EPAM Systems, Inc. — Q2 2012 Form 10-Q
Reporting period: Three and six months ended June 30, 2012; compared with the corresponding 2011 periods. Unaudited consolidated results. EPAM provides global IT services, with delivery centers primarily in Central and Eastern Europe and the CIS.
Financial performance
| Metric | Q2 2012 | Six months 2012 | Comparison |
|---|---|---|---|
| Revenue | $103.8 million | $198.2 million | Up 29.5% and 29.6%, respectively, year over year |
| Operating income | $16.8 million | $30.6 million | Up 54.7% and 34.9% |
| Operating margin | 16.2% | 15.4% | Versus 13.6% and 14.8% |
| Net income | $13.3 million | $25.4 million | Up 60.9% and 41.1% |
| Diluted EPS, common | $0.29 | $0.55 | 2011 reported loss per share of $0.41 and $0.22, respectively |
| Operating cash flow | $1.6 million for six months | Down from $10.8 million in 2011 |
- Non-GAAP operating margin was 18.4% in Q2 and 17.8% for the half, compared with 17.0% and 17.3%. These company-defined measures exclude specified items and should be considered alongside GAAP results.
- Cash and cash equivalents were $104.9 million at June 30, up from $88.8 million at year-end. Current assets were $224.8 million and current liabilities $43.9 million (approximately 5.1 times current-asset coverage).
- No revolver borrowings were outstanding. The $30 million facility had $24.7 million of availability; the company reported covenant compliance. Total liabilities were $45.4 million.
- Six-month investing cash use was $16.5 million, including $6.4 million for property and equipment, $3.2 million for the Minsk building, and $7.0 million net cash paid for Thoughtcorp. Financing provided $31.1 million, principally from the IPO.
Material changes and business developments
- Growth was attributed to demand from existing customers, new clients, expansion in Europe, and the Thoughtcorp acquisition. Management cited broad-based growth, particularly in Banking and Financial Services, Retail and Consumer, and ISV and Technology.
- Thoughtcorp, a Canadian software-solutions provider, was acquired in May for approximately $7.6 million cash and 217,274 common shares valued at $3.6 million. A further 217,272 restricted shares, also valued at $3.6 million, are employment-contingent compensation over two years. The purchase-price allocation is provisional; acquired revenue included in Q2 was $1.1 million.
- The February IPO generated $34.8 million gross proceeds for EPAM from company-issued shares and approximately $29.0 million net proceeds. Selling stockholders sold additional shares but EPAM received no proceeds from those sales. Preferred shares converted into common stock at the IPO; common shares outstanding increased substantially.
- Revenue mix remained led by software development (66.8% of Q2 revenue). Time-and-material contracts generated 84.8% of Q2 revenue. The top ten clients accounted for 46.8% of Q2 revenue; no customer exceeded 10% in 2012.
Outlook, risks and notable items
- The filing provides no specific numerical revenue or earnings guidance. Management expects continued business expansion, says SG&A should increase in absolute dollars but generally remain steady or decline slightly as a percentage of revenue, and expects time-and-material work to remain the majority of revenue. It also intends to pursue strategic acquisitions.
- Operating cash flow weakened despite higher earnings, principally reflecting increased receivables and unbilled revenue and lower accrued compensation after bonus payments. Unbilled revenue rose to $36.8 million from $24.5 million at year-end; accounts receivable rose to $68.2 million from $59.5 million.
- Foreign-exchange losses were $1.4 million in Q2 and $1.3 million for the half. EPAM does not hedge currency exposure; management estimated that a 1% move in either the euro or British pound against the U.S. dollar would change net income by approximately $0.1 million, based on first-half results.
- Of cash, $67.6 million was held outside the United States, including $42.4 million in U.S.-dollar accounts in Belarus. The company said it did not intend to repatriate these funds; repatriation could trigger foreign withholding and U.S. taxes. Tax benefits in Belarus and Hungary, and changes in geographic income mix, affect the effective tax rate.
- Commitments included $23.5 million of operating leases and $13.7 million remaining for the Minsk office building, expected to be operational in Q1 2013. Employee loan guarantees totaled $0.6 million; management considered material losses remote. No material legal proceedings or material changes to previously disclosed risk factors were reported.
- EPAM was an emerging growth company and expected to use the exemption from auditor attestation under Sarbanes-Oxley Section 404(b). Management concluded disclosure controls were effective as of June 30, 2012; no material change in internal control was reported.
Important facts for investors to verify
- Whether receivables and unbilled revenue convert to cash, given the sharp year-over-year decline in operating cash flow.
- How much reported margin improvement reflects sustainable operating leverage versus the absence of the prior-year goodwill impairment and the exclusions in non-GAAP measures; also track rising stock-based compensation.
- The final Thoughtcorp purchase-price allocation, acquisition performance, and expense associated with employment-contingent shares.
- Customer concentration and retention, particularly the top-ten revenue share and continued growth among major clients.
- Cash accessibility and potential tax costs outside the United States, foreign-exchange exposure, and execution of the Minsk construction commitment.
- Share dilution from the IPO, acquisition consideration, restricted stock, and outstanding options; diluted weighted-average shares increased materially year over year.