GDYN 2024Q2

Good afternoon, everyone. Welcome to Grid Dynamics Second Quarter 2024 Earnings Conference Call. I'm Cary Savas, Director of Branding and Communications. At this time, all participants are in listen-only mode. Joining us on the call today are CEO, Leonard Livschitz; and CFO, Anil Doradla. Following their prepared remarks, we will open the call to your questions. Please note that today's conference is being recorded. Before we begin, I would like to remind everyone that today's discussion will contain forward-looking statements. This includes our business and financial outlook and the answers to some of your questions. Such statements are subject to the risks and uncertainties described in the company's earnings release and other filings with the SEC. During this call, we will discuss certain non-GAAP measures of our performance. GAAP to non-GAAP financial reconciliations and supplemental financial information are provided in the earnings press release and the 8-K filed with the SEC. You can find all the information I just described in the Investor Relations section of our website. I'll now turn the call over to Leonard, our CEO.

Thank you, Cary. Good afternoon, everyone, and thank you for joining us today. Grid Dynamics' second quarter results were above our guidance range and exceeded Wall Street expectations, both on revenue and non-GAAP EBITDA. We achieved important milestones in the quarter. I'm happy to report that our second quarter revenue was the highest in the company's history, and all of it was organic in nature. We also exited the second quarter with the highest number of billable engineers in the company's history. The strong results were due to the strengths from both existing and new customers and are commendable given the recent backdrop of economic cycles. It is a testament that Grid Dynamics' efforts to stay the course and maintain laser focus on delivering value to our customers is paying off. Our stated goals around the company growing profitability and becoming a $1 billion revenue company remain unchanged. In many ways, our second quarter revenue growth of 4% on a sequential basis reflects the company's differentiation. Last quarter, I highlighted the key factors influencing our growth and discussed how we're uniquely positioned across the IT industry. These were, first, our revenue represents a small proportion of our customers' overall spend, and therefore, the opportunities for growth are significant. Second, the new deals that we're winning are tied to our customers' key areas of focus and are, in many cases, mission-critical. Third, across the majority of our customers, their spending levels are either being maintained at the current level or increasing. And finally, the headwind we were facing last year, driven by drops in a handful of customers, has reversed. Many of those customers have returned to growth. There are many exciting trends shaping our business, some of which I will share with you today. More importantly, I believe these trends will persist in shaping the company, both in the second half of 2024 and leading into 2025, paving the way to a brighter future. Now, coming to the demand environment. Similar to the first quarter, we witnessed improving demand across most of our customers. Incrementally, last quarter, when customers were more focused on sharing the outlook and forecast plans, this quarter, they were more willing to release the budget to implement those plans. We benefited from this trend and expect it to continue as the year progresses. Regarding the third quarter, the trends that I highlighted about the second quarter extend into the next quarter as well. We have already seen increasing customer activity in June. AI activities continue to be robust. We believe this forms the basis for our continued positive outlook as we look toward the third quarter and the remainder of 2024. We are in what I call the post-vendor consolidation market. As we highlighted over the last two to three quarters, customers have been scaling back on the number of IT vendors they work with. For example, one of the global brands plans to reduce the number of IT providers by more than two-thirds, with Grid Dynamics being one of the remaining strategic partners. With this customer, and many more in similar situations, there is heightening interest in partnering with IT vendors that are strong in technology and catalysts for them to achieve their business goals, both in revenue and cost savings. Time and again, our technological and operational excellence has risen to the top. I'm also thrilled to announce that in the second quarter, Grid Dynamics won four industry awards across various categories, including Most Innovative Projects and Best Composable E-commerce Project, among others. This widespread industry recognition reinforces our company as a benchmark of engineering excellence, empowering businesses to navigate the complexities of the modern technology landscape with agility and innovation. We expanded our AI capabilities considerably and now have approximately 30 solution and service offerings targeting Fortune 500 companies across various industries. These solutions focus on enhancing revenue and reducing costs for enterprises. On the revenue side, our solutions focus on enhancing customer experiences and optimizing marketing, pricing, and product decisions. On the cost side, the focus is centered on efficiency improvements and better regulatory compliance. Our broad offering positions us well to positively impact the business results of our clients. We're witnessing a significant uptick in customers wanting to engage us on MVP and pilot programs beyond the initial approved concepts. Our sales pipeline continues to show robust growth with dozens of active AI opportunities in progress. Enterprises are increasingly seeking to incorporate AI in their business processes as well as services and platforms. It's worth noting that we continue to adapt and develop AI tools and best practices to improve the productivity of our engineers. This goes beyond just coding copilots, extending to tools specifically designed for legacy modernization, test automation, and quick prototyping. These internal investments boost our efficiency and enhance our ability to deliver cutting-edge AI solutions to our clients. Let me highlight a few noteworthy GenAI projects for the second quarter. For a top workforce solution company, we're developing a comprehensive AI ops and data platform. This platform will host numerous AI applications for job seekers, recruiters, and business owners, significantly enhancing the efficiency and effectiveness of the workforce management process. For one of the largest U.S. auto part providers, we’re using GenAI to harmonize and enrich large commerce catalogs, streamlining the product onboarding process. Additionally, we are analyzing product attributes to create consistent product titles and descriptions that resonate with buyers. This leads to enhanced customer experience and higher sales through all channels. Additionally, for a leading European regulatory compliance firm, we're developing an AI-enabled solution to streamline the product certification process. This project showcases how AI can significantly enhance efficiency in complex regulatory environments. Within our organization, there was significant activity both in AI and non-AI areas during the quarter. This included numerous completed programs across AI, data, machine learning engineering, commerce solutions, and search. Some completed projects included intelligent document processing tailored for the financial industry and conversation-powered interior design systems. Like previous quarters, our architects and CTO team were instrumental in opening new accounts. In the quarter, there were some trends I want to share with you. Regarding logo momentum, in the second quarter, we signed six new logos, many of them in very large enterprises. Of these customers, one is a leading North American home improvement supplier; another is a large American consumer goods company focused on personal and household products; one is a major global lifestyle brand; and another represents a large European department store chain. Partnerships are at an all-time high, contributing 17% of revenue in the first half of 2024. The quality and quantity of our partnership leads are changing. Three noteworthy trends are shaping our partnership business. First, our commitment to technological innovation and engineering excellence has resulted in greater appreciation from global enterprise customers, leading to Grid Dynamics being chosen by many of our partners as a Tier 1 supplier. Second, our relationships with partners are evolving. We're now more engaged in strategic discussions with senior management of our key partners. Third, at an operational level, we have enhanced collaboration between the sales and marketing teams at Grid Dynamics and our partners. All these translate into more opportunities, including GenAI initiatives, and potential global projects across industry verticals. Regarding delivery allocation support, during the quarter, we made progress across multiple areas with our global strategic delivery organizations. As we highlighted in the past, our follow-the-sun strategy provides the framework for scaling our global locations. With the Bangalore hub operationalized, we now have three fully functional locations in India. India is now one of our top two countries by headcount, supporting numerous accounts, many of which are key accounts. Our focus on acquiring high-quality talent from universities continues, along with our engagement with Hekaton and dynamic topics throughout the quarter. In Europe, Poland continues to serve as an anchor point, and in Mexico, we support customers seeking nearshore capabilities. Regarding European business, with roughly mid-teens of our revenue, Europe continues to be strategic for our growth. Our AI focus and expertise continue to attract enterprise customers serious about adapting AI to enable business efficiencies and improve customer experiences. Recently, at one of our clients, a leader in food and pharma testing, we started developing an AI-based solution. In addition to our AI wins, we provided a platform organizational roadmap to a major UK-based retailer that supports their expansion, and we migrated their existing homegrown commerce platform to the cloud. We are launching a composable commerce B2C solution for a global autoparts company, orchestrated using MACH technologies. We expect this effort to continue in Q3, enabling the client to consolidate their technology landscapes and scale their business. During the quarter, Grid Dynamics delivered some notable projects. As a leading global technology company, we modernized their data analytics platform, including data governance and data pipeline throughput, ensuring compliance with strict data privacy and security regulations. Our efforts yielded reduced infrastructure costs and improved overall performance. For a leading home improvement retailer, we modernized their legacy monolithic commerce platform, opening the path to implement AI-enabled services such as search on the Azure platform. For a major CPG brand, we implemented a wholesale order platform for its North American business, significantly reducing manual labor associated with processing validated orders. This platform integrates order flow data into the client's next-generation ERP system, streamlining operations and enhancing efficiency. For a leading automotive parts supplier, we migrated product data to automotive industry standards, consolidating B2B as well as B2C search capabilities on a common platform. This will improve overall customer experience and enhance product sales. It's also the first step for the company rolling out a conversational AI shopping assistant. For a global footwear brand, we launched 40 country-specific sites in under six months, providing localized features for in-country personalization, shipping, and fulfillment. This achievement was made possible by leveraging the underlying MACH architecture we developed, further extending our long-term relationship with the brand. With that, let me turn the call over to Anil, who will discuss Q2 results in more detail.

Thanks, Leonard. Good afternoon, everyone. Our second quarter results were solid as we exceeded our expectations, both on revenue and non-GAAP EBITDA. Our second quarter revenue of $83 million was ahead of our guidance range of $80 million to $82 million, and our non-GAAP EBITDA of $11.7 million was ahead of our guidance range of $10.5 million to $11.5 million. The strong results were driven by a wide range of customers across various industry verticals. During the second quarter, our retail and TMT were the two largest verticals, accounting for 32.2% and 28% of our revenues, respectively. Our retail vertical grew 8.7% and 2.9% on a sequential and year-over-year basis, respectively. On a sequential basis, we witnessed growth from multiple customers in the specialty retail and home improvement space. TMT decreased by 3.3% and 3.6% on a sequential and year-over-year basis, respectively. On a sequential basis, the decline was largely driven by a technology startup in the security space. Nevertheless, our largest customer in our TMT vertical grew on both a sequential and year-over-year basis. Regarding the revenue mix from other verticals, our CPG and manufacturing represented 11.9% of our revenue in the second quarter, with a sequential increase of 3% and a year-over-year decrease of 9.5%. Revenues from our top three customers in CPG and manufacturing grew on a sequential basis. Our finance vertical was the strongest on both a sequential and year-over-year basis, showing growth from customers across the fintech and insurance sectors. Our newly disaggregated healthcare and pharma represented 3.8% of our revenues, showing a 5% increase sequentially but a 14.8% decrease year-over-year. Lastly, the other vertical represented 9% of our second quarter revenue, down 10.6% sequentially but up 26.7% year-over-year. We ended the second quarter with a total headcount of 3,961, up from 3,892 employees in the first quarter of 2024 and up from 3,862 in the second quarter of 2023. At the end of the quarter, our total U.S. headcount was 347, representing 8.8% of the company's total headcount, up from 8.2% in the prior year quarter. Our non-U.S. headcount located in Europe, the Americas, and India was 3,614, or 91.2%. In Q2, revenues from our top five and top ten customers were 38.5% and 57%, respectively, compared to 37.6% and 56.6% in the same period a year ago. During the quarter, we had a total of 208 customers, down from 210 in the first quarter of 2024 and 216 in the year-ago quarter. We added several customers during the quarter, some of which Leonard referred to in his prepared remarks. The year-over-year decline in the number of customers was primarily due to our continued efforts to rationalize our portfolio of non-strategic customers. Moving to the income statement, our GAAP gross profit during the quarter was $29.6 million, or 35.6% compared to $27.7 million, or 34.7% in Q1 2024 and $28.3 million, or 36.6% in the year-ago quarter. On a non-GAAP basis, our gross profit was $30.1 million, or 36.2%, up from $28.1 million, or 35.3% in Q1 2024 and up from $28.8 million, or 37.3% in the year-ago quarter. The increase in gross profit, both in dollar and percentage terms on a sequential basis, was mainly driven by a combination of higher revenue levels and better utilization of engineering resources. Our non-GAAP EBITDA during the second quarter, which excludes stock-based compensation, depreciation and amortization, restructuring and expenses related to geographic reorganization, transaction and other related costs, was $11.7 million, or 14.1% of sales, up from $10.3 million, or 12.9% of sales in Q1 2024 but down from $12 million, or 15.5% in the year-ago quarter. The sequential increase was largely due to higher revenues, partially offset by an increase in operating expenses. Our GAAP net loss in the second quarter was $0.8 million, or a loss of $0.01 based on a basic share count of 76.6 million shares, compared to a loss of $3.9 million or a loss of $0.05 based on a basic share count of 76.2 million in Q1 and an income of $2.6 million or $0.03 per share based on 75.1 million basic shares in the year-ago quarter. The sequential decrease in GAAP net loss was largely due to higher gross profit and lower levels of stock-based compensation, partially offset by provisions for income taxes. On a non-GAAP basis, our second quarter non-GAAP net income was $6 million, or $0.08 per share based on 77.9 million diluted shares compared to a non-GAAP net income of $5.2 million, or $0.07 per share based on 78.4 million diluted shares in Q1 and $7 million, or $0.09 per share based on 76.9 million diluted shares in the year-ago quarter. On June 30, 2024, our cash and cash equivalents totaled $256 million, up from $249.4 million in Q1 2024. Regarding our guidance for Q3, we expect revenues to be in the range of $84 million to $86 million. We expect non-GAAP EBITDA in Q3 to be in the range of $12.3 million to $13.3 million. For Q3 2024, we expect our basic share count to be in the range of 77 million to 78 million and our diluted share count to be in the range of 79 million to 80 million. That concludes my prepared remarks. We are now ready to take questions.

Thank you, Anil. The first question will come from Maggie Nolan of William Blair. Go ahead.

Hey, how are you doing?

Good. Thanks, Maggie.

Congratulations. So I wanted to ask about the talent landscape for you all. So you're back to hiring some time has passed since you've reorganized the footprint of the business since you started talking about Follow-the-Sun as well as the thought structure that you rolled out. So I'm curious how you're thinking about managing margins from here on an account-by-account basis now that you have all these different pieces in place and how we might start to see that manifest in the P&L?

Well, you just answered the question, right, Maggie? So managing the margins account by account for the key accounts is what it really comes down to. From the hiring perspective, we continue to hire across all the regions where we execute the Follow-the-Sun program. There is definitely an emphasis on India; it continues to expand. We are still putting a lot of effort into Europe, but we are doing a little bit more smart hiring. We're adding more interns for the program, bringing engineers in and promoting from within. As the projects have stabilized and grown with the part solution offering, we're able to expand the breadth of the teams. When you have deeper projects, you can actually manage cost efficiency within the teams. The short answer is yes, the key is to manage profitability for key clients.

Thank you. And then you also talked about maybe an increased willingness of customers to either maintain or even increase their spend. I'm wondering if there is a notable change in the scope of projects, type of projects, duration of projects as you see that resurgence of willingness to spend. Any thoughts you might have on why this is slightly different from some of your competitors in the space.

So I think fundamentally, when we talk about our differentiation, it's always been the market for Grid Dynamics to focus on technology projects. When we do technology projects, the scope is around solutions that greatly impact sales. The reason I emphasize AI is not just because it's fashionable; it's about the possibility to implement numerous internal solutions. I also noted that from the proof of concept stage to broader implementations is indeed a progression. So yes, technology remains the core focus. We're broadening the number of platforms we use for our innovative AI projects, starting from open-source products to specialized solutions to private models, building co-pilots together with clients. As we expand our partnerships, we have a broader range of project implementations with clients. To summarize, technology focus and the breadth of AI are moving from conceptual stages to wide-ranging implementations, supported by the reputation that comes with years of managing various data aspects for our clients.

Great. Thanks, Leonard, and Anil, congrats again.

Thank you, Maggie.

Can we go to the next question?

The next question goes to Gates Schwartzmann from Citi. Please go ahead.

Gates, are you there? We'll come back to you. Cary, why don’t we go to the next?

The next question comes from Bryan Bergin of TD Cowen. Bryan, please go ahead.

Hi, guys. Thanks, good to see you. I wanted to start on the guidance. It's nice to see the sequential performance in Q2 and then what's implied in Q3, the continued momentum there. As you develop the Q3 plan and consider the balance of the year into Q4, can you share some perspective on whether there was thought to reinstating that full-year outlook? I'm asking just curious as a signal around overall business visibility.

So Bryan, this is a very good question because this is a constant discussion. Let me leave a couple of thoughts here. Number one is that things are improving. The likelihood of reinstating full-year guidance is higher than what it was maybe a month ago, two months ago, or three months ago. We are moving in the right direction. We tend to be conservative, and when we're ready for it, we will communicate that out. But the internal bias leans toward providing full-year guidance. Leonard's inclination is to give as much visibility as possible for the Street, and that's what we're working on. So at the right time, we will make that announcement, but we definitely have more of a bias towards that direction.

Okay, that makes sense. And then just on the new logos, can you speak to some of the pace of scaling these larger enterprise logos? You've had good momentum each quarter here signing several, but how are those ramping faster too? Can you speak to some trends in those new relationships that may be common?

Well, the story isn't any different from past years of growth, Bryan. Typically, when you sign a logo, especially from new relationships, the projects start relatively small. It's still a land-and-expand strategy. Usually, it's from a highly technical field, and Grid Dynamics is often referred as a technology partner among large enterprises. In some cases, they may have faced issues with prior partners and found us to be a better fit. It's crucial to understand their business models as a more technically astute partner helps us better serve these clients. In a few instances, the leadership of clients has known us for a long time. Those situations are the most straightforward, as you do not need to prove yourself anymore. When that trust is established, it leads to new opportunities based on past performance, but you have to rapidly adapt and deliver. As we grow over the past 18 years, these types of circumstances are becoming more common. Our new relationships, as well as existing partnerships, are expanding from technological engagements to more significant implementations across multiple fields.

Great. That's helpful. Thank you very much.

Thank you, Bryan.

Thank you, Bryan. The next question comes from Mayank Tandon at Needham. Mayank, please unmute yourself and you can start your video.

Yeah, can you guys hear me?

Yes, Mayank. We can hear you.

I’m trying to restart my video, let’s see. Yeah, hi. Thank you for taking my question and good evening, Leonard and Anil. Congrats on the quarter. I wanted to ask you about revenue growth for the third quarter. As you look ahead, could you unpack the growth in terms of headcount additions and utilization? How much more room do you have to expand it and also pricing? Is there more leverage on the upside, or is pricing basically running flat at this time?

I’ll take that as the privilege of Anil. Obviously, he rolls on acquisition strategies, but let me try to focus on the key areas because it's a very fundamental question. I don't see a rapid increase in client pricing. In some instances, it's not about increasing pricing; it's about fair value for the solutions. When you work on a time-and-materials basis, there’s seldom a price increase. However, in project-based work, when you offer a customer a complete proposal, that does happen. Ultimately, it’s about return on investment. Demand is still critical, but we need to be smart about pricing strategies. Overall, we see some improvements. Additionally, balancing the teams and enhancing the efficiencies, as I mentioned when Maggie asked her question about the projects, allows better cost management within the teams. If I summarize, demand is present for Grid Dynamics. If we focus on one area, there may not be a huge change in financial performance, but we are expanding into multiple areas. The efficiencies are improving, and the efficiency stems from a broader talent pool. Even during economic downturns, we did not slow down our internship and training programs, or internal university services. Therefore, those initiatives have picked up significantly. Moreover, we have increased our investment in R&D, resulting in the development of over 30 solutions. These are impactful solutions, and when discussing Fortune 500 clients, these create actionable outcomes that drive implementation paths for both performance and financial efficiency. I hope this gives you a better flavor of our market position.

As a quick follow-up, Leonard and Anil, I wanted to dive into the clients where you have top 5, top 10. Where do you see them in terms of penetration? Is there more headroom to grow within these clients? Or do you think the growth will really come from your non-top 10 as you look beyond 2024 to 2025?

Well, let me start. We recently conducted our internal executive reviews, which we do on a semi-annual basis to assess our position. Our strategy comes in three tiers. The top tier consists of our largest clients; the second tier includes large companies where our footprint is still considerably smaller; and the third tier comprises new innovative clients that we attract either through strategic partnerships or active hunting efforts. Regardless of what we do, there is still concentration among our clients. However, this pattern differs from a few years ago when we had more diversity across industries. We still engage with major customers and we need to ensure engagement is continuous and 24/7 because our success is closely tied to theirs. When some of these major clients experience downturns, it adversely affects us. We select firms wisely that inspire growth and have the capability to enhance their market positions. In terms of the second tier, we experience growth from every client opportunity. The potential for our existing clients is sizable—often just a small percentage can yield high returns—so it’s our duty to deliver technology that contributes significantly to their success. Lastly, we allocate significant resources to partnerships, focusing on joint implementations while simultaneously working on independent ventures.

Perfect. Thank you so much, Leonard. Thank you.

Thank you.

Thank you, Mayank. Appreciate your questions. The next question comes from Puneet Jain of JPMorgan. Go ahead, Puneet. You're on mute.

Puneet, I think you’re on mute.

Puneet, go ahead, sir. You're now connected.

Okay. I just asked all my questions. So thanks, anyway. So in this quarter, over the last couple of years, you have added around 50 to 60 enterprise customers. Some of them, for example, the one in financial services, have done really well. Can you provide the state of affairs on those clients you added? For some of them, like those that may still be under scale, what’s keeping them from ramping up? What’s the potential for those clients?

This essentially expands on my previous response regarding the second group, not the top one. Everyone focuses on successes, but we need to acknowledge those which are in transition, the so-called silent majority. We recently had a deep account-by-account review because there aren’t a huge number of clients—maybe 25 to 30—who are still progressing to scale from 2, 5, 10, and beyond to 20. These clients are where the thrust lies because crossing certain thresholds results in becoming a preferred supplier. Furthermore, during this period of consolidation, it’s crucial to remain relevant, not just to one team but across many within those organizations. I've identified about half of these clients as strategic targets that we will engage more deeply with to enhance our business cases and understand why success hasn’t materialized. We must ensure their technology roadmap aligns with our services while also fostering the necessary mindset and capacity for growth. Doing proof of concept is easy; driving actual business value is our challenge. With about half of those clients, we want to deepen engagements to move them beyond the pilot phase.

That’s wonderful. You have about $250 million in cash on the balance sheet. In the press release, I noticed that you mentioned most or all of the growth is organic now, meaning that it’s been over a year since your last acquisition. Can you talk to us about your cash priorities over the near term? What are you looking for in potential M&A targets?

You don’t see him in the room because he’s behind the scenes, but it's our Head of M&A that will guide us on future strategies. I can’t disclose too much about acquisition plans, but there’s tremendous engagement currently. First, let’s remember we’re discussing not only technology but also geography. Currently, everything seems aligned as we have the geographic spread we need, and our technology is now credible. We wouldn’t invest in a company unless there’s a clear benefit for them or they require enhanced support as part of our broader enterprise. When that time comes, I can’t commit to the exact timing. However, we’re quite optimistic about potential acquisition opportunities emerging over the next few weeks; we have found our rhythm. The maturity we have developed through the previous acquisitions positions us well moving forward. We view this as an opportunity to bring additive value as we grow into 2025 and beyond.

That’s good to know. Thank you.

Thank you, Puneet.

Ladies and gentlemen, this concludes the Q&A session of our call today. I will now turn it over to Leonard for closing comments.

Thank you, everybody, for joining us on the call today. Our message is consistent with past commentary over the last couple of quarters regarding steady improvement in Grid Dynamics' business. Visibility is getting better. Customers are more willing to put plans into action and budget, and more importantly, customers are laser-focused on evaluating the technological competencies of their IT partners. I'm excited about these opportunities in the second half of 2024 and into 2025. I look forward to updating you at the next earnings call. Thank you.