EPAM Systems (EPAM) Q2 2024 Earnings Call Transcript

EPAM Systems (EPAM -8.70%)
Q2 2024 Earnings Call
Aug 08, 2024, 8:00 a.m. ET

Contents:

• Prepared Remarks
• Questions and Answers
• Call Participants

Prepared Remarks:

Operator

Good day, and welcome to the second quarter 2024 EPAM Systems earnings conference call. (Operator instructions) And finally, I would like to advise all participants that this call is being recorded. Thank you. I’d now like to welcome Mike Rowshandel, head of investor relations to begin the conference.

Mike, over to you.

Mike Rowshandel — Head of Investor Relations

Good morning, everyone, and thank you for joining us today. As the operator just mentioned, I’m Mike Rowshandel, head of investor relations. By now, you should have received your copy of the earnings release for the company’s second quarter 2024 results. If you have not, 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 would like to remind those listening that some of the comments made on today’s call may contain forward-looking statements. These statements are subject to 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 will now turn the call over to Ark.

Arkadiy Dobkin — Chairman, President, and Chief Executive Officer

Thank you, Mike. Good morning, everyone. Thank you for joining us today. First, I would like to start off with our second quarter results, which came generally in line with our expectations.

We believe our performance in the second quarter of 2024 reflects our continued strong execution and adaptability amid a still complex demand environment. Let me share some current highlights of our business from Q2 up to today. Our underlying business continues to show signs of stabilization. In the second quarter, we delivered very strong growth in our healthcare and life sciences vertical and strong growth in our emerging verticals, where we also saw some slight sequential improvements in financial services.

In some of the verticals, namely business information, and media, we continue to work through the impact of the ramp-downs from the few large clients we have mentioned before. On the demand environment, we do see broad-based signs of stabilization as well across both EMEA and North America. At the same time, clients are still cautious with larger programs and our visibility to a significant increase continues to be constrained by a mix of clients, cost-saving priorities, delays in program starts, and clients’ own business changes. As a result of this complex environment, we are currently assuming no net improvements in overall demand for the remainder of the year.

Jason will provide more details of our updated outlook for 2024. To be clear, notwithstanding the overall demand picture, we are optimistic about certain sectors of our target market and our current portfolio returning to modest growth story in the next two, three quarters as we see it now. In overall, while we adjust our offerings and our delivery mix to see the parameters of the current demand environment, we continue to see significant traction in our data and analytics, core engineering, and digital engagement offerings, especially through the broad transformation of each with AI, as well as increasing agents that our consulting and advanced technology capabilities are driving new top of the final opportunities for us. So meanwhile, we remain focused on responsibly managing our business in this part of the cycle, building on our strong fundamentals and ensuring that the EPAM continues to be the partners of choice while the demand environment improves.

Turning now to our global delivery strategy. In Europe, our differentiated capabilities continue to create significant opportunities for our clients to leverage the top talent on their most complex business and technical challenges. We believe this traditional EPAM advantage will continue to serve our clients well, especially as a turn from mostly cost-driven considerations back toward driving growth and innovation through the use of advanced technologies for their complex transformation and modernization efforts. We are also continuously investing in our more recently established delivery hubs across Western and Central Asia, which are emerging talent markets and where we are enabling strong and experienced tech talent to responsibly lead our future growth in the region.

India remains a priority and is on track to becoming our largest delivery location by the end of the year. We have built scaled centers of excellence in data and analytics, digital marketing, commerce, sales force, SAP, and other key horizontal and vertical service lines. Our primary focus is on building a scale, EPAM grade quality engineering, while blending in with many unique enterprise-level capabilities present in India and not available in most of other EPAM locations around the globe. We believe this approach will differentiate EPAM India our clients and create strong growth opportunities for our people.

We are also continuing to expand our core engineering capabilities in Lat Am. In addition to Mexico and Colombia, we now have a short delivery hub in Argentina. We will continue assessing and developing new local talents across the region. In each of these years, we are investing in our existing and new technical capabilities, including crucial for the future gen AI data, ML and predictive AI, and in corresponding IP development.

In short, we are building full-service gen AI delivery practices through a network of gen AI x-labs across major debt centers to enable and scale gen AI-enabled client reduction activities. In addition, both in India and Lat Am, we are evolving into strategies that includes not only differentiated delivery capabilities but also being able to offer compelling in-market presence end solutions, particularly as we seek to serve our global clients in a more complete and strategic manner, which means building locally a much stronger partner ecosystem as well. Finally, in all our locations, and specifically in our major client markets, we continue to focus on our client engagement programs and to improve our consulting and domain industry capabilities across our service effects. Now let’s turn in a bit more details on our gen AI approach.

For the last decade and despite all challenges during the last several years, we are continuously a recognized leader in advanced technology, digital engineering, and complete data transformation programs. This naturally extends to EPAM being regarded to the company who understands the complexities of AI transformation, something we are doing for ourselves, our partners, and our clients for some time now. Today, I would like to highlight our up-to-date progress in that area and how EPAM is helping clients pragmatically initiate and then move use cases beyond pilots into production deployments. Our current approach to AI transformation is three dimensional.

Dimension one, EPAM internal transformation and gen AI-enablement investments. We set an ambition goal for ourselves to upskill and effectively train an absolute majority of the company on the usage of gen AI fundamentals and to do so both responsibly and with the EPAM level technical debt. A dedicated program was established to execute this. And today, with the help of our educational platforms, internal specialized tools, and our global maintaining community, close to 100% of the EPAMers have gone through training and applying AI in their daily work activities.

While most of the companies have announced similar programs, we believe that during the last 24 months, our early and highly focused efforts across a broad range of EPAMers allow us to better understand future opportunities and to invest in differentiated IP and accelerators around gen AI-enabled engineering solution. Our combination of training IP and open-source style internal initiatives have now become drivers of scaling our advanced gen AI practitioner communities across all EPAM organizational unit and practices. We assume that well over 10% of EPAMers are now advanced generic technical practitioners, while over 1,000 are becoming strong internal AI Champions with ability to lead gen AI-enabled business solutions. We believe all that have enabled our dimension to client transformation opportunities.

Our AI client project today have evolved from exploratory pilots and proof-of-concept late last year to now EPAM being selected by clients as a primary AI partner with involvement into hundreds of gen AI-led engagements. We are helping to change the full value chain of HDLC from one side and enabling implementation of real gen AI-driven business use cases from another. Let me briefly highlight just a few IP investments. EPAM DIAL is a unified gen AI orchestration platform helping enterprises speed the experimentation and innovation efforts to implement real business use cases and gen AI-enabled solutions by connecting into meaningful workflow and load balancing a set of public and proprietary LLMs and SLMs together with different type of internal, external data sources, AI native applications and customer dots.

EPAM AI/Run is a gen AI power delivery framework that accelerates the entire software development life cycle and helps clients recognize ROI of the AI investments by improving time to market speed up to 30%. EPAM EliteA, a comprehensive collaboration platform for teams that streamline the development, accessibility, and management of large language model assets, including prompts, templates, and agents. Now a few specific examples for the clients, which operate across completely different user environments. For Unity, the world-leading platform of gaming tools for creators to build and grow real-time games apps and experiences across multiple platforms.

We help build Unity use. From a multi-cloud migration to Microsoft Azure to aid in gen AI capabilities to make game creation faster and easier for 1 million developers by using natural language prompts to generate sprites, textures, and animations and also providing chat-based assistance and troubleshooting, as well as the ability to either create behavior trees. Xsolis, a leader in healthcare system purpose-built solutions and industry-leading AI, will help to develop a new generation AI platform on AWS enhancing Dragonfly, Xsolis flagship product. The platform provides real-time data and predictive analytics to nurses, case managers, physician advisors, utilization management, and revenue cycle leaders across 500 hospitals and health systems with more than 500 pairs connections.

Finally, for the IMF as a part of modernization of the data platform, we built StatGPT, which is SDMX-driven gen AI application for statistical organizations, allowing their users, economists, and statisticians to quality transform, analyze, visualize, and interpret statistical data using a natural language interface via proprietary talk to data framework powered by EPAM DIAL and EPAM QuantHub accelerators. Initial results showed a 50% increase in research productivity and 35% increase in research accuracy. And overall, we are seeing a significant rise of gen AI engagements across every vertical and a very broad set of use cases. And this is now driving transformation in both front-end customer experiences, as well as significant back-office and process-related use cases.

Finally, all that, in turn, allow us to enable dimension three for AI transformation, extended partner network. First of all, because we saw that we are very practical in our approach. Our technology and AI transformation program are much larger and more complex today than where we started just a few quarters ago and encompasses both consulting and engineering services, as well as a broader range of partnerships. With more than 150 strategic partners, we’re accelerating modernization, adopting cloud-native architecture, and leveraging AI and advanced analytics, particularly when our clients projects have a high degree of technical and business complexity.

We are our partners partner of choice for making corporate engagement real. In fact, just very recently, we’ve been named Partner of the Year by several of our cloud data and digital partners, including Data Brief disruption Partner of the Year, recognized for the industry-leading design and implementation of gen AI power conversational interfaces, state-of-the-art machine learning and large language model framework. By the way, as elite-level partner, we are one of only five companies with dedicated Databricks center of excellence. Google Cloud Talent Development Partner of the Year award recognized for our commitment to training, upskilling, and reskilling our team, cloud, and AI skills.

Microsoft Gaming Partner of the Year recognized for the pushing the boundaries of creativity and technology. (Inaudible) commercetools recognized for delivery best-in-class modern commerce experience for our clients. It’s easy to assume the next question, what is the revenue impact of these programs? I guess the answer is probably predictable as well. We are still in early days of the AI wave.

But at the same time, we are very optimistic about the accelerating pipeline opportunities coming from AI-led transformation, and what that can bring downstream for us is a highly trusted and valid partner. We remain focused on expanding our efforts to drive demand. Remaining relevant to our clients and what they need and proactively expanding our global market share. We also remain committed to managing our delivery footprint, expanding to cost-efficient locations and generally optimizing our ways of working, so we can continue to provide premium service at attractive value to our global client base.

I firmly believe EPAM continues to be well-positioned to capture rebounding market demand, driven by long-term pressures for legacy modernization with needs for advanced customer-centric solution and by significant interest to understand how to apply gen AI and gen AI capabilities to build new platform and solutions. With this, I would like to pass to Jason to provide additional details on our results in Q2 and our future performance.

Jason Peterson — Senior Vice President, Chief Financial Officer, and Treasurer

Thank you, Ark, and good morning, everyone. In the second quarter, EPAM generated revenue of $1.147 billion, a year-over-year decrease of 2% on a reported basis or 1.7 % in constant-currency terms, reflecting a negative foreign exchange impact of 30 basis points. Due to our exit from the Russian market, we no longer generate revenue from Russian clients. The impact of this exit had an approximate 50-basis-point negative impact on year-over-year revenue growth.

Excluding Russia revenues, year-over-year revenue for reported and constant currency would have decreased by 1.5% and 1.2%, respectively. Moving to our vertical performance. Life sciences and healthcare delivered very strong year-over-year growth of 22.4%. Growth in the quarter was driven by clients in both life sciences and healthcare.

Consumer goods, retail, and travel decreased 7.7% on a year-over-year basis, largely due to the declines in retail, partially offset by solid growth in travel. Financial Services decreased 5.6% year over year, driven by softness in asset management, banking, and payments. In the quarter, the vertical delivered slight sequential growth, indicating stabilizing demand. Software and hi-tech contract to 3.7% year over year.

Business information and media declined 12.6% compared to Q2 2023. Revenue in the quarter was substantially impacted by the previously discussed ramp-down of the top 20 client. And finally, our emerging verticals delivered solid year-over-year growth of 10.6%, driven by clients in energy and telecom. From a geographic perspective, Americas, our largest region, representing 60% of our Q2 revenues, grew 1.8% year over year on a reported basis and 2% in constant-currency terms.

EMEA representing 38% of our Q2 revenues, contracted 6% year over year and 5.6% in constant currency. And finally, APAC declined 0.6% year over year or 0.2% in constant-currency terms and now represents 2% of our revenues. In Q2, revenues from our top 20 clients declined 3.7% year over year, while revenues from clients outside our top 20 declined 1.1%. The relatively stronger performance of this latter group was driven by both new client and inorganic revenue contributions.

Moving down the income statement. Our GAAP gross margin for the quarter was 29.3%, compared to 30.9% in Q2 of last year. Non-GAAP gross margin for the quarter was 30.8%, compared to 32.6% for the same quarter last year. Relative to Q2 2023, gross margin in Q2 2024 was negatively impacted by the strengthening of currencies associated with certain delivery locations, as well as the impact of compensation increases, including those resulting from our recent promotion campaign, which we were not able to offset through pricing.

The negative impact of foreign exchange and compensation increases exceeded the benefit of improved utilization. GAAP SG&A was 16.9% of revenue, compared to 16.7% in Q2 of last year. Non-GAAP SG&A in Q2 2024 came in at 14.3% of revenue, compared to 14.8% in the same period last year. SG&A improvement in the quarter is the result of our ongoing focus on managing our cost base and increased efficiency in our spend.

GAAP income from operations was $121 million or 10.5% of revenue in the quarter, compared to $144 million or 12.3% of revenue in Q2 of last year. Non-GAAP income from operations was $175 million or 15.2% of revenue in the quarter, compared to $191 million or 16.3% of revenue in Q2 of last year. Our GAAP effective tax rate for the quarter came in at 26.3%, and our non-GAAP effective tax rate was 24.3%. Diluted earnings per share on a GAAP basis was $1.70.

Our non-GAAP diluted EPS was $2.45, compared to $2.64 in Q2 of last year, reflecting a $0.19 decrease year over year. EPS was positively impacted by a Serbian government investment incentive received and recognized in the quarter, which improved Q2 diluted EPS by $0.06, although the benefit from this incentive was contemplated in the full-year guidance communicated during our Q1 earnings call. At that time, we had expected to receive the incentive and recognize the benefit in Q3. In Q2, there were approximately 58.1 million diluted shares outstanding.

Turning to our cash flow and balance sheet. Cash flow from operations for Q2 was $57 million, compared to $89 million in the same quarter of 2023. Free cash flow was $52 million, compared to free cash flow of $82 million in the same quarter last year. At the end of Q2, DSO was 76 days and compares to 73 days for Q1 2024 and 71 days for the same quarter last year.

The uptick in DSO reflects an increase in the time some clients are taking in the review and approval of payments, combined with the last few days of the quarter falling on a weekend. Share repurchases in the second quarter were approximately 1.16 million shares for 214 million at an average price of $184.97 per share. In June 2024, EPAM completed the share repurchase program authorized on February 13, 2023. Over a period of 16 months, 2.24 million shares were repurchased at an average share price of $222.9.

On August 1, 2024, the board of directors approved a new share repurchase program with authorization to purchase up to another $500 million of EPAM common stock over a term of 24 months. We ended the quarter with approximately $1.8 billion in cash and cash equivalents. Moving on to a few operational metrics. We ended Q2 with more than 47,000 consultants, designers, engineers, and architects, a decline of 4.8%, compared to Q2 2023.

Sequentially, production headcount remained unchanged as the company reduced head count in certain on-site locations while continuing to hire in India. Our total headcount for the quarter was more than 52,650 employees. Utilization was 77.5%, compared to 75.1% in Q2 of last year and 76.8% in Q1 2024. However, on-site utilization remains below targeted levels, and the company will continue to take actions to optimize on-site resource levels to improve utilization.

Now let’s turn to our business outlook. Although client demand has stabilized, we continue to see very little improvement in the near-term demand environment. We are experiencing growth in certain verticals seeing relatively high levels of new logo activity and working with clients to bring gen AI programs into production. We are also beginning to see some constructive improvement in client discussions with regards to future programs.

But decision-making continues to be relatively cautious as some clients continue to have challenges with their own end markets and revenue generated by individual new logo accounts is on average less than that generated in prior years. Although we believe clients are beginning to more actively engage around new initiatives, our guidance assumes macroeconomic stability with no improvement in the aggregate demand environment for the remainder of the year. We are hopeful that change in the tone of client conversations will result in an improved demand environment in 2025. For the remainder of 2024, we are expecting a slight increase in Q3 revenue relative to Q2, driven by greater buildouts in the quarter, substantially offset by higher vacation levels.

We are expecting a modest sequential decline in Q4 revenues, driven largely by some of the seasonal factors mentioned previously. We are maintaining our focus on demand generation, and we’ll continue to prioritize revenue growth for the remainder of 2024. At the same time, we are taking steps to improve cost efficiency and on-site utilization and now expect to operate at a higher level of profitability in the fiscal year. Finally, our operations in Ukraine continue to run at high levels of utilization, a testament to our team’s dedication and focus on maintaining uninterrupted quality of delivery.

Our guidance assumes that we will continue to be able to deliver from our Ukraine delivery centers at the productivity levels similar to levels achieved in 2023. Moving to our full-year outlook. Revenue is now expected to be in the range of $4.590 to $4.625 billion, a negative growth rate of 1.8% at the midpoint of the range. The impact of foreign exchange rate growth is expected to have a positive impact of approximately 10 basis points.

At this time, we expect approximately 1% of revenue contribution from already completed acquisitions. We expect GAAP income operations to now be in the range of 10.5% to 11% and non-GAAP income from operations to now be in the range of 15.5% to 16%. We expect our GAAP effective tax rate to now be 21%. Our non-GAAP effective tax rate, which excludes excess tax benefits related to stock-based compensation will continue to be 24%.

For earnings per share, we expect the GAAP diluted EPS will now be in the range of $7.18 to $7.38 for the full year, and non-GAAP diluted EPS will now be in the range of $10.20 to $10.40 for the full year. We now expect weighted average share count of 57.9 million fully diluted shares outstanding. Moving to our Q3 2024 outlook. We expect revenue to be in the range of $1.145 billion to $1.155 billion, producing a year-over-year decline of 0.2% at the midpoint of the range.

And on a constant-currency basis, we expect Q3 revenue to be flat year over year. For the third quarter, we expect 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 16% to 17%. We expect our GAAP effective tax rate to be approximately 24% and our non-GAAP effective tax rate to be approximately 24%. For earnings per share, we expect GAAP diluted EPS to be in the range of $1.75 to $1.83 for the quarter and non-GAAP diluted EPS to be in the range of $2.65 to $2.73 for the quarter.

We expect a weighted average share count of 57.4 million diluted shares outstanding. Finally, a few key assumptions that support our GAAP to non-GAAP measurements for the remainder of the year. Stock-based compensation expense is expected to be approximately $45 million for each of the next two quarters. Amortization of intangibles is expected to be approximately $6 million for each of the remaining quarters.

The impact of foreign exchange is expected to be a $1 million loss for each of the remaining quarters. Tax effective non-GAAP adjustments is expected to be around $13 million for each of the remaining quarters. We expect excess tax benefits to be around $1 million for each of the remaining quarters. Severance, driven by our cost optimization program, is expected to be around $10 million for each of the remaining quarters.

Finally, one more assumption outside of our GAAP to non-GAAP items, with our significant cash position, we are generating a healthy level of interest income and are now expecting interest and other income to be approximately $13 million for each of the remaining quarters. While we work our way through this cycle of lower demand, we will continue to run EPAM efficiently, positioning the company to capitalize on a more normalized demand environment. Lastly, my continued thanks to all our employees for their dedication and focus on serving our clients and driving results for EPAM. Operator, let’s open the call up for questions.

Questions & Answers:

Operator

(Operator instructions) Your first question comes from the line of Maggie Nolan of William Blair. Your line is open.

Maggie Nolan — Analyst

Thank you. I wanted to dig into the utilization and the dynamics between on-site and offshore. So first of all, what percentage of the workforce is considered to be on site this quarter? And then is offshore utilization running higher than what you view as sustainable to offset some of that weakness on on-site because you’re not too far off from your historical range here?

Jason Peterson — Senior Vice President, Chief Financial Officer, and Treasurer

Yeah. The — I think we feel that the offshore utilization is actually quite healthy. And I’m struggling right now to remember exactly what our on-site percentage is, but from a total head count — but from a utilization standpoint, it’s definitely lower than we would traditionally run at and it continues to be the area that I think we find ourselves somewhat challenged in. And so it probably is also contributing somewhat to revenue growth for the remainder of the year, where we continue to see more demand for offshore and incrementally more demand for India and again, continue to run at somewhat lower levels of utilization on site.

And that’s something that we are working to address pull-through demand generation and also through taking some actions, as I referred to in my prepared remarks.

Maggie Nolan — Analyst

Got it. And then somewhat related, just building on that, the improvement in the margin outlook, is that primarily related to those actions that you want to take on utilization? Are there other levers you’re pulling? And have you already seen some progress here in the third quarter to fuel that optimism and the increased number that you gave?

Jason Peterson — Senior Vice President, Chief Financial Officer, and Treasurer

No, absolutely. And so the focus has been on sort of cost optimization after we reset our expectations for revenue growth. So we’ve been more efficient in corporate functions and SG&A. We’ve been working on utilization.

And so yes, the actions that we intended to take are underway, and it is beginning to show up probably even in a little bit of the benefit that we saw in profitability in Q2.

Maggie Nolan — Analyst

Got it. Thanks, Jason.

Operator

Your next question comes from the line of Bryan Bergin from TD Cowen. Your line is open.

Bryan Bergin — Analyst

Hi, guys. Good morning. Thank you. I hear you on the overall complex demand environment.

I wanted to dig in on the demand progression in the top accounts that you saw over the last three months, as well as just how you see the top clients, particularly the top five to 10, performing in the second half and as you exit this year.

Arkadiy Dobkin — Chairman, President, and Chief Executive Officer

So I think despite of the opticality of decline for the top five, there is only one line which is declining, and this is basically a continuation of the trend, which we saw before. And even this client decline — kind of getting less and getting more stable environment right now. So — but in general, it’s exactly like we commented before. It is pretty stable.

Jason Peterson — Senior Vice President, Chief Financial Officer, and Treasurer

Yeah. And that top five clients, this is the one that we talked about in the past, which is a European business information and media client.

Bryan Bergin — Analyst

OK. All right. That’s helpful. And then just on the gen AI front, can you dig in a little bit more on the progression of gen AI-related work as far as just maybe any rough quantification on the size of some of these programs and the mix of really the POCs that are moving into production?

Arkadiy Dobkin — Chairman, President, and Chief Executive Officer

So it is pretty challenging, especially when we’re thinking that — we’re trying to understand how some of our galaxy is quantifying this, and it’s very much all around the web. So that’s why for our internal understanding and progression, we have kind of fewer gen AI-related projects and some influence revenue and so on and so on. So from this pure type of stuff, a lot of small POC now approaching millions of dollars. This is already starting to happen.

So — and this is dozens in our case. And again, it’s very difficult to compare apple to apple when we hit in some numbers for competition. At the same time, from influence point of view, we started to go already to tens and hundreds of millions as well, so very different even from six, nine months ago.

Bryan Bergin — Analyst

OK. I understood. Thank you.

Arkadiy Dobkin — Chairman, President, and Chief Executive Officer

Still, if you think about it, it’s a very small portion of our revenue. And I think general trend that — when during the POC, there is a confirmation potential ROI and excitement, then it’s coming back to the technical debt, which we were talking about during the last quarter. And companies realize that to actually get the benefit of this, it requires, really, investments and go to — some data modernization programs, which is much bigger and require much more investment. And that’s actually one of the showstoppers to real progression because they are not ready yet.

Bryan Bergin — Analyst

Got it. Thank you.

Operator

Your next question comes from the line of Darrin Peller from Wolfe Research. Your line is open.

Darrin Peller — Analyst

Hey, guys. Thanks. Could we just touch for a minute on the sequential math, looking at the guide, it looks like the dollars of revenue expected is pretty much exactly flat or almost exactly flat going from second through the end of the year. And I know you’re trying not to embed any type of upside or inflection.

Just — I know there’s also some seasonality typically in Q4, although things like budget flows have been tougher lately. But maybe just touch on that for a minute in terms of your expectations on a per quarter basis and then really just go back to the overall demand environment, where you’re seeing clients spend what you think you can do that maybe much — a little bit less related to the macro and more idiosyncratic as we’ve been seeing more and more IT services companies trying to really address current needs as much as possible. So anything more you can just comment on where the demand is today, especially if the macro holds at a slower level for a while, what you think you’re doing that’s resonating the most?

Jason Peterson — Senior Vice President, Chief Financial Officer, and Treasurer

Yes. So I’ll just start with the more technical, I guess, and I’ll leave Ark to answer maybe the harder questions. And so from a Q2 to Q3, you’d have higher mutation in more builders. And so you get a — you should see a somewhat modest improvement, but you should see some improvement in revenues just based on what you call kind of technical or seasonal factors.

And then in Q4, it will depend on what type of vacation levels we see. But usually, you would see even a little bit higher levels of vacation in Q4, lower bill days. And then, of course, the question is going to be what type of furlough activity we see. So generally, there is a somewhat significant impact just due to seasonality.

And so that’s kind of what we’re modeling at this time is, again, is that generally a very modest improvement up from Q2 to Q3 based on seasonal factors. And then some degree, a decline, unless, as you said, we see some type of budget flush, or again, we’re able to influence the level of vacations that employees take. Ark, do you want to talk a little bit about overall demand or where we’re seeing?

Arkadiy Dobkin — Chairman, President, and Chief Executive Officer

I think our equipment very much in line with the last quarter. So we — as we mentioned last time that we don’t — we don’t think we can project the market in current situation. So I think it’s very much similar. And if quarter ago, our production range was much broader than today — in just saying that our expectation of good news, we are not confirmed.

And our expectation for the great news actually didn’t happen as well with narrowing and it’s a reflection of the type of projects in play right now. There is no big modernization talk. There are conversations about it, but it’s not turning to real things. There are a lot of noise around gen AI, which not converting to revenue as well.

But running the business, keeping the status quo on production systems, that’s what we’re focusing, improving, and again, looking for kind of one-off modernization play where we can really bring the value, but it’s very competitive and again, not necessarily decided for the client. I don’t now if I’m giving you answer what you were asking for, but I would —

Jason Peterson — Senior Vice President, Chief Financial Officer, and Treasurer

I would just add that we’re working to change the trajectory in Europe, and we are beginning to see some better conversations and opportunities kind of appear there. Again, that’s an area where we’re looking to sort of, let’s say, change the picture. The other thing I think you see in our fixed fee, which continues to go up, we’re continuing to sort of explore and work with clients to have more of a committed kind of model around what we’ll deliver for a fixed fee or a fixed monthly fee and that’s a reflection of what we’re trying to do to respond to customer needs and win more business.

Darrin Peller — Analyst

OK. Actually, one quick one just on hiring — is just on — I mean, do you anticipate — if utilization stays in these ranges, do you anticipate needing to hire more? Or I mean, maybe AI or other types of efficiencies can help maintain?

Jason Peterson — Senior Vice President, Chief Financial Officer, and Treasurer

There’s certainly some programs where we’re clearly working to include AI productivity improvements. But now we would continue to hire. And I think you’ll continue to see hiring in the types of geographies we’ve been talking about, which is more kind of offshore and certainly with somewhat more of a focus on India and Latin America.

Darrin Peller — Analyst

OK. Got it. Thanks, guys. Appreciate it.

Operator

Your next question comes from the line of Jim Schneider from Goldman Sachs. Your line is open.

Jim Schneider — Analyst

Good morning. Thanks for taking my question. First of all, on the discretionary demand environment, it’s not surprising to hear the constraints given what the environment is out there. But what are your clients telling you about the conditions under which they would start to release more spending or more aggressive with new projects in 2025? Is that tied to macro? Is that tied to more certainty around their AI strategy or other priorities they have internally in terms of IT spending?

Arkadiy Dobkin — Chairman, President, and Chief Executive Officer

So we do believe that majority of the kind of decision-making is macro related right now because as soon as kind of situation would be a little bit better I think investment in general data infrastructure, cloud infrastructure, which was delayed, will be triggered because everybody understands the impact of gen AI. And without fixing first this, it would be very difficult to move forward. So I think market is holding right now.

Jim Schneider — Analyst

And then maybe just in terms of the margins, obviously delivered good growth and operating margin leverage in the quarter. That was good to see. Was that mostly driven by the mix of headcount shifting to India? Or are there other factors there besides the SG&A line? And then, I guess, going into ’25, as we exit this year, what kind of further gross margin leverage do you expect to deliver is sustainable from here?

Jason Peterson — Senior Vice President, Chief Financial Officer, and Treasurer

Yes. So we’re continuing to work on utilization and to the improvement in Q2 was probably a combination of efficiency with SG&A and continued to focus on improving utilization. I think what we’ve talked about over the last couple of quarters is that we continue to have an opportunity because we’ve got a fairly heavy pyramid still including in India. And so what we need to do is make sure that we’re introducing more juniors into the mix, which generally has a broader sort of pyramid improves profitability overall, also can allow you to be a little bit sharper with pricing.

But the Q2 improvement in profitability was not driven by a shift in India. Again, it was more kind of these operational kind of efficiency factors that we’re continuing to work on throughout the remainder of the year.

Jim Schneider — Analyst

And in terms of the forward improvement there?

Jason Peterson — Senior Vice President, Chief Financial Officer, and Treasurer

Forward improvement, again, is the work that we’re doing on utilization improvement, reducing the bench, and ongoing efficiency in SG&A. So again, it’s just a focus on certain areas of our operations that we think we can see some further sort of reduction in spend certainly as a percentage of revenue.

Jim Schneider — Analyst

Thank you.

Jason Peterson — Senior Vice President, Chief Financial Officer, and Treasurer

Welcome.

Operator

Your next question comes from the line of Jonathan Lee from Guggenheim Securities. Your line is open.

Jonathan Lee — Guggenheim Partners — Analyst

Great. Thanks for taking our questions. I want to get a better sense of how India is progressing. Can you help unpack the type of volumes you’re seeing there whether expanded presence has had any sort of influence on new types of demand or types of contract structures being utilized, especially if you think about the revenue and margin dynamics that are contemplating the outlook?

Jason Peterson — Senior Vice President, Chief Financial Officer, and Treasurer

Yeah. So I’ll let Ark talk a little bit more about the type of work in progress. What I would say is that from the last time we spoke with you, Jonathan, is that India is likely to make a somewhat — a very slightly greater percentage of headcount by the end of the year. So last time Ark and I were talking about something approaching 20%.

We now think that India will be slightly above 20% by the end of the year. And what you are seeing is a modest pressure on average bill rates as a result. And that probably is also sort of shaping how we look at the second half. So it’s not super significant.

But I think last time, sometimes we would utter the word 19.5%, and right now, we think that India is going to account for just over 20% of our headcount by the end of the year. So we continue to see a modest gradual shift there. while at the same time, we are seeing improved utilization in our other areas of operation Europe and Western and Central Asia. So it’s not as if all the demand is shifting to India, but we are seeing ongoing kind of implement in India.

Ark, do you want to talk about work?

Arkadiy Dobkin — Chairman, President, and Chief Executive Officer

Type of work — like, I think that’s what we shared already today. We consider like there is — India, there is a pricing pressure. So this is definitely a very objective kind of component. At the same time, the type of work which we do not changing much from location to location.

And as we said before, EPAM has a kind of reputation for more complex quality engineering solutions. And as we said, we’re building actually in the very strong data engineering competency. We bring it like everything what we do around gen AI productivity improvement for GLC, we build a digital engagement practice. So it’s very much in line with the broader EPAM, and the type of work is, again, very, very similar.

So from a overall perspective, it’s also creating different profile of our operation in India because when we started to move work there, we have to bring much more proportionally experienced teams there, and only after this, we will be able to scale to the different pyramid, and that’s what’s happening for us simultaneously. some movement of the work, rebuilding the pyramid, and still investing in quality to be exactly in line with my expectations because they expect from EPAM independently from location, similar type of service.

Jonathan Lee — Guggenheim Partners — Analyst

Thanks for the detail there. Can you unpack your comments on the lack of improvement contemplated in the outlook? I want to understand what that means for deals that have been signed, but perhaps not yet launched or ramped. And how much go get or pipeline conversion is still required to achieve your outlook at both the high end and the low end?

Jason Peterson — Senior Vice President, Chief Financial Officer, and Treasurer

Yeah. And the last time we guided, Jonathan, we did talk about still expecting a very modest improvement in demand and what we’re now saying is we don’t see that improvement in demand. And so we try to be quite prudent with our guide clearly within this quarter, and clearly, how we set the full-year guide, which obviously is how we’re thinking about Q4, it does very much particularly if you take the full guide of $4.590 billion to $4.625 billion. It does encompass even things like some potential reductions in demand due to cost reduction efforts at clients or that type of thing.

And so I think we feel pretty confident that, again, we have a little bit of sort of downside as clients continue to be sort of cost sensitive. And then the upside probably would be a little bit more in the lighter furloughs, maybe just a little bit of kind of budget openness in the remainder of the year. And again, our ability to probably influence the level of vacation taken by employees to again, give us a little bit more capacity in Q4.

Operator

Your next question comes from the line of Ramsey El-Assal from Barclays. Your line is open.

Ramsey El-Assal — Barclays — Analyst

Hi. Thanks for taking my question. It looks like your percentage of fixed-price contracts has been trending up, and it’s a little higher now than it’s been at least going back quite a ways in our model. What is driving that mix shift sort of away from time and materials work toward fixed price work? Is it geographic? Is it gen AI related? And I guess, are there any implications for margins when it comes to fixed price versus time and materials work?

Jason Peterson — Senior Vice President, Chief Financial Officer, and Treasurer

Yeah. So you’re correct that it has been trending up and probably will continue to trend up somewhat. And so it’s a mix of what would we call percentage of completion and what is sort of a fixed monthly fee. And so it probably does reflect the fact that we’re beginning to try to address clients’ needs in a way that’s a little bit nontraditional for EPAM where we have traditionally been kind of more leading-edge, complex projects where it was difficult to estimate.

We clearly have that type of work, but we are trying to be able to sit with our clients and say we can do this for a fixed amount of money or fixed amount of money on a monthly basis. The other thing I think you are probably seeing is some opportunity with gen AI to introduce not only traditional sort of productivity improvement or productivity improvement from gen AI and commit to a series of savings over a period of time. And so you are seeing us also enter into engagements with clients. It may be more a multi-quarter or in some cases, even multiyear, that do reflect what we believe is a productivity improvement that we can achieve over time.

And that could go either way, right? It can be net positive to margins. If obviously, we’ve estimated or sort of delivered poorly, it can be negative. But generally, with fixed fee, you do have the opportunity to improve profitability relative to time and materials because it just gives you more flexibility in how you deliver.

Ramsey El-Assal — Barclays — Analyst

OK. And a follow-up for me on M&A. I guess, given the buybacks in the quarter, and the additional share repurchase authorization, is larger scale M&A off the table? Assuming you’re still in the market for tuck-ins to plug capability gaps, what types of assets might you be looking to bring into EPAM?

Arkadiy Dobkin — Chairman, President, and Chief Executive Officer

I think that’s a little off the table. So as always, in the past, we constantly have conversations and opportunities for different sizes of acquisitions. And — but — by insurance back is actually very much functions of if it’s going to happen or not. So it’s not must condition.

It’s a direction which we will be executing only if we think that it broke up with any other aspects of the business. So if this would be happening, we will be adjusting the numbers, if necessary.

Jason Peterson — Senior Vice President, Chief Financial Officer, and Treasurer

Yes. So we’ll do both. But clearly, our bias would be toward acquisitions. And as Ark said, doing something somewhat but certainly not off the table.

Ramsey El-Assal — Barclays — Analyst

Got it. Thank you very much.

Jason Peterson — Senior Vice President, Chief Financial Officer, and Treasurer

Thank you.

Operator

Your next question comes from line of Surinder Thind of Jefferies. Your line is open.

Surinder Thind — Analyst

Thank you. Just a question around the global delivery footprint. As you look ahead, if revenues was to remain stable, at what point do you think you’ll get to your target delivery footprint?

Arkadiy Dobkin — Chairman, President, and Chief Executive Officer

When you say revenue will be stable, what do you mean that revenue?

Surinder Thind — Analyst

I think there was commentary on the call about on-site utilization being a little bit below expectations. And so there’s continued shift for the requirement of resources in lower-cost regions. I think there’s previous commentary around maybe not as much demand in nearshore or Western Europe shifting some of those resources through natural attrition to other parts of the world. So that was the — what I was trying to get at.

Arkadiy Dobkin — Chairman, President, and Chief Executive Officer

I think let me try to answer slightly differently. First of all, we definitely move into global diversification from risk mitigation stability and 24/7 on the growing global client base. And from this point of view, we will be much more diversified than in the past. And right now, it’s also — as we mentioned, probably will be the most balanced global direct company.

That’s a direction. What exactly proportion of this, it’s much more difficult question to answer because it would be a function of general demand. When you say like, for example, nearshore in Europe is not so much in demand, it’s, in many ways, subject of the type of work, number one, and the cost pressure, number two. As soon as the market will start to come back to kind of fix the technical debt, which we’re talking about, that modernization cloud and data program will accelerate to get make the progress of gen AI transformation much more real.

The demand will come back for practically any region and because of complexity and creativity of these type of engagements proximity will become much more important and pricing component will become less important. So it would influence the structure as well. So again, number one, we will be much more diversified in India and LatAm, it will be the proportion of the total, but exactly proportion to identify is right now very difficult? So we version this quarterly how to (Inaudible)

Surinder Thind — Analyst

That’s helpful. And then related to that, when you think about all of the new talent that you’re hiring, how do you differentiate or attract that talent in the sense that others obviously have large delivery operations out of India? They have well-established connections to the local universities, whereas I would argue you’re newer to that region. I realize you’ve been there since 2015, but just on a relative basis.

Arkadiy Dobkin — Chairman, President, and Chief Executive Officer

So we’re talking about India specifically, I think a couple of factors need to be taken. Like we have an image of different type of services company. We have an image of how much more quality engineering company and much more closer to what people would think about software tech companies. And from that talent point of view, we compete with this type of companies, the same — like with some captives which are trying to build high-end tech purchases in India.

So the image is there already. So at the same time, we’re also kind of an underdog in India, which means that we have the opportunity to play differently and specific parts of the (Inaudible), including like breeding our training capabilities and different type of work. I think while there are large companies, it’s — for us, it’s relatively clear how to differentiate ourselves for the labor market, for the talent market. And if you say that we’re growing much, much more like our — you see like how India is growing pretty strongly in this situation.

Operator

Thank you. Your next question comes from the line of David Grossman. Your line is open.

David Grossman — Analyst

Good morning. Thanks. Just quick — a couple of quick follow-ups. If I recall, you said the headwind from India, the mix shift in India was going to be about 200 basis points this year on revenue.

Is that still a fair assumption? And do you have any initial thoughts on whether — or the magnitude of the headwinds would be in 2025?

Jason Peterson — Senior Vice President, Chief Financial Officer, and Treasurer

Yeah. I would say that 2% is generally correct. It probably has gone up slightly from when we guided at the end of the Q1 call. And then I would say for next year, my guess is the headwind from India might be greater than 2%.

So I guess that’s how I’d respond to that, David.

David Grossman — Analyst

And that’s just because of the ramp of headcount? Is that why it’s higher in ’25?

Jason Peterson — Senior Vice President, Chief Financial Officer, and Treasurer

Yeah. It’s probably a little bit higher in billable India and a little bit lower in billable on site. And those two things are kind of producing what is probably a modestly lower average bill rate for the company.

David Grossman — Analyst

Got it. And similarly, I know you’ve talked quite a bit about the loss clients, I think one was M&A and one was something else. And I’m just trying to remember whether you quantified that headwind this year and next and when we comp out against that headwind.

Jason Peterson — Senior Vice President, Chief Financial Officer, and Treasurer

Yeah. So the one that is kind of the M&A-like exit, which is the one I usually refer to, I think we comp out at the end of the year. And then it was double-digit revenue — like it was over $10 million a quarter. So it was a significant number.

And then the other one is the one that has been sort of slowly reducing their demand for our services and that continues to be an ongoing trend. And that was a little bit related to their hesitation around our Ukrainian footprint. And then I think they’re also just doing a little bit of work around bringing some positions in-house. But we still, again, have demand from them, but just there’s been a gradual decline over time.

And I think you’ll continue to see that for the next couple of quarters.

David Grossman — Analyst

Got it. And just one last thing. Just on the DSO, Jason, I know it was up last quarter, and it was up again sequentially. Should we see that or do that as maybe a macro dynamic that’s affecting all your accounts? Or is this another way of providing better terms to remain more competitive? Or is there something else going on?

Jason Peterson — Senior Vice President, Chief Financial Officer, and Treasurer

Yeah. I would say that on the 76 was definitely a result of just the last couple of days being on a weekend, and so we saw a significant amount of cash coming on the Monday and Tuesday but that was here in Q3. But David, I would say that as we’ve moved toward more fixed fee, that is having an impact on DSO because it does kind of impact the invoicing, and I do think that you’re likely to see something closer to 74 for the second half of the year. And again, that’s due to the shifting in the type of contracting we’ve been doing.

So then I guess with that, maybe we’re — Operator, we have time for one more question.

Operator

Thank you. The final question comes from the line of Jamie Friedman from Susquehanna. Your line is open.

Jamie Friedman — Analyst

Hi. Thanks for squeezing me in here. So with regard to your last answer, Jason, that was really interesting about the fixed price to DSO. I’m just wondering also just related to that, is fixed — is the growth in fixed price related to generative AI or outcomes-based pricing? That’s my first one.

And then my second one, I’ll just ask it upfront, is Ark, could you call out what’s going on in Life Science? I know Jason mentioned it’s a combination of both healthcare and life sciences in his prepared remarks. It was a featured topic at the Analyst Day a couple of years ago. It seems like it’s working now. So any high-level stuff.

First, on fixed price and second on life science.

Jason Peterson — Senior Vice President, Chief Financial Officer, and Treasurer

Fix fees, certainly, there’s, I would say, some experimentation with sort of fixed fee with productivity that’s gen AI-driven. I don’t think that’s showing up in the numbers right now, but it may continue to sort of show up in increased fixed fee. I would say more so — again, clients are looking for us to step in and say, we can deliver a certain program for a fixed amount of money or we can deliver a certain amount of story points for a fixed amount of money on a monthly basis. And again, it is — it allows us to be a little bit more competitive.

And then we are doing a little bit more business in the Middle East, and that market tends to be more fixed fee oriented as well. And so those would be the two things on that. And then growth in life sciences and healthcare, Ark?

Arkadiy Dobkin — Chairman, President, and Chief Executive Officer

Yeah. I think we were talking about it, we were talking about 1 billion more industry expertise in this area. And in general, from our conversation several years back, it was positive growth, while it was a couple of things when client situation was actually changed. Right now, it’s pretty positive.

I think concentration of data programs in our life sciences and healthcare business is actually very high, which still in demand today. And again, combination of industry expertise, which we invested in some level of consultancy, and again data program proportion makes this benefit for us. And that’s what how we look into some other industries, how we can change the trend similar to what happened here.

Jason Peterson — Senior Vice President, Chief Financial Officer, and Treasurer

Thank you.

Arkadiy Dobkin — Chairman, President, and Chief Executive Officer

I think time is over. And as usual, thank you for joining us today. So I think we’re trying to communicate that while situation as it is right now, we do believe that EPAM is all focused on cloud data engineering, advances in gen AI we think will position for future growth when markets come back. So I know we repeated this each time, but it’s actually we very much believe it.

And we will be ready for comeback anticipation. We’ll see how many quarters we will have to still wait for this. But again, thank you, and let’s talk in three months.

Operator

(Operator signoff)

Duration: 0 minutes

Call participants:

Mike Rowshandel — Head of Investor Relations

Arkadiy Dobkin — Chairman, President, and Chief Executive Officer

Jason Peterson — Senior Vice President, Chief Financial Officer, and Treasurer

Maggie Nolan — Analyst

Bryan Bergin — Analyst

Ark Dobkin — Chairman, President, and Chief Executive Officer

Darrin Peller — Analyst

Jim Schneider — Analyst

Jonathan Lee — Guggenheim Partners — Analyst

Ramsey El-Assal — Barclays — Analyst

Surinder Thind — Analyst

David Grossman — Analyst

Jamie Friedman — Analyst

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