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Executives

Shirley Singleton - President and CEO

Dave Clancey - EVP, CSO and CTO

Tim Oakes - CFO, CAO, Treasurer and Corporate Secretary

Analysts

Lee Jagoda - CJS Securities

Bob Poole - Bricoleur Capital

George Melas - MKH Management

Presentation

Edgewater Technology Inc. (EDGW) Q1 2010 Earnings Call May 5, 2010 10:00 AM ET

Operator

Good day ladies and gentlemen and thank you for standing by. Welcome to the Edgewater Technology Incorporated First Quarter 2010 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. At the request of the company, we'll open the conference up for questions-and-answers following the presentation.

I will now turn the conference over to Ms. [Cheryl Charles] of Investor Relations for introduction.

Unidentified Company Representative

Thank you. Good morning everyone and welcome to Edgewater’s first quarter financial results call. I’m here today with Shirley Singleton, Edgewater’s Chairman, President and CEO; David Clancey, Edgewater’s EVP and Chief Strategy and Technology Officer and Timothy Oakes, 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 risk 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. The statements made during today's call are made only as of the date of today's call and the company undertakes no obligation 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, [Cheryl]. Good morning, everyone. And in nutshell we had a great quarter. Our EPM related business was effective with seasonality which we expected. However, let’s look at some of the other things that occurred during the quarter. Our original tech offerings surged 20% sequentially, our newly acquired Microsoft Dynamics AX business which is in the form when we talk about it Fullscope also posted strong sequential growth which was a little bit unexpected.

Utilization is up across the board and we're beginning to hire again. On a net of price level if I tinted the [masterly] this morning, if we rolled it all up. Sequential organic growth is full stop, it's been on board in Q4 is approximately 6%. During Q1 we secured 25 new customers of which 23 new customers came from our tuck-in EPM offerings, that number is double what we did in Q1 '09. New wins, I think you're going to recognize some of these names include General Mills, Sun Capital, Dish Network, Osram Sylvania, Hiscox in the UK, Orange County Container, and Tempur Pedic.

The addition of the Fullscope AX practice and a strategic change in our tech offerings has changed the complexion of our business. And what we finally would do this morning is Dave and I would like to get more time on a strategy and talk to you about the shift that we're seeing. We started looking at a shift about 18 months ago and when I talk about a shift, our core strategy has not changed, i.e. the core strategy has been, lets march up the pyramid of services. What has changed is some of the tactics as we march up that pyramid of services.

We have historically been a custom development shop and part of the switch in tactics is related to product centric consulting. So, Dave maybe you could talk to our investors about why the shift.

Dave Clancey

The shift into product centric consulting is really there for one big reason and few small ones. Big reason is as long as reduction of risk. By using products to leverage up the amount of time it takes to get a solution in you reduce your risk and you have the product in as a buying business, you have the product in and running much more quickly, you're able to push that product installation down below the 18 month period, usually 18 months is a magic number in almost all IT projects anything that goes more than 18 months has a better than 70% possibility of failure. If you can bring that down you are going to wind up with a successful installation, that’s what they want to do.

It also reduces the amount of total labor and when you are operating in the United States or any of the developed nations Europe, Canada, etcetera labor is your biggest component, it's even greater than your royalty cost in terms of licensing. So, anything that brings that down allows the staff we're going to do the installation and be on site and provides you with a functionality you need is really what you're going to target for and that’s why people are really looking at product centric solutions rather than looking for custom solutions or solutions where they're going to be building a bulk of it even offshore because there you have a QA risk of bringing it on. So, the big piece there is I get my solution, I get it in quickly and I get it in at a much advantage price because we're not writing thousands of lines of custom code.

Shirley Singleton

But that doesn’t mean the end of custom development.

Dave Clancey

Doesn’t mean the end of custom development, what it means now is, is that we're seeing the middle market come in with a full replacement cycle off of what occurred through year, let's call it 1998 through 2001 timeframe when the ERP world was revamped and the first generation of internet came in etcetera. So, what you have is the middle market retooling their pieces. Large companies have backed down; everyone knows what the economy has been like and regulation's been like etcetera. So no one wants to take on the added risk of custom systems.

When you build a custom system, you're building something that’s very strategic and its even higher risk than really putting in a product or anything because you're changing the way you do business completely with no model going forward, you are doing everything on a comp so to speak. So what happens here is, is that you'll see everyone come up to speed, everyone ante's into the game, they match the proven technology, they get the proven products and then for innovation, someone will be appraised, a new way of doing business will happen, you'll have custom systems come back and if you have to start the cycle all over again.

Shirley Singleton

And we are ready to go back into that cycle if and when that occurs.

Dave Clancey

We are perfectly ready to do that, because we’ve kept all of our key channel in that area and where they work now rather than building completely custom systems is we build interfaces now. We're building the glue code that really puts together the various pieces of the system. If you think about it, the dynamics product we like a great deal because its second generation, you're operating in a much higher level development platform which gives you a lot more leverage in terms of creating functionality. If I pick on the CRM product within the dynamics package I can take that particular CRM product and I can turn it quickly into an order entry system. I can turn into outbound direct marketing; I can have it handle IVRs pretty much out of the box. So what happens here is, is rather than looking at a development platform it's just some syntax, I've actually got functional, fully tested product level code that allows me to deploy solution very, very quickly. But it also has to be deployed by people and know what they are doing and we’ve kept those people. So they will be ready for custom systems as we move on.

Shirley Singleton

So we’ve accelerated into the shift by acquiring Fullscope actually and they are our answer to that replacement cycle that we believe is happening in the ERP space. Dave mentioned the Microsoft AX product is key within that. We picked Fullscope not only because they were the number one AX provider in the United States but they actually have developed some intellectual property and we see that as an accelerator in terms of taking generic products that Microsoft produces in this case, Microsoft and verticalizing it. These accelerators, these small snap-in IP code that they developed actually creates a barrier to entry.

Dave Clancey

Right it creates a mode. So what happens here is While they creates a most, so what happens here is, as you want to really have the brand value being able to say that you know something is specifically. So what Fullscope now specifically is a process manufacturing business. They are well know in the industry for it and that process manufacturing piece prior our purchase is sold to Microsoft. And Microsoft now maintains it. So we we're are moving on to build up some intellectual property in the area of chemicals, pharmaceuticals etcetera, so that we will be able to take that add-on that fits on top of the existing products in the stack and we’ll be known as the people the Go-To people when you really want and take and put an implementation like that in.

Shirley Singleton

And that’s the barrier to entry…

Dave Clancey

That’s the barrier to entry, because who is going to hire someone who has no reputation for putting that type of thing in. If you want to do process manufacturing right now, you know to go to Fullscope in that particular space.

Shirley Singleton

And you mentioned CRM, I just wanted to point out to our investors that Microsoft is also pushing their CRM product. It seems to be gaining traction that is one of the key components that we’ve injected into the original tech business and that is part of why that growth is occurring in tech. And then lastly what I wanted to point out and hopefully this kind of completes the picture for all you folks is that, the Dynamics AX product, the ERP product doesn’t come with a built-in EPM system that would do strategic finance, planning, budgeting, consolidation. It has some of those elements but it doesn’t have the level of EPM pieces that it needs to have and in fact Microsoft tried to do a product last year in the form of what they call PPF and abandon that market. So what happens here is our SAP in our Oracle offerings will snap on top of AX.

So from our point of view Fullscope filled into the middle between tech and our APM creating one cohesive haul and actually and people get into this that actually has evened our revenue streams out giving us the three legged stool. So with that let’s get into the numbers Tim.

Tim Oakes

Thank you, Shirley. Following our standard quarterly review format we’ll start the financial part of this call with revenue. Total revenue for the first quarter was $20.3 million a 36% increase in total revenue of the $14.9 million we recognized in the year ago quarter. Looking at the total revenue growth from the year-over-year basis, the growth is primarily driven by the Fullscope acquisition of which we completed on December 31 of 2009 and accordingly started recognizing revenues related to Fullscope during our first quarter of 2010 and at this point in time we have essentially fully integrated Fullscope operations in to our core business operations.

Its worth noting that the first quarter of 2009 is the last quarter in which we’ve recognized revenue from our larger legacy accounts. As we move forward on a quarterly basis in 2010, our quarterly revenue comparison as they relate to our organic service offerings what we've based upon more normalized comparative revenue. Specifically they will not reflect the wild periodic swings we have been reporting in connection with the pull back in the legacy account spending which has significantly impacted our comparative 2009 performance metrics

Service revenue which excludes software, royalty and reimbursable expenses was also rough over the year ago quarter. First quarter service revenue totaled $15.7 million a 16% year-over-year increase as service revenue was $13.6 million in the first quarter of 2009.

As Shirley mentioned in her opening comments, we are pleased to report sequential service revenue growth on an organic basis. Organic revenue growth on our core service offerings was driven by an uptake in business and our tech related offerings which coincide with the increase in bidding proposal activity which we highlighted during our fourth quarter earnings call. The sequential growth in our tech related service offerings offset the seasonal first quarter drop in our EPM related service offerings. Additionally as we mentioned in our fourth quarter earnings call, Fullscope had a strong second half of 2009. Given the significant growth in the later part of '09, we entered 2010 anticipating that first quarter revenues would be inline with their fourth quarter service revenue performance. We were pleasantly surprised to see continued sequential growth in their service revenues during the first quarter of 2010.

Software revenue which includes associated maintenance revenue increased by $2.6 million during the first quarter to $2.9 million and represented 14.9% of our total revenue. Worth noting our reported software revenue was primarily attributable to Fullscope and we anticipate as we move forward that software revenue will be a material part of our future total revenue. Unlike our historical operating results, our go forward operating results maybe material influenced by our software revenue. It's important to note that quarterly software revenue can be volatile and is subject to customers demand for such third party after sell software.

Quickly touching upon some of our other first quarter revenue metrics before moving on to gross profit. Our annualized service revenue per billable consultant metric was $326,000 in the first quarter compared to $341,000 in the first quarter of 2009. Given the acceleration of Fullscope's growth and the time sensitive nature of Fullscope's ERP related engagements, we were unable to recruit non-board billable recourses in a timely manner and elected to supplement billable employees through the usage of contractors. We acknowledge that the user contractors negatively impacts or gross margin and additionally in this case excuse our annualized revenue per billable consultant metric. Reason being, as we calculate our service revenue per billable consultant metrics, we calculated on an absolute basis with regards to the total number of billable employees we utilize each quarter.

As it relates the contractors, we assume each is fully utilized on a weekly basis. However, given the modular specific technical requirements associated with Fullscope's ERP engagement this isn’t necessarily an accurate reflection of what the total billable headcount is. Of the 268 billable recourses we're reporting at the end of the first quarter, 34 contractors, adjusting that number of contractors for their actual usage would actually decrease the reported number of contractors to approximately 15 to 17 on a full time equivalent basis.

As we incorporate that downward adjustment, it would enter the determination of the metric this would result in an annualized revenue for a service revenue per billable consultant of approximately $342,000 which is in line with the year ago quarter.

Shirley Singleton

The reason why we're highlighting this is, we did get a question in the last earnings call, is the addition of Fullscope going to decrement our annualized revenue and we answered back then, no it was not and it isn’t. This is steeling from the part time contractor.

Dave Clancey

You are right. And Edgewater has been there before, we have done that in prior year so as we have reported that metric on a sequential quarterly basis, its sort of an normally in this quarter.

Shirley Singleton

Right.

Dave Clancey

Continuing on as Shirley just mentioned in her opening remarks, we entered into engagements with 25 new customers during the current quarter compared to 11 new customer engagements in the year ago quarter. 23 of these new customer engagements were related to our support service offerings and similarly reflect the increase in bidding proposal activity we experienced in the later part of the fourth quarter of 2009. Service revenue generated by our top 10 customers in the current quarter represented 30.3% of total service revenue compared to 37.6% in the first quarter of 2009.

Moving on to gross profit, our gross profit metrics were slightly improved on year-over-year basis. Total gross profit as a percentage of total revenue improved to 33.1% in the current quarter compared to 31.2% in the year ago quarter. Similarly, service gross profit margin improved a 34.1% in the current quarter compared to 33.4% in the year ago quarter. The year-over-year comparative improvements in our gross profit margins were related to improvements in our utilization rates offset by increases in fringe expenses typically medical and dental premiums and an increase in contractor related expenses.

Lightly touching upon our billable consultant utilization rate, our billable consultant utilization rate was 75.3% during the first quarter of 2010 compared to 67.8% in the year ago quarter. The comparative improvement in the utilization rate is directly related to the Fullscope acquisition plus the proactive management of our billable recourses in an effort to maintain an alignment of capacity with anticipated revenues.

Additionally we would also like to highlight that on a sequential basis, the utilization related to our technical; service offerings improved by 25% which is the primary driver of our sequential utilization improvement. As previously mentioned, one downside of the continued growth and Fullscope service offerings related to the use of contractors to facilitate their delivery needs. Contractors while certainly are more flexible, are an expensive labor source. The usage of contractors during the first quarter impacted some of the year-over-year gross profit margin improvement. As we have in the past, we will monitor our future contract usage and we'll seek to lessen our alliance through a combination of strategic hiring and training programs where the conversion of contractors when possible to full time employees.

Moving on to SG&A expenses, SG&A expense as a percentage of total revenue was 33.2% during the current quarter compared to 31.9% in the year ago quarter. In absolute dollar terms SG&A expense increased approximately $2 million in the current quarter. The majority of the increase in SG&A expense in the current quarter is attributable to the incremental expense associated with the Fullscope acquisition, in to a lesser extent we also had higher SG&A expenses associated with our core operations during the current quarter, the increase is primarily related to increases in bonuses, commissions, fringe and travel related expenses.

Shirley Singleton

And lets stop right there, the bonus accruals weren’t there in Q1 because we were already working at decreasing revenues in ‘09. So on a year-over-year it doesn’t math.

Dave Clancey

That’s correct, I mean obviously our annual bonus programs are performance based bonus programs, when we came out of the gate in Q1 in 2009 we were below plans in terms of what our metrics were and we did not accrue for the annual components of the bonus programs as we went. Conversely this year we are on plan and have accordingly recognized the expense related to those bonus programs.

Continuing on, as anticipated in our fourth quarter earnings call the addition skill provided through the Fullscope acquisition has brought our first quarter SG&A expense within our historical range for this operating metric. We have been able to leverage our existing SG&A infrastructure as we have integrated Fullscope into Edgewater’s existing business.

Below SG&A depreciation and amortization expense increased by $294,000; interest income decreased by $62,000; and the company recorded a loss on foreign currency translation of approximately $30,000 in the current quarter. Quite simply the increase in depreciation and amortization expense is primarily due to the new amortization associated with the Fullscope acquisition. The decrease in interest income is due to a decrease in the invested marketable security balances as a result of the cash payments we made in December in connection with the Fullscope acquisition. And the current quarter loss in foreign currency transactions is directly related to foreign denominated transactions associated with the Fullscope business. Net loss during the current quarter was $639,000 or $0.05 per diluted share compared to a net loss of $454,000 or $0.04 per diluted share in the year ago quarter.

In terms of headcount, total company headcount was 352 at the end of the first quarter of which 268 were billable resources.

Touching on cash flow, we used approximately $5.0 million in cash for operating activities during the first quarter compared to a use of $2.4 million in cash in the year ago quarter. Given the significance and importance of the swinging cash flow from operations in the current quarter, we think it's certainly important to highlight that while the outflows of cash were anticipated, this outflow is higher than our normal first quarter flows which have averaged approximately $2.4 million over the last three years.

Traditionally our first quarter cash flows are influenced by outflows associated with annual performance based bonus program payouts and our annual insurance policy renewals. Cash flows in the first quarter of 2010 were additionally impacted by payments of liabilities and soon being in connection with the Fullscope acquisition. Significant payments made in connection with the Fullscope acquisition related to payments of state and federal income taxes, quarterly and annual bonus programs and payments to Microsoft for software sales reported during the fourth quarter of 2009.

We think its also important to note that each of these amounts paid and which were accrued on the opening balance sheet for Fullscope were influenced by Fullscope’s growth and related profitability in the second-half of 2009.

Further we would also like to emphasize that we have not experienced a degradation of our accounts receivable age. As of March 31, 2009 only 20% of our bills receivables had been outstanding for a period of time greater than 60 days which is comparable to the year ago quarter.

Finally one last comment on cash flow, we typically see cash flow improved throughout the year and similarly in 2010 we anticipate that we'll be cash flow positive from operations in the second quarter of 2010.

Quickly touching on some balance sheet items, from balance sheet perspective, cash and marketable securities totaled $6.7 million at the end of the first quarter compared to $12.7 million at the end of 2009. Our cash and marketable securities represent $0.55 per diluted share as of March 31.

As of today’s earnings call, our cash and marketable securities balances are approximately $9 million. Accounts receivable balances including unbilled AR totaled $19.1 million at the end of the quarter. Our DSO metric unbilled AR was 56 days at the end of the quarter compared to 51 days at the end of the first quarter of 2009.

And then finally comments on our stock repurchase program, we did not make any repurchases to common stock under repurchase program during the first quarter. As of March 31, we had a remaining stock repurchase authorization of $2.8 million and our current repurchase program expires in September of 2010.

With that I'll now hand the call back to Shirley for final comments.

Shirley Singleton

Thanks, Tim. I wish I could say it’s a slam dunk that we're going to grow again in Q2 but I’m a little worried about sentiment. Dave you have some thoughts on that?

David Clancey

Yeah, what we have seen over time is that if people feel that they are worried about where the economy is going or what’s going to come in for regulation etcetera it tends to slow down signing in the pipeline it tends to really extend the sales process etcetera. So, if people feel that we are at the new normal and they don’t sense a lot of problems coming down the pipe, I think that we won't have any problem signing things and I think at that point Shirley stating that we could be up a little would be true but if the people start getting worried holding their horns in, not wanting to push forward with projects because some of the riskiest you think you can do on our organization is put a new IT project through. So, its all going to depend on how they feel, do they feel confident and they need to move forward or do they feel nervous and that has a big effect on how the pipeline moves.

Shirley Singleton

Well, we have a good pipeline. I stop by ahead of sales before I came into the current call here this morning and I said how are we doing? I’m going in to talk to the investors, it's only hey, we just closed the 600 KBL unexpectedly this morning. So, mathematically I guess there was showing growth again in Q2 but I’m going to play it safe and just say we're going to be flat with an upward bias as to guidance. And with that, Caron I’d like to open it up for questions.

Question-and-Answer Session

Operator

Thank you. The question-and-answer session will begin now. (Operators Instructions). Your questions will be taken in the order they are received. Please standby for your first question. Thank you. Our first question comes from the line of Arnie Ursaner of CJS Securities. Please state your affiliation followed by your question.

Lee Jagoda - CJS Securities

Hi this actually Lee Jagoda for Arnie Ursaner. How are you? Just first question relates to the process royalties as part of your revenue line. Looks like it was around $400,000. It's a new item and it appears to flow straight to the bottom line. Can you break out what that is and what should we expect going forward on that line?

Dave Clancey

The process royalty line is a new line in our financial statement this quarter. And it directly relates to Fullscope's business process unit and that is the piece of the Fullscope business that is subject to the contingent earn out that we entered into in connection of the stock purchase. And Fullscope in June of 2009 sold IP to Microsoft and in connection with that sale, Fullscope now receives future royalties for basically a two year period from June of 2009 to June of 2011. So, in those royalties really don’t fit into service revenue line item or a software line item, we escalated to expand the revenue captions to account for that royalty revenue.

Expectation point of view go forward, its sort of difficult to say, its really based upon what royalties get pushed down by Microsoft through their sale. And in terms of it being a straight drop to the bottom line, that’s not necessarily true given that that royalty revenue plus some additional service revenue related to some other development and sustaining engineering and sales support statements of work that the business process unit will work on over an 18 month period will offset part of that revenue as it falls to the bottom line.

Lee Jagoda - CJS Securities

Revenue margin on that $400,000, how should I think about that?

Dave Clancey

We don’t break out profitability by division or what not, I really cant give you an answer on that one.

Lee Jagoda - CJS Securities

Well, simplistically, is it higher or lower than, let's say, your service gross profit?

Dave Clancey

I think its going to be higher. I think if you are assuming it was higher than the typical margin we would get on our services that would be fine.

Lee Jagoda - CJS Securities

Okay. And then is there a way you can break out the Fullscope business on revenue, gross profit, and utilization, as compared to your core Edgewater business in the quarter?

Shirley Singleton

Well we reported in one segment, we can give you a sense on percentage of revenue among the three.

Dave Clancey

Yeah we haven’t historically broken our profitability metrics as it relates to EPM, as it relates to tech, as it relates to Fullscope. I think if you look at it in terms of the first quarter revenue number at 15.7 million in service, Fullscope would represent roughly 30% of that number, EPM would be roughly 45% with tax making up the remaining 25%.

Lee Jagoda - CJS Securities

Got it. And one last question and then I'll hop back in queue. Just trying to understand the 75% utilization you reported. I fully understand the issue with billing billable consultants at 100% utilization and it's only 15 to 17 on a full-time equivalent basis. Do you have an adjusted utilization number looking at consultants on a utilized basis rather than a 100% utilized?

Dave Clancey

You know Lee, we don’t and the reason why I say that is as we look at our consultants that we utilized, we really don’t pay consultants for downtime so if you were to look at for instance a 40 hour a week, if a billable consultant or a contractor only worked 20 hours, we wouldn't report them at a 50% utilization nor would we pay them for 40 hours, we would only pay them for 20 hours.

Operator

(Operator Instructions). And we do have a follow-up from Arnie.

Lee Jagoda - CJS Securities

Hi, this is Lee again, just a few more to follow-up. Did you quantify the amount of cash taxes you paid for Fullscope in Q1?

Dave Clancey

We paid $2 million in cash taxes for Fullscope, breaking that down that would be roughly $1.6 million and federal to remainder in state. I would like to add sort of a benefit of Fullscope being combined into Edgewater’s tax group beginning January 1. Now that $1.6 million from an Edgewater perspective is an anomaly given that we have the federal NOLs which we can use on a go forward basis and essentially grow tax rate, on a federal income tax perspective.

Lee Jagoda - CJS Securities

And I know you said you expect to be cash flow positive in Q2, given that you are going through I guess $5.5 million of cash in Q1, is your expectation that will flat to up for cash flow for moderations for the full year?

Dave Clancey

For the full year, yes. We expect to be flat to up for the full year.

Lee Jagoda - CJS Securities

And if you would, could you break out how much was spike and other one time related expenses in SG&A?

Dave Clancey

If I look at it in total, in terms of what the FICA reloads were across the board? I can't break it out between SG&A and cost of revenue. But we’re looking at FICA expense because the reload sequential in Q1 of just under $0.5 million.

Operator

And our next question is from the line of Bob Poole of Bricoleur Capital.

Bob Poole - Bricoleur Capital

Hi. Could you sort of give the shareholders a sense for how you get from the current level of revenues and basically break even EBITDA results to a more acceptable level of profitability from an outsiders perspective, you’ve got $26 million - $27 million of profits being generated by your consultants but its all being consumed by the fact that you're a small company and you can't profitably drop that consultant profit to the bottom line. So, can you just describe for investors how you're actually going to do that overtime? Thank you.

Shirley Singleton

Sure, excellent question. Part of it was a steel problem as we came down in bulk if you will on billable resources last year with the turn in tech, offerings down. That obviously affected our ability to turn a profit. With the addition of Fullscope, its given us our scale back, number one. Number two the normalization of the utilization back end to striking distance of those normal ranges, usually and that being done, with increased revenue its not being done by headcount of cost pull back or actually growing is going to point the profitability. So I would think that you're going to see some of that this year.

Bob Poole - Bricoleur Capital

Shirley, I think we’ve also believed that sort of an acceptable level of profitability for this company would be on the order of the 10% EBITDA margin. That’s on your current revenue run rate, that’s $8 million of EBITDA that you sort of theoretically ought to be generating at this level of revenues. How do you get there?

Shirley Singleton

Its just what I just said. The normalization of revenue, the FICA rest has given us a little bit of flux here in Q1. I believe you're going to see some return to profitability this year. And keep in mind, we’ve come off an eighteen months downturn, and we're not the only one, a lot of companies have been struggling. I think this turnaround that we're doing is actually remarkable given the circumstances. So I'm very proud of were we are as well as we’re going to put our money where our mouth is. I think you are going to see us put up some profit.

Bob Poole - Bricoleur Capital

Okay, and would you agree that a 10% EBITDA margin, is it reasonable expectation for this company in a normal economy?

Shirley Singleton

In a normalized economy, yes. I would agree that that is a number.

Bob Poole - Bricoleur Capital

And then just finally, it sounds like in the month and a half or not even a month and a half of this quarter, your cash balance has increased by $2.3 million or I'm not sure how to count the restricted cash but either $1.6 million or $2.3 million increase in cash so far this quarter. To what do you attribute that level of cash flow production?

Dave Clancey

Bob, I’m going to jump on that one. That really comes down to timing. If you look at Q1 in terms of how the cash outflow is related from a timing perspective, as we acquire Fullscope, we had to pay down the Microsoft payables. You look at when we process income tax payments, you look at when Edgewater paid out its annual bonus programs. All of those from a timing perspective coincided or occurred in the middle of March. So from a cash outflow perspective as we approach the tail end of the quarter, we had a significant amount of cash going out the door related to those types of liabilities. Additionally on March 29 was our last regular payroll for the quarter. So, you add that all together and it really comes down to an accelerated timing of outflows. So, as we enter into the second quarter and you commented on the $2.3 million, restricted cash is ignored, its not included in that number. So it is a $2.3 million plus number that we're looking at. It comes down, its really having a chance to breath in the second quarter and start to remove ourselves from those payments some of which aren’t really normal operating payments then our focus on the income taxes in an Edgewater operating environment.

Bob Poole - Bricoleur Capital

But when your EBITDA sort of breakeven, you're not generating cash from the operation, it's coming from working capital. What have your receivables gone down and your payables up since the end of the quarter? Is that what drives that?

Unidentified Company Representative

No, if we look at it, it'd be really a part of generating or collecting on receivables. Receivables are going to build, we increased revenue in the first quarter to $20 million coming of the fourth quarter and receivables only increased $1 million. So, yeah your point about getting cash out of networking capital, yes collection of receivables will be a part of that number.

Bob Poole - Bricoleur Capital

Okay. Well, thanks. I think you all know that I think you've got to find a way to get profitable to move forward as independent public company. The sort of current structure doesn't seem to make a whole lot of sense from a shareholder standpoint. So I hope you'll fix that one way or another. Thanks.

Shirley Singleton

I look forward to making you happy and I appreciate your point of view Bob.

Operator

Thank you and our next question is from the line of George Melas of MKH Management.

George Melas - MKH Management

So, I look at the numbers, Shirley. I listen to what you guys say, and there seems to be a lot of good things happening, but I'm very puzzled by one thing. I look at the utilization at 75%. And last year, the utilization was significantly lower, almost 10 points lower. But the margins have barely moved up. I understand that you've had sort of a tough time hiring people, so you brought in some contractors. And you get a hit on the gross margin there. But I still don't understand at the 75% utilization, it seems to me that you should be showing much stronger margins than you have. And sort of I'm puzzled because I'm going, where is the upside? When you were sort of at breakeven or slightly below breakeven at utilization in the mid-60s, I could see where the upside was. Now we have much higher utilization but we're still showing a loss. Granted, it's the first quarter, there're some FICA things, but it still seems below what I would have expected at that level of utilization.

Shirley Singleton

Tim you want to talk about, part of it is George’s bonus accruals etcetera, but go ahead.

Timothy Oakes

Part of it is bonus accruals…

George Melas - MKH Management

Bonus accruals, that should be part of your normal expense structure, right?

Tim Oakes

But as we look at it George, you would highlight it on contractors, contractor expense with the 34 contractors was a significant number. You did acknowledge that as we did in the call. Additionally if we look at some fringe expense outside of the reset to FICA in Q1 which would happen on a comparative quarter as well with the increased headcount we've got vacation accruals that lowed up. The first quarter is not a heavy vacation usage course so that number drops right into the margin, right to the bottom-line but I’d also like to highlight that as we continue to look at fringe, we have increases in medical and dental premiums this year over last year. We have increases in unemployment taxes this year over last year. So there are some other expense items that flow through that gross margin line.

Shirley Singleton

There is also another piece that I wanted to point which would be in the queue which is fixed price contract. We've gone from literally zero fixed price contract to 10%, is it…

Timothy Oakes

It’s a little less than 10%, it’s probably sz5% to 6%, or that number in itself is higher than we have had in the last 15 months.

Shirley Singleton

So from a revenue recognition point of view, we're not allowed to take some of the revenue for some of that work George, so that gets accrued going forward.

George Melas - MKH Management

But, do you also accrue the cost or the expense associated with that revenue? You must, right?

Tim Oakes

George the revenue gets recognized on a percentage of completion so as the costs fold in on the quarter, the costs remain. There is detrimental costs on a percentage of completion.

George Melas - MKH Management

So your cost gets fully pass through? Working for those guys.

Shirley Singleton

Right.

George Melas - MKH Management

I see what you’re seeing but I feel like there is something missing. It seems like you're talking about growth but at the same time, you have a hard time hiring people, so you have to rely on contractors. Have you been able to hire anybody since the end of the quarter sort of, but how are you trying to address the contractor issue?

Shirley Singleton

Okay. Multi party answer. We have been able to hire people in tech. We have been able to hire people in EPM. We have an all out push within the AX practice; we have done some hiring in the AX practice. However, we’re putting together with Russell Smith who is the person who runs that, that practice for us. Our plan on how we can reduce some of that contractor or headcount since the contractor are in the mix and working, we can't just pull them out. The customer…

George Melas - MKH Management

Sure.

Shirley Singleton

You know what I'm saying, you get it. So, yeah we’re going to work on the plan on that and I think you're going to see some changes in terms of EBITDA profitability in Q2. So let state you’re expecting.

George Melas - MKH Management

And where does that change come from Shirley? Is that increasing gross margin that comes from utilization from, where does it come from? Can you give us a sense of that?

Shirley Singleton

Well normally, the EPM offerings come off their softness, their seasonality in Q1. So they should be up and running and they do command a higher bill rate than the rest of the organization. So that’s one thing. The normalization of the revenue, it came up in not a hockey stick but it came up slowly and we’re not degrading. So as we hold steady for an entire quarter which I believe is going to happen, that does have effects to the bottom line.

George Melas - MKH Management

One thing Jim, I didn’t quite understand. Revenue from the legacy accounts, were there still some in Q1 or did that end in Q4?

Tim Oakes

No. It’s a very good a question. There was still some residual revenues that went into the first quarter of 2009.

George Melas - MKH Management

Okay. First quarter of 2009. First quarter of 2010 you mean.

Tim Oakes

Well first quarter of this year. I'm sorry, I misconstrued. There was really no revenue from those customers in the first quarter of 2010.

George Melas - MKH Management

Okay, very good. So it ended in the fourth quarter pretty much.

Operator

And if there are not further questions, I will now turn the conference call back to Miss Shirley Singleton for closing comments.

Shirley Singleton

Okay. Thank you very much for listening and asking questions today. Our annual shareholder’s meeting will be held on June 16th and our Q2 earnings call will be on August 4th and if you have, you want to explore deeper into some of the numbers like George was asking or whatever, give Tim a call. Thank you. Sharon?

Operator

Thank you. Ladies and gentlemen, if you wish to access the replay for this conference, you may do so by dialing 800-642-1687 or 706-645-9291 using code 67345039. Again, those numbers are 800-642-1687 or 706-645-9291, access code 67345039. This concludes our conference for today. Thank you for participating and have a nice day. All parties may now disconnect.

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Source: Edgewater Technology Inc. Q1 2010 Earnings Call Transcript
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