now turn the call over to Ark..

Thank you, David, and good morning, everyone. I hope that all of you are staying safe and healthy at the time and thank you for joining us today. Before I go into the second quarter highlights, I would like to reflect on the overall environment in the context of EPAM business.

First of all, since our last conversation in the beginning of May, the environment has definitely stabilized across our client portfolio, as our customers were responding to the many disruptions and, in some cases, permanent changes in the end markets.

At the same time, very much in line with what we shared during our Q1 earnings call, the impact we are seeing is very immediate, serious and localized for each and every one of us and our customers. And more importantly, while it's not a news anymore for anybody, we do understand that we are still far from the end of the event.

A steady dynamic environment continues to be influenced daily by global health crisis, social unrest and economic anxieties. We also can state that there are many examples where the current situation is changing the way our clients are doing business, engaging their customers and dealing with their end markets.

As a result, this change has required them to accelerate digital programs and projects, or in some cases, new models of engagement.

We ourselves have taken the challenge of COVID to drive much further our own adaptive program by bringing EPAM leadership closer to the field and making the field operations across EPAM market locations collaborating at much higher levels.

This closeness has taken our agility to the next level, enabling us to be more responsive to our clients' needs, new business opportunities as well as making faster money from our decisions.

The enhanced view of demand also has been pivotal to helping us gain much more real-time insight, be able to better mention global supply to the clients' needs and to optimize business efficiencies and to drive results.

And as remote working model has quickly become widely accepted and proven way to serve our clients, we believe this way of working will serve us well in the future as we continue to manage the downside risk, but also take advantage of expanded options when it comes to the talent acquisition and retention.

In the result, we are working very closely with our clients' teams to define and respond to demand in much more condensed time frame.

These new partners of engagement are supported by our increased investment in knowledge management, collaboration and productivity platforms, enabling quicker access to information and improve business processes to empower our teams to connect faster and share information seamlessly and be more productive when responding to relentlessly fast-paced environment.

Today, that is one of the most important areas of focus for us. Moving to our second quarter results. We delivered revenue of $632 million, representing 15.5% in constant currency growth, a non-GAAP EPS of $1.46, a 15% rounded year-over-year increase.

Our Q2 results reflect an efficiency and execution on lower levels of demand, while focusing on driving higher levels of performance across the company. Within the quarter, there were a few highlights that are worth mentioning to bring better insight to what we already stated in general terms.

As I shared previously, there is a level of stability in our end markets, which has allowed many of our customers to resume or move forward with the change programs. A number of our customers are focusing on streamlining their efforts as they reduce the number of service providers and consolidate across fewer key workers.

In many of such cases, we are benefiting by being asked to do more in helping with critical business and transformational efforts. To balance this, there are some industries and specific customers, which remain significantly impacted by the global pandemic, and we don't know when they will return to business as usual level of activity.

We know that there are some cases which are showing not stacking growth even in the current environment.

For example, Epic Games achieved that no other gaming company has before, a digital ecosystem that provides infrastructure and services needed to power gaming in Fortnite measured scale for every developer to access across any platform, engine and store.

Combined with a healthy library of games through the Epic Games store as well as the Unreal Engine, the world's most open and advanced real-time 3D tool. We are proud to have been part of Epic Games story since before the creation of Fortnite.

With our big data, software engineers and AWS expertise, EPAM has collaborated with Epic Games to provide the flexibility, reliability and scalability needed to continue to push the boundaries of online gaming and help Fortnite growing from one million players in 2017 to 350 million today.

In Q2, we also began working for several large new customers who have undertaken a multiyear transformation of their business. EPAM has been engaged to help with application development and enhancement efforts across several key areas of the organization.

And while it's still early days in the relationship, we believe there is a potential to add one or two of them to top 20 customers list over the next 12, 24 months.

We are also proud to share our recent partnership with UNICEF, resulted into developing a multi-featured HealthBuddy COVID-19 information app, designed to protect children, families and communities across Europe and Central Asia by dispelling the myth and rumors circulated with COVID-19.

And lastly, probably as a result of everything we just shared, in recent quarterly sector outlook for IT services webinar, Gartner provided competitive assessment across 15 legislative service providers, highlighting EPAM as one of only two companies, which are best positioned for COVID and after COVID types.

With that, let me share how we are looking at the second half of our fiscal 2020. We expect some continued disruption in our end markets, which will result in lower growth in a few industries we serve.

While some of the variability in our client behavior has reduced, we still believe it's challenging to talk about our business outlook beyond the next quarter, which Jason will cover right after. Similarly, as we shared with you during our previous earnings call, our key priorities remain unchanged.

We will continue to protect our people and our financial position as well as to make continuous investment in our core capabilities and platform to be prepared for eventual comeback.

We strongly believe our position as a leading provider of digital product and platform engineering services, combined with our integrated and maturing consulting expertise, is our key differentiator.

That is why we are very confident in our ability to come out of this challenging time, be even more value and result-driven company and continue growing in post pandemic environment with 20% plus rate. Now let me hand the call over to Jason..

Thank you, Ark, and good morning, everyone. During the second quarter, EPAM focused on supporting our customers' needs and operating our organization efficiently in an uncertain demand environment. The result of this effort was a quarter where we delivered better-than-expected results across multiple financial and operational metrics.

In the second quarter, revenue came in at $632.4 million, a year-over-year increase of 14.6% on a reported basis and 15.5% increase in constant currency terms, reflecting a negative foreign exchange impact of approximately 1%.

Revenue for the quarter was higher than our previously guided range due to somewhat better-than-expected demand, combined with greater availability across our delivery organization and, therefore, higher billable utilization. Moving to our industry verticals.

In Q2, we saw greater variability across the portfolio due to the impact of the pandemic on certain customers and their end markets. Business information and media, which delivered very strong results, posted 42.9% growth in the quarter and continues to be our largest industry vertical.

Life Sciences and Health Care grew 16.4%, reflecting a lower level of growth for both industries. The vertical was impacted by a tougher year-over-year comparison. Software & Hi-Tech grew 13.2% in the quarter. Financial services grew 6.3% in Q2. Growth in the quarter was impacted in part by an expected ramp down of the European banking clients.

Travel and Consumer was flat in the quarter. Growth in this vertical was impacted by a decline in travel and, to a lesser extent, retail, offset by growth across some consumer branded goods customers. And our Emerging vertical delivered 11.9% growth, driven primarily by clients in telecommunications, offset by a slowdown in the energy sector.

From a geographic perspective, North America, our largest region, representing 60.4% of our Q2 revenues, grew 14.1% year-over-year or 14.4% in constant currency. Europe, representing 33.4% of our Q2 revenues, grew 19% year-over-year or 19.8% in constant currency.

CIS, representing 3.5% of our Q2 revenues, declined 12% year-over-year and 3.3% in constant currency. And finally, APAC grew 20.5% year-over-year or 21.9% in constant currency terms and now represents 2.7% of our revenues.

In the second quarter, growth in our top 20 clients was 26% and growth outside our top 20 clients was 7% compared to the same quarter last year.

We saw increased concentration among our top 20 customers as our larger clients appear to be more resilient during the quarter and continue to make investments in response to the changing business environment. COVID-19 appears to have had a greater impact on clients who are midsized.

And as the business environment improves, we anticipate the revenue contribution from these clients to increase. Now moving down the income statement. Our GAAP gross margin for the quarter was 33.7% compared to 35.5% in Q2 of last year. Non-GAAP gross margin for the quarter was 35.1% compared to 36.8% for the same quarter last year.

Gross margin in the quarter was impacted by COVID-19-related customer concessions that were provided on a limited and temporary basis. GAAP SG&A was 18.1% of revenue compared to 20.3% in Q2 of last year and non-GAAP SG&A came in at 16% of revenue compared to 18.5% in the same period last year.

Our reduced SG&A levels in the quarter were substantially driven by a lower level of activity related to hiring, relocations, travel, and marketing events. GAAP income from operations was $83.4 million or 13.2% of revenue in the quarter compared to $72.9 million or 13.2% of revenue in Q2 of last year.

Non-GAAP income from operations was $108.2 million or 17.1% of revenue in the quarter compared to $92.6 million or 16.8% of revenue in Q2 of last year. Our GAAP effective tax rate for the quarter came in at 12.4%, which includes a greater-than-expected level of excess tax benefits related to stock-based compensation.

Our non-GAAP effective tax rate, which excludes excess tax benefits, was 22.3%. Diluted earnings per share on a GAAP basis was $1.14. Non-GAAP EPS was $1.46, reflecting a 14.1% increase over the same quarter in fiscal 2019. In Q2, there were approximately 58.2 million diluted shares outstanding. Now turning to our cash flow and balance sheet.

Cash flow from operations for Q2 was $146.2 million compared to $44 million in the same quarter for 2019. Free cash flow was $134.7 million compared to $32.4 million in the same quarter of last year, resulting in 158% conversion of adjusted net income.

EPAM ended the quarter with more than $1.2 billion in cash and available borrowing capacity, made up of $993.7 million in cash and cash equivalents, $60 million in short-term investments and $275 million available on our revolver. DSO was 73 days compared to 76 days at the end of Q1 2020 and 79 days in the same quarter last year.

Now moving on to a few operational metrics. We ended the quarter with approximately 32,300 engineers, designers and consultants, a 9.7% increase year-over-year and a sequential decline from Q1. Our total headcount for Q2 was 36,400 employees. Utilization was 83.9% compared to 78.4% in the same quarter last year and 79.5% in Q1 2020.

The high level of utilization in Q2 was the result of the greater capacity across the delivery organization, given the stay-at-home restrictions and limitations on travel during the quarter. We expect utilization to return to levels in the high 70s during the second half of fiscal 2020. Now let's turn to guidance.

With the continued uncertainty in the market due to the current pandemic, we will continue providing a quarterly business outlook while holding off on a full year view. As Ark mentioned, we've seen a stable level of activity in our portfolio over the last 90 days as our customers are adjusting to changes in their end markets.

Looking forward, we expect continued stability in Q3 with some improvement in the demand environment. Our capacity to generate revenue in Q3 will again be dependent on our ability to add headcount to meet improvements in demand while operating at more typical utilization levels.

For Q3 of fiscal year '20, revenues will be in the range of $633 million to $643 million, producing a year-over-year growth rate of 8.5% at the midpoint of the range. For the third quarter, 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 16.5% to 17.5%.

We expect our GAAP effective tax rate to be approximately 16% and non-GAAP effective tax rate to be approximately 23%. For earnings per share, we expect GAAP diluted EPS to be in the range of $1.15 to $1.24 for the quarter and non-GAAP diluted EPS to be in the range of $1.40 to $1.49 for the quarter.

We expect a weighted average share count of 58.6 million diluted shares outstanding. Finally, a few key assumptions that support our GAAP to non-GAAP measurements for Q3. Stock compensation expense is expected to be approximately $19 million. Amortization of acquired intangible assets is expected to be approximately $3 million.

The impact of foreign exchange is expected to be approximately a $3 million loss for the quarter. Tax effect of non-GAAP adjustments is expected to be around $5.6 million. We expect excess tax benefits to be around $5.9 million. All in all, we delivered a good quarter, successfully navigating a challenging business environment.

I would like to thank our employees across the globe for their hard work and dedication to EPAM's success. Operator, let's open the call up for questions..

[Operator Instructions] Our first question comes from Ramsey El-Assal with Barclays. Your line is open..

Hi, guys and thanks for taking my question. I was wondering if you could comment on the kind of competitive environment in the context of this pandemic. I mean, you mentioned consolidation of vendors among clients and that could potentially be a tailwind for you guys.

If you could just give us a little bit more color on that, particularly on that process in terms of vendor consolidation.

How strong of a force do you think that is in the market? How could that change the competitive environment?.

I wish it would be easy to answer the question because like, as we mentioned, the situation is not stable at all. But definitely, one of the reaction of the clients on this change was consolidation. And we've seen this clearly, specifically across large clients.

So it's not something really new, but it was accelerated during the last two quarters, practically. And I don't know what – how exactly to quantify it. It's definitely happening at a number of large clients..

Okay. And then I wanted to ask about the – you'd mentioned kind of limited and temporary concessions. I'm just curious how much of an impact that might have had in the quarter and expectations there about – around that continuing into next quarter.

Is that a headwind we should sort of expect again? Or is that really just sort of a one-and-done phenomenon this past quarter?.

Yes. So in the quarter – in Q2, and then I'll talk about Q3 as well, we'd have had a modest impact on revenue, but it did show up in our gross margin number.

And to be clear, if you think about clients, particularly, for instance, a midsized airline that is doing 10% of the revenue that they had expected to do and they have – asking their employees to work two days a week and take a 60% or greater sort of pay cut.

When you have a discussion with that type of client, it's very hard to say, hey, look, we're not going to do something to support you. And so we had a series of those types of conversations, again, for definitely a minority of our customers, those who had very challenged kind of revenue models.

The discounts are definitely sort of temporary, intended to sort of bridge through a COVID period. We expect that the impact will decline between Q2 and Q3 and then, again, in Q4. And again, it's a temporary to just be a supportive partner of certain of our more challenged clients..

All right, terrific. Thanks so much. I appreciate it..

Sure..

Thank you. Our next question comes from Jason Kupferberg with Bank of America. Your line is open..

Hey, good morning, guys. I just wanted to ask a question about the Q3 revenue guide. I know at the midpoint, you're looking for 8.5% constant currency growth versus the 15.5% we just saw in the second quarter. So understandably, you want to continue to be conservative in this environment.

But I'm wondering if there's some specific call-outs that would drive the slowdown? How much of it is supply driven? And do you think that Q3 will be the trough for year-over-year top line growth?.

Yes. So we feel clearly much better about the demand environment. What we saw in Q2, I think, consistent with what some of our peers have said is sort of stabilization kind of in the middle of the quarter. And then we've also seen some really interesting growth opportunities, both with existing clients.

And actually, we've had some nice new logo wins even during the pandemic when we couldn't meet with clients and they couldn't come visit us in our delivery centers. So clearly, the demand environment is improving. At the same time, you'll note that we really didn't add any headcount. Actually, headcount declined between Q1 and Q2.

And so we've turned back the recruiting engine. We've turned the recruiting engine back on, but we've kind of had a quarter where we didn't add headcount. And so that is going to have an impact on the growth rate as a percentage growth rate.

We're clearly back hiring relatively aggressively at this time to support what we see is a solid improvement in the demand environment..

Okay. Yes. No, okay. I think I get it. So maybe....

I mean, you got to think about the fact that we usually would have hired, I don't know, 1,500-plus employees, and those employees aren't here right now, right. So that is going to have an impact on. So again, it is very much – or much more so supply-driven. Right now, we're back in a time where demand feels certainly improving.

And now it's all about putting supply in place..

Right. Right. So a few months ago, obviously, things felt worse and you were less willing to keep the recruiting engine on and now you've ramped it back up, I'd say.

I guess as part of that, any issues finding the right talent in the right geographies?.

Issues finding the right talent in the right geographies..

I'm smiling because even in this situation, like I can repeat what repeating for the last several years. So it's a very different environment in general. But for the talent it's very similar because like with the situation, as you heard – as you see, the kind of competition for talent on global level only growing.

So – and while revenue impact because of specifically all these budgets and all these uncertainties happen, gave kind of relief for some period of time. It seems like in the future it will be very, very competitive. And it's feel and visible even right now..

Yes. So we feel comfortable with our ability to hire to support the demand. But as Ark said, the market continues to be somewhat challenging..

Right. Just a follow-up on margins.

I guess, to the extent that those stabilize or even creep higher, would that more likely be driven by improved top line growth or SG&A leverage, recognizing that utilization coming down in the second half of the year?.

Yes, correct. So we had very high utilization in Q2. We expect that, that utilization level will decline between Q2 and Q3. At the same time, I expect you're going to see a solid improvement in gross margin between Q2 and Q3. And that's driven by a number of factors. One, as I said, the discounts are time-based and temporary.

So the level of discount will decline between Q2 and Q3. We had some revenue recognition impact in Q2, largely related to Russian financial institutions. And again, it's something that we occasionally experience where we start work, but we don't have a signed contract and so we're not able to recognize revenue. We'll have less of that impact in Q3.

Then we usually – the usual impact of Q3 is there's more available workdays in Q3. So that has a positive. So those three positives will exceed the impact of lower utilization. And I expect a solid improvement in gross margin between Q2 and Q3.

And that's part of the reason for the guide of 16.5% to 17.5% despite the fact we also expect an elevated SG&A as a percentage of revenue relative to the 16% we booked in Q2..

Got it. All right, thanks for the commentary..

Thank you. Our next question comes from Bryan Bergin with Cowen. Your line is open..

Hi, good morning. Thank you. I wanted to ask here just 2Q outperformance, the bridge then to the 3Q view.

So can you just talk about some of the drivers of the better 2Q results versus your expectation? Was there any shorter-term work benefits there that contributed any industries that pulled some things forward? So I'm trying to get a sense on pipeline tone that you have here and whether 3Q is the trough from growth, so to speak?.

So Q2 situation just reflects how volatile the whole environment was at the beginning of Q2 and how it's ended up. So the level of uncertainty between clients and utility was very different at the end of the quarter.

So – because I understand your question you're asking why Q2 results were so much higher than expected, right?.

Yes. It was, obviously, solid outperformance relative to where we stood three months ago. And understanding you're giving a relatively, I guess, prudent view here for 3Q, given the uncertainty. So I'm just trying to understand whether there were things pulled forward that caused you to outperform here and that's why you're your 3Q is down..

No, no. This is just very volatile environment where clients were making kind of one assumption at the beginning of the quarter and change it then. So – and that's exactly, I think, a reflection of how we were like communicating at this point. And right now, as we mentioned already, environment feels much more stable.

So there is no like daily changes or weekly changes in client behavior. It's much more predictable. That's why we feel that Q3 feels better. But as you know, it's still not business as usual, and that's why we're still not comfortable to predict what's going to happen in Q4..

Yes. So Ark kind of talked about market and customers and the fact that we didn't pull anything in. I think I'll just answer simply from an algebraic standpoint. We had this, what I call, a slightly perverse impact of the pandemic. Demand was somewhat better than we expected, as Ark said. But we – people couldn't go on vacations.

In many cases, those of us who were in major cities, you couldn't go outdoors to do anything other than to grocery shop and walk your dog. And so you had people who would have had booked vacations that did not take those vacations, and instead, they worked.

And so we saw much higher levels of utilization, and that helped – in the T&M business that helped drive some of the revenue overage. And we expect that the utilization levels will return to normal, which again is high 70s.

And so part of what you're seeing is arguably a supply constraint that's a result of people beginning to take vacations in Q3 when they didn't take vacations in Q2, if that's clear..

Okay. Yes. And then just a follow-up here.

Just as revenue growth does recover, are there aspects of what you've done in the cost structure that will enable you to sustain margins at a higher level? Understanding utilization is going to come back down, but anything on the corporate side or anything like that, that helps you have a more confident view here on profitability going forward?.

So I wanted to, first, I think comment on the negative. So we ran at 16% SG&A, and we do expect that to head back towards the 18% to 19% range that I've guided to in the past. It will take some time, so I don't expect to end up in that range in Q3, but we probably would end up in the 17% to 18% range.

I do think, though, that we clearly have learned during this process, right. And so we did a lot more – a lot better job, to be honest, probably of matching supply and demand and being very nimble to respond to changes in individual clients. So for instance, you had a ramp down of one client and a ramp-up in another.

Rather than hiring to support the ramp-up, we were very careful to try to match staff that were coming off one customer to – and then to put them on the ramping account. So I think we got more nimble there. So who knows what impact that could have on bench and utilization.

And I think, that what you'll continue to see now, particularly in both the SG&A and to a certain extent in the gross margin line is renewed investment to support that in excess of 20% growth rate that we expect to return to in the not overly distant future.

But again, so I think there'll probably be things that will be kind of on the margin in terms of positive impact, including probably less travel and some of that.

But I think, I would still sort of articulate that our greater than 20% growth rate with a profitability range of 16% to 17% sort of consistent profitability is how we intend to land once we kind of get through the challenging economic times..

Okay, understood. Thank you..

Thank you..

Our next question comes from Maggie Nolan with William Blair. Your line is open..

Hey, this is Ted on for Maggie. Thanks for the taking the question.

Ark and Jason, could you talk a little bit about the hiring in this type of environment? And maybe how that differs to a year ago, just largely speaking, the work-from-home environment?.

So I think it would be more proper to talk about it like next quarter because like if you understand like what's happening dynamically in the market, and Q2 wasn't exactly the quarter where people were hiring a lot. So that's why it's difficult to answer the question. It definitely was very different than last year. It was mild softer labor market.

But again, Q2 probably will be an exception. So I think that question would be interesting to kind of review next quarter when some stabilization happen and people will start to kind of hiring again in bigger numbers.

I understand a little bit confusion because we're saying that it's still a very competitive market, and it is a very competitive market, okay. But Q2, again, was an exception and wasn't much hiring was happening. So mostly like numbers was natural attrition, which is also lower. Involuntary attrition was higher than usual, okay? So that's all changes.

Demand from clients was clearly lower than previous quarter. Everybody understand Q2 still huge different versus Q1. But right now, since the market stabilize, right now, the labor market starting to be – getting hotter as well. So – and I think next quarter will show the differences..

Yes. And we kind of ran the recruiting engine in kind of idle mode. We've turned that back on. As I think you've seen in the past, we've been able to add, in some cases, I think, in excess of 2,000 net additions.

And so clearly, it will take us a little bit of time to go from idle to sort of fully running, but we're clearly doing work that we've always done with universities. We're beginning to do lateral hires. Again, our brand as a hirer continues to improve. And so I think you'll see us sort of turn it on and certainly push it harder as we go from Q3 to Q4..

Okay. That's helpful. And then as you mentioned, Ark, the demand for digital transformation has accelerated. So I guess coming out of COVID, do you believe, I guess, just qualitatively speaking that EPAM could see a period of time where growth kind of exceeded that historical, like, 20% organic growth, right.

Not necessarily looking for specific guidance, just more in terms of kind of the growth trajectory and maybe if the floor for that revenue growth kind of in the medium-term here has maybe moved up at all. Appreciate your thoughts on that..

I think I would rather confirm what we shared already today in our kind of general update that we would like to see how we return to 20-plus percent growth.

And I think it's very, very visible because higher growth at this size, very difficult to accomplish because all of these components of the quality metrics which we need like to provide and everything else which we talked in the past many, many times. So, I think, the goal right now to return to normal for us, 20% growth.

And, I think, the market definitely will support it. Higher than that, it's a different issue than just market demand..

Yes. And so as Ark said, generally, we've been operating at greater than 20% growth. So I think those types of growth rates which, I think, historically, have been more in the sort of 22% to 23% to even 25%..

Okay. And if I could quick follow-up question.

What was the organic growth rate this quarter? And what's included in guidance for Q3?.

Yes. So the organic growth rate, so I'm going to decompose. So we've got 14.6% reported, on a constant currency basis we've got 15.5%. And then we've got about 2% benefit from inorganic. And so that was a 13.6% organic constant currency growth rate. We expect to get less of a benefit from, let's say, M&A related or inorganic.

So we think that, that contribution is going to go from 2% in both Q1 and Q2 to 1% or maybe slightly above in Q3. So again, the – I think we feel pretty good about the growth rate considering the market. And again, very little of that is acquisition driven..

Thank you very much..

Thank you. Our next question comes from Surinder Thind with Jefferies. Your line is open..

Hi, good morning. Just visiting kind of the comments – some of the earlier comments about revenues and growth.

If I was to parse your comments about supply constraints, are you suggesting that 3Q marks the bottom for revenue growth? How should we think about that?.

Yes. I mean the challenge without my sort of doing the algebra on the phone call, which I'm going to avoid, is – but I'm going to maybe help you with that. You have to probably go back and look at how many – how much headcount we were adding, let's say, in 2019 on a quarterly basis and then look at what we added in Q2, which was net negative.

And think that, that comes out of the revenue number for a while until we can sort of catch that back up. And so, naturally, I think, going to take you to a place where you realize that it's hard to get in excess of 20% growth rate in the near-term because you've got a lot of hiring catch-up that you need to do.

Again, solid demand environment, we're continuing to hire, but we have a quarter where we were appropriately responding to a very unclear and, as Ark said, sort of declining demand environment as we went from Q1 to Q2. Ark, do you have? Okay..

And then as a follow-up, can you help me understand the comment about the supply constraints and the fact that adding headcount still remains quite challenging, if I understood you correctly. Going back to last year, obviously, when you were growing above 20%, headcount was growing mid-teens.

And so is there any reason you can't grow mid-teens plus or a lot faster than that at this point? Like what is – even at the....

Yes. I think we're missing the point of how the whole process working and what it means in terms of supply chain when you need to hire like thousands of people. So when something like was starting to happen in March and April, with predictions that everything will go down and clients' reactions as well.

So you have to stop it, the whole engine of bringing people in, okay. And this engine, you cannot start just in one day or in one week, and that's what we're talking about. There is no anything systematic like problem which not recall, but we need like probably another quarter to restore the whole engine to work properly..

So – and maybe I wasn't clear enough, is that in the case of Q2 we're running at very little bench, right. So when we entered the quarter and we gave guidance, we said that, hey, if demand slacked, we were going to maintain our workforce and maintain our capacity for a return. And we guided to $590 million to $605 million.

And here, we ran at $632 million. And so you can – so there's not a lot of inventory left in the form of bench, and so we've got to build our inventory back up again. And again, it means that we feel good about the demand environment. It means that we expect ongoing revenue growth.

But as Ark said, it just takes a while to hire the thousands of employees that you need to get back to an in excess of 20% revenue growth rate..

Understand. So....

Plus, it's still like there is like from the market point of view, it's not the market's clear from demand to support 20%. Let's not forget this as well. It's not like we are in a normal environment. We are not. And we all understand that volatility is very, very strong. And like even what's happened in Q2 alone, it's stabilized.

At the same time, many of us were thinking that the whole pandemic kind of situation going to improve and then the second wave started. And we still don't know how the second wave will come up like in another month or two and what it means actually for business. And business still haven't got potentially second wave.

That's why we're talking about it's, by far, not business as usual still. It's much more stable than three months ago when we were talking about what we see. In May, it's much more stable, but it's incomparable with last year..

I think I understand in the sense that given the uncertainty you have to – obviously, it takes time to ramp up, but you also have to be cautious in the sense that there may be a second wave or something....

That's absolutely true because we don't want to ramp up and then have again situation like we were facing this at the beginning of Q2 or end of Q1..

That's helpful. And then as a follow-up, maybe a little bit more color on the demand environment and kind of the sales strategy. It seems like revenue concentration in your top five customers continues to climb. I'm assuming this is simply a function of them continuing to spend.

These are larger clients in the downturn, whereas maybe your client – your smaller clients have gotten more defensive.

So how are clients outside of the top 20 evolving at this point from a demand perspective? And the mix of new clients versus – is the vast majority of your growth at this point coming from existing clients of that 15.5%?.

So I think during my kind of general overview, I was trying to bring specifically the points. Like I think, yes, largest client with whom we have strong relationship and level of trust, we're benefiting from consolidation, okay.

There are a lot of opportunities for growth in large clients which feel better and more strategically jumping to prepare themselves for kind of unexpected situation like happened already, because somebody was asking about if we're seeing that all this digital transformation will allow us to grow faster than 20%.

From this point of view, I think everybody understands that digital will be winning even more and demand will be even more and everything what's happened pushing us like for five, 10 years ahead than we expected like six months ago. So all of this happening.

So on specific points, there are companies like there are new clients, and we have a number of new clients, pretty large ones, which, as we mentioned, we're thinking that probably in another 18, 24 months might become top 20. There are some growth in below 20 across a number of clients.

At the same time, there are some impact on smaller clients, which not certain or didn't have financial resources to put together or actually in the industries which is very much impacted. So – and that's created this a little bit increase in concentration.

So – but in general, we don't see any specific like or something unusual from reaction across the portfolio. I think it's pretty good feeling about opportunities throughout the portfolio..

Thank you..

Thank you..

Our next question comes from Ashwin Shirvaikar with Citi. Your line is open..

Hey, good morning, Ark and Jason.

How are you?.

Very good. Thank you..

Yes, good to hear from you guys. Thank you for all the comments and details. One thing I wanted to understand was sort of a rate of change, if you will.

So which verticals – or your conversations in which verticals are getting better and in which verticals are they getting worse? In other words, is there any kind of – the – I guess, the initial verticals that things like travel get hit, understood.

But where are things getting incrementally better? Where are they getting incrementally worse?.

Yes. So the funny thing, even at travel, which would have had an immediate impact coming into April by the – by, let's say, late in the quarter, you began to see certain of the travel customers come back and say, hey, look, we need to do certain things to be able to respond to the changes in the market.

And so I would say it's, in some cases, maybe better, but at the same time, we clearly expect that that's going to continue to be challenged from an annual growth rate perspective. We continue to see strong and expect to see strong growth in the business information and media.

Large companies looking to modernize their technology – large technology budgets. So we think that continues to be a strong opportunity for us. Health care, as Ark has talked about, we not only feel good about health care but also we've got some new opportunities there, new logos. And then, I think, the financial services might be a little bit mixed.

As we talked about, we had a ramp down of a European bank, and that will show up again in the Q3 growth rates. But – and again, the technology is a little bit mixed for us. We've got some large technology clients, including one that Ark talked about in his – at the beginning of the conversation that continues to show good growth.

And then we've got some smaller tech clients that probably continue to take a more defensive stance..

So I think like, in general, it's almost like practically each industry right now looking what they need to do next to prevent the situation. That's why like it really feels that there are opportunities across almost each industries, even the most impacted exactly because they were most impacted and they're thinking what to do during the next time.

The problem still there that nobody understand where economy going to be in six months. So – and the juggling decision, jump right now or wait a little bit, or some of them have resources, some of them not. So – but my short answer would be that opportunities practically all over the place.

And this is like at beginning of Q2 some of them completely stopped and then at the end they reverse decisions..

Understand. I understand. So as you kind of try to figure out some of these puts and takes, and you've clearly given your new outlook for 3Q here. When you gave your outlook for 2Q, there was a level of visibility.

And as we went through that quarter, it looks like visibility increased and visibility – what's the visibility for 3Q relative to the same time 2Q? How are you feeling about that in terms of the potential for the upside?.

Yes. So I think, we've talked about the fact that we've always had a series of systems and processes that are supported by the systems that we use to track demand and update on a daily basis.

At the beginning of Q2, we also initiated a series of what we call standup meetings, Europe in the morning and North America in the afternoon, where we were very carefully collecting feedback on customer behavior. And certainly, there was an awful lot of ramp down activity at the beginning of Q2, which informed our guidance, okay.

Right now, obviously, the tone of those conversations are radically, and I would say, kind of 180 degrees different. And so clearly now, we have much more comfort. We've talked about sort of improving demand. I would say, maybe strangely, more the uncertainty is around supply.

And, again, this is going to sound kind of funny, but true, it depends on, to a certain extent, on how much available work we have, whether or not employees are on vacation or whether they're staying at home and working. And you understand how that dynamic would work in a T&M business..

Yes, absolutely. Got it. That color is useful. Thank you..

Thank you. Our next question comes from James Faucette with Morgan Stanley. Your line is open..

Hi, this is Jonathan on for James. Congrats on the quarter guys.

You mentioned being the beneficiary of vendor consolidation, but have you seen any pressure from larger diversified competitors? Or are customers still looking for best-in-class partners?.

In our view, customers looking best-in-class partners specifically right now because everybody understands – again, coming back to how this crisis showing how important digital going to be in the future. And from our point of view, we're winning in some consolidation game exactly because of considering to be best-in-class right now..

Got it. That's helpful. And then you touched on the strengthened demand environment, but can you provide color on sort of the pace of project starts by vertical.

So which verticals are seeing sort of faster upstarts than others?.

Honestly, in my view, it's still more specific customer dependent than specific vertical dependent. Again, probably, at least this is how it feel inside of our portfolio. But we're definitely seeing some acceleration across capital clients and health care, life science and media and communication as well. But there is still a lot of volatility.

So it's very difficult to answer this question. This is certain that this industry growing much faster than others. Because like I mentioned like even some of them impacted, some of them making strategic decision and sometimes be surprised..

That’s helpful. Thank you..

Thank you. Our next question comes from David Grossman with Stifel. Your line is open..

Thank you. Good morning.

I'm wondering if you could just talk a little bit about what's the client's perspective as well as your own on the dynamic of work-from-home? How that – how you would expect that to evolve in the back half of the year? And whether the percentages you think stay at an elevated level, even when the pandemic has abated?.

I think it's kind of the second – the most interesting outcome of the whole situation in addition to acceleration of digital like the acceptance of working-from-home environment. And again, at some point, we expect that the clients will be much more demanding to return to more normal setup.

But again, the second wave, practically starting this, and it's turned into a much longer exercise working-from-home. I think we still will get lessons from this because one thing when people considering, okay, I need to do it like for three, six months and then another like changing for almost permanent.

But in short, I'm not going to say anything new here. Everybody understands that it was much, much better than anybody expected. And companies were able to turn to this environment and stay productive, much better than expected. And it's, for sure, that this environment is going to be with us for long term.

The proportion of this is going to be 20/80 or 80/20 or 50/50, we will still have to see. Probably like in another six months, we will be having much better answer. But we definitely rethinking the whole infrastructure right now and how it works.

While, again, we were preparing for this, I probably mentioned before that we probably one of the most distributed company with a number of small offices in comparison to any our competitors. So better prepare it for this. Now we're going like to improving the systems and operation and platforms to support even higher level of distribution.

And I think we'll be benefiting from this. But again, the exact proportions, we'll still have to see..

And what is your preference? What is the best outcome for EPAM in your mind?.

The best – it's definitely given additional level of flexibility in terms of finding the best talent independently of where its location and how it can work, from office or not from office, from large city or small city. From this point of view, it's additional dimension for talent, but it's not going to benefit just EPAM.

It can benefit anybody who will be able to provide the right infrastructure. We do believe that we have advantage here..

Right. Okay. And then just – I want to go back to the customer cohort question about – so much of your growth historically has come outside that top 20. So I did hear your explanation, so you don't need to repeat that.

But is there an element of supply here also where you're redirecting the limited supply that you did have in the quarter to your bigger clients as well as all the other things that you mentioned? And the only reason I ask is just so much of your growth historically is coming from outside the top 20 accounts.

I'm just wondering if there – is this a temporary shift or is this something more permanent?.

We do believe that outside 20 we'll start grow – and we'll be growing eventually faster. In this very dynamic environment, it's a little bit different because if you have established relationship and opinion changing quickly and you understand what you're doing, so sometimes it's easier to focus on known relationships and known facts.

So it's part of this. But in general, like, let's not be confused about top 20. We have like – inside of top 50 or top 100, we have so many opportunities to grow that we're absolutely sure that it would be rebalanced again 1%, 2%, 3% up and down between all of this..

Right. Okay. And then just one last thing. I mean, Jason, I think you indicated you didn't want to go through the algebra, which I understand. But just back of the envelope, if I just kind of look at historic headcount growth, it looks like the absence of growth in headcount kind of hurt you a bit, about 5%.

If you assume that the pricing is offset by utilization, it looks like you're about 500 basis point impact from the headcount issue.

Does that sound about right to you?.

Let me just look at it for a second here. Yes, I'm concerned about maybe what conclusion you might draw, but my rough math kind of, yes, would be somewhat consistent with that..

Got it. All right, guys. Thanks very much..

Thank you. Our last question is from Edward Caso with Wells Fargo. Your line is open..

Hi, good morning. Thank you. I was just – could you just remind us how you hire people historically? How many are in-person interviews? How much is done virtually? How many from recent grads versus laterals? Just trying to get a sense of how you did it in the past, and I assume most hiring at the moment is virtual.

And I'd be curious about the school cycle of recent grads. So how that might impact your ability to reaccelerate hiring? Thanks..

Yes, different locations is different. But in much more scalable locations, probably 50% of people coming from universities, but we have special infrastructure to go through like internal boot camps to bring the level of people to the right level. And it could be hundreds of thousands of people in these boot camps.

And that's part of the style which was kind of slow down as well. And that's why we're explaining the whole logistic. But we're talking like almost each quarter about our platform and system. It includes like already distributed platform to interview and process and the whole workflow, which is part of our ecosystem.

So from this point of view, doing this virtually, it's very much part of the culture as well. So....

My other question – oh, go ahead..

From this point of view, we should be able to reengage the whole engine relatively quickly. But again, it still takes time, taking into account how much is distributed across multiple development centers and how much we need to like to put efforts around boot camps and all..

Right. My other question around is your M&A efforts. What the pipeline looks like? I assume you kind of put it on hold in the last few months. So you're back looking again.

And then given your significant balance sheet capabilities and sort of what areas are you looking?.

From M&A point of view, I don't think there are any changes. So it never was put on hold. So it's actually – I would say that it's probably even accelerated area of focus, very, very similar to what were in the past. So there is no change here. The thinking is as usual. So when it would be happening so we will announce. But again, nothing change in M&A..

Thank you..

Thank you. This concludes the question-and-answer session. I would now like to turn the call back over to Arkadiy Dobkin for closing remarks..

Thank you for joining us. And again, hope that everybody is safe in this interesting time. And we're pretty positive about what's happening right now. It's much better than we thought will be like three months ago. So again, environment is stabilizing. Hopefully, it will be continuously stabilizing and let's see what we can share in three months.

Thank you..

Ladies and gentlemen, this concludes today's conference call. Thank you for participating. You may now disconnect..