NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
(US Dollars in
thousands, except share and per share data)
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1.
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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, media and entertainment, 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, 2016
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 our 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.
Change in Presentation of Certain Financial Information
— During the first quarter of 2017, the Company changed the presentation of geographic area information about its consolidated revenues. Historically, information about geographic location of revenues excluded reimbursable expenses and other revenues, which primarily consist of travel and entertainment costs that are chargeable to clients. Effective January 1, 2017, the Company began reporting reimbursable expenses and other revenues based on location of clients to which these costs are chargeable and allocating them to respective geographic locations. These changes did not result in any adjustments to the Company’s previously issued financial statements and were applied retrospectively beginning on January 1, 2015. Comparative information for the three and six months ended June 30, 2016 follows:
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|
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Three Months Ended June 30, 2016
|
|
As Reported
|
|
After Reclassification
|
|
(in thousands except percentages)
|
United States
|
$
|
145,882
|
|
|
51.4
|
%
|
|
$
|
147,364
|
|
|
51.9
|
%
|
United Kingdom
|
45,016
|
|
|
15.9
|
%
|
|
45,652
|
|
|
16.1
|
%
|
Switzerland
|
32,456
|
|
|
11.4
|
%
|
|
32,596
|
|
|
11.5
|
%
|
Canada
|
15,173
|
|
|
5.3
|
%
|
|
15,327
|
|
|
5.4
|
%
|
Russia
|
10,484
|
|
|
3.7
|
%
|
|
10,505
|
|
|
3.7
|
%
|
Germany
|
9,663
|
|
|
3.4
|
%
|
|
9,736
|
|
|
3.4
|
%
|
Hong Kong
|
5,091
|
|
|
1.8
|
%
|
|
5,283
|
|
|
1.9
|
%
|
Sweden
|
5,888
|
|
|
2.1
|
%
|
|
6,033
|
|
|
2.1
|
%
|
Netherlands
|
3,165
|
|
|
1.1
|
%
|
|
3,326
|
|
|
1.2
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%
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Belgium
|
2,529
|
|
|
0.9
|
%
|
|
2,571
|
|
|
0.9
|
%
|
Ireland
|
1,296
|
|
|
0.5
|
%
|
|
1,304
|
|
|
0.5
|
%
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Italy
|
993
|
|
|
0.4
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%
|
|
1,006
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|
|
0.4
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%
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China
|
413
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|
|
0.1
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%
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|
413
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|
|
0.1
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%
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Other locations
|
2,657
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|
|
0.9
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%
|
|
2,716
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|
|
0.9
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%
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Reimbursable expenses and other revenues
|
3,126
|
|
|
1.1
|
%
|
|
—
|
|
|
—
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%
|
Total
|
$
|
283,832
|
|
|
100.0
|
%
|
|
$
|
283,832
|
|
|
100.0
|
%
|
|
|
|
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|
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|
|
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Six Months Ended June 30, 2016
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As Reported
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After Reclassification
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(in thousands except percentages)
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United States
|
$
|
281,440
|
|
|
51.3
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%
|
|
$
|
284,003
|
|
|
51.8
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%
|
United Kingdom
|
88,006
|
|
|
16.1
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%
|
|
89,212
|
|
|
16.3
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%
|
Switzerland
|
63,221
|
|
|
11.5
|
%
|
|
63,448
|
|
|
11.6
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%
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Canada
|
30,874
|
|
|
5.6
|
%
|
|
31,173
|
|
|
5.7
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%
|
Russia
|
19,436
|
|
|
3.5
|
%
|
|
19,470
|
|
|
3.5
|
%
|
Germany
|
18,369
|
|
|
3.4
|
%
|
|
18,475
|
|
|
3.4
|
%
|
Hong Kong
|
10,845
|
|
|
2.0
|
%
|
|
11,227
|
|
|
2.0
|
%
|
Sweden
|
9,948
|
|
|
1.8
|
%
|
|
10,161
|
|
|
1.9
|
%
|
Netherlands
|
5,712
|
|
|
1.0
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%
|
|
5,973
|
|
|
1.0
|
%
|
Belgium
|
4,653
|
|
|
0.9
|
%
|
|
4,723
|
|
|
0.9
|
%
|
Ireland
|
2,480
|
|
|
0.5
|
%
|
|
2,490
|
|
|
0.5
|
%
|
Italy
|
1,629
|
|
|
0.3
|
%
|
|
1,674
|
|
|
0.3
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%
|
China
|
707
|
|
|
0.1
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%
|
|
707
|
|
|
0.1
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%
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Other locations
|
5,422
|
|
|
1.0
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%
|
|
5,578
|
|
|
1.0
|
%
|
Reimbursable expenses and other revenues
|
5,572
|
|
|
1.0
|
%
|
|
—
|
|
|
—
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%
|
Total
|
$
|
548,314
|
|
|
100.0
|
%
|
|
$
|
548,314
|
|
|
100.0
|
%
|
Revenue Recognition —
The Company recognizes revenue when the following criteria are met: (1) persuasive evidence of an arrangement exists; (2) delivery has occurred; (3) the sales price is fixed or determinable; and (4) 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 reported.
The Company derives its revenues from a variety of service offerings, which represent specific competencies of its 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 the appropriate revenue recognition. Fees for these contracts may be in the form of time-and-materials or fixed-price arrangements. If there is an uncertainty about the project completion or receipt of payment for the services, revenue is deferred until the uncertainty is sufficiently resolved. At the time revenue is recognized, the Company provides for any contractual deductions and reduces the revenue accordingly. 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 Company defers amounts billed to its clients for revenues not yet earned. Such amounts are anticipated to be recorded as revenues when services are performed in subsequent periods. Unbilled revenue is recorded when services have been provided but billed subsequent to the period end in accordance with the contract terms.
Fair Value of Financial Instruments
— The Company makes assumptions about fair values of its financial assets and liabilities in accordance with the Financial Accounting Standards Board (“FASB”) Accounting Standards Codification (“ASC”) Topic 820, “Fair Value Measurement”, and utilizes the following fair value hierarchy in determining inputs used for valuation:
Level 1 — Quoted prices for identical assets or liabilities in active markets.
Level 2 — Inputs other than quoted prices within Level 1 that are observable either directly or indirectly, including quoted prices in markets that are not active, quoted prices in active markets for similar assets or liabilities, and observable inputs other than quoted prices such as interest rates or yield curves.
Level 3 — Unobservable inputs reflecting our view about the assumptions that market participants would use in pricing the asset or liability.
Where the fair values of financial assets and liabilities recorded in the condensed consolidated balance sheets cannot be derived from an active market, they are determined using a variety of valuation techniques. These valuation techniques include a net present value technique, comparison to similar instruments with market observable inputs, option pricing models and other relevant valuation models. To the extent possible, observable market data is used as inputs into these models but when it is not feasible, a degree of judgment is required to establish fair values.
Changes in fair value could cause a material impact to, and volatility in the Company’s operating results. See Note
3
for disclosures related to fair value.
Business Combinations
— The Company accounts for its business combinations using the acquisition accounting method, which requires it 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.” The Company identifies and attributes fair values and estimated lives to the intangible assets acquired and allocates 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. The Company bases its fair value estimates on assumptions it believes are reasonable, but recognizes that the assumptions are inherently uncertain.
All acquisition-related costs, other than the costs to issue debt or equity securities, are accounted for as expenses in the period in which they are incurred. Changes in fair value of contingent consideration arrangements that are not measurement period adjustments are recognized in earnings. Payments to settle contingent consideration up to the acquisition-date fair value are reflected in cash flows used in financing activities and amounts paid in excess of acquisition-date fair value are reflected in cash flows from operating activities in the Company’s condensed consolidated statements of cash flows.
The acquired assets typically consist of customer relationships, trade names, non-competition agreements, and assembled workforce. A portion of the purchase price is usually allocated to goodwill and other intangible assets.
Goodwill and Other Intangible Assets
— Goodwill and other intangible assets that have indefinite useful lives are accounted for in accordance with FASB ASC 350, “Intangibles - Goodwill and Other.” The Company conducts its evaluation of goodwill impairment at the reporting unit level on an annual basis during its fourth quarter, and more frequently if events or circumstances indicate that the carrying value of a reporting unit exceeds its fair value. A reporting unit is an operating segment or one level below. The Company does not have intangible assets that have indefinite useful lives.
Intangible assets that have finite useful lives are amortized over their estimated useful lives on a straight-line basis. When facts and circumstances indicate potential impairment of amortizable intangible assets, the Company evaluates the recoverability of the asset’s carrying value, using estimates of future cash flows over the remaining asset life. The estimates of future cash flows attributable to intangible assets require significant judgment based on the Company’s historical and anticipated results. Any impairment loss is measured by the excess of carrying value over fair value.
Stock-Based Compensation
— The Company recognizes the cost of its stock-based incentive awards based on the fair value of the award at the date of grant, net of estimated forfeitures. The cost is expensed evenly over the service period. The service period is the period over which the employee performs the related services, which is normally the same as the vesting period. Over time, the forfeiture assumption is adjusted to the actual forfeiture rate and such change may affect the timing of the total amount of expense recognized over the vesting period. Equity-based awards that do not require future service are expensed immediately. Equity-based awards that do not meet the criteria for equity classification are recorded as liabilities and adjusted to fair value at the end of each reporting period.
Off-Balance Sheet Financial Instruments
— The Company uses FASB ASC Topic 825, “Financial Instruments” to identify and disclose off-balance sheet financial instruments, which include credit instruments, such as commitments to make employee loans and related guarantees, standby letters of credit and certain guarantees issued under customer contracts. The face amount for these items represents the exposure to loss, before considering available collateral or the borrower’s ability to repay. Loss contingencies arising from off-balance sheet financial instruments are recorded as liabilities when the likelihood of loss is probable and an amount or range of loss can be reasonably estimated. The Company does not believe such matters exist that will have a material effect on the condensed consolidated financial statements.
Goodwill by reportable segment was as follows:
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North America
|
|
Europe
|
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Total
|
Balance as of January 1, 2017
|
$
|
76,812
|
|
|
$
|
32,477
|
|
|
$
|
109,289
|
|
Other acquisitions
|
199
|
|
|
4,533
|
|
|
4,732
|
|
Other acquisitions purchase accounting adjustments
|
(285
|
)
|
|
505
|
|
|
220
|
|
Effect of net foreign currency exchange rate changes
|
332
|
|
|
1,666
|
|
|
1,998
|
|
Balance as of June 30, 2017
|
$
|
77,058
|
|
|
$
|
39,181
|
|
|
$
|
116,239
|
|
There were
no
accumulated impairment losses in the North America or Europe reportable segments as of
June 30, 2017
or
December 31, 2016
.
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3.
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FAIR VALUE MEASUREMENTS
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The Company carries contingent liabilities and certain equity-based awards at fair value on a recurring basis on its consolidated balance sheets. Changes in the fair values of these financial liabilities are recorded in cost of revenues and selling, general and administrative expenses on the Company’s consolidated statements of income and comprehensive income.
The following tables show the fair values of the Company’s financial liabilities measured at fair value on a recurring basis as of
June 30, 2017
and
December 31, 2016
:
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|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
As of June 30, 2017
|
|
|
Balance
|
|
Level 1
|
|
Level 2
|
|
Level 3
|
Cash-settled restricted stock units
|
|
$
|
1,172
|
|
|
$
|
1,172
|
|
|
—
|
|
|
—
|
|
Total liabilities measured at fair value on a recurring basis
|
|
$
|
1,172
|
|
|
$
|
1,172
|
|
|
$
|
—
|
|
|
$
|
—
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
As of December 31, 2016
|
|
|
Balance
|
|
Level 1
|
|
Level 2
|
|
Level 3
|
Performance-based equity awards
|
|
$
|
3,789
|
|
|
$
|
3,789
|
|
|
$
|
—
|
|
|
$
|
—
|
|
Cash-settled restricted stock units
|
|
2,111
|
|
|
2,111
|
|
|
—
|
|
|
—
|
|
Total liabilities measured at fair value on a recurring basis
|
|
$
|
5,900
|
|
|
$
|
5,900
|
|
|
$
|
—
|
|
|
$
|
—
|
|
Performance-based equity awards carried at fair value on a recurring basis represent contractual liabilities related to certain business combination transactions completed in 2014. All of these awards have vested as of
June 30, 2017
and the related liabilities have been settled.
The fair value of the cash-settled restricted stock units is measured using quoted stock market prices and thus represent Level 1 measurements within the above–defined fair value hierarchy.
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 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;
|
|
|
•
|
restricted cash and time deposits;
|
|
|
•
|
borrowings under the 2017 Credit Facility (or for the dates prior to May 24, 2017, the 2014 Credit Facility) (Note
4
)
|
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
|
June 30, 2017
|
|
|
|
|
|
|
|
|
|
|
Financial Assets:
|
|
|
|
|
|
|
|
|
|
|
Cash and cash equivalents
|
|
$
|
443,501
|
|
|
$
|
443,501
|
|
|
$
|
443,501
|
|
|
$
|
—
|
|
|
$
|
—
|
|
Restricted cash and time deposits
|
|
$
|
3,318
|
|
|
$
|
3,318
|
|
|
$
|
—
|
|
|
$
|
3,318
|
|
|
$
|
—
|
|
Employee loans
|
|
$
|
5,238
|
|
|
$
|
5,238
|
|
|
$
|
—
|
|
|
$
|
—
|
|
|
$
|
5,238
|
|
Financial Liabilities:
|
|
|
|
|
|
|
|
|
|
|
Borrowings under 2017 Credit Facility
|
|
$
|
25,018
|
|
|
$
|
25,018
|
|
|
$
|
—
|
|
|
$
|
25,018
|
|
|
$
|
—
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Fair Value Hierarchy
|
|
|
Balance
|
|
Estimated Fair Value
|
|
Level 1
|
|
Level 2
|
|
Level 3
|
December 31, 2016
|
|
|
|
|
|
|
|
|
|
|
Financial Assets:
|
|
|
|
|
|
|
|
|
|
|
Cash and cash equivalents
|
|
$
|
362,025
|
|
|
$
|
362,025
|
|
|
$
|
362,025
|
|
|
$
|
—
|
|
|
$
|
—
|
|
Restricted cash and time deposits
|
|
$
|
3,042
|
|
|
$
|
3,042
|
|
|
$
|
—
|
|
|
$
|
3,042
|
|
|
$
|
—
|
|
Employee loans
|
|
$
|
5,978
|
|
|
$
|
5,978
|
|
|
$
|
—
|
|
|
$
|
—
|
|
|
$
|
5,978
|
|
Financial Liabilities:
|
|
|
|
|
|
|
|
|
|
|
Borrowings under 2014 Credit Facility
|
|
$
|
25,019
|
|
|
$
|
25,019
|
|
|
$
|
—
|
|
|
$
|
25,019
|
|
|
$
|
—
|
|
Revolving Line of Credit
— On May 24, 2017, the Company entered into a new 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”) to replace its former revolving credit facility (the “2014 Credit Facility”). 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. 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%
.
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
June 30, 2017
, the Company was in compliance with all covenants contained in the 2017 Credit Facility.
As of
June 30, 2017
the outstanding debt of the Company under the 2017 Credit Facility was
$25,000
. As of
December 31, 2016
, the outstanding debt of the Company under the 2014 Credit Facility was
$25,000
. Both borrowings are subject to a LIBOR-based interest rate, which resets regularly at issuance, based on lending terms. In addition, the Company has a
$942
unused irrevocable standby letter of credit associated with its insurance program that was issued under the 2014 Credit Facility and moved to the 2017 Credit Facility.
As of
June 30, 2017
, the borrowing capacity of the Company under the 2017 Credit Facility was
$274,058
. As of
December 31, 2016
, the borrowing capacity of the Company under the 2014 Credit Facility was
$74,058
.
In determining its interim provision for 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
June 30, 2017
and
2016
was
13.2%
and
21.0%
, respectively and
14.9%
and
21.0%
during the six months ended
June 30, 2017
and
2016
, respectively. The decrease in the three and
six
months ended
June 30, 2017
as compared to the same period last year was primarily due to the recognition of excess tax benefits in the first and second quarter of 2017 following the adoption of ASU No. 2016-09 on January 1, 2017. Refer to Note
10
, “Recent Accounting Pronouncements,” for further information.
Our Belarus subsidiary is eligible for certain income tax holiday benefits granted by the local government for its export activities conducted within the Hi-Tech Park. Income tax holidays are effective for
15 years
starting from 2006. Other subsidiaries of the Company are primarily taxed at the jurisdictions’ statutory rate, most of which are lower than U.S. federal statutory rates.
|
|
6.
|
STOCK-BASED COMPENSATION
|
The following costs related to the Company’s stock compensation plans were included in the condensed consolidated statements of income and comprehensive income:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended
June 30,
|
|
Six Months Ended
June 30,
|
|
2017
|
|
2016
|
|
2017
|
|
2016
|
Cost of revenues
|
$
|
4,189
|
|
|
$
|
4,438
|
|
|
$
|
9,539
|
|
|
$
|
8,082
|
|
Selling, general and administrative expenses - Acquisition related
|
3,277
|
|
|
2,970
|
|
|
7,851
|
|
|
5,980
|
|
Selling, general and administrative expenses - All other
|
5,461
|
|
|
5,322
|
|
|
11,313
|
|
|
9,632
|
|
Total
|
$
|
12,927
|
|
|
$
|
12,730
|
|
|
$
|
28,703
|
|
|
$
|
23,694
|
|
Equity Plans
2015 Long-Term Incentive Plan
— On June 11, 2015, the Company's stockholders approved the 2015 Long Term Incentive Plan (“2015 Plan”) to be used to issue equity awards to Company personnel. As of
June 30, 2017
,
5,684,419
shares remained available for issuance under the 2015 Plan. All of the stock option awards issued pursuant to the 2015 Plan expire
10 years
from the date of grant.
2012 Non-Employee Directors Compensation Plan
— On January 11, 2012, the Company approved the 2012 Non-Employee Directors Compensation Plan (“2012 Directors Plan”) to be used to issue equity awards to its non-employee directors. The Company authorized
600,000
shares of common stock to be reserved for issuance under the plan. The 2012 Directors Plan will expire after
10 years
and is administered by the Company’s Board of Directors. As of
June 30, 2017
,
539,772
shares remained available for issuance under the 2012 Directors Plan.
2012 Long-Term Incentive Plan
— On January 11, 2012, the Company approved the 2012 Long-Term Incentive Plan (“2012 Plan”) to be used to issue equity grants to company personnel. In June 2015, the 2012 Plan was discontinued; however, outstanding awards remain subject to the terms of the 2012 Plan and any shares that are subject to an award that was previously granted under the 2012 Plan and that expire or terminate for any reason prior to exercise will become available for issuance under the 2015 Plan. All of the stock option awards issued pursuant to the 2012 Plan expire
10 years
from the date of grant.
2006 Stock Option Plan
— Effective May 31, 2006, the Board of Directors of the Company adopted the 2006 Stock Option Plan (the “2006 Plan”) to grant stock options to directors, employees, and certain independent contractors. In January 2012, the 2006 Plan was discontinued; however, outstanding awards remain subject to the terms of the 2006 Plan and any shares that are subject to an option award that was previously granted under the 2006 Plan and that expire or terminate for any reason prior to exercise will become available for issuance under the 2015 Plan. All of the awards issued pursuant to the 2006 Plan expire
10 years
from the date of grant.
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, 2017
|
6,637,239
|
|
|
$
|
37.20
|
|
|
|
|
|
Options granted
|
261,373
|
|
|
$
|
73.40
|
|
|
|
|
|
Options exercised
|
(1,277,952
|
)
|
|
$
|
29.57
|
|
|
|
|
|
Options forfeited/cancelled
|
(112,646
|
)
|
|
$
|
55.98
|
|
|
|
|
|
Options outstanding at June 30, 2017
|
5,508,014
|
|
|
$
|
40.30
|
|
|
$
|
241,196
|
|
|
6.6
|
|
|
|
|
|
|
|
|
Options vested and exercisable at June 30, 2017
|
3,522,106
|
|
|
$
|
30.97
|
|
|
$
|
187,094
|
|
|
6.0
|
Options expected to vest at June 30, 2017
|
1,890,939
|
|
|
$
|
56.54
|
|
|
$
|
52,095
|
|
|
7.8
|
As of June 30, 2017
,
$37,181
of total remaining unrecognized stock-based compensation cost related to unvested stock options, net of forfeitures, is expected to be recognized over the weighted-average remaining requisite service period of
1.6 years
.
As of June 30, 2017
, a total of
3,049
shares underlying options exercised through
June 30, 2017
, were in transfer with the Company’s transfer agent.
There were no material changes with respect to the assumptions used in the Black-Scholes option valuation model during the
six
months ended
June 30, 2017
, as compared with the assumptions disclosed in Note 14 to the audited consolidated financial statements included in the Company’s Annual Report on Form 10-K for the fiscal year ended
December 31, 2016
.
Restricted Stock and Restricted Stock Units
Under the Company’s 2012 Directors Plan, the Company granted awards of restricted stock until April 2017, and thereafter, restricted stock units (“RSUs”), to non-employee directors. Under the Company’s 2015 Plan (and prior to its approval, under the 2012 Plan), the Company grants awards of RSUs to Company personnel. In addition, the Company has issued in the past, and may issue in the future its equity securities to compensate employees of acquired businesses for future services. Equity-based awards granted in connection with acquisitions of businesses are generally issued in the form of service-based awards with vesting dependent only on continuing employment and performance-based awards with vesting occurring only if certain specified performance conditions are met. The awards issued in connection with acquisitions of businesses are subject to the terms and conditions contained in the applicable award agreement and acquisition documents with a typical vesting period of
three years
, with
33.3%
of the awards granted vesting in equal installments on the first, second and third anniversaries of the grant.
Service-Based Awards
The table below summarizes activity related to the Company’s equity-classified and liability-classified service-based awards for the
six
months ended
June 30, 2017
.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
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, 2017
|
154,125
|
|
|
$
|
40.89
|
|
|
485,188
|
|
|
$
|
67.69
|
|
|
204,501
|
|
|
$
|
70.53
|
|
Awards granted
|
—
|
|
|
$
|
—
|
|
|
419,469
|
|
|
$
|
73.70
|
|
|
168,544
|
|
|
$
|
73.92
|
|
Awards modified
|
—
|
|
|
$
|
—
|
|
|
(2,570
|
)
|
|
$
|
48.49
|
|
|
2,570
|
|
|
$
|
73.27
|
|
Awards vested
|
(136,275
|
)
|
|
$
|
42.88
|
|
|
(118,019
|
)
|
|
$
|
65.27
|
|
|
(52,001
|
)
|
|
$
|
70.56
|
|
Awards forfeited/cancelled
|
—
|
|
|
$
|
—
|
|
|
(36,947
|
)
|
|
$
|
69.52
|
|
|
(4,202
|
)
|
|
$
|
71.62
|
|
Unvested service-based awards outstanding at June 30, 2017
|
17,850
|
|
|
$
|
48.43
|
|
|
747,121
|
|
|
$
|
71.42
|
|
|
319,412
|
|
|
$
|
72.32
|
|
As of
June 30, 2017
$365
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
1.2 years
.
As of
June 30, 2017
$40,151
of total remaining unrecognized stock-based compensation cost related to service-based equity-classified RSUs is expected to be recognized over the weighted-average remaining requisite service period of
2.1 years
.
As of
June 30, 2017
$18,411
of total remaining unrecognized stock-based compensation cost related to service-based liability-classified RSUs is expected to be recognized over the weighted-average remaining requisite service period of
2.1 years
.
Performance -Based Awards
The table below summarizes activity related to the Company’s equity-classified and liability-classified performance-based awards for the
six
months ended
June 30, 2017
.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Equity-Classified
Restricted Stock
|
|
Liability-Classified
Restricted Stock
|
|
Equity-Classified
Equity-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 performance-based awards outstanding at January 1, 2017
|
5,573
|
|
|
$
|
33.47
|
|
|
105,602
|
|
|
$
|
38.86
|
|
|
4,667
|
|
|
$
|
70.22
|
|
Awards granted
|
—
|
|
|
$
|
—
|
|
|
—
|
|
|
$
|
—
|
|
|
—
|
|
|
$
|
—
|
|
Awards vested
|
(3,956
|
)
|
|
$
|
27.64
|
|
|
(105,602
|
)
|
|
$
|
38.86
|
|
|
—
|
|
|
$
|
—
|
|
Awards forfeited/cancelled
|
—
|
|
|
$
|
—
|
|
|
—
|
|
|
$
|
—
|
|
|
(2,333
|
)
|
|
$
|
70.22
|
|
Unvested performance-based awards outstanding at June 30, 2017
|
1,617
|
|
|
$
|
47.74
|
|
|
—
|
|
|
$
|
—
|
|
|
2,334
|
|
|
$
|
70.22
|
|
As of
June 30, 2017
,
$29
of total remaining unrecognized stock-based compensation cost related to performance-based equity-classified restricted stock is expected to be recognized over the weighted-average remaining requisite service period of
0.4 years
.
As of
June 30, 2017
, the Company determined that there is a remote probability of achieving the performance conditions underlying the unvested and outstanding performance-based equity-classified RSUs and therefore is not recognizing any compensation costs for these RSUs. The Company will continue to reassess the probability of achieving the performance criteria throughout the remaining performance period and will recognize compensation expense if the performance conditions become probable of being achieved.
Modifications
During the three months ended March 31, 2017, the Company modified certain awards held by a named executive officer of the Company in connection with the execution of a separation agreement on February 28, 2017. Fair value of the modified awards immediately before and after modification was
$0
and
$563
, respectively. The Company also reclassified certain awards to other personnel from equity to liability when it became probable that it would settle the awards in cash. As a result of these modifications, the Company recorded incremental share-based compensation expense for the three and six months ended June 30, 2017 of
$318
and
$485
, respectively.
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.
The following table sets forth the computation of basic and diluted earnings per share of common stock as follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended
June 30,
|
|
Six Months Ended
June 30,
|
|
2017
|
|
2016
|
|
2017
|
|
2016
|
Numerator for basic and diluted earnings per share:
|
|
|
|
|
|
|
|
Net income
|
$
|
37,359
|
|
|
$
|
24,430
|
|
|
$
|
61,000
|
|
|
$
|
48,329
|
|
Numerator for basic and diluted earnings per share
|
$
|
37,359
|
|
|
$
|
24,430
|
|
|
$
|
61,000
|
|
|
$
|
48,329
|
|
|
|
|
|
|
|
|
|
Denominator:
|
|
|
|
|
|
|
|
|
|
Weighted average common shares for basic earnings per share
|
51,899
|
|
|
50,211
|
|
|
51,431
|
|
|
49,688
|
|
Net effect of dilutive stock options, restricted stock units and restricted stock awards
|
2,949
|
|
|
3,060
|
|
|
2,940
|
|
|
3,115
|
|
Weighted average common shares for diluted earnings per share
|
54,848
|
|
|
53,271
|
|
|
54,371
|
|
|
52,803
|
|
|
|
|
|
|
|
|
|
Net income per share:
|
|
|
|
|
|
|
|
|
|
Basic
|
$
|
0.72
|
|
|
$
|
0.49
|
|
|
$
|
1.19
|
|
|
$
|
0.97
|
|
Diluted
|
$
|
0.68
|
|
|
$
|
0.46
|
|
|
$
|
1.12
|
|
|
$
|
0.92
|
|
The number of shares underlying equity–based awards that was excluded from the calculation of diluted earnings per share as their effect would be anti–dilutive was
654
and
1,463
during the
three and six
months ended
June 30, 2017
, respectively. The number of shares underlying equity–based awards that was excluded from the calculation of diluted earnings per share as their effect would be anti–dilutive was
2,396
and
2,307
during the
three and six
months ended
June 30, 2016
, respectively.
|
|
8.
|
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 and intellectual property rights 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, it 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 adverse effect on the Company’s business, financial condition, results of operations and cash flows.
The Company determines its business segments and reports segment information in accordance with the management approach, which designates internal reporting used by management to make operating decisions and assess performance as the source of the Company’s reportable segments.
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.
The Company’s reportable segments are North America, Europe, Russia and Other. The revenues in the Other segment represented less than 1% of total segment revenues in 2015 due to the ending of certain customer relationships and contractual changes with other clients. As no substantial clients remained in the segment, during the first quarter of 2016, the Company shifted managerial responsibility for the remaining clients to the Russia segment. This change did not represent a change in the Company’s segments but rather a movement in responsibility for several clients that represented less than 1% of total segment revenue.
The Company’s Chief Operating Decision Maker (“CODM”) evaluates performance and allocates resources based on the segment’s revenues and operating profit. 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 expenses that are not controllable at the segment level are not allocated to specific segments. Such “unallocated” expenses are deducted against the Company’s total income from operations and are not allocated to individual segments in internal management reports used by the CODM.
Revenues from external customers and operating profit, before unallocated expenses, for the North America, Europe, and Russia reportable segments for the
three and six
months ended
June 30, 2017
and
2016
, were as follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended
June 30,
|
|
Six Months Ended
June 30,
|
|
2017
|
|
2016
|
|
2017
|
|
2016
|
Segment revenues:
|
|
|
|
|
|
|
|
North America
|
$
|
194,025
|
|
|
$
|
157,110
|
|
|
$
|
372,328
|
|
|
$
|
304,600
|
|
Europe
|
141,319
|
|
|
115,726
|
|
|
274,026
|
|
|
223,569
|
|
Russia
|
13,677
|
|
|
11,141
|
|
|
27,370
|
|
|
20,622
|
|
Total segment revenues
|
$
|
349,021
|
|
|
$
|
283,977
|
|
|
$
|
673,724
|
|
|
$
|
548,791
|
|
Segment operating profit:
|
|
|
|
|
|
|
|
|
|
North America
|
$
|
43,622
|
|
|
$
|
38,339
|
|
|
$
|
80,714
|
|
|
$
|
68,994
|
|
Europe
|
20,658
|
|
|
13,413
|
|
|
40,469
|
|
|
30,245
|
|
Russia
|
1,895
|
|
|
2,876
|
|
|
5,444
|
|
|
4,036
|
|
Total segment operating profit
|
$
|
66,175
|
|
|
$
|
54,628
|
|
|
$
|
126,627
|
|
|
$
|
103,275
|
|
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 six
months ended
June 30, 2017
. During the
three and six
months ended
June 30, 2016
, revenues from
one
customer,
UBS AG
, were
$36,570
and
$72,239
, respectively, and accounted for more than 10% of total revenues. Revenues from this customer were included in the Company’s Europe segment in the periods indicated.
Accounts receivable and unbilled revenues are generally dispersed across our clients in proportion to their revenues. As of
June 30, 2017
, unbilled revenues from
one
customer,
UBS AG
, individually exceeded 10% and accounted for
16.0%
of our unbilled revenues.
No
customers individually exceeded 10% of our accounts receivable as of
June 30, 2017
.
Reconciliation of segment revenues to consolidated revenues and segment operating profit to consolidated income before provision for income taxes is presented below:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended
June 30,
|
|
Six Months Ended
June 30,
|
|
2017
|
|
2016
|
|
2017
|
|
2016
|
Total segment revenues
|
$
|
349,021
|
|
|
$
|
283,977
|
|
|
$
|
673,724
|
|
|
$
|
548,791
|
|
Other revenues
|
(44
|
)
|
|
(145
|
)
|
|
(96
|
)
|
|
(477
|
)
|
Revenues
|
$
|
348,977
|
|
|
$
|
283,832
|
|
|
$
|
673,628
|
|
|
$
|
548,314
|
|
|
|
|
|
|
|
|
|
Total segment operating profit:
|
$
|
66,175
|
|
|
$
|
54,628
|
|
|
$
|
126,627
|
|
|
$
|
103,275
|
|
Unallocated amounts:
|
|
|
|
|
|
|
|
Other revenues
|
(44
|
)
|
|
(145
|
)
|
|
(96
|
)
|
|
(477
|
)
|
Stock-based compensation expense
|
(12,927
|
)
|
|
(12,730
|
)
|
|
(28,703
|
)
|
|
(23,694
|
)
|
Taxes other than income taxes
|
(1,795
|
)
|
|
(1,437
|
)
|
|
(5,246
|
)
|
|
(2,517
|
)
|
Professional fees
|
(2,476
|
)
|
|
(2,460
|
)
|
|
(4,820
|
)
|
|
(4,186
|
)
|
Depreciation and amortization
|
(1,905
|
)
|
|
(2,576
|
)
|
|
(3,880
|
)
|
|
(4,267
|
)
|
Bank charges
|
(446
|
)
|
|
(386
|
)
|
|
(843
|
)
|
|
(727
|
)
|
Other acquisition-related expenses
|
(330
|
)
|
|
(307
|
)
|
|
(898
|
)
|
|
(307
|
)
|
Other corporate expenses
|
(5,570
|
)
|
|
(2,507
|
)
|
|
(10,493
|
)
|
|
(4,689
|
)
|
Income from operations
|
40,682
|
|
|
32,080
|
|
|
71,648
|
|
|
62,411
|
|
Interest and other income, net
|
802
|
|
|
1,138
|
|
|
1,386
|
|
|
2,349
|
|
Foreign exchange gain (loss)
|
1,562
|
|
|
(2,295
|
)
|
|
(1,393
|
)
|
|
(3,585
|
)
|
Income before provision for income taxes
|
$
|
43,046
|
|
|
$
|
30,923
|
|
|
$
|
71,641
|
|
|
$
|
61,175
|
|
Geographic Area Information
Long-lived assets include property and equipment, net of accumulated depreciation and amortization, and management has determined that it is not practical to allocate these assets by segment since such assets are used interchangeably among the segments. Geographical information about the Company’s long-lived assets based on physical location of the assets was as follows:
|
|
|
|
|
|
|
|
|
|
As of
June 30,
2017
|
|
As of
December 31,
2016
|
Belarus
|
$
|
46,500
|
|
|
$
|
46,011
|
|
Russia
|
8,410
|
|
|
7,203
|
|
Ukraine
|
5,564
|
|
|
5,610
|
|
Hungary
|
3,791
|
|
|
3,485
|
|
United States
|
3,403
|
|
|
2,618
|
|
Poland
|
2,772
|
|
|
2,213
|
|
China
|
1,736
|
|
|
1,887
|
|
India
|
1,346
|
|
|
1,650
|
|
Other
|
3,593
|
|
|
2,939
|
|
Total
|
$
|
77,115
|
|
|
$
|
73,616
|
|
The table below presents information about the Company’s revenues by client location, including reimbursable expenses and other revenues of
$4,167
and
$3,126
for the three months ended
June 30, 2017
and
2016
, respectively, and
$8,092
and
$5,572
for the
six months ended
June 30, 2017
and
2016
, respectively. See Note 1 for discussion on reclassifications to conform to the current presentation.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended
June 30,
|
|
Six Months Ended
June 30,
|
|
2017
|
|
2016
|
|
2017
|
|
2016
|
United States
|
$
|
192,319
|
|
|
$
|
147,364
|
|
|
$
|
369,149
|
|
|
$
|
284,003
|
|
United Kingdom
|
46,112
|
|
|
45,652
|
|
|
92,706
|
|
|
89,212
|
|
Switzerland
|
28,119
|
|
|
32,596
|
|
|
57,215
|
|
|
63,448
|
|
Russia
|
13,326
|
|
|
10,505
|
|
|
26,535
|
|
|
19,470
|
|
Germany
|
14,144
|
|
|
9,736
|
|
|
26,238
|
|
|
18,475
|
|
Canada
|
13,649
|
|
|
15,327
|
|
|
26,143
|
|
|
31,173
|
|
Netherlands
|
12,556
|
|
|
3,326
|
|
|
21,227
|
|
|
5,973
|
|
Sweden
|
8,177
|
|
|
6,033
|
|
|
15,643
|
|
|
10,161
|
|
Hong Kong
|
4,491
|
|
|
5,283
|
|
|
9,268
|
|
|
11,227
|
|
United Arab Emirates
|
3,201
|
|
|
—
|
|
|
5,249
|
|
|
—
|
|
China
|
1,909
|
|
|
413
|
|
|
3,493
|
|
|
707
|
|
Ireland
|
1,600
|
|
|
1,304
|
|
|
2,989
|
|
|
2,490
|
|
Italy
|
1,517
|
|
|
1,006
|
|
|
2,797
|
|
|
1,674
|
|
Belgium
|
1,398
|
|
|
2,571
|
|
|
2,642
|
|
|
4,723
|
|
Other locations
|
6,459
|
|
|
2,716
|
|
|
12,334
|
|
|
5,578
|
|
Total
|
$
|
348,977
|
|
|
$
|
283,832
|
|
|
$
|
673,628
|
|
|
$
|
548,314
|
|
|
|
10.
|
RECENT ACCOUNTING PRONOUNCEMENTS
|
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.
Stock-Based Compensation
— Effective January 1, 2017, the Company adopted Accounting Standard Update (“ASU”) No. 2016-09,
Compensation
—
Stock Compensation (Topic 718): Improvements to Employee Share-Based Payment Accounting
. The provisions of the new guidance affecting the Company require excess tax benefits and tax deficiencies to be recorded in the income statement when the awards vest or are settled; remove the requirement to include hypothetical excess tax benefits in the application of the treasury stock method when computing earnings per share; and provide for a new policy election to either: (1) continue applying forfeiture rate estimates in the determination of compensation cost, or (2) account for forfeitures as a reduction of share-based compensation cost as they occur. The new guidance also requires cash flows related to excess tax benefits to be classified as an operating activity in the statement of cash flows and now requires shares withheld for tax withholding purposes to be classified as a financing activity.
As a result of this adoption:
|
|
•
|
the Company prospectively recognized discrete tax benefits of
$4,138
and
$5,832
in the provision for income taxes within the condensed consolidated statements of income and comprehensive income for the three and six months ended June 30, 2017, respectively, related to excess tax benefits upon vesting and exercise of stock–based awards in those periods;
|
|
|
•
|
the Company recognized a
$1,740
increase in retained earnings as of January 1, 2017 for previously unrecognized tax benefits using the modified retrospective method of transition, as required by the standard;
|
|
|
•
|
the Company elected to adopt the cash flow presentation of the excess tax benefits prospectively where these benefits are classified along with other income tax cash flows as operating cash flows. Accordingly, prior period information has not been restated;
|
|
|
•
|
the Company elected to continue to estimate the number of stock-based awards expected to forfeit, rather than electing to account for forfeitures as they occur to determine the amount of compensation cost to be recognized in each period;
|
|
|
•
|
the Company excluded the excess tax benefits from the assumed proceeds available to repurchase shares in the computation of diluted earnings per share for the three and six months ended June 30, 2017;
|
Simplifying the Measurement for Goodwill
— Effective January 1, 2017, the Company early adopted the new accounting guidance simplifying the accounting for goodwill impairment. The guidance removes Step 2 of the goodwill impairment test, which requires a hypothetical purchase price allocation. A goodwill impairment will now be the amount by which a reporting unit’s carrying value exceeds its fair value, not to exceed the carrying amount of goodwill. The new guidance is adopted on a prospective basis. The adoption of this amended guidance did not have an impact on the Company’s financial results.
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.
Revenue Recognition
— In May 2014, the FASB issued ASU 2014-09,
Revenue from Contracts with Customers (Topic 606)
. The core principle of Topic 606 is that an entity should 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. Topic 606 as amended, will replace most existing revenue recognition guidance in GAAP and requires expanded disclosure about the nature, amount, timing and uncertainty of revenue and cash flows arising from customer contracts, including significant judgments and changes in judgments. The standard allows for two methods of adoption: the full retrospective method, which requires the standard to be applied to each prior period presented, or the modified retrospective method, which requires the cumulative effect of adoption to be recognized as an adjustment to opening retained earnings in the period of adoption as well as incremental disclosure comparing results presented under Topic 606 to results that would have been presented utilizing current accounting. The Company plans to adopt Topic 606 as issued and amended on January 1, 2018 using the modified retrospective method.
The Company is completing its initial assessment of the impact of Topic 606 and 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. Based on the assessment procedures completed to date, the Company does not expect a significant change in the timing or pattern of revenue recognition upon adoption. Due to the complexity of certain of the Company’s contracts, actual revenue recognition treatment required under the new standard depends on contract-specific terms and may vary in some instances. For most of the Company’s time-and-materials contracts, EPAM expects to continue to recognize revenues as services are performed consistent with the Company’s current policy. For fixed-price contracts, the Company generally expects to continue to recognize revenues over time based on the measured progress of satisfaction of the performance obligations which is consistent with the Company’s current proportional performance method. The most impactful changes expected upon adoption include a delay in revenue recognition related to (1) cash collections on contracts when collectability is uncertain and (2) discounted services determined to represent material rights granted to certain customers. The Company has not completed its assessment of the impact of the change in accounting to capitalize certain contract fulfillment costs. Upon adoption, EPAM expects to provide incremental disclosure in its consolidated financial statements related to revenue recognition including disaggregated information related to the Company’s key verticals, contract balances, remaining performance obligations, and significant judgments and estimates. The expected impact may change as the Company finalizes its overall assessment.
Leases
— Effective January 1, 2019, the Company will be required to adopt the new guidance of ASC Topic 842,
Leases
(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 requires lessees and lessors to recognize and measure leases at the beginning of the earliest period presented using a modified retrospective approach. The modified retrospective approach includes 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 at each reporting date 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 not yet completed its assessment of the impact of the new guidance on its consolidated financial statements, when it will adopt the standard, or concluded on whether it will elect to apply practical expedients.
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.
Tax Accounting for Intra-Entity Asset Transfers
— Effective January 1, 2018, with early adoption permitted, the Company will be required to adopt the accounting guidance ASU 2016-16,
Accounting for Income Taxes: Intra-Entity Asset Transfers of Assets Other than Inventory,
that will require the tax effects of intra-entity asset transfers to be recognized in the period when the transfer occurs. Under current guidance, the tax effects of intra-entity sales of assets are deferred until the transferred asset is sold to a third party or otherwise recovered through use. The new guidance does not apply to intra-entity transfers of inventory and is required to be applied on a modified retrospective basis through a cumulative effect adjustment to retained earnings as of the beginning of the period of adoption. The Company will adopt this standard on January 1, 2018. The Company has not yet completed its assessment of the impact of the new guidance on its consolidated financial statements.