IT player EPAM Systems (NYSE:EPAM) has done an excellent job of riding higher demand for software development, and turning it into strong growth. Instead of choosing a global sourcing strategy similar to what industry giant Accenture (NYSE:ACN) uses, EPAM relies on programmers from the Eastern European region for access to lower-cost, high-quality work.
Coming into Wednesday's third-quarter financial report, EPAM investors expected the company to keep delivering the same pace of sales and earnings growth that they've come to expect from the software developer. Yet EPAM's results included a rare miss on the top line, and its guidance suggested the possibility of slowing growth in the future. Let's look more closely at how EPAM Systems did, and whether the quarter's results are the beginning of a longer-term trend.
How EPAM only gave investors half of what they wanted
EPAM Systems' third-quarter results didn't satisfy every investor. Revenue jumped 22.5%, to $236 million, but that fell short of the nearly 25% growth rate that most investors had expected EPAM to post for the quarter. On the bottom line, though, EPAM delivered better performance, with 30% growth in adjusted operating income translating to adjusted earnings of $0.70 per share, $0.02 better than the consensus forecast among investors.
Looking more closely at the numbers, some of the same issues that have plagued EPAM Systems in the past continued to appear. Overhead costs rose 29%, with the company once again having to limit its costs of revenue by enough of a margin to keep overall operating margins wider than in the year-ago period. Similarly, stock-based compensation was up more than 60% from the year-ago quarter, affecting both overhead figures and overall costs of revenue, even though they mostly reflect the big increase in EPAM's share price.
CEO Arkadiy Dobkin didn't seem troubled by the revenue shortfall. "Our significant and continued efforts to evolve our capabilities and bring new value-add services to our clients strongly contributed to our overall growth," Dobkin said, and he was particularly pleased at how EPAM managed to overcome fierce currency headwinds to produce that growth.
Signs of sluggishness from EPAM Systems
Still, not everyone will be happy with the guidance that EPAM Systems gave for the remainder of the year. For the full 2015 year, EPAM expects about $900 million in sales, which is below the current consensus projection of $910 million due to further foreign-currency weakness. Adjusted net income growth of 25% is slightly higher than the 22% to 24% boost that EPAM predicted earlier in the year, but adjusted earnings of $2.65 per share would be about $0.05 below the current forecast among investors following the stock.
Industry experts aren't worried about EPAM. In September, the company joined the ranks of Fortune's 100 Fastest-Growing Companies for 2015, with a leadership role in the information technology services industry. Nevertheless, it's important to realize that Fortune's list is purely backward looking, using earnings per share and revenue growth, along with total investor return, as the metrics for judging performance.
Yet IT services are still subject to general economic conditions, and even giants in the industry have seen pressure from poor economic performance in some areas. Accenture saw sales rise only 1%, with a 6% rise in earnings representing a much slower pace of growth than Accenture investors had grown accustomed to seeing. At the same time, Accenture built up its backlog, pointing to better times ahead. If EPAM can match that performance, then it, too, could bounce back from this quarter's revenue miss.
EPAM Systems has been impressive, and it still has room to grow. Yet the stock fell following the company's earnings announcement, suggesting that investors are far from certain about its future prospects.
The question is whether it can keep growing quickly enough to satisfy longtime investors. If conditions in the IT market get better, then EPAM will be in a great position to take advantage of the larger opportunity. Otherwise, this quarter might be the beginning of a longer-term slowdown for EPAM.