Grid Dynamics Holdings, Inc. (NASDAQ:GDYN) Q2 2023 Earnings Call Transcript August 6, 2023
Bin Chiang: Good afternoon, everyone. Welcome to Grid Dynamics Second Quarter 2023 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 for 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 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 have just described in the Investor Relations section of our website. With that, I will now turn the call over to Leonard, our CEO.
Leonard Livschitz: Thank you, Bin. Good afternoon, everyone, and thank you for joining us today. As you have seen from our published results, Grid Dynamic’s second quarter revenue was in our guidance range and non-GAAP EBITDA significantly exceeded expectations. Also, on a GAAP basis, we achieved record net income since becoming a public company. Our results are commendable and reflect the company’s un-relentless commitment to our clients. There were some noteworthy trends, including strong new logo wins, meaningful contributions from logos that we won over the past couple of quarters, and deeper relationships with our partnership ecosystem. This has been a recurring theme for the past several quarters and reflects the strengths of our offering.
Additionally, a significant interest and engagement with our clients on artificial intelligence initiatives continued to positively impact our business. With our GigaCube initiative, we operationalized many KPIs across the company. On the macro, our opinions have remained unchanged. During the quarter, with many of our clients, we witnessed continued recalibration of spending priorities and investments. Also, customers continued to transition their projects from higher cost locations to lower cost offshore locations. And this is in plain to our favor, as we have a global delivery footprint in locations of choice for our clients. During the quarter, we ensured our spending level aligned with the current demand environment and this discipline paid off with our second quarter profitability.
We’re also witnessing three important trends that lead us to the incrementally positive conclusions. These trends are expected to play out in the third quarter too. First, the magnitude of resets across our customers are diminishing. Second, we’re seeing stabilization in business across the majority of our accounts. And finally, thirdly, our forms of new engagements, both with the new clients and existing clients, are on the rise. This includes enhanced activities with partnerships, engagements on artificial intelligence, and willingness of new logos to work with us on their digital transformation needs. While certainties persist, and it’s too early to make any definitive commentary around the demand snapback, we believe underlying trends are moving in the right direction, leading us to the incrementally positive view.
Yet, we remain conservative in our third quarter outlook. As I highlighted in the past, coming out of economic cycles, Grid Dynamic’s is stronger as the company proves to be a reliable partner in delivering our customers’ business objectives in an efficient manner. Also, the current economic cycle has provided us a great opportunity to realign and organize according to our GigaCube initiatives. This includes adding new talent across different industry verticals, both in sales and city organizations. We’re also witnessing great access to high quality talent as our strengths and differentiation became more visible across the industry. Over the past couple of quarters, we have incrementally invested in our engineering resources toward building new R&D artifacts, accelerators, and artificial intelligence capabilities.
There are many positive trends with our technology organization. This includes several exciting opportunities with AI. Generative AI has been front and center across a broad range of clients, and we’re witnessing exponential interest in our enterprise AI solutions, particularly in generative AI, including conversational AI, data harmonization solutions, and others. We’re currently engaged in multiple billable projects and have created a robust portfolio of demos, capabilities, and solutions. R&D organization completed nine AI projects during the quarter and we’re currently involved with over 20 enterprise clients. As a reminder, Grid Dynamics AI engagements are based on more than seven years of internal research and successful implementations.
With our Generative AI offering, we partner with customers to employ large language models and prompt guided image generation to the application in product design and visualization, as well as knowledge retrieval, wealth management, and customer support. During the quarter, we announced a significant global partnership with Google Cloud to develop and implement innovative generative AI solutions. This partnership will result in incremental customer wins for Grid Dynamics in the second half of 2023 and beyond. Also, this partnership is a reflection of Grid Dynamics’ position as an industry leader in AI. Grid Dynamics will leverage Google Cloud Vertex AI, a platform that incorporates powerful foundational large language models and advanced image generation capabilities.
With this partnership, we expect to significantly accelerate and develop innovative AI solutions across the financial services and insurance manufacturing and life science pharma industries. On the GigaCube initiative, we continue to make good progress. As you know, GigaCube is a strategic blueprint that lays out a framework for our company to over $1 billion revenue. It involves all parts of the organization that includes sales, R&D, marketing, operations, as well as M&A. We made some exciting additions to our team. This includes a senior sales leader and specialist sales executive across automotive, Pharma and insurance. These additions will accelerate our new industrial vertical penetration highlighted in our GigaCube initiatives. In the quarter, there were several notable trends and I would like to share with you some of them.
Logo momentum. In the second quarter, we signed nine large enterprise clients. This brings the new enterprise logos added in 2023 total to 18. Additionally, we added new customers from our recent acquisitions. We believe Q2 client acquisition is a further testament of competency and the confidence for large global enterprises to sign up with Grid Dynamics in the current environment. Some of the most notable ones to mention include a leading digital payment service company, a global consumer health company, a global athletic wear company, a global hotel and hospitality chain, and a North American art and craft change. We’re very proud of our achievements and this is a testament of our differentiation value we bring to our customers. Delivery location support.
Moving to our delivery operations, our execution remains flawless. At some more recent logo wins, we were able to quickly put together and ramp up dedicated teams across our global delivery locations. Additionally, our integration with NextSphere and Mutual Mobile is in a full swing and have started to implement synergies across engineering operations and other back-end functions. Today, our customers have a choice of over a dozen countries across North America, Central Europe, and India. Our follow the sun strategy enables our clients to be served in an interrupted fashion around the clock. Clients support our geographic diversification and choice of locations for engineering support. European business. During the quarter, we made good progress in expanding our footprint across industry verticals with our European clients.
As a global specialty automotive part company, we’re implementing a major composable commerce modernization platform. At another global automotive entire company, we’re involved in a significant digital transformation initiative tied to automotive tire wear and their predictive maintenance using data engineering and analytics. With artificial intelligence, we’re also engaged with a high-end apparel company in Netherlands in our domaining process description using product attributes and images. And finally, with European-based global truck manufacturer, part of our growth and have become a significant contributor to lead generation. In addition to the generative AI partnership with Google Cloud that I spoke a few minutes ago, we’re also working with many of our clients across industry verticals as they move from advanced rule concepts to real world business transformation solutions.
Our relationship with Microsoft Azure and AWS are expanding in the future. Grid Dynamics has been recognized for its advanced specialization by Microsoft, which earned us the membership of Microsoft Azure migration and modernization program. Additionally, we continue to invest in growing number of independence of vendor partnerships in supply chain, digital experience, marketing, and commerce domains. We’re expecting and enhancing the value we deliver across the entire C-suite. We’re engaging with Chief Operating Officer, Chief Market Officer, Chief Product Officer, and others. M&A. With M&A, the integration of our acquisition of NextSphere Technologies, which we acquired April 18, 2023, is working well. To remind you, this acquisition strengthens our presence in strategic verticals such as healthcare, fintech, and manufacturing.
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I’m happy to report that in a short time of three plus months, we were able to integrate the operational backend functions. Additionally, we’re able to relocate the employees in Hyderabad to the new constructed Grid Dynamics office. We also have an office in Chennai as well. We’re currently working on a business development synergies and expect to start cross-selling across our customer base in the next couple of quarters. Beyond our recent acquisitions, the pipeline for M&A opportunities is robust. We’re actively working on multiple opportunities and we’ll be happy to provide updates as the time becomes right. As a reminder, our M&A focuses on capabilities, key clients, and delivery locations. During the quarter, Grid Dynamics delivered some notable projects.
At the renowned financial services and wealth management firm, we’re piloting an innovative AI-based knowledge management platform. This platform offers thousands of financial advisors with direct access to the firm’s best enterprise data via natural languages. Leveraging retrieval augmented generation technology and leading large language models, the platform will improve productivity of financial advisors and help them to create highly personalized updates and offerings to their clients. We’re a leading global technology company. We successfully executed a massive migration of user segmentation pipelines to a new cloud data platform. These pipelines play a crucial role in processing an extensive range of data signals, encompassing diverse aspects such as user demographics, spending deciles, usage frequencies, and more.
This solution ensures better scalability to address growing amounts of data and fault tolerance. At a prominent membership-only chain, we modernized their mobile app to enable and enhance better security, frictionless payments, and user experience. The effort resulted in an increase in the browse-to-pay conversion and substantially reduced the uninstalled rate by a factor of 7x. Currently, the mobile app is serving tens of millions of shoppers in the United States. For a major CPG brand, we delivered a solution that significantly shorted checkout time in their physical stores, even for orders with many small items. It uses existing security tags to scan shopping bags and requires minimum modification to their store layout or POS hardware. Once deployed across the client’s 900-plus stores has potential to significantly decrease labor costs and increase customer satisfaction.
With that, let me turn the call over to Anil, who will discuss Q2 results in more detail. Anil?
Anil Doradla : Thanks, Leonard. Good afternoon, everyone. Our second quarter revenue of $77.3 million was within our guidance range of $76 million to $78 million that we provided to you all in our earnings call in May and reiterated it on June 6. On a year-over-year basis, both on a reported and constant currency, the growth was flat as the impacts of currency movements were negligible. On a sequential basis, our revenue declined by 3.4%. During the quarter, we witnessed headwinds from some of our customers as they continued to rationalize their spending levels. During the quarter, new logo revenues contributions offset macro-driven caution from others. During the second quarter, retail, our largest vertical representing 33.7% of our revenues, increased by 2.5% on a sequential basis and grew 2.3% on a year-over-year basis.
Within the retail vertical, on a sequential basis, we witnessed growth from areas such as home improvement, department stores, and specialty retail. TMT, our second largest vertical, represented 31.2% of our second quarter revenues, decreased by 10% on a sequential basis, and grew 3% on a year-over-year basis. On a sequential basis, we witnessed continued caution at some of our large TMT customers. This was offset by growth both from existing and new logos. Here are the details of the revenue mix of other verticals. Our CPG and manufacturing represented 14.1% of our revenue. In the second quarter, a decrease of 14% on a sequential basis and 32.4% on a year-over-year basis. The decline on a sequential and year-over-year basis came from some of our large customers, as they readjusted their spending levels to the current macro environment.
The finance vertical represented 8.7% of revenues, an increase of 3.6% on a sequential basis, and 33.7% on a year-over-year basis. The growth in the quarter came from a combination of financial technology customers as well as new logos. And finally, other segments represented 12.3% of our second quarter revenue and was up 10.1% on a sequential basis. The strong sequential growth was driven by growth at our healthcare and pharma customers. We exited the second quarter with a total headcount of 3,862, up from 3,744 employees in the first quarter of 2023 and up from 3,763 in the second quarter of 2022. The sequential increase of 118 employees, or 3.2% was largely due to our recent acquisition of NextSphere Technologies, which we acquired in April.
At the end of the second quarter of 2023, our total U.S. headcount was 317, or 8.2% of the company’s total headcount. This remained on the same level compared to 8.1% in the first quarter of 2023 and slightly decreased from 8.7% in the year-over-year quarter. The year-over-year slight decline as a percentage of total revenue was largely driven by growth at our offshore locations, resulting in greater mix of non-U.S. headcount. Our non-U.S. headcount located in Central Eastern Europe, India, UK, the Netherlands, Mexico, and other locations was 3,545, or 91.8%. In the second quarter, revenues from our top five and top 10 customers were 37.6% and 56.6% respectively versus 44.2% and 60.2% in the same period a year ago respectively. During the quarter, we had a total of 216 customers, down from 220 in the first quarter of 2023, and up from 208 in the year-ago quarter.
The decline in customers on a sequential basis was largely from our commercial business, which focuses on smaller customers. During the quarter, we signed nine new logos from our enterprise business. Moving to the income statement, our GAAP gross profit during the quarter was $28.3 million, or 36.6% versus $28.6 million, or 35.7% in the first quarter of 2023 and down from $28.9 million, or 37.3% in the year-ago quarter. On a non-GAAP basis, our gross margin was $28.8 million, or 37.3% versus $29 million, or 36.3% in the first quarter of 2023, and down from $29.1 million, or 37.7% in the year-ago quarter. The increase in gross margin as a percentage on a sequential basis, both on a GAAP and non-GAAP basis, was largely due to higher utilization of engineering resources.
Non-GAAP EBITDA during the second quarter that excluded stock-based compensation, depreciation and amortization, restructuring, and expenses related to geographic organizations. Transaction and other related costs was $12 million, or 15.5% up from $10.8 million, or 13.5% in the first quarter of 2023 and down from $13.3 million, or 17.2% in the year-ago quarter. The sequential increase in non-GAAP EBITDA was largely due to a combination of higher levels of gross margin as a percentage compared with lower operating expenses. On a year-over-year basis, the decline in non-GAAP EBITDA was driven by increase in operating expenses from our recent acquisitions. Our GAAP net income in the second quarter totaled $2.6 million, or a $0.03 based on a basic share count of 75.1 million shares, compared to the first quarter loss of $8 million, or $0.11 based on a basic share count of 74.5 million, and a loss of $13.2 million, or loss of $0.20 per share based on 67.1 million basic shares in the year-ago quarter.
The year-over-year increase in GAAP net income was largely due to lower levels of stock-based compensation and significant decrease in geographic reorganization expenses. On a sequential basis, the increase in GAAP net income was largely driven by a reduction in stock-based compensation expenses. On a non-GAAP basis, in the second quarter, our non-GAAP net income was $7 million, or $0.09 per share based on 76.9 million diluted shares, compared to the first quarter non-GAAP net income of $6.5 million, or $0.08 per share based on 77.1 million diluted shares, and $8.2 million, or $0.12 per diluted share based on 69.9 million diluted shares in the year-ago quarter. The increase in non-GAAP net income from the second quarter was largely due to higher gross margins and lower operating expense.
The decrease in the non-GAAP net income in comparison to the year-ago quarter was largely from higher levels of operating expenses. On June 30, 2023, our cash and cash equivalents totaled $246.2 million, down from $258.4 million in the first quarter of 2023. The key reason for the decrease on a sequential basis was due to the all-cash acquisition of NextSphere Technologies, which was made on April 18. Coming to the third quarter guidance, we expect both revenues and non-GAAP EBITDA to be at similar levels to what we guided for Q2 in May. We expect revenues to be in the range of $76 million to $78 million, and non-GAAP EBITDA to be in the range of $10 million to $11 million. For the third quarter, we expect our basic share count to be in the $75 million to $76 million range, and for diluted share count, we expect it to be in the $78 million to $79 million range.
That concludes my prepared remarks. Bin, we are ready to take questions.
A – Bin Chiang: Thank you, Anil. As we go to the Q&A session, I will first announce your name. At this moment, please unmute your line and turn on your camera. Our first question comes from the line of Puneet Jain from JPMorgan. Please go ahead.
Puneet Jain : Hey, thanks for taking our question. Leonard, like you talked about like 20 clients who you are providing some sort of AI services, which I believe is out of a total of 100 enterprise customers, so that would be like 20% of total customers to whom you are providing generative AI services. So can you talk about what type of services you are providing to those clients in AI? And since some of these customers also outsource to your peers as well, how are you going to win share in AI at those clients?
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Q&A Session
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Leonard Livschitz: Hey, Puneet. Well, it’s quite a comprehensive question, so thank you for pointing out the percentage to. We’re quite proud that we’re still basically at the cradle of AI expansion revolution, so we already captured a substantial percentage of our client base. The projects we have started, some of them actually run from before the AI was defined as a modernization of technologies. We’ve been knowing of our own investments in machine learning, data science, large models, data formatting, and other features. So now when it kind of becomes more as a part of creating some tangible monetization for the clients, we’ve seen some trends where we actually participate. First and foremost, generative AI is only a subset of what we do.
Since we are focused on large enterprises mostly, the ultimate definition for us, is the enterprise artificial intelligence, which comes with a supply chain of predicted models for the supply and demand, logistic travel, the variances of the forecast, and others. When it comes to the wealth management financial companies, it’s basically accelerating the adjustments, which relate to the personal bespoke portfolios. When we talk about medical clients in areas of pharmaceutical life science, those relate to their own models, which help them to accelerate the decision on certain internal critical development, and so on and so forth, not to forget about our beloved consumer world, where most of the work is B2C. So far, I’ve mentioned B2B mostly.
In the B2C world, it’s a lot of customer and consumer behaviors, which are scaling to the very large amount of the preparation. We anticipate a significant cost savings associated with those businesses. Now, in terms of our competition, it’s absolutely true. I mean, everybody stands up and says, we are the leaders in artificial intelligence. We are taking a more modest approach. We’re looking at more and more proven cases of the ROIs, in other words, where the customer financial gains start to become intangible. So, we do quite a few proper concepts, but I think one of the key advantages of to Grid Dynamics, since we started this initiative over seven years ago, some of the proven convertible analytics comes into fruition even as we speak. So, we’ll continue to update you if we need a new team, and we look very bullish on expansion in the United States.
Puneet Jain : No, thanks for a comprehensive answer as well. So, let me ask about a new logo contribution you have talked about in the past 85-15, 85-10-5 model. So, given like the strong client activity, new logo contribution that you are seeing, is that at a point where you’d expect to be in any normal year, like the new client contribution? And I understand the remaining 95% of business is weak, but our new clients are at a point where you’d expect them to be in a normal year?
Leonard Livschitz: Very good question, very good memory. The reality is, you know yourself well that some of the traditional clients, which started at a high a year ago have reduced their spending, right? So, the reason why it’s important that we reported 18 new clients in enterprise level since the beginning of the year, we expect that second half of the year monetization will come at a full swing. Now, we tend to be continuously cautious because the first projects were not all of them, but quite a few of them were still in the lend and expand mode. There are hyperscaler engagements for their cloud transformation with some notable ISVs. Some of them come into the work related to the defined project, like in the payment systems, but there are a few we started much higher level.
So, we see that the numbers are increasing, but I want to make sure that five is beaten, not because the 85 goes down, but because the absolute value returns. So, but the answer is, yes, more likely we’ll see the higher contribution.
