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Edgewater Technology, Inc. (NYSE:CNI)

Q2 2009 Earnings Call

August 5, 2009 10:00 am ET

Executives

Timothy Oakes – Investor Relations

Shirley Singleton – Chairman, President and Chief Executive Officer

Kevin Rhodes – Chief Financial Officer

David Clancey – Executive Vice President, Chief Strategy and Technology Officer

Analysts

Arnold Ursaner - CJS Securities

Robert Poole - Bricoleur Capital

Operator

Please stand by. We’re about to begin. Good morning and welcome, ladies and gentlemen, to the Edgewater Technology, Incorporated, second quarter 2009 financial results conference call. At this time I would like to inform you that this conference is being recorded for re-broadcast and that all participants are in a listen only mode. (Operator Instructions)

I will now turn the conference over to Mr. Timothy Oakes of Investor Relations for introductions. Please go ahead.

Timothy Oakes

Thank you, Gwen. Good morning everyone and welcome to Edgewater Technology’s second quarter 2009 earnings call. I’m here today with Shirley Singleton, Edgewater’s Chairman, President and Chief Executive Officer, David Clancey, Edgewater’s Executive Vice President and Chief Strategy and Technology Officer and Kevin Rhodes, Edgewater’s Chief Financial Officer.

Before we begin, I would like to remind everyone that today’s call may contain forward-looking statements as described under the Securities acts. Investors are cautioned that such statements could involve risks and uncertainties that could cause actual results to differ from current expectations with respect to such statements. These types of statements and the underlying factors related 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 and is posted on our Investor Relations website.

The statements made during today’s call are made only as of the date of today’s call, and the company undertakes no obligations to update the forward-looking statements to reflect subsequent events or circumstances.

With that, I will now turn the call over to Shirley.

Shirley Singleton

Thanks Tim. Good morning everyone. During Q2 we secured business from 21 new customers and Kevin in Q1 we only had secured 13.

Kevin Rhodes

Thirteen. Correct.

Shirley Singleton

So I’m pretty happy with that uptick in new customer acquisitions given our slow start to the quarter. New wins in the quarter include names such as Hologic, Cancer Treatment Centers of America, Coventry Health Care, General Cable, Southern Mississippi Electric. It’s also of note that we did secure a partnership with PWC. I think I may have talked about it last quarter. And that has resulted in a number of new customers for us as well which include Verizon, Dolby, Dr. Pepper and Northeast Utilities.

I typically don’t break down the quarter into monthly comments, but in this case I do want to make a comment about the first month of the quarter. We were concerned about the lack of signings that we were seeing exiting Q1. In fact, we talked about 49% of our proposals were still outstanding as we were exiting Q1 and we were really concerned about how fast or how slow the pace of signings would be in April. So we had decided to do a staff reduction action in the first week of April, and it turns out that that was the right call and it was incredibly good timing in terms of our call because April was soft.

I am pleased at what I’m seeing for May, June and the continued acceleration into Q3. We’re not out of the woods, but I’m actually pretty happy.

Let’s have Kevin get into the numbers.

Kevin Rhodes

Thank you, Shirley. Good morning everyone. First I’ll provide some color on the revenue for the quarter, then I’ll dive into the cost saving measures that we recently implemented and the anticipated effect those actions will have on our third quarter operating performance. After that I’ll run through the financial results, some key metrics and cover the balance sheet. And then I’ll pass the call back to Shirley to discuss the outlook.

Total revenue during the second quarter of 2009 amounted to $12 million compared to $19.6 million in the year ago quarter. The $7.6 million year-over-year reduction in revenue was primarily due to the pull back in legacy account spending and a general slowdown in the economy, as we’ve discussed this in prior calls.

And to add some additional insight into the impact that the legacy account pull back has had on Edgewater, three of our customers accounted for more than 60% of our year-to-date decrease in service revenue. The remaining drop off is due to slower project initiations and relatively smaller projects, primarily due to the economy and its effect on IT spending across the marketplace.

We also had deferred revenue of approximately $200,000 during the second quarter, of which we expect to recognize that revenue in the third quarter. The deferred revenue amount is higher than we normally have and so I thought I’d point that out to everyone.

While the selling environment continues to be somewhat challenging in this economic climate, we are starting to see some good signs of stabilization. We’re generating leads, we’re making proposals and securing new customers like the 21 that we secured in the second quarter.

Edgewater’s taken this opportunity to get in front of our customers, to emphasize our value proposition, and we’re making very good progress there as well. We hope to be well positioned when the economy makes a recovery and investment starts to reoccur again.

Looking at the concentration of our revenue, it’s pretty consistent on a year-over-year basis, despite the loss of revenue from our legacy accounts. Our top 10 customers represented 37% of our revenue in ’09 compared to 44% in ’08. Our current service revenue mix is as follows. Enterprise performance management is 67% of our revenue, technology consulting is 30% of our revenue and management consulting rounds out 3% of our revenue.

Now let’s take a quick look at some of the cost saving measures that we enacted during the second quarter. I would like to highlight that we continue to manage our costs tightly and have taken a very careful review of our expense structure across the organization.

Related to staff reductions, we have reduced our billable headcount by 84 consultants over the past year. This reduction has been response to the service revenue drop. To date we have made staff reductions equivalent to $3.9 million in annualized savings, and in the second quarter alone our staff reductions amounted to $2.3 million in savings. I would like to point out that the $2.3 million in savings is a part of the $3.9 million in savings for the full year, not addition to that. The net effect, though, is that we expect to see an improvement in the cost of revenue during the third quarter of approximately $850,000. Our staff headcount is now 253 and it’s on a total basis, of which 192 are billable consultants.

We’ve also tightened our belt on the SG&A expenses line, which has decreased $1.7 million on a year-over-year basis. We’ve reduced expenses related to travel, professional fees, training, telecommunications and some marketing programs which traditionally require travel. We’ve also reduced bonus accruals throughout the company. While being able to effectively manage our expense structure, we continue to value our employees very much. At this point we do not believe we will need additional staff reductions. However, we cannot make any guarantees. As a management team, we know that the decisions that we’ve made in the past are for the best and long term success of the company, its shareholders and our employees. We’re now looking forward to the future.

Now I’ll cover some of the operating results and metrics. Our gross profit margin on service revenue amounted to 28.2% as compared to 41.9% in the year ago quarter. The decline in margin is due to the lower revenue annualization experienced in the quarter, as we will not see the impact of the cost saving measures until the third quarter.

Utilization was 62.5% as compared to 76.6% in the second quarter of 2008. We continue to work on balancing utilization and our billable resources with our sales pipeline and opportunities, and to that end and based on our service revenue guidance for next quarter, we do anticipate that we’ll see an uplift in our utilization during the third quarter as compared to the second quarter.

Depreciation and amortization expense was down over the year ago quarter to $694,000, compared to $1.036 million. The reduction is primarily due to lower amortization due to our intangible assets and the 2008 second quarter impairment charges that we had on those assets.

Net loss amounted to $1.3 million or $0.11 per diluted share, compared to a loss of $20.1 million or $1.52 per diluted share in the year ago quarter. The current quarter was obviously affected by the decline in revenue in utilization that I discussed earlier, and in the year ago quarter it was affected by the non-cash, goodwill and intangible asset impairment charges of $24.7 million.

Looking at our non-GAAP results, the adjusted EBITDA amounted to a loss of $1.5 million or $0.13 per diluted share, compared to positive adjusted EBITDA of $1.3 million or $0.10 per diluted share in the year ago quarter. Stock-based compensation amounted to $339,000 in the second quarter, compared to $439,000 in the year ago quarter.

Now touching on cash flow. Edgewater generated $1.4 million in operating cash flow during the second quarter, despite the fall in revenue and profitability. The cash in flow of $1.4 million compares to $3.6 million in the year ago quarter. We repurchased 78,600 shares of our stock during the second quarter for $214,000. As of the end of the quarter, we had 12.2 million shares outstanding with $3.1 million remaining under our stock repurchase authorization. We had no capital expenditures during the quarter.

I would like to point out that our balance sheet remains very healthy. Our working capital amounted to $28.1 million, with our cash and marketable securities ticking up from last quarter to $23.2 million or $1.92 per share. Our receivables amounted to $9.8 million in the second quarter, and our DSO metric was 65 days. Our receivables are quite healthy, and are actually in better shape now than they were a year ago.

And with that I’ll now pass the call back to Shirley for final comments.

Shirley Singleton

Okay. Thanks Kev. Customer mood now seems to be a bit more positive than in Q1 and in the early part of Q2. There are indications that IT initiatives are no longer effectively frozen and key projects are starting to move forward, but we still remain cautious.

I took the opportunity about 20 minutes ago to go see the head of sales and had a chat with him about, “Give me some, your real raw gut, from the field, what seems to be happening out there,” in his words and I tend to agree with his assessment. He’s saying that there’s still some funding pressure, but the pace seems to be quickening. There’s starting to be a faster turnaround of decisions where people are now saying I’d like to start September first, I’d like to start August twentieth. They have some start dates in mind which is really good.

The values in the pipeline look like they’re climbing a bit. I’m starting to see more million dollar opportunities in the pipeline. It doesn’t mean they’re signed, but they’re at least appearing there. We’re having discussions with customers where they are talking about, “I want to build momentum.” They’re talking about momentum coming into a recovery, and therefore as they look at putting these projects together, they are trying to match that investment into hopefully a recovery. And they are also mentioning that they’re looking at something of quicker turnaround for value. So you’re seeing discussions around ROI, definitely less than two years, and in some cases they’re asking for six month ROI on certain initiatives. So that hopefully gives our investors a sense of a moment in time of what’s happening out there in the field.

We are going to continue to block and tackle. We’re over communicating with the customers. I will comment that the contract negotiations have gotten tougher. The buyers are really, in some cases, being overly demanding in what they’re asking for. Dave, did you want to comment a little bit about on that environment?

David Clancey

Yes. That environment’s sort of a push from two different directions. One direction comes really from the area of how the purchasing agents and those folks are being compensated, and they’re being compensated by discounts. So there’s an increased pressure for discounts so they can get their bonuses. On the other side of it, there are real fears in and around the ability to recoup, not only what they may spend on us but anything they may have expended within their own staff and in hardware and whatnot. So there’s a lot of discussions around limitation and liability, things along these lines. So what you really see is some real pressure and real focus that we haven’t seen in a long time in and around contracts.

Shirley Singleton

Okay. Thanks. Looking through to Q3, if all things remain stable and I’m pretty happy with what we’re looking at right now, we anticipate that service revenue will be flat compared to Q2 service revenue.

And with that, Gwen, we’d like to open it up for questions.

Question-and-Answer Session

Operator

Thank you. (Operator Instructions) Your first question comes from Arnold Ursaner - CJS Securities.

Arnold Ursaner - CJS Securities

Shirley, you mentioned you won 21 new customers in the quarter, which is a very impressive number. Can you give us a little bit of a feel for the length of contract that you’re seeing? Or, you know in the past you’ve had some that extend two or three years. And which segment you’re seeing that growth in, whether it’s EPM or tech.

Shirley Singleton

Okay. The 21 new customers, it’s heavily weighted towards EPM. I’m looking at a list right here. However, as time goes forward, Edgewater, the original business, is starting to climb on the new customer list. In terms of verticals, I’ll say it’s a lot of utilities, copper, electric, insurance, healthcare seems to be things that are gaining traction. In terms of how long my sales guys are telling me they’re characterizing these wins as the opening door of runs. I can’t characterize for you how long they’re going, but they’re not an end game, a one shot engagement and then we cease. So they’re seeing some legs in this, but I can’t characterize it two, three years or whatever.

We are being pulled internationally. I don’t know if I’ve mentioned that. Have I mentioned that before, Arnie? Internationally?

Arnold Ursaner - CJS Securities

I don’t think so, Shirley.

Shirley Singleton

Okay. I was quite surprised. When we look at, and it’s primarily the EPM business that’s bringing us internationally, we look at companies like Avon Products, the Gap, they’re international companies and we’ve been awarded jobs to effectively go to 15 different countries and work on their financials and budgeting, planning, etc. We just completed Avon and they’re very happy with our work. Chevron is another one that we’ve just finished and very happy. We did a lot of consolidation work for them. So, quite surprised that we’ve now done work in 15 countries. I hadn’t been paying attention in terms of the headcount on that.

I have been contacted by some companies in London, and I’m sending Robin over there to talk with some folks about opening some business in the UK in EPM.

Arnold Ursaner - CJS Securities

And you mentioned service revenue could be flat with Q2. Normally the seasonal issues cause it not to be, so you obviously have a little more optimism about Q3 than you would normally have. Is that just based on this level of inquiry that you’re seeing?

Shirley Singleton

I’m so happy you’re asking that question. No, I’m pretty happy because Q3 tends to be a tough quarter for us because of seasonality, but I see enough in the pipeline that can get us right in there. It’s flat, which is thrilling for me.

Arnold Ursaner - CJS Securities

But I’m assuming that has to be driven by September activity, correct? It wouldn’t be likely that you would see it in August.

Shirley Singleton

Actually, not necessarily. We’re seeing some pretty good start up in August, which is again a surprise to me. I think the swing factor for us, when I look at the whole company, as we have probably I’m going to guess doubled our healthcare pipeline and they’re a little bit more tricky to close in a given cycle. They tend to wait and ponder and think about it, and they don’t come off the dime as fast as some of the other verticals. But our healthcare pipeline has doubled. And they are front ending jobs that lead to more work.

I would say the characteristic about all of these projects are it’s all about data. People are really looking at, “How can I leverage my data to increase my revenue streams?” They’re very interested in, “Where is my profitability coming from?” And that all leads back to the original Edgewater business as well as the EPM.

Arnold Ursaner - CJS Securities

You mentioned at the end of Q1, your 49% of your proposals were still outstanding. If we were to look at that same metric today, what do you think it would look like? Or saying it another way, did you close on many of the proposals or have an answer on the proposals that were outstanding?

Shirley Singleton

I asked our proposal guy to tell me what’s my percentage, and it was 39% of yesterday. What I haven’t done is gone back and looked at it on a detail level, how many of those are still leftovers if you will and how many were replacements.

Arnold Ursaner - CJS Securities

Final question for me and I’ll jump back in queue. Are you aware of any sizable contracts that run off that we should be building into our thinking?

Shirley Singleton

You know, I think we’ve run off anything that we’ve had. And what you’re looking at in Q2 is a year ago quarter it was the highest of high of our run, our three or four year run where we were growing, growing, growing and then a year of having some tough times. So I’m thinking that, you know, we could look back at this point in time where we are comparing at the highest of highs against the lowest of low, and we’re going from here.

Arnold Ursaner - CJS Securities

Let me ask two more questions. I’m sorry. Utilization in the quarter was unusually low and you mentioned you had reduced headcount. To the extent that service revenue stays flat in Q2, what sort of thought do you have about utilization, which has a dramatic impact on margin?

Shirley Singleton

Well, as you know we have typically run the business for 16, 17 years trying to hit that 78 to 82% and that range is really not possible given the economic climate that we’ve been through. So we’re actually striving to be somewhere closer to the low to mid-75s, around 75%. We have seen holding steady at 68. Kevin is that fair?

Kevin Rhodes

Yes. That’s about right. What we’ve seen recently.

Shirley Singleton

Yes. And with the pipeline and some closings, I think we have an opportunity to drive that utilization up, which is exactly what we wanted when we had that staff reduction.

Operator

Your next question comes from Robert Poole - Bricoleur Capital.

Robert Poole - Bricoleur Capital

A couple of questions. [Audio impairment] in the second quarter attributable to downsizing that were sort of one time in nature? What would you, how would you, what would you say that number was?

Kevin Rhodes

Well, in essence we had, we will have a about $850,000 benefit in the third quarter over the second quarter in terms of our cost of sales line item. The actual total annualized cost that we took out of the company was $2.3 million. So if you divide that by four, you’re roughly around $800,000.

Robert Poole - Bricoleur Capital

Okay. So I got, what was the nature of those exp, you know somewhere in your release you talked about all of the costs of the downsizing being in the second quarter. And you just referred to the savings, but I guess your $850,000 answer gives me some quarter-to-quarter sense for what those costs were. What was the nature of those costs? Was there severance in the second quarter and?

Kevin Rhodes

Sure. All severance records in the second quarter.

Robert Poole - Bricoleur Capital

And order of magnitude? How much was that?

Kevin Rhodes

It was around $400,000. Total severance cost.

Robert Poole - Bricoleur Capital

And then a second sort of more strategic question for Shirley and, I guess ultimately the board, is this if you’ve got, and it really relates to the size of the company and the cost of being a public company and such, your working consultants are here at the low of lows. Your working consultants are probably generating something like $15 million in contribution on an annualized basis. Does that sound about right to you guys?

David Clancey

Working consultants.

Robert Poole - Bricoleur Capital

Right. So the guys who are actually on the job, working for somebody, not on the bench are probably generating gross profits of something like $15 million.

David Clancey

Of gross profits you’re saying. [Inaudible] the first time. Okay.

Robert Poole - Bricoleur Capital

Does that sound?

Shirley Singleton

I don’t know. Is that correct, Kevin?

Kevin Rhodes

Seems about right.

Robert Poole - Bricoleur Capital

So the question from a shareholders perspective, from a strategic perspective is you take those working consultants generating $15 million of profit and you layer them into somebody else’s organization, that’s worth a lot of money to somebody. It’s worth, I don’t know, $5 or $6 per share of yours, which in addition to your cash, you know, $7 or $8 a share and you’re sort of here at $2.70 and sort of here at $2.70 pretty much based on your, you know, your balance sheet and not reflecting any sort of real ability to obviously make any money which, you know, that $15 million is more than covered by your SG&A.

So the strategic question is is, and especially Shirley as you mentioned, you know, this international pull and international opportunity which for a larger company probably is, you know, easier to pull off than for a small company like yours, where the cost of expanding internationally can be quite high. Isn’t there a huge difference for Edgewater and its value between being an independent company and being part of somebody else’s company? And isn’t that difference so large that, you know, a board really has to, you know, take a hard look at that as a strategic alternative?

Shirley Singleton

So are you asking me why are we not for sale?

Robert Poole - Bricoleur Capital

I am asking you and your board, I want to make sure that you and your board are sort of looking at that analysis very carefully and doing the right thing for the shareholders.

Shirley Singleton

We always examine every alternative for our company, and given the price and given actually your analysis that you just did, you’re underscoring that we are under valued. So our point has been that we need to continue to nose to the grindstone, grow the company, and if your core value is grow then other opportunities will open up. Perhaps somebody coming in and chatting with us in the future. Worse case we continue to recover and get back to the nice profits and EBITDA and so forth that we’ve had in the long run prior to this hit in the economy. And we always examine every option. We talk about it in a very critical nature at every board meeting.

Robert Poole - Bricoleur Capital

And the only sort of incremental you know sort of point that I’m trying to make versus what you said, Shirley, is that the value of the company that is much higher than where the stock is today is only realizable through a sale and the elimination of the burden of, you know, basically putting the consultants to work in an existing infrastructure, so that you don’t have to carry the 16 million. In effect the high value comes from eliminating having to carry the, you know, $18 million per year of overhead that you currently carry today. You know, you capitalize that value and that by itself is just worth a lot of money.

It’s really a question of scale. Does Edgewater have the scale? You know is it’s small size just destroying value? And that’s nobody’s fault, it’s just a question that needs to be considered, is that small size is a big issue here, especially if, as you’re saying, there’s demand for your EPM business globally. Again, tough for little old Edgewater to go out and span the globe doing that business, not so tough for, you know, a company that already spans the globe. So that’s all.

David Clancey

Certain aspects, this is Dave, could be a little deceiving because in the EPM business, you know, we’re in the top 5 worldwide for oracle services.

Shirley Singleton

In planning and budgeting.

David Clancey

In planning and budgeting. And we’re aggressively growing the SAP business. So I would contend that there is a certain strategic value to being able to grab such a large piece of that particular market. But on the face of it, I wouldn’t really argue with your analysis.

Robert Poole - Bricoleur Capital

All right Dave. Thanks. And again I think the strategic value is it has to be realized away from, you know, the $18 million overhead. Not that you guys have to cover. The public markets just won’t give you, you know, value unless you can, you know out-earn that, you know, you can make more than that, significantly more than that overhead. And it’s just, you know, a challenge for a company your size to get over that hump. The costs of being public are, you know, very high. So that’s all. I’m just throwing that out there as, you know, food for thought. You know I love you guys and I’ve been a long time shareholder. I think there’s a lot of inherent value here. So that’s all. Thanks.

Operator

And that concludes our question-and-answer session. I’d like to turn the conference back over to Shirley Singleton for closing comments.

Shirley Singleton

Okay. Well, I really appreciate everybody joining in and listening this morning. And Kevin and I and the team will be around today if you’d like to give us a call and talk about anything offline. Our next earnings call, Q3 earnings call, will be November 4 and we look forward to talking with you then. Thank you very much. Gwen, we’re done.

Operator

Thank you. Ladies and gentlemen, if you wish to access the replay for this call you may do so by dialing 888-203-1112 or 719-457-0820 using pass code 7456156. This concludes our conference for today. Thank you for your participation. Have a nice day. All parties may now disconnect.

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