EPAM Systems, Inc. — FY 2012 Form 10-K
Reporting period: Year ended December 31, 2012. This is an annual filing, not a standalone Q4 filing; quarterly figures below are included in the 10-K. Amounts are in U.S. dollars unless stated otherwise.
Business context
EPAM provides software engineering and IT services, primarily from delivery centers in Central and Eastern Europe and the CIS. Its principal markets include North America and Europe, and its major verticals include banking and financial services, ISVs and technology, travel and consumer, and business information and media. In 2012, 47.7% of revenue came from North America, 35.8% from Europe and 15.0% from the CIS.
Key financial metrics
| Metric | FY 2012 | FY 2011 | Change |
|---|---|---|---|
| Revenue | $433.8 million | $334.5 million | +29.7% |
| Income from operations | $66.0 million | $55.0 million | +20.0% |
| Operating margin | 15.2% | 16.4% | Down 1.2 percentage points |
| Net income | $54.5 million | $44.4 million | +22.8% |
| Diluted EPS | $1.17 | $0.63 | Up; share and preferred-stock structure changed after IPO |
| Operating cash flow | $48.5 million | $54.5 million | Down $6.0 million |
Non-GAAP operating margin was 17.3% in 2012 versus 18.2% in 2011; the company’s adjustments include stock compensation, acquisition costs and other specified items. These non-GAAP measures are not substitutes for GAAP results.
At December 31, 2012, cash and cash equivalents were $118.1 million, current assets were $251.0 million and current liabilities were $59.4 million. Total liabilities were $64.5 million and stockholders’ equity was $286.3 million. There were no borrowings outstanding on the revolving credit line; $28.1 million was available under the facility at year-end. In January 2013, the company increased the facility’s maximum capacity to $40 million and extended its maturity to January 15, 2015.
Investing cash outflow was $59.6 million, including $33.0 million net cash paid for acquisitions and $13.7 million for construction of corporate facilities. Financing cash inflow was $38.8 million, principally reflecting IPO proceeds and stock-option activity.
Material changes and Q4 detail
- Revenue growth was driven mainly by deeper business with existing clients ($71.3 million of the increase), new clients ($20.3 million) and acquisitions ($7.7 million). Europe revenue grew 45.0%; Banking and Financial Services revenue increased 46.1%.
- FY 2012 cost of revenue rose to 62.3% of revenue from 61.4%; higher compensation and benefits, incentive compensation and stock-based compensation contributed to margin pressure. Stock-based compensation was $6.8 million, versus $2.9 million.
- Full-year Q4 2012 revenue was $125.5 million versus $95.1 million in Q4 2011. Operating income was $18.7 million versus $15.4 million, and net income was $15.0 million versus $12.4 million. Diluted EPS was $0.32 versus $0.29.
- EPAM completed the acquisitions of Thoughtcorp in May and Empathy Lab in December. The acquisitions added capabilities in areas including agile development, enterprise mobility, business intelligence, e-commerce and digital strategy. Purchase-price allocations, particularly for Empathy Lab, were provisional at year-end.
- The February 2012 IPO generated $29.0 million of net proceeds for the company. Preferred shares converted into common shares in connection with the IPO.
- The top five clients generated 31.0% of revenue and the top ten 44.4%. Thomson Reuters, which had exceeded 10% of revenue in 2011 and 2010, contributed 6.0% in 2012.
Outlook, risks and unusual items
- Management expected existing cash and operating cash flow to cover anticipated operating and capital needs for at least the next 12 months, and intended to continue pursuing strategic acquisitions and investments. The filing provides no specific numerical revenue or earnings guidance.
- Management cited rapid growth, hiring and retention, wage inflation, utilization, project estimates and pricing as important execution and margin risks. Many client engagements can be terminated, and clients generally do not commit to long-term purchases.
- Geographic risks are significant: most delivery capacity and employees are in the CIS and CEE, where political, legal, banking, economic, tax and currency conditions may be less predictable. At year-end, $76.2 million of cash was held in CIS countries, including $50.6 million in Belarus; corporate deposits in CIS countries generally were not insured.
- Tax benefits in Belarus and Hungary reduce the effective tax burden but may change or expire. The filing reports $8.5 million of aggregate tax-holiday benefits in 2012 and anticipates the phase-out of Hungarian credits by 2015. EPAM also intended to permanently reinvest approximately $188.7 million of undistributed foreign earnings.
- Foreign-exchange loss was $2.1 million in 2012. The company did not use derivatives to hedge currency or interest-rate exposure. Belarus reported very high inflation in 2012, though Belarusian-ruble-denominated revenue was 0.5% of total revenue.
- The company reported no material legal proceeding and stated that disclosure controls and internal control over financial reporting were effective. As an emerging growth company, it did not include an auditor attestation on internal controls.
Investor verification priorities
- Verify that revenue growth is translating into sustainable margins and cash generation, given the lower operating margin and decline in operating cash flow.
- Review working-capital trends, especially accounts receivable and unbilled revenue, which increased alongside growth.
- Assess client concentration, retention and renewal exposure, including the disclosed client option to assume operations of a dedicated offshore center.
- Evaluate acquisition integration, provisional purchase accounting, goodwill and the continuing stock-compensation and dilution burden.
- Confirm the availability and practical accessibility of cash held outside the United States, alongside CIS banking, currency, tax and geopolitical exposures.
- Track the durability of Belarusian and Hungarian tax incentives and the impact of their expiration or any repatriation of foreign earnings.