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Executives

Barbara Warren-Sica - Investor Relations

Shirley Singleton - Chairman, President and CEO

Tim Oakes - CFO

David Clancey - EVP, Chief Strategy and Technology Officer

Analyst

Arnie Ursaner - CJS Securities

Bob Poole - Bricoleur Capital

Edgewater Technology Inc. (EDGW) Q3 2009 Earnings Call November 4, 2009 10:00 AM ET

Operator

Welcome, ladies and gentlemen, to the Edgewater Technology, Inc.'s Third Quarter 2009 Financial Results Conference Call. At this time I would like to inform you that this conference is being recorded for re-broadcast and that all participants are in a listen only mode. At the request of the company, we will open the conference up for questions and answers following the presentation.

I will now turn the conference over to Ms. Barbara Warren-Sica of Investor Relations for introductions.

Barbara Warren-Sica

Thank you, Gwen. Good morning again everyone and welcome to Edgewater Technology’s third quarter 2009 financial results call. I’m here today with Shirley Singleton, Edgewater’s Chairman, President and Chief Executive Officer, David Clancey, Edgewater’s EVP and Chief Strategy and Technology Officer and Tim 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 acts. 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 are 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 would like to now turn the call over to Shirley. Shirley?

Shirley Singleton

Thank you Barbara and please pardon my laryngitis and don’t take the laryngitis as a dampening on my enthusiasm for what we're doing with the company. I'm very pleased.

During the third quarter we improved our gross profit margin on service revenue from 28% to 38%. We increased billable utilization from 62% to 65% and reduced our project and personnel cost by over a $1 million.

During Q3, we secured business from 18 new customers which is right in our trend line that we like to see. New wins include such names as Delta Dental of Colorado, Millipore, Pensky, Iron Gold, MySpace, MVP Health and eMASS.

We feel we have formed a new baseline and given the reasonable macro economic trends we know that we can build the growth story from here. I am very, very pleased with what's happening in the company.

With that let me turn it over to Tim Oakes to get into the numbers. Tim?

Tim Oakes

Thank you, Shirley. Good morning everyone. Sticking to our standard quarterly review process, we'll provide an overview of revenues for the quarter and then discuss our financial results, some key performance metrics and finally cover some balance sheet items. After that I'll pass the call back to Shirley for final comments.

Total revenue for the third quarter was $11.8 million compared to $18.3 million in the third quarter of 2008. The $6.5 million year-over-year decrease in revenue as we have highlighted on our previous 2009 quarterly earnings calls is directly related to the pullback and spending by our larger legacy accounts and the effects of the continued economic downturn.

From a year-to-date perspective, three of our legacy accounts, the same ones we highlighted in our second quarter earnings call represented 58% of the comparative year-over-year decrease in our service revenue.

On a sequential basis, our third quarter service revenue of $10.9 million is essentially flat compared to service revenue of $11 million in the second quarter of 2009. At the second quarter earnings call, our guidance calls for a flat quarter and we are pleased to report that we are able to execute to that guidance. We would like to highlight that the economic downturn has not impacted our ability to secure new engagements with new customers.

As Shirley mentioned in her opening remarks during the third quarter, we secured work with 18 new customers giving us a total of 52 new customer engagements in the 2009 year-to-date period. Comparatively, we secured business with 64 new customers in the 2008 year-to-date period

Breaking down service revenue for the current quarter, we note that EPM engagements represented 72% of our third quarter's sales revenue. Clients in technology consulting engagements represented 26% of our service revenue and management consulting engagements represented 2%.

Touching upon revenue concentration, on a year-to-date basis, our top-10 customers represented 20.6% of our total services revenue. This is down from 2008 year-to-date period during which our top-10 customers accounted for 27.8% of total service revenue.

Traditionally, our technology consulting engagements have been larger in value and had longer project cycles giving them more stickiness over a longer period of time. We are seeing a shift in our current plans of IT consulting engagements where they are taking on project type characteristics similar to our EPM-related engagements.

They are smaller in size, have shorter project cycles, and are becoming centralized around the core product set. We believe that this shift combined with our higher concentration of EPM-related engagements is resulting in more evenly distributed service revenue across our entire customer base.

Now, I'll cover some of the operating results and metrics for the third quarter. Starting with gross margin related to service revenue. Our gross margin on service revenue for the third quarter was 38.6%, compared to 43% in the third quarter of 2008. The primary driver of our year-over-year decrease is due to the decline in quarterly service revenue and reduction in our available consulting utilization rate.

Utilization rates during the current quarter was 65.1% compared to 71.9% during the year ago quarter. As we discussed in our second quarter earnings call, we implemented a staff reduction in the early part of the second quarter in response to excess capacity associated with a decrease in anticipated future service revenues.

Due to the timing of the staff reductions and associated severance costs, we did not realize the benefit from the action in the second quarter. As anticipated, the cost reduction initiatives did favorable impact on a sequential basis our third quarter operating results.

Specifically, in comparison to the second quarter of 2009 we've improved gross profit margin on service revenue from 28.2% to 38.6% in the current quarter, increased billable consultant utilization from 62.6% to 65.1% and reduced current quarter project and personnel costs by approximately $1.2 million.

As of the end of the current quarter, we have 185 billable consultants. We have reduced our billable consultant headcount on a year-over-year basis by 76 compared to total billable consultants of 261 at the end of the third quarter of 2008.

Moving on to SG&A expenses, we have managed to achieve comparative reductions in virtually all of our SG&A expense categories. On a year-to-date basis we reduced current quarter SG&A expenses by $1.8 million.

Quickly touching upon depreciation and amortization, depreciation and amortization has decreased by 163,000 on a year-over-year basis during the current quarter. The decrease is essentially related to the impairment charges recognized by the company during the second and fourth quarters of 2008.

We expect sequential amortization expense in the fourth quarter to decrease by approximately 75,000 in connection with the completion of amortization related to certain intangible assets associated with our 2004 acquisition of Ranzal & Associates.

Net loss in the current quarter was $249,000 or $0.02 per diluted share, compared to net income of $788,000 or $0.06 per diluted share in the third quarter of 2008. The current quarter net loss is attributable to the comparative quarterly decline in revenue and billable consultant utilization, somewhat offset by our comparative year-over-year reductions in operating expenses associated with our cost reduction initiatives.

Focusing upon non-GAAP results, adjusted EBITDA for the third quarter was essentially breakeven at 53,000 compared to adjusted EBITDA of 1.5 million or $0.12 per diluted share in the year ago quarter.

Stock-based compensation amounted to $223,000 in the current quarter, compared to $299,000 in the third quarter of 2008.

With respect to cash flow, we generated $735,000 in operating cash during the third quarter compared to $2.4 million generated in the comparative 2008 quarterly period.

In September 2009, our Board of Directors approved an extension to our stock repurchase program. Shares can now be purchased subject to the programs 8.5 million repurchase authorization through September of 2010. We repurchased a total of 90,000 shares during the third quarter as an aggregate purchase price of 268,000. As of September 30th, we had 2.8 million on our stock repurchase authorization.

We did not make any material capital expenditures during the current quarter. Additionally, in September Lynx completed its second and final earnout period. In connection with their financial performance over the 12 month earnout period we recorded an estimated contingent earnout consideration of 130,000. It is anticipated that this amount will be paid in cash during the fourth quarter of 2009.

There have been no material changes to our balance sheet during the current quarter. Our balance sheet remains healthy. Working capital amounted to $28.3 million with our cash and marketable securities representing $23.6 million or a $1.95 per diluted share. Our accounts receivable totaled $8.7 million as of the end of third quarter and our DSO metric improved to 53 days compared to 65 days at the end of the second quarter.

That concludes of our review of the third quarter financial results. With that I'll now pass the call back to Shirley.

Shirley Singleton

Thanks, Tim. Good job. Looking to Q4, we anticipate that service revenues will be flat. We put in the press release flat to slightly down. What I am worried about, we have one less build a naturally from traditional seasonality in Q4 but last year there was a move by customers to close down their facilities because of their economic conditions.

So some of our customers close shop during the last two weeks of the year for cost savings measures and talking with our EPM group. They wanted me to factor that in as we thought about guidance that showed our customers close their facilities even though we have backlog revenue, we might not be able to go in there to work.

The other factor that could put a little drag on it, is just the flu season itself, where our facility could be shutdown or we can't fly or something because our consultants are constantly on the move, so right I'm calling it flat to slightly down. If I had another extra build there or two I could probably say that flat to slightly up.

The number of proposals coming in the door are looking quite healthy. I think that EPM continue in it's merry way and I think the services offerings and changes that we've made into the core of tech consulting is starting to gain traction, specifically in healthcare and insurance as those are the two verticals that we are heavily focused on and our message is resonating.

We are pleased to be able to call stabilization again for Q4. I think we actually have some visibility in Q1. I haven't been able to say that for the last couple of earnings call, to be able to say I have visibility, not just in this current quarter but a quarter out. So I think that bodes well for us , and we look forward to leveraging up from our current baseline.

With that Tony, I'd like to turn it over for some questions, please?

Question-and-Answer Session

(Operator Instructions) We'll go first to Arnie Ursaner from CJS Securities.

Arnie Ursaner - CJS Securities

Quick question. First the growth rate year-over-year in EPM and in classic or technology and can you also give us those numbers sequentially please?

Shirley Singleton

Year-over-year growth rate of EPM and tech on sequential?

Tim Oakes

On sequential. I mean, we really haven’t highlighted individual growth. What we've done is we referred to the concentration of our service revenue in the 10-Q and in the filings in terms of what the percentage of service revenue mix is attributable to each one.

Shirley Singleton

I think in total overall service revenue, we obviously had a decline. EPM has not grown in the double-digit manner it has in the past and tech consulting is obviously retracted to the point of percentage that Tim mentioned earlier on overall service revenue.

Arnie Ursaner - CJS Securities

Probably back into the from the numbers you gave last year?

Shirley Singleton

Yes.

Arnie Ursaner - CJS Securities

My second question Shirley, one of the things I've sensed in our conversations with you is that customers are shifting a little more to targeting mass customization around a set of more basic products and data. Are you in fact seeing that and how is it impacting your business?

Shirley Singleton

You bring up an excellent point. The original Edgewater business, the way to think about it from a need analogy is that Dave Clancey actually mentioned to me at one point was, in the old days you'd go to a tailor and he'd measure you up and he'd do a template and a suit made for you would be totally custom.

These days, when you go buy a suit; you go to men's warehouse. There are certain sizes but there is no specific tailoring. You pick out a suit and then you have it tailored. That’s what's happening in tech consulting. The original Edgewater did custom tailoring. What we're doing now is looking at what products out there are gaining traction that people can use as a starter kit, if you will a framework to launch quicker into a solution and then customizing around the edges.

Arnie Ursaner - CJS Securities

I have got a question if I may, the contracts you are signing, for quite a while you've seen this being changed or reduced or people trying to lower cost especially. Even in the last call you had mentioned you are starting to see a little bit, a few of them or more of them being executed as proposed. Is that still happening?

Shirley Singleton

It is still happening and actually we are seeing the pendulum swing the other way. I don't want to jinx myself but we are seeing more million dollar plus deals that are stacking up interestingly enough both on EPM, which has historically had a smaller turn, a smaller number of several repeatable follow-ons. So we are seeing 800,000 as something that is coming into the EPM side and on the tech consulting side with a new offerings, things that are stacking up for Q1 2010, are over a $1 million, there are several of them.

Operator

(Operator Instructions). Well take our next question from Bob Poole, Bricoleur Capital.

Bob Poole - Bricoleur Capital

So I want to try and frame the Edgewater situation a little differently than its being framed now because I think there is a big, how do you think about the value of the company is a lot different depending on how you frame the question. So on this I have got a few questions. The bench that you carried this quarter, would I be right in thinking that the bench 35% of your consultant group, I am thinking that's about 60 to 70 people. Am I right in thinking that probably costs are in the order of $2 million a quarter?

Shirley Singleton

No. That would not be accurate. It is not 65 or whatever; it is a number of people that you said. I think we don't express the bench in terms of headcount, what we do is we express our business in terms of utilization.

Bob Poole - Bricoleur Capital

How many consultants do you have now?

Shirley Singleton

185.

Tim Oakes

185.

Bob Poole - Bricoleur Capital

185, so the number on the bench is not 35% of that?

Shirley Singleton

No.

Bob Poole - Bricoleur Capital

If utilization is 65% not utilized, isn't that 35%?

Shirley Singleton

Yes.

Bob Poole - Bricoleur Capital

How do I do not assume that there are 65 people who are not utilized?

Shirley Singleton

That's because not everybody is 100% utilized, some jobs have people that do partial work across multiple opportunities, so you can't express it of 100% or 65 people are working 100% and 35 people are not working 100%.

Tim Oakes

You really have to factor in travel time, you have to factor in training, you have to factor in sick time, and you have to factor in all the typical things that people do, so that to assume you could run any organization at 100% or 110% is just not feasible.

Shirley Singleton

Your point is bench removal or is that what your point that you are driving at or?

Bob Poole - Bricoleur Capital

What I'm really trying to drive at is, look. Your working consultants are probably producing something north of $20 million in contribution per year. The market is valuing that at basically zero today. I don't think it's the market's fault that it's valuing that at zero today, because all of that consultant profit is consumed by bench and overhead.

So the company needs to find a way to unlock the value of those working consultants. Those working consultants are in effect, as it relates to the shareholders working for nothing right now and the shareholders include themselves. They're getting no value from the market for their efforts. So in order to correct that, they have to work for a company that can leverage their efforts as opposed to consume their efforts in overhead.

Bottom line is the company is too small and it cant really, realistically get big enough in a reasonable timeframe for it to make sense versus pursuing some strategic alternative. So we can argue about whether the bench consumes 1 million or 2 million a quarter but its somewhere in that range where its clear what overhead consumes a quarter. All the rest, $4 million a quarter and so the shareholders, and you know I'm a large one and I've been a long-term shareholder. So I haven’t been arguing here for some quick hit but I do believe that the elephant in the room is that the company is too small and it doesn’t make sense in its current size and something needs to change. That’s the point?

Shirley Singleton

Okay, I appreciate your thoughts and I do understand your point of view. We have received your emails. We have received your calls and we have heard you on the prior earnings call and today as well. I have taken all of your points to the Board, but at this time the Board feels we need to stay the course Bob.

Bob Poole - Bricoleur Capital

Okay. I think what I need to hear from the Board and what I need to hear from the Board is why and I need to understand how the Board is incented to do the right thing. The Board doesn't appear to, you know, the working members of the Board own a fair amount of stock but the non-working members of the Board don’t seem to have much incentive to do the right thing.

So what is their explanation for why this course is the better course and how do we shareholders get comfort that the board Actually has our interest in Shareholders first and foremost in their mind?

David Clancey

This is Dave Clancey and maybe I'm cutting things too short but I would say to summarize it that the Board, Management doesn't feel that you optimize shareholder value by selling at a bottom as a market and that's the shortest tightest way to put it and I don't want to go through a lot long discussion to go through all the points but that's really where it crystallizes out to.

Bob Poole - Bricoleur Capital

Okay. I think the board would have said the same thing a year ago and a twice the price, so for two years I think the Board has been saying for ever there is such a huge gap between the value of the company as part of another company and the value of the company as an independent company where the Board is included, I think the board I was just looking at the proxy, the board consumes $500,000 a year which first well for a company with $40 million in revenue is a lot of money. The Board is just wrong and we'll just have to work on that, so thanks.

(Operator Instructions) The next question is a follow up from Arnie Ursaner from CJS Securities.

Arnie Ursaner - CJS Securities

Well, following Bob's comments. Surely in your prepared remarks you did an interesting sentence that I wanted you to perhaps expand up on that you can achieve an operating base line against which you evaluate the impact of strategic initiatives and actions, could you care to expand on that?

Shirley Singleton

I think that we have spent the down part of this market relooking at the piece of Edgewater that had the biggest hit, namely the legacy accounts that were along 17 and 10-year customers, respectfully that left, so we had an opportunity to retrain, retool and look hard at Edgewater, the tech consulting portion and said to ourselves just like we did in 2003, when we identified EPM as a trend.

Are there particular trends, are there pockets of growth that are growing even in this tough time, and we feel we have identified some of those pockets of growth. We are not prepared to discuss all of them today, because I don't want to reveal part of our strategy at this point, but I am very comfortable that we have identified some legs that are in front of us, they are so much through EPM that we identified in 2003.

That in combination of retooling the offerings we have in healthcare insurance, healthcare alone you have a lot of churn happening as people debate what's going to happen in healthcare, and when you boil that all down from our perspective data, a raw data manipulation is at the heart of the healthcare problem, whether you go by pay-by-performance or pay-by-outcome, or whatever the way that they decide that healthcare goes.

The issue you are going to have is reporting to the government, reporting to people about what's happening in healthcare itself that goes right down to our data services, it goes right down to EPM. So data services is wrapping around EPM and working side by side very nicely in both healthcare and insurance.

The other thing I would point out is your insurance companies has stayed on the sideline in the year 2000, which was where the other bubble burst in IT and they haven’t really spent a good deal of money relooking at their back office infrastructure for the last nine years. They're getting long in the tooth and we're getting people starting to say I better look at my policy administration system. I better look at the way that I'm communicating to my agents.

The consumer is changing. Its an instant message world and you're insurance company is, some of them like GEICO and Progressive are out there and you can see it on the television. They are leveraging the web. They are leveraging internet commerce and other pieces. You've got a lot of people that have not done that and stayed on the sideline. We've got massive consolidation occurring in insurance right now, both in P&C and life.

So we have identified these as trends. Lastly, when you have the economic churn like we've had in the last year, the whole economy, you have lots of consolidation, you have lots of M&A. What does that do for Edgewater's business? Every time you're changing players like trading cards. You're selling this division and adding that division. It changes planning, budgeting and consolidation. So it creates add-on work for existing accounts that we already had.

Secondly, it requires M&A consultation and the back office consolidation, which goes right into the warehouse of what we got from the NDS acquisition and the original Edgewater tech systems integration. So we're very bullish of where we're going. I could go on for an hour on all of the things that we have in the air in terms of where Edgewater is going to grow. I think you're going to see a growth story, starting at this base line.

Arnie Ursaner - CJS Securities

Thank you for the answer. The question I have regarding various changes in management that have occurred and obviously Dave has announced his intentions going forward and Dave we wish you the best of luck. I guess one of the questions I have really is Dave has played an important role functioning as kind of COO. He's overseen one of your key business unit, so I am assuming you at some point have to bring in someone of the senior level to replace him. How should we think about and you've also again Tim is doing is excellent, he is Interim CFO at some point you may you or the Board may choose to change that. How should we think about SG&A expense going forward and is part of your plan perhaps to make of these reductions a little more permanent?

Shirley Singleton

On the immediate horizon as it relates to the COO is to not replace Dave. There is a number of reasons why I think its safe to make that call along with the research that I had HR do that a lot of public companies that are on the smaller side have eliminated a COO role.

That being said I'm luck in that Tim when he joined Edgewater five years ago actually played a heavy role with Dave Gallo on the budgeting and planning side of the equation, which is heavily into the operations. Time personally took on the EPM side while Dave was managing the Tech Consulting. We know what happened, the EPM thing has blossomed and grown into a very substantial part of our business and Tim has been at the helm on the operational side of EPM this entire time.

So Dave's departure after 17 years we will miss him greatly. He is a good friend and a loyal Edgewater supporter. It's thankfully not going to hurt us because we've done a great job with succession management and making sure we have the right players. Tim is prepared to assist me with managing the overall COO without adding that extra SG&A expense.

Arnie Ursaner - CJS Securities

Well, again relative to my model and I appreciate I'm the consensus, the SG&A line for me this quarter came in dramatically lower than I have modeled. Tim, I don't know if you could give us some views on what sort of run rate SG&A we should be looking at in Q4 and on a go-forward basis?

Tim Oakes

Arnie, that's a good question. I think that really it dovetails nicely in terms of your question to Shirley earlier about forming the new baseline for the company. If you look at year-over-year quarter and year-over-year, year-to-date, service revenue was off in the mid-30s, and if you look at our third quarter SG&A as a percentage of revenue, we are at 35%.

Given that the quarterly change year-over-year is the revenue is down 36%, the G&A expense and the operating expenses are off 30%. I think what you see in the third quarter really is a baseline to move into the fourth quarter.

Shirley Singleton

I actually think personally, Arnie, you are going to see that a little bit more contraction in expenses in Q4.

Arnie Ursaner - CJS Securities

We look forward to spending sometime with you next week in New York City.

Shirley Singleton

I'm very excited about that we'll be seeing you on Tuesday and we can spend more time with you on looking at the go-forward expense if you like. Tony, I think that that would be it for the questions for today.

Operator

I'll now turn the conference back over to Ms. Singleton for any closing comments.

Shirley Singleton

I really appreciate everyone's comments on the earnings call today and I would look forward to speaking with everybody for the Q4 earnings call on March 3, 2010, and I look forward to our road show next week in New York. Thank you Tony.

Operator

Ladies and gentlemen, if you wish to access the replay for this call, you may do so by dialing 1-888-203-1112 with the passcode of 5402126. 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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