Edgewater Technology, Inc. (NASDAQ:EDGW) Q2 2016 Results Earnings Conference Call August 3, 2016 10:00 AM ET
Paul McNeice - Vice President of Finance
Shirley Singleton - Chief Executive Officer and Chairman of the Board
Tim Oakes - Chief Financial Officer
Dan Moore - CJS Securities
Good day, ladies and gentlemen, and welcome to the Q2 2016 Edgewater Technology, Inc. financial results conference call. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session and instructions will be given at that time. [Operator Instructions] As a reminder, this conference is being recorded.
I would now like to introduce your first speaker for today, Vice President of Finance, Mr. Paul McNeice. Please go ahead, sir.
Thank you, Andrew. Good morning, everyone, and welcome to Edgewater Technology’s second quarter 2016 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 Tim Oakes Edgewater’s Chief Financial Officer.
Before we begin, I'd 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 risk and uncertainties that could cause actual results to differ from current expectations with respect to such statement. These types of statements and the underlying factors related to these statements are listed in reported and filed information with the Securities and Exchange Commission as well as 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’ll now turn the call over to Shirley.
Thank you, Paul. Good morning, everyone. As you can see in our press release that we issued earlier today, we posted another strong quarter. We reached a historic high in service revenue as well as improvement in all of our key operating metrics. We’ve been really focused on making our company move in lockstep with the opportunities that come with embracing the cloud services. We’re really pleased to report that our Q2 cloud services revenue has significantly grown over Q2 2015.
And so, what are our cloud services? They’re really not related to just a package solution within the Oracle and Microsoft channel. We’re seeing cloud opportunity across all of our offering, everything from cloud and technical roadmap, infrastructure advise, infrastructure upgrade, on through deploying package as well as hybrid applications to the cloud. So we’re firing on all cylinders on that topic. And I really think that's important based on customer demand.
The Zero2Ten acquisition that we did early in 2015 helped us celebrate the transition at least in the Microsoft space to the cloud. This acquisition was really inspirational for us because it caused us to pause and really think about how classic marketing, sales and delivery needs to change to successfully compete in a cloud world. And we’ve taken a lot of the lessons from Zero2Ten. Paul Colella, who leads that practice, has really taught us a lot and we’re injecting some of that knowledge into the Oracle piece and into the classic piece and how to think and approach cloud opportunities.
In the Oracle channel, we have an excellent track record of deploying planning and budgeting in the cloud. We have something like 23 installs and growing, nice pipeline in front of us, as well as Oracle is coming out with a number of new modules and Robin Ranzal who runs that practice has done a great job in terms of getting our staff prepared, trained, ready to go as these models are released. And as a matter of fact, significant influence in the Oracle channel vis-à-vis talking to the product team itself that are developing these modules, so that we get an early peak where things are going, thus arming us to do a better job from a quality delivery point of view.
So cloud, what I'm talking about today is very important to our company. So with that, let’s go over to Tim and have him talk a little bit more about the details of the quarter.
Thanks, Shirley. Good morning, everyone. Following our stated quarterly process, we’ll start with our prepared comments on the financial results for the second quarter and we’ll follow with some additional commentary and closing remarks and then open up the call for analyst questions.
Overall, very pleased with the quarter and how our business is progressing. We're leveraging our 2015 acquisitions as well as some organic growth to drive topline revenue expansion and improve our profitability and other operating metrics.
Looking at our second quarter financial results, total revenue for the second quarter of 2016 was $34 million compared to $30.5 million in the second quarter of 2015. This represents a 12% increase in year-over-year total revenue. An increase in our year-over-year service revenue was the sole driver of the lift in our 2016 total revenue in the second quarter of 2016. Service revenue during the second quarter totaled $28.6 million compared to $24.6 million in the year-ago quarter representing a 16% year-over-year increase in our service revenue
Incremental service revenue contributions from our 2015 acquisition, which includes Branchbird and M2 Dynamics, but excludes Zero2Ten as that acquisition was completed during the first quarter of 2015, and what’s fully integrated into our comparative second quarter 2015 financial results was the key driver of our strong year-over-year service revenue growth.
Software revenue was $3.6 million during the second quarter of 2016, down from $4.1 million during the year-ago quarter. Software revenue during the second quarter of 2016 represented a higher amount of Dynamics AX maintenance renewals and CRM software license revenue as compared to the second quarter of 2015.
As we caution each quarter, we’d like to remind investors of the volatile nature of our software revenue, the timing of which and the associated accounting recognition methodology applied is subject to the purchasing habits of our customers.
With respect to our other standard quarterly revenue metrics, we note that our annualized service revenue per billable consultant was $358,000 in the second quarter of 2016 compared to $359,000 in the second quarter of 2015. Periodic changes in this reporting metric are for the most driven by fluctuations in our total service revenue mix as well as the consistency of our standard billing rates during each of the comparable quarterly periods.
We entered into first-time engagements with 40 new customers during the second quarter of 2016 compared to 36 new customer engagements in the second quarter of 2015. Service revenue generated by our top ten customers during the second quarter of 2016 represented 23% of total service revenue compared to 24% in the second quarter of 2015. No customers represented more than 5% of our total service revenue during the second quarters of 2016 or 2015.
Our EPM service offerings accounted for approximately 55% of our total service revenue during the second quarter of 2016 compared to 51% in the year-ago quarter.
At the end of the second quarter of 2016, we maintained 422 total billable resources, which includes 41 contractors. This compares to billable headcount of 404 including 42 contractors at the end of the second quarter of 2015.
The 2015 acquisitions of Branchbird and M2, which occurred during the third and fourth quarters of 2015 respectively, increased billable headcount by 56, six of which were contractors. The remaining year-over-year decrease in billable consultant headcount is attributable to normal attrition without replacement in select staff trimming.
Total gross margin in the second quarter of 2016 was 38% compared to 34% in the year-ago quarter, while gross margin related to service revenue in the second quarter of 2016 was 40% compared to 34% in the second quarter of 2015. The comparative improvements in both total gross margin and service gross margin during the second quarter of 2016 were primarily attributable to the current-year increase in service revenue, along with the associated improvement in comparable quarterly billable consultant utilization rates.
Our billable consultant utilization rate for the second quarter of 2016 was 76% compared to 70% in the second quarter of 2015.
Moving on to SG&A expense, SG&A expense excluding charges associated with changes in the fair value of contingent consideration and consent solicitation expenses totaled $9.7 million in the second quarter of 2016 compared to $9 million in the year-ago quarter.
The comparative increase in SG&A expense is to a large extent attributable to the incremental SG&A expenses associated with the 2015 acquisitions and, to a lesser extent, an increase in bonus and commission-related expenses in alignment with second quarter and year-to-date 2016 operating performance as compared to second quarter and year-to-date 2015 operating performance.
Outside of these changes, SG&A expenses remain consistent with our recent quarterly run rates. We routinely evaluate the performance of our acquisitions against their established earn-out related financial measures. Our earn-out agreements are structured in a manner which requires the acquired companies to generate meaningful year-over-year growth in both revenue and EBITDA in order to achieve additional contingent consideration.
During the second quarter of 2016, in connection with our periodic reviews, we reported a reduction in operating expenses of $928,000 in connection with a reduction in our estimates to the fair value of the contingent consideration to be earned in connection with our 2015 acquisitions. The majority of this reduction was associated with our acquisition of Branchbird and, to a significantly lesser extent, Zero2Ten.
We concluded that Branchbird would not achieve the minimum financial measures necessary to achieve an earn-out payment during their first 12-month earn-out period, which is scheduled to conclude in August 2016 and similarly that they would not achieve full earn-out consideration during their 12-month earn-out period.
This resulted in a $798,000 reduction in the estimated fair value of Branchbird’s contingent consideration liability, which is reported as part of our current period selling, general and administrative expenses and as a reduction to our periodic operating expenses.
We're reporting $1 million in depreciation and amortization during the second quarter of 2016 compared to $323,000 in the year-ago quarter. The increase in the comparative quarterly periods is attributable to amortization expense recorded against the identified intangible assets associated with the 2015 acquisitions of Zero2Ten, Branchbird and M2 Dynamics.
Other expense net was $568,000 in the second quarter of 2016 compared to $504,000 in the year-ago quarter. The increase in this reported amount is in large part due to expense associated with the periodic recognition of the discount applied against the company's estimate of the contingent consideration to be earned by the companies we acquired during 2015. To a lesser extent, the reported amount is also affected by foreign currency gains and losses.
The company's reporting an income tax provision of $1.1 million, representing an effective income tax rate of 45% during the second quarter of 2016. This compares to an income tax provision of $379,000, representing an effective income tax rate of 43% in the second quarter of 2015. The increase in our effective income tax rate during the second quarter and full year 2016 period is due to an increase in the income tax expense associated with the recording of certain foreign and US-based estimated income tax provision to actual filed return true-up adjustments during the second quarter of 2016.
Net income during the second quarter of 2016 was $1.3 million or $0.09 per diluted share compared to a net income of $494,000 or $0.04 per diluted share during the second quarter of 2015. The change in the periodic net income is due to the previously discussed service revenue growth, the improvement in billable consultant utilization, and the reduction in operating expenses associated with the change in the fair value of the contingent consideration.
With respect to our non-GAAP financial measures, adjusted EBITDA totaled $3.4 million or 10.1% of total revenue during the second quarter of 2016 compared to $1.9 million or 6.2% of total revenue in the year-ago quarter.
Additional information regarding our use of non-GAAP measures, including a reconciliation to the most comparable GAAP measures can be found in the press release we issued earlier this morning, which is also available on the Investor Relations section of our website at www.edgewater.com.
On June 30, 2016, cash and cash equivalents totaled 10.7 million compared to $12 million on December 31, 2015. During the second quarter of 2016, we paid $3.9 million in cash in connection with the first 12-month earn-out period associated with the Zero2Ten acquisition.
Cash flow provided by operations during the second quarter of 2016 was $5.2 million compared to cash flow provided by operations of $945,000 during the second quarter of 2015. As described during our first quarter earnings call, there is a timing element involved in the comparative quarterly cash flow performance amount.
Part of the change in the year-over-year operating cash flows is related to the funding of a seventh payroll on the last day of the first quarter of 2016, which served to decrease our first quarter cash flow performance. This payroll has historically been funded during the second quarter. The absence of this payroll funded during the second quarter of 2016 increases our comparative quarterly cash flow performance by approximately $3 million during the second quarter of 2016.
Accounts receivable balances, including unbilled AR, totaled $29.1 million at the end of the second quarter of 2016 compared to $27.8 million as of December 31, 2015. Our DSO metric related to the billed AR was approximately 60 days as compared to 56 days at the end of the first quarter – at the end of the second quarter of 2015.
A closing comment regarding our stock repurchase program, which expires in September 2016, we did not have any repurchase activity under the program during the second quarter of 2016. And as of June 30, 2016, there remains approximately $8.7 million of purchased authorization under the program.
With that, I’d now like to turn the call back to Shirley for further comments.
Thank you and good job. I want to go back to some final cloud thoughts here. Our software vendors – and when I say that, I'm primarily talking about Oracle and Microsoft – are rapidly deploying new cloud offerings. And simultaneously, what they’re doing internally is they’re reorganizing their own sales and delivery channels.
On the customer side, customers are contemplating if and when they should go to the cloud and some of the considerations they’re weighing is functionality in the cloud, assessing the risk of going there and being one of the first pioneers, in some cases, of the modules that are new and coming to market and actually looking at ROI or the cost side of the equation, whichever way they care to look at it in terms of consideration. So we’ve got a little bit of – these rapid changes can cause turbulence in the sales channel.
I think that Edgewater has a great opportunity to capitalize on these rapid changes. So I look at it as a good thing rather than a bad thing. And here are some of the reasons why. One is, the cloud further opens up the middle-market. That’s really where some of the new offerings are really going to kick in. And Edgewater has always had a core strength in the middle market. Edgewater also enjoys a meaningful presence specifically in our niches in the channels in terms of presence, influences and scale in the Oracle business analytics space, cloud space, as well as in the Microsoft newly-renamed Dynamics 365 space.
We had a press release on Inner Circle in the case of Fullscope the other day. You’ll be seeing a press release come out shortly about our presence in the bid data space and the Oracle business analytics space, et cetera. So we do have presence and we’re in there, as I mentioned, working with product teams as well.
And lastly, Edgewater has demonstrated the ability to effectively handle all three delivery mechanisms – on-premise, cloud and hybrid. So we really don't see the cloud as being a binary switch where all of a sudden everyone’s going to jump from on-prem and move to the cloud. We think it’s going to be a transition where some people may not choose to go to the cloud and that might be a question on functionality that’s provided or comfort in terms of data security in the cloud. There’s a variety of reasons why people may not go and there’s others that would make sense. So because we have the breadth of all three delivery mechanisms, I think that gives us strength there.
So if we go on to Q3 guidance, we do some seasonal effects. I want to – I hate to use the word conservative, but we have a lot of people taking summer vacations this year. So we’re giving guidance between $29 million and $30 million. But we certainly have a wonderful backlog. In fact, while we don’t reveal the backlog number, one of the things you look at is, ‘is your backlog smaller quarter-over-quarter, are you selling more?’ So we stay even. And I can tell you that our backlog continues to grow. So we’re not eating our seed corn, if you will.
And with that, Andrew, I’d like to open it up for analyst questions.
Certainly. [Operator Instructions] And I’m showing our first question or comment comes from the line of Lee Jagoda with CJS Securities. Your line is now open.
Thank you. Good morning. This is Dan Moore filling in for Lee.
Good morning, Dan.
First, I guess, as we look into Q3, how should we think about utilization and should we expect any material headcount additions or use of contractors just as we look at those trends over the next couple of months.
We don't give guidance on utilization. We are constantly looking to see if we can reduce that contractor headcount. As you could hear in Tim’s remarks, it was 41, 42 year-over-year. Contractor usage gives us less on the margin side, but it gives us a little bit more cushion in terms of – Tim?
Yeah, it’s flexibility of headcount.
Flexibility of headcount. We don't see any material adds per se that I can think of, except maybe a little bit on the cloud side in Ranzal.
Okay, that’s helpful. Go ahead, I’m sorry.
In the Oracle space. I said Ranzal. I should say Oracle.
Got it. Yes, that’s helpful. You mentioned, obviously, mid to longer-term opportunity, but some turbulence in the sales channel. Maybe just expand on that. Are you trying to signal anything different about the outlook for the next kind of two, three quarters as it relates to opportunity?
I think what I'm signaling is timing. Timing becomes key when you run a consulting practice. If you look at last year and the first half of 2015, we had secured a bunch of projects, but the timing of the launch of them severely impeded our ability to show growth in the first half even though we had that locked up. So that’s an example of timing. So when I think about cloud, for example, we’ve just closed two large cloud deals in the AX space. Microsoft just released their cloud AX piece and those projects won’t start until the beginning of the fall, September/October time frame. We’re not clear on the start date, but there are signed and done deal. So it’s the timing that causes me to give a little caution in terms of when the cloud comes in, especially if you’re a manufacturing plant and you’re going to rely on AX as your core software to run your plant. I think people will be cautious on that side of the house.
CRM is not a bill wall to climb, if you will, in terms of deployment and it can have more controlled deployment as you move forward. So I don’t see that hanging us up. Classic consulting seems to be doing real well, growing quite heavily, and really not constrained by modules, et cetera, in terms of running their pieces. So it’s more – the turbulence is – actually, my worry would be, when I see software vendors changing their sales commissions and they change their delivery organizations, the turbulence is not here with us. It’s with the people that we interact with. And I'm not sure of the cascading effect. That’s why I was emphasizing that delivery on all three mechanisms actually is a really healthy place for us to be. We’re not going to [indiscernible] on one delivery mechanism. Does that help, Dan?
It does. It does. That’s good color. Appreciate it. And then, I guess, lastly, any comments or update you might have on the strategic review process?
Sure. We announced on November 30 that we were launching a strategic alternative process. And at that time, we noted that there was no set timetable for that process. But I will show assure you that Edgewater is going to provide an update when the Board approved a specific action or otherwise determines that disclosure is appropriate or necessary. You can tell that I’m reading that. That’s not me. That’s not normally how I talk. But that’s really how we have to position than answer.
Understood. Thank you, again.
And at this time, I’m showing no further questions or comments. So that's it. I'd like to turn the conference back over to Chairman, President and CEO, Ms. Shirley Singleton for closing remarks.
Thank you very much, Andrew. Good job. Our next earnings call is going to be November 2, 2016. And Paul and Time will be here this afternoon answering your questions and we thank you for attending our call today. Thank you, Andrew.
My pleasure. Ladies and gentlemen, thank you for participating in today's conference. This does conclude the program and you may now disconnect. Everyone, have a wonderful day.