EPAM Systems, Inc.: Form 10-Q for the period ended Mar 31, 2023

You should read the following discussion and analysis of our financial condition and results of operations together with our Annual Report on Form 10-K for the year ended December 31, 2022 and the unaudited condensed consolidated financial statements and the related notes included elsewhere in this quarterly report. In addition to historical information, this discussion contains forward-looking statements that involve risks, uncertainties and assumptions that could cause actual results to differ materially from management’s expectations. Factors that could cause such differences are discussed in the sections entitled “Forward-Looking Statements” in this item and in “Part I. Item 1A. Risk Factors” in our Annual Report on Form 10-K for the year ended December 31, 2022. We assume no obligation to update any of these forward-looking statements.

In this quarterly report, “EPAM,” “EPAM Systems, Inc.,” the “Company,” “we,” “us” and “our” refer to EPAM Systems, Inc. and its consolidated subsidiaries.

“EPAM” is a trademark of EPAM Systems, Inc. All other trademarks and service marks used herein are the property of their respective owners.

Executive Summary

We are a leading digital transformation services and product engineering company, providing digital platform engineering and software development services to many of the world’s leading organizations.

We deliver business and technology transformation from start to finish, leveraging agile methodologies, proven customer collaboration frameworks, engineering excellence tools, hybrid teams and our award-winning proprietary global delivery platform. We leverage our software engineering heritage with strategic business and innovation consulting, design thinking, and physical-digital capabilities to deliver real business value to our customers. Our customers depend on us to solve their complex technical challenges and rely on our expertise in core engineering, advanced technology, digital design and intelligent enterprise development. We focus on building long-term partnerships with our customers in a market that is constantly challenged by the pressures of digitization through our innovative strategy and scalable software solutions, integrated advisory, business consulting and experience design, and a continually evolving mix of advanced capabilities. Through increased specialization in focused verticals and a continued emphasis on strategic partnerships, we are leveraging our roots in software engineering to grow as a recognized brand in software development and end-to-end digital transformation services for our customers.

Our global delivery model and centralized support functions, combined with the benefits of scale from the shared use of fixed-cost resources, enhance our productivity levels and enable us to better manage the efficiency of our global operations. As a result, we have created a delivery base whereby our applications, tools, methodologies and infrastructure allow us to seamlessly deliver services and solutions from our delivery centers to global customers across all geographies. Our teams of developers, architects, consultants, strategists, engineers, designers, and product experts have the capabilities and skill sets to deliver business results.

Business Update Regarding the War in Ukraine

On February 24, 2022, Russian forces attacked Ukraine and its people and EPAM has repeatedly called for an immediate end to this unlawful and unconscionable attack. EPAM’s highest priority is the safety and security of its employees and their families in Ukraine as well as the broader region, and we have continued to support relocating our employees to lower risk locations, both in Ukraine and to other countries where we operate. The vast majority of our Ukraine employees are in safe locations and operating at levels of productivity consistent with those achieved prior to the attack. As of March 31, 2023, Ukraine remains the delivery location with the most delivery professionals. Furthermore, we have maintained our $100 million humanitarian aid commitment to our people in Ukraine in addition to our other donations and volunteer efforts.

Prior to the attack in February 2022, Russia was our third largest delivery location by the number of delivery professionals. In April 2022, the Company announced the beginning of a phased exit of our operations in Russia in close collaboration with our employees, contractors, and customers. We have discontinued services to certain customers located in Russia and on April 7, 2023, we amended and restated the agreement to sell substantially all of our remaining holdings in Russia to a third party. The completion of the sale is subject to customary closing conditions, including regulatory approvals by the Russian and U.S. governments. Subsequent to March 31, 2023, the required approvals from the Russian government were received to proceed with the sale.

The impact of the war on our operations, personnel, and physical assets in Ukraine has had, and, along with any escalation of the war that includes Belarus’ territory or military, could continue to have a material adverse effect on our operations. Actions taken by other countries, including new and stricter sanctions by Canada, the United Kingdom, the European Union, the U.S. and other companies and organizations against officials, individuals, regions, and industries in Russia and Belarus, and each of those country’s responses to such sanctions, including counter-sanctions and other actions, has had and could continue to have a material adverse effect on our operations. Customers have and may continue to seek altered terms, conditions, and delivery locations for the performance of services, delay planned work or seek services from alternate providers, or suspend, terminate, fail to renew, or reduce existing contracts or services, which could have a material adverse effect on our financial condition. Some of our customers have implemented steps to block internet communications with Russia, Ukraine, and Belarus to protect against potential cyberattacks or other information security threats, which has caused a material adverse effect on our ability to deliver our services to these customers from those locations. Such material adverse effects disrupt our delivery of services, cause us to shift all or portions of our work occurring in the region to other countries, restrict our ability to engage in certain projects in the region and serve certain customers in or from the region, and could negatively impact our personnel, operations, financial results and business outlook. Our Board of Directors continues its oversight of our strategic, geopolitical, and cybersecurity risks and the risks related to our geographic expansion. Our Board has received updates from management during both regular and special meetings, while also providing oversight of the risks associated with Russia’s invasion of Ukraine and other strategic areas of importance related to the war.

Moving Forward

We continue to execute our business continuity plans and adapt to developments as they occur to protect the safety of our people and address impacts to our delivery infrastructure, including reallocating work to other geographies within our global footprint. We have engaged both our personnel and our customers to meet their needs and to mitigate delivery challenges. EPAM continues to operate productively in more than 50 countries and provides consistent high-quality delivery to our customers. Our global delivery centers have sufficient resources, including infrastructure and capital, to support ongoing operations. We continue to rapidly respond to the difficult conditions in Ukraine while maintaining a focus on customers and long-term growth.

Implementation and execution of our business continuity plans, relocation costs, our humanitarian commitment to our people in Ukraine, and the cost of our phased exit from Russia have resulted in materially increased expenses during 2022 and in the first three months of 2023. We expect some of those expenses will continue to occur in subsequent quarters for some time in the future. In addition to the charges recorded during 2022 related to our exit from Russia, based on the information available through the date of issuance of the financial statements, we expect to record a loss upon the earlier of classification of the assets and liabilities to be sold as held for sale or closing of a sale, and such loss is not expected to be material based on the information available through the date of issuance of these financial statements. Fluctuations in foreign currency exchange rates could impact the gain or loss the Company could recognize in the future. If unable to complete a sale, the Company could recognize other charges including restructuring costs.

We have no way to predict the progress or outcome of the attack against Ukraine because the conflict and government reactions change quickly and are beyond our control. Prolonged military activities, broad-based sanctions and counter-sanctions, or escalation of the war that includes Belarus’ territory or military could have a material adverse effect on our operations and financial condition. The information contained in this section is accurate as of the date hereof but may become outdated due to changing circumstances beyond our control or present awareness. For additional information on the various risks posed by the attack against Ukraine and the impact in the region as well as other disruptors to our business, please read “Part I. Item 1A. Risk Factors” in our Annual Report on Form 10-K for the year ended December 31, 2022 and “Part II. Item 1A. Risk Factors” in this quarterly report.

Year-to-Date 2023 Developments and Trends

Our business was disrupted by the war in Ukraine that began in the latter part of the first quarter of 2022 and continued to create uncertainties through the quarter ended March 31, 2023 and beyond. In addition, our business and operating results were negatively impacted in the first quarter of 2023 by reduced demand for our services as our customers took action to reduce spending in light of the anticipated global slowdown in demand. For the first three months of 2023, our revenues were $1.211 billion, an increase of 3.4% over $1.172 billion reported for the same period of 2022. Income from operations as a percentage of revenues decreased to 9.9% for the three months ended March 31, 2023 as compared to 11.0% for the three months ended March 31, 2022, largely driven by lower utilization due to the slowdown in global demand and some year-over-year compression in account margins.

Critical Accounting Policies

The discussion and analysis of our financial position and results of operations is based on our unaudited condensed consolidated financial statements which have been prepared in accordance with U.S. GAAP. The preparation of these condensed consolidated financial statements in accordance with U.S. GAAP requires us to make estimates and judgments that may affect the reported amounts of assets, liabilities, revenues and expenses, and related disclosure of contingent assets and liabilities. On a recurring basis, we evaluate our estimates and judgments, including those related to revenue recognition and related allowances, impairments of long-lived assets including intangible assets, goodwill and right-of-use assets, income taxes including the valuation allowance for deferred tax assets, and stock-based compensation. Actual results may differ materially from these estimates under different assumptions and conditions. In addition, our reported financial condition and results of operations could vary due to a change in the application of a particular accounting standard.

During the three months ended March 31, 2023, there have been no material changes to our critical accounting policies as reported in our Annual Report on Form 10-K for the year ended December 31, 2022.

Results of Operations

The following table sets forth a summary of our consolidated results of operations for the periods indicated. This information should be read together with our unaudited condensed consolidated financial statements and related notes included elsewhere in this quarterly report. The operating results in any period are not necessarily indicative of the results that may be expected for any future period.

(in thousands, except percentages and per share data)

(1) Includes $16,011 of stock-based compensation expense and $424 of stock-based compensation benefit for the three months ended March 31, 2023 and 2022, respectively.

(2) Includes $22,568 and $7,536 of stock-based compensation expense for the three months ended March 31, 2023 and 2022, respectively.

Consolidated Results Review

Revenues

During the three months ended March 31, 2023, our total revenues grew to $1.211 billion or 3.4% compared to the corresponding period in 2022. Revenues have been negatively impacted by our decision to exit Russia and discontinue services to customers there, and fluctuations in foreign currency exchange rates which decreased our revenue growth by 1.5% during the three months ended March 31, 2023 as compared to the same period last year.

Revenues by customer location for the three months ended March 31, 2023 and 2022 were as follows:

(in thousands, except percentages)

(1) Americas includes revenues from customers in North, Central and South America.

(2) EMEA includes revenues from customers in Western Europe and the Middle East.

(3) APAC includes revenues from customers in East Asia, Southeast Asia and Australia.

(4) CEE includes revenues from customers in Russia, Belarus, Kazakhstan, Ukraine, Uzbekistan and Georgia.

During the three months ended March 31, 2023, the United States continued to be our largest customer location, with revenues increasing 3.4% to $679.4 million during the first quarter of 2023 from $657.0 million in the first quarter of 2022.

The top three revenue contributing customer location countries in EMEA were the United Kingdom, Switzerland and the Netherlands, generating $155.3 million, $89.9 million and $59.1 million in revenues, respectively, during the three months ended March 31, 2023. Revenues from customers in these three countries were $153.2 million, $81.8 million, and $50.2 million, respectively, in the corresponding period last year. Revenues in the EMEA region were negatively impacted by the weakening of the euro and the British pound relative to the U.S. dollar during the three months ended March 31, 2023 as compared to the same period in the previous year. Revenues in the region during the three months ended March 31, 2023 benefited from acquisitions which contributed $1.4 million to revenue growth.

During the three months ended March 31, 2023, revenues from customers in the APAC region decreased by $2.8 million, or 9.4% compared to the corresponding period of 2022, mainly due to decline in the Financial Services vertical.

During the three months ended March 31, 2023, revenues in the CEE geography experienced a decrease of $22.9 million as compared to the corresponding period of 2022. Revenues in the region during the three months ended March 31, 2023 included $5.9 million of revenues from customers in Russia. On March 4, 2022, we announced that we will discontinue our services to customers located in Russia and have been providing transition support for customers in this market while administering the transition. On April 7, 2023, we amended and restated the agreement to sell substantially all of our remaining holdings in Russia to a third party. The completion of the sale is subject to customary closing conditions, including regulatory approvals by the Russian and U.S. governments. Subsequent to March 31, 2023, the required approvals from the Russian government were received to proceed with the sale. As a result of this agreement, the revenues from this geography are expected to decline in the future.

Cost of Revenues (Exclusive of Depreciation and Amortization)

The principal components of our cost of revenues (exclusive of depreciation and amortization) are salaries, bonuses, fringe benefits, stock-based compensation, project-related travel costs and fees for subcontractors who are assigned to customer projects. Salaries and other compensation expenses of our delivery professionals are reported as cost of revenues regardless of whether the employees are actually performing customer services during a given period. Our employees are a critical asset, necessary for our continued success and, therefore, we are continuously exploring new geographies, markets, and sources to locate talented personnel and present them with competitive compensation programs and educational opportunities.

During the three months ended March 31, 2023, cost of revenues (exclusive of depreciation and amortization) was $855.9 million representing an increase of 9.6% from $780.8 million in the corresponding period of 2022. The increase was primarily due to higher compensation and benefits costs, attributable to salary increases and promotions for existing delivery professionals as well as due to the relocation of employees to higher cost geographies, $16.4 million of higher stock-based compensation expenses, and $4.8 million of higher expenses for unbilled business continuity resources, partially offset by $16.7 million of reduced costs associated with our humanitarian efforts in Ukraine during the three months ended March 31, 2023 as compared to the same period in 2022. Additionally, during the three months ended March 31, 2022, we reversed $21.4 million of previously accrued discretionary compensation expenses.

Expressed as a percentage of revenues, cost of revenues (exclusive of depreciation and amortization) was 70.7% and 66.6% in the first quarter of 2023 and 2022, respectively. The year-over-year increase in the first quarter of 2023 as compared to the corresponding period of the prior year is primarily due to lower utilization attributable to uneven demand for our services.

Selling, General and Administrative Expenses

Selling, general and administrative expenses represent expenditures associated with promoting and selling our services and general and administrative functions of our business. These expenses include the costs of salaries, bonuses, fringe benefits, stock-based compensation, severance, bad debt, travel, legal and accounting services, insurance, facilities including operating leases, advertising, and other promotional activities. Additionally, selling, general and administrative expenses contain costs of relocating our employees and various one-time and unusual expenses such as impairment charges.

During the three months ended March 31, 2023, selling, general and administrative expenses were $211.9 million representing a 10.7% decrease as compared to $237.3 million in the corresponding period of 2022. The decrease in selling, general and administrative expenses was largely driven by an $18.5 million decrease in expenses associated with the geographic repositioning of our workforce and a $2.9 million decrease in expenses associated with our humanitarian efforts in Ukraine, partially offset by a $15.0 million increase in stock-based compensation expenses and $9.5 million of severance expenses recorded in the first quarter of 2023. Additionally, the three months ended March 31, 2022 were impacted by the recognition of $19.6 million of impairment charges related to our long-lived assets in Russia and $8.4 million of bad debt expense attributable to customers located in Russia.

Expressed as a percentage of revenues, selling, general and administrative expenses decreased by 2.8% to 17.5% for the three months ended March 31, 2023 as compared to the same period from the prior year, primarily driven by a reduction in impairment charges, expenses associated with our geographic repositioning of our workforce, and bad debt expense.

Depreciation and Amortization Expense

During the three months ended March 31, 2023, depreciation and amortization expense was $22.8 million, as compared to $24.3 million in the corresponding period last year. The decrease in depreciation and amortization expense is primarily the result of lower depreciation on leasehold improvements and desktop hardware driven by our phased exit from our operations in Russia, partially offset by increased depreciation on software licenses during the three months ended March 31, 2023, as compared to the corresponding period last year. Expressed as a percentage of revenues, depreciation and amortization expense decreased to 1.9% during the three months ended March 31, 2023, as compared to 2.1% in the corresponding period of 2022.

Interest and Other Income/(Loss), Net

Interest and other income/(loss), net includes interest earned on cash and cash equivalents and short-term investments, gains and losses from certain financial instruments, interest expense related to our borrowings, government grant income, and changes in the fair value of contingent consideration. Interest and other income/(loss), net increased from a $0.2 million loss during the three months ended March 31, 2022, to a gain of $11.5 million during the three months ended March 31, 2023. This increase was largely driven by an $8.6 million increase in interest income earned from our cash and cash equivalents and short-term investments, a $3.1 million decrease in loss due to the change in fair value of contingent consideration, and a $2.0 million increase in government grant income.

Foreign Exchange Loss

For discussion of the impact of foreign exchange fluctuations see “Item 3. Quantitative and Qualitative Disclosures About Market Risk.”

Provision for Income Taxes

In determining its interim provision for income taxes, the Company uses an estimated annual effective tax rate, which is based on expected annual profit before tax, statutory tax rates and tax planning opportunities available in the various jurisdictions in which the Company operates. Certain significant or unusual items are separately recognized in the quarter in which they occur and can be a source of variability in the effective tax rates from quarter to quarter.

During the first quarter of 2022, the Company recorded its interim tax provision using the discrete method rather than using an estimated annual effective tax rate. The discrete method treats the year-to-date period as if it were the annual period and determines the income tax expense or benefit on that basis. The discrete method is applied when the application of the estimated annual effective tax rate is impractical because it is not possible to reliably estimate the annual effective tax rate. During the second, third and fourth quarters of 2022, the Company used an estimated annual effective tax rate. The change did not have a material impact on the condensed consolidated interim financial statements.

Determining the consolidated provision for income tax expense, deferred income tax assets and liabilities and any potential related valuation allowances involves judgment. We consider factors that may contribute, favorably or unfavorably, to the overall effective tax rate in the current year as well as the future. These factors include statutory tax rates and tax law changes in the countries where we operate and excess tax benefits upon vesting or exercise of equity awards as well as consideration of any significant or unusual items.

Our effective tax rate was 19.6% and 15.6% for the three months ended March 31, 2023 and 2022, respectively. The increase in the effective tax rate in the three months ended March 31, 2023, as compared to the corresponding period in the prior year, is primarily attributable to lower excess tax benefits recorded upon vesting or exercise of stock-based awards as a percentage of pre-tax income in the current period, partially offset by the impact of the Company’s election in the current period to disregard certain foreign subsidiaries of the Company as separate entities for U.S. tax purposes as well as the impact of a change in certain tax regulations in the corresponding period in the prior year. Our provision for income taxes was impacted by excess tax benefits recorded upon vesting or exercise of stock-based awards of $6.0 million and $13.1 million during the three months ended March 31, 2023 and 2022, respectively.

Results by Business Segment

Our operations consist of three reportable segments: North America, Europe, and Russia. The segments represent components of EPAM for which separate financial information is available and used on a regular basis by our chief executive officer, who is also our chief operating decision maker (“CODM”), to determine how to allocate resources and evaluate performance. Our CODM makes business decisions based on segment revenues and operating profit. Segment operating profit is defined as income from operations before unallocated costs. Expenses included in segment operating profit consist principally of direct selling and delivery costs as well as an allocation of certain shared services expenses. Certain corporate expenses are not allocated to specific segments as these expenses are not controllable at the segment level. Such expenses include certain types of professional fees, certain taxes included in operating expenses, compensation to non-employee directors and certain other general and administrative expenses, including compensation of specific groups of non-production employees. In addition, the Company does not allocate stock-based compensation, amortization of intangible assets acquired through business combinations, goodwill and other asset impairment charges, acquisition-related costs and certain other one-time charges and benefits. These unallocated amounts are combined with total segment operating profit to arrive at consolidated income from operations.

We manage our business primarily based on the managerial responsibility for its client base and market. As managerial responsibility for a particular customer relationship generally correlates with the customer’s geographic location, there is a high degree of similarity between customer locations and the geographic boundaries of our reportable segments. In some cases, managerial responsibility for a particular customer is assigned to a management team in another region and is usually based on the strength of the relationship between customer executives and particular members of EPAM’s senior management team. In such cases, the customer’s activity would be reported through the management team’s reportable segment.

On March 4, 2022, we announced that we will discontinue our services to customers located in Russia while staying committed to providing transition support for customers in this market and in April 2022 began the process of a phased exit of our operations in Russia. On April 7, 2023, we amended and restated the agreement to sell substantially all of our remaining holdings in Russia to a third party. The completion of the sale is subject to customary closing conditions, including regulatory approvals by the Russian and U.S. governments. Subsequent to March 31, 2023, the required approvals from the Russian government were received to proceed with the sale.

Segment revenues from external customers and segment operating profit, before unallocated expenses, for the North America, Europe and Russia reportable segments for the three months ended March 31, 2023 and 2022 were as follows:

(in thousands)

North America Segment

During the three months ended March 31, 2023, revenues for the North America segment increased $22.2 million, or 3.2%, compared to the same period last year and segment operating profit decreased $3.9 million, or 3.1%, compared to the same period last year. During the three months ended March 31, 2023, revenues from our North America segment were 58.6% of total segment revenues, a decrease from 58.7% reported in the corresponding period of 2022. The North America segment’s operating profit margin decreased to 17.3% during the first quarter of 2023 from 18.4% in the first quarter of 2022. This decrease is primarily attributable to increased personnel-related costs in part attributable to supplementing delivery resources on certain projects with standby resources able to support projects if delivery resources impacted by the invasion of Ukraine become unable to work and lower utilization during the first quarter of 2023 compared to the first quarter of 2022.

The following table presents North America segment revenues by industry vertical for the periods indicated:

(in thousands, except percentages)

34

During the three months ended March 31, 2023 compared to the same period in the prior year, Software & Hi-Tech remained the largest industry vertical in the North America segment, which was a result of the continued focus on engaging with our technology customers. However, a reduction in revenues from a former top 20 customer and overall declines in the technology sector in the U.S. during the first quarter of 2023 impacted growth in this vertical. Financial Services grew 19.5% during the three months ended March 31, 2023, largely due to growth in a group of wealth management customers, a financial data service provider that is now one of our top 20 customers, and growth from insurance customers added in the last 12 months. Travel and Consumer grew 1.2% during the three months ended March 31, 2023, primarily due to growth from customers in the travel industry, partially offset by declines from our retail customers. Business Information & Media grew 4.7% during the three months ended March 31, 2023, primarily due to growth from customers in the information providing, publishing and media industries. Life Sciences & Healthcare declined 13.3% during the three months ended March 31, 2023, primarily due to a ramp down of a large transformation program at a customer that was previously in our top 10 customers. Emerging Verticals grew 20.1% during the three months ended March 31, 2023 due to growth from various customers in industries such as energy, agriculture, government, and manufacturing.

Europe Segment

During the three months ended March 31, 2023, Europe’s segment revenues were $493.1 million, representing an increase of $41.2 million, or 9.1%, from the same period last year. Acquisitions contributed $1.6 million to revenues during the three months ended March 31, 2023. Revenues were negatively impacted by changes in foreign currency exchange rates during the first quarter of 2023. Had our Europe segment revenues been expressed in constant currency terms using the exchange rates in effect during the first quarter of 2022, we would have reported revenue growth of 12.4%. Europe’s segment revenues accounted for 40.7% and 38.6% of total segment revenues during the three months ended March 31, 2023 and 2022, respectively. During the first quarter of 2023, the segment’s operating profit increased 5.6% to $59.9 million compared to the first quarter of 2022. Expressed as a percentage of revenues, Europe’s segment operating profit decreased to 12.1% compared to 12.5% in the same period of the prior year. Segment operating profit as a percentage of revenues was negatively impacted by changes in foreign currency exchanges rates and lower utilization during the first quarter of 2023 compared to the first quarter of 2022.

The following table presents Europe segment revenues by industry vertical for the periods indicated:

(in thousands, except percentages)

Revenues in Travel & Consumer grew 11.9% during the three months ended March 31, 2023, as compared to the corresponding period in 2022 primarily due to increased demand from customers in the retail and distribution industries. During the three months ended March 31, 2023, revenues in Financial Services experienced 5.4% growth, primarily driven by increased revenues from insurance and investment banking customers as well as customers who provide various other financial services. During the three months ended March 31, 2023, the increase in revenues in Business Information & Media was largely attributable to the expansion of services provided to one of our top 5 customers. For the three months ended March 31, 2023, the increase in revenues in the Software & Hi-Tech vertical was largely attributable to the expansion of services provided to one of our top 20 customers. Revenues in Emerging Verticals experienced higher growth primarily attributable to growth in existing customers in the energy and automotive industries, as well as a new energy customer that we added in 2022.

Russia Segment

During the three months ended March 31, 2023, revenues from our Russia segment accounted for 0.7% of total segment revenues and decreased $24.1 million, or 75.5%, as compared to the corresponding period in the prior year. The decrease in revenues was primarily attributable to decreased operations in Russia as we proceed with the phased exit from Russia while discontinuing services to customers there. During the three months ended March 31, 2023, operating loss from the Russia segment improved to $3.0 million as compared to $19.5 million in the corresponding period last year. Operating loss in the first quarter of 2022 was largely impacted by increased bad debt expense and expenses incurred for services provided to customers for which revenue was not recognized as collectability was not considered probable after announcing the discontinuance of services to customers in Russia.

The following table presents Russia segment revenues by industry vertical for the periods indicated:

(in thousands, except percentages)

On March 4, 2022, EPAM announced that it will discontinue services to customers located in Russia and will provide transition support for the customers in this market. In April 2022, we began the process of a phased exit of our operations in Russia and on April 7, 2023, we amended and restated the agreement to sell substantially all of our remaining holdings in Russia to a third party. The completion of the sale is subject to customary closing conditions, including regulatory approvals by the Russian and U.S. governments. Subsequent to March 31, 2023, the required approvals from the Russian government were received to proceed with the sale. As a result of these announcements, the revenues from this segment are expected to dissipate in the future. See Note 2 “Impact of the Invasion of Ukraine” for more information regarding the Company’s decisions to no longer serve customers in Russia and exit our operations in Russia. The Russia segment includes revenues from certain clients that are located in countries other than Russia and the increase in Emerging Verticals during the three months ended March 31, 2023, as compared to the corresponding period in 2022 is primarily due to growth in revenues from several customers located in Ukraine and Uzbekistan.

Effects of Inflation

Economies in many countries where we operate have periodically experienced high rates of inflation. Periods of higher inflation may affect various economic sectors in those countries and increase our cost of doing business there. We do not believe that inflation has had a material impact on our business, results of operations or financial condition to date. We continue to track the impact of inflation, particularly on wages, while attempting to minimize its effects through pricing and cost management strategies. A higher-than-normal rate of inflation in the future could adversely affect our operations and financial condition. For a discussion of our potential risks and uncertainties, including those related to inflation, see “Part I. Item 1A. Risk Factors” in our Annual Report on Form 10-K for the year ended December 31, 2022.

Liquidity and Capital Resources

Capital Resources

Our cash generated from operations has been our primary source of liquidity to fund operations, investments to support the growth of our business and share repurchases. As of March 31, 2023, our principal sources of liquidity were cash and cash equivalents totaling $1.749 billion, short-term investments totaling $60.4 million as well as $675.0 million of available borrowings under our revolving credit facility. See Note 8 “Debt” of our condensed consolidated financial statements in “Part I. Item 1. Financial Statements (Unaudited)” for information regarding our debt.

Cash Flows

The following table summarizes our cash flows for the periods indicated:

(in thousands)

Operating Activities

Net cash provided by operating activities during the three months ended March 31, 2023 was $87.3 million, an increase of $139.2 million compared to $51.8 million used in operating activities in the corresponding period of 2022. The first quarter of 2022 was negatively impacted by an increase in days sales outstanding and a higher level of variable compensation payments made based on 2021 performance.

Investing Activities

Net cash used in investing activities during the three months ended March 31, 2023 was $17.7 million compared to $34.6 million used in investing activities during the same period in 2022. During the first three months of 2023, the cash used in investing activities was primarily attributable to $7.9 million used for capital expenditures compared to cash used for capital expenditures of $23.3 million during the comparable period in 2022. During the first three months of 2022 we used $8.2 million for the acquisitions of businesses, net of cash acquired, and we had no such cash outflows in the corresponding period of 2023.

Financing Activities

Net cash used in financing activities was $15.3 million in the first three months of 2023 compared to $9.6 million net cash used in financing activities in the same period of 2022. During the first three months of 2023, we commenced a program to repurchase shares of EPAM common stock pursuant to the publicly announced share repurchase program and repurchased 30 thousand shares of our common stock in the open market at a total cost of $8.5 million in cash. In addition, we used cash for the payments of withholding taxes related to net share settlements of restricted stock units of $3.2 million in the first three months of 2023, compared to $3.9 million paid in the corresponding period of 2022. Additionally, the first three months of 2023 included cash outflows to settle contingent consideration obligations for previously acquired businesses of which $4.7 million was attributable to the acquisition-date fair value of these obligations and classified in financing activities compared to $0.2 million in the first quarter of 2022. The three months ended March 31, 2023, include repayments of debt of $1.4 million, compared to $6.8 million of repayments of debt in the corresponding period of 2022. These cash outflows were partially offset by cash received from the exercises of stock options issued under our long-term incentive plans of $2.5 million in the first quarter of 2023, compared to $3.4 million received from the exercises of stock options in the corresponding period of 2022.

Future Capital Requirements

We believe that our existing cash, cash equivalents and short-term investments, combined with our expected cash flow from operations, will be sufficient to meet our projected operating and capital expenditure requirements for at least the next twelve months and that we possess the financial flexibility to execute our strategic objectives, including the ability to make acquisitions and strategic investments in the foreseeable future. However, the invasion of Ukraine and the consequences and related measures to contain its impact have caused material disruptions in both national and global financial markets and economies. The future impact of the invasion of Ukraine and responsive measures cannot be predicted with certainty and may increase our borrowing costs and other costs of capital and otherwise adversely affect our business, results of operations, financial condition and liquidity.

Our ability to expand and grow our business in accordance with current plans and to meet our long-term capital requirements will depend on many factors, including the rate at which our cash flows increase or decrease and the availability of public and private debt and equity financing. We may require additional cash resources due to changed business conditions or other future developments, including any investments or acquisitions we may decide to pursue. Our ability to generate cash is subject to our performance, general economic conditions, industry trends and other factors including the impact of the invasion of Ukraine, as described elsewhere in this Management’s Discussion and Analysis of Financial Condition and Results of Operations. To the extent that existing cash, cash equivalents, short-term investments, and operating cash flows are insufficient to fund our future activities and requirements, we may need to raise additional funds through public or private equity or debt financing. If we issue equity securities in order to raise additional funds, substantial dilution to existing stockholders may occur. If we raise cash through the issuance of additional indebtedness, we may be subject to additional contractual restrictions on our business. There is no assurance that we would be able to raise additional funds on favorable terms or at all.

See Note 13 “Commitments and Contingencies” of our condensed consolidated financial statements in “Part I. Item 1. Financial Statements (Unaudited)” of this Quarterly Report and “Part II. Item 7. Future Capital Requirements” of our Annual Report on Form 10-K for the year ended December 31, 2022 for information regarding contractual obligations.

Off-Balance Sheet Commitments and Arrangements

We do not have any material obligations under guarantee contracts or other contractual arrangements other than as disclosed in Note 13 “Commitments and Contingencies” of our condensed consolidated financial statements in “Part I. Item 1. Financial Statements (Unaudited).” We have not entered into any transactions with unconsolidated entities where we have financial guarantees, subordinated retained interests, derivative instruments, or other contingent arrangements that expose us to material continuing risks, contingent liabilities, or any other obligation under a variable interest in an unconsolidated entity that provides financing, liquidity, market risk, or credit risk support to us, or engages in leasing, hedging, or research and development services with us.

Recent Accounting Pronouncements

See Note 1 “Business and Summary of Significant Accounting Policies” to our unaudited condensed consolidated financial statements in “Part I. Item 1. Financial Statements (Unaudited)” for additional information.

Forward-Looking Statements

This quarterly report on Form 10-Q contains estimates and forward-looking statements made pursuant to the safe harbor provisions of the Private Securities Litigation Reform Act of 1995, principally in “Part I. Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations” and “Part II. Item 1A. Risk Factors.” Our Annual Report on Form 10-K for the year ended December 31, 2022 also contains estimates and forward-looking statements, principally in “Part I. Item 1A. Risk Factors.” Our estimates and forward-looking statements are mainly based on our current expectations and estimates of future events and trends, which affect or may affect our business and operations. Those future events and trends may relate to, among other things, developments relating to the war in Ukraine and escalation of the war in the surrounding region, political and civil unrest or military action in the geographies where we conduct business and operate, difficult conditions in global capital markets, foreign exchange markets and the broader economy, and the effect that these events may have on our revenues, operations, access to capital and profitability. Although we believe that these estimates and forward-looking statements are based upon reasonable assumptions, they are subject to several risks, uncertainties and assumptions as to future events that may not prove to be accurate and are made in light of information currently available to us. Important factors, in addition to the factors described in this quarterly report and in our Annual Report, may materially and adversely affect our results as indicated in forward-looking statements. You should read this quarterly report, our Annual Report and the documents that we have filed as exhibits hereto completely and with the understanding that our actual future results may be materially different from what we expect.

The words “may,” “will,” “should,” “could,” “expect,” “plan,” “anticipate,” “believe,” “estimate,” “predict,” “intend,” “potential,” “might,” “would,” “continue” or the negative of these terms or other comparable terminology and similar words are intended to identify estimates and forward-looking statements. Estimates and forward-looking statements speak only as of the date they were made, and, except to the extent required by law, we undertake no obligation to update, to revise or to review any estimate and/or forward-looking statement because of new information, future events or other factors. Estimates and forward-looking statements involve risks and uncertainties and are not guarantees of future performance. As a result of the risks and uncertainties described above, the estimates and forward-looking statements discussed in this quarterly report and our Annual Report on Form 10-K for the year ended December 31, 2022 might not occur and our future results, level of activity, performance or achievements may differ materially from those expressed in these forward-looking statements due to, including, but not limited to, the factors mentioned above, and the differences may be material and adverse. Because of these uncertainties, you should not place undue reliance on these forward-looking statements.

We are exposed to certain market risks in the ordinary course of our business. These risks primarily result from changes in concentration of credit, foreign currency exchange rates and interest rates. In addition, our international operations are subject to risks related to differing economic conditions, civil unrest, political instability or uncertainty, military activities, broad-based sanctions, differing tax structures, and other regulations and restrictions.

Concentration of Credit and Other Credit Risks

Financial instruments that potentially subject us to significant concentrations of credit risk consist primarily of cash, cash equivalents, restricted cash, short-term investments and trade receivables.

We maintain our cash, cash equivalents and short-term investments with financial institutions. We believe that our credit policies reflect normal industry terms and business risk. We do not anticipate non-performance by the counterparties.

We have cash in several countries, including Ukraine, Belarus and Russia, which could be impacted by the invasion of Ukraine and where the banking sector remains subject to periodic instability; banking and other financial systems in these countries generally do not meet the banking standards of more developed markets, and bank deposits made by corporate entities are not insured. As of March 31, 2023, we had $68.3 million of cash and cash equivalents in banks in Ukraine, $34.0 million of cash and cash equivalents in banks in Belarus, and $27.1 million of cash and cash equivalents in banks in Russia. Cash in Ukraine and Belarus is used for the operational needs of the local entities and cash balances change with the expected operating needs of these entities. We regularly monitor cash held in these countries and, to the extent the cash held exceeds amounts required to support our operations in these countries, we distribute the excess funds into markets with more developed banking sectors to the extent it is possible to do so. Due to restrictions imposed by the Russian government, our ability to distribute excess funds from Russia to other countries is limited. On April 7, 2023, we amended and restated the agreement to sell substantially all of our remaining holdings in Russia, including cash and cash equivalents, to a third party. The completion of the sale is subject to customary closing conditions, including regulatory approvals by the Russian and U.S. governments. Subsequent to March 31, 2023, the required approvals from the Russian government were received to proceed with the sale. We place our cash and cash equivalents with financial institutions considered stable in the region, limit the amount of credit exposure with any one financial institution and conduct ongoing evaluations of the credit worthiness of the financial institutions with which we do business. However, a banking crisis, bankruptcy or insolvency of banks that process or hold our funds, or sanctions may result in the loss of our deposits or adversely affect our ability to complete banking transactions, which could adversely affect our business and financial condition.

Trade receivables are generally dispersed across many customers operating in different industries; therefore, concentration of credit risk is limited and we do not believe significant credit risk existed at March 31, 2023. Though our results of operations depend on our ability to successfully collect payment from our customers for work performed, historically, credit losses and write-offs of trade receivables have not been material to our condensed consolidated financial statements. If any of our customers enter bankruptcy protection or otherwise take steps to alleviate their financial distress, our credit losses and write-offs of trade receivables could increase, which would negatively impact our results of operations. As of March 31, 2023, we do not have significant trade receivables and contract assets in Russia and we are actively monitoring these receivables from our customers in Russia for any deterioration of creditworthiness.

Interest Rate Risk

We are exposed to market risk from changes in interest rates. Exposure to interest rate risk results primarily from variable rates related to our cash and cash equivalent deposits, short-term investments, and our borrowings, mainly under our 2021 Credit Agreement, which is subject to a variety of rates depending on the currency and timing of funds borrowed. We do not believe we are exposed to material direct risks associated with changes in interest rates related to these deposits, investments and borrowings.

Foreign Exchange Risk

Our global operations are conducted predominantly in U.S. dollars. Other than U.S. dollars, we generate revenues principally in euros, British pounds, Swiss francs and Canadian dollars and incur expenditures principally in euros, Polish zlotys, British pounds, Indian rupees, Swiss francs, Hungarian forints, Mexican pesos, Canadian dollars, Colombian pesos, and Chinese yuan renminbi. As a result, exchange rate fluctuations in any of these currencies relative to the U.S. dollar could negatively impact our results of operations. During the three months ended March 31, 2023, approximately 33.7% of consolidated revenues and 62.6% of consolidated operating expenses were denominated in currencies other than the U.S. dollar.

To manage the risk of fluctuations in foreign currency exchange rates and hedge a portion of our forecasted foreign currency denominated operating expenses incurred in the normal course of business, we implemented a hedging program through which we enter into a series of foreign exchange forward contracts with durations of twelve months or less that are designated as cash flow hedges of forecasted Polish zloty, Hungarian forint, and Indian rupee transactions. As of March 31, 2023, all of EPAM’s foreign exchange forward contracts, were designated as hedges and there is no financial collateral (including cash collateral) required to be posted related to the foreign exchange forward contracts.

During the quarter ended March 31, 2022, in response to the invasion of Ukraine, EPAM de-designated our Russian ruble foreign exchange forward contracts as hedges and entered into offsetting foreign exchange forward contracts with the same counterparty. The Company determined it was probable the underlying forecasted foreign currency transactions which were hedged would not occur and reclassified the accumulated loss of $43.9 million on the underlying hedge into income which is classified as foreign exchange loss in the condensed consolidated statement of income.

During the three months ended March 31, 2023, foreign exchange loss was $4.6 million compared to a loss of $22.8 million reported in the corresponding period last year. Foreign exchange loss was primarily driven by the impact of fluctuations in foreign currencies on the Company’s assets and liabilities denominated in foreign currencies. During the first quarter of 2022, foreign exchange loss was largely driven by the impact of the appreciation of the Russian ruble on the Company’s intercompany payables denominated in Russian rubles and U.S. dollar denominated assets held by our subsidiaries in Russia.

Management supplements results reported in accordance with United States generally accepted accounting principles, referred to as GAAP, with non-GAAP financial measures. Management believes these measures help illustrate underlying trends in our business and uses the measures to establish budgets and operational goals, communicated internally and externally, for managing our business and evaluating its performance. When important to management’s analysis, operating results are compared on the basis of “constant currency,” which is a non-GAAP financial measure. This measure excludes the effect of foreign currency exchange rate fluctuations by translating the current period revenues and expenses into U.S. dollars at the weighted average exchange rates of the prior period of comparison.

During the first quarter of 2023, we reported revenue growth of 3.4% compared to the first quarter of 2022. Had our consolidated revenues been expressed in constant currency terms using the exchange rates in effect during the first quarter of 2022, we would have reported revenue growth of 4.9%. Our revenues were negatively impacted mainly by the depreciation of the euro and British pound relative to the U.S. dollar. During the first quarter of 2023, we reported a decrease in income from operations of 6.9% compared to the first quarter of 2022. Had our consolidated results been expressed in constant currency terms using the exchange rates in effect during the first quarter of 2022, we would have reported a decrease in income from operations of 9.8%. Income from operations was positively impacted largely by the depreciation of the Polish zloty and Colombian peso, partially offset by the depreciation of the euro and British pound relative to the U.S. dollar during the first quarter of 2023 compared to the same period in the prior year.

Conclusion Regarding the Effectiveness of Disclosure Controls and Procedures

Based on management’s evaluation, with the participation of our Chief Executive Officer and Chief Financial Officer, as of the end of the period covered by this report, these officers have concluded that our disclosure controls and procedures, as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended (the “Exchange Act”), are effective to provide reasonable assurance that information required to be disclosed by us in reports that we file or submit under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in SEC rules and forms, and is accumulated and communicated to management, including our principal executive officer and principal financial officer, as appropriate, to allow timely decisions regarding required disclosure.

Changes in Internal Control Over Financial Reporting

There has been no change in our internal control over financial reporting during the quarter ended March 31, 2023 that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.

For a discussion of our potential risks and uncertainties, including our significant operations in Belarus and Ukraine and the material adverse effect the invasion of Ukraine by Russia has had and may have on our operations, business, and financial results, see the risk factors disclosed under the heading “Part I. Item 1A. Risk Factors” in our Annual Report on Form 10-K for the year ended December 31, 2022.

The risks and uncertainties that we face are not limited to those set forth in our Annual Report on Form 10-K. Additional risks and uncertainties not presently known to us or that we currently believe to be immaterial may also adversely affect our business and the trading price of our common stock.