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Greetings, and welcome to the EPAM Systems First Quarter 2018 Earnings Call. At this time, all participants are in a listen-only mode. A question-and-answer session will follow the formal presentation. [Operator Instructions]
As a reminder, this conference is being recorded. I would now like to turn the conference over to your host, Mr. David Straube, Head of Investor Relations for EPAM Systems. Thank you. You may begin.
Thank you, operator, and good morning, everyone. By now, you should have received your copy of the earnings release for the company’s first quarter 2018 results. If you have not, a copy is available at epam.com in the Investors section. With me on today’s call are Arkadiy Dobkin, CEO and President; and Jason Peterson, our Chief Financial Officer.
Before we begin, I’d like to remind you that some of the comments made on today’s call may contain forward-looking statements. These statements are subject to risk and uncertainties as described in the company’s earnings release and SEC filings.
Additionally, all references to reported results that are non-GAAP measures have been reconciled to GAAP and are available in our Q1 earnings materials located in the Investors section of our website.
With that said, I will now turn the call over to Ark.
Thank you David and good morning everyone. Thanks for joining us. Let me begin with few financial highlights. We delivered a strong first quarter with revenue of US$424 million reflecting 31% year-over-year growth or 26% in constant currency terms. Our revenue growth was broad based both geographically and across all of our industry verticals. In addition, we delivered a strong non-GAAP earnings per share of $0.93, which represents 29% growth from Q1 of 2017.
Our strong start to 2018 is in part the result of the continued execution of our strategy across the three major pillars of our business; our capabilities and offerings, our people and our key markets and customers.
Looking at our capabilities and offerings, we remain focused on expanding our leadership position in digital transformation programs and connect to digital platform services, helping our clients develop and integrate a full range of offerings to optimize their processes and deliver positive returns on their technology investments.
We are putting a lot of our attention today in to developing capabilities in the area of intelligence automation, RPA and AI and machine learning, which is becoming very important for us as cross-functional effort among our engineering, general consultant and specific industry focused teams. We also see growing opportunities in the IOT space, where closely connected networks and devices are challenging businesses to create full cycle intelligent enterprises covering end-to-end business needs of certain customers where data-driven decision making creates a completely different level of efficiencies and triggers opportunities to bring new revenue generating ideas and corresponding business models to life much faster than it was possible before.
It is very clear that the use of digital in the industrial and manufacturing sectors is only just starting and will require to fully realize a very unique mix of creative capabilities and strong engineering disciplines. We do believe that focusing more and more on IT technologies together with advanced automation and DevOps, we are going to be well positioned to help our clients in such sectors to bring to life new solutions and to navigate successfully the challenges ahead, and in turn to allow us to grow further too.
In response, we are continuously expanding our capabilities both organically as well as through acquisitions. Our most recent example specifically related to the need in strong cross-over capabilities between physical and digital worlds. In March, we announced the acquisition of Continuum Innovation, a design firm headquartered in Boston with studios in Milan, Seoul and Shanghai. This acquisition is important to us, because while we strengthen our general consultant capabilities and enhances our existing digital and service design practices, it also brings to EPAM a human centered approach to physical design and physical product development.
In addition, with this acquisition, we would be able to expand our R&D efforts, which we started by introducing of EPAM (inaudible). Now with Continuum (inaudible) approach, which enable multi-functional teams to collaborate much more seamlessly across the product development lifecycles to enable sophisticated physical and digital prototyping, we would be able to test complete product, ideas and experiences practically in real time with instant customer feedback.
Lastly to bring it all together, we are very much focusing on developing our consultant services across business experience and technology disciplines in to our mainstream integrated (inaudible) to increase overall value for the solutions we deliver for clients.
Moving to our people, engagement, productivity and talent development. We ended the quarter with over 23,700 delivery professionals, a 21% increase year-over-year and net addition of more than 700 production professionals during Q1. Our total headcount ended at more than 26,700 employees. Simply put focus on our people and their development remains critical to our success.
In Q1, we continued our investments in learning and development programs across all key locations. At the same time, we are putting a lot of efforts in rethinking many of such programs taking in account new advances in educational methods and the growing needs for skills and capabilities necessary for the engagement we are going to be involved with our clients in the very near future..
Sizeable continued investments also directed to our constantly advanced talent development and employee engagement ecosystems, as well as in to engineering productivity platforms and tools, some of which we are bringing to open source market.
Turning to a few clients’ highlights and market update; all of our clients in every industry recognize the landscape they compete in. Client fundamental has shifted on the focus on customer experience and engagement from one side and analytics and highest possible level of automation from another are even more critical for success.
EPAM has been working with Aer Lingus digital and mobile group in the areas of web and mobile development, backend services, DevOps and enterprise service business integration resulting in significant growth of its digital commercial area.
Recently, we extended our five year relationship with Aer Lingus to develop new ways to enhance the Aer Lingus guest experience and automated services and operations. This multi-year relationship highlights our expertise in building specific solution to increase customer satisfaction including leveraging advanced data analytics to provide more personalized insight and online and offline (inaudible) that connect the physical and digital customer experience.
Another example of delivering differentiated solutions is our work with AS Watson, the world’s largest health and beauty retail group with over 14,000 stores in 24 markets, serving over 28 million customers per week. Our teams develop and support AS Watson e-commerce platform, provide necessary changes to their European store system to be in sync with engagement initiatives and in addition bring big data analytics, [client] management and business process automation capabilities to glue all of that together.
In result and close collaboration with AS Watson, we collectively develop and support a full range of digital transformation strategies and have been honored to be recognized as an official technology partner for ASW Group.
Taking a look at our vertical performance in the first quarter, financial services our largest vertical, finished the quarter with 38% growth year-over-year, driven by clients responding to regulatory changes, digitalization and transformation, in addition to demand for EPAM wealth management platform.
Travel and consumer grew 28% for the quarter, customer experience and e-commerce sufficiency is major focus for clients in the vertical with the main focus on personalization to help drive better customer engagement and loyalty.
Software and Hi-Tech grew approximately 20% year-over-year for the quarter, with growth coming from continued demand for strong software engineering skills and advanced technology practices necessary to accelerate product delivery to the market. We’ve also partnered with our clients in this sector to push the boundaries of digital innovation through advanced technologies such as artificial intelligence, machine learning and augmented reality.
Business information and media, formerly we called it media and entertainment posted 32% growth year-over-year driven by engagement focused on productizing voice and video platform in the telecom and cable industries as well as the technologies to help clients manage the creation and distribution of content. Life science and healthcare grew 19% over the same quarter last year, driven by the healthcare industry focus on delivering patient centric care through interactive apps and hospitals of the future initiatives. In addition, we are helping our life science clients to streamline the end-to-end processes to maintain with compliance while driving smart engagement initiative with physicians and consumers.
And lastly, our emerging vertical continues a strong trajectory delivering 54% growth, driven primarily by industrial engineering energy and automotive. And finally, by looking at customer concentration across our clients, we’d like to share that our top 20 accounts grew more than 22% and growth outside the top 20 account was more than 38% compared to the same quarter last year.
With that let met turn it over to Jason for a detailed financial update.
Thank you Ark and good morning everyone. I’ll start with some financial highlights, then talk about profitability, cash flow and end on guidance for fiscal 2018 and with Q2. In the first quarter, we delivered very strong topline performance, exceeded our profitability expectations and grew earnings per share.
Here are a few key highlight from the quarter. Revenue closed at $424.1 million, reflecting a 30.6% year-over-year growth rate or 26% growth in constant currency terms. Sequentially our Q1 growth rate was 6.2%. From a geographic perspective, North America our largest region representing 56.5% of our Q1 revenues grew 26.5% year-over-year. Europe, representing 36.1% of our Q1 revenues grew 33.9% year-over-year or 23.4% in constant currency. CIS representing 5.1% of our Q1 revenues grew 49.8% year-over-year or 46.8% in constant currency. And finally APAC grew 51.9% or 46.3% in constant currency and now represents 2.3% of our revenues.
Moving on the income statement, our GAAP gross margin for the quarter was 34.5% compared to 36% in Q1 of last year. Non-GAAP gross margin for the quarter was 36.5%, compared to 37.7% for the same quarter last year. The year-over-year decline in gross margin reflects the impact of foreign exchange and a higher level of accrued variable compensation based on the strong start to the year.
GAAP SG&A was 2.07% of revenue compared to 24.2% in Q1 of last year and non-GAAP SG&A came in at 18.6% of revenue compared to 20.8% in the same period last year. We are pleased with the efficiency we have achieved in our SG&A spend and will continue to manage SG&A closely in both dollar terms and as a percentage of revenues.
For the remainder of the year, we expect to manage SG&A at a slightly higher level measure as a percentage of revenues. Our current level of SG&A reflects our continued investment in talent acquisition, the expansion of our global footprint and expansion of capabilities with a focus on supporting long term sustainable growth.
GAAP income from operations was 48.7 million or 11.5% of revenue in the quarter compared to 31 million or 9.5% of revenue in the Q1 last year. Non-GAAP income from operations was 67.7 million or 16% of revenue in the quarter compared to 49.3 million or 15.2% of revenue in Q1 of last year.
Our GAAP effective tax rate for the quarter came in at negative 34.5%, which reflects the impact of a 22.5 million one-time net benefit related to tax planning and the recently passed US tax reform legislation. Our non-GAAP effective tax rate which excludes the one-time benefit and other adjustments was 22%.
Diluted earnings per share on a GAAP basis was $1.15 which includes lower tax rate partially offset by higher stock compensation expense in the quarter. Excluding the one-time tax benefit previously mentioned, GAAP EPS was $0.75. Non-GAAP EPS was $0.93, reflecting a 29.2% increase over the same quarter in fiscal 2017.
In Q1 there were approximately 56.2 million diluted shares outstanding. Utilization was 77.6% compared to 77.5% in the same quarter last year and 78.8% in Q4. Turning to our cash flow and balance sheet, cash from operations for Q1 was $7.3 million compared to $31.2 million in the same quarter last year. Free cash flow was negative $3.4 million compared to a positive $23.4 million in the same quarter last year.
Our cash flow from operations in Q1 reflects a payout of a higher level of variable compensation, related to 2017 performance in addition to an uptick in DSO. Total organic DSO was 83 days compared to 81 days at the end of Q4 fiscal 2017 and 77 days in the same quarter last year. We continue to focus on managing our total DSO performance in the low 80s.
Turning now to guidance, starting with fiscal 2018, revenue growth for fiscal 2018 will now be at least 27% reported or at least 25% in constant currency, after factoring in 2% estimated currency tailwinds. As a reminder, our full year revenue outlook reflects approximately a 2% contribution from inorganic revenues.
We expect GAAP income from operations to continue to be in the range of 12% to 13% and non-GAAP income from operations to continue to be in the range of 16% to 17%. We expect our GAAP effective tax rate to now be approximately 4% which reflects our tax spending efforts in response to the US tax reform legislation. We expect non-GAAP tax rate to continue to be approximately 22%.
Earnings per share, we now expect GAAP diluted EPS will be at least $3.77 for the full year and non-GAAP EPS will now be at least $4.11 for the full year. We now expect weighted average share count of 56.9 million fully diluted shares outstanding.
For Q2 of FY ’18 revenues will be at least 445 million for the second quarter, reflecting a growth rate of approximately 28% reported or approximately 26% in constant currency, after factoring in approximately 2% estimated currency tailwinds. For the second quarter, we expect GAAP income from operations to be in the range of 11.5% to 12.5% and non-GAAP income from operations to be in the range of 15.5% to 16.5%.
We expect our GAAP effective tax rate to be approximately 10% and non-GAAP effective tax rate to be approximately 22%. For earnings per share, we expect GAAP diluted EPS will be at least $0.82 for the quarter and non-GAAP EPS will be at least $0.98 for the quarter. We expect a weighted average share count of 56.9 million fully diluted shares outstanding.
And finally a few key assumptions which support our GAAP to non-GAAP measurements. Stock compensation expense is now expected to approximately 14.2 million in Q2, 14.6 million in Q3 and 15 million in Q4. Amortization of intangibles is now expected to be approximately 2.2 million in each remaining quarter for the fiscal year. The impact of foreign exchange is expected to be approximately 1.5 million in each remaining quarter. Tax effect on non-GAAP adjustments is now expected to be around 4 million in each remaining quarter. Lastly, we expect excess tax benefits to now be around 6.1 million in Q2 and 3.3 million in each remaining quarter.
In summary, we’re pleased for the Q1 results, which reflects strong broad based growth across our verticals and geographies. A result is a diverse mix of projects and works we are delivering for our clients. A unique position in the market combined with our solid fundamentals positions us well for continued growth in fiscal 2018.
With that let’s open the call for questions.
[Operator Instructions] our first question comes from the line of Ashwin Shirvaikar with Citigroup. Please proceed with your question.
The raised guidance just to clarify that primarily reflects outperformance in 1Q, and then as we look at sort of the cadence of revenue growth to the rest of the year, good to see in 1Q that headcount growth reaccelerated. Should we make that continuing assumption so that the gap between headcount growth and revenue growth sort of narrows as we proceed through the year?
Our expectation would be that utilization will actually increase somewhat in Q2 and probably throughout the remainder of the year, certainly in the second half. And so utilization, we guided to the fact and we expected that utilization would come down from Q4 to Q1 of 2018, with the idea that we wanted to make certain that we had sufficient resources to be able to support our growth in the year. But throughout the remainder of the year, you should expect that utilization will increase somewhat.
Is there a utilization target, although that’s not my follow-up question, if you could just adjust that and could you just repeat the first one? Let me ask the second already which that -.
Ash this is Arkadiy. So you’re breaking out connections is not too good. But as I understand you’re asking if increasing revenue in Q1 is a one-time situation or it would be propagated over the – and does this pull in as we as the year number as we’re seeing and that’s what we’re guiding to. And increase in number of people, it’s a reflection of how high utilization numbers at the end of last year and do we play in to improved fertilizations slightly during the year, that’s what Jason was referring to.
You mentioned a couple of times progress on SG&A hires, which really is sort of the front end consulting type of people I’m assuming. Can you comment on the progress, what kind of people you are looking for in any particular end market, how that effort is going?
So that’s a different combination of people clearly, and we always were saying that one of the opportunities for us to improve and create better end market connection with our clients. So we’re looking for consultants which is partially not billable account managers, number of account managers and vertical expert is very different utilization target that our general population of engineering. So that’s why I created pressure on the G&A as well.
Our next question comes from the line of Ramsey El-Assal with Jefferies. Please proceed with your question.
I wanted to ask you about the general talent market, we’ve had some of your competitors talk about intensifying competition for talent. Are you seeing any sort of more sudden intensification out there versus what’s just been going on in the course of business recently, and I also want to just ask what is your sort of toolkit in terms of retention? Obviously you can throw money at employees, but what else can you do to sort of make sure that they stick around?
I think it’s pretty consistent creation of our public life, and I think a situation with silent competition, all of this was very difficult. And I think we’re talking about it practically each quarter, and it’s not related to Eastern Europe or India. Again as you’re really pointing out, it’s all over the United States and rest of Europe as well. So this is constant pressure. And we’re living in this situation for most of our years of existence.
At the same time, we paying a lot of attention to retention and it feels like, we mentioned today that we’re continually investing in internal system to understand motivations of our people and we’re creating different rotational programs, different competency spot, different conferences like the type of project each people have opportunity to participate, highly (inaudible) as well.
So there is no one simple answer and probably it would be like very separate discussion. But we’re putting a lot of efforts around this. And our investment probably in talent management and retention over the last year is certainly the way I like is increasing too. We’ll probably discuss how much we invested in each of our function and how different it is today versus like five, six years ago when we started with a public company.
So we continue to be successful in terms of bringing resources in to EPAM in addition to the attrition rate throughout 2017 decline on a quarter-over-quarter basis throughout the entire year. And the attrition that we saws here in Q1 is actually quite a bit lower than what we saw in Q1 of 2017. So we think we’ve done a fair job of managing retention and adding resources. So we feel good about our ability to continue to drive revenue growth based on resource availability.
But it’s a challenge and a challenge for everybody. So this is one of the main challenges in the industry.
And a follow-up, I wanted to ask you about the internal implementation at some of the productivity enhancing digital technology delivering to clients. In other words, what is the internal opportunity for technologies such as AI or intelligent automation or advanced analytics? Are you implementing these things internally or is there an opportunity too and could that have any impact on your expense line in the future, kind of a long dated question.
Good question and the answer is yes. We’re trying to apply whatever we’re thinking might apply to clients and experimenting in our kind of internal (inaudible) how we can improve internal efficiency, because of our SG&A cost and just improving services insight of a (inaudible). So that’s one of the things we’re constantly doing. And this is through, not only for this, but any type of technology we could impart internal operations. So this always was part of our effort, and some proof of concept which we’re doing internally including demonstrating to the clients as an example how it could be visualized.
Our next question comes from the line of Jason Kupferberg with Bank of America Merrill Lynch. Please proceed with your question.
I just wanted to start with a question on guidance. I know you took up the full year EPS by $0.04, you did just beat Q1 by a few pennies and I think you are picking up a few more pennies from the lower share count outlook for the year. So, I just wanted to see that this implies relative to your margin outlook. I know you’re maintaining a 16% to 17%, but can we get to the middle of the range of does the lower part of the range seem more likely because obviously you took up the revenue outlook again although a little bit. So I just wanted to make sure we’ve got the different pieces calibrated here.
So we expect to be in the range of 16% to 17%, as we’ve sort of guided. We do think that we’ll see an improvement in revenue that’s largely associated with our organic revenue, so that’s not coming from the Continuum acquisition yet. So again it’s an improvement in the demand environment and what we are seeing on the horizon. I don’t think I could comment as to exactly where we’re going to be in the range, but generally what we do see is in the second half of the year is that we do see improvements in our adjusted IFO, yet our (inaudible) revenues grow and that’s when we see an improvement in the utilization numbers.
Just a revenue question, so you mentioned financial services vertical growing 38% year-over-year, I think you did have an easy comparison there, but nonetheless including some strong underlying trends. I wanted to see if you can give us a little bit more color there, was it UBS, was it a combination of clients and maybe you can just talk more broadly about what you’re seeing in terms of project based spending at some of the larger banks, because it seems like there has been some mixed signals in the market as far as where that stands at this juncture in the year.
There’s definitely not one answer to the question, so it’s a combination of things. And as we – again over the last quarters we are pointing out that we are not necessary with representation of financial services across the global delivery industry and we’re focusing on a little bit different subset of engagement and applications which has given us better opportunity to grow.
And this is probably consistent with previous statements this quarter. But on top of this we have a couple of new logos which we started within last nine to six months, where each contributed the growth in financial services for Q1.
So we’re seeing growth from both the existing customers and then we’re seeing significant growth from new customers. So that’s why you see the high growth rate in our business, and as Ark said we are just participating in a different space, wealth management platform, asset management platforms being more customer facing technologies.
Our next question comes from the line of Moshe Khatri with Wedbush Securities. Please proceed with your question.
So guys this is a usually strong quarter for Q1. Am I right here in terms of the growth that we’re seeing in terms of the guidance raised? Is there an uptick in the [management] or anything that’s kind of fundamentally pushing this, that’s a big picture question? And then in terms of some of the metrics, maybe you could talk a bit about organic growth for the quarter, organic growth that’s embedded in the actual guidance and then what do are we factoring on the guidance side in terms of pricing and legislations.
It probably sounds unusual from the numbers point of view, probably doesn’t sound so unusual for us internally here. And then I think we’ve seen bigger number which is attributed to a number of clients which were growing pretty flat during the last couple of quarters. And again, for the rest of the year, we’ve seen exactly what we’re guiding for and as we try to do each time.
I can talk a little bit about Q1, so if you look at the quarters, we’ve probably picked up about $1 million related to foreign exchange versus the rates that we were using at the time of guidance. You’ll remember that the Continuum acquisition occurred at the very tail end of Q1, so we only had about two weeks worth of revenue from Continuum. So that had a very modest impact on revenues and so really what you saw versus guidance is just substantial has kind of over performed based on demand in the market.
What about pricing and legislation in terms of what’s embedded in the guidance?
It’s consistent with the guidance that we had at the beginning of the year. I will reiterate that in terms of the growth and the increase in the guidance is that at this time it’s exclusively from our organic revenue. We’re seeing some nice traction in terms of customer engagement and in meetings and we do think that longer term that you’ll see some nice benefit from the Continuum acquisition. At this time the take-up in guidance for revenue is exclusively due to our organic growth.
From a wage inflation standpoint, it’s pretty consistent with what we’ve talked about in the past. It’s maybe up slightly, but I would put in kind of the modest as we continue to get price increases from customers on an annual basis at least a subset of our customer base. We continue to see opportunities for full price increases with new engagements, and generally I think that the pricing opportunities and the wage inflation are not materially different than what we’ve seen in the past.
Our next question comes from the line of Arvind Ramnani with KeyBanc Capital Markets. Please proceed with your question.
This is Brian [James] sitting in for Arvind Ramnani. Just a quick question here, our checklist clients have been overwhelmingly positive on the quality of technology talent and productivity that they get from EPAM. These companies are much larger IT services providers – vendors. Have you found a competitive set change in the last couple of years and what are you doing to make sure that you stay ahead of the competition?
Again it could be very little concern, just in a couple of sentence we say already [key] towards the communication to [denote] this time. We’re coming from a really strong contingent on the ground and on top of this we’re trying to push the right client facing capabilities, industry expertise, any means consultant experience, experience designed in experience consultancy. And with all this we’re trying to keep up our engineering strength because that’s what actually matter when you delivering whatever that wasn’t required. And that’s a continuous effort and that’s what we think probably still differentiate us, and we don’t want to lose this advantage and engineering part, while we’re trying to go up in value chain with additional services. That’s not so magical.
Our next question comes from the line of Maggie Nolan with William Blair. Please proceed with your question.
I wanted to ask about Continuum, it seems like those employees have a slightly different skillset than some of your core EPAM employees. So I’m wondering if you think that this business is scalable for EPAM and then what does that integration timeline look like in terms of when you’ll be able to really start driving revenue synergies.
I think we’ll be able to answer in much more detail like in 18 to 24 months from now. But in general, within the last five, six years we were aiding different type of skills to a point which we didn’t have inside and continuing one of these attempts as well to bring different type of people and see how together we would be able to impart clients better.
And at the same time, it’s not completely different to EPAM because Continuum is a combination of user experience and design thinking together it’s a physical product expertise from industrial design to prototyping of real physical products and to reducing with our attempt to play better role in or a key role with our clients with industrial engineering and utility energy. So that would be very important addition to us, the same like in healthcare and retail.
So we’ll see how it would be working out, there’s no simple answer right now.
So we haven’t really included any revenue synergies in our guidance. We’re seeing that we already are sort of engaging mutually with clients, and what we think overtime that we’ll be collectively able to engage on larger programs as we sort of combine the capabilities of the two different companies.
And was there any customer overlap with Continuum customers and EPAM customers and are there any clients that you think could become meaningful contributors to EPAM’s growth kind of in a later timeline that you’ve outlined?
I do believe there are a number of opportunities between our client portfolios and there is some slight love, but we’re working in different direction, but the whole goal is how actually to putting it together. That’s exactly the point. I think we will see how to work in line 18 to 24 months with a short term impact.
Our next question comes from the line of Mayank Tandon with Needham & Company. Please proceed with your question.
Ark wanted to get your thoughts on pricing, in terms of, are you seeing an increase in transaction based and outcome based pricing, some of peers have called that out as being a driver? Just wanted to get your thoughts in terms of if you’re seeing model shift with your clients?
I think, in general, our pricing model is not changing much. So there are some experimentation with our companies but it’s extremely small number or proportion of our revenue right now. Very insignificant, but we experimented with this. In general, it’s the same challenge we have. We still need to improve in market capabilities to make sure that we reflect on potentially better outcome and solution in case we do it. So, again, I don’t think anything changing significantly in our pricing situation.
So we are still around or above 90% in terms of T&M pricing or time and materials pricing.
And then just another question around the verticals, obviously really strong quarter across the board, but I guess the one area that might be a little bit softer was the healthcare life sciences. So if you could, just maybe, talk about that, just any shift in the trends there?
I think it’s also in line. Last quarter’s Healthcare Life science was softer than other, but I don’t seem it to get the reflection of the market. It’s a specific situation, several clients and we do believe that life science healthcare will reach the same level of growth which we felt like in several next few quarters.
Our next question comes from the line of Joseph Foresi with Cantor Fitzgerald. Please proceed with your question.
The move in to consulting’s been obviously difficult and expensive for others. So I just want to get a sense of what your strategy is as you move up the value chain, and any thoughts on what margins could do longer term as you take on more expensive consultants.
Our approach right now is relatively simple. We’re not trying to build completely separated line of business or revenue stream coming from consultant. We’re trying to find the right kind of combination for consulting and design heavily supported by our engineering capabilities. So basically we’re trying to empower final solution in which we build through right decisions and right design. So that’s why our consultant line of revenue not necessary will be soon leased to the separate one, because this is how we’re trying to bring more value to the clients and probably eventually improve margins not to kind of make more operations to margins. But it would require investments and that’s what we’re doing and clearly in some of the quarters it would be pressure once the margins before you achieve what we already confirmed.
And then just on the margin side of things, what’s the balance between gross margin and SG&A or operating margins look like throughout the year. It looks like you’re headed towards the upper end of the guided range, and where is the SG&A leverage coming from? Is that coming from upside due to topline, is it better utilization, how should we think about those moving factors?
The overall profitability standpoint is, we had expected that we would see a dip in gross margin in part because we had intended to take down the utilization so that we could grow throughout the remainder of the year. At the same time we’ve been very focused on improving our SG&A efficiency and you kind of get there two ways, one is by looking at – there are probably three ways.
One is looking at current spending and seeing what you can do to optimize that spending. Other is to make certain that you’re adding appropriate headcount and making investments in the areas that will most effectively certify revenue for office. The third obviously is the revenue growth, and so to the extent that you’re growing revenues rapidly and then you’re controlling your SG&A expense that the outer (inaudible) produces in the SG&A efficiency and that’s something that we’ve been very focused on. Well since we’ve put our plan in place for 2018 and as we execute throughout the year.
And we were like talking about lack of additional corporate structures for our site as we were growing very fast, and during the last year we put a lot of investment in this area including (inaudible) issue, people attrition, people management, talent acquisition. So and now we’re kind of a little bit are benefiting from this, because we build structure and now we just need to support it.
Our next question comes from the line of James Friedman with Susquehanna International Group. Please proceed with your question.
It’s Jamie at Susquehanna. I just wanted to ask my two upfront. Jason I apologize to ask you to do this again, is the Continuum in or not in because I thought, I heard you say that numbers or DNA that’s my first one. And then second one is, Ark is there anything unique about the CIS Eastern Europe delivery organization in terms of either attrition or supply, because everyone else in the industry is calling on rapid attrition range inflation etcetera. Is there anything unique to that specific delivery region.
So first up from the Continuum standpoint, for our full year guidance Continuum is in at somewhere less than 2% of revenues and that’s consistent with the press release we did at the time of the acquisition as well as the updated guidance. The point that I was trying to make earlier on (inaudible) wasn’t clear is that the increase in our guided growth rate for 2018 is a result of our [mechanic] revenue growth, not due to synergies associated with Continuum at this time. And so Continuum is in the number, but we’ve actually taken up the growth rate guidance for the full year, and that’s exclusively due to the strength that we see in the organic demand.
And as to talent pool, I think we experienced the same pressure which everybody else. So the relatively is there are significant differences between different Eastern European countries we operate in. But in general we’re experiencing exactly the same challenges which all companies experiencing globally. So there is a global lack of talent, there is a pressure on rate inflation, there are a lot of efforts which we need to put to retain people and let away people. So that’s all over the place.
Our next question comes from the line of Louis Miscioscia with Pivotal Research Group. Please proceed with your question.
I was going to ask question on margins, but I think you hit that pretty well so far. So let me ask you about automation, it seems that RPA in automation to Cognizant is really started to kick in. Could you maybe talk about how much you’re seeing that and what customers are asking you to do. And then my follow-up question would be to expand that out, to also talk about what you’re seeing with the other new types of technology, AI, you know everything is block chain.
Well we’ve definitely seen a lot of interest in automation because for many company that’s one of the few opportunities actually to improve the iterations and for many traditional establishing companies and financial services, insurance space, this could be huge savings as there are a lot of experimentation there, and it’s very challenging because of usually a combination of what people say in automation but change of the process and internally engineering as well as a combination of all.
You guys been seeing this, you’re paying attention to this, we are participating in this as well. Probably very much in line with what Cognizant and (inaudible). But again we try to bring our engineering advantage there, because with all these new technologies, with all this new products on the market, there are a lot of engineering challenges to make it efficient and implement it. So we hope that we will benefit from this.
So with regards to block chain and machine learning and artificial intelligence, this is still pretty (inaudible), but we do believe that it would withdraw faster (inaudible) and western incompetence’s and expertise all the time. Also just to mention that we traditionally have some advantage because we have a good portion of our revenue coming from software technology companies and we see and are helping to experiment even in units of project development stages with our clients.
And we’re seeing through their eyes sometimes what and how first implementation look like and actually bringing it back to our quarterly clients as well. So I think we have some advantage because of our heritage and portfolio of our clients.
On the automation side, could you possibly quantify maybe how much of the different project you’re working on or if it’s moving from more proof of concepts to scale or something?
So on (inaudible) it’s probably dozens of projects and some of them are definitely moving to implementations. But it’s still experimentation because this implementation still have to prove that it wants which products.
Our next question comes from the line of Vladimir Bespalov with VTB Capital. Please proceed with your question.
I have a couple of questions, one is on working capital, you mentioned that your day sales outstanding increased and this reduced the cash flow from operations. So how should we look at this going forward, are you going to decrease the sale outstanding in the coming quarters, just could you comment on this? And the second question is on your client concentration. When I look at the trends quarter-by-quarter, throughout last year there was a decrease in like top five client’s concentration, top 10 client concentration and top 20 client concentration. But if we compare the first quarter with the fourth quarter and there is slight increase in each category. So basically do you think that the current client concentration mix is optimal and you’re going to reduce it further in terms of like servicing both big clients and small clients, getting big orders and small orders and so on.
Just in terms of the working capital, yes, DSO did go up by a couple of days between Q4 and Q1. So that did have a negative impact on working capital. But someone just going to get a significant amount of focus throughout the remainder of the year, and we remain committed to keeping DSO in the low-80s.
The other thing that we talked about we have a variable compensation program, it’s in part, the program that we use to retain our employees. There is an annual payout of that variable compensation plan and that occurs for the most part in Q1 of other fiscal year, and then a little bit of that variable compensation is actually paid out in Q2 in certain other countries in the CIS region.
So generally what you see is that there is somewhat lower cash flow generation in Q1, just courtesy of the variable compensation payout. Then all things equal you see an improvement in cash flow generation in Q2 and again an improvement in Q3 again all things held equal. So I that would kind of address the cash flow item.
In terms of concentration of customers, do you want to talk about Ark?
I think it’s also a consistent trend during the last couple of years. So we – as we mentioned we have new logos come in and some of them growing pretty fast, and growth below our top 20 is way over 20% right now. So, I think this is just a deflection of reality in the specification.
And quite simply we are growing both with existing customers and with new customers. We have a significant amount of revenue coming from again what we call new customers, which are measured as customers, which we engineered revenues in the last 12 months and so we’re getting about 40% of our revenue growth from those customer and then the 60% from the existing accounts and there’s substantial growth opportunities in both the existing customers and in new customer opportunities.
Ladies and gentlemen, our final question today comes from the line of Avishai Kantor with Cowen & Company. Please proceed with your question.
From a consulting perspective, have you considered any joint ventures or partnerships with standalone consultancies or front end strategic opportunities? Do you think it’s critical for you to keep those skills in-house?
We’re always open for any type of partnership and opportunities to work with. As a company it would kind of complement our capabilities and allow us to grow to bigger programs. But there is no such an issues, we can talk about it and that’s been happening from time to time. At the same time, we strongly believe that we need to have some consultant capabilities really inside of the company to blend with our other services much, much tighter.
And my next question is regarding your plans to further diversify your global presence in delivery capabilities, any specific regions or countries that you’re focusing on at this point?
I think we have pretty well diversified number of locations right now. So clearly everybody is thinking about us as Eastern European, the center kind of become, but at the same time we have India, China and Mexico. At this point, we’re paying a lot of attention to make sure that we have well balanced delivery locations and focusing how to grow all of them because that’s practically a function of client demand and client who wanted us to have this locations and clients location in many cases and driving operations in all of this global places.
Mr. Dobkin there are no further questions at this time. I’ll turn the floor back to you for any final comments.
Thank you everybody for joining today. I would like to thank all of our employees for the good start of the year, and if you have any questions David is always available to address and talk to you in three months. Thank you.
Thank you. This concludes today’s teleconference. You may disconnect your lines at this time. Thank you for your participation.