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Executives

Paul Neice - Director of Finance

Shirley Singleton - Chairman, President and CEO

David Clancey – EVP, Chief Strategy Officer and Chief Technology Officer

Timothy Oakes - CFO

Analysts

Lee Jagoda - CJS Securities

John Vandermosten - Singular Research

Edgewater Technology (EDGW) Q4 2012 Earnings Conference Call February 27, 2013 10:00 AM ET

Operator

Good morning and welcome ladies and gentlemen to Edgewater Technology Inc, fourth quarter and full year 2012 financial results conference call. (Operator Instructions).

At the request of the company, we will open the conference up for questions and answers following the presentation.

I would like to turn the conference over to Paul Neice, Director of Finance for introductions.

Paul Neice

Thanks Shawn. Good morning everyone and welcome to Edgewater Technology’s Fourth Quarter and Full Year 2012 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 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 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

Thank you. Good morning everyone, during the last earnings call I mentioned that signings were on the upswing as we existed Q3 and they definitely were and in particularly were that upswing was occurring was in a spot that has suffered the most which is our classic consulting. We did sign a number of new startup deals that I mentioned in our Q3 earnings call. However the trend didn’t continue throughout the quarter I think the biggest surprise that we had was our Oracle EPM business had I will call it for a lack of better word, a fiesta going on with their customers and their pipeline they just, we had failure to launch during the latter stages of Q4 and that is something that we have never seen in the eight years that we have had the Oracle EPM business if they have softness, you typically see it in Q1, when CFOs are looking up their budgets for the new year but for some reason they decided to pull horns in and didn’t launch new pieces of business I will call it from the mid to the tail end of Q4.

The good news is even though they pull their horns and again EPM is better than 50% of our business so you can feel the effects on the service line and thus utilization, even though all they pull their horns in the jobs didn’t disappear from the pipeline, it truly was a pause. I’m happy to tell you that we’re seeing a noticeable uptick in closing as we speak. We just came from a meeting this morning where I’m hearing about new things closing as well. So we’re seeing really good uptick in closings that were left over if you will from Q4 and that’s very promising for us but before I go into any more details let’s turn it over Tim so he can give you some details with the Q4 itself.

Timothy Oakes

Thanks Shirley. Good morning everyone and thanks for joining us in this morning’s call, I will jump right into the financial results for the fourth quarter ended December 31, 2012. Total revenue for the fourth quarter was 24.2 million compared to 26.4 million in the fourth quarter of 2011 while service revenue was 19.5 million during the fourth quarter compared to 20.8 million in the fourth quarter of 2011.

As described in our press release issued earlier this morning, our reported fourth quarter service revenue is 19.5 million reflects the continuation of the uncertainty we experienced in the third quarter of this year. Our pipeline remains robust but many planned launches of new projects were delayed by customers who cited uncertainty of budgets in general economic concerns.

We secured first time engagements with 16 new customers in the fourth quarter however we typically see 25 to 30 new customers per quarter. This statistics illustrates the failure to launch mentality that was the factor in the later stages of the fiscal year. The strong first half of 2012 was enough to offset the softness in the latter half of the year resulting in a 5% organic service revenue growth in 2012. The majority of the business in our fourth quarter pipeline remains active and we have seen several of these opportunities close as Shirley mentioned in the first quarter of 2013.

Software revenue was 3.2 million during the fourth quarter of 2012, compared to 3.8 million in the fourth quarter of 2011, our quarterly software revenue was historically consisted of resales of Dynamics AX software and related maintenance. Software revenue in the fourth quarter of 2012 includes revenue recognized in conjunction with the sale of Fullscope’s Process Industries 2 or PI2 software and intellectual property which was sold to Microsoft for 3.25 million in the second quarter of 2012.

Revenue directly associated with the sales of the PI2 solution has been proportionally recognized to services that are performed under certain underlying statements award related to additional development and training services.

During the fourth quarter of 2012 we recognized 434,000 in software revenues associated with the PI solution sale to Microsoft. We would also like to remind you that quarterly software revenue is volatile due to its exposure to customer demand and that the second quarter is typically the strongest software quarter for us as it coincides with Microsoft’s fiscal year end.

With respect to other standard quarterly revenue metrics we note that our annualized service revenue per billable consultant metric was 344,000 in the fourth quarter of 2012 which is consistent with 346,000 in the fourth quarter of 2011.

We entered into first time engagements with 16 new customers during the fourth quarter bringing our 2012 full year total to 103, this compares to 28 new customer engagements in the fourth quarter of 2011 and 129 total new customer engagements in full year 2011.

Service revenue generated during the quarter by our top 10 customers represented 26.4% of total service revenue compared to 23.5% in the fourth quarter of 2011. No additional customer represented more than 5% of our total quarterly service revenue during the fourth quarter of 2012 or 2011.

Similarly no customer accounted for more than 5% of our total service revenue during either the 2012 or 2011 fiscal year. At the end of the fourth quarter of 2012 we maintained 333 total billable consultants which included 23 contractors, this compares to billable headcount of 313 which included 26 contractors at the end of 2011.

Billable consultant utilization was 67.7% during the fourth quarter of 2012 compared to 75.6% in the fourth quarter of 2011. The drop in our utilization rate is reflective of project delays and holds we experienced across all of our service offerings during the quarter. Comparatively billable consultant utilization was 69.5% in the third quarter of 2012.

Total gross margin in the fourth quarter was 34.8% compared to 37.5% during the same quarter of 2011 while gross margin related to service revenue was 36% in the fourth quarter of 2012 when compared to 41.6% in the fourth quarter of 2011. The comparative decrease is primarily the result of the 1.3 million decline in fourth quarter 2012 service revenue and the associated decline in billable consultant utilization.

Gross margin related to software revenue improved to 44.6% during the fourth quarter of 2012 compared to 32.7% during the fourth quarter of 2011. The improvement in reported software revenue gross margin is directly related to the fourth quarter recognition of the 434,000 in software revenues associated with the PI2 solution sold to Microsoft.

SG&A expense totaled 7.5 million in the fourth quarter of 2012 down from 8.6 million in the fourth quarter of 2011.

The 1.1 million decrease in SG&A expense is reflective of broad based decreases in SG&A expenses across all areas most notably in salaries and wages, inclusive of commission, stock based compensation expenses and bonuses and reductions in recruiting fees, occupancy related expenses and travel expenses.

Net income in the fourth quarter was 345,000 or $0.03 per diluted share compared to a net loss of 1.9 million or $0.17 per diluted share during the fourth quarter of 2011. The reported net loss in the fourth quarter of 2011 includes a $2.2 million non-cash lease abandonment charge.

With respect to our non-GAAP measures, adjusted EBITDA was 1.4 million in the quarter compared to 1.6 million in the fourth quarter of 2011. Standard Blurb additional information regarding our non-GAAP measures is included in - related reconciliations to most comparable GAAP measures can be found in our press release that was issued earlier this morning and it's also available on the investor relation section of our website at www.edgewater.com.

As of December 31, we continue to maintain a very strong balance sheet. On December 31 cash and cash equivalents totaled 16.7 million compared to 10.3 million on December 31, 2011. As of December 31, our cash and cash equivalents represented $1.44 per diluted share. Additionally the company continues to carry no debt, accounts receivable balances including billed AR totaled 18.3 million at the end of the fourth quarter and our DSO metric related to billed AR was approximately 73 days compared to 64 days at the end of the fourth quarter of 2011. During the fourth quarter we repurchased a total of 126,000 shares of common stock at an aggregate purchase price of 461,000 or $3.65 per share. As of December 31, there is approximately 4.5 million remaining under our repurchase authorization which is scheduled to expire in September of 2013.

Cash flow from operations during the quarter was 3.9 million compared to cash outflow from operations of 25,000 in the fourth quarter of 2011. The increase in cash flow from operations is primarily attributable to the collection of accounts receivable balances during the quarter. On a full year basis we generated cash flow from operations of 8.8 million in 2012 compared to 5.8 million in fiscal 2011.

With that I would like to turn the call back over to Shirley for further comments on the recently completed quarter.

Shirley Singleton

Thanks Tim, I will peak at some of the new customers that we brought on board during the fourth quarter. Customer such as General Motors, (inaudible), Delta Dental of Missouri, Modern Woodmen Insurance and Camper Insurance. We’re clearly seeing some movement in the insurance space and for those of you that happen to have being at the Sidoti Conference in January in the New York we talked about there is a replacement cycle coming and insurance is one of the places we have our eye on typically you will see legacy systems being upgraded, replaced within a 10 year cycle and we’re seeing that we’re in year 13 of a 10 year cycle. We’re people have patched software and they are now at the point where they need to make a commitment, some of these started phase is that we won in Q4 were in the insurance space where people are looking at, what should I do next with my legacy systems.

On the full year both our ERP and EPM offerings posted organic service revenue growth, I mentioned Classic Consulting is the one that was hit with hardest by the recession but while these jobs insurance et cetera have been in the pipeline we have put the staff work, they have organically grew our new CRM practice into a multi-million dollar piece of business for us as well we put the staff to work to build several new pieces of IT that will be used in our Microsoft channel work.

So if you take another little dive down into okay so what did you build that’s going to work in the channel for Microsoft, we’re in the later stages of completing a module that will enable better tracking of channel partners and associated deal flows. We have dubbed it internally as the dealer portal and this new piece of IP is geared toward the manufacturing industry that should make sense to long term investors send full scale in the Microsoft channel work we do its heavily manufactured waiting. And it's built upon core Microsoft products. We have actually blended three Microsoft products, CRM, SharePoint and AX with custom code to create this stellar portal.

We believe that this piece of software, this piece of vertically focused IP will reinforce our brand and reach within the Microsoft solution provider channel, so I thought just for a second we would update plans to our Chief Strategist talk about why we’re looking at IP and IP is part of consulting.

Dave Clancey

We believe that IP is going to be the strategic cutting edge and providing consulting because it does two things, one is that it allows you to differentiate yourself and have a certain amount of channel control both up the channel for example Microsoft, they will come to you because they know you have cap for solution on top of the stack for various verticals, the other thing it does is by broadening it out we bring more of their product in play, both of those things in gender they are providing you with more leads, moving up the chain also shows you’re expert in particular areas, it makes customers more likely to choose you. So anything that in (inaudible) that type of channel control and software is a good thing.

Second piece that allows you to do is it allows you to work with utilization as you know anytime and any consultant is ideal those hours are lost by taking those hours it would normally be lost and investing in critical IP that you have derived to working in this channel to cap on top of this deck and in effect enable to take and make those things that were nothing imminently valuable. So as you come into an engagement now and engagement rather than coming in saying Mr. Customer what do you want, we can do this, we can do that what we do is we come in and we say we have this critical software and this software will do this for you and it's a jumpstart. It's almost like getting a modular house versus having someone deliver a big pile of sticks to assemble into our house.

So we see that as a new cutting edge of where consulting is going to go, the days of just coming in and saying we can use this language or that language or yes certain basic skills that’s over, that’s slow margin it's moved away.

Shirley Singleton

And Oracle and Microsoft are two big product channels they are asking for vertical solutions.

Dave Clancey

Everyone is looking for the stack to be “capped and broadened”. The cap is as you have keep growing that stack, the stack is software as it moves it, it moves up from operating system to database to basic manufacturing et cetera, et cetera and when you get more and more differentiation, you get more and more specialized, you specialize in foods, you specialize in chemicals, you specialize in pharmaceuticals. You get into some very optimization of warehousing and scheduling and things like this and all of these are very critical to company sales specially in the mid-market because they have just as greater need for software, the big guys but they have to avail themselves within the product space and within I would call semi-custom space in other words where you have startup product and if you just tune it and they tune in their business process accordingly.

Shirley Singleton

Thanks Dave. So that is organic initiative such as IP are going to be a key component of our go forward strategy and of course we’re not rolling off strategic acquisitions either. As to go forward guidance as I mentioned in the opening remarks we’re seeing an uptick in signings and that uptick started about mid-February and even starting at that later date we do see that we have an opportunity, we have service revenue up during the quarter, I wish it launched January 1 but that’s not how the cards roll. So things are bright in for us, we’re trending towards new customer acquisition at a rate that we normally do and the reason why that’s possible is because they were already in the pipeline, they were just going to pass the latter half of Q4.

So with that we’re done with our prepared remarks Shawn and we would like to take some questions.

Question-and-Answer Session

Operator

Thank you. (Operator Instructions). Your first question comes from Lee Jagoda, please state your affiliation followed by your question.

Lee Jagoda - CJS Securities

Lee Jagoda from CJS Securities. Tim do you have the number of billing days you had in Q4 and then the number of billing days per quarter for 2013?

Timothy Oakes

Yeah, in Q4 of ’12 we had a total of 62 billed days, as we move into 2013 the quarterly play is going to be Q1 will be 62 as well, in Q2 they will be 64, Q3 64, Q4, 62; full year total for 13 will be 252 billed days.

Lee Jagoda - CJS Securities

Okay and given you have the same number of billed days in Q1 and you don’t have the holidays like Christmas in New Year’s that both fell on a Tuesday or mid-week. It seems reasonable to assume that without any headcount reduction Q1 utilization could end up similar to Q4 and gross margins could be the same or slightly less when you add in fringe benefits. Are you planning any headcount reductions or do you see utilization kind of flattish in Q1 and then moderately improving throughout the year.

Shirley Singleton

What we have done is we have looked at the businesses, if you look at the top level number of billable consultants at year end it shows that we’re up by 20 is that, year-over-year is by 20 and that doesn’t tell the whole story of what’s going on underneath the cover. So if we dive down classic consulting is the one that got the hit the hardest, so we have done headcount reductions in classic consulting that was completed before year end. What we have done is invested in headcount in product based consulting which is where a lot of the growth was coming that those headcount - investment in headcount particularly in the Oracle piece is the reason why the utilization dropped so precipitously because of the pause they went through on the last half of the Q4. So I’m not sure your premise is correct because we have got some traction coming in with closings and we have that headcount they’re going up on billing so it's not a question of number of bill days, it's a question of them on-boarding like on some new projects that are now coming in. Does that make sense?

Lee Jagoda - CJS Securities

It does. When you talk about closing is that just new customer acquisition or is that projects that either has been on hold or are new projects that are set to actually begin rather than just kind of rolled up and put in a tube.

Shirley Singleton

It's both. We have a very robust follow on when somebody wants to buy something from us whether it's sequentially or a pause and then come back. It's summer in the high 90 percentile that lot of people come back and buy from us. We also have a nice statistic that when people have a proposal in their hands we have about 70% to 75% chance of winning once they decide to sign.

So the answer is that it's both. It’s closing, it’s occurring on repetitive buys from somebody, but the one that I really focused in and we tend to offer a special bonus or commission if you will to the sales force is net new, we want to see net new customers coming in and when we talk about you know 25 to 30 on average those are net new customers, new logos coming into the fold.

Lee Jagoda - CJS Securities

I will ask one more and I will hop back in the queue. The larger projects that got started and then were put on hold, is there any movement with any of those and have you been able to sort of go back and like you were talking about in the last call renegotiate some of the terms to make it easier to keep your crews working?

Shirley Singleton

Yeah, one project went away and that was because they felt financially they weren’t strong enough given the conditions that - I’m not privy to their financials but given the conditions they wanted to put that on permanent hold. So we lost one of them who fell out because of the economic worries. But the others are all there and what they are doing is they are having us come back and build the next SOW or statement of work that’s in a smaller chunk but it's all mapping to this 3 to 5 year plan.

Timothy Oakes

And some of the approach, it's like they are converting from getting a full meal to go into dimsum, you know what they are trying to do is break some of these larger projects down into smaller pieces, less of a buy of licensing upfront, less aggressive in terms of how much functionality they want to go for that type of thing, so they still want what they want but they are willing to go at it in smaller pieces and our feeling is that they are really looking for risk reduction and they are planning ahead for possible slowing things, speeding them up in other words to adjust to the macro-economic environment, and that’s not something you typically saw with IT projects in the past. They are doing things much more cautious.

Operator

(Operator Instructions). Your next question comes from John Vandermosten, please state your affiliation followed by your question.

John Vandermosten - Singular Research

Yes, this is John Vandermosten with Singular Research. I had a question just concerning the strength of recurring customers, I know that had been something that had been focused on before. How do you see that trend? I mean with the new customers kind of tailing off of it, have you seen recurring customers strength accelerate at all?

Shirley Singleton

I don’t think I have a ready statistics for you but the statistic I just used a couple of minutes ago which is we have a very sticky relationship with our customer as well they tend to come back and buy again and again. What I can’t give you a stat on right the second but maybe Tim and I could figure it out later is what’s the average pause between buys. If you look at EPM since we’re putting in budgeting, planning, financial consolidation they will tend to do it maybe one P&L at a time or one division at a time, the trend seems to be buying more enterprise, modules upfront than one at a time than prior which is they bought one module at a time but then they are parceling out the work dimsum style like Dave just mentioned, that’s what I see in Oracle EPM.

In our Fullscope ERP that tends to run in nine month cycle so if we sell the stuff we’re licensed, then it's normally nine months of service revenue following that license sale and then we actually have a growing after care or whatever you want to call, a support arm that comes in and provides support to these customer base. I did see a statistic yesterday that I thought was pretty interesting. I mentioned that we built the CRM practice from scratch to a multi-million dollar business. I see from a one of my dashboard reports that we’re supporting over 1700 customers in CRM post implementation that’s indicative of support after the fact.

So I don’t know if I’m fully answering your question for you but I’m giving you some sound bites, things that I can pull right off the top of my head.

John Vandermosten - Singular Research

Since the customers are breaking up the projects into parts I guess has the project size I guess the average project size declined recently?

Shirley Singleton

Fair question, what we’re seeing is we call it ROM the order of magnitude if you will of a total job it's still large and but when they want to break it down dimsum style into manageable pieces. So when we’re bidding we will give them a rough order of magnitude of a whole.

Timothy Oakes

Right it's more of like if you remember silly-putty someone take silly-putty, you’re tapping and just stretching it. So it's a similar type of buy, they are just doing it over a longer piece of time and they are setting it up so that it has more natural breaks. So the challenge there is to really accommodate our project plans to where they want to go and try and squeeze as much idle time out as we possibly can.

Shirley Singleton

And actually John I can give you another example it's something we’re working on right now is I’m not sure everyone understands the influence of Apple and other platforms that allow you to download, the app store concept and so what customers are saying is if I want to replace my policy admin system within insurance which is a huge job to do that and it would be comprised of different types of life insurance policies, they are looking at that almost like an app so I want to have a whole life app, I want to have annuity app, and I want to download the mentality is that I want to download that app and deploy it within my universe and thus take my risk down, get everybody going on that new app and then I will go get the next app. Whereas in the past and the old day consulting you would do I’m going to replace your policy admin system it's $5 million and it's three years and we will let you when we’re done. Does that help?

John Vandermosten - Singular Research

Yeah it does and just a final kind of help on the utilization rate, I mean I guess when you said you saw I guess an upswing, uptick first of all is that quarter-over-quarter or year-over-year and then I guess with that do you anticipate the bottom that you have already seen the bottom of the utilization rate so far and it's kind of on upswing at this point?

Shirley Singleton

Okay we don’t go forward guidance on utilization but that being said when I say uptick I mean sequentially that 60 new customers in Q4 we’re trending much higher than that for Q1 and those customers are moving fairly quickly and launching, they are not hesitating. So you can infer that utilization to let you, goes up with that with a slight delay.

Operator

There are no further questions, I will now turn the call back over to Ms. Shirley Singleton for closing comments.

Shirley Singleton

Thank you very much Shawn, I did want to point out we have been invited to a new conference. We’re going to the Roth Conference on Tuesday March, 19th so if you’re going to be there hopefully you can stop by and say hi and our next quarter earnings call is May 1st and that will be it Shawn.

Operator

Thank you. Ladies and gentlemen if you wish to access the replay for this call, you may do so by dialing 1855-585-8367. 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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