EPAM Systems, Inc. — Q1 2012 Form 10-Q
Reporting period: Three months ended March 31, 2012; unaudited. Amounts are in U.S. dollars. EPAM provides software development and related IT services, with delivery centers primarily in Central and Eastern Europe and the CIS.
Financial results
| Metric | Q1 2012 | Q1 2011 | Change |
|---|---|---|---|
| Revenue | $94.4 million | $72.8 million | +29.6% |
| Income from operations | $13.8 million | $11.8 million | +16.7% |
| Operating margin | 14.6% | 16.3% | Down 1.7 percentage points |
| Net income | $12.1 million | $9.7 million | +24.2% |
| Net margin | 12.8% | 13.4% | Down 0.6 percentage points |
| Diluted EPS | $0.27 | $0.18 | Increased |
| Operating cash flow | $(4.7) million | $0.4 million | Declined |
Cost of revenues rose 32.2% to $60.2 million and increased from 62.5% to 63.8% of revenue, primarily reflecting higher compensation and contractor costs. SG&A increased 27.8% to $17.6 million but eased slightly as a share of revenue, to 18.7% from 18.9%. The effective tax rate declined to 15.6% from 17.9%, mainly due to geographic income mix and lower statutory rates in certain countries.
Liquidity, cash flow and capital
- Cash and cash equivalents were $112.7 million at March 31, up from $88.8 million at year-end; current assets were $223.1 million and current liabilities $47.1 million.
- Operating cash outflow was $4.7 million, versus $0.4 million provided in Q1 2011. Management attributed the deterioration principally to higher bonus payments relating to 2011 performance and increased receivables and unbilled revenue.
- Investing cash outflow was $3.7 million, including $3.3 million of property and equipment purchases and $0.6 million for construction of a building in Belarus. Financing provided $31.3 million, primarily from the IPO. Ending cash also reflected $1.1 million of favorable exchange-rate effects.
- No borrowings were outstanding under the revolving credit facility. Reported borrowing availability was $23.4 million under the $30 million facility, which expires October 15, 2013; the company reported compliance with its covenants.
- EPAM completed its February IPO at $12 per share. The company sold 2.9 million shares and received approximately $29.0 million in net proceeds; selling stockholders sold another 4.0 million shares and received no proceeds for the company. Preferred shares converted into common stock.
- There is no conventional funded debt reported on the balance sheet. Contractual obligations totaled $41.8 million, including $25.5 million of operating leases and $16.3 million of other long-term obligations, principally associated with the Minsk office-building construction agreement.
Performance changes and business mix
Growth was led by Europe, where client-location revenue rose 62.2% to $35.3 million, and North America, up 25.5% to $46.8 million. CIS revenue declined to $11.2 million from $12.6 million. Banking and Financial Services revenue grew 38.4% to $22.6 million; Retail and Consumer also increased substantially. Software development remained the largest service line at $62.9 million, or 66.6% of revenue. Time-and-material contracts represented 89.3% of revenue, versus 86.6% a year earlier.
The top five clients represented 34.5% of revenue and the top ten 48.2%. No client exceeded 10% of Q1 2012 revenue; one client exceeded that threshold in Q1 2011. Management said 80.6% of Q1 2012 revenue came from clients served for at least two years.
Outlook, risks and unusual items
- The filing gives no specific financial guidance. Management expects software development to remain the majority of revenue and time-and-material arrangements to continue to predominate. It expects SG&A to rise in absolute dollars as the business expands, while remaining steady or declining slightly as a percentage of revenue.
- Management cites demand and economic conditions, competition, skilled-worker availability and wage inflation, client retention and growth, utilization, and exchange-rate movements as important operating factors. The company does not hedge foreign-exchange exposure; management estimated a 1% movement in the euro or British pound against the U.S. dollar would change net income by approximately $0.1 million, respectively.
- Cash held outside the United States totaled $64.5 million, including $40.5 million in U.S.-dollar accounts in Belarus. The company said it did not intend to repatriate these funds; repatriation could involve withholding and U.S. taxes.
- Q1 included a $0.6 million non-cash stock charge related to shares issued for a prior asset acquisition, and stock-based compensation rose to $1.6 million from $0.7 million. The IPO and conversion of preferred shares materially changed the capital structure and share count.
- The company reported no material legal proceedings and no material changes to the risk factors in its 2011 Form 10-K. Management concluded disclosure controls were effective as of March 31, 2012 and reported no material change in internal control over financial reporting during the quarter.
Investor verification priorities
- Assess whether revenue growth can translate into improved margins given rising delivery compensation costs and the decline in operating margin.
- Track cash conversion, especially unbilled revenue, receivables and the timing of bonus payments, alongside operating cash flow.
- Review client concentration and the sustainability of growth in Europe and key verticals; compare segment and client-location disclosures on their differing bases.
- Evaluate workforce and foreign-exchange exposure, cash held abroad, and the tax consequences of any repatriation.
- Check the impact of IPO-related dilution, stock compensation and the Minsk building commitment on future per-share results and liquidity.