EPAM Systems, Inc. — 2013 Form 10-K Summary
Business context and reporting period
EPAM provides software engineering and IT services, with delivery operations concentrated in Central and Eastern Europe and the CIS. This 10-K covers the fiscal year ended December 31, 2013; fourth-quarter figures are included below where available. The financial statements received an unqualified audit opinion.
Key financial metrics
| Metric | 2013 | 2012 |
|---|---|---|
| Revenue | $555.1 million | $433.8 million |
| Operating income / margin | $76.5 million / 13.8% | $66.0 million / 15.2% |
| Net income / margin | $62.0 million / 11.2% | $54.5 million / 12.6% |
| Diluted EPS | $1.28 | $1.17 |
| Cash from operations | $58.2 million | $48.5 million |
| Cash and cash equivalents at year-end | $169.2 million | $118.1 million |
| Revolver borrowings at year-end | None | None |
Fourth-quarter 2013 revenue was $157.6 million, operating income was $23.2 million, and net income was $18.8 million; diluted EPS was $0.38.
Operating cash flow less purchases of property and equipment and construction spending was approximately $42.3 million in 2013, a derived measure. Year-end current assets were $331.0 million and current liabilities were $54.7 million (approximately 6.1x current ratio). The company had a $40 million revolving credit facility, with no outstanding balance, maturing January 15, 2015. Operating lease obligations totaled $31.3 million.
Material changes versus the prior comparable period
- Revenue grew 28.0%, driven by existing clients ($98.4 million of growth) and new clients ($21.7 million). Banking and Financial Services revenue rose 39.7%; ISVs and Technology rose 26.3%.
- North American client-location revenue grew 36.2%; European revenue grew 29.0%. CIS revenue was nearly flat, increasing 0.5%.
- Operating income increased 15.9%, but operating margin fell 1.4 percentage points. Cost of revenue rose to 62.6% of revenue from 62.3%, while SG&A rose to 21.0% from 19.8%.
- Net income increased 13.8%, but net margin declined to 11.2% from 12.6%. The effective tax rate rose to 19.2% from 17.3%, mainly due to geographic profit mix.
- Stock-based compensation increased to $13.2 million from $6.8 million. Management’s non-GAAP operating margin, which excludes specified items including stock compensation, was 16.5%, down from 17.3%.
- Operating cash flow increased $9.7 million. Investing cash outflow fell to $21.8 million from $59.6 million, mainly because 2012 included acquisition payments; 2013 included $8.0 million in employee housing loans issued, partly offset by repayments.
Outlook, management commentary, risks and unusual items
- The filing gives no numerical earnings or revenue guidance. Management said existing cash and expected operating cash flow should cover projected operating and capital needs for at least 12 months, and described continued investment in people, processes and infrastructure.
- Management cited acquisition benefits from the 2012 Thoughtcorp and Empathy Lab deals. Subsequent to year-end, EPAM agreed to acquire assets of Netsoft Holdings and Ozsoft for aggregate consideration, including potential earn-outs, capped at $6 million.
- EPAM disclosed heightened political turmoil in Ukraine and reported Russian military activity in Crimea. At the filing date, its offices in Ukraine and Russia remained open and it had experienced no operational interruption; it was monitoring events and had relocation and contingency plans. Prolonged unrest or broad sanctions could materially affect operations.
- Other key risks include competition for skilled employees and rising compensation, client and industry concentration, project pricing and revenue-recognition estimates, foreign exchange exposure, and legal, regulatory and banking risks in CIS and CEE markets. Attrition among IT professionals with at least six months’ service increased to 13.1% from 10.7%.
- Cash concentration is a notable risk: $143.5 million was held outside the United States, and the filing highlights uninsured corporate deposits and banking-system risks in CIS countries. EPAM did not hedge foreign-exchange exposure; reported 2013 foreign exchange loss was $2.8 million.
- Belarusian and Hungarian tax incentives reduced taxes; related tax-holiday benefits were approximately $9.7 million in 2013. The Hungary credit is scheduled to phase out in 2015, and changes to incentives could raise the effective tax rate or operating costs.
- Fixed-price project timing affected segment results: EPAM estimated $2.5 million of Russia-segment revenue remained unrecognized at year-end, while related costs were already reflected. No material legal proceeding was reported. Management concluded disclosure controls and internal control over financial reporting were effective; auditor attestation of internal controls was not included under the company’s emerging-growth-company status.
Important facts for investors to verify
- Whether margin pressure from compensation, stock-based awards and increased SG&A persists as revenue grows.
- Cash conversion and collection trends, especially rising billed and unbilled receivables and fixed-price project acceptance timing.
- Exposure to Ukraine/Russia developments, sanctions, and the location and accessibility of cash held outside the United States.
- The sustainability of tax benefits and the effect of their phase-out or changes in geographic profit mix.
- Client concentration and contract risk: the top ten clients generated 42.3% of revenue; the largest generated 9.6%, and one major client had special step-in and transfer rights under its agreement.
- Potential dilution and compensation expense from equity awards: 5.8 million options were outstanding at year-end, with $28.9 million of unrecognized compensation cost.