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Executives

Paul McNeice – Director, IR

Shirley Singleton – President and CEO

Timothy Oakes – CFO

Analysts

Lee Jagoda – CJS Securities

Nick Halen – Sidoti & Company

George Melas – MKH Management

Edgewater Technology Inc. (EDGW) Q3 2011 Earnings Call November 2, 2011 10:00 AM ET

Operator

Good morning, and welcome ladies and gentlemen, to Edgewater Technology Inc.’s Third Quarter 2011 Financial Results Conference Call. At this time I would like to inform you that this conference is being recorded for a rebroadcast 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 Mr. Paul McNeice of Investor Relations for introductions.

Paul McNeice

Thank you, Mary. Good morning everyone and welcome to Edgewater Technology’s Third Quarter 2011 Financial Results Call. I’m here today with Shirley Singleton, Edgewater’s Chairman, President and CEO; David Clancey, Edgewater’s EVP and Chief Strategy and Technology Officer; and 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 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 today’s date and the company undertakes no obligation to update the forward looking statements to reflect subsequent events or circumstances.

With that, I’ll now turn the call over to Shirley.

Shirley Singleton

Thanks Paul. Good morning, everyone. We are very, very happy with our quarter. During Q3 we secured business from 38 new customers, which is the highest number we have seen in many years in an individual quarter.

We are trending towards finishing the year at a $100 million in total revenue. The new wins from the quarter are recognizable names to many. One is Discover, Delta Dental of Rhode Island. Cognex is a medical device company here in Massachusetts, Rockwater Energy and Hertz [ph].

But let’s have Tim get into the details please.

Timothy Oakes

Thank you, Shirley. Again, echoing Shirley’s comments from her opening script, we are very pleased to (inaudible). We ended the quarter with some concern centered upon our ability to maintain billable consultant utilization. As we discussed during our second quarter earnings call, we did have concerns related to our transition away from Fullscope’s process related contracts and noted project delivery gaps created by delays in customer project approvals into our project starts.

During the quarter, we were able to successfully manage billable consultant utilization which resulted in an increase in service revenue on both the sequential and year-over-year basis, and another all-time high in quarterly service revenue.

Total revenue for the third quarter was $25 million. That’s compared to $21.4 million in the third quarter of 2010; while service revenue was $20.1 million during the third quarter compared to service revenue of $18.1 million during the third quarter 2010.

On a year-over-year basis, we are reporting growth in both total revenue and service revenue. The year-over-year growth in third quarter total revenue and service revenue was 17.1% and 11% respectively, which is entirely organic revenue growth as the Meridian acquisition was completed in the second quarter of 2010.

It’s also worth mentioning that we achieved this growth, absent any contributions from the Fullscope process related contracts, which contributed both to service revenue and royalty revenue in the third quarter of 2010. As discussed in our second quarter earnings call and our periodic SEC filings, Fullscope’s process related contracts concluded at the end of the second quarter of 2011.

Year-over-year service revenue growth in the third quarter is driven by demand for our product based service offerings. Quarterly growth continues to be fueled by strength in our EPM related service offerings.

On a sequential basis, total revenue decreased by $2.3 million or 8.6% compared to the second quarter of 2011. The sequential decrease in total revenue was anticipated, given the cyclical nature of second quarter software revenue, which has historically been the strongest quarter in each fiscal year due to the fact that it coincides with Microsoft’s year-end, and the absence of service revenue and royalty revenue generated on the Fullscope process related contracts.

Service revenue on a sequential basis increased by $1.4 million or 7.7% compared to the second quarter of 2011. The sequential increase in third quarter service revenue is attributable to an increase in the billable consultant utilization rate, which increased to 75.5% compared to 72.2% in the second quarter, while increasing consultant head count by 13. As with our increase in year-over-year quarterly service revenue, sequential quarterly revenue growth is similarly being driven by our product based consulting services.

Software revenue, which includes related maintenance revenue was $3 million during the third quarter and represented 11.9% of our total quarterly revenue. This compared to $1.2 million or 5.6% of total revenue during the third quarter of 2010. Our quarterly software revenues primarily comprised of re sales of Microsoft Dynamics AX software and maintenance.

As we have stated in the past, quarterly software revenue is volatile and is subject to customer demand. Compared to the third quarter of 2010, 2011 third quarter software revenue was aided by the closing of several larger private deals.

Other standard quarterly revenue metrics included the following. Annualized service revenue per billable consultant metric was $341,000 in the third quarter compared to $324,000 in the third quarter of 2010. We entered into first time engagements with 38 new customers during the third quarter compared to 23 new customer engagements in the year-ago quarter.

On a year-to-date basis, we have entered into first time engagements with 101 new customers compared to 72 in the year ago nine-month period. Similarly as a point of reference, we entered into a total of 102 customer engagements during all of 2010.

Shirley Singleton

So we have in effect, met last year’s total new customer count already by the end of Q3.

Timothy Oakes

That is correct.

Shirley Singleton

Okay.

Timothy Oakes

And finally service revenue generated during the quarter by our top 10 customers represented 23% of total service revenue compared to 31% in the third quarter of 2010. No customer accounted for more than 5% of our total service revenue during the third quarter of 2011.

Moving on to gross profit, total gross profit as a percentage of total revenue was 37.4% during the third quarter compared to 36.6% during the third quarter of 2010 and 39.5% in the second quarter of 2011. Gross profit margin related to service revenue was 40.6% in the third quarter compared to 38.9% in the third quarter of 2010 and 36.3% in the second quarter of 2011.

Current quarter year-over-year improvement in total gross profit is attributable to the comparative increase in service revenue and the gross margin contribution from third quarter software revenue.

The decrease in total gross margin on a sequential basis is primarily attributable to the absence of royalty revenue from the Fullscope process related contracts. The year-over-year and sequential increases in our service revenue gross margin is attributable to comparative increases in periodic service revenue, reflective of our maintaining or increasing our billable consultant utilization rates, while increasing comparative billable consultant head count.

Billable consultant utilization was 75.5% during the third quarter of 2011 compared to 75% in the year-ago quarter and 72.2% in the second quarter of 2011. As of the end of the third quarter of 2011, we maintained a total of 322 billable consultants, which includes 30 contractors. Billable head count was 294 at the end of the third quarter of 2010 and 309 at the end of the second quarter of 2011.

Quickly touching upon SG&A expenses, excluding any adjustments related to the estimated share value of contingent consideration, SG&A expense as a percentage of total revenue was 32% during the third quarter of 2011 compared to 34.9% in the year ago quarter and 29.2% during the second quarter of 2011.

In absolute dollar terms, SG&A expense totaled $8 million for the third quarter, which represented a year-over-year increase in SG&A expense of approximately $600,000 as compared to the third quarter of 2010.

The year-over-year increase in SG&A expense is related to increases in sales related salaries and wages inclusive of commissions related to our growth in revenue, product development expenses, travel expenses and marketing expenses, which are partially offset by a reduction in professional services related fees.

On a sequential basis, again excluding any consideration of the changes to the estimated fair value of the contingent consideration, third quarter SG&A expense on an absolute dollar basis was consistent with that in the second quarter of 2011.

During the third quarter, we incurred approximately $12,000 in embezzlement related expenses compared to $99,000 during the third quarter of 2010. While we did not incur a significant expense during the third quarter associated with the embezzlement issue, we continue to caution investors that we may incur additional costs related to this issue in the future. As we have stated in our periodic earnings calls, we do not have an estimate for anticipated future cost associated with the embezzlement issue at this time.

Our third quarter results include a $1.4 million reduction in the estimated fair value of contingent earn out consideration associated with both the Meridian and Fullscope acquisitions. During the quarter, in connection with the routine periodic review of Meridian’s projected operating performance, we reduced the carrying value of Meridian’s contingent consideration by approximately $1.2 million. We reduced the earnout consideration as the go forward projections at this time were below the minimum performance measurements required to achieve additional contingent consideration.

Additionally the company lowered the carrying value of the contingent consideration related to the Fullscope acquisition by approximately $230,000 during the third quarter and this is in connection with the finalization at the tax treatment for a previously estimated amount. As required by current accounting standards, any changes to the estimated fair value of contingent consideration, is to be reported as part of the company’s operating expenses.

Depreciation and amortization expense decreased on a year-over-year basis by approximately $300,000. The anticipated decrease is primarily associated with the reduction in amortization expense recorded against the intangible assets identified in connections with the company’s previously completed acquisitions.

We are reporting net income during the third quarter of $1.5 million or $0.13 per diluted share compared to a net loss of $22.7 million or $1.86 per diluted share in the year-ago quarter. A reminder that net income in the third quarter of 2010 includes a $21.1 million non-cash income tax charge associated with an increase to our previously established deferred tax valuation allowance.

Looking at our non-GAAP measures, adjusted EBITDA was $1.4 million or 5.4% of total revenue and $0.11 per diluted share in the third quarter. This compared to adjusted EBITDA of $515,000 or $0.04 per diluted share in the year-ago quarter.

Additional information regarding our use of non-GAAP measures including a reconciliation to the most comparable GAAP measures can be found in our press release that was issued earlier this morning and is posted on the Investor Relations section of our website at www. edgewater.com

Moving on to some final operating metrics. Total company head count was 424 at the end of the third quarter, of which 322 were billable consultants including 30 contractors. Positive news to report from a consolidated cash and cash flow perspective this quarter; cash and cash equivalents totaled $13.3 million as of September 30 compared to $10.9 million at the end of 2010.

During the third quarter, we increased our consolidated cash position by $1 million, while spending $3.1 million on stock repurchases during the quarter. Our ending cash balance as of September 30th, was supported by the generation of strong cash flows from operations during the quarter. Cash flow provided by operations was $4.2 million during the third quarter of 2011 compared to cash flow provided by operations of $1.3 million during the third quarter of 2010.

On a year-to-date basis, the company has generated $5.9 million in positive cash flows from operations. As of September 30, our cash and cash equivalents now represent a $1.18 per share.

Account receivable balances, including unbilled AR totaled $20.2 million at the end of the third quarter. Our DSO metric related to billed AR was approximately 57 days compared to 65 days at the end of the third quarter of 2010.

A final comment updating our stock repurchase authorization. During the third quarter, the company repurchased a total of 1.2 million shares of common stock at an aggregate purchase price of 3.1 million.

In September of 2011, the Company’s Board of Directors approved both an extension of the current repurchase authorization, which now runs through September of 2012 and an increase to the repurchase authorization from $8.5 million to $13.5 million. As of September 30, 2011, we have $4.7 million remaining on our stock repurchase authorization.

With that, I’ll now pass the call back to Shirley for final comments.

Shirley Singleton

Thanks, Tim. There’s no question in our mind that we’re getting operationally stronger and stronger. We’re continuing to be very happy with the execution against our strategic plan and I guess the core of that would be adding more and more product based consulting into the mix.

The ongoing performance of our ERP and our EPM unit is stellar. I’m very pleased with them. The integration of Fullscope has gone really well. They’re now fully integrated into the whole enterprise and we’re getting some traction on the newer Microsoft product based offerings that we’ve been tactically trying to move to over the last year.

Due to less billed days over the holidays, we always worry that customer shut down et cetera. We’re going to try to hold the line and try to not be slightly lower but as it stands right today, we will guide sequentially down, slightly down at the end of Q4 but we will be up year-over-year.

And with that Mary, we would like to take some questions.

Question-and-Answer Session

Operator

(Operator Instructions). Our first question comes from the line of Lee Jagoda from CJS Securities. Your line is open.

Lee Jagoda – CJS Securities

So software revenue was more than double what it was in Q3 a year ago. How should we think about the time it takes for that software revenue to turn into higher surface revenue in terms of -- did it happen all in this quarter or is there so going to be further follow through in Q4 and then in 2012?

Timothy Oakes

No I mean if you think let me ask you a question if you think of Fullscope’s delivery process. I mean these are longer life delivery projects than say an EPM project. So looking at the high level of product sales that they had in the second quarter which is typical because of Microsoft’s year-end combining with the software number in the third quarter, what that does is that serves to increase the delivery backlog pipeline for Fullscope and we would expect that to then burn out over the fourth quarter and to the first quarter of 2012 and beyond.

Lee Jagoda – CJS Securities

Great. And then in Q3 it looks like you were able to achieve about a 55% incremental service gross margin on incremental revenue, is there anything unusual either positive or negative in that number or is that sort of a good run rate number to use in Q4 and then beyond as you look at incremental revenue?

Timothy Oakes

I mean we’re not investing any time in trying to breakdown the incremental increase of 55%. I would look at it and say that we achieved growth in service revenue without a significant growth in billable consultants. So by default, we’re going to get better leverage from a profitability point of view on that additional incremental revenue.

Lee Jagoda – CJS Securities

Sure. And then one more question and I’ll hop back in the queue. Tim, do you have the end of quarter fully diluted share count?

Timothy Oakes

End of quarter fully diluted share count is $11.982 million.

Lee Jagoda – CJS Securities

And then did you make any additional repurchases after the quarter ended?

Timothy Oakes

No, I mean what we disclosed for stock repurchases was done in the third quarter. Obviously we’re in an earnings window; we’re not without a 105B1 program going to make any purchases while we’re in that window.

Operator

Thank you. Our next question comes from the line of Nick Halen from Sidoti & Company. Your line is open.

Nick Halen – Sidoti & Company

First question I had was, I know you mentioned you guys took on 38 new customers in the quarter and you already did through the first three quarters yet as manage did all of last year. I was just wondering I know you mentioned a few, but what industries in particular are you guys starting to see some demand ramp up?

Shirley Singleton

Okay, let me look through here, it looks like energy, manufacturing, healthcare, less so on financial services, but it looks like financial services we’re starting to pick up slightly, but I think on healthcare, energy and manufacturing.

Nick Halen – Sidoti & Company

Okay, it seems pretty broad base.

Shirley Singleton

It does. We have a huge insurance pipeline and it doesn’t seem to be breaking yet. So when you talk to me next time, I might be having insurance in that file as well.

Nick Halen – Sidoti & Company

Okay. And then just I’m sorry, go ahead.

Shirley Singleton

Well, go ahead.

Nick Halen – Sidoti & Company

And then I guess, just can you talk a little bit about what pricing is looking like in the current environment? Things seems to be picking up, but I mean in terms of pricing, is that getting any better or are we very similar to what we’ve been in the past?

Shirley Singleton

The pricing has got a little lift and you can see that when you look at that average annualized revenue per head. I think what has changed, and Dave Clancey can speak a little bit more of this is that contract negotiations with customers is really, really tough, there is a lot of pushback.

Timothy Oakes

We’re spending a lot of time. In the past, you typically use some standard boiler plate and everyone, both sides knew what it was, you did a little bit of a kabuki dance and you’re done. But now what goes on is people are really looking to carve out and manage their risks. So everyone seems to be unique. Another piece we’re seeing an interesting transition for is as we’re moving more to billing every hour away from going to say a daily bill rate. So as you start to see these pieces in negotiations go on and things get little bit more flexible, in fact some contracts they wanted to embed the travel within the total price of the contract?

Shirley Singleton

Yes, a little bit of contract changes going on.

Operator

Thank you. (Operator Instructions). We have a follow up from Lee Jagoda from CJS Securities. Your line is open.

Lee Jagoda – CJS Securities

Hi, Tim just one quick follow up, the payroll periods in Q4 of this year versus last year, do you have that?

Timothy Oakes

The pay I don’t have the actual number, but I think we are driving at cash flow for the quarter and we will have some downward drag on cash flow for the quarter as our last payroll of the period coincides with the last day of the quarter.

Lee Jagoda – CJS Securities

Is that a downward drag year-over-year or sequentially?

Timothy Oakes

I want to say in Lee, I have to clarify this after, but I believe that our last payroll period -- last year was actually the week before.

Lee Jagoda – CJS Securities

Okay. So, it should be the same number of payroll periods apples-to-apples Q4 last year to Q4 this year.

Timothy Oakes

I’d have to confirm. I don’t have that actual number in front of me.

Operator

And our next question comes from the line of George Melas from MKH Management. Your line is open.

George Melas – MKH Management

I just want to ask a fairly general question. Can you give a little bit more color on the three parts of the business, EP and ERP and sort of the other catch on and see if you’re getting traction on the other Microsoft product CRM?

Shirley Singleton

Sure. Well, there are the EPM business is primarily oracle channel where reportedly in the top side worldwide on budgeting and planning, we have all four major pieces of the modules that oracle produces in the EPM world. And we’ve opened an office in the UK recently and we are growing that business quite aggressively.

We actually have 10 employees in the UK. So the EPM business is going well. We won a couple of jobs over there in Europe and we see that as a growth area and as well as North America footprint continuing to grow.

On the ERP side its primarily comprised of Microsoft AX product that has been growing really nicely both the EPM and ERP seem to -- whether the recession of calendar ‘08, ‘09 and someone into ‘10 much better than our third business which is I will call it classic consulting that has a mixture of management consulting and technical consulting as well as custom development. What we have added in terms of that last piece the Tech consulting piece is the Microsoft product based consulting mix which primarily consist of Microsoft CRM and Microsoft share point.

We are getting traction more on CRM and SharePoint -- SharePoint is coming up, but I would call out CRM seems to be getting significant traction there is a fair amount of customers out there that are looking for a different way to handle their customer base and it’s not just can I keep my contacts in my note.

The Microsoft product itself towards has some extensions, it’s almost a development platform on to itself, so it works really nicely to extend the code and put customization into it. And where we’re seeing a little niche is actually in the coding process itself. When you’re going to whatever you’re selling whether it’s manufacturing visit or some kind of service, normally you have some kind of coding process. And your standard CRM packages are lean on that process. And the reason there lean is because everyone runs a coding process a little bit differently. So it’s a nice little marriage there of custom development, where that text routes with the product base consulting package that needs customization particularly in the coding process. So that is starting to gain attraction.

And then lastly what I’ll say across the board George is you will see us with the new service offering in 2012, which is high end application support. If you think about it, when people hire us to come in and do budgeting, planning in the Oracle space or AX in the Microsoft space or CRM in the again the Microsoft channel.

They don’t necessarily have internal folks that can take over these very high end applications. They might need some additional support. So I will characterize it as a call center, end user calls up and says, hey how do I write this report or get this information, it’s more technical people within the company contacting our technical crew on a trusted advisor level. And we are seeing some traction on all three platforms with the support of high end apps. Does that help?

George Melas – MKH Management

Yes, that’s helped a lot. This is a follow-up to that on the high end app support. Do you already have customers for that or have you sort of test -- have you sort of tested the service and does it seem to get traction?

Shirley Singleton

I wish I could say that -- I am glad you asked me that question I would have IMed you George for asking me that question, it’s a good one. The answer is, the support generate is working progress so I won’t characterize it is fully built out we have our work to do but and for instance in the Tech world we secured five new customers in Q3 in just that space in support.

George Melas – MKH Management

Okay. And give us a sense of what would be the revenue per customer per year for that type of apps supports?

Shirley Singleton

I hate to answer this way because it sounds like I am being cagey but I am not, it depends we would like to look at some kind of annuity revenue stream where there is a monthly retainer for their services and the answer is it depends because it depends on the breadth and depth of what they may need and again it’s a work in progress. I will be able to give you more characterization of that. As we start to finish building this out towards.

Operator

And if there are no further questions. I would like to turn the conference back to Ms. Shirley Singleton for closing remarks.

Shirley Singleton

Thank you, Mary. I did want to point out that Russell Smith, whose is our Senior Vice President who heads up our growing AX unit. He is going to be with Tim, our CFO out in San Diego on November 8, at the TechAmerica Classic Investor Conference. And I would encourage all of you to go out and say hi to them, and listen to maybe more of where we’re going with this. Our Q4 earnings call and year end call will be Wednesday, February 29, 2012, leap year.

With that Mary, I think we are all set.

Operator

Ladies and gentlemen, if you wish to access the replay for this call you may do so by dialing 1800-340-8014 or 404-537-3406. 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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