EPAM Systems, Inc. — Q2 2013 Form 10-Q
Reporting period: Three and six months ended June 30, 2013; comparisons are with the corresponding 2012 periods. Amounts below are in U.S. dollars, millions, unless otherwise noted. EPAM provides software development, engineering, testing, maintenance and related IT services.
Financial performance
| Metric | Q2 2013 | Q2 2012 | Six months 2013 | Six months 2012 |
|---|---|---|---|---|
| Revenue | $133.2 | $103.8 | $257.4 | $198.2 |
| Revenue growth | 28.3% | — | 29.9% | — |
| Operating income | $17.5 | $16.8 | $33.1 | $30.6 |
| GAAP operating margin | 13.2% | 16.2% | 12.8% | 15.4% |
| Net income | $14.1 | $13.3 | $26.8 | $25.4 |
| Diluted EPS | $0.29 | $0.29 | $0.56 | $0.55 |
| Operating cash flow | Not reported separately for the quarter | $(3.8) | $1.6 |
- Q2 cost of revenues, excluding depreciation and amortization, was 62.7% of revenue, versus 61.5% a year earlier; the corresponding six-month proportions were 62.7% and 62.6%.
- At June 30, cash and cash equivalents were $107.5, down from $118.1 at December 31, 2012. Current assets were $273.5 and current liabilities $47.3.
- No borrowings were outstanding under the $40.0 revolving credit facility; the full $40.0 was available. Total liabilities were $49.3. The filing reports no other outstanding debt.
- Six-month investing cash outflow was $14.0, including $9.0 for property and equipment and $5.2 in employee housing loans, partly offset by repayments. Financing provided $8.6; the net cash decrease was $10.6.
Material changes and drivers
- Revenue grew strongly, while operating income and net income grew more slowly. GAAP operating margin fell 3.0 percentage points in Q2 and 2.6 points for the first half; net income rose 6.0% and 5.4%, respectively.
- Management attributed revenue growth to expansion of existing accounts, new clients and the 2012 acquisitions of Thoughtcorp and Empathy Lab. North America and Europe were important growth markets; Banking and Financial Services and ISVs and Technology were prominent growth verticals.
- Operating costs rose with demand and staffing: the company added 1,143 IT professionals year over year. SG&A growth also reflected higher headcount, onsite staffing, facilities, public-company costs and stock-based compensation.
- Stock-based compensation was $3.9 in Q2 and $6.4 for the first half, compared with $1.8 and $3.3 in 2012. Management’s non-GAAP operating margin was 16.3% for Q2 and 15.8% for the first half, versus 18.4% and 17.8%; these measures exclude specified expenses and are not GAAP.
- The effective tax rate increased to 19.0% from 16.2% in Q2 and from 15.9% for the first half of 2012. The filing cites a greater share of U.S. profits and shifts in delivery work from Belarus to higher-tax Ukraine and Russia.
Outlook, risks and contingencies
- Management said cash and expected operating cash flow should cover operating and capital needs for at least the next 12 months. The filing provides no quantified revenue or earnings guidance.
- Management attributed negative first-half operating cash flow principally to a $12.2 increase in trade and unbilled receivables; unbilled revenue rose to $57.7 from $33.4 at year-end, which management linked to revenue growth and a higher proportion of fixed-price work.
- $84.7 of cash was held outside the United States, including $55.9 in U.S.-dollar accounts in Belarus. Management said it did not intend to repatriate these funds; repatriation could incur withholding and U.S. taxes. The filing highlights CIS banking-system risk and notes corporate deposits there are not insured.
- Customer concentration remained notable: Barclays Capital represented 10.0% of Q2 revenue and 9.8% for the first half. The top ten clients represented 42.2% and 41.8% of revenue in those periods. One customer accounted for 16.5% of unbilled revenue at quarter-end.
- Foreign exchange losses were $0.9 in Q2 and $1.4 for the first half; currency translation reduced comprehensive income by $1.0 and $3.4, respectively. The company does not use derivatives to hedge foreign-exchange volatility.
- Commitments included $31.3 of operating leases, $5.1 remaining for a Minsk office building and $2.2 under the employee housing program. The company disclosed no material legal proceedings and said there were no material changes to previously disclosed risk factors, apart from risks related to employee loans and potential share sales by Siguler Guff affiliates.
Investor verification points
- Track conversion of unbilled revenue and receivables into cash, especially as fixed-price project activity grows.
- Assess whether revenue growth can translate into stronger GAAP margins as staffing, SG&A and stock-based compensation rise.
- Monitor cash exposure in Belarus and other CIS markets, tax and repatriation implications, and foreign-exchange effects.
- Review customer concentration, including Barclays Capital and the customer representing 16.5% of unbilled revenue.
- Verify progress and remaining costs for the Minsk office project, employee housing commitments, and potential sales of registered shares by selling stockholders.