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EDGW > SEC Filings for EDGW > Form 10-Q on 2-Nov-2012All Recent SEC Filings

Show all filings for EDGEWATER TECHNOLOGY INC/DE/

Form 10-Q for EDGEWATER TECHNOLOGY INC/DE/


2-Nov-2012

Quarterly Report


ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

The following information should be read in conjunction with the information contained in the Unaudited Condensed Consolidated Financial Statements and notes thereto appearing elsewhere in this Quarterly Report on Form 10-Q. This Quarterly Report on Form 10-Q contains forward-looking statements that involve risks and uncertainties. See "Risk Factors" and "Special Note Regarding Forward-Looking Statements" included elsewhere herein. We use the terms "we," "our," "us," "Edgewater" and "the Company" in this report to refer to Edgewater Technology, Inc. and its wholly-owned subsidiaries.

Business Overview

Edgewater is a strategic consulting firm that brings a blend of specialty services in the areas of business advisory, analytics, data management and technology to its customer base. We target "C"-level executives, assisting them with transformational projects. Our customer base tends to be in the upper mid-market and selectively in the Global 2000 market, with a primary focus in North America.

Edgewater offers a full spectrum of services and expertise. Our consulting services are consolidated into three major offerings: (1) Business Advisory Services, (2) Product-Based Consulting and (3) Technology Consulting. The diagram that follows illustrates these offerings:

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Edgewater has the proven expertise to plan, deliver and manage integration services that improve performance and maximize business results. We focus on deploying new systems and unlocking the value of the existing corporate assets. This proven expertise enables us to bring complex technologies and systems together while minimizing risk, leveraging our customers' technology investments and delivering tailored solutions.

The following are Edgewater's service categories with sample services:

Business advisory services

Monetization of knowledge, new revenue streams from corporate data

Customer transformation, moving from business-to-business to business-to-customer or the reverse for new revenue opportunities

Cloud Architecture and On-Ramping strategic services

Business process rejuvenation with industry best practice and cross pollination

Specialized operational, due diligence and technology management expertise to mergers and acquisitions, private equity and venture capital

Strategic advice, costing, estimates to complete, failing or failed programs or project initiatives

Independent package selection and Request for Information or Proposal process design and implementation


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Product-based consulting services

Effect business transformation through the use of packaged software solutions

Enterprise performance management with Oracle budgeting, planning, consolidation and strategic finance

Enterprise resource planning with Microsoft Dynamics AX, discrete manufacturing and a specialty of process-based manufacturing

Customer relationship management with Microsoft CRM

Industry specific platform and best practice solutions

Blended solutions; Microsoft CRM/XRM and custom

Technology consulting services

Technical architecture and roadmaps

Technical evaluations and design

Custom component design and implementation

Web-centric solutions: internal, external and/or collaborative

Cloud integration and phasing solutions

On-going support services

Infrastructure optimization and redesign, disaster recovery and business continuity specialized design and assistance

In addition to the above services, the Company also provides services in the area of data management and analytics. Examples of such services include the following:

Enterprise information management services

Provide for data related matters: master data management, data governance, logical and physical data base design, data warehouse strategies and design

Provide practical data architectures and roadmaps to support transactional systems, enterprise performance management, through advanced analytics

Provide forms of data manipulation, transformation and quality services

Analytics services

Lead derivation of key financial and operational performance indicators and correlation of their measurement, visualization and action for a given organization

Advise on opportunities for the use of predictive techniques, external data and benchmarks to improve business performance measurement and forecasting

Advise on the creation and adoption of analytics architectures, roadmaps and supporting organizations

Advise, design and roadmap analytics-based near real-time to real-time alerting strategies and implementations

Our consultants are expected to travel and to be onsite with the customer to provide the highest level of service and support in all of these endeavors. We work with varying degrees of customer project assistance and will incorporate customer resources for technology transfer or cost optimization purposes. Independent teams and proper project process and delineation provide conflict-free transition points among all key service offerings as well as independent entry points. Leads for offerings are internally driven with assistance from the respective vendors for software product solutions.

Factors Influencing Our Results of Operations

Revenue. The Company derives its service revenue from time and materials-based contracts, fixed-price contracts and retainer-based arrangements. Time and materials-based contracts represented 93.2% and 94.8% of service revenue for the three- and nine-month periods ended September 30, 2012, respectively. Time and materials-based contracts represented 95.7% and 95.0% of service revenue for the three- and nine-month periods ended September 30, 2011, respectively. Revenue under time and materials-based contracts is recognized as services are rendered and performed at contractually agreed upon rates. Fixed-price contracts represented 4.3% and 2.6% of service revenue for the three- and nine-month periods ended September 30, 2012, respectively. Fixed-price contracts represented 2.4% and 2.9% of service revenue for the three- and nine-month periods ended September 30, 2011, respectively. Revenue pursuant to fixed-price contracts is recognized under the proportional performance method of accounting. Retainer-based contracts represented 2.5% and 2.6% of service revenue during the three-and nine- month periods ended September 30, 2012, respectively. Retainer-based contracts represented 1.9% and 2.1% of service revenue during the three- and nine- month periods ended September 30, 2011, respectively. Revenue under retainer-based contracts is recognized ratably over the contract period, as outlined within the respective contracts.


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Estimates of total project costs are continuously monitored during the term of an engagement. There are situations where the number of hours to complete projects may exceed our original estimate, as a result of an increase in project scope, unforeseen events that arise, or the inability of the client or the delivery team to fulfill its responsibilities. Accordingly, recorded revenues and costs are subject to revision throughout the life of a project based on current information and historical trends. Such revisions may result in increases or decreases to revenue and income and are reflected in the consolidated financial statements in the periods in which they are first identified.

Currently, in connection with our addition of product-based consulting offerings, software revenue represents a material portion of our revenues. Software revenue is recognized upon delivery, except in the infrequent situation where the Company provides maintenance services, in which case the related maintenance is recognized ratably over the maintenance period. The consulting services we provide are not considered by us to be essential to the functionality of the software. Software revenue is expected to fluctuate between quarters, dependent on our customers' demand for such third-party off-the-shelf software. Fluctuations in software revenue may have an impact upon our periodic operating performance, including gross margin.

Operating Expenses. The largest portion of our operating expenses consists of cash and non-cash compensation and benefits associated with our project consulting personnel and related expenses. Non-cash compensation includes stock-based compensation expense arising from restricted stock and option grants to employees. Project personnel expenses also consist of payroll costs and related benefits associated with our professional staff. Other related expenses include travel, subcontracting costs, third-party vendor payments and non-billable expenses associated with the delivery of services to our customers. We consider the relationship between project personnel expenses and service revenue to be an important measure of our operating performance. The relationship between project personnel expenses and service revenue is driven largely by the chargeability of our consultant base, the prices we charge our customers and the non-billable costs associated with securing new customer engagements and developing new service offerings. The remainder of our recurring operating expense is composed of expenses associated with the development of our business and the support of our customer-serving professionals, such as professional development and recruiting, marketing and sales, and management and administrative support. Professional development and recruiting expenses consist primarily of recruiting and training content development and delivery costs. Marketing and sales expenses consist primarily of the costs associated with the development and maintenance of our marketing materials and programs. Management and administrative support expenses consist primarily of the costs associated with operations including finance, information systems, human resources, facilities (including the rent of office space) and other administrative support for project personnel.

We regularly review our fees for services, professional compensation and overhead costs to ensure that our services and compensation are competitive within the industry and that our overhead costs are balanced with our revenue levels. In addition, we monitor the progress of customer projects with customer senior management. We manage the activities of our professionals by closely monitoring engagement schedules and staffing requirements. However, a rapid decline in the demand for the professional services that we provide could result in lower utilization of our professionals than we planned. In addition, because most of our customer engagements are terminable by our customers without penalty, an unanticipated termination of a customer project could require us to maintain underutilized employees. While professional staff levels must be adjusted to reflect active engagements, we must also maintain a sufficient number of consulting professionals to oversee existing customer engagements and to participate in sales activities to secure new customer assignments.

Adjustments to Fair Value of Contingent Consideration. During the three- and nine- month periods ended September 30, 2012 and 2011, we have made adjustments to the estimated fair value of certain acquisition-related contingent consideration liabilities. We remeasure the estimated carrying value of contingent consideration each quarter, with any changes (income or expense) in the estimated fair value recorded as an operating expense. Changes in the carrying value of contingent consideration liabilities may fluctuate significantly in future periods depending on changes in estimates, including probabilities associated with achieving individual performance measures and the period in which we estimate these performance measures will (or will not) be achieved.

Non-Routine Professional Services-Related Expenses. During fiscal 2011 and the first nine months of 2012, we incurred certain non-routine professional service-related expenses associated with our identification of embezzlement activities at Fullscope, one of our wholly-owned subsidiaries (the "Fullscope Embezzlement Issue"). We incurred a majority of our embezzlement-related expenses during fiscal 2010 in connection with our identification and investigation of the embezzlement activity.

During the second quarter of 2012, the Company increased the previously recorded accrual for pre-acquisition sales and use tax exposure by $550 thousand. As of September 30, 2012, the adjusted accrual for pre-acquisition sales and use tax exposure was $1.5 million. The potential sales and use tax-related liability was created by the methods employed by a former employee of Fullscope


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to conceal the discovered fraudulent activity. While the Company has accounted for this liability as a period expense, we believe that any amounts actually paid to resolve this issue will be recoverable from an existing, fully funded escrow account in the amount of $4.6 million, which was established in connection with our acquisition of Fullscope. Future amounts recovered, if any, will be recorded by the Company in the period in which the amounts are determined to be probable of recovery from escrow.

We anticipate that we may continue to incur additional expenses associated with the Fullscope Embezzlement Issue as we intend to aggressively pursue recovery through all possible avenues, including a claim against the escrow account established in connection with the Fullscope Acquisition. We anticipate that we will be able to recover some, if not all, of the receivable amounts embezzled during 2010, the professional service expenses we have incurred to-date, or will incur in the future, addressing this situation, and any amounts paid to settle any of the identified sales and use tax liability amounts. Amounts recovered, if any, will be recorded during the period in which settlement is determined to be certain.

Company Performance Measurement Systems and Metrics. The Company's management monitors and assesses its operating performance by evaluating key metrics and indicators on an ongoing basis. For example, we regularly review performance information related to annualized revenue per billable consultant, periodic consultant utilization rates, gross profit margins, average bill rates and billable employee headcount. Edgewater has also developed internal Enterprise Performance Management systems which aid us in measuring our operating performance and consultant utilization rates. The matching of sales opportunities to available skill sets in our consultant base is one of our greatest challenges and therefore, we monitor consultant utilization closely. These metrics, along with other operating and financial performance metrics, are used in evaluating management's overall performance. These metrics and indicators are discussed in more detail under "Results for the Three and Nine Months Ended September 30, 2012, Compared to Results for the Three and Nine Months Ended September 30, 2011," included elsewhere in this Quarterly Report on Form 10-Q.


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Results for the Three and Nine Months Ended September 30, 2012, Compared to Results for the Three and Nine Months Ended September 30, 2011

The financial information that follows has been rounded in order to simplify its presentation. The amounts and percentages below have been calculated using the detailed financial information contained in the unaudited condensed consolidated financial statements, the notes thereto, and the other financial data included in this Quarterly Report on Form 10-Q.

The following table sets forth the percentage of total revenue of items included in our unaudited condensed consolidated statements of operations:

                                          Three Months Ended           Nine Months Ended
                                             September 30,               September 30,
                                          2012           2011          2012          2011
  Revenue:
  Service revenue                            83.7 %        80.1 %         83.0 %       76.8 %
  Software revenue                            8.4 %        11.9 %          9.2 %       12.2 %
  Process royalties                            -  %          -  %           -  %        3.6 %
  Reimbursable expenses                       7.9 %         8.0 %          7.8 %        7.4 %

  Total revenue                             100.0 %       100.0 %        100.0 %      100.0 %

  Cost of revenue:
  Project and personnel costs                51.3 %        47.6 %         51.0 %       47.2 %
  Software costs                              4.3 %         7.0 %          6.1 %        7.5 %
  Reimbursable expenses                       7.9 %         8.0 %          7.8 %        7.4 %

  Total cost of revenue                      63.5 %        62.6 %         64.9 %       62.1 %

  Gross profit                               36.5 %        37.4 %         35.1 %       37.9 %

  Operating expenses:
  Selling, general and administrative        31.0 %        26.5 %         31.3 %       31.1 %
  Depreciation and amortization               1.9 %         2.8 %          1.8 %        2.8 %

  Total operating expenses                   32.9 %        29.3 %         33.1 %       33.9 %

  Operating income                            3.6 %         8.1 %          2.0 %        4.0 %

  Other (income) expense, net                (0.4 )%        0.7 %           -  %        0.2 %

  Income before income taxes                  4.0 %         7.4 %          2.0 %        3.8 %
  Income tax provision                        0.7 %         1.2 %          0.5 %        0.9 %

  Net income                                  3.3 %         6.2 %          1.5 %        2.9 %

Revenue. Total revenue decreased by $(883) thousand, or (3.5)%, to $24.2 million for the three-month period ended September 30, 2012, compared to total revenue of $25.0 million in the three-month period ended September 30, 2011. Total revenue increased by $595 thousand, or 0.8%, to $76.6 million for the nine-month period ended September 30, 2012, compared to total revenue of $76.0 million in the nine-month period ended September 30, 2011. With respect to the comparative changes in year-over-year total revenue, service revenue increased by $168 thousand, or 0.8%, and $5.2 million, or 8.9%, in the three- and nine-month periods ended September 30, 2012, respectively. Conversely, software revenue decreased by $(941) thousand and $(2.3) million, in the three- and nine-month periods ended September 30, 2012, respectively.

Our year-over-year 2012 service revenue growth, both quarterly and year-to-date, is entirely organic. Additionally, total revenue during the nine-month period ended September 30, 2012 excludes service revenue and royalty revenue generated under the Fullscope process contracts, which expired in June of 2011.

The year-over-year improvement in 2012 year-to-date service revenue is the result of continued growth within our product-based service offerings and, to a lesser extent, increases in our business advisory and support services revenue. A strong Oracle-based EPM sales pipeline has provided the catalyst for and been the primary driver of our service revenue growth on a year-over-year basis.


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On a sequential quarterly basis, service revenue in the third quarter of 2012 decreased by $(1.4) million, or (6.3)%, compared to the second quarter of 2012. During the third quarter, we continued to experience delays in the signing and starting of new project engagements (or subsequent project phases of on-going projects) across each of our service offerings. These delays contributed to a sequential decline in billable consultant utilization during the third quarter of 2012, reducing third quarter service revenue.

We believe the delays in the signing and initiation of new projects continues to be reflective of uncertainty in the marketplace. While some customers are pushing out start dates to the near future, we do not see a significant pullback in spending. We believe the pipeline for our service offerings remains active, and we are continuing to drive current opportunities to closure. We did notice an uptick in our ability to bring several sales pipeline opportunities to closure during the latter part of the third quarter and into the early stages of the fourth quarter.

Utilization, which is the rate at which we are able to generate revenue from our consultants, decreased to 69.5% during the third quarter of 2012 compared to 75.5% during the third quarter of 2011. Third quarter of 2012 utilization decreased in comparison to second quarter of 2012 utilization of 73.2%. The sequential quarterly decline in utilization was primarily the result of volatility in our ability to consistently utilize our billable consultants for extended periods of time as a result of the project delays in both new and existing projects, as described above.

Annualized service revenue per billable consultant, as adjusted for utilization, was $359 thousand during the three- and nine- month periods ended September 30, 2012, an increase from annualized service revenue per billable consultant of $341 thousand and $333 thousand during the comparative 2011 periods. The improvement in the annualized service revenue rate is largely attributable to a higher concentration of revenue being generated by our Oracle-based EPM service offerings.

During the three- and nine- month periods ended September 30, 2012, software revenue totaled $2.0 million and $7.0 million, or 8.4% and 9.2% of total revenue, respectively, compared to software revenue of $3.0 million and $9.3 million, or 11.9% and 12.2%, in the three- and nine- month periods ended September 30, 2011, respectively. Our software revenue is primarily related to our resale of Microsoft Dynamics AX ERP software. We believe that the comparative decrease in 2012 periodic software revenue is the result of extended sales cycles attributable to the hesitancy of customers to launch transformational projects, such as ERP replacement initiatives. We believe this to be directly related to customer concern with respect to uncertainty and instability in the marketplace. Software revenue is expected to fluctuate on a periodic basis dependent upon our customers' demand for such third-party off-the-shelf software. We anticipate that revenue generated from software resales will continue to have an influence on our quarterly and annual revenues in future periods.

During the three- and nine-month periods ended September 30, 2012, software revenue included revenue recognized from the sale of our Microsoft Dynamics AX-based Process Industries 2 software and intellectual property (the "PI2 Solution") to Microsoft (the "Microsoft IP Sale"). The sale of the PI2 Solution was completed in June of 2012, along with the execution of underlying agreements calling for the provision of additional development and training services (which will be recognized as service revenue concurrent with the performance of services). We will continue to recognize revenue associated with the Microsoft IP Sale in direct proportion to the actual periodic services performed, as compared to the anticipated development services to be performed over the duration of the agreement.

Our gross margins related to software revenue have generally been much lower than those achieved on our consulting services. Our ERP-related software revenue, which represents the majority of our 2011, 2012 and anticipated future software revenue, has historically been sold at a higher margin than our Oracle EPM-related software. Because software revenue has become a more significant percentage of our total revenue, periodic fluctuations in the amount of software revenue recognized by the Company may have a material impact upon our gross margins.

During the nine-month periods ended September 30, 2011, we recognized $3.2 million in combined service and royalty revenue from Fullscope's process contracts. As per the terms of the earnout agreement, our obligation ended on September 30, 2011 concurrent with the termination of the service and royalty revenue generated by the process contracts. No revenues have been generated under the process contracts since September 2011, and the Company does not anticipate that any future revenue will be generated under the process contracts.

Generally, we are reimbursed for our out-of-pocket expenses incurred in connection with our customers' consulting projects. Reimbursed expense revenue decreased approximately $(110) thousand, to $1.9 million for the three-month period ended September 30, 2012, as compared to $2.0 million in the comparative 2011 quarterly period. Reimbursed expense revenue increased approximately $366 thousand, to $6.0 million for the nine-month period ended September 30, 2012, as compared to $5.6 million in the comparative 2011 year-to-date period. The aggregate amount of reimbursed expenses will fluctuate from period-to-period depending on the number of billable consultants as well the location of our customers, the general fluctuation of travel costs, such as airfare, and the number of our projects that require travel.


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The number of customers the Company served during the nine-month period ended September 30, 2012 totaled 375, as compared to 377 customers during the nine-month period ended September 30, 2011. During the first nine months of 2012, we had 87 new customer engagements, compared to 101 new customer engagements during the first nine months of 2011.

Cost of Revenue. Cost of revenue primarily consists of project personnel costs principally related to salaries, payroll taxes, employee benefits, software costs and travel expenses for personnel dedicated to customer projects. These costs represent the most significant expense we incur in providing our services. In total, cost of revenue decreased by $(329) thousand, or (2.1)%, to $15.4 million for the three-month period ended September 30, 2012 compared to $15.7 million in the comparative 2011 quarterly period. Cost of revenue increased by $2.5 million, or 5.4%, to $49.8 million during the year-to-date period ended September 30, 2012 compared to $47.2 million in the comparative 2011 year-to-date period.

The primary driver of the 2012 year-over-year quarterly decrease in cost of revenue, on an absolute dollar basis, was the decrease in software-related sales. The increase in cost of revenue on a comparative year-to-date basis was primarily due to the growth in billable headcount necessary to support our projected service revenue growth and an increase in fringe-related expenses attributable to the growth in billable headcount. The Company maintained 308 billable consultants (excluding contractors) as of the quarter ended September 30, 2012 compared to 292 billable consultants (excluding contractors) at the end of the comparative prior-year quarter.

We continue to monitor and look to reduce our reliance on external contractors; however, such services remain necessary and appropriately complement our full-time consultant base. We have utilized contractors to support our service delivery needs as a direct result of growth within our product-based service offerings. Contractor expense totaled $679 thousand during the three-month period ended September 30, 2012 compared to $976 thousand during the three-month period ended September 30, 2011. Contractor expense totaled $2.7 million and . . .

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