GDYN 2022Q2

Good afternoon, everyone. Welcome to Grid Dynamics Second Quarter 2022 Earnings Conference Call. I'm Bin Chiang, Head of Investor Relations. 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, 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 answers to some of your questions. Such statements are subject to the risks and uncertainties as 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 reconciliation and supplemental financial information are provided in the earnings press release and the 8-K filed with the SEC. You can find all of 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. Q2 2022 was another record revenue quarter of $77.3 million, marking the eighth consecutive quarter of record revenue in the company's history. I want to emphasize these results, which are exceptional, given the circumstances the world has been facing over the past five months. Grid Dynamics executed flawlessly in transitioning a significant proportion of the workforce while continuing to build our projects in a timely manner. I will go into details shortly. Three months ago, I committed that we would exit Russia. Today, I would like to report that Russian activities have been concluded, and we are now geographically more diversified while continuing to expand across all our industry client verticals. More importantly, our customers are demonstrating unwavering faith in Grid Dynamics' capabilities. I'm confident in our strength and our ability to navigate the business successfully in the future, despite geopolitical challenges. As reported in our quarterly results, we progressed across multiple fronts of our business. This includes scaling our global presence with new locations, expanding our partnerships, and adding new customers. Grid Dynamics' solid results over the past several quarters have shown the company's incredible resilience in bouncing back stronger from the global pandemic crisis and recently from challenges related to Russia. It is a true testament to the company's strong fundamentals, teamwork, and commitment to the business and shareholders. On this call, we'll provide insights into the demand environment, global operations, financial performance for the second quarter of 2022, and also provide an outlook for the third quarter. Again, in the second quarter, our revenue of $77.3 million exceeded our expectations that we shared with you three months ago. We ended the second quarter with an adjusted EBITDA of $13 million, which is 17% of our revenue. The better-than-expected performance was due to a couple of factors. First, we witnessed stronger demand across our industry verticals and customers. Second, we experienced minimal disruption to billability as we transitioned out of Russia. And more importantly, customer interest in engaging our services around digital engineering continued to be strong in this quarter. During the quarter, our geographic footprint grew globally. In Europe, our new office in Switzerland will become our European headquarters, while London and Amsterdam will continue to serve as customer-facing centers of excellence. India, Mexico, and Poland will play strategic roles in scaling our delivery footprint over time. India, with its extensive talent pool, offers an unmatched ability to scale our operations in the long-term. Mexico, with its large pool of talented engineers and convenient time zone for our U.S.-based clients, offers an excellent nearshore presence. Our large clients have welcomed our nearshore strategy and have expressed interest in partnering with our Mexican operation. Finally, Poland, being one of the largest countries in Central Europe with a strong IT presence, will continue to support our operations as we scale in Europe. We have also ramped up hiring engineering talent in several countries such as Romania, Armenia, Serbia, and others. Each of these countries offers unique advantages in our global growth. In the quarter, several positive trends emerged, which I would like to share, and there are a few notable ones. Demand trends: In the second quarter, demand across our verticals and customers was strong. This was indicated by sequential and year-over-year growth across all our industries and the majority of our clients. As you know, current macro recession concerns have been on everyone's mind, and our clients have not been immune. Currently, we are not witnessing significant widespread headwinds; it's still more customer-specific in nature. There are a couple of reasons for this. First, many of our clients are prioritizing digital transformation initiatives, increasingly involving projects of strategic importance compared to some past experiences. Second, we are now a more diversified company with less exposure to recession-sensitive retail brick-and-mortar business. Even within our retail business, there is a shift away from some of those sensitive areas. Finally, the healthy pickup in our new logos over several quarters has enabled us to be more resilient as we engage across a larger customer base. Regarding additional second quarter segment commentary. Similar to last quarter, our largest technology customer continues to ramp aggressively and support our growth as we expand into new geographies. Strong sequential growth was driven by our e-commerce-friendly retail customers. At our largest CPG customer, we continue to grow, and more importantly, we finalized several key programs, not just for this year, but for 2023 as well. We're bullish on our prospects and will continue leveraging our position as strategic partners to many. Logo momentum: In the quarter, we added five new logos across industries. These included a global footwear manufacturing retailer, one of the largest distributors of beverages in the United States, a delivery service operation, and additional logos in the technology and healthcare space. Our pipeline in the third quarter is healthy, and I expect to share some significant logo wins next quarter. Partnerships: We’re witnessing good momentum on the partnership front. In the second quarter, we saw healthy growth in our pipeline and expect partnerships to play increasingly important roles in our growth. We received an award from the MACH Alliance for the best healthcare project during the quarter. Our capabilities and strengths are gaining greater prominence across our partners' ecosystems, leading to new opportunities. We’re also enhancing our team by adding a senior sales executive to focus specifically on building opportunities with one of the top three cloud providers. Finally, some of the largest cloud provider partners will launch new products and enhance our competencies and specializations. During the quarter, Grid Dynamics also delivered some notable projects. For a global technology company, we've built a centralized continuous integration platform. Our solution standardized best practices for collaboration among engineering teams and increased their productivity and transparency for engineering leadership. The platform currently serves over 1,000 engineers and is planned for company-wide rollout. At a global CPG company, we implemented a unified interface system for wholesale orders. This system will significantly reduce the amount of manual work and speed up order processing and fulfillment. As a key technology partner to a global cybersecurity company, Grid Dynamics helped build the next-generation cloud solution with security incident and event management. Our solution migrated the on-premise storage model to the major cloud platform. We developed a high-volume, high-velocity security event ingestion pipeline, anomaly detection, and behavior analytics. This solution provides a competitive edge in the marketplace by offering near-infinite scale, speed, and low operational costs. For one of the largest manufacturing and services companies, we developed an intelligent cloud-based supply chain platform that provides real-time visibility across the entire ecosystem. It covers the entire process from planning to delivery and utilizes big data, machine learning, and predictive analytics. The system allows users to identify and quantify potential risk losses and suggest mitigation options with appropriate cost estimates. Currently, our client uses the system to manage tens of thousands of suppliers globally. With that, let me turn the call over to Anil, who will discuss Q2 results in more detail. Anil?

Thanks, Leonard. Good afternoon, everyone. Our second quarter revenue of $77.3 million exceeded our guidance of $72 million to $73.5 million and was up 8.3% sequentially and 62.2% year-over-year. The better-than-expected revenue in the quarter was driven by strong demand for our services across industry verticals. During the second quarter, retail, our largest vertical, represented 32.9% of revenues, and grew 9.2% sequentially and 100% year-over-year. The strong sequential and year-over-year growth was driven by strength across our customer base, from e-commerce-friendly and brick-and-mortar retailers, as they continue to focus on digital transformation initiatives. Our TMT vertical was our second largest, representing 30.2% of our second quarter revenues and grew 9.1% sequentially and 45.2% year-over-year. We witnessed strength across our customer base. Initially, during the quarter, one of our largest technology customers grew aggressively as we expanded into new geographies. Here are the details of the revenue mix of other verticals. Our CPG and manufacturing represented 20.8% of our revenue in the second quarter and grew 7.4% sequentially and 62.5% year-over-year. The growth during the quarter primarily came from the ramp at our largest CPG customer. Finance represented 6.5% of revenue, increasing 11.5% sequentially and growing 24% year-over-year. Finally, the other segment represented 9.6% of our second quarter revenue and was up 2.8% sequentially. The growth came from healthcare and our new customers. We exited the second quarter with a total headcount of 3,763, up from 3,671 employees in the first quarter of 2022 and up from 2,510 in the second quarter of 2021. In the second quarter, we hired aggressively across our locations in Europe, India, and North America. This headcount addition was offset by two factors. First, as we exited Russia, there were headcount reductions that included the ramp-down of overhead and administration personnel. Second, we scaled down our bench of engineers, which had grown to compensate for any war-related supply disruptions. As we progress through the second half of the year, we expect our headcount to continue expanding. At the end of the second quarter of 2022, our total U.S. headcount was 326, or 9% of the company's total headcount, remaining at the same level compared to the first quarter of 2022 and down 11% in the year-ago quarter. The year-over-year decline as a percentage of the total headcount was largely driven by the greater mix of our non-U.S. headcount. Our non-U.S. headcount, which we sometimes refer to as offshore, located in Central and Eastern Europe, U.K., Netherlands, Mexico, and other locations, was 3,437, or 91%. In the second quarter, revenues from our top five and top 10 customers were 44.2% and 60.2%, respectively. During the same period a year ago, our top five and top 10 customer concentration was 45.4% and 62.3%, respectively. The diversification across our top five and top 10 was driven by a combination of factors that included new logo ramp-up, industry diversification, and our acquisition. During the second quarter, we had a total of 208 customers, down from 213 customers in the first quarter and 212 customers in the year-ago quarter. The sequential decline in our customers was largely driven by our commercial business, our Daxx, which we acquired in December of 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 $28.9 million or 37.3%, up from $26.8 million or 37.5% in the first quarter of 2022, and up from $19.8 million or 41.5% in the year-ago quarter. On a non-GAAP basis, our gross profit was $29.1 million or 37.7%, up from $27 million or 37.8% in the first quarter of 2022, and up from $19.9 million or 41.8% in the year-ago quarter. The sequential and year-over-year increase in gross profit was largely driven by the increase in revenues. Non-GAAP EBITDA during the second quarter that excluded stock-based compensation, depreciation and amortization, and expenses related to geographic reorganization and other related costs was $13.3 million or 17.2% of revenue, up from $11.4 million or 15.9% in the first quarter of 2022 and up from $9.7 million or 20.4% in the year-ago quarter. The sequential increase in EBITDA was due to higher levels of revenue and flattish operating expenses. Our GAAP net loss in the second quarter totaled a loss of $13.2 million or a loss of $0.20 based on a share count of 67 million shares compared to the first quarter loss of $2.7 million or a loss of $0.04 per share based on 67 million shares and a loss of $1.5 million or a loss of $0.03 per share based on 54 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. During the second quarter, we incurred $6 million in geographic reorganization costs. On a non-GAAP basis, our non-GAAP net income was $8.2 million or $0.12 per share based on 70 million diluted shares compared to the first quarter of 2022 non-GAAP net income of $6.9 million or $0.10 per diluted share based on 70 million diluted shares and $6.1 million or $0.10 per diluted share based on 61 million diluted shares in the year-ago quarter. The key reasons for the increase in non-GAAP net income on a sequential basis were higher levels of revenue and flattish operating expenses. The increase in non-GAAP net income in comparison to the year-ago quarter was largely from higher levels of revenue, partially offset by higher operating expenses. On June 30, 2022, our cash and cash equivalents totaled $150 million, down from $153.3 million in the first quarter of 2022 and up from $144.4 million in the fourth quarter of 2021. During the second quarter, we paid down our line of credit by $5 million. Additionally, in the second quarter, we accrued short-term liabilities of roughly $3 million that we expect to pay out in the third quarter. We also invested $1 million into a technology company. Coming to the third quarter guidance, we expect revenues to be in the range of $78.5 million to $80 million. We expect our non-GAAP EBITDA in the third quarter to be in the range of $12.6 million to $13.6 million, or 16% to 17% of revenue. For Q3 2022, we expect our basic share count to be in the 67 million to 68 million range and our diluted share count to be in the 70 million to 71 million range. That concludes my prepared remarks. Bin, we're ready to take questions.

Thank you, Anil. As we go to the Q&A session of this call, I will first announce your name; at that point, please unmute your line and turn on the camera. Our first question comes from Puneet Jain from JP Morgan. Your line is open.

Hey, can you hear me?

Yes. Hey, Puneet. Can you please turn on your camera?

Trying to. It's not Sorry, nice quarter, really nice quarter. I just had a quick question. Is the active relocation of employees or projects away from Eastern Europe completely behind you now? And should we expect you to operate in a steady state from here onwards?

It's more of a statement than a question, Jain. Good to hear from you. Yes, of course, Russia is behind us. There are still a lot of uncertainties in the region; work is far from over. We look very optimistically as we grow our position outside of the traditional risk area. We remain committed to Ukraine and continue to operate from Ukraine. With the diversity of the workforce and scalable capability, we see a very positive reaction from our clients.

Understood. As we think about the macro environment, specifically over the last few months, are there any differences in client behavior or their priorities across different verticals? Maybe like retail, CPG; clients might be more impacted by inflation compared to tech or other verticals. Have you seen any changes in client behavior or the spending pattern type of projects to execute across different verticals?

Sure. There is a difference. We've seen several customers tighten their budgets already. Some customers are considering tightening their budgets as well. We're not 100% immune, but we feel very good where we are. There may be some softness; this is the reality of the world. We're more diversified than we were. If you notice, we're delivering our growth, and we're also positioned more strategically than before. The importance lies in how deeply you're entrenched with the customer execution on the strategy. One thing about retail, as I'm sure this question will arise again, e-commerce-related or more e-commerce-driven enterprises in the retail CPG space tend to be more capable of withstanding market variations than those who are more brick-and-mortar dependent.

Yes, sir. Thank you.

Of course. Thank you.

Thanks, Puneet. Next question comes from Mayank Tandon from Needham. Please go ahead.

Great. Leonard and Anil, good to see you. Congratulations on the quarter. I just wanted to ask about the guidance coming off this really strong second quarter performance. The Q3 guidance does call for a deceleration; could you speak to that? Also, any sort of framework to think about Q4? And maybe I'm being a little greedy here, but could you also share any initial indications for '23?

I'm going to start a little bit on a high level, Mayank, and then I'll have Anil provide a bit more color on the guidance. By nature, we are conservative. We prefer to be conservative because, as you know, from the week after we became a public company in March 2020, turmoil ensued, and it seems to have never stopped. When we look at macro indicators and other factors, we simply want to ensure that we react properly. Growth and profitability should go hand in hand. We want to ensure we continue responsibly while also having the ability to scale. My big focus remains on technology innovation, regardless of the region; we are still about client offerings. I believe we are on the path to continue growing. However, in terms of specific sensitive variances in forecasting, I think Anil can provide more insights.

Thank you, Leonard. And Mayank, thanks for the question. You're right; as we transition from Q2 to Q3 seasonally, you all know how the quarters shape up, which typically shows strong sequential growth. Leonard summarized it very well. We look at all our clients and their forecasts, and the environment has many moving parts. There is nothing fundamental to worry about; there’s no loss of clients or business. It’s essentially a bottoms-up analysis, allowing us to provide the best forecast possible at this stage. We will monitor how the macro environment unfolds and will follow up in three months.

Not letting me unmute. Could you guys hear me now?

We can.

Okay. A little lag there. Just a quick follow-up on the supply side. Given all the cost issues that everyone in the industry is seeing, how are you able to offset that? Are your clients receptive to price increases with these cola provisions? Any commentary around that would be very helpful. Thank you.

Of course. I wanted to start by saying what cost issues, right? There are certainly pressures and some variation, but there are cost issues on one side and a bit of a tailwind from a stronger dollar. When you consider fundamentals, as you scale teams and move from one cost operating zone to another, the driver is how well you attract talent. We believe we've prepared well for key countries, which I previously described. So we have mitigation plans in place. For more senior talents, there will always be cost pressure. We are growing and still positioned as a fairly young company. From the customer perspective, there's a significant level of understanding of the high quality and performance of the teams we offer for strategic projects. We're not out of the woods globally, but we feel very comfortable balancing regions, talent, and client relationships.

Thank you. Appreciate it.

Thank you.

Thank you, Mayank. The next question comes from Maggy Nolan from William Blair. Please go ahead.

Hi, guys. This is Justin on for Maggie. Congrats on a nice quarter. We had a couple of questions for you regarding talent. So first, could you talk about how progress is going in India and Mexico? I know we've been discussing expansion plans in those two geographies recently.

Great. Thanks for the question. When we look at Mexico, it's steady. We're growing. I see more relationships forming with universities, more hiring, and more collaborations with clients that include Mexico. This is proportionate. Regarding India, I have seen growth at a disproportionate rate over time. India is a strategic number one location. Currently, the growth is somewhat slower than I'd like, not due to any issues on our part, but due to the incorporation process and direct hiring challenges we've faced due to formalities. That's progressing well. Another factor influencing the overall picture is that we planned for some catastrophic events in one of the countries. The resilience of our delivery and the quality of work remains strong. Most of the Russian engineers have relocated, and the Ukrainian team performs well in other countries too. While we see India growing, the urgent demand aligns with continued growth. We will keep you updated as we grow. The good news is, we’ve overcome various formal hurdles, and I can assure you that Indian Grid Dynamics will maintain the same quality, performance, and capabilities as any other location.

Okay. That's helpful color. For my follow-up, I wanted to discuss attrition. If you adjust for the exit from Russia, how did attrition trend in this quarter? What are the factors impacting attrition?

I think Anil summarized it quite well. It's in line with the past; in some areas, it has actually slowed down. During turbulent times, people tend to hold onto their positions with the company. We are very respectful of how we manage our workforce, so I believe voluntary attrition is in line, if not decreasing slightly. However, involuntary attrition has increased compared to previous quarters due to the reasons we've mentioned. Overall, I am comfortable with the direction of our employee retention.

All right. Good. Thanks for taking my questions.

Of course.

Thanks. The next question comes from Bryan Bergin from Cowen. Your line is open. Please go ahead.

Hi, good afternoon. It's great to see you all. I wanted to follow up on the operating footprint here. Can you give some color on how you see the global footprint mix evolve? As we exit the year, can you provide any sense of a rough composition of where your professionals will be located?

As you know, Bryan, we guide quarter-over-quarter. This is more of a philosophical question for the end of the year. What is the end of the year? What company will you work for? A lot can change in the world. Congrats on the acquisition. The reality is we've announced our strategic footprint. We emphasized that India, Mexico, and Poland are our three strategic growth areas. Currently, we are not yet calling India and Mexico our largest locations. We maintain a strong continuity in Ukraine and are committed to supporting the engineers there. However, we are growing elsewhere too. We certainly had a significant influx of Russian engineers moving there, as did Armenia. Despite the changes, our priority regions remain. While we are seeing growth in India and Mexico, Ukraine remains a strong focus, and we'll adjust as necessary based on business priorities. The U.S. is an exceptionally strong priority for us, but as you can see, we are also enhancing our focus on Europe.

Okay. Understood. Regarding margin, I'm trying to understand the partnerships you've developed and the financial implications. You're using established partners to build talent in new locations, such as India. Are there any significant costs associated with that this year? What should we consider regarding the return to profitability vis-à-vis those relationships?

You asked a good question about partners in business development, which is exciting. However, you shifted to the supplier side. On partnerships, as I've stated before, we have established a fully operational breadth organization. Our growth priorities will be direct. For immediate needs, I’m fortunate to have reliable partners contributing, but from a financial perspective, it won't have a significant impact. Anil, do you want to add anything?

No, I think that's exactly right. We’ve always maintained a two-pronged strategy, as Leonard mentioned—going directly and partnering with these firms. As we scale up, reliance on partners diminishes, and there's often a transfer of partner employees to our direct hiring.

Okay. That's fair. Leonard, since you opened the door, how are you thinking about potential M&A in this environment?

M&A strategy is critical for us. It’s very important because we have ambitious plans for expansion and investments, focusing primarily on innovation. When we consider M&A, we look for specific fields that combine technology, knowledge, and business acumen. We are focusing on core knowledge in the verticals we are enhancing, such as cybersecurity, supply chain, and life sciences. These areas require building acumen over time. Therefore, the message is clear: we will ensure our M&A pursuits are financially efficient and responsible for our shareholders while we continue to grow.

Okay. Appreciate the detail. Thanks.

Of course.

Thanks, Bryan.

Thanks, Bryan. The next question comes from Ryan Potter from Citibank. Please go ahead.

Hi, guys. Thanks for taking the question, and congrats on the great quarter. I want to start with your diversification across locations such as India. Are you seeing new skill sets coming into the mix? Additionally, are you attracting new clients due to your operations in places like India?

Let me clarify; was your question about whether India brings in new capabilities?

Yes, specifically regarding new skill sets and new clients resulting from your presence in India.

The first part today is… not much yet. We're actually bringing some contingent from Europe to India to ensure we have a good blend. We'll continue seeing new talent emerge, but we have some work to do first. On the client side, it’s accurate to say there are strong segments as part of our expansion, especially with notable U.S. clients preferring India as a center of excellence. We are thereby focusing on locations in India, such as Hyderabad, which is a prime area for our value-add innovations.

Got it. Focusing specifically on the retail vertical, growth has been robust in recent quarters. How much of this growth is inorganic? Can you share insights on what’s driving demand in retail? Is it catch-up post-pandemic, or do you see growth with existing clients and new logos?

On the question of organic versus non-organic growth, Anil, what is the non-organic portion in our revenue recognition?

Yes. Last year, we only had one month of non-organic revenue, roughly about $4 million, due to our acquisition being toward the end of May. If we remove that, we still achieved over 50% year-over-year growth.

Regarding the demand, I wouldn't describe it as a catch-up. Grid Dynamics made an incredible V-shaped recovery in 2020, and we are now aggressively pursuing a broad base of clients. Our growth derives from their needs in the competitive environment, rather than any defensive strategies. While we may see some defensive shifts due to economic turmoil, our clients continue to execute their plans. They also assess which budgets to commit for how long. That best summarizes the growth environment.

Thanks, and congrats again.

Thank you.

Thank you, Ryan.

At this point, we have no further questions. Ladies and gentlemen, that would be all for the Q&A session today. I will now pass the call back to Leonard for the closing remark.

Thank you, everybody, for joining us today. Our second quarter results and our third quarter guidance once again highlighted Grid Dynamics' ability to deliver on our stated goals and our commitment to the business. Grid Dynamics employees have shown exceptional teamwork and have worked relentlessly to ensure our business continues uninterrupted, and I want to thank each and every one of them for their tremendous effort. I look forward to providing you with a business update in three months. Thank you very much.

This concludes today's conference call. Thank you all for participating. You may now disconnect.