GDYN 2022Q3

Good afternoon everyone. Welcome to Grid Dynamics Third Quarter 2022 Earnings Conference Call. I am Bin Chiang, Head of Investor Relations. 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, 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’ll 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 have just described in the Investor Relations section of our website. With that, I will now turn the call over to Leonard, our CEO.

Thank you, Bin. Good afternoon, everyone and thank you for joining us today. Q3 2022 was another record revenue quarter of $81.2 million, and this marked the ninth consecutive quarter of record revenue in the company’s history. We performed exceptionally well across multiple areas. Additionally, our third quarter results exceeded our guidance with respect to revenue and profitability. For the first time as a public company, we surpassed our target operating model of 40% gross margin and 20% EBITDA margin on a non-GAAP basis. The better-than-expected performance was due to a couple of factors. First, during the quarter, we witnessed strong demand across some of our large technology customers as they continued to ramp up on both existing and new programs; and second, we witnessed strong momentum with recent logo wins. Notably, we enter the fourth quarter of 2023 with a very robust pipeline with new client business. Customers are increasingly seeking to partner with Grid Dynamics for their strategic digital transformation initiatives, and we’re increasingly viewed as a company that can provide scalable, high-quality engineering. I’m confident in our strengths and believe the company is well positioned to grow successfully. Let’s talk about locations. In Poland, our second largest delivery country, our profile and status have been elevated as a technology leader in the Polish business community. We’re now fully functioning across the four largest cities in Poland: Warsaw, Krakow, Gdansk, and Wroclaw. Grid Dynamics internships expand across all these locations. In addition, Poland’s great support of Ukraine has resulted in our offices posting a substantial number of Ukrainian employees. During the quarter, I’m happy to highlight that the Grid Dynamics leadership team was invited by the United States Ambassador to Poland to lead a round table business discussion with U.S. corporations, Polish academia, and other institutions during the visit to Warsaw. This is a true testament to the company’s strengths, and we expect such recognitions to help us in recruiting high-quality talent and attracting new global customers who are operating in Poland and other European countries. In India, we completed the incorporation and are now directly hiring on our payroll. We have augmented our leadership in HR, delivery, and operations and partnered with one of the leading universities for internships. In a couple of weeks, we’re opening our new office in one of the premium locations in Hyderabad Knowledge Park, and expect our presence in this location to help us in attracting and recruiting high-quality talent. We also ramped up hiring engineering talent in several countries, such as Mexico, Serbia, Armenia, Romania, and others. In each of these countries, we offer unique advantages for our global growth. During the quarter, we expanded our relationship with universities and hired our first group of interns in Armenia and Romania, while expanding our office in Serbia, and opening two new engineering centers in two cities in Romania. As you all know, over the past couple of quarters, we executed flawlessly in transitioning a significant proportion of our workforce while continuing to deliver projects in a timely manner. I’m happy to report we continue to operate across all our geographies without any disruptions. With our distributed delivery model, projects are spread across different geographic regions, thereby lowering geographic delivery risks. Our company has always been at the forefront of emerging technologies. Within the IT service industry, we’re one of the first companies to embrace cloud engineering, big data, machine learning, as well as other innovative products and offerings for large enterprise clients. We continue to maintain our technology leadership and always keep R&D at the center of our service offerings. Our Chief Technical Officer, with his team, spearheads a number of strategic initiatives to support growing customer digital transformation demand. Regarding personnel, we have hired subject matter experts to build expertise in selected verticals such as manufacturing, supply chain, life science, and financial services as well as insurance. Regarding capabilities, we’ve made substantial progress in building custom IP solutions targeting specific industry verticals. This includes accelerators and engineering implementation frameworks, leveraging distributed agile, cloud, and DevOps, as well as automation. Such initiatives clearly demonstrate the reduction of implementation risks and customer costs. In the quarter, there were several positive trends that I want to share with you, a few notable ones. Demand trends: In Q3, we witnessed enhanced budget scrutiny across customer bases with some retail clients being more sensitive. We expect this trend to persist in Q4. Meanwhile, the majority of our clients continue to invest in revenue-generating programs, which tend to be more insulated from macro headwinds. In addition, Q3 revenue also benefited from our new logo business development and based on current trends in Q4, we expect continued strength from the new logos. Coming to some additional third-quarter segment commentary, our Technology segment was the largest during the quarter, and similar to Q2, some of our largest technology customers continued to ramp aggressively and support our growth as we expanded into new geographies. Our Financial segment grew healthily, benefiting from new programs tied to wealth management applications. Regarding logo momentum in the third quarter, we added several new logos across industries, which included a Fortune 500 climate control equipment manufacturer, a specialty retail company, and a large online consumer platform. I’m happy to report that in September, we signed new contracts and started engagement with two Fortune 30 companies: one is a global automotive manufacturer, and another one is the leading membership-only discount chain. We received revenues from these two customers starting in October. European business expansion: During the quarter, we made good progress with our European clients. Cybersecurity is one of our strategic focus areas, and we expanded our business with a number of cybersecurity and software companies. Additionally, we witnessed a strong ramp with a global footwear company. We also continued to scale our business with a large U.K.-based home improvement chain and secured new business with a major Nordic truck manufacturer. New business pipeline: We entered Q4 2023 with a robust pipeline of new logos and strong demand across our non-retail verticals. On the new logo front, we’re witnessing strong momentum and expect to add more logos in Q4 than we did in Q3 this year. With some of our new large customers, we also witnessed faster ramp-up, as they are willing to scale business more rapidly. We’re expanding our business within existing programs and expect these to contribute meaningfully in 2023. Partnerships: Partnerships are increasingly playing an important role in our ability to attract new clients. In Q3, our new logo wins came through our partnership channel. We also made progress with our large cloud partners with Microsoft Azure, where we confirmed gold status. At AWS, we were recognized as a launch partner for their EKS delivery program, which focuses on application modernization across enterprises. At Google Cloud Platform, we have one of the largest numbers of specializations among IT service providers. In addition to hyperscaler cloud partners, we strengthened our alliances with SaaS and product companies in digital commerce, data, and advanced analytics. M&A: M&A continues to be an important component of our growth strategy. As a reminder, our M&A focuses on capabilities, key customers, and delivery locations. In early September, we successfully concluded raising primary capital. One of the key reasons for this raise was M&A. Our current pipeline is robust, and we’re actively exploring multiple acquisition opportunities to expand our capabilities, complemented by our geographic expansion strategy. During the quarter, Grid Dynamics delivered some notable projects. Firstly, for a global technology company, we proposed, designed, and implemented Snowflake integration to run business intelligence reports on petabytes of data. As a result, end users were provided with enhanced reporting capabilities to drive the company’s business and operational decisions. This solution met all the required data service level agreements for large-scale data management and resolved previously observed challenges in maintenance, capacity, and scalability. For a global technology leader in the cloud space, Grid Dynamics was a key partner in the development of one of the core B2B products dedicated to artificial intelligence-driven product capabilities. Grid Dynamics' contribution included end-to-end quality engineering of the product and customer onboarding tool suite. The product provides end users with a tailored product discovery experience and dramatically increases conversion through better search and recommendations relevance. For one of the largest manufacturing service companies, we developed an intelligent cloud-based module for their supply chain management system. This module aggregates information about excessive stock matches against contractual terms and allows the generation of claims. It’s currently in production and has helped our client in collecting additional revenues. With that, let me turn the call over to Anil, who will discuss Q3 in more detail. Anil?

Thank you, Leonard, and good afternoon, everyone. Our third-quarter revenue of $81.2 million exceeded our guidance range of $78.5 million to $80 million and was up 4.9% on a sequential basis and 40.1% on a year-over-year basis. During the quarter, our revenue was negatively impacted by the weaker euro and British pound against the U.S. dollar. On a constant currency basis, our revenue growth on a sequential and year-over-year basis was 5.8% and 43.1%, respectively. The better-than-expected revenue in the quarter was driven by strong demand from our large technology customers and revenue contribution from recent logo wins. TMT, our largest vertical, represented 32.4% of our third-quarter revenues and grew 12.6% on a sequential basis and 49.7% on a year-over-year basis. We witnessed strength across our customer base with some of our largest technology customers, where we grew business across existing new programs. During the third quarter, Retail, our second-largest vertical, represented 31.1% of our revenues and decreased 0.8% on a sequential basis and grew 38.3% on a year-over-year basis. The sequential decline was largely driven by some customers who were more cautious in spending during ongoing macro concerns. We expect these concerns to persist in Q4 with some of these customers. The revenue mix of other verticals: Our CPG and Manufacturing segment represented 19.8% of our revenue in the third quarter and decreased 0.2% on a sequential basis and grew 43.3% on a year-over-year basis. The slight decline on a sequential basis came from a decline at some customers, offset by growth at our largest CPG customer. Finance represented 7.5% of revenue, increasing 20.3% on a sequential basis and growing 16.3% on a year-over-year basis. On a sequential basis, we witnessed growth across most of our customers tied to financial services, banking, and insurance. Finally, the other segment represented 9.2% of our third-quarter revenue and was up 1.1% on a sequential basis. We exited the third quarter with a total headcount of 3,746, down from 3,763 employees in the second quarter of 2022 and up from 2,884 in the third quarter of 2021. The headcount reduction was driven by a couple of factors. First, at a company-wide level, we streamlined our engineering bench. Second, our pace of hiring moderated to align with demand during the quarter. That said, our average billable headcount increased on a sequential basis in the third quarter over the second quarter, which partially contributed to the increase in revenue. At the end of the third quarter of 2022, our total U.S. headcount was 322, or 9% of the company’s total headcount, which remained on the same level compared to the second quarter of 2022 and down from 11% in the year-ago quarter. The year-over-year decline as a percentage of the total headcount was largely driven by a greater mix of non-U.S. headcount. Our non-U.S. headcount, which we sometimes refer to as offshore, located in Central Eastern Europe, UK, Netherlands, Mexico, and other locations was 3,424 or 91% of our total headcount. In the third quarter, revenues from our top five and top ten customers were 44.5% and 61.1%, respectively. In the second quarter, our top five and top ten customer concentration was 44.2% and 60.2%, respectively. During the same period a year ago, our top five and top ten customer concentration was 42% and 58.2%, respectively. During the quarter, we had a total of 200 customers, down from 208 customers in the second quarter and 215 customers in the year-ago quarter. The sequential decline in our customers was largely driven by our commercial business or Daxx, which we acquired in December 2020. As a reminder, we only count the revenue-generating customers in the quarter and do not include customers who were inactive during the quarter. Moving to the income statement, our GAAP gross profit during the quarter was $32.7 million or 40.3%, up from $28.9 million or 37.3% in the second quarter of 2022 and up from $25.3 million or 43.6% in the year-ago quarter. On a non-GAAP basis, our gross profit was $33 million or 40.7%, up from $29.1 million or 37.7% in the second quarter of 2022 and up from $25.4 million or 43.9% in the year-ago quarter. The sequential increase in gross margin as a percentage of revenue was driven by a combination of third quarter seasonality with more working days and favorable FX trends with the stronger dollar. Non-GAAP EBITDA during the third quarter excluded stock-based compensation, depreciation and amortization, expenses related to geographic reorganization, transaction, and other related costs and was $17.1 million or 21.1% of revenue, up from $13.3 million or 17.2% in the second quarter of 2022 and up from $12.5 million or 21.6% in the year-ago quarter. The sequential increase in EBITDA, both in terms of dollars and percentage of revenue was due to higher levels of revenue, flat operating expenses, and favorable FX trends. Our GAAP net loss in the third quarter totaled $6.7 million, or a loss of $0.10 based on a share count of 69 million shares compared to the second quarter loss of $13.2 million or $0.20 per share based on 67 million shares and a loss of $0.5 million or $0.01 per share based on 63 million shares in the year-ago quarter. The sequential and year-over-year increase in GAAP net loss was largely due to higher levels of stock-based compensation and geographic reorganization costs, offset by higher levels of revenue. On a non-GAAP basis, in the third quarter, our non-GAAP net income was $11 million, or $0.15 per share based on 72 million diluted shares, compared to the second quarter of 2022 non-GAAP net income of $8.2 million or $0.12 per diluted share based on 70 million diluted shares and $7.9 million or $0.11 per diluted share based on 69 million diluted shares in the year-ago quarter. The key reasons for the increase in the non-GAAP net income on a sequential basis were higher levels of revenue and flat operating expenses. The increase in non-GAAP net income compared to the year-ago quarter was largely from higher levels of revenue, partially offset by higher levels of operating expenses. Now coming to the balance sheet. On September 30, 2022, our cash and cash equivalents totaled $255.2 million, up from $150 million in the second quarter of 2022 and up from $144.4 million in the fourth quarter of 2021. During the quarter, we conducted a primary share offering and raised $115 million, of which $109.5 million was received by the company. Coming to the fourth-quarter guidance, we expect revenues to be in the range of $77 million to $78 million. With this, our full year 2022 revenue expectations will be in the range of $307 million to $308 million or 45% to 46% growth on a year-over-year basis. We expect our non-GAAP EBITDA in the fourth quarter to be in the range of 16.4% to 17% or $12.6 million to $13.2 million. For Q4 2022, we expect our basic share count to be in the 74 million to 75 million range and our diluted share count to be in the 77 million to 78 million range. That concludes my prepared remarks. Bin, we’re ready to take questions.

Yes, hi. Thanks for taking my question. And congratulations on the results today. So with concerns over global growth slowdown, can you provide some updated color on the robust demand environment, specifically your ability to continue to win new logos in this uncertain macro environment? What commentary are you hearing from new clients that are driving them to your services? Thank you.

Thank you, Josh. It’s always good to be first. You can ask any question, right. So the feedback we’re getting is actually what I mentioned in my remarks that the dynamics of growth in multiple industries continue to expand geared toward revenue generation. As we know, we’re all kind of heading toward a recession or inflationary pressure, or other challenges. So it’s more about a situation where winners take it all. The competition for dollar becomes more fierce. We see that the digital services we offer, both engineering and customer service as well as partnerships with product companies become more vital for securing revenue dollars for the clients.

Excellent. Thank you for the color. And Anil, I’d love to dive a little deeper into the strong margin we saw this quarter and the guidance for Q4, especially considering your recent focus on building out into new geographies. Can you walk us through some of the margin tailwinds that you expect as we move into the fourth quarter?

Sure. Well, you meant third quarter, right? When we go into the fourth quarter, really, when you look at it, there are some puts and takes. On the plus side, we continue to expect some tailwinds from the FX side, right? Now on the other side, if you look at the size of the quarter, fourth quarter typically shows furloughs and fewer billable hours. So, you’re going to see some headwinds there. However, when you look at revenue, Josh, extrapolating from Q3 to Q4, we are going to continue maintaining some level of OpEx control. The drop in revenue will flow through to the EBITDA front, but the larger reason is a number of working days.

Yes, I just want to add, Josh, that the Q3 result, by and large, when I was giving the guidance to the public when we were heading into our IPO more than 2.5 years ago. The 40% gross margin and 20% EBITDA is our goal, and very few companies can accomplish that. It wasn’t a strange goal then, but we encountered a lot of obstacles over time. If the world normalizes, that’s where we want to be; that’s where we will be. When the time comes for more stable growth, I think we’ve just given the inspiration to the community to show where we are actually able to deliver.

Thank you, Josh. Thanks for your question. Next question comes from the line of Ryan Potter from Citi. Please go ahead.

Hey, guys. Thanks for taking my question. I want to start by touching on the situation in Ukraine and with the recent escalations there and with infrastructure instability and some plant blackouts, have you seen any incremental headwinds in terms of productivity or utilization in Ukraine; has that impacted your client conversations at all?

Right. So the short answer is no, but it would be too simple to answer, Ryan. Months ahead, we were preparing for what is called in Eastern Europe, the heating season. There is a lot of centralized activities. We, of course, did not know about the Russian attacks during October. But we knew when this whole situation arose, that the infrastructure would be a bit more stressed during the war. We need to be prepared in advance, which we have been; knock on wood, our people are safe. We’re adding more micro-offices throughout Ukraine. We actually plan to add up to nine of them by the end of November, which will provide further autonomous control over power generators, water supply, food supply, and internet connectivity. So we have a smaller number of people in Ukraine; it’s still our largest location by number. But looking at how we drive our business, the dependency on enterprise businesses has greatly reduced from the Ukrainian operations. Much of the business derives more from smaller, start-up companies. But by and large, we are in good shape.

Got it. That’s good to hear. And then touching on verticals and the Retail and TMT vertical, in particular, could you just provide an overview of the overall trends you’re seeing? For Retail, is the softness you’re seeing more of an industry vertical theme or is it more client-specific? For TMT, has the focus on cost or hiring freezes led to any changes in trajectories with your clients?

Well, we’re not immune. Retail is retail. As we learned many lessons during the early COVID days with the incredible decline of our relationship with department stores, we took it very seriously. The majority of our retail customers are less dependent on brick-and-mortar stores, so they are a bit less affected. They are more efficient and are planning to go into recession mode. Don’t forget we’re close to the holiday season. At the same time, usual suspects are putting restrictions on spending that were there two years ago, so there is a sequential decline driven by cost savings. We expect it to last some time, but we are compensating with scaling other businesses. It's also important to note that the work we do is primarily driven by revenue generation initiatives; thus, while we are not the most critical supplier, the core teams largely remain intact, which positions us well for a faster rebound when the industry returns.

Thank you, Ryan. Next question comes from Maggie Nolan from William Blair. Please go ahead.

Hi, thank you. Maybe to follow up on that last topic a little bit. Can you talk about how your retail client base compares to what it maybe looked like a couple of years ago in terms of any notable differences in the type of clients and the projects that you’re working on?

Yes. So you know us quite well by now and we’ve been in constant communication. The critical client relationships in retail are driven by pricing, logistics, and supply chain management. Those are key areas of our relationship. We have brought in a number of clients both in the U.S. and in Europe that tend to be more modernized in their approach. While we have seen some declines, the focus of our product and our delivery is different. In particular, from the retail side, we are seeing fewer U.S.-based employees, with more coming from nearshoring in Mexico and Jamaica as well as offshore in other regions like India. So we are not only prepared from the client base and product base, but from a cost efficiency perspective.

That’s very helpful, Leonard. Thanks. And then my follow-up question is just can you elaborate a little bit on what you did to streamline the engineering bench, as Anil referred to? Are these efforts going to continue into the coming quarters?

Yes. Some of the bench relates to the transition from Q2 to Q3 when we exited Russia. The other area is that we tend to look at our bench with the skill sets that we project to be less relevant during recession times to be more efficient. At the same time, we are making significant investments into internship programs across all the countries, including Ukraine and others. We signed university partnerships in India, Mexico, Poland, Romania, and Armenia. There are other investments we do as well; we believe it’s crucial to invest in R&D and the sales development to enhance subject matter expertise. Our clients have a tendency to want to retain continuity during downturns, and we work hard to help them in this regard.

Thanks for taking my question. So, Leonard, regarding the projects that typically get delayed in the retail vertical or others, based on past experiences, how long do clients take to come back with those projects that have been delayed?

There are some notable declines that may take longer not as material, but most happen temporarily. We talk with clients to make sure their projects continue, and we understand the importance of maintaining the core projects to ensure continuity. If clients need to retain their workforce, we encourage alternative projects to keep things moving. We feel confident in our position and that we can leverage our expertise to assist in various projects that continue on the ground and may shift forward as projects normalize.

And second, for your tech vertical, what’s driving the strong growth? Is it defensive work for your technology clients, or are you seeing a shift in types of projects?

I would not want to anger my big customers by divulging too much. But we have high capable teams contributing to strategic elements that are growing within those companies. I wouldn’t say we are only on a defensive development for cost savings; rather, we are driving key elements that directly relate to manufacturing, supply chains, logistics, and e-commerce areas. The digital initiatives are still present, and our role in those projects is vital.

Hi guys. Good afternoon and thank you. You had good strong momentum here in the new logos that you cited. I’m curious, are the priorities of these new clients any different compared to your existing base as it relates to efficiency versus growth initiatives?

Yes, Bryan. The efficiencies are beyond just the revenue generation; the way new clients generate business varies significantly. I cannot provide specific strategies, but the new engagements have a revolutionary aim for how they intend to operate. High-level executives are seeking substantial changes rather than linear approaches, which sets the bar higher for what we provide. Yes, I believe we see consistent growth toward increased profitability in the second half of next year. Our guidance has been conservative, reflecting some variance we can expect over the holiday season. However, our long-term goals for 2023 remain aggressive.

Thank you, Mayank. At this point, we have no more questions in the queue. That will be all for the Q&A session today. I will now pass the call back to Leonard for closing comments.

Thank you everybody for joining us on the call today. Our solid results and performance highlight our company’s strong value to customers and incredible resilience. Our track record of successfully delivering large and complex projects and our reputation as a high-end engineering provider is driving our growth. I am confident that in the course of 2023, we will continue to see strong momentum as the company continues to expand our relationships with global enterprise customers. I look forward to giving you a business update early next year. Thank you.

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