UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

 

FORM 10-Q

 

(Mark One)

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

 

For the quarterly period ended June 30, 2021

 

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: 001-38685

 

Grid Dynamics Holdings, Inc.

(Exact Name of Registrant as Specified in its Charter)

 

Delaware   83-0632724

(State or other jurisdiction

of incorporation or organization)

 

(I.R.S. Employer

Identification No.)

 

5000 Executive Parkway, Suite 520

San Ramon, CA 94583

(Address of principal executive offices)

 

(650) 523-5000

(Registrant’s telephone number, including area code)

 

Securities registered pursuant to Section 12(b) of the Act:

 

Title of each class   Trading Symbol(s)   Name of each exchange on which registered
Common Stock, par value $0.0001 per share   GDYN   The NASDAQ Stock Market LLC
Redeemable warrants, exercisable for shares of common stock at an exercise price of $11.50 per share   GDYNW   The NASDAQ Stock Market LLC

 

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 ☒   No ☐

 

Indicate by check mark whether the registrant has submitted electronically, every Interactive Data File required to be submitted 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 such files). Yes ☒   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.

 

Large accelerated filer Accelerated filer
Non-accelerated filer 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 ☒

 

As of August 2, 2021, there were 62,111,831 shares of registrant’s common Stock issued and outstanding.

 

 

 

 

 

 

TABLE OF CONTENTS

 

      Page
PART I. FINANCIAL INFORMATION    
Item 1. Financial Statements (unaudited)   1
  Condensed Consolidated Balance Sheets   1
  Condensed Consolidated Statements of Loss and Comprehensive Loss   2
  Condensed Consolidated Statements of Convertible Preferred Stock and Stockholders’ Equity   3
  Condensed Consolidated Statements of Cash Flows   4
  Notes to Condensed Consolidated Financial Statements   5
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations   21
Item 3. Quantitative and Qualitative Disclosures About Market Risk   34
Item 4. Controls and Procedures   36
       
PART II. OTHER INFORMATION    
Item 1. Legal Proceedings   37
Item 1A. Risk Factors   37
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds   63
Item 3. Default Upon Senior Securities   63
Item 4. Mine Safety Disclosures   63
Item 5. Other Information   63
Item 6. Exhibits   64
       
SIGNATURES   65

 

i

 

 

SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS

 

This Quarterly Report on Form 10-Q contains forward-looking statements within the meaning of the federal securities laws, which statements involve substantial risks and uncertainties. Forward-looking statements generally relate to future events or our future financial or operating performance. Forward-looking statements include all statements that are not historical facts and can be identified by terms such as “anticipates,” “believes,” “could,” “seeks,” “estimates,” “expects,” “intends,” “may,” “plans,” “potential,” “predicts,” “projects,” “should,” “will,” “would,” or similar expressions and the negatives of those terms. Forward-looking statements contained in this Quarterly Report on Form 10-Q include, but are not limited to, statements about:

 

the evolution of the digital engineering and information technology services landscape facing our customers and prospects;

 

our ability to educate the market regarding the advantages of our digital transformation products;

 

our ability to maintain an adequate rate of revenue growth;

 

our future financial and operating results;

 

our business plan and our ability to effectively manage our growth and associated investments;

 

beliefs and objectives for future operations;

 

our ability to expand a leadership position in enterprise-level digital transformation;

 

our ability to attract and retain customers;

 

our ability to further penetrate our existing customer base;

 

our ability to maintain our competitive technological advantages against new entrants in our industry;

 

our ability to timely and effectively scale and adapt our existing technology;

 

our ability to innovate new products and services and bring them to market in a timely manner;

 

our ability to maintain, protect, and enhance our brand and intellectual property;

 

our ability to capitalize on changing market conditions;

 

our ability to develop strategic partnerships;

 

benefits associated with the use of our services;

 

our ability to expand internationally;

 

our ability to raise financing in the future;

 

operating expenses, including changes in research and development, sales and marketing, and general administrative expenses;

 

the effects of seasonal trends on our results of operations;

 

our ability to grow and manage growth profitably and retain our key employees;

 

the expected benefits and effects of strategic acquisitions of business, products or technologies;

 

ii

 

 

our ability to maintain the listing of our shares of common stock and our warrants on the NASDAQ;

 

costs related to being a public company;

 

changes in applicable laws or regulations;

 

the possibility that we have been and may continue to be adversely affected by other economic, business, and/or competitive factors, including the effects of the global COVID-19 pandemic; and

 

other risks and uncertainties indicated in this Quarterly Report on Form 10-Q, including those set forth in Item 1A, “Risk Factors.”

 

We caution you that the foregoing list may not contain all of the forward-looking statements made in this Quarterly Report on Form 10-Q.

 

You should not rely upon forward-looking statements as predictions of future events. We have based the forward-looking statements contained in this Quarterly Report on Form 10-Q primarily on our current expectations and projections about future events and trends that we believe may affect our business, financial condition, results of operations, and prospects. The outcome of the events described in these forward-looking statements is subject to risks, uncertainties, and other factors, including those described in in Item 1A, “Risk Factors” and elsewhere in this Quarterly Report on Form 10-Q. Moreover, new risks and uncertainties emerge from time to time and it is not possible for us to predict all risks and uncertainties that could have an impact on any forward-looking statements contained in this Quarterly Report on Form 10-Q. We cannot assure you that the results, events, and circumstances reflected in the forward-looking statements will be achieved or occur, and actual results, events, or circumstances could differ materially from those described in such forward-looking statements.

 

Neither we nor any other person assumes responsibility for the accuracy and completeness of any of these forward-looking statements. Moreover, the forward-looking statements made in this Quarterly Report on Form 10-Q relate only to events as of the date on which the statements are made. We undertake no obligation to update any forward-looking statements made in this Quarterly Report on Form 10-Q to reflect events or circumstances after the date of this Quarterly Report on Form 10-Q or to reflect new information or the occurrence of unanticipated events, except as required by law. We may not actually achieve the plans, intentions or expectations disclosed in our forward-looking statements and you should not place undue reliance on our forward-looking statements. Our forward-looking statements do not reflect the potential impact of any future acquisitions, mergers, dispositions, restructurings, joint ventures, partnerships, or investments we may make.

 

In addition, statements that “we believe” and similar statements reflect our beliefs and opinions on the relevant subject. These statements are based upon information available to us as of the date of this Quarterly Report on Form 10-Q, and while we believe such information forms a reasonable basis for such statements, such information may be limited or incomplete, and our statements should not be read to indicate that we have conducted an exhaustive inquiry into, or review of, all potentially available relevant information. These statements are inherently uncertain and investors are cautioned not to unduly rely upon these statements.

 

iii

 

 

PART I — FINANCIAL INFORMATION

 

Item 1. Financial Statements

 

GRID DYNAMICS HOLDINGS, INC.

UNAUDITED CONDENSED CONSOLIDATED BALANCE SHEETS

(In thousands, except share and per share data)

 

    As of  
    June 30,
2021
    December 31,
2020
 
Assets            
Current assets            
Cash and cash equivalents   $ 67,974     $ 112,745  
Accounts receivable, net of allowance of $205 and $418 as of June 30, 2021 and December 31, 2020, respectively     29,051       16,890  
Unbilled receivables     3,997       1,799  
Prepaid income taxes     1,050       821  
Prepaid expenses and other current assets     5,395       2,361  
Total current assets     107,467       134,616  
Property and equipment, net     5,160       4,095  
Intangible assets, net     20,342       8,125  
Deferred tax assets     4,865       5,609  
Goodwill     35,299       14,690  
Total assets   $ 173,133     $ 167,135  
                 
Liabilities and equity                
Current liabilities                
Accounts payable   $ 2,489     $ 757  
Accrued liabilities     1,490       628  
Accrued compensation and benefits     11,099       7,479  
Accrued income taxes     1,830       1,248  
Other current liabilities     8,251       3,206  
Total current liabilities     25,159       13,318  
                 
Deferred tax liabilities     4,962       2,093  
Total liabilities     30,121       15,411  
                 
Stockholders’ equity (Note 9)                
Common stock, $0.0001 par value; 110,000,000 shares authorized; 54,728,586 and 50,878,780 issued and outstanding as of June 30, 2021 and December 31, 2020, respectively     5       5  
Additional paid-in capital     123,749       128,930  
Retained earnings     19,248       22,793  
Accumulated other comprehensive income/(loss)     10       (4 )
Total stockholders’ equity     143,012       151,724  
Total liabilities and stockholders’ equity   $ 173,133     $ 167,135  

   

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

 

1

 

 

GRID DYNAMICS HOLDINGS, INC.

UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF LOSS AND

COMPREHENSIVE LOSS

(In thousands, except per share data)

 

    Three Months Ended
June 30,
    Six Months Ended
June 30,
 
    2021     2020     2021     2020  
Revenue   $ 47,676     $ 22,368     $ 86,810     $ 54,825  
Cost of revenue     27,879       13,982       51,676       36,621  
Gross profit     19,797       8,386       35,134       18,204  
                                 
Operating expenses                                
Engineering, research, and development     1,772       2,577       3,555       5,117  
Sales and marketing     2,837       1,637       5,869       5,206  
General and administrative     13,804       7,359       26,104       18,102  
Total operating expenses     18,413       11,573       35,528       28,425  
                                 
Income/(loss) from operations     1,384       (3,187 )     (394 )     (10,221 )
Other income/(expenses), net     (79 )     208       (1,129 )     (36 )
Income/(loss) before income taxes     1,305       (2,979 )     (1,523 )     (10,257 )
Provision/(benefit) for income taxes     2,788       (813 )     2,022       (3,495 )
Net loss   $ (1,483 )   $ (2,166 )   $ (3,545 )   $ (6,762 )
                                 
Foreign currency translation adjustments, net of tax     (35 )    
      14      
 
Comprehensive loss   $ (1,518 )   $ (2,166 )   $ (3,531 )   $ (6,762 )
                                 
Loss per share                                
Basic   $ (0.03 )   $ (0.04 )   $ (0.07 )   $ (0.17 )
Diluted   $ (0.03 )   $ (0.04 )   $ (0.07 )   $ (0.17 )
                                 
Weighted average shares outstanding                                
Basic     54,431       49,626       53,044       39,731  
Diluted     54,431       49,626       53,044       39,731  

  

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

 

2

 

 

GRID DYNAMICS HOLDINGS, INC.

UNAUDITED CONSOLIDATED STATEMENT OF CONVERTIBLE PREFERRED STOCK AND STOCKHOLDERS’ EQUITY

(In thousands)

  

                            Accumulated        
    Convertible           Additional           other     Total  
    Preferred Stock     Common Stock     paid-in     Retained     comprehensive     stockholders’  
    Shares     Amount     Shares     Amount     capital     earnings     income/(loss)     equity  
Balance at December 31, 2020    
    $
      50,879     $ 5     $ 128,930     $ 22,793     $ (4 )   $ 151,724  
Net loss          
           
     
      (2,062 )    
      (2,062 )
Stock-based compensation          
           
      5,671      
     
      5,671  
Exchange of warrants into common stock    
     
      2,221      
     
     
     
     
 
Exercise of stock options    
     
      41      
      162      
     
      162  
Issuance of shares and payments of tax obligations resulted from net share settlement of vested stock awards    
     
      1,030      
      (15,297 )    
     
      (15,297 )
Foreign currency translation adjustment, net of tax          
           
     
     
      49       49  
Balance at March 31, 2021    
    $
      54,171     $ 5     $ 119,466     $ 20,731     $ 45     $ 140,247  
Net loss          
           
     
      (1,483 )    
      (1,483 )
Stock-based compensation          
           
      6,675      
     
      6,675  
Exchange of warrants into common stock          
      271      
      918      
     
      918  
Exercise of stock options          
      138      
      254      
     
      254  
Issuance of shares and payments of tax obligations resulted from net share settlement of vested stock awards          
      149      
      (3,564 )    
     
      (3,564 )
Foreign currency translation adjustment, net of tax          
           
     
     
      (35 )     (35 )
Balance at June 30, 2021         $
      54,729     $ 5     $ 123,749     $ 19,248     $ 10     $ 143,012  

  

                            Accumulated        
    Convertible           Additional           other     Total  
    Preferred Stock     Common Stock     paid-in     Retained     comprehensive     stockholders’  
    Shares     Amount     Shares     Amount     capital     earnings     income/(loss)     equity  
Balance at December 31, 2019     622     $ 9,187       12,847     $ 8,117     $ 10,535     $ 35,392     $
    $ 54,044  
Retroactive application of recapitalization (Note 3)     426      
      8,797       (8,115 )     8,115      
     
     
 
Adjusted balance beginning of period     1,048     $ 9,187       21,644     $ 2     $ 18,650     $ 35,392     $
    $ 54,044  
Net loss          
           
     
      (4,596 )    
      (4,596 )
Stock-based compensation          
           
      4,804      
     
      4,804  
Conversion of preferred stock     (1,048 )     (9,187 )     1,048       1       9,187      
     
      9,188  
Consideration paid to Grid shareholders          
           
      (123,865 )    
     
      (123,865 )
ChaSerg shares recapitalized, net of transaction costs of $4,142          
      28,088       2       204,323      
     
      204,325  
Conversion of promissory note to common stock    
     
      53      
      530      
     
      530  
Balance at March 31, 2020    
    $
      50,833     $ 5     $ 113,629     $ 30,796     $
    $ 144,430  
Net loss          
           
     
      (2,166 )    
      (2,166 )
Stock-based compensation          
           
      3,654      
     
      3,654  
Exercise of stock options          
      6      
      59      
     
      59  
Balance at June 30, 2020         $
      50,839     $ 5     $ 117,342     $ 28,630     $
    $ 145,977  

   

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

 

3

 

 

GRID DYNAMICS HOLDINGS, INC.

UNAUDITED CONDENSED CONSOLIDATED STATEMENT OF CASH FLOWS

(In thousands)

 

    For the six months ended
June 30,
 
    2021     2020  
Cash flows from operating activities            
Net loss   $ (3,545 )   $ (6,762 )
Adjustments to reconcile net loss to net cash provided by/(used in) operating activities:                
Depreciation and amortization     2,100       1,234  
Bad debt expense     (65 )     781  
Deferred income taxes     1,115       (4,274 )
Stock-based compensation     12,346       8,458  
Change in fair value of warrants     839      
 
Changes in assets and liabilities:                
Accounts receivable     (8,779 )     (1,111 )
Unbilled receivables     (371 )     4,058  
Prepaid income taxes     (229 )     (611 )
Prepaid expenses and other current assets     (1,666 )     (1,961 )
Accounts payable     1,393       51  
Accrued liabilities     358       (519 )
Accrued compensation and benefits     1,410       (99 )
Accrued income taxes     376       (34 )
Other current liabilities     1,368       (132 )
Net cash provided by/(used in) operating activities     6,650       (921 )
                 
Cash flows from investing activities                
Purchase of property and equipment     (1,940 )     (1,110 )
Acquisition of Companies, net of cash acquired (Note 4)     (30,585 )    
 
Net cash used in investing activities     (32,525 )     (1,110 )
                 
Cash flows from financing activities                
Cash received from ChaSerg    
      208,997  
GDI shares redeemed for cash    
      (123,865 )
Equity issuance costs     (465 )     (2,264 )
Payments of tax obligations resulted from net share settlement of vested stock awards     (18,861 )    
 
Proceeds from exercises of stock options     416       59  
Net cash (used in)/provided by financing activities     (18,910 )     82,927  
                 
Effect of exchange rate changes on cash and cash equivalents     14      
 
                 
Net (decrease)/increase in cash and cash equivalents     (44,771 )     80,896  
Cash and cash equivalents, beginning of period     112,745       42,189  
Cash and cash equivalents, end of period   $ 67,974     $ 123,085  
                 
Supplemental disclosure of cash flow information:                
Cash paid for income taxes   $ 1,150     $ 1,144  
                 
Supplemental disclosure of non-cash activities                
Conversion of preferred stock to common stock   $
    $ 9,187  
Conversion of warrants   $ 918      
 
Fair value of contingent consideration issued for acquisition of business   $ 3,400      
 

  

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

 

4

 

 

GRID DYNAMICS HOLDINGS, INC.

NOTES TO THE UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS 

(In thousands, except per share data)

 

Note 1 — Background and nature of operations

 

Grid Dynamics Holdings, Inc. (the “Company” or “GDH”) provides enterprise-level digital transformation in the areas of search, analytics, and release automation to Fortune 1000 companies. The Company’s headquarters and principal place of business is in San Ramon, California.

 

The Company was originally incorporated in Delaware on May 21, 2018 as a special purpose acquisition company under the name ChaSerg Technology Acquisition Corp. (“ChaSerg”) for the purpose of effecting a merger, capital stock exchange, asset acquisition, stock purchase, reorganization or similar business combination involving ChaSerg and one or more businesses. On March 5, 2020 (the “Closing”), the Company consummated its business combination with Grid Dynamics International, Inc. (“GDI”) pursuant to the Agreement and Plan of Merger (the “Merger Agreement”), dated November 13, 2019 (the “Business Combination”). In connection with the Closing, the Company changed its name from ChaSerg Technology Acquisition Corp. to Grid Dynamics Holdings, Inc. The Company’s common stock is now listed on the NASDAQ under the symbol “GDYN” and warrants to purchase the common stock at an exercise price of $11.50 per share are listed on the NASDAQ under the symbol “GDYNW.”

 

Unless the context otherwise requires, the “Company” refers to the combined company and its subsidiaries following the Business Combination, “ChaSerg” refers to the Company prior to the Closing, and “GDI” refers to GDI prior to the Closing. Refer to Note 3 for further discussion of the Business Combination.

 

Note 2 — Basis of presentation and summary of significant accounting policies

 

The following is a summary of the significant accounting policies consistently applied in the preparation of the accompanying consolidated financial statements.

 

Unaudited Interim Financial Statements

 

The accompanying unaudited condensed consolidated financial statements have been prepared in accordance with generally accepted accounting principles in the United States (“U.S. GAAP”) for interim financial information and in accordance with the rules and regulations of the Securities and Exchange Commission (“SEC”). Accordingly, they do not include all of the information and footnotes required by U.S. GAAP for complete financial statements. The unaudited condensed consolidated financial statements reflect all normal and recurring adjustments that are, in the opinion of the Company’s management, necessary for the fair presentation of the results of operations for the interim periods. Operating results for the three and six months ended June 30, 2021 are not necessarily indicative of the results that may be expected for the year ending December 31, 2021. These interim financial statements should be read in conjunction with GDH’s audited financial statements for the year ended December 31, 2020 included in the Company’s annual report on Form 10-K that the Company filed with the SEC on March 5, 2021.

 

Basis of presentation

 

The Business Combination was accounted for as a reverse recapitalization in accordance with U.S. GAAP. Although ChaSerg was the legal acquirer, for accounting purposes, GDI was deemed to be the accounting acquirer. GDI was determined to be the accounting acquirer based on evaluation of the following facts and circumstances:

  

GDI holds executive management roles for the Company and those individuals are responsible for the day-to-day operations;

 

GDI’s former owners have the largest minority voting rights in the Company;

 

From a revenue and business operation standpoint, GDI was the larger entity in terms of relative size;

 

GDI’s San Ramon, CA headquarters are the headquarters of the Company; and

 

The intended strategy of the Company will continue GDI’s strategy of driving enterprise-level digital transformation in the Fortune 1000 companies.

 

5

 

 

In conjunction with the Business Combination, outstanding shares of GDI were converted into common stock of the Company, par value $0.0001 per share, shown as a recapitalization, and the net assets of ChaSerg were acquired at historical cost, with no goodwill or other intangible assets recorded. GDI was deemed to be the predecessor of the Company, and the consolidated assets and liabilities and results of operations prior to the Closing (for the years ended December 31, 2019 and 2018 and the period from January 1, 2020 to March 5, 2020) are those of GDI. ChaSerg’s assets and liabilities, which include net cash from the trust of $85.1 million, and results of operations were consolidated with GDI beginning on the Closing.

 

In accordance with guidance applicable to these circumstances, the equity structure has been restated in all comparative periods up to the Closing Date, to reflect the number of shares of the Company’s common stock, $0.0001 par value per share, issued to GDI shareholders in connection with the recapitalization transaction. As such, the shares and corresponding capital amounts and earnings per share related to GDI preferred and common stock prior to the Business Combination have been retroactively restated as shares reflecting the exchange ratio established in the Business Combination.

 

Principles of consolidation

 

The accompanying condensed financial statements include the accounts of the Company and all of its subsidiaries that are directly or indirectly owned or controlled. Intercompany transactions and balances have been eliminated upon consolidation.

 

Use of estimates

 

The preparation of the consolidated condensed financial statements in accordance with U.S. GAAP requires the Company to make estimates and assumptions that affect the amounts reported in the condensed consolidated financial statements and accompanying notes. Actual results could differ from these estimates and such differences could be material. Significant estimates include allowances for receivables, calculation of accrued liabilities, capitalization of internally developed software, stock-based compensation, contingent consideration payable, determination of fair value, useful lives and recoverability of intangible assets and goodwill, determination of provision for income taxes and uncertain tax positions.

 

Certain significant risks and uncertainties

 

The Company is subject to risks, including but not limited to customer concentration, concentrations of credit and foreign currency risks. Refer to the section below for additional information. Additionally, the Company has been impacted by the recent coronavirus (“COVID-19”) pandemic. The global pandemic of COVID-19 has negatively affected the U.S. and global economy, disrupted global supply chains, resulted in significant travel and transport restrictions, including mandated closures and orders to “shelter-in-place,” and created significant disruption of the financial market. In 2020 the COVID-19 pandemic impacted the Company’s revenues, and the Company’s business continues to be exposed to risks and uncertainties related to the pandemic. The impact of the COVID-19 pandemic had been more pronounced with the Company’s retail customers, which depended on keeping their stores open. Additionally, in situations where the Company’s customers encountered financial difficulties, there was a risk associated with the Company’s inability to collect money from customers. In 2020 the Company took several actions to deal with the COVID-19 pandemic. These included enabling its employees to work from home, company-wide salary and compensation cuts, hiring freezes, and suspending all non-essential travel. Some of these actions such as working from home as well as suspending all non-essential travel continues to be currently in place. As the Company's business recovered in 2021, the Company discontinued some of the cost saving measures such as compensation cuts and hiring freezes. The Company now is facing the opposite challenges including employee retention and shortage of talent on the job market. The ultimate impact and the extent to which the COVID-19 pandemic will continue to affect the business, results of operation and financial condition is difficult to predict and depends on numerous evolving factors outside of the Company’s control including: the duration and scope of the pandemic, including from renewed waves and new variants; government, social, business and other actions that have been and will be taken in response to the pandemic; and the effect of the pandemic on short and long-term general economic conditions.

 

Concentrations of credit risk and significant customers

 

The Company records its accounts receivable and unbilled receivables at their face amounts less allowances. Accounts receivable and unbilled receivables are generally dispersed across the Company’s customers in proportion to their revenue. Three customers individually exceeded 10% of the Company’s accounts receivable balance as of June 30, 2021 and December 31, 2020. One customer individually exceeded 10% of the unbilled receivables as of June 30, 2021 and three customers individually exceeded 10% of the unbilled receivables as of December 31, 2020. Two and three customers individually accounted for greater than 10% of the sales for the three months ended June 30, 2021 and 2020, respectively. Two and three customers individually accounted for greater than 10% of the sales for the six months ended June 30, 2021 and 2020, respectively.

 

6

 

 

Cash and cash equivalents

 

The Company considers cash equivalents to be highly liquid investments with original maturities of three months or less from the date of purchase. Cash equivalents are stated at cost, which approximates fair value. At times, cash deposits with banks may exceed federally insured limits.

 

Accounts receivable and allowance for doubtful accounts

 

Accounts receivable, less allowance for doubtful accounts, reflect the net realizable value of receivables and approximate fair value. The Company maintains an allowance against accounts receivable for the estimated probable losses on uncollectible accounts. The allowance is based upon historical loss experience, current economic conditions within the industries the Company serves as well as determination of the specific risk related to certain customers. Accounts receivable are charged off against the reserve when, in management’s estimation, further collection efforts would not result in a reasonable likelihood of receipt. The allowance for doubtful accounts balance decreased to $0.2 million as of June 30, 2021 compared to $0.4 million as of December 31, 2020.

 

    As of  
    June 30,
2021
    December 31,
2020
 
    (in thousands)  
Trade accounts receivable   $ 29,256     $ 17,308  
Allowance for doubtful accounts     (205 )     (418 )
Total trade accounts receivable, net   $ 29,051     $ 16,890  

 

Unbilled receivables

 

Generally, the Company will not bill customers until the services have been completed. From time-to-time, a service period may overlap with a period-end and the unbilled receivables represent amounts for services performed through period-end, but not yet billed. The unbilled receivable represents the amount expected to be billed and collected for services performed through period-end in accordance with contract terms. The unbilled receivables balances were $4.0 million and $1.8 million as of June 30, 2021 and December 31, 2020, respectively.

 

Goodwill

 

Goodwill represents the excess of purchase price over the fair value of the net assets of businesses acquired. On an annual basis, the Company makes a qualitative assessment to determine if it is more likely than not that the fair value of the reporting unit is less than its carrying amount, including goodwill. If the Company determines that the fair value of the reporting unit is less than its carrying amount, it will perform a quantitative analysis; otherwise, no further evaluation is necessary. For the quantitative impairment assessment, the Company compares the fair value of the reporting unit to its carrying value, including goodwill. The Company uses the discounted cash flow method of the income approach and market approach to determine the fair value of the reporting unit. If the fair value of the reporting unit exceeds the carrying value of the net assets assigned to that unit, goodwill is not impaired, and no further testing is performed. If the carrying value of the net assets assigned to the reporting unit exceeds the fair value of the reporting unit, then the Company will recognize a loss equal to the excess, limited to the total amount of goodwill allocated to that reporting unit. Impairments, if any, are charged directly to earnings. As of June 30, 2021, the Company has a single reporting unit and determined there were no indicators of impairment.

 

Intangible assets

 

Finite-lived intangible assets are stated at cost less accumulated amortization. Amortization is computed on the straight-line basis over the asset’s useful lives ranging between 2 and 12 years. Intangible assets are evaluated for impairment whenever events or changes in circumstances indicate that the carrying value of the assets may not be fully recoverable. If facts and circumstances indicate that the carrying value might not be recoverable, projected undiscounted net cash flows associated with the related asset or group of assets over their estimated remaining useful lives is compared against their respective carrying amounts. If an asset is found to be impaired, the impairment charge will be measured as the amount by which the carrying amount of an entity exceeds its fair value. As of June 30, 2021, the Company determined there were no indicators of impairment.

 

7

 

 

Revenue recognition

 

The Company accounts for a contract with a customer when 1) the parties to the contract have approved the contract and are committed to performing their respective obligations, 2) the contract identifies each party’s rights regarding the goods or services to be transferred, 3) the contract identifies the payment terms for the goods or services to be transferred, 4) the contract has commercial substance, and 5) collection of substantially all consideration pursuant to the contract is probable.

 

The Company derives its revenue from offering a suite of digital engineering and information technology (“IT”) consulting services, including digital transformation strategy, emerging technology, lean labs and legacy system replatforming. For most contracts, the Company uses master agreements to govern the overall relevant terms and conditions of the business arrangement between the Company and its customers. When the Company and a customer enter into a Master Services Agreement (“MSA”), purchases are generally made by the customer via a statement of work (“SOW”) which explicitly references the MSA and specifies the services to be delivered. Fees for these contracts may be in the form of time-and-materials or fixed-fee arrangements. The majority of the Company’s revenues are generated under time-and-material contracts which are billed using hourly rates to determine the amounts to be charged directly to the customer. Fees are billed and collected as stipulated in the contract, and revenue is recognized as services are performed. If there is an uncertainty about the receipt of payment for the services, revenue is recognized to the extent that a significant reversal of revenue would not be probable.

 

Consulting services revenue is a single performance obligation earned through a series of distinct daily services and may include services such as those described above. The Company recognizes revenue for services over time as the customer simultaneously receives and consumes the benefits as the Company performs IT consulting services. For revenue contracts, the customer derives value from the Company providing daily consulting services, and the value derived corresponds to the labor hours expended. Therefore, the Company measures the progress and recognizes revenue using an effort-based input method. For fixed fee contracts, the Company recognizes revenue as the work is performed, the monthly calculation of which is based upon actual labor hours incurred and level of effort expended throughout the duration of the contract.

 

For time-and-material contracts, the Company applies the variable consideration allocation exception. Therefore, instead of allocating the variable consideration to the entire performance obligation, the Company determined the variable consideration should be allocated to each distinct service to which the variable consideration relates, which is providing the customer daily consulting services. The Company also offers volume discounts or early settlement discounts. Volume discounts apply once the customer reaches certain contractual spend thresholds. Early settlement discounts are issued contingent upon the timing of the payment from the customer. If the consideration promised in a contract includes a variable amount, the Company only includes estimated amounts of consideration in the transaction price to the extent it is probable that a significant reversal of cumulative revenue recognized will not occur when the uncertainty associated with the variable consideration is resolved. These estimates may require management to make subjective judgments and to make estimates about the effects of matters inherently uncertain. The determination of whether to constrain consideration in the transaction price are based on information (historical, current and forecasted) that is reasonably available to the Company, taking into consideration the type of customer, the type of transaction and the specific facts and circumstances of each arrangement. Although the Company believes that its approach in developing estimates and its reliance on certain judgments and underlying inputs is reasonable, actual results may differ from management’s estimates, judgments and assumptions. These estimates have historically not been material to the consolidated financial statements.

 

Remaining performance obligation

 

ASC 606 requires that the Company disclose the aggregate amount of transaction price that is allocated to performance obligations that have not yet been satisfied as of June 30, 2021. This disclosure is not required for:

 

1) contracts with an original duration of one year or less, including contracts that can be terminated for convenience without a substantive penalty,
     
2) contracts for which the Company recognizes revenues based on the right to invoice for services performed,
     
3) variable consideration allocated entirely to a wholly unsatisfied performance obligation or to a wholly unsatisfied promise to transfer a distinct good or service that forms part of a single performance obligation in accordance with ASC 606-10-25-14(b), for which the criteria in ASC 606-10-32-40 have been met, or
     
4) variable consideration in the form of a sales-based or usage-based royalty promised in exchange for a license of intellectual property.

 

All of the Company’s contracts met one or more of these exemptions as of June 30, 2021.

 

8

 

 

Stock-based compensation expense

 

Stock-based compensation expense is measured based on the grant-date fair value of the share-based awards. Forfeitures are recognized as incurred. The Company estimates stock options grant-date fair value using the Black-Scholes-Merton option pricing model. The model requires management to make a number of key assumptions including expected volatility, expected term, risk-free interest rate, and expected dividends. The Company evaluates the assumptions used to value its share-based awards on each grant date. The fair market value of Grid Dynamics stock is determined based on the closing price on NASDAQ on the measurement date. The Company amortizes the grant-date fair value of all share-based compensation awards over the employee’s requisite service period for the entire award on a straight-line basis, which is generally the vesting period. For an award with graded vesting that is subject only to a service condition (e.g., time-based vesting), the Company uses the straight-line attribution method under ASC 718 under which they recognize compensation cost on a straight-line basis over the total requisite service period for the entire award (i.e., over the requisite service period of the last separately-vesting tranche of the award). Additionally, the Company applies the “floor” concept so that the amount of compensation cost that is recognized as of any date is at least equal to the grant-date fair value of the vested portion of the award on that date. That is, if the straight-line expense recognized to date is less than the grant date fair value of the award that is legally vested at that date, the company will increase its recognized expense to at least equal the fair value of the vested amount. Refer to Note 10 — Stock-based compensation for additional information.

 

Income taxes

 

The Company follows the asset and liability method of accounting for income taxes. Under this method, deferred income taxes are recognized for the tax consequences of temporary differences between the financial statement carrying amounts and the tax basis of the assets and liabilities. The determination of the provision for income taxes requires significant judgment, the use of estimates and the interpretation and application of complex tax laws. The provision for income taxes reflects a combination of income earned and taxed in the various U.S. federal and state, international and other jurisdictions. Jurisdictional tax law changes, increases or decreases in permanent differences between book and tax items, accruals or adjustments of accruals for tax contingencies or valuation allowances, and the change in the mix of earnings from these taxing jurisdictions all affect the overall effective tax rate.

 

In assessing the realizability of deferred tax assets, management considers whether it is more likely than not that some portion, or all, of the deferred tax assets will not be realized. Management considers all available evidence, both positive and negative, in determining whether a valuation allowance is required. Such evidence includes prior earnings history, the scheduled reversal of deferred tax liabilities, projected future taxable income, carryback and carryforward periods of tax attributes, and tax planning strategies that could potentially enhance the likelihood of realization of a deferred tax asset in making this assessment. The weight given to the positive and negative evidence is commensurate with the extent to which the evidence may be objectively verified.

 

The Company evaluates for uncertain tax positions at each balance sheet date. When it is more likely than not that a position will be sustained upon examination by a tax authority that has full knowledge of all relevant information, the Company measures the amount of tax benefit from the position and records the largest amount of tax benefit that is greater than 50% likely of being realized after settlement with a tax authority. The Company’s policy for interest and/or penalties related to underpayments of income taxes is to include interest and penalties in income tax expense.

 

Recently adopted accounting pronouncements

 

Changes to U.S. GAAP are established by the Financial Accounting Standards Board (the “FASB”), in the form of Accounting Standards Updates (“ASUs”), to the FASB’s ASC. The Company has elected not to opt out of the extended transition period and thus when a standard is issued or revised and it has different application dates for public or private companies, the Company, as an emerging growth company, can adopt the new or revised standard at the time private companies adopt the new or revised standard.

 

In December 2019, the FASB issued Accounting Standard Update No. 2019-12, Income Taxes (Topic 740): Simplifying the Accounting for Income Taxes (ASU 2019-12), which simplifies the accounting for income taxes by removing certain exceptions to the general principles and also simplification of areas such as franchise taxes, step-up in tax basis goodwill, separate entity financial statements and interim recognition of enactment of tax laws or rate changes. The update is effective for fiscal years and interim periods within those fiscal years beginning after December 15, 2020, and early adoption is permitted. The Company adopted the standard as of January 1, 2021 and has determined that the adoption of this guidance did not have a material effect on the consolidated financial statements.

 

9

 

 

Recently issued accounting pronouncements

 

The Company considered the applicability and impact of all ASUs. ASUs not listed below were assessed and determined to be either not applicable or are expected to have minimal impact on the consolidated financial statements.

 

In February 2016, the FASB issued ASU No. 2016-2, Leases. ASU 2016-2 requires lessees to put most leases on their balance sheet while recognizing expense in a manner similar to existing accounting. ASU 2016-2 states that a lessee would recognize a lease liability for the obligation to make lease payments and a right-to-use asset for the right to use the underlying asset for the lease term. 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. The Company will adopt the standard 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. The new accounting guidance is effective for the Company for fiscal periods beginning after December 15, 2021. The Company expects the impact to be material but has not yet determined the impact that the adoption of this guidance will have on the consolidated financial statements.

 

In June 2016, the FASB issued ASU 2016-13, Financial Instruments-Credit Losses (Topic 326) — Measurement of Credit Losses on Financial Instruments. Topic 326 was subsequently amended by ASU 2019-4, Codification Improvements to Topic 326, Financial Instruments — Credit Losses, ASU 2019-5, Financial Instruments — Credit Losses (Topic 326): Targeted Transition Relief, and clarified the guidance with the release of ASU 2020-2 Financial Instruments—Credit Losses (Topic 326) and Leases (Topic 842). These ASUs replace the current incurred loss impairment methodology with a methodology that reflects expected credit losses measured at amortized cost and certain other instruments, including loans, held-to-maturity debt securities, net investments in leases, and off-balance sheet credit exposures. The update is effective for fiscal years beginning after December 15, 2022, and interim periods with fiscal years after December 15, 2022. The Company has not yet determined the impact that the adoption of this guidance will have on the consolidated financial statements.

 

In March 2020, FASB issued ASU No. 2020-3, Codification to Financial Instruments. This ASU improves and clarifies various financial instruments topics, including the current expected credit losses standard issued in 2016. The ASU includes seven different issues that describe the areas of improvement and the related amendments to U.S. GAAP, intended to make the standards easier to understand and apply by eliminating inconsistencies and providing clarifications. The amendments related to Issue 1, Issue 2, Issue 3, Issue 4, and Issue 5 were effective upon issuance of this update. The new guidance did not have a material impact on the consolidated financial statements. The amendments related to Issue 6 and Issue 7 are effective for the Company the earlier of January 1, 2023 or when the Company adopts ASU 2016-13, if early adopted. The Company is currently evaluating the impact these topics will have on the consolidated financial statements.

 

Note 3 – Business combination

 

On March 5, 2020, ChaSerg consummated its business combination with GDI pursuant to the Merger Agreement. Immediately following the Business Combination, there were 50.8 million shares of common stock with a par value of $0.0001, and 11.3 million warrants outstanding.

 

GDI began operations in September 2006 to provide next-generation e-commerce platform solutions in the areas of search, analytics, and release automation to Fortune 1000 companies. Under ASC 805, Business Combinations, GDI was deemed the accounting acquirer, and the Business Combination was accounted for as a reverse recapitalization, with no goodwill or other intangible assets recorded in accordance with U.S. GAAP. ChaSerg was treated as the “acquired” company for financial reporting purposes. Accordingly, for accounting purposes, the Business Combination was treated as the equivalent of GDI issuing stock for the net assets of ChaSerg, accompanied by a recapitalization. The net assets of ChaSerg were stated at historical cost, with no goodwill or other intangible assets recorded. Reported shares and earnings per share available to holders of the Company’s common stock, prior to the Business Combination, have been retroactively restated as shares reflecting the exchange ratio established in the Business Combination (approximately 1.685 GDH shares to 1.0 GDI share).

 

10

 

 

The aggregate consideration for the Business Combination was $396.5 million, consisting of $130.0 million in cash and 27.0 million shares of ChaSerg’s common stock valued at $10.19 per share, less a post-Closing share adjustment amount of 0.9 million shares which were placed in escrow post-Closing. The shares transferred at Closing included 4.3 million options to purchase the Company’s shares that were vested, outstanding and unexercised, which were determined using 1.7 million vested options at Closing converted at an exchange ratio of approximately 2.48. Additionally, 0.4 million options to purchase the Company’s common stock that were unvested, outstanding and unexercised were assumed by the Company, which were determined using 0.1 million unvested options at Closing converted at an exchange ratio of approximately 2.48. The following represents the aggregate consideration for the Business Combination (in thousands except for per share amount):

 

Shares transferred at Closing     27,006  
Less: Post-Closing share adjustment     (857 )
Total shares transferred at Closing     26,149  
Value per share   $ 10.19  
Total share consideration   $ 266,459  
Plus: Cash transferred to GDI stockholders     130,000  
Closing merger consideration   $ 396,459  

 

In connection with the Closing, 0.1 million shares of common stock were redeemed at a price per share of approximately $10.21.

 

In connection with the Business Combination, the Company incurred direct and incremental costs of approximately $4.7 million, consisting of legal and professional fees, of which $4.1 million were related to equity issuance costs and recorded to additional paid-in capital as a reduction of proceeds and $0.6 million were recorded to general and administrative expenses.

 

In connection with the Business Combination, all outstanding retention bonus obligations from a 2017 acquisition totaling $3.4 million were accelerated and paid in full to Grid Dynamics’ personnel immediately prior to the Closing and were recorded in cost of revenue and operating expenses in the consolidated financial statements.

 

Note 4 — Acquisition of Tacit Knowledge Inc.

 

On May 29, 2021, the Company acquired 100% of the equity interest of the global consultancy company Tacit Knowledge Inc. (“Tacit”). Founded in 2002, Tacit is a global provider of digital commerce solutions, serving customers across the UK, North America, Continental Europe, and Asia. The acquisition of Tacit added approximately 180 employees to the Company's headcount. The acquisition will augment the Company's service offerings and will strengthen its competitive position within the market. Additionally, the acquisition will also enable the Company to leverage near-shore capabilities with Tacit’s presence in Mexico.

 

The total purchase consideration is $37.0 million and included cash consideration of $33.6 million paid at closing and fair value of the contingent consideration at the date of the acquisition of $3.4 million. The maximum amount of potential contingent cash consideration is $5.0 million. The contingent consideration is payable based on revenue and EBITDA metrics to be achieved by Tacit within 12 months. The Company recorded a liability for the contingent consideration amount based on the Company’s best estimate of the fair value of the expected payout.

 

The primary areas of the preliminary purchase price allocations that have not been finalized relate to the finalization of working capital, the valuation and useful lives of intangible assets, the valuation of the earn-out, and the deferred tax liabilities. Upon completion of the fair value assessment, the Company anticipates that the ultimate intangible assets may differ from the preliminary assessment outlined above. Any change in the finalization of working capital will reduce or increase the cash consideration. Any changes to the preliminary estimates of the fair value of the and intangible assets or earn-out will be adjusted to goodwill during the measurement period, with subsequent changes in estimates recorded in the Company’s Consolidated Statements of Loss and Comprehensive Loss.

 

11

 

 

The purchase price of Tacit has been preliminarily allocated to the assets acquired and liabilities assumed based on their estimated respective fair values as of May 29, 2021 with the excess purchase price allocated to goodwill. The Company’s preliminary allocation of the purchase price to the net tangible and intangible assets acquired and liabilities assumed is as follows (in thousands):

 

Fair market values      
Current assets   $ 9,145  
Property, plant and equipment     466  
Customer relationships     11,737  
Tradename     1,176  
Goodwill     20,603  
Total assets acquired   $ 43,127  
         
Accounts payable and accrued expenses   $ (3,675 )
Deferred taxes     (2,500 )
Total liabilities assumed   $ (6,175 )
Purchase price allocation   $ 36,952  

 

The preliminary fair value of identifiable intangible assets as of the date of acquisition is as follows:

 

(In thousands)   Fair Value     Useful Life   Amortization
method
Customer relationships   $ 11,737     12 years   Straight-line
Tacit tradename     1,176     4 years   Accelerated
Total identified intangible assets   $ 12,913          

 

As a result of the acquisition, the Company recognized a total of $20.6 million of goodwill. The purchase price was assigned to assets acquired and liabilities assumed based on their estimated fair values as of the date of acquisition, and any excess was allocated to goodwill, as shown in the table above. Goodwill represents the value the Company expects to achieve through the implementation of operational synergies and growth opportunities as the Company expands its global reach. The goodwill is not deductible for income tax purposes. 

 

The Company used various valuation techniques to determine fair value, with the primary techniques being discounted cash flow analysis, relief-from-royalty, and multi-period excess earnings valuation approaches, which use significant unobservable inputs, or Level 3 inputs, as defined by the fair value hierarchy. Under these valuation approaches, the Company is required to make estimates and assumptions about sales, operating margins, growth and attrition rates, royalty rates and discount rates based on budgets, business projections, anticipated future cash flows, and marketplace data.

 

The acquisition of Tacit was accounted for using the acquisition method of accounting, and consequently, the results of operations for Tacit are reported in the consolidated financial statements from the date of acquisition. Tacit revenue was approximately $2.5 million and net income was approximately $0.5 million from the date of acquisition to June 30, 2021.

 

The following unaudited pro forma information presents the combined results of operations as if the acquisition of Tacit had occurred at the beginning of 2020. Tacit pre-acquisition results have been added to the Company’s historical results. The pro forma results contained in the table below include adjustment for amortization of acquired intangibles. Any potential cost savings or other operational efficiencies that could result from the acquisition are not included in these pro forma results. 

 

The 2021 pro forma results include transaction related expenses incurred by the Company prior to the acquisition of $0.6 million including items such as consultant fees and other deal costs.

 

12

 

 

These pro forma results have been prepared for comparative purposes only and are not necessarily indicative of the results of operations as they would have been had the acquisitions occurred on the assumed dates, nor are they necessarily an indication of future operating results.

 

    Six Months Ended
June 30,
 
(Unaudited)   2021     2020  
Revenue   $ 94,842     $ 70,422  
Net loss   $ (1,755 )   $ (6,629 )
Loss per share   $ (0.03 )   $ (0.17 )

 

Note 5 — Property and equipment, net

 

Property and equipment consist of the following (in thousands):

 

   

Estimated

    As of  
    Useful Life
(In Years)
    June 30,
2021
    December 31,
2020
 
Computers and equipment     2-5     $ 8,538     $ 6,447  
Machinery and automobiles     5       601       551  
Furniture and fixtures     3-7       1,051       643  
Software     5       513       554  
Leasehold improvements     3-12       460       236  
              11,163       8,430  
Less: Accumulated depreciation and amortization             (7,405 )     (5,622 )
              3,758       2,809  
                         
Capitalized software development costs     2-3       4,216       3,531  
Less: Accumulated amortization             (2,814 )     (2,245 )
              1,402       1,287  
Property and equipment, net           $ 5,160     $ 4,095  

 

Note 6 — Intangible assets, net

 

Intangible assets consist of the following (in thousands):

 

    Estimated     As of  
    Useful Life
(In Years)
    June 30,
2021
    December 31,
2020
 
Customer relationships     8-12     $ 15,971     $ 4,234  
Tradename     4-10       4,676       3,500  
Non-compete agreements     2       440       440  
              21,087       8,174  
Less: Accumulated amortization             (745 )     (49 )
Intangible assets, net           $ 20,342     $ 8,125  

 

13

 

 

Note 7 — Other current liabilities

 

The components of other current liabilities were as follows (in thousands):

 

    As of  
    June 30,
2021
    December 31,
2020
 
Customer deposits   $ 767     $ 731  
Other liabilities     2,137       528  
Contingent consideration payable     5,347       1,947  
Total other current liabilities   $ 8,251     $ 3,206  

  

In connection with the acquisition of Daxx on December 14, 2020, the Company recorded a contingent consideration payable, which is a post-closing earn-out consideration, estimated based on fair value. In connection with the acquisition of Tacit on May 29, 2021, the Company recorded a contingent consideration payable, which is a post-closing earn-out consideration, estimated based on fair value.

 

Note 8 — Income taxes

 

The Company recorded income tax expense of $2.8 million and income tax benefit of $(0.8) million for the three months ended June 30, 2021 and 2020, respectively. The Company’s effective tax rate was 213.6% and 27.3% for the three months ended June 30, 2021 and 2020, respectively. The increase in effective tax rate for the three months ended June 30, 2021, as compared to the same periods in 2020 was attributable mainly to Section 162 (m) compensation deduction limitations partially offset by stock-based compensation excess tax benefit. Additionally, the United Kingdom’s (“UK”) recently enacted Finance Act 2021 has increased its corporate tax rate to 25% for companies with profits exceeding 250,000 pounds, effective beginning April 1, 2023. As a result of this change in tax law, the Company remeasured its UK deferred taxes which resulted in a $0.5 million discrete tax expense in the three months ended June 30, 2021. The Company recorded income tax expense of $2.0 million and income tax benefit of $(3.5) million for the six months ended June 30, 2021 and 2020, respectively. The Company’s effective tax rate was (132.8)% and 34.1% for the six months ended June 30, 2021 and 2020, respectively. The increase in effective tax rate for the three months ended June 30, 2021, as compared to the same periods in 2020 was attributable mainly to Section 162 (m) compensation deduction limitations partially offset by stock-based compensation excess tax benefit. For the three and six months ended June 30, 2021, the Company used a discrete effective tax rate method to calculate income taxes due to sensitivity of the forecast. The Company determined that small changes in estimated “ordinary” income would result in significant changes in the estimated annual effective tax rate causing material distortion in the year-to-date tax provision. Similarly, for the three and six months ended June 30, 2020, due to uncertainties created by the COVID-19 pandemic, the Company’s estimated annual effective tax rate method would not provide a reliable estimate and therefore was not used.

 

On March 27, 2020, the U.S. President signed into law the CARES Act, an economic stimulus package in response to the COVID-19 global pandemic. The CARES Act contains several corporate income tax provisions, including making remaining alternative minimum tax credits immediately refundable; providing a 5-year carryback of net operating loss carryforwards (“NOLs”) generated in tax years 2018, 2019, and 2020, and removing the 80% taxable income limitation on utilization of those NOLs if carried back to prior tax years or utilized in tax years beginning before 2021; and temporarily liberalizing the interest deductibility rules under Section 163(j) of the Tax Cuts and Jobs Act, by raising the adjusted taxable income limitation from 30% to 50% for tax years 2019 and 2020 and giving taxpayers the election of using 2019 adjusted taxable income for purposes of computing 2020 interest deductibility. The CARES Act did not have a significant impact on the Company’s tax provision for the three and six months ended June 30, 2021 or 2020. As additional guidance is released, the Company will evaluate whether there would need to be a change in the period when such guidance is issued.

 

14

 

 

Note 9 — Stockholders’ equity

 

The following description summarizes the material terms and provisions of the securities that the Company has authorized.

 

Common stock

 

The Company is authorized to issue 110.0 million shares of common stock. At Closing, March 5, 2020, the Company had issued 50.8 million shares of common stock. As of June 30, 2021 the Company had 54.7 million shares of common stock that were outstanding.

 

Preferred Stock

 

As of December 31, 2019 GDI had 1.0 million shares of no par value shares of preferred stock outstanding convertible on a 1:1basis with GDI’s common stock. At the Closing, the preferred stock outstanding was converted into common stock of the Company, par value $0.0001 per share.

 

Founders and underwriter shares subject to earnout provisions

 

At the Closing, the Company had 1.2 million shares of common stock issued and outstanding subject to earnout provisions (the “Earnout Shares”). The Earnout Shares were subject to transfer restrictions and the owners of the Earnout Shares could not sell, transfer, or otherwise dispose of their respective shares until the respective earnout provisions were achieved as described further below. The Earnout Shares have full ownership rights including the right to vote and receive dividends and other distributions thereon. Dividends and other distributions are not subject to forfeiture in accordance with the Amended and Restated Sponsor Share Letter filed with the SEC on January 26, 2020. The Earnout Shares were eligible to vest and were no longer subject to the transfer restrictions as follows:

 

399,999; 400,000; and 400,001 Earnout Shares would vest if the closing price of the Company’s common stock on the principal exchange on which the securities are listed or quoted have been at or about $12.00; $13.50; and $15.00 per share, respectively, for 20 trading days (which need not be consecutive) over a thirty-trading day period at any time.

 

As of December 31, 2020, none of the Earnout Shares were vested. On January 20, 2021, 399,999 Earnout Shares vested and are no longer subject to transfer restrictions. On March 2, 2021, 400,000 Earnout Shares vested and are no longer subject to transfer restrictions. On March 29, 2021, 400,001 Earnout Shares vested and are no longer subject to transfer restrictions. Accordingly, as of March 29, 2021, all of the Earnout Shares have vested.

 

Warrants

 

On April 12, 2021, the Staff of the SEC issued the “Staff Statement on Accounting and Reporting Considerations for Warrants Issued by Special Purpose Acquisition Companies (“SPACs”)” (the “Staff Statement”). The Staff Statement provided new guidance for all SPAC-related companies regarding the accounting and reporting for their warrants that could result in the warrants issued by SPACs being classified as a liability measured at fair value, with non-cash fair value adjustments reported in earnings at each reporting period. The Company reviewed the accounting for both its public warrants and private warrants following the Staff Statement. The Company determined that the accounting for its public warrants as equity was consistent with the Staff Statement. The Company determined that its private warrants should be accounted for as liabilities but that the related accounting errors during the year ended December 31, 2020 were not material to the required financial statements and disclosures included in its annual report on Form 10-K filed on March 5, 2021. In the three months ended March 31, 2021, the Company began accounting for the private warrants correctly, as disclosed in its quarterly report on Form 10-Q filed on May 6, 2021.

 

As of June 30, 2021, there were a total of 0.01 million private warrants outstanding and 4.2 million public warrants outstanding. As part of its initial public offering (“IPO”), ChaSerg issued 22.0 million units including one share of common stock and one-half of one redeemable warrant. Simultaneously with its IPO, ChaSerg issued 0.6 million private placement units to its sponsor underwriter, each consisting of one common share and one-half of one redeemable warrant. ChaSerg issued 0.1 million units as a result of the conversion of a working capital sponsor loan consisting of one common share and one-half of one redeemable warrant. 

 

Each whole warrant entitles the holder to purchase one share of common stock at a price of $11.50. Warrants may only be exercised for a whole number of shares for common stock. No fractional shares will be issued upon exercise of the warrants. Each warrant is currently exercisable and will expire March 5, 2025 (five years after the completion of the Business Combination), or earlier upon redemption or liquidation.

 

The Company may call the warrants for redemption at a price of $0.01 per warrant upon a minimum 30 days’ prior written notice of redemption, if and only if, the reported last sale price of the Company’s common stock equals or exceeds $18.00 per share for any 20 trading days within a 30-trading day period ending three business days before the Company sends the notice of redemption to the warrant holders; and if and only if, there is a current registration statement in effect with respect to the shares of common stock underlying such warrants.

 

15

 

 

On February 17, 2021, the Company and Riverview Group LLC, an affiliate of Millennium Management LLC, a holder of 6.4 million of the outstanding publicly traded warrants (the “Public Warrants”) entered into a Warrant Exchange Agreement (the “Exchange Agreement”). Pursuant to the Exchange Agreement, the holder exchanged each of its public warrants for 0.3480 shares of the Company’s common stock, i.e., 2.2 million shares. During the three months ended June 30, 2021, the Company entered into agreements with investors resulting in exchange of 0.8 million of its private warrants for 0.3 million shares of the Company's common stock.

 

Note 10 — Stock-based compensation

 

2018 Stock Plan

 

GDI had previously adopted a stock plan in 2018 (the “2018 Stock Plan”). Under the terms of the 2018 Stock Plan, certain option grants were accelerated in full or by an additional 12 months as a result of the Business Combination. Therefore, on the date of Closing, the acceleration of vesting for 2.6 million stock options resulted in a stock compensation charge and corresponding increase to additional paid-in capital of $2.5 million. Additionally, at Closing, a percentage of outstanding vested GDI stock options were settled in exchange for cash consideration, pursuant to the terms of the Merger Agreement.

 

The remaining portion of outstanding vested options totaling 1.7 million and all unvested options totaling 0.1 million were automatically assumed and converted into options to purchase the Company’s common stock as of the Closing. The number of each participant’s assumed options and the exercise price were adjusted as provided in the Merger Agreement. There was no incremental compensation cost attributable to the incremental fair value of the modified options compared to the original options on the modification date. The assumed stock options will continue to be subject to the same terms and conditions, including vesting schedule terms, in accordance with the 2018 Stock Plan. Exercise prices for 2018 Stock Plan options range between $3.51 and $3.54 per share.

 

The following table sets forth the activity for the 2018 Stock Plan, including the conversion of the vested and unvested options, for the six months ended June 30, 2021:

 

    Options
Outstanding,
in thousands
 
Balance at December 31, 2019     2,734  
Cashed out     (829 )
Forfeited     (19 )
Balance at March 31, 2020 (prior to exchange ratio conversion)     1,887  
Converted vested balance     4,314  
Converted unvested balance     364  
Balance at March 6, 2020 (post to exchange ratio conversion)     4,678  
Exercised in 2020     (28 )
Forfeited/Cancelled in 2020     (50 )
Options Outstanding as of December 31, 2020     4,600  
Exercised in quarter ended March 31, 2021     (37 )
Forfeited/Cancelled in quarter ended March 31, 2021     (11 )
Options Outstanding as of March 31, 2021     4,552  
Exercised in quarter ended June 30, 2021     (257 )
Forfeited/Cancelled in quarter ended June 30, 2021     (3 )
Options Outstanding as of June 30, 2021     4,291  

 

As of June 30, 2021, since the conversion, a total of 0.08 million shares were forfeited, and 0.32 million shares were exercised for the total proceeds of $0.4 million in cash and 0.13 million shares net withheld for exercise price and taxes. The number of shares exercisable as of June 30, 2021 was 4.1 million with the average exercise price $3.54 per share. The intrinsic value of the 4.3 million total outstanding shares of 2018 Plan Options as of June 30, 2021, was $49.3 million with the remaining contractual term of 7.50 years. The unrecognized compensation expenses related to 2018 Plan options as of June 30, 2021 was $0.2 million, net of forfeitures, to be expensed on a straight-line basis over 2.19 years.

 

16

 

 

2020 Equity Incentive Plan

 

Effective March 5, 2020, our board of directors approved an equity incentive plan (the “2020 Plan”). The 2020 Plan permits the Company to grant a maximum aggregate amount of 16.3 million Incentive Stock Options, Non-Statutory Stock Options (“NSOs”), Restricted Stock, Restricted Stock Units (“RSUs”), Stock Appreciation Rights, Performance Units (“PSUs”), and Performance Shares (“PSAs”) (collectively, the “Awards”) to employees, directors, and consultants of the Company. Our board of directors or any committee appointed by the board has the authority to grant Awards. During the quarter ended June 30, 2021, our board of directors granted 0.11 million NSOs and 0.02 million target PSUs at a maximum payout at 300%. The following table represent the number of shares available for grants from 2020 Equity Incentive Plan (in thousands):

 

   

Available

for grant

 
Available for grant, December 31, 2020     9,881  
Options granted     (231 )
RSU granted     (7 )
PSU granted (100% target)     (566 )
Options forfeited     607  
Traded for taxes (returned to the pool)     1,311  
Available for grant, June 30, 2021     10,996  

 

Stock Options

 

The total of 0.11 million NSOs shares granted during the quarter ended June 30, 2021 from 2020 Equity Incentive Plan are subject to the following time-based vesting conditions: one-fourth of the NSOs will vest on one year after the grant date; and thereafter one-sixteenth of the NSOs will vest each subsequent three-month anniversary. The NSOs have a ten-year exercise term, and once the NSOs are vested, the recipients have the right to purchase the Company’s stock at a fixed exercise price.

 

The grant date fair value of each NSO was estimated on the date of grant using the Black-Scholes-Merton option pricing model. The key assumptions for 2021 grants are provided in the following table.

 

    2021  
Dividend yield     0 %
Expected volatility     40 %
Risk-free interest rate     0.96 %
Expected term in years     6.11  
Grant date fair value of common stock   $ 14.98  

 

The Company used a zero percent dividend yield assumption for all Black-Scholes-Merton stock option-pricing calculations. Since the Company’s shares were not publicly traded prior to the Closing and its shares were rarely traded privately, expected volatility is estimated based on the average historical volatility of similar entities with publicly traded shares. The risk-free rate for the expected term of the options is based on the U.S. Treasury yield curve at the date of grant. Expected term is estimated using the simplified method, which takes into account vesting and contractual term. The simplified method is being used to calculate expected term instead of historical experience due to a lack of relevant historical data resulting from changes in option vesting schedules and changes in the pool of employees receiving option grants. The following table summarizes option activity for the six months ended June 30, 2021 (shares in thousands):

 

    Shares     Price (1)     Term (2)  
Options outstanding as of December 31, 2020 (2020 Plan)     1,942     $ 8.38       9.22  
Options granted     231     $ 14.98          
Options exercised     (10 )   $ 8.13          
Options forfeited     (284 )   $ 8.55          
Options outstanding as of June 30, 2021 (2020 Plan)     1,879     $ 9.17       8.76  

 

 

(1) Represents the weighted average exercise price

(2) Represents weighted average remaining contractual term

 

17

 

 

0.48 million shares of 2020 NSO grants were vested and outstanding as of June 30, 2021. The aggregated fair value of 0.23 million NSOs granted during the six months ending June 30, 2021 was $1.4 million or $5.95 per share. The intrinsic value of the 1.9 million total outstanding shares of 2020 Plan Options as of June 30, 2021, was $11.1 million. The total unrecognized compensation expenses related to 2020 Stock Plan options as of June 30, 2021 was $4.9 million to be expensed on a straight-line basis over the remaining 2.99 years.

 

Restricted Stock Units

 

The RSUs granted to employees generally are subject to the following time-based vesting conditions: one-fourth vest on the first anniversary of the grant; and thereafter one-sixteenth of the RSUs will vest each subsequent three-month anniversary. RSUs granted do not participate in earnings, dividends, and do not have voting rights until vested. RSUs granted to the Board in lieu of the quarterly payments vest immediately.

 

For the quarter ended June 30, 2021, approximately 0.15 million shares were issued upon vesting of the RSUs to the executives and 0.14 million shares were withheld to cover $2.2 million of employees’ tax obligations. 0.3 million unvested RSUs were forfeited as two members of the executive team resigned in June of 2021. The following table summarizes RSU activity for the six months ended June 30, 2021(in thousands):

 

    Shares  
RSUs outstanding as of December 31, 2020 (2020 Plan)     2,996  
RSUs granted     7  
RSUs released     (912 )
RSU forfeited     (291 )
RSUs outstanding as of June 30, 2021     1,799  

 

The total unrecognized compensation expenses related to 2020 Stock Plan RSUs as of June 30, 2021 was $14.2 million to be expensed on a straight-line basis over 2.7 years.

 

Performance Stock Units

 

On March 2, 2021, the Company granted 0.5 million Performance Stock target shares under the 2020 Stock Plan with the maximum payout capped at 300%. The performance goals for these grants consist of:

 

1)

Year-over-year growth in non-retail revenue for the Performance Period, which is Fiscal Year 2021, expressed as a percentage increase over the fiscal year 2020 non-retail revenue (“Revenue Growth”), and

 

2)

Contribution Margin for the Performance Period as a percentage of Non-Retail revenue for the Performance Period.

 

Fifty percent (50)% of the target number of performance shares granted will vest (if at all) based on the extent of achievement of Revenue Growth for the Performance Period and the remaining fifty percent (50)% of the target number of performance shares granted will vest (if at all) based on the extent of achievement of the Contribution Margin.

 

Additionally, 0.02 million shares of PSU were granted on June 16th, 2021, per a consulting agreement with a former executive with the performance goals being consistent with those described above.

 

Performance shares will be certified and vested no later than March 1, 2022 with the payout shortly after. As of June 30, 2021, the Company assessed the vesting of the Performance Share Units as probable and the payout is estimated at 225% of the target goal. Stock-based compensation expense related to Performance Stock Units granted in 2021 was $6.0 million for the six months ended June 30, 2021. The unrecognized expense for PSUs as of June 30, 2021, was $12.9 million.

 

18

 

 

Stock-Based Compensation Expense

 

The Company classifies awards issued under the stock-based compensation plans as equity. Total compensation expense for the three months ended June 30, 2021 and 2020 was $6.7 million and $3.7 million respectively. Employee stock-based compensation recognized was as follows (in thousands):

 

   

Three months ended

June 30,

   

Six months ended

June 30,

 
    2021     2020     2021     2020  
Cost of revenue   $ 149     $ 60     $ 260     $ 675  
Engineering, research, and development     617       460       1,171       1,056  
Sales and marketing     453       602       1,244       1,737  
General and administrative     5,456       2,532       9,671       4,990  
Total stock-based compensation   $ 6,675     $ 3,654     $ 12,346     $ 8,458  

 

As of June 30, 2021, there was approximately $32.2 million of unrecognized stock-based compensation expense.

 

Note 11 — Earnings per share

 

The Company computed earnings per share (“EPS”) in conformity with the two-class method required for participating securities. Undistributed earnings allocated to participating securities are subtracted from net income in determining net income attributable to common stockholders. The Company allocated income between its common and preferred shareholders only for the periods the preferred stock was outstanding, which was January 1, 2020 to March 4, 2020. There was no preferred stock outstanding from March 5, 2020 to June 30, 2021. As the Company was in a net loss position for the periods between January 1, 2020 to March 4, 2020 and March 5, 2020 to June 30, 2021, the net loss was allocated entirely to common shareholders.

 

All participating securities are excluded from basic weighted-average number of common shares outstanding. Diluted EPS is computed by dividing net 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, restricted stock units, performance stock units, and convertible preferred securities. The dilutive effect of potentially dilutive securities is reflected in diluted EPS in order of dilution and by application of the treasury stock method and the if-converted method for stock-based compensation and convertible preferred securities, respectively.

 

The following table sets forth the computation of basic and diluted EPS of common stock as follows (in thousands except per share data):

 

   

Three months ended

June 30,

   

Six months ended

June 30,

 
    2021     2020     2021     2020  
Numerator for basic and diluted loss per share                        
Net loss   $ (1,483 )   $ (2,166 )   $ (3,545 )   $ (6,762 )
                                 
Denominator for basic and diluted loss per share                                
Weighted-average shares outstanding – basic and diluted     54,431       49,626       53,044       39,731  
                                 
Net loss per share                                
Basic   $ (0.03 )   $ (0.04 )   $ (0.07 )   $ (0.17 )
Diluted   $ (0.03 )   $ (0.04 )   $ (0.07 )   $ (0.17 )

 

19

 

 

The following table represents the number of share equivalents outstanding during the period that were excluded from the calculation of diluted net loss per share attributable to common stockholders because including them would have had an anti-dilutive effect.

 

   

Three months ended

June 30,

   

Six months ended

June 30,

 
Potential common shares (in ‘000s)   2021     2020     2021     2020  
Convertible preferred stock    
     
     
      1,048  
Stock options to purchase common stock     6,666       6,105       6,773       8,571  
Restricted stock units     2,381       2,934       3,002       2,934  
Performance stock units     1,274       1,292       2,726       1,292  
Warrants to purchase common stock     4,963       11,347       11,347       11,347  
Total     15,284       21,678       23,848       25,192  

 

Note 12 — Commitments and contingencies

 

Legal Matters

 

The Company is subject to legal proceedings and claims that arise in the ordinary course of its business. Management evaluates each claim and provides for potential loss when the claim is probable to be paid and reasonably estimable. While adverse decisions in certain of these litigation matters, claims and administrative proceedings could have a material effect on a particular period’s results of operations, subject to the uncertainties inherent in estimating future costs for contingent liabilities, management believes that any future accruals with respect to these currently known contingencies would not have a material effect on the financial condition, liquidity or cash flows of the Company. There were no amounts required to be reflected in these consolidated financial statements related to contingencies.

 

Note 13 — Subsequent events

 

The Company performed its subsequent event procedures through August 5, 2021, the date these condensed consolidated financial statements were issued.

 

On July 6, 2021, the Company closed a follow-on public offering of 11,615,301 shares of its common stock, which included 5,470,039 shares offered by Grid Dynamics and 6,145,262 shares offered by certain selling stockholders, at a price to the public of $15.03 per share. These amounts include shares sold upon exercise in full of the underwriters' option to purchase additional shares. J.P. Morgan Securities, LLC, William Blair & Company, L.L.C. and Cowen and Company, LLC were acting as joint book-running managers for the offering. Needham & Company, LLC and Cantor Fitzgerald & Co. were acting as co-managers for the offering. The Company did not receive any proceeds from the sale of the shares by the selling stockholders. The net proceeds from this offering, after deducting underwriting discounts and commissions and estimated offering expenses were $78.3 million.

 

On July 28, 2021, the Company announced the redemption of its 2.8 million then outstanding public warrants. Any public warrants not exercised prior to 5:00 p.m., New York City time, on August 30, 2021 will be redeemed at that time for $0.01 per warrant. The public warrants are exercisable at a price of $11.50 per share, representing a total of approximately $31.9 million in potential proceeds to Grid Dynamics if all 2.8 million outstanding warrants are exercised prior to the redemption date.

 

20

 

 

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

 

Forward-Looking Statements

 

The following discussion of the financial condition and results of operations of Grid Dynamics Holdings, Inc. should be read in conjunction with the unaudited condensed consolidated financial statements and the related notes thereto included elsewhere in this Quarterly Report on Form 10-Q and the audited financial statements and notes thereto and Management’s Discussion and Analysis of Financial Condition and Results of Operations for the fiscal year ended December 31, 2020, which has been filed with the Securities and Exchange Commission (“SEC”) on March 5, 2021.

 

The statements contained in this Quarterly Report on Form 10-Q that are not historical facts are forward-looking statements (within the meaning of Section 21E of the Securities Exchange Act of 1934, as amended, or the Exchange Act) that involve risks and uncertainties. Such forward-looking statements may be identified by, among other things, the use of forward-looking terminology such as “believes,” “expects,” “may,” “will,” “should,” “seek,” “intends,” “plans,” “estimates,” “projects,” “anticipates,” or the negative thereof or other variations thereon or comparable terminology, or by discussions of strategy that involve risks and uncertainties. Actual results may differ significantly from those projected in the forward-looking statements. Factors that might cause future results to differ materially from those projected in the forward-looking statements include, but are not limited to, those discussed in the sections titled “Risk Factors” and “Cautionary Note Regarding Forward Looking Statements,” included elsewhere in this Quarterly Report on Form 10-Q.

 

Overview

 

Grid Dynamics Holdings, Inc. (“Grid Dynamics,” “GDH,” the “Company,” “we,” “us,” or “our”) is an emerging leader in enterprise-level digital transformations in Fortune 1000 companies. For enterprises that create innovative digital products and experiences, Grid Dynamics offers close collaboration to provide digital transformation initiatives that span strategy consulting, development of early prototypes and enterprise-scale delivery of new digital platforms. Since its inception in 2006 in Menlo Park, California, as a grid and cloud consultancy firm, Grid Dynamics has been on the forefront of digital transformation, working on big ideas like cloud computing, NOSQL, DevOps, microservices, big data and AI, and quickly established itself as a provider of choice for technology and digital enterprise companies.

 

As a leading global digital engineering and IT services provider with its headquarters in Silicon Valley and engineering centers in the United States, Mexico and multiple European countries, Grid Dynamics’ core business is to deliver focused and complex technical consulting, software design, development, testing and internet service operations. Grid Dynamics also helps organizations become more agile and create innovative digital products and experiences through its deep expertise in emerging technology, such as AI, data science, cloud computing, big data and DevOps, lean software development practices and a high-performance product culture. Grid Dynamics believes that the key to its success is a business culture that puts products over projects, client success over contract terms and real business results over pure technical innovation. By leveraging Grid Dynamics’ proprietary processes optimized for innovation, emphasis on talent development and technical expertise, Grid Dynamics has been able to achieve significant growth.

 

We are a former blank check company that completed our initial public offering on May 21, 2018. In March 2020, Grid Dynamics, formerly known as ChaSerg Technology Acquisition Corp (“ChaSerg”), completed its acquisition of Grid Dynamics International, Inc. (“GDI”) pursuant to the business combination agreement dated November 13, 2019 (the “Business Combination”). In conjunction with the completion of the Business Combination, ChaSerg was renamed as Grid Dynamics Holdings, Inc.

 

The Business Combination was accounted for as a reverse recapitalization for which GDI was determined to be the accounting acquirer. Outstanding shares of GDI were converted into our common shares, presented as a recapitalization, and the net assets of ChaSerg were acquired at historical cost, with no goodwill or other intangible assets recorded.

 

21

 

 

The following table sets forth a summary of Grid Dynamics’ financial results for the periods indicated:

 

   

Three months ended

June 30,

 
(dollars in thousands, except per share data)   2021     2020  
          % of revenue           % of revenue  
Revenues   $ 47,676       100.0 %   $ 22,368       100.0 %
Gross profit     19,797       41.5 %     8,386       37.5 %
Income/(loss) from operations     1,384       2.9 %     (3,187 )     (14.2 )%
Net loss     (1,483 )     (3.1 )%     (2,166 )     (9.7 )%
Comprehensive loss     (1,518 )     (3.2 )%     (2,166 )     (9.7 )%
Diluted loss per share   $ (0.03 )     n/a     $ (0.04 )     n/a  
Non-GAAP Financial Information(1)                                
Non-GAAP EBITDA(1)     9,731       20.4 %     1,198       5.4 %
Non-GAAP Net Income(1)     6,090       12.8 %     433       1.9 %
Non-GAAP Diluted EPS(1)   $ 0.10       n/a     $ 0.01       n/a  

 

 

(1)

Non-GAAP EBITDA, Non-GAAP Net Income and Non-GAAP Diluted EPS are non-GAAP financial measures. See “Non-GAAP Measures” below for additional information and reconciliations to the most directly comparable GAAP financial measures.

 

   

Six months ended

June 30,

 
(dollars in thousands, except per share data)   2021     2020  
          % of revenue           % of revenue  
Revenues   $ 86,810       100.0 %   $ 54,825       100.0 %
Gross profit     35,134       40.5 %     18,204       33.2 %
Loss from operations     (394 )     (0.5 )%     (10,221 )     (18.6 )%
Net loss     (3,545 )     (4.1 )%     (6,762 )     (12.3 )%
Comprehensive loss     (3,531 )     (4.1 )%     (6,762 )     (12.3 )%
Diluted loss per share   $ (0.07 )     n/a     $ (0.17 )     n/a  
Non-GAAP Financial Information(1)                                
Non-GAAP EBITDA(1)     14,994       17.3 %     4,243       7.7 %
Non-GAAP Net Income(1)     9,155       10.5 %     1,978       3.6 %
Non-GAAP Diluted EPS(1)   $ 0.15       n/a     $ 0.05       n/a  

 

(2)

 

Recent Developments

 

In the three months ended June 30, 2021, our revenues of $47.7 million were up 8.5 million or 21.8% in comparison to the three months ended March 31, 2021, and up 113.1% from the three months ended June 30, 2020. Our three months ended June 30, 2021 revenues included $9.3 million in revenue contribution from the acquisitions of Daxx and Tacit. Excluding contribution from acquisitions, in the three months ended June 30, 2021, our revenues of $38.4 million were up $5.8 million or 17.7% in comparison to the three months ended March 31, 2021, and up $16.0 million or 71.6% from the three months ended June 30, 2020 and was the highest revenue quarter in the company’s history. Similar to the last two quarters, in the three months ended June 30, 2021, we witnessed healthy business trends. This is largely reflected in the double-digit sequential growth over the three months ended March 31, 2021. The three months ended June 30, 2021 also marked the fourth consecutive sequential growth quarter since witnessing a bottom in revenues in the three months ended June 30, 2020. During the quarter, we witnessed strong demand from our customers across our industry verticals as digital transformation initiatives take center stage.

 

22

 

 

During the three months ended June 30, 2021, our largest industry vertical continued to be the Technology Media, and Telecom (“TMT”) at 33.8% of our revenue, while Consumer Packaged Goods (“CPG”)/Manufacturing, Finance, and Other verticals contributed to 20.8%, 8.5%, and 10.2% respectively. Revenues from our Top 5 customers during the quarter was 45.4%, down from 66.7% in the same quarter year ago. The diversification in our Top 5 customer concentration was driven by a combination of factors that included success in ramping business at new customers and growing business at existing customers, aided by our recent acquisitions.

 

We continue to focus on revenue diversification by increasing our customer base with new customers’ additions. During the three months ended June 30, 2021, we received revenues from a total of 212 customers, up from 188 customers in the three months ended March 31, 2021 and 37 customers in the three months ended June 30, 2020. Of these, 161 customers came from our recent acquisitions of Tacit and Daxx. Excluding customers from our recent acquisitions, we exited the quarter with 51 paying customers that included 5 new customers added during the three months ended June 30, 2021.

 

We exited the three months ended June 30, 2021 with $(1.5) million, or (3.1)% in GAAP Net Loss, an improvement from a GAAP Net Loss of $(2.1) million, or (5.3)% in the three months ended March 31, 2021 and a GAAP Net Loss of $(2.2) million, or (9.7)% in the three months ended June 30, 2020. We exited the three months ended June 30, 2021 with $9.7 million, or 20.4% in Non-GAAP EBITDA, up from $5.3 million, or 13.4% in the three months ended March 31, 2021 and $1.2 million, or 5.4% in the three months ended June 30, 2020. The sequential increase in profitability was largely driven by increase in billable personnel and billable work hours combined by contributions from our recent acquisitions of Tacit and Daxx.

 

Acquisition of Tacit Knowledge Inc.

 

On May 29, 2021, we acquired UK based Tacit Knowledge Inc. (“Tacit”) in an all-cash transaction. Headquartered in UK, Tacit is a global consultancy focused on digital commerce serving customers in the UK, North America, Continental Europe, and Asia. The company serves leading global brands across technology, CPG, financial, and retail markets. The company has approximately 180 employees with engineering centers situated in Moldova and Mexico. The acquisition will augment our service offerings and will strengthen our competitive position within the market. Additionally, the acquisition will also enable us to leverage near-shore capabilities with the company’s presence in Mexico.

 

Acquisition of Daxx

 

On December 14, 2020, we acquired Netherland based Daxx in an all-cash transaction. Headquartered in Amsterdam, and with approximately 490 employees, the company has engineering centers situated in major tech hubs across Ukraine. The company has over 20 years of experience in delivering software services to clients across a wide range of industry verticals that include high-tech, digital media, healthcare, and education. Some of the key capabilities include consulting services spanning agile process reengineering, lean development, and DevOps. Daxx serves customers in the Netherlands, Germany, U.K., and U.S., and with strong relationships with high-growth start-ups and established software companies. We believe the acquisition of Daxx will enable our company to have a stronger foothold in Europe and will enable the company to continue diversifying its business.

 

COVID-19 Related Updates

 

In December 2019, a novel coronavirus COVID-19 was reported in China, and in March 2020, the World Health Organization declared it a pandemic. This contagious disease pandemic has continued to spread across the globe, including extensively within the U.S., and is impacting worldwide economic activity and financial markets, significantly increasing economic volatility and uncertainty. In response to this global pandemic, several local, state, and federal governments have been prompted to take unprecedented steps that include, but not limited to, travel restrictions, closure of businesses, social distancing, and quarantines.

 

Starting in March 2020, headwinds to our business from the pandemic were largely centered around our retail customers as many of them witnessed a slowdown in their sales. After witnessing a low point in the month of May 2020, our business has steadily improved as we have added new customers and have grown existing business across industry verticals. We continue to take precautionary measures intended to minimize the risk of the virus to our employees, our customers, and the communities in which we operate that include suspension of all non-essential travel. Although a significant proportion of our employees continue to work remotely, all our facilities have been opened for employees to work following local government guidelines. We continue to deliver services to our clients in this fashion and this has resulted in minimal disruption in our operational and delivery capabilities.

 

23

 

 

Business Combination

 

On March 5, 2020, a wholly-owned subsidiary (“Merger Sub 1”) of ChaSerg merged with and into GDI, with GDI surviving the merger (the “Initial Merger”). Immediately following the Initial Merger, GDI merged with and into another wholly-owned subsidiary of ChaSerg (“Merger Sub 2”) with Merger Sub 2 surviving; Merger Sub 2 was then renamed “Grid Dynamics International, LLC,” and ChaSerg was then renamed “Grid Dynamics Holdings, Inc.” (the “Business Combination”). As of the open of trading on March 6, 2020, the common stock and warrants of Grid Dynamics Holdings, Inc. (“Grid Dynamics”), formerly those of ChaSerg, began trading on The NASDAQ Stock Market LLC as “GDYN” and “GDYNW,” respectively.

 

Comparability of Financial Information

 

Grid Dynamics’ results of operations and statements of assets and liabilities may not be comparable between periods as a result of the Business Combination on March 5, 2020 and the other events and transactions discussed below.

 

Key Performance Indicators and Other Factors Affecting Performance

 

Grid Dynamics uses the following key performance indicators and assesses the following other factors to analyze its business performance, to make budgets and financial forecasts and to develop strategic plans:

 

Employees by Region

 

Attracting and retaining the right employees is critical to the success of Grid Dynamics’ business and is a key factor in Grid Dynamics’ ability to meet client needs and grow its revenue base. Grid Dynamics’ revenue prospects and long-term success depend significantly on its ability to recruit and retain qualified IT professionals. A substantial majority of Grid Dynamics’ personnel is comprised of such IT professionals.

 

The following table shows the number of Grid Dynamics personnel (including full-time employees and contractors serving in similar capacities) by region, as of the dates indicated:

 

    As of June 30,  
    2021     2020  
United States and Mexico     317       251  
Central and Eastern Europe(1), U.K. and the Netherlands     2,193       986  
Total     2,510       1,237  

 

 

(1)

Includes Ukraine, Russia, Poland, Serbia, and Moldova.

 

Attrition

 

There is competition for IT professionals in the regions in which Grid Dynamics operates, and any increase in such competition may adversely impact Grid Dynamics’ business and gross profit margins. Employee retention is one of Grid Dynamics’ main priorities and is a key driver of operational efficiency. Grid Dynamics seeks to retain top talent by providing the opportunity to work on exciting, cutting-edge projects for high profile clients, a flexible work environment and training and development programs. Grid Dynamics’ management targets a voluntary attrition rate no higher than the mid-teen percentages, in line with the industry.

 

24

 

 

Hours and Utilization

 

As most of Grid Dynamics’ customer projects are performed and invoiced on a time and materials basis, Grid Dynamics’ management tracks and projects billable hours as an indicator of business volume and corresponding resource needs for IT professionals. To maintain its gross profit margins, Grid Dynamics must effectively utilize its IT professionals, which depends on its ability to integrate and train new personnel, to efficiently transition personnel from completed projects to new assignments, to forecast customer demand for services and to deploy personnel with appropriate skills and seniority to projects. Grid Dynamics’ management generally tracks utilization with respect to subsets of employees, by location or by project, and calculates the utilization rate for each subset by dividing (x) the aggregate number of billable hours for a period by (y) the aggregate number of total available hours for the same period. Grid Dynamics’ management analyzes and projects utilization to measure the efficiency of its workforce and to inform management’s budget and personnel recruiting decisions. 

 

Customer Concentration

 

Grid Dynamics’ ability to retain and expand its relationships with existing customers and add new customers are key indicators of its revenue potential. Grid Dynamics grew its customer base from 42 customers in the first half of 2020 to 226 customers in the same period of 2021, including 172 customers that were acquired as part of Daxx and Tacit acquisitions. Grid Dynamics’ procurement of new customers has a direct impact on its ability to diversify its sources of revenue and replace customers that may no longer require its services. Grid Dynamics has a relatively high level of revenue concentration with certain customers.

 

The following table shows the evolution of Grid Dynamics’ customer base and revenue concentration, as of the dates and for the periods indicated:

 

   

Three months ended

June 30,

 
    2021     2020  
             
Total customers (for the period) (1)     212       37  
Of which (customer revenue amounts annualized for interim periods):                
>$5.0 million     9       7  
>$2.5 – 5.0 million     4       2  
>$1.0 – 2.5 million     15       6  
Top five customers     45.4 %     66.7 %
Top ten customers     62.3 %     84.5 %
Top five customers   $ 21,634     $ 14,924  
Top ten customers   $ 29,690     $ 18,891  

 

 

(1)

Number of customers acquired as a result of Daxx and Tacit acquisitions for the three months ended June 30, 2021 is 161.

 

   

Six Months Ended

June 30,

 
    2021     2020  
             
Total customers (for the period) (1)     226       42  
Of which (customer revenue amounts annualized for interim periods):                
>$5.0 million     9       7  
>$2.5 – 5.0 million     4       2  
>$1.0 – 2.5 million     15       6  
Top five customers     48.6 %     61.8 %
Top ten customers     64.3 %     84.0 %
Top five customers   $ 42,213     $ 33,884  
Top ten customers   $ 55,786     $ 46,047  

 

 

(1)

Number of customers acquired as a result of Daxx and Tacit acquisitions for the six months ended June 30, 2021 is 172.

 

25

 

 

Foreign Currency Exchange Rate Exposure

 

Grid Dynamics is exposed to foreign currency exchange rate risk and its profit margins are subject to volatility between periods due to changes in foreign currency exchange rates relative to the U.S. dollar. Grid Dynamics’ functional currency apart from the U.S. dollar includes EURO, British pounds, Mexican pesos and Moldovan leu. Grid Dynamics contracts with customers for payment in and generates predominantly all of its revenue in U.S. dollars, except for Daxx and Tacit that generate revenue predominantly in EURO and British pounds. Its non-U.S. subsidiaries’ operations relate substantially to performing services under those contracts. Several of Grid Dynamics’ subsidiaries conduct operations and employ or contract personnel in Russia, Ukraine, Poland and Serbia, but keep their books and records in U.S. dollars. Daxx’s books are kept in EURO. Tacit’s books are kept in local currencies. Grid Dynamics’ foreign currency transaction exposure is a result of having to convert U.S. dollars into the local currencies of the countries in which it must pay expenses, typically by transferring funds to its non-U.S. subsidiaries. These expenses are primarily comprised of compensation and benefits and other operating costs, such as rent. Subsidiary transactions executed in local currencies are converted into U.S. dollars at the exchange rate in effect on the date of the transaction, in the case of asset and liability transactions, or at the average monthly exchange rate, in the case of income and expense transactions. Certain balances in local currencies, particularly cash and financial instruments, are adjusted at each balance sheet date to reflect the then-current exchange rate, which is the rate at which the related receivable or payable could be settled at that date. As a result, Grid Dynamics’ assets, liabilities, profit margins and other measures of profitability may be subject to volatility due to changes in the exchange rate of the U.S. dollar against the currencies in which Grid Dynamics’ subsidiaries incur operating expenses, hold assets, or owe liabilities, and may not be comparable between periods.

 

In the three and six months ended June 30, 2021, approximately 25.3%, 11.9% and 7.4% of Grid Dynamics’ $46.3 million and approximately 25.3%, 11.4% and 7.6% of Grid Dynamics’ $87.2 million of combined cost of revenue and total operating expenses were denominated in the Ukrainian hryvnia, Russian ruble, and Polish zloty, respectively. Comparatively, the same foreign currencies accounted for approximately 9.9%, 12.6% and 10.6% of Grid Dynamics’ $25.6 million and 10.7%, 15.6%, and 10.0% of Grid Dynamics’ $65.0 million of combined cost of revenue and total operating expenses in the three and six months ended June 30, 2020. Grid Dynamics does not currently hedge its foreign currency exposure, although it seeks to minimize such exposure by limiting cash transfers to amounts necessary to fund subsidiary operating expenses for a short period, typically one to two weeks. When and where possible, Grid Dynamics seeks to match expenses to the U.S. dollar. For example, in Ukraine, Grid Dynamics generally pays salaries in the current hryvnia equivalent of an agreed U.S. dollar amount, consistent with local requirements. As a result, a significant portion of Grid Dynamics’ exposure to fluctuations in the value of the Ukrainian hryvnia against the U.S. dollar is naturally hedged. Management carefully evaluates its exposure to foreign currency risk and, though Grid Dynamics does not currently hedge this exposure using financial instruments, it may do so in the future. See Item 7A, “Quantitative and Qualitative Disclosures about Market Risk—Foreign Currency Exchange Rate Risk” below for more information about Grid Dynamics’ exposure to foreign currency exchange rates.

 

Seasonality

 

Grid Dynamics’ business is subject to seasonal trends that impact its revenues and profitability between quarters. Some of the factors that influence the seasonal trends include the timing of holidays in the countries in which Grid Dynamics operates and the U.S. retail cycle, which drives the behavior of Grid Dynamics’ retail customers. Excluding the impact of growth in its book of business, Grid Dynamics has historically recorded higher revenue and gross profit in the second and third quarters of each year compared to the first and fourth quarters of each year. The Christmas holiday season in Russia and Ukraine, for example, falls in the first quarter of the calendar year, resulting in reduced activity and billable hours. In addition, many of Grid Dynamics’ retail sector customers tend to slow their discretionary spending during the holiday sale season, which typically lasts from late November (before Thanksgiving) through late December (after Christmas).

 

Non-GAAP Measures

 

To supplement Grid Dynamics’ consolidated financial data presented on a basis consistent with U.S. GAAP, this Quarterly Report contains certain non-GAAP financial measures, including Non-GAAP EBITDA, Non-GAAP Net Income and Non-GAAP Diluted Earnings Per Share, or EPS. Grid Dynamics has included these non-GAAP financial measures because they are financial measures used by Grid Dynamics’ management to evaluate Grid Dynamics’ core operating performance and trends, to make strategic decisions regarding the allocation of capital and new investments and are among the factors analyzed in making performance-based compensation decisions for key personnel. These measures exclude certain expenses that are required under U.S. GAAP. Grid Dynamics excludes these items because they are not part of core operations or, in the case of stock-based compensation, non-cash expenses that are determined based in part on Grid Dynamics’ underlying performance.

 

26

 

 

Grid Dynamics believes these supplemental performance measurements are useful in evaluating operating performance, as they are similar to measures reported by its public industry peers and those regularly used by security analysts, investors and other interested parties in analyzing operating performance and prospects. These non-GAAP financial measures are not intended to be a substitute for any GAAP financial measures and, as calculated, may not be comparable to other similarly titled measures of performance of other companies in other industries or within the same industry.

 

There are significant limitations associated with the use of non-GAAP financial measures. Further, these measures may differ from the non-GAAP information, even where similarly titled, used by other companies and therefore should not be used to compare our performance to that of other companies. Grid Dynamics compensates for these limitations by providing investors and other users of its financial information a reconciliation of non-GAAP measures to the related GAAP financial measures. Grid Dynamics encourages investors and others to review its financial information in its entirety, not to rely on any single financial measure and to view its non-GAAP measures in conjunction with GAAP financial measures.

 

Grid Dynamics defines and calculates its non-GAAP financial measures as follows:

 

Non-GAAP EBITDA: Net income/(loss) before interest income/expense, provision for income taxes and depreciation and amortization, and further adjusted for the impact of stock-based compensation expense, transaction-related costs (which include, when applicable, professional fees, retention bonuses, and consulting, legal and advisory costs related to Grid Dynamics’ merger and acquisition and capital-raising activities), impairment of goodwill and other income/expenses, net (which includes mainly interest income and expense, foreign currency transaction losses and gains, fair value adjustments and other miscellaneous expenses), and restructuring costs.

 

Non-GAAP Net Income: Net income/(loss) adjusted for the impact of stock-based compensation, impairment of goodwill, transaction-related costs, restructuring costs, other income/expenses, net, and the tax impacts of these adjustments.

 

Non-GAAP Diluted EPS: Non-GAAP Net income, divided by the diluted weighted-average number of common shares outstanding for the period.

 

The following table presents the reconciliation of Grid Dynamics’ Non-GAAP EBITDA to its consolidated net loss, the most directly comparable GAAP measure, for the periods indicated:

 

   

Three months ended

June 30,

   

Six Months Ended

June 30,

 
(in thousands)   2021     2020     2021     2020  
GAAP net loss   $ (1,483 )   $ (2,166 )   $ (3,545 )   $ (6,762 )
Adjusted for:                                
Depreciation and amortization     1,154       588       2,100       1,234  
Provision/(benefit) for income taxes     2,788       (813 )     2,022       (3,495 )
Stock-based compensation     6,675       3,654       12,346       8,458  
Transaction and transformation-related costs (1)     518             942       3,940  
Restructuring costs (2)           143             832  
Other (income)/expenses, net (3)     79       (208 )     1,129       36  
Non-GAAP EBITDA   $ 9,731     $ 1,198     $ 14,994     $ 4,243  

 

 

(1)

Transaction and transformation-related costs include, when applicable, external deal costs, transaction-related professional fees, transaction-related retention bonuses, which are allocated proportionally across cost of revenue, engineering, research and development, sales and marketing and general and administrative expenses as well as other transaction-related costs including integration expenses consisting of outside professional and consulting services.

(2) We implemented a cost reduction plan during first quarter of 2020. During the three and six months ended June 30, 2020, we incurred restructuring and severance charges of $0.1 million and $0.8 million, respectively, primarily resulting from a reduction in workforce and other charges. We did not incur any restructuring expenses during the three and six months ended June 30, 2021.

(3)

Other expenses consist primarily of losses and gains on foreign currency transactions, fair value adjustments, and other miscellaneous non-operating expenses and other income consists primarily of interest on cash held at banks.

 

27

 

 

The following table presents a reconciliation of Grid Dynamics’ Non-GAAP Diluted EPS and its Non-GAAP Net Income to its consolidated net loss for the periods indicated:

 

   

Three months ended

June 30,

   

Six Months Ended

June 30,

 
(in thousands, except per share data)   2021     2020     2021     2020  
GAAP net loss   $ (1,483 )   $ (2,166 )   $ (3,545 )   $ (6,762 )
Adjusted for:                                
Stock-based compensation     6,675       3,654       12,346       8,458  
Transaction and transformation-related costs (1)     518             942       3,940  
Restructuring costs (2)           143             832  
Other (income)/expenses, net (3)     79       (208 )     1,129       36  
Tax impact of non-GAAP adjustments (4)     301       (990 )     (1,717 )     (4,526 )
Non-GAAP Net Income   $ 6,090     $ 433     $ 9,155     $ 1,978  
Non-GAAP Diluted EPS(5)   $ 0.10     $ 0.01     $ 0.15     $ 0.05  
Number of shares used in the Non-GAAP Diluted EPS     60,996       53,082       60,799       43,888  

 

 

(1)

Transaction and transformation-related costs include, when applicable, external deal costs, transaction-related professional fees, transaction-related retention bonuses, which are allocated proportionally across cost of revenue, engineering, research and development, sales and marketing and general and administrative expenses as well as other transaction-related costs including integration expenses consisting of outside professional and consulting services.

(2) We implemented a cost reduction plan during first quarter of 2020. During the three and six months ended June 30, 2020, we incurred restructuring and severance charges of $0.1 million and $0.8 million, respectively, primarily resulting from a reduction in workforce and other charges. We did not incur any restructuring expenses during the three and six months ended June 30, 2021.

(3)

Other expenses consist primarily of losses and gains on foreign currency transactions, fair value adjustments, and other miscellaneous non-operating expenses and other income consists primarily of interest on cash held at banks.

(4)

Reflects the estimated tax impact of the non-GAAP adjustments presented in the table.

(5)

Non-GAAP Diluted EPS is calculated by dividing Non-GAAP Net Income/(Loss) by the diluted weighted-average shares outstanding. From the three months ended December 31, 2020 onwards, we have chosen to calculate its Non-GAAP Diluted EPS based on the diluted share count even in net GAAP loss situation. This methodology differs from the prior approach when we applied the basic share count in situations of a net GAAP loss and a positive non-GAAP net income. Management believes that the new methodology provides better representation of the company’s financial results as it takes into account the significance of the dilutive impact from any outstanding equity instruments in a GAAP net loss/non-GAAP Net income situation.

(1)

 

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Key Components of Revenue and Expenses

 

Revenue

 

Grid Dynamics generates revenue by providing focused and complex services in the area of software engineering, development, integration, testing, and operations of digital services. Grid Dynamics provides services mainly on a time and materials basis and, to a much lesser extent, on a fixed-fee basis. While fixed-fee contracts currently represent an immaterial portion of overall revenue for the periods presented, Grid Dynamics expects proportionate revenue from fixed-fee contracts to increase in future periods. On a time and materials basis, Grid Dynamics earns and recognizes revenue as hours and costs are incurred. On its current and future fixed fee contracts, Grid Dynamics earns and recognizes revenue as the work is performed, the monthly calculation of which is based upon actual labor hours incurred and level of effort expended throughout the duration of the contract. For both time and materials contracts and fixed fee contracts, hourly rates are typically determined based on the location and experience of Grid Dynamics personnel selected to perform the service and are negotiated for each contract or statement of work, as the case may be. For fixed fee contracts, the fixed fee generally remains constant for the contracted project period unless the customer directs a change in scope of project work or requests additional Grid Dynamics employees in excess of those scheduled for a specific project.

 

In select cases, Grid Dynamics offers volume discounts or early settlement discounts, which are recorded as contra-revenue items. Volume discounts apply once the customer reaches certain contractual spend thresholds. Early settlement discounts are issued contingent upon the timing of the payment from the customer. If there is uncertainty about project completion or receipt of payment for services provided, revenue is deferred until the uncertainty is sufficiently resolved.

 

Costs and Expenses

 

Cost of Revenue. Cost of revenue consists primarily of salaries and employee benefits, including performance bonuses and stock-based compensation, and travel expenses for client-serving personnel. Cost of revenue also includes depreciation and amortization expense related to client-serving activities.

 

Engineering, Research and Development. Engineering, research and development expenses consist mainly of salaries and employee benefits including performance bonuses and stock-based compensation for personnel engaged in the design and development of solutions. Engineering, research and development expenses also include depreciation and amortization expenses related to such activities. Engineering, research and development costs are expensed as incurred.

 

Sales and Marketing. Sales and marketing expenses consist primarily of expenses associated with promoting and selling Grid Dynamics’ services and consists mainly of salaries and employee benefits, including performance bonuses and stock-based compensation, marketing events, travel, as well as depreciation and amortization expenses related to such activities.

 

General and Administrative. General and administrative expenses consist primarily of administrative personnel and officers’ salaries and employee benefits including performance bonuses and stock-based compensation, legal and audit expenses, insurance, operating lease expenses (mainly facilities and vehicles) and other facility costs, workforce global mobility initiatives, restructuring and employee relocations cost (not in connection with customer projects), and depreciation and amortization expenses related to such activities. General and administrative expenses include a substantial majority of Grid Dynamics’ stock-based compensation costs for the financial periods discussed herein.

 

Provision for Income Taxes. Grid Dynamics follows the asset and liability method of accounting for income taxes, whereby deferred income taxes are recognized for the tax consequences of temporary differences between the financial statement carrying amounts and the tax basis of the assets and liabilities. The provision for income taxes reflects income earned and taxed in the various U.S. federal and state and non-U.S. jurisdictions. Jurisdictional tax law changes, increases or decreases in permanent differences between book and tax items, accruals, or adjustments of accruals for tax contingencies or valuation allowances, and the change in the mix of earnings from these taxing jurisdictions all affect the overall effective tax rate.

 

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Results of Operations

 

The three and six months ended June 30, 2021compared to the three and six months ended June 30, 2020

 

The following table sets forth a summary of Grid Dynamics’ consolidated results of operations for the interim periods indicated, and the changes between periods:

 

   

Three months ended

June 30,

             
(unaudited, in thousands, except percentages)   2021     2020     Change  
Revenue   $ 47,676     $ 22,368     $ 25,308     113.1 %
Cost of revenue     27,879       13,982       13,897       99.4 %
Gross profit     19,797       8,386       11,411       136.1 %
Engineering, research, and development     1,772       2,577       (805 )     (31.2 )%
Sales and marketing     2,837       1,637       1,200       73.3 %
General and administrative     13,804       7,359       6,445       87.6 %
Total operating expense     18,413       11,573       6,840       59.1 %
Profit/(loss) from operations     1,384       (3,187 )     4,571       (143.4 )%
Other income/(expenses), net     (79 )     208       (287 )     (138.0 )%
Profit/(loss) before income taxes     1,305       (2,979 )     4,284       (143.8 )%
Provision/(benefit) for income taxes     2,788       (813 )     3,601       (442.9 )%
Net loss     (1,483 )     (2,166 )     683       (31.5 )%
Foreign currency translation adjustments, net of tax     (35 )           (35 )     n.m.  
Comprehensive loss   $ (1,518 )   $ (2,166 )   $ 648     (29.9 )%

 

 

n.m. = not meaningful.

 

   

Six Months Ended

June 30,

             
(unaudited, in thousands, except percentages)   2021     2020     Change  
Revenue   $ 86,810     $ 54,825     $ 31,985       58.3 %
Cost of revenue     51,676       36,621       15,055       41.1 %
Gross profit     35,134       18,204       16,930       93.0 %
Engineering, research, and development     3,555       5,117       (1,562 )     (30.5 )%
Sales and marketing     5,869       5,206       663       12.7 %
General and administrative     26,104       18,102       8,002       44.2 %
Total operating expense     35,528       28,425       7,103       25.0 %
Loss from operations     (394 )     (10,221 )     9,827       (96.1 )%
Other expenses, net     (1,129 )     (36 )     (1,093 )     3,036.1 %
Loss before income taxes     (1,523 )     (10,257 )     8,734       (85.2 )%
Provision/(benefit) for income taxes     2,022       (3,495 )     5,517       (157.9 )%
Net loss     (3,545 )     (6,762 )     3,217       (47.6 )%
Foreign currency translation adjustments, net of tax     14             14       n.m.  
Comprehensive loss   $ (3,531 )   $ (6,762 )   $ 3,231       (47.8 )%

 

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Revenues by Vertical. We assign our customers into one of our four main vertical markets or a group of various industries where we are increasing our presence, which we label as “Verticals”. The following table presents our revenues by vertical and revenues as a percentage of total revenues by vertical for the periods indicated:

 

    Three months ended June 30,  
(unaudited, in thousands, except percentages)   2021     % of revenue     2020     % of revenue  
Technology, Media and Telecom   $ 16,115       33.8 %   $ 11,975       53.5 %
Retail     12,729       26.7 %     4,000       17.9 %
Finance     4,071       8.5 %     3,522       15.7 %
CPG/Manufacturing     9,899       20.8 %     2,472       11.1 %
Other     4,862       10.2 %     399       1.8 %
Total   $ 47,676       100.0 %   $ 22,368       100.0 %

 

    Six months ended June 30,  
(unaudited, in thousands, except percentages)   2021     % of revenue     2020     % of revenue  
Technology, Media and Telecom   $ 30,526       35.2 %   $ 22,052       40.2 %
Retail     21,579       24.9 %     20,099       36.7 %
Finance     7,509       8.6 %     7,555       13.8 %
CPG/Manufacturing     18,624       21.5 %     4,655       8.5 %
Other     8,572       9.8 %     464       0.8 %
Total   $ 86,810       100.0 %   $ 54,825       100.0 %

 

Revenue. Revenue increased by $25.3 million, or 113.1%, to $47.7 million in the three months ended June 30, 2021 from $22.4 million in the three months ended June 30, 2020. Revenue increased by $32.0 million, or 58.3%, to $86.8 million in the six months ended June 30, 2021 from $54.8 million in the six months ended June 30, 2020. The year- over- year increases, both on a three month and six-month basis, were largely driven by the improved business conditions as the company recovered from the impact of COVID-19 that resulted in increased billable headcount and billable hours. Additionally, the acquisitions of Daxx and Tacit contributed to the year-over-year growth, both on a three month and six-month basis. Combined, these two acquisitions contributed a total of $9.3 million and $15.8 million during the three and six months ended June 30, 2021, respectively.

 

Cost of Revenue and Gross Profit. Cost of revenue increased by $13.9 million, or 99.4%, to $27.9 million in the three months ended June 30, 2021 from $14.0 million in the three months ended June 30, 2020 largely from increased costs of personnel to support higher revenue. This was offset by lower expenses, such as travel related costs. Cost of revenue increased by $15.1 million, or 41.1%, to $51.7 million in the six months ended June 30, 2021 from $36.6 million in the same period of June 30, 2020, largely from increased costs of personnel to support higher revenue offset by lower expenses, such as travel related expenses and retention bonuses.

 

Gross profit increased by $11.4 million, or 136.1%, to $19.8 million in the three months ended June 30, 2021 from $8.4 million in the three months ended June 30, 2020. Gross margin (gross profit as a percentage of revenue) increased by 4.0 percentage points to 41.5% in the three months ended June 30, 2021 from 37.5% in the three months ended June 30, 2020. Gross profit increased by $16.9 million, or 93.0%, to $35.1 million in the six months ended June 30, 2021 from $18.2 million in the six months ended June 30, 2020. Gross margin (gross profit as a percentage of revenue) increased by 7.3 percentage points to 40.5% in the six months ended June 30, 2021 from 33.2% in the same period of 2020. The increase in gross margins, both on a three month and six-month basis, was largely driven by a combination of increased billable workforce utilization and greater mix shift towards offshore delivery locations. Additionally, in the three and six months ended June 30, 2020, our business was severely impacted by COVID-19 which resulted in a significant proportion of our workforce becoming non-billable resulting in lower gross margins in comparison to the three and six months ended June 30, 2021.

 

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Engineering, Research and Development. Engineering, research and development expenses decreased by $0.8 million to $1.8 million during the three months ended June 30, 2021, a 31.2% decrease from $2.6 million in the second quarter of 2020. During the first half of 2021, engineering, research and development expenses decreased by 30.5% to $3.6 million from $5.1 million during the six months ended June 30, 2020. The decrease was primarily due to high utilization of our personnel and decrease in retention bonuses.

 

Sales and Marketing. Sales and marketing expenses increased by $1.2 million, or 73.3% to $2.8 million in the three months ended June 30, 2021. The increase was mainly due to increase in sales personnel and new sales initiatives as well as increase in wages in 2021. Sales and marketing expenses accounted for 6.0% of Grid Dynamics’ revenue in the three months ended June 30, 2021 compared to 7.3% in the same period of last year, a decrease of 1.3%. The decrease was due mainly to decrease in marketing and sales events due to the COVID-19 pandemic. Sales and marketing expense remained on relatively the same level during the first half of 2021 compared to the same period of 2020. Sales and marketing expense accounted for 6.8% of Grid Dynamics’ revenue in the six months ended June 30, 2021 compared to 9.5% in the six months ended June 30, 2020, a decrease of 2.7 percentage points mainly to decrease in marketing and sales events due to the COVID-19 pandemic.

 

General and Administrative. General and administrative expenses increased by $6.4 million to $13.8 million in the three months ended June 30, 2021 and increased by $8.0 million, or 44.2%, to $26.1 million in the six months ended June 30, 2021 from $18.1 million in the same period of 2020. The increase was mainly due to increase in stock-based compensation, 2021 wages and bonuses, increase in legal and professional fees due to the recent acquisition of Tacit in May of 2021 and additional facilities expenses as well as amortization of intangibles resulting from it. General and administrative expenses accounted for 30.1% of Grid Dynamics’ revenue in the first half of 2021, a decrease of 2.9 percentage points from 33.0% in the six months ended June 30, 2020.

 

Other Income/(Expenses), Net. Other expenses, net changed by $0.3 million for the three months ended June 30, 2021 as compared to Other income, net recorded in the same period last year reflecting increased interest, other income and miscellaneous expenses. Other income/(expenses), net changed by $1.1 million for the six months ended June 30, 2021 as compared to the six months ended June 30, 2020, mainly due to changes in the fair value of private warrants of $0.9 million in the first quarter of 2021.

 

Provision/(Benefit) for Income Tax. During the three months ended June 30, 2021 we recognized a provision for income tax of $2.8 million compared to benefit for income tax of $(0.8) million in the same period of 2020. The difference in tax provision was attributable mainly to Section 162(m) compensation deduction limitations partially offset by stock-based compensation excess tax benefit. Additionally, the United Kingdom’s (“UK”) recently enacted Finance Act 2021 has increased its corporate tax rate to 25% for companies with profits exceeding 250,000 pounds, effective beginning April 01, 2023. As a result of this change in tax law, the Company remeasured its UK deferred taxes which resulted in a $0.5 million discrete tax expense in the three months ended June 30, 2021. Provision for income tax was $2.0 million in the six months ended June 30, 2021 compared to benefit for income tax of $(3.5) million in the six months ended June 30, 2020.

 

During three and six months ended June 30, 2021, we recognized net loss of $(1.5) million and $(3.5) million, respectively, compared to net loss of $(2.2) million and $(6.8) million in the same periods of 2020 due to the reasons stated above.

 

Liquidity and Capital Resources

 

Grid Dynamics measures liquidity in terms of its ability to fund the cash requirements of its business operations, including working capital needs, capital expenditures, contractual obligations, and other commitments with cash flows from operations and other sources of funding. Grid Dynamics’ current liquidity needs relate mainly to compensation and benefits of Grid Dynamics’ employees and contractors and capital expenditures for computer hardware and office furniture. Grid Dynamics’ ability to expand and grow its business will depend on many factors including its capital expenditure needs and the evolution of its operating cash flows. Grid Dynamics may need more cash resources due to changed business conditions or other developments, including investments or acquisitions. Grid Dynamics believes that its current cash position on its balance sheet of $68.0 million as of June 30, 2021, as well as the net proceeds received as a result of our follow-on public offering that closed on July 6, 2021, as described in Note 13 to the condensed consolidated financial statements, is sufficient to fund its currently expected levels of operating, investing and financing expenditures for a period of twelve months from the date of this filing. However, if Grid Dynamics’ resources are insufficient to satisfy its cash requirements, it may need to seek additional equity or debt financing, which may be subject to conditions outside of Grid Dynamics’ control and may not be available on terms acceptable to Grid Dynamics’ management or at all.

 

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As of June 30, 2021, Grid Dynamics had cash and cash equivalents amounting to $68.0 million (compared to $112.7 million at December 31, 2020). Of this amount, $7.4 million was held outside the United States, namely in Russia, Ukraine, Poland, Serbia, the Netherlands, UK, Mexico, Moldova, and Singapore (compared to $3.1 million as of December 31, 2020). As many of Grid Dynamics’ assets, operations and employees are located in these countries, Grid Dynamics expects that all such cash and cash equivalents will be used to fund future operating needs and Grid Dynamics’ management has no intention of repatriating the funds. If Grid Dynamics decided to remit funds from these countries to the United States in the future, whether in the form of inter-company dividends or otherwise, they may be subject to foreign withholding taxes. In addition, Grid Dynamics’ cash in banks in Russia, Ukraine, Poland, Moldova, Serbia, and Mexico may be subject to other risks, as the banking sector in certain of these countries is subject to periodic instability, may be subject to sanctions and may be subject to capital adequacy and other banking standards that are substantially less rigorous than those of the United States.

 

On July 6, 2021, Grid Dynamics closed a follow-on public offering of common stock that resulted in $78.3 million net proceeds, after deducting underwriting discounts and commissions and estimated offering expenses payable by the Company.

 

Grid Dynamics does not have any debt outstanding as of June 30, 2021 and or December 31, 2020.

 

Our performance stock units, or PSUs, vested upon the satisfaction of a performance-based vesting condition. The compensation committee of our board of directors certified that the performance conditions of the PSUs were met, and PSUs were released on February 12, 2021. Approximately 0.7 million shares were issued upon vesting of the PSUs and 0.75 million shares were net withheld to cover $10.7 million employees’ tax withholding obligations. In the six months ending June 30, 2021, approximately 0.8 million shares underlying RSUs held by our officers being vested. Upon vesting of the RSUs, approximately 0.4 million shares were released, and 0.4 million shares were net withheld to cover the employees’ tax withholding obligations. We have determined that our policy will be to require individuals to withhold to cover taxes, so approximately 52% of the vested shares were withheld on the settlement date, with the equivalent value being paid by us from our working capital. The total net tax withholding obligations for the six months ended June 30, 2021 were approximately $18.9 million in the aggregate for the option exercises, RSU and PSU releases.

 

Cash Flows

 

The following table summarizes Grid Dynamics’ cash flows for the periods indicated:

 

   

Six Months Ended

June 30,

 
(unaudited, in thousands)   2021     2020  
Net cash provided by/(used in) operating activities   $ 6,650     $ (921 )
Net cash used in investing activities   $ (32,525 )   $ (1,110 )
Net cash provided by/(used in) financing activities   $ (18,910 )   $ 82,927  
Effect of exchange rate changes on cash and cash equivalents   $ 14     $  
Net increase/(decrease) in cash and cash equivalents   $ (44,771 )   $ 80,896  
Cash, cash equivalents (beginning of period)   $ 112,745     $ 42,189  
Cash, cash equivalents (end of period)   $ 67,974     $ 123,085  

 

Operating Activities. Net cash provided by operating activities for the six months ended June 30, 2021 increased by $7.6 million to $6.7 million from $(0.9) million used in the same period in 2020, driven by higher cash operating profit (before non-cash depreciation and amortization and stock-based compensation charges). The key reasons for the increase in cash operating profit in the six months ended June 30, 2021 in comparison to the six months ended June 30, 2020, were higher levels of revenue and greater billable utilization resulting in higher profitability.

 

Investing Activities. Net cash used in investing activities during the six months ended June 30, 2021 was $(32.5) million, which primarily reflects the acquisition of Tacit, compared to $(1.1) million used in the same period in 2020 reflecting mainly capital expenditures for computer hardware, related equipment and software.

 

Financing Activities. Net cash used in financing activities was $(18.9) million in the six months ended June 30, 2021, reflecting primarily the tax withholding obligations due to issuance of shares in connection with vested awards. Net cash provided by financing activities was $82.9 million in the six months ended June 30, 2020, reflecting primarily the proceeds from the Business Combination.

 

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Contractual Obligations

 

Grid Dynamics’ outstanding operating leases and software service agreement obligations have not changed materially since December 31, 2020. In addition, Grid Dynamics purchases software licenses in the ordinary course of business.

 

Non-perpetual licenses are typically renewed annually. Grid Dynamics does not have any material obligations under contractual arrangements other than as disclosed in this report.

 

Off-Balance Sheet Arrangements and Commitments

 

Except for its credit support for the letter of credit and balances on corporate credit cards, Grid Dynamics does not have any off-balance sheet arrangements of the kind required to be disclosed under SEC rules and does not have any off-balance sheet or contingent commitments, except as described above with respect to operating leases.

 

As a result of analysis related to Grid Dynamics’ functional control of subcontractor GD Ukraine, LLC, the subcontractor was determined to be a variable interest entity (“VIE”) and is therefore consolidated in Grid Dynamics’ financial statements. The assets and liabilities of this VIE consist primarily of intercompany balances and transactions, all of which have been eliminated in consolidation.

 

Critical Accounting Policies

 

Grid Dynamics management’s discussion and analysis of our financial condition and results of operations is based on the condensed consolidated financial statements, which have been prepared in accordance with U.S. GAAP. Preparation of the financial statements requires Grid Dynamics to make judgments, estimates and assumptions that impact the reported amount of revenue and expenses, assets and liabilities and the disclosure of contingent assets and liabilities. Grid Dynamics considers an accounting judgment, estimate or assumption to be critical when (1) an estimate or assumption is complex in nature or requires a high degree of judgment, and (2) the use of different judgments, estimates and assumptions could have a material impact on Grid Dynamics’ condensed consolidated financial statements. Grid Dynamics’ critical accounting policies are described in Note 2 to its condensed consolidated financial statements.

 

Emerging Growth Company Accounting Election

 

Section 102(b)(1) of the Jumpstart Our Business Startups Act of 2012 (“JOBS Act”) exempts emerging growth companies from being required to comply with new or revised financial accounting standards until private companies are required to comply with the new or revised financial accounting standards. The JOBS Act provides that a company can choose not to take advantage of the extended transition period and comply with the requirements that apply to non-emerging growth companies and any such election to not to take advantage of the extended transition period is irrevocable. Prior to the Business Combination, ChaSerg was an “emerging growth company” as defined in Section 2(a) of the Securities Act and has elected to take advantage of the benefits of this extended transition period. Following the consummation of the Business Combination, Grid Dynamics remains an emerging growth company and continues to take advantage of the benefits of the extended transition period.

 

Recently Adopted and Issued Accounting Pronouncements

 

Recently issued and adopted accounting pronouncements are described in Note 2 to Grid Dynamics’ condensed consolidated financial statements.

 

Item 3. Quantitative and Qualitative Disclosures About Market Risk

 

Grid Dynamics has in the past and may in the future be exposed to certain market and credit risks in the ordinary course of business, including exposure related to fluctuations in foreign currency rates, and on occasion and to a lesser extent, changes in interest rates and concentration of credit risk. In addition, Grid Dynamics’ international operations are subject to risks related to differing economic conditions, changes in political climate, differing tax structures, and other regulations and restrictions. See the section titled “Risk Factors” for additional information.

 

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Foreign Currency Exchange Rate Risk

 

Grid Dynamics is exposed to foreign currency exchange rate risk and its profit margins are subject to volatility between periods due to changes in foreign currency exchange rates relative to the U.S. dollar. Grid Dynamics’ functional currency apart from the U.S. dollar includes EURO, British pounds, Mexican pesos, Moldovan leu. In addition, Grid Dynamics’ profit margins are subject to volatility as a result of changes in foreign exchange rates. When and where possible, Grid Dynamics seeks to match expenses to the U.S. dollar, and believes, due to Ukrainian payroll being pegged to the U.S. dollar, that a significant portion of its foreign currency exchange rate exposure to the Ukrainian hryvnia is naturally hedged. In future periods, Grid Dynamics may also become materially exposed to changes in the value of the Serbian dinar, Mexican pesos and Moldovan leu against the U.S. dollar, due to the recent acquisitions and continuous expansion of operations.

 

In the three months ended June 30, 2021, approximately 25.3%, 11.9% and 7.4% of Grid Dynamics’ $46.3 million of combined cost of revenue and total operating expenses were denominated in the Ukrainian hryvnia, Russian ruble, and Polish zloty, respectively. Comparatively, the same foreign currencies accounted for approximately 9.9%, 12.6% and 10.6% of Grid Dynamics’ $25.6 million of combined cost of revenue and total operating expenses in the three months ended June 30, 2020.

 

In the three months ended June 30, 2021:

 

a 10% decrease in the value of the Russian rouble against the U.S. dollar would have resulted in a $0.5 million increase in Grid Dynamics’ income from operations, while a 10% increase in the rouble’s value would have resulted in a $0.6 million decrease in income from operations.

 

a 10% decrease in the value of the Polish zloty against the U.S. dollar would have resulted in a $0.3 million increase in Grid Dynamics’ income from operations, while a 10% increase in the zloty’s value would have resulted in a $0.4 million decrease in income from operations.

 

In the three months ended June 30, 2020:

 

a 10% decrease in the value of the Russian rouble against the U.S. dollar would have resulted in a $0.3 million increase in Grid Dynamics’ income from operations, while a 10% increase in the rouble’s value would have resulted in a $0.4 million decrease in income from operations.

 

a 10% decrease in the value of the Polish zloty against the U.S. dollar would have resulted in a $0.2 million increase in Grid Dynamics’ income from operations, while a 10% increase in the zloty’s value would have resulted in a $0.3 million decrease in income from operations.

 

In the six months ended June 30, 2021, approximately 25.3%, 11.4% and 7.6% of Grid Dynamics’ $87.2 million of combined cost of revenue and total operating expenses were denominated in the Ukrainian hryvnia, Russian ruble, and Polish zloty, respectively. Comparatively, the same foreign currencies accounted for approximately 10.7%, 15.6%, and 10.0% of Grid Dynamics’ $65.0 million of combined cost of revenue and total operating expenses in the six months ended June 30, 2020.

 

In the six months ended June 30, 2021:

 

a 10% decrease in the value of the Russian rouble against the U.S. dollar would have resulted in a $0.9 million increase in Grid Dynamics’ income from operations, while a 10% increase in the rouble’s value would have resulted in a $1.1 million decrease in income from operations.

 

a 10% decrease in the value of the Polish zloty against the U.S. dollar would have resulted in a $0.6 million n increase in Grid Dynamics’ income from operations, while a 10% increase in the zloty’s value would have resulted in a $0.7 million decrease in income from operations.

 

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In the six months ended June 30, 2020:

 

a 10% decrease in the value of the Russian ruble against the U.S. dollar would have resulted in a $0.9 million increase in Grid Dynamics’ income from operations, while a 10% increase in the ruble’s value would have resulted in a $1.2 million decrease in income from operations.

 

a 10% decrease in the value of the Polish zloty against the U.S. dollar would have resulted in a $0.6 million increase in Grid Dynamics’ income from operations, while a 10% increase in the zloty’s value would have resulted in a $0.7 million decrease in income from operations.

 

Grid Dynamics analyses sensitivity to the rouble and zloty separately because, in management’s experience, fluctuations in the value of these currencies against the U.S. dollar are frequently driven by distinct macroeconomic and geopolitical factors.

 

Grid Dynamics does not currently hedge its foreign currency exposure, although it seeks minimize it by limiting cash transfers to amounts necessary to fund subsidiary operating expenses for a short period, typically one week. Grid Dynamics’ management may evaluate new hedging strategies in future periods.

 

Item 4. Controls and Procedures

 

Evaluation of Disclosure Controls and Procedures

 

Our management, with the participation of our Chief Executive Officer and Chief Financial Officer, has evaluated the effectiveness of our disclosure controls and procedures (as such term is defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended (the “Exchange Act”)) as of the end of the period covered by this quarterly report. Based on such evaluation, our Chief Executive Officer and Chief Financial Officer have concluded that, as of the end of such period, our disclosure controls and procedures were effective in recording, processing, summarizing and reporting on a timely basis, information required to be disclosed by us in the reports that we file or submit under the Exchange Act and were effective in ensuring that information required to be disclosed by us in the reports that we file or submit under the Exchange Act is accumulated and communicated to our management, including our Chief Executive Officer and Chief Financial Officer, as appropriate to allow timely decisions regarding required disclosure.

 

Changes in Internal Control Over Financial Reporting

 

Our management, including the CEO and CFO, confirmed there have been no changes in our internal control over financial reporting during the three months ended June 30, 2021 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

 

Inherent Limitations on Effectiveness of Controls

 

Our management, including our CEO and CFO, do not expect that our disclosure controls or our internal control over financial reporting will prevent all errors and all fraud. A control system, no matter how well conceived and operated, can provide only reasonable, not absolute, assurance that the objectives of the control system are met. Further, the design of a control system must reflect the fact that there are resource constraints, and the benefits of controls must be considered relative to their costs. Because of the inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that all control issues and instances of fraud, if any, have been detected. These inherent limitations include the realities that judgments in decision-making can be faulty, and that breakdowns can occur because of a simple error or mistake. Additionally, controls can be circumvented by the individual acts of some persons, by collusion of two or more people or by management override of the controls. The design of any system of controls is also based in part upon certain assumptions about the likelihood of future events, and there can be no assurance that any design will succeed in achieving its stated goals under all potential future conditions; over time, controls may become inadequate because of changes in conditions, or the degree of compliance with policies or procedures may deteriorate. Because of the inherent limitations in a cost-effective control system, misstatements due to error or fraud may occur and not be detected.

 

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PART II — OTHER INFORMATION

 

Item 1. Legal Proceedings

 

Although we may, from time to time, be involved in litigation and claims arising out of our operations in the normal course of business, we are not currently a party to any material legal proceeding. In addition, we are not aware of any material legal or governmental proceedings against us or contemplated to be brought against us. Future litigation may be necessary, among other things, to defend us or our customers by determining the scope, enforceability, and validity of third-party proprietary rights or to establish our proprietary rights. The results of any litigation cannot be predicted with certainty and, regardless of the outcome, litigation can have an adverse impact on our company because of defense and settlement costs, diversion of management resources and other factors.

 

Item 1A. Risk Factors

 

This Quarterly Report on Form 10-Q contains forward-looking statements that are subject to risks and uncertainties that could cause actual results to differ materially from those projected. These risks and uncertainties include, but are not limited to, the risk factors set forth below. The risks and uncertainties described in this Quarterly Report on Form 10-Q are not the only ones we face. Additional risks and uncertainties not presently known to us or that we currently believe are immaterial may also affect our business. See the section titled “Special Note Regarding Forward-Looking Statements” of this Quarterly Report on Form 10-Q for a discussion of the forward-looking statements that are qualified by these risk factors. If any of these known or unknown risks or uncertainties actually occurs and have a material adverse effect on us, our business, financial condition and results of operations could be seriously harmed.

 

Summary of Risk Factors

 

Our business is subject to numerous risks and uncertainties that you should consider before investing in our company, as fully described below. The principal factors and uncertainties that make investing in our company risky include, among others:

 

We have a relatively short operating history and operate in a rapidly evolving industry, which makes it difficult to evaluate our future prospects and may increase the risk that we will not continue to be successful and may adversely impact our stock price.

 

We may be unable to effectively manage our growth or achieve anticipated growth, which could place significant strain on our management personnel, systems and resources.

 

Our revenues have historically been highly dependent on a limited number of clients and industries that are affected by seasonal trends, and any decrease in demand for outsourced services in these industries may reduce our revenues and adversely affect our business, financial condition and results of operations.

 

The impact of the COVID-19 pandemic has and may continue to affect our overall financial performance, business operations, and stock price.

 

Our revenues are highly dependent on clients primarily located in the U.S. Any economic downturn in the U.S. or in other parts of the world, including Europe, or disruptions in the credit markets may have a material adverse effect on our business, financial condition and results of operations.

 

We face intense competition.

 

Damage to our reputation may adversely impact our ability to generate and retain business.

 

Our failure to successfully attract, hire, develop, motivate and retain highly skilled personnel could have a significant adverse effect on our business, financial condition, and results of operations.

 

Our business operations may be severely disrupted if we lose the services of our senior executives and key employees.

 

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Failure to adapt to changing technologies, methodologies, and evolving industry standards may have a material adverse effect on our business, financial condition, and results of operations.

 

Security breaches, system failures or errors, and other disruptions to our network could result in disclosure of confidential information and expose us to liability, which would cause our business and reputation to suffer.

 

Undetected software design defects, errors or failures may result in loss of business or in liabilities that could have a material adverse effect on our reputation, business and results of operations.

 

Acquisitions, strategic investments, partnerships or alliances could be difficult to identify and integrate, divert the attention of management, disrupt our business, dilute stockholder value and adversely affect our financial condition and results of operations, we may not achieve the financial and strategic goals that were contemplated at the time of a transaction, and we may be exposed to claims, liabilities and disputes as a result of the transaction that may adversely impact our business, operating results and financial condition.

 

Risks Related to Our Business, Operations and Industry

 

We have a relatively short operating history and operate in a rapidly evolving industry, which makes it difficult to evaluate future prospects and may increase the risk that we will not continue to be successful and may adversely impact our stock price.

 

We were founded in 2006 and have a relatively short operating history in the technology services industry, which is competitive and continuously evolving, subject to rapidly changing demands and constant technological developments. As a result, success and performance metrics are difficult to predict and measure. Since services and technologies are rapidly evolving and each company within the industry can vary greatly in terms of the services it provides, its business model and its results of operations, it can be difficult to predict how any company’s services, including ours, will be received in the market.

 

While many Fortune 1000 enterprises, including our clients, have been willing to devote significant resources to incorporate emerging technologies and related market trends into their business models, they may not continue to spend any significant portion of their budgets on services like those provided by us in the future. Neither our past financial performance nor the past financial performance of any other company in the technology services industry is indicative of how we will fare financially in the future. Our future profits may vary substantially from those of other companies and our past profits, making an investment in us risky and speculative. If clients’ demand for our services declines as a result of economic conditions, market factors or shifts in the technology industry, our business, financial condition and results of operations would be adversely affected.

 

As a recently formed public company, our stock performance is highly dependent on our ability to successfully execute and grow the business. Consequently, our stock price may be adversely impacted by our inability to execute to our plan, our inability to meet or exceed forward looking financial forecasts, and our inability to achieve our stated short-term and long-term goals.

 

We may be unable to effectively manage our growth or achieve anticipated growth, which could place significant strain on our management personnel, systems and resources.

 

Continued growth and expansion may increase challenges we face in recruiting, training and retaining sufficiently skilled professionals and management personnel, maintaining effective oversight of personnel and delivery centers, developing financial and management controls, coordinating effectively across geographies and business units, and preserving our culture and values. Failure to manage growth effectively could have a material adverse effect on the quality of the execution of our engagements, our ability to attract and retain IT professionals, as well as our business, financial condition and results of operations.

 

In addition, as we increase the size and complexity of projects that we undertake with clients, add new delivery sites, introduce new services or enter into new markets, we may face new market, technological, operational, compliance and administrative risks and challenges, including risks and challenges unfamiliar to us. We may not be able to mitigate these risks and challenges to achieve our anticipated growth or successfully execute large and complex projects, which could materially adversely affect our business, prospects, financial condition and results of operations.

 

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Our revenues have historically been highly dependent on a limited number of clients and industries that are affected by seasonal trends, and any decrease in demand for outsourced services in these industries may reduce our revenues and adversely affect our business, financial condition and results of operations.

 

Our revenues have historically been highly dependent on a limited number of clients. In the three months ended June 30, 2021 and 2020, we generated a significant portion of our revenues from our largest clients. For example, we generated approximately 62.3% and 84.5% of our revenue from our 10 largest clients during the three months ended June 30, 2021 and 2020, respectively, and approximately 64.3% and 84.0% of our revenue from our 10 largest clients during six months ended June 30, 2021 and 2020, respectively. Our top two and three clients each accounted for greater than 10% of our revenue for the three months ended June 30, 2021 and 2020, respectively. Two and three customers individually accounted for greater than 10% of the sales for the six months ended June 30, 2021 and 2020, respectively. Since a substantial portion of our revenue is derived through time and materials contracts, which are mostly short-term in nature, a major client in one year may not provide the same level of revenues for us in any subsequent year. In addition, a significant portion of our revenues is concentrated in our top two industry verticals: technology and retail. Our growth largely depends on our ability to diversify the industries in which we serve, continued demand for our services from clients in these industry verticals and other industries that we may target in the future, as well as on trends in these industries to outsource the type of services we provide.

 

Our business is also subject to seasonal trends that impact our revenues and profitability between quarters, driven by the timing of holidays in the countries in which we operate and the U.S. retail cycle, which drives the behavior of several of our retail clients. Excluding the impact of growth in our book of business, we have historically recorded higher revenue and gross profit in the second and third quarters of each year compared to the first and fourth quarters of each year. The Christmas holiday season in Russia and Ukraine, for example, falls in the first quarter of the calendar year, resulting in reduced activity and billable hours of our engineering personnel. In addition, many of our retail sector clients tend to slow their discretionary spending during the holiday sale season, which typically lasts from late November (before Thanksgiving) through late December (after Christmas). Such seasonal trends may cause reductions in our profitability and profit margins during periods affected.

 

A reduction in demand for our services and solutions caused by seasonal trends, downturns in any of our targeted industries, a slowdown or reversal of the trend to outsource IT services in any of these industries or the introduction of regulations that restrict or discourage companies from outsourcing may result in a decrease in the demand for our services and could have a material adverse effect on our business, financial condition and results of operations.

 

The impact of the COVID-19 pandemic has and may continue to affect our overall financial performance, business operations, and stock price.

 

In December 2019, a novel coronavirus COVID-19 was reported in China, and in March 2020, the World Health Organization declared it a pandemic. This contagious disease pandemic has continued to spread across the globe and is impacting worldwide economic activity and financial markets, significantly increasing economic volatility and uncertainty. In response to this global pandemic, local, state, and federal governments have been prompted to take unprecedented steps that include, but are not limited to, travel restrictions, closure of businesses, social distancing, and quarantines.

 

From March 2020 onwards, we started witnessing the impacts of the COVID-19 pandemic to our revenues, largely as a consequence of the effect of the pandemic on the business conditions at some of our customers’ operations. The impacts have been more pronounced at our customers exposed to the retail vertical where store closures resulted in sales being severely impacted. Although we witnessed sequential growth in this vertical in the second half of 2020, revenues from most of our retail customers have not come back to pre-COVID-19 levels. The impact of the pandemic to other verticals of our business has largely been determined by customer-specific dynamics. The ongoing COVID-19 pandemic may pose risks in the future to our business as some of our customers are unable to recover to pre-COVID 19 levels of operation. Examples of the COVID-19 pandemic’s impact to our business have included a temporary scale back to our personnel on projects, our customers placing projects and statements of work (“SOWs”) on temporary hold, and request for longer payment terms. Additionally, because more of our personnel are working remotely, we face increased cyber threats that may affect our systems and networks or those of our clients and contractors, and we anticipate the potential for increased costs to maintain and help secure our infrastructure and data.

 

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Although recent vaccine approvals and rollout have raised hopes of a turnaround in the COVID-19 pandemic later this year, renewed waves and new variants pose concerns for the outlook. Growth may be stymied if virus surges (including from new variants) prove difficult to contain, infections and deaths mount rapidly before vaccines are widely available, and social distancing or lockdowns are more stringent than anticipated. Slower-than-anticipated progress on medical interventions could dampen hopes of a relatively quick exit from the COVID-19 pandemic and weaken confidence. Specifically, vaccine rollout could suffer delays or be uneven, widespread hesitancy could hamper vaccine take-up, vaccines could deliver shorter-lived immunity than anticipated and advances on therapies could be limited. Intensifying social unrest, including due to higher inequality and unequal access to vaccines and therapies, could further complicate the recovery. Moreover, if policy support is withdrawn before full economic recovery, bankruptcies of viable but illiquid companies could mount, leading to further employment and income losses. The ensuing tighter financial conditions could increase rollover risks for vulnerable borrowers, add to the already large number of economies in debt distress, and increase insolvencies among corporations and households.

 

In the United States, given the widespread impact of the COVID-19 pandemic, substantial governmental support is still required and the recently passed American Rescue Plan may be insufficient for long-term economic sustainability should there be a protracted recovery. Furthermore, investors fleeing the Dollar could elevate inflation expectations and interest rates. Additionally, high unemployment could lead to mortgage and rental defaults adding losses to the commercial banking industry, resulting in higher loan-loss provision, tighter lending standards and lending curtailment. If the impacts of the COVID-19 pandemic are materially prolonged, it could result in a cascade of additional corporate filings for bankruptcies, further eroding market confidence and increasing unemployment rates. Together, these uncertainties and risks could have a material adverse impact not only on our financial condition, business and results of operations in the United States, but also on our consolidated financial conditions, business and results of operations.

 

There are no comparable recent events which may provide guidance as to the effect of the spread and the ultimate impact of the COVID-19 pandemic. Consequently, the total magnitude of impact to our business and duration of impact is uncertain and difficult to reasonably estimate at this time.

 

We continue to take precautionary measures intended to minimize the risk of the virus to our employees, our customers, and the communities in which we operate that include suspension of all non-essential travel. All of our facilities in the Central and Eastern Europe (“CEE”) region have been opened for employees to work following local government guidelines. That said, the COVID-19 pandemic has placed restrictions in movement, and the majority of our employees continue to work remotely. Additionally, we have been successful in transitioning the majority of our workforce to work remotely and this has resulted in minimal disruption in our ability to deliver services to our customers.

 

As of June 30, 2021 and December 31, 2020 our allowance for doubtful accounts was $0.2 million and $0.4 million, respectively and we continue to be engaged with all of our customers regarding their ability to fulfill their payment obligations. We continue to review our accounts receivable on a regular basis and have put in place regular review and processes to ensure payments from our customers.

 

Our revenues are highly dependent on clients primarily located in the U.S. Any economic downturn in the U.S. or in other parts of the world, including Europe, or disruptions in the credit markets may have a material adverse effect on our business, financial condition and results of operations.

 

The IT services industry is particularly sensitive to the economic environment and tends to decline during general economic downturns. We derive the majority of our revenues from clients in the U.S. In the event of an economic downturn in the U.S. or in other parts of the world, including Europe (where we have gained customers in the Netherlands, Germany and the United Kingdom through our acquisition of Daxx Web Industries B.V.("Daxx") in December 2020), as well as through our acquisition of Tacit in May 2021 our existing and prospective clients may reduce or postpone their technology spending significantly, which may in turn lower the demand for our services and may have a material adverse effect on our business, financial condition and results of operations. In addition, if a disruption in the credit markets were to occur, it could pose a risk to our business if clients or vendors are unable to obtain financing to meet payment or delivery obligations to us or if we are unable to obtain necessary financing. The COVID-19 pandemic has had adverse effects on economies and financial markets globally, which have particularly impacted many small, medium as well as large-sized businesses. Although the U.S. government and others throughout the world have or have taken steps to provide monetary and fiscal assistance to individuals and businesses affected by the pandemic, it is unclear whether these government actions will be sufficient to successfully avert or mitigate any economic downturn. Any economic downturn resulting from the COVID-19 pandemic and preventative measures taken by governments and private business worldwide could decrease technology spending and negatively affect demand for our offerings, which could materially adversely affect our business, prospects, financial condition and results of operations.

 

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We face intense competition.

 

The market for technology and IT services is highly competitive and subject to rapid change and evolving industry standards and we expect competition to persist and intensify. We face competition from offshore IT services providers in other outsourcing destinations with low wage costs such as India, China, CEE countries and Latin America, as well as competition from large, global consulting and outsourcing firms and in-house IT departments of large corporations. Industry clients tend to engage multiple IT services providers instead of using an exclusive IT services provider, which could reduce our revenues to the extent that our clients obtain services from competing companies. Industry clients may prefer IT services providers that have more locations or that are based in countries that are more cost-competitive, stable and/or secure than some of the emerging markets in which we operate.

 

Our primary competitors include IT service providers such as Andersen Lab, Ciklum, EPAM Systems, Inc., Globant S.A. and Endava plc; global consulting and traditional IT services companies, such as Accenture plc, Capgemini SE, Cognizant Technology Solutions Corporation, SoftServe, Inc. and Tata Consultancy Services Limited; and in-house development departments of our clients. Many of our present and potential competitors have substantially greater financial, marketing and technical resources, and name recognition than we do. Therefore, they may be able to compete more aggressively on pricing or devote greater resources to the development and promotion of technology and IT services and we may be unable to retain our clients while competing against such competitors. Increased competition as well as our inability to compete successfully may have a material adverse effect on our business, prospects, financial condition and results of operations.

 

Damage to our reputation may adversely impact our ability to generate and retain business.

 

Since our business involves providing tailored services and solutions to clients, we believe that our corporate reputation is a significant factor when an existing or prospective client is evaluating whether to engage our services as opposed to those of our competitors. In addition, we believe that our brand name and reputation also play an important role in recruiting, hiring and retaining highly skilled personnel.

 

However, our brand name and reputation is potentially susceptible to damage by factors beyond our control, including actions or statements made by current or former clients and employees, competitors, vendors, adversaries in legal proceedings, government regulators and the media. There is a risk that negative information about us, even if untrue, could adversely affect our business. Any damage to our reputation could be challenging to repair, could make potential or existing clients reluctant to select us for new engagements, could adversely affect our recruitment and retention efforts, and could also reduce investor confidence.

 

Our failure to successfully attract, hire, develop, motivate and retain highly skilled personnel could have a significant adverse effect on our business, financial condition, and results of operations.

 

Our continued growth and success and operational efficiency is dependent on our ability to attract, hire, develop, motivate and retain highly skilled personnel, including IT engineers and other technical personnel, in the geographically diverse locations in which we operate. Competition for highly skilled IT professionals can be intense in the regions in which we operate, and we may experience significant employee attrition rates due to such competition. While our management targets a voluntary attrition rate (expressed as a percentage) no higher than in the low-twenties, the significant market demand for highly skilled IT personnel and competitors’ activities may induce our qualified personnel to leave and make it more difficult for us to recruit new employees with suitable knowledge, experience and professional qualifications. High attrition rates of IT personnel would increase our operating costs, including hiring and training costs, and could have an adverse effect on our ability to complete existing contracts in a timely manner, meet client objectives and expand our business. Failure to attract, hire, develop, motivate and retain personnel with the skills necessary to serve our clients could decrease our ability to meet and develop ongoing and future business and could materially adversely affect our business, financial condition and results of operations.

 

Our business operations may be severely disrupted if we lose the services of our senior executives and key employees.

 

Our success depends substantially upon the continued services of our senior executives and other key employees. If we lose the services of one or more of such senior executives or key employees, as recently occurred in June 2021 when Victoria Livschitz resigned as Executive Vice President of Customer Success and became our consultant and Max Martynov resigned as our Chief Technology Officer, our business operations can be disrupted, and we may not be able to replace them easily or at all. In addition, competition for senior executives and key personnel in our industry is intense, and we may be unable to retain our senior executives and key personnel or attract and retain new senior executives and key personnel in the future, in which case our business may be severely disrupted.

 

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Failure to adapt to changing technologies, methodologies, and evolving industry standards may have a material adverse effect on our business, financial condition, and results of operations.

 

We operate in an industry characterized by rapidly changing technologies, methodologies and evolving industry standards. Our future success depends in part upon our ability to anticipate developments in our industry, enhance our existing services and to develop and introduce new services to keep pace with such changes and developments and to meet changing client needs. 

 

Development and introduction of new services and products is expected to become increasingly complex and expensive, involve a significant commitment of time and resources, and subject to a number of risks and challenges, including:

 

difficulty or cost in updating services, applications, tools and software and in developing new services quickly enough to meet clients’ needs;

 

difficulty or cost in making some features of software work effectively and securely over the internet or with new or changed operating systems;

 

difficulty or cost in updating software and services to keep pace with evolving industry standards, methodologies, regulatory and other developments in the industries where our clients operate; and

 

difficulty or cost in maintaining a high level of quality and reliability as we implement new technologies and methodologies.

 

We may not be successful in anticipating or responding to these developments in a timely manner, and even if we do so, the services, technologies or methodologies we develop or implement may not be successful in the marketplace. Furthermore, services, technologies or methodologies that are developed by competitors may render our services non-competitive or obsolete. Our failure to adapt and enhance our existing services and to develop and introduce new services to promptly address the needs of our clients may have a material adverse effect on our business, financial condition and results of operations.

 

Security breaches, system failures or errors, and other disruptions to our network could result in disclosure of confidential information and expose us to liability, which would cause our business and reputation to suffer.

 

We often have access, or are required, to collect, process, transmit and store sensitive or confidential client and customer data, including intellectual property, proprietary business information of Grid Dynamics and our clients, and personally identifiable information of our clients, customers, employees, contractors, service providers, and others. We use our data centers and networks, and certain networks and other facilities and equipment of our contractors and service providers, for these purposes. Despite our security measures, our information technology and infrastructure may be vulnerable to attacks and disruptions by hackers or other third parties or otherwise may be breached due to human error, phishing attacks, social engineering, malfeasance or other disruptions. During the COVID-19 pandemic, because more of our personnel are working remotely, we face increased risks of such attacks and disruptions that may affect our systems and networks or those of our clients and contractors. Any such breach or disruption could compromise our data centers, networks and other equipment and the information stored or processed there could be accessed, disclosed, altered, misappropriated, lost or stolen. In addition, any failure or breach of security in a client’s system relating to the services we provide could also result in loss or misappropriation of, or unauthorized access, alteration, use, acquisition or disclosure of sensitive or confidential information, and may result in a perception that we or our contractors or service providers caused such an incident, even if Grid Dynamics’ and our contractors’ networks and other facilities and equipment were not compromised.

 

Our contractors and service providers face similar risks with respect to their facilities and networks used by us, and they also may suffer outages, disruptions, and security incidents and breaches. Breaches and security incidents suffered by us and our contractors and service providers may remain undetected for an extended period. Any such breach, disruption or other circumstance leading to loss, alteration, misappropriation, or unauthorized use, access, acquisition, or disclosure of sensitive or confidential client or customer data suffered by us or our contractors or service providers, or the perception that any may have occurred, could expose us to claims, litigation, and liability, regulatory investigations and proceedings, cause us to lose clients and revenue, disrupt our operations and the services provided to clients, damage our reputation, cause a loss of confidence in our products and services, require us to expend significant resources to protect against further breaches and to rectify problems caused by these events, and result in significant financial and other potential losses.

 

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Our errors and omissions insurance covering certain damages and expenses may not be sufficient to compensate for all liability. Although we maintain insurance for liabilities incurred as a result of certain security-related damages, we cannot be certain that our coverage will be adequate for liabilities actually incurred, that insurance will continue to be available to us on economically reasonable terms, or at all, or that any insurer will not deny coverage as to any future claim. The successful assertion of one or more large claims against us that exceeds available insurance coverage, or the occurrence of changes in our insurance policies, including premium increases or the imposition of large deductible or co-insurance requirements, could have a material adverse effect on our business, including our financial condition, results of operations, and reputation.

 

Undetected software design defects, errors or failures may result in loss of business or in liabilities that could have a material adverse effect on our reputation, business and results of operations.

 

Our services involve developing software solutions for our clients and we may be required to make certain representations and warranties to our clients regarding the quality and functionality of our software. Given that our software solutions have a high degree of technological complexity, they could contain design defects or errors that are difficult to detect or correct. We cannot provide assurances that, despite testing by us, errors or defects will not be found in our software solutions. Any such errors or defects could result in litigation, other claims for damages against us, the loss of current clients and loss of, or delay in, revenues, loss of market share, a failure to attract new clients or achieve market acceptance, diversion of development resources, increased support or service costs, as well as reputational harm and thus could have a material adverse effect on our reputation, business, prospects, financial condition and results of operations.

 

We do not have long-term commitments from our clients, and our clients may terminate contracts before completion or choose not to renew contracts.

 

Our clients are generally not obligated for any long-term commitments to us. Although a substantial majority of our revenues are generated from repeated business, which we define as revenues from a client who also contributed to our revenues during the prior year, our engagements with our clients are typically for projects that are singular in nature. In addition, our clients can terminate many of our master services agreements and work orders with or without cause, and in most cases without any cancellation charge. Therefore, we must seek to obtain new engagements when our current engagements are successfully completed or are terminated as well as maintain relationships with existing clients and secure new clients to expand our business.

 

There are a number of factors relating to our clients that are outside of our control which might lead them to terminate a contract or project with us, including:

 

financial difficulties for the client;

 

a change in strategic priorities, resulting in elimination of the impetus for the project or a reduced level of technology spending;

 

a change in outsourcing strategy resulting in moving more work to the client’s in-house technology departments or to our competitors;

 

the replacement by our clients of existing software with packaged software supported by licensors; and

 

mergers and acquisitions or significant corporate restructurings.

 

Failure to perform or observe any contractual obligations could result in cancellation or non-renewal of a contract, which could cause us to experience a higher than expected number of unassigned employees and an increase in our cost of revenues as a percentage of revenues, until we are able to reduce or reallocate our headcount. The ability of our clients to terminate agreements makes our future revenues uncertain. We may not be able to replace any client that elects to terminate or not renew its contract with us, which could materially adversely affect our revenues and thus our results of operations.

 

In addition, some of our agreements specify that if a change of control of our company occurs during the term of the agreement, the client has the right to terminate the agreement. If any future event triggers any change-of- control provision in our client contracts, these master services agreements may be terminated, which would result in loss of revenues.

 

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Failure to successfully deliver contracted services or causing disruptions to clients’ businesses may have a material adverse effect on our reputation, business, financial condition, and results of operations.

 

Our business is dependent on our ability to successfully deliver contracted services in a timely manner. Any partial or complete failure of our equipment or systems, or any major disruption to basic infrastructure like power and telecommunications in the locations in which we operate, could impede our ability to provide contracted services to our clients. In addition, if our professionals make errors in the course of delivering services to our clients or fail to consistently meet the service requirements of a client, these errors or failures could disrupt the client’s business. Any failure to successfully deliver contracted services or causing disruptions to a client’s business, including the occurrence of any failure in a client’s system or breach of security relating to the services provided by us, may expose us to substantial liabilities and have a material adverse effect on our reputation, business, financial condition and results of operations.

 

Additionally, our clients may perform audits or require us to perform audits and provide audit reports with respect to the IT and financial controls and procedures that we use in the performance of services for our clients. Our ability to acquire new clients and retain existing clients may be adversely affected and our reputation could be harmed if we receive a qualified opinion, or if we cannot obtain an unqualified opinion in a timely manner, with respect to our controls and procedures in connection with any such audit. We could also incur liability if our controls and procedures, or the controls and procedures we manage for a client, were to result in an internal control failure or impair our client’s ability to comply with its own internal control requirements. If we or our partners fail to meet our contractual obligations or otherwise breach obligations to our clients, we could be subject to legal liability, which may have a material and adverse effect on our reputation, business, financial condition, and results of operations.

 

We rely on software, hardware and SaaS technologies from third parties that may be difficult to replace or that may cause errors or defects in, or failures of, our services or solutions.

 

We rely on software and hardware from various third parties as well as hosted Software as a Service ("SaaS") applications from third parties to deliver our services and solutions. If any of these software, hardware or SaaS applications become unavailable due to loss of license, extended outages, interruptions, or because they are no longer available on commercially reasonable terms, there may be delays in the provisioning of our services until equivalent technology is either developed by us, or, if available, is identified, obtained and integrated, which could increase our expenses or otherwise harm our business. Furthermore, any errors or defects in or failures of third-party software, hardware or SaaS applications could result in errors or defects in or failures of our services and solutions, which could be costly to correct and have an adverse effect on our reputation, business, financial condition and results of operations.

 

Existing insurance coverage and limitation of liability provisions in service contracts may be inadequate to protect us against losses.

 

We maintain certain insurance coverage, including professional liability insurance, director and officer insurance, property insurance for certain of our facilities and equipment, and business interruption insurance for certain of our operations. However, we do not insure for all risks in our operations and if any claims for injury are brought against us, or if we experience any business disruption, litigation or natural disaster, we might incur substantial costs and diversion of resources.

 

Most of the agreements we have entered into with our clients require us to purchase and maintain specified insurance coverage during the terms of the agreements, including commercial general insurance or public liability insurance, umbrella insurance, product liability insurance, and workers’ compensation insurance. Some of these types of insurance are not available on reasonable terms or at all in some countries in which we operate.

 

Our liability for breach of our obligations is in some cases limited under client contracts. Such limitations may be unenforceable or otherwise may not protect us from liability for damages. In addition, our existing contracts may not limit certain liabilities, such as claims of third parties for which we may be required to indemnify our clients. The successful assertion of one or more large claims against us in amounts greater than those covered by our current insurance policies could materially adversely affect our business, financial condition and results of operations. Even if such assertions against us are unsuccessful, we may incur reputational harm and substantial legal fees.

 

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If we are not able to maintain an effective system of internal control over financial reporting, current and potential investors could lose confidence in our financial reporting, which could harm our business and have an adverse effect on our stock price. Management identified a material weakness in our internal controls over financial reporting in 2019 and although this material weakness has since been remediated, we cannot provide assurances that additional material weaknesses, or significant deficiencies, will not occur in the future.

 

Any failure to maintain effective internal controls over our financial reporting could materially and adversely affect us. Section 404 of the Sarbanes-Oxley Act requires us to include in our annual reports on Form 10-K an assessment by management of the effectiveness of our internal controls over financial reporting. In addition, we will be required to have our independent public accounting firm attest to and report on management’s assessment of the effectiveness of our internal control over financial reporting when we cease qualifying as an “emerging growth company” pursuant to the JOBS Act. If we are unable to conclude that we have effective internal control over financial reporting or, if our independent auditors are unable to provide us with an attestation and an unqualified report as to the effectiveness of our internal control over financial reporting, investors could lose confidence in the reliability of our financial statements, which could result in a decrease in the value of our securities.

 

In 2019, management identified a material weakness in our internal control over financial reporting. A material weakness is defined as a deficiency, or a combination of deficiencies, in internal control over financial reporting, such that there is a reasonable possibility that a material misstatement of our financial statements will not be prevented or detected on a timely basis. Subsequent to the original issuance of the private company financial statements for the year ended December 31, 2018, we identified balances that were accounted for or presented incorrectly under GAAP relating to stock-based compensation and the presentation of retention bonuses and depreciation on the consolidated statement of income and comprehensive income.

 

The material weakness identified was a lack of sufficient resources with appropriate depth and experience to interpret complex accounting guidance and prepare financial statements and related disclosures in accordance with GAAP.

 

We have taken steps to enhance our internal control environment, including hiring a new Chief Financial Officer in December 2019, hiring a Global Controller in May 2020, and hiring additional qualified accounting and financial reporting personnel. Additionally, our new enterprise resource planning system, which has been implemented in phases since January 2020, has enhanced our internal controls over financial reporting. Given a combination of increased personnel, greater automation with software systems, and implementation of more detailed processes and procedures over the course of the year ended December 31, 2020, management considers this material weakness to have been remediated as of December 31, 2020.

 

If additional material weaknesses, or significant deficiencies, in internal controls are discovered in the future, they may adversely affect our ability to record, process, summarize and report financial information in a timely and accurate manner and, as a result, our financial statements may contain material misstatements or omissions.

 

Our global business, especially in CIS and CEE countries, exposes us to significant legal, economic, tax and political risks.

 

We have significant operations in certain emerging market economies, which creates legal, economic, tax and political risks. Risks inherent in conducting international operations include:

 

less established legal systems and legal ambiguities, inconsistencies and anomalies;

 

changes in laws and regulations;

 

application and imposition of protective legislation and regulations relating to import or export, including tariffs, quotas and other trade protection measures;

 

difficulties in enforcing intellectual property and/or contractual rights;

 

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bureaucratic obstacles and corruption;

 

compliance with a wide variety of foreign laws, including those relating to privacy and data protection;

 

restrictions on the repatriation of dividends or profits;

 

expropriation or nationalization of property;

 

restrictions on currency convertibility and exchange controls;

 

fluctuations in currency exchange rates;

 

potentially adverse tax consequences;

 

competition from companies with more experience in a particular country or with international operations;

 

civil strife;

 

unstable political and military situations; and

 

overall foreign policy and variability of foreign economic conditions, including the effects of the COVID-19 pandemic.

 

The legal systems of Russia, Ukraine, Poland and Serbia, where we have significant operations, as well as Moldova, where we have acquired operations through the Tacit acquisition completed on May 29, 2021, are often beset by legal ambiguities as well as inconsistencies and anomalies due to the relatively recent enactment of many laws that may not always coincide with market developments. Furthermore, legal and bureaucratic obstacles and corruption exist to varying degrees in each of these countries. In such environments, our competitors may receive preferential treatment from governments, potentially giving them a competitive advantage. Governments may also revise existing contract rules and regulations or adopt new ones at any time and for any reason, and government officials may apply contradictory or ambiguous laws or regulations in ways that could materially adversely affect our business and operations in such countries. Any of these changes could impair our ability to obtain new contracts or renew or enforce contracts under which we currently provide services or to which we are a party. Any new contracting methods could be costly or administratively difficult for us to implement, which could materially adversely affect our business and operations. We cannot guarantee that regulators, judicial authorities or third parties in Russia, Ukraine, Poland and Serbia will not challenge our (including our subsidiaries’) compliance with applicable laws, decrees and regulations. In addition to the foregoing, selective or arbitrary government actions may include withdrawal of licenses, sudden and unexpected tax audits, criminal prosecutions and civil actions, all of which could have a material adverse effect on our business, financial condition and results of operations.

 

The banking and other financial systems in certain Commonwealth of Independent States (“CIS”) and CEE countries where we operate remain subject to periodic instability and generally do not meet the banking standards of more developed markets. A financial crisis or the bankruptcy or insolvency of banks through which we receive, or with which we hold, funds may result in the loss of our deposits or adversely affect our ability to complete banking transactions in that region, which could materially adversely affect our business and financial condition.

 

Furthermore, existing tensions and the emergence of new or escalated tensions in CIS and CEE countries could further exacerbate tensions between such countries and the U.S. Such tensions, concerns regarding information security, and potential imposition of additional sanctions by the U.S. and other countries may discourage existing or prospective clients to engage our services, have a negative effect on our ability to develop or maintain our operations in the countries where we currently operate, and disrupt our ability to attract, hire and retain employees. The occurrence of any such event may have a material adverse effect on our business, financial condition and results of operations.

 

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As a result of our acquisition of Tacit on May 29, 2021, we have acquired operations in Guadalajara, Mexico. The laws and regulations in Mexico to which we have become subject thereby, and interpretations thereof, may change, sometimes substantially, as a result of a variety of factors beyond our control, including political, economic, regulatory or social events. As a result of amendments in May 2019 to the Mexican Federal Labor Law (Ley Federal del Trabajo) and other related regulations, among other things, new labor authorities and courts were created, new bargaining procedures were implemented and provisions related to employees’ freedom of association and organization, collective bargaining agreements, and rules against labor discrimination were issued or amended. We cannot assure you that these changes will not lead to an increase in litigation, labor activism or increasingly contentious labor relations, which in turn may adversely affect our business, financial condition, results of operations and prospects, particularly in Mexico. These and any other policies, laws and regulations which are further adopted could result in a deterioration of investment sentiment, political and economic uncertainty, and increased costs for our business, which may in turn have a material adverse effect on our business, financial condition, liquidity and results of operations.

 

The extent to which the COVID-19 pandemic continues to impact our results will depend on future developments, which are highly uncertain and cannot be predicted, including the duration of the pandemic, travel restrictions and social distancing in the CIS and CEE countries, the U.S. and other countries, business closures or business disruptions and the effectiveness of actions taken by governments and private businesses to attempt to contain and treat the disease. Any prolonged shut down of a significant portion of global economic activity or downturn in the global economy, along with any adverse effects on industries in which our customers operate, could materially and adversely impact our business, results of operations and financial condition.

 

Our results of operations and financial condition could be materially affected by the enactment of legislation implementing changes in the U.S. taxation of international business activities or the adoption of other tax reform policies.

 

On April 7, 2021, the U.S. Department of the Treasury released the Made in America tax plan. The document describes President Biden’s proposals for U.S. tax reform, which include raising the U.S. federal corporate income tax from 21% to 28% and replacing the Base Erosion and Anti-Abuse Tax with SHIELD (Stopping Harmful Inversions and Ending Low-tax Developments), a regime for preventing foreign corporations from shifting profits to lower-taxed jurisdictions. If enacted, these and other proposed changes could have an adverse impact on our business, results of operations, financial condition and cash flow.

 

The tax rates and rules applicable to our stockholders could be materially affected by the enactment of legislation implementing changes in U.S. tax law.

 

There have been reports that President Biden’s tax reform proposals may include increases to the tax rates applicable to individuals, including the long-term capital gains rate for individuals whose gross income exceeds certain limits. If these or other proposals are enacted, the tax consequences to U.S. Holders (as defined below) of owning and disposing of our common shares may differ from those discussed below in “Material U.S. Federal Income and Estate Tax Consequences for Non-U.S. Holders of Common Stock.” Potential Investors are urged to consult their own tax advisors on the potential impact of U.S. tax reform to an investment in our common shares.

 

Our effective tax rate could be adversely affected by several factors.

 

We conduct business globally and file income tax returns in multiple jurisdictions. Our effective tax rate could be materially adversely affected by several factors, including changes in the amount of income taxed by, or allocated to, the various jurisdictions in which we operate that have differing statutory tax rates; changing tax laws, regulations and interpretations of such tax laws in multiple jurisdictions; and the resolution of issues arising from tax audits or examinations and any related interest or penalties. In particular, there have been significant changes to the taxation systems in CEE countries in recent years as the authorities have gradually replaced or introduced new legislation regulating the application of major taxes such as corporate income tax, value-added tax, corporate property tax, personal income taxes and payroll taxes. Furthermore, any significant changes to the Tax Cuts and Jobs Act (“U.S. Tax Act”) enacted in 2017, or to regulatory guidance associated with the U.S. Tax Act, could materially adversely affect our effective tax rate.

 

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The determination of our provision for income taxes and other tax liabilities requires estimation, judgment and calculations where the ultimate tax determination may not be certain. Our determination of tax liability is always subject to review or examination by authorities in various jurisdictions. If a tax authority in any jurisdiction reviews any of our tax returns and proposes an adjustment, including a determination that the transfer prices and terms we have applied are not appropriate, such an adjustment could have an adverse effect on our business, financial condition and results of operations.

 

We are unable to predict what tax reforms may be proposed or enacted in the future or what effect such changes would have on our business, but such changes, to the extent they are brought into tax legislation, regulations, policies or practices in jurisdictions in which we operate, could increase the estimated tax liability that we have expensed to date and paid or accrued on our balance sheets, and otherwise affect our financial position, future results of operations, cash flows in a particular period and overall or effective tax rates in the future in countries where we have operations, reduce post-tax returns to our stockholders and increase the complexity, burden and cost of tax compliance.

 

There may be adverse tax and employment law consequences if the independent contractor status of some of our personnel or the exempt status of our employees is successfully challenged.

 

Certain of our personnel are retained as independent contractors. The criteria to determine whether an individual is considered an independent contractor or an employee are typically fact intensive and vary by jurisdiction, as can the interpretation of the applicable laws. If a government authority or court makes any adverse determination with respect to some or all of our independent contractors, we could incur significant costs, including for prior periods, in respect of tax withholding, social security taxes or payments, workers’ compensation and unemployment contributions, and recordkeeping, or we may be required to modify our business model, any of which could materially adversely affect our business, financial condition and results of operations.

 

Global mobility of employees may potentially create additional tax liabilities for us in different jurisdictions.

 

In performing services to clients, our employees may be required to travel to various locations. Depending on the length of the required travel and the nature of employees’ activities the tax implications of travel arrangements vary, with generally more extensive tax consequences in cases of longer travel. Such tax consequences mainly include payroll tax liabilities related to employee compensation and, in cases envisaged by international tax legislation, taxation of profits generated by employees during their time of travel.

 

We have internal procedures, policies and systems, including an internal mobility program, for monitoring our tax liabilities arising in connection with the business travel. However, considering that the tax authorities worldwide are paying closer attention to global mobility issues, our operations may be adversely affected by additional tax charges related to the activity of our mobile employees.

 

Loss of taxation benefits related to our employment-related taxes that are enjoyed in Russia could have a negative impact on our operating results and profitability.

 

The Russian government provides qualified Russian IT companies with substantial tax benefits through a reduced social contribution charge rate program. This program resulted in savings for us of approximately $1.8 million in the fiscal year ended December 31, 2020 and approximately $2.3 million in the fiscal year ended December 31, 2019. However, the reduced tax rates for social contributions (16% in total) are a temporary measure. In 2016, application of reduced rates was prolonged until 2023, after which the Russian government may take the decision to gradually increase the tax rates. If the Russian government were to change its favorable treatment of Russian IT companies by modifying or repealing its current favorable tax measures, or if we become ineligible for such favorable treatment, it would significantly impact our financial condition and results of operations.

 

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Tax authorities may disagree with our positions and conclusions regarding certain tax positions, or may apply existing rules in an arbitrary or unforeseen manner, resulting in unanticipated costs, taxes or non-realization of expected benefits.

 

A tax authority may disagree with tax positions that we have taken, which could result in increased tax liabilities. For example, a tax authority could challenge our allocation of income by tax jurisdiction and the amounts paid between our affiliated companies pursuant to our intercompany arrangements and transfer pricing policies, including methodologies for valuing developed technology and amounts paid with respect to our intellectual property development.

 

A tax authority may take the position that material income tax liabilities, interest and penalties are payable by us, where there has been a technical violation of contradictory laws and regulations that are relatively new and have not been subject to extensive review or interpretation, in which case we expect that we might contest such assessment. High-profile companies can be particularly vulnerable to aggressive application of unclear requirements. Many companies must negotiate their tax bills with tax inspectors who may demand higher taxes than applicable law appears to provide. Contesting such an assessment may be lengthy and costly and if we were unsuccessful in disputing the assessment, the implications could increase our anticipated effective tax rate, where applicable.

 

Our business, financial condition and results of operations may be adversely affected by fluctuations in foreign currency exchange rates.

 

Grid Dynamics is exposed to foreign currency exchange rate risk and its profit margins are subject to volatility between periods due to changes in foreign currency exchange rates relative to the U.S. dollar. Grid Dynamics’ functional currency apart from the U.S. dollar includes EURO, British pounds, Mexican pesos and Moldovan leu. We are exposed to foreign currency exchange transaction risk related to funding our non-U.S. operations and to foreign currency translation risk related to certain of our subsidiaries’ cash balances that are denominated in currencies other than the U.S. dollar as we do not currently hedge our foreign currency exposure. In addition, our profit margins are subject to volatility as a result of changes in foreign exchange rates. In the three and six months ended June 30, 2021, approximately 25.3%, 11.9% and 7.4% of Grid Dynamics’ $46.3 million and approximately 25.3%, 11.4% and 7.6% of Grid Dynamics’ $87.2 million of combined cost of revenue and total operating expenses were denominated in the Ukrainian hryvnia, Russian ruble, and Polish zloty, respectively. Comparatively, the same foreign currencies accounted for approximately 9.9%, 12.6% and 10.6% of Grid Dynamics’ $25.6 million and 10.7%, 15.6%, and 10.0% of Grid Dynamics’ $65.0 million of combined cost of revenue and total operating expenses in the three and six months ended June 30, 2020. Any significant fluctuations in currency exchange rates may have a material impact on our business and results of operations. In some countries, we may be subject to regulatory or practical restrictions on the movement of cash and the exchange of foreign currencies, which would limit our ability to use cash across our global operations and increase our exposure to currency fluctuations. This risk could increase as we continue expanding our global operations, which may include entering emerging markets that may be more likely to impose these types of restrictions. Currency exchange volatility caused by political or economic instability or other factors, could also materially impact our results. See the section titled, “Quantitative and Qualitative Disclosures about Market Risk—Foreign Currency Exchange Rate Risk” in our most recent annual report on Form 10-K and this quarterly report on Form 10-Q for more information about our exposure to foreign currency exchange rates.

 

We may be exposed to liability for actions taken by its subsidiaries.

 

In certain cases, we may be jointly and severally liable for losses of our subsidiaries. Irrespective of incurring liability for losses of our subsidiaries, we may incur secondary liability and, in certain cases, liability to creditors for obligations of our subsidiaries in certain instances involving bankruptcy or insolvency.

 

In particular, under Article 53, Part 1 of the Russian Civil Code, a “controlling person” of a legal entity may be held directly liable for losses that the entity suffers because of his or her “fault,” and any agreement that seeks to limit or waive such liability will not be valid. Generally, a controlling person is anyone who holds the power to determine the entity’s actions, including the right to direct the actions of officers or executives. When a controlling person causes losses, officers and executives may all be held jointly and severally liable (a parent entity may also be held jointly liable with a subsidiary for actions directed by the parent or made with its consent). Liability may also apply to stockholders or controlling persons when the company is a foreign legal entity but conducts its business primarily in Russia.

 

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Further, an effective parent is secondarily liable for an effective subsidiary’s debts if the effective subsidiary becomes insolvent or bankrupt as a result of the action or inaction of the effective parent. Compensation for the effective subsidiary’s losses from the effective parent that caused the effective subsidiary to take action or fail to take action, knowing that such action or failure to take action would result in losses, may be claimed, inter alia, by the other stockholders of the effective subsidiary, the administrators and creditors in an insolvency proceeding. We could be found to be the effective parent of the subsidiaries, in which case we could become liable for their debts, which could have a material adverse effect on our business, financial condition and results of operations or prospects.

 

Our profitability may suffer if we are unable to maintain our resource utilization and productivity levels.

 

As most of our client projects are performed and invoiced on a time and materials basis, our management tracks and projects billable hours as an indicator of business volume and corresponding resource needs for IT professionals. To maintain our gross profit margins, we must effectively utilize our IT professionals, which depends on our ability to:

 

integrate and train new personnel;

 

efficiently transition personnel from completed projects to new assignments;

 

forecast customer demand for services; and

 

deploy personnel with appropriate skills and seniority to projects.

 

If we experience a slowdown or stoppage of work for any client, or on any project for which we have dedicated personnel or facilities, including any adverse impacts from the COVID-19 pandemic, which occurred in the second quarter, and to a lesser extent, in the third quarter of 2020, we may be unable to reallocate these personnel or assets to other clients and projects to keep their utilization and productivity levels high. If we are unable to maintain appropriate resource utilization levels, our profitability may suffer.

 

If we are unable to accurately estimate the cost of service or fail to maintain favorable pricing for our services, our contracts may be unprofitable.

 

While fixed-fee contracts currently represent an immaterial portion of overall revenue for the periods presented, Grid Dynamics expects proportionate revenue from fixed-fee contracts to increase in future periods. In order for our contracts to be profitable, we must be able to accurately estimate our costs to provide the services required by the applicable contract and appropriately price our contracts. Such estimates and pricing structures used by us for our contracts are highly dependent on internal forecasts, assumptions and predictions about our projects, the marketplace, global economic conditions (including foreign exchange volatility) and the coordination of operations and personnel in multiple locations with different skill sets and competencies. Due to the inherent uncertainties that are beyond our control, we may underprice our projects, fail to accurately estimate the costs of performing the work or fail to accurately assess the risks associated with potential contracts. In select cases, we also offer volume discounts once a client reaches certain contractual spend thresholds, which may lower the reference price for a client or result in a loss of profits if we do not accurately estimate the amount of discounts to be provided. We may not be able to recognize revenues from fixed-fee contracts in the period in which our services are performed, which may cause our margins to fluctuate. Any increased or unexpected costs, delays or failures to achieve anticipated cost savings, or unexpected risks we encounter in connection with the performance of our contracts, including those caused by factors outside our control, could make these contracts less profitable or unprofitable.

 

We face risks associated with the long selling and implementation cycle for our services that require significant resource commitments prior to realizing revenues for those services.

 

We have a long selling cycle for our services, which requires us to expend substantial time and resources to educate clients on the value of our services and our ability to meet their requirements. In certain cases, we may begin work and incur costs prior to executing a contract. Our selling cycle is subject to many risks and delays over which we have little or no control, including clients’ decisions to choose alternatives to our services (such as other IT services providers or in-house resources) and the timing of clients’ budget cycles and approval processes. Therefore, selling cycles for new clients can be especially unpredictable and we may fail to close sales with prospective clients to whom we have devoted significant time and resources. Any significant failure to generate revenues or delays in recognizing revenues after incurring costs related to sales processes could have a material adverse effect on our business, financial condition and results of operations.

 

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Failure to obtain engagements for and effectively manage increasingly large and complex projects may have an adverse effect on our business, financial condition and results of operations.

 

Our operating results are dependent on the scale of our projects and the prices we are able to charge for our services. In order to successfully perform larger and more complex projects, we need to establish and maintain effective, close relationships with our clients, continue high levels of client satisfaction and develop a thorough understanding of our clients’ needs. We may also face a number of challenges managing larger and more complex projects, including:

 

maintaining high quality control and process execution standards;

 

maintaining planned resource utilization rates on a consistent basis;

 

using an efficient mix of on-site, off-site and offshore staffing;

 

maintaining productivity levels;

 

implementing necessary process improvements;

 

recruiting and retaining sufficient numbers of highly skilled IT personnel; and

 

controlling costs.

 

There is no guarantee that we may be able to overcome such challenges. In addition, large and complex projects may involve multiple engagements or stages, and there is a risk that a client may choose not to retain us for additional stages or may cancel or delay additional planned engagements. Our failure to successfully obtain engagements for and effectively manage large and complex projects may have an adverse effect on our business, financial condition and results of operations.

 

Increases in compensation expenses, including stock-based compensation expenses, could lower our profitability, and dilute our existing stockholders.

 

Wages and other compensation costs in the countries in which we maintain significant operations and delivery centers are lower than comparable wage costs in more developed countries. However, wages in the technology industry in these countries may increase at a faster rate than in the past, which may make us less competitive unless we are able to increase the efficiency and productivity of our people. If we increase operations and hiring in more developed economies, our compensation expenses will increase because of the higher wages demanded by technology professionals in those markets. Wage inflation, whether driven by competition for talent or ordinary course pay increases, could increase our cost of services as well as selling, general and administrative expenses and reduce our profitability if we are not able to pass those costs on to our customers or charge premium prices when justified by market demand.

 

In addition, we have granted certain equity-based awards under our equity incentive plans and expect to continue doing so. For the three months ended June 30, 2021 and 2020, Grid Dynamics recorded $6.7 million and $3.7 million, respectively, of stock-based compensation expense related to the grant of equity-based awards. For the six months ended June 30, 2021 and 2020, Grid Dynamics recorded $12.3 million and $8.5 million, respectively, of stock-based compensation expense related to the grant of equity-based awards. If we do not grant equity awards, or if we reduce the value of equity awards we grant, we may not be able to attract, hire and retain key personnel. If we grant more equity awards to attract, hire and retain key personnel, the expenses associated with such additional equity awards could materially adversely affect our results of operations. If the anticipated value of these equity awards does not materialize because of volatility or lack of positive performance in our stock price, we may be unable to retain our key personnel or attract and retain new key employees in the future, in which case our business may be severely disrupted our ability to attract and retain personnel could be adversely affected. The issuance of equity-based compensation may also result in dilution to stockholders.

 

Failure to collect receivables from, or bill for unbilled services to, clients may have a material adverse effect on our results of operations and cash flows.

 

Our business depends on our ability to successfully obtain payment from our clients of the amounts they owe for work performed. We usually bill and collect such amounts on relatively short cycles and maintain allowances for doubtful accounts. However, actual losses on client balances could differ from those that we anticipate and, as a result, we might need to adjust our allowances.

 

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There is no guarantee that we will accurately assess the creditworthiness of our clients. If clients suffer financial difficulties, it could cause them to delay payments, request modifications to their payment arrangements that could increase our receivables balance, or default on their payment obligations.

 

In addition, some of our clients may delay payments due to changes in internal payment procedures driven by rules and regulations to which they are subject. Timely collection of client balances also depends on our ability to complete our contractual commitments and bill and collect contracted revenues. If we are unable to meet our contractual requirements, we may experience delays in collection of or inability to collect accounts receivable. If this occurs, our financial condition, results of operations and cash flows could be materially adversely affected.

 

We may need additional capital and failure to raise additional capital on terms favorable to us, or at all, could limit our ability to grow our business and develop or enhance our service offerings to respond to market demand or competitive challenges.

 

We may require additional cash resources due to changed business conditions or other future developments. If existing resources are insufficient to satisfy cash requirements, we may seek to sell additional equity or debt securities or obtain one or more credit facilities. The sale of additional equity securities could result in dilution to stockholders. The incurrence of indebtedness would result in increased debt service obligations and could require us to agree to operating and financing covenants that would restrict our operations. Our ability to obtain additional capital on acceptable terms is subject to a variety of uncertainties, including investors’ perception of, and demand for, securities of IT services companies, conditions in the capital markets in which we may seek to raise funds, our future results of operations and financial condition, and general economic and political conditions. Financing may not be available in amounts or on terms acceptable to us, or at all, which could limit our ability to grow our business and develop or enhance our service offerings to respond to market demand or competitive challenges.

 

War, terrorism, other acts of violence, or natural or manmade disasters may affect the markets in which we operate, our clients and our service delivery.

 

Our business may be adversely affected by instability, disruption or destruction in a geographic region in which we operate, regardless of cause, including war, terrorism, riot, civil insurrection or social unrest, and natural or manmade disasters, including famine, flood, fire, earthquake, storm or pandemic events and spread of disease, such as the COVID-19 pandemic. Such events may cause clients to delay their decisions on spending for the services provided by us and give rise to sudden significant changes in regional and global economic conditions and cycles. These events also pose significant risks to our personnel and to physical facilities and operations, which could materially adversely affect our financial results.

 

Acquisitions could be difficult to identify and integrate, divert the attention of management, disrupt our business, dilute stockholder value and adversely affect our financial condition and results of operations, we may not achieve the financial and strategic goals that were contemplated at the time of a transaction, and we may be exposed to claims, liabilities and disputes as a result of the transaction that may adversely impact our business, operating results and financial condition.

 

We continuously review and consider strategic acquisitions of businesses, products or technologies. We recently acquired Daxx Web Industries B.V., a Netherlands-based software development and technology consulting company, as well as Tacit, a global provider of digital commerce solutions, and we may in the future seek to acquire or invest in other businesses, products or technologies that we believe could complement or expand our services, enhance our technical capabilities or otherwise offer growth opportunities. The pursuit of potential acquisitions may divert the attention of management and cause us to incur various expenses in identifying, investigating and pursuing suitable acquisitions, whether or not the acquisition purchases are completed. Additionally, we may not be able to find and identify desirable acquisition targets or be successful in entering into an agreement with any particular target or obtain adequate financing to complete such acquisitions. If we acquire businesses, we may not be able to successfully integrate the acquired personnel, operations, and technologies, or effectively manage the combined business following the acquisition.

 

Additionally, we may not be able to find and identify desirable acquisition targets or be successful in entering into an agreement with any particular target or obtain adequate financing to complete such acquisitions. Acquisitions could also result in dilutive issuances of equity securities or the incurrence of debt, which could adversely affect our financial condition, cash flows and results of operations. In addition, if an acquired business fails to meet our expectations, we may not achieve the financial and strategic goals that were contemplated at the time of a transaction, and our business, financial condition and results of operations may be adversely affected. Furthermore, we may acquire businesses that have inferior margins and profitability levels in comparison to our existing business and this may dilute our overall profitability of the company. This, in turn, may result in adverse financial results and dilution to existing stockholders.

 

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Our operating results or financial condition may be adversely impacted by claims or liabilities that we assume from an acquired company or technology or other claims or liabilities otherwise related to an acquisition, including, among others, claims from governmental and regulatory agencies or bodies, terminated employees, current or former customers, current or former stockholders or other third parties, or arising from contingent payments related to the acquisition; pre-existing contractual relationships that we assume from an acquired company that we would not have otherwise entered into, the termination or modification of which may be costly or disruptive to our business; unfavorable revenue recognition or other accounting treatment as a result of an acquired company’s practices; and intellectual property claims or disputes. We may fail to identify or assess the magnitude of certain liabilities, shortcomings or other circumstances prior to acquiring a company or technology, which could result in unexpected litigation or regulatory exposure and other adverse effects on our business, operating results and financial condition.

 

We face risks associated with the transparency, quality, and reliability of financial information of a business we acquire.

 

Although we perform due diligence on a targeted business that we intend to acquire, we are exposed to risks associated with the quality and reliability of the financial statements of the acquired business. This risk may be higher with smaller businesses and businesses that are operated in jurisdictions and countries with poorer regulatory and compliance requirements. In such situation where we acquire a target with unreliable financial statements, we are exposed to material risks that may impact the reliability of our overall financial statements and may adversely impact our stock price.

 

We also cannot assure you that the diligence we conduct when evaluating future acquisitions will reveal all material issues that may be present, that it would be possible to uncover all material issues through a customary amount of due diligence, or that factors outside of our control will not later arise. Even if our due diligence successfully identifies certain risks, unexpected risks may arise and previously known risks may materialize in a manner not consistent with our preliminary risk analysis. Further, as a result of a completed acquisition, purchase accounting, and integration of the acquired business, we may be required to take write-offs or write-downs, restructuring and impairment or other charges that could negatively affect our business, assets, liabilities, prospects, outlook, financial condition and results of operations.

 

Some of the additional risks associated with acquiring a business include, but not limited to the following:

 

inability to integrate or benefit from acquired technologies or services;

 

product synergies, cost reductions, increases in revenue and economies of scale may not materialize as expected;

 

the business culture of the acquired entity may not match well with our culture;

 

unforeseen delays, unanticipated costs and liabilities may arise when integrating operations, processes and systems in geographies where we have not conducted business;

 

unanticipated costs or liabilities associated with the strategic transactions;

 

incurrence of transaction-related costs;

 

assumption of the existing obligations or unforeseen liabilities of the acquired business;

 

difficulty integrating the accounting systems, security infrastructure, operations, and personnel of the acquired business;

 

difficulties and additional expenses associated with supporting legacy products and hosting infrastructure of the acquired business;

 

difficulty converting the current and prospective customers of the acquired business onto our platform and contract terms, including disparities in the revenue, licensing, support, or professional services model of the acquired company;

 

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