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Edgewater Technology, Inc. (NASDAQ:EDGW)

Q1 2013 Earnings Conference Call

May 1, 2013 10:00 am ET

Executives

Paul McNeice - Director of Finance

Shirley Singleton – President & CEO

David Clancey – EVP, CSO & CTO

Tim Oakes - CFO

Analysts

Lee Jagoda - CJS Securities

John Vandermosten - Singular Research

Operator

Good morning and welcome ladies and gentlemen to Edgewater Technology Inc’s First Quarter 2013 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 now turn the conference over to Paul McNeice, Director of Finance for introductions.

Paul McNeice

Thank you, Mary. Good morning everyone and welcome to Edgewater Technology’s First Quarter 2013 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 Technical 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 and 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 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. When I sit back and I look at Q1, I think I like to characterize it in three parts. It started of very slow we mentioned that in our last earnings call actually. We stabilized in the middle of the quarter and then we really saw some increased sales activity as we – at the ending part of the quarter and continues today. Except for larger capital investment projects we started to see a noticeable uptick in closing. I say about mid-February which is what I said in the last earnings call.

March is heralding in even stronger sales activity; however, the timing of these closing did not allow us to have as much lift as we hope. We are up 1% sequentially. We are actually hoping for a larger than that. But the timing is everything. But let’s get into the details Tim.

Tim Oakes

Thanks Shirley. I will now get into the details for the first quarter.

Total revenue for the first quarter 2013 was $23.5 million compared to $25.3 million in the first quarter of 2012. Service revenue for the first quarter of 2013 totaled $19.7 million compared to $21.8 million in the year ago quarter. However, as Shirley mentioned on a sequential basis we are reporting a modest 1% increase in quarterly sequential service revenue.

Our year-over-year first quarter service revenue decline is reflective of the softness in deal signings and the project delays we experienced in the second half of 2012, which carried into the early part of the first quarter of 2013. The softness of our pipeline activity did not provide us with a significant amount of momentum as we entered the first quarter of 2013.

As the quarter progressed we started to see our sales activity accelerate evidenced by the fact that we secured first time project engagements for 21 new customers. We view this as a positive sign as we edge back towards to our historical norms recovering somewhat from the 16 new customer engagements we secured during the fourth quarter of 2012.

While we appear to gain momentum as we approached the back half of the first quarter, the new customer engagement signed in the quarter did not kick off in time to provide any meaningful lift to our first quarter service revenue.

In direct correlation to decline in service revenue, our billable consultant utilization for the first quarter of 2013 was 69% compared to 75.4% in the first quarter of 2012. Sequentially our utilization rate increased from 67.7% in the fourth quarter 2012.

Software revenue was $2 million during the first quarter compared to $1.4 million during the first quarter of 2012. The increase in the software revenue was primarily due to $460,000 of revenue recognized in conjunction with our 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. Through the first quarter of 2013, we have recognized in aggregate approximately $1.2 million in revenue from the PI2 asset sale.

Revenue directly associated with the sale of the PI2 assets is being proportionally recognized as services are performed under certain underlying statements of work for development and training services.

As we always do during our earnings call, we would like to remind our investors that quarterly software revenue is volatile due to its exposure to customer demand. The second quarter of our fiscal year 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 was $346,000 in the first quarter of 2013, which is relatively consistent with $352,000 in the first quarter of 2012. The consistency in this metric comes from our ability to maintain current billing rate across all of our service offerings as well as our EPM service offering making up a larger portion of our total service revenue mix. Our EPM service offering accounted for approximately 58% of our total service revenue during the first quarter of 2013, compared to 56% in the year ago quarter.

As previously discussed despite a slow start to the first quarter of 2013, we entered into first time engagement with 21 new customers during the first quarter. Comparatively we secured 27 new customer engagements in the first quarter of 2012 and 16 in the fourth quarter of 2012.

Service revenue generated during the quarter by our top 10 customers represented 30.9% of total service revenue compared to 24.7% in the first quarter of 2012. No individual customer represented more than 5% of our total service revenue during either the first quarter of 2013 or 2012.

Total gross margin in the first quarter of 2013 was 30.4% compared to 33.9% in the same year ago quarter. While gross margin related to service revenue was 32.4% during the first quarter of 2013, excuse me. Gross margin related to service revenue was 32.4% during the first quarter of 2013 compared to 37.4% during the first quarter of 2012.

Shirley Singleton

Losing your place there Tim?

Tim Oakes

I was. I’m sorry about that.

The decline in total gross margin and gross margin related to service revenue is due to the aforementioned decline in billable consultant utilization. Gross margin related to service revenue improved 750 basis points to 38.1% during the first quarter of 2013, compared to 30.6% during the first quarter of 2012. The increase in reported software revenue gross margin is primarily due to the recognition of the $460,000 in software revenue from the PI2 asset sale which as a very high gross margin contribution.

Moving on to SG&A; SG&A expenses totaled $7.5 million in the first quarter of 2013, compared to $8 million in the same year ago quarter. We continue to proactively manage our SG&A spend rates. The comparative improvement in SG&A related expenditures is attributable to reductions in sales related wages including commissions, recruiting costs, facility related expenses and travel expenses which were offset by increases in stock-based compensation expense, product development cost and professional services fees.

Net loss for the first quarter of 2013 was $889,000 or $0.08 per diluted share compared to net income of $175,000 or $0.02 per diluted share during the same year ago quarter.

With respect to our non-GAAP measures, adjusted EBITDA was $198,000 or $0.02 per diluted share and represented approximately 1% of total revenue in the first quarter of 2013 compared to adjusted EBITDA of $990,000 or $0.09 per diluted share which represented approximately 4% of total revenue in the year ago quarter. The comparative change in reported quarterly adjusted EBITDA is primarily attributable to the year-over-year decline in service revenue.

Additional information regarding our use of non-GAAP measures including reconciliation to the 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 Relations Section of our website at www.edgewater.com

As of March 31, 2013, we continued to maintain a strong balance sheet and carry no debt. On March 31, 2013, cash and cash equivalents totaled $13.5 million compared to $16.7 million on December 31, 2012. The net change in our consolidated cash position is the combined result of first quarter outflows from operating activities of $2.2 million which included approximately $266,000 in payments associated with the settlement of Fullscope embezzlement related sales and use tax obligations.

A $150,000 in upfront payments related to our March 2013 acquisition of a Microsoft Dynamics based trade promotion management solution and intellectual property and $661,000 in stock repurchases.

Quickly touching upon the Microsoft Dynamics TTM acquisition, we acquired the TTM asset as part of our strategy to invest in vertically focused intellectual property. We believe that this offer will augment our own recently developed CRM add-on module which provides enhanced channel management primarily in the chemical, life sciences, pharmaceutical, food and consumer product goods manufacturing industries.

As of March 31, our cash and cash equivalents represented $1.24 per diluted share, accounts receivable balances including unbilled AR totaled approximately $18.3 million at the end of the first quarter of 2013 and our DSL metric related to billed AR was approximately 62 days as compared to 67 days at the end of the first quarter of 2012.

Finally, a quick update on our stock repurchase program. During the first quarter of 2013, we repurchased 164,000 shares of common stock at an aggregate purchase price of $661,000. As of March 31, it was approximately $3.9 million of purchase authorization remaining under the stock repurchase program which is scheduled to expire in September of 2013. Now, I’d like to turn the call back over to Shirley for further comment on the first quarter.

Shirley Singleton

Thanks Tim.

So, you characterized the quarter as it’s a revenue issue, our expenses are in line, utilization was a factor of revenue and we thought we have more list but sales came in at – more as a tail-end.

Tim Oakes

Absolutely, absolutely. I think we have done a very good job proactively controlling our SG&A spend rates and if you look at them on it right now where we’re from an inflection point, it’s really a matter of driving revenue growth to get profitability lifting them all.

Shirley Singleton

Okay. So, let’s dive into a little bit of those 21 new customers that Tim talked about, some of them that we onboarded as new is FAST Technology which is an insurance play. Motel 6, we are getting some hospitality work coming in extended stay with a recent customer not too long ago. These are stemming from the Blackstone work that we did when Blackstone went on an acquisition trail with all those hotels and we were the ones doing the business and technology advisory behind the Blackstone acquisitions.

So we are revisiting some of those customers and they are coming back to us on standalone deals. And also in discussions with Blackstone, see if we can help with their other deals. Massachusetts Port Authority is a new customer of ours; Trinity Health, (Took) City and we are doing the EPM work for Facebook that came in during the quarter as well.

If I were to characterize what’s driving it, the acquisition of customers, it would be our EPM and Classic Consulting offerings who were the major driver of the new customer this quarter. Tim mentioned IP software, we bought some, we talked a little bit about intellectual property last earnings call. Dave, maybe you could just, small some bites on why we consider IP an important part of the go-forward strategy of our company.

David Clancey

What’s driving the value of IP is, if you take a look at the total ticket that it cost to put, software and services gathering a bigger and bigger share of the cost as the price of hardware comes down, the prices services do to cloud are driven lower. And if software comes down and total licensing fees, it’s the cost of service that’s come up, and when you think about it IP on top of the stack whether it would be methodology, your software is a way to encapsulate and value price service and literally capitalize time when a consult maybe on the bench, they could be putting that together and sets on top and that’s why we are looking at IP and CRM is to give people a more, so we say cost advantage.

What we are looking at not so much is to evaluate the lowest price per hour per head and look at it like an employee, you have to look at what is the productivity you are getting and what is the value you get from any particular initiative. So, we are finding now in certain cases more senior, more highly trained people are far more productive than looking at someone who doesn’t have experience to operate at the top of the stack or in other words, pretty high up in a vertical.

Shirley Singleton

Okay. So in other words, we are managing more to deliverables rather than a straight people view.

David Clancey

It’s to manage more, it’s more of, as they say in the consulting role more of a prodding approach rather than managing everything as employees, let’s start managing the deliverable, managing the contract. Cloud strategy is going to take in that direction anyway, if you look at it, I would expect that you are going to see most IT departments, more contract managers than they are really people and technology managers.

Shirley Singleton

Okay, thanks Dave.

So IP is important part of our go-forward strategy, and of course we are not ruling out any strategic acquisitions as well as another opportunity for growth. As to go forward guidance we are guiding up for second quarter, the sales activity we have experienced in March has led us to believe that, we have a better shot at it and up than what happened in first quarter was only 1% sequential and so that good news as well.

So, with that I would like to open it up for questions, please Mary.

Question-and-Answer Session

Operator

Thank you. The question-and-answer session will begin now. (Operator Instructions). Your questions will be taken in order they were received. Please standby for your first question. And our first question comes from Lee Jagoda from CJS Securities. Your line is open.

Lee Jagoda - CJS Securities

Hi, good morning.

Shirley Singleton

Hi, Lee.

Tim Oakes

Hey, Lee.

Lee Jagoda - CJS Securities

Shirley, you mentioned trends improved throughout the quarter, can you comment on the follow through, you may have seen in April?

Shirley Singleton

Yeah, I think I can characterize it. We have three offerings. We have classic consulting. We have EPM and we have ERP. And what’s been happening over the last couple of quarters is two out of three are off. If we look at the latter half of 2012, we saw EPM kind of pull back the signings not the jobs in the pipeline, pull back in the fourth quarter but EPM came on strong in mid-quarter and beyond.

So, EPM is a big part of our go-forward push for Q2 in terms of revenue. Our Classic Consulting is up, it is really jumping right into the fray of analysis paralysis that people have in terms of where should I go with my technology. There is – we have talked about a replacement cycle of 10 years, its 13 and it’s going.

David Clancey

It’s really extending, the difference maybe another way to look at it is, is when you go with the Fullscope offering which is ERP. That goes predominantly to the upper mid market and that’s the best of company capital investment. And given the macro environment what’s happened is, these people are trying to make their capital last longer.

I mean, if you look in New York City and you have building managers typically replace their air-conditioning every 10 years, now they are forcing those puppies to last 12, 13, 15 years. People are ready to engage on full board capital projects. If you look at EPM and advisory, those typically are quicker hits, its not a strong use of capital it has more of a short-term of type a thing. ERP could last you 10 years in some case these people are pushing it, really pushing the envelope, so it’s almost, I feel like I’m waiting for Godot in terms of the replacement cycle of enterprise software at this level.

Shirley Singleton

So, I want to give you all that background Lee, so Q2 really has Classic advisory and EPM pushing the way. ERP there is a phenomenal amount of sales activity in fact Russell Smith who heads up that unit recent – told me last week that this is the most sales activity he seen in three years. Does that translate to everyone making an ERP large capital investment decision? I don't know but he is happy about the activity that’s going on and with Q2 being the end of the Microsoft fiscal year there tends to be a flurry of signings in Q2. Does that answer your question Lee?

Lee Jagoda - CJS Securities

It goes, thank you. That was very helpful.

Shirley Singleton

You’re welcome.

Lee Jagoda - CJS Securities

Also Tim, just on the software gross profit side, in the quarter was about a 1000 basis points less than it was in Q3 of 2012 and both were positively impacted by the process the PI2 revenue. Can you quantify the factors that negatively impacted Q1 and are they likely to continue?

Tim Oakes

Yeah, I think Lee if you look at it, the PI2 revenue was 460 in this quarter obviously that comes to the high contribution margin. In the third quarter of 2012 that PI2 revenue was I think a little bit lower maybe $354,000. So, net-net you shake that sort of out of the equation rough math says that the Q3 product margin was in the high 30s versus about 23% in the first quarter and that really just comes down to the mix. You know Q1 would have more maintenance mix than product mix and Q3 of 2012 would have more of a product’s flavor. It goes to what Shirley is saying in terms of we have the pipeline opportunities there, it‘s just the matter of wrestling them to the ground and the timing as to when it happens. We always reference that product sales and our software revenue is going to be volatile quarter-to-quarter.

Lee Jagoda - CJS Securities

Sure. One more question and I’ll hop back in the queue. Shirley, can you update us on the progress you’re making internationally and what are sort of the next steps you think about there?

Shirley Singleton

The UK stronghold that we have in EPM, as I mentioned in the previous earnings call, I think I did. They are doing really well. They have strong growth year-over-year and so we’re very happy that we've transitioned to a full-time Managing Director over there to run the practice. We’re able to pull back two U.S. people that actually started that from scratch for us. I see us opening up some doors in the Asia Pacific area and that’s primarily driven by Oracle bringing us into the table to some accounts over there. That’s where we are on the international scene.

Lee Jagoda - CJS Securities

Thanks very much.

Shirley Singleton

You’re welcome.

Operator

Thank you. (Operator Instructions). Our next question comes from John Vandermosten from Singular Research.

Shirley Singleton

Hi, John

John Vandermosten - Singular Research

How are you?

Shirley Singleton

Good.

John Vandermosten - Singular Research

Just a couple of questions for you. The first I wanted to ask is just in terms of the margin direction on the personnel and project costs, it looks like sequentially it declined even though productivity went up even though the utilization went up from 67.7% to 69%. I was wondering if you could just comment in terms of what the details were there and why we saw one go up and one decline?

Tim Oakes

Yeah. I think really, I'd sum it up sort of in three ways, John. First, being is that we have a lesser reliance on contractors during the quarter which takes some expense out of the cost of revenue line. Secondarily, I would say that the variable component of people’s compensation programs that’s revenue based is lower this quarter and comparative quarter given what the rev gen was for the quarter. And then, finally, there really isn’t that much of a sequential lift in productivity coming from 67.7% to 69% utilization.

John Vandermosten - Singular Research

Okay. Thank you for that. And then the second question I had was just on, I saw a few articles recently on Microsoft Dynamics AX for retail and I know that’s not one of your main verticals but I was wondering if that was an area that you had seen some customer interest in or an area that you might push a little bit into?

David Clancey

Yeah. We do have a customer who is in a retail mini mart fuel business, its looking at it. And we have seen some interest there. So there is increasing interest for AX in that environment versus SAP and what not. That’s a tough environment as you probably well know the margins there extend and what not. So there is a fair amount of exploratory work into exactly how AX will hook in. Primary focus is in and around that financial aspect of AX versus actually trying to get into the retail outlet itself for example drive cash registers and drive fuel deliveries, drive gas pumps et cetera. So that is an area that is very interesting.

John Vandermosten - Singular Research

Okay. Thank you for the answers.

Shirley Singleton

Thanks John.

Operator

If there are no further questions, I will now turn the conference back to Ms. Shirley Singleton for a closing comment.

Shirley Singleton

Okay. Thank you. We have a full schedule coming up here. We have a shareholder meeting on June 5 that will be in Wakefield at the Sheraton. We have a Sidoti Conference that we are going to on June 7 and that’s in New York.

Tim Oakes

Correct.

Shirley Singleton

Then we are going to the Singular Conference, New York

Tim Oakes

New York.

Shirley Singleton

June 13 and B. Riley, looks like we forget them Wednesday, May 22 will be in San Diego and the next earnings call is July 31. So we have got a full scheduling ahead of us. Tim and all of us will be around this afternoon if you would like to call in and check with us about this quarter and thank you very much for listening. That’s it Mary.

Operator

Thank you. Ladies and gentlemen, if you wish to access the replay for this call, you may do so by dialing 1855-859-2056 or 404-537-3046 and using the access code 29452479. 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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