EPAM Systems, Inc. - Quarter Report: 2019 March (Form 10-Q)

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

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

For the quarterly period ended March 31, 2019

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

For the transition period from ________to________

Commission file number: 001-35418

EPAM SYSTEMS, INC.

(Exact Name of Registrant as Specified in its Charter)



Delaware	22-3536104
(State or other jurisdiction of incorporation or organization)	(I.R.S. Employer Identification No.)

41 University Drive, Suite 202 Newtown, Pennsylvania	18940
(Address of principal executive offices)	(Zip code)

267-759-9000

(Registrant’s telephone number, including area code)

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes x No ¨

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes x No ¨

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company” and “emerging growth company” in Rule 12b-2 of the Exchange Act. (Check one):



Large accelerated filer	x	Accelerated filer	¨
Non-accelerated filer	¨ (Do not check if a smaller reporting company)	Smaller reporting company	¨
Emerging growth company	¨

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ¨

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ¨ No x



Title of Each Class	Trading Symbol	Name of Each Exchange on which Registered
Common Stock, par value $0.001 per share	EPAM	New York Stock Exchange

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date.



Title of Each Class		Outstanding as of April 30, 2019
Common Stock, par value $0.001 per share		54,631,565 shares

EPAM SYSTEMS, INC.

TABLE OF CONTENTS



	Page
PART I. FINANCIAL INFORMATION	3
Item 1. Financial Statements (Unaudited)	3
Condensed Consolidated Balance Sheets as of March 31, 2019 and December 31, 2018	3
Condensed Consolidated Statements of Income and Comprehensive Income for the Three Months Ended March 31, 2019 and 2018	4
Condensed Consolidated Statements of Changes in Stockholders’ Equity for the Three Months Ended March 31, 2019 and 2018	5
Condensed Consolidated Statements of Cash Flows for the Three Months Ended March 31, 2019 and 2018	6
Notes to Condensed Consolidated Financial Statements	8
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations	25
Item 3. Quantitative and Qualitative Disclosures About Market Risk	35
Item 4. Controls and Procedures	36
PART II. OTHER INFORMATION	37
Item 1. Legal Proceedings	37
Item 1A. Risk Factors	37
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds	37
Item 3. Defaults Upon Senior Securities	37
Item 4. Mine Safety Disclosures	37
Item 5. Other Information	37
Item 6. Exhibits	38
SIGNATURES	39

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PART I. FINANCIAL INFORMATION

Item 1. Financial Statements (Unaudited)

EPAM SYSTEMS, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED BALANCE SHEETS

(Unaudited)

(In thousands, except share and per share data)



	As of March 31, 2019			As of December 31, 2018
Assets
Current assets
Cash and cash equivalents	$	762,529		$	770,560
Accounts receivable, net of allowance of $1,415 and $1,557, respectively	307,202			297,685
Unbilled revenues	144,152			104,652
Prepaid and other current assets	30,864			26,171
Total current assets	1,244,747			1,199,068
Property and equipment, net	105,805			102,646
Operating lease right-of-use assets	173,091			—
Intangible assets, net	50,087			57,065
Goodwill	167,707			166,832
Deferred tax assets	69,345			69,983
Other noncurrent assets	20,653			16,208
Total assets	$	1,831,435		$	1,611,802

Liabilities
Current liabilities
Accounts payable	$	4,397		$	7,444
Accrued expenses and other current liabilities	72,793			127,937
Due to employees	86,012			49,683
Deferred compensation due to employees	9,673			9,920
Taxes payable, current	69,835			67,845
Operating lease liabilities, current	39,856			—
Total current liabilities	282,566			262,829
Long-term debt	25,000			25,031
Taxes payable, noncurrent	43,679			43,685
Operating lease liabilities, noncurrent	127,935			—
Other noncurrent liabilities	14,030			17,661
Total liabilities	493,210			349,206
Commitments and contingencies (Note 11)
Stockholders’ equity
Common stock, $0.001 par value; 160,000,000 authorized; 54,584,243 and 54,099,927 shares issued, 54,564,508 and 54,080,192 shares outstanding at March 31, 2019 and December 31, 2018, respectively	54			54
Additional paid-in capital	553,532			544,700
Retained earnings	820,287			759,533
Treasury stock	(177		)	(177		)
Accumulated other comprehensive loss	(35,471		)	(41,514		)
Total stockholders’ equity	1,338,225			1,262,596
Total liabilities and stockholders’ equity	$	1,831,435		$	1,611,802

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

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EPAM SYSTEMS, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF INCOME AND COMPREHENSIVE INCOME

(Unaudited)

(In thousands, except per share data)



	Three Months Ended March 31,
	2019			2018
Revenues	$	521,333		$	424,148
Operating expenses:
Cost of revenues (exclusive of depreciation and amortization)	344,689			277,634
Selling, general and administrative expenses	101,786			89,641
Depreciation and amortization expense	10,200			8,176
Income from operations	64,658			48,697
Interest and other income/(loss), net	3,076			(551		)
Foreign exchange loss	(3,484		)	(247		)
Income before provision for/(benefit from) income taxes	64,250			47,899
Provision for/(benefit from) income taxes	3,496			(16,519		)
Net income	$	60,754		$	64,418
Foreign currency translation adjustments, net of tax	2,943			3,309
Unrealized gain on cash-flow hedging instruments, net of tax	3,100			69
Comprehensive income	$	66,797		$	67,796

Net income per share:
Basic	$	1.12		$	1.21
Diluted	$	1.06		$	1.15
Shares used in calculation of net income per share:
Basic	54,245			53,079
Diluted	57,236			56,241

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

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EPAM SYSTEMS, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF CHANGES IN

STOCKHOLDERS’ EQUITY

(Unaudited)

(In thousands, except share data)



	Common Stock				Additional Paid-in Capital			Retained Earnings		Treasury Stock				Accumulated Other Comprehensive Loss			Total Stockholders’ Equity
	Shares		Amount							Shares	Amount
Balance, January 1, 2019	54,080,192		$	54	$	544,700		$	759,533	19,735	$	(177	)	$	(41,514	)	$	1,262,596
Restricted stock units vested	242,414		—		—			—		—	—			—			—
Restricted stock units withheld for employee taxes	(81,562	)	—		(13,483		)	—		—	—			—			(13,483		)
Stock-based compensation expense	—		—		10,425			—		—	—			—			10,425
Proceeds from stock option exercises	323,464		—		11,890			—		—	—			—			11,890
Foreign currency translation adjustments, net of tax	—		—		—			—		—	—			2,943			2,943
Change in unrealized gains and losses on cash flow hedges, net of tax	—		—		—			—		—	—			3,100			3,100
Net income	—		—		—			60,754		—	—			—			60,754
Balance, March 31, 2019	54,564,508		$	54	$	553,532		$	820,287	19,735	$	(177	)	$	(35,471	)	$	1,338,225



	Common Stock				Additional Paid-in Capital			Retained Earnings		Treasury Stock				Accumulated Other Comprehensive Loss			Total Stockholders’ Equity
	Shares		Amount							Shares	Amount
Balance, January 1, 2018	52,983,685		$	53	$	473,874		$	518,820	19,735	$	(177	)	$	(17,623	)	$	974,947
Restricted stock units vested	186,327		—		—			—		—	—			—			—
Restricted stock units withheld for employee taxes	(61,950	)	—		(6,986		)	—		—	—			—			(6,986		)
Stock-based compensation expense	—		—		11,485			—		—	—			—			11,485
Proceeds from stock option exercises	198,936		—		7,649			—		—	—			—			7,649
Foreign currency translation adjustments, net of tax	—		—		—			—		—	—			3,309			3,309
Change in unrealized gains and losses on cash flow hedges, net of tax	—		—		—			—		—	—			69			69
Cumulative effect of adoption of ASU 2014-09	—		—		—			457		—	—			—			457
Net income	—		—		—			64,418		—	—			—			64,418
Balance, March 31, 2018	53,306,998		$	53	$	486,022		$	583,695	19,735	$	(177	)	$	(14,245	)	$	1,055,348

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

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EPAM SYSTEMS, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(Unaudited)

(In thousands)



	For the Three Months Ended March 31,
	2019			2018
Cash flows from operating activities:
Net income	$	60,754		$	64,418
Adjustments to reconcile net income to net cash (used in)/provided by operating activities:
Depreciation and amortization expense	10,200			8,176
Operating lease right-of-use assets amortization expense	12,187			—
Bad debt (recovery)/expense	(133		)	199
Deferred taxes	846			(23,290		)
Stock-based compensation expense	21,856			16,596
Other	520			(1,982		)
Changes in assets and liabilities:
Accounts receivable	(8,820		)	12,475
Unbilled revenues	(39,523		)	(48,193		)
Prepaid expenses and other assets	401			(7,623		)
Accounts payable	(2,488		)	2,520
Accrued expenses and other liabilities	(51,079		)	(31,470		)
Operating lease liabilities	(13,175		)	—
Due to employees	24,297			11,656
Taxes payable	(16,045		)	3,848
Net cash (used in)/provided by operating activities	(202		)	7,330
Cash flows from investing activities:
Purchases of property and equipment	(13,424		)	(10,711		)
Acquisition of businesses, net of cash acquired (Note 2)	—			(50,264		)
Other investing activities, net	(5,136		)	811
Net cash used in investing activities	(18,560		)	(60,164		)
Cash flows from financing activities:
Proceeds from stock option exercises	11,402			7,588
Payments of withholding taxes related to net share settlements of restricted stock units	(1,208		)	(106		)
Repayment of debt	(4		)	(3,466		)
Other financing activities, net	(9		)	—
Net cash provided by financing activities	10,181			4,016
Effect of exchange rate changes on cash, cash equivalents and restricted cash	548			3,040
Net decrease in cash, cash equivalents and restricted cash	(8,033		)	(45,778		)
Cash, cash equivalents and restricted cash, beginning of period	771,711			582,855
Cash, cash equivalents and restricted cash, end of period	$	763,678		$	537,077

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EPAM SYSTEMS, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(Unaudited)

(In thousands)

(Continued)

The following table provides a reconciliation of cash, cash equivalents and restricted cash reported within the condensed consolidated balance sheets:



	As of March 31, 2019		As of December 31, 2018
Balance sheet classification
Cash and cash equivalents	$	762,529	$	770,560
Restricted cash in Prepaid and other current assets	14		14
Restricted cash in Other noncurrent assets	1,135		1,137
Total restricted cash	1,149		1,151
Total cash, cash equivalents and restricted cash	$	763,678	$	771,711

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

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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

(In thousands, except share and per share data)


1.	BUSINESS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

EPAM Systems, Inc. (the “Company” or “EPAM”) is a leading global provider of digital platform engineering and software development services to customers located around the world, primarily in North America, Europe, Asia and Australia. The Company’s industry expertise includes financial services, travel and consumer, software and hi-tech, business information and media, life sciences and healthcare, as well as other industries in which it is continuously growing. The Company is incorporated in Delaware with headquarters in Newtown, PA.

Basis of Presentation — The accompanying unaudited condensed consolidated financial statements of EPAM have been prepared in accordance with generally accepted accounting principles in the United States (“GAAP” or “U.S. GAAP”) and Article 10 of Regulation S-X under the Securities Exchange Act of 1934, as amended. The condensed consolidated financial statements include the financial statements of EPAM Systems, Inc. and its subsidiaries with all intercompany balances and transactions eliminated.

These unaudited condensed consolidated financial statements and accompanying notes should be read in conjunction with the Company’s audited consolidated financial statements and the notes thereto for the year ended December 31, 2018 included in its Annual Report on Form 10-K. The preparation of these condensed consolidated financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the amounts reported in these condensed consolidated financial statements and accompanying notes. Actual results could differ from those estimates, and such differences may be material to the condensed consolidated financial statements. Operating results for the interim periods are not necessarily indicative of results that may be expected to occur for the entire year. In management’s opinion, all adjustments considered necessary for a fair presentation of the accompanying unaudited condensed consolidated financial statements have been included, and all adjustments are of a normal and recurring nature.

Adoption of New Accounting Standards

Unless otherwise discussed below, the adoption of new accounting standards did not have an impact on the Company’s consolidated financial position, results of operations, changes in stockholders’ equity and cash flows.

Leases — In February 2016, the FASB issued ASU 2016-02, Leases (“Topic 842”). The standard supersedes previously existing lease guidance (“Topic 840”) and requires entities to recognize all leases, with the exception of leases with a term of twelve months or less, on the balance sheet as right-of-use assets (“RoU Assets”) and lease liabilities. The guidance also changes disclosure requirements with a focus on providing information that will enable users of financial statements to assess the amount, timing and uncertainty of cash flows arising from leases.

The Company adopted Topic 842, effective January 1, 2019, using the optional transition approach, which allows the Company to apply the provisions of the standard at the effective date without adjusting the comparable periods and carry forward disclosures under previously existing guidance for those periods presented within the Company’s financial statements.

The Company determines if an arrangement is a lease or contains a lease at inception. The Company performs an assessment and classifies the lease as either an operating lease or a financing lease at the lease commencement date with a right-of-use asset and a lease liability recognized in the statement of financial position under both classifications. The Company does not have finance leases that are material to the Company’s condensed consolidated financial statements.

Lease liabilities are initially measured at the present value of lease payments not yet paid. The present value is determined by applying the readily determinable rate implicit in the lease or, if not available, the incremental borrowing rate of the lessee. The Company determines the incremental borrowing rate of the lessee on a lease-by-lease basis by developing an estimated centralized U.S. dollar borrowing rate for a fully collateralized obligation with a term similar to the lease term, and adjusts the rate to reflect the incremental risk associated with the currency in which the lease is denominated. Lease agreements of the Company may include options to extend or terminate the lease and the Company includes such options in the lease term when it is reasonably certain that the Company will exercise that option. RoU Assets are recognized based on the initial measurement of the lease liabilities plus initial direct costs less lease incentives and RoU Assets are subject to periodic impairment tests. Lease expense for operating leases is recognized on a straight-line basis over the lease term.

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The Company elected a practical expedient to account for lease and non-lease components together as a single lease component. The Company also elected the short-term lease recognition exemption for all classes of lease assets with an original term of twelve months or less. As part of the transition, the Company elected a package of practical expedients allowing it to carry forward historical accounting for any expired or existing contracts that are or contain lease contracts, including classification of such contracts and initial direct costs associated with them.

The adoption of Topic 842 on January 1, 2019 resulted in the recognition of RoU Assets for operating leases of $177,597 and operating lease liabilities of $173,863. The adoption of Topic 842 did not have an impact on the condensed consolidated statement of income and comprehensive income, condensed consolidated statement of changes in stockholders’ equity or the condensed consolidated statement of cash flows.

See Note 6 “Leases” in the condensed consolidated interim financial statements for additional information regarding leases.

Pending Accounting Standards

From time to time, new accounting pronouncements are issued by the FASB or other standards-setting bodies that the Company will adopt according to the various timetables the FASB specifies. Unless otherwise discussed below, the Company believes the impact of recently issued standards that are not yet effective will not have a material impact on its consolidated financial position, results of operations and cash flows upon adoption.

Measurement of Credit Losses on Financial Instruments — Effective January 1, 2020, the Company will be required to adopt the amended guidance of FASB ASC Topic 326, Financial Instruments - Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments, (with early adoption permitted effective January 1, 2019.) The amendments in this update change how companies measure and recognize credit impairment for many financial assets. The new expected credit loss model will require companies to immediately recognize an estimate of credit losses expected to occur over the remaining life of the financial assets (including trade receivables) that are in the scope of the update. The update also made amendments to the current impairment model for held-to-maturity and available-for-sale debt securities and certain guarantees. Entities are required to adopt the standard using a modified-retrospective approach through a cumulative effect adjustment to retained earnings as of the beginning of the period of adoption. The Company has not yet completed its assessment of the impact of the new guidance on its consolidated financial statements and expects to adopt the standard on January 1, 2020.


2.	ACQUISITIONS

Continuum — On March 15, 2018, the Company acquired all of the outstanding equity of Continuum Innovation LLC together with its subsidiaries (“Continuum”) to enhance the Company’s consulting capabilities as well as its digital and service design practices. Continuum, headquartered in Boston with offices located in Milan, Seoul, and Shanghai, focuses on four practices including strategy, physical and digital design, technology and its Made Real Lab. The acquisition of Continuum added approximately 125 design consultants to the Company’s headcount.

In connection with the Continuum acquisition, the Company paid $52,515 of cash. Furthermore, subject to attainment of specified performance targets in the 12 months after the acquisition, the Company will make a cash earnout payment with a maximum amount payable of $3,135. The Company recorded $2,400 related to this earnout payment as contingent consideration as of the acquisition date. During the third quarter of 2018, the Company recorded a $900 reduction to the fair value of the contingent consideration.

Think — On November 1, 2018, the Company acquired all of the equity interests of Think Limited (“Think”), a digital transformation agency headquartered in London, UK. This acquisition is intended to strengthen EPAM’s digital and organizational consulting capabilities in the UK and Western European markets and enhance the Company’s global product and design offerings.

In connection with the Think acquisition, the Company paid $26,254 of cash. Furthermore, subject to attainment of specified performance targets in the 12 months after the acquisition, the Company will make a cash earnout payment with a maximum amount payable of $8,156. The Company recorded $5,990 related to this earnout payment as contingent consideration as of the acquisition date.

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The following table summarizes the estimated fair values of the assets acquired and liabilities assumed at the dates of acquisition as updated for any changes as of March 31, 2019:



	Continuum		Think
	As of March 15, 2018		As of November 1, 2018
Cash and cash equivalents	$	2,251	$	2,344
Accounts receivable	6,676		2,259
Unbilled revenues	2,463		284
Prepaid and other current assets	936		609
Goodwill	26,617		22,482
Intangible assets	14,450		6,882
Property and equipment and other noncurrent assets	8,902		642
Total assets acquired	$	62,295	$	35,502
Accounts payable, accrued expenses and other current liabilities	$	2,745	$	2,205
Due to employees	1,001		13
Long-term debt	3,220		—
Other noncurrent liabilities	490		1,040
Total liabilities assumed	$	7,456	$	3,258
Net assets acquired	$	54,839	$	32,244

During the first quarter of 2019, there were no adjustments recorded related to the estimated fair values of the assets acquired and liabilities assumed at the date of acquisition.

During the first quarter of 2019, the Company finalized the fair value of the assets acquired and liabilities assumed in the acquisition of Continuum. The Company adjusted initially recognized intangible assets and their useful lives as well as recognized an additional intangible asset in the form of a favorable lease and removed a noncurrent liability associated with an initially recognized unfavorable lease. The Company also finalized a working capital adjustment that resulted in cash collection in the amount of $76 reducing the original amount of the net assets acquired. These adjustments and a revaluation of contingent consideration resulted in a corresponding decrease to the originally recognized value of acquired goodwill.

For Think, estimated fair values of the assets acquired and liabilities assumed remain provisional and based on the information that was available as of the acquisition date. The Company expects to complete the purchase price allocations as soon as practicable but no later than one year from the acquisition date.

As of March 31, 2019, the following table presents the estimated fair values and useful lives of intangible assets acquired from Continuum and Think:



	Continuum			Think
	Weighted Average Useful Life (in years)	Amount		Weighted Average Useful Life (in years)	Amount
Customer relationships	6.5	$	5,800	7	$	6,117
Favorable lease	11.2	5,500		—	—
Contract royalties	8	1,900		—	—
Trade names	5	1,250		5	765
Total		$	14,450		$	6,882

In connection with the adoption of Topic 842, effective January 1, 2019, the Company reclassified the favorable lease intangible asset to Operating lease right-of-use assets.

The goodwill recognized as a result of the acquisitions is attributable primarily to strategic and synergistic opportunities related to the consulting and design businesses, the assembled workforces acquired and other factors. The goodwill acquired as a result of the Continuum acquisition is expected to be deductible for income tax purposes while the goodwill acquired as a result of the Think acquisition is not expected to be deductible for income tax purposes.

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Revenues generated by Continuum and Think totaled $6,754 and $3,832, respectively during the three months ended March 31, 2019. Pro forma results of operations have not been presented because the effect of the Continuum and Think acquisition on the Company’s condensed consolidated financial statements was not material individually or in the aggregate.


3.	GOODWILL

Goodwill by reportable segment was as follows:



	North America		Europe		Total
Balance as of January 1, 2019	$	103,542	$	63,290	$	166,832
Effect of net foreign currency exchange rate changes	—		875		875
Balance as of March 31, 2019	$	103,542	$	64,165	$	167,707

There were no accumulated impairment losses in the North America or Europe reportable segments as of March 31, 2019 or December 31, 2018.


4.	FAIR VALUE MEASUREMENTS

The Company carries certain assets and liabilities at fair value on a recurring basis on its consolidated balance sheets. The following tables present the fair values of the Company’s financial assets and liabilities measured at fair value on a recurring basis as of March 31, 2019 and December 31, 2018:



	As of March 31, 2019
	Balance		Level 1		Level 2		Level 3
Foreign exchange derivative assets	$	1,067	$	—	$	1,067	$	—
Total assets measured at fair value on a recurring basis	$	1,067	$	—	$	1,067	$	—

Foreign exchange derivative liabilities	$	362	$	—	$	362	$	—
Contingent consideration	7,625		—		—		7,625
Total liabilities measured at fair value on a recurring basis	$	7,987	$	—	$	362	$	7,625



	As of December 31, 2018
	Balance		Level 1		Level 2		Level 3
Foreign exchange derivative assets	$	181	$	—	$	181	$	—
Total assets measured at fair value on a recurring basis	$	181	$	—	$	181	$	—

Foreign exchange derivative liabilities	$	3,475	$	—	$	3,475	$	—
Contingent consideration	7,468		—		—		7,468
Total liabilities measured at fair value on a recurring basis	$	10,943	$	—	$	3,475	$	7,468

The Level 2 foreign exchange derivatives are valued using pricing models and discounted cash flow methodologies based on observable foreign exchange data at the measurement date. See Note 5 “Derivative Financial Instruments” for further information regarding the Company’s derivative financial instruments.

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As of March 31, 2019, contingent consideration included amounts payable in cash in connection with the acquisitions of Continuum and Think (Note 2 “Acquisitions”). The fair value of the contingent consideration is based on the expected future payments to be made to the sellers of the acquired businesses in accordance with the provisions outlined in the respective purchase agreements. In determining fair value, the Company considered a variety of factors, including future performance of the acquired businesses using financial projections developed by the Company and market risk assumptions that were derived for revenue growth and earnings before interest and taxes. The Company estimated future payments using the earnout formulas and performance targets specified in the purchase agreements and adjusted those estimates to reflect the probability of their achievement. Those estimated future payments were then discounted to present value using a rate based on the weighted-average cost of capital of guideline companies. Although there is significant judgment involved, the Company believes its estimates and assumptions are reasonable. Changes in financial projections, market risk assumptions, discount rates or probability assumptions related to achieving the various earnout criteria would result in a change in the fair value of the recorded contingent liabilities. Such changes, if any, are recorded within Interest and other income, net in the Company’s consolidated statement of income and comprehensive income.

A reconciliation of the beginning and ending balances of acquisition-related contractual contingent liabilities using significant unobservable inputs (Level 3) for the three months ended March 31, 2019 is as follows:



	Amount
Contractual contingent liabilities as of January 1, 2019	$	7,468
Effect of net foreign currency exchange rate changes	157
Contractual contingent liabilities at March 31, 2019	$	7,625

Estimates of fair value of financial instruments not carried at fair value on a recurring basis on the Company’s consolidated balance sheets are generally subjective in nature, and are determined as of a specific point in time based on the characteristics of the financial instruments and relevant market information. The Company uses the following methods to estimate the fair values of its financial instruments:


•	for financial instruments that have quoted market prices, those quoted prices are used to estimate fair value;


•	for financial instruments for which no quoted market prices are available, fair value is estimated using information obtained from independent third parties, or by discounting the expected cash flows using an estimated current market interest rate for the financial instrument;


•	for financial instruments for which no quoted market prices are available and that have no defined maturity, have a remaining maturity of 360 days or less, or reprice frequently to a market rate, the Company assumes that the fair value of these instruments approximates their reported value, after taking into consideration any applicable credit risk.

The generally short duration of certain of the Company’s assets and liabilities results in a significant number of assets and liabilities for which fair value equals or closely approximates the amount recorded on the Company’s consolidated balance sheets. The Company’s financial assets and liabilities that are not carried at fair value on a recurring basis on the Company’s consolidated balance sheets are as follows:


•	cash and cash equivalents;


•	restricted cash and time deposits;


•	employee loans;


•	long-term debt (Note 7 “Long-Term Debt”).

The housing loans are measured using the Level 3 inputs within the fair value hierarchy under FASB ASC Topic 820, Fair Value Measurement because they are valued using significant unobservable inputs. The fair value of employee housing loans is estimated using information on the rates of return that market participants in Belarus would require when investing in unsecured U.S. dollar-denominated government bonds with similar maturities (a “risk-free rate”), after taking into consideration any applicable credit and liquidity risk.

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The following tables present the reported amounts and estimated fair values of the financial assets and liabilities for which disclosure of fair value is required, as they would be categorized within the fair value hierarchy, as of the dates indicated:



					Fair Value Hierarchy
	Balance		Estimated Fair Value		Level 1		Level 2		Level 3
March 31, 2019
Financial Assets:
Cash and cash equivalents	$	762,529	$	762,529	$	762,529	$	—	$	—
Restricted cash	$	1,149	$	1,149	$	1,149	$	—	$	—
Employee loans	$	3,121	$	3,121	$	—	$	—	$	3,121
Financial Liabilities:
Borrowings under the 2017 Credit Facility	$	25,017	$	25,017	$	—	$	25,017	$	—



					Fair Value Hierarchy
	Balance		Estimated Fair Value		Level 1		Level 2		Level 3
December 31, 2018
Financial Assets:
Cash and cash equivalents	$	770,560	$	770,560	$	770,560	$	—	$	—
Restricted cash	$	1,151	$	1,151	$	1,151	$	—	$	—
Employee loans	$	3,525	$	3,525	$	—	$	—	$	3,525
Financial Liabilities:
Borrowings under the 2017 Credit Facility	$	25,020	$	25,020	$	—	$	25,020	$	—


5.	DERIVATIVE FINANCIAL INSTRUMENTS

In the normal course of business, the company uses derivative financial instruments to manage the risk of fluctuations in foreign currency exchange rates. The Company has a hedging program whereby it enters into a series of foreign exchange forward contracts with durations of twelve months or less that are designated as cash flow hedges of forecasted Russian ruble, Polish zloty and Indian rupee transactions. As of March 31, 2019, all of the Company’s foreign exchange forward contracts were designated as hedges and there is no financial collateral (including cash collateral) required to be posted by the Company related to the foreign exchange forward contracts.

The fair value of derivative instruments on the Company’s consolidated balance sheets as of March 31, 2019 and December 31, 2018 were as follows:



		As of March 31, 2019				As of December 31, 2018
	Balance Sheet Classification	Asset Derivatives		Liability Derivatives		Asset Derivatives		Liability Derivatives
Foreign exchange forward contracts - Designated as hedging instruments	Prepaid and other current assets	$	1,067			$	181
	Accrued expenses and other current liabilities			$	362			$	3,475

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

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The changes in the fair value of foreign currency derivative instruments in our unaudited condensed consolidated statements of income and comprehensive income for the three months ended March 31, 2019 and 2018 were as follows:



	Three Months Ended March 31,
	2019			2018
Foreign exchange forward contracts - Designated as hedging instruments:
Change in fair value recognized in accumulated other comprehensive loss	$	3,999		$	90
Net loss reclassified from accumulated other comprehensive loss into cost of revenues (exclusive of depreciation and amortization)	$	(452	)	$	—
Foreign exchange forward contracts - Not designated as hedging instruments:
Net gain recognized in foreign exchange loss	$	—		$	44

6. LEASES

The Company leases office space, corporate apartments, office equipment, and vehicles. The Company leases office space in order to minimize risks associated with ownership such as fluctuations in real estate prices. The leasing of corporate apartments is used to minimize costs associated with business trips of Company personnel. Many of the Company’s leases contain charges for common area maintenance or other miscellaneous expenses that are variable. Due to this variability, the cash flows associated with these charges are not included in the minimum lease payments used in determining the RoU Assets and associated lease liabilities. The Company subleases a portion of its office space to third parties. The Company leases office equipment for those assets requiring extensive customer support including maintenance, repairs and replacement of obsolete parts. The Company leases vehicles in certain locations primarily as an employee benefit.

The Company’s leases have remaining lease terms ranging from 9 days to 11.8 years. Certain lease agreements, mainly for office space, include options to extend or terminate the lease before the expiration date. The Company considers such options when determining the lease term when it is reasonably certain that the Company will exercise that option.

A portion of the leases for office space are subject to annual changes in base rent rates. Changes in such rates are treated as variable lease payments and are recognized in the period in which the obligation of such payments is incurred. The Company does not remeasure its lease liabilities as a result of these annual changes in base rent rates.

During the three months ended March 31, 2019, the components of lease expense were as follows:



	Income Statement Classification	Three Months Ended March 31, 2019
Operating lease cost	Selling, general and administrative expenses	$	13,719
Variable lease cost	Selling, general and administrative expenses	2,097
Short-term lease cost	Selling, general and administrative expenses	898
Sublease income	Interest and other income, net	(455		)
Total lease cost		$	16,259

Supplemental cash flow information related to leases was as follows:



	Three Months Ended March 31, 2019
Cash paid for amounts included in the measurement of lease liabilities:
Operating cash flows used for operating leases	$	14,696
Right-of-use assets obtained in exchange for lease obligations:
Operating leases	$	12,825
Non-cash net decrease due to lease modifications:
Operating lease right-of-use assets	$	5,174
Operating lease liabilities	$	5,106

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Weighted average lease terms and discount rates as of March 31, 2019:



	As of March 31, 2019
Weighted average remaining lease term, in years:
Operating leases	5.9
Weighted average discount rate:
Operating leases	4.0	%

As of March 31, 2019, operating lease liabilities will mature as follows:



Year ending December 31,	Lease Payments
2019 (excluding three months ended March 31, 2019)	$	34,903
2020	39,415
2021	31,324
2022	20,199
2023	15,911
Thereafter	48,096
Total lease payments	189,848
Less: imputed interest	(22,057		)
Total	$	167,791

There were no lease agreements that contained material restrictive covenants or material residual value guarantees as of March 31, 2019. There were no lease agreements signed with related parties as of March 31, 2019.

As of March 31, 2019, the Company had committed to payments of $57,716 related to operating lease agreements that had not yet commenced. These operating leases will commence during various dates during 2019 through 2020 with lease terms ranging from 1.3 to 12.0 years. The Company did not have any material finance lease agreements that had not yet commenced.


7.	LONG-TERM DEBT

Revolving Line of Credit — On May 24, 2017, the Company entered into an unsecured credit facility (the “2017 Credit Facility”), as may be amended from time to time, with PNC Bank, National Association; PNC Capital Markets LLC; Citibank N.A.; Wells Fargo Bank, National Association; Fifth Third Bank and Santander Bank, N.A. (collectively the “Lenders”). The 2017 Credit Facility provides for a borrowing capacity of $300,000, with potential to increase the credit facility up to $400,000 if certain conditions are met. The 2017 Credit Facility matures on May 24, 2022.

Borrowings under the 2017 Credit Facility may be denominated in U.S. dollars or up to a maximum of $100,000 equivalent in British pounds sterling, Canadian dollars, euros or Swiss francs and other currencies as may be approved by the administrative agent and the Lenders. Borrowings under the 2017 Credit Facility bear interest at either a base rate or Euro-rate plus a margin based on the Company’s leverage ratio. The base rate is equal to the highest of (a) the Overnight Bank Funding Rate, plus 0.5%, (b) the Prime Rate, and (c) the Daily LIBOR Rate, plus 1.0%. As of March 31, 2019, the Company’s outstanding borrowings are subject to a LIBOR-based interest rate which resets regularly at issuance, based on lending terms.

The 2017 Credit Facility includes customary business and financial covenants that may restrict the Company’s ability to make or pay dividends (other than certain intercompany dividends) if a potential or an actual event of default has occurred or would be triggered. As of March 31, 2019, the Company was in compliance with all covenants contained in the 2017 Credit Facility.

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The following table presents the outstanding debt and borrowing capacity of the Company under the 2017 Credit Facility:



	As of March 31, 2019			As of December 31, 2018
Outstanding debt	$	25,000		$	25,000
Interest rate	3.5		%	3.5		%
Irrevocable standby letters of credit	$	374		$	382
Available borrowing capacity	$	274,626		$	274,618
Current maximum borrowing capacity	$	300,000		$	300,000


8.	REVENUES

Disaggregation of Revenues

The Company’s revenues are sourced from four geographic markets: North America, Europe, CIS and APAC. CIS includes revenues from customers in Belarus, Kazakhstan, Russia and Ukraine and APAC, which stands for Asia Pacific, includes revenues from customers in Southeast Asia and Australia. The following tables present the disaggregation of the Company’s revenues by customer location, including a reconciliation of the disaggregated revenues with the reportable segments (Note 13 “Segment Information”) for the periods indicated:



	Three Months Ended March 31, 2019
	Reportable Segments
	North America		Europe		Russia		Total Segment Revenues		Other Income Included in Segment Revenues			Consolidated Revenues
Customer Locations
North America	$	303,745	$	12,891	$	16	$	316,652	$	—		$	316,652
Europe	4,747		168,767		141		173,655		(147		)	173,508
CIS	1,739		13		16,423		18,175		(1		)	18,174
APAC	458		12,552		—		13,010		(11		)	12,999
Revenues	$	310,689	$	194,223	$	16,580	$	521,492	$	(159	)	$	521,333



	Three Months Ended March 31, 2018
	Reportable Segments
	North America		Europe		Russia		Total Segment Revenues		Other Income Included in Segment Revenues			Consolidated Revenues
Customer Locations
North America	$	226,070	$	13,361	$	15	$	239,446	$	—		$	239,446
Europe	2,740		150,480		42		153,262		(177		)	153,085
CIS	2,003		63		19,714		21,780		—			21,780
APAC	383		9,439		15		9,837		—			9,837
Revenues	$	231,196	$	173,343	$	19,786	$	424,325	$	(177	)	$	424,148

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The following tables present the disaggregation of the Company’s revenues by industry vertical, including a reconciliation of the disaggregated revenues with the reportable segments (Note 13 “Segment Information”) for the periods indicated:



	Three Months Ended March 31, 2019
	Reportable Segments
	North America		Europe		Russia		Total Segment Revenues		Other Income Included in Segment Revenues			Consolidated Revenues
Industry Verticals
Financial Services	$	38,394	$	61,988	$	13,032	$	113,414	$	(153	)	$	113,261
Travel & Consumer	47,000		55,202		2,124		104,326		—			104,326
Software & Hi-Tech	79,121		20,370		440		99,931		—			99,931
Business Information & Media	62,361		32,536		140		95,037		(5		)	95,032
Life Sciences & Healthcare	50,156		4,556		62		54,774		—			54,774
Emerging Verticals	33,657		19,571		782		54,010		(1		)	54,009
Revenues	$	310,689	$	194,223	$	16,580	$	521,492	$	(159	)	$	521,333



	Three Months Ended March 31, 2018
	Reportable Segments
	North America		Europe		Russia		Total Segment Revenues		Other Income Included in Segment Revenues			Consolidated Revenues
Industry Verticals
Financial Services	$	21,956	$	65,818	$	16,225	$	103,999	$	(177	)	$	103,822
Travel & Consumer	40,687		49,454		1,673		91,814		—			91,814
Software & Hi-Tech	60,564		20,294		764		81,622		—			81,622
Business Information & Media	57,337		18,870		—		76,207		—			76,207
Life Sciences & Healthcare	27,467		4,823		—		32,290		—			32,290
Emerging Verticals	23,185		14,084		1,124		38,393		—			38,393
Revenues	$	231,196	$	173,343	$	19,786	$	424,325	$	(177	)	$	424,148

The following tables present the disaggregation of the Company’s revenues by contract type including a reconciliation of the disaggregated revenues with the Company’s reportable segments (Note 13 “Segment Information”) for the periods indicated:



	Three Months Ended March 31, 2019
	Reportable Segments
	North America		Europe		Russia		Total Segment Revenues		Other Income Included in Segment Revenues			Consolidated Revenues
Contract Types
Time-and-material	$	284,725	$	168,213	$	11,272	$	464,210	$	—		$	464,210
Fixed-price	24,740		25,246		5,287		55,273		—			55,273
Licensing	836		398		6		1,240		—			1,240
Other revenues	388		366		15		769		(159		)	610
Revenues	$	310,689	$	194,223	$	16,580	$	521,492	$	(159	)	$	521,333

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	Three Months Ended March 31, 2018
	Reportable Segments
	North America		Europe		Russia		Total Segment Revenues		Other Income Included in Segment Revenues			Consolidated Revenues
Contract Types
Time-and-material	$	214,316	$	159,466	$	10,096	$	383,878	$	—		$	383,878
Fixed-price	15,992		12,953		9,672		38,617		—			38,617
Licensing	662		619		10		1,291		—			1,291
Other revenues	226		305		8		539		(177		)	362
Revenues	$	231,196	$	173,343	$	19,786	$	424,325	$	(177	)	$	424,148

Timing of Revenue Recognition

The following tables present the timing of revenue recognition for the periods indicated:



	Three Months Ended March 31, 2019
	Reportable Segments
	North America		Europe		Russia		Total Segment Revenues		Other Income Included in Segment Revenues			Consolidated Revenues
Timing of Revenue Recognition
Transferred at a point of time	$	404	$	205	$	1	$	610	$	(159	)	$	451
Transferred over time	310,285		194,018		16,579		520,882		—			520,882
Revenues	$	310,689	$	194,223	$	16,580	$	521,492	$	(159	)	$	521,333



	Three Months Ended March 31, 2018
	Reportable Segments
	North America		Europe		Russia		Total Segment Revenues		Other Income Included in Segment Revenues			Consolidated Revenues
Timing of Revenue Recognition
Transferred at a point of time	$	344	$	428	$	10	$	782	$	(177	)	$	605
Transferred over time	230,852		172,915		19,776		423,543		—			423,543
Revenues	$	231,196	$	173,343	$	19,786	$	424,325	$	(177	)	$	424,148

During the three months ended March 31, 2019 and March 31, 2018, the Company recognized $1,704 and $5,404 of revenues, respectively, from performance obligations satisfied in previous periods.

The following table includes the estimated revenues expected to be recognized in the future related to performance obligations that are partially or fully unsatisfied as of March 31, 2019. The Company applies a practical expedient and does not disclose the value of unsatisfied performance obligations for contracts that (i) have an original expected duration of one year or less and (ii) contracts for which it recognizes revenues at the amount to which it has the right to invoice for services provided:



	Less than 1 year		1 Year		2 Years		3 Years		Total
Contract Type
Fixed-price	$	8,962	$	530	$	310	$	—	$	9,802

The Company applies a practical expedient and does not disclose the amount of the transaction price allocated to the remaining performance obligations nor provide an explanation of when the Company expects to recognize that amount as revenue for certain variable consideration.

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Contract Balances

The following table provides information on the classification of contract assets and liabilities in the condensed consolidated balance sheets:



	As of March 31, 2019		As of December 31, 2018
Contract assets included in Unbilled revenues	$	17,827	$	13,522
Contract liabilities included in Accrued expenses and other current liabilities	$	8,696	$	4,558
Contract liabilities included in Other noncurrent liabilities	$	146	$	224

Contract assets included in unbilled revenues are recorded when services have been provided but the Company does not have an unconditional right to receive consideration. The Company recognizes an impairment loss when the contract carrying amount is greater than the remaining consideration receivable, less directly related costs to be incurred. Contract assets have increased from December 31, 2018 primarily due to new contracts entered into in 2019 where the Company’s right to bill is contingent upon achievement of contractual milestones.

Contract liabilities comprise amounts collected from the Company’s customers for revenues not yet earned. Such amounts are anticipated to be recorded as revenues when services are performed in subsequent periods. Contract liabilities have increased from December 31, 2018 primarily due to the seasonal increase in customer prepayments during the three months ended March 31, 2019. During the three months ended March 31, 2019, the Company recognized $3,051 of revenues that were included in Accrued expenses and other current liabilities at December 31, 2018.


9.	INCOME TAXES

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

The Company’s worldwide effective tax rates for the three months ended March 31, 2019 and 2018 were 5.4% and (34.5)%, respectively.

The Company’s effective tax rates benefited from excess tax benefits recorded upon vesting or exercise of stock-based awards of $11,513 and $4,690 during the three months ended March 31, 2019 and 2018, respectively.

The interim benefit from income taxes in the three months ended March 31, 2018 was favorably impacted by the recognition of $24,634 of net deferred tax assets resulting from the Company’s decision to change the tax status and to classify most of its foreign subsidiaries as disregarded for U.S. income tax purposes. This was partially offset by a provisional $2,157 increase in income taxes payable associated with the one-time transition tax on accumulated foreign subsidiary earnings not previously subject to U.S. income tax imposed by the Tax Cuts and Jobs Act (“U.S. Tax Act”).


10.	EARNINGS PER SHARE

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

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The following table sets forth the computation of basic and diluted earnings per share of common stock as follows:



	Three Months Ended March 31,
	2019		2018
Numerator for basic and diluted earnings per share:
Net income	$	60,754	$	64,418
Numerator for basic and diluted earnings per share	$	60,754	$	64,418

Denominator:
Weighted average common shares for basic earnings per share	54,245,133		53,078,529
Net effect of dilutive stock options, restricted stock units and restricted stock awards	2,991,294		3,162,010
Weighted average common shares for diluted earnings per share	57,236,427		56,240,539

Net income per share:
Basic	$	1.12	$	1.21
Diluted	$	1.06	$	1.15

The number of shares underlying equity–based awards that were excluded from the calculation of diluted earnings per share as their effect would be anti–dilutive was 26,203 and 53,230 during the three months ended March 31, 2019 and 2018, respectively.


11.	COMMITMENTS AND CONTINGENCIES

Indemnification Obligations — In the normal course of business, the Company is a party to a variety of agreements under which it may be obligated to indemnify the other party for certain matters. These obligations typically arise in contracts where the Company customarily agrees to hold the other party harmless against losses arising from a breach of representations or covenants for certain matters such as title to assets, intellectual property rights and data privacy matters associated with certain arrangements. The duration of these indemnifications varies, and in certain cases, is indefinite.

The Company is unable to reasonably estimate the maximum potential amount of future payments under these or similar agreements due to the unique facts and circumstances of each agreement and the fact that certain indemnifications provide for no limitation to the maximum potential future payments under the indemnification. Management is not aware of any such matters that would have a material effect on the condensed consolidated financial statements of the Company.

Litigation — From time to time, the Company is involved in litigation, claims or other contingencies arising in the ordinary course of business. The Company accrues a liability when a loss is considered probable and the amount can be reasonably estimated. When a material loss contingency is reasonably possible but not probable, the Company does not record a liability, but instead discloses the nature and the amount of the claim, and an estimate of the loss or range of loss, if such an estimate can be made. Legal fees are expensed as incurred. In the opinion of management, the outcome of any existing claims and legal or regulatory proceedings, if decided adversely, is not expected to have a material effect on the Company’s business, financial condition, results of operations or cash flows.


12.	STOCK-BASED COMPENSATION

The following table summarizes the components of stock-based compensation expense recognized in the Company’s condensed consolidated statements of income and comprehensive income for the periods indicated:



	Three Months Ended March 31,
	2019		2018
Cost of revenues (exclusive of depreciation and amortization)	$	12,781	$	8,289
Selling, general and administrative expenses	9,075		8,307
Total	$	21,856	$	16,596

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Stock Options

Stock option activity under the Company’s plans is set forth below:



	Number of Options		Weighted Average Exercise Price		Aggregate Intrinsic Value		Weighted Average Remaining Contractual Term (in years)
Options outstanding at January 1, 2019	4,082,944		$	44.54
Options granted	131,849		$	169.13
Options modified	17,871		$	163.55
Options exercised	(323,464	)	$	36.76
Options forfeited/cancelled	(2,624	)	$	61.38
Options outstanding at March 31, 2019	3,906,576		$	49.92	$	465,698	5.4

Options vested and exercisable at March 31, 2019	3,422,907		$	41.11	$	438,196	5.0
Options expected to vest at March 31, 2019	445,175		$	111.17	$	25,804	8.6

As of March 31, 2019, $17,097 of total remaining unrecognized stock-based compensation cost related to unvested stock options, net of estimated forfeitures, is expected to be recognized over the weighted-average remaining requisite service period of 3.1 years.

Restricted Stock and Restricted Stock Units

Service-Based Awards

The table below summarizes activity related to the Company’s equity-classified and liability-classified service-based awards for the three months ended March 31, 2019.



	Equity-Classified Restricted Stock			Equity-Classified Equity-Settled Restricted Stock Units				Liability-Classified Cash-Settled Restricted Stock Units
	Number of Shares	Weighted Average Grant Date Fair Value Per Share		Number of Shares		Weighted Average Grant Date Fair Value Per Share		Number of Shares		Weighted Average Grant Date Fair Value Per Share
Unvested service-based awards outstanding at January 1, 2019	793	$	63.10	797,903		$	92.13	302,967		$	83.99
Awards granted	—	$	—	242,783		$	168.95	48,632		$	169.13
Awards modified	—	$	—	6,897		$	170.74	668		$	168.36
Awards vested	—	$	—	(242,414	)	$	85.38	(102,902	)	$	80.55
Awards forfeited/cancelled	—	$	—	(9,769	)	$	91.07	(1,653	)	$	86.79
Unvested service-based awards outstanding at March 31, 2019	793	$	63.10	795,400		$	118.33	247,712		$	102.34

As of March 31, 2019, $32 of total remaining unrecognized stock-based compensation cost related to service-based equity-classified restricted stock is expected to be recognized over the weighted-average remaining requisite service period of 1.3 years.

As of March 31, 2019, $80,152 of total remaining unrecognized stock-based compensation cost related to service-based equity-classified restricted stock units (“RSUs”), net of estimated forfeitures, is expected to be recognized over the weighted-average remaining requisite service period of 3.1 years.

As of March 31, 2019, $33,762 of total remaining unrecognized stock-based compensation cost related to service-based liability-classified RSUs, net of estimated forfeitures, is expected to be recognized over the weighted-average remaining requisite service period of 2.5 years.

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The liability associated with the service-based liability-classified RSUs as of March 31, 2019 and December 31, 2018, was $9,673 and $9,920, respectively, and was classified as Deferred compensation due to employees in the condensed consolidated balance sheets.

Performance-Based Awards

The table below summarizes activity related to the Company’s equity-classified performance-based awards for the three months ended March 31, 2019.



	Equity-Classified Equity-Settled Restricted Stock Units
	Number of Shares		Weighted Average Grant Date Fair Value Per Share
Unvested performance-based awards outstanding at January 1, 2019	29,592		$	121.75
Awards modified	(29,592	)	$	121.75
Unvested performance-based awards outstanding at March 31, 2019	—		$	—

During the first quarter of 2019, the Company and holders of the unvested performance-based equity-classified RSUs mutually agreed to cancel the performance-based RSU awards and the Company issued service-based stock option and RSU awards with four-year vesting terms to those same recipients. As of March 31, 2019, there is no remaining unrecognized stock-based compensation cost related to performance-based equity-classified RSUs.


13.	SEGMENT INFORMATION

The Company determines its business segments and reports segment information in accordance with how the Company’s chief operating decision maker (“CODM”) organizes the segments to evaluate performance, allocate resources and make business decisions. Segment results are based on the segment’s revenues and operating profit, where segment operating profit is defined as income from operations before unallocated costs. 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, non-corporate taxes, 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 amortization of acquisition-related intangible assets, goodwill and other asset impairment charges, stock-based compensation expenses, acquisition-related costs and certain other one-time charges. These unallocated amounts are combined with total segment operating profit to arrive at consolidated income from operations as reported below in the reconciliation of segment operating profit to consolidated income before provision for/(benefit from) income taxes. Additionally, management has determined that it is not practical to allocate identifiable assets by segment since such assets are used interchangeably among the segments.

The Company manages its 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 the Company’s 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.

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Revenues from external customers and operating profit, before unallocated expenses, by reportable segments for the three months ended March 31, 2019 and 2018, were as follows:



	Three Months Ended March 31,
	2019		2018
Segment revenues:
North America	$	310,689	$	231,196
Europe	194,223		173,343
Russia	16,580		19,786
Total segment revenues	$	521,492	$	424,325
Segment operating profit:
North America	$	64,457	$	43,960
Europe	31,785		28,890
Russia	589		5,347
Total segment operating profit	$	96,831	$	78,197

Intersegment transactions were excluded from the above on the basis that they are neither included in the measure of a segment’s profit and loss results, nor considered by the CODM during the review of segment results.

There were no customers that accounted for more than 10% of total segment revenues during the three months ended March 31, 2019 and 2018. Accounts receivable and unbilled revenues are generally dispersed across the Company’s customers in proportion to their revenues. There were no customers individually exceeding 10% of total unbilled revenues as of March 31, 2019 and December 31, 2018. There were no customers individually exceeding 10% of total accounts receivable as of March 31, 2019 and December 31, 2018.

Reconciliation of segment revenues to consolidated revenues and segment operating profit to consolidated income before provision for/(benefit from) income taxes is presented below:



	Three Months Ended March 31,
	2019			2018
Total segment revenues	$	521,492		$	424,325
Other income included in segment revenues	(159		)	(177		)
Revenues	$	521,333		$	424,148

Total segment operating profit:	$	96,831		$	78,197
Unallocated amounts:
Other income included in segment revenues	(159		)	(177		)
Stock-based compensation expense	(21,856		)	(16,596		)
Non-corporate taxes	(1,728		)	(2,560		)
Professional fees	(1,769		)	(1,916		)
Depreciation and amortization expense	(2,140		)	(1,769		)
Bank charges	(606		)	(589		)
One-time charges and other acquisition-related expenses	(546		)	(620		)
Other operating expenses	(3,369		)	(5,273		)
Income from operations	64,658			48,697
Interest and other income/(loss), net	3,076			(551		)
Foreign exchange loss	(3,484		)	(247		)
Income before provision for/(benefit from) income taxes	$	64,250		$	47,899

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Geographic Area Information

Long-lived assets include property and equipment, net of accumulated depreciation and amortization, and management has determined that it is not practical to allocate these assets by segment since such assets are used interchangeably among the segments. Physical locations and values of the Company’s long-lived assets are presented below:



	As of March 31, 2019		As of December 31, 2018
Belarus	$	50,065	$	50,085
United States	14,028		13,101
Russia	11,191		9,902
Ukraine	9,435		8,433
India	6,863		7,019
Hungary	3,144		3,168
Poland	2,759		2,637
China	2,479		2,651
Other	5,841		5,650
Total	$	105,805	$	102,646

The table below presents information about the Company’s revenues by customer location for the three months ended March 31, 2019 and 2018.



	Three Months Ended March 31,
	2019		2018
United States	$	299,680	$	223,683
United Kingdom	65,739		51,730
Switzerland	36,233		35,604
Netherlands	20,616		17,649
Germany	19,154		19,488
Canada	16,972		15,763
Russia	15,892		19,412
Other	47,047		40,819
Total	$	521,333	$	424,148

14. SUBSEQUENT EVENTS

On April 30, 2019, the Company acquired 100% of the equity interests of a crowdtesting company, test IO GmbH, and its subsidiary. The purchase price was approximately $17,300 which was paid in cash at closing.

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

You should read the following discussion and analysis of our financial condition and results of operations together with our Annual Report on Form 10-K for the year ended December 31, 2018 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 “Part I. Item 1A. Risk Factors.” 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.

Executive Summary

We are a leading global provider of digital platform engineering and software development services offering specialized technological solutions to many of the world’s leading organizations.

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 continuously explore opportunities in new industries to expand our core industry client base in software and technology, financial services, business information and media, travel, hospitality, retail, distribution, and life sciences and healthcare. Our teams of developers, architects, consultants, strategists, engineers, designers, and product experts have the capabilities and skill sets to deliver business results.

Our global delivery model and centralized support functions, combined with the benefits of scale from the shared use of fixed-cost resources, enhance our productivity levels and enable us to better manage the efficiency of our global operations. As a result, we have created a delivery base whereby our applications, tools, methodologies and infrastructure allow us to seamlessly deliver services and solutions from our delivery centers to global customers across all geographies, further strengthening our relationships with them.

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.

Year-to-Date 2019 Developments and Trends

We began 2019 with a strong start as reflected in our results and continued execution of our strategy. For the first three months of 2019, our revenues were $521.3 million, an increase of 22.9% over $424.1 million reported for the same period of 2018. Our account management teams work to expand the scope and size of our engagements with existing customers while at the same time we grow our customer base through our business development efforts and our strategic acquisitions.

We have built an increasingly diversified portfolio across numerous verticals, geographies and service offerings. Our performance remained strong across our key verticals, with our largest vertical, Financial Services, contributing 21.7% of total revenues for the first three months of 2019.

Summary of Results of Operations

The following table presents a summary of our results of operations for the three months ended March 31, 2019 and 2018:



	Three Months Ended March 31,
	2019					2018
	(in thousands, except per share data and percentages)
Revenues	$	521,333		100.0	%	$	424,148		100.0	%
Income from operations	$	64,658		12.4	%	$	48,697		11.5	%
Net income	$	60,754		11.7	%	$	64,418		15.2	%
Effective tax rate	5.4		%			(34.5		)%
Diluted earnings per share	$	1.06				$	1.15

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The key highlights of our consolidated results for the three months ended March 31, 2019, as compared to the corresponding period of 2018, were as follows:

•

Revenues for the first quarter of 2019 were $521.3 million, or a 22.9% increase from $424.1 million reported in the same period last year. The first quarter of 2019 was negatively impacted by $14.2 million or 3.4% due to changes in certain foreign currency exchange rates as compared to the corresponding period last year. Acquisitions completed during 2018, Continuum and Think, contributed $6.8 million and $3.8 million of revenues, respectively, to the total revenues for the first quarter of 2019.

•

Income from operations grew 32.8% to $64.7 million from $48.7 million during the three months ended March 31, 2019, as compared to the corresponding period in 2018. Expressed as a percentage of revenues, income from operations for the first quarter of 2019 was 12.4% compared to 11.5% in the first quarter last year. The increase as a percentage of revenues was primarily driven by an improvement in selling, general and administrative expenses as a percentage of revenues partially offset by an increase in cost of revenues as a percentage of revenues as compared to the same period last year.

•

Our effective tax rate was 5.4% in the first three months of 2019 compared to (34.5)% in the corresponding period last year. The interim benefit from income taxes in the three months ended March 31, 2018 was favorably impacted by the recognition of $24.6 million of net deferred tax assets resulting from the Company’s decision to change the tax status and to classify most of its foreign subsidiaries as disregarded for U.S. income tax purposes.

•

Net income decreased 5.7% to $60.8 million for the three months ended March 31, 2019, compared to $64.4 million reported in the corresponding period last year. Expressed as a percentage of revenues, net income was 11.7%, a decrease of 3.5% compared to 15.2% reported in the corresponding period of 2018. This trend is largely driven by the lower effective tax rate during the first quarter of 2018 partially offset by the improvement in income from operations as a percentage of revenues.


•	Diluted earnings per share was $1.06 for the three months ended March 31, 2019, a decrease of $0.09 compared to the corresponding period last year.


•	Cash used in operating activities was $0.2 million during the three months ended March 31, 2019 as compared to cash provided by operating activities of $7.3 million in the corresponding period last year.

The operating results in any period are not necessarily indicative of the results that may be expected for any future period.

Critical Accounting Policies

The discussion and analysis of our financial position and results of operations is based on our 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.

Other than as discussed below, during the three months ended March 31, 2019, there have been no material changes to our critical accounting policies or in the underlying accounting assumptions and estimates used in such policies as reported in our Annual Report on Form 10-K for the year ended December 31, 2018.

Leases — The Company determines if an arrangement is a lease or contains a lease at inception. The Company performs an assessment and classifies the lease as either an operating lease or a financing lease at the lease commencement date with a right-of-use asset (“RoU Assets”) and a lease liability recognized in the statement of financial position under both classifications.

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Lease liabilities are initially measured at the present value of lease payments not yet paid. The present value is determined by applying the readily determinable rate implicit in the lease or, if not available, the incremental borrowing rate of the lessee. The Company determines the incremental borrowing rate of the lessee on a lease-by-lease basis by developing an estimated centralized U.S. dollar borrowing rate for a fully collateralized obligation with a term similar to the lease term, and adjusts the rate to reflect the incremental risk associated with the currency in which the lease is denominated. Lease agreements of the Company may include options to extend or terminate the lease. The Company includes such options into the lease term when it is reasonably certain that the Company will exercise that option. RoU Assets are recognized based on the initial measurement of the lease liabilities plus initial direct costs less lease incentives. Lease expense for operating leases is recognized on a straight-line basis over the lease term. RoU Assets are subject to periodic impairment tests.

The Company has elected a practical expedient to account for lease and non-lease components together as a single lease component. In addition, the Company elected the short-term lease recognition exemption for all classes of lease assets.

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.



	Three Months Ended March 31,
	2019					2018
	(in thousands, except percentages)
Revenues	$	521,333		100.0	%	$	424,148		100.0	%
Operating expenses:
Cost of revenues (exclusive of depreciation and amortization)⁽¹⁾	344,689			66.1	%	277,634			65.5	%
Selling, general and administrative expenses⁽²⁾	101,786			19.5	%	89,641			21.1	%
Depreciation and amortization expense	10,200			2.0	%	8,176			1.9	%
Income from operations	64,658			12.4	%	48,697			11.5	%
Interest and other income/(loss), net	3,076			0.6	%	(551		)	(0.1	)%
Foreign exchange loss	(3,484		)	(0.7	)%	(247		)	(0.1	)%
Income before provision for/(benefit from) income taxes	64,250			12.3	%	47,899			11.3	%
Provision for/(benefit from) income taxes	3,496			0.6	%	(16,519		)	(3.9	)%
Net income	$	60,754		11.7	%	$	64,418		15.2	%

Effective tax rate	5.4		%			(34.5		)%
Diluted earnings per share	$	1.06				$	1.15


(1)	Includes $12,781 and $8,289 of stock-based compensation expense for the three months ended March 31, 2019 and 2018, respectively.


(2)	Includes $9,075 and $8,307 of stock-based compensation expense for the three months ended March 31, 2019 and 2018, respectively.

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Consolidated Results Review

Revenues

During the three months ended March 31, 2019, our total revenues grew 22.9% over the corresponding period in 2018 to $521.3 million. This growth results from our ability to retain existing customers and increase the level of services we provide to them and our ability to produce revenues from new customer relationships. Continuous diversification of our client portfolio is demonstrated by revenues from our top five, top ten and top twenty customers decreasing as a percentage of total revenues for the three months ended March 31, 2019 as compared to the same period last year. Revenues during the three months ended March 31, 2019 as compared to the corresponding period last year have been positively impacted from the acquisitions of Continuum and Think, which contributed 2.1% to our revenue growth, and negatively impacted by the fluctuations in foreign currency, which reduced our revenue growth by 3.4%.

Revenues by customer location for the three months ended March 31, 2019 and 2018 were as follows:



	Three Months Ended March 31,
	2019				2018
	(in thousands, except percentages)
North America	$	316,652	60.7	%	$	239,446	56.5	%
Europe	173,508		33.3	%	153,085		36.1	%
CIS⁽¹⁾	18,174		3.5	%	21,780		5.1	%
APAC⁽²⁾	12,999		2.5	%	9,837		2.3	%
Revenues	$	521,333	100.0	%	$	424,148	100.0	%


(1)	CIS includes revenues from customers in Belarus, Kazakhstan, Russia and Ukraine.


(2)	APAC, which stands for Asia Pacific, includes revenues from customers in Southeast Asia and Australia.

During the three months ended March 31, 2019, the United States continued to be our largest customer location with revenues of $299.7 million compared to $223.7 million in the first quarter of 2018, driving 34.0% growth in revenues in the North American geography. Revenues in the North American geography were negatively impacted by the reassignment of a certain customer’s revenues to the European geography as a result of a change in location where we serve that customer, along with a change in managerial responsibility for the customer relationship. Without this reassignment, revenue growth in North America would have been 37.0%.

The top three revenue contributing customer location countries in Europe were the United Kingdom, Switzerland and Germany, contributing $65.7 million, $36.2 million and $19.2 million, respectively, during the three months ended March 31, 2019. Revenues from customers in these three countries were $51.7 million, $35.6 million, and $19.5 million, respectively, in the corresponding period last year. Revenues in the European geography were negatively impacted by fluctuations in foreign currency exchange rates with the U.S. dollar, particularly the euro and the British pound, during the three months ended March 31, 2019 compared to the same period last year. Revenues in the European geography benefited from the reassignment of a certain customer’s revenues from North America as a result of a change in location where we serve that customer along with a change in managerial responsibility for the customer relationship. Without this reassignment, revenue growth in Europe would have been 5.9% rather than 13.3%.

During the three months ended March 31, 2019, revenues in the CIS geography included $15.9 million from customers in Russia, a decrease of $3.5 million over the corresponding period of 2018. The revenues in the CIS geography were adversely impacted by the timing of revenue recognition associated with the execution of contracts and were negatively affected by currency fluctuations, primarily Russian rubles, contributing a 12.5% decline to the year-over-year decrease of reported revenues in this geography in the first quarter of 2019 as compared to the same period last year.

During the first quarter of 2019, revenues from the customers in the APAC region increased by $3.2 million, or 32.1%, over the corresponding period of 2018.

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Cost of Revenues (Exclusive of Depreciation and Amortization)

The principal components of our cost of revenues (exclusive of depreciation and amortization) are salaries, bonuses, fringe benefits, stock-based compensation expense, project-related travel costs and fees for subcontractors who are assigned to customer projects. Salaries and other compensation expenses of our revenue generating professionals are reported as cost of revenues regardless of whether the employees are actually performing customer services during a given period. Our employees are a critical asset, necessary for our continued success and therefore we expect to continue hiring talented employees and providing them with competitive compensation programs.

We manage the utilization levels of our professionals through strategic hiring and efficient staffing of projects. Some of our IT professionals are hired and trained to work for specific customers or on specific projects and some of our offshore development centers are dedicated to specific customers or projects. Our staff utilization also depends on the general economy and its effect on our customers and their business decisions regarding the use of our services.

During the three months ended March 31, 2019, cost of revenues (exclusive of depreciation and amortization) was $344.7 million representing an increase of 24.2% from $277.6 million in the corresponding period of 2018. The increase was primarily due to an increase in compensation costs largely driven by the 17.0% growth in the average number of production headcount during the three months ended March 31, 2019 as compared to the same period in 2018 partially offset by a 4.7% favorable impact from changing foreign currency exchange rates.

Expressed as a percentage of revenues, cost of revenues (exclusive of depreciation and amortization) was 66.1% and 65.5% in the first quarter of 2019 and 2018, respectively. The year-over-year increase is primarily due to an incremental $5.1 million of expense associated with the mark-to-market for cash-settled RSUs granted to our revenue generating personnel driven by the increase in our stock price.

Selling, General and Administrative Expenses

Selling, general and administrative expenses represent expenses 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 expense, severance, travel, legal and audit services, insurance, operating leases including lease exit costs, advertising and other promotional activities. In addition, we pay a membership fee of 1% of revenues generated in Belarus to the administrative organization of the Belarus High-Technologies Park. We expect our selling, general and administrative expenses to continue to increase in absolute terms as our business expands but generally to remain steady as a percentage of our revenues in the foreseeable future.

During the three months ended March 31, 2019, selling, general and administrative expenses were $101.8 million representing an increase of 13.5% as compared to $89.6 million in the corresponding period of 2018. The increase in selling, general and administrative expenses was primarily driven by a $9.3 million increase in personnel-related costs including stock-based compensation, talent acquisition and development expenses and a $5.3 million increase in facilities and infrastructure related expenses to support our growth.

Expressed as a percentage of revenue, selling, general and administrative expenses decreased 1.6% to 19.5% for the three months ended March 31, 2019 as compared to the same period from the prior year primarily due to the slower growth in selling, general and administrative expenses as compared to the growth in revenues in the period.

Depreciation and Amortization Expense

During the three months ended March 31, 2019, depreciation and amortization expense was $10.2 million as compared to $8.2 million in the corresponding period last year. The increase in depreciation and amortization expense is primarily the result of increased investment in computer equipment used by our employees and amortization of acquired intangible assets, all of which have finite useful lives. Expressed as a percentage of revenues, depreciation and amortization expense remained consistent during the three months ended March 31, 2019 as compared to the corresponding period of 2018.

Interest and Other Income, Net

Interest and other income, net includes interest earned on cash and cash equivalents and employee housing loans, gains and losses from certain financial instruments, interest expense related to our revolving credit facility and changes in the fair value of contingent consideration. There were no material changes in interest and other income, net during the three months ended March 31, 2019 as compared to the same period in 2018.

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Provision for/(Benefit from) Income Taxes

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 annual 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.

As a global company, we are required to calculate and provide for income taxes in each of the jurisdictions in which we operate. Our effective tax rate was 5.4% for the three months ended March 31, 2019, and (34.5)% for the three months ended March 31, 2018.

Our effective tax rates benefited from excess tax benefits recorded upon vesting or exercise of stock-based awards of $11,513 and $4,690 during the three months ended March 31, 2019 and 2018, respectively

The interim benefit from income taxes in the three months ended March 31, 2018 was favorably impacted by the recognition of $24,634 of net deferred tax assets resulting from the Company’s decision to change the tax status and to classify most of our foreign subsidiaries as disregarded for U.S. income tax purposes. This was partially offset by a provisional $2,157 increase in income taxes payable associated with the one-time transition tax on accumulated foreign subsidiary earnings not previously subject to U.S. income tax imposed by the Tax Cuts and Jobs Act (“U.S. Tax Act”).

Foreign Exchange Loss

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

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. Such expenses include certain types of professional fees, non-corporate taxes, 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 amortization of acquisition-related intangible assets, goodwill and other asset impairment charges, stock-based compensation expenses, acquisition-related costs and certain other one-time charges. These unallocated amounts are combined with total segment operating profit to arrive at consolidated income from operations.

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.

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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, 2019 and 2018 were as follows:



	Three Months Ended March 31,
	2019		2018
	(in thousands)
Segment revenues:
North America	$	310,689	$	231,196
Europe	194,223		173,343
Russia	16,580		19,786
Total segment revenues	$	521,492	$	424,325
Segment operating profit:
North America	$	64,457	$	43,960
Europe	31,785		28,890
Russia	589		5,347
Total segment operating profit	$	96,831	$	78,197

North America Segment

During the three months ended March 31, 2019, revenues for the North America segment increased $79.5 million, or 34.4%, compared to the same period last year and segment operating profits increased $20.5 million, or 46.6%, compared to the same period last year. Revenues were negatively impacted by the reassignment of a certain customer to the Europe segment from the North America segment as a result of a change in managerial responsibility. Without this reassignment, North America segment growth would have been 39.3%. During the three months ended March 31, 2019, revenues from our North America segment were 59.6% of total segment revenues, an increase from 54.5% reported in the corresponding period of 2018.

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



	Three Months Ended March 31,				Change
	2019		2018		Dollars		Percentage
Industry Vertical	(in thousands, except percentages)
Software & Hi-Tech	$	79,121	$	60,564	$	18,557	30.6	%
Business Information & Media	62,361		57,337		5,024		8.8	%
Life Sciences & Healthcare	50,156		27,467		22,689		82.6	%
Travel & Consumer	47,000		40,687		6,313		15.5	%
Financial Services	38,394		21,956		16,438		74.9	%
Emerging Verticals	33,657		23,185		10,472		45.2	%
Revenues	$	310,689	$	231,196	$	79,493	34.4	%

Software & Hi-Tech remained the largest industry vertical in the North America segment during the first quarter of 2019. It grew 30.6% during the three months ended March 31, 2019, as compared to the corresponding periods from the prior year, which was a result of the continued focus on working with our technology customers. The revenues from the Life Sciences & Healthcare, Financial Services and Emerging Verticals each grew in excess of 45% during the three months ended March 31, 2019 compared to the same period in the prior year. The revenues from Business Information & Media grew 8.8% as compared to the corresponding period from the prior year and were adversely impacted by the reassignment of a certain customer to the Europe segment. Without this reassignment, the Business Information & Media vertical would have grown 28.6%.

The North America segment’s operating profit margin increased to 20.7% during the first quarter of 2018 from 19.0% in the first quarter of 2018. This increase reflects the impact from depreciation of foreign currencies in which our global delivery centers operate.

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Europe Segment

During the three months ended March 31, 2019, Europe’s segment revenues were $194.2 million, representing an increase of $20.9 million, or 12.0%, from the same period last year. Revenues were negatively impacted by changes in foreign currency exchange rates during the first quarter of 2019. Had our Europe segment revenues been expressed in constant currency terms using the exchange rates in effect during the first quarter of 2018, we would have reported revenue growth of 17.8%. Revenues benefited from the reassignment of a certain customer to the Europe segment from the North America segment as a result of a change in managerial responsibility. Without this reassignment, Europe segment growth would have been 5.5%. Europe’s segment revenues accounted for 37.2% and 40.9% of total segment revenues during the three months ended March 31, 2019 and 2018, respectively.

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



	Three Months Ended March 31,				Change
	2019		2018		Dollars			Percentage
Industry Vertical	(in thousands, except percentages)
Financial Services	$	61,988	$	65,818	$	(3,830	)	(5.8	)%
Travel & Consumer	55,202		49,454		5,748			11.6	%
Software & Hi-Tech	20,370		20,294		76			0.4	%
Business Information & Media	32,536		18,870		13,666			72.4	%
Life Sciences & Healthcare	4,556		4,823		(267		)	(5.5	)%
Emerging Verticals	19,571		14,084		5,487			39.0	%
Revenues	$	194,223	$	173,343	$	20,880		12.0	%

The Europe segment benefited from strong growth of the Business Information & Media vertical of 72.4% during the three months ended March 31, 2019, as compared to corresponding periods of 2018. This is primarily due to the reassignment of a certain customer to the Europe segment from the North America segment as a result of a change in managerial responsibility. Without this reassignment, Business Information & Media growth would have been 12.0%. Financial Services remained the largest industry vertical in the Europe segment during the three months ended March 31, 2019. Revenues in Financial Services decreased during the three months ended March 31, 2019 as compared to the three months ended March 31, 2018 primarily due to depreciation of the euro and British pound. During the first quarter of 2019 compared to the first quarter of 2018, the segment’s operating profit increased $2.9 million, or 10.0%, to $31.8 million.

Russia Segment

During the three months ended March 31, 2019, revenues from our Russia segment accounted for 3.2% of total segment revenues, and segment revenues decreased $3.2 million, or 16.2%, as compared to the corresponding period last year. Russia segment revenues were adversely impacted by the timing of revenue recognition associated with the execution of contracts.

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



	Three Months Ended March 31,				Change
	2019		2018		Dollars			Percentage
Industry Vertical	(in thousands, except percentages)
Financial Services	$	13,032	$	16,225	$	(3,193	)	(19.7	)%
Travel & Consumer	2,124		1,673		451			27.0	%
Software & Hi-Tech	440		764		(324		)	(42.4	)%
Business Information & Media	140		—		140			100.0	%
Life Sciences & Healthcare	62		—		62			100.0	%
Emerging Verticals	782		1,124		(342		)	(30.4	)%
Revenues	$	16,580	$	19,786	$	(3,206	)	(16.2	)%

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During the three months ended March 31, 2019, operating profit of the Russia segment was $0.6 million, representing a decrease of $4.8 million, or 89.0%, as compared to the corresponding period last year. Currency fluctuations of the Russian ruble typically impact the results in the Russia segment. Ongoing economic and geo-political uncertainty in the region and the volatility of the Russian ruble can significantly impact reported revenues and operating profits in this geography. We continue to monitor geo-political forces, economic and trade sanctions, and other issues involving this region.

Effects of Inflation

Economies in some countries where we operate, particularly Belarus, Russia, Kazakhstan, Ukraine and India 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. Inflation may increase some of our expenses such as wages. While inflation may impact our results of operations and financial condition and it is difficult to accurately measure the impact of inflation, we believe the effects of inflation on our results of operations and financial condition are not significant.

Liquidity and Capital Resources

Capital Resources

Our cash generated from operations has been our primary source of liquidity to fund operations and investments to support the growth of our business. As of March 31, 2019, our principal sources of liquidity were cash and cash equivalents totaling $762.5 million and $274.6 million of available borrowings under our revolving credit facility.

We have cash in banks in Belarus, Russia, Ukraine, Kazakhstan, Armenia and Uzbekistan, where the banking sector remains subject to periodic instability, banking and other financial systems 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, 2019, the total amount of cash held in these countries was $205.4 million and of this amount, $147.8 million was located in Belarus.

As of March 31, 2019, we had $274.6 million available for borrowing under our revolving credit facility and our outstanding debt of $25.0 million represents the minimal required borrowing to keep the credit facility active. As of March 31, 2019, we were in compliance with all covenants specified under the credit facility and anticipate being in compliance for the foreseeable future. See Note 7 “Long-Term Debt” of our condensed consolidated financial statements in “Part I. Item 1. Financial Statements (Unaudited)” for information regarding our long-term debt.

Our ability to expand and grow our business in accordance with current plans and to meet our long-term capital requirements will depend on many factors, including the rate at which our cash flows increase or decrease and the availability of public and private debt and equity financing. We may require additional cash resources due to changed business conditions or other future developments, including any investments or acquisitions we may decide to pursue. If our resources are insufficient to satisfy our cash requirements, we may seek to sell additional equity or debt securities or obtain another credit facility.

Cash Flows

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



	Three Months Ended March 31,
	2019			2018
	(in thousands)
Condensed Consolidated Statements of Cash Flow Data:
Net cash (used in)/provided by operating activities	$	(202	)	$	7,330
Net cash used in investing activities	(18,560		)	(60,164		)
Net cash provided by financing activities	10,181			4,016
Effect of exchange rate changes on cash, cash equivalents and restricted cash	548			3,040
Net decrease in cash, cash equivalents and restricted cash	(8,033		)	(45,778		)
Cash, cash equivalents and restricted cash, beginning of period	771,711			582,855
Cash, cash equivalents and restricted cash, end of period	$	763,678		$	537,077

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Operating Activities

Net cash used in operating activities during the three months ended March 31, 2019 was $0.2 million compared to $7.3 million provided by operating activities in the corresponding period of 2018. Cash flows from operating activities in the first quarter are impacted by annual payments of variable compensation related to the prior performance year.

Investing Activities

Net cash used in investing activities during the three months ended March 31, 2019 was $18.6 million compared to $60.2 million used in the same period in 2018. During the first three months of 2019, the cash used in investing activities was primarily attributable to capital expenditures, which increased by $2.7 million compared to the same period last year. During the first three months of 2018, cash used in investing activities was primarily related to the $50.3 million acquisition of Continuum.

Financing Activities

Net cash provided by financing activities was $10.2 million in the first three months of 2019 compared to $4.0 million in the same period of 2018. During the first three months of 2019, net cash received from the exercises of stock options issued under our long-term incentive plans was $11.4 million, an increase of $3.8 million from the $7.6 million received during the same period last year.

Contractual Obligations and Future Capital Requirements

We believe that our existing cash and cash equivalents combined with our expected cash flow from operations will be sufficient to meet our projected operating and capital expenditure requirements for at least the next twelve months and that we possess the financial flexibility to execute our strategic objectives, including the ability to make acquisitions and strategic investments in the foreseeable future. However, our ability to generate cash is subject to our performance, general economic conditions, industry trends and other factors. To the extent that existing cash and cash equivalents and operating cash flow are insufficient to fund our future activities and requirements, we may need to raise additional funds through public or private equity or debt financing. If we issue equity securities in order to raise additional funds, substantial dilution to existing stockholders may occur. If we raise cash through the issuance of additional indebtedness, we may be subject to additional contractual restrictions on our business. There is no assurance that we would be able to raise additional funds on favorable terms or at all.

There have been no material changes with respect to the contractual obligations disclosed in “Part II. Item 7. Contractual Obligations and Future Capital Requirements” of our Annual Report on Form 10-K for the year ended December 31, 2018.

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 7 “Long-Term Debt” and Note 11 “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.

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Forward-Looking Statements

This quarterly report on Form 10-Q contains estimates and forward-looking statements, 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 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. Although we believe that these estimates and forward-looking statements are based upon reasonable assumptions, they are subject to several risks and uncertainties and are made in light of information currently available to us. Important factors, in addition to the factors described in this quarterly report, may materially and adversely affect our results as indicated in forward-looking statements. You should read this quarterly 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 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.

Item 3. Quantitative and Qualitative Disclosures About Market Risk

We are exposed to certain market risks in the ordinary course of our business. These risks primarily result from changes in concentration of credit risks, interest rates and foreign currency exchange rates. In addition, our international operations are subject to risks related to differing economic conditions, changes in political climate, differing tax structures, and other regulations and restrictions.

Concentration of Credit and Other Credit Risks

Financial instruments that potentially subject us to significant concentrations of credit risk consist primarily of cash and cash equivalents, trade accounts receivable and unbilled revenues.

We maintain our cash and cash equivalents and short-term investments with financial institutions. We believe that our credit policies reflect normal industry terms and business risk and we do not anticipate non-performance by the counterparties. We have cash in banks in countries such as Belarus, Russia, Ukraine, Kazakhstan, Armenia and Uzbekistan, where the banking sector remains subject to periodic instability, banking and other financial systems 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, 2019, $205.4 million of total cash was kept in banks in these countries, of which $147.8 million was held in Belarus. In this region, and particularly in Belarus, a banking crisis, bankruptcy or insolvency of banks that process or hold our funds, may result in the loss of our deposits or adversely affect our ability to complete banking transactions in the region, which could adversely affect our business and financial condition. Cash in this region is used for short-term operational needs and cash balances in those banks move with the needs of those entities.

Accounts receivable and unbilled revenues are generally dispersed across many customers operating in different industries; therefore, concentration of credit risk is limited. There were no customers individually exceeding 10% of our accounts receivable, unbilled revenues or total revenues as of March 31, 2019 and 2018.

Interest Rate Risk

Our exposure to market risk is influenced by the changes in interest rates on our cash and cash equivalent deposits and paid on any outstanding balance on our borrowings, mainly under our 2017 Credit Facility, which is subject to a variety of rates depending on the type and timing of funds borrowed. We do not believe we are exposed to material direct risks associated with changes in interest rates related to these deposits and borrowings.

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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, Canadian dollars and Russian rubles. Other than U.S. dollars, we incur expenditures principally in Russian rubles, Hungarian forints, Polish zlotys, British pounds, Swiss francs, euros, Indian rupees and Chinese yuan renminbi. As a result, currency fluctuations, specifically the depreciation of the euro, British pound, and Canadian dollar and the appreciation of Russian rubles, Hungarian forints, Polish zlotys, Chinese yuan renminbi and Indian rupees relative to the U.S. dollar, could negatively impact our results of operations.

During the quarter ended March 31, 2019, foreign exchange loss was $3.5 million compared to a loss of $0.2 million reported in the corresponding period last year.

During the quarter ended March 31, 2019, approximately 33.0% of consolidated revenues and 45.0% 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 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 Russian ruble, Polish zloty and Indian rupee transactions. As of March 31, 2019, the net unrealized gain from these hedges was $0.7 million.

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 2019, we reported revenue growth of 22.9% over the first quarter of 2018. Had our consolidated revenues been expressed in constant currency terms using the exchange rates in effect during the first quarter of 2018, we would have reported revenue growth of 26.3%. The revenues have been mainly impacted from the depreciation of the euro, British pound and Russian ruble relative to the U.S. dollar. During the first quarter of 2019, we reported a net income decrease of 5.7% over the first quarter of 2018. Had our consolidated results been expressed in constant currency terms using the exchange rates in effect during the first quarter of 2018, we would have reported a net income decrease of 9.3%. Net income has been most positively impacted by depreciation of the Russian ruble, Hungarian forint and Polish zlotys relative to the U.S. dollar partially offset by the depreciation of the euro and British pound relative to the U.S. dollar.

Item 4. Controls and Procedures

Conclusion Regarding the Effectiveness of Disclosure Controls and Procedures

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

Changes in Internal Control Over Financial Reporting

There has been no change in our internal control over financial reporting during the quarter ended March 31, 2019 that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.

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PART II. OTHER INFORMATION

Item 1. Legal Proceedings

From time to time, we are involved in litigation and claims arising out of our operations in the normal course of business. We are not currently a party to any material legal proceeding, nor are we aware of any material legal or governmental proceedings pending or contemplated to be brought against us.

Item 1A. Risk Factors

There have been no material changes with respect to the risk factors disclosed in “Part I. Item 1A. Risk Factors” of our Annual Report on Form 10-K for the year ended December 31, 2018.

Item 2. Unregistered Sales of Equity Securities and Use of Proceeds

None.

Item 3. Defaults Upon Senior Securities

None.

Item 4. Mine Safety Disclosures

Not Applicable.

Item 5. Other Information

None.

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Item 6. Exhibits



Exhibit Number		Description

10.1†		Form of Senior Management Restricted Stock Unit Award Agreement (under the EPAM Systems, Inc. 2015 Long Term Incentive Plan)
31.1		Certification of the Chief Executive Officer pursuant to Rule 13a-14(a)/15d-14(a) of the Securities Exchange Act of 1934
31.2		Certification of the Chief Financial Officer pursuant to Rule 13a-14(a)/15d-14(a) of the Securities Exchange Act of 1934
32.1		Certification of the Chief Executive Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
32.2		Certification of the Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
101.INS		XBRL Instance Document
101.SCH		XBRL Taxonomy Extension Schema Document
101.CAL		XBRL Taxonomy Extension Calculation Linkbase Document
101.DEF		XBRL Taxonomy Extension Definition Linkbase Document
101.LAB		XBRL Taxonomy Extension Label Linkbase Document
101.PRE		XBRL Taxonomy Extension Presentation Linkbase Document

†		Indicates management contracts or compensatory plans or arrangements

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SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

Date: May 9, 2019



	EPAM SYSTEMS, INC.

	By:	/s/ Arkadiy Dobkin
		Name: Arkadiy Dobkin
		Title: Chairman, Chief Executive Officer and President (principal executive officer)

	By:	/s/ Jason Peterson
		Name: Jason Peterson
		Title: Senior Vice President, Chief Financial Officer and Treasurer (principal financial officer)