Document
 

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

FORM 10-Q

x QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended September 30, 2018

OR

¨ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from ________to________

Commission file number: 001-35418

EPAM SYSTEMS, INC.
(Exact Name of Registrant as Specified in its Charter)


Delaware
22-3536104
(State or other jurisdiction of
incorporation or organization)
(I.R.S. Employer
Identification No.)
 
 
41 University Drive, Suite 202
Newtown, Pennsylvania
18940
(Address of principal executive offices)
(Zip code)
267-759-9000
(Registrant’s telephone number, including area code)

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 whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company” and “emerging growth 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 Exchange Act).    Yes  ¨    No   x
Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date.
Title of Each Class
Outstanding as of October 31, 2018
Common Stock, par value $0.001 per share
54,009,372 shares

 


EPAM SYSTEMS, INC.

TABLE OF CONTENTS

 
Page



Table of Contents

PART I. FINANCIAL INFORMATION
Item 1. Financial Statements (Unaudited)
EPAM SYSTEMS, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
(Unaudited)
(In thousands, except share and per share data)

 
As of  
 September 30, 
 2018
 
As of  
 December 31, 
 2017
Assets
 
 
 
Current assets
 
 
 
Cash and cash equivalents
$
685,108

 
$
582,585

Accounts receivable, net of allowance of $3,039 and $1,186, respectively
282,276

 
265,639

Unbilled revenues
129,683

 
86,500

Prepaid and other current assets, net of allowance of $50 and $45, respectively
29,646

 
23,196

Employee loans, current, net of allowance of $23 and $0, respectively
2,289

 
2,113

Total current assets
1,129,002

 
960,033

Property and equipment, net
99,465

 
86,419

Employee loans, noncurrent, net of allowance of $0 and $0, respectively
1,456

 
2,097

Intangible assets, net
52,669

 
44,511

Goodwill
144,987

 
119,531

Deferred tax assets
61,905

 
24,974

Other noncurrent assets, net of allowance of $0 and $140, respectively
14,498

 
12,691

Total assets
$
1,503,982

 
$
1,250,256

 
 
 
 
Liabilities
 

 
 

Current liabilities
 

 
 

Accounts payable
$
8,422

 
$
5,574

Accrued expenses and other current liabilities
98,442

 
89,812

Due to employees
52,405

 
38,757

Deferred compensation due to employees
9,174

 
5,964

Taxes payable
52,530

 
40,860

Total current liabilities
220,973

 
180,967

Long-term debt
25,028

 
25,033

Taxes payable, noncurrent

50,242

 
59,874

Other noncurrent liabilities
11,804

 
9,435

Total liabilities
308,047

 
275,309

Commitments and contingencies (Note 11)


 


Stockholders’ equity
 

 
 

Common stock, $0.001 par value; 160,000,000 authorized; 54,011,579 and 53,003,420 shares issued, 53,991,844 and 52,983,685 shares outstanding at September 30, 2018 and December 31, 2017, respectively
54

 
53

Additional paid-in capital
530,837

 
473,874

Retained earnings
699,568

 
518,820

Treasury stock
(177
)
 
(177
)
Accumulated other comprehensive loss
(34,347
)
 
(17,623
)
Total stockholders’ equity
1,195,935

 
974,947

Total liabilities and stockholders’ equity
$
1,503,982

 
$
1,250,256


The accompanying notes are an integral part of the unaudited condensed consolidated financial statements.

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Table of Contents

EPAM SYSTEMS, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF INCOME AND COMPREHENSIVE INCOME
(Unaudited)
(In thousands, except share and per share data)

 
Three Months Ended 
 September 30,
 
Nine Months Ended 
 September 30,
 
2018
 
2017
 
2018
 
2017
Revenues
$
468,186

 
$
377,523

 
$
1,337,981

 
$
1,051,151

Operating expenses:
 
 
 
 
 
 
 
Cost of revenues (exclusive of depreciation and amortization)
301,081

 
239,369

 
867,890

 
667,231

Selling, general and administrative expenses
92,490

 
81,190

 
272,110

 
240,062

Depreciation and amortization expense
9,319

 
7,174

 
26,457

 
20,866

Other operating expenses, net
736

 
542

 
4,030

 
2,096

Income from operations
64,560

 
49,248

 
167,494

 
120,896

Interest and other income, net
1,941

 
1,416

 
2,442

 
2,802

Foreign exchange (loss)/gain
(514
)
 
(77
)
 
1,069

 
(1,470
)
Income before provision for/(benefit from) income taxes
65,987

 
50,587

 
171,005

 
122,228

Provision for/(benefit from) income taxes
369

 
7,953

 
(9,286
)
 
18,594

Net income
$
65,618

 
$
42,634

 
$
180,291

 
$
103,634

Foreign currency translation adjustments, net of tax
(2,118
)
 
5,703

 
(14,643
)
 
16,640

Unrealized net loss on cash-flow hedging instruments, net of tax
(74
)
 

 
(2,081
)
 

Comprehensive income
$
63,426

 
$
48,337

 
$
163,567

 
$
120,274

 
 
 
 
 
 
 
 
Net income per share:
 
 
 
 
 
 
 
Basic
$
1.22

 
$
0.81

 
$
3.37

 
$
2.00

Diluted
$
1.15

 
$
0.77

 
$
3.19

 
$
1.90

Shares used in calculation of net income per share:
 
 
 
 
 
 
 
Basic
53,851,865

 
52,545,155

 
53,485,339

 
51,806,700

Diluted
56,962,867

 
55,228,781

 
56,599,638

 
54,661,196


The accompanying notes are an integral part of the unaudited condensed consolidated financial statements.


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Table of Contents

EPAM SYSTEMS, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
(In thousands)

                                               
Nine Months Ended 
 September 30,
 
2018
 
2017
Cash flows from operating activities:
 
 
 
Net income
$
180,291

 
$
103,634

Adjustments to reconcile net income to net cash provided by operating activities:
 
 
 
Depreciation and amortization expense
26,457

 
20,866

Bad debt expense
1,765

 
79

Deferred taxes
(36,372
)
 
1,386

Stock-based compensation expense
46,736

 
39,920

Other
(3,434
)
 
(3,496
)
Changes in operating assets and liabilities:
 

 
 

(Increase)/decrease in operating assets:
 

 
 

Accounts receivable
(16,258
)
 
(24,396
)
Unbilled revenues
(41,544
)
 
(42,540
)
Prepaid expenses and other assets
(1,765
)
 
2,036

Increase/(decrease) in operating liabilities:
 

 
 

Accounts payable
1,574

 
1,885

Accrued expenses and other liabilities
9,625

 
18,725

Due to employees
4,009

 
5,939

Taxes payable
(1,996
)
 
(2,458
)
Net cash provided by operating activities
169,088

 
121,580

Cash flows from investing activities:
 

 
 

Purchases of property and equipment
(27,465
)
 
(16,881
)
Employee housing loans issued
(264
)
 
(618
)
Proceeds from repayments of employee housing loans
1,213

 
1,897

Decrease/(increase) in time deposits, net
418

 
(408
)
Acquisition of businesses, net of cash acquired
(50,264
)
 
(6,810
)
Other investing activities, net
(1,471
)
 
(1,304
)
Net cash used in investing activities
(77,833
)
 
(24,124
)
Cash flows from financing activities:
 

 
 

Proceeds from stock option exercises
32,007

 
44,315

Payments of withholding taxes related to net share settlements of restricted stock units
(7,068
)
 
(3,088
)
Proceeds from debt (Note 6)

 
25,000

Repayment of debt (Note 6)
(3,485
)
 
(25,089
)
Other financing activities, net
(603
)
 
(922
)
Net cash provided by financing activities
20,851

 
40,216

Effect of exchange rate changes on cash, cash equivalents and restricted cash
(8,660
)
 
10,435

Net increase in cash, cash equivalents and restricted cash
103,446

 
148,107

Cash, cash equivalents and restricted cash, beginning of period
582,855

 
364,664

Cash, cash equivalents and restricted cash, end of period
$
686,301

 
$
512,771




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Table of Contents

EPAM SYSTEMS, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
(In thousands)
(Continued)

The following table provides a reconciliation of cash, cash equivalents and restricted cash reported within the condensed consolidated balance sheets:
                                               
As of  
 September 30, 
 2018
 
As of
December 31,
2017
Balance sheet classification
 
 
 
Cash and cash equivalents
$
685,108

 
$
582,585

 
 
 
 
Restricted cash in Prepaid and other current assets
56

 
91

Restricted cash in Other noncurrent assets
1,137

 
179

Total restricted cash
1,193

 
270

Total cash, cash equivalents and restricted cash
$
686,301

 
$
582,855


The accompanying notes are an integral part of the unaudited condensed consolidated financial statements.

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Table of Contents

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
(In thousands, except share and per share data)
 
1.
SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES    
EPAM Systems, Inc. (the “Company” or “EPAM”) is a leading global provider of digital platform engineering and software development services to clients located around the world, primarily in North America, Europe, Asia and Australia. The Company has expertise in various industries, including software and hi-tech, financial services, business information and media, travel and hospitality, retail and distribution and life sciences and healthcare. The Company is incorporated in Delaware and headquartered in Newtown, PA.
Basis of Presentation — The accompanying unaudited condensed consolidated financial statements of EPAM have been prepared in accordance with generally accepted accounting principles in the United States (“GAAP”) and Article 10 of Regulation S-X under the Securities Exchange Act of 1934, as amended. The condensed consolidated financial statements include the financial statements of EPAM Systems, Inc. and its subsidiaries with all intercompany balances and transactions eliminated.
These unaudited condensed consolidated financial statements and accompanying notes should be read in conjunction with the Company’s audited consolidated financial statements and the notes thereto for the year ended December 31, 2017 included in its Annual Report on Form 10-K. The preparation of these condensed consolidated financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the amounts reported in these condensed consolidated financial statements and accompanying notes. Actual results could differ from those estimates, and such differences may be material to the condensed consolidated financial statements. Operating results for the interim periods are not necessarily indicative of results that may be expected to occur for the entire year. In management’s opinion, all adjustments considered necessary for a fair presentation of the accompanying unaudited condensed consolidated financial statements have been included, and all adjustments are of a normal and recurring nature.
Adoption of New Accounting Standards
Unless otherwise discussed below, the adoption of new accounting standards did not have an impact on the Company’s consolidated financial position, results of operations, and cash flows.
Revenue Recognition — Effective January 1, 2018, the Company adopted the new accounting standard ASU 2014-09, Revenue from Contracts with Customers (Topic 606) as amended using the modified retrospective method. The standard effectively replaced previously existing revenue recognition guidance (Topic 605) and requires entities to recognize revenue to depict the transfer of promised goods or services in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services as well as requires additional disclosure about the nature, amount, timing and uncertainty of revenues and cash flows arising from customer contracts, including significant judgments and changes in judgments.
The following table summarizes the cumulative effect of adopting Topic 606 using the modified retrospective method of adoption as of January 1, 2018:
 
Balance as of
December 31, 2017
 
Adjustments
Due to Topic 606
 
Balance as of
January 1, 2018
Balance Sheet
 
 
 
 
 
Assets
 
 
 
 
 
   Unbilled revenues
$
86,500

 
$
(78
)
 
$
86,422

   Deferred tax assets
$
24,974

 
$
(173
)
 
$
24,801

Liabilities
 
 
 
 
 
    Accrued expenses and other current liabilities
$
89,812

 
$
(708
)
 
$
89,104

Stockholders’ equity
 
 
 
 
 
    Retained earnings
$
518,820

 
$
457

 
$
519,277

The Company applied a practical expedient to aggregate the effect of all contract modifications that occurred before the adoption date.

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Table of Contents

See Note 7 “Revenues” in the condensed consolidated interim financial statements for additional information regarding revenues.
Restricted cash and restricted cash equivalents — Effective January 1, 2018, the Company adopted Accounting Standard Update (“ASU”) No. 2016-18, Statement of Cash Flows (Topic 230): Restricted Cash which requires the Company to include in its cash and cash equivalents balances presented in the statements of cash flows amounts that are deemed to be restricted in nature. As a result of the adoption, the Company restated its condensed consolidated statements of cash flows for all of the prior periods presented. The impact of adoption on the Company’s condensed consolidated statement of cash flows was as follows for the nine months ended September 30, 2017:
 
As Originally Reported
 
Restated
 
Effect
Cash flows from operating activities:
 
 
 
 
 
Changes in operating assets and liabilities:
 
 
 
 
 
Prepaid expenses and other assets
$
4,436

 
$
2,036

 
$
(2,400
)
Net cash provided by operating activities
$
123,980

 
$
121,580

 
$
(2,400
)
Cash flows from investing activities:
 
 
 
 
 
Decrease in restricted cash and time deposits, net
$
(268
)
 
$
(408
)
 
$
(140
)
Acquisition of businesses, net of cash acquired
$
(6,840
)
 
$
(6,810
)
 
$
30

Net cash used in investing activities
$
(24,014
)
 
$
(24,124
)
 
$
(110
)
Effect of exchange rate changes on cash, cash equivalents, and restricted cash
$
10,286

 
$
10,435

 
$
149

Net increase in cash, cash equivalents and restricted cash
$
150,468

 
$
148,107

 
$
(2,361
)
Cash, cash equivalents and restricted cash, beginning of period
362,025

 
364,664

 
2,639

Cash, cash equivalents and restricted cash, end of period
$
512,493

 
$
512,771

 
$
278

Derivatives and Hedging — Effective April 1, 2018, the Company early-adopted ASU 2017-12, Derivatives and Hedging (Topic 815): Targeted Improvements to Accounting for Hedging Activities. The new guidance is intended to simplify and amend hedge accounting and reporting to better align and disclose the economic results of an entity’s risk management activities in its financial statements. The ASU makes more financial and non-financial hedging strategies eligible for hedge accounting. It also changes how companies assess hedge effectiveness and amends the presentation and disclosure requirements by eliminating the requirement to separately measure and report hedge ineffectiveness and generally requires companies, for qualifying hedges, to present the entire change in the fair value of a hedging instrument in the same income statement line as the hedged item. The guidance also eases documentation and assessment requirements and modifies the accounting for components excluded from the assessment of hedge effectiveness. The guidance requires entities to apply the amended presentation and disclosure guidance prospectively as of the period of adoption. The adoption of this guidance did not have any effect on the consolidated financial results.
The Company enters into derivative financial instruments to manage exposure to fluctuations in certain foreign currencies. During 2018, for accounting purposes, these foreign currency forward contracts became designated as hedges, as defined under FASB ASC Topic 815, Derivatives and Hedging. The Company measures these foreign currency derivative contracts at fair value on a recurring basis utilizing Level 2 inputs. The Company records changes in the fair value of these hedges in accumulated other comprehensive income/(loss) in our consolidated balance sheet until the forecasted transaction occurs. When the forecasted transaction occurs, the related gain or loss on the cash flow hedge is reclassified to the same line item in the statement of income as the forecasted transaction is recorded. In the event the underlying forecasted transaction does not occur, or it becomes probable that it will not occur, the Company reclassifies the gain or loss on the underlying hedge from accumulated other comprehensive income/(loss) into income. The cash flow impact of derivatives identified as hedging instruments is reflected as cash flows from operating activities. The cash flow impact of derivatives not identified as hedging instruments is reflected as cash flows from investing activities.
Pending Accounting Standards
From time to time, new accounting pronouncements are issued by the FASB or other standards-setting bodies that the Company will adopt according to the various timetables the FASB specifies. Unless otherwise discussed below, the Company believes the impact of recently issued standards that are not yet effective will not have a material impact on its consolidated financial position, results of operations and cash flows upon adoption.

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Table of Contents

Leases — Effective January 1, 2019, the Company will be required to adopt the new guidance of ASC Topic 842, Leases (Topic 842) (with early adoption permitted effective January 1, 2018). This amendment supersedes previous accounting guidance (Topic 840) and requires all leases, with the exception of leases with a term of twelve months or less, to be recorded on the balance sheet as lease assets and lease liabilities. The standard allows for two methods of adoption to recognize and measure leases: retrospectively to each prior period presented in the financial statements with the cumulative effect of initially applying the guidance recognized at the beginning of the earliest comparative period presented or retrospectively at the beginning of the period of adoption with the cumulative effect of initially applying the guidance recognized at the beginning of the period in which the guidance is first applied. Both adoption methods include a number of optional practical expedients that entities may elect to apply. These practical expedients relate to the identification and classification of leases that commenced before the effective date, initial direct costs for leases that commenced before the effective date, and the ability to use hindsight in evaluating lessee options to extend or terminate a lease or to purchase the underlying asset. An entity that elects to apply the practical expedients will, in effect, continue to account for leases that commence before the effective date in accordance with previous GAAP unless the lease is modified, except that lessees are required to recognize a right-of-use asset and a lease liability for all operating leases based on the present value of the remaining minimum rental payments that were tracked and disclosed under previous GAAP. The transition guidance in Topic 842 also provides specific guidance for the amounts previously recognized in accordance with the business combinations guidance for leases. The Company has developed a transition plan, which includes making necessary changes to policies, processes, internal controls and system enhancements to generate the information necessary to comply with the new standard. The Company has identified a global lease management and accounting software solution, which is currently being tested and implemented. The Company has collected relevant data and is finalizing its evaluation of lease arrangements, potential embedded leases and accounting policy elections. While the Company is currently assessing the quantitative impact, the Company expects the new guidance will have a material impact on its consolidated balance sheet due to the addition of right-of-use assets and lease liabilities principally related to its office space leases. EPAM does not expect the new guidance to have a material impact on its consolidated statement of income and comprehensive income or its consolidated statement of cash flows. The Company expects to adopt this standard on January 1, 2019 using the method of adoption whereby the cumulative effect of adoption is recognized at the beginning of the period of adoption.
Measurement of Credit Losses on Financial Instruments — Effective January 1, 2020, the Company will be required to adopt the amended guidance of ASC Topic 326, Financial Instruments - Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments, (with early adoption permitted effective January 1, 2019.) The amendments in this update change how companies measure and recognize credit impairment for many financial assets. The new expected credit loss model will require companies to immediately recognize an estimate of credit losses expected to occur over the remaining life of the financial assets (including trade receivables) that are in the scope of the update. The update also made amendments to the current impairment model for held-to-maturity and available-for-sale debt securities and certain guarantees. Entities are required to adopt the standard using a modified-retrospective approach through a cumulative effect adjustment to retained earnings as of the beginning of the period of adoption. The Company has not yet completed its assessment of the impact of the new guidance on its consolidated financial statements or concluded on when it will adopt the standard.
2.
ACQUISITIONS
Continuum — On March 15, 2018, the Company acquired all of the outstanding equity of Continuum Innovation LLC together with its subsidiaries (“Continuum”) to enhance the Company’s consulting capabilities as well as its digital and service design practices. Continuum, headquartered in Boston with offices located in Milan, Seoul, and Shanghai, focuses on four practices including strategy, physical and digital design, technology and its Made Real Lab. The acquisition of Continuum added approximately 125 design consultants to the Company’s headcount.
In connection with the Continuum acquisition, the Company paid $52,515 as cash consideration, of which $5,410 was placed in escrow for a period of 9 to 15 months as security for the indemnification obligations of the sellers under the terms of the equity purchase agreement. Furthermore, subject to attainment of specified performance targets in the 12 months after the acquisition, the Company will make a cash earnout payment with a maximum amount payable of $3,135. The Company recorded $2,400 related to this earnout payment as contingent consideration as of the acquisition date. During the three months ended September 30, 2018, the Company recorded a $900 reduction to the fair value of the contingent consideration (Note 4 “Fair Value Measurements”).

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Table of Contents

The following table summarizes the preliminary fair values of the assets acquired and liabilities assumed in connection with the acquisition of Continuum as originally reported and as adjusted as of September 30, 2018:
 
As Originally Reported
 
As Adjusted
Cash and cash equivalents
$
2,251

 
$
2,251

Accounts receivable
6,676

 
6,676

Unbilled revenues
2,463

 
2,463

Prepaid and other current assets
942

 
942

Goodwill
29,805

 
26,693

Intangible assets
16,600

 
14,450

Property and equipment and other noncurrent assets
8,902

 
8,902

Total assets acquired
$
67,639

 
$
62,377

Accounts payable, accrued expenses and other current liabilities
$
2,991

 
$
2,751

Due to employees
1,001

 
1,001

Long-term debt (Note 6)
3,220

 
3,220

Other noncurrent liabilities
5,412

 
490

Total liabilities assumed
$
12,624

 
$
7,462

Net assets acquired
$
55,015

 
$
54,915

During the three months ended September 30, 2018, the Company updated the valuation of the acquired intangible asset related to a favorable lease decreasing its value by $400. This adjustment resulted in a corresponding increase in the value of acquired goodwill. The effect of the adjustment recorded during the three months ended September 30, 2018 that would have been recognized in a prior period if the adjustment to the preliminary amounts had been recognized as of the acquisition date was not material. The Company expects to complete the purchase price allocation as soon as practicable but no later than one year from the acquisition date.
The following table presents the estimated fair values and useful lives of intangible assets acquired in connection with the acquisition of Continuum:
 
Continuum
 
Weighted Average Useful Life (in years)
 
Amount
Customer relationships
6.5
 
$
5,800

Favorable lease
11.2
 
5,500

Contract royalties
8
 
1,900

Trade names
5
 
1,250

Total
 
 
$
14,450

The goodwill recognized as a result of the Continuum acquisition is attributable primarily to strategic and synergistic opportunities related to the consulting business, the assembled workforce of Continuum and other factors. The goodwill is expected to be deductible for income tax purposes.
Revenues generated by Continuum totaled $8,472 and $18,696 during the three and nine months ended September 30, 2018. Pro forma results of operations have not been presented because the effect of the Continuum acquisition on the Company’s condensed consolidated financial statements was not material.

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Table of Contents

3.
GOODWILL
Goodwill by reportable segment was as follows:
 
North America
 
Europe
 
Total
Balance as of December 31, 2017
$
77,290

 
$
42,241

 
$
119,531

Continuum acquisition (Note 2)
26,693

 

 
26,693

Effect of net foreign currency exchange rate changes
(193
)
 
(1,044
)
 
(1,237
)
Balance as of September 30, 2018
$
103,790

 
$
41,197

 
$
144,987

There were no accumulated impairment losses in the North America or Europe reportable segments as of September 30, 2018 or December 31, 2017.

4.
FAIR VALUE MEASUREMENTS
The Company carries certain assets and liabilities at fair value on a recurring basis on its consolidated balance sheets. The following table shows the fair values of the Company’s financial assets and liabilities measured at fair value on a recurring basis as of September 30, 2018:
 
 
As of September 30, 2018
 
 
Balance
 
Level 1
 
Level 2
 
Level 3
Foreign exchange derivative assets
 
$
114

 
$

 
$
114

 
$

Total assets measured at fair value on a recurring basis
 
$
114

 
$

 
$
114

 
$

 
 
 
 
 
 
 
 
 
Contingent consideration
 
$
1,500

 
$

 
$

 
$
1,500

Foreign exchange derivative liabilities
 
2,806

 

 
2,806

 

Total liabilities measured at fair value on a recurring basis
 
$
4,306

 
$

 
$
2,806

 
$
1,500

The Company had no material financial assets or liabilities measured at fair value on a recurring basis as of December 31, 2017.
Our Level 2 foreign exchange derivatives are valued using pricing models and discounted cash flow methodologies based on observable foreign exchange data at the measurement date. See Note 5 “Derivative Financial Instruments” for further information regarding the Company’s derivative financial instruments.
As of September 30, 2018, contingent consideration included amounts payable in cash in connection with the acquisition of Continuum (Note 2 “Acquisitions”). The fair value of the contingent consideration is based on the expected future payments to be made to the sellers of the acquired business in accordance with the provisions outlined in the purchase agreement. In determining fair value, the Company considered a variety of factors, including future performance of the acquired businesses using financial projections developed by the Company and market risk assumptions that were derived for revenue growth and earnings before interest and taxes. The Company estimated future payments using the earnout formula and performance targets specified in the purchase agreement and adjusted those estimates to reflect the probability of their achievement. Those future payments were then discounted to present value using a rate based on the weighted-average cost of capital of guideline companies. The Company believes its estimates and assumptions are reasonable; however, there is significant judgment involved. Changes in financial projections, market risk assumptions, discount rates or probability assumptions related to achieving the various earnout criteria would result in a change in the fair value of the recorded contingent liability. Such changes, if any, are recorded within Interest and other income, net in the Company’s consolidated statement of income and comprehensive income.


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Table of Contents

A reconciliation of the beginning and ending balances of acquisition-related contractual contingent liabilities using significant unobservable inputs (Level 3) for the nine months ended September 30, 2018 is as follows:
 
 
Amount
Contractual contingent liabilities at December 31, 2017
 
$

Acquisition date fair value of contractual contingent liabilities — Continuum (Note 2)
 
2,400

Changes in fair value of contractual contingent liabilities included in Interest and other income, net
 
(900
)
Contractual contingent liabilities at September 30, 2018
 
$
1,500

Estimates of fair value of financial instruments not carried at fair value on a recurring basis on the Company’s consolidated balance sheets are generally subjective in nature, and are determined as of a specific point in time based on the characteristics of the financial instruments and relevant market information. The Company uses the following methods to estimate the fair values of its financial instruments:
for financial instruments that have quoted market prices, those quoted prices are used to estimate fair value;
for financial instruments for which no quoted market prices are available, fair value is estimated using information obtained from independent third parties, or by discounting the expected cash flows using an estimated current market interest rate for the financial instrument;
for financial instruments for which no quoted market prices are available and that have no defined maturity, have a remaining maturity of 360 days or less, or reprice frequently to a market rate, the Company assumes that the fair value of these instruments approximates their reported value, after taking into consideration any applicable credit risk.
The generally short duration of certain of the Company’s assets and liabilities results in a number of assets and liabilities for which fair value equals or closely approximates the amount recorded on the Company’s condensed consolidated balance sheets. These types of assets and liabilities which are reported on the Company’s condensed consolidated balance sheets include:
cash and cash equivalents;
time deposits and restricted cash;
employee loans;
borrowings under the Company’s 2017 Credit Facility (Note 6 “Long-Term Debt”).
The fair value of employee housing loans is estimated using information on the rates of return that market participants in Belarus would require when investing in unsecured U.S. dollar-denominated government bonds with similar maturities (a “risk-free rate”), after taking into consideration any applicable credit and liquidity risk.
The following tables present the reported amounts and estimated fair values of the financial assets and liabilities for which disclosure of fair value is required, as they would be categorized within the fair value hierarchy, as of the dates indicated:
 
 
 
 
 
 
Fair Value Hierarchy
 
 
Balance
 
Estimated Fair Value
 
Level 1
 
Level 2
 
Level 3
September 30, 2018
 
 
 
 
 
 
 
 
 
 
Financial Assets:
 
 
 
 
 
 
 
 
 
 
Cash and cash equivalents
 
$
685,108

 
$
685,108

 
$
685,108

 
$

 
$

Restricted cash
 
$
1,193

 
$
1,193

 
$
1,193

 
$

 
$

Employee loans
 
$
3,745

 
$
3,745

 
$

 
$

 
$
3,745

Financial Liabilities:
 
 
 
 
 
 
 
 
 
 
Borrowings under the 2017 Credit Facility
 
$
25,016

 
$
25,016

 
$

 
$
25,016

 
$


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Table of Contents

 
 
 
 
 
 
Fair Value Hierarchy
 
 
Balance
 
Estimated Fair Value
 
Level 1
 
Level 2
 
Level 3
December 31, 2017
 
 
 
 
 
 
 
 
 
 
Financial Assets:
 
 
 
 
 
 
 
 
 
 
Cash and cash equivalents
 
$
582,585

 
$
582,585

 
$
582,585

 
$

 
$

Time deposits and restricted cash
 
$
673

 
$
673

 
$

 
$
673

 
$

Employee loans
 
$
4,210

 
$
4,210

 
$

 
$

 
$
4,210

Financial Liabilities:
 
 
 
 
 
 
 
 
 
 
Borrowings under the 2017 Credit Facility

 
$
25,009

 
$
25,009

 
$

 
$
25,009

 
$

5.
DERIVATIVE FINANCIAL INSTRUMENTS
The Company conducts a large portion of its operations in international markets that subject it to foreign currency fluctuations. To manage the risk of fluctuations in foreign currency exchange rates, during the nine months ended September 30, 2018, the Company implemented a hedging program whereby it entered into a series of foreign exchange forward contracts with durations of twelve months or less that are designated as cash flow hedges of forecasted Russian ruble, Polish zloty and Indian rupee transactions.
The Company measures derivative instruments and hedging activities at fair value and recognizes them as either assets or liabilities in its consolidated balance sheets. Accounting for the gains and losses resulting from changes in fair value depends on the use of the derivative and whether it is designated and qualifies for hedge accounting. As of September 30, 2018, all of the Company’s foreign exchange forward contracts were designated as hedges. To receive hedge accounting treatment, all hedging relationships are formally documented at the inception of the hedge, and the hedges must be highly effective in offsetting changes to future cash flows on hedged transactions.
Derivatives may give rise to credit risks from the possible non-performance by counterparties. The Company has limited its credit risk by entering into derivative transactions only with highly-rated financial institutions and by conducting an ongoing evaluation of the creditworthiness of the financial institutions with which the Company does business. There is no financial collateral (including cash collateral) required to be posted by the Company related to the foreign exchange forward contracts.
The fair value of derivative instruments on the Company’s consolidated balance sheets as of September 30, 2018 and December 31, 2017 were as follows:
 
 
 
 
As of September 30, 2018
 
As of December 31, 2017
 
 
Balance Sheet Classification
 
Asset Derivatives
 
Liability Derivatives
 
Asset Derivatives
 
Liability Derivatives
Foreign exchange forward contracts -
Designated as hedging instruments
 
Prepaid and other current assets
 
$
114

 
 
 
$

 
 
 
 
Accrued expenses and other current liabilities
 
 
 
$
2,806

 
 
 
$

 
 
 
 
 
 
 
 
 
 
 
Foreign exchange forward contracts -
Not designated as hedging instruments
 
Prepaid and other current assets
 
$

 
 
 
$
114

 
 
The Company records changes in the fair value of its cash flow hedges in accumulated other comprehensive income/(loss) in the consolidated balance sheet until the forecasted transaction occurs. When the forecasted transaction occurs, the Company reclassifies the related gain or loss on the cash flow hedge to cost of revenues (exclusive of depreciation and amortization). In the event the underlying forecasted transaction does not occur, or it becomes probable that it will not occur, the Company reclassifies the gain or loss on the related cash flow hedge into income. If the Company does not elect hedge accounting, or the contract does not qualify for hedge accounting treatment, the changes in fair value from period to period are recorded in income.

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Table of Contents

The changes in the fair value of foreign currency derivative instruments in our unaudited condensed consolidated statements of income and comprehensive income for the three and nine months ended September 30, 2018 and 2017 were as follows:
 
Three Months Ended 
 September 30,
 
Nine Months Ended September 30,
 
2018
 
2017
 
2018
 
2017
Foreign exchange forward contracts - Designated as hedging instruments:
 
 
 
 
 
 
 
Change in fair value recognized in accumulated other comprehensive loss 
(86
)
 

 
(2,692
)
 

Net loss reclassified from accumulated other comprehensive loss into cost of revenues (exclusive of depreciation and amortization)
(1,604
)
 

 
(2,541
)
 

Foreign exchange forward contracts - Not designated as hedging instruments:
 
 
 
 
 
 
 
Net gain recognized in foreign exchange (loss)/gain

 
111

 
44

 
270


6.
LONG-TERM DEBT
Revolving Line of Credit — On May 24, 2017, the Company entered into an unsecured credit facility (the “2017 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. (collectively the “Lenders”). The 2017 Credit Facility provides for a borrowing capacity of $300,000, with potential to increase the credit facility up to $400,000 if certain conditions are met. The 2017 Credit Facility matures on May 24, 2022.
Borrowings under the 2017 Credit Facility may be denominated in U.S. dollars or up to a maximum of $100,000 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. The base rate is equal to the highest of (a) the Overnight Bank Funding Rate, plus 0.5%, (b) the Prime Rate, and (c) the Daily LIBOR Rate, plus 1.0%. As of September 30, 2018, the Company’s outstanding borrowings are subject to a LIBOR-based interest rate which resets regularly at issuance, based on lending terms.
The 2017 Credit Facility includes customary business and financial covenants that may restrict the Company’s ability to make or pay dividends (other than certain intercompany dividends) if a potential or an actual event of default has occurred or would be triggered. As of September 30, 2018, the Company was in compliance with all covenants contained in the 2017 Credit Facility.
The following table presents the outstanding debt and borrowing capacity of the Company under the 2017 Credit Facility:
 
As of  
 September 30, 
 2018
 
As of  
 December 31, 
 2017
Outstanding debt
$
25,000

 
$
25,000

Interest rate
3.2
%
 
2.6
%
Irrevocable standby letters of credit
$
387

 
$
1,294

Available borrowing capacity
$
274,613

 
$
273,706

Current maximum borrowing capacity
$
300,000

 
$
300,000

As part of the acquisition of Continuum, the Company assumed $3,448 of long-term debt associated with a leased facility and payable to Continuum’s landlord. The debt was payable in monthly installments through March 2029 and bore interest at a rate of 8% per annum. In March 2018, the Company paid $3,448 to settle this assumed long-term debt.


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Table of Contents

7.
REVENUES
Adoption of ASC Topic 606, “Revenue from Contracts with Customers” and Change in Accounting Policies
Effective January 1, 2018, the Company adopted ASU No. 2014-09, Revenue from Contracts with Customers (Topic 606) as amended. The Company adopted the new guidance using the modified retrospective method by recognizing the cumulative effect of adoption as an adjustment to retained earnings as of January 1, 2018. Results for reporting periods beginning after January 1, 2018 are presented under Topic 606, while prior period amounts are not adjusted and continue to be reported in accordance with Topic 605. The impact of adoption of the new guidance on the Company’s consolidated financial statements as of January 1, 2018 are presented in Note 1 “Summary of Significant Accounting Policies.”
The Company recognizes revenues when control of goods or services is passed to a customer in an amount that reflects the consideration the Company expects to be entitled to in exchange for those goods or services. Such control may be transferred over time or at a point in time depending on satisfaction of obligations stipulated by the contract. Consideration expected to be received may consist of both fixed and variable components and is allocated to each separately identifiable performance obligation based on the performance obligation’s relative standalone selling price. Variable consideration usually takes the form of volume-based discounts, service level credits, price concessions or incentives. Determining the estimated amount of such variable consideration involves assumptions and judgment that can have an impact on the amount of revenues reported.
The Company derives its revenues from a variety of service offerings, which represent specific competencies of its IT professionals. Fees for these contracts may be in the form of time-and-materials or fixed-price arrangements. The majority of the Company’s revenues are generated under time-and-material contracts which are billed using hourly, daily or monthly rates to determine the amounts to be charged directly to the client. The Company applies a practical expedient and revenues related to time-and-material contracts are recognized based on the Company’s right to invoice for services performed.
Fixed-price contracts include maintenance and support arrangements, which may exceed one year in duration, as well as application development arrangements. Maintenance and support arrangements generally relate to the provision of ongoing services. Revenues for such agreements are recognized ratably over the expected service period. Application development arrangements are accounted for using input or output methods for measuring the progress towards satisfaction of the performance obligation. Input methods are used only when there is a direct correlation between hours incurred and the end product delivered. Assumptions, risks and uncertainties inherent in the estimates used to measure progress could affect the amount of revenues, receivables and deferred revenues at each reporting period. Revenues from licenses which have significant stand-alone functionality are recognized at a point in time when control of the license is transferred to the customer. Revenues from licenses which do not have stand-alone functionality are recognized over time.
If there is an uncertainty about the receipt of payment for the services, revenue is deferred until the uncertainty is sufficiently resolved. The Company applies a practical expedient and does not assess the existence of a significant financing component if the period between when the Company transfers the service to a customer and when the customer pays for that service is one year or less.
The Company reports gross reimbursable “out-of-pocket” expenses incurred as both revenues and cost of revenues in the condensed consolidated statements of income and comprehensive income.
The following tables summarize the impacts of changes in accounting policies after adoption of Topic 606 on the Company’s condensed consolidated financial statements for the three and nine months ended September 30, 2018, which primarily resulted from deferring the timing of revenue recognition for contracts that were previously recognized on a cash basis and recognizing revenues from certain license agreements at a point-in-time rather than over time:
 
As of September 30, 2018
 
As Reported
 
Balances Without Adoption of Topic 606
 
Effect of Change Higher/(Lower)
Balance Sheet
 
 
 
 
 
Liabilities
 
 
 
 
 
  Accrued expenses and other current liabilities
$
98,442

 
$
98,354

 
$
88

Other noncurrent liabilities
11,804

 
11,823

 
(19
)
Stockholders’ equity
 
 
 
 
 
  Retained earnings
$
699,568

 
$
699,637

 
$
(69
)

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Table of Contents

 
Three Months Ended September 30, 2018
 
Nine Months Ended September 30, 2018
 
As Reported
 
Balances Without Adoption of Topic 606
 
Effect of Change
 
As Reported
 
Balances Without Adoption of Topic 606
 
Effect of Change
Income Statement
 
 
 
 
 
 
 
 
 
 
 
Revenues
$
468,186

 
$
468,257

 
$
(71
)
 
$
1,337,981

 
$
1,338,069

 
$
(88
)
Income from operations
$
64,560

 
$
64,631

 
$
(71
)
 
$
167,494

 
$
167,582

 
$
(88
)
Provision for/(benefit from) income taxes

$
369

 
$
385

 
$
(16
)
 
$
(9,286
)
 
$
(9,267
)
 
$
(19
)
Net income
$
65,618

 
$
65,673

 
$
(55
)
 
$
180,291

 
$
180,360

 
$
(69
)
Disaggregation of Revenues
The following tables show the disaggregation of the Company’s revenues by major client location, including a reconciliation of the disaggregated revenues with the reportable segments (Note 12 “Segment Information”) for the three and nine months ended September 30, 2018:
 
Three Months Ended September 30, 2018
Reportable Segments
North America
 
Europe
 
Russia
 
Total Segment Revenues
 
Other Income Included in Segment Revenues
 
Consolidated Revenues
Client Locations
 
 
 
 
 
 
 
 
 
 
 
North America
$
271,551

 
$
12,536

 
$
17

 
$
284,104

 
$
(27
)
 
$
284,077

Europe
5,408

 
146,990

 
3

 
152,401

 
(166
)
 
152,235

CIS
2,208

 
142

 
16,184

 
18,534

 

 
18,534

APAC
1,671

 
11,814

 
4

 
13,489

 
(149
)
 
13,340

        Revenues
$
280,838

 
$
171,482

 
$
16,208

 
$
468,528

 
$
(342
)
 
$
468,186

 
Nine Months Ended September 30, 2018
Reportable Segments
North America
 
Europe
 
Russia
 
Total Segment Revenues
 
Other Income Included in Segment Revenues
 
Consolidated Revenues
Client Locations
 
 
 
 
 
 
 
 
 
 
 
North America
$
747,894

 
$
40,074


$
46


$
788,014

 
$
(40
)
 
$
787,974

Europe
11,234

 
444,468


45


455,747

 
(623
)
 
455,124

CIS
6,300

 
233


53,192


59,725

 

 
59,725

APAC
3,709

 
31,545


91


35,345

 
(187
)
 
35,158

        Revenues
$
769,137

 
$
516,320

 
$
53,374

 
$
1,338,831

 
$
(850
)
 
$
1,337,981

The following tables show the disaggregation of the Company’s revenues by industry vertical, including a reconciliation of the disaggregated revenues with the reportable segments (Note 12 “Segment Information”) for the three and nine months ended September 30, 2018:

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Table of Contents

 
Three Months Ended September 30, 2018
Reportable Segments
North America
 
Europe
 
Russia
 
Total Segment Revenues
 
Other Income Included in Segment Revenues
 
Consolidated Revenues
Industry Verticals
 
 
 
 
 
 
 
 
 
 
 
Financial Services
$
30,488

 
$
61,713

 
$
12,786

 
$
104,987

 
$
(189
)
 
$
104,798

Travel & Consumer
45,690

 
53,634

 
1,891

 
101,215

 
(122
)
 
101,093

Software & Hi-Tech
68,572

 
19,035

 
569

 
88,176

 

 
88,176

Business Information & Media

64,152

 
17,650

 

 
81,802

 

 
81,802

Life Sciences & Healthcare
39,550

 
5,078

 
12

 
44,640

 
(31
)
 
44,609

Emerging Verticals
32,386

 
14,372

 
950

 
47,708

 

 
47,708

        Revenues
$
280,838

 
$
171,482

 
$
16,208

 
$
468,528

 
$
(342
)
 
$
468,186

 
Nine Months Ended September 30, 2018
Reportable Segments
North America
 
Europe
 
Russia
 
Total Segment Revenues
 
Other Income Included in Segment Revenues
 
Consolidated Revenues
Industry Verticals
 
 
 
 
 
 
 
 
 
 
 
Financial Services
$
79,176

 
$
190,027

 
$
43,102

 
$
312,305

 
$
(697
)
 
$
311,608

Travel & Consumer
133,481

 
155,208

 
5,356

 
294,045

 
(122
)
 
293,923

Software & Hi-Tech
193,672

 
59,186

 
1,957

 
254,815

 

 
254,815

Business Information & Media

181,021

 
54,637

 

 
235,658

 

 
235,658

Life Sciences & Healthcare
99,893

 
15,550

 
12

 
115,455

 
(31
)
 
115,424

Emerging Verticals
81,894

 
41,712

 
2,947

 
126,553

 

 
126,553

        Revenues
$
769,137

 
$
516,320

 
$
53,374

 
$
1,338,831

 
$
(850
)
 
$
1,337,981

The following tables show the disaggregation of the Company’s revenues by contract type including a reconciliation of the disaggregated revenues with the Company’s reportable segments (Note 12 “Segment Information”) for the three and nine months ended September 30, 2018:
 
Three Months Ended September 30, 2018
Reportable Segments
North America
 
Europe
 
Russia
 
Total Segment Revenues
 
Other Income Included in Segment Revenues
 
Consolidated Revenues
Contract Types
 
 
 
 
 
 
 
 
 
 
 
Time-and-material
$
256,549

 
$
155,797

 
$
9,441

 
$
421,787

 
$

 
$
421,787

Fixed-price
23,241

 
15,001

 
6,759

 
45,001

 

 
45,001

Licensing
798

 
173

 
1

 
972

 

 
972

Other revenues
250

 
511

 
7

 
768

 
(342
)
 
426

        Revenues
$
280,838

 
$
171,482

 
$
16,208

 
$
468,528

 
$
(342
)
 
$
468,186

 
Nine Months Ended September 30, 2018
Reportable Segments
North America
 
Europe
 
Russia
 
Total Segment Revenues
 
Other Income Included in Segment Revenues
 
Consolidated Revenues
Contract Types
 
 
 
 
 
 
 
 
 
 
 
Time-and-material
$
704,612

 
$
471,900

 
$
29,302

 
$
1,205,814

 
$

 
$
1,205,814

Fixed-price
61,716

 
42,035

 
24,038

 
127,789

 

 
127,789

Licensing
2,098

 
1,119

 
12

 
3,229

 

 
3,229

Other revenues
711

 
1,266

 
22

 
1,999

 
(850
)
 
1,149

        Revenues
$
769,137

 
$
516,320

 
$
53,374

 
$
1,338,831

 
$
(850
)
 
$
1,337,981



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Table of Contents

Timing of Revenue Recognition
The following tables show the timing of revenue recognition:
 
Three Months Ended September 30, 2018
Reportable Segments
North America
 
Europe
 
Russia
 
Total Segment Revenues
 
Other Income Included in Segment Revenues
 
Consolidated Revenues
Timing of Revenue Recognition
 
 
 
 
 
 
 
 
 
 
 
Transferred at a point of time
$
194

 
$
289

 
$

 
$
483

 
$
(342
)
 
$
141

Transferred over time
280,644

 
171,193

 
16,208

 
468,045

 

 
468,045

        Revenues
$
280,838

 
$
171,482

 
$
16,208

 
$
468,528

 
$
(342
)
 
$
468,186

 
Nine Months Ended September 30, 2018
Reportable Segments
North America
 
Europe
 
Russia
 
Total Segment Revenues
 
Other Income Included in Segment Revenues
 
Consolidated Revenues
Timing of Revenue Recognition
 
 
 
 
 
 
 
 
 
 
 
Transferred at a point of time
$
832

 
$
1,351

 
$
10

 
$
2,193

 
$
(850
)
 
$
1,343

Transferred over time
768,305

 
514,969

 
53,364

 
1,336,638

 

 
1,336,638

        Revenues
$
769,137

 
$
516,320

 
$
53,374

 
$
1,338,831

 
$
(850
)
 
$
1,337,981

During the three and nine months ended September 30, 2018, the Company recognized $3,610 and $6,627 of revenues, respectively, from performance obligations satisfied in previous periods.
The following table includes the estimated revenues expected to be recognized in the future related to performance obligations that are partially or fully unsatisfied as of September 30, 2018. The Company applies a practical expedient and does not disclose the value of unsatisfied performance obligations for contracts that (i) have an original expected duration of one year or less and (ii) contracts for which it recognizes revenues at the amount to which it has the right to invoice for services provided:
 
Less than 1 year
 
1 Year
 
2 Years
 
3 Years
 
Total
Contract Type
 
 
 
 
 
 
 
 
 
Fixed-price
$
4,590

 
$
568

 
$
126

 
$

 
$
5,284

The Company applies a practical expedient and does not disclose the amount of the transaction price allocated to the remaining performance obligations nor provide an explanation of when the Company expects to recognize that amount as revenue for certain variable consideration.
Contract Balances
The following table provides information on the classification of contract assets and liabilities in the condensed consolidated balance sheets:
 
As of  
 September 30, 
 2018
 
As of  
 December 31, 
 2017
Contract assets included in unbilled revenues
$
19,180

 
$
7,901

Contract liabilities included in accrued expenses and other current liabilities
$
3,376

 
$
4,498

Contract assets included in unbilled revenues are recorded when services have been provided but the Company does not have an unconditional right to receive consideration. The Company recognizes an impairment loss when the contract carrying amount is greater than the remaining consideration receivable, less directly related costs to be incurred. Contract assets have increased from December 31, 2017 primarily due to new contracts entered into in 2018 where the Company’s right to bill is contingent upon achievement of contractual milestones.

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Table of Contents

Contract liabilities comprise amounts collected from the Company’s clients for revenues not yet earned. Such amounts are anticipated to be recorded as revenues when services are performed in subsequent periods. During the three and nine months ended September 30, 2018, the Company recognized $258 and $3,690 of revenues, respectively, that were included in Accrued expenses and other current liabilities at January 1, 2018.

8.
INCOME TAXES
In determining its interim provision for/(benefit from) income taxes, the Company uses an estimated annual effective tax rate, which is based on expected annual profit before tax, statutory tax rates and tax planning opportunities available in the various jurisdictions in which the Company operates. Certain significant or unusual items are separately recognized in the quarter in which they occur and can be a source of variability in the effective tax rates from quarter to quarter.
The Company’s worldwide effective tax rate for the three months ended September 30, 2018 and 2017 was 0.6% and 15.7%, respectively, and (5.4)% and 15.2% during the nine months ended September 30, 2018 and 2017, respectively.
The interim provision for/(benefit from) income taxes in the three months ended September 30, 2018 was unfavorably impacted by the recognition of $252 of net deferred tax liabilities and the interim provision for/(benefit from) income taxes in the nine months ended September 30, 2018 was favorably impacted by the recognition of $25,088 of net deferred tax assets as a result of the election to disregard as separate entities for U.S. tax purposes certain foreign subsidiaries of the Company. In addition, the Company recorded excess tax benefits upon vesting or exercise of stock-based awards of $6,067 and $2,620 during the three months ended September 30, 2018 and 2017, respectively, and $16,197 and $8,452 during the nine months ended September 30, 2018 and 2017, respectively.
Due to the timing of the enactment and the complexity involved in applying the provisions of the Tax Cuts and Jobs Act (“U.S. Tax Act”), the Company made reasonable estimates of the effects and recorded provisional amounts in its financial statements as of December 31, 2017. As the Company collects and prepares necessary data and interprets 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 refines the calculations, the Company may make adjustments to the provisional amounts recorded. During the three and nine months ended September 30, 2018, the Company further refined its estimate and recorded net provisional reductions of $7,053 and $4,896, respectively, associated with the provisional charge for the one-time transition tax on accumulated foreign subsidiary earnings not previously subject to U.S. income tax which now totals $59,425. The provisional reductions were primarily driven by a decrease in repatriation taxes as a result of the Company completing its analysis of the earnings of relevant foreign subsidiaries in the third quarter of 2018. Of this amount, $49,117 is classified as Taxes payable, noncurrent as of September 30, 2018. The Company continues to analyze the impact of certain foreign tax credits, continues to assess the application of certain state income tax laws and expects to complete its analysis during the fourth quarter 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.
The U.S. Tax Act subjects a U.S. shareholder to tax on global intangible low-taxed income (“GILTI”) earned by certain foreign subsidiaries. The FASB Staff Q&A, Topic 740, No. 5, Accounting for Global Intangible Low-Taxed Income, states that an entity can make an accounting policy election to either recognize deferred taxes for temporary basis differences expected to reverse as GILTI in future years or provide for the tax expense related to GILTI in the year the tax is incurred. During the nine months ended September 30, 2018, the Company elected to provide for the tax expense related to GILTI in the year the tax is incurred. This election did not have a material impact on the interim financial statements for the three and nine months ended September 30, 2018.

9.
STOCK-BASED COMPENSATION
The following table summarizes the components of stock-based compensation expense recognized in the Company’s condensed consolidated statements of income and comprehensive income for the periods indicated:
 
Three Months Ended 
 September 30,
 
Nine Months Ended 
 September 30,
 
2018
 
2017
 
2018
 
2017
Cost of revenues (exclusive of depreciation and amortization)
$
7,492

 
$
4,913

 
$
22,835

 
$
14,452

Selling, general and administrative expenses
7,838

 
6,304

 
23,901

 
25,468

Total
$
15,330

 
$
11,217

 
$
46,736

 
$
39,920


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Stock Options
Stock option activity under the Company’s plans is set forth below:
 
Number of
Options 
 
Weighted Average
Exercise Price 
 
Aggregate
Intrinsic Value 
 
Weighted Average
Remaining Contractual Term (in years)
Options outstanding at January 1, 2018
4,901,748

 
$
40.91

 
 
 
 
Options granted
157,133

 
$
112.91

 
 
 
 
Options exercised
(863,365
)
 
$
36.90

 
 
 
 
Options forfeited/cancelled
(30,819
)
 
$
63.39

 
 
 
 
Options expired
(250
)
 
$
61.38

 
 
 
 
Options outstanding at September 30, 2018
4,164,447

 
$
44.29

 
$
388,977

 
5.7
 
 
 
 
 
 
 
 
Options vested and exercisable at September 30, 2018
3,251,127

 
$
35.94

 
$
330,834

 
5.2
Options expected to vest at September 30, 2018
870,538

 
$
73.59

 
$
55,810

 
7.5
As of September 30, 2018, $16,124 of total remaining unrecognized stock-based compensation cost related to unvested stock options, net of estimated forfeitures, is expected to be recognized over the weighted-average remaining requisite service period of 2.0 years.
As of September 30, 2018, a total of 1,000 shares underlying options exercised through September 30, 2018, were in transit with the Company’s transfer agent.
Effective January 1, 2018, the Company changed the methodology for estimating volatility used in the Black-Scholes option valuation model. Prior to January 1, 2018, the Company estimated the volatility of its common stock by using the historical volatility of peer public companies including the Company’s historical volatility. In the first quarter of 2018, the Company began exclusively using its own historical volatility as it believes this is a more accurate estimate of future volatility of the price of the Company’s common stock. The Company did not change the methodology for estimating any other Black-Scholes option valuation model assumptions as disclosed in Note 13 “Stock-Based Compensation” to the audited consolidated financial statements included in the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 2017.
Restricted Stock and Restricted Stock Units
Service-Based Awards
The table below summarizes activity related to the Company’s equity-classified and liability-classified service-based awards for the nine months ended September 30, 2018.
 
Equity-Classified
 Restricted Stock
 
Equity-Classified
Equity-Settled
Restricted Stock Units
 
Liability-Classified
Cash-Settled
Restricted Stock Units
 
Number of
Shares 
 
Weighted Average Grant Date
Fair Value Per Share 
 
Number of
Shares 
 
Weighted Average Grant Date
Fair Value Per Share 
 
Number of
Shares 
 
Weighted Average Grant Date
Fair Value Per Share 
Unvested service-based awards outstanding at January 1, 2018
1,840

 
$
54.37

 
688,012

 
$
71.60

 
314,829

 
$
72.50

Awards granted

 
$

 
332,683

 
$
114.35

 
85,380

 
$
112.65

Awards modified

 
$

 
(2,299
)
 
$
72.80

 
2,299

 
$
116.63

Awards vested
(1,047
)
 
$
47.76

 
(215,263
)
 
$
70.09

 
(91,052
)
 
$
72.42

Awards forfeited/cancelled

 
$

 
(39,644
)
 
$
82.59

 
(6,998
)
 
$
79.19

Unvested service-based awards outstanding at September 30, 2018
793

 
$
63.10

 
763,489

 
$
90.08

 
304,458

 
$
83.96

As of September 30, 2018, $44 of total remaining unrecognized stock-based compensation cost related to service-based restricted stock is expected to be recognized over the weighted-average remaining requisite service period of 1.8 years.

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As of September 30, 2018, $51,937 of total remaining unrecognized stock-based compensation cost related to service-based equity-classified restricted stock units (“RSUs”), net of estimated forfeitures, is expected to be recognized over the weighted-average remaining requisite service period of 2.7 years. As of September 30, 2018, there were 3,894 restricted share units vested for which the holders elected to defer delivery of EPAM Systems, Inc. ordinary shares. During the first quarter of 2018, 44,228 RSUs were granted in connection with the acquisition of Continuum.
As of September 30, 2018, $29,486 of total remaining unrecognized stock-based compensation cost related to service-based liability-classified RSUs, net of estimated forfeitures, is expected to be recognized over the weighted-average remaining requisite service period of 2.5 years.
The liability associated with the service-based liability-classified RSUs as of September 30, 2018 and December 31, 2017, was $9,174 and $5,964, respectively, and was classified as Deferred compensation due to employees in the condensed consolidated balance sheets.
Performance-Based Awards
The table below summarizes activity related to the Company’s equity-classified performance-based awards for the nine months ended September 30, 2018.
 
Equity-Classified
Equity-Settled
Restricted Stock Units
 
Number of
Shares 
 
Weighted Average Grant Date
Fair Value Per Share 
Unvested performance-based awards outstanding at January 1, 2018

 
$

Awards granted
45,375

 
$
121.75

Awards vested

 
$

Awards forfeited/cancelled

 
$

Unvested performance-based awards outstanding at September 30, 2018
45,375

 
$
121.75

As of September 30, 2018, $4,514 of total remaining unrecognized stock-based compensation cost related to performance-based equity-classified restricted stock units is expected to be recognized over the weighted-average remaining requisite service period of 2.1 years.
Performance-based equity-classified RSUs were granted during the period in connection with the acquisition of Continuum and have a variable vesting period, subject to satisfaction of the applicable performance conditions with each vesting portion having its own service inception date. Compensation is recognized over the vesting period and adjusted for the probability of achievement of the performance criteria for each vesting portion separately. As of September 30, 2018, the Company reduced the expected likelihood of achieving the performance conditions underlying these unvested and outstanding performance-based equity-classified RSUs based on performance to date and expectations for future performance and therefore reduced the compensation cost recognized by $183 associated with these RSUs. The Company will continue to reassess the probability of achievement of the performance criteria and adjust the amount of compensation expense accordingly.

10.
EARNINGS PER SHARE
Basic earnings per share is computed by dividing income available to common shareholders by the weighted-average number of shares of common stock outstanding during the period. Diluted earnings per share is computed by dividing income available to common shareholders by the weighted-average number of shares of common stock outstanding during the period increased to include the number of additional shares of common stock that would have been outstanding if the potentially dilutive securities had been issued. Potentially dilutive securities include outstanding stock options, unvested restricted stock and unvested equity-settled RSUs. The dilutive effect of potentially dilutive securities is reflected in diluted earnings per share by application of the treasury stock method.

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The following table sets forth the computation of basic and diluted earnings per share of common stock as follows:
 
Three Months Ended 
 September 30,
 
Nine Months Ended 
 September 30,
 
2018
 
2017
 
2018
 
2017
Numerator for basic and diluted earnings per share:
 
 
 
 
 
 
 
Net income
$
65,618

 
$
42,634

 
$
180,291

 
$
103,634

Numerator for basic and diluted earnings per share
$
65,618

 
$
42,634

 
$
180,291

 
$
103,634

 
 
 
 
 
 
 
 
Denominator:
 

 
 

 
 
 
 
Weighted average common shares for basic earnings per share
53,851,865

 
52,545,155

 
53,485,339

 
51,806,700

Net effect of dilutive stock options, restricted stock units and restricted stock awards
3,111,002

 
2,683,626

 
3,114,299

 
2,854,496

Weighted average common shares for diluted earnings per share
56,962,867

 
55,228,781

 
56,599,638

 
54,661,196

 
 
 
 
 
 
 
 
Net income per share:
 

 
 

 
 
 
 
Basic
$
1.22

 
$
0.81

 
$
3.37

 
$
2.00

Diluted
$
1.15

 
$
0.77

 
$
3.19

 
$
1.90

The number of shares underlying equity–based awards that were excluded from the calculation of diluted earnings per share as their effect would be anti–dilutive was 157,316 and 121,896 during the three and nine months ended September 30, 2018, respectively. The number of shares underlying equity–based awards that were excluded from the calculation of diluted earnings per share as their effect would be anti–dilutive was 606,047 and 1,177,453 during the three and nine months ended September 30, 2017, respectively.

11.
COMMITMENTS AND CONTINGENCIES
Indemnification Obligations  In the normal course of business, the Company is a party to a variety of agreements under which it may be obligated to indemnify the other party for certain matters. These obligations typically arise in contracts where the Company customarily agrees to hold the other party harmless against losses arising from a breach of representations or covenants for certain matters such as title to assets, intellectual property rights and data privacy matters associated with certain arrangements. The duration of these indemnifications varies, and in certain cases, is indefinite.
The Company is unable to reasonably estimate the maximum potential amount of future payments under these or similar agreements due to the unique facts and circumstances of each agreement and the fact that certain indemnifications provide for no limitation to the maximum potential future payments under the indemnification. Management is not aware of any such matters that would have a material effect on the condensed consolidated financial statements of the Company.
Litigation — From time to time, the Company is involved in litigation, claims or other contingencies arising in the ordinary course of business. The Company accrues a liability when a loss is considered probable and the amount can be reasonably estimated. When a material loss contingency is reasonably possible but not probable, the Company does not record a liability, but instead discloses the nature and the amount of the claim, and an estimate of the loss or range of loss, if such an estimate can be made. Legal fees are expensed as incurred. In the opinion of management, the outcome of any existing claims and legal or regulatory proceedings, if decided adversely, is not expected to have a material effect on the Company’s business, financial condition, results of operations or cash flows.


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12.
SEGMENT INFORMATION
The Company determines its business segments and reports segment information in accordance with how the Company’s chief operating decision maker (“CODM”) organizes the segments to evaluate performance, allocate resources and make business decisions. Segment results are based on the segment’s revenues and operating profit, where segment operating profit is defined as income from operations before unallocated costs. Generally, operating expenses for each reportable segment have similar characteristics and are subject to similar factors, pressures and challenges. Expenses included in segment operating profit consist principally of direct selling and delivery costs as well as an allocation of certain shared services expenses. Certain corporate expenses are not allocated to specific segments as these expenses are not controllable at the segment level. Such expenses include certain types of professional fees and recruitment and development expenses, non-corporate taxes, compensations to non-employee directors and certain other general and administrative expenses, including compensation of specific groups of non-production employees. In addition, the Company does not allocate amortization of acquisition-related intangible assets, goodwill and other assets impairment charges, stock-based compensation expenses, acquisition-related costs and certain other one-time charges. These unallocated amounts are combined with total segment operating profit to arrive at consolidated income from operations as reported below in the reconciliation of segment operating profit to consolidated income before provision for/(benefit from) income taxes.
The Company manages its business primarily based on the managerial responsibility for its client base. As 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 the Company’s reportable segments. In some cases, managerial responsibility for a particular client is assigned to a management team in another region and is usually based on the strength of the relationship between client executives and particular members of EPAM’s senior management team. In such cases, the client’s activity would be reported through the management team’s reportable segment.
Revenues from external customers and operating profit, before unallocated expenses, by reportable segments for the three and nine months ended September 30, 2018 and 2017, were as follows:
 
Three Months Ended 
 September 30,
 
Nine Months Ended 
 September 30,
 
2018
 
2017
 
2018
 
2017
Segment revenues:
 
 
 
 
 
 
 
North America
$
280,838

 
$
206,389

 
$
769,137

 
$
578,717

Europe
171,482

 
157,446

 
516,320

 
431,472

Russia
16,208

 
14,455

 
53,374

 
41,825

Total segment revenues
$
468,528

 
$
378,290

 
$
1,338,831

 
$
1,052,014

Segment operating profit:
 

 
 

 
 
 
 
North America
$
60,763

 
$
45,529

 
$
155,944

 
$
126,243

Europe
28,871

 
25,984

 
84,329

 
66,453

Russia
543

 
1,685

 
8,211

 
7,129

Total segment operating profit
$
90,177

 
$
73,198

 
$
248,484

 
$
199,825

Intersegment transactions were excluded from the above on the basis that they are neither included in the measure of a segment’s profit and loss results, nor considered by the CODM during the review of segment results.
There were no customers that accounted for more than 10% of total revenues during the three and nine months ended September 30, 2018 and 2017.
Accounts receivable and unbilled revenues are generally dispersed across the Company’s clients in proportion to their revenues. There were no customers individually exceeding 10% of total unbilled revenues as of September 30, 2018. As of December 31, 2017, unbilled revenues from one customer, individually exceeded 10% and accounted for 13.0% of total unbilled revenues. There were no customers individually exceeding 10% of total accounts receivable as of September 30, 2018 and December 31, 2017.

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Table of Contents

Reconciliation of segment revenues to consolidated revenues and segment operating profit to consolidated income before provision for/(benefit from) income taxes is presented below:
 
Three Months Ended 
 September 30,
 
Nine Months Ended 
 September 30,
 
2018
 
2017
 
2018
 
2017
Total segment revenues
$
468,528

 
$
378,290

 
$
1,338,831

 
$
1,052,014

Other income included in segment revenues
(342
)
 
(767
)
 
(850
)
 
(863
)
Revenues
$