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Edgewater Technologies, Inc. (NASDAQ:EDGW)

Q4 2008 Earnings Call

March 4, 2009 10:00 am ET

Executives

Shirley Singleton – Chairman, President, CEO

Kevin Rhodes – Chief Financial Officer

David Clancey - Executive Vice President, Chief Strategy & Technology Officer

David Gallo – Chief Operating Officer

Analysts

Arnold Ursaner – CJS Securities

Operator

Welcome to the Edgewater Technologies, Inc. fourth quarter 2008 financial results conference call. (Operator Instructions) I would now turn the conference over to Mr. Timothy Oakes of Investor Relations for introductions.

Timothy Oakes

Good morning everyone and welcome Edgewater's fourth quarter, full year 2008 earning call. I'm here today with Shirley Singleton, Edgewater's Chairman, President and CEO, David Clancy, Edgewater's Executive Vice President and Chief Strategy and Technology Officer, Kevin Rhodes, Edgewater's Chief Financial Officer and David Gallo, Edgewater's Chief Operating Officer.

Before we begin, I would like to remind everyone that today's call could contain forward-looking statements under the Securities Acts. Investors are cautioned that such statements could involve risks and uncertainties that could cause actual results to differ from the current expectations with respect to such statements.

These types of statements and underlying factors relating to these statements are listed and are reported in filed information with the Securities and Exchange Commission as well as in the company's press release that was distributed earlier this morning.

Statements made during today's call are made only as of the day of today's call and the company undertakes no obligation to update the forward-looking statements to reflect subsequent events or circumstance. With that, I will now turn the call over to Shirley Singleton.

Shirley Singleton

Good morning everybody and thanks for being with us. During 2008 Edgewater grew service revenue by 8% and that's shy of the double digit growth that I had hoped, but our opinion is, if you look at it, it is still a solid performance given the current economic conditions.

If we break that desire to do double digit growth when we were entering 2008, we were hopeful that our investments in building a larger EPM footprint, but also in combination with some modest increase in revenue in our legacy offerings would lock in that double digit growth for us in '08.

During the year, and those of you that have been following us for awhile, knew that we saw some softness in the business and tech offerings gradually over the year of '08, but it was offset by the continued growth in the EPM business. At the end of 2007, if we look at EPM alone, that service revenue entering '08 was 35% of service revenue, and as we exited '08 the EPM was better than 60% of total service revenues.

As to Q4, one of the surprises we had, and it was an unpleasant one, one of our oldest and largest customers, one that's in the student loan arena, informed us that they regretfully had to let us go, and they released a very large team earlier than expected. We did not know that at the time of our last earnings call.

And not only that, they said that we're going to have to actually put you on hold for 2009. They're caught up in some contracts with the government and they're not really sure what's happening to them at this point in time.

Since we were now in a situation where the go forward pipeline was not strong enough to support our desired utilization, we took a really tough decision and decided to downsize our consultant staff. That was hard.

These series of events in combination with two less bill days in our holiday season caused our Q4 revenues to be down. But I want to give you the silver lining here because not all the news is bad.

We did put out an awfully lot of proposals in Q4. Granted, they were sitting on people's desk, but the proposals were out there and people were interested. During Q4, Edgewater did welcome 19 new customers including such names and Blue Cross/Blue Shield of Massachusetts, Newmont Mining, Ticket Master, El Dorado Gold and Brookstone.

As well our cash flow for the year was strong and we still maintained a positive adjusted EBITDA, so let's have Kevin get into those numbers for you.

Kevin Rhodes

I'll follow my usual format by first discussing our revenue and operating results and then I'll touch upon cash flow followed by other financial and employee metrics.

The total revenue was $16.3 million in the fourth quarter compared to total revenues of $17.3 million in the year ago quarter. Service revenue which excludes reimbursable expenses and software sales was $15 million compared to $15.9 million in the fourth quarter of 2007.

The full year total revenue amounted to $73.7 million compared to $68.5 million in 2007 and service revenue amounted to $68.1 million compared to $63.2 million in 2007, an 8% full year increase in revenue.

Let me add a little color on the revenue picture in the fourth quarter. As Shirley mentioned, we experienced our traditional seasonality during the fourth quarter compared to the third quarter in terms of higher vacation days due to the holidays and two fewer bill days.

However, we were also challenged with the unplanned drop in revenue from one of those large customers and that did require job actions on our part during the fourth quarter. At the end of the fourth quarter we did receive some good and some bad news from another large customers.

The news was that the spend rate would continue in 2009, but it was anticipated to be half the amount spent in 2008, but fortunately this verbal commitment was pulled back in late January, due to the budget constraints on their end, and so their spending rate may be actually less than 20% of the 2009 spend rate in 2009.

As a result of those factors, Edgewater again acted quickly to manage our expenses and our utilization during the first quarter with a job action again.

The reduction of the client spending in the fourth quarter did have an impact on our revenue gross profit margins and our utilization. That said, we were able to offset some of the revenue reduction by making some effective and efficient cost management decisions. So as a result, we were able to generate $1.5 million in adjusted EBITDA during the fourth quarter, which is on par with the third quarter.

Another quick note on revenue, during 2008 we recorded revenue from 308 customers, of which 81 were new customers as compared to recording revenue from 265 customers in 2007 of which 73 were new customers. And so both those measures improved on a year over year basis.

Gross profit during the fourth quarter was $6.3 million compared to $6.8 million in the year ago quarter, and was down primarily as a result of that lower revenue I just discussed. Gross profit margin was 38.4% compared to 39.5% in the year ago quarter.

On a full year basis, our gross profit was $28.8 million compared to $28.1 million in 2007, and our gross profit margin was 39% compared to 41% in the year ago. Fourth quarter utilization amounted to 68.3% as compared to 74.5 % in the year ago quarter and full year utilization was 73.5% compared to 80.1% in 2007.

While these utilization rates are lower than our historical operating levels, we have tightly managed our cost of sales and SG&A expenses and will continue to do so during this turbulent economic environment. And so to that end, throughout 2008 we adjusted our head count costs by approximately $6.1 million on an annualized basis.

Looking at SG&A expense, it was $4.8 million during the fourth quarter which decreased $.5 million over the fourth quarter of 2007. On the full year, our SG&A expense was $23.2 million, compared to $21.3 million and 31.5% of revenue compared to 31.2% of revenue for 2008 and 2007 respectively.

The quarterly decline in SG&A was primarily due to reductions in staff headcount and also lower bonus accruals, while the full year increase was primarily due to additional sales and operations personnel that we added along with the 2007 acquisition.

In the first quarter of 2009, SG&A expense will go up a bit over Q4 as we will continue to accrue bonuses again and also FICA taxes reset during the first quarter.

Looking at our good will impairment, as we discussed during our third quarter conference call, we performed our annual review of good will and intangible assets during the fourth quarter. As a result of our review, we reported a non cash impairment charge to our good will and intangible assets in the amount of $23.9 million.

The fourth quarter impairment was driven by factors affecting our market, but also due to a reconciliations of the company's market capitalization to the fair value determined under FAS 142. The full year non cash and intangible asset charges amounted to $48.6 million.

Excluding the $23.9 million in impairment charges in Q4, our operating profit would have been $632,000 compared to $770,000 in the fourth quarter of 2007. Excluding the full year $48.6 million in impairment charges, our operating profit would have been $1.8 million in 2008 compared to $4.3 million in 2007.

Looking at the bottom line, the company reported a net loss of $47 million or $3.66 per share, but that's primarily associated with the non cash impairment charges I just discussed.

As I mentioned earlier, adjusted EBITDA which is EBITDA adjusted through good will and intangible asset impairment charges amounted to $1.5 million during the fourth quarter and $5.6 million for the full year 2008. In 2007, adjusted EBITDA was also $1.5 million in the fourth quarter and was $6.8 million for the full year.

Now let's turn to cash flow. Cash flow continued to be strong in 2008 despite a challenging economic environment. For the full year, we generated $7.7 million in operating cash flow compared to $9.2 million in 2007. I would like to point out as in our past, we will have negative cash flow in the first quarter due to annual bonus payments as well as our annual insurance renewals.

Our year end cash and marketable securities amounted to $24.6 million or $1.88 per share compared to $22.8 million or $1.67 per share at the end of 2007. From a high level the year over year growth in our cash and marketable security balance is significant for two reasons. First, we purchased 1,344,000 of Edgewater's common stock during 2008 for $5.1 million, and second, we made two write up payments for a total of $1.2 million during 2008 and yet our year over year cash and marketable securities balance increased from 2008 versus 2007.

Standing share count was 12,162,000 shares at the end of the year and our diluted share count at the end of the fourth quarter was 12,136,000 shares.

In terms of other financial and employee metrics, our day sales outstanding was 61 days on billed A/R compared to 56 days in the prior year quarter. Our total employee and consultant head count was 298 at the end of the year, of which 241 were billable.

Our annualized revenue per billable consultant improved 13% in 2008 to $340,000 on an annualized basis compared to the previous year when we had $300,000.

Shirley Singleton

That's because of the service mix primarily.

Kevin Rhodes

Absolutely. In the EPM, the growth in the EPM. So with that, I'll pass it back to you Shirley.

Shirley Singleton

Dave Clancey and I are going try to give you some perspective of where we think 2009, we're going to double team this part. With the ramp down of the two key legacy accounts, we estimate that approximately $9 million in new business will need to be generated in 2009 to back fill the loss of the revenue.

Beginning our come back in Q1 is tough, because if you recall, and again if you followed us for awhile, you know that EPM is traditionally soft in January as CFO's are busy doing their year end closings etc., and that continues in '09 just like it has in the last couple of years. So EPM coming out strong is not possible, and also selling in general, no matter what service is tough in the current economic conditions.

The tech and business offerings did have a good deal of proposals that were in customer hands that were put out there in Q4, and those requests were in areas such as health care, web analytics and all things data. Those are the areas that are gaining traction.

We were real excited as we entered '09 as we did see some solid signings of these offerings that are in the tech and business area. But, I would still characterize this piece of our business as choppy.

David Clancey

Let's take a look at things from two different aspects. The first aspect we'll look at is how are we going to fill that $9 million hole that was left by legacy. If you remember back in the 2003/2004 range we were facing a similar type of problem where you saw your classic bills business dissipating or under severe pressure from overseas.

So we were faced with a decision as to whether or not to go out and build an offshore component and try and fight down at that particular level in a commodity business, or should we move upstream, and higher up on the pyramid and get into EPM, analytics, etc. We made the decision to move up the pyramid and not fight it out on the commodity basis and moved the company forward for significant growth. It proved to be a very solid decision.

Today we're faced by the same decision and what we're looking at here is, you can see the melting away of the legacy business, and that's going to be very hard fought over, and it's going to be probably low margin etc. Now, it's the type of thing where we will not turn away business in that area, but we are not going to heavily invest or fight in that particular business.

Instead, we're going to try and capitalize on where we see the business going, and some of that's going to go to the strengths that we're gaining by training our people last year in terms of data, web 2.0 types of projects, restarting projects, things along these lines, because that's where we feel the strength is and is further up the pyramid.

Now let's take a look at why. If we take a look at the market the way it is now, just about every corporation is squeezing the CIO and saying, you've got to cut costs. You've got to bring it down. Well the easiest way for a CIO to bring the cost down is to take the existing systems and in effect freeze them, apply as little maintenance as possible just to keep it alive. Don't open it up. Don't look for innovation in that particular area, and squeeze that part of the budget down.

The part of the budget they're going to focus on, and we can see it in some of the bids that we're going to now and some we've recently won is, is that say I have a CRM system and I have a way to squeeze that particular system, rearrange the data and in effect get more growth in terms of selling more items to an individual, being able to go out an bring another company in and put more stuff down my pipeline, etc.

So what we're going to see is a focus on companies that way, and they're not going to focus on the legacy side. So we're going to extend all of our sales and marketing effort into going down that particular path to fill that $9 million hole.

So in effect, that's where we're going to focus, and that's where I'm going to go and we're very excited about it in terms of being able to in effect make 2009 not a bad year. It won't be a great year, but not a bad year.

The next piece to look at, the second piece is really the way the economy is looking and what we're being hit with. We saw a little of a reprieve in terms of people being more positive. We saw some signings in the December/January time frame but what you're going to have is another leg down, you have more fear, and every time we shift, we have people call up.

And what it comes to is, we'll put a bid it. They'll say, yup we like it. Oh, we're scared, we've got to hold it. Wait a minute, why don't you turn it back on. No, maybe we'll do it later in the year. So you've got a lot of uncertainty here and until people get some certainty as to where things are going to go, we're going to see a very choppy business pipeline, and we're going to see some real difficulty in getting any true visibility as to what we'll exactly close.

Shirley Singleton

Let's look at EPM, Dave's comments in general about consulting but specifically business and tech. Early indications in the EPM offering is, they're beginning to ramp out of the January doldrums. They've had some projects put on hold and released which is new for them, but their pipeline is growing tremendously. Very pleased with the pipeline, and we have been ramping on the marketing side and we are EPM sponsored webinars is soaring. The attendance is soaring.

Our feeling is that this business continues to have legs and there is still an opportunity for growth in this offering during 2009. The oracle related pieces remains solid and we are seeing good activity in the SAP EPM space.

To that end, we think that Q1 revenues will be down as we won't have enough time to offset that slow start of EPM in combination with the pull back in the tech and business offerings.

I do want to end my comments on a positive note however. The management team has been through tough times before and stands ready to continue to make some tough decision. Let's not forget our credit, really clean and strong balance sheet and the continued generation of positive cash flow on a yearly basis.

We will push marketing and sales right into the areas of traction with the intention of hammering away at the $9 million drop off. Strategically, our method of attacking as Dave said, is we're going to push data projects. We're going to push web 2.0 initiatives. We're going to push project restarts.

We're having people come to us with having attempted to do a project and failed and they wanted us to fix it, and they only have one more shot of fixing it in terms of their patience and their money, and we're going to continue that BI EPM push, all the areas that we aggressively retrained the staff in during 2008.

We believe this strategy is the right call and we're going to take one quarter at a time and block and tackle our way through it. So with that, I would like to take some questions.

Question-and-Answer Session

Operator

(Operator Instructions) Your first call comes from Arnold Ursaner – CJS Securities.

Arnold Ursaner – CJS Securities

I assume you didn't mention that there was no repurchase activity in Q4?

Kevin Rhodes

There was some repurchase activity. The most part was in Q3, 1,344,000 shares that we had was for the full year. $5.1 million for the total year.

Arnold Ursaner – CJS Securities

And what was it in Q4?

Kevin Rhodes

Q4 it was somewhere around 30,000 to 40,000 shares.

Shirley Singleton

We did it on daily volume.

Arnold Ursaner – CJS Securities

It's not a material change. You can come back with that number later?

Kevin Rhodes

Yes, it wasn't material at all.

Arnold Ursaner – CJS Securities

You mentioned that you did have two earn outs that you did pay through the course of 2008. Do you have any earn out payments remaining in 2009 that we should be looking for?

Kevin Rhodes

One possible one on one of the earn outs. It's again subject to meeting certain thresholds. The maximum amount of that is $350,000 in 2009.

Arnold Ursaner – CJS Securities

And then you mentioned the unplanned drop in revenues that occurred in Q4. Can you quantify what that was?

Shirley Singleton

The unplanned drop off in Q4.

Arnold Ursaner – CJS Securities

From the student loan customer that unfortunately had to stop their work with you. What was the unplanned loss of revenue or unplanned drop in revenue.

Shirley Singleton

Dave Gallo, do you know that number?

David Gallo

I'd say it was about three-quarters of a million in Q4 based on the early termination, and then I think Shirley made the adjustment in the full year effect with the $9 million drop off in 2009.

Arnold Ursaner – CJS Securities

If I look at my $16.6 million revenue in service versus the $15 million you reported, this is the biggest chunk of the short fall, this specific one time item.

Shirley Singleton

Yes.

Arnold Ursaner – CJS Securities

Thinking about Q1, you mentioned you have $9 million that you have to back fill with new work. Have you quantified or can you quantify the amount that $9 million you had last year in Q1 to give us a better feel for kind of a base number for '08 excluding the $9 million loss.

Kevin Rhodes

Last year in Q1 of 2008 the two legacy accounts we're talking about represented about $3 million of our total revenue in that quarter, and then in Q4, they represent about $4 million of our revenue.

Arnold Ursaner – CJS Securities

So the $1.4 million again is, if I think about the miss, it's the entire miss of these two clients, essentially.

Shirley Singleton

Yes.

Arnold Ursaner – CJS Securities

And just the breakdown of your Q4 revenue by the two segments if you can versus EPM?

Kevin Rhodes

61% was on the EPM side. So the 39% would be in the business and tech.

Arnold Ursaner – CJS Securities

And the customers that you lost or the customers that are no longer working with you, are they in the EPM or the tech side?

Kevin Rhodes

They're in tech.

Arnold Ursaner – CJS Securities

What was the 123-R expense in the quarter.

Kevin Rhodes

123-R in this quarter was $342,000.

Shirley Singleton

I think what we'll do here is close down the call. I do want to mention that two items of note that Edgewater is re-launching a brand new website. You should see it sometime in April, and it's actually embracing web analytics and web 2.0 and a lot of the things that we've been talking about so we intend to eat our own dog food here and make sure that our website reflects what it is that we do for a living.

And then secondly, our next earning call for Q1 will be Wednesday, May 6, 2009.

Kevin and I and the team will be around all day today, and we'd love to have you call in if you have additional questions. With that, we're all done.

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Source: Edgewater Technology, Inc. Q4 2008 Earnings Call Transcript
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