EPAM Systems, Inc. (EPAM)- Hidden Challenges in the Path to Turnaround
A look at earnings quality problems in 2Q24
EPAM Systems (EPAM) is a software engineering firm that assists businesses in building advanced software platforms, intelligent enterprise applications, and digital engagement solutions. Originally, the bulk of the company’s software engineering work was performed by employees in Ukraine, Belarus, and Russia. The Russian invasion of Ukraine threw a wrench into this arrangement, leading to a 70% decline in the share price in 2022. Since then, the stock has hovered in the $175-$220 range as investors await signs of a recovery in growth.
The company has been cutting guidance for some time, and yet still beating forecasts amid lower sales and margins. In 1Q24, the company beat both top and bottom-line forecasts, but analysts were still not impressed. Price targets were lowered and the stock fell some 25%.
2Q24 adjusted EPS of $2.45 was another typical result. The company reported non-GAAP EPS of $2.45 which beat by 19 cents. However, y/y it was down from $2.64. Revenue fell by 2% y/y – but beat forecasts by $6.5 million.
The company continues to low-ball forecasts on margins and revenue – but the key is the forecasts are still declining and the y/y results are still dropping for revenue, margin, and EPS. This is despite a restructuring program that is cutting headcount and canceling unprofitable contracts. That is the easiest type of restructuring and should provide immediate savings. So, far of the $45.5 million in charges, $41.7 million has been spent since 3Q23. EPAM expects only another $20 million in charges and to complete all of this in 2024. The goal is $100 million in lower costs and EPAM has had four quarters of this so far. $100 million would help quarterly EPS by 30-33 cents. It’s also supposed to help adjusted margins by 2%-3%. Investors should be benefitting from this already – yet margins keep falling along with EPS:
There is hope among the bulls that the company’s AI initiatives will bring a return to solid growth. Assessing the likelihood of that is beyond the scope of this report. However, an analysis of the company’s earnings quality turned up several areas of concern in the way of unsustainable benefits to recent results and questionable adjustments to earnings which could make a solid turnaround in the near future more difficult than some may be anticipating.
Let’s explore behind the numbers…