EPAM Systems, Inc. — Q1 2013 Form 10-Q
Reporting period: Three months ended March 31, 2013; comparisons are with Q1 2012 unless stated otherwise. EPAM provides global software engineering and IT services. Amounts below are in U.S. dollars; financial figures are in millions unless noted.
Financial performance
| Metric | Q1 2013 | Q1 2012 | Change |
|---|---|---|---|
| Revenue | $124.2 | $94.4 | +31.6% |
| Income from operations | $15.5 | $13.8 | +12.7% |
| GAAP operating margin | 12.5% | 14.6% | Down 2.1 percentage points |
| Net income | $12.7 | $12.1 | +4.8% |
| Diluted EPS | $0.27 | $0.27 | Unchanged |
| Net cash used in operating activities | $(11.7) | $(4.7) | Greater cash use |
| Cash and cash equivalents, at period end | $102.8 | $112.7 | Down $9.9 year over year |
- Cost of revenues, excluding depreciation and amortization, was 62.8% of revenue versus 63.8% a year earlier. SG&A rose to 21.8% of revenue from 18.7%; depreciation and amortization was 2.9% versus 2.3%.
- Non-GAAP operating income was $18.8 million and non-GAAP operating margin was 15.2%, compared with $16.1 million and 17.1%. The company excludes stock-based compensation, acquired-intangible amortization, acquisition costs and, where applicable, one-time charges; these measures are not GAAP.
- Cash from operations was negative principally because unbilled revenue increased and accrued expenses and taxes payable declined. Unbilled revenue rose to $51.8 million from $33.4 million at December 31, 2012.
Balance sheet and liquidity
- At March 31, 2013, total assets were $356.7 million, current assets $255.4 million, current liabilities $48.4 million, total liabilities $53.3 million and stockholders’ equity $303.5 million.
- EPAM had no borrowings under its $40 million revolving credit facility, which matures January 15, 2015 and bears interest at LIBOR plus 1.25%. Cash plus available facility capacity was approximately $142.8 million.
- Cash declined $15.3 million during the quarter. Investing activities used $6.5 million, including $2.8 million for employee housing loans; financing provided $4.0 million. The prior-year financing inflow included $31.2 million of IPO proceeds.
- Of $102.8 million in cash, $97.7 million was held outside the U.S.; the filing says EPAM did not intend to repatriate these funds. Remittance could incur foreign withholding and U.S. corporate income taxes.
Material changes and management commentary
- Revenue growth reflected expansion with existing clients, new customers and $8.3 million of revenue from the 2012 Thoughtcorp and Empathy Lab acquisitions. Banking and Financial Services revenue grew $10.2 million (45.9%); ISVs and Technology grew $8.8 million (37.5%).
- North America revenue increased 47.1% to $63.1 million; Europe rose 15.8% to $46.2 million; Russia rose 30.3% to $12.4 million. Europe segment operating profit decreased to $8.4 million from $8.7 million despite revenue growth.
- Higher SG&A reflected increased headcount, onsite-resource needs, recruitment and facility costs, acquisition-related stock compensation, and $0.7 million in incremental public-company costs. The effective tax rate rose to 19.1% from 15.6%, attributed to profit mix shifting toward the U.S. and delivery shifting from Belarus toward Ukraine and Russia.
- Management stated that existing cash and expected operating cash flow should cover projected operating and capital expenditure needs for at least the next 12 months. No specific earnings or revenue guidance is provided in the filing.
Risks, commitments and unusual items
- Management identifies exposure to foreign exchange, interest rates, client credit and international operating conditions. Q1 included a $0.5 million transactional foreign-exchange loss and a $2.3 million currency translation loss in other comprehensive income.
- Banking-system risk is notable: $85.7 million of cash was held in CIS countries, including $67.5 million in Belarus. The filing notes that corporate bank deposits in CIS countries are not insured.
- Top ten clients generated 42.0% of Q1 revenue, down from 48.2% a year earlier; no individual client exceeded 10%. One large customer’s revenue declined $3.2 million, partly tempering Business Information and Media growth.
- Contractual obligations totaled $41.5 million, including $32.6 million of operating leases, $5.5 million of other long-term obligations and $3.3 million of remaining Employee Housing Program commitments. Construction commitments included $5.2 million for a Belarus office building and $0.3 million for corporate apartments.
- The employee housing program had $2.8 million of loans issued in Q1; total outstanding employee loans were $3.3 million, with no allowance recorded. The company added employee lending risk as a risk factor.
- EPAM filed a shelf registration statement that became effective May 7, 2013, allowing up to $50 million of company securities to be offered and allowing selling stockholders to offer up to 17,939,673 shares. EPAM would receive no proceeds from sales by those stockholders.
- No material legal proceedings were reported. Management concluded disclosure controls were effective as of March 31, 2013; no material change in internal control was reported.
Important facts for investors to verify
- Whether higher unbilled revenue converts to billed receivables and cash, and whether operating cash flow improves.
- Whether revenue growth and client expansion can support margins as SG&A and acquired-intangible amortization rise.
- Cash concentration in Belarus and other CIS banking systems, and potential tax costs if foreign cash is repatriated.
- Execution and funding of construction, lease and employee housing commitments, including credit performance of housing loans.
- Potential dilution or market supply from the effective shelf registration and selling-stockholder share registration.