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Perficient, Inc. (NASDAQ:PRFT)

Q3 2008 Earnings Call Transcript

November 6, 2008, 9: 00 am ET

Executives

Jack McDonald - Chairman & CEO

Paul Martin - CFO

Jeff Davis - President & COO

Analysts

Peter Jacobson - Brean Murray, Carret & Co.

Colin Gillis - Canaccord Adams

John Maietta - Needham & Company

Brian Kintslinger - Sidoti & Company

Operator

Good day, ladies and gentlemen, and welcome to the third quarter 2008 Perficient earnings conference call. My name is Carmen. I'll be your coordinator for today.

At this time, all participants are in a listen-only mode. We will be facilitating a question-and- answer session towards the end of this conference.

(Operator Instructions). As a reminder, ladies and gentlemen, this conference call is being recorded for replay purposes. I would now like to turn the presentation over to your host for today's call, Chairman and CEO, Jack McDonald. Please proceed.

Jack McDonald

Good morning. This is Jack McDonald. On the phone with me today I've got Jeff Davis, our President and COO, and also Paul Martin, our CFO. I want to thank everybody for their time today. Typical format, we'll have about 10 or 15 minutes of prepared comments after which we'll open up the call for questions. Paul, could you read the Safe Harbor statement, please.

Paul Martin

Sure. Thanks, Jack and good morning. Some of the things we will discuss in today's call concerning future company performance will be forward-looking statements within the meaning of the securities laws. Actual results may materially differ from those disclosed in these forward-looking statements, and we encourage you to refer to the additional information contained in our SEC filings concerning factors that could cause those results to be different than contemplated in today's discussion.

In addition, our earnings press release including a reconciliation of certain non-GAAP financial measures to the most directly comparable financial measures prepared in accordance with Generally Accepted Accounting Principles, or GAAP, is posted on our website at www.perficient.com under News and Events. We have also posted a reconciliation of certain non-GAAP goals to the most directly comparable financial measures prepared in accordance with GAAP on our website under Investor Relations. Jack?

Jack McDonald

So, Q3 for us was a pretty solid quarter in what I think we'll all acknowledge is a mixed economic environment. We had pre-announced a confirmation of our revenue guidance for the quarter, so of course, revenues came in in-line with our original guidance.

As we indicated in the release, $10 million of EBITDA ex stock comp and a couple of non-cash charges that I'll talk more about in a moment. Our cash position continues to build, and we've talked about the fact that we feel our stock is significantly undervalued at these levels. We had announced a $10 million stock buyback earlier this year and over the past 90 or so days, we've executed aggressively against that, buying back about $5 million of stock in the market under that program. And even after those buybacks, our cash position as of this morning is north of $20 million. So the Company continues to generate significant cash.

In terms of the demand environment that we're seeing out there, and Jeff Davis will talk a little bit more about this later. But we're continuing to see, I would say a pretty reasonable demand environment. I'd say probably for the vast majority of our customers it's moving forward, business as usual. Obviously, there are some slowdowns that we're seeing with some customers in terms of sales cycle and in terms of project initiation, but we are not seeing wholesale project cancellations, and in fact, again, as Jeff will speak about more later, our pipeline is stronger really than it's ever been. So you know, difficult economic environment, but we continue to remain optimistic in general.

Balance sheet again continues to strengthen. Really have never had a more solid balance sheet than today, $54 million in net current assets, and again that includes quarter end about $15 million in cash, and that's again closer to $20 million today, and that's after the repurchase of about $5 million in stock. Continue to have a zero balance under our new $50 million credit facility and remember that facility itself is expandable to up to $75 million, so strong cash, no debt, and great access to credit if we need it.

One of the things that we wanted to do this quarter in light of the economic environment is make sure that we are proactive and take this opportunity, frankly, to do any sort of clean-up that makes sense or to review reserves and make sure that we're in the most solid possible position given the current economic environment. So there were two steps that we took there. The first is we did a full review of customer accounts and accounts receivable and decided to increase our accounts receivable reserve for doubtful accounts by about $1.5 million. So really going kind of account-by-account and just to be proactive and increase those reserves for accounts receivable.

Doesn't mean we think those are not collectable, but obviously you look at a variety of factors. They may well be collectable, but we wanted to make sure that we were putting in an appropriate reserve in the current economic environment. So we have done that, $1.5 million that is a non-cash charge. It does not impact our actual current cash position. In addition to that, given our strong balance sheet, the fact that we have access to credit, we have zero debt; we are generating significant cash flow on an operating basis from the business.

But given the fact that we are net buyers of our stock today under our stock repurchase program and that we do not anticipate any near-term stock issuances. We decided to write off the deferred offering cost that we've had on the balance sheet since way back in 2005. You'll recall those were costs about $940,000 that we incurred and paid back in 2005 in connection with a secondary offer and we were considering. We ultimately converted that registration statement and it was shelf registration statement. As I say, we've never used it. It'll still be out there for us if we want to use it, but this seem like an opportune time to sort of clean that item off the balance sheet.

It's not something we had to do, but we decided at this point. It made sense to do that and again, we took the action on the increasing accounts receivable reserve, as well. So, you know, we continue to feel good about the business and our ability to handle whatever challenges the economy might present. We've talked about this before. Perficient has a very flexible cost structure. We've got low fixed costs. We've got low CapEx requirements. We've got a culture and a management team that has shown an ability on a proven basis through other challenging economic environments to manage costs, and we will continue to do that.

We're focusing on customers and on cash flow and on building our balance sheet and we will continue again to look to repurchase our own stock. We believe that the stock is undervalued at these levels, so you will see us continue to execute on a measured basis as it makes sense against our $10 million stock repurchase program. Again, we've got $5 million of capacity left under that plan, and it may well be when that's done that we would look at additional purchases. Obviously, those things will be considered through time and announced as decisions are made. So feeling good about where we are in general, given the environment.

I also want to talk about the outlook for full-year earnings guidance. Our current range is $0.75 to $0.80. You see the outlook. We're going to talk a little bit more about the outlook for Q4, which we see as a little light, again, given the environment. Based on the Q4 outlook alone, we would take our full-year earnings guidance down a nickel. So going from $0.75 to $0.80 to $0.70 to $0.75. When you add in the non-cash charges which are really again, the pro-active non-cash charges that we decided to take this quarter, that takes a few more pennies off, so in light of that we'll take the full range down for the year to $0.65 to $0.70.

There are some additional information and a reconciliation to GAAP and other required disclosures that are available as of now on our website for folks that want to check that.

So with that, I'm going to turn the call over to Paul Martin to walk in detail through third quarter financial results. Paul?

Paul Martin

Thanks, Jack. Total revenues for the third quarter of 2008 were $58.3 million, a 10% increase over a year-ago quarter. Services revenue, excluding reimbursable expenses, were $52.5 million with organic growth of approximately negative 3.6% on a trailing four-quarter average annualized basis, including businesses owned at least two quarters. The sequential revenue growth in the third quarter compared to the second quarter was negative 2.1%.

Gross margin for services, excluding stock compensation and reimbursed expenses for the third quarter was 37.1%, which is down from 39.2% in the third quarter of 2007. The decline in gross margins is primarily a result of lower utilization associated with project delays and a pause in organic revenue growth.

SG&A was $13 million in the third quarter including $1.6 million of non-cash stock compensation expense and $1.5 million of an incremental allowance for doubtful accounts associated with the estimated impact of the current economic environment on certain customers' financial stability and payment history. Excluding non-cash stock compensation and the incremental allowance for doubtful accounts, SG&A expense was $9.9 million compared to $8.7 million in the comparable 2007 quarter.

SG&A excluding stock compensation and the incremental allowance for doubtful accounts as a percentage of revenues was 17% in the third quarter of 2008 compared to 16.4% in the third quarter of 2007. EBITDA for the third quarter of 2008 was $6.1 million compared to $9.2 million for the third quarter of 2007. The third quarter of 2008 results included a $1.5 million incremental allowance for doubtful accounts associated with the estimated impact of the current economic environment on certain customers' financial stability and payment history and $0.8 million more non-cash stock compensation expense compared to the third quarter of 2007.

Excluding these items, EBITDA declined 7%. Net income decreased to $2.2 million compared to $4.5 million for the third quarter of 2007. This is our 21st consecutive quarter of positive net income. Diluted GAAP earnings per share decreased to $0.07 a share compared to $0.15 a share for the third quarter or 2007. The third quarter of 2008 includes a one-time non-cash charge of $900,000 that Jack referred to or $0.02 related to the write-off of deferred offering cost and a charge of $1.5 million or $0.03 as a result of the incremental allowance for doubtful accounts.

Non-GAAP earnings per share was $0.16 for the third quarter of 2008 compared to $0.21 per share in the year-ago quarter. Excluding the incremental allowance for doubtful accounts, non-GAAP EPS was $0.19, 10% lower than the year-ago period. Non-GAAP EPS is defined as GAAP earnings per share plus non-cash amortization expense and non-cash stock compensation expense, net of related taxes divided by average fully diluted outstanding shares for the period.

Looking at the full year, year-to-date revenues for the nine months ended September 30, 2008 were $174.7 million, a 12% increase over the comparable period last year. Year-to-date services revenue were $158.2 million for the nine months ended September 30, 2008, an increase of 15% over the comparable prior year period. Services, gross margin, excluding reimbursed expenses and stock compensation was 36.6% in the nine months ended September 30, 2008 compared to 39.1% in the prior year. The lower margin is primarily a result of lower utilization, delays in start dates of projects and a pause in our organic growth.

SG&A was $35.4 million for the nine months ended September 30, 2008 including $4.8 million of non-cash stock compensation expense and a $1.5 million charge in the third quarter for the incremental allowance for doubtful accounts. Excluding non-cash stock compensation in the increase allowance for doubtful accounts, SG&A expense was $29 million compared to $26.7 million the comparable prior year period. SG&A, excluding stock compensation and the incremental allowance for doubtful accounts as a percentage of revenues decreased to 16.6% from 17.1% in the comparable 2007 period.

Net income was $9.2 million in the nine months ended September 30, 2008 with fully diluted earnings per share of $0.30 down $0.09 from the prior year period. Excluding the write-off of deferred offering costs in the incremental allowance for doubtful accounts, net income was $0.35 down $0.04 from the prior year.

Non-GAAP earnings per share was $0.53 in the first nine months compared to $0.56 in the year-ago period. Excluding the incremental allowance for doubtful accounts non-GAAP earnings per share was $0.56, which is flat compared to the prior year.

Our average billable headcount for the third quarter of 2008 was 1,156, which includes 1,025 billable consultants and 131 subcontractors. In addition to the billable headcount, we currently have 171 SG&A personnel, which results in total colleague headcount of 1,327 as of September 30, 2008.

As Jack mentioned, during the quarter we spent $4.8 million on repurchasing 637,000 shares. We continue to believe our shares are undervalued, and the repurchases will drive future accretion in shareholder value.

We continue to also generate strong operating cash flows. Our operating cash flow year-to-date has increased 26% over the comparable prior year period. We entered the quarter with no debt and $15.6 million of cash on hand. Our day sales outstanding on accounts receivable was 75 days at the end of the third quarter. Our goal is to maintain DSOs between 70 and 75 days.

I'll now turn the call over to Jeff Davis for a little more commentary behind these metrics. Jeff?

Jeff Davis

Thanks, Paul. As jack mentioned earlier, in spite of I think a difficult macroeconomic situation, Perficient delivered a solid quarter. You know we continue to manage the business profitably with most of our key operating metrics well within target ranges. Example, utilization was healthy at 83% including subs and we saw a meaningful increase in September relative to mid-summer. Also we're not seeing any notable price pressure at this point.

Our average bill rate actually tipped higher sequentially and remained consistent with this time last year. Our average yield sides actually increased significantly over the prior year quarter, up 17%.

During Q3, we closed 22 deals valued at greater than half a million dollars, which is up meaningfully over the same period 2007, which saw 12 deals in that range and consistent with prior quarters in this year. We had 23 of those in Q2 and 21 in Q1. The number of large deals closing during the quarter I think further validates what we've been saying all along, that the projects are still there. In fact, our gross pipeline is larger than ever. What we are seeing in this environment is extended sales cycles, but the work we do is not going away.

I also want to provide a brief update on the progress of our vertical practice expansion. On the last two calls, we referenced investments we've been making in building out practices focused on the healthcare and Telecom industries. We're already seeing returns on those investments with closed business in Q3 and with additional opportunities in the pipeline. One deal we've closed recently in the healthcare space represents the potential multi-year, multi-million dollar arrangement that provides a blended on-shore and offshore project teams, as well as support and maintenance resources leveraging our China Development Center.

We also see meaningful future opportunity in the integration work driven by the significant number of company consolidations that have been occurring in recent months. Remember that integration technology is a key area of strength for us, and in fact, we've identified a senior business development executive to focus specifically on integration in the financial services space. So while the market is temporarily slowed, Perficient is really the same firm as it's always been. The discipline and the focus that took us from start-up to our leadership position today remain in place and I'm confident when the economy begins to thaw, we're very well positioned to resume our path of strong growth.

With that I'll turn the call back over the Jack to review our Q4 outlook.

Jack McDonald

As it was indicated in the press release we're looking at fourth quarter services and software revenue, including reimbursed expenses to be in the range of $52.3 to $57.5 million, and that is comprised of $50.5 to $53.5 of revenue from services. That's including reimbursed expenses and about $2 million to $4 million of revenue from the sale of software. So that guidance range of services revenue, including reimbursed expenses represents a decrease in services revenue of between 7% and 12% from the fourth quarter of 2007, so some shrinkage from last year, again due to the slower economy.

And again, in light of that Q4 outlook alone, we would have taken our full-year earnings guidance down by a nickel from $0.75 to $0.80 down to $0.70 to $0.75, and then you add in those two non-cash charges that we proactively took this quarter to just get ahead of any potential issues and also to just take that deferred offer in costs off the balance sheet and with that, what we're taking it down to $0.65 to $0.70.

So with that, let's go ahead and open the call up for questions.

Question-and-Answer Session

Operator

(Operator Instructions) And the first question comes from the line of Peter Jacobson. Please proceed.

Peter Jacobson - Brean Murray, Carret & Co.

Thanks and good morning, everybody.

Jack McDonald

Good morning.

Peter Jacobson - Brean Murray, Carret & Co.

Hi. Can you go over the leading verticals and their share as a percentage of total revenue, please?

Jack McDonald

Sure, Paul. Paul, are you on mute?

Paul Martin

Yes, sure; sorry about that. Yes, healthcare is our largest vertical at 18%. Energy and utilities at 14%, business services at 12%, Telecom at 11% and financial services at 10% are the top five.

Peter Jacobson - Brean Murray, Carret & Co.

Okay, and thank you. And what is the share of business on the IBM platform and the Oracle platforms?

Paul Martin

Sure, so by platform, IBM is 26% for the quarter, Oracle 19%, TIBCO, 13%, Microsoft 12%. Those are the top four.

Peter Jacobson - Brean Murray, Carret & Co.

Okay, great. And I know that it's difficult, but can you offer any kind of visibility into 1Q '09 or '09 in general as far as anticipated growth?

Jack McDonald

You know, I think it's too early to really talk about 2009 at this point. Obviously, you know, frankly, based on what we're seeing on a macro basis in the economy, I'm relatively pleased with these results. Obviously Q3 came in in-line and the earnings were quite strong and the cash flow was quite strong continuing at a $40 million annualized rate of EBITDA ex stock comp and before those special charges. Q4 looks decent to me. Again, given the environment, we're trying to be a little extra conservative on guidance methodology for the fourth quarter, again, given the economic environment. And then we will obviously know more as the next couple of months play out here.

Peter Jacobson - Brean Murray, Carret & Co.

And just a last question, I thought the comment regarding additional revenue opportunity associated with consolidations and particularly in financial services, I guess how optimistic are you that financial services, due to that environment, might actually see some pickup as opposed to what's generally considered a sector that's going to continue to show some softness?

Jack McDonald

Yes, I mean we're reasonably optimistic there. You know we've been working pretty hard over the past few years to diversify vertically. If you looked at Perficient three, four years ago, our financial services exposure was north of 30%, in some quarters as high as close to 40%. Today it's running at around 9% or 10%. So we have very little exposure kind of from a risk perspective to financial services. That said, as Jeff mentioned, integration is what we do. A lot of this consolidation we think is going to drive exactly the kind of work Perficient does, the kind of work that we've done historically in connection with financial services industry consolidation. So we are, you know, reasonably optimistic about that.

And as Jeff said, we've appointed one, a point person to focus the resources of the organization against that opportunity. And that along with the opportunity we see with China, along with the opportunity we see in CRM and the opportunities we see in the verticals of healthcare and Telecom really form the basis for our organic growth plan for 2009.

Peter Jacobson - Brean Murray, Carret & Co.

Okay, and I'd assume no 10% customers?

Paul Martin

That's correct.

Peter Jacobson - Brean Murray, Carret & Co.

Okay. All right. Thank you very much.

Jack McDonald

Thank you.

Operator

And the next question comes from the line of Colin Gillis. Please proceed.

Colin Gillis - Canaccord Adams

Hey, guys. Thanks for taking my question.

Jack McDonald

Sure.

Colin Gillis - Canaccord Adams

You know, when you look out at the landscape, what's your appetite to pick off some of the seasoned people at the Accenture to the world to continue to build out and grow your verticals, to basically to expand in this current cycle to get ready for the next up cycle?

Jeff Davis

Yes, we're doing that. That's exactly where we're sourcing our folks to build those out. We've got Accenture, former Accenture partner, E&Y partner, Cognizant, head Executive Salesperson from Cognizant, so it's good. And their availability is good. We're encouraged by their interest in coming to a smaller firm. I think with a little bit different culture and the industry is so much stagnated right now and that's true for Accenture and they're enjoying some growth, and a lot of the re-engineering work they're doing, but across the board, things have slowed a bit.

So I think some of these folks particular the more junior partners or younger folks are looking for opportunities, and we've managed to network with some of them and convince them to come here, and it's been, I think, really the foundation for those verticals. We're very excited about it. Like I said, we're already seeing results and not just the big guys. We've gone after some of our more mid-sized competitors as well. We've hired quite a number senior level folks in the last say six months or so. As we've had two things underway, that vertical build-out that I mentioned earlier and that you brought up, but also a strategic hiring initiative where we're really positioning the Company we believe as I mentioned before as the economy stabilizes and begins to turn around to really take a step forward and a step up as we march down that path to $500 million.

Colin Gillis - Canaccord Adams

Yes, and then Jeff, when you look out in 2009, is the stock price, where it's at, is that a possible lever that you can use to help bring on this talent?

Jeff Davis

It is. And we're actually using equity for some of those more strategic hires, beginning to use that more than we did in the past. We shied away from that, but as you well know, when you're going after somebody who's been a partner or who is currently a partner, that level of individual principal that's what it takes to attract them and we're doing that. And to your point, we're maintaining our philosophy around compensation of being weighted more towards the stock, which I think better aligns their incentives around the interest of the shareholders and a good blend.

Colin Gillis - Canaccord Adams

I guess the final one is while no one has a lot of visibility, do you think you're going to be able to maintain your utilization levels within a certain reasonable bandwidth?

Jeff Davis

Yes, I think we will. You know, we're a large enough company now to where I think we can manage that unless things just decline to a dramatic point. And I don't see that happening personally. We've got a good pipeline. A lot of those are our own ideals, where they might get delayed and not start in Q1, and it isn't, you know, we don't have that crystal ball we've talked about before in terms of what the outlook for '09 economically is. If the economy is good, I think we're in good shape. Like I said, we've got a good pipeline that's built around some '09 opportunities that our clients right now are telling us they're still committed to; it's a matter of when.

So I'm optimistic that that won't happen. Utilization is difficult clearly. Utilization and gross margins are difficult to manage when you're really focused on cost management; right, and managing costs down. In a growth mode, it's much easier to manage. And I think there'll be a differential there. I think 36% to 38% that is stock comp while we're managing in this cost containment environment, and back to 38% to 40%, potentially better in the long run, we're back in the growth mode.

Colin Gillis - Canaccord Adams

Great. Thank you.

Jeff Davis

Thank you.

Operator

And the next question comes from the line of John Maietta. Please proceed.

John Maietta - Needham & Company

Okay. Thank you very much. At this point, Jeff, are you actually growing headcount in China as you scale that operation?

Jeff Davis

We're continuing to grow it. We've got large engagements in there right now, those kind of ebb and flow. But we are continuing to incrementally grow China. That's probably the only part of the Company really that's growing substantially. The Oracle business, RBI business, there are a few pockets of areas that are still doing well that we're continuing to grow, and China is one. We've actually picked up headcount this year not as aggressively as we'd hoped to. We'd planned for more growth this year than we realized, but we are ticking it up. And as I mentioned that healthcare deal, earlier that's leveraging the GDC is exciting in a couple of ways.

It's validation of the healthcare vertical and the continuing spend we see there, but it also validates that the GDC is a real viable offshore alternative. We can compete with the bigger guys and of course we're going to work well in the upper end of the SMB space and the lower end of Enterprise. Some of these companies are pretty large companies in approaching really that Fortune 1000 level, so it's right in that bubble between say Fortune 1000 and high SMB that we see a lot of interest. And we do compete with the big guys.

That was the deal particularly that we've competed with Cognizant on, and we were the incumbent, so fortunately we were able to keep them at bay. But we see the big guys occasionally and we still feel like we've got a better value proposition. I think we'd better service, you know, the high end of SMB, maybe even the lower end of Fortune 1000 than those big guys do who want to come in and take over everything. We tend to do a better job of tailoring deals. That particular deal we created a template. It was pathfinder for us and we're out now marketing that same solution, that same arrangement with a lot of other companies at the moment.

John Maietta - Needham & Company

Okay. And Jeff, were some of these clients, these prospects actually saying, "Hey, you know, we'd love to have a strategy outside of India. Help us diversify."

Jeff Davis

Yes, I think they're satisfied with China. We're not getting a lot of questions around, Gosh, China versus India. I think India was there first, but I think China has done a great job. You know, that facility is CMMI Level 5-Certified, which is the highest certification you can have for quality. So we're really not getting much question around that at all. I think for the most part, the clients we're dealing with see sort of offshore as offshore, and that's played very well. We've not had any pushback on that. By the way, Paul is just -- this just in, Paul has sent me a note saying that we grew China from 109 headcount in Q2 to 133 ended in Q3.

John Maietta - Needham & Company

Okay. And you know my question, I'm sorry; less around pushback but more around has China been a competitive advantage where people are looking to actually make incremental offshore spend outside of India?

Jeff Davis

Offshore in general, yes, absolutely. Yes, we've seen great opportunity. It's played very well. It's resonated very well, and we really just started. We had that thing for about a year, but it's really only been in the last, say, you know, 90 to 120 days where we've really taken the focus from a couple of large engagements that we had underway there, and really began to try to leverage it more as I said, in this kind of blended, the way I described the healthcare count, they just kind of blended on-shore, offshore focus towards a smaller team size. You know maybe it's 10 to 15 to 20 folks versus the hundreds that the big guys do.

And we found a way we believe and have proven to be very profitable for us and very effective for the customer. It's played very well. There's a lot of -- no doubt in this climate, the customer is always looking for ways to save money. There's a little bit of skepticism still around offshore, but there's a lot more interest now than there was even I would say nine to twelve months ago.

John Maietta - Needham & Company

And then just the other question I had and just to piggyback around an earlier question around the financial services integration practice, are you actively engaged in conversations with prospects now are you just kind of building ahead in anticipation of a wave of activity there?

Jeff Davis

It's a combination. We still have, I won't name the names; I don't think we're allowed to, but we still have a large bank, one of the largest that's actually in the process right now or doing an acquisition of another bank, big bank that is also currently a customer of ours. So we're engaged with these guys now. The engagements we're doing today are less around integration because I really believe that technical integration work is going to come later in '09 probably maybe even in the second half. I think it'll start -- the dialogue will start in maybe some of the planning engagements may begin in the first half of '09.

But when you look at, you can imagine the size of those acquisitions, those initial I think really months are going to be just trying to figure out you know, how's this all going to play out and then what do we need to go do from a system standpoint, but there will be a lot of integration. Good example of that is the work we did with Cingular and AT&T for years. We assisted with an integration around the TIBCO platform, so I expect that we'll see definitely opportunities around that. It might be again in earnest more in the latter half of next year, just takes them time to sort of get their heads around what are we going to do, how are we going to integrate from a business standpoint and that drives the systems.

John Maietta - Needham & Company

Got you. Okay, and then Paul, just housekeeping question, average bill rate in the quarter?

Paul Martin

Yes, the average bill rate all in was 108 up a buck from Q2.

John Maietta - Needham & Company

Okay. Okay, thanks very much.

Jack McDonald

Thank you.

Operator

(Operator Instructions). And the next question comes from the line of Brian Kintslinger. Please proceed.

Brian Kintslinger - Sidoti & Company

Yes, hi, good morning. The first question that I had was related to the bad debt expense. Was that related to the failure or financial condition of the client, or is that related to the client on a fixed price engagement that may or may not have been happy with the services?

Jack McDonald

Well, it was really neither of those two things. As I indicated earlier, Brian that was a proactive step on our part to go through and do a review of all accounts receivable, and to proactively take a reserve or increase reserves just to make sure we are properly positioned given the economic environment. Our bad debt expense if you look at it over the past few years has run less than 0.5% of 1%.

So, we've got really for the most part, pretty much blue chip accounts receivable, but we as a company in terms of how we've always managed this business is to try to be proactive and get ahead of things. And so we took that step of increasing the reserves on a number of different accounts.

Brian Kintslinger - Sidoti & Company

And when you say a number, so it wasn't one or two particular accounts?

Paul Martin

No, Brian. Let me add a little color on that. The process was a combination of, as Jack had mentioned, on a specific account-by-account basis, going through and looking at updates on credit ratings, looking at updates on payment histories and it involved a multiple number of accounts.

Brian Kintslinger - Sidoti & Company

Okay. And on pricing, it seems that rates are relatively stable, but if you pull back China, how does the bill rate, you know, domestically, has that been adjusted at all?

Jeff Davis

It's still going to be, you know, the bill rates fluctuate to some degree due to fixed fee, when we calculate the bill rate, we literally just divide hours booked by revenue and by services revenue and there tends to be a lot of overtime work done. On some accounts that doesn't get billed, net/net, I will tell you it's about the same. In other words, China rates are not going up and pulling up the US rates, it's about the same, but flat with about a year ago. Which I think in the environment we're in is a good thing and I'm always cautious to work with the sales guys to not lose deals based on rate alone.

Now there's only so low you'll go, of course, deals have to be profitable, but we're not getting the pressure right now. I'm not having sales folks or executives call and say, "Hey we've got to do this deal at this level." I'm not saying we don't see any of that, you know, there's always some of it.

Brian Kintslinger - Sidoti & Company

How many 500K deals did you say you closed? Did you say how many you closed you said the last couple of quarters you gave --

Jeff Davis

Yes, 22 in Q3 and about that same amount; it was 23 I think in Q2 and 21 in Q1.

Brian Kintslinger - Sidoti & Company

Great. Now, when you look at those numbers in past quarters, is it taking time to get those already started, A and B, is the scope of what you signed changed because I've heard from some other companies out there that the scope has actually become a little bit smaller than originally anticipate given what's going on in the economy?

Jeff Davis

Yes, we have had a couple of not of those deals that I specifically mentioned. We have had a couple that have cut back. Now, the overall deal size, remember these are just initial phases. Most of these deals end up being multi-million dollar deals. And so that's Phase 1 or Project 1, and they typically end up being three, four, or five phases or projects, so nearly all those deals will end up being multi-million dollars.

Certainly, there has been some clients in the last probably more this quarter than the past, that have cut back in some areas. Likewise though, on the flip side, and I would say that's probably maybe 20%, 10% to 20%. On the flip side, the other 80%, 90% still seem quite healthy and are actually taking on quite a lot more scope and expanding the project beyond what our original expectation was. So there's a decent offset there.

Brian Kintslinger - Sidoti & Company

Great. And when you take a look at the fourth quarter and Jack mentioned that you're looking for a slight decline in revenue, and taking a look at the economic conditions, have you thought about scaling back resources at all?

Jeff Davis

Yes, certainly. We always monitor that very closely and as we kind of discussed earlier, we intend to maintain those utilization rates. Now, utilization and even in November but especially December, we're going to let go low. It's a seasonal time and we don't net out vacation, okay, from utilization calc, so we use the 2000-hour year. And so utilization will naturally fall a little bit in November and then again in December.

What we will really be watching for is -- and by the way, yes, we're managing costs effectively for what we expect to be our top line in the fourth quarter, but we're really watching closely and mostly concerned about is how is January and total Q1 going to shape up. But yes, we'll continue to manage the business in the bottom line aggressively when it comes to managing costs to top line.

Brian Kintslinger - Sidoti & Company

So what was third quarter utilization? What do you expect fourth quarter to come in at?

Jeff Davis

Utilization was 83%. I don't know that I've got a projection for the fourth quarter, but it'll probably--.

Brian Kintslinger - Sidoti & Company

Only five points lower?

Jeff Davis

Yes, it'll probably be below 80% and that's typical for the fourth quarter against seasonality. The reality is actually October was a great month. And actually the utilization I'm sure was higher than 83% in October. And that's typical, as well. October tends to be a good strong start to the fourth quarter and then the holidays creep in at the end of November and carry through December.

Brian Kintslinger - Sidoti & Company

When you say you are taking active measures to control costs, is that through reductions of head count or in other areas?

Jeff Davis

Both, in both we were looking at all areas in opportunity and of course, sub contractors is our first target and other maybe non-strategic spending that could be deferred, and then of course, last resort is headcount reduction, but that sometimes is necessary as well.

Brian Kintslinger - Sidoti & Company

What about SG&A? We heard about the $10 million to exclude the one-time sort of non-cash charge, do we expect that to trend up or down going forward?

Jeff Davis

I think SG&A and I'll let Paul weigh in on this, too. He manages a good chunk of that. Some of it obviously is on the operating side, a lot of it to the back office, but I think it'll be flat. We'll manage some discretionary costs within SG&A that fall in that bucket down to a reasonable level, not to where we're hampering the business. But that's one that I'd say a little more flat or expected to be a little more flat. We may do some trimming there, as well. Paul, do you have any comments on that?

Jack McDonald

Let me take that one, Jeff.

Jeff Davis

Sorry, Jack.

Jack McDonald

Brian, I think if you look at the business, through time I think we've done a very effective job at managing the gross margin line. We've managed utilization very effectively. We've built the business to be quite flexible in terms of our cost structure. We deploy subcontractors for 10% or 15% of total billable headcount. So that's an immediate shock absorber. We have a compensation system at the company which is lower based in general, higher incentive competition, and so as a result, if revenue declines, you see immediate reductions. You've got a couple of built-in sort of automatic accordion features.

We are big believers in Class B office space. That's the thing that's a killer. We saw that in the last downturn where so many of our competitors signed these ego-driven triple Class A office leases in cities across the countries and those things put them out of business and we'll probably see some more of that this time around if the economy slows. We have not done that; we have kept our fixed cost low. And finally we've got a culture where we consistently manage costs. We are constantly evaluating resource levels and making adjustments, making cuts, making additions where necessary, cuts where necessary, on a regular basis in good times and bad and that will continue here.

If you look at our EBITDA margins ex stock comp this quarter, running I think at around 17%, so we will continue to target strong EBITDA margin levels and obviously we will monitor revenue and demand levels out there. We'll make appropriate adjustments, but this is a business that can run nicely cash flow positive. Again, look at this quarter before there's non-cash charges and stock comp $40 million annualized in EBITDA. So we're very comfortable. This Company is a well-positioned firm. We're survivors.

We made it through the last situation which I think is a lot worse than anything we're going to face here. And obviously there's some nervousness out there in the financial community and elsewhere and that's okay. We're focused on customers where we're delivering value. We're focused on cash flow; that means managing costs as we're doing and we're going to make it through this and we will come out stronger on the other end.

Brian Kintslinger - Sidoti & Company

Great. Two last questions. First of all, stock-based compensation has gone up from -- to 4% from 3%. I can't remember who mentioned it that you guys were starting to use it more in retaining and hiring people. Do you expect that will continue to stay at the 4% range, maybe even increase as you use that more for compensation?

Jack McDonald

What we've talked about is stock compensation running at about 15% to 20% of cash earnings per share. And if you look at a little bit of the down turn in cash EPS, you'll probably could see that stock comp charge ticking up to 22% or 23% until you get some burn off that comes through a option divesting and restricted stock vesting that'll take it back down into the target range. So it's a marginal difference, nothing substantial.

Brian Kintslinger - Sidoti & Company

Great. Last question. I didn't hear, and maybe I missed it, free operating cash flow and CapEx for the quarter?

Paul Martin

Yes, I've got the CapEx here, I'm sorry, for the full year. It was fairly modest; the CapEx was about $1.3 million for the year. I don't have the second quarter in front of me, but I think it was about $300,000 this month. I'm sorry; what was the other?

Brian Kintslinger - Sidoti & Company

Operating cash flow for the quarter?

Paul Martin

Yes, operating cash. The Q has been filed so that's all available, but it's $12.8 million for the nine months up 26% from $10.2 million in the nine months last year.

Brian Kintslinger - Sidoti & Company

Perfect. Thank you.

Operator

And there's no further questions. I would now like to turn the call back over to Mr. Jack McDonald for closing remarks.

Jack McDonald

Okay. Well, thank you very much for your time this morning and we look forward to speaking with you again at the end of the quarter. Thank you very much.

Operator

This concludes the presentation. Once again, ladies and gentlemen, you may now disconnect. Have a wonderful day.

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Source: Perficient, Inc. Q3 2008 Earnings Call Transcript
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