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, 2017
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 x No ¨
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 (§ 232.405 of this chapter) 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 (§ 229.405 of this chapter) 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. ¨
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 | ¨ | |||
Emerging growth company | ¨ | |||||
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ¨
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act). Yes ¨ No x
As of June 30, 2017 the aggregate market value of the registrant’s common stock held by non-affiliates of the registrant was approximately $4,178 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, $0.001 par value, of the registrant outstanding as of February 12, 2018 was 53,039,832 shares.
DOCUMENTS INCORPORATED BY REFERENCE
The registrant intends to file a definitive Proxy Statement for its 2018 annual meeting of stockholders pursuant to Regulation 14A within 120 days of the end of the registrant’s fiscal year ended December 31, 2017. 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, 2017
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 9001:2015” and “ISO 27001:2013” are trademarks of the International Organization for Standardization. “ISAE” is a trademark of the International Federation of Accountants. 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.
GEOGRAPHICAL REFERENCES
We use the terms “CIS”, “CEE” and “APAC” 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. APAC, which stands for Asia Pacific, includes all of Asia (including India) and Australia.
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PART I
Item 1. Business
Company Background
We are a leading global provider of software product development and digital platform engineering services to clients located around the world, primarily in North America, Europe, Asia and Australia. With a strong focus on innovative and scalable software solutions and a continually evolving mix of advanced capabilities, we leverage industry standard and custom developed technology, tools and platforms to deliver results for the most complex business challenges. We focus on building long-term partnerships with clients in industries such as financial services, travel and consumer, software and hi-tech, media and entertainment, life sciences and healthcare, as well as other emerging industries.
Our work with global leaders in enterprise software platforms and emerging technology companies has allowed us to develop vertical-specific domain expertise. Our culture of innovation, technology leadership, process excellence and high-quality project delivery has helped us continue to build a strong reputation in the marketplace.
Our historical core competency, software development and product engineering services created our foundation for the evolution of our other offerings, which include advanced technology software solutions, intelligent enterprise services and digital engagement. Our strategic acquisitions have further expanded our global footprint and service offering portfolio, including our capabilities in the healthcare and financial services industries, digital strategy and design, consulting and test automation. We expect our strategic acquisitions will continue to enable us to offer a broader range of services to our clients from a wider variety of locations.
Our Services
Our service offerings cover the full software 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. We meet the standards of ISAE 3402 Type 2, ISO 27001:2013 and ISO 9001:2015, and these certifications provide our clients with third-party verification of our information security, quality management and general controls practices.
We also work closely with leading companies in other industries to enable our clients to better leverage technology and address the simultaneous pressures of driving value for the consumer and offering a more engaging experience. Our digital strategy and experience design practice provides strategy, design, creative and program management services for clients looking to improve their customer experience. We 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.
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 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.
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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 9001:2015 and we employ industry-recognized and proprietary defect tracking tools to deliver a comprehensive range of 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.
Application Maintenance and Support
We deliver application maintenance and support services through a dedicated team of IT professionals. 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
We offer infrastructure management services to address clients’ increased need for tighter enterprise integration between software development, testing and maintenance with private, public and mobile infrastructures. 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 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.
Enterprise Information Management
We build enterprise technologies that offer smarter analytics, improve business processes, and result in greater operational excellence. Our global delivery framework and industry-specific blueprints allow us to meet the needs of our clients’ enterprises and build business application platforms and their components in areas including customer relationship management, sales automation, enterprise resource planning, enterprise content management, business intelligence and cloud management. We deploy the platforms and services that enable data-driven business decisions by turning data into intelligence. Our agile engineering expertise allows us to offer services around business process management, enterprise content management and more, including 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.
Our Vertical Markets
Strong vertical-specific 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 five main industry verticals and a group of emerging verticals.
Financial Services. We have significant experience working with global investment banks, firms, and brokerages, commercial and retail banks, credit card companies, wealth management institutions, depositories, corporate treasuries, pension funds, and market data providers. We assist these clients with challenges stemming from new regulations, compliance requirements, customer-based needs and risk management. Our financial services domain experts have been recognized with industry awards for engineering and deploying unique applications and business solutions that facilitate growth, competitiveness, and customer loyalty while driving cost efficiency for global financial institutions.
Travel and Consumer. 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. Some of the world’s leading airlines, hotel providers and travel agencies rely on our knowledge in creating high-quality tools for operating and managing their business. Within this vertical, we also serve global, regional and local retailers, online retail brands, consumer goods manufacturers and distributors and online marketplaces. We deliver a wide range of services to retail and eCommerce clients from complex system modernizations to leading edge innovations in multi-channel sales and distribution. We have transformed organizations to use technology to expand and revolutionize their business models. Our services directly impact the consumer experience of our clients’ brands, and allow our clients to reach more consumers.
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Software and Hi-Tech. Our core competency is in providing complex software product development services to meet software and technology companies’ constant need for innovation and agility. We help some of the most prominent software brands in the world build, what we believe to be, the best software. Through our extensive experience with many industry leaders in Hi-Tech R&D, software engineering and integration, we have developed proprietary internal processes, methodologies and IT infrastructure, which give us an edge when it comes to serving customers in the Hi-Tech and Software Product markets. Our services span the complete software development lifecycle for software product development using our comprehensive development methodologies, testing, performance tuning, deployment, maintenance and support.
Media and Entertainment. We help our media and entertainment clients build products and solutions for all modern platforms including web media streaming and mobile information delivery. Our solutions help clients develop new revenue sources, accelerate the creation, collection, packaging and management of content and reach broader audiences. We serve varied clients in this vertical including search engine providers, entertainment media, news providers, broadcasting companies, financial information providers, content distributors, knowledge management organizations and advertising networks.
Life Sciences and Healthcare. We help our customers in the Healthcare industry respond to changing regulatory environments and improve the quality of care while managing the cost of care. Our professionals deliver an end-to-end experience that includes strategy, architecture, development and managed services to clients ranging from the traditional healthcare providers to innovative startups. In the Life Sciences category, we partner with global pharmaceutical, medical technology and biotechnology companies to deliver sophisticated scientific informatics and innovative enterprise technology solutions. Our personnel in Life Sciences leverage their vast technology expertise to offer deep scientific and mathematical knowledge to broad-based initiatives. Our Life Sciences solutions enable clients to speed research and accelerate time-to-market while improving collaboration, knowledge management and operational excellence.
We also serve the diverse technology needs of clients in the energy, telecommunications, automotive and manufacturing industries, as well as government clients. These clients are included in our Emerging verticals which are further discussed in “Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations” in Part II of this annual report.
Clients
Our clients primarily consist of Forbes Global 2000 corporations located in North America, Europe, CIS and APAC. We maintain a geographically diverse client base with 58.0% of our 2017 revenues derived from clients located in North America, 35.2% from clients in Europe, 4.7% from clients in the CIS and 2.1% from our clients in APAC. Our sustained growth and increased capabilities are furthered by both organic growth and strategic acquisitions. We continually evaluate potential acquisition targets that can expand our vertical-specific domain expertise, geographic footprint, service portfolio, client base and management expertise.
Our focus on delivering quality to our clients is reflected by an average of 94.9% and 85.7% of our revenues in 2017 coming from clients that had used our services for at least one and two years, respectively. We have long-standing relationships with many of our top customers, however, we remain committed to diversifying our client base and we expect client concentration from our top clients to continue to decrease over the long-term. The following table shows revenues from the top five and ten customers in the respective year as a percentage of revenues for that year:
% of Revenues for Year Ended December 31, | ||||||||
2017 | 2016 | 2015 | ||||||
Top five clients | 24.0 | % | 28.4 | % | 32.8 | % | ||
Top ten clients | 33.9 | % | 38.4 | % | 44.1 | % | ||
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 | 2017 | 2016 | 2015 | ||
$0.1 million | 460 | 431 | 365 | ||
$0.5 million | 316 | 266 | 211 | ||
$1 million | 232 | 182 | 136 | ||
$5 million | 63 | 45 | 33 | ||
$10 million | 26 | 19 | 14 | ||
$20 million | 10 | 7 | 7 | ||
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See “Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations” in Part II of this annual report for additional information related to revenue.
See Note 17 “Segment Information” in the notes to our consolidated financial statements in this Annual Report on Form 10-K for information regarding long-lived assets and client revenue by geographic location as well as financial information related to our reportable segments.
Sales and Marketing
Our sales and marketing efforts support our business strategy to increase revenues from new and existing clients through our senior management, sales and business development staff, account managers, and technical specialists. We maintain a dedicated sales force and a marketing team, which coordinates corporate-level branding efforts such as participation in and hosting of industry conferences and events and sponsorship of programming competitions.
Given our focus on providing technical solutions to our clients’ complex challenges, our IT professionals play an integral role in engaging with clients on potential business opportunities. Our account managers maintain direct client relationships and are tasked with identifying new business opportunities and responding to requests-for-proposals (“RFPs”). Account managers typically engage technical and other specialists when pursuing opportunities. This sales model has been effective in promoting repeat 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.
Our Delivery Model
We believe the development of a robust global delivery model creates a key competitive advantage, enabling us to better understand and meet our clients’ diverse needs and to provide a compelling value proposition. We serve clients through on-site, off-site and offshore locations across the world in Belarus, Ukraine, Russia, Hungary, Poland, India, China, Kazakhstan, Mexico, Bulgaria, Armenia, Czech Republic, Slovakia, the United States, Canada, the United Kingdom, Germany, Sweden, Switzerland, Netherlands, the United Arab Emirates, Singapore, Hong Kong, Austria, Spain, Ireland and Australia. Our delivery centers are located strategically to offer a strong, diversified and cost-effective delivery platform to serve clients across North America, Europe and APAC. Our largest delivery centers are located in Belarus, Russia and Ukraine. We continuously grow our delivery platform both organically and through acquired delivery centers and client management locations. Our revenue generating personnel numbered 22,998 as of December 31, 2017.
As of December 31, 2017 we had 7,372 IT professionals located in Belarus. The majority of these IT professionals are located in Minsk, the capital of Belarus, which is well-positioned to serve as a prime IT outsourcing destination given its strong industrial base and established educational infrastructure. Furthermore, the IT industry in Belarus has been strongly supported by its government, which has taken steps to encourage investment in the IT sector through long-term tax incentives.
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. As of December 31, 2017, we had 4,818 IT professionals in Ukraine and 3,802 IT professionals in Russia. Our delivery model has not been materially affected by the political and economic uncertainty in Russia or Ukraine to date.
Our other significant locations with IT professionals are Hungary with 1,460, the United States with 1,316, Poland with 1,167, India with 822 and China with 509 as of December 31, 2017.
Human Capital
Attracting and retaining employees is a key factor in our ability to grow our revenues and meet our clients’ needs. We have dedicated full-time employees that oversee all aspects of our human capital management process including a professional talent acquisition team whose objective is to locate and attract qualified and experienced IT professionals within various EPAM locations. It is critical that we effectively plan our short-term and long-term recruitment needs and deploy the necessary personnel and processes to optimize utilization and quickly satisfy the demands of our clients. As our business grows, we also focus on hiring and retaining individuals with appropriate skills to fill our executive, finance, legal, HR and other key management positions.
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At December 31, 2017, 2016 and 2015, we had a total of 25,962, 22,383 and 18,354 employees, respectively. Of these employees, as of December 31, 2017, 2016 and 2015, respectively, 22,998, 19,670 and 16,078 were revenue generating IT professionals.
In our competitive industry, the ability to hire and retain highly-skilled information technology professionals is critical to our success. We believe the quality of our employees serves as a key point of differentiation in how we deliver a superior value proposition to our clients. To attract, retain and motivate our IT professionals, we offer a challenging work environment, ongoing skills development initiatives, attractive career advancement, and promotion opportunities thus providing an environment and culture that rewards entrepreneurial initiative and performance.
Historically, we developed our base of IT professionals by hiring highly-qualified, experienced IT professionals from the CIS and CEE regions and by recruiting students from the regions’ leading universities. The quality and academic prestige of the CIS and CEE educational systems are renowned worldwide and we have strong relationships with the leading institutions in these geographies. 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.
We believe that we maintain a good working relationship with our employees and our employees have not entered into any collective bargaining agreements (other than broad industry-wide agreements as required in certain countries in Europe and Mexico) or engaged in any labor disputes.
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.
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 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 in order to support the development of middle and senior management through formal leadership training, evaluation, development and promotion.
Quality and Process Management
We have invested resources in developing a proprietary suite of internal applications and tools to manage all aspects of our delivery process. These applications and tools are targeted to reduce costs and security risks, while providing control and visibility across all project lifecycle stages both internally and to our clients. In addition, these applications, tools, methodologies and infrastructure allow us to seamlessly deliver services and solutions to global clients, further strengthening our relationships with them.
We are an ISAE 3402 Type 2 certified IT services provider. This certification is a widely recognized auditing standard developed by the American Institute of Certified Public Accountants 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 27001:2013 and ISO 9001:2015 attestations, underscores our focus on establishing stringent security standards and internal controls.
Our proprietary ISO 9001:2015 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.
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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. |
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, effectiveness and oversight, and improving maintenance time.
Competition
The markets in which we compete are changing rapidly and we face competition from both global technology solutions providers as well as those based primarily in specific geographies with lower cost labor such as CEE, India and China. 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 Accenture, Atos Origin, Capgemini, Cognizant Technology Solutions, Deloitte Digital, DXC Technology, Exlservice, Genpact, GlobalLogic, Globant S.A., HCL Technologies, HP Enterprise, IBM Global Services, Infosys Technologies, Luxoft Holding, Inc., Mindtree, Syntel, Inc., Perficient, Tata Consultancy Services, Virtusa Corporation, and Wipro, among others. Additionally, we compete with numerous smaller local companies in the various geographic markets in which we operate.
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.
Intellectual Property
Protecting our intellectual property rights is important 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. 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, vendors 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 remains confidential.
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We also enter into confidentiality and non-disclosure agreements with our clients. These customary agreements cover our use of the clients’ software systems and platforms as our clients usually own the intellectual property in the products 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.
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, including export restrictions, 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 most recent investor presentation are also available on our website. The information on our website does not constitute a part of this annual report.
Item 1A. Risk Factors
Our operations and financial results are subject to various risks and uncertainties, including but not limited to those described below, which could adversely affect our business, financial condition, results of operations, cash flows, and the trading price of our common stock. You should carefully review the following discussion of the most significant risk factors applicable to us, which we have listed below and are not necessarily in order of importance or probability of occurrence. Additionally, 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, both organically and through acquisitions. 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 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; |
• | coordinating effectively across geographies and business units to execute our strategic plan; and |
• | developing and improving our internal administrative, operational and financial infrastructure. |
Moreover, we intend to continue our expansion for the foreseeable future and pursue available opportunities. As we introduce new services or enter into new markets, we may face new market, technological, operational, compliance and administrative risks and challenges. As a result of these challenges 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.
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Our failure to successfully attract, train and retain new IT professionals with the qualifications necessary to fulfill the needs of our existing and future clients could materially adversely affect our ability to provide high quality services to those clients.
The ability to hire and retain highly-skilled information technology professionals is critical to our success. To maintain and renew existing engagements and obtain new business, we must attract, train and retain skilled IT professionals, including those with management experience. Competition for IT professionals can be intense in the markets where we operate. If we are unable to hire or retain all of the IT professionals necessary to meet our ongoing and future business needs, we may have to forgo projects due to lack of resources.
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. In addition, 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 may suffer.
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 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. Wage inflation may also increase our cost of providing services and reduce our profitability.
Additionally, we have granted certain equity-based awards under our stock incentive plans and entered into other stock-based compensation arrangements in the past, and expect to continue this practice. The expenses associated with stock-based compensation may reduce the attractiveness to us of issuing equity awards under our equity incentive plan. However, if we do not grant equity awards, or if we reduce the value 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 also results 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.
Our profitability will suffer if we are not able to maintain our resource utilization and productivity levels.
Our profitability is significantly impacted by our utilization and productivity levels of fixed-cost resources, such as our professionals as well as other resources such as computers and office space. Our ability to manage our utilization levels depends significantly on our ability to hire and train high-performing IT professionals, to plan effectively for future needs, 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 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.
Our global business exposes us to operational and economic risks.
We are a global company with substantial international operations. Our revenues from clients outside North America represented 42.0%, 42.2% and 46.4% of our revenues including reimbursable expenses and other revenues for 2017, 2016 and 2015, respectively. The majority of our personnel, along with our development and delivery centers, are located in the CIS and CEE. The global nature of our business creates operational and economic risks.
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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, including tariffs, quotas and other trade protection measures; |
• | difficulties in enforcing intellectual property and/or contractual rights; |
• | complying with a wide variety of foreign laws; |
• | potentially adverse tax consequences; |
• | competition from companies with more experience in a particular country or with international operations; and |
• | overall foreign policy and variability of foreign economic conditions. |
We earn our revenues and incur our expenses in multiple currencies, which exposes us to foreign exchange risks relating to revenues, receivables, compensation, purchases and capital expenditures. Currency exchange volatility caused by political or economic instability or other factors, could materially impact our results. See “Item 7A. Quantitative and Qualitative Disclosures about Market Risk.”
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 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 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, India and other Asian countries, which are generally considered to be emerging markets. Emerging markets are vulnerable to market downturns and economic slowdowns elsewhere in the world and are subject to greater risks than more developed markets, including those that may result from foreign laws and regulations, the potential imposition of trade or foreign exchange restrictions or sanctions, tax increases, fluctuations in exchange rates, inflation, unstable political and military situations, labor issues, and less established legal systems. The economies of certain countries where we operate have experienced periods of considerable instability and have been subject to abrupt downturns. Such economic instability and any future deterioration in the international economic situation could materially adversely affect our business, financial condition and results of operations.
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Our operations may be adversely affected by ongoing conflict in Ukraine.
Continuing military activities in Ukraine have combined with Ukraine’s weak economic conditions to fuel ongoing economic uncertainty in Ukraine, Russia and other markets. The European Union, United States and other nations have imposed, and may continue imposing further, economic sanctions, including specific sanctions on certain Russian entities (specifically in the energy, defense and financial sectors). Prolonged political instability in Ukraine, sanctions against Russia and Russia’s potential response to such sanctions could have a material adverse effect on our operations. We have delivery centers in the Ukraine employing 4,818 IT professionals as of December 31, 2017, none of which are located in the most volatile regions of Eastern Ukraine. We also have delivery centers in Russia, employing 3,802 IT professionals as of December 31, 2017 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 needed to support our clients. We continue to monitor the situation closely. Our contingency plans include relocating work and/or personnel to other locations and adding new locations, as appropriate.
The U.S. Congress and Trump administration may make substantial changes to fiscal, political, regulatory and other federal policies that may adversely affect our business, financial condition, operating results and cash flows.
Changes in general economic or political conditions in the United States or other regions could adversely affect our business. For example, the administration under President Donald Trump has indicated that it may propose significant changes with respect to a variety of issues, including international trade agreements, import and export regulations, tariffs and customs duties, foreign relations, immigration laws, and corporate governance laws, that could have a positive or negative impact on our business.
We do not have long-term commitments from our clients, and our clients may terminate contracts before completion or choose not to renew contracts. A loss of business from significant clients could materially affect our results of operations.
Our ability to maintain continuing 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 generally do not have long-term commitments from clients to purchase our services. The ability of our clients to terminate engagements with or without cause makes our future revenues uncertain. 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. Therefore, we must seek to obtain new engagements when our current engagements end.
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 thus compress our margins until we are able to reduce or reallocate our headcount. 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, if not replaced by new client engagements, 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 five specific industry verticals: Financial Services; Software and Hi-Tech; Media and Entertainment; Travel and Consumer; and Life Sciences and Healthcare. Our business growth largely depends on continued demand for our services from clients in these five industry verticals and other industries that we may target in the future, as well as on trends in these industries to outsource IT services.
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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. 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 face a number of risks when pricing our contracts and setting terms with our clients. Our pricing is highly dependent on our internal forecasts, assumptions and predictions about our projects, the marketplace, global economic conditions (including foreign exchange volatility), and 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 may include anticipated long-term cost savings that we expect to achieve and sustain over the life of the contract. Because of these inherent uncertainties, we may 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. 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 costs (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.
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; |
• | 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. 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, failure to effectively manage these large and complex projects could damage our reputation, cause us to lose business, compress our margins and adversely affect our business and results of operations.
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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. Before potential clients commit to use our services, they 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 select another IT service provider or in-house resources to perform the services 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 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 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. There is no guarantee that we will accurately assess the creditworthiness of our clients. If our clients suffer financial difficulties, it 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. We usually bill and collect on relatively short cycles. 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.
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 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, 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 of the emerging markets in which we operate.
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, which could 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, therefore, we may be unable 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. Client buying patterns can change if clients become more price sensitive and accepting of low-cost suppliers with less emphasis on quality.
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 contribute to our efforts to recruit and retain talented employees.
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However, our corporate reputation is potentially susceptible to damage by actions or statements made by current or former clients and employees, 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 untrue, could adversely affect our business. In particular, damage to our reputation could be challenging to repair, could make potential or existing clients reluctant to select us for new engagements, 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, anticipate or respond to these changes 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 materially adversely affect our business.
Undetected software design defects, errors or failures may result in loss of business or in liabilities that could materially adversely affect our business.
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. Physical security and 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. 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 these events. Any such access, disclosure or other loss of information could result in legal claims or proceedings, liability under applicable laws, and regulatory penalties and could adversely affect our business, revenues and competitive position.
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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 personnel, 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 the 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, and could also result in a client terminating our engagement. 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 damages against us, regardless of our responsibility for such failure. The assertion of one or more large claims against us, whether or not successful, could materially adversely affect our reputation, business, financial condition and results of operations.
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. 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. 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 invest substantial cash in new facilities and physical infrastructure, and our profitability could be reduced if our business does not grow proportionately.
As our business grows, we may invest in new facilities and physical infrastructure. 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 do not perform to our expectations, our overall profitability and growth plans could be materially adversely affected.
Part of our expansion strategy includes strategic acquisitions. These transactions involve significant challenges, including the risk that an acquisition does not advance our business strategy, that we do not achieve a satisfactory return on our investment, that we are unable to successfully integrate an acquired company’s employees, client relationships and operations, and that the transactions divert significant management attention and financial resources from our ongoing business. These challenges could disrupt our ongoing business and increase our expenses, including causing us to incur significant one-time expenses and write-offs, and making 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.
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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 such tax laws in multiple jurisdictions; and the resolution of issues arising from tax audits or examinations and any related interest or penalties.
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, but not limited to, 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.
The ongoing effects of the U.S. Tax Cuts and Jobs Act (“U.S. Tax Act”) and the refinement of provisional estimates could make our results difficult to predict.
Our effective tax rate may fluctuate in the future as a result of the U.S. Tax Act, which was enacted on December 22, 2017. The U.S. Tax Act introduces significant changes to U.S. income tax law that will have a meaningful impact on our provision for income taxes. Accounting for the income tax effects of the U.S. Tax Act requires significant judgments and estimates in the interpretation and calculations of the provisions of the U.S. Tax Act.
Due to the timing of the enactment and the complexity involved in applying the provisions of the U.S. Tax Act, we made reasonable estimates of the effects and recorded provisional amounts in our financial statements for the year ended December 31, 2017. The U.S. Treasury Department, the Internal Revenue Service (“IRS”), and other standard-setting bodies may issue guidance on how the provisions of the U.S. Tax Act will be applied or otherwise administered that is different from our interpretation. As we collect and prepare necessary data, and interpret the U.S. Tax Act and any additional guidance issued by the IRS or other standard-setting bodies, we may make adjustments to the provisional amounts that could materially affect our financial position and results of operations as well as our effective tax rate in the period in which the adjustments are made.
Our operating results may be negatively impacted by the loss of certain tax benefits provided by the governments of Belarus and other countries 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 until 2049 and taxed at other reduced rates on a variety of other taxes. 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 these tax benefits 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.”
There may be adverse tax and employment law consequences if the independent contractor status of some of our personnel or the exempt status of our employees is successfully challenged.
Certain of our personnel are retained as independent contractors in several countries. The criteria to determine whether an individual is considered an independent contractor or an employee are typically fact sensitive and vary by jurisdiction, as can the interpretation of the applicable laws. If a government authority or court makes any adverse determination with respect to some or all of our independent contractors, we could incur significant costs, 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. In addition, we classify our U.S. employees as “exempt” or “non-exempt” under the Federal Labor Standards Act (“FLSA”), and the FLSA criteria for these classifications are subject to change from time to time. 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.
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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 some countries in which we operate.
The banking and financial systems in less developed markets where we hold funds 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. A 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 that region, which could materially adversely affect our business and financial condition.
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. 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 some 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 certain vendors; however, these agreements may not fully protect our trade secrets, know-how or other proprietary information in the event of any unauthorized use, misappropriation or disclosure. 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. 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 provide assurance that competitors will not infringe our trademarks, or that we will have adequate resources to enforce our trademarks.
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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.
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 pay damages on behalf of our clients, redesign or cease offering our allegedly infringing services or solutions, or obtain licenses for the intellectual property that 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. 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, 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 anti-bribery and anti-corruption laws in other countries. 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, although adherence to local customs and practices is generally not a defense under U.S. and other anti-bribery laws.
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We have a compliance program with controls and procedures designed to ensure our compliance with the FCPA, OFAC sanctions, and other 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, which could have a material adverse effect on our results of operations and financial condition 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.
Changes in the European regulatory environment regarding privacy and data protection regulations could expose us to risks of noncompliance and costs associated with compliance
In Europe, we are subject to the 1995 European Union Directive on Data Protection (“1995 Data Protection Directive”), which requires European Union member states to impose minimum restrictions on the collection and use of personal data that, in some respects, are more stringent, and impose more significant burdens on subject businesses, than current privacy standards in the United States. We may also face audits or investigations by one or more foreign government agencies relating to our compliance with these regulations that could result in the imposition of penalties or fines. The European Union member state regulations establish several obligations that organizations must follow with respect to use of personal data, including a prohibition on the transfer of personal information from the European Union to other countries whose laws do not protect personal data to an adequate level of privacy or security. On December 15, 2015, the European Parliament and the Council of the European Union reached a political agreement on the future European Union data protection legal framework referred to as the General Data Protection Regulation (“GDPR”), which will replace the 1995 Data Protection Directive. The GDPR will have significant impacts on how businesses can collect and process the personal data of European Union individuals. The GDPR will become effective in May 2018.
The Company is undertaking measures to seek to comply with the GDPR by the effective date. The costs of compliance with, and other burdens imposed by, such laws, regulations and policies that are applicable to us may limit the use and adoption of our products and solutions, alter the way we conduct business and/or could otherwise have a material adverse impact on our results of operations. We may be unsuccessful in establishing legitimate means of transferring data from the European Economic Area, we may experience hesitancy, reluctance, or refusal by European or multi-national customers to continue to use our services due to the potential risk exposure to such customers as a result of the implementation of GDPR, and we and our customers are at risk of enforcement actions taken by the European Union data protection authority until such point in time that we ensure that all data transfers to us from the European Economic Area are legitimized. We may find it necessary to establish systems to maintain EU-origin data in the European Economic Area, which may involve substantial expense and distraction from other aspects of our business. Further, the costs of compliance with, and other burdens imposed by, such laws, regulations and policies that are applicable to us, may limit the use and adoption of our products and solutions and could have a material adverse impact on our results of operations.
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 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 necessary locations around the world depends on their ability to obtain the required visas and work permits, and this process can be lengthy and difficult. Immigration laws 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. It is possible that pending legislation in the United States regarding offshore outsourcing may impose restrictions on our ability to deploy employees holding U.S. work visas to client locations, which could adversely impact our business. 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.
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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.
The 2017, U.S. executive order, “Protecting the Nation From Foreign Terrorist Entry Into the United States,” restricts entry into the United States of non-U.S. nationals from a number of enumerated countries in the Middle East and suspends a visa interview waiver program that was in place at U.S. consulates worldwide. While the travel restrictions do not extend to nationals of CIS and CEE countries, it is possible that there could be delays in visa processing before CIS and CEE nationals can enter the United States and their wait times for visa interviews may increase significantly. Delays in the process to obtain visas may result in delays in the ability of our personnel to travel to meet with our clients, provide services to our clients or to continue to provide services on a timely basis, which could have a material adverse effect on our business, results of operations, financial condition and cash flows.
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. This legislation creates a risk that companies outsourcing their business in whole or in part to an IT services provider effectively give the affected employees of the company or its previous IT services provider, whose positions have been impacted, the right to become employees of the new IT services provider, generally on the same terms and conditions as their original employment. There is also a related risk of unfair dismissal claims arising from dismissals of employees who were employed by the company or the previous IT services provider immediately prior to the outsourcing. This risk could materially affect our ability to obtain new business and 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 for 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.
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, and we cannot be certain that such additional financing would be available on terms acceptable to us. The sale of additional equity securities could result in dilution to our stockholders, and additional indebtedness would result in increased debt service obligations and could impose operating and financial covenants that would restrict our operations.
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 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.
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Our liability-classified restricted stock units, which are subject to mark-to-market accounting, and the calculation of weighted-average diluted shares outstanding in accordance with the treasury method are both affected by our stock price. Any fluctuations in the price of our stock will affect our future operating results.
Item 1B. Unresolved Staff Comments
None.
Item 2. Properties
Our headquarters are located in Newtown, Pennsylvania with delivery centers in Belarus, Ukraine, Russia, Hungary, Poland, India, China, Kazakhstan, Mexico, Bulgaria, Armenia, Czech Republic, Slovakia, the United States, Canada, the United Kingdom, Germany, Sweden, Switzerland, Netherlands, the United Arab Emirates, Singapore, Hong Kong, Austria, Spain, Ireland and Australia. We have office and building space in more than 47 cities and 25 countries around the world. The majority of our office space is leased under long-term leases with varying expiration dates. We own one office building in Minsk, Belarus with a capacity of 21,669 square meters, which is used by both administrative and IT personnel. 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 (“NYSE”) under the symbol “EPAM.”
The price range per share of common stock presented below represents the highest and lowest intraday sales prices for the Company’s common stock on the NYSE during each quarter of the two most recent years.
2017 | ||||||||
Quarter Ended | High | Low | ||||||
December 31 | $ | 109.07 | $ | 86.53 | ||||
September 30 | $ | 88.18 | $ | 77.96 | ||||
June 30 | $ | 86.98 | $ | 73.49 | ||||
March 31 | $ | 76.16 | $ | 63.32 | ||||
2016 | ||||||||
Quarter Ended | High | Low | ||||||
December 31 | $ | 69.20 | $ | 54.53 | ||||
September 30 | $ | 71.79 | $ | 61.47 | ||||
June 30 | $ | 78.40 | $ | 61.32 | ||||
March 31 | $ | 78.04 | $ | 54.88 | ||||
As of February 12, 2018, we had approximately 17 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.
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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 our 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 revolving credit facility restricts our ability to make or pay dividends (other than certain intercompany dividends) unless no potential or actual event of default has occurred or would be triggered thereby.
Equity Compensation Plan Information
See “Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters” in Part III of this Annual Report for our equity compensation plan information.
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 December 31, 2012 and ending December 31, 2017. 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.
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COMPARISON OF CUMULATIVE TOTAL RETURN (1)(2)
Among EPAM, the S&P 500 Index and a Peer Group Index(3) (Capitalization Weighted)
Company/Index | Base period 12/31/2012 | 12/31/2013 | 12/31/2014 | 12/31/2015 | 12/31/2016 | 12/31/2017 | ||||||||||||||||||
EPAM Systems, Inc. | $ | 100.00 | $ | 193.04 | $ | 263.81 | $ | 434.36 | $ | 355.30 | $ | 593.54 | ||||||||||||
Peer Group Index | $ | 100.00 | $ | 144.62 | $ | 148.77 | $ | 162.90 | $ | 141.32 | $ | 165.33 | ||||||||||||
S&P 500 Index | $ | 100.00 | $ | 129.60 | $ | 144.36 | $ | 143.31 | $ | 156.98 | $ | 187.47 | ||||||||||||
(1) | Graph assumes $100 invested on December 31, 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), Globant S.A. (NASDAQ:GLOB), Infosys Ltd ADR (NYSE:INFY), Luxoft Holding, Inc (NASDAQ:LXFT), Syntel, Inc. (NASDAQ:SYNT), and Wipro Ltd. (ADR) (NYSE:WIT). |
Unregistered Sales of Equity Securities
There were no unregistered sales of equity securities by the Company during the year ended December 31, 2017.
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Purchases of Equity Securities by the Issuer and Affiliated Purchasers
Under our equity-based compensation plans, on the date of vesting of stock-based compensation awards to our personnel, the Company withholds a number of shares of vested stock to satisfy tax withholding obligations arising on that date. The number of shares of stock to be withheld is calculated based on the closing price of the Company’s common stock on the vesting date. The following table provides information about shares withheld by the Company during the year ended December 31, 2017:
Period | Total Number of Shares Purchased | Average Price Paid Per Share | Total Number of Shares Purchased as Part of Publicly Announced Plans or Programs | Maximum Dollar Amount of Shares That May Yet Be Purchased Under the Program | |||||||||
March 1, 2017 to March 31, 2017 | 36,629 | $ | 73.54 | — | — | ||||||||
June 1, 2017 to June 30, 2017 | 93 | $ | 83.56 | — | — | ||||||||
July 1, 2017 to July 30, 2017 | 2,889 | $ | 84.33 | — | — | ||||||||
August 1, 2017 to August 31, 2017 | 2,010 | $ | 81.76 | — | — | ||||||||
October 1, 2017 to October 30, 2017 | 406 | $ | 90.80 | — | — | ||||||||
November 1, 2017 to November 30, 2017 | 460 | $ | 103.61 | — | — | ||||||||
December 1, 2017 to December 30, 2017 | 992 | $ | 106.70 | — | — | ||||||||
Total | 43,479 | $ | 75.89 | — | — | ||||||||
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Item 6. Selected Financial Data
The following table represents selected financial data for each of the last five 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 consolidated financial statements and related notes included elsewhere in this annual report.
Year Ended December 31, | |||||||||||||||||||
2017 | 2016 | 2015 | 2014 | 2013 | |||||||||||||||
(in thousands, except per share data) | |||||||||||||||||||
Consolidated Statement of Income Data: | |||||||||||||||||||
Revenues | $ | 1,450,448 | $ | 1,160,132 | $ | 914,128 | $ | 730,027 | $ | 555,117 | |||||||||
Operating expenses: | |||||||||||||||||||
Cost of revenues (exclusive of depreciation and amortization) | 921,352 | 737,186 | 566,913 | 456,530 | 347,650 | ||||||||||||||
Selling, general and administrative expenses | 324,855 | 264,658 | 222,759 | 163,666 | 116,497 | ||||||||||||||
Depreciation and amortization expense | 28,562 | 23,387 | 17,395 | 17,483 | 15,120 | ||||||||||||||
Goodwill impairment loss | — | — | — | 2,241 | — | ||||||||||||||
Other operating expenses/(income), net | 2,733 | 1,205 | 1,094 | 3,924 | (643 | ) | |||||||||||||
Income from operations | 172,946 | 133,696 | 105,967 | 86,183 | 76,493 | ||||||||||||||
Interest and other income, net | 4,601 | 4,848 | 4,731 | 4,769 | 3,077 | ||||||||||||||
Change in fair value of contingent consideration | — | — | — | (1,924 | ) | — | |||||||||||||
Foreign exchange loss | (3,242 | ) | (12,078 | ) | (4,628 | ) | (2,075 | ) | (2,800 | ) | |||||||||
Income before provision for income taxes | 174,305 | 126,466 | 106,070 | 86,953 | 76,770 | ||||||||||||||
Provision for income taxes | 101,545 | 27,200 | 21,614 | 17,312 | 14,776 | ||||||||||||||
Net income | $ | 72,760 | $ | 99,266 | $ | 84,456 | $ | 69,641 | $ | 61,994 | |||||||||
Net income per share of common stock: | |||||||||||||||||||
Basic | $ | 1.40 | $ | 1.97 | $ | 1.73 | $ | 1.48 | $ | 1.35 | |||||||||
Diluted | $ | 1.32 | $ | 1.87 | $ | 1.62 | $ | 1.40 | $ | 1.28 | |||||||||
Shares used in calculation of net income per share: | |||||||||||||||||||
Basic | 52,077 | 50,309 | 48,721 | 47,189 | 45,754 | ||||||||||||||
Diluted | 54,984 | 53,215 | 51,986 | 49,734 | 48,358 | ||||||||||||||
As of December 31, | ||||||||||||||||||||
2017 | 2016 | 2015 | 2014 | 2013 | ||||||||||||||||
(in thousands) | ||||||||||||||||||||
Consolidated Balance Sheet Data: | ||||||||||||||||||||
Cash and cash equivalents | $ | 582,585 | $ | 362,025 | $ | 199,449 | $ | 220,534 | $ | 169,207 | ||||||||||
Accounts receivable, net | $ | 265,639 | $ | 199,982 | $ | 174,617 | $ | 124,483 | $ | 95,431 | ||||||||||
Unbilled revenues | $ | 86,500 | $ | 63,325 | $ | 95,808 | $ | 55,851 | $ | 43,108 | ||||||||||
Property and equipment, net | $ | 86,419 | $ | 73,616 | $ | 60,499 | $ | 55,134 | $ | 53,315 | ||||||||||
Total assets | $ | 1,250,256 | $ | 925,811 | $ | 778,536 | $ | 594,026 | $ | 432,877 | ||||||||||
Long-term debt | $ | 25,033 | $ | 25,048 | $ | 35,000 | $ | — | $ | — | ||||||||||
Total liabilities | $ | 275,309 | $ | 144,399 | $ | 165,313 | $ | 129,976 | $ | 56,776 | ||||||||||
Total stockholders’ equity | $ | 974,947 | $ | 781,412 | $ | 613,223 | $ | 464,050 | $ | 376,101 | ||||||||||
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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.
Executive Summary
We are a leading global provider of product development and software engineering solutions offering specialized technological consulting to many of the world’s leading organizations.
Our clients depend on us to solve their complex technical challenges and rely on our expertise in core engineering, advanced technology, digital engagement and intelligent enterprise development. We are continuously venturing into new industries to expand our core industry client base in software and technology, financial services, media and entertainment, travel and consumer, retail and distribution and life sciences and healthcare. Our teams of developers, architects, strategists, engineers, designers, and product experts have the capabilities and skill sets to deliver business results.
Our global delivery model and centralized support functions, combined with the benefits of scale from the shared use of fixed-cost resources, enhance our productivity levels and enable us to better manage the efficiency of our global operations. 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.
Leveraging our roots in software engineering, along with our vertical expertise and strong strategic partnerships, we have become a recognized brand in software development and end-to-end digital transformation services for our clients. We are confident that our strategy of combining our traditional technology and engineering advantage with proven capabilities in digital transformation, design, and emerging consultancy should enable us to navigate considerable market, geo-political and economic uncertainties.
Overview of 2017 and Financial Highlights
The following table presents a summary of our results of operations for the years ended December 31, 2017, 2016 and 2015:
Year Ended December 31, | ||||||||||||||||||||
2017 | 2016 | 2015 | ||||||||||||||||||
% of revenues | % of revenues | % of revenues | ||||||||||||||||||
(in millions, except percentages and per share data) | ||||||||||||||||||||
Revenues | $ | 1,450.4 | 100.0 | % | $ | 1,160.1 | 100.0 | % | $ | 914.1 | 100.0 | % | ||||||||
Income from operations | $ | 172.9 | 11.9 | % | $ | 133.7 | 11.5 | % | $ | 106.0 | 11.6 | % | ||||||||
Net income | $ | 72.8 | 5.0 | % | $ | 99.3 | 8.6 | % | $ | 84.5 | 9.2 | % | ||||||||
Effective tax rate | 58.3 | % | 21.5 | % | 20.4 | % | ||||||||||||||
Diluted earnings per share | $ | 1.32 | $ | 1.87 | $ | 1.62 | ||||||||||||||
The key highlights of our consolidated results for 2017 were as follows:
• | We recorded revenues of $1.45 billion, or a 25.0% increase from $1.16 billion last year. |
• | Income from operations grew 29.4% to $172.9 million from $133.7 million in 2016. Expressed as a percentage of revenues, income from operations was 11.9% compared to 11.5% last year. The slight increase was primarily driven by improvements in utilization. |
• | Our effective tax rate was 58.3% compared to 21.5% last year. This increase is principally due to the provisional $74.6 million charge related to U.S. Tax Reform in 2017. |
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• | Net income decreased 26.7% to $72.8 million compared to $99.3 million in 2016. Expressed as a percentage of revenues, net income decreased 3.6% compared to last year, which was largely driven by the higher effective tax rate in 2017. |
• | Diluted earnings per share decreased 29.4% to $1.32 for the year ended December 31, 2017 from $1.87 in 2016. |
• | Cash provided by operations increased $30.5 million, or 18.5%, to $195.4 million during 2017. |
The operating results in any period are not necessarily indicative of the results that may be expected for any future period.
Critical Accounting Policies
We prepare our consolidated financial statements in accordance with U.S. generally accepted accounting principles (“GAAP”), which require us to make judgments, estimates and assumptions that affect: (i) the reported amounts of assets and liabilities, (ii) disclosure of contingent assets and liabilities at the end of each reporting period and (iii) the reported amounts of revenues and expenses during each reporting period. We evaluate these estimates and assumptions based on historical experience, knowledge and assessment of current business and other conditions, and expectations regarding the future based on available information and reasonable assumptions, which together form a basis for making judgments about matters not readily apparent from other sources. Since the use of estimates is an integral component of the financial reporting process, actual results could differ from those estimates. Some of our accounting policies require higher degrees of judgment than others in their application. When reviewing our audited consolidated financial statements, you should consider (i) our selection of critical accounting policies, (ii) the judgment and other uncertainties affecting the application of such policies and (iii) the sensitivity of reported results to changes in conditions and assumptions. We consider the policies discussed below to be critical to an understanding of our consolidated financial statements as their application places significant demands on the judgment of our management.
An accounting policy is considered critical if it requires an accounting estimate to be made based on assumptions about matters that are highly uncertain at the time the estimate is made, and if different estimates that reasonably could have been used, or changes in the accounting estimates that are reasonably likely to occur periodically, could materially impact the consolidated financial statements. We believe that the following critical accounting policies are the most sensitive and require more significant estimates and assumptions used in the preparation of our consolidated financial statements. You should read the following descriptions of critical accounting policies, judgments and estimates in conjunction with our audited consolidated financial statements and other disclosures included elsewhere in this annual report.
Revenues — We recognize revenue when realized or realizable and earned, which is when the following criteria are met: persuasive evidence of an arrangement exists; delivery has occurred; the sales price is fixed or determinable; and collectability is reasonably assured. Determining whether and when some of these criteria have been satisfied often involves assumptions and judgments that can have a significant impact on the timing and amount of revenue we report. If there is uncertainty about the project completion or receipt of payment for the services, revenues are deferred until the uncertainty is sufficiently resolved. At the time revenues are recognized, we provide for any contractual deductions and reduce revenues accordingly. We defer amounts billed to our clients for revenues not yet earned. Such amounts are anticipated to be recorded as revenues as services are performed in subsequent periods. Unbilled revenues represent services provided which are billed subsequent to the period end in accordance with the contract terms.
We derive our revenues from a variety of service offerings, which represent specific competencies of our IT professionals. Contracts for these services have different terms and conditions based on the scope, deliverables, and complexity of the engagement, which require management to make judgments and estimates in determining appropriate revenue recognition. Fees for these contracts may be in the form of time-and-materials or fixed-price arrangements.
The majority of our revenues (90.3% of revenues in 2017, 88.2% in 2016 and 85.8% in 2015) are generated under time-and-material contracts whereby revenues are recognized as services are performed with the corresponding cost of providing those services reflected as cost of revenues. The majority of such revenues are billed using hourly, daily or monthly rates by which actual time incurred is charged directly to the client. We expect time-and-material arrangements to continue to comprise the majority of our revenues in the future.
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Revenues from fixed-price contracts (8.3% of revenues in 2017, 10.4% in 2016 and 12.8% in 2015) include fixed-price maintenance and support arrangements, which may exceed one year in duration, as well as fixed-price application development arrangements. Revenues from maintenance and support arrangements are generally recognized ratably over the expected service period. Revenues from fixed-price application development arrangements are determined using the proportional performance method. In instances where final acceptance of the product, system, or solution is specified by the client, revenue is deferred until all acceptance criteria have been met. In the absence of a sufficient basis to measure progress towards completion, revenue is recognized upon receipt of final acceptance from the client. Assumptions, risks and uncertainties inherent in the estimates used in the application of the proportional performance method of accounting could affect the amount of revenues, receivables and deferred revenues at each reporting period.
Business Combinations — We account for our business combinations using the acquisition accounting method, which requires us to determine the fair value of net assets acquired and the related goodwill and other intangible assets in accordance with the FASB ASC Topic 805, “Business Combinations.” We identify and attribute fair values and estimated lives to the intangible assets acquired and allocate the total cost of an acquisition to the underlying net assets based on their respective estimated fair values. Determining the fair value of assets acquired and liabilities assumed requires management’s judgment and involves the use of significant estimates, including projections of future cash inflows and outflows, discount rates, asset lives and market multiples. There are different valuation models for each component, the selection of which requires considerable judgment. These determinations will affect the amount of amortization expense recognized in future periods. We base our fair value estimates on assumptions we believe are reasonable, but recognize that the assumptions are inherently uncertain.
If initial accounting for the business combination has not been completed by the end of the reporting period in which the business combination occurs, provisional amounts are reported to present information about facts and circumstances that existed as of the acquisition date. Once the measurement period ends, which in no case extends beyond one year from the acquisition date, revisions of the accounting for the business combination are recorded in earnings.
Goodwill and Other Intangible Assets — We assess goodwill for impairment on an annual basis as of October 31st, and more frequently if events or changes in circumstances indicate that the fair value of a reporting unit has been reduced below its carrying value. Effective January 1, 2017, we early-adopted ASU 2017-04 which simplifies the subsequent measurement of goodwill by removing the requirement to calculate the implied fair value of goodwill when measuring an impairment. As a result, when conducting our annual goodwill impairment assessment, we use a two-step process. The first step is to perform an optional qualitative evaluation as to whether it is more likely than not that the fair value of a reporting unit is less than its carrying value using an assessment of relevant events and circumstances. In performing this assessment, we are required to make assumptions and judgments including but not limited to an evaluation of macroeconomic conditions as they relate to our business, industry and market trends, as well as the overall future financial performance of a reporting unit and future opportunities in the markets in which it operates. If we determine that it is not more likely than not that the fair value of our reporting unit is less than its carrying value, we are not required to perform any additional tests in assessing goodwill for impairment. However, if we conclude otherwise or elect not to perform the qualitative assessment, we perform a second step consisting of a quantitative assessment of goodwill impairment. This quantitative assessment requires us to estimate impairment by comparing the fair value of a reporting unit with its carrying amount. An impairment charge should be recognized for the amount by which the carrying amount exceeds the reporting unit’s fair value; however, the loss recognized should not exceed the total amount of goodwill allocated to that reporting unit.
Historically, a significant portion of the purchase consideration related to our acquisitions was allocated to customer relationships. In valuing customer relationships, we typically utilize the multi-period excess earnings method, a form of the income approach. The principle behind this method is that the value of the intangible asset is equal to the present value of the after-tax cash flows attributable to the intangible asset only. We amortize our intangible assets that have finite lives on a straight-line basis or, if reliably determinable, the pattern in which the economic benefit of the asset is expected to be consumed utilizing expected discounted future cash flows. Amortization is recorded over the estimated useful lives that predominantly range from five to ten years. We do not have any intangible assets with indefinite useful lives.
We review our intangible assets subject to amortization to determine if any adverse conditions exist or a change in circumstances has occurred that would indicate impairment or a change in the remaining useful life. If the carrying value of an asset exceeds its undiscounted cash flows, we will write down the carrying value of the intangible asset to its fair value in the period identified. In assessing fair value, we must make assumptions regarding estimated future cash flows and discount rates. If these estimates or related assumptions change in the future, we may be required to record impairment charges. If the estimate of an intangible asset’s remaining useful life is changed, we will amortize the remaining carrying value of the intangible asset prospectively over the revised remaining useful life.
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Accounting for Income Taxes — We estimate our income taxes based on the various jurisdictions where we conduct business and we use estimates in determining our provision for income taxes. We estimate separately our deferred tax assets, related valuation allowances, current tax liabilities and deferred tax liabilities. The calculation of our tax liabilities involves dealing with uncertainties in the application of complex tax rules and the potential for future adjustment of our uncertain tax positions by the U.S. Internal Revenue Service or other taxing jurisdictions.
The provision for income taxes includes federal, state, local and foreign taxes. Deferred tax assets and liabilities are recognized for the estimated future tax consequences of temporary differences between the consolidated financial statement carrying amounts and their respective tax bases. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the year in which the temporary differences are expected to be reversed. Changes to enacted tax rates would result in either increases or decreases in the provision for income taxes in the period of change. We evaluate the realizability of deferred tax assets and recognize a valuation allowance when it is more likely than not that all or a portion of deferred tax assets will not be realized.
The realization of deferred tax assets is primarily dependent on future earnings. Any reduction in estimated forecasted results may require that we record valuation allowances against deferred tax assets. Once a valuation allowance has been established, it will be maintained until there is sufficient positive evidence to conclude that it is more likely than not that the deferred tax assets will be realized. A pattern of sustained profitability will generally be considered as sufficient positive evidence to reverse a valuation allowance. If the allowance is reversed in a future period, the income tax provision will be correspondingly reduced. Accordingly, the increase and decrease of valuation allowances could have a significant negative or positive impact on future earnings.
On December 22, 2017, the United States enacted the Tax Cuts and Jobs Act (“U.S. Tax Act”). The U.S. Tax Act significantly changes U.S. corporate income tax laws including a reduction of the U.S. corporate income tax rate from 35.0% to 21.0% effective January 1, 2018 and the creation of a territorial tax system with a one-time transition tax on accumulated foreign subsidiary earnings not previously subject to U.S. income tax. In addition, the Tax Act creates new taxes on certain foreign-sourced earnings and certain related party payments, which are referred to as the global intangible low-taxed income tax and the base erosion anti-abuse tax, respectively.
Due to the timing of the enactment and the complexity involved in applying the provisions of the U.S. Tax Act, we have made reasonable estimates of the effects and recorded provisional amounts in our financial statements as of December 31, 2017. As we collect and prepare necessary data and interpret the U.S. Tax Act and any additional guidance issued by the U.S Treasury Department, the IRS, and other standard-setting bodies, and further refine our calculations, we may make adjustments to the provisional amounts recorded. We will complete our analysis over a one-year measurement period ending in the second half of 2018. Any adjustments during this measurement period will be included in the provision for income taxes in the reporting period when such adjustments are determined.
Stock-Based Compensation — Stock-based compensation expense relating to the issuance of equity-classified share-based awards to employees is based on the fair value of the award at the date of grant, which is expensed over the requisite service period, net of estimated forfeitures. Equity-based awards that do not require future service are expensed immediately.
Adjusting stock-based compensation expense for estimated forfeitures requires judgment. If we change our assumptions, stock-based compensation expense may differ significantly from what we have recorded in the past.
Stock-based compensation expense in a period could be impacted, favorably or unfavorably, by differences between forfeiture estimates and actual forfeitures. If there are any modifications or cancellations of the underlying unvested securities, we may be required to accelerate, increase or cancel any remaining unvested stock-based compensation expense.
Equity-based awards that do not meet the criteria for equity classification are recorded as liabilities and adjusted to fair value based on the closing price of our stock at the end of each reporting period. Future stock-based compensation expense related to our liability-classified awards may increase or decrease as a result of changes in the market price for our stock, adding to the volatility in our operating results.
Our adoption of ASU 2016-09 effective January 1, 2017 increased income tax expense volatility. Our future operating results will depend on the fluctuations in the stock price on the dates the awards vest or options are exercised and the magnitude of transactions occurring in each reporting period, among other factors.
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Change in Presentation of Certain Financial Information — As part of our discussion and analysis, we analyze revenues by client location and by vertical. Prior to the first quarter of 2017, management did not include reimbursable expenses and other revenues in its discussion of revenue performance across locations and verticals. Effective in the first quarter of 2017, we have allocated reimbursable expenses and other revenues (which primarily include travel and entertainment costs chargeable to clients) to corresponding geographies and verticals. We believe this change allows us to more effectively analyze our verticals and geographies by streamlining the presentation of revenues, both internally and externally, using a standardized approach. These changes did not result in any adjustments to our previously issued financial statements and were applied retrospectively beginning on January 1, 2015. Comparative information for the years ended December 31, 2016 and 2015 is presented in the following tables:
Year Ended December 31, 2016 | |||||||||||||
As Reported | After Reclassification | ||||||||||||
Client Location | (in thousands except percentages) | ||||||||||||
North America | $ | 664,598 | 57.3 | % | $ | 670,581 | 57.8 | % | |||||
Europe | 412,075 | 35.5 | % | 417,813 | 36.0 | % | |||||||
CIS | 46,033 | 4.0 | % | 46,115 | 4.0 | % | |||||||
APAC | 24,905 | 2.1 | % | 25,623 | 2.2 | % | |||||||
Reimbursable expenses and other revenues | 12,521 | 1.1 | % | — | — | % | |||||||
Revenues | $ | 1,160,132 | 100.0 | % | $ | 1,160,132 | 100.0 | % | |||||
Year Ended December 31, 2015 | |||||||||||||
As Reported | After Reclassification | ||||||||||||
Client Location | (in thousands except percentages) | ||||||||||||
North America | $ | 485,075 | 53.1 | % | $ | 490,311 | 53.6 | % | |||||
Europe | 352,489 | 38.6 | % | 356,518 | 39.0 | % | |||||||
CIS | 43,043 | 4.7 | % | 43,124 | 4.8 | % | |||||||
APAC | 24,010 | 2.6 | % | 24,175 | 2.6 | % | |||||||
Reimbursable expenses and other revenues | 9,511 | 1.0 | % | — | — | % | |||||||
Revenues | $ | 914,128 | 100.0 | % | $ | 914,128 | 100.0 | % | |||||
Year Ended December 31, 2016 | |||||||||||||
As Reported | After Reclassification | ||||||||||||
Vertical | (in thousands except percentages) | ||||||||||||
Financial Services | $ | 291,845 | 25.2 | % | $ | 295,419 | 25.5 | % | |||||
Travel & Consumer | 259,420 | 22.4 | % | 262,282 | 22.6 | % | |||||||
Software & Hi-Tech | 237,437 | 20.5 | % | 239,316 | 20.6 | % | |||||||
Media & Entertainment | 174,017 | 15.0 | % | 176,325 | 15.2 | % | |||||||
Life Sciences & Healthcare | 105,072 | 9.1 | % | 105,943 | 9.1 | % | |||||||
Emerging Verticals | 79,820 | 6.7 | % | 80,847 | 7.0 | % | |||||||
Reimbursable expenses and other revenues | 12,521 | 1.1 | % | — | — | % | |||||||
Revenues | $ | 1,160,132 | 100.0 | % | $ | 1,160,132 | 100.0 | % | |||||
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Year Ended December 31, 2015 | |||||||||||||
As Reported | After Reclassification | ||||||||||||
Vertical | (in thousands except percentages) | ||||||||||||
Financial Services | $ | 248,526 | 27.2 | % | $ | 250,218 | 27.4 | % | |||||
Travel & Consumer | 215,303 | 23.6 | % | 218,338 | 23.9 | % | |||||||
Software & Hi-Tech | 192,989 | 21.1 | % | 194,575 | 21.3 | % | |||||||
Media & Entertainment | 120,616 | 13.2 | % | 122,098 | 13.4 | % | |||||||
Life Sciences & Healthcare | 73,327 | 8.0 | % | 74,279 | 8.1 | % | |||||||
Emerging Verticals | 53,856 | 5.9 | % | 54,620 | 5.9 | % | |||||||
Reimbursable expenses and other revenues | 9,511 | 1.0 | % | — | — | % | |||||||
Revenues | $ | 914,128 | 100.0 | % | $ | 914,128 | 100.0 | % | |||||
Recent Accounting Pronouncements
See Note 2 “Recent Accounting Pronouncements” in the notes to our consolidated financial statements in this Annual Report on Form 10-K for information regarding recent accounting pronouncements.
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.
Year Ended December 31, | ||||||||||||||||||||
2017 | 2016 | 2015 | ||||||||||||||||||
(in thousands, except percentages and per share data) | ||||||||||||||||||||
Revenues | $ | 1,450,448 | 100.0 | % | $ | 1,160,132 | 100.0 | % | $ | 914,128 | 100.0 | % | ||||||||
Operating expenses: | ||||||||||||||||||||
Cost of revenues (exclusive of depreciation and amortization)(1) | 921,352 | 63.5 | 737,186 | 63.6 | 566,913 | 62.0 | ||||||||||||||
Selling, general and administrative expenses(2) | 324,855 | 22.4 | 264,658 | 22.8 | 222,759 | 24.4 | ||||||||||||||
Depreciation and amortization expense | 28,562 | 2.0 | 23,387 | 2.0 | 17,395 | 1.9 | ||||||||||||||
Other operating expenses, net | 2,733 | 0.2 | 1,205 | 0.1 | 1,094 | 0.1 | ||||||||||||||
Income from operations | 172,946 | 11.9 | 133,696 | 11.5 | 105,967 | 11.6 | ||||||||||||||
Interest and other income, net | 4,601 | 0.3 | 4,848 | 0.4 | 4,731 | 0.5 | ||||||||||||||
Foreign exchange loss | (3,242 | ) | (0.2 | ) | (12,078 | ) | (1.0 | ) | (4,628 | ) | (0.5 | ) | ||||||||
Income before provision for income taxes | 174,305 | 12.0 | 126,466 | 10.9 | 106,070 | 11.6 | ||||||||||||||
Provision for income taxes | 101,545 | 7.0 | 27,200 | 2.3 | 21,614 | 2.4 | ||||||||||||||
Net income | $ | 72,760 | 5.0 | % | $ | 99,266 | 8.6 | % | $ | 84,456 | 9.2 | % | ||||||||
Effective tax rate | 58.3 | % | 21.5 | % | 20.4 | % | ||||||||||||||
Diluted earnings per share | $ | 1.32 | $ | 1.87 | $ | 1.62 | ||||||||||||||
(1) | Included $20,868, $16,619 and $13,695 of stock-based compensation expense for the years ended December 31, 2017, 2016 and 2015, respectively; |
(2) | Included $31,539, $32,625 and $32,138 of stock-based compensation expense for the years ended December 31, 2017, 2016 and 2015, respectively. |
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Revenues
Our revenues are derived primarily from providing software development services to our clients. Revenues include revenue from services as well as license revenues, reimbursable expenses and other revenues.
During the year ended December 31, 2017, our revenues were $1.45 billion, growing 25.0% over last year. Total revenues in 2017 and 2016 included $17.1 million and $12.5 million of reimbursable expenses and other revenues, respectively, which increased 36.9% in 2017 as compared to 2016, but remained relatively flat as a percentage of total revenues. Growth in revenue is attributable to both the expansion of existing business with current clients and deeper penetration into verticals where we have an established and increasing presence.
During 2016, our revenues grew 26.9% over 2015, from $914.1 million to $1.16 billion. Total revenues in 2016 and 2015 included $12.5 million and $9.5 million of reimbursable expenses and other revenues, respectively, which increased by 31.6% in 2016 as compared to 2015, but remained relatively flat as a percentage of total revenues.
We discuss below the breakdown of our revenue by client location, service offering, vertical, contract type, and client concentration.
Revenues by Vertical
We analyze our revenue by separating our clients into five main industry sectors, or verticals, as detailed in the following table. Also, we serve clients in other industries such as oil and gas, telecommunications and several others, which are reported in the aggregate under Emerging Verticals.
Prior to the first quarter of 2017, we did not include reimbursable expenses and other revenues in our revenue results across locations and verticals. Effective in the first quarter of 2017, we have allocated reimbursable expenses and other revenues (which primarily include travel and entertainment costs chargeable to clients) to corresponding geographies and verticals. We believe this change allows us to more effectively analyze our verticals and geographies by streamlining the presentation of revenues, both internally and externally, using a standardized approach. These changes did not result in any adjustments to our previously issued financial statements and were applied retrospectively effective January 1, 2015. Our revenues by vertical and as a percentage of revenue for the periods presented are as follows:
Year Ended December 31, | ||||||||||||||||||||
2017 | 2016 | 2015 | ||||||||||||||||||
Financial Services | $ | 338,899 | 23.4 | % | $ | 295,419 | 25.5 | % | $ | 250,218 | 27.4 | % | ||||||||
Travel and Consumer | 317,415 | 21.9 | 262,282 | 22.6 | 218,338 | 23.9 | ||||||||||||||
Software & Hi-Tech | 287,633 | 19.8 | 239,316 | 20.6 | 194,575 | 21.3 | ||||||||||||||
Media & Entertainment | 256,267 | 17.7 | 176,325 | 15.2 | 122,098 | 13.4 | ||||||||||||||
Life Sciences & Healthcare | 120,591 | 8.3 | 105,943 | 9.1 | 74,279 | 8.1 | ||||||||||||||
Emerging Verticals | 129,643 | 8.9 | 80,847 | 7.0 | 54,620 | 5.9 | ||||||||||||||
Revenues(1) | $ | 1,450,448 | 100.0 | % | $ | 1,160,132 | 100.0 | % | $ | 914,128 | 100.0 | % | ||||||||
(1) | Includes reimbursable expenses of $17,138, $12,521 and $9,511 for the years ended December 31, 2017, 2016 and 2015, respectively. |
Revenues by Client Location
Our revenues are sourced from four geographic markets: North America, Europe, CIS, and APAC. 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 consolidated financial statements included elsewhere in this annual report. Segments are not based on the geographic location of the clients, but instead they are based on the location of the Company’s management responsible for a particular client.
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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, | ||||||||||||||||||||
2017 | 2016 | 2015 | ||||||||||||||||||
(in thousands, except percentages) | ||||||||||||||||||||
North America | $ | 840,692 | 58.0 | % | $ | 670,581 | 57.8 | % | $ | 490,311 | 53.6 | % | ||||||||
Europe | 511,319 | 35.2 | 417,813 | 36.0 | 356,518 | 39.0 | ||||||||||||||
CIS | 68,390 | 4.7 | 46,115 | 4.0 | 43,124 | 4.8 | ||||||||||||||
APAC | 30,047 | 2.1 | 25,623 | 2.2 | 24,175 | 2.6 | ||||||||||||||
Revenues(1) | $ | 1,450,448 | 100.0 | % | $ | 1,160,132 | 100.0 | % | $ | 914,128 | 100.0 | % | ||||||||
(1) | Includes reimbursable expenses of $17,138, $12,521 and $9,511 for the years ended December 31, 2017, 2016 and 2015, respectively. |
2017 compared to 2016
During the year ended December 31, 2017, revenues in our largest geography, North America, closed at $840.7 million growing $170.1 million, or 25.4%, from $670.6 million reported for the year ended December 31, 2016. Revenues from this geography accounted for 58.0% of total revenues in 2017, a level consistent with the prior year.
Within North America, we experienced strong growth across all verticals with the Media and Entertainment vertical contributing 31.7% of total growth in the North American geography. In addition, our traditionally strong Software & Hi-Tech portfolio grew 19.6% year over year. We saw continued growth in Emerging Verticals with 44.2% growth in revenues with 29.7% of the growth coming from customers who have been with us less than one year.
Revenues in our Europe geography were $511.3 million, an increase of $93.5 million, or 22.4% over $417.8 million last year. Revenues in this geography accounted for 35.2% of consolidated revenues in 2017 as compared to 36.0% last year. Europe experienced strong growth in the Media and Entertainment, Life Sciences and Healthcare, and Emerging Verticals, each of which grew over 55% during 2017. Over 70% of the growth in our Europe geography in 2017 came from customers who have been with us less than two years. Financial Services remained our largest vertical in this geography accounting for 41.1% of the Europe geography’s revenues in 2017 as compared to 47.7% in 2016.
Revenues in the CIS geography increased $22.3 million, or 48.3%, from last year. The increase in CIS revenues came predominantly from customers within the Financial Services and Emerging verticals. Revenues in this geography benefited by $5.9 million from the appreciation of the Russian ruble relative to the U.S. dollar.
2016 compared to 2015
During the year ended December 31, 2016, revenues in our largest geography, North America, closed at $670.6 million growing $180.3 million, or 36.8%, from $490.3 million reported for the year ended December 31, 2015. Revenues from this geography accounted for 57.8% of total revenues in 2016, an increase of 4.2% from 53.6% reported in 2015.
Within North America, we experienced strong growth across all verticals despite considerable market, geo-political, and economic uncertainties: each of the two verticals, Media and Entertainment and Life Sciences and Healthcare, grew above 40%; while Emerging Verticals and Financial Services grew 59.6% and 94.9%, respectively. In addition, our traditionally strong Software & Hi-Tech portfolio grew 27.3%, which allowed us to keep this important segment at our strategic target of 20% of consolidated revenues.
We saw continued traction with customers in the pharmaceutical segment of our Life Sciences and Healthcare vertical, and significantly grew our portfolio of customers in Emerging Verticals with over 30% growth in revenues there coming from customers who have been with us less than one year. Combined growth in our Software & Hi-Tech and Media & Entertainment verticals accounted for 48.6% of the overall growth in the North America geography, of which $19.6 million, or 22.4%, was attributable to the expansion of existing relationship with certain long-standing customers within our Media and Entertainment vertical.
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Revenues in our Europe geography were $417.8 million, an increase of $61.3 million, or 17.2% over $356.5 million reported in 2015. Revenues in this geography accounted for 36.0% of consolidated revenues in 2016 as compared to 39.0% in 2015. The slowdown in revenue growth in 2016 was largely attributable to decelerated growth in revenues from our top customer in this geography, coupled with increased internal and external pressures on customers within our Travel and Consumer vertical, and currency headwinds, primarily due to the depreciation of the British pound relative to the U.S. dollar.
Consistent with results in our North America geography, Europe experienced strong growth in the Media and Entertainment, Life Sciences and Healthcare, and Emerging Verticals, each of which grew over 48% during 2016. Over 40% of growth in Life Sciences and Healthcare and Emerging Verticals came from customers who have been with us less than one year. Financial Services remained our largest vertical in this geography and accounted for 34.0% of the overall growth in 2016.
Revenues in the CIS geography showed an increase of $3.0 million, or 6.9%, from 2015. The increase in CIS revenues came predominantly from customers within the Financial Services and Travel and Consumer verticals.
Revenues by Client Concentration
While we seek to grow revenues from our existing clients by continually expanding the scope and size of our engagements, we expect client concentration from our top clients to continue to decrease over the long-term. The following table sets forth revenues including reimbursable expenses contributed by our top one, top five, top ten and top twenty clients by amount and as a percentage of our revenues for the periods indicated:
Year Ended December 31, | ||||||||||||||||||||
2017 | 2016 | 2015 | ||||||||||||||||||
(in thousands, except percentages) | ||||||||||||||||||||
Top client | See (1) | See (1) | $ | 137,599 | 11.9 | % | $ | 130,221 | 14.2 | % | ||||||||||
Top five clients | $ | 348,219 | 24.0 | % | $ | 329,324 | 28.4 | % | $ | 299,655 | 32.8 | % | ||||||||
Top ten clients | $ | 491,742 | 33.9 | % | $ | 445,814 | 38.4 | % | $ | 403,052 | 44.1 | % | ||||||||
Top twenty clients | $ | 648,786 | 44.7 | % | $ | 563,057 | 48.5 | % | $ | 500,186 | 54.7 | % | ||||||||
(1) | No single client comprises more than 10% of the Company’s revenues including reimbursable expenses for the year ended December 31, 2017. |
During the year ended December 31, 2017, our revenue growth outside the top twenty accounts was $204,587 or 34.3%.
We have long-standing relationships with many of our customers, and revenues derived from these customers may fluctuate as these accounts mature or upon completion of multi-year projects. Our focus on delivering quality to our clients is reflected by an average of 94.9% and 85.7% of our revenues in 2017 coming from clients that had used our services for at least one and two years, respectively. While we believe there’s a significant potential for future growth as we expand our capabilities and offerings within specific domains and verticals, we continue to focus on diversification of our client concentration and building up a portfolio of accounts that we believe have significant revenue potential. We anticipate the contribution of these accounts to our total revenues to increase in the mid- to long-term and offset the slower growth rate of some of our largest customers as those accounts mature.
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Revenues by Service Offering
Our end-to-end service offerings are grouped into five main categories with software development representing our core competency and a 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, | ||||||||||||||||||||
2017 | 2016 | 2015 | ||||||||||||||||||
(in thousands, except percentages) | ||||||||||||||||||||
Software development | $ | 1,060,286 | 73.2 | % | $ | 841,916 | 72.6 | % | $ | 644,732 | 70.6 | % | ||||||||
Application testing services | 276,270 | 19.0 | 223,010 | 19.2 | 174,259 | 19.1 | ||||||||||||||
Application maintenance and support | 92,630 | 6.4 | 74,475 | 6.4 | 70,551 | 7.7 | ||||||||||||||
Licensing | 3,529 | 0.2 | 3,141 | 0.3 | 3,764 | 0.4 | ||||||||||||||
Infrastructure services | 595 | — | 5,069 | 0.4 | 11,311 | 1.2 | ||||||||||||||
Reimbursable expenses and other revenues | 17,138 | 1.2 | 12,521 | 1.1 | 9,511 | 1.0 | ||||||||||||||
Revenues | $ | 1,450,448 | 100.0 | % | $ | 1,160,132 | 100.0 | % | $ | 914,128 | 100.0 | % | ||||||||
Revenues by Contract Type
Our engagement models are based 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. Our two types of service arrangements are time-and-material and fixed-price contracts. Historically, the majority of our revenues have been generated under time-and-material contracts and we expect time-and-material arrangements to continue to comprise the majority of our revenues in the future.
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 agreed intervals.
The following table sets forth revenues by contract type by amount and as a percentage of our revenues for the periods indicated:
Year Ended December 31, | ||||||||||||||||||||
2017 | 2016 | 2015 | ||||||||||||||||||
(in thousands, except percentages) | ||||||||||||||||||||
Time-and-material | $ | 1,309,762 | 90.3 | % | $ | 1,023,781 | 88.2 | % | $ | 784,153 | 85.8 | % | ||||||||
Fixed-price | 120,019 | 8.3 | 120,689 | 10.4 | 116,700 | 12.8 | ||||||||||||||
Licensing | 3,529 | 0.2 | 3,141 | 0.3 | 3,764 | 0.4 | ||||||||||||||
Reimbursable expenses and other revenues | 17,138 | 1.2 | 12,521 | 1.1 | 9,511 | 1.0 | ||||||||||||||
Revenues | $ | 1,450,448 | 100.0 | % | $ | 1,160,132 | 100.0 | % | $ | 914,128 | 100.0 | % | ||||||||
Cost of Revenues (Exclusive of Depreciation and Amortization)
The principal components of our cost of revenues (exclusive of depreciation and amortization) are salaries, bonuses, fringe benefits, stock-based compensation expense, project related travel costs and fees for subcontractors who are assigned to client projects. Salaries and other compensation expenses of our revenue generating professionals are reported as cost of revenues regardless of whether the employees are actually performing client services during a given period. Our employees are a critical asset, necessary for our continued success and therefore we expect to continue hiring talented employees and providing them with competitive compensation programs.
We manage the utilization levels of our professionals through strategic hiring and efficient staffing of projects. Some of our IT professionals are 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 projects. 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.
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2017 compared to 2016
During the year ended December 31, 2017, cost of revenues (exclusive of depreciation and amortization) was $921.4 million, representing an increase of 25.0% from $737.2 million reported last year. The increase was primarily due to an increase in compensation costs as a result of a 15.0% growth in the average number of production headcount for the year as well as a 2.3% impact from appreciation of foreign currencies.
Expressed as a percentage of revenues, cost of revenues (exclusive of depreciation and amortization) was 63.5% and 63.6% during the years ended December 31, 2017 and 2016, respectively. Our utilization in 2017 improved by 3.8% as compared to 2016 which was offset by higher compensation expense and the unfavorable impact of appreciation of the Russian ruble, Hungarian forint and Polish zloty as compared to the U.S. dollar.
2016 compared to 2015
During the year ended December 31, 2016, cost of revenues (exclusive of depreciation and amortization) was $737.2 million, representing an increase of 30.0% from $566.9 million reported in 2015. The increase was primarily due to an increase in compensation costs as a result of a 34.2% growth in the average number of production headcount for the year.
Expressed as a percentage of revenues, cost of revenues (exclusive of depreciation and amortization) was 63.6% and 62.0% during the years ended December 31, 2016 and 2015, respectively. Of this increase, 1.5% was attributable to a decrease in utilization during the year ended December 31, 2016, as compared to the same period in 2015.
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 the costs of salaries, bonuses, fringe benefits, stock-based compensation expense, commissions, travel, legal and audit services, insurance, operating leases, advertising and other promotional activities. In addition, we pay a membership fee of 1% of revenues generated in Belarus to the administrative organization of the Belarus Hi-Tech Park.
2017 compared to 2016
As a result of our expanding operations, acquisitions, and the hiring of a number of senior managers to support our growth, our selling, general and administrative expenses have been increasing. During the year ended December 31, 2017, selling, general and administrative expenses were $324.9 million, representing an increase of 22.7% as compared to $264.7 million reported last year. The increase in selling, general and administrative expenses in 2017 was driven by a $27.6 million increase in personnel-related costs, a $16.6 increase related to investments in facilities and infrastructure to support the increased headcount, and $7.0 million of higher spending related to talent acquisition and development.
Expressed as a percentage of revenue, selling, general and administrative expenses decreased 0.4% to 22.4% for the year ended December 31, 2017. We expect our selling, general and administrative expenses to continue to increase in absolute terms as our business expands but generally to remain steady or slightly decrease as a percentage of our revenues over time.
2016 compared to 2015
During the year ended December 31, 2016, selling, general and administrative expenses were $264.7 million, representing an increase of 18.8% as compared to $222.8 million reported in 2015. The increase in selling, general and administrative expenses in 2016 was primarily driven by a $14.6 million increase in personnel-related costs, coupled with a $16.5 million increase in general and administrative expenses related to investments in facilities and infrastructure to support the increased headcount, and $4.0 million higher spending related to talent acquisition and development.
Expressed as a percentage of revenue, selling, general and administrative expenses decreased 1.6% to 22.8% for the year ended December 31, 2016. The decrease was primarily attributable to higher revenue growth as compared to the growth in compensation driven by the increased headcount and wage inflation, coupled with relatively limited growth in stock-based compensation.
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Depreciation and Amortization Expense
2017 compared to 2016
During the year ended December 31, 2017, depreciation and amortization expense was $28.6 million, representing an increase of $5.2 million from $23.4 million reported last year. The increase in depreciation and amortization expense is primarily due to an increase in computer equipment to support headcount growth. Depreciation and amortization expense includes amortization of acquired finite-lived intangible assets. Expressed as a percentage of revenues, depreciation and amortization expense remained consistent during the year ended December 31, 2017 as compared to 2016.
2016 compared to 2015
During the year ended December 31, 2016, depreciation and amortization expense was $23.4 million, representing an increase of $6.0 million from $17.4 million reported in 2015. The increase was predominantly driven by depreciation of computer equipment and infrastructure related to increased headcount and amortization of intangible assets purchased with the acquisitions of businesses completed in 2015. Expressed as a percentage of revenues, depreciation and amortization expense was 2.0%, a slight increase from 1.9% reported in the same period in 2015.
Other Operating Expenses, Net
There were no material changes in other operating expenses, net during the year ended December 31, 2017 as compared to 2016 and 2015.
Interest and Other Income, Net
Interest and other income, net is comprised of interest earned on cash accounts in Belarus, interest earned on employee housing loans, and other income and is partially offset by interest expense related to our revolving credit facility. There were no material changes in interest and other income, net in 2017 as compared to 2016 and 2015.
Provision for Income Taxes
Determining the consolidated provision for income tax expense, deferred income tax assets and liabilities and related valuation allowances, 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 2017, 2016 and 2015, we had $180.9 million, $135.8 million and $113.8 million, respectively, in income before provision for income taxes attributed to our foreign jurisdictions. Changes in the geographic mix or level of annual pre-tax income can 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 expense. 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 provide assurance 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.
In Belarus, member technology companies of High-Technologies Park have a full exemption from Belarus income tax. This tax holiday was recently extended through January 2049. The aggregate dollar benefits derived from this tax holiday approximated $15.5 million, $13.6 million and $20.8 million for the years ended December 31, 2017, 2016 and 2015, respectively. The benefit the tax holiday had on diluted net income per share approximated $0.28, $0.26 and $0.40 for the years ended December 31, 2017, 2016 and 2015, respectively.
As we continue to grow our onsite presence and expand the geographic footprint of our delivery centers, this may result in volatility in our effective tax rate. Other factors that may contribute, favorably or unfavorably, to the overall effective tax rate in 2018 and beyond must be considered as well. These factors include statutory tax rate changes in the countries that are part of our geographic footprint and excess tax benefits upon vesting or exercise of equity awards.
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2017 compared to 2016
The provision for income taxes was $101.5 million in 2017 and $27.2 million in 2016. The increase in the effective tax rate from 21.5% in 2016 to 58.3% in 2017 was primarily due to a provisional $74.6 million charge as a result of the United States Tax Cuts and Jobs Act (“U.S. Tax Act”) enacted on December 22, 2017. The U.S. Tax Act significantly changes U.S. corporate income tax laws including a reduction of the U.S. corporate income tax rate from 35.0% to 21.0% effective January 1, 2018 and the creation of a territorial tax system with a one-time transition tax on accumulated foreign subsidiary earnings not previously subject to U.S. income tax. In addition, the U.S. Tax Act creates new taxes on certain foreign-sourced earnings and certain related party payments, which are referred to as the global intangible low-taxed income tax and the base erosion tax, respectively. The charge was comprised of a $64.3 million provisional charge due to a one-time transition tax on accumulated foreign subsidiary earnings not previously subject to U.S. income tax as well as a $10.3 million provisional charge due to the impact of the change in the U.S. statutory tax rate from 35.0% to 21.0% in the periods in which the net deferred tax assets are expected to be realized as a result of the U.S. Tax Act.
In 2017, we also reassessed our accumulated foreign earnings in light of the U.S. Tax Act and determined $97.0 million of our accumulated earnings in Belarus are no longer indefinitely reinvested. As a result, we recorded a charge of $4.9 million in the provision for income taxes during the year ended December 31, 2017 for the withholding tax that will be payable to Belarus when the earnings are expatriated.
These charges were partially offset by the adoption of a new accounting standard in the first quarter of 2017 whereby excess tax benefits of $9.3 million were recognized for the year ended December 31, 2017 in the income tax provision rather than additional paid-in-capital.
Other factors include changes in the geographic mix of our earnings attributable to foreign operations toward jurisdictions with lower statutory income tax rates as well as small decreases in statutory tax rates in Hungary, Ukraine and the United Kingdom.
2016 compared to 2015
Provision for income taxes was $27.2 million in 2016 and $21.6 million in 2015. The increase in the effective tax rate from 20.4% in 2015 to 21.5% in 2016 was predominantly caused by the changes in the geographic mix of our earnings, including:
• | higher earnings attributable to our U.S. operations in 2016 driven by the growth in onsite presence in the U.S. and lower earnings attributable to foreign jurisdictions due to currency headwinds, among other factors; |
• | changes in the geographic mix of our earnings attributable to foreign operations toward jurisdictions with higher statutory income tax rates; |
• | full-year impact of inclusion of operating results of AGS, a 2015 acquisition with its primary delivery centers in India, which has a significantly higher tax rate. |
Foreign Exchange Gain / Loss
For discussion of the impact of foreign exchange fluctuations see “Item 7A. Quantitative and Qualitative Disclosures About Market Risk — Foreign Exchange Risk.”
Effects of Inflation
Economies in CIS countries, particularly Belarus, Russia, Kazakhstan and Ukraine, have periodically experienced high rates of inflation. Periods of higher inflation may slow economic growth in those countries and as a result negatively impact the business of our existing clients and decrease demand for our services. We do not rely on borrowed funds for operations in those locations; therefore, increases in interest rates typical for inflationary environments do not currently pose a risk to our business. Inflation may increase some of our expenses such as wages.
While inflation may impact our results of operations and financial condition and it is difficult to accurately measure the impact of inflation, we believe the effects of inflation on our results of operations and financial condition are not significant.
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Results by Business Segment
Our operations consist of four reportable segments: North America, Europe, Russia and Other. There were no operations in the Other segment for 2017 and 2016. The segments represent components of EPAM for which separate financial information is available and is used on a regular basis by our chief executive officer, who is also our chief operating decision maker (“CODM”), to determine how to allocate resources and evaluate performance. Our CODM makes business decisions based on segment revenues and operating profit. Segment operating profit is defined as income from operations before unallocated costs. Expenses included in segment operating profit consist principally of direct selling and delivery costs as well as an allocation of certain shared services expenses and facilities costs. 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. Certain expenses that are not controllable at the segment level are not allocated to specific segments.
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. However, in some specific cases, 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 cases, the client’s activity would be reported through that management team’s reportable segment.
Segment revenues from external clients and segment operating profit, before unallocated expenses, for the North America, Europe, Russia and Other reportable segments for the years ended December 31, 2017, 2016 and 2015 were as follows:
Year Ended December 31, | |||||||||||
2017 | 2016 | 2015 | |||||||||
(in thousands) | |||||||||||
Segment revenues: | |||||||||||
North America | $ | 796,126 | $ | 642,216 | $ | 471,603 | |||||
Europe | 593,167 | 474,988 | 400,460 | ||||||||
Russia | 62,994 | 43,611 | 37,992 | ||||||||
Other | — | — | 4,911 | ||||||||
Total segment revenues | $ | 1,452,287 | $ | 1,160,815 | $ | 914,966 | |||||
Segment operating profit/(loss): | |||||||||||
North America | $ | 169,340 | $ | 143,021 | $ | 112,312 | |||||
Europe | 92,080 | 67,545 | 68,717 | ||||||||
Russia | 13,906 | 7,555 | 5,198 | ||||||||
Other | — | — | (94 | ) | |||||||
Total segment operating profit | $ | 275,326 | $ | 218,121 | $ | 186,133 | |||||
North America Segment
2017 compared to 2016
North America segment revenues increased $153.9 million, or 24.0%, over last year and remained consistent at 54.8% and 55.3% of total revenues for 2017 and 2016, respectively. The North America segment’s operating profits increased $26.3 million, or 18.4%, as compared to 2016, to $169.3 million. North America’s operating profit represented 21.3% of North America segment revenues as compared to 22.3% in 2016. The Media & Entertainment, Financial Services & Emerging verticals each grew over 30% as compared to 2016 and in total represented 60.8% of the growth in North America segment revenues from 2016.
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2016 compared to 2015
North America segment revenues were 55.3% and 51.5% of total revenues representing an increase of $170.6 million, or 36.2%, over 2015. The North America segment’s operating profits increased $30.7 million, or 27.3%, as compared to 2015, to $143.0 million net operating profit. North America remains our most profitable segment with operating profit composing 22.3% of North America segment’s revenues. Strong performance of our North America segment was predominantly driven by continued expansion of existing top customer relationships across all our key verticals, as well as strong performance of the U.S. dollar against foreign currencies.
Europe Segment
Our Europe segment includes the business in the APAC region, which is managed by the same management team.
2017 compared to 2016
Europe segment revenues were $593.2 million, representing an increase of $118.2 million, or 24.9%, from last year. During the years ended December 31, 2017 and 2016, revenues from our Europe segment were 40.8% and 40.9% of total segment revenues, respectively. During 2017, this segment’s operating profits increased $24.5 million, or 36.3% as compared to last year, to $92.1 million net operating profit. The Financial Services vertical remained our largest vertical in this segment and grew 5.8% in 2017 as compared to 2016. Over half of the growth in the Europe segment was attributable to the Travel & Consumer and Media & Entertainment verticals.
2016 compared to 2015
Europe segment revenues were $475.0 million, representing an increase of $74.5 million, or 18.6%, from 2015. During the years ended December 31, 2016 and 2015, revenues from our Europe segment were 40.9% and 43.8% of total segment revenues, respectively. During 2016, this segment’s operating profits decreased $1.2 million, or 1.7%, as compared to 2015, to $67.5 million net operating profit.
During 2016, the segment’s operating results were adversely affected by a slowdown in growth of our top customer, significantly increasing pressures on operating margins and overall profitability of the segment. In January 2017, we announced a multi-year arrangement with this customer, which extended our nine-year relationship and established a minimum revenue commitment of at least $300 million over the next three years.
The segment’s operating results were adversely affected by exchange rate fluctuations, and particularly, the depreciation of the British pound relative to the U.S. dollar, which is the primary currency for the majority of the delivery centers that service our U.K. accounts. The Financial Services vertical remained our largest vertical in this segment and accounted for 30.8% of the overall growth of this segment in 2016.
Russia and Other Segments
2017 compared to 2016
Revenues from our Russia reportable segment increased $19.4 million relative to 2016. Operating profits of our Russia segment increased $6.4 million when compared to 2016. Expressed as a percentage of revenues, the Russia segment’s operating profits were 22.1% and 17.3% in 2017 and 2016, respectively. This growth is partially attributable to the strengthening of the Russian ruble against the U.S. dollar during 2017 as compared to 2016. Ongoing economic and geo-political uncertainty in this region as well as significant volatility of the Russian ruble impact this segment.
2016 compared to 2015
During 2016, we completed multi-year engagements with certain customers, which significantly decreased the portfolio of accounts in our Other reportable segment. As a result, managerial responsibility for the remaining accounts in the Other reportable segment was transferred to our Russia segment. This change does not represent a change in our reportable segments, but is rather a movement in responsibility for a number of customers, accounting for less than 1% of total segment revenue.
Revenues from our Russia reportable segment increased $0.7 million relative to the revenues of our Russia and Other segments in 2015. Operating profits of our Russia segment increased $2.5 million when compared to the operating profits of our Russia and Other segments in 2015. Expressed as a percentage of the Russia and Other segments’ revenues, operating profits were 17.3% and 11.9% in 2016 and 2015, respectively.
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Liquidity and Capital Resources
Capital Resources
Historically, cash generated from operations has been our primary source of liquidity to fund operations and investments to support the growth of our business. At December 31, 2017, our principal sources of liquidity were cash and cash equivalents totaling $582.6 million and $273.7 million of available borrowings under our revolving credit facility.
Many of our operations are conducted outside the United States and as of December 31, 2017, $433.5 million of our total cash, including time deposits and restricted cash, was held internationally. Of this amount, $240.1 million was held in CIS countries, and $196.7 million of this total was located in Belarus. Banking and other financial systems in the CIS region are less developed and regulated than in some more developed markets, and bank deposits made by corporate entities in the CIS region are not insured. Our subsidiaries in the CIS and APAC regions do not maintain significant balances denominated in currencies other than U.S. dollars.
All cash and cash equivalents held at locations outside of the United States, except for $97.0 million held in Belarus, are for future operating needs and we have no intention of repatriating those funds. As part of our ongoing liquidity assessments, we regularly monitor the mix of domestic and international cash flows and cash balances and we may decide to repatriate some or all of our funds to the United States. If we decide to remit funds to the United States in the form of dividends, $324.5 million, including all of the total cash held in Belarus, would be subject to foreign withholding taxes. We believe that our available cash and cash equivalents held in the United States and cash flow to be generated from domestic operations will be sufficient to fund our domestic operations and obligations for the foreseeable future.
On May 24, 2017, we entered into a revolving credit facility with PNC Bank, National Association; PNC Capital Markets LLC; Wells Fargo Bank, National Association; Santander Bank, N.A.; Fifth Third Bank and Citibank N.A. to replace the former revolving credit facility. The revolving credit facility provides for a borrowing capacity of $300.0 million with potential to increase the credit facility up to $400.0 million if certain conditions are met. The revolving credit facility will mature and all amounts outstanding thereunder will be due and payable on May 24, 2022. Borrowings under the credit facility may be denominated in United States dollars or, up to a maximum of $100.0 million equivalent in British pounds sterling, Canadian dollars, euros or Swiss francs (or other currencies as may be approved by the administrative agent and the lenders). Borrowings under the 2017 Credit Facility bear interest at either a base rate or Euro-rate plus a margin based on the Company’s leverage ratio. At December 31, 2017, we had outstanding debt of $25.0 million and unused letters of credit issued under the revolving credit facility totaling $1.3 million, primarily for securing collateral requirements under certain insurance programs and office rent, with the balance of the credit limit of $273.7 million remaining available for borrowing.
We were in compliance with all covenants in the revolving credit facility as of December 31, 2017, and anticipate being in compliance with all covenants for the foreseeable future.
Our ability to expand and grow our business in accordance with current plans and to meet our long-term capital requirements will depend on many factors, including the rate at which our cash flows increase or decrease and the availability of public and private debt and equity financing. We may require additional cash resources due to changed business conditions or other future developments, including any investments or acquisitions we may decide to pursue. If our resources are insufficient to satisfy our cash requirements, we may seek to sell additional equity or debt securities or obtain another credit facility.
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Cash Flows
The following table summarizes our cash flows for the periods indicated:
Year Ended December 31, | |||||||||||
2017 | 2016 | 2015 | |||||||||
(in thousands) | |||||||||||
Consolidated Statements of Cash Flow Data: | |||||||||||
Net cash provided by operating activities | $ | 195,364 | $ | 164,817 | $ | 76,393 | |||||
Net cash used in investing activities | (36,173 | ) | (9,322 | ) | (125,494 | ) | |||||
Net cash provided by financing activities | 49,746 | 10,467 | 33,764 | ||||||||
Effect of exchange rate changes on cash and cash equivalents | 11,623 | (3,386 | ) | (5,748 | ) | ||||||
Net increase/(decrease) in cash and cash equivalents | $ | 220,560 | $ | 162,576 | $ | (21,085 | ) | ||||
Cash and cash equivalents, beginning of period | 362,025 | 199,449 | 220,534 | ||||||||
Cash and cash equivalents, end of period | $ | 582,585 | $ | 362,025 | $ | 199,449 | |||||
Operating Activities
2017 Compared to 2016
Net cash provided by operating activities during the year ended December 31, 2017 increased $30.5 million, or 18.5%, to $195.4 million, as compared to 2016 primarily driven by the $39.3 million increase in income from operations. The $74.3 million increase in the provision for income taxes had minimal impact on cash flow as it was offset by a $70.5 million increase in Taxes payable primarily attributable to the U.S. Tax Act which are expected to be paid over the next 8 years.
2016 Compared to 2015
Net cash provided by operating activities during the year ended December 31, 2016 increased $88.4 million, or 115.7%, to $164.8 million, as compared to 2015. The increase in operating cash flows was primarily attributable to higher customer collections as we made substantial progress in managing our billed and unbilled trade receivables, and decreased the ratio of billed and unbilled trade receivables to revenues over the course of 2016.
Investing Activities
2017 Compared to 2016
Net cash used in investing activities during the year ended December 31, 2017 was $36.2 million compared to $9.3 million used in the same period in 2016. During 2017, the investing cash outflow was primarily attributed to capital expenditures of $29.8 million and was consistent with capital expenditures of $29.3 million in 2016. Our capital expenditures during 2017 were driven by our continuous investment in facilities and computer equipment to support our increased headcount. Cash inflows during 2016 included a $30.0 million increase in cash upon maturity of certain time deposits, while there were no material time deposit maturities during 2017.
2016 Compared to 2015
Net cash used in investing activities during the year ended December 31, 2016 was $9.3 million compared to $125.5 million used in the same period in 2015. During 2016, cash spent on capital expenditures increased by $11.4 million which was more than offset by a $71.4 million decrease in cash spent on acquisitions of businesses in 2016 and a $59.5 million increase in net cash inflows as a result of movements in restricted cash and time deposits.
Financing Activities
2017 Compared to 2016
During the year ended December 31, 2017, net cash provided by financing activities was $49.7 million, representing a $39.3 million increase from $10.5 million cash provided by financing activities in 2016. The increase was primarily attributable to higher proceeds from increased exercises of stock options issued under our long-term incentive plans. During 2017, stock option exercises contributed $54.0 million of cash compared to $18.0 million during 2016.
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2016 Compared to 2015
During the year ended December 31, 2016, net cash provided by financing activities was $10.5 million, representing a $23.3 million decrease from $33.8 million cash provided by financing activities in 2015. The decrease was primarily attributable to a $45.1 million decrease related to borrowings under our revolving credit facility coupled with lower proceeds related to our long-term incentive plans. This was partially offset by lower payments of deferred consideration related to acquisitions of businesses which decreased $28.0 million in 2016 compared to last year.
Contractual Obligations and Future Capital Requirements
Contractual Obligations
Set forth below is information concerning our significant fixed and determinable contractual obligations as of December 31, 2017.
Total | Less than 1 Year | 1-3 Years | 3-5 Years | More than 5 Years | |||||||||||||||
(in thousands) | |||||||||||||||||||
Operating lease obligations | $ | 138,501 | $ | 39,359 | $ | 47,914 | $ | 25,628 | $ | 25,600 | |||||||||
Cash-settled restricted stock units(1) | 33,822 | 9,836 | 19,568 | 4,418 | — | ||||||||||||||
Long-term debt obligations(2) | 27,459 | 564 | 1,110 | 25,785 | — | ||||||||||||||
Total contractual obligations | $ | 199,782 | $ | 49,759 | $ | 68,592 | $ | 55,831 | $ | 25,600 | |||||||||
(1) | We estimate our future obligations for cash-settled restricted stock units issued under our long-term incentive plan by assuming the price per share of our common stock in effect at December 31, 2017 remains constant into the future. This is an estimate and ultimate payout will vary as our stock price varies over time. |
(2) | We estimate our future obligations for interest on our floating rate 2017 Credit Facility by assuming the weighted average interest rates in effect on each floating rate debt obligation at December 31, 2017 remain constant into the future. This is an estimate, as actual rates will vary over time. In addition, for the 2017 Credit Facility, we assume that the balance outstanding as of December 31, 2017 remains the same for the remaining term of the agreement. The actual balance outstanding under our 2017 Credit Facility may fluctuate significantly in future periods, depending on the availability of cash flow from operations and future investing and financing considerations. |
Letters of credit
At December 31, 2017, we had two irrevocable standby letters of credit totaling $1.3 million under the 2017 Credit Facility, which are required to secure commitments for certain insurance policies and office rent. The letters of credit expire on April 27, 2018 and August 20, 2018, respectively with a possibility of automatic extension for an additional period of one year from the present or any future expiration date.
Future Capital Requirements
We believe that our existing cash and cash equivalents combined with our expected cash flow from operations will be sufficient to meet our projected operating and capital expenditure requirements for at least the next twelve months and that we possess the financial flexibility to execute our strategic objectives, including the ability to make acquisitions and strategic investments in the foreseeable future. However, our ability to generate cash is subject to our performance, general economic conditions, industry trends and other factors. To the extent that existing cash and cash equivalents and operating cash flow are insufficient to fund our future activities and requirements, we may need to raise additional funds through public or private equity or debt financing. If we issue equity securities in order to raise additional funds, substantial dilution to existing stockholders may occur. If we raise cash through the issuance of additional indebtedness, we may be subject to additional contractual restrictions on our business. There is no assurance that we would be able to raise additional funds on favorable terms or at all.
Off-Balance Sheet Commitments and Arrangements
We do not have any obligations under guarantee contracts or other contractual arrangements other than as disclosed in Note 15 “Commitments and Contingencies” in the notes to our consolidated financial statements in this Annual Report on Form 10-K. We have not entered into any transactions with unconsolidated entities where we have financial guarantees, subordinated retained interests, derivative instruments, or other contingent arrangements that expose us to material continuing risks, contingent liabilities, or any other obligation under a variable interest in an unconsolidated entity that provides financing, liquidity, market risk, or credit risk support to us, or engages in leasing, hedging, or research and development services with us.
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Item 7A. Quantitative and Qualitative Disclosures About Market Risk
We are exposed to certain market risks in the ordinary course of our business. These risks result primarily from concentrations of credit, changes in foreign currency exchange rates and interest rates. In addition, our international operations are subject to risks related to differing economic conditions, changes in political climate, differing tax structures, and other regulations and restrictions.
Concentration of Credit and Other Credit Risks
Financial instruments that potentially subject us to significant concentrations of credit risk consist primarily of cash and cash equivalents, trade accounts receivable and unbilled revenues.
We maintain our cash and cash equivalents and short-term investments with financial institutions. We believe that our credit policies reflect normal industry terms and business risk. We do not anticipate non-performance by the counterparties. We hold a significant balance of cash in banks in the CIS countries where banking and other financial systems generally do not meet the banking standards of more developed markets and bank deposits made by corporate entities in the CIS region are not insured. As of December 31, 2017, $240.1 million of total cash was held in banks in CIS countries, of which $196.7 million was held in Belarus. The CIS banking sector remains subject to periodic instability and the transparency of the banking sector lags behind international standards. Particularly in Belarus, a banking crisis, bankruptcy or insolvency of banks that process or hold our funds, may result in the loss of our deposits or adversely affect our ability to complete banking transactions in the region, which could have a material adverse impact on our business and financial condition. Cash in other CIS locations is used for short-term operational needs and cash balances in those banks move with the needs of the entities.
Accounts receivable and unbilled revenues are generally dispersed across many clients operating in different industries; therefore, concentration of credit risk is limited. As of December 31, 2017 there were no customers individually exceeding 10% of our billed trade receivables. As of December 31, 2017, unbilled trade receivables from one customer individually exceeded 10% and accounted for 13.0% of our total unbilled trade receivables.
There were no customers individually exceeding 10% of our total revenues as of December 31, 2017. During the years ended December 31, 2016 and 2015, the Company had one customer, UBS AG, which contributed revenues including reimbursable expenses and other revenues of $137.6 million and $130.2 million, respectively, which accounted for more than 10% of total revenues in the periods indicated.
During the year ended December 31, 2017, our top five customers accounted for 24.0% of our total revenues, and our top ten customers accounted for 33.9% of our total revenues. During the year ended December 31, 2016, our top five customers accounted for 28.4% of our total revenues, and our top ten customers accounted for 38.4% of our total revenues.
Historically, credit losses and write-offs of trade accounts receivable balances have not been material to our consolidated financial statements. However, our results of operations depend on our ability to successfully collect payment from our clients for work performed.
Interest Rate Risk
Our exposure to market risk is influenced by the changes in interest rates on our cash and cash equivalent deposits and paid on any outstanding balance on our borrowings, mainly under our 2017 Credit Facility, which is subject to a variety of rates depending on the type and timing of funds borrowed. We do not believe we are exposed to material direct risks associated with changes in interest rates related to these borrowings and deposits and we have not been exposed to material risks due to changes in market interest rates and, therefore, we do not use derivative financial instruments to hedge our risk of interest rate volatility.
Foreign Exchange Risk
Our global operations are conducted predominantly in U.S. dollars. Other than U.S. dollars, we generate a significant portion of our revenues in various currencies, principally, euros, British pounds, Canadian dollars, Swiss francs and Russian rubles and incur expenditures principally in Hungarian forints, Russian rubles, Polish zlotys, Swiss francs, British pounds, Indian rupees and Chinese yuan renminbi associated with the location of our delivery centers.
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Our international operations expose us to foreign currency exchange rate changes that could impact translations of foreign denominated assets and liabilities into U.S. dollars and future earnings and cash flows from transactions denominated in different currencies. We are exposed to fluctuations in foreign currency exchange rates primarily on accounts receivable and unbilled revenues from sales in foreign currencies and cash outflows for expenditures in foreign currencies. Our results of operations, primarily revenues and expenses denominated in foreign currencies, can be affected if any of the currencies which we use materially in our business appreciate or depreciate against the U.S. dollar. Additionally, to the extent that we need to convert U.S. dollars into foreign currencies for our operations, appreciation of such foreign currencies against the U.S. dollar would adversely affect the amount of such foreign currencies we receive from the conversion.
During the year ended December 31, 2017, foreign exchange losses decreased $8.8 million to $3.2 million compared to a $12.1 million loss reported last year. The improvement in foreign exchange impact was primarily driven by movements in exchange rates relative to local currencies in our foreign operations, particularly Russian rubles and British pounds.
Management supplements results reported in accordance with United States generally accepted accounting principles, referred to as GAAP, with non-GAAP financial measures. Management believes these measures help illustrate underlying trends in our business and uses the measures to establish budgets and operational goals, communicated internally and externally, for managing our business and evaluating its performance. When important to management’s analysis, operating results are compared on the basis of “constant currency”, which is a non-GAAP financial measure. This measure excludes the effect of foreign currency exchange rate fluctuations by translating the current period revenues and expenses into U.S. dollars at the weighted average exchange rates of the prior period of comparison.
During the year ended December 31, 2017, we reported revenue growth of 25.0%. Had our consolidated revenues been expressed in constant currency terms using the exchange rates in effect during 2016, we would have reported revenue growth of 23.9%. During 2017, revenues have benefited from the appreciation of the Russian ruble and euro relative to the U.S. dollar which was partially offset by the overall depreciation in British pounds relative to the U.S. dollar. During the year ended December 31, 2017, foreign currency fluctuation did not have a significant impact on our net income expressed in constant currency terms as we continue to be naturally diversified across locations and currencies in which we operate.
During the year ended December 31, 2017, approximately 36.0% of consolidated revenues and 41.7% of operating expenses were denominated in currencies other than the U.S. dollar.
Item 8. Financial Statements and Supplementary Data
The information required is included in this Annual Report on Form 10-K beginning on page F-1.
Item 9. Changes In and Disagreements with Accountants on Accounting and Financial Disclosure
None.
Item 9A. Controls and Procedures
Conclusion Regarding the Effectiveness of Disclosure Controls and Procedures
Based on management’s evaluation, with the participation of our Chief Executive Officer and Chief Financial Officer, as of the end of the period covered by this report, these officers have concluded that our disclosure controls and procedures, as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended (the “Exchange Act”), are effective to provide reasonable assurance that information required to be disclosed by us in reports that we file or submit under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in SEC rules and forms, and is accumulated and communicated to management, including our principal executive officer and principal financial officer, as appropriate, to allow timely decisions regarding required disclosure.
Changes in Internal Control Over Financial Reporting
There were no changes in our internal control over financial reporting during the quarter ended December 31, 2017 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.
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Management’s Report on Internal Control Over Financial Reporting
Our management is responsible for establishing and maintaining adequate internal control over financial reporting as defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with U.S. generally accepted accounting principles.
Under the supervision and with the participation of our management, including our principal executive officer and principal financial officer, we conducted an evaluation of the effectiveness of our internal control over financial reporting based on the criteria established in Internal Control — Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission.
Based on this assessment, management concluded that our internal control over financial reporting was effective as of December 31, 2017 to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with U.S. generally accepted accounting principles.
The effectiveness of our internal control over financial reporting as of December 31, 2017 has been audited by Deloitte & Touche LLP, an independent registered public accounting firm, as stated in their report, which appears in “Part IV. Item 15 Exhibits, Financial Statement Schedule” of this Annual Report on Form 10-K.
Inherent Limitations on Effectiveness of Controls
Our management, including the CEO and CFO, does not expect that our disclosure controls or our internal control over financial reporting will prevent or detect all errors and all fraud. A control system, no matter how well designed and operated, can provide only reasonable, not absolute, assurance that the control system’s objectives will be met. The design of a control system must reflect the fact that there are resource constraints, and the benefits of controls must be considered relative to their costs. Further, because of the inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that misstatements due to error or fraud will not occur or that all control issues and instances of fraud, if any, have been detected. The design of any system of controls is based in part on certain assumptions about the likelihood of future events, and there can be no assurance that any design will succeed in achieving its stated goals under all potential future conditions. Projections of any evaluation of the effectiveness of controls to future periods are subject to risks. Over time, controls may become inadequate because of changes in conditions or deterioration in the degree of compliance with policies or procedures.
Item 9B. Other Information
None.
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PART III
Item 10. Directors, Executive Officers and Corporate Governance
We incorporate by reference the information required by this Item from the information set forth under the captions “Board of Directors”, “Corporate Governance”, “Our Executive Officers”, and “Section 16(a) Beneficial Ownership Reporting Compliance” in our definitive proxy statement for our 2018 annual meeting of stockholders, to be filed within 120 days after the end of the year covered by this Annual Report on Form 10-K, pursuant to Regulation 14A under the Securities Exchange Act of 1934, as amended ( our “2018 Proxy Statement”).