Shirley Singleton – Chairman, President, Chief Executive Officer
Timothy Oakes – Chief Financial Officer
David Clancey – Executive Vice President, Chief Strategy and Technology Officer
Paul McNeice – Director of Finance
Arnie Ursaner – CJS Securities
Edgewater Technology Inc. (EDGW) Q4 2010 Earnings Call March 2, 2011 10:00 AM ET
Good morning and welcome ladies and gentlemen to the Edgewater Technology’s Fourth Quarter 2010 preliminary financial results conference call. At this time, I would like to inform you that this conference is being recorded for rebroadcast and that all participants are in a listen-only mode. At the request of the Company, we will open up the conference for questions and answers following the presentation.
I will now turn the conference over to Mr. Paul McNeice of Investor Relations for introductions.
Thank you. Good morning everyone and welcome to Edgewater Technology’s preliminary fourth quarter, full-year 2001 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 Act. 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 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 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.
Thanks, Paul. Good morning everyone. Before we start with our comments, I wanted to—Tim, I was wondering if you could clarify for everyone on the phone why our results are preliminary.
Sure, Shirley. You know, from an issuance point of view, we typically issue final results as part of our quarterly or year-end earnings calls. This time, obviously, we have designated these financial statements or the operational performance as preliminary. Edgewater has historically been a services-based company, and over the past year we have introduced new elements to our revenue streams, most notably as it relates to software product revenue and other elements that touch product software revenue, whether it be PCS, et cetera. As we go through our year and we look at our software revenue, we don’t have a long-term historical track record in terms of having similar transaction types, such as our services which do go in time and we are able to document and demonstrate and build models sort of supporting the fair value of the services that we offer.
If we evaluate our software on a standalone basis, because we don’t have that track record, it takes us some time to put together a model upon which we can value and support the revenue we recognize on these transactions. So as it relates to our earnings call today, we have not quite fully completed our documentation behind our valuation model related to the fair value of the individual elements, so we have taken the position of issuing preliminary financial results which will be followed with financial results once we can complete that documentation process.
As it relates to the results today, we believe the results are supportive of the positions we have taken, but for us we want to make sure that documentation process, given the lack of a long-term history in this area, is fully completed before we come out and say that they’re final results.
As it relates to the completion of this process, we would anticipate that we should be able to complete this process on or before the filing of our 10-K, which is due on March 31. We do not anticipate that this process will cause a delay in the filing of our K, and that it will be filed on time.
Okay, thanks. Well, you can tell by the results we finished the year strong. We’re so pleased with our performance. We have better than 20% year-over-year organic growth in our core offerings that we put up in the fourth quarter.
During Q4, we secured business from 30 new customers, and some of the customer names I think you’re going to recognize. One is Chobani Yogurt, a fast-growing Greek yogurt that’s out in the market. Google is a new customer. The Music Publishers of Canada, the Volkswagen Group, Green Mountain Coffee, GlaxoSmithKline – this is just to name a few. We’re very pleased with our progress, so let’s have Tim get into all the great details.
All right. Thank you, Shirley. Again, just going back to that first foray into the preliminary results, anything we talk about with respect to our prepared remarks as it relates to financial performance are obviously based upon the currently presented preliminary results.
Similar to our prior quarter calls, comments with respect to our preliminary fourth quarter performance will continue to be more focused upon the sequential quarterly change in performance as opposed to the year-over-year changes. Year-over-year changes in our financial performance are significantly influenced from a year-over-year comparison perspective by the December 2009 Fullscope acquisition.
We’ve gradually been able to capitalize upon the strategic initiatives that we planned in 2009 and executed in 2010. This is evident in our gradual improvement in operating metrics and growth in organic service revenue associated with our core service offerings. We are pleased to report that our preliminary fourth quarter results reflect continued improvement in our operations. While we still have a way to go in our drive to return the Company to its historical operating metrics, our preliminary fourth quarter operating metrics, such as gross margin, gross margin related to service revenues, adjusted EBITDA, are more reflective of metrics that we last reported during the 2008 fiscal year.
Total revenue for the fourth quarter was 23.5 million compared to 11.4 million in the year-ago quarter. Service revenue was 17.7 million during the fourth quarter compared to service revenue of 10.7 million in the fourth quarter of 2009. Year-over-year quarterly growth and total revenue in service revenue is reflective of incremental revenue generated by Fullscope and 22% organic growth in our core service offerings. Organic revenue in the fourth quarter was evenly distributed between our classic technology and EPM-related service offerings.
We would like to highlight that we entered into new engagements with 30 new customers during the fourth quarter, bringing our year-to-date total of new customer engagements to 102. Comparatively, we entered into a total of 64 new customer engagements in 2009.
On a sequential basis, we note that total revenue increased by 2.2 million or 10% compared to total revenue of 21.4 million in the third quarter of 2010. The sequential increase in total revenue is directly attributable to our generation of 3.6 million in software revenue associated with our Fullscope operations. Our fourth quarter software revenue includes a recognition of 659,000 in software that was deferred at the end of the third quarter.
During the fourth quarter software revenue, which includes related maintenance revenue, represented 15.4% of our total revenue compared to 5.6% during the third quarter of 2010. As we have stated in previous earnings calls, we anticipate that software revenue will be a material part of our future total revenue and that our future operating results can be materially influenced by our ability to recognize software revenue.
Also, we would like to reemphasize that quarterly software revenue can be volatile. It’s subject to our customers’ demand for such off-the-shelf third party software and can be impacted by software-based revenue recognitions.
Service revenue has decreased on a sequential basis by 395,000 or 2.2% to 17.7 million compared to service revenue of 18.1 million in the third quarter of 2010. Current quarter service revenue was influenced by the combined effect of having one less bill day in the quarter and a $400,000 pullback in service revenue related to project delivery issues experienced on certain Fullscope projects.
Fullscope experienced strong double-digit growth during 2010. This has led to a higher than normal reliance upon contractor resources to support Fullscope’s growth in service revenue. During the fourth quarter, we experienced project delivery issues directly attributable to this growth which led to the current quarter pullbacks in service revenue. We have been diligently working to integrate Edgewater’s best practices in delivery management into Fullscope’s engagements.
Quickly touching upon some other fourth quarter revenue metrics before moving on to gross profit – annualized service revenue per billable consultant metric was 314,000 in the fourth quarter, which is below our third quarter metric of 324,000. As previously highlighted, we entered into engagements with 30 new customers during the fourth quarter compared to 12 new customer engagements in the year-ago quarter. For the year, we have secured engagements with 102 new customers compared to 64 in 2009. Of note, 84 of these new customer engagements related to our core service offerings and support the sustained bid and proposal activity we have discussed on our quarterly calls throughout 2010.
On a full-year basis, service revenue generated by our top customers represented 24.9% of total service revenue compared to 31.4% in 2009. No individual customer accounted for more than 5% of total service revenue, which reduces potential forward-looking risk associated with our reliance upon a few key customers.
Moving on to gross profit, total gross profit as a percentage of total revenue was 38% during the current quarter compared to 36.2% during the fourth quarter of 2009 and 36.6% in the third quarter of 2010. Gross profit margin related to service revenue was 39.5% in the current quarter compared to 38.9% in the year-ago quarter and 36.6% in the third quarter of 2010. Current quarter improvement in our fourth quarter total gross profit margin is directly related to the current quarter increase in software revenue. The sequential stability in our gross profit margin related to service revenue is due to our ability to drive fourth quarter billable consultant utilization to 75.7% in what has historically been a tough quarter due to the seasonal influences of the holidays within the fourth quarter, and a reduction in fringe-related expenses primarily associated with vacation usage during the quarter.
During the fourth quarter, it’s also necessary to highlight we’ve continued to lessen our reliance upon contractors. We reduced contractor headcount by 10 during the fourth quarter, which we offset with the addition of only six full-time billable consultants. We will continue to focus upon our contractor reliance as we enter 2011.
Moving on to billable consultant utilization, as previously mentioned billable consultant utilization was 75.7% during the fourth quarter compared to 66.5% in the year-ago quarter and 75% during the third quarter of 2010. On a full-year basis, 2010 utilization was up to 75.4% compared to 65.5% in 2009. During the fourth quarter, we decreased our total billable consultant headcount to 290 billable consultants, which includes contractors, from 294 at the end of the third quarter 2010.
Moving on to SG&A expenses, SG&A expenses as a percentage of total revenue was 31% during the current quarter compared to 42.8% in the year-ago quarter and 35.4% during the third quarter of 2010. In absolute dollar terms, fourth quarter SG&A decreased by 281,000 compared to the third quarter of 2010. The sequential decrease in SG&A is primarily related to a reduction in fringe-related expenses directly associated with our SG&A labor, a reduction in legal and professional fees associated with the embezzlement issue, and the receipt of insurance proceeds related to the recovery of some of our previously incurred embezzlement costs. These decreases were partially offset by an increase in sales commissions as a result of the current quarter increases in revenue, an increase in allowance for doubtful accounts, and a periodic non-cash adjustment associated with the fair value of our considerations related to the acquisitions that we have completed in December of 2009 and May of 2010.
While we did not incur any significant expense during the fourth quarter associated with the embezzlement issue, we caution that we will continue to incur costs related to this issue in the future; however, we do not have an estimate for anticipated future costs at this time.
Quickly touching upon depreciation and amortization, depreciation and amortization expense increased on a year-over-year basis by 396,000 but remained consistent on a sequential quarterly basis. The increase in depreciation and amortization expense is primarily attributable to the increase in amortization associated with both the Fullscope and Meridian acquisitions. On a go-forward basis, we anticipate that 2011 amortization expense related to these acquisitions will be decreased to 1.9 million compared to 3.1 million recognized in the current year.
We are reporting preliminary net income during the current quarter of 676,000 or $0.06 per diluted share compared to a net loss of 1.9 million or $0.15 per diluted share in the year-ago quarter. Looking at our non-GAAP measures, adjusted EBITDA was 1.5 million or 6.3% of total revenue and $0.12 per diluted share in the fourth quarter compared to an adjusted EBITDA loss of 165,000 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 costs or recovered amounts associated with the Meridian acquisition and the Fullscope embezzlement issue.
Moving on to some final operating metrics, total Company headcount was 380 at the end of the fourth quarter, of which 290 were billable consultants including 22 contractors. We generated approximately 1.6 million in cash flow from operating activities during the fourth quarter. As we commented upon during our third quarter earnings call, we indicated that we were driving to be cash flow positive on a full-year basis and we’re pleased to report that we generated approximately 700,000 in cash flow from operating activities on a full-year basis.
From a balance sheet perspective, our cash and cash equivalents totaled 10.9 million as of December 31 compared to 12.7 million at the end of 2009. Our cash and cash equivalents represented approximately $0.88 per diluted share as of December 31.
As previously reported, during the second quarter of 2010 the Company had identified fraudulent activities within the acquired Fullscope division. We are pleased to report that we are in the final stages of our investigation into this matter. Our consolidated financial statements as of December 31 include an estimated liability accrual of 950,000 related to the underpayment of sales and use tax liabilities in the Fullscope division during the 2003 through 2009 years, and similarly we had established a corresponding receivable in the exact same amount. We expect to recover the amounts related to this liability through a fully funded escrow account as provided for under the indemnification provisions of the Agreement and Plan of Merger and Reorganization we entered into in connection with the Fullscope acquisition.
Finally, a reminder that we have 2.8 million remaining on our stock repurchase authorization as of December 31, and we did not make any repurchases of our common stock under the repurchase program during the fourth quarter.
And with that, I will pass the call back to Shirley.
Okay, thanks Tim. Let’s try to give you some color on why we did well in Q4, and more importantly why we think we’re going to do real well in Q1 ’11. The EPM offerings are off to a terrific start. They had incredible sales closings in Q4 which has really pumped their revenue and their pipeline for Q1; so they’re off to a terrific start and I would comment that it’s both Oracle and SAP channels that are firing.
As relates to Q4 product sales that Tim mentioned, they were an upside surprise for us in terms of how much product was sold, but you need to take the product sales in the light of it’s a positive effect for service revenue for Q1 because we now need to execute on helping put services wrapped around those product sales that were sold in Q4.
We also successfully completed an IP asset that Fullscope had had under development, and namely it’s called a chemical accelerator bolt-on to the Microsoft AX product, and we view it as strategic because it’s a component to beat our competition, if you will, if we can come in with some accelerated code that solves a particular issue, then it does serve as somewhat of a barrier to entry for someone else taking the service revenue away from us in the AX channel.
So we’re really pleased with Fullscope. We believe it was a transitional, transformational acquisition of us. We’re seeing a lot of synergy between that acquisition and the tech piece, specifically since Fullscope’s channel is Microsoft and they tend to work the channel well with the reps and the BDMs and the account executives and everyone within Microsoft. Our new tech CRM offering which is Microsoft products is starting to gain traction. We’re leveraging that existing ERP Microsoft channel that we gained in the acquisition from Fullscope to help accelerate the CRM practice, and I can give you an example. Fullscope had a large biotech firm here in the Boston area where they put in an AX system. They told that customer, who was happy with their work, about Edge’s tech side offering in CRM. We got introduced and we’ve just won that as a CRM customer. It doesn’t appear in our new customer count, but it’s a new customer for tech. So I believe that there’s synergies going on there with the accelerations.
You know, if I would have put one critique in what I’d like to tweak up, it would be a couple of the larger scale projects that we had in tech that exited in beginning of—was it ’09?
Yeah. I’ve got some good and bad news, I guess. The good news is there are opportunities now to bid on some large projects. We went for a large one. There were 14 companies bidding. We got it down to two. We were against the incumbent. It was a $5 million deal that was going to last two years. We lost in the end, so that would be the bad news or else I’d be sitting here going woohoo, off the charts for tech! But the good news is that there are opportunities there, and we intend to exploit them in the tech side.
We’re driving into our utilization zone. We’re there and we’re hiring, and it’s specifically within EPM and ERP. Those two pieces are hot. We believe that we hold one of the highest metrics of revenue per billable consultant as compared to our peer group, and if I were to sum it up in terms of why are people buying from us, it’s if you think about our offerings – EPM, ERP and tech – it forms a wonderful basket of services for the office of the CFO and other C-level execs, and that’s ultimately who is buying our services.
With that, I’m going to tell you that we’re going to see strong organic growth in Q1. I do want to give investors a heads-up for the second half of the year as it relates to one piece of Fullscope process unit that will wind down after June, so could you talk about that, Tim?
Right, right. And it’s not so much a process unit, really. It’s really the winding down of Fullscope’s business process contracts as it relates to their Microsoft sale in June of 2009. As we’ve stated in our acquisition-related documents, there is an earn-out associated with the Fullscope acquisition. It is singularly focused upon performance under these Microsoft contracts. Those contracts are currently scheduled to expire in June of 2011, at which point in time most notably we would no longer receive process royalties as it relates to our revenue stream.
So what does that mean for investors for the second half for their model?
For the second half of the year, we look at process royalties in 2010 of approximately 2.4 million. We get them through June. It would be a 1.2 million detriment to the revenue in the second half related to that.
Okay, okay. We just wanted to make sure we were pointing that out in advance for everybody.
And if I could, as I stumbled through my prepared remarks – and I apologize for that – I just want to clarify that I did misstate as it related to comparisons on service related gross profit margins. The correct statement was that the service revenue gross margin was 39.5% in the fourth quarter compared to 38.4% in the year-ago quarter and 38.9% for the third quarter of 2010.
So we’re up?
Yeah, I misstated and I needed to clarify.
That’s okay. Okay. All right, Karen?
I think we’re ready to take some questions.
Question and Answer Session
Certainly. Ladies and gentlemen, the question and answer session will begin now. If you are using a speakerphone, please pick up the handset before pressing any numbers. Should you have a question, please press star followed by the number one key on your pushbutton telephone. If you wish to withdraw your question, press the pound key. Your questions will be taken in the order they are received. Please stand by for the first question.
And our first question comes from the line of Arnie Ursaner of CJS Securities.
Arnie Ursaner – CJS Securities
Good morning. My first question is a question for Tim to follow up on his last comment. Tim, in our model for process royalties, we’ve built about a million of process royalty revenue ending in June and basically attribute almost 100% margin to that. I know it’s a simplistic approach, but is that not a bad way to think about that?
On an absolute extreme modeling approach, you could look at it that way. There is some cost. It’s not 100% that falls down to the bottom. There are some costs that we have to support that revenue stream. If you look at the process contracts in total, we looked at—yeah, there is certainly the royalty revenue that goes away, but we will migrate and transition the resources that are currently working on those contracts into Fullscope’s current service offering project, or current billable projects, which will have the added effect of reducing our leverage and reliance upon contractors.
Arnie Ursaner – CJS Securities
Okay. Fullscope is now anniversaried for the entire year, and you mentioned that it had strong—you know, you emphasized strong double-digit growth. Can you give us a better feel for the organic growth in the core business for Q4 and for 2010 independent of Fullscope, please?
Yeah, looking at it on a full year basis the core service offerings—I mean, primarily which relate to tech, which relate to our EPM, we were up organically 7% for the year during 2010. Looking at the fourth quarter on a standalone basis, our core service offerings were up 22%.
Arnie Ursaner – CJS Securities
Okay. And you gave a lot of numbers, and maybe I want to focus on the SG&A as a percent of revenue. But you gave some positive and negative items, and I’m trying to get a better feel for how they would have affected your number. You mentioned sequentially you had lower legal expense, you had reduced fringes, and you got a positive insurance settlement. When I net out all of those items, maybe the way to think of it is what is a base number or core number for SG&A, and perhaps on a go-forward basis looking ahead, and I know it’s volume dependent and revenue dependent, how should we think about SG&A in 2011 as a percent of sales? What sort of goal do you have?
First of all on SG&A, baseline is a difficult answer to give primarily because of the seasonal influences. Q1 is always a heavier SG&A expense load because of the fixed price aspect of people, right? FICA limits reset, et cetera, so it will ride higher. The expectation would be that it would be higher in the beginning in the year, lower in the end of the year. As we look at it today and in the fourth quarter, I would expect SG&A to be pretty much similar to where it is in the fourth quarter with an upward bias. So I guess you’d look at a range of between 7.3 and 7.6, but that’s an estimate. That’s not a solid number.
As a percentage of total revenue, we’ve talked about the percentage of SG&A expenses being higher than what our normal ranges are. Our normal ranges have been on or around 30 to 32%. If you look at the fourth quarter compared to the third quarter, it’s a good demonstration of scale. With the revenues at 24 million, SG&A comes down to 31% of total revenue. We are going to drive our business into 2011 to maintain SG&A expenses as a percentage of total revenue in that range. I mean, our targeted goal would be to drive SG&A expense downwards to very close to 30%, if not lower, if we can get it there.
Arnie Ursaner – CJS Securities
Thank you very much.
Thank you. And again, if you do have a question you may press star and then one at this time. And one moment for any further questions.
And again, if you do have a question, please press star and then one.
Okay, there being no other questions, Karen, I think we’d like to wrap up with reminding everybody that our Q1 earnings call will be May 4, and we look forward to telling you about Q1 results.
Thank you. Ladies and gentlemen, if you wish to access the replay for this call, you may do so by dialing 800-642-1687 or 706-645-9291 and enter the code 42519083. Those number again are 800-642-1687 or 706-645-9291, code 42519083. 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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