Company Quick10K Filing
ChaSerg Technology Acquisition
Price10.15 EPS0
Shares22 P/E127
MCap223 P/FCF-78
Net Debt-0 EBIT2
TEV223 TEV/EBIT89
TTM 2019-09-30, in MM, except price, ratios
S-1 2020-10-02 Public Filing
10-Q 2020-09-30 Filed 2020-12-07
10-Q 2020-09-30 Filed 2020-11-05
10-Q 2020-06-30 Filed 2020-08-06
S-1 2020-05-12 Public Filing
10-Q 2020-03-31 Filed 2020-05-11
10-K 2019-12-31 Filed 2020-03-04
10-Q 2019-09-30 Filed 2019-11-13
10-Q 2019-06-30 Filed 2019-08-14
10-Q 2019-03-31 Filed 2019-05-15
10-K 2018-12-31 Filed 2019-03-20
S-1 2018-09-12 Public Filing
8-K 2021-02-17 Enter Agreement, Sale of Shares, Exhibits
8-K 2021-01-20 Officers
8-K 2020-12-15 Shareholder Vote
8-K 2020-12-14 Other Events, Exhibits
8-K 2020-12-09 Other Events, Exhibits
8-K 2020-11-10 Sale of Shares, Other Events, Exhibits
8-K 2020-11-05
8-K 2020-10-26 Enter Agreement, Sale of Shares, Amend Bylaw, Exhibits
8-K 2020-10-26 Other Events, Exhibits
8-K 2020-08-06
8-K 2020-06-29
8-K 2020-05-11
8-K 2020-04-30
8-K 2020-04-01
8-K 2020-03-13
8-K 2020-03-09
8-K 2020-03-05
8-K 2020-03-05
8-K 2020-03-04
8-K 2020-01-26
8-K 2019-12-19
8-K 2019-11-21
8-K 2019-11-13
8-K 2018-10-25
8-K 2018-10-10

CTAC 10Q Quarterly Report

Part I - Financial Information
Item 1. Financial Statements
Note 1 - Background and Nature of Operations
Note 2 - Basis of Presentation and Summary of Significant Accounting Policies
Note 3 - Business Combination
Note 4 - Concentrations of Credit Risk
Note 5 - Property and Equipment, Net
Note 6 - Accrued Liabilities
Note 7 - Income Taxes
Note 8 - Stockholders' Equity
Note 9 - Stock - Based Compensation
Note 10 - Earnings per Share
Note 11 - Commitments and Contingencies
Note 12 - Subsequent Events
Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations
Item 3. Quantitative and Qualitative Disclosures About Market Risk
Item 4. Controls and Procedures
Part II - Other Information
Item 1. Legal Proceedings
Item 1A. Risk Factors
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds.
Item 3. Default Upon Senior Securities
Item 4. Mine Safety Disclosures
Item 5. Other Information
Item 6. Exhibits.
EX-31.1 f10q0920ex31-1_griddynamics.htm
EX-31.2 f10q0920ex31-2_griddynamics.htm
EX-32.1 f10q0920ex32-1_griddynamics.htm
EX-32.2 f10q0920ex32-2_griddynamics.htm

ChaSerg Technology Acquisition Earnings 2020-09-30

Balance SheetIncome StatementCash Flow

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

 

FORM 10-Q

 

(Mark One) 

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

 

For the quarterly period ended September 30, 2020

 

OR

 

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

 

For the transition period from                      to                     

 

Commission File Number: 001-38685 

 

Grid Dynamics Holdings, Inc.

(Exact Name of Registrant as Specified in its Charter)

 

Delaware   83-0632724
(State or other jurisdiction
of incorporation or organization)
  (I.R.S. Employer
Identification No.)

 

5000 Executive Parkway, Suite 520

San Ramon, CA 94583

(Address of principal executive offices)

 

(619) 736-6855

(Registrant’s telephone number, including area code)

 

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

 

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

  

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

 

Indicate by check mark whether the registrant has submitted electronically, every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files). Yes ☒      No ☐

 

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

 

Large accelerated filer ☐  Accelerated filer
Non-accelerated filer Smaller reporting company
Emerging growth company    

 

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

 

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

 

As of October 31, 2020, there were 50,859,760 shares of Common Stock issued and outstanding.

 

 

 

 

 

 

TABLE OF CONTENTS

 

    Page
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements (unaudited) 1
  Condensed Consolidated Balance Sheets 1
  Condensed Consolidated Statements of Income (Loss) and Comprehensive Income (Loss) 2
  Condensed Consolidated Statements of Stockholders’ Equity 3
  Condensed Consolidated Statements of Cash Flows 4
  Notes to Condensed Consolidated Financial Statements 5
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations 17
Item 3. Quantitative and Qualitative Disclosures About Market Risk 30
Item 4. Controls and Procedures 32
     
PART II. OTHER INFORMATION  
Item 1. Legal Proceedings 33
Item 1A. Risk Factors 33
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds 55
Item 3. Default Upon Senior Securities 55
Item 4. Mine Safety Disclosures 55
Item 5. Other Information 55
Item 6. Exhibits 56
     
SIGNATURES 57

 

i

 

 

SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS

 

This Quarterly Report on Form 10-Q contains forward-looking statements that are based on our management’s beliefs and assumptions and on information currently available to our management. The forward-looking statements are contained principally in, but not limited to, the sections titled “Risk Factors” and “Management’s Discussion and Analysis of Financial Condition and Results of Operations”. Forward-looking statements include all statements that are not historical facts and can be identified by terms such as “anticipates,” “believes,” “could,” “seeks,” “estimates,” “expects,” “intends,” “may,” “plans,” “potential,” “predicts,” “projects,” “should,” “will,” “would,” or similar expressions and the negatives of those terms. Forward-looking statements include, but are not limited to, statements about:

 

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

 

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

 

  our ability to maintain an adequate rate of revenue growth;

 

  our future financial and operating results;

 

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

 

  beliefs and objectives for future operations;

 

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

 

  our ability to attract and retain customers;

 

  our ability to further penetrate our existing customer base;

 

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

 

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

 

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

 

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

 

  our ability to capitalize on changing market conditions;

 

  our ability to develop strategic partnerships;

 

  benefits associated with the use of our services;

 

  our ability to expand internationally;

 

  our ability to raise financing in the future;

 

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

 

  the effects of seasonal trends on our results of operations;

 

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

 

ii

 

 

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

 

  costs related to being a public company;

 

  changes in applicable laws or regulations;

 

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

 

  other risks and uncertainties indicated in this Quarterly Report on Form 10-Q, including those set forth under the section titled “Risk Factors.”

 

Forward-looking statements involve known and unknown risks, uncertainties and other factors that may cause our actual results, performance or achievements to be significantly different from any future results, performance or achievements expressed or implied by the forward-looking statements. We discuss these risks in greater detail in the section titled “Risk Factors” and elsewhere in this Quarterly Report on Form 10-Q. Given these uncertainties, you should not place undue reliance on these forward-looking statements. Also, forward-looking statements represent our management’s beliefs and assumptions only as of the date of this Quarterly Report on Form 10-Q. You should read this Quarterly Report on Form 10-Q completely and with the understanding that our actual future results may be significantly different from what we expect.

 

Except as required by law, we assume no obligation to update these forward-looking statements publicly, or to update the reasons actual results could differ significantly from those anticipated in these forward-looking statements, even if new information becomes available in the future. 

 

iii

 

  

PART I — FINANCIAL INFORMATION

 

Item 1. Financial Statements

 

GRID DYNAMICS HOLDINGS, INC.
UNAUDITED CONDENSED CONSOLIDATED BALANCE SHEETS

(In thousands, except share and per share data)

 

   As of 
   September 30,
2020
   December 31,
2019
 
Assets        
Current assets        
Cash and cash equivalents  $126,526   $42,189 
Accounts receivable, net of allowance of $418, and $20 as of September 30, 2020 and December 31, 2019   15,634    13,893 
Unbilled receivables   2,063    5,036 
Prepaid income taxes   1,130    308 
Deferred transaction costs   
    1,878 
Prepaid expenses and other current assets   2,486    2,711 
Total current assets   147,839    66,015 
Property and equipment, net   3,969    4,024 
Intangible assets, net   
    18 
Deferred income taxes   5,993    1,474 
Total assets  $157,801   $71,531 
           
Liabilities and equity          
Current liabilities          
Accounts payable  $518   $768 
Accrued liabilities   612    1,188 
Accrued compensation and benefits   5,685    5,337 
Accrued income taxes   979    869 
Other current liabilities   2    138 
Total liabilities   7,796    8,300 
           
Commitments and contingencies (Note 11)   
 
    
 
 
Convertible preferred stock, no par value, 0 and 1,047,942 shares authorized and outstanding as of September 30, 2020 and December 31, 2019, respectively
   
    9,187 
           
Stockholders’ equity (Note 8)          
Common stock, $0.0001 par value; 110,000,000 shares authorized; 50,859,760 and 21,644,392 issued and outstanding as of September 30, 2020 and December 31, 2019, respectively   5    2 
Additional paid-in capital   122,487    18,650 
Retained earnings   27,513    35,392 
Total stockholders’ equity   150,005    54,044 
Total liabilities, convertible preferred stock, and stockholders’ equity  $157,801   $71,531 

 

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

  

1

 

 

GRID DYNAMICS HOLDINGS, INC.
UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF INCOME/(LOSS) AND COMPREHENSIVE INCOME/(LOSS)
(In thousands, except per share data)

 

   Three months ended
September 30,
   Nine months ended
September 30,
 
   2020    2019      2020     2019 
Revenue  $26,332   $31,422   $81,157   $86,325 
Cost of revenue   15,178    17,626    51,799    50,754 
Gross profit   11,154    13,796    29,358    35,571 
                     
Operating expenses                    
Engineering, research, and development   2,076    1,083    7,193    3,284 
Sales and marketing   2,245    1,764    7,451    5,262 
General and administrative   8,504    5,364    26,606    15,545 
Total operating expenses   12,825    8,211    41,250    24,091 
                     
Income/(loss) from operations   (1,671)   5,585    (11,892)   11,480 
Other income/(expenses), net   455    (89)   419    (172)
                     
Income/(loss) before income taxes   (1,216)   5,496    (11,473)   11,308 
Provision/(benefit) for income taxes   (99)   1,043    (3,594)   2,608 
Net income/(loss) and comprehensive income/(loss)  $(1,117)  $4,453   $(7,879)  $8,700 
                     
Earnings/(loss) per share                    
Basic  $(0.02)  $0.20   $(0.18)  $0.40 
Diluted  $(0.02)  $0.20   $(0.18)  $0.40 
                     
Weighted average shares outstanding                    
Basic   49,651    21,644    43,074    20,941 
Diluted   49,651    22,692    43,074    21,505 

 

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

 

2

 

  

GRID DYNAMICS HOLDINGS, INC.
UNAUDITED CONDENSED CONSOLIDATED STATEMENT OF STOCKHOLDERS’ EQUITY
(In thousands)

 

Nine months ended September 30, 2020

 

   Temporary equity     
   Convertible Preferred Stock   Common Stock   Additional paid-in   Retained   Total 
   Shares   Amount   Shares   Amount   capital   earnings   equity 
Balance at December 31, 2019
(as previously reported)
   622   $9,187    12,847   $8,117   $10,535   $35,392   $54,044 
Conversion of stock   426    
-
    8,797    (8,115)   8,115    
-
    
-
 
Balance at December 31, 2019, effect of reverse recapitalization
(refer to Note 3)
   1,048   $9,187    21,644   $2   $18,650   $35,392   $54,044 
Net loss   -    
-
    -    
-
    
-
    (4,596)   (4,596)
Stock-based compensation   -    
-
    -    
-
    4,804    
-
    4,804 
Merger recapitalization   (1,048)   (9,187)   1,048    1    9,187    
-
    9,188 
Consideration paid to Grid shareholders   -    
-
    -    
-
    (123,865)   
-
    (123,865)
ChaSerg shares recapitalized, net of transaction costs of $4,142   
-
    
-
    28,088    2    204,323    
-
    204,325 
Conversion of promissory note to common stock   
-
    
-
    53    
-
    530    
-
    530 
Balance at March 31, 2020   
-
   $
-
    50,833   $5   $113,629   $30,796   $144,430 
Net loss   -    
-
    -    
-
    
-
    (2,166)   (2,166)
Stock-based compensation   -    
-
    -    
-
    3,654    
-
    3,654 
Exercise of stock options   
-
    
-
    6    
-
    59    
-
    59 
Balance at June 30, 2020   
-
   $
-
    50,839   $5   $117,342   $28,630   $145,977 
Net loss   -    -    -    -    -    (1,117)   (1,117)
Stock-based compensation   -    -    -    -    5,126    -    5,126 
Exercise of stock options   -    -    6    -    19    -    19 
Issuance of shares in connection with vested RSUs   -    -    15    
-
    -    -      
Balance at September 30, 2020   -   $-    50,860   $5   $122,487   $27,513   $150,005 

 

Nine months ended September 30, 2019

 

   Temporary equity     
   Convertible Preferred Stock   Common Stock   Additional paid-in   Retained   Total 
   Shares   Amount   Shares   Amount   capital   earnings   equity 
Balance at December 31, 2018
(as previously reported)
   
-
   $
-
    12,000   $
-
   $8,794   $24,585   $33,379 
Conversion of stock   
-
    
-
    8,217    2    (2)   
-
    
-
 
Balance at December 31, 2018, effect of reverse recapitalization
(refer to Note 3)
   
-
   $
-
    20,217   $2   $8,792   $24,585   $33,379 
Net income   -    
-
    -    
-
    
-
    712    712 
Stock-based compensation   -    
-
    -    
-
    1,658    
-
    1,658 
Balance at March 31, 2019   
-
   $
-
    20,217   $2   $10,450   $25,297   $35,749 
Net income   -    
-
    -    
-
    
-
    3,535    3,535 
Stock-based compensation   -    
-
    -    
-
    238    
-
    238 
Issuance of common and preferred stock, net of $96 issuance costs   1,048    9,187    1,048    
-
    5,717    
-
    5,717 
Exercise of stock options   
-
    
-
    379    
-
    1,700    -    1,700 
Balance at June 30, 2019   1,048   $9,187    21,644   $2   $18,105   $28,832   $46,939 
Net Income   -    -    -    -    -    4,453    4,453 
Stock-based compensation   -    -    -    -    129    -    129 
Balance of September 30, 2019   1,048   $9,187    21,644   $2   $18,234   $33,285   $51,521 

   

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

 

3

 

 

GRID DYNAMICS HOLDINGS, INC.
UNAUDITED CONDENSED CONSOLIDATED STATEMENT OF CASH FLOWS
(In thousands)

 

   Nine months ended
September 30,
 
   2020   2019 
Cash flows from operating activities        
Net income/(loss)  $(7,879)  $8,700 
Adjustments to reconcile net income to net cash provided by operating activities:          
Depreciation and amortization   1,896    1,681 
Impairment of goodwill       139 
Bad debt expense   398    
 
Deferred income taxes   (4,519)   (41)
Stock-based compensation   13,584    2,025 
Changes in assets and liabilities:          
Accounts receivable   (2,139)   (97)
Unbilled receivables   2,973    (1,197)
Prepaid income taxes   (822)   (1,132)
Deferred transaction cost       (1,414)
Prepaid expenses and other current assets   10    (393)
Accounts payable   (250)   (137)
Accrued liabilities   (576)   (142)
Accrued compensation and benefits   348    2,308 
Accrued income taxes   110    773 
Other current liabilities   (136)   (257)
Net cash provided by operating activities   2,998    10,816 
           
Cash flows from investing activities          
Purchase of property and equipment   (1,607)   (2,099)
Net cash used in investing activities   (1,607)   (2,099)
           
Cash flows from financing activities          
Cash received from ChaSerg   208,997    
 
GDI shares redeemed for cash (net of cash received from exercise of accelerated options)   (123,865)   
 
Equity issuance costs   (2,264)   
 
Sales of common and preferred stock   
    14,904 
Proceeds from exercises of stock options   78    1,700 
Payments of dividends   
    (2,000)
Net cash provided by financing activities   82,946    14,604 
           
Net increase in cash and cash equivalents   84,337    23,321 
Cash and cash equivalents, beginning of period   42,189    17,862 
Cash and cash equivalents, end of period  $126,526   $41,183 
           
Cash paid for income taxes  $1,370   $3,828 
Significant non-cash activities          
Conversion of preferred stock to common stock  $9,187   $
 

 

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

 

4

 

  

GRID DYNAMICS HOLDINGS, INC.
NOTES TO THE UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(In thousands, except share and per share data)

 

Note 1 — Background and nature of operations

 

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

 

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

 

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

 

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

 

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

 

Unaudited Interim Financial Statements 

 

The accompanying unaudited condensed consolidated financial statements have been prepared in accordance with generally accepted accounting principles in the United States (“U.S. GAAP”) for interim financial information and in accordance with the rules and regulations of the Securities and Exchange Commission (“SEC”). Accordingly, they do not include all of the information and footnotes required by U.S. GAAP for complete financial statements. The unaudited condensed consolidated financial statements reflect all normal and recurring adjustments that are, in the opinion of the Company’s management, necessary for the fair presentation of the results of operations for the interim periods. Operating results for the nine months ended September 30, 2020 are not necessarily indicative of the results that may be expected for the year ending December 31, 2020. These interim financial statements should be read in conjunction with GDI’s audited financial statements for the year ended December 31, 2019 included in the Current Report on Form 8-K that the Company filed with the SEC on March 9, 2020.

 

Basis of presentation

 

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

 

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

 

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

 

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

 

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

 

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

 

In conjunction with the Business Combination, outstanding shares of GDI were converted into common stock of the Company, par value $0.0001 per share, shown as a recapitalization, and the net assets of ChaSerg were acquired at historical cost, with no goodwill or other intangible assets recorded. GDI was deemed to be the predecessor of the Company, and the consolidated assets and liabilities and results of operations prior to the Closing (for the year ended December 31, 2019 and three months ended March 31, 2020 and for the three and nine months ended September 30, 2019) are those of GDI. ChaSerg’s assets and liabilities, which include net cash from the trust of $85.1 million, and results of operations were consolidated with GDI beginning on the Closing. The shares and corresponding capital amounts and earnings per share available to common stockholders, prior to the Business Combination, have been retroactively restated as shares reflecting the exchange ratio established in the Merger Agreement.

 

5

 

 

Principles of consolidation

 

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

 

Use of estimates

 

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

 

Certain significant risks and uncertainties

 

The Company is subject to risks, including but not limited to customer concentration, concentrations of credit and foreign currency risks. Refer to Note 4 below for additional information. Additionally, the Company has been impacted by the recent coronavirus (“COVID-19”) pandemic. The global pandemic of COVID-19 has negatively affected the U.S. and global economy, disrupted global supply chains, resulted in significant travel and transport restrictions, including mandated closures and orders to “shelter-in-place,” and created significant disruption of the financial market. The COVID-19 pandemic has impacted the Company’s revenues and the Company’s business continues to be exposed to risks and uncertainties related to the pandemic.  The impact of the COVID-19 pandemic has been more pronounced with the Company’s retail customers, which depend on keeping their stores open. Additionally, in situations where the Company’s customers encounter financial difficulties, there is a risk associated with the Company’s inability to collect money from customers. The Company has taken several actions to deal with the COVID-19 pandemic. These include enabling its employees to work from home, company-wide salary and compensation cuts, hiring freezes, and suspending all non-essential travel. The ultimate impact and the extent to which the COVID-19 pandemic will continue to affect the business, results of operation and financial condition is difficult to predict and depends on numerous evolving factors outside of the Company’s control including: the duration and scope of the pandemic; government, social, business and other actions that have been and will be taken in response to the pandemic; and the effect of the pandemic on short and long-term general economic conditions.

 

Cash and cash equivalents

 

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

 

Accounts receivable and allowance for doubtful accounts

 

Accounts receivable, less allowance for doubtful accounts, reflect the net realizable value of receivables and approximate fair value. The Company maintains an allowance against accounts receivable for the estimated probable losses on uncollectible accounts. The allowance is based upon historical loss experience, current economic conditions within the industries the Company serves as well as determination of the specific risk related to certain customers. Accounts receivable are charged off against the reserve when, in management’s estimation, further collection efforts would not result in a reasonable likelihood of receipt. The allowance for doubtful accounts balance increased $0.4 million as of September 30, 2020 compared to December 31, 2019. 

 

   As of 
   September 30,
2020
   December 31,
2019
 
Trade accounts receivable  $16,052   $13,913 
Allowance for doubtful accounts   (418)   (20)
Total trade accounts receivable, net  $15,634   $13,893 

 

Revenue recognition

 

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

 

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

 

6

 

 

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

 

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

  

Remaining performance obligation

 

ASC 606 requires that the Company disclose the aggregate amount of transaction price that is allocated to performance obligations that have not yet been satisfied as of September 30, 2020. This disclosure is not required for:

 

  1) contracts with an original duration of one year or less, including contracts that can be terminated for convenience without a substantive penalty,

 

  2) contracts for which the Company recognizes revenues based on the right to invoice for services performed,

 

  3) variable consideration allocated entirely to a wholly unsatisfied performance obligation or to a wholly unsatisfied promise to transfer a distinct good or service that forms part of a single performance obligation in accordance with ASC 606-10-25-14(b), for which the criteria in ASC 606-10-32-40 have been met, or

 

  4) variable consideration in the form of a sales-based or usage-based royalty promised in exchange for a license of intellectual property.

 

All of the Company’s contracts met one or more of these exemptions as of September 30, 2020.

 

Income taxes

 

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

 

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

 

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

 

7

 

  

Restructuring

 

The Company initiated a restructuring plan focused on optimizing utilization. For the three months ended September 30, 2020 and for the nine months ended September 30, 2020, the Company incurred and paid total restructuring expenses of $0.1 million and $0.9 million, respectively, which mostly included employee termination costs. This amount is included as a component of general and administrative expenses in the condensed consolidated financial statements.

 

Recently adopted accounting pronouncements

 

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

 

In August 2018, the FASB issued ASU 2018-13, Fair Value Measurement (Topic 820): Disclosure Framework — Changes to the Disclosure Requirements for Fair Value Measurement, which amends ASC 820, Fair Value Measurement. ASU 2018-13 modifies the disclosure requirements for fair value measurements by removing, modifying or adding certain disclosures. The accounting standard update was effective beginning in the first quarter of fiscal year 2020, with removed and modified disclosures to be adopted on a retrospective basis, and new disclosures to be adopted on a prospective basis. The Company has determined that the adoption of this guidance did not have a material effect on the consolidated financial statements.

 

In October 2018, the FASB issued ASU No. 2018-17, “Consolidation (Topic 810): Targeted Improvements to Related Party Guidance for Variable Interest Entities”. The new standard changes how entities evaluate decision-making fees under the variable interest entity guidance. The new standard is effective for fiscal years beginning after December 15, 2019, and interim periods within those fiscal years. The standard should be applied on a modified retrospective basis through a cumulative-effect adjustment directly to retained earnings at the beginning of the period of adoption. The Company has determined that the adoption of this guidance did not have a material effect on the consolidated financial statements.

 

Recently issued accounting pronouncements

 

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

 

In February 2016, the FASB issued ASU No. 2016-02, Leases. ASU 2016-02 requires lessees to put most leases on their balance sheet while recognizing expense in a manner similar to existing accounting. ASU 2016-02 states that a lessee would recognize a lease liability for the obligation to make lease payments and a right-to-use asset for the right to use the underlying asset for the lease term. The standard allows for two methods of adoption to recognize and measure leases: retrospectively to each prior period presented in the financial statements with the cumulative effect of initially applying the guidance recognized at the beginning of the earliest comparative period presented or retrospectively at the beginning of the period of adoption with the cumulative effect of initially applying the guidance recognized at the beginning of the period in which the guidance is first applied. Both adoption methods include a number of optional practical expedients that entities may elect to apply. The Company will adopt the standard retrospectively at the beginning of the period of adoption with the cumulative effect of initially applying the guidance recognized at the beginning of the period in which the guidance is first applied. In November 2019, the FASB issued ASU No. 2019-10, Financial Instruments — Credit Losses (Topic 326), Derivatives and Hedging (Topic 815), and Leases (Topic 842), delaying the effective implementation date for ASC 842 by one year for entities that have not yet adopted the standard. In June 2020, the FASB issued ASU No. 2020-5 delaying the transition and effective implementation date for ASC 842 by one year for entities that have not yet adopted the standard. The new accounting guidance is effective for the Company for fiscal periods beginning after December 15, 2021. The Company has not yet determined the impact that the adoption of this guidance will have on the consolidated financial statements.

 

In June 2016, the FASB issued ASU 2016-13, Financial Instruments-Credit Losses (Topic 326) — Measurement of Credit Losses on Financial Instruments. Topic 326 was subsequently amended by ASU 2019-04, Codification Improvements to Topic 326, Financial Instruments — Credit Losses, ASU 2019-05, Financial Instruments — Credit Losses (Topic 326): Targeted Transition Relief, and clarified the guidance with the release of ASU 2020-02 Financial Instruments—Credit Losses (Topic 326) and Leases (Topic 842). These ASUs replace the current incurred loss impairment methodology with a methodology that reflects expected credit losses measured at amortized cost and certain other instruments, including loans, held-to-maturity debt securities, net investments in leases, and off-balance sheet credit exposures. In November 2019 the FASB issued ASU No. 2019-10, Financial Instruments — Credit Losses (Topic 326), Derivatives and Hedging (Topic 815), and Leases (Topic 842), delaying the effective implementation date for Topic 326 by one year for entities that have not yet adopted the standard. The update is effective for fiscal years beginning after December 15, 2022, and interim periods with fiscal years after December 15, 2022. The Company has not yet determined the impact that the adoption of this guidance will have on the consolidated financial statements.

 

In December 2019, the FASB issued Accounting Standard Update No. 2019-12, Income Taxes (Topic 740): Simplifying the Accounting for Income Taxes (ASU 2019-12), which simplifies the accounting for income taxes by removing certain exceptions to the general principles and also simplification of areas such as franchise taxes, step-up in tax basis goodwill, separate entity financial statements and interim recognition of enactment of tax laws or rate changes. The update is effective for fiscal years beginning after December 15, 2021, and interim periods with fiscal years after December 15, 2022 on a prospective basis, and early adoption is permitted. The Company is currently evaluating the impact of the new guidance on the consolidated financial statements.

 

8

 

 

In March 2020, FASB issued ASU No. 2020-03, Codification to Financial Instruments. This ASU improves and clarifies various financial instruments topics, including the current expected credit losses standard issued in 2016. The ASU includes seven different issues that describe the areas of improvement and the related amendments to U.S. GAAP, intended to make the standards easier to understand and apply by eliminating inconsistencies and providing clarifications. The amendments related to Issue 1, Issue 2, Issue 3, Issue 4, and Issue 5 were effective upon issuance of this update. The new guidance did not have a material impact on the consolidated financial statements. The amendments related to Issue 6 and Issue 7 are effective for the Company the earlier of January 1, 2023 or when the Company adopts ASU 2016-13, if early adopted. The Company is currently evaluating the impact these topics will have on the consolidated financial statements. 

 

Note 3 – Business combination

 

On March 5, 2020, ChaSerg consummated its business combination with GDI pursuant to the Merger Agreement. Fees and expenses paid in connection with the Business Combination were settled using funds from the trust account. Immediately following the Business Combination, there were 50,833,619 shares of common stock with a par value of $0.0001, and 11,346,500 warrants outstanding.

 

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

 

The aggregate consideration for the Business Combination was $396.5 million, consisting of $130.0 million in cash and 27,006,251 shares of ChaSerg’s common stock valued at $10.19 per share, less a post-Closing share adjustment amount of 857,143 shares which were placed in escrow post-Closing. The shares transferred at Closing included 4,313,917 options to purchase the Company’s shares that were vested, outstanding and unexercised, which were determined using 1,739,932 vested options at Closing converted at an exchange ratio of approximately 2.48. Additionally, 364,094 options to purchase the Company’s common stock that were unvested, outstanding and unexercised were assumed by the Company, which were determined using 146,865 unvested options at Closing converted at an exchange ratio of approximately 2.48. The following represents the aggregate consideration for the Business Combination:

 

(in thousands, except for share and per share amounts)      
Shares transferred at Closing     27,006,251  
Less: Post-Closing share adjustment     (857,143 )
Total shares transferred at Closing     26,149,108  
Value per share     10.19  
Total share consideration   $ 266,459  
Plus: Cash transferred to GDI stockholders     130,000  
Closing merger consideration   $ 396,459  

 

In connection with the Closing, 51,715 shares of common stock were redeemed at a price per share of approximately $10.21. See Note 8 for details of the Company’s common stock prior to and subsequent to the Business Combination.

 

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

 

In connection with the Business Combination, all outstanding retention bonus obligations from a 2017 acquisition totaling $3,363,000 were accelerated and paid in full to Grid Dynamics’ personnel immediately prior to the Closing and were recorded in the cost of revenue and operating expenses in the condensed consolidated financial statements. 

 

Note 4 — Concentrations of credit risk

 

The Company records its accounts receivable and unbilled receivables at their face amounts less allowances. Accounts receivable and unbilled receivables are generally dispersed across the Company’s customers in proportion to their revenue. Two customers individually exceeded 10% of the Company’s accounts receivable balance at September 30, 2020. Three customers individually exceeded 10% of the Company’s accounts receivable balance at December 31, 2019. Four customers individually exceeded 10% of the unbilled receivables at September 30, 2020 and two customers individually exceeded the unbilled receivables balance at December 31, 2019.

 

9

 

 

Two and three customers accounted for greater than 10% of the sales for the three months ended September 30, 2020 and 2019, respectively. Two and three customers accounted for greater than 10% of the sales for the nine months ended September 30, 2020 and 2019, respectively.

 

Note 5 — Property and Equipment, net

 

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

 

   Estimated Useful  As of 
   Life
(In Years)
  September 30,
2020
   December 31,
2019
 
Computers and equipment  3  $5,580   $5,470 
Machinery and automobiles  5   162    129 
Furniture and fixtures  7   457    544 
Software  5   513    407 
Leasehold improvements  7   153    119 
       6,865    6,669 
Less: Accumulated depreciation and amortization      (4,388)   (3,784)
       2,477    2,885 
              
Capitalized software development costs  2   3,395    2,478 
Less: Accumulated amortization      (1,903)   (1,339)
       1,492    1,139 
Property and equipment, net     $3,969   $4,024 

 

10

 

 

Note 6 — Accrued liabilities

 

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

 

   As of 
   September 30,
2020
   December 31,
2019
 
Accrued customer discounts  $334   $298 
Accrued retention bonus   
-
    648 
Other accrued liabilities   278    242 
Total accrued liabilities  $612   $1,188 

 

Note 7 — Income taxes

 

The Company recorded income tax expense/(benefit) of $(0.1) million and $1.0 million for the three months ended September 30, 2020 and 2019, respectively, and $(3.6) million and $2.6 million for the nine months ended September 30, 2020 and 2019, respectively. The Company’s effective tax rate was 8.1% and 19.0% for the three months ended September 30, 2020 and 2019, respectively, and 31.3% and 23.1% for the nine months ended September 30, 2020 and 2019, respectively. The increase/decrease in effective tax rate for the three and nine months ended September 30, 2020, as compared to the same periods in 2019 was primarily due to excess tax benefits of stock-based compensation. The tax benefit recognized in the current nine months is primarily due to net operating losses generated by stock compensation deductions as a result of the Business Combination and year-to-date book losses. For the three-and nine-month periods ended September 30, 2020, the Company used a discrete  effective tax rate method to calculate income taxes. The Company determined that small changes in estimated “ordinary” income would result in significant changes in the estimated annual effective tax rate due to uncertainties created by the COVID-19 pandemic. The estimated annual effective tax rate method would not provide a reliable estimate and therefore has not been used for the three-and nine-month periods ended September 30, 2020.

 

On March 27, 2020, the U.S. President signed into law the CARES Act, an economic stimulus package in response to the COVID-19 global pandemic. The CARES Act contains several corporate income tax provisions, including making remaining alternative minimum tax credits immediately refundable; providing a 5-year carryback of net operating loss carryforwards (“NOLs”) generated in tax years 2018, 2019, and 2020, and removing the 80% taxable income limitation on utilization of those NOLs if carried back to prior tax years or utilized in tax years beginning before 2021; and temporarily liberalizing the interest deductibility rules under Section 163(j) of the Tax Cuts and Jobs Act, by raising the adjusted taxable income limitation from 30% to 50% for tax years 2019 and 2020 and giving taxpayers the election of using 2019 adjusted taxable income for purposes of computing 2020 interest deductibility. The Company anticipates being in a loss position at year end and will be able to take advantage of the NOL carryback provision. The Company is still evaluating the impact but does not currently expect the provisions of the CARES Act to have a material effect on the realizability of deferred income tax assets or tax expense. There is no material impact for the three and nine months ended September 30, 2020. As additional guidance is released, the Company will evaluate whether there would need to be a change in the period when such guidance is issued. 

 

Note 8 — Stockholders’ equity

 

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

 

Common stock

 

The Company is authorized to issue 110,000,000 of common stock. At Closing, the Company had issued 50,833,619 shares of common stock. As of September 30, 2020, the Company had 50,859,760 shares of common stock that were outstanding, of which: a) 26,888,285 shares were issued to the stockholders of ChaSerg who did not redeem their shares, b) 1,200,000 shares legally issued and outstanding to the ChaSerg Founders and underwriter subject to earnout provisions as discussed further below, c) 53,000 shares issued to the Sponsor of ChaSerg (the “Sponsor”) at $10.00 per share as the result of a promissory note of $0.5 million converted to the Company’s common stock, d) 19,490,295 shares issued to GDD International Holding Company, e) 2,094,850 shares issued to BGV Opportunity Fund, L.P., and f) 1,133,330 shares issued to former shareholders of GDI. Additionally at Closing, there were 4,313,917 outstanding vested options to purchase the Company’s common stock.

 

Preferred Stock

 

As of December 31, 2019 GDI had 1,047,942 shares of no par value shares of preferred stock outstanding convertible on a 1:1 basis with GDI’s common stock. At the Closing, the preferred stock outstanding was converted into common stock of the Company, par value $0.0001 per share. Therefore, as of September 30, 2020 there was no preferred stock outstanding.

 

11

 

 

Founders and underwriter shares subject to earnout provisions

 

At the Closing, the Company had 1,200,000 shares of common stock issued and outstanding subject to earnout provisions (the “Earnout Shares”). The Earnout Shares are subject to transfer restrictions and the owners of the Earnout Shares cannot sell, transfer or otherwise dispose of their respective shares until the respective earnout provisions have been achieved as described further below. The Earnout Shares have full ownership rights including the right to vote and receive dividends and other distributions thereon. Dividends and other distributions are not subject to forfeiture in accordance with the Amended and Restated Sponsor Share Letter filed with the SEC on January 26, 2020. The Earnout Shares vest and are no longer subject to the transfer restrictions as follows:

 

  1) 399,999; 400,000; and 400,001 Earnout Shares vest if the closing price of the Company’s common stock on the principal exchange on which the securities are listed or quoted have been at or about $12.00; $13.50; and $15.00 per share, respectively, for 20 trading days (which need not be consecutive) over a thirty trading day period at any time;

 

The Earnout Shares automatically vest upon and immediately prior to any of the following events:

 

  1) The Company engages in a “going private” transaction pursuant to Rule 13e-3 under the Exchange Act of 1934, as amended (the “Exchange Act”), or otherwise cease to be subject to reporting obligations under Sections 13 or 15(d) of the Exchange Act;

 

  2) The Company’s common stock ceases to be listed on a national securities exchange;

 

  3) The Company is amalgamated, merged, consolidated or reorganized with or into another company or person (an “Acquiror”) and as a result of such amalgamation, merger, consolidation or reorganization, fewer than 50.1% (whether by voting or economic rights) of the outstanding equity securities or other capital interests of the Acquiror or surviving or resulting entity is owned in the aggregate by the shareholders of the Company, directly or indirectly, immediately prior to such amalgamation, merger, consolidation or reorganization, excluding from such computation the interests of the Acquiror or any affiliate of the Acquiror;

 

  4) The Company and/or its subsidiaries sell, assign, transfer or otherwise dispose of (including by bulk reinsurance outside of the ordinary course of business consistent with past practice), in one or a series of related transactions, all or substantially all of the assets of the Company and its subsidiaries, taken as a whole, to an Acquiror, fewer than 50.1% (whether by voting or economic rights) of the outstanding equity securities or other capital interests of which, immediately following such sale, assignment or transfer, are owned in the aggregate by the pre-transaction Company stockholders; or

 

  5) If a Schedule 13D or Schedule 13G report (or any successor schedules, form or report), each as promulgated pursuant to the Exchange Act, is filed with the SEC disclosing that any person or group (as the terms “person” and “group” are used in Section 13(d) or Section 14(d) of the Exchange Act and the rules and regulations promulgated thereunder) has become the beneficial owner (as the term “beneficial owner” is defined in Rule 13d-3 or any successor rule or regulation promulgated under the Exchange Act) of a percentage of shares of the outstanding Company common shares as shall be greater than the percentage of such shares that, at the date of such filing, is held by any other person or group that held more than 50% of the voting or economic power of Company immediately after the Closing.

 

The Earnout Shares released for any event as noted above shall be subject to an equitable adjustment for share splits, share dividends, reorganizations, combinations, recapitalizations and similar transactions affecting the common stock after the Closing. Additionally, each such price threshold shall be reduced by the amount of the aggregate cash or the fair market value of any securities or other assets paid or payable by the Company to the holders of common stock, on a per share basis, as an extraordinary dividend or distribution following the Closing; provided that the declaration and payment of any such extraordinary dividend or distribution shall be subject to all applicable laws. An “extraordinary dividend or distribution” means any dividend or distribution other than a regularly-scheduled dividend or distribution.

 

As of September 30, 2020, none of the Earnout Shares have vested.

 

Warrants

 

As of September 30, 2020, there were a total of 11,346,500 warrants outstanding. As part of its initial public offering (“IPO”), ChaSerg issued 22,000,000 units including one share of common stock and one-half of one redeemable warrant. Simultaneously with its IPO, ChaSerg issued 640,000 private placement units to its sponsor underwriter, each consisting of one common share and one-half of one redeemable warrant. ChaSerg issued 53,000 units as a result of the conversion of a working capital sponsor loan consisting of one common share and one-half of one redeemable warrant.

 

12

 

 

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

 

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

 

Note 9 — Stock-based compensation

 

2018 Stock Plan

 

The Company had previously adopted a stock plan in 2018 (the “2018 Stock Plan”). Under the terms of the 2018 Stock Plan, certain option grants were accelerated in full or by an additional 12 months as a result of the Business Combination. Therefore, on the date of Closing, the acceleration of vesting for 2,568,523 stock options resulted in a stock compensation charge and corresponding increase to additional paid-in capital of $2.5 million. Additionally, at Closing, a percentage of outstanding vested GDI stock options were settled in exchange for cash consideration, pursuant to the terms of the Merger Agreement.

 

The remaining portion of outstanding vested options totaling 1,739,932 and all unvested options totaling 146,865 were automatically assumed and converted into options to purchase the Company’s common stock as of the Closing. The number of each participant’s assumed options and the exercise price were adjusted as provided in the Merger Agreement. There was no incremental compensation cost attributable to the incremental fair value of the modified options compared to the original options on the modification date. The assumed stock options will continue to be subject to the same terms and conditions, including vesting schedule terms, in accordance with the 2018 Stock Plan. Exercise prices for 2018 Stock Plan options range between $3.51 and $3.54 per share.

 

The following table sets forth the activity, including the conversion of the vested and unvested options, for the three months ended March 31, 2020:

  

   Options Outstanding 
Balance at December 31, 2019   2,734,327 
Cashed out   (828,590)
Forfeited   (18,940)
Balance at March 31, 2020 (prior to exchange ratio conversion)   1,886,797 
Converted vested balance   4,313,917 
Converted unvested balance   364,094 
Balance at March 31, 2020 (post to exchange ratio conversion)   4,678,011 

  

As of September 30, 2020 28,641 shares were forfeited and 22,217 shares were exercised for the total proceeds of $0.1 million. The number of shares exercisable as of September 30, 2020 was 4,357,125 with the average exercise price $3.54 per share.

 

2020 Equity Incentive Plan

 

Effective March 5, 2020, our board of directors approved an equity incentive plan (the “2020 Plan”). The 2020 Plan permits the Company to grant a maximum aggregate amount of 16,300,000 Incentive Stock Options, Nonstatutory Stock Options (“NSOs”), Restricted Stock, Restricted Stock Units (“RSUs”), Stock Appreciation Rights, Performance Units (“PSUs”), and Performance Shares (“PSAs”) (collectively, the “Awards”) to employees, directors, and consultants of the Company. Our board of directors or any committee appointed by the board has the authority to grant Awards. As of September 30, 2020, our board of directors granted 1,897,000 NSOs, 2,993,455 RSUs, and 574,188 target PSU at a maximum payout at 300%.

 

Stock Options

 

The 1,552,100 NSOs granted on March 13, 2020, 239,400 NSOs granted on May 4, 2020 and 105,500 NSOs granted on August 3, 2020 are subject to the following time-based vesting conditions: one-fourth of the NSOs will vest on one year after the grant date; and thereafter one-sixteenth of the NSOs will vest each subsequent three-month anniversary. The NSOs have approximately a ten-year exercise term, and once the NSOs are vested, the recipients have the right to purchase the Company’s stock at a fixed and specified exercise price.

 

13

 

 

The grant date fair value of each NSO was estimated on the date of grant using the Black-Scholes option pricing model, as determined by our board of directors. The key assumptions for 2020 grants are provided in the following table.

  

   2020 
Dividend yield   0%
Expected volatility   40%
Risk-free interest rate   0.31%-0.80%
Expected term in years   6.11 
Grant date fair value of common stock   $6.86-8.26 

  

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

 

None of the 2020 NSO grants are vested as of September 30, 2020. The aggregated fair value of 1,897,000 NSOs granted during the nine months ended September 30, 2020 was $6.1 million. The total unrecognized compensation expenses related to 2020 Stock Plan options as of September 30, 2020 was $4.9 million to be expensed on a straight-line basis over 3.49 years.

 

Restricted Stock Units

 

A total of 2,993,455 RSUs granted as of September 30, 2020 were granted at the average fair market value of the Company’s stock of $8.17. The RSUs granted to employees generally are subject to the following time-based vesting conditions: one-fourth vest on the first anniversary of the grant; and thereafter one-sixteenth of the RSUs will vest each subsequent three-month anniversary.   RSUs granted do not participate in earnings, dividends, and do not have voting rights until vested.

 

15,120 RSUs granted to the Board were released as of September 30, 2020. The aggregated fair value of RSUs granted during the nine months ended September 30, 2020 was $24.5 million. The total unrecognized compensation expenses related to 2020 Stock Plan RSUs as of September 30, 2020 was $21.0 million to be expensed on a straight-line basis over 3.43 years. 

 

Performance Stock Units

 

On May 4, 2020, the Company granted 574,188 Performance Stock target shares under the 2020 Stock Plan with the maximum payout capped at 300%. The performance goals for these grants consist of:

 

1) Year-over-year growth in non-retail revenue for the Performance Period, which is Fiscal Year 2020, expressed as a percentage increase over the Fiscal Year 2019 non-retail revenue (“Revenue Growth”), and

 

2) Contribution Margin for the Performance Period as a percentage of non-retail revenue for the Performance Period.

 

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

 

Performance shares will be certified and vested no later than March 1, 2021 with the payout shortly after. As of September 30, 2020, the Company assessed the vesting of the Performance Share Units as probable. Stock-based compensation expense related to Performance Stock  Units was $3.1 million and $5.1 million in the three and nine months ended September 30, 2020.

 

Stock-Based Compensation Expense

 

The Company classifies awards issued under the stock-based compensation plans as equity. Total compensation expense for the three months ended September 30, 2020 was $5.1 million, which included $0.02 million of compensation expense related to the 2018 Stock Plan and the rest of compensation expense related to the 2020 Plan. Total compensation expense for the three months ended September 30, 2019 was $0.1 million. Total compensation expense for the nine months ended September 30, 2020 was $13.6 million, which included $2.0 million of compensation expense related to the 2018 Stock Plan, $2.5 million of compensation expense related to the acceleration of vesting of awards under the 2018 Stock Plan, and the rest of compensation expense related to the 2020 Plan. Total compensation expense for the nine months ended September 30, 2019 was $2.0 million. Employee stock-based compensation recognized was as follows (in thousands):

 

14

 

  

   Three months ended
September 30
   Nine months ended
September 30
 
   2020   2019   2020   2019 
Cost of revenue  $66   $28   $740   $58 
Engineering, research, and development   621    12    1,678    143 
Sales and marketing   808    6    2,545    34 
General and administrative   3,631    83    8,621    1,790 
Total stock-based compensation  $5,126   $129   $13,584   $2,025 

  

As of September 30, 2020 and 2019, there was approximately $31.4 million and $4.5 million of unrecognized stock-based compensation expense, respectively.

 

Note 10 — Earnings per share

 

The Company computed earnings per share (“EPS”) in conformity with the two-class method required for participating securities. Undistributed earnings allocated to participating securities are subtracted from net income in determining net income attributable to common stockholders. The Company allocated income between its common and preferred shareholders only for the periods the preferred stock was outstanding, which was January 1, 2020 to March 4, 2020 and May 6, 2019 to September 30, 2019. There was no preferred stock outstanding March 5, 2020 to September 30, 2020 and January 1, 2019 to May 6, 2019. As the Company was in a net loss position for the periods between January 1, 2020 to March 4, 2020 and March 5, 2020 to September 30, 2020, the net loss was allocated entirely to common shareholders.

 

All participating securities are excluded from basic weighted-average number of common shares outstanding. Diluted EPS is computed by dividing net income available to common shareholders by the weighted-average number of shares of common stock outstanding during the period increased to include the number of additional shares of common stock that would have been outstanding if the potentially dilutive securities had been issued. Potentially dilutive securities include outstanding stock options, restricted stock units, performance stock units, and convertible preferred securities. The dilutive effect of potentially dilutive securities is reflected in diluted EPS in order of dilution and by application of the treasury stock method and the if-converted method for stock-based compensation and convertible preferred securities, respectively.

 

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

  

   Three months ended
September 30,
   Nine months ended
September 30,
 
   2020   2019   2020   2019 
Numerator for basic earnings/(loss) per share                    
Net income/(loss)  $(1,117)  $4,453   $(7,879)  $8,700 
Less: Income attributable to preferred shareholders   
-
    (206)   
-
    (280)
Net income/(loss) available to common shareholders   (1,117)   4,247    (7,879)   8,420 
                     
Denominator for basic earnings per share                    
Weighted-average shares outstanding – basic   49,651    21,644    43,074    20,941 
Basic earnings/(loss) per share  $(0.02)  $0.20   $(0.18)  $0.40 
                     
Numerator for diluted earnings/(loss) per share                    
Net income/(loss) available to common shareholders  $(1,117)  $4,247   $(7,879)  $8,420 
Add-back: Income allocated to preferred shareholders assumed converted   
-
    206    
-
    280 
Net income/(loss) available to common shareholders   (1,117)   4,453    (7,879)   8,700 
                     
Denominator for diluted earnings/(loss) per share                    
Basic weighted-average common shares outstanding   49,651    21,644    43,074    20,941 
Add: Preferred stock assumed converted into common stock   
-
    1,048    
-
    564 
Weighted-average shares outstanding for diluted earnings per share   49,651    22,692    43,074    21,505 
Diluted earnings/(loss) per share  $(0.02)  $0.20   $(0.18)  $0.40 

  

15

 

 

The denominator used in the calculation of basic and diluted EPS has been retrospectively adjusted for the recapitalization of the Company’s shares as a result of the Business Combination as further described in Note 3. The following potential common shares, presented based on amounts outstanding at each period end and adjusted for the stock split as a result of the transaction, were excluded from the calculation of diluted net loss per share attributable to common stockholders for the periods indicated because including them would have had an anti-dilutive effect:

  

   Three months ended
September 30,
   Nine months ended
September 30,
 
Potential common shares (in ‘000s)  2020   2019   2020   2019 
Convertible preferred stock   -    
-
    1,048    
-
 
Stock options to purchase common stock   6,467    6,786    8,676    7,370 
Restricted stock units   2,963    
-
    2,993    
-
 
Performance stock units   1,292    
-
    1,292    
-
 
Warrants to purchase common stock   11,347    
-
    11,347    
-
 
Total   22,069    6,786    25,356    7,370 

  

Note 11 — Commitments and contingencies

 

Legal Matters

 

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

 

Note 12 — Subsequent events

 

The Company performed its subsequent event procedures through November 5, 2020, the date these condensed consolidated financial statements were issued.

 

16

 

 

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

 

Forward-Looking Statements

 

The following discussion of the financial condition and results of operations of Grid Dynamics Holdings, Inc. should be read in conjunction with the condensed consolidated financial statements and the related notes thereto included elsewhere in this Quarterly Report on Form 10-Q and the audited financial statements and notes thereto and Management’s Discussion and Analysis of Financial Condition and Results of Operations for the fiscal year ended December 31, 2019, included in the Current Report on Form 8-K which has been filed with the Securities and Exchange Commission (“SEC”) on March 9, 2020.

 

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

 

Overview

 

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

 

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

 

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

 

The Business Combination was accounted for as a reverse recapitalization for which GDI was determined to be the accounting acquirer. Outstanding shares of GDI were converted into our common shares, presented as a recapitalization, and the net assets of ChaSerg were acquired at historical cost, with no goodwill or other intangible assets recorded. The following table sets forth a summary of Grid Dynamics’ financial results for the periods indicated:

  

   Three months ended
September 30,
 
(dollars in thousands, except per share data)  2020   2019 
       % of revenue       % of revenue 
Revenues  $26,332    100.0%  $31,422    100.0%
Gross profit   11,154    42.4%   13,796    43.9%
Income/(loss) from operations   (1,671)   (6.3)%   5,585    17.8%
Net income/(loss)   (1,117)   (4.2)%   4,453    14.2%
Non-GAAP Financial Information(1)                    
Adjusted EBITDA(1)   4,173    15.8%   7,014    22.3%
Adjusted Net Income(1)   2,492    9.5%   5,146    16.4%
Adjusted Diluted EPS(1)  $0.05    n/a   $0.23    n/a 

 

17

 

 

   Nine months ended
September 30,
 
(dollars in thousands, except per share data)  2020   2019 
       % of revenue       % of revenue 
Revenues  $81,157    100.0%  $86,325    100.0%
Gross profit   29,358    36.2%   35,571    41.2%
Income/(loss) from operations   (11,892)   (14.7)%   11,480    13.3%
Net income/(loss)   (7,879)   (9.7)%   8,700    10.1%
Non-GAAP Financial Information(1)                    
Adjusted EBITDA(1)   8,416    10.4%   16,960    19.6%
Adjusted Net Income(1)   4,803    5.9%   11,746    13.6%
Adjusted Diluted EPS(1)  $0.11    n/a   $0.55    n/a 

  

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

  

Recent Developments

 

Overall, in the three months ended September 30, 2020, we witnessed improving business trends in comparison to the three months ended June 30, 2020 as our customers steadily worked towards returning to normal levels of operations. This is largely reflected in the 18% sequential revenue growth in the three months ended September 30, 2020. That said, the ongoing COVID-19 pandemic continues to impact our business as we are yet to return to pre-COVID levels (revenue & profitability). In the three months ended September 30, 2020, our revenues of $26.3 million were down 16% in comparison to the three months ended September 30, 2019, and down 19% from the three months ended March 31, 2020.

 

In the three months ended September 30, 2020, our non-retail segments combined contributed 77% of our revenue and in the aggregate, grew 10% on a sequential basis and 47% on a year-over-year basis. The growth has been driven by a combination of factors including our technical expertise, our success in engaging with new customers, and existing customers seeking to accelerate their engagements as digital transformation increasingly becomes important.

 

18

 

 

In the three months ended September 30, 2020, our retail business was 23% of our revenue and grew 53% on a sequential basis and declined by 65% on a year-over-year basis. During the quarter, we witnessed a sequential pickup in demand across most of our retail customers with a subset of the customers contributing to majority of the growth in the three months ended September 30, 2020. As we highlighted last quarter, the impacts from the COVID-19 pandemic were more pronounced on our retail customers as the pandemic resulted in business disruption that included closure of stores resulting in sales being severely impacted. Although we witnessed a sequential growth in this segment in the three months ended September 30, 2020, revenues from most of our retail customers have not come back to pre-COVID-19 levels.

 

We continue to focus on revenue diversification by increasing our customer base with new logos. In the three months ended September 30, 2020, we finished the quarter with 42 paying customers, up from 37 paying customers in the three months ended June 30, 2020, and 35 paying customers in the three months ended September 30, 2019. Furthermore, in the three months ended September 30, 2020, we added five new logos across industry verticals that included Technology, Financials, and Medical Devices.

 

We exited the three months ended September 30, 2020 with $4.2 million, or 16% of our revenue in Adjusted EBITDA, down from $7.0 million, or 22% of our revenue from the three months ended September 30, 2019. The year-over-year decline in the three months ended September 30, 2020 over the three months ended September 30, 2019 was largely driven by lower revenue and higher stock-based compensation expenses.

  

COVID-19 Related Updates

 

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

 

We continue to take precautionary measures intended to minimize the risk of the virus to our employees, our customers, and the communities in which we operate that include suspension of all non-essential travel. Although a significant proportion of our employees continue to work remotely, all of our facilities in the Central and Eastern Europe (CEE) region have been opened for employees to work following local government guidelines. We continue to deliver services to our clients in this fashion and this has resulted in minimal disruption in our operational and delivery capabilities.

 

In the three months ended June 30, 2020, we took an allowance of $0.8 million for doubtful accounts due to risks posed by the COVID-19 pandemic on our customers’ ability to make payments. We continue to be engaged with all of our customers regarding their ability to fulfill their payment obligations. In the course of the three months ended September 30, 2020, we received payments from multiple customers, including some of the higher risk retail customers. After reassessing our risk profile with customers’ ability to fulfill their payment obligations, we have lowered our allowance of doubtful accounts from $0.8 million at June 30, 2020 to $0.4 million at September 30, 2020. We continue to review our accounts receivable on a regular basis and have put in place processes to ensure payments from our customers.

 

Business Combination

 

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

 

19

 

 

Comparability of Financial Information

 

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

 

Key Performance Indicators and Other Factors Affecting Performance

 

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

 

Employees by Region

 

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

 

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

  

   As of September 30, 
   2020   2019 
United States   249    244 
Central and Eastern Europe (1)   955    1,106 
Total   1,204    1,350 

  

(1) Includes Russia, Ukraine, Poland and Serbia.

  

Attrition

 

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

 

Hours and Utilization

 

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

 

20

 

 

Customer Concentration

 

Grid Dynamics’ ability to retain and expand its relationships with existing clients and add new clients are key indicators of its revenue potential. Grid Dynamics grew its customer base from 35 customers as of September 30, 2019 to 42 customers as of September 30, 2020. Grid Dynamics’ procurement of new customers has a direct impact on its ability to diversify its sources of revenue and replace customers that may no longer require its services. Grid Dynamics has a relatively high level of revenue concentration with certain customers. Of Grid Dynamics’ customers, two customers each accounted for 10% or more of Grid Dynamics’ revenue in the three and nine months ended September 30, 2020 and three customers each accounted for 10% or more of Grid Dynamics’ revenue in the three and nine months ended September 30, 2019.

 

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

  

  

Three months ended
September 30,

 
   2020   2019 
     
Total customers (as of period end)   42    35 
Of which (customer revenue amounts annualized for interim periods):          
>$5.0 million   7    7 
>$2.5 – 5.0 million   3    3 
>$1.0 – 2.5 million   7    5 
Top five customers   60%   67%
Top ten customers   78%   85%
Top five customers  $15,782   $20,968 
Top ten customers  $20,463   $26,762 

 

 

  

Nine months ended
September 30,

 
   2020   2019 
     
Total customers (as of period end)   47    36 
Of which (customer revenue amounts annualized for interim periods):          
>$5.0 million   7    7 
>$2.5 – 5.0 million   3    3 
>$1.0 – 2.5 million   7    5 
Top five customers   59%   68%
Top ten customers   81%   88%
Top five customers  $47,724   $58,358 
Top ten customers  $65,925   $75,706 

  

21

 

 

Foreign Currency Exchange Rate Exposure

 

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

 

In the three and nine months ended September 30, 2020, approximately 12%, 11% and 10% of Grid Dynamics’ $28.0 million and approximately 14%, 11% and 10% of Grid Dynamics’ $93.0 million, respectively, of combined cost of revenue and total operating expenses were denominated in the Russian rouble, Ukrainian hryvnia and Polish zloty, respectively. Comparatively, the same foreign currencies accounted for approximately 22%, 13%, and 11% of Grid Dynamics’ $25.8 million and 21%, 12%, and 11% of Grid Dynamics’ $74.8 million of combined cost of revenue and total operating expenses in the three and nine months ended September 30, 2019. Grid Dynamics does not currently hedge its foreign currency exposure, although it seeks to minimize such exposure by limiting cash transfers to amounts necessary to fund subsidiary operating expenses for a short period, typically one to two weeks. When and where possible, Grid Dynamics seeks to match expenses to the U.S. dollar. For example, in Ukraine, Grid Dynamics generally pays salaries in the current hryvnia equivalent of an agreed U.S. dollar amount, consistent with local requirements. As a result, a significant portion of Grid Dynamics’ exposure to fluctuations in the value of the Ukrainian hryvnia against the U.S. dollar is naturally hedged. Management carefully evaluates its exposure to foreign currency risk and, though Grid Dynamics does not currently hedge this exposure through the use of financial instruments, it may do so in the future. See Part I, Item 3, “Quantitative and Qualitative Disclosures about Market Risk—Foreign Currency Exchange Rate Risk” below for more information about Grid Dynamics’ exposure to foreign currency exchange rates.

 

Seasonality

 

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

 

22

 

 

Non-GAAP Measures

 

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

 

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

 

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

 

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

  

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

  

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

 

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

 

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

  

  

Three months ended

September 30,

  

Nine months ended

September 30,

 
(in thousands)  2020   2019   2020   2019 
GAAP net income/(loss)  $(1,117)   4,453    (7,879)  $8,700 
Adjusted for:                    
Depreciation and amortization   662    601    1,896    1681 
Impairment of goodwill   -    139    -    139 
Provision/(benefit) for income taxes   (99)   1,043    (3,594)   2,608 
Stock-based compensation   5,126    129    13,584    2,025 
Transaction and transformation-related costs (1)   -    560    3,940    1,635 
Restructuring costs (2)   56    -    888    - 
Other (income)/expenses, net (3)   (455)   89    (419)   172 
Adjusted EBITDA  $4,173    7,014    8,416   $16,960 

  

(1) Transaction and transformation-related costs include, when applicable, external deal costs, transaction-related professional fees, transaction-related retention bonuses, and other transaction-related costs including integration expenses consisting of outside professional and consulting services.

 

(2) In the three months ended March 31, 2020, we implemented a cost reduction plan and incurred restructuring and severance charges of $0.7 million, primarily resulting from a reduction in workforce and other charges. We have incurred restructuring and severance charges of $0.1 million under this plan in the three months ended September 30, 2020 and $0.9 million in the nine months ended September 30, 2020.

 

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

 

23

 

 

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

 

    Three months ended
September 30,
 
(in thousands, except share and per share data)   2020     2019  
GAAP net income/(loss)   $ (1,117)     $ 4,453  
Adjusted for:                
Stock-based compensation     5,126       129  
Impairment of goodwill     -       139  
Transaction and transformation-related costs (1)     -       560  
Restructuring costs (2)     56       -  
Other (income)/expenses, net (3)     (455 )     89  
Tax impact of non-GAAP adjustments (4)     (1,118 )     (224 )
Non-GAAP Net Income (5)   $ 2,492     $ 5,146  
Non-GAAP Diluted EPS   $ 0.05     $ 0.23  
Number of shares used in the Non-GAAP Diluted EPS     49,650,667       22,692,331  

 

 

   Nine months ended
September 30,
 
(in thousands, except share and per share data)  2020   2019 
GAAP net income/(loss)  $(7,879)  $8,700 
Adjusted for:          
Stock-based compensation   13,584    2,025 
Impairment of goodwill   -    139 
Transaction and transformation-related costs (1)   3,940    1,635 
Restructuring costs (2)   888    - 
Other (income)/expenses, net (3)   (419)   172 
Tax impact of non-GAAP adjustments (4)   (5,311)   (925)
Non-GAAP Net Income (5)  $4,803   $11,746 
Non-GAAP Diluted EPS  $0.11   $0.55 
Number of shares used in the Non-GAAP Diluted EPS   43,074,180    21,505,164 

   

(1) Transaction and transformation-related costs include, when applicable, external deal costs, transaction-related professional fees, transaction-related retention bonuses, and other transaction-related costs including integration expenses consisting of outside professional and consulting services.

  

(2) In the three months ended March 31, 2020, we implemented a cost reduction plan and incurred restructuring and severance charges of $0.7 million, primarily resulting from a reduction in workforce and other charges. We have incurred restructuring and severance charges of $0.1 million under this plan in the three months ended September 30, 2020 and $0.9 million in the nine months ended September 30, 2020.

  

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

  

(4) Reflects the estimated tax impact at a normalized tax rate of the non-GAAP adjustments presented in the table.

  

(5) Non-GAAP Net Income for the period divided by the diluted weighted-average shares outstanding of 49.7 million and 22.7 million for the three months ended September 30, 2020 and 2019, respectively.  Non-GAAP Net Income for the period divided by the diluted weighted-average shares outstanding of 43.1 million and 21.5 million for the nine months ended September 30, 2020 and 2019, respectively.

 

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Key Components of Revenue and Expenses

 

Revenue

 

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

 

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

 

Costs and Expenses

 

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

 

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

 

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

 

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

 

Provision for Income Taxes. Grid Dynamics follows the asset and liability method of accounting for income taxes, whereby deferred income taxes are recognized for the tax consequences of temporary differences between the financial statement carrying amounts and the tax basis of the assets and liabilities. The provision for income taxes reflects income earned and taxed in the various U.S. federal and state and non-U.S. jurisdictions. Jurisdictional tax law changes, increases or decreases in permanent differences between book and tax items, accruals or adjustments of accruals for tax contingencies or valuation allowances, and the change in the mix of earnings from these taxing jurisdictions all affect the overall effective tax rate. Grid Dynamics’ effective tax rate was 8.1% and 19.0% in the three months ended September 30, 2020 and 2019, respectively, and 31.3% and 23.1% in the nine months ended September 30, 2020 and 2019, respectively. The differences in effective tax rate between the three and nine months ended September 30, 2020 and 2019 were attributable mainly to an increase in stock compensation deductions as well as a change in mix of taxing jurisdictions.

 

25

 

 

Results of Operations

 

The Three and Nine months Ended September 30, 2020 Compared to the Three and Nine months Ended September 30, 2019

 

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

  

   Three months ended
 September 30,
         
(unaudited, in thousands, except percentages)  2020   2019   Change 
Revenue  $26,332   $31,422   $(5,090)   (16.2)%
Cost of revenue   15,178    17,626    (2,448)   (13.9)%
Gross profit   11,154    13,796    (2,642)   (19.2)%
Engineering, research, and development   2,076    1,083    993    91.7%
Sales and marketing   2,245    1,764    481    27.3%
General and administrative   8,504    5,364    3,140    58.5%
Total operating expense   12,825    8,211    4,614    56.2%
Income/(loss) from operations   (1,671)   5,585    (7,256)   (129.9)%
Other income/(expenses), net   455    (89)   544     n.m. 
Income/(loss) before income taxes   (1,216)   5,496    (6,712)   (122.1)%
Provision/(benefit) for income taxes   (99)   1,043    (1,142)   (109.5)%
Net income/(loss)  $(1,117)  $4,453   $(5,570)   (125.1)%

 

    Nine months ended September 30,              
(unaudited, in thousands, except percentages)   2020     2019     Change  
Revenue   $ 81,157     $ 86,325     $ (5,168 )     (6.0 )%
Cost of revenue     51,799       50,754       1,045       2.1 %
Gross profit     29,358       35,571       (6,213 )     (17.5 )%
Engineering, research, and development     7,193       3,284       3,909       119.0 %
Sales and marketing     7,451       5,262       2,189       41.6 %
General and administrative     26,606       15,545       11,061       71.2 %
Total operating expense     41,250       24,091       17,159       71.2 %
Income/(loss) from operations     (11,892 )     11,480       (23,372 )     (203.6 )%
Other income/(expenses), net     419       (172 )     591        n.m.  
Income/(loss) before income taxes     (11,473 )     11,308       (22,781 )     (201.5 )%
Provision/(benefit) for income taxes     (3,594 )     2,608       (6,202 )     (237.8 )%
Net income/(loss)   $ (7,879 )   $ 8,700     $ (16,579 )     (190.6 )%.

  

n.m. = not meaningful.

 

26

 

 

Revenue. Revenue decreased by 5.1 million, or 16.2%, to $26.3 million in the three months ended September 30, 2020 from $31.4 million in the three months ended September 30, 2019. The revenue decrease was largely driven by the adverse impacts of the COVID-19 pandemic on our retail customers offset by growth across our non-retail segments. Grid Dynamics’ top five customers contributed $15.8 million and $21.0 million to revenue for the three months ended September 30, 2020 and 2019, respectively. Furthermore, between the three months ended September 30, 2020 and 2019, three out of the five customers remained in the top five customer group.

 

Revenue decreased by $5.2 million, or 6.0%, to $81.1 million in the nine months ended September 30, 2020 from $86.3 million in the nine months ended September 30, 2019. The revenue decrease was largely driven by decrease in revenues on our retail customers in the nine months ended September 30, 2020 due to the adverse impacts of the COVID-19 pandemic offset by growth across our non-retail segments. Grid Dynamics’ top five customers contributed $47.7 million and $58.4 million to revenue for the nine months ended September 30, 2020 and 2019, respectively. Furthermore, between the nine months ended September 30, 2020 and 2019, four out of the five customers remained in the top five customer group.

 

Cost of Revenue and Gross Profit. Cost of revenue decreased by $2.4 million, or 13.9%, to $15.2 million in the three months ended September 30, 2020 from $17.6 million in the three months ended September 30, 2019, largely driven by Grid Dynamics’ decreased business volume due to the headwinds from the COVID-19 pandemic.

 

Cost of revenue increased by $1.0 million, or 2.1%, to $51.8 million in the nine months ended September 30, 2020 from $50.8 million in the nine months ended September 30, 2019, largely from increased costs associated with stock-based compensation and retention bonus, offset by decreased costs from lower business volume due to the headwinds from the COVID-19 pandemic.

 

Gross profit decreased by $2.6 million, or 19.2%, to $11.2 million in the three months ended September 30, 2020 compared to $13.8 million in the three months ended September 30, 2019. Gross margin (gross profit as a percentage of revenue) decreased by 1.5 percentage points to 42.4% in the three months ended September 30, 2020 from 43.9% in the three months ended September 30, 2019. The gross margin decline was attributable to a combination of lower levels of revenue in the three months ended June 2020 due to the impacts of the ongoing COVID-19 pandemic and increased costs associated with stock-based compensation.

 

Gross profit decreased by $6.2 million, or 17.5%, to $29.4 million in the nine months ended September 30, 2020 compared to $35.6 million in the nine months ended September 30, 2019. Gross margin (gross profit as a percentage of revenue) decreased by 5 percentage points to 36.2% in the nine months ended September 30, 2020 from 41.2% in the nine months ended September 30, 2019. The gross margin decline was attributable to a combination of increased costs associated with stock-based compensation and retention bonuses resulting from the Business Combination and lower levels of revenue in the nine months ended September 30, 2020 due to the impacts of the ongoing COVID-19 pandemic.

 

Engineering, Research and Development. Engineering, research and development expenses increased by $1.0 million to $2.1 million in the three months ended September 30, 2020, a 91.7% increase from $1.1 million in the three months ended September 30, 2019. The increase was primarily due to a combination of enhanced efforts around engineering and development projects, costs associated with stock-based compensation, and reallocation of delivery personnel to strategic R&D initiatives and projects.

 

Engineering, research and development expenses increased by $3.9 million to $7.2 million in the nine months ended September 30, 2020, a 119.0% increase from $3.3 million in the nine months ended September 30, 2019, reflecting Grid Dynamics’ efforts to enhance its solutions and expertise as well as due to the increased costs associated with stock-based compensation and retention bonuses resulting from the Business Combination.

 

Sales and Marketing. Sales and marketing expenses increased by $0.4 million, or 27.3%, to $2.2 million in the three months ended September 30, 2020 from $1.8 million in the three months ended September 30, 2019. Sales and marketing expenses accounted for 8.5% of Grid Dynamics’ revenue in the three months ended September 30, 2020 compared to 5.6% in the three months ended September 30, 2019, an increase of 2.9 percentage points. The increase in expense was due to an increase in stock-based compensation offset by a decrease in marketing and sales events from the restrictions imposed with the COVID-19 pandemic.

 

27

 

 

Sales and marketing expenses increased by $2.2 million, or 41.6%, to $7.5 million in the nine months ended September 30, 2020 from $5.3 million in the nine months ended September 30, 2019. Sales and marketing expenses accounted for 9.2% of Grid Dynamics’ revenue in the nine months ended September 30, 2020 compared to 6.1% in the nine months ended September 30, 2019, an increase of 3.1 percentage points. The increase was due mainly to the increased costs associated with stock-based compensation and retention bonuses resulting from the Business Combination and partially offset by a decrease in marketing and sales events due to the COVID-19 pandemic.

 

General and Administrative. General and administrative expenses increased by $3.1 million, or 58.5%, to $8.5 million in the three months ended September 30, 2020 from $5.4 million in the three months ended September 30, 2019, largely from the increased expenses associated with stock-based compensation expenses. As a result, general and administrative expenses accounted for 32.3% of Grid Dynamics’ revenue in the three months ended September 30, 2020, an increase of 15.2 percentage points from 17.1% in the three months ended September 30, 2019.

 

General and administrative expenses increased by $11.1 million, or 71.2%, to $26.6 million in the nine months ended September 30, 2020 from $15.5 million in the nine months ended September 30, 2019, largely due to the increased costs associated with stock-based compensation and retention bonuses resulting from the Business Combination. As a result, general and administrative expenses accounted for 32.8% of Grid Dynamics’ revenue in the nine months ended September 30, 2020, an increase of 14.8 percentage points from 18.0% in the nine months ended September 30, 2019.

  

Other income/(expenses), net. Other net income increased by $0.5 million to $0.5 million in the three months ended September 30, 2020 over the three months ended September 2019, mainly due to interest and other income offset by miscellaneous expenses.

 

Other income/(expenses) increased by $0.6 million to $0.4 million in the nine months ended September 30, 2020 over the nine months ended September 30, 2019 reflecting increased interest and other income and miscellaneous expenses.

 

Provision/(benefit) for Income Tax. Provision/(benefit) for income tax was ($0.1) million in the three months ended September 30, 2020 compared to $1.0 million in the three months ended September 30, 2019. The difference in tax provision is primarily due to net operating losses generated by stock compensation deductions and year-to-date book losses.

 

Provision/(benefit) for income tax was ($3.6) million in the nine months ended September 30, 2020 compared to $2.6 million in the nine months ended September 30, 2019. The difference in tax provision is primarily driven by excess tax benefits of stock-based compensation resulted from the Business Combination.

 

Net Income/(loss). Net income decreased to ($1.1) million in the three months ended September 30, 2020 from $4.5 million in the three months ended September 30, 2019, for the reasons discussed above.

 

Net income/(loss) decreased to ($7.9) million in the nine months ended September 30, 2020 from $8.7 million in the nine months ended September 30, 2019, for the reasons discussed above.

 

Liquidity and Capital Resources

 

Grid Dynamics measures liquidity in terms of its ability to fund the cash requirements of its business operations, including working capital needs, capital expenditures, contractual obligations and other commitments with cash flows from operations and other sources of funding. Grid Dynamics’ current liquidity needs relate mainly to compensation and benefits of Grid Dynamics’ employees and contractors and capital expenditures for computer hardware and office furniture. Grid Dynamics’ ability to expand and grow its business will depend on many factors including its capital expenditure needs and the evolution of its operating cash flows. Grid Dynamics may need more cash resources due to changed business conditions or other developments, including investments or acquisitions. Grid Dynamics believes that its current cash position on its balance sheet of $126.5 million is sufficient to fund its currently expected levels of operating, investing and financing expenditures for a period of twelve months from the date of this filing. However, if Grid Dynamics’ resources are insufficient to satisfy its cash requirements, it may need to seek additional equity or debt financing, which may be subject to conditions outside of Grid Dynamics’ control and may not be available on terms acceptable to Grid Dynamics’ management or at all.

 

28

 

 

As of September 30, 2020, Grid Dynamics had cash and cash equivalents amounting to $126.5 million. Of this amount, $2.0 million was held outside the United States, namely in Russia, Ukraine, Poland and Serbia. As many of Grid Dynamics’ assets, operations and employees are located in these countries, Grid Dynamics expects that all such cash and cash equivalents will be used to fund future operating needs and Grid Dynamics’ management has no intention of repatriating the funds. If Grid Dynamics decided to remit funds from these countries to the United States in the future, whether in the form of inter-company dividends or otherwise, they may be subject to foreign withholding taxes. In addition, Grid Dynamics’ cash in banks in Russia, Ukraine, Poland and Serbia may be subject to other risks, as the banking sector in certain of these countries is subject to periodic instability, may be subject to sanctions and may be subject to capital adequacy and other banking standards that are substantially less rigorous than those of the United States.

 

Grid Dynamics does not have any debt outstanding at the date of this report and did not have any debt outstanding at any balance sheet date presented.

 

All of our performance stock units, or PSUs, vest upon the satisfaction of a performance-based vesting condition, which is expected no later than March 1, 2021. We currently estimate that approximately 1.28 million shares will be issued upon vesting of the PSUs. The first vesting event for our restricted stock units, or RSUs, will also occur no later than March 13, 2021, by which time approximately 0.6 million shares underlying RSUs held by our officers and employees will have vested and settled into shares of our common stock. We currently expect that the average withholding tax rate for such individuals will be approximately 50%. We have determined that our policy will be to require individuals to withhold to cover, so approximately 50% of the vested shares would be withheld on the settlement date, with the equivalent value being paid by us from our working capital. If the price of our common stock at the time of settlement of our PSUs and RSUs in the first quarter of 2021 were equal to the share price on September 30, 2020 of $7.73 per share, we estimate that this tax withholding obligation in the first quarter of 2021 would be approximately $7.1 million in the aggregate. 

 

Cash Flows

 

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

  

   Nine months ended
September 30,
 
(unaudited, in thousands)  2020   2019 
Net cash provided by operating activities  $2,998   $10,816 
Net cash used in investing activities   (1,607)   (2,099)
Net cash provided by financing activities   82,946    14,604 
Net increase in cash and cash equivalents   84,337    23,321 
Cash, cash equivalents (beginning of period)   42,189    17,862 
Cash, cash equivalents (end of period)  $126,526   $41,183 

  

Operating Activities. Net cash provided by operating activities during the nine months ended September 30, 2020 decreased by $7.8 million, or 72.3%, to $3.0 million from $10.8 million in the same period in 2019, driven by lower cash operating profit (before non-cash depreciation and amortization and stock-based compensation charges). The key reasons for the decline in cash operating profit were retention bonuses paid out to employees due to the successful Business Combination on March 5, 2020, lower level of revenues due to the impact of the COVID-19 pandemic in the period of March through September 30, 2020, and higher costs associated with our delivery centers.

 

Investing Activities. Net cash used in investing activities during the nine months ended September 30, 2020 was $(1.6) million compared to $(2.1) million used in the same period in 2019, and in both periods reflected mainly capital expenditures for computer hardware, related equipment and software.

 

Financing Activities. Net cash provided by financing activities was $83.0 million in the nine months ended September 30, 2020, reflecting primarily the proceeds from the Business Combination. Net cash provided by financing activities was $14.6 million in the nine months ended September 30, 2019 reflecting primarily $14.9 million in proceeds from the sale of common and preferred stock and $1.7 million in proceeds from stock option grant exercises in 2019, offset by dividends paid of $(2.0) million.

 

Contractual Obligations

 

Grid Dynamics’ outstanding operating leases and software service agreement obligations have not changed materially since December 31, 2019. In addition, Grid Dynamics purchases software licenses in the ordinary course of business.

 

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

 

Off-Balance Sheet Arrangements and Commitments

 

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

 

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

 

29

 

 

Critical Accounting Policies

 

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

 

Emerging Growth Company Accounting Election

 

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

 

Recently Adopted and Issued Accounting Pronouncements

 

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

 

In particular, Grid Dynamics implemented Accounting Standards Codification (ASC) Topic 606 (Revenue from Contracts with Customers) in January 2019. Grid Dynamics adopted the standard using the modified retrospective method, where it recognized the cumulative effect of initially applying the standard as an adjustment to the opening balance of retained earnings while prior period amounts are not adjusted and continue to be reported in accordance   with Grid Dynamics’ legacy accounting under ASC Topic 605. The implementation of the new standard did not materially affect our consolidated financial statements as discussed further in Note 2 to Grid Dynamics’ condensed consolidated financial statements.

 

Item 3. Quantitative and Qualitative Disclosures About Market Risk

 

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

 

Foreign Currency Exchange Rate Risk

 

Grid Dynamics is exposed to foreign currency exchange transaction risk related to funding its non-US operations and to foreign currency translation risk related to certain of its subsidiaries’ cash balances that are denominated in currencies other than the U.S. dollar, which is Grid Dynamics’ functional currency. In addition, Grid Dynamics’ profit margins are subject to volatility as a result of changes in foreign exchange rates. When and where possible, Grid Dynamics seeks to match expenses to the U.S. dollar, and believes, due to Ukrainian payroll being pegged to the U.S. dollar, that a significant portion of its foreign currency exchange rate exposure to the Ukrainian hryvnia is naturally hedged. In future periods, Grid Dynamics may also become materially exposed to changes in the value of the Serbian dinar against the U.S. dollar, as it continues to expand its operations in Serbia.

  

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In the three months ended September 30, 2020, approximately 12%, 11% and 10% of Grid Dynamics’ $28.0 million of combined cost of revenue and total operating expenses were denominated in the Russian rouble, Ukrainian hryvnia and Polish zloty, respectively. Comparatively, the same foreign currencies accounted for approximately 22%, 13%, and 11% of Grid Dynamics’ $25.8 million of combined cost of revenue and total operating expenses in the three months ended September 30, 2019.

 

In the three months ended September 30, 2020:

  

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

  

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

  

In the three months ended September 30, 2019:

 

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

  

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

  

In the nine months ended September 30, 2020, approximately 14%, 11% and 10% of Grid Dynamics’ $93.0 million of combined cost of revenue and total operating expenses were denominated in the Russian rouble, Ukrainian hryvnia and Polish zloty, respectively. Comparatively, the same foreign currencies accounted for approximately 21%, 12%, and 11% of Grid Dynamics’ $74.8 million of combined cost of revenue and total operating expenses in the three months ended September 30, 2019.

 

In the nine months ended September 30, 2020:

  

  a 10% decrease in the value of the Russian rouble against the U.S. dollar would have resulted in a $1.2 million increase in Grid Dynamics’ income from operations, while a 10% increase in the rouble’s value would have resulted in a $1.5 million decrease in income from operations.

  

  a 10% decrease in the value of the Polish zloty against the U.S. dollar would have resulted in a $0.8 million increase in Grid Dynamics’ income from operations, while a 10% increase in the zloty’s value would have resulted in a $1.0 million decrease in income from operations.

  

In the nine months ended September 30, 2019:

  

a 10% decrease in the value of the Russian rouble against the U.S. dollar would have resulted in a $1.5 million increase in Grid Dynamics’ income from operations, while a 10% increase in the rouble’s value would have resulted in a $1.8 million decrease in income from operations.

 

a 10% decrease in the value of the Polish zloty against the U.S. dollar would have resulted in a $0.8 million increase in Grid Dynamics’ income from operations, while a 10% increase in the zloty’s value would have resulted in a $0.9 million decrease in income from operations.

  

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

 

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

 

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Item 4. Controls and Procedures

 

Evaluation of Disclosure Controls and Procedures

 

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

 

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

 

Grid Dynamics was not required to perform an evaluation of internal control over financial reporting as of December 31, 2019, 2018, and 2017 in accordance with the provisions of the Sarbanes-Oxley Act as it was then a private company. Had such an evaluation been performed, additional control deficiencies may have been identified by Grid Dynamics’ management, and those control deficiencies could have also represented one or more material weaknesses.

 

An evaluation was conducted under the supervision and with the participation of management, including our Chief Executive Officer (“CEO”) and Chief Financial Officer (“CFO”), of the effectiveness of our disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and Exchange Act Rules 15d-15(e)) as of September 30, 2020. Based on that evaluation, the CEO and CFO concluded that our disclosure controls and procedures were not effective at the reasonable assurance level as of such date because of the material weakness.

 

We have taken steps to enhance our internal control environment, including hiring a new Chief Financial Officer in December 2019, hiring a Global Controller in May 2020, and hiring additional qualified accounting and financial reporting personnel. Additionally, our new ERP system, which has been implemented in phases since January 2020, has enhanced our internal controls over financial reporting. Over the course of the last three quarters of 2020, with a combination of increased personnel, greater automation with software systems, and implementation of more detailed processes and procedures, we believe we are well positioned to remediate our material weakness. Although we seek to complete this remediation process as quickly as possible, we cannot at this time estimate how long it will take.

 

We have discussed the matters above with our Audit Committee, including the evaluation of disclosure controls and procedures, the material weakness, and the steps we are taking to remediate the material weakness.

 

Internal Control Over Financial Reporting

 

Our management, including the CEO and CFO, confirmed there were no changes in our internal control over financial reporting during the three months ended September 30, 2020 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting, except for the improvements discussed above.

 

Inherent Limitations on Effectiveness of Controls

 

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

 

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PART II — OTHER INFORMATION

 

Item 1. Legal Proceedings

 

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

 

Item 1A. Risk Factors

 

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

 

Risks Related to Our Business, Operations and Industry

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

We generate a significant portion of our revenues from our largest clients and have a limited client base of fewer than 45 total revenue generating clients. For example, we generated approximately 78% and 85% of our revenue from our 10 largest clients during the three months ended September 30, 2020 and 2019, respectively, and approximately 81% and 88% during the nine months ended September 30, 2020 and 2019, respectively. Our two largest clients each accounted for 10% or more of our revenue during the three and nine months ended September 30, 2020 and our top three clients each accounted for 10% or more of our revenue during the three months and nine months ended September 30, 2019. Since we derive substantially all of our revenue through time and materials contracts, which are mostly short-term in nature, a major client in one year may not provide the same level of revenues for us in any subsequent year. In addition, a significant portion of our revenues is concentrated in two specific industry verticals: technology and retail. Our growth largely depends on continued demand for our services from clients in these two industry verticals and other industries that we may target in the future, as well as on trends in these industries to outsource the type of services we provide.

 

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

 

A reduction in demand for our services and solutions caused by seasonal trends, downturns in any of our targeted industries, a slowdown or reversal of the trend to outsource IT services in any of these industries or the introduction of regulations that restrict or discourage companies from outsourcing may result in a decrease in the demand for our services and could have a material adverse effect on our business, financial condition and results of operations. In addition to the potential impact of these seasonal trends, the global COVID-19 pandemic has had adverse effects on the retail industry, which could lead to additional adverse effects on our business.

 

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

 

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

 

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The COVID-19 pandemic is currently impacting and will impact our sales and revenue in the near term. From March 2020 onwards, we started witnessing the impacts of the COVID-19 pandemic to our revenues, largely as a consequence of the impacts of the pandemic to the business conditions at some of our customers’ operations. The impacts have been more pronounced at our customers exposed to the retail segment as they depend on consumer spending and their ability to keep their stores open for customers. While the impact is more pronounced on our retail business, the impacts to other segments of our business have largely been determined by customer-specific dynamics. Examples of the COVID-19 pandemic’s impact to our business have included a temporary scale back to our personnel on projects, our customers placing projects and SOWs on temporary hold, and request for longer payment terms. Additionally, because more people are working remotely, we face increased cyber threats that may affect our systems and networks or those of our clients and contractors, and we anticipate the potential for increased costs to maintain and help secure our infrastructure and data.

 

There are no comparable recent events which may provide guidance as to the effect of the spread and the ultimate impact of the COVID-19 pandemic. Consequently, the magnitude of impact to our business and duration of impact is uncertain and difficult to reasonably estimate at this time. Furthermore, the heightened uncertainty and diminished visibility has reduced our ability to forecast our business.

 

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

 

In the three months ended June 30, 2020, we took an allowance of $0.8 million for doubtful accounts due to risks posed by the COVID-19 pandemic on our customers’ ability to make payments. We continue to be engaged with all of our customers regarding their ability to fulfill their payment obligations. In the three months ended September 30, 2020, we received payments from multiple customers, including some of the higher risk retail customers. After reassessing our risk profile with our customers’ ability to fulfill their payment obligations, we have lowered our allowance of doubtful accounts from $0.8 million in the three months ended June 30, 2020 to $0.4 million in the three months ended September 30, 2020. We continue to review our accounts receivable on a regular basis and have put in place incremental processes to ensure payments from our customers.

 

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

 

The IT services industry is particularly sensitive to the economic environment and tends to decline during general economic downturns. We derive nearly all of our revenues from clients in the U.S. In the event of an economic downturn in the U.S., our existing and prospective clients may reduce or postpone their technology spending significantly, which may in turn lower the demand for our services and may have a material adverse effect on our business, financial condition and results of operations. In addition, if a disruption in the credit markets were to occur, it could pose a risk to our business if clients or vendors are unable to obtain financing to meet payment or delivery obligations to us or if we are unable to obtain necessary financing. The COVID-19 pandemic has had adverse effects on economies and financial markets globally, which have particularly impacted many small, medium as well as large-sized businesses. Any economic downturn resulting from the COVID-19 pandemic and preventative measures taken by governments and private business worldwide could decrease technology spending and adversely affect demand for our offerings and harm our business and results of operations. Although the U.S. government and others throughout the world have or have taken steps to provide monetary and fiscal assistance to individuals and businesses affected by the pandemic, it is unclear whether government actions will successfully avert or mitigate any economic downturn.

 

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We face intense competition.

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

Our success depends substantially upon the continued services of our senior executives and other key employees. If we lose the services of one or more of such senior executives or key employees, our business operations can be disrupted, and we may not be able to replace them easily or at all. In addition, competition for senior executives and key personnel in our industry is intense, and we may be unable to retain our senior executives and key personnel or attract and retain new senior executives and key personnel in the future, in which case our business may be severely disrupted.

 

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

 

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

 

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

  

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

  

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

  

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

  

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

  

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

We rely on software and hardware from various third parties as well as hosted SaaS applications from third parties to deliver our services and solutions. If any of these software, hardware or SaaS applications become unavailable due to loss of license, extended outages, interruptions, such as adverse impacts from the COVID-19 pandemic, or because they are no longer available on commercially reasonable terms, there may be delays in the provisioning of our services until equivalent technology is either developed by us, or, if available, is identified, obtained and integrated, which could increase our expenses or otherwise harm our business. Furthermore, any errors or defects in or failures of third-party software, hardware or SaaS applications could result in errors or defects in or failures of our services and solutions, which could be costly to correct and have an adverse effect on our reputation, business, financial condition and results of operations.

 

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

 

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

 

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

 

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

 

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

 

Any failure to maintain effective internal controls over our financial reporting could materially and adversely affect us. Section 404 of the Sarbanes-Oxley Act requires us to include in our annual reports on Form 10-K an assessment by management of the effectiveness of our internal controls over financial reporting. In addition, we will be required to have our independent public accounting firm attest to and