UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
x ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
For the Fiscal Year Ended December 31, 2014
OR
¨ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
Commission file number: 001-35418
EPAM SYSTEMS, INC.
(Exact Name of Registrant as Specified in its Charter)
Delaware | 223536104 | |
(State or other jurisdiction of incorporation or organization) | (I.R.S. Employer Identification No.) | |
EPAM Systems, Inc.
41 University Drive,
Suite 202
Newtown, Pennsylvania 18940
(Address of principal executive offices, including zip code)
267-759-9000
(Registrant’s telephone number, including area code)
Securities registered pursuant to Section 12(b) of the Act:
Title of Each Class | Name of Each Exchange on Which Registered | |
Common Stock, par value $0.001 per share | New York Stock Exchange | |
Securities registered pursuant to Section 12(g) of the Act: None.
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes ¨ No x
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. Yes ¨ No x
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes x No ¨
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes x No ¨
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. x
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):
Large accelerated filer | x | Accelerated filer | ¨ | |||
Non-accelerated filer | ¨ (Do not check if a smaller reporting company) | Smaller reporting company | ¨ | |||
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ¨ No x
As of June 30, 2014 the aggregate market value of the registrant’s common stock held by non-affiliates of the registrant was approximately $1,589 million based on the closing sale price as reported on the New York Stock Exchange. Solely for purposes of the foregoing calculation, “affiliates” are deemed to consist of each officer and director of the registrant, and each person known to the registrant to own 10% or more of the outstanding voting power of the registrant.
The number of shares of common stock, $0.001par value, of the registrant outstanding as of February 24, 2015 was 48,858,032 shares.
DOCUMENTS INCORPORATED BY REFERENCE
The registrant intends to file a definitive Proxy Statement for its 2015 annual meeting of stockholders pursuant to Regulation 14A within 120 days of the end of the fiscal year ended December 31, 2014. Portions of the registrant’s Proxy Statement are incorporated by reference into Part III of this Form 10-K. With the exception of the portions of the Proxy Statement expressly incorporated by reference, such document shall not be deemed filed with this Form 10-K.
EPAM SYSTEMS, INC.
FORM 10-K
FOR THE YEAR ENDED DECEMBER 31, 2014
TABLE OF CONTENTS
Page | |
In this annual report, “EPAM,” “EPAM Systems, Inc.,” the “Company,” “we,” “us” and “our” refer to EPAM Systems, Inc. and its consolidated subsidiaries.
“EPAM” is a trademark of EPAM Systems, Inc. “CMMI” is a trademark of the Software Engineering Institute of Carnegie Mellon University. “ISO 9001:2000” and “ISO 27001:2005” are trademarks of the International Organization for Standardization. All other trademarks and servicemarks used herein are the property of their respective owners.
Unless otherwise indicated, information contained in this annual report concerning our industry and the markets in which we operate, including our general expectations and market position, market opportunity and market share, is based on information from various sources (including industry publications, surveys and forecasts and our internal research), on assumptions that we have made, which we believe are reasonable, based on such data and other similar sources and on our knowledge of the markets for our services. The projections, assumptions and estimates of our future performance and the future performance of the industry in which we operate, are subject to a high degree of uncertainty and risk due to a variety of factors, including those described under “Item 1A. Risk Factors” and elsewhere in this annual report. These and other factors could cause results to differ materially from those expressed in the estimates included in this annual report.
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SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS
This annual report on Form 10-K contains estimates and forward-looking statements, principally in “Item 1. Business,” “Item 1A. Risk Factors” and “Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations.” Our estimates and forward-looking statements are mainly based on our current expectations and estimates of future events and trends, which affect or may affect our businesses and operations. Although we believe that these estimates and forward-looking statements are based upon reasonable assumptions, they are subject to several risks and uncertainties and are made in light of information currently available to us. Important factors, in addition to the factors described in this annual report, may adversely affect our results as indicated in forward-looking statements. You should read this annual report and the documents that we have filed as exhibits hereto completely and with the understanding that our actual future results may be materially different from what we expect.
The words “may,” “will,” “should,” “could,” “expect,” “plan,” “anticipate,” “believe,” “estimate,” “predict,” “intend,” “potential,” “might,” “would,” “continue” or the negative of these terms or other comparable terminology and similar words are intended to identify estimates and forward-looking statements. Estimates and forward-looking statements speak only as of the date they were made, and, except to the extent required by law, we undertake no obligation to update, to revise or to review any estimate and/or forward-looking statement because of new information, future events or other factors. Estimates and forward-looking statements involve risks and uncertainties and are not guarantees of future performance. As a result of the risks and uncertainties described above, the estimates and forward-looking statements discussed in this annual report might not occur and our future results, level of activity, performance or achievements may differ materially from those expressed in these forward-looking statements due to, including, but not limited to, the factors mentioned above, and the differences may be material and adverse. Because of these uncertainties, you should not place undue reliance on these forward-looking statements. We undertake no obligation to update or revise any forward-looking statements, whether as a result of new information, future events, or otherwise, except as may be required under applicable law.
EMERGING GROWTH COMPANY STATUS
In April 2012, several weeks after our initial public offering in February 2012, President Obama signed into law the Jumpstart Our Business Startups Act of 2012 (the “JOBS Act”). The JOBS Act contains provisions that relax certain requirements for “emerging growth companies” that otherwise apply to larger public companies. For as long as a company retains emerging growth company status, it will not be required to (1) provide an auditor’s attestation report on the Company’s internal control over financial reporting, otherwise required by Section 404(b) of the Sarbanes-Oxley Act of 2002, (2) comply with any new or revised financial accounting standard applicable to public companies until such standard is also applicable to private companies, (3) comply with certain new requirements adopted by the Public Company Accounting Oversight Board, (4) provide certain disclosure regarding executive compensation required of larger public companies or (5) hold shareholder advisory votes on matters relating to executive compensation. Based on our market capitalization on June 30, 2014, we were deemed a large accelerated filer as of December 31, 2014. Therefore, we no longer qualify as an emerging growth company.
GEOGRAPHICAL REFERENCES
We use the terms “CIS” and “CEE” to describe a portion of our geographic operations and assets. CIS, which stands for the Commonwealth of Independent States, is comprised of constituents of the former U.S.S.R., including Armenia, Azerbaijan, Belarus, Georgia, Kazakhstan, Kyrgyzstan, Moldova, Russia, Tajikistan, Turkmenistan, Ukraine and Uzbekistan. CEE, which stands for Central and Eastern Europe, includes Albania, Bosnia and Herzegovina, Bulgaria, Croatia, Czech Republic, Estonia, Hungary, Latvia, Lithuania, Poland, Republic of Macedonia, Romania, Serbia, Montenegro, Slovakia, and Slovenia.
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PART I
Item 1. Business
Company Background
We are a leading global provider of complex software engineering solutions and information technology services to clients in locations worldwide. Our clients rely on us to deliver a broad range of software engineering, consulting and IT services, with a significant share of proactive, domain-led, high-value services aimed at improving the client’s ability to innovate and reduce time to market. We draw on our extensive vertical, technology and process expertise and leverage industry standard technology, tools, platforms as well a portfolio of internally and externally developed assets in our delivery. We focus on building long-term partnerships with clients in various industries that demand technologically advanced skills and solutions and require quality and agility in delivery. Our industry expertise includes industries such as software and technology, banking and capital markets, business information and media, travel and hospitality, retail, energy, life sciences, healthcare, telecommunications, and government. We deliver services to clients located primarily in North America, Europe, and the CEE region and, beginning in 2014, Asia.
Since our inception in 1993, we have focused on software product development services for major independent software vendors (ISVs) and technology companies and refined this core competency through repeat multi-year engagements. These companies produce advanced software and technology products that demand sophisticated software engineering talent, tools, methodologies and infrastructure to deliver solutions that support functionality and configurability to sustain multiple generations of platform innovation. Software product development for ISVs and technology companies requires high-quality software engineering talent, advanced knowledge of current methodologies and productivity tools, and strong project management practices. As a result, we have developed a culture focused on innovation, technology leadership and process excellence, which helps us maintain a strong reputation with our clients for technical expertise and high-quality project delivery.
Our work with ISVs and technology companies, including both global leaders in enterprise software platforms and emerging, innovative technology companies focusing on new trends, exposes us to their customers’ business and strategic challenges, allowing us to develop vertical-specific domain expertise. Unlike custom application development, which is tailored to specific business requirements, software products of ISVs must be designed with a higher level of product configurability and operational performance to address the needs of a diverse set of end-users working in multiple industries and operating in a variety of deployment environments. In-depth understanding of how vertically-oriented ISVs and technology companies solve their clients’ challenges allows us to focus and grow our business in multiple industry verticals, predominantly Banking and Financial Services, Business Information and Media, and Travel and Consumer.
Our historical core competency is full lifecycle software development and product engineering services including design and prototyping, product development and testing, component design and integration, product deployment, performance tuning, porting and cross-platform migration. Our extensive experience in each of these areas created an unparalleled foundation for the evolution of our other offerings, which include custom application development, application testing, enterprise application platforms, application maintenance and support, and infrastructure management.
In 2014, we completed several acquisitions to expand our global footprint and service offering. Our 2014 acquisitions of Netsoft Holdings LLC, Joint Technology Development Limited, GGA Software Services, LLC and Great Fridays Ltd. expanded our capabilities in the healthcare, financial services and digital design areas. We expect these strategic acquisitions will enable us to offer a wider range of services to our clients from a wider variety of locations. We added approximately 761 IT, design professionals and scientists to our employee base through these acquisitions in 2014.
Our Approach
Our delivery centers in Belarus, Ukraine, Russia, Hungary, Kazakhstan, Bulgaria, Armenia, Poland and China are strategically located in centers of software engineering talent and educational excellence.
We believe the quality of our employees underpins our success and serves as a key point of differentiation in how we deliver a superior value proposition to our clients. Our highly-skilled information technology, or IT professionals, combined with our extensive experience in delivering custom solutions that meet our clients’ pressing business needs, has allowed us to develop a deep culture of software engineering excellence. We believe this culture enables us to attract, train and retain talented IT professionals.
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We employ highly-educated IT professionals, nearly all of whom hold a master’s equivalent university degree in math, science or engineering and are generally proficient in English. To ensure we attract the best candidates from this deep talent pool, we have developed close relationships with leading universities across CEE, whereby we actively support curriculum development and engage students to identify their talents and interests. We continue to expand these efforts throughout the major talent hubs within CEE.
Since inception, we have invested significant resources into developing a proprietary suite of internal applications and tools to manage all aspects of our delivery process. These applications and tools are effective in reducing risks, such as security breaches and cost overruns, while providing control and visibility across all project lifecycle stages to both our clients and us. In addition, these applications and tools enable us to provide solutions using the optimal software product development methodologies, including iterative methodologies such as Agile development. Our applications, tools, methodologies and infrastructure allow us to seamlessly deliver services and solutions from our delivery centers to global clients, thereby further strengthening our relationships with them.
We believe we are the only ISAE 3402 Type 2 certified IT services provider with multiple delivery centers in CEE, based on our analysis of publicly available information of IT services providers. This certification is a widely recognized auditing standard developed by the American Institute of Certified Public Accountants, or AICPA, and it serves as additional assurance to our clients regarding the control environment and the security of their sensitive data. Furthermore, this is an important certification for firms in data and information-intensive industries, as well as any organization that is subject to the internal controls certification requirements of the Sarbanes-Oxley Act of 2002, as amended, or the Sarbanes-Oxley Act. Our ISAE 3402 Type 2 certification, in addition to our multiple ISO/IEC 27001:2005 and ISO 9001:2008 attestations, underscores our focus on establishing stringent security standards and internal controls.
Our clients primarily consist of Forbes Global 2000 corporations located in North America, Europe and the CIS. We maintain a geographically diverse client base with 50.4% of our 2014 revenues from clients located in North America, 39.0% from clients in Europe, 7.6% from clients in the CIS and 1.8% from our clients in APAC. Our focus on delivering quality to our clients is reflected by an average of 93.1% and 81.5% of our revenues in 2014 coming from clients that had used our services for at least one and two years, respectively. In addition, we have significantly grown the size of existing accounts. For example, from 2008 to 2014, the number of clients accounting for over $5.0 million in annual revenues increased from seven to 24, and those accounting for $1.0 million or more in revenues increased from 42 to 116.
Our Services
Our service offerings cover the full software and product development lifecycle from digital strategy and customer experience design to enterprise application platforms implementation and program management services and from complex software development services to maintenance, support, custom application development, application testing, and infrastructure management. Our key service offerings include:
Software Product Development Services
We provide a comprehensive set of software product development services including product research, customer experience design and prototyping, program management, component design and integration, full lifecycle software testing, product deployment and end-user customization, performance tuning, product support and maintenance, managed services, as well as porting and cross-platform migration. We focus on software products covering a wide range of business applications as well as product development for multiple mobile platforms and embedded software product services.
Custom Application Development Services
We offer complete custom application development services to meet the requirements of businesses with sophisticated application development needs not adequately supported by packaged applications or by existing custom solutions. Our custom application development services leverage our experience in software product development as well as our industry expertise, prebuilt application solution frameworks and specific software product assets. Our range of services includes business and technical requirements analysis, user experience design, solution architecture creation and validation, development, component design and integration, quality assurance and testing, deployment, performance tuning, support and maintenance, legacy applications re-engineering/refactoring, porting and cross-platform migration and documentation.
Application Testing Services
We maintain a dedicated group of testing and quality assurance professionals with experience across a wide range of technology platforms and industry verticals. Our Quality Management System complies with global quality standards such as ISO 9001:2008 and we employ industry-recognized and proprietary defect tracking tools to deliver a comprehensive range of
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testing services. Our application testing services include: (i) software application testing, including test automation tools and frameworks; (ii) testing for enterprise IT, including test management, automation, functional and non-functional testing, as well as defect management; and (iii) consulting services focused on helping clients improve their existing software testing and quality assurance practices.
Enterprise Application Platforms
As a proven provider of software product development services to major ISVs, we have participated in the development of industry standard technology and business application platforms and their components in such specific areas as customer relationship management and sales automation, enterprise resource planning, enterprise content management, business intelligence, e-commerce, mobile, Software-as-a-Service and cloud deployment. Our experience in such areas allows us to offer services around Enterprise Application Platforms, which include requirements analysis and platform selection, deep and complex customization, cross-platform migration, implementation and integration, as well as support and maintenance. We use our experience, custom tools and specialized knowledge to integrate our clients’ chosen application platforms with their internal systems and processes and to create custom solutions filling the gaps in their platforms’ functionality necessary to address the needs of the clients’ users and customers.
Application Maintenance and Support
We deliver application maintenance and support services through a dedicated team of IT professionals. Our application maintenance and support offerings meet rigorous CMMI and ISAE 3402 Type 2 requirements. Our clients benefit from our proprietary distributed project management processes and tools, which reduce the time and costs related to maintenance, enhancement and support activities. Our services include incident management, fault investigation diagnosis, work-around provision, application bug fixes, release management, application enhancements and third-party maintenance.
Infrastructure Management Services
Given the increased need for tighter enterprise integration between software development, testing and maintenance with private, public and mobile infrastructures, our service offerings also cover infrastructure management services. We have significant expertise in implementing large infrastructure monitoring solutions, providing real-time notification and control from the low-level infrastructure up to and including applications. Our ISAE 3402 Type 2, ISO/IEC 27001:2005 and ISO 9001:2008 certifications provide our clients with third-party verification of our information security policies. Our solutions cover the full lifecycle of infrastructure management including application, database, network, server, storage and systems operations management, as well as incident notification and resolution.
Our Vertical Markets
Strong vertical-specific domain knowledge, backed by extensive experience merging technology with the business processes of our clients, allows us to deliver tailored solutions to various industry verticals. We have categorized our customers into four main industry verticals as follows:
• | Independent Software Vendors (ISVs) and Technology; |
• | Banking and Financial Services; |
• | Business Information and Media; and |
• | Travel and Consumer. |
We also serve the diverse technology needs of clients in the energy, telecommunications, automotive, manufacturing, insurance, retail, healthcare and life sciences industries and the government. These industries comprise our Other vertical.
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The following table sets forth our revenues by vertical by amount and as a percentage of our revenues for the periods presented:
For the Years Ended December 31, | ||||||||||||||||||||
2014 | 2013 | 2012 | ||||||||||||||||||
Banking and Financial Services | $ | 215,425 | 29.5 | % | $ | 156,340 | 28.2 | % | $ | 111,941 | 25.8 | % | ||||||||
ISVs and Technology | 157,944 | 21.6 | 134,970 | 24.3 | 106,852 | 24.6 | ||||||||||||||
Travel and Consumer | 157,756 | 21.6 | 117,248 | 21.1 | 95,965 | 22.1 | ||||||||||||||
Business Information and Media | 91,726 | 12.6 | 75,677 | 13.6 | 62,398 | 14.4 | ||||||||||||||
Other | 98,766 | 13.5 | 63,256 | 11.4 | 50,226 | 11.6 | ||||||||||||||
Reimbursable expenses and other revenues | 8,410 | 1.2 | 7,626 | 1.4 | 6,417 | 1.5 | ||||||||||||||
Revenues | $ | 730,027 | 100.0 | % | $ | 555,117 | 100.0 | % | $ | 433,799 | 100.0 | % | ||||||||
ISVs and Technology. Since our inception, we have focused on providing complex software product development services to meet ISVs and technology companies’ constant need for innovation and rapid time-to-market. Through our experience with many industry leaders, we have developed rigorous standards for software product development, as well as proprietary internal processes, methodologies and IT infrastructure. Our services span the complete software development lifecycle for software product development using our comprehensive development methodologies, testing and performance tuning, deployment and maintenance and support. In addition, we are establishing close partner relationships with many of our ISV and technology company clients and are offering distributed professional services around their product offerings directly to our corporate clients.
Banking and Financial Services. We have significant experience working with global retail and investment banks, investment firms, depositories, corporate treasuries, pension funds and market data providers. We offer a broad portfolio of services in asset and wealth management, corporate and retail banking, cards and payments, investment banking and brokerage, research and analysis, as well as governance, risk and compliance. We have also established a Capital Markets Competency Center, which facilitates knowledge exchange, education and collaboration across our organization and develops new software products, frameworks and components to further enhance our industry-specific solutions and services.
Business Information and Media. We have established long-term relationships with leading business information and media companies, which enable us to bring sustainable value creation and enhanced return-on-content for organizations within this vertical. Our solutions help clients develop new revenue sources, accelerate the creation, collection, packaging and management of content and reach broader audiences. We serve clients in a range of business information and media sub-sectors, including entertainment media, news providers, broadcasting companies, financial information providers, content distributors and advertising networks. Our Business Information Competency Center enables us to provide our clients with solutions that help them overcome challenges related to operating legacy systems, manage varied content formats, rationalize their online assets and lower their cost of delivery. In addition, we provide knowledge discovery platform services through our InfoNgen business, which combines custom taxonomy development with web crawling, internal file and e-mail classification, newsletter and feed publication and content trend analysis.
Travel and Consumer. We have extensive experience in designing, implementing and supporting solutions for the travel and hospitality industry. This has led to the development of a substantial repository of knowledge components and solutions, such as our Loyalty, Marketing and Booking Engine frameworks, which results in accelerated development and implementation of solutions, while ensuring enterprise-class reliability. Our capabilities span a range of platforms, applications and solutions that businesses in travel and hospitality use to serve their customers, capture management efficiencies, control operating expenses and grow revenues.
We also work closely with leading companies in the other industries to enable our clients to better leverage technology and address simultaneous pressures of driving value for the consumer and offering a more engaging experience. Our expertise allows us to integrate our services with our clients’ existing enterprise resource planning, billing fulfillment and customer relationship management solutions. Our digital strategy and experience design practice, EPAM Empathy Lab, provides strategy, design, creative, and program management services for clients looking to improve their customer experience. In 2014, we added a UK-based digital design presence through our acquisition of Great Fridays Limited. We also offer deep expertise across several domains including business-to-business and business-to-consumer e-commerce, customer/partner self-service, employee portals, online merchandising and sales, web content management, mobile solutions and billing.
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Our Delivery Model
We have delivery centers located in Belarus, Ukraine, Russia, Hungary, Kazakhstan, Bulgaria, Armenia, Poland and China. We have client management locations in the United States, Canada, United Kingdom, Germany, Sweden, Switzerland, Netherlands, Russia, Kazakhstan, Singapore, Hong Kong and Australia. We believe the development of a robust global delivery model creates a key competitive advantage, enabling us to better understand and meet our client’s diverse needs and provide a compelling value proposition.
Our primary delivery centers are located in Belarus, where we have 4,194 IT professionals as of December 31, 2014. The majority of these IT professionals are located in Minsk, the capital of Belarus, which is a major educational and industrial center in CEE. Minsk is well-positioned to serve as a prime IT outsourcing destination given its strong industrial base, good educational infrastructure and legacy as the center of computer science for the former Soviet Union. Furthermore, the IT industry in Belarus has been strongly supported by the government, which has taken steps to encourage investment in the IT sector through long-term tax incentives.
Our delivery centers in Ukraine have 2,956 IT professionals as of December 31, 2014. Our delivery centers in Russia have 1,714 IT professionals as of December 31, 2014. Our locations in Ukraine and Russia offer many of the same benefits as Belarus, including educational infrastructure, availability of qualified software engineers and government support of the IT industry. We believe our locations in Ukraine and Russia, along with our delivery centers in Belarus, offer a strong and diversified delivery platform across CEE. Our business has not been materially affected by the political and economic uncertainty in Russian or Ukraine to date.
Our delivery centers in Hungary have 1,013 IT professionals as of December 31, 2014, and serve as the center for our nearshore delivery capabilities to European clients. Hungary’s geographic proximity, cultural affinity and similar time zones with our clients in Europe enables increased interaction that creates closer client relationships, increased responsiveness and more efficient delivery of our solutions.
Quality and Process Management
We have built complex proprietary applications and tools to manage quality, security and transparency of the delivery process in a distributed environment. Our proprietary ISO 9001:2008 and CMMI-certified Quality Management System has been documented, implemented and maintained to ensure the timely delivery of software development services to our clients. We have also developed sophisticated project management techniques facilitated through our Project Management Center, a web-based collaborative environment for software development, which we consider critical to meeting or exceeding the service levels required by our clients.
Our Quality Management System ensures that we provide timely delivery of software development services to enhance client satisfaction by enabling:
• | objective valuation of the performed process, work products and services against the client’s process descriptions, standards and procedures; |
• | identification, documentation and timely resolution of noncompliance issues; |
• | feedback to the client’s project staff and managers on the results of quality assurance activities; |
• | monitoring and improvement of the software development process to ensure adopted standards and procedures are implemented and flaws are detected and resolved in a timely manner; and |
• | execution of planned and systematic problem prevention activities. |
Our proprietary Project Management Center supports our software development delivery model. Our Project Management Center is effective in reducing risks and providing control and visibility across all project lifecycle stages based on the following features:
• | multi-site, multi-project capabilities; |
• | activity-based software development lifecycle, which fully tracks the software development activities through the project documentation; |
• | project, role-based access control, which can be available to us, clients and third parties; |
• | fully configurable workflow engine with built-in notification and messaging; |
• | extensive reporting capabilities and tracking of key performance indicators; and |
• | integration with Microsoft Project and Outlook. |
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The transparency and visibility into software development project deliverables, resource management, team messaging and project-related documents and files provided by our Project Management Center promotes collaboration and strengthens our relationships with our clients. Improved traceability enables significant time savings and cost reductions for business users and IT management during change management for the software development lifecycle. The combination of our Project Management Center with our other proprietary internal applications enhances our offering by reducing errors, increasing quality and improving maintenance time. Combining applications can lead to more efficient communications and oversight for both clients and our staff.
Sales and Marketing
Our sales and marketing strategy seeks to increase our revenues from new and existing clients through our account managers, sales and business development managers, vertical specialists, technical specialists and subject-matter experts. Given our focus on complex application development and the needs of our clients, we believe our IT professionals play an integral role in engaging with clients on potential business opportunities.
Our account managers are organized vertically and maintain direct client relationships. They are responsible for handling inbound requests and referrals, identifying new business opportunities and responding to requests-for-proposals, or RFPs. Account managers typically engage technical and other specialists in responding to RFPs and pursuing opportunities. This sales model has been effective in promoting repeated business and growth from within our existing client base. In addition to effective client management, we believe that our reputation as a premium provider of software engineering solutions and information technology services drives additional business from inbound requests, referrals and RFPs. We enjoy published recognition from third-party industry observers, such as Forrester Research, Forbes Research, Everest Group, Zinnov, CIO Magazine, Information Week, and Software Magazine.
We also maintain a dedicated sales force as well as a marketing team, which coordinates corporate-level branding efforts that range from sponsorship of programming competitions to participation in and hosting of industry conferences and events.
Clients
Our clients primarily consist of Forbes Global 2000 corporations. During 2014, one customer, UBS AG, accounted for over 10% of our revenues. No customer accounted for over 10% of our revenues in 2013 or 2012.
The following table presents the percentage of our revenues by client location:
% of Revenues for Year Ended December 31, | ||||||||
Client location | 2014 | 2013 | 2012 | |||||
North America | 50.4 | % | 50.8 | % | 47.7 | % | ||
Europe | 39.0 | 36.1 | 35.8 | |||||
CIS | 7.6 | 11.7 | 15.0 | |||||
APAC | 1.8 | — | — | |||||
Reimbursable expenses and other revenues | 1.2 | 1.4 | 1.5 | |||||
Revenues | 100.0 | % | 100.0 | % | 100.0 | % | ||
Revenues by client location above differ from our segment information. Our operations consist of four reportable segments: North America, Europe, Russia and Other. This determination is based on the unique business practices and market specifics of each region and that each region engages in business activities from which it earns revenues and incurs expenses. Our reportable segments are based on managerial responsibility for a particular client. Because managerial responsibility for a particular client relationship generally correlates with the client’s geographic location, there is a high degree of similarity between client locations and the geographic boundaries of our reportable segments. In some specific cases, however, managerial responsibility for a particular client is assigned to a management team in another region, usually based on the strength of the relationship between client executives and particular members of our senior management team. In such case, the client’s activity would be reported through the reportable segment. Particularly, our newly acquired clients in the APAC region are reported as part of the Europe segment based on the managerial responsibility for those clients. The following table presents
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the percentage of our revenues by reportable segment:
% of Segment Revenues for Year Ended December 31, | ||||||||
Segment | 2014 | 2013 | 2012 | |||||
North America | 51.3 | % | 51.3 | % | 45.5 | % | ||
Europe | 41.0 | 36.8 | 38.9 | |||||
Russia | 6.9 | 10.0 | 11.7 | |||||
Other | 0.8 | 1.9 | 3.9 | |||||
Segment Revenues | 100.0 | % | 100.0 | % | 100.0 | % | ||
The following table sets forth the percentage of our revenues by client vertical for the periods presented:
% of Revenues for Year Ended December 31, | ||||||||
Vertical | 2014 | 2013 | 2012 | |||||
Banking and Financial Services | 29.5 | % | 28.2 | % | 25.8 | % | ||
ISVs and Technology | 21.6 | 24.3 | 24.6 | |||||
Travel and Consumer | 21.6 | 21.1 | 22.1 | |||||
Business Information and Media | 12.6 | 13.6 | 14.4 | |||||
Other | 13.5 | 11.4 | 11.6 | |||||
Reimbursable expenses and other revenues | 1.2 | 1.4 | 1.5 | |||||
Revenues | 100.0 | % | 100.0 | % | 100.0 | % | ||
The following table shows the distribution of our clients by revenues for the periods presented:
Year Ended December 31, | |||||
Revenues Greater Than or Equal To | 2014 | 2013 | 2012 | ||
$0.1 million | 306 | 263 | 216 | ||
$0.5 million | 181 | 147 | 114 | ||
$1 million | 116 | 95 | 81 | ||
$5 million | 24 | 22 | 16 | ||
$10 million | 12 | 12 | 7 | ||
$20 million | 6 | 4 | 4 | ||
See Note 18 in the notes to our consolidated financial statements in this Annual Report on Form 10-K for information regarding total assets, operating results and other financial information regarding our operating segments.
We typically enter into master services agreements with our clients, which provide a framework for services that is then supplemented by statements of work, which specify the particulars of each individual engagement, including the services to be performed, pricing terms and performance criteria.
Competition
The markets in which we compete are changing rapidly and we face competition from both global IT services providers as well as those based in CEE, India, China and other geographies. We believe that the principal competitive factors in our business include technical expertise and industry knowledge, end-to-end solution offerings, reputation and track record for high-quality and on-time delivery of work, effective employee recruiting, training and retention, responsiveness to clients’ business needs, scale, financial stability and price.
We face competition primarily from:
• | India-based technology outsourcing IT services providers, such as Cognizant Technology Solutions (NASDAQ:CTSH), Luxoft Holding, Inc. (NYSE:LXFT), GlobalLogic, HCL Technologies, Infosys Technologies (NASDAQ:INFY), Mindtree, Sapient (NASDAQ:SAPE), Symphony Technology Group, Tata Consultancy Services and Wipro (NASDAQ:WIT); |
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• | Local CEE technology outsourcing IT services providers; |
• | Large global consulting and outsourcing firms, such as Accenture, Atos Origin, Capgemini, CSC and IBM; |
• | China-based technology outsourcing IT services providers such as Camelot Information Services, and Pactera; and |
• | In-house IT departments of our clients and potential clients. |
We believe that our focus on complex software product development solutions, our technical employee base, and the development and continuous improvement in process methodologies, applications and tools position us well to compete effectively in the future. However, we face competition from offshore IT services providers in other outsourcing destinations with low wage costs, such as India and China. Our present and potential competitors may also have substantially greater financial, marketing or technical resources; may also be able to respond more quickly to new technologies or processes and changes in client demands; may be able to devote greater resources towards the development, promotion and sale of their services than we can; and may also make strategic acquisitions or establish cooperative relationships among themselves or with third parties that increase their ability to address the needs of our clients.
Human Capital
Our people are critical to the success of our business. Attracting and retaining employees is a key factor in our ability to grow our revenues and meet our clients’ needs. At December 31, 2014, 2013 and 2012, we employed 14,109, 11,056 and 10,043 professionals, respectively. Of these employees, approximately 86.0% were located in the CIS and CEE, 5.5% were located in Western Europe (excluding Hungary), 6.3% were located in North America and 2.1% were located in Asia at December 31, 2014. We believe that we maintain a good working relationship with our employees and we have not experienced any labor disputes. Our employees have not entered into any collective bargaining agreements.
Recruitment and Retention
We have dedicated full-time employees that oversee all aspects of our human capital management process. Through our proprietary internal tools, we effectively plan our short-term and long-term recruitment needs and deploy the necessary personnel and processes to optimize utilization and to quickly satisfy the demands of our clients. We believe our company culture and reputation enhances our ability to recruit and retain highly sought-after employees, particularly in CIS and CEE.
Historically, we have developed our base of IT professionals by hiring highly-qualified, experienced IT professionals from the CIS and CEE region and by recruiting students from leading universities there. The quality and academic prestige of the CIS and CEE educational system is renowned world-wide. We have strong relationships with the leading institutions in these geographies, such as the Belarusian State University, Belarusian State University of Informatics and Radioelectronics, the Saint Petersburg State University of Information Technologies, Mechanics and Optics, the Moscow State University, the Moscow Institute of Physics & Technology, the Moscow State University of Instrument Engineering and Computer Sciences and the National Technical University of Ukraine. The participants from these universities are frequent and consistent winners in the ACM International Collegiate Programming Contest (ICPC), the oldest, largest, and most prestigious programming contest in the world. In the 2014 ACM International Collegiate Programming Contest (“ICPC,”) seven out of twelve top ranked finishers were from CEE, and a top Belarusian university finished in the top 13.
We have established EPAM delivery centers near many of these university campuses. Our ongoing involvement with these universities includes supporting EPAM-branded research labs, developing training courses, providing teaching equipment, actively supporting curriculum development and engaging students to identify their talents and interests. Our relationships with these technical institutions provide us access to a highly-qualified talent pool of programmers, and allow us to consistently attract highly-skilled students from these institutions. We also conduct lateral hiring through a dedicated IT professional talent acquisition team whose objective is to locate and attract qualified and experienced IT professionals within the region.
To attract, retain and motivate our IT professionals, we seek to provide an environment and culture that rewards entrepreneurial initiative and performance. In addition, we offer a challenging work environment, ongoing skills development initiatives and attractive career advancement and promotion opportunities.
Training and Development
We dedicate significant resources to the training and development of our IT professionals. We believe in the importance of supporting educational initiatives and we sponsor employees’ participation in internal and external training and certifications. Furthermore, we actively pursue partner engagements with technical institutions in CEE.
We provide training, continuing education and career development programs for both entry-level and experienced IT professionals. Entry-level IT professionals undergo a rigorous training program that consists of approximately three to six
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months of classroom training, as well as numerous hours of hands-on training through actual engagements. This comprehensive program results in employees who are highly proficient and possess deep technical expertise that enables them to immediately serve our clients’ needs. For our mid-level and senior IT professionals, we offer continuing education programs aimed at helping them advance in their careers. We also provide mentoring opportunities, management and soft skills training, intensive workshops and management and technical advancement programs. We are committed to systematically identifying and nurturing the development of middle and senior management through formal leadership training, evaluation, development and promotion.
Intellectual Property
Our intellectual property rights are important to our business. We rely on a combination of intellectual property laws, trade secrets, confidentiality procedures and contractual provisions to protect our intellectual property. We require our employees and independent contractors to enter into written agreements upon the commencement of their relationships with us, which assign to us all intellectual property and work product made, developed or conceived by them in connection with their employment with us. These agreements also provide that any confidential or proprietary information disclosed or otherwise made available by us be kept confidential. We also enter into confidentiality and non-disclosure agreements with our clients and vendors.
We customarily enter into non-disclosure agreements with our clients with respect to the use of their software systems and platforms. Our clients usually own the intellectual property in the software or systems we develop for them. Furthermore, we usually grant a perpetual, worldwide, royalty-free, nonexclusive, transferable and non-revocable license to our clients to use our preexisting intellectual property, but only to the extent necessary in order to use the software or systems we developed for them.
Protecting our intellectual property rights is critical to our business. We have invested, and will continue to invest, in research and development to enhance our domain knowledge and create complex, specialized solutions for our clients.
Long-lived Assets
The table below sets forth the locations of our long-lived assets:
December 31, 2014 | December 31, 2013 | December 31, 2012 | |||||||||
Belarus | $ | 41,652 | $ | 38,697 | $ | 40,095 | |||||
Ukraine | 4,392 | 5,525 | 5,357 | ||||||||
Hungary | 2,773 | 2,644 | 3,234 | ||||||||
Russia | 2,196 | 3,414 | 2,048 | ||||||||
United States | 2,001 | 2,217 | 1,744 | ||||||||
Other | 2,120 | 818 | 657 | ||||||||
Total | $ | 55,134 | $ | 53,315 | $ | 53,135 | |||||
Acquisitions
We have acquired a number of companies in order to expand our vertical-specific domain expertise, geographic footprint, service portfolio, client base and management proficiency.
On October 31, 2014, we acquired Great Fridays Limited and its subsidiaries to expand our product and design service portfolio. Great Fridays Limited, headquartered in Manchester, UK, with offices in London, San Francisco and New York, focuses on bridging the gap between business and design. The acquisition of Great Fridays added approximately 50 creative design professionals to our headcount. We expect this acquisition to further expand our product and design services capabilities.
On June 6, 2014, we acquired substantially all of the assets and assumed certain specified liabilities of each of GGA Software Services, LLC, Institute of Theoretical Chemistry, Inc., and GGA’s Russian affiliate (collectively, “GGA”). Established in 1994, GGA develops scientific informatics applications, content databases, algorithms and models, and delivers IT support, maintenance, and quality assurance services to leading healthcare and life sciences companies. The acquisition added over 300 IT professionals and over 120 scientists to our highly-experienced employee base and created a significant growth opportunity in the life sciences and healthcare industries. We also see tremendous potential in combining our traditionally recognized strengths with GGA’s algorithm development, mathematical modeling, and sophisticated content
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database development capabilities. The capability to develop and operationalize platforms, combining tools, models and data, has broad applications across other strategic industries on which EPAM focuses, including the Banking and Financial Services, Business Information and Media, and Retail and Consumer verticals.
On April 30, 2014, we acquired all of the outstanding equity of Joint Technology Development Limited, a company organized under the laws of Hong Kong, including its wholly-owned subsidiaries Jointech Software (Shenzhen) Co., Ltd., a company organized under the laws of China, and Jointech Software Pte. Ltd., a company organized under the laws of Singapore (collectively, “Jointech”). Jointech provides strategic technology services in the investment banking, wealth and asset management industries. The acquisition of Jointech added over 200 IT professionals to our headcount and significantly extended our footprint in South-East Asia. With this acquisition, we expect to create an integrated global platform focused on serving large multinational customers within the Banking and Financial Services vertical, and extend our global value proposition in the region.
On March 5, 2014, we completed an acquisition of substantially all of the assets and assumed certain specific liabilities of U.S.-based healthcare technology consulting firm Netsoft Holdings LLC and Armenia-based Ozsoft, LLC (collectively, “Netsoft”). Netsoft works with leading health plans in the U.S. on their medical management and claims systems, and specializes in working with leaders in pioneering fields such as accountable care organizations, tele-medicine, healthcare analytics, personalized medicine, health information exchanges, and online self-service capabilities. The Netsoft acquisition added approximately 40 IT professionals to our headcount.
In December 2012, we completed the acquisition of Empathy Lab, LLC, a U.S.-based digital strategy and multi-channel experience design firm with approximately 85 IT professionals. The acquisition has enhanced our strong capabilities in global delivery of software engineering services with Empathy Lab’s proven expertise in two important growth areas - development and execution of enterprise-wide eCommerce initiatives and transformation of media consumption and distribution channels. In addition to strengthening our Travel and Consumer and Business Information and Media verticals, Empathy Lab brings significant expertise in digital marketing strategy consulting and program management.
In May 2012, we completed the acquisition of Thoughtcorp, a Canadian company with a 17-year history of successfully delivering high-value IT solutions and complex software applications to some of Canada’s most prominent companies within the telecommunications, financial and retail sectors. With the Thoughtcorp acquisition, we have strengthened our Banking and Financial Services, and Travel and Consumer verticals, and have gained significant telecommunications expertise with a highly skilled and experienced employee base of approximately 50 IT professionals. The acquisition also expands our North American geographic footprint and complements our global delivery capabilities with expertise in areas important for us, such as Agile Development, Enterprise Mobility and Business Intelligence.
Regulations
Due to the industry and geographic diversity of our operations and services, our operations are subject to a variety of rules and regulations. Several foreign and U.S. federal and state agencies regulate various aspects of our business. See “Item 1A. Risk Factors — Risks Relating to Our Business — We are subject to laws and regulations in the United States and other countries in which we operate concerning our operations, including export restrictions, U.S. economic sanctions and the Foreign Corrupt Practices Act, or FCPA, and similar anti-corruption laws. If we are not in compliance with applicable legal requirements, we may be subject to civil or criminal penalties and other remedial measures.”
Corporate Information
EPAM Systems, Inc. was incorporated in the State of Delaware on December 18, 2002. Our predecessor entity was founded in 1993. Our principal executive offices are located at 41 University Drive, Suite 202, Newtown, Pennsylvania 18940 and our telephone number is 267-759-9000. We maintain a website at http://www.epam.com. Our website and the information accessible through our website are not incorporated into this annual report.
We make certain filings with the Securities and Exchange Commission (“SEC”), including our annual report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, and all amendments and exhibits to those reports. We make such filings available free of charge through the Investor Relations section of our website, http://investors.epam.com, as soon as reasonably practicable after they are filed with the SEC. The filings are also available through the SEC at the SEC’s Public Reference Room at 100 F Street, N.E., Washington, D.C. 20549 or by calling 1-800-SEC-0330. In addition, these filings are available on the internet at http://www.sec.gov. Our press releases and recent analyst presentations are also available on our website. The information on our website does not constitute a part of this annual report.
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Item 1A. Risk Factors
Risk factors, which could cause actual results to differ from our expectations and which could negatively impact our financial condition and results of operations, are discussed below and elsewhere in this annual report. The risks and uncertainties described below are not the only ones we face. If any of the risks or uncertainties described below or any additional risks and uncertainties actually occur, our business, results of operations and financial condition could be materially and adversely affected. In particular, forward-looking statements are inherently subject to risks and uncertainties, some of which cannot be predicted or quantified. See “Special Note Regarding Forward-Looking Statements.”
Risks Relating to Our Business
We may be unable to effectively manage our rapid growth or achieve anticipated growth, which could place significant strain on our management personnel, systems and resources.
We have experienced rapid growth and significantly expanded our business over the past several years. Our revenues grew from $221.8 million in 2010 to $730.0 million in 2014 as a result of organic growth and growth through strategic acquisitions. As of December 31, 2014, we had 11,824 IT professionals, as compared to 5,344 IT professionals as of December 31, 2010. We have also grown our support function headcount, including finance, legal and other areas.
Our rapid growth has placed and will continue to place significant demands on our management and our administrative, operational and financial infrastructure. Continued expansion increases the challenges we face in:
• | recruiting, training and retaining sufficiently skilled IT professionals and management personnel; |
• | adhering to and further improving our high-quality and process execution standards and maintaining high levels of client satisfaction; |
• | managing a larger number of clients in a greater number of industries and locations; |
• | maintaining effective oversight of personnel and delivery centers; |
• | preserving our culture, values and entrepreneurial environment; |
• | coordinating effectively across geographies and business units to execute our strategic plan; and |
• | developing and improving our internal administrative infrastructure, particularly our financial, operational, communications and other internal systems. |
Moreover, we intend to continue our expansion for the foreseeable future to pursue existing and potential market opportunities. As we introduce new services or enter into new markets, we may face new market, technological, operational, compliance and administrative risks and challenges, and we may not be able to mitigate these risks and challenges to successfully grow those services or markets. As a result of these problems associated with expansion, we may not be able to achieve our anticipated growth and our business, prospects, financial condition and results of operations could be materially adversely affected.
Our failure to attract, train and retain IT professionals with the qualifications necessary to fulfill the needs of our existing and future clients or to assimilate new IT professionals successfully could materially adversely affect our ability to provide high quality services to our clients.
Our success depends largely on the contributions of our IT professionals. To maintain and renew existing engagements and obtain new business, we must attract, train and retain skilled IT professionals, including experienced management IT professionals. Competition for IT professionals in the markets in which we operate can be intense and, accordingly, we may not be able to retain or hire all of the IT professionals necessary to meet our ongoing and future business needs. If we are unable to attract and retain the highly-skilled IT professionals we need, we may have to forgo projects for lack of resources or be unable to staff projects optimally. The total attrition rates among our IT professionals who have worked for us for at least six months were 11.8%, 13.1% and 10.7% for 2014, 2013 and 2012, respectively. We may encounter higher attrition rates in the future. Any reductions in headcount for economic or business reasons, however temporary, could negatively affect our reputation as an employer and our ability to hire IT professionals to meet our business requirements. A significant increase in the attrition rate among IT professionals with specialized skills could decrease our operating efficiency and productivity and could lead to a decline in demand for our services.
Increases in wages for our IT professionals and other compensation expense could prevent us from sustaining our competitive advantage and result in dilution to our stockholders.
Wage costs for IT professionals in CIS, CEE and APAC, and certain other geographies in which we operate are lower than comparable wage costs in more developed countries. However, wage costs in the service industry in these countries may
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increase at a faster rate than in the past, which ultimately may make us less competitive unless we are able to increase the efficiency and productivity of our IT professionals as well as the prices we can charge for our services. Increases in wage costs may reduce our profitability.
Additionally, we have granted certain equity-based awards under our stock incentive plans and entered into certain other stock-based compensation arrangements in the past, as a result of which we have recorded $24.6 million, $13.2 million and $6.8 million as stock-based compensation expenses for the years ended December 31, 2014, 2013 and 2012, respectively.
Generally Accepted Accounting Principles in the United States (“GAAP”) prescribe how we account for stock-based compensation, which could adversely or negatively impact our results of operations or the price of our common stock. GAAP requires us to recognize stock-based compensation as compensation expense in the statement of operations generally based on the fair value of equity awards on the date of the grant, with compensation expense recognized over the period in which the recipient is required to provide service in exchange for the equity award. The expenses associated with stock-based compensation may reduce the attractiveness of issuing equity awards under our equity incentive plan. However, if we do not grant equity awards, or if we reduce the number of equity awards we grant, we may not be able to attract and retain key personnel. If we grant more equity awards to attract and retain key personnel, the expenses associated with such additional equity awards could materially adversely affect our results of operations. The issuance of equity-based compensation would also result in additional dilution to our stockholders.
Our success depends substantially on the continuing efforts of our senior executives and other key personnel, and our business may be severely disrupted if we lose their services.
Our future success heavily depends upon the continued services of our senior executives and other key employees. If one or more of our senior executives or key employees are unable or unwilling to continue in their present positions, it could disrupt our business operations, and we may not be able to replace them easily or at all. In addition, competition for senior executives and key personnel in our industry is intense, and we may be unable to retain our senior executives and key personnel or attract and retain new senior executives and key personnel in the future, in which case our business may be severely disrupted.
If any of our senior executives or key personnel, such as business development managers, joins a competitor or forms a competing company, we may lose clients, suppliers, know-how and key IT professionals and staff members to them. Additionally, there could be unauthorized disclosure or use of our technical knowledge, practices or procedures by such personnel. If any dispute arises between our senior executives or key personnel and us, any non-competition, non-solicitation and non-disclosure agreements we have with our senior executives or key personnel might not provide effective protection to us, especially in CIS and CEE countries where some of our senior executives and key employees reside, in light of uncertainties with legal systems in CIS and CEE countries.
Our subcontracting practices may expose us to technical uncertainties, potential liabilities and reputational harm.
In order to meet our personnel needs, increase workforce flexibility, and improve pricing competitiveness, we use subcontractors and freelancers primarily to perform short-term assignments in certain specialty areas or on other projects where it is impractical to use our employees, where we need to supplement our resources, or for other purposes as needed. Although we try to source competent and credible third parties as our subcontractors, they may not be able to deliver the level of service that our clients expect us to deliver. Furthermore, we enter into confidentiality agreements with our subcontractors, but we cannot guarantee that they will not breach the confidentiality of our clients or us and misappropriate our or our clients’ proprietary information and technology in the course of providing service. We, as the party to the contract with the client, are directly responsible for the losses our subcontractors cause our clients. Under the subcontracting agreements we enter into, our subcontractors generally promise to indemnify us for damages caused by their breach, but we may be unable to collect under these agreements. Moreover, their breaches may damage our reputation, cause us to lose existing business and adversely affect our ability to acquire new business in the future.
Adverse or uncertain economic, political and social conditions may significantly and adversely affect our business, prospects, results of operations and financial condition.
We are a global company with substantial international operations. Our revenues from clients outside North America represented 48.5%, 47.8% and 50.8% of our revenues excluding reimbursable expenses for 2014, 2013 and 2012. Deterioration of social, political, labor or economic conditions in a specific country or region, and our failure to successfully anticipate changing conditions in these markets, could challenge our ability to conduct operations in those countries or regions or increase our operating costs. In addition, the majority of our employees, along with our development and delivery centers, are located in the CIS and CEE.
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Risks inherent in conducting international operations include:
• | foreign exchange fluctuations; |
• | application and imposition of protective legislation and regulations relating to import or export; |
• | difficulties in enforcing intellectual property and/or contractual rights; |
• | complying with a wide variety of foreign laws; |
• | potentially adverse tax consequences; |
• | tariffs, quotas and other trade protection measures; |
• | competition from companies with more experience in a particular country or with international operations; |
• | potential difficulties integrating new facilities and new employees into our operations and culture; |
• | potential difficulties in collecting accounts receivable; |
• | overall foreign policy and variability of foreign economic conditions. |
The IT services industry is particularly sensitive to the economic environment and the industry tends to decline during general economic downturns. Given our significant revenues from North America and Europe, if those economies further weaken or slow, pricing for our services may be depressed and our clients may reduce or postpone their technology spending significantly, which may in turn lower the demand for our services and negatively affect our revenues and profitability.
War, terrorism, other acts of violence or natural or manmade disasters may affect the markets in which we operate, our clients, and our service delivery.
Our business may be negatively affected by instability, disruption or destruction in a geographic region in which we operate, regardless of cause, including war, terrorism, riot, civil insurrection or social unrest; and natural or manmade disasters, including famine, flood, fire, earthquake, storm or disease. Such events may cause clients to delay their decisions on spending for IT services and give rise to sudden significant changes in regional and global economic conditions and cycles. These events also pose significant risks to our people and to physical facilities and operations around the world, whether the facilities are ours or those of our clients, which could materially adversely affect our financial results. By disrupting communications and travel, giving rise to travel restrictions, and increasing the difficulty of obtaining and retaining highly-skilled and qualified IT professionals, these events could make it difficult or impossible for us to deliver services to some or all of our clients. Travel restrictions could cause us to incur additional unexpected labor costs and expenses or could restrain our ability to retain the skilled IT professionals we need for our operations. In addition, any extended disruptions of electricity, other public utilities or network services at our facilities, as well as system failures at, or security breaches in, our facilities or systems, could also adversely affect our ability to serve our clients.
Emerging markets are subject to greater risks than more developed markets, including significant legal, economic, tax and political risks.
We have significant operations in CIS and CEE countries, and beginning in 2014 in Asia, which are generally considered to be emerging markets. Investors in emerging markets should be aware that these markets are vulnerable to market downturns and economic slowdowns elsewhere in the world and are subject to greater risks than more developed markets, including complying with foreign laws and regulations and the potential imposition of trade or foreign exchange restrictions or sanctions, tax increases, fluctuations in exchange rates, inflation and unstable political and military situations, and labor issues. For example, the economies of Belarus, Russia, Ukraine, Hungary and other CIS and CEE countries where we operate have experienced periods of considerable instability and have been subject to abrupt downturns. Moreover, these markets have less established legal systems, which can be characterized by gaps in regulatory structures, selective enforcement of laws, and limited judicial and administrative guidance on legislation, among other limitations. As has happened in the past, financial problems or an increase in the perceived risks associated with investing in emerging economies could dampen foreign investment in these markets and materially adversely affect their economies. Such economic instability, and any future deterioration in the international economic situation could materially adversely affect our business, financial condition and results of operations.
Our operations may be adversely affected by ongoing developments in the Ukraine.
Escalating military activities in Ukraine and on its eastern border have combined with Ukraine’s weak economic conditions to create uncertainty in Ukraine, Russia and other markets. The actions in Ukraine have prompted condemnation from the international community and combined with the continuing political and economic uncertainties in Ukraine have had an adverse effect on the Ukrainian and Russian economies. In April 2014, the United States Office of Foreign Assets Control (“OFAC”) added certain individuals and entities to its list of Specially Designated Nationals. In July and September 2014, OFAC imposed limited, specific sanctions on certain Russian entities by listing them on the Sectoral Sanctions Identification
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List (“SSI List”); the SSI List includes entities in the energy, defense and financial sectors. The EU imposed similar sanctions in July 2014, and separate sanctions were imposed by countries including Canada, Japan and Switzerland. Resolution of Ukraine’s political and economic conditions may not occur for some time and the disputes in Ukraine could devolve into increased violence or economic distress.
We have delivery centers in the Ukraine employing approximately 2,956 IT professionals, none of which are located in Crimea. We also have delivery centers in Russia, employing approximately 1,714 IT professionals located in various cities including Moscow and St. Petersburg. To date we have not experienced any interruption in our office infrastructure, utility supply or Internet connectivity. All EPAM offices remain open and fully functional, including those we use in the Ukraine and Russia to support our clients. We continue to monitor the situation closely. Our contingency plans include relocating work or personnel to other locations and adding new locations, as appropriate. We have no way to predict the progress or outcome of the situation, as the political and civil unrest and reported military activities are fluid and beyond our control. Prolonged unrest, military activities, or broad-based sanctions, should they be implemented, could have a material adverse effect on our operations.
We generate a significant portion of our revenues from a concentrated client base, and any loss of business from these clients could materially reduce our revenues.
Our ability to maintain close relationships with our major clients is essential to the growth and profitability of our business. However, the volume of work performed for any specific client is likely to vary from year to year, especially since we generally are not our clients’ exclusive IT services provider and we do not have long-term commitments from any clients to purchase our services. The IT services we provide to our clients, and the revenues and net income from those services, may decline or vary based on the type and quantity of services we provide, wage inflation and other pricing considerations. Furthermore, our reliance on any individual client for a significant portion of our revenues may give that client a certain degree of pricing leverage against us when negotiating contracts and terms of service. The loss of any of our major clients, or a significant decrease in the volume of work they outsource to us or the price at which we sell our services to them, could materially adversely affect our revenues and thus our results of operations.
We do not have long-term commitments from our clients, and our clients may terminate contracts before completion or choose not to renew contracts.
Ability of our clients to terminate agreements makes our future revenues uncertain, as our clients are generally not obligated for any long-term commitments to us. Although a substantial majority of our revenues are generated from clients who also contributed to our revenues during the prior year, our engagements with our clients are typically for projects that are singular in nature. In addition, our clients can terminate many of our master services agreements and work orders with or without cause. Therefore, we must seek to obtain new engagements when our current engagements end. Our failure to perform or observe any contractual obligations could also result in termination or non-renewal of a contract, as could a change of control of our company.
There are a number of factors relating to our clients that are outside of our control, which might lead them to terminate a contract or project with us, including a client's:
• | financial difficulties; |
• | corporate restructuring, or mergers and acquisitions activity; |
• | change in strategic priorities, resulting in elimination of the impetus for the project or a reduced level of technology spending; |
• | change in outsourcing strategy resulting in moving more work to the client’s in-house technology departments or to our competitors; and |
• | replacement of existing software with packaged software supported by licensors. |
Termination or non-renewal of a customer contract could cause us to experience a higher than expected number of unassigned employees and an increase in our cost of revenues as a percentage of revenues, until we are able to reduce or reallocate our headcount. We may not be able to replace any client that elects to terminate or not renew its contract with us, which could materially adversely affect our revenues and results of operations.
Our revenues are highly dependent on a limited number of industries, and any decrease in demand for outsourced services in these industries could reduce our revenues and adversely affect our results of operations.
A substantial portion of our clients is concentrated in four specific industry verticals: Banking and Financial Services; ISVs and Technology; Business Information and Media; and Travel and Consumer. Our business growth largely depends on
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continued demand for our services from clients in these four industry verticals and other industries that we may target in the future, as well as on trends in these industries to outsource IT services.
A downturn in any of our targeted industries, a slowdown or reversal of the trend to outsource IT services in any of these industries or the introduction of regulations that restrict or discourage companies from outsourcing could result in a decrease in the demand for our services and materially adversely affect our business, financial condition and results of operations. For example, a worsening of economic conditions in the financial services industry, or significant consolidation in any of these industries may reduce the demand for our services and negatively affect our revenues and profitability. Other developments in the industries in which we operate may also lead to a decline in the demand for our services, and we may not be able to successfully anticipate and prepare for any such changes. Decreased demand for our services, or increased pricing pressure on us from our clients in these key industries could adversely affect our results of operations.
If our pricing structures are based on inaccurate expectations and assumptions regarding the cost and complexity of performing our work, or if we are not able to maintain favorable pricing for our services, then our contracts could be unprofitable.
We negotiate pricing terms with our clients utilizing a range of pricing structures and conditions. We face a number of risks when pricing our contracts. Our pricing is highly dependent on our internal forecasts and predictions about our projects, the marketplace and global economic conditions (including foreign exchange volatility), which may be based on limited data and could be inaccurate. Many of our projects entail the coordination of operations and personnel in multiple locations with different skill sets and competencies. Our pricing and cost estimates for the work that we perform sometimes include anticipated long-term cost savings from transformational and other initiatives that we expect to achieve and sustain over the life of the contract. There is a risk that we will underprice our projects, particularly with fixed-price contracts, fail to accurately estimate the costs of performing the work or fail to accurately assess the risks associated with potential contracts. In particular, any increased or unexpected costs, delays or failures to achieve anticipated cost savings, or unexpected risks we encounter in connection with the performance of this work, including those caused by factors outside our control, could make these contracts less profitable or unprofitable. Moreover, if we are not able to pass on to our clients increases in compensation cost (whether driven by competition for talent or ordinary-course pay increases) or charge premium prices when justified by market demand or the type of service, our profitability may suffer.
In addition, a number of our contracts contain pricing terms that condition a portion of the payment of fees by the client on our ability to meet defined performance goals, service levels and completion schedules set forth in the contracts. Our failure to meet such performance goals, service levels or completion schedules or our failure to meet client expectations in such contracts may result in less profitable or unprofitable engagements.
Our profitability will suffer if we are not able to maintain our resource utilization levels and productivity levels.
Our profitability is significantly impacted by our utilization levels of fixed-cost resources, including human resources as well as other resources such as computers and office space, and our ability to increase our productivity levels. We have expanded our operations significantly in recent years, which has resulted in a significant increase in our headcount and fixed overhead costs. Some of our IT professionals are specially trained to work for specific clients or on specific projects and some of our offshore development centers are dedicated to specific clients or specific projects. Our ability to manage our utilization levels depends significantly on our ability to hire and train high-performing IT professionals and to staff projects appropriately and on the general economy and its effect on our clients and their business decisions regarding the use of our services. If we experience a slowdown or stoppage of work for any client or on any project for which we have dedicated IT professionals or facilities, we may not be able to efficiently reallocate these IT professionals and facilities to other clients and projects to keep their utilization and productivity levels high. If we are not able to maintain optimal resource utilization levels without corresponding cost reductions or price increases, our profitability will suffer.
If we are not successful in managing increasingly large and complex projects, we may not achieve our financial goals and our results of operations could be adversely affected.
To successfully perform larger and more complex projects, we need to establish and maintain effective, close relationships with our clients, continue high levels of client satisfaction and develop a thorough understanding of our clients’ operations. In addition, we may face a number of challenges managing larger and more complex projects, including:
• | maintaining high-quality control and process execution standards; |
• | maintaining planned resource utilization rates on a consistent basis and using an efficient mix of onsite and offshore staffing; |
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• | maintaining productivity levels and implementing necessary process improvements; and |
• | controlling costs. |
Our ability to successfully manage large and complex projects depends significantly on the skills of our management personnel and IT professionals, some of whom do not have experience managing large-scale or complex projects. In addition, large and complex projects may involve multiple engagements or stages, and there is a risk that a client may choose not to retain us for additional stages or may cancel or delay additional planned engagements. Such cancellations or delays may make it difficult to plan our project resource requirements. If we fail to successfully obtain engagements for large and complex projects, we may not achieve our revenue growth and other financial goals. Even if we are successful in obtaining such engagements, a failure by us to effectively manage these large and complex projects could damage our reputation, cause us to lose business, impact our margins and adversely affect our business and results of operations.
We face risks associated with having a long selling and implementation cycle for our services that require us to make significant resource commitments prior to realizing revenues for those services.
We have a long selling cycle for our IT services, which requires significant investment of human resources and time by both our clients and us. Before committing to use our services, potential clients require us to expend substantial time and resources educating them on the value of our services and our ability to meet their requirements. Therefore, our selling cycle is subject to many risks and delays over which we have little or no control, including our clients’ decision to choose alternatives to our services (such as other IT services providers or in-house resources) and the timing of our clients’ budget cycles and approval processes. If our sales cycle unexpectedly lengthens for one or more large projects, it would negatively affect the timing of our revenues and hinder our revenue growth. For certain clients, we may begin work and incur costs prior to executing a contract. A delay in our ability to obtain a signed agreement or other persuasive evidence of an arrangement, or to complete certain contract requirements in a particular quarter, could reduce our revenues in that quarter.
Implementing our services also involves a significant commitment of resources over an extended period of time from both our clients and us. Our clients may experience delays in obtaining internal approvals or delays associated with technology, thereby further delaying the implementation process. Our current and future clients may not be willing or able to invest the time and resources necessary to implement our services, and we may fail to close sales with potential clients to whom we have devoted significant time and resources. Any significant failure to generate revenues or delays in recognizing revenues after incurring costs related to our sales or services process could materially adversely affect our business.
If we are unable to collect our receivables from, or bill our unbilled services to, our clients, our results of operations and cash flows could be materially adversely affected.
Our business depends on our ability to successfully obtain payment from our clients of the amounts they owe us for work performed. We usually bill and collect on relatively short cycles. We maintain allowances against receivables. Actual losses on client balances could differ from those that we currently anticipate and, as a result, we might need to adjust our allowances. There is no guarantee that we will accurately assess the creditworthiness of our clients. Weak macroeconomic conditions and related turmoil in the global financial system could also result in financial difficulties, including limited access to the credit markets, insolvency, or bankruptcy for our clients, and, as a result, could cause clients to delay payments to us, request modifications to their payment arrangements that could increase our receivables balance, or default on their payment obligations to us. Timely collection of client balances also depends on our ability to complete our contractual commitments and bill and collect our contracted revenues. If we are unable to meet our contractual requirements, we might experience delays in collection of and/or be unable to collect our client balances, and if this occurs, our results of operations and cash flows could be materially adversely affected. Moreover, in the event of delays in payment from our governmental and quasi-governmental clients, we may have difficulty collecting on receivables owed. In addition, if we experience an increase in the time to bill and collect for our services, our cash flows could be materially adversely affected.
We face intense competition for clients and opportunities from onshore and offshore IT services companies, and increased competition, our inability to compete successfully against competitors, pricing pressures or loss of market share could materially adversely affect our business.
The market for IT services is highly competitive, and we expect competition to persist and intensify. We believe that the principal competitive factors in our markets are reputation and track record, industry expertise, breadth and depth of service offerings, quality of the services offered, language, marketing and selling skills, scalability of infrastructure, ability to address clients’ timing requirements and price.
We face competition from offshore IT services providers in other outsourcing destinations with low wage costs such as India and China, as well as competition from large, global consulting and outsourcing firms and in-house IT departments of large corporations. Clients tend to engage multiple IT services providers instead of using an exclusive IT services provider,
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which could reduce our revenues to the extent that clients obtain services from other competing IT services providers. Clients may prefer IT services providers that have more locations or that are based in countries more cost-competitive or more stable than some CIS and CEE countries.
Current or prospective clients may elect to perform certain services themselves or may be discouraged from transferring services from onshore to offshore IT services providers to avoid negative perceptions that may be associated with using an offshore IT services provider. This shift away from offshore outsourcing would seriously harm our ability to compete effectively with competitors that provide services from within the countries in which our clients operate.
Some of our present and potential competitors may have substantially greater financial, marketing or technical resources than EPAM. Client buying patterns can change if clients become more price sensitive and accepting of low-cost suppliers with less emphasis on quality. Therefore, we cannot assure you that we will be able to retain our clients while competing against such competitors. Increased competition, our inability to compete successfully, pricing pressures or loss of market share could materially adversely affect our business.
Our ability to generate and retain business depends on our reputation in the marketplace.
Our services are marketed to clients and prospective clients based on a number of factors. Since many of our specific client engagements involve unique services and solutions, our corporate reputation is a significant factor in our clients’ evaluation of whether to engage our service, and our clients’ perception of our ability to add value through our services is critical to the profitability of our engagements. We believe the EPAM brand name and our reputation are important corporate assets that help distinguish our services from those of our competitors and also contribute to our efforts to recruit and retain talented employees.
However, our corporate reputation is potentially susceptible to damage by actions or statements made by current or former clients, competitors, vendors, adversaries in legal proceedings, government regulators, as well as members of the investment community and the media. There is a risk that negative information about our company, even if based on false rumor or misunderstanding, could adversely affect our business. In particular, damage to our reputation could be difficult and time-consuming to repair, could make potential or existing clients reluctant to select us for new engagements, resulting in a loss of business, and could adversely affect our recruitment and retention efforts. Damage to our reputation could also reduce the value and effectiveness of the EPAM brand name and could reduce investor confidence in us.
If we are unable to adapt to rapidly changing technologies, methodologies and evolving industry standards we may lose clients and our business could be materially adversely affected.
Rapidly changing technologies, methodologies and evolving industry standards are inherent in the market for our services. Our future success will depend in part upon our ability to anticipate developments in IT services, enhance our existing services and to develop and introduce new services to keep pace with such changes and developments and to meet changing client needs. The process of developing our client solutions is extremely complex and is expected to become increasingly complex and expensive in the future due to the introduction of new platforms, operating systems, technologies and methodologies. Our ability to keep pace with changes in technology, methodology and business is subject to a number of risks, including that:
• | we may find it difficult or costly to update our services, applications, tools and software and to develop new services quickly enough to meet our clients’ needs; |
• | we may find it difficult or costly to make some features of our software work effectively and securely over the Internet or with new or changed operating systems; |
• | we may find it difficult or costly to update our software and services to keep pace with business, evolving industry standards, methodologies, regulatory and other developments in the industries where our clients operate; and |
• | we may find it difficult to maintain a high level of quality in implementing new technologies and methodologies. |
We may not be successful in anticipating or responding to these developments in a timely manner, or if we do respond, the services, technologies or methodologies we develop or implement may not be successful in the marketplace. Further, services, technologies or methodologies that are developed by our competitors may render our services non-competitive or obsolete. Our failure to enhance our existing services and to develop and introduce new services to promptly address the needs of our clients could cause us to lose clients and materially adversely affect our business.
Undetected software design defects, errors or failures may result in loss of or delay in market acceptance of our services or in liabilities that could materially adversely affect our business.
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Our software development solutions involve a high degree of technological complexity, have unique specifications and could contain design defects or software errors that are difficult to detect and correct. Errors or defects may result in the loss of current clients and loss of, or delay in, revenues, loss of market share, loss of client data, a failure to attract new clients or achieve market acceptance, diversion of development resources and increased support or service costs. We cannot provide assurance that, despite testing by our clients and us, errors will not be found in new software product development solutions, which could result in litigation, other claims for damages against us, as well as reputational harm and thus could materially adversely affect our business.
Security breaches and other disruptions to network security could compromise our information and expose us to liability, which would cause our business and reputation to suffer.
In the ordinary course of business, we have access to, collect, store, process and transmit sensitive or confidential data, including intellectual property, our proprietary business information and that of our clients, and personally identifiable information of our clients and employees, in our data centers and on our networks. The secure processing, maintenance and transmission of this information is critical to our operations and business strategy. Despite our security measures, our information technology and infrastructure may be vulnerable to attacks by hackers or breached due to human error, malfeasance or other disruptions. Any such breach could compromise our networks and the information stored there could be accessed, publicly disclosed, misappropriated, lost or stolen. Any such access, disclosure or other loss of information could result in legal claims or proceedings, liability under laws that protect the privacy of personal information and regulatory penalties. Such a breach or disruption could also disrupt our operations and the services we provide to customers, damage our reputation, and cause a loss of confidence in our products and services, as well as require us to expend significant resources to protect against further breaches and to rectify problems caused by such a breach or disruption. Any of these results could adversely affect our business, revenues and competitive position.
A significant failure in our telecommunications or IT infrastructure or systems could harm our service model, which could result in a reduction of our revenue and otherwise disrupt our business.
Part of our service model is to maintain active voice and data communications, financial control, accounting, customer service and other data processing systems between our clients’ offices, our delivery centers and our client management locations (including our headquarters in Newtown, PA). Moreover, many of our key systems for corporate operations are internally-developed applications. Our business activities may be materially disrupted in the event of a partial or complete failure of any of these internet, IT or communication systems, which could be caused by, among other things, software malfunction, computer virus attacks, conversion errors due to system upgrading, damage from fire, earthquake, power loss, telecommunications failure, unauthorized entry, demands placed on internet infrastructure by growing numbers of users and time spent online or increased bandwidth requirements or other events beyond our control. Internally-developed systems may not possess the same level of control, security or support that traditional third-party systems and applications do. Loss of all or part of the infrastructure or systems for a period of time could hinder our performance or our ability to complete client projects on time which, in turn, could lead to a reduction of our revenue or otherwise materially adversely affect our business and business reputation.
We may be liable to our clients for damages caused by the disclosure of confidential information, system failures or errors.
If any person, including any of our employees, misappropriates sensitive or confidential client information, including personally identifiable information, we could be subject to significant liability from our clients or from our clients’ customers for breaching contractual confidentiality provisions or privacy laws. Some of our client agreements do not limit our potential liability for certain occurrences, including breaches of confidentiality and infringement indemnity. Furthermore, breaches of confidentiality may entitle the aggrieved party to equitable remedies, including injunctive relief. Any such breach or misappropriation resulting in unauthorized disclosure of sensitive or confidential client information, or a violation of intellectual property rights, whether through employee misconduct, breach of our computer systems, systems failure or otherwise, may subject us to liabilities, damage our reputation and cause us to lose clients.
If we cause disruptions to our clients’ businesses or provide inadequate service, our clients may have claims for substantial damages against us, which could cause us to lose clients, have a negative effect on our reputation and adversely affect our results of operations.
If our IT professionals make errors in the course of delivering services to our clients or fail to consistently meet service requirements of a client, these errors or failures could disrupt the client’s business, which could result in a reduction in our revenues or a claim for substantial damages against us. In addition, a failure or inability to meet a contractual requirement could seriously damage our reputation and affect our ability to attract new business. Any failure in a client’s system or breach of security relating to the services we provide to the client could damage our reputation or result in a claim for substantial
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damages against us, regardless of our responsibility for such failure. Furthermore, any errors by our employees in the performance of services for a client, or poor execution of such services, could result in a client terminating our engagement and seeking damages from us. The successful assertion of one or more large claims against us could materially adversely affect our business, financial condition and results of operations. Even if such assertions against us are unsuccessful, we may incur reputational harm and substantial legal fees.
We are investing substantial cash in new facilities and physical infrastructure, and our profitability could be reduced if our business does not grow proportionately.
We have made and continue to make significant contractual commitments related to capital expenditures on construction or expansion of our delivery centers, such as in Minsk, Belarus. We may encounter cost overruns or project delays in connection with new facilities. These expansions will likely increase our fixed costs and if we are unable to grow our business and revenues proportionately, our profitability may be reduced.
If we fail to integrate or manage acquired companies efficiently, or if the acquired companies are difficult to integrate, divert management resources or do not perform to our expectations, we may not be able to realize the benefits envisioned for such acquisitions, and our overall profitability and growth plans could be materially adversely affected.
We have from time to time expanded our service capabilities and gained new clients through strategic acquisitions. Our ability to successfully integrate acquired assets or an acquired entity and realize the benefits of an acquisition requires, among other things, successful integration of technologies, operations and personnel in a timely and efficient manner. Challenges we face in the acquisition and integration process include:
• | diverting significant management attention and financial resources from our other operations and disrupting our ongoing business; |
• | unforeseen or undisclosed liabilities and integration costs; |
• | incurring liabilities from the acquired businesses for infringement of third-party intellectual property rights or other claims for which we may not be successful in seeking indemnification; |
• | incurring debt, amortization expenses related to intangible assets, large and immediate write-offs, assuming unforeseen or undisclosed liabilities, or issuing common stock that would dilute our existing stockholders’ ownership; |
• | generating sufficient revenues and net income to offset acquisition costs; |
• | potential loss of, or harm to, employee or client relationships; |
• | properly structuring our acquisition consideration and any related post-acquisition earn-outs and successfully monitoring any earn-out calculations and payments; |
• | failing to realize the potential cost savings or other financial benefits and/or the strategic benefits of the acquisition; |
• | retaining key senior management and other personnel of the acquired operations; |
• | potential incompatibility of solutions, services and technology or corporate cultures; |
• | consolidating and rationalizing corporate, information technology and administrative infrastructures; |
• | integrating and documenting processes and controls; |
• | entry into unfamiliar markets; and |
• | increased complexity from potentially operating additional geographically dispersed sites, particularly if we acquire a company or business with facilities or operations outside of the countries in which we currently have operations. |
The primary value of many potential acquisition targets in the IT services industry lies in their skilled IT professionals and established client relationships. Transitioning these types of assets to our business can be particularly difficult due to different corporate cultures and values, geographic distance and other intangible factors. For example, some newly acquired employees may decide not to work with us or to leave shortly after their move to our company and some acquired clients may decide to discontinue their commercial relationships with us. These challenges could disrupt our ongoing business, distract our management and employees and increase our expenses, including causing us to incur significant one-time expenses and write-offs, and make it more difficult and complex for our management to effectively manage our operations. If we are not able to successfully integrate an acquired entity and its operations and to realize the benefits envisioned for such acquisition, our overall growth and profitability plans may be adversely affected.
Our effective tax rate could be materially adversely affected by several factors.
We conduct business globally and file income tax returns in multiple jurisdictions. Our effective tax rate could be materially adversely affected by several factors, including changes in the amount of income taxed by or allocated to the various jurisdictions in which we operate that have differing statutory tax rates; changing tax laws, regulations and interpretations of
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such tax laws in multiple jurisdictions; and the resolution of issues arising from tax audits or examinations and any related interest or penalties.
We report our results of operations based on our determination of the amount of taxes owed in the various jurisdictions in which we operate. We have transfer pricing arrangements among our subsidiaries in relation to various aspects of our business, including operations, marketing, sales and delivery functions. U.S. transfer pricing regulations, as well as regulations applicable in other countries in which we operate, require that any international transaction involving associated enterprises be on arm’s-length terms. We consider the transactions among our subsidiaries to be on arm’s-length terms. The determination of our provision for income taxes and other tax liabilities requires estimation, judgment and calculations where the ultimate tax determination may not be certain. Our determination of tax liability is always subject to review or examination by authorities in various jurisdictions.
If a tax authority in any jurisdiction reviews any of our tax returns and proposes an adjustment, including as a result of a determination that the transfer prices and terms we have applied are not appropriate, such an adjustment could have a negative impact on our business.
Our earnings could be adversely affected if we change our intent not to repatriate earnings in the CIS and CEE or such earnings become subject to U.S. tax on a current basis.
We do not accrue incremental U.S. taxes on all CIS and CEE earnings as these earnings (as well as other foreign earnings for all periods) are considered to be indefinitely reinvested outside of the United States. While we have no plans to do so, events may occur in the future that could effectively force us to change our intent not to repatriate our foreign earnings. If we change our intent and repatriate such earnings, we will have to accrue the applicable amount of taxes associated with such earnings and pay taxes at a substantially higher rate than our effective income tax rate in 2014. These increased taxes could materially adversely affect our financial condition and results of operations.
Our operating results may be negatively impacted by the loss of certain tax benefits provided by the governments of Belarus, Hungary and Russia to companies in our industry.
Our subsidiary in Belarus is a member of the Belarus Hi-Tech Park, in which member technology companies are 100% exempt from Belarusian income tax (which as of the date of this annual report was 18%) and from the value added tax, for a period of 15 consecutive years effective July 1, 2006 and levied at a reduced rate on a variety of taxes. In addition, our subsidiary in Hungary benefited from a tax credit of 10% of qualified salaries, taken over a four-year period, for up to 70% of the total tax due for that period. We have been able to take the full 70% credit for 2007 to 2012. The Hungarian tax authorities repealed the tax credit beginning with 2012. Credits earned in years prior to 2012, however, will be allowed through 2014. We have fully utilized the 70% limit in 2014. Our subsidiary in Russia benefits from a substantially reduced rate on social contributions and an exemption on value added tax in certain circumstances, which is a benefit to qualified IT companies in Russia. If the tax holiday relating to our Belarusian subsidiary, the tax incentives relating to our Hungarian subsidiary or the lower tax rates and social contributions relating to our Russian subsidiary are changed, terminated, not extended or comparable new tax incentives are not introduced, we expect that our effective income tax rate and/or our operating expenses would increase significantly, which could materially adversely affect our financial condition and results of operations. See “Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations -Provision for Income Taxes.”
Changes in, or interpretations of, accounting principles could have a significant impact on our financial position and results of operations
U.S. GAAP, under which we prepare our consolidated financial statements, is subject to interpretation by the Securities and Exchange Commission (“SEC”) and various bodies formed to interpret and create appropriate accounting principles. A change in these principles can have a significant effect on our reported results and may even retroactively affect previously reported transactions.
For example, the U.S.-based Financial Accounting Standards Board (“FASB”) is currently working together with the International Accounting Standards Board (“IASB”) on several projects to further align accounting principles and facilitate more comparable financial reporting between companies who are required to follow GAAP under SEC regulations and those who are required to follow International Financial Reporting Standards outside of the U.S. These efforts by the FASB and IASB may result in different accounting principles under GAAP that may result in materially different financial results for us in areas including, but not limited to, principles for recognizing revenue and lease accounting.
There may be adverse tax and employment law consequences if the independent contractor status of our IT professionals or the exempt status of our employees is successfully challenged.
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Some of our IT professionals are retained as independent contractors. Although we believe that we have properly classified these individuals as independent contractors, there is nevertheless a risk that the IRS or another federal, state, provincial or foreign authority will take a different view. Furthermore, the tests governing the determination of whether an individual is considered to be an independent contractor or an employee are typically fact sensitive and vary from jurisdiction to jurisdiction. Laws and regulations that govern the status and misclassification of independent contractors are subject to change or interpretation by various authorities. If a federal, state, provincial or foreign authority or court enacts legislation or adopts regulations that change the manner in which employees and independent contractors are classified or makes any adverse determination with respect to some or all of our independent contractors, we could incur significant costs under such laws and regulations, including for prior periods, in respect of tax withholding, social security taxes or payments, workers’ compensation and unemployment contributions, and recordkeeping, or we may be required to modify our business model, any of which could materially adversely affect our business, financial condition and results of operations. There is also a risk that we may be subject to significant monetary liabilities arising from fines or judgments as a result of any such actual or alleged non-compliance with federal, state, provincial or foreign tax laws. Further, if it were determined that any of our independent contractors should be treated as employees, we could possibly incur additional liabilities under our applicable employee benefit plans.
In addition, we have classified nearly all of our U.S. employees as “exempt” under the Federal Labor Standards Act, or the FLSA. If it were determined that any of our U.S. employees should be classified as “non-exempt” under the FLSA, we may incur costs and liabilities for back wages, unpaid overtime, fines or penalties and/or be subject to employee litigation.
Our insurance coverage may be inadequate to protect us against losses.
Although we maintain some insurance coverage, including professional liability insurance, property insurance coverage for certain of our facilities and equipment and business interruption insurance coverage for certain of our operations, we do not insure for all risks in our operations. If any claims for injury are brought against us, or if we experience any business disruption, litigation or natural disaster, we might incur substantial costs and diversion of resources.
Most of the agreements we have entered into with our clients require us to purchase and maintain specified insurance coverage during the terms of the agreements, including commercial general insurance or public liability insurance, umbrella insurance, product liability insurance, and workers’ compensation insurance. Some of these types of insurance are not available on reasonable terms or at all in CIS and CEE countries. Although to date no client has brought any claims against us for such failure, our clients have the right to terminate these agreements as a result of such failure.
The banking and financial systems in the CIS remain less developed than those in some more developed markets, and a banking crisis could place liquidity constraints on our business and materially adversely affect our business and financial condition.
Banking and other financial systems in the CIS are less developed and regulated than in some more developed markets, and legislation relating to banks and bank accounts is subject to varying interpretations and inconsistent application. Banks in the CIS generally do not meet the banking standards of more developed markets, and the transparency of the banking sector lags behind international standards. Furthermore, in Russia, Belarus and other CIS countries, bank deposits made by corporate entities generally are not insured. As a result, the banking sector remains subject to periodic instability. Another banking crisis, or the bankruptcy or insolvency of banks through which we receive or with which we hold funds, particularly in Belarus, may result in the loss of our deposits or adversely affect our ability to complete banking transactions in the CIS, which could materially adversely affect our business and financial condition.
Fluctuations in currency exchange rates could materially adversely affect our financial condition and results of operations.
We have significant international operations, and we earn our revenues and incur our expenses in multiple currencies. Doing business in different foreign currencies exposes us to foreign currency risks, including risks related to revenues and receivables, compensation of our personnel, purchases and capital expenditures. The majority of our revenues are in U.S. dollars, British pounds, Russian rubles and euros, and the majority of our expenses, particularly salaries of IT professionals, are denominated in U.S. dollars but payable in Belarusian rubles or in other local currencies at the exchange rate in effect at the time. To the extent that we increase our business and revenues, which are denominated in Belarusian rubles, Ukrainian hryvnia, Hungarian forints or other local currencies, we will also increase our receivables denominated in those currencies and therefore increase our exposure to fluctuations in their exchange rates against the U.S. dollar, our reporting currency. Also, economic instability in Russia and other countries can affect the local currency’s exchange rates, such as the recent plunge in the value of the Russian ruble. Any capital expenditures, such as for computer equipment, which are payable in the local currency of the countries in which we operate but are imported to such countries, and any deposits we hold in local currencies, can be materially affected by depreciation of the local currency against the U.S. dollar and the effect of such depreciation on the local
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economy. Due to the increasing size of our international operations, fluctuations in foreign currency exchange rates could materially impact our results. See “Item 7A. Quantitative and Qualitative Disclosures About Market Risk.”
Our business could be negatively affected if we incur legal liability, including with respect to our indemnification obligations, in connection with providing our solutions and services.
If we fail to meet our contractual obligations or otherwise breach obligations to our clients, we could be subject to legal liability. We may enter into non-standard agreements because we perceive an important economic opportunity or because our personnel did not adequately adhere to our guidelines. In addition, the contracting practices of our competitors may cause contract terms and conditions that are unfavorable to us to become standard in the marketplace. If we cannot or do not perform our obligations, we could face legal liability and our contracts might not always protect us adequately through limitations on the scope and/or amount of our potential liability. As a result, we might face significant legal liability and payment obligations, and our financial condition and results of operations could be materially adversely affected.
We may not be able to prevent unauthorized use of our intellectual property, and our intellectual property rights may not be adequate to protect our business and competitive position.
We rely on a combination of copyright, trademark, unfair competition and trade secret laws, as well as intellectual property assignment and confidentiality agreements and other methods to protect our intellectual property rights. Protection of intellectual property rights and confidentiality in CIS and CEE countries, and other countries in which we operate, may not be as effective as that in the United States or other countries with more mature legal systems.
We require our employees and independent contractors to enter into written agreements with us upon the commencement of their relationship with us, which assign to EPAM all intellectual property and work product made, developed or conceived by them in connection with their employment or engagement with us. These agreements also provide that any confidential or proprietary information disclosed or otherwise made available by us be kept confidential. We also enter into confidentiality and non-disclosure agreements with our clients and vendors. These agreements may not provide meaningful protection for trade secrets, know-how or other proprietary information in the event of any unauthorized use, misappropriation or disclosure of such trade secrets, know-how or other proprietary information. The steps we have taken may be inadequate to prevent the misappropriation of our and our clients’ proprietary technology. Reverse engineering, unauthorized copying or other misappropriation of our and our clients’ proprietary technologies, tools and applications could enable third parties to benefit from our or our clients’ technologies, tools and applications without paying us for doing so, and our clients may hold us liable for that act and seek damages and compensation from us, which could harm our business and competitive position.
We rely on our trademarks, trade names, service marks and brand names to distinguish our services and solutions from the services of our competitors, and have registered or applied to register many of these trademarks. We cannot assure you that our trademark applications will be approved. Third parties may oppose our trademark applications, or otherwise challenge our use of our trademarks. In the event that our trademarks are successfully challenged, we could be forced to rebrand our services and solutions, which could result in loss of brand recognition, and could require us to devote resources to advertising and marketing new brands. Further, we cannot assure you that competitors will not infringe our trademarks, or that we will have adequate resources to enforce our trademarks.
We may need to enforce our intellectual property rights through litigation. Litigation relating to our intellectual property may not prove successful and might result in substantial costs and diversion of resources and management attention.
In addition, we rely on certain third-party software to conduct our business. If we lose the licenses which permit us to use such software, they may be difficult to replace and it may be costly to do so.
We may face intellectual property infringement claims that could be time-consuming and costly to defend. If we fail to defend ourselves against such claims, we may lose significant intellectual property rights and may be unable to continue providing our existing services.
Our success largely depends on our ability to use and develop our technology, tools, code, methodologies and services without infringing the intellectual property rights of third parties, including patents, copyrights, trade secrets and trademarks. We may be subject to litigation involving claims of patent infringement or violation of other intellectual property rights of third parties.
We typically indemnify clients who purchase our services and solutions against potential infringement of intellectual property rights, which subjects us to the risk of indemnification claims. These claims may require us to initiate or defend protracted and costly litigation on behalf of our clients, regardless of the merits of these claims and are often not subject to liability limits or exclusion of consequential, indirect or punitive damages. If any of these claims succeed, we may be forced to
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pay damages on behalf of our clients, redesign or cease offering our allegedly infringing services or solutions, or obtain licenses for the intellectual property such services or solutions allegedly infringe. If we cannot obtain all necessary licenses on commercially reasonable terms, our clients may be forced to stop using our services or solutions.
The holders of patents and other intellectual property rights potentially relevant to our service offerings may make it difficult for us to acquire a license on commercially acceptable terms. In addition, we may be unaware of intellectual property registrations or applications relating to our services that may give rise to potential infringement claims against us. There may also be technologies licensed to and relied on by us that are subject to infringement or other corresponding allegations or claims by third parties, which may damage our ability to rely on such technologies.
Further, our current and former employees and/or subcontractors could challenge our exclusive rights in the software they have developed in the course of their employment. In Russia and certain other countries in which we operate, an employer is deemed to own the copyright in works created by its employees during the course, and within the scope, of their employment, but the employer may be required to satisfy additional legal requirements in order to make further use and dispose of such works. While we believe that we have complied with all such requirements, and have fulfilled all requirements necessary to acquire all rights in software developed by our independent contractors and/or subcontractors, these requirements are often ambiguously defined and enforced. As a result, we cannot assure that we would be successful in defending against any claim by our current or former employees, independent contractors and/or subcontractors challenging our exclusive rights over the use and transfer of works those employees, independent contractors and/or subcontractors created or requesting additional compensation for such works.
Parties making infringement claims may be able to obtain an injunction to prevent us from delivering our services or using technology involving the allegedly infringing intellectual property. Intellectual property litigation is expensive, time-consuming and could divert management’s attention from our business. A successful infringement claim against us, whether with or without merit, could, among others things, require us to pay substantial damages, develop non-infringing technology, or rebrand our name or enter into royalty or license agreements that may not be available on acceptable terms, if at all, and would require us to cease making, licensing or using products that have infringed a third party’s intellectual property rights. Protracted litigation could also result in existing or potential clients deferring or limiting their purchase or use of our software product development services or solutions until resolution of such litigation, or could require us to indemnify our clients against infringement claims in certain instances. Any of these actions, regardless of the outcome of litigation or merits of the claim, could damage our reputation and materially adversely affect our business, financial condition and results of operations.
We are subject to laws and regulations in the United States and other countries in which we operate, including export restrictions, U.S. economic sanctions and the Foreign Corrupt Practices Act, or FCPA, and similar anti-corruption laws. If we are not in compliance with applicable legal requirements, we may be subject to civil or criminal penalties and other remedial measures.
As a company with international operations, we are subject to many laws and regulations restricting our operations, including activities involving restricted countries, organizations, entities and persons that have been identified as unlawful actors or that are subject to U.S. sanctions imposed by the Office of Foreign Assets Control, or OFAC, or other international sanctions that prohibit us from engaging in trade or financial transactions with certain countries, businesses, organizations and individuals. We are subject to the FCPA, which prohibits U.S. companies and their intermediaries from bribing foreign officials for the purpose of obtaining or keeping business or otherwise obtaining favorable treatment, and other laws concerning our international operations. The FCPA’s foreign counterparts contain similar prohibitions, although varying in both scope and jurisdiction and not limited to transactions with government officials. We operate in many parts of the world that have experienced governmental corruption to some degree, and, in certain circumstances, strict compliance with anti-bribery laws may conflict with local customs and practices.
We have a compliance program with controls and procedures designed to ensure our compliance with the FCPA, OFAC sanctions, and similar sanctions, laws and regulations. The continuing implementation and ongoing development and monitoring of such program may be time consuming and expensive, and could result in the discovery of issues or violations with respect to the foregoing by us or our employees, independent contractors, subcontractors or agents of which we were previously unaware.
Any violations of these or other laws, regulations and procedures by our employees, independent contractors, subcontractors and agents could expose us to administrative, civil or criminal penalties, fines or business restrictions and would adversely affect our reputation and the market for shares of our common stock and may require certain of our investors to disclose their investment in our company under certain state laws.
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Anti-outsourcing legislation and restrictions on immigration, if adopted, may affect our ability to compete for and provide services to clients in the United States or other countries, which could hamper our growth and cause our revenues to decline.
The vast majority of our employees are nationals of CIS and CEE countries. Some of our projects require a portion of the work to be undertaken at our clients’ facilities, which are sometimes located outside the CIS and CEE. The ability of our employees to work in the United States, Europe, the CIS and CEE, and other countries outside the CIS and CEE depends on their ability to obtain the necessary visas and work permits. Historically, the process for obtaining visas for nationals of CIS and CEE countries to certain countries, including the United States and Europe, has been lengthy and cumbersome. Immigration laws in the United States and in other countries are subject to legislative change, as well as to variations in standards of application and enforcement due to political forces and economic conditions.
In addition, the issue of companies outsourcing services to organizations operating in other countries is a topic of political discussion in many countries, including the United States, which is our largest source of revenues. Many organizations and public figures in the United States and Europe have publicly expressed concern about a perceived association between offshore outsourcing IT services providers and the loss of jobs in their home countries, and there are legislative measures under consideration in the U.S. Congress and in various state legislatures to address this concern. It is possible that pending legislation in the United States may impose restrictions on our ability to deploy employees holding U.S. work visas to client locations, which could adversely impact our ability to do business in the jurisdictions in which we have clients. It is generally difficult to predict the political and economic events that could affect immigration laws, or the restrictive impact they could have on obtaining or maintaining business visas for our employees. However, if enacted, such measures may broaden restrictions on outsourcing by federal and state government agencies and on government contracts with firms that outsource services directly or indirectly, impact private industry with measures such as tax disincentives or intellectual property transfer restrictions, and/or restrict the use of certain work visas.
Our reliance on visas for a number of employees makes us vulnerable to such changes and variations as it affects our ability to staff projects with employees who are not citizens of the country where the work is to be performed. We may not be able to obtain a sufficient number of visas for our employees or we may encounter delays or additional costs in obtaining or maintaining such visas, in which case we may not be able to provide services to our clients on a timely and cost-effective basis or manage our sales and delivery centers as efficiently as we otherwise could, any of which could hamper our growth and cause our revenues to decline.
Similarly, legislation enacted in certain European jurisdictions and any future legislation in European jurisdictions or any other country in which we have clients restricting the performance of services from an offshore location could also materially adversely affect our business, financial condition and results of operations. For example, legislation enacted in the United Kingdom, based on the 1977 EC Acquired Rights Directive, has been adopted in some form by many European Union countries, and provides that if a company outsources all or part of its business to an IT services provider or changes its current IT services provider, the affected employees of the company or of the previous IT services provider are entitled to become employees of the new IT services provider, generally on the same terms and conditions as their original employment. In addition, dismissals of employees who were employed by the company or the previous IT services provider immediately prior to that transfer are automatically considered unfair dismissals that entitle such employees to compensation. As a result, in order to avoid unfair dismissal claims, we may have to offer, and become liable for, voluntary redundancy payments to the employees of our clients who outsource business to us in the United Kingdom and other European Union countries who have adopted similar laws. This legislation could materially affect our ability to obtain new business from companies in the United Kingdom and European Union and to provide outsourced services to companies in the United Kingdom and European Union in a cost-effective manner.
Our CIS subsidiaries can be forced into liquidation on the basis of formal noncompliance with certain legal requirements.
We operate in CIS countries primarily through locally organized subsidiaries. Certain provisions of Russian law and the laws of other CIS countries may allow a court to order liquidation of a locally organized legal entity on the basis of its formal noncompliance with certain requirements during formation, reorganization or during its operations. If the company fails to comply with certain requirements including those relating to minimum net assets, governmental or local authorities can seek the involuntary liquidation of such company in court, and the company’s creditors will have the right to accelerate their claims or demand early performance of the company’s obligations as well as demand compensation of any damages. If involuntary liquidation of any of our subsidiaries were to occur, such liquidation could materially adversely affect our financial condition and results of operations.
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We may need additional capital, and a failure by us to raise additional capital on terms favorable to us, or at all, could limit our ability to grow our business and develop or enhance our service offerings to respond to market demand or competitive challenges.
We believe that our current cash, cash flow from operations and revolving line of credit are sufficient to meet our anticipated cash needs for at least the next 12 months. We may, however, require additional cash resources due to changed business conditions or other future developments, including any investments or acquisitions we may decide to pursue. If these resources are insufficient to satisfy our cash requirements, we may seek to sell additional equity or debt securities or obtain another credit facility. The sale of additional equity securities could result in dilution to our stockholders. The incurrence of indebtedness would result in increased debt service obligations and could require us to agree to operating and financing covenants that would restrict our operations. Our ability to obtain additional capital on acceptable terms is subject to a variety of uncertainties, including:
• | investors’ perception of, and demand for, securities of IT services companies; |
• | conditions of the United States and other capital markets in which we may seek to raise funds; |
• | our future results of operations and financial condition; |
• | government regulation of foreign investment in the CIS and CEE and other countries in which we operate or in which we plan to expand; and |
• | economic, political and other conditions both globally and in emerging markets. |
Our stock price is volatile.
Our common stock has at times experienced substantial price volatility as a result of variations between our actual and anticipated financial results, announcements by our competitors and us, projections or speculation about our business or that of our competitors by the media or investment analysts or uncertainty about current global economic conditions. The stock market, as a whole, also has experienced extreme price and volume fluctuations that have affected the market price of many technology companies in ways that may have been unrelated to these companies’ operating performance. Furthermore, we believe our stock price should reflect future growth and profitability expectations and, if we fail to meet these expectations, our stock price may significantly decline.
Compliance with changing regulation of corporate governance and public disclosure may result in additional expense and affect our operations.
Changing laws, regulations and standards relating to corporate governance and public disclosure, including the Dodd-Frank Wall Street Reform and Consumer Protection Act, SEC regulations and New York Stock Exchange, or NYSE, rules, are creating uncertainty for companies such as ours. These new or changed laws, regulations and standards are subject to varying interpretations in many cases due to their lack of specificity, and as a result, their application in practice may evolve over time as new guidance is provided by regulatory and governing bodies, which could result in continuing uncertainty regarding compliance matters and higher costs necessitated by ongoing revisions to disclosure and corporate governance practices. As a result, our efforts to comply with evolving laws, regulations and standards have resulted in, and are likely to continue to result in, increased general and administrative expenses and a diversion of management time and attention from revenue-generating activities to compliance activities. If our efforts to comply with new or changed laws, regulations and standards differ from the activities intended by regulatory or governing bodies due to ambiguities related to practice, our reputation may be harmed.
Item 1B. Unresolved Staff Comments
None.
Item 2. Properties
We are incorporated in Delaware with headquarters in Newtown, PA, with multiple delivery centers located in Belarus, Ukraine, Russia, Hungary, Kazakhstan, Bulgaria, China, Armenia and Poland, and client management locations in the United States, Canada, the United Kingdom, Germany, Sweden, Switzerland, Netherlands, Russia, Kazakhstan, Singapore, Hong Kong and Australia.
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The table below sets forth our principal properties:
Location | Square Meters Leased | Square Meters Owned | Total Square Meters | ||||||
Delivery Centers and Client Management Locations: | |||||||||
Belarus | 31,863 | 7,655 | 39,518 | ||||||
Ukraine | 29,366 | — | 29,366 | ||||||
Russia | 17,775 | — | 17,775 | ||||||
Hungary | 12,087 | — | 12,087 | ||||||
United States | 4,204 | — | 4,204 | ||||||
China | 2,909 | — | 2,909 | ||||||
Kazakhstan | 2,894 | — | 2,894 | ||||||
Poland | 2,515 | — | 2,515 | ||||||
Bulgaria | 1,850 | — | 1,850 | ||||||
Canada | 810 | — | 810 | ||||||
United Kingdom | 617 | — | 617 | ||||||
Armenia | 302 | — | 302 | ||||||
Sweden | 220 | — | 220 | ||||||
Switzerland | 112 | — | 112 | ||||||
Total | 107,524 | 7,655 | 115,179 | ||||||
Executive Office: | |||||||||
Newtown, PA, United States | 1,050 | — | 1,050 | ||||||
Our facilities are used interchangeably among all of our segments. We believe that our existing facilities are adequate to meet our current requirements, and that suitable additional or substitute space will be available, if necessary.
Item 3. Legal Proceedings
From time to time, we are involved in litigation and claims arising out of our operations in the normal course of business. We are not currently a party to any material legal proceeding. In addition, we are not aware of any material legal or governmental proceedings against us, or contemplated to be brought against us.
Item 4. Mine Safety Disclosures
None.
PART II
Item 5. Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities
Market Information
Our common stock is traded on the New York Stock Exchange, or the NYSE, under the symbol “EPAM.”
Our shares have been publicly traded since February 8, 2012. The following table shows the per share range of high and low sales prices for shares of our common stock, as listed for quotation on the NYSE for the quarterly periods indicated.
2014 | ||||||||
Quarter Ended | High | Low | ||||||
December 31 | $ | 52.89 | $ | 40.42 | ||||
September 30 | $ | 44.36 | $ | 36.81 | ||||
June 30 | $ | 45.99 | $ | 29.44 | ||||
March 31 | $ | 46.70 | $ | 31.34 | ||||
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2013 | ||||||||
Quarter Ended | High | Low | ||||||
December 31 | $ | 39.76 | $ | 32.36 | ||||
September 30 | $ | 35.34 | $ | 25.10 | ||||
June 30 | $ | 27.70 | $ | 20.50 | ||||
March 31 | $ | 23.80 | $ | 18.44 | ||||
As of February 24, 2015, we had approximately 55 stockholders of record of our common stock. The number of record holders does not include holders of shares in “street name” or persons, partnerships, associations, corporations or other entities identified in security position listings maintained by depositories.
Dividend Policy
We have not declared or paid any cash dividends on our common stock and currently do not anticipate paying any cash dividends in the foreseeable future. Instead, we intend to retain all available funds and any future earnings for use in the operation and expansion of our business. Any future determination relating to dividend policy will be made at the discretion of our board of directors and will depend on our future earnings, capital requirements, financial condition, future prospects, applicable Delaware law, which provides that dividends are only payable out of surplus or current net profits, and other factors that our board of directors deems relevant. In addition, our credit facility restricts our ability to pay dividends.
Performance Graph
The following graph compares the cumulative total stockholder return on our common stock with the cumulative total return on the S&P 500 Index and a Peer Group Index (capitalization weighted) for the period beginning February 8, 2012, which is the date of our initial public offering, and ending on the last day of our last completed fiscal year. The stock performance shown on the graph below is not indicative of future price performance. The following performance graph and related information shall not be deemed “soliciting material” or to be “filed” with the SEC, nor shall information be incorporated by reference into any future filing under the Securities Act of 1933 or Securities Exchange Act of 1934, each as amended, except to the extent that we specifically incorporate it by reference into such filing.
COMPARISON OF CUMULATIVE TOTAL RETURN (1)(2)
Among EPAM, the S&P 500 Index and a Peer Group Index(3) (Capitalization Weighted)
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Company / Index | ||||||||||||
Base Period | EPAM Systems, Inc. | S&P 500 Index | Peer Group Index | |||||||||
12/31/2014 | $ | 341.07 | $ | 152.52 | $ | 127.74 | ||||||
9/30/2014 | $ | 312.79 | $ | 146.10 | $ | 120.55 | ||||||
6/30/2014 | $ | 312.50 | $ | 145.21 | $ | 118.41 | ||||||
3/31/2014 | $ | 235.00 | $ | 138.70 | $ | 124.76 | ||||||
12/31/2013 | $ | 249.57 | $ | 136.92 | $ | 124.18 | ||||||
9/30/2013 | $ | 246.43 | $ | 124.56 | $ | 103.03 | ||||||
6/30/2013 | $ | 194.14 | $ | 118.99 | $ | 80.39 | ||||||
3/31/2013 | $ | 165.93 | $ | 116.24 | $ | 99.89 | ||||||
12/31/2012 | $ | 129.29 | $ | 105.65 | $ | 85.86 | ||||||
9/30/2012 | $ | 135.29 | $ | 106.72 | $ | 89.48 | ||||||
6/30/2012 | $ | 121.36 | $ | 100.90 | $ | 83.91 | ||||||
3/31/2012 | $ | 146.57 | $ | 104.33 | $ | 102.94 | ||||||
2/8/2012 | $ | 100 | $ | 100 | $ | 100 | ||||||
(1) | Graph assumes $100 invested on February 8, 2012, in our common stock, the S&P 500 Index, and the Peer Group Index (capitalization weighted). |
(2) | Cumulative total return assumes reinvestment of dividends. |
(3) | We have constructed a Peer Group Index of other information technology consulting firms consisting of Virtusa Corporation (NASDAQ:VRTU), Cognizant Technology Solutions Corp. (NASDAQ:CTSH), Infosys Ltd ADR (NYSE:INFY), Sapient Corporation (NASDAQ:SAPE), Syntel, Inc. (NASDAQ:SYNT) and Wipro Ltd. (ADR) (NYSE:WIT). |
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Unregistered Sales of Equity Securities
The Company reported unregistered sales of equity securities in connection with its acquisitions of Netsoft, GGA and Jointech at the time of acquisition.
In addition, in connection with the Company’s acquisition of all of the outstanding equity of Great Fridays Limited, we issued 90,864 shares of the Company’s common stock as partial purchase price under the stock purchase agreement. Certain sellers of Great Fridays Ltd. may also potentially receive up to an additional 10,092 shares of the Company’s common stock based on achievement of certain performance metrics measured over the six-month period commencing November 1, 2014.
All of the shares of common stock issued or issuable in connection with these transactions are restricted securities (as defined in Rule 144 of the Securities Act of 1933, as amended (the “Securities Act”)). No underwriter was involved in these transactions and no underwriting commissions were paid. The transactions were exempt from the registration requirements pursuant to Section 4(a)(2) of the Securities Act, since such transactions did not involve any public offering.
Purchases of Equity Securities by the Issuer and Affiliated Purchasers
There were no purchases of equity securities by the issuer and affiliated purchasers during the quarterly period ended December 31, 2014.
Item 6. Selected Financial Data
The following table represents the selected financial data for each of the last five fiscal years. Our historical results are not necessarily indicative of the results to be expected for any future period. The following selected financial data should be read in conjunction with “Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations” and our audited consolidated financial statements and related notes included elsewhere in this annual report.
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Year Ended December 31, | |||||||||||||||||||
2014 | 2013 | 2012 | 2011 | 2010 | |||||||||||||||
(in thousands, except per share data) | |||||||||||||||||||
Consolidated Income Statement Data: | |||||||||||||||||||
Revenues | $ | 730,027 | $ | 555,117 | $ | 433,799 | $ | 334,528 | $ | 221,824 | |||||||||
Operating expenses: | |||||||||||||||||||
Cost of revenues (exclusive of depreciation and amortization) | 456,530 | 347,650 | 270,361 | 205,336 | 132,528 | ||||||||||||||
Selling, general and administrative expenses | 163,666 | 116,497 | 85,868 | 64,930 | 47,635 | ||||||||||||||
Depreciation and amortization expense | 17,483 | 15,120 | 10,882 | 7,538 | 6,242 | ||||||||||||||
Goodwill impairment loss | 2,241 | — | — | 1,697 | — | ||||||||||||||
Other operating expenses/(income), net | 3,924 | (643 | ) | 682 | 19 | 2,629 | |||||||||||||
Income from operations | 86,183 | 76,493 | 66,006 | 55,008 | 32,790 | ||||||||||||||
Interest and other income, net | 4,769 | 3,077 | 1,941 | 1,422 | 486 | ||||||||||||||
Change in fair value of contingent consideration | (1,924 | ) | — | — | — | — | |||||||||||||
Foreign exchange loss | (2,075 | ) | (2,800 | ) | (2,084 | ) | (3,638 | ) | (2,181 | ) | |||||||||
Income before provision for income taxes | 86,953 | 76,770 | 65,863 | 52,792 | 31,095 | ||||||||||||||
Provision for income taxes | 17,312 | 14,776 | 11,379 | 8,439 | 2,787 | ||||||||||||||
Net income | $ | 69,641 | $ | 61,994 | $ | 54,484 | $ | 44,353 | $ | 28,308 | |||||||||
Net income per share of common stock(1): | |||||||||||||||||||
Basic (common) | $ | 1.48 | $ | 1.35 | $ | 1.27 | $ | 0.69 | $ | 0.84 | |||||||||
Basic (puttable common) | $ | — | $ | — | $ | — | $ | 1.42 | $ | 0.84 | |||||||||
Diluted (common) | $ | 1.40 | $ | 1.28 | $ | 1.17 | $ | 0.63 | $ | 0.79 | |||||||||
Diluted (puttable common) | $ | — | $ | — | $ | — | $ | 0.77 | $ | 0.79 | |||||||||
Shares used in calculation of net income per share of common stock: | |||||||||||||||||||
Basic (common) | 47,189 | 45,754 | 40,190 | 17,094 | 17,056 | ||||||||||||||
Basic (puttable common) | — | — | — | 18 | 141 | ||||||||||||||
Diluted (common) | 49,734 | 48,358 | 43,821 | 20,473 | 19,314 | ||||||||||||||
Diluted (puttable common) | — | — | — | 18 | 141 | ||||||||||||||
(1) | In connection with the completion of our initial public offering, we effected an 8-for-1 common stock split as of January 19, 2012. All historical common stock and per share information has been changed to reflect the common stock split. |
As of December 31, | ||||||||||||||||||||
2014 | 2013 | 2012 | 2011 | 2010 | ||||||||||||||||
(in thousands) | ||||||||||||||||||||
Consolidated Balance Sheet Data: | ||||||||||||||||||||
Cash and cash equivalents | $ | 220,534 | $ | 169,207 | $ | 118,112 | $ | 88,796 | $ | 54,004 | ||||||||||
Accounts receivable, net | 124,483 | 95,431 | 78,906 | 59,472 | 41,488 | |||||||||||||||
Unbilled revenues | 55,851 | 43,108 | 33,414 | 24,475 | 23,883 | |||||||||||||||
Property and equipment, net | 55,134 | 53,315 | 53,135 | 35,482 | 25,338 | |||||||||||||||
Total assets | 594,026 | 432,877 | 350,814 | 235,613 | 170,858 | |||||||||||||||
Accrued expenses and other liabilities | 32,203 | 20,175 | 19,814 | 24,782 | 15,031 | |||||||||||||||
Deferred revenue | 3,220 | 5,076 | 7,632 | 6,949 | 5,151 | |||||||||||||||
Total liabilities | 129,976 | 56,776 | 64,534 | 54,614 | 35,900 | |||||||||||||||
Preferred stock; Series A-1 convertible redeemable preferred stock and Series A-2 convertible redeemable preferred stock | — | — | — | 85,940 | 68,377 | |||||||||||||||
Total stockholders’ equity | 464,050 | 376,101 | 286,280 | 95,059 | 66,249 | |||||||||||||||
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Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations
You should read the following discussion and analysis of our financial condition and results of operations together with our audited consolidated financial statements and the related notes included elsewhere in this annual report. In addition to historical information, this discussion contains forward-looking statements that involve risks, uncertainties and assumptions that could cause actual results to differ materially from management’s expectations. Factors that could cause such differences are discussed in the sections entitled “Special Note Regarding Forward-Looking Statements” and “Item 1A. Risk Factors.” We assume no obligation to update any of these forward-looking statements. Please note that we effected an 8-for-1 common stock split on January 19, 2012, and all historical common stock and per share information has been changed to reflect the common stock split.
Executive Summary
From software products to core business applications, we are a leading global provider of expert consulting, development, testing, support and infrastructure services to many of the world’s leading organizations. As we evolve into a global, not just regional, leader in software and application outsourcing, we recognize that our history, our culture, our delivery model, and our people are at the core of what makes us excel in the industry. We deliver complex solutions to clients around the world utilizing our distributed delivery model, which now includes advanced capabilities.
Our delivery focus has not wavered since our inception over 20 years ago, even as our capabilities, tools, and practices have progressed over time. Our delivery evolved to accommodate the needs of our customers across multiple continents and lines of business and to ensure consistent quality in every project deliverable. Our global delivery model and centralized support functions, combined with the benefits of scale from the shared use of fixed-cost resources, such as computers and office space, enhance our productivity levels and enable us to better manage the efficiency of our global operations by maintaining adequate resource utilization levels and implementing company-wide cost-management programs. As a result, we have created a delivery base whereby our applications, tools, methodologies and infrastructure allow us to seamlessly deliver services and solutions from our delivery centers to global clients across all geographies, further strengthening our relationships with them.
Through increased specialization in focused verticals and a continued emphasis on strategic partnerships, we are leveraging our roots in software engineering to become a recognized brand in IT services and software development. We are continuously venturing into new industries to expand our core industry client base in software and technology, banking and capital markets, business information and media, travel and hospitality. Our clients depend on us to solve complex technical challenges and our teams are integral parts of engineering efforts that cross products and industries.
Overview of 2014
During the year ended December 31, 2014, total revenues were $730.0 million, an increase of approximately 31.5% over $555.1 million reported for the same period a year ago. Our performance remained strong, driving revenue growth in North America and Europe both organically and through acquisitions.
We remain committed to maintaining and improving a well-balanced portfolio of clients and seek to grow revenues from our existing clients by continually expanding the scope and size of our engagements, as well as by growing our key client base through business development efforts and strategic acquisitions. During 2014, we made progress in this strategy and increased the reach of our offerings, both geographically and across industry verticals. During 2014, our top five and top ten customers accounted for 32.8% and 43.9% of consolidated revenues, respectively.
On March 5, 2014, we completed an acquisition of substantially all of the assets and assumed certain specific liabilities of U.S.-based healthcare technology consulting firm Netsoft Holdings LLC and Armenia-based Ozsoft, LLC (collectively, “Netsoft”). Netsoft works with leading health plans in the U.S. on their medical management and claims systems, and specializes in working with leaders in pioneering fields such as accountable care organizations, tele-medicine, healthcare analytics, personalized medicine, health information exchanges, and online self-service capabilities. The Netsoft acquisition added approximately 40 IT professionals to our headcount.
On April 30, 2014, we acquired all of the outstanding equity of Joint Technology Development Limited, a company organized under the laws of Hong Kong, including its wholly-owned subsidiaries Jointech Software (Shenzhen) Co., Ltd., a company organized under the laws of China, and Jointech Software Pte. Ltd., a company organized under the laws of Singapore (collectively, “Jointech”). Jointech provides strategic technology services in the investment banking, wealth and asset management industries. The acquisition of Jointech added over 200 IT professionals to our headcount and significantly extended our footprint in South-East Asia. With this acquisition, we expect to create an integrated global platform focused on serving large multinational customers within the Banking and Financial Services vertical, and extend our global value proposition in the region.
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On June 6, 2014, we acquired substantially all of the assets and assumed certain specified liabilities of each of GGA Software Services, LLC, Institute of Theoretical Chemistry, Inc., and GGA’s Russian affiliate (collectively, “GGA”). Established in 1994, GGA develops scientific informatics applications, content databases, algorithms and models; and delivers IT support, maintenance, and quality assurance services to leading healthcare and life sciences companies. The acquisition added over 300 IT professionals and over 120 scientists to our highly-experienced employee base and created a significant growth opportunity in the life sciences and healthcare industries. We also see tremendous potential in combining our traditionally recognized strengths with GGA’s algorithm development, mathematical modeling, and sophisticated content database development capabilities. The capability to develop and operationalize platforms, combining tools, models and data, has broad applications across other strategic industries on which EPAM focuses, including the Banking and Financial Services, Business Information and Media, and Retail and Consumer verticals.
On October 31, 2014, we acquired Great Fridays Limited and its subsidiaries to expand our product and design service portfolio. Great Fridays Limited, headquartered in Manchester, UK, with offices in London, San Francisco and New York, focuses on bridging the gap between business and design. The acquisition of Great Fridays added approximately 50 creative design professionals to our headcount. We expect this acquisition to further expand our product and design services capabilities.
Summary of Results of Operations and Non-GAAP Financial Measures
The following table presents a summary of our results of operations for the years ended December 31, 2014, 2013 and 2012:
Year Ended December 31, | ||||||||||||||||||||
2014 | 2013 | 2012 | ||||||||||||||||||
(in millions, except percentages) | ||||||||||||||||||||
Revenues | $ | 730.0 | 100.0 | % | $ | 555.1 | 100.0 | % | $ | 433.8 | 100.0 | % | ||||||||
Income from operations | 86.2 | 11.8 | 76.5 | 13.8 | 66.0 | 15.2 | ||||||||||||||
Net income | 69.6 | 9.5 | 62.0 | 11.2 | 54.5 | 12.6 | ||||||||||||||
For 2014, we reported results of operations consistent with the continued execution of our strategy. In 2014, our operating expenses increased in line with increase in revenues. We continue to invest in our people, processes and infrastructure to support our goal to deliver high-quality offerings that meet the needs of our customers, differentiate our value proposition from that of our competition, and drive scale and growth.
The key highlights of our consolidated results for 2014 and 2013 were as follows:
• | The European segment continued its strong performance, generating revenue growth of $95.1 million during the year ended December 31, 2014, or 46.6% over 2013; |
• | Revenue increased in all our key verticals in 2014 as compared to 2013, specifically within the Banking and Financial Services and Travel and Consumer verticals, which grew $59.1 million and $40.5 million respectively. |
• | Our organic growth was complemented by four strategic acquisitions completed during 2014, which expanded our highly skilled employee base, geographic footprint and service capabilities. Through acquisitions, we added capabilities in the healthcare and life sciences industries, forming a foundation for emerging verticals. |
• | Income from operations grew by 12.7% for the year ended December 31, 2014, compared with 2013 while income from operations as a percentage of revenues decreased by 2.0%. The decrease was due to a combination of factors, including an increase of $11.5 million in stock-based compensation expense, a $2.6 million increase in amortization and depreciation expenses related to our 2014 acquisitions, a $2.6 million write-down of prepaid assets to adjust the book value of prepaid construction costs to an estimated recoverable amount and a $1.1 million write-down of construction in progress costs, as well as a $2.2 million write off due to goodwill impairment in the Russia segment. |
• | Net income increased by 12.3% during 2014 compared with 2013. Expressed as a percentage of revenues, net income decreased by 1.7% due to the items noted above, as well as the effects of significant adverse foreign exchange rate changes to several currencies, specifically the Russian ruble, in 2014 as compared to 2013. |
The operating results in any period are not necessarily indicative of the results that may be expected for any future period.
33
In our quarterly earnings press releases and conference calls, we discuss the following key measures that are not calculated according to U.S.GAAP:
• | Non-GAAP income from operations is the income from operations as reported on our consolidated statements of income and comprehensive income exclusive of certain expenses and benefits. |
• | Non-GAAP operating margin is the non-GAAP income from operations as a percentage of reported revenues. |
We believe that these non-GAAP measures help illustrate trends in our core business and we use these measures to establish budgets and operational goals, manage our business and evaluate our performance. We exclude certain expenses and benefits from non-GAAP income from operations that we believe are not reflective of these underlying business trends and are not useful measures in determining our operational performance and overall business strategy. Because our reported non-GAAP financial measures are not calculated according to GAAP, these measures are not comparable to GAAP and may not be comparable to similarly described non-GAAP measures reported by other companies within our industry. Consequently, our non-GAAP financial measures should not be evaluated in isolation from or supplant comparable GAAP measures, but, rather, should be considered together with our financial statements, which are prepared according to GAAP. The following table presents a reconciliation of income from operations as reported on our consolidated statements of income and comprehensive income to non-GAAP income from operations and non-GAAP operating margin for the years ended December 31, 2014, 2013 and 2012:
For the Years Ended December 31, | ||||||||||||
2014 | 2013 | 2012 | ||||||||||
(in thousands, except percent) | ||||||||||||
GAAP income from operations | $ | 86,183 | $ | 76,493 | $ | 66,006 | ||||||
Stock-based compensation expense | 24,620 | 13,150 | 6,826 | |||||||||
Amortization of purchased intangible assets | 5,349 | 2,785 | 1,024 | |||||||||
Acquisition-related costs | 904 | 218 | 500 | |||||||||
Goodwill impairment loss | 2,241 | — | — | |||||||||
Other expenses/(income) and one-time items | 3,845 | (807 | ) | 584 | ||||||||
Non-GAAP income from operations | $ | 123,142 | $ | 91,839 | $ | 74,940 | ||||||
GAAP operating margin | 11.8 | % | 13.8 | % | 15.2 | % | ||||||
Effect of the adjustments detailed above | 5.1 | 2.7 | 2.1 | |||||||||
Non-GAAP operating margin | 16.9 | % | 16.5 | % | 17.3 | % | ||||||
From time to time, we acquire businesses and as such incur operating expenses, which are not related to our core company or segment operations and may include acquisition-related costs and amortization of acquired intangible assets. These costs vary with the size and complexity of the related acquisition and are generally inconsistent in amount and frequency, therefore, the size, complexity and volume of past acquisitions, which often drive the magnitude of acquisition-related costs, may not be indicative of the size, complexity and volume of future transactions and costs.
Amortization of purchased intangible assets is excluded from our non-GAAP measures to allow management to evaluate our operating results as if these assets have been developed internally rather than acquired in a business combination. We believe this approach provides a supplemental measure of performance in which the acquired intangible assets are treated in a manner comparable to the internally developed assets.
Stock-based compensation expense is excluded from our non-GAAP measures because we believe such exclusion allows for a more accurate comparison of our operating results among the periods, as well as enhances comparability with operating results of peer companies.
We also exclude certain other expenses and one-time charges that we believe are not indicative of what we consider to be organic continuing operations. Such items include impairment write-offs of goodwill and other assets, legal settlement expenses, and certain other non-cash one-time charges and write offs.
See our “Results of Operations” section below for a more detailed discussion and analysis of these charges.
We have significant international operations, and we earn revenues and incur expenses in multiple currencies. When important to management’s analysis, operating results are compared in “constant currency terms”, a non-GAAP financial
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measure that excludes the effect of foreign currency exchange rate fluctuations. The effect of rate fluctuations is excluded by translating the current period’s revenues and expenses into U.S. dollars at the weighted average exchange rates of the prior period of comparison. See Item 7A, “Quantitative and Qualitative Disclosures About Market Risk” of this report for a discussion of our exposure to exchange rates.
Effects of Inflation
Economies in CIS countries such as Belarus, Russia, Kazakhstan and Ukraine have periodically experienced high rates of inflation.
Ukraine has been experiencing heightened political and economic turmoil with no improvement as of the date of this report. Various news sources estimate that inflation has been increasing and the rate of increase has been accelerating throughout 2014. According to news reports, the peace talks continue and efforts to improve the government are in progress, however, the cost of the continuing crisis is severely impacting the Ukrainian economy. The Ukrainian currency has been weakened and the negative outlook in the Ukrainian economy continues. The functional currency for financial reporting purposes in Ukraine is US dollars.
Due to Russia’s annexation of Crimea, which was a part of Ukraine, the United States and the European Union have imposed and expanded sanctions targeting Russian government and government-controlled interests and certain government officials. The expanded sanctions issued by the US Department of Treasury and the European Union also restrict involvement in certain extensions of credit and financing activities for Russian debtors and restrict certain business activities in sectors such as off-shore oil and defense. We believe these sanctions do not prevent us from providing our services to our customers.
In February 2014, the government of Kazakhstan devalued the local currency, the tenge, by 19%. The government kept inflation for 2014 within forecasted range of 6% to 8% with forecast of around 7% for 2015 with a steady decrease towards 6% later that year. However, political and economic instability in the region may contribute to the economic uncertainty in Kazakhstan.
Belarus over the last several years has been experiencing hyperinflation. The measures currently used by the Belarusian government to control this recent inflation include monetary policy and pricing instruments, including increasing interest rates and the use of anti-monopoly laws to prevent the increase in pricing of goods, as well as privatization and using foreign borrowings to replenish the budget and stabilize the local currency. Inflation, government actions to combat inflation and public speculation about possible additional actions have also contributed to economic uncertainty in Belarus. Belarus may experience high levels of inflation in the future. For the year ended December 31, 2014, we had approximately $1.5, or 0.2%, of our revenues denominated in Belarusian rubles. The functional currency for financial reporting purposes in Belarus is US dollars.
Periods of higher inflation may slow economic growth in those countries. Inflation also is likely to increase some of our costs and expenses, which we may not be able to pass on to our clients and, as a result, may reduce our profitability. Inflationary pressures could also affect our ability to access financial markets and lead to counter-inflationary measures that may harm our financial condition, results of operations or adversely affect the market price of our securities.
Results of Operations
The following table sets forth a summary of our consolidated results of operations for the periods indicated. This information should be read together with our consolidated financial statements and related notes included elsewhere in this annual report. The operating results in any period are not necessarily indicative of the results that may be expected for any future period.
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Year Ended December 31, | ||||||||||||||||||||
2014 | 2013 | 2012 | ||||||||||||||||||
(in thousands, except percentages) | ||||||||||||||||||||
Revenues | $ | 730,027 | 100.0 | % | $ | 555,117 | 100.0 | % | $ | 433,799 | 100.0 | % | ||||||||
Operating expenses: | ||||||||||||||||||||
Cost of revenues (exclusive of depreciation and amortization)(1) | 456,530 | 62.5 | 347,650 | 62.6 | 270,361 | 62.3 | ||||||||||||||
Selling, general and administrative expenses(2) | 163,666 | 22.4 | 116,497 | 21.0 | 85,868 | 19.8 | ||||||||||||||
Depreciation and amortization expense | 17,483 | 2.4 | 15,120 | 2.7 | 10,882 | 2.5 | ||||||||||||||
Goodwill impairment loss | 2,241 | 0.3 | — | — | — | — | ||||||||||||||
Other operating expenses, net | 3,924 | 0.6 | (643 | ) | (0.1 | ) | 682 | 0.2 | ||||||||||||
Income from operations | 86,183 | 11.8 | 76,493 | 13.8 | 66,006 | 15.2 | ||||||||||||||
Interest and other income, net | 4,769 | 0.7 | 3,077 | 0.5 | 1,941 | 0.5 | ||||||||||||||
Change in fair value of contingent consideration | (1,924 | ) | (0.3 | ) | — | — | — | — | ||||||||||||
Foreign exchange loss | (2,075 | ) | (0.3 | ) | (2,800 | ) | (0.5 | ) | (2,084 | ) | (0.5 | ) | ||||||||
Income before provision for income taxes | 86,953 | 11.9 | 76,770 | 13.8 | 65,863 | 15.2 | ||||||||||||||
Provision for income taxes | 17,312 | 2.4 | 14,776 | 2.6 | 11,379 | 2.6 | ||||||||||||||
Net income | $ | 69,641 | 9.5 | % | $ | 61,994 | 11.2 | % | $ | 54,484 | 12.6 | % | ||||||||
(1) | Included $8,648, $4,823 and $2,809 of stock-based compensation expense for the years ended December 31, 2014, 2013 and 2012, respectively; |
(2) | Included $15,972, $8,327 and $4,017 of stock-based compensation expense for the years ended December 31, 2014, 2013 and 2012, respectively. |
Revenues
Our revenues are derived primarily from providing software development services to our clients. We discuss below the breakdown of our revenue by service offering, vertical, client location, contract type and client concentration. Revenues consist of IT services revenues and reimbursable expenses and other revenues, which primarily include travel and entertainment costs that are chargeable to clients.
Revenues by Service Offering
Software development includes software product development, custom application development services and enterprise application platforms services, and has historically represented, and we expect to continue to represent, the substantial majority of our business. The following table sets forth revenues by service offering by amount and as a percentage of our revenues for the periods indicated:
Year Ended December 31, | ||||||||||||||||||||
2014 | 2013 | 2012 | ||||||||||||||||||
Software development | $ | 504,590 | 69.1 | % | $ | 374,426 | 67.4 | % | $ | 290,139 | 66.8 | % | ||||||||
Application testing services | 140,363 | 19.2 | 109,222 | 19.7 | 85,849 | 19.8 | ||||||||||||||
Application maintenance and support | 58,840 | 8.1 | 45,971 | 8.3 | 36,056 | 8.3 | ||||||||||||||
Infrastructure services | 14,198 | 1.9 | 14,433 | 2.6 | 12,424 | 2.9 | ||||||||||||||
Licensing | 3,626 | 0.5 | 3,439 | 0.6 | 2,914 | 0.7 | ||||||||||||||
Reimbursable expenses and other revenues | 8,410 | 1.2 | 7,626 | 1.4 | 6,417 | 1.5 | ||||||||||||||
Revenues | $ | 730,027 | 100.0 | % | $ | 555,117 | 100.0 | % | $ | 433,799 | 100.0 | % | ||||||||
Revenues by Vertical
We analyze our revenue by separating our clients into four main industry sectors or verticals as detailed in the following table. Also, we serve clients in other industries such as oil and gas, telecommunications, healthcare, life sciences, retail, insurance and several others, which are currently reported in aggregate under Other verticals. The following table sets
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forth revenues by vertical by amount and as a percentage of our revenues for the periods indicated:
Year Ended December 31, | ||||||||||||||||||||
2014 | 2013 | 2012 | ||||||||||||||||||
Banking and Financial Services | $ | 215,425 | 29.5 | % | $ | 156,340 | 28.2 | % | $ | 111,941 | 25.8 | % | ||||||||
ISVs and Technology | 157,944 | 21.6 | 134,970 | 24.3 | 106,852 | 24.6 | ||||||||||||||
Travel and Consumer | 157,756 | 21.6 | 117,248 | 21.1 | 95,965 | 22.1 | ||||||||||||||
Business Information and Media | 91,726 | 12.6 | 75,677 | 13.6 | 62,398 | 14.4 | ||||||||||||||
Other | 98,766 | 13.5 | 63,256 | 11.4 | 50,226 | 11.6 | ||||||||||||||
Reimbursable expenses and other revenues | 8,410 | 1.2 | 7,626 | 1.4 | 6,417 | 1.5 | ||||||||||||||
Revenues | $ | 730,027 | 100.0 | % | $ | 555,117 | 100.0 | % | $ | 433,799 | 100.0 | % | ||||||||
Revenues by Client Location
Our revenues are sourced from three geographic markets: North America, Europe and CIS. In 2014, we established a new geographic market in the APAC region as a result of an acquisition. We present and discuss our revenues by client location based on the location of the specific client site that we serve, irrespective of the location of the headquarters of the client or the location of the delivery center where the work is performed. Revenue by client location is different from the revenue by reportable segment in our audited consolidated financial statements included elsewhere in this annual report. Segments are not based on the geographic location of the clients but are rather based on the geography of the management responsible for a particular client regardless of client's physical location. The following table sets forth revenues by client location by amount and as a percentage of our revenues for the periods indicated:
Year Ended December 31, | ||||||||||||||||||||
2014 | 2013 | 2012 | ||||||||||||||||||
North America | $ | 367,498 | 50.4 | % | $ | 281,738 | 50.8 | % | $ | 206,901 | 47.7 | % | ||||||||
Europe | 284,853 | 39.0 | 200,137 | 36.1 | 155,168 | 35.8 | ||||||||||||||
United Kingdom | 141,366 | 19.4 | 108,892 | 19.6 | 98,346 | 22.7 | ||||||||||||||
Switzerland | 87,111 | 11.9 | 51,941 | 9.4 | 30,120 | 6.9 | ||||||||||||||
Other | 56,376 | 7.7 | 39,304 | 7.1 | 26,702 | 6.2 | ||||||||||||||
CIS | 55,807 | 7.6 | 65,616 | 11.7 | 65,313 | 15.0 | ||||||||||||||
Russia | 48,945 | 6.7 | 53,328 | 9.6 | 47,536 | 11.0 | ||||||||||||||
Other | 6,862 | 0.9 | 12,288 | 2.1 | 17,777 | 4.0 | ||||||||||||||
APAC | 13,459 | 1.8 | — | — | — | — | ||||||||||||||
Reimbursable expenses and other revenues | 8,410 | 1.2 | 7,626 | 1.4 | 6,417 | 1.5 | ||||||||||||||
Revenues | $ | 730,027 | 100.0 | % | $ | 555,117 | 100.0 | % | $ | 433,799 | 100.0 | % | ||||||||
Revenues by Contract Type
Our services are performed under both time-and-material and fixed-price arrangements. Our engagement models depend on the type of services provided to a client, the mix and locations of professionals involved and the business outcomes our clients are looking to achieve. Historically, the vast majority of our revenues have been generated under time-and-material contracts. Under time-and-material contracts, we are compensated for actual time incurred by our IT professionals at negotiated hourly, daily or monthly rates. Fixed-price contracts require us to perform services throughout the contractual period and we are paid in installments on pre-agreed intervals. We expect time-and-material arrangements to continue to comprise the majority of our revenues in the future.
The following table sets forth revenues by contract type by amount and as a percentage of our revenues for the periods indicated:
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Year Ended December 31, | ||||||||||||||||||||
2014 | 2013 | 2012 | ||||||||||||||||||
Time-and-material | $ | 618,725 | 84.7 | % | $ | 456,938 | 82.3 | % | $ | 364,853 | 84.1 | % | ||||||||
Fixed-price | 99,266 | 13.6 | 87,114 | 15.7 | 59,615 | 13.7 | ||||||||||||||
Licensing | 3,626 | 0.5 | 3,439 | 0.6 | 2,914 | 0.7 | ||||||||||||||
Reimbursable expenses and other revenues | 8,410 | 1.2 | 7,626 | 1.4 | 6,417 | 1.5 | ||||||||||||||
Revenues | $ | 730,027 | 100.0 | % | $ | 555,117 | 100.0 | % | $ | 433,799 | 100.0 | % | ||||||||
Revenues by Client Concentration
We have grown our revenues from our clients by continually expanding the scope and size of our engagements, and we have grown our key client base through internal business development efforts and several strategic acquisitions.
Our focus on delivering quality to our clients is reflected by an average of 93.1% and 81.5% of our revenues in 2014 coming from clients that had used our services for at least one and two years, respectively. In addition, we have significantly grown the size of existing accounts. The number of clients that accounted for over $5.0 million in annual revenues increased to 24 in 2014 from 10 in 2010, and the number of clients that generated at least $0.5 million in revenues increased to 181 in 2014 from 72 in 2010.
The following table sets forth revenues contributed by our top one, top five and top ten clients by amount and as a percentage of our revenues for the periods indicated:
Year Ended December 31, | ||||||||||||||||||||
2014 | 2013 | 2012 | ||||||||||||||||||
Top client | $ | 97,639 | 13.4 | % | $ | 53,136 | 9.6 | % | $ | 39,854 | 9.2 | % | ||||||||
Top five clients | 239,396 | 32.8 | 169,987 | 30.6 | 134,484 | 31.0 | ||||||||||||||
Top ten clients | 320,126 | 43.9 | 234,955 | 42.3 | 192,426 | 44.4 | ||||||||||||||
Operating Expenses
Cost of Revenues (Exclusive of Depreciation and Amortization)
The principal components of our cost of revenues (exclusive of depreciation and amortization) are salaries, employee benefits, stock compensation expense, travel costs and subcontractor fees for IT professionals and subcontractors that are assigned to client projects. Salaries and other compensation expenses of our IT professionals are reported as cost of revenue regardless of whether they are actually performing client services during a given period.
The cost of revenues are dependent on utilization levels. Our ability to manage our utilization levels depends significantly on our ability to hire and train high-performing IT professionals and to staff projects appropriately. Our staff utilization also depends on the general economy and its effect on our clients and their business decisions regarding the use of our services. Some of our IT professionals are specifically hired and trained to work for specific clients or on specific projects, and some of our offshore development centers are dedicated to specific clients or specific projects.
Selling, General and Administrative Expenses
Selling, general and administrative expenses represent expenses associated with promoting and selling our services and general administrative functions of our business. These expenses include senior management, administrative personnel and sales and marketing personnel salaries; stock compensation expense, related fringe benefits, commissions and travel costs for those employees; legal and audit expenses, insurance, operating lease expenses, and the cost of advertising and other promotional activities. In addition, we pay a membership fee of 1% of revenues collected in Belarus to the administrative organization of the Belarus Hi-Tech Park.
Our selling, general and administrative expenses have increased primarily as a result of our expanding operations, acquisitions, and the hiring of a number of senior managers to support our growth. We expect our selling, general and administrative expenses to continue to increase in absolute terms as our business expands but will generally remain steady or slightly decrease as a percentage of our revenues.
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Provision for Income Taxes
Determining the consolidated provision for income tax expense, deferred income tax assets and liabilities and related valuation allowance, if any, involves judgment. As a global company, we are required to calculate and provide for income taxes in each of the jurisdictions in which we operate. During 2014, 2013 and 2012, we had $94.2, $69.8 million, and $56.6 million, respectively, in income before provision for income taxes attributed to our foreign jurisdictions. The statutory tax rate in our foreign jurisdictions is lower than the statutory U.S. tax rate. Additionally, we have secured special tax benefits in Belarus and Hungary as described below. As a result, our provision for income taxes is low in comparison to income before taxes due to the benefit received from increased income earned in low tax jurisdictions. The foreign tax rate differential represents this significant reduction. Changes in the geographic mix or estimated level of annual pre-tax income can also affect our overall effective income tax rate.
Our provision for income taxes also includes the impact of provisions established for uncertain income tax positions, as well as the related net interest. Tax exposures can involve complex issues and may require an extended period to resolve. Although we believe we have adequately reserved for our uncertain tax positions, we cannot assure you that the final tax outcome of these matters will not be different from our current estimates. We adjust these reserves in light of changing facts and circumstances, such as the closing of a tax audit, statute of limitation lapse or the refinement of an estimate. To the extent that the final tax outcome of these matters differs from the amounts recorded, such differences will impact the provision for income taxes in the period in which such determination is made.
Our subsidiary in Belarus is a member of the Belarus Hi-Tech Park, in which member technology companies are 100% exempt from the current Belarusian income tax rate of 18%. The “On High-Technologies Park” Decree, which created the Belarus Hi-Tech Park, is in effect for a period of 15 years from July 1, 2006.
Our subsidiary in Hungary benefits from a tax credit of 10% of annual qualified salaries, taken over a four-year period, for up to 70% of the total tax due for that period. We have been able to take the full 70% credit for 2007 to 2012. The Hungarian tax authorities repealed the tax credit beginning with 2012. Credits earned in years prior to 2012, however, were allowed through 2014. We have utilized up to the 70% limit until 2014.
Our domestic income before provision for income taxes differs from the North America segment income before provision for income taxes because segment operating profit is a management reporting measure, which does not take into account most corporate expenses, as well as the majority of non-operating costs and stock compensation expenses. We do not hold our segment managers accountable for these expenses, as they cannot influence these costs within the scope of their operating authority, nor do we believe it is practical to allocate these costs to specific segments, as they are not directly attributable to any specific segment. All our segments are treated consistently with respect to such expenses when determining segment operating profit.
2014 Compared to 2013
During 2014, our revenues grew in excess of 30.0% over 2013, from $555.1 million to a record $730.0 million. The increase was attributable to a combination of factors, including deeper penetration to existing customers and attainment of new customers, both organically and through acquisitions. In 2014, revenue from new customers was $49.7 million, primarily resulting from our 2014 acquisitions, and does not include new clients that are affiliates of existing customers. Our 2014 acquisitions increased our total revenues by $39.8 million, however, some of the acquired clients are affiliated with our existing clients and, therefore, we consider them an expansion of existing business. In addition, total revenues in 2014 and 2013 included $8.4 million and $7.6 million of reimbursable expenses and other revenues, respectively, which increased by 10.3% in 2014 as compared to 2013, but remained relatively flat as a percentage of revenues.
During the year ended December 31, 2014, revenues in our largest geography, North America, grew $85.8 million, or 30.4%, as compared with the year ended December 31, 2013. Expressed as a percentage of consolidated revenues, the North America geography accounted for 50.4% in 2014, which represented a decrease of 0.4% over 2013. The slight decrease was primarily a result of accelerated growth in the European geography.
Revenues from all verticals in North America grew during the year ended December 31, 2014 as compared with the year ended December 31, 2013. The largest growth was in the North America's Other vertical due to acquiring new clients in the healthcare, insurance and life sciences industries through a 2014 acquisition as well as creating synergies with existing customers in those markets. During the year ended December 31, 2014 combined revenue growth from customers in the Other vertical accounted for $33.8 million, representing a 94.3%, growth over prior year.
Our Travel and Consumer vertical in North America geography increased by $15.0 million, or 28.4%, as compared with the year ended December 31, 2013. The increase in this vertical was primarily driven by the rapid expansion of our strategic
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relationship with a large retail chain, a relationship we acquired in 2012. During the year ended December 31, 2014, revenues from the Business Information and Media vertical in North America increased by $12.5 million, or 21.8%, as compared with the year ended December 31, 2013. The growth in this vertical in 2014 was attributable to resumed growth in revenues from certain long-time major customers who had decreased demand for our services in 2013. North America's largest vertical, ISVs and Technology, experienced growth of $19.8 million or 16.2% during the year ended December 31, 2014 as compared with the year ended December 31, 2013.
During the year ended December 31, 2014, our Banking and Financial Services vertical remained our dominant vertical in Europe geography. In 2014 revenues from the Banking and Financial Services vertical increased by $42.5 million, or 39.9%, respectively, over the corresponding periods of 2013. Continued solid performance of the Banking and Financial Services vertical was attributable to an increased demand for our services and ongoing relationships with existing top customers located in Europe. We experienced increased business from our top customer located in Switzerland, nearly doubling the revenue during 2014 as compared with the year ended December 31, 2013. Furthermore, we continue to see growing demand for our services from European-based customers within the Travel and Consumer and Business Information and Media verticals. During the year ended December 31, 2014 combined revenues from these verticals increased by $30.9 million, respectively, year ended December 31, 2014 and accounted for 36.4% of total growth in this geography during periods indicated. Europe's Other vertical grew 65.0% or $8.0 million in 2014, mainly due to addition of new clients through our 2014 acquisitions.
Revenues in the CIS geography showed a decrease of $9.8 million or 14.9% on a year-to-date bases compared to 2013. The decrease in revenues was primarily attributable to budgetary delays with certain customers located in Russia, as well as a decline in business from one of our largest customers in Kazakhstan. Additionally, significant foreign currency fluctuations in Russia and CIS countries had a material negative impact on the revenues from those locations.
Cost of Revenues (Exclusive of Depreciation and Amortization)
During the years ended December 31, 2014 and 2013, cost of revenues (exclusive of depreciation and amortization) was $456.5 million and $347.7 million, respectively, representing an increase of 31.3% for the year ended December 31, 2014 over the corresponding period of 2013, mainly due to increase in hiring of revenue generating professionals. As a percentage of revenues, cost of revenues (exclusive of depreciation and amortization), decreased 0.1% over the corresponding period of 2013, to 62.5% of consolidated revenues.
The increase in cost of revenues (exclusive of depreciation and amortization) in 2014 was primarily driven by a $107.9 million increase in personnel-related costs, the main component of cost of revenue, as well as an increase in stock-based compensation expense for our revenue generating IT professionals of $3.8 million. The increases in all of these costs were the result of organic increase in headcount as well as personnel additions from acquisitions.
Selling, General and Administrative Expenses
We continued to invest in key areas, including sales, infrastructure, industry expertise, and other functions supporting global operations.
During the year ended December 31, 2014, selling, general and administrative expenses totaled $163.7 million, representing an increase of 40.5% from $116.5 million during 2013. As a percentage of revenue, selling, general and administrative expenses represent 22.4% of consolidated revenues, an increase of 1.4% over last year. The increase in selling, general and administrative expenses in 2014 was primarily driven by a $30.2 million increase in total personnel-related costs, which include stock based compensation relating to the non-production personnel impact of the four 2014 acquisitions. During the year ended December 31, 2014, we incurred $13.4 million of selling, general and administrative costs related to our 2014 acquisitions, including $4.1 million of stock-based compensation expense, which resulted in a 1.8% increase in selling, general and administrative expenses expressed as a percentage of revenues.
Depreciation and Amortization Expense
Depreciation and amortization expense was $17.5 million in 2014, representing an increase of $2.4 million over 2013. Expressed as a percentage of revenues, depreciation and amortization expense totaled 2.4% and remained at the same level compared with 2013.
Goodwill Impairment Loss
We performed an annual goodwill impairment test as of October 31, 2014 in accordance with prescribed guidance. In assessing impairment both qualitatively and quantitatively based on the total of the expected future discounted cash flows directly related to the reporting unit, the Company determined that the fair value of the Russia reporting unit was below the carrying value of the reporting unit. The Company completed the second step of the goodwill impairment test, resulting in an
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impairment charge of $2.2 million as of December 31, 2014. All assets that related to the Russia segment, excluding goodwill and including any unrecognized intangible assets, were assessed by management and deemed to not be impaired.
Other Operating Expenses, Net
During the year ended December 31, 2014, we recorded a $2.6 million write-down in prepaid assets and a 1.1 million write-down of capitalized costs related to the construction of our corporate facilities in Belarus. Please see Note 16 in the notes to our consolidated financial statements in this Annual Report on Form 10-K for further information.
Interest and Other Income, Net
Net interest and other income was $4.8 million in 2014, representing an increase of 55.0% from $3.1 million received in 2013. The increase was primarily driven by interest received on cash accounts in Belarus and, to a lesser extent, interest earned on employee housing loans.
Provision for Income Taxes
The Company's effective tax rate was 19.9% and 19.2% in 2014 and 2013, respectively. The primary factors that caused this increase in the rate for the above-mentioned periods are: (a) the four acquisitions completed during 2014, which added other tax jurisdictions into the Company’s worldwide effective tax rate analysis; (b) a larger portion of the Company’s pre-tax profits attributable to tax jurisdictions with relatively higher effective tax rates (as compared to effective tax rates within the CIS region) were seen in 2014 and (c) a relative shift in offshore services that were performed in Belarus to other countries in the CIS region (specifically Ukraine and, to a lesser extent, Russia). Both of those locations have higher income tax rates than Belarus, where the Company is currently entitled to a 100% exemption from Belarusian income tax.
2013 Compared to 2012
Revenues
Revenues were $555.1 million and $433.8 million in 2013 and 2012, respectively, representing an increase of 28.0%. The increase was attributable to a combination of factors, including higher sales to existing and acquisition of new customers, which contributed $98.4 million and $21.7 million, respectively, to consolidated revenue growth. In addition, total revenues in 2013 and 2012 included $7.6 million and $6.4 million of reimbursable expenses and other revenues, respectively, which increased by 18.8% in 2013 as compared to 2012, but remained relatively flat as a percentage of revenues.
During the year ended December 31, 2013, North America, our largest geography, grew $74.8 million, or 36.2%, as compared with the year ended December 31, 2012. As a percentage of revenues, our North American geography accounted for 50.8% in 2013, which represented an increase of 3.1% over 2012. The growth in North America was driven by many realized opportunities in virtually every vertical. In particular, our ISVs and Technology vertical grew 30.0% as compared to 2012, primarily driven by an expansion of existing client relationships, which accounted for $25.9 million, or 91.6%, of the growth of this vertical over 2012. Solid performance of our North American geography was also a reflection of additional revenue streams created by our 2012 acquisitions. This was especially noticeable in the Business Information and Media vertical, which grew 8.9% in 2013 as compared to 2012 despite a significant decrease in revenues from one of our largest customers, Thomson Reuters. Without the impact of declining revenues from this customer, the Business Information and Media vertical increased $11.6 million, or 43.6% in 2013 over the corresponding periods of 2012. Additionally, our Travel and Consumer vertical grew $18.7 million, or 55.1%, in 2013 as compared to 2012 and accounted for 25.0% of total growth in our North American geography in 2013. Most of this increase was attributable to revenues from one of our strategic customers acquired in 2012, which had been on our “top ten” customer list since the second quarter of 2013. During the year ended December 31, 2013, revenues from this customer accounted for 20.7% of total revenue growth in North America, respectively.
During the year ended December 31, 2013, the Banking and Financial Services vertical remained our dominant vertical in Europe and accounted for 78.9% of total revenue growth in this geography. In 2013, revenues from Banking and Financial Services vertical increased $35.5 million, or 49.8%, over 2012. It was also our largest and fastest growing vertical on a consolidated basis. Strong performance of this vertical can be attributed to an increased demand for our services and ongoing relationship with existing customers located in Europe. In particular, 29.5% of total revenue growth during 2013 over the 2012 results was attributable to increased business from certain of our largest Banking and Financial Services customers located in the United Kingdom and Switzerland. Additionally, over the course of the year ended December 31, 2013, our Business Information and Media vertical grew significantly into the European markets. During the year ended December 31, 2013, this vertical increased $7.3 million, or 86.5%, over 2012, and accounted for 16.2% of the total growth in the European geography.
Revenues in the CIS geography increased $0.3 million, or 0.5%, in 2013 as compared to 2012. A slower growth rate as compared with the performance of other geographies in 2013 was due to a combination of factors. Following the addition of a
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number of new customers in the fourth quarter of 2012, revenues from our Travel and Consumer vertical increased $2.7 million, or 49.1%, in 2013 as compared with 2012. However, that growth in the Travel and Consumer vertical was more than offset by a lower growth rate in the Banking and Financial Services vertical, the largest vertical in this geography, which increased $2.6 million, or 8.1%, in 2013 over 2012. In addition, included in 2012 results were $4.0 million of revenues recognized upon completion of a fixed-priced project that did not recur in 2013.
Cost of Revenues (Exclusive of Depreciation and Amortization)
During the years ended December 31, 2013 and 2012, cost of revenues (exclusive of depreciation and amortization) was $347.7 million and $270.4 million, respectively, representing an increase of 28.6% in 2013 over the corresponding period of 2012.
The increase in cost of revenues (exclusive of depreciation and amortization) in 2013 as compared to 2012 was primarily driven by a net increase of 845 IT professionals, from 8,495 as of December 31, 2012, to 9,340 as of December 31, 2013, to support the growth in demand for our services. As a percentage of revenues, cost of revenues (exclusive of depreciation and amortization) increased by 0.3% in 2013, as compared to the corresponding period of 2012, primarily as a result of higher compensation and benefits of our IT professionals.
Selling, General and Administrative Expenses
During the year ended December 31, 2013, selling, general and administrative expenses were $116.5 million, representing an increase of 35.7% from $85.9 million in 2012. As a percentage of revenues, selling, general and administrative expenses increased to 21.0% in 2013, or 1.2%, compared to 2012. Most of this increase was attributable to higher compensation and benefits of our non-production staff in 2013 as compared to 2012 as we continued to invest into key areas, including sales, industry expertise, and other functions supporting global operations. In addition, selling, general and administrative expenses included $3.3 million of additional stock-based compensation expense related to our 2012 acquisitions, which caused our selling, general, and administrative expenses to increase by 0.5% as a percentage of revenues in 2013 over 2012.
Depreciation and Amortization Expense
Depreciation and amortization expense was $15.1 million in 2013, representing an increase of $4.2 million over 2012. The increase was driven by additional capital expenditures to support headcount growth. As a percentage of revenues, depreciation and amortization expense increased to 2.7% in 2013 from 2.5% in 2012 primarily as a result of $1.9 million of additional expenses related to amortization of purchased intangible assets acquired in 2012.
Other Operating (Income)/ Expenses, Net
Net other operating income was $0.6 million in 2013 as compared to $0.7 million of expenses recorded in the corresponding period of 2012. Net other operating expenses recorded in 2012 were primarily attributable to the issuance of 53,336 shares of common stock to Instant Information Inc., a 2010 asset acquisition, upon the completion of our initial public offering in the first quarter of 2012, which did not recur in 2013. Additionally, during 2013 we received $0.8 million in connection with prior-year write-offs of other assets.
Interest and Other Income, Net
Net interest and other income was $3.1 million in 2013, representing an increase of 58.5% from $1.9 million received in 2012. The increase was largely driven by an increase in interest income earned on cash accounts in Belarus and, to a lesser extent, interest earned on employee housing loans in 2013 which accounted for $0.3 million.
Provision for Income Taxes
Our worldwide effective tax rate was 19.2% and 17.3% in 2013 and 2012, respectively. The increase in the worldwide effective tax rate in 2013, as compared to the corresponding period of 2012, was primarily due to (a) a higher portion of pre-tax profits attributable to our North American tax jurisdiction as a result of an acquisition completed in the second half of 2012; and (b) a relative shift in offshore services performed in Belarus, where we currently entitled to a 100% exemption from Belarusian income tax, to Ukraine, and, to a lesser extent, Russia, both of which have higher income tax rates.
Results by Business Segment
Our operations consist of four reportable segments: North America, Europe, Russia and Other. The segments represent components of EPAM for which separate financial information is available that is used on a regular basis by our chief executive
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officer, who is also our chief operating decision maker (“CODM”), in determining how to allocate resources and evaluate performance. This determination is based on the unique business practices and market specifics of each region and that each region engages in business activities from which it earns revenues and incurs expenses. Our reportable segments are based on managerial responsibility for a particular client. Because managerial responsibility for a particular client relationship generally correlates with the client’s geographic location, there is a high degree of similarity between client locations and the geographic boundaries of our reportable segments. In some specific cases, however, managerial responsibility for a particular client is assigned to a management team in another region, usually based on the strength of the relationship between client executives and particular members of our senior management team. In a case like this, the client’s activity would be reported through the management team’s reportable segment. Our CODM evaluates the Company’s performance and allocates resources based on segment revenues and operating profit.
Segment operating profit is defined as income from operations before unallocated costs. Generally, operating expenses for each operating segment have similar characteristics and are subject to similar factors, pressures and challenges. Expenses included in segment operating profit consist principally of direct selling and delivery costs as well as an allocation of certain shared services expenses. We use globally integrated support organizations to realize economies of scale and efficient use of resources. As a result, a majority of our expenses is shared by all segments. These shared expenses include Delivery, Recruitment and Development, Sales and Marketing, and support functions such as IT, Finance, Legal, and Human Resources. Generally, shared expenses are allocated based on measurable drivers of expense, e.g., recorded hours or headcount. However, certain expenses are not specifically allocated to specific segments, as management does not believe it is practical to allocate such costs to individual segments because they are not directly attributable to any specific segment. Further, stock based compensation expense is not allocated to individual segments in internal management reports used by the chief operating decision maker. Accordingly, these expenses are separately disclosed as “unallocated” and adjusted only against our total income from operations.
Revenues from external clients and segment operating profit, before unallocated expenses, for the North America, Europe, Russia and Other reportable segments for the fiscal years ended December 31, 2014, 2013 and 2012 were as follows:
Year Ended December 31, | |||||||||||
2014 | 2013 | 2012 | |||||||||
(in thousands) | |||||||||||
Total segment revenues: | |||||||||||
North America | $ | 374,509 | $ | 284,636 | $ | 197,271 | |||||
Europe | 299,279 | 204,150 | 168,913 | ||||||||
Russia | 50,663 | 55,764 | 50,552 | ||||||||
Other | 5,552 | 10,493 | 16,986 | ||||||||
Total segment revenues | $ | 730,003 | $ | 555,043 | $ | 433,722 | |||||
Segment operating profit: | |||||||||||
North America | $ | 90,616 | $ | 66,814 | $ | 38,671 | |||||
Europe | 50,189 | 34,573 | 32,750 | ||||||||
Russia | 7,034 | 7,077 | 9,049 | ||||||||
Other | (3,220 | ) | 844 | 6,985 | |||||||
Total segment operating profit | $ | 144,619 | $ | 109,308 | $ | 87,455 | |||||
2014 Compared to 2013
North America Segment
During the years ended December 31, 2014 and 2013 revenues from our North America segment were 51.3% and 51.3% of total revenues representing an increase of $89.9 million, or 31.6%, over the corresponding period in 2013. The North America segment's operating profits increased by $23.8 million, or 35.6%, as compared to the same period of 2013, to $90.6 million net operating profit.
The increase in revenues during the year ended December 31, 2014, was primarily driven by continued expansion of existing customer relationships, as well, as our recent acquisitions. The largest growth was in the Other vertical due to acquiring new clients in the healthcare, insurance and life sciences industries through a 2014 acquisition as well as creating synergies with existing customers in those markets. During the year ended December 31, 2014, combined revenue growth from customers in the Other vertical accounted for $34.8 million, representing a 97.4% growth over prior year.
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All other verticals in the North America segment experienced revenue growth and increases in operating profit in 2014 as compared to 2013, mainly due to increased business from our long term clients with some contribution from the clients acquired in connection with acquisitions. The largest vertical, the ISVs and Technology, grew revenues by $22.1 million, or 18.6%, in 2014 as compared to the corresponding period of 2013. Revenues from our Travel and Consumer vertical in 2014 increased by $14.6 million, or 26.7%, as compared to the corresponding period in 2013. Banking and Financial Services had an increase in revenue of $5.9 million or 45.4%, and operating profit increased by 104.9% in this vertical in 2014 compared with the year ended December 31, 2013. Business Information and Media grew in revenue $12.5 million or 20% for the year ended December 31, 2014 as compared to the same period in 2013.
Europe Segment
During the years ended December 31, 2014 and 2013, revenues from our Europe segment were 41.0% and 36.8% of total segment revenues, respectively, representing an increase of $95.1 million, or 46.6%, in 2014 over the 2013 results. During 2014, the Europe segment’s operating profits increased by $15.6 million, or 45.2%, as compared to the corresponding period of 2013, to $50.2 million net profit from the segment’s operations.
Europe continues to be a rapidly growing segment in our portfolio, given our nearshore delivery capabilities, and our value proposition in delivering quality software engineering solutions and services. Our business model continues to gain considerable traction with European-based clients primarily in the Banking and Financial Services and Travel and Consumer verticals. Furthermore, our Europe segment benefited from the acquisition of Jointech, a company with locations in South-East Asia, which created a new value proposition for our existing customers within the Banking and Financial Services vertical, particularly in the areas of investment banking, wealth and asset management, and extended our reach into new geography. We expect that many of our new and existing customers in other business verticals will use our services in that fast-growing region resulting in possible revenue and operating profit increases to the Europe segment.
Russia and Other Segments
During the years ended December 31, 2014, revenues from the Russia and Other operating segments decreased by $5.1 million and $4.9 million, respectively, over corresponding period of 2013. Operating profits of the Russia segment showed no changes when compared with the operating profits of this segment in 2013, while profits of Other segments decreased $4.1 million compared to 2013.
Revenues and operating profits in the Russia and Other segments are subject to volatility resulting from revenue recognition delays related to finalizing budgets for certain arrangements with major customers in those segments. As a result, we recorded the cost related to the performance of services in 2014 with no associated revenues recognized in the period that services were rendered. These business arrangements were further exacerbated by strong foreign currency fluctuations in the fourth quarter of 2014, negatively impacting our business in Russia and CIS countries.
2013 Compared to 2012
North America Segment
During the years ended December 31, 2013 and 2012, revenues from the North America segment were 51.3% and 45.5% of total segment revenues, respectively, representing an increase of $87.4 million, or 44.3%, in 2013 over the 2012 results. The North America segment's operating profits increased by $28.1 million, or 72.8%, as compared to the corresponding period of 2012, to $66.8 million net profit from the segment’s operations.
The increase in revenues during year ended December 31, 2013, was primarily driven by continued expansion of existing client relationships, as well as by revenues contributed by new clients, including through the acquisitions of Thoughtcorp and Empathy Lab completed in 2012. Within the segment, revenue from our ISVs and Technology vertical increased $29.0 million, or 32.3%, in 2013 as compared to the corresponding period of 2012, representing 33.2% of the overall segment growth. Our Travel and Consumer vertical was the fastest growing vertical in 2013 with revenues increasing by $26.5 million, or 94.6%, in 2013 as compared to the corresponding period in 2012. The increase in the segment’s operating profit in 2013 as compared to 2012 was primarily driven by increased revenues and improved profitability, partially offset by an increase in compensation and benefits of our IT professionals primarily as a result of added headcount to support our revenue growth and continued demand for onsite resources.
Europe Segment
During the years ended December 31, 2013 and 2012, revenues from our Europe segment were 36.8% and 38.9% of total segment revenues, respectively, representing an increase of $35.2 million, or 20.9%, in 2013 over the 2012 results. During
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2013, the Europe segment’s operating profits increased by $1.8 million, or 5.6%, as compared to the corresponding period of 2012, to $34.6 million net profit from the segment’s operations.
Europe continues to be a rapidly growing segment in our portfolio, given our nearshore delivery capabilities, and our value proposition in delivering quality software engineering solutions and services is continuing to gain considerable traction with European-based clients. Within the segment, growth was the strongest in our Banking and Financial Services vertical, with 2013 revenues increasing by approximately $36.9 million, or 52.0%, over the corresponding period of 2012. The decrease in the segment’s operating profit as a percentage of the European segment’s revenues in 2013 as compared to 2012, was primarily due to an increase in compensation expense relative to recognized service revenues in 2013 as compared to 2012.
Russia Segment
During the years ended December 31, 2013 and 2012, revenues from our Russia segment were 10.0% and 11.7% of total segment revenues, respectively. In 2013, revenues from the Russia segment were $55.8 million, representing an increase of $5.2 million, or 10.3%, over the 2012 results. During 2013, our Russia segment's operating profits decreased by $2.0 million, or 21.8%, as compared to the corresponding period of 2012, to $7.1 million net profit from the segment’s operations.
Within the segment, 2013 revenues from the Banking and Financial Services and Travel and Consumer verticals increased $2.4 million and $2.8 million, respectively, accounting for most of the segment's growth in the period indicated. The decrease in operating profits of the Russia segment in 2013 when compared to 2012 was primarily attributable to revenue recognition delays related to fixed-price projects. Revenue recognition on such projects is susceptible to timing delays. As a result, there may be instances where we record the cost related to the performance of services with no associated revenue recognized in the period that services were rendered. In particular, we estimate a total of $2.5 million of revenues remained unrecognized as of December 31, 2013 in the Russia segment, with related costs reflected in the segment's operating results for the year then ended. Similarly, we may record revenue in a period where the underlying expenses have been recorded in a previous period, which would significantly improve the operating margin of the Russia segment in the period of recognition. Consequently, a higher concentration of fixed-price projects in the Russia segment affects the period-over-period comparability of the segment’s operating results.