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Executives

Shirley Singleton - Chairman, President & Chief Executive Officer

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

Timothy Oakes - Chief Financial Officer

Shira Charles - Investor Relations

Analysts

Arnie Ursaner - CJS Securities

Bob Poole - Bricoleur Capital

Edgewater Technology, Inc. (EDGW) Q3 2010 Earnings Call November 3, 2010 10:00 AM ET

Operator

Good morning and welcome ladies and gentlemen to Edgewater Technology Inc. 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 will open the conference up for questions and answers following the presentation.

I will now turn the conference over to Ms. Shira Charles of Investor Relations for introductions.

Shira Charles

Thank you. Good morning everyone and welcome to Edgewater Technology’s third quarter financial results call. I am 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, Shira. Good morning, everyone. For Q3 we have guided that services revenue would be flat with an upward bias and I’m happy to report that we grew 4% sequentially on service revenue and that we have year-over-year double-digit organic growth. During Q3, we secured business from 23 new customers; new wins included such names as Harris Peter, Kraft Foods, Catterton Partners, ING Americas and Terry International.

If I look at the summer I can break it down for you. June we were coming strong, July, it looks strong and then we hit the soft part and continue to moving in to August and then August started to take off and September continued the lift.

So I would characterize it as a little bit of a hockey stick in the summer, but slow and steady improvement as time went on. EPM continues to grow, they looked for this quarter.

I mentioned in previous earnings call that I thought that there was going to be some synergy vis-à-vis cross-selling with our new acquisition Fullscope and that did come to bear with a large project in the PE space where a company was divesting of one of their assets and the PE firm was picking it up and we actually, EdgeTech and Fullscope worked together to put bring up a brand new company in a 120 days, which is complete with financials and infrastructure and best practices, which we are very proud of and that was delivered during the quarter as well.

But let’s get – have Tim get into the details.

Timothy Oakes

Thanks Shirley. Good morning everyone. There is quite a bit to talk about as it relates to our third quarter results. As we have done in recent calls, we will focus some of our comments related to changes in our operating performance upon sequential and organic changes rather than year-over-year changes. Given the year-over-year change in our business, we believe that this approach is more meaningful to investors when discussing trends in our business.

Excluding the effects of the current quarter $21.9 million non-cash charge associated with an increase of valuation allowance of fight against the carrying value of our deferred tax assets, third quarter results reflects growth in our service revenue and a continued stabilization in our operating metrics.

Total revenue and service revenue are up on a year-over-year basis and service revenue, both consolidated and organic is up on a sequential quarterly basis. As we proceed with our review of the third quarter, we would like to highlight the fact that third quarter operating performance does not include approximately $220,000 of service revenue and $659,000 of software revenue, with services and software delivered and sold during the current quarter.

The revenue amounts were deferred in accordance with the company’s revenue recognition policy and were primarily based upon payment contingencies and deemed delivery of software. Have these amounts been recognized, the reported gross profit adjusted EBITDA amount would have increased by $546,000 representing gross profit contribution associated with the deferred revenue items.

Total revenue for the third quarter was $21.4 million, compared to $11.8 million in the year ago quarter. Service revenue was $18.1 million during the third quarter, compared to service revenue of $10.9 million in the third quarter of 2009. Incremental revenue generated by Fullscope and growth in our core service offerings, drove our third quarter year-over-year growth in total revenue and service revenue.

Revenue increases in our core service offerings reflects the current year improvement in bidding proposal activity and the cross-selling synergies resulting from the combination of our technology and management service offerings with Fullscope’s ERP related service offerings. These are the primary drivers of a 20.7% current quarter year-over-year service revenue increase in our organic core service offerings.

Looking at revenue from a sequential viewpoint, we know that total revenue decreased by $2 million or 8.4%, compared to total revenue of $23.4 million in the second quarter of 2010. The sequential decrease in total revenue is directly associated with decreases in software and royalty revenues, each of which are primarily associated with our Fullscope operations.

Software revenue, which includes related maintenance revenue was $1.2 million during the third quarter and represented 5.6% of our total revenue. We anticipate that it will be a material part of our future total revenue and our future operating results can be materially influenced by our software revenue. It is important to note that quarterly software revenue can be volatile and is subject to our customers’ demand for such off-the-shelf third-party software.

On a sequential basis, software revenue decreased by $2.6 million, compared to the second quarter of 2010. The sequential quarterly change is attributable primarily to the seasonal fluctuations associated with Microsoft’s yearend and to a lesser extent the current quarter deferral of $659,000 of software revenue.

The second quarter has historically represented a significant portion of Fullscope’s annual software revenue, which serves to amplify the periodic fluctuation in reported software.

Service revenue has increased on a sequential basis by $688,000 or 4% to $18.1 million, compared to service revenue of $17.4 million in the second quarter of 2010. The sequential increase in service revenue was driven by increases in our organic core service offerings. Sequential growth in our core service offerings was largely due to growth in our traditional technology consulting services, as well as improvement in our EPM-related service offerings.

We have been touching upon some other third-quarter revenue metrics before moving on to gross profit. Our annualized service revenue per billable consultant metric was $324,000 in the third quarter, which is slightly improved from the second quarter of 2010. We entered into engagements with 23 new customers during the current quarter compared to 18 new customer engagements in the year-ago quarter.

For the year, we’ve secured engagements with 72 new customers, compared to 52 new customers in the 2009 nine-month period. 61 of these new customer engagements were related to our core service offerings and reflect a sustained bidding proposal activity we have seen during 2010.

Service revenue generated by our top-10 customers represented 30.9% of total service revenue in the current quarter, compared to 32.7% in the comparative 2009 period. The periodic change in our customer/revenue concentration is attributable to both the Fullscope acquisition and the current year increase in new customer engagements, each of which has reduced potential forward-looking risk associated with our reliance upon a few key customers.

Moving on to gross profit. Total gross profit as a percentage to total revenue was 36.6% during the current quarter, compared to 35.6% during the third quarter of 2009 and 36.8% in the second quarter of 2010. Gross profit margin related to service revenue was 38.9% in the current quarter, compared to 38.6% in the year ago quarter and 39.2% in the second quarter of 2010.

The sequential stability in our gross profit margins, given the current quarter decrease in software and royalty related revenues, is attributable to the consistent gross profit margin we have recognized on our service revenue in the comparative quarterly periods.

During our first and second quarter earnings calls, we discussed our usage of contractors in the overall drag the related expense had on our gross profit margins. During the third quarter, we managed to reduce our reliance upon contractors decreasing comparative sequential contractor expense by $287,000. We reduced contractor head count by 14 during the third quarter, which we offset with the addition of 10 full-time billable consultants. We will continue to work on reducing our leveraging of contractors, as part of our go forward business model.

Our current quarter gross margin performance on both the total dollar basis and as a percentage of total revenue and service revenue was affected by the previously described revenue deferrals. On a pro forma basis, have the company recognized the related revenue and associated costs, third quarter gross profit would have increased by $546,000, lifting total gross margin and service gross margin as a percentage of revenue to 37.6% and 39.7% respectively, reflecting sequential improvement over our second quarter gross margin numbers.

With respect to billable consultant utilization, our billable consultant utilization, which includes utilization performance associated with our contractors was 75% during the third quarter, compared to 65.1% in the year ago quarter and 75.7% in the second quarter of 2010. During the third quarter, we decreased our total billable consultant head count to 294 billable consultants, which includes contractors from 298 at the end of the second quarter of 2010.

Moving onto SG&A expenses. SG&A expense as a percentage of total revenue was 35.4% during the current quarter, compared to 35.1% in the year ago quarter and 33% during the second quarter of 2010. In absolute dollar terms, third quarter SG&A decreased by 117,000, compared to the second quarter of 2010.

The sequential decrease in SG&A is primarily related to the comparative reduction in non-routine expenses related to the Meridian acquisition and the Fullscope Embezzlement issue, a decrease in bonus related expenses and increases in expenses associated with the company’s transition from a cost-cutting mode to growth mode. These costs specifically include increases associated with the full quarter of incremental SG&A related to the mid-second quarter acquisition of Meridian; non-cash adjustments associated with the fair value of contingent earn out consideration, recruiting, telecom, and computer equipment, commissions and travel related expenses.

Focusing upon the non-routine items. During the third quarter, we reduced total non-routine expenses associated with the Meridian acquisition and the Fullscope Embezzlement issue from $562,000 in the second quarter of 2010 to $139,000 in the third quarter. In the current quarter, cost associated with the Meridian acquisition totaled $40,000, compared to $358,000 in the second quarter of 2010. Similarly cost associated with the Fullscope Embezzlement issue totaled $99,000, compared to $204,000 in the second quarter of 2010.

As we commented upon in our second quarter earnings call, we caution that we may continue to incur cost related to the Fullscope Embezzlement issue in the future. However, we do not have an estimate for anticipated future costs.

Below SG&A, third quarter depreciation and amortization expense on a year-over-year basis increased by $317,000. Interest income decreased by $30,000 and the company recorded a gain of foreign currency translation of $75,000 in the current quarter. The increase in depreciation and amortization expense was primarily attributable to the increase in amortization associated with the Fullscope and Meridian acquisitions.

The lower interest income was due to a drop in average invested balance and reduced yields, while the current quarter gain on foreign currency transactions is directly related to the foreign-denominated transactions associated with our Fullscope business.

Net loss during the current quarter was $22.7 million or $1.86 per diluted share, compared to a net loss of $249,000 or $0.02 per diluted share in the year-ago quarter. The primary driver of the year-over-year change in reported net loss is the $21.9 million non-cash charge related to an increase in the valuation allowance recorded against the gross carrying value of our deferred tax assets.

Our decision to increase the valuation allowance in the current quarter is more indicative of a lagging performance indicator, as opposed to a forward-looking indicator. We routinely review the carrying value of our deferred tax assets on a quarterly basis. This review requires a significant amount of judgment and incorporates a review of various supporting information, such as historical financial performance, future growth and profitability projections, et cetera.

Historical performance in this instance has given the greatest weight in our review. While the company’s plans and projections target future growth and profitability, a review of the company’s recent three year financial performance in cumulative loss position, leads us to our decision to place the full valuation allowance on the deferred tax assets.

A final comment on the deferred tax adjustment. We want to emphasize that the provision of a full valuation allowance against these assets does not limit our ability to realize income tax benefit on a go forward basis. The company still maintains its ability to increase profitability on a federal tax-free basis.

Looking at our non-GAAP measures, adjusted EBITDA was $389,000 or 1.8% of total revenue and $0.03 per diluted share in the current quarter, compared to adjusted EBITDA of $84,000 or $0.01 per diluted share in the year-ago quarter. As presented in the earnings release issued early this morning, our adjusted EBITDA calculation excludes cost associated with the Meridian acquisition and the Fullscope Embezzlement issue.

Similar to our early revenue and gross profit margin related comments, our reported adjusted EBITDA metric for the third quarter was also affected by the current quarter service and software related revenue deferrals. On a pro forma basis have the company recognize these revenues during the current quarter, adjusted EBITDA would have increased by $546,000 and would have totaled $935,000 or 4.2% of total revenue and $0.08 per diluted share.

As evidenced by the current quarter changes associated with our revenue deferrals, we’d like to highlight that our operating performance given the size of the company can be significantly affected by relatively minor fluctuations and items such as service revenue, software revenue, billable consultant utilization, operating expenses and income taxes.

Moving on, just some final operating metrics. Total company headcount was 391 at the end of the third quarter, of which 294 were billable. We generated approximately $1.3 million in cash flow from operating activities during the third quarter, compared to cash flow from operations of $735,000 in the year ago quarter.

On a year-to-date basis at the end of the third quarter, we reported cash outflows from operations of $858,000. We are driving to be cash flow positive in the fourth quarter of 2010 and similarly to be cash flow positive from operations on a full year basis. There will be pressure on obtaining this goal given that the fourth quarter has seven payroll periods with the final payroll of the year scheduled to be funded on the last day of the year.

From a balance sheet perspective, our cash and cash equivalents totaled $9.4 million, compared to $12.7 million at the end of 2009. Our cash and cash equivalents represented approximately $0.70 per diluted share. Accounts receivable balances including an unbilled AR, totaled $18.3 million at the end of the current quarter. Our DSO metric related to billed AR was 63 days, compared to 53 days at the end of the third quarter of 2009.

A final closing comment. In September of 2010, our Board of Directors approved an extension of our stock repurchase program. The company can repurchase their shares subject to the program’s $8.5 million repurchase authorization through September of 2011. We did not make any repurchase of our common stock under our repurchase program during the third quarter.

As of September 30th, we have a remaining stock repurchase authorization of $2.8 million. With that, I’ll now pass the call back to Shirley for final comments.

Shirley Singleton

Thanks Tim. So I think the bottom-line is it looks like the recovery is sticking for us. If you peel back all of Tim’s comments, you’ve either heard stabilization in our key metrics or actually in some cases improvement in our key metrics. I think it’s fair to say we’ve shifted from a cost-cutting mode and fighting to keep ourselves afloat in 2009 to actually a growth mode again.

We’re still trying to drive to break-even cash flow, like Tim just mentioned, and we we’re knocking on the door of our preferred utilization range. And that is really the key to the profitability. With two quarters back-to-back 75% utilization, I just bring up a couple more points, I think there will be a major difference in the profitability and then it’s a little muddied with these deferred things that happened in the quarter like Tim mentioned.

When I look at guidance for Q4 and this isn’t new to some of the investors who have been with us for a while, is that some of our larger customers do shutdown for the holiday season and we don’t have any control over that. And I want to point out there’s one less bill day in Q4. So I think it’s prudent and we’ve been pretty good on hitting our guidance. I’d say that we’re going to be slightly down if I’m going to call it for today.

But I also want to point out that as at the end of third quarter, our service revenues have exceeded the full service revenue number for 2009 and we’re trending to meet or exceed the high-watermark of service revenue achieved in 2008, which will be a historic high for our company. So, I think we’re going in the right direction.

Certainly, a lot better environment for selling. We have a really good pipeline. I would say that, the lion’s share of the pipeline is in the prospect part is growing. We break our pipeline down into prospect and then actual proposals in people’s hands and then 75% probability and kind of break our work-up that way. Where seeing the building up of the pipeline is in the early stages. We have some nice pipeline with proposals, but I’m seeing a nice growth in the prospects category.

And with that, Nemy [ph], I would like to turn it over for some questions.

Question-and-Answer Session

Operator

(Operator Instructions) Our first question comes from Arnie Ursaner of CJS Securities. Your line is open.

Arnie Ursaner – CJS Securities

Good morning Shirl, good morning Tim.

Shirley Singleton

Hi Arnie.

Timothy Oakes

Hi Arnie.

Arnie Ursaner – CJS Securities

Just a clarification, you mentioned in your prepared remarks or comments that you thought Q4 might be down slightly, and I just want to clarify that you have about $800,000 of revenues that were deferred. I’m assuming that you already recognize them now in Q4. When you say that Q4 would be down slightly, are you including or excluding the $800,000 of deferred revenue that now is part of Q4, or hopefully as part of Q4?

Timothy Oakes

Arnie remember when we talk about go forward guidance for Q4, we’re really focused upon service revenue and it’s really targeted to that $18.1 million number. So, the $659,000 related to the stock where it really wouldn’t impact that go forward guidance.

Arnie Ursaner – CJS Securities

Right. But the service revenue part with?

Timothy Oakes

Right and the service revenue not to bring it into a technical accounting rule this really related to be upon payment contingencies. So as we get paid, that part gets recognized but there is the potential to gen additional payment contingency related items in the quarter. So I think from that part with the one less bill date, the guidance has weighted on the $18.1 million is slightly down.

Arnie Ursaner – CJS Securities

Okay, and just to clarify within your 298 consultant count at the end of – I’m sorry 294 at the end of Q3 down from 298 at the end of Q2, how many of the 294 are the short-term consultants?

Timothy Oakes

32.

Arnie Ursaner – CJS Securities

And what was that in Q – you said it was down 14 sequentially?

Timothy Oakes

Yes it was 46 at the end of the second quarter.

Arnie Ursaner – CJS Securities

Got it. And you gave a number and that – maybe I can calculate this, but you gave the number of 810,000 that was non-routine operating expenses within – or about Meridian for the year. And can you just break it down for Q3? Is that the $40,000 across on the $99,000 of legal expense? Are those the two that occurred in Q3 if I’m correct?

Timothy Oakes

That is correct Arnie. I mean, those are the non-routine expenses related to the Meridian acquisition and the Fullscope Embezzlement Issue.

Arnie Ursaner – CJS Securities

Okay. Shirley, you know what – we’ll I’ll jump back in queue in case there are some others. I do have some follow-ups for Shirley but I’ll jump back in queue. Thanks.

Shirley Singleton

Okay.

Operator

(Operator Instructions) I’m showing we have a question from Bob Poole of Bricoleur Capital. Your line is open.

Bob Poole - Bricoleur Capital

Hi guys.

Shirley Singleton

Hi Bob.

Bob Poole - Bricoleur Capital

How are you doing?

Shirley Singleton

Good.

Bob Poole - Bricoleur Capital

Good. Year-over-year organic revenue increased by about $2 million if I’m doing the math correctly, is that about right?

Timothy Oakes

That’s about right.

Bob Poole - Bricoleur Capital

And my understanding from about a year ago, when utilization was very low, was that, if we could grow organic revenue and get that utilization rate back up that we would have very high flow through of organic revenues to profits, off of the low base like that. And EBITDA increased year-over-year by about $300,000 purely from that organic. We only got a $300,000 EBITDA increase off of $2 million of incremental organic revenue. How do we explain that?

Timothy Oakes

Bob, I really look at it in terms of looking at the EBITDA change. I mean, there are certain things that go along with going into growth mode from sort of the cost-cutting mode of 2009. And there are incremental costs associated with that increased performance, sales related, commissions related, looking at some of the SG&A changes funding of bonus payments in the comparative periods et cetera. So it’s not essentially a revenue goes up we realize the gross margin contribution and it falls 100% here into the bottom.

Bob Poole - Bricoleur Capital

Right, well part of the thought was that and I think Arnie has done a good job of explaining why it ought to be the case, that incremental organic revenue should drop significantly more than your gross margin contribution. Because we are already paying for people who are just getting more revenue out of them and it doesn’t seem like that that is happening. And I think we also need to question whether going from growth mode from, expense control mode to growth mode makes sense when we are still sitting near at a 1.8% EBITDA margin. Can you comment on that?

Shirley Singleton

Yes, EdgeTech itself, which was the lion share of the downdraft last year in ’09, did not received much bonus at all. This business is bouncing back and it is growing and as such, we have to give some level of bonus to that staff for retention purposes et cetera. That’s the billable staff, that’s performance-based. So that’s part of the uptick. And when we say cost-cutting versus growth, it means that we are not looking to downsize staff.

We’re looking at the pipeline as I mentioned earlier and its relationship to our staff that can fulfill those jobs, should they come in. And so, we’re not looking at layoffs or things like that. We’re seeing gradual lift. We’re seeing improvement. We are seeing the pipeline improve. And we do need to drive those utilization rates back to their historic place. We’ve made a stab at it. We are not there yet, but we’re certainly trending in the right direction.

Bob Poole - Bricoleur Capital

Okay. So that’s the organic revenue piece. It doesn’t, I guess I still don’t see they were getting, the shareholders, maybe the company and maybe management perceives improvement, but it’s not flowing to shareholders necessarily. We spent about $13 million on acquisition since last year, the quarter. And again, let’s say we don’t get any benefit from organic revenue growth. It doesn’t appear that we are getting much as anything from the $13 million of acquisitions from a profitability standpoint. How do we, what was your commentary on that?

Shirley Singleton

Well, my comment is, is Meridian came in May. So the measurement period of May to October is not a long duration to reach that conclusion. And as it relates to Fullscope, part of the drive for cross-selling is exactly the example I gave earlier in my comments with the PE firm for example. There are several items in our pipeline. We are combining the talents of the original tech group with the Fullscope AX folks to kind of bring together what we are calling a instant company or a company in a box to be able to bring people up into a new environment with brand new financials, et cetera. So that cross-selling takes a while to reach fruition. So I wouldn’t reach that conclusion that there has been no advantages from the acquisition.

Bob Poole - Bricoleur Capital

Okay. Well, I hear you on that. But presumably, Fullscope had some level of profitability when you acquired it. Some EBITDA level or profitability when you acquired it and it doesn’t, it’s not showing in the number.

From a profitability standpoint, the improvements that you’re talking about year-over-year just aren’t showing in the profitability numbers and I think, it goes back to the point I’ve been making for sometime is that, there is something wrong strategically with trying to run this company in such a small size and again the shareholders get no benefit from the $32 million of annualized consultant profits you’re generating.

And that has to mean, either that overhead is too high or you’re just too small and to be public and independent. And I hope that the Board is focused on the fact that, you’ve made these investments you’ve made – you fought the good fight. You’ve raised revenues organically. But it doesn’t translate into anything for shareholders. And that’s not right, I hope you’ll agree.

And you’ve got to figure out how to change that. I have no – I own almost 10% in order to funds I manage own or once 10% of the company, I’ve no reason to be caste a negative light on the company and its performance. But, it seems, the point I’m making is almost inarguable and I was asked a year or so ago to give you six months or a year to show return in profitability. And I’ve been relatively silence since then. And it’s just not – we’re not seeing it.

And again, I just ask that the Board, if they’re listening, ask the questions about what has to be done to get the shareholders a reward for – there is value here. There is tremendous value here, but it’s not – the shareholders aren’t seeing it.

Shirley Singleton

I appreciate your point of view. I think that the metrics as mentioned is that it has been improving and stabilizing and I see – continuing to push that way, but I will certainly pass on your comments to the Board.

Operator

Thank you. We have a follow-up question from Arnie Ursaner of CJS Securities. Your line is open.

Arnie Ursaner - CJS Securities

Shirley, in your prepared remarks you mentioned that the tech segment showing very nice improvement and very – probably the strongest growth we’ve seen in three or four years. Can you give us a revenue breakdown between tech and your EPM type business in the quarter? And did we in fact see some growth in that part as well?

Shirley Singleton

Tim and just the number…

Dave Clancey

Yes, Arnie it is. I mean, if you look at the sequential growth in the third quarter, in total which is 4%, that number is essentially driven by growth in the organic core service offerings that includes sequential growth in both the tech side as well as the EPM side.

Arnie Ursaner - CJS Securities

Okay. We had 20% organic growth year-over-year and you mentioned related to the classic tech-related services. So I’m trying to, I guess, equate the 20% organic with the 6% comment you just gave us.

Timothy Oakes

Well, I was looking

Arnie Ursaner - CJS Securities

Comment you just gave us. Sequential, I’m sorry.

Timothy Oakes

I mean, I’m looking at sequential Arnie and organically if you look at it, I mean tech is up on an organic basis year-over-year by over 40%.

Arnie Ursaner - CJS Securities

Okay. And what is BPM up on the same basis?

Dave Clancey

On the same basis EPM, you got to bear with me for one minute on that one,

Arnie Ursaner - CJS Securities

EPM, sorry.

Dave Clancey

It’s fine. EPM on the year-over-year basis here is up over 10%, I mean its double-digit growth on a year-over-year basis.

Arnie Ursaner - CJS Securities

Okay, so going back to Bob’s points, you are clearly seeing some restoration of the multi-year historic double-digit growth you used to show as a company. And obviously the economy is poised for some continued improvement, which kind of leads me to my next question, which is a follow-up to Bob’s in some sense.

You’ve talked a lot about cross-selling synergies. We are seeing an improvement in the economy. I know you are not going to provide a formal guidance for next year. But, to take Bob’s comment, could you comment generally about the types of revenue growth you’re looking at next year, directionally what would cause it to be mid-single, high-single, whatever number you’d throw out?

And then focusing on the SG&A line, 35.4% of revenues for SG&A is a pretty high number for most public companies. Can you break down the piece that’s corporate if you will versus lying people that are entitled to improve bonuses, but how much of that $7.6 million we have this quarter or 35% of revenue, is at the corporate level? And maybe in response to Bob, if that could be a number that that probably needs some tightening? A lot of questions, I’m sorry.

Shirley Singleton

That’s okay. From a directional point of view for your question for next year, we are just working on our business plans now. But I think we’re looking at double-digit organic growth for next year.

Arnie Ursaner - CJS Securities

Okay. And do you intend to change headcount any material way to accomplish that goal?

Shirley Singleton

In some cases, strategically you need to, if it’s a particular skill set that’s like AX, where you have to have certain quals and you can’t, if you will recycle some people through, but we are going to be prudent on hiring. We just had a meeting on that yesterday actually.

Arnie Ursaner - CJS Securities

Would you have a number out there for utilization to the extent you replace contractors with permanent people that lowers your utilization? I am trying to think how we should…

Shirley Singleton

No way that actually – if you would just swap a contractor with a full-time employee, the utilization would be similar to, Tim is including that, what changes, however, is the profitability?

Timothy Oakes

Right, Arnie, twofold answer to that question. You had actually asked a similar question last quarter when you had said, hey guys, if you swap a partially used contractor with the full-time billable, essentially you’ve got all these unused hour on the full-time employee. Had we not reported consistent utilization at 75% from Q2-to-Q3, that would have supported your argument or your position on hey it would degrade the utilization.

But if you look at, we drop contractor head count by 14 in the quarter we added 10 billable consults, full-time billable consultants and maintained consistent utilization. So what that implies is, is that the head count we added, not only absorbed the partial fraction of what the consultants or contractors were working on, but also similarly were billable above and beyond that with their non-consumed piece by the contractor.

I also want to point out if I could another thing, if you look at the sequential change in service revenue; we grew service revenue by $688,000 in the quarter. If you do the math and look at the generated contribution on that service revenue, as it relates to the services gross margin, the total dollar basis of this services gross margin increased by $215,000. That would imply a 31% gross margin on that additionally generated service revenue.

However, if you added in the $220,000 of generated revenue, but deferred because of the contractual obligations, that would have increased that service revenue number from $688,000 to over $900,000, it would have increased the $215,000 over $400,000. And it would have returned the gross margin of over – of somewhere in the ballpark of 45% or so on that incremental revenue increase.

So that does go to support that, when we switch the contractors with full-time billable, we did sort of get the sequential lift in profitability as it relates to our service revenue that we had anticipated.

Arnie Ursaner - CJS Securities

And again, I am assuming a lot of the contractor expense if you will, the consultant expenses you’ve covered in your COGS. So going back again to Bob’s point, if you were to have double-digit revenue growth, how should we think about your SG&A as a percent of sales? And frankly are you keeping your corporate cost under the tight controls that public shareholders expected to do?

Timothy Oakes

We, I mean, we are keeping our corporate COGS. I don’t have the analysis in front of me to give you sort of breakdown what the corporate piece is versus that. Certainly something you can follow-up with me and we can go over. But from a year-over-year basis, if you look at management cost and what not, we probably reduced management cost given the number of heads we’ve stripped out comparatively. So, it’s not really driven by a function of increased or exorbitant corporate SG&A expenses.

Arnie Ursaner - CJS Securities

Right, but again, if we were to think about next year which we have to do as a sell-side firm, creating a model. I mean, to the extent you had double-digit organic revenue growth and you don’t let corporate expenses run up, there should be quite meaningful operating income leverage. I just want to make sure we’re doing this math right. So, again, let’s focus on the consultant side. I’m assuming that your incremental margin might be similar to what you just modeled out, something in the 40% to 50% range incrementally unless you add excessive headcount?

Timothy Oakes

That’s a fair statement. All things being equal right and if you look at it based upon the third quarter numbers, a 1% change in utilization, everything else remaining constant would represent on a quarterly basis about $250,000 of additional service revenue.

Arnie Ursaner - CJS Securities

I guess I’m still frown a little bit. I run a small business. CJS is a small business and our incremental margins are probably 90%. Why are yours only 45% or 50%?

Timothy Oakes

Well, I think if you look at, I mean it’s too run now you’re looking at the sequential change. In the sequential change, as we look at it, we had a layered addition of headcount in the second quarter. The changes in the third quarter sequentially would include the 10 full-time, less the contractors that we get us in, plus the full quarter impact of the headcount we added in the second quarter. So, it muddies that comparative example. It’s not simply an assessment based upon what changed in the current quarter.

Arnie Ursaner - CJS Securities

I would like to try to follow up with a little more of a better understanding of how much of your corporate expenses are fixed? And why we’re not seeing more leverage in the operating margin line? And just remind me Shirley if you could, when does the Board set the executive comp structure for 2011?

Shirley Singleton

That would be February, March, somewhere in there.

Arnie Ursaner - CJS Securities

Okay, so you are already well into next year before that’s set. And remind us what is the current key driver of executive bonus comp?

Shirley Singleton

Revenue and profitability, EBITDA.

Arnie Ursaner - CJS Securities

Okay, that’s it for me, thanks.

Operator

Thank you. If there are no further questions, I will return the conference call back to Ms. Shirley Singleton for closing comments.

Shirley Singleton

Okay, so our Q4 year-end earnings call will be March 02, 2011. And we encourage you to call in and you want to dive in with more details, give Tim a call and we all will be here today. Thank you.

Operator

Ladies and gentlemen, if you wish to access the replay for this call, you may do so by dialing 800-642-1687. This concludes our conference for today. Thank you all for participating and have a nice day. All parties may now disconnect.

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