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Executives

Paul Neice – Director of Finance

Shirley Singleton – Chairman, President and Chief Executive Officer

Timothy Oakes – Chief Financial Officer

Analysts

Lee Jagoda – CJS Securities

Nick Halen – Sidoti & Company

Edgewater Technology, Inc. (EDGW) Q1 2012 Earnings Conference Call May 2, 2012 10:00 AM ET

Operator

Good morning and welcome ladies and gentlemen to Edgewater Technology Inc.'s First Quarter 2012 Financial Results Conference Call. At this time, I would like to inform you that this conference is being recorded for 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 would like to turn the conference over to Paul Neice, Director of Finance for introductions. Please go ahead.

Paul Neice – Director of Finance

Thank you, (Marie). Good morning everyone and welcome to Edgewater Technology’s First Quarter 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 you 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 – Chairman, President and Chief Executive Officer

Thanks, Paul. Good morning everybody. We are really pleased to put up another strong quarter. Our previous guidance as it relates to service revenue was we've predicted will be sequentially flat typically and we see Q1 as a little bit softer with CFOs deciding to finish up their year end and not venture into new projects, but that was not the case this quarter, instead we grew 5% sequentially and we grew 10% year-over-year.

Let me share with you where the growth is coming. The growth is coming from traction in the channel-based offerings. On the last earnings call, I spent I would say a good deal of time, more time than I usually do describing all of the offerings that Edgewater brings to market and I mentioned that the Microsoft and Oracle channels we were seeing some expansion there.

The proposals going out the door in Q1 continued to be of an increased size both in depth and breadth, and in particular, if I spoke within on EPM that Oracle EPM offering, we have traditionally gone to market from a horizontal point of view. Robin Ranzal was actually bringing more vertical into that space and we are starting to sell more aggressively vertically as well as horizontally. And in particular, I wanted to call out energy and utility seems to be a place, where we are getting traction.

We are also starting to see some cross-selling synergies, particularly selling around the Microsoft Dynamics brands. Last call, I talked about that the X business is moving right along, that's the ERP portion and that we were organically growing a CRM practice, both of AX and CRM are under what they call the Microsoft Dynamics brands, and in particular, we are seeing traction of those two things cross-selling each other, which is relatively new for us in the process and discrete manufacturing space.

If we look at how many customers, we secured during the quarter, it was 27 and I'll name a few, Georgia Gulf, St. Luke's, TripAdvisor, United Healthcare, and here comes our energy ones, Tucson Electric Power, SM Energy, CCS Energy Services, and 5Star Life Insurance.

With that, I'd like to turn it over to Tim and will get into the details.

Timothy Oakes – Chief Financial Officer

Thank you, Shirley. Good morning everyone. I'll quickly jump right into our prepared comments on the first quarter. Total revenue for the first quarter was $25.3 million compared to $23.6 million in the first quarter of 2011. Service revenue was $21.8 million during the first quarter compared to service revenue of $19.7 million in the first quarter of 2011.

On a year-over-year basis, we are reporting 7.2% and 10.6% growth in both total revenue and service revenue respectively. The year-over-year growth is all organic and reflects meaningful growth given the absence of service and royalty revenue contributions from Fullscope's process-related contracts recorded during the first quarter of 2011.

As described in our press release issued already this morning, we believe that our pipeline continues to grow in breadth and depth. We are starting to see expansion in potential deal sizes, especially in our key product-based service offerings. Additionally during the quarter, we continued to add new customers securing first-time engagements with 27 new customers, which is consistent with previous quarters. We are able to leverage this growth in expansion to drive first quarter 2012 service revenue growth.

On a sequential basis, total revenues decreased by $1.1 million or 4.3% compared to the fourth quarter of 2011. The sequential decrease in total revenue was the net result of a $1.1 million or 4.6% increase in sequential service revenue offset by a $2.4 million decrease in software revenue. As with our increase in year-over-year quarterly service revenue, sequential quarterly growth is similarly being driven by the demand for our product-based consulting services.

Software revenue, which includes related maintenance revenue was $1.4 million during the first quarter and represented 5.5% of our total quarterly revenue. This compared to $1.6 million or 6.7% of total revenue during the first quarter of 2011. Our quarterly software revenue primarily consists of re-sales of Microsoft Dynamics AX software and maintenance.

As we do each quarter, we'd like to remind you that quarterly software revenue is volatile and is subject to customer demand. With respect to other standard quarterly revenue metrics, we note that our annualized service revenue per billable consultant metric was $352,000 in the first quarter of 2012 compared to $327,000 in the first quarter of 2011 with the increase in this metric being the result of periodic service revenue mix. As I previously mentioned, we entered into first-time engagements with 27 new customers during the first quarter, which is in line with the 32 new customer engagements we entered into in the first quarter of 2011.

Service revenue generated during the quarter by top 10 customers represented 24.7% of total service revenue compared to 25.9% in the first quarter of 2011. No customers accounted for more than 5% of our total service revenue during either the 2012 or 2011 quarterly periods.

Moving on to gross profit, total gross profit as a percentage of total revenue was 33.9% during the first quarter compared to 36.4% during the first quarter of 2011 and 37.5% in the fourth quarter of 2011. Gross profit margin related to the service revenue was 37.4% in the first quarter compared to 38.5% in the first quarter of 2011 and 41.6% in the fourth quarter of 2011. The decrease in first quarter year-over-year total gross profit is primarily the net result of growth in our quarterly service revenue tempered by the increase in salary and wage-related expenses associated with the increase in billable consultant headcount and the absence of royalty revenue from the Fullscope process-related contracts.

During the first quarter of 2012, we increased billable headcount by 18 as we hired in trained consultants into key product-based offerings ahead of anticipated demand. First quarter total gross margin on a sequential basis is reflective of the increase in first quarter service revenues again tempered by the increase in billable consultant headcount and a decrease in gross margin contribution due to the overall decrease in software revenues.

The year-over-year sequential decreases on our service revenue gross margin is attributable to the comparative increases in periodic service revenue offset by the salary and wage related increases due to the periodic increases in billable consultant headcount and to a lesser extent fluctuations in our billable consultant utilization rates. We maintained billable consultant utilization at 75.5% during the first quarter despite the increase in billable consultant headcount.

Comparatively, billable consultant utilization was 79.3% during the first quarter of 2011 and 75.6% during the fourth quarter of 2011. As of the end of the first quarter, we maintained a total of 331 billable consultants, which included 27 contractors. Billable headcount including contractors was 311 at the end of the first quarter of 2011. Touching upon SG&A, SG&A as a percentage of total revenue was 31.5% during the first quarter of 2012 as compared to 31.9% in the year ago quarter and 41.4% during the fourth quarter of 2011. A reminder that SG&A expense during the fourth quarter of 2011 included a $2.2 million non-cash charge associated with the company's abandonment of certain lease base within its corporate headquarters.

In absolute dollar terms, SG&A expenses totaled $8 million in the first quarter, which represented a year-over-year increase in SG&A expense of $424,000 as compared to SG&A expense of $7.5 million in the first quarter 2011. The year-over-year increase in SG&A expense is primarily associated with increases in sales related salaries and wages, inclusive of increases in commission expense, as a result of our revenue growth. Recruiting expenses in connection with our growth in billable consultant headcount head to a lesser extent product development expenses. These comparative increases were partially offset as anticipated in connection with actions taken by the company during 2011 by reductions in both rent-related expense and professional services fees.

On a sequential basis, SG&A expense on an absolute dollar basis decreased by $3 million, remainder of that $2.2 million of this decrease is directly related to the fourth quarter lease abandonment charge. Other sequential quarterly decreases in SG&A are attributable to decreases in salaries and wages exclusive of fringe-related expenses, which increased during the first quarter as a result of FICA limit resets. Bonus and commission expenses due to the resetting of performance based bonus programs, rent expense, and product development costs.

During the first quarter, we did not incur any significant expense associated with the Fullscope embezzlement issue. While we did not incur any significant expense, 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.

Depreciation and amortization expense decreased during the first quarter as compared to the first quarter of 2011 by approximately $261,000. The decrease is primarily associated with the reduction in amortization expense recorded against the intangible assets identified in connection with the company’s previously completed acquisitions.

We are reporting net income of $175,000 or $0.02 per diluted share during the first quarter of 2012 compared to net income of $310,000 or $0.03 per dilute share during the first quarter of 2011. With respect to our non-GAAP measures, adjusted EBITDA was $1 million or 3.9% of total revenue and $0.09 per diluted share in the first quarter of 2012 compared to adjusted EBITDA of $1.4 million or $0.11 per diluted share in the year ago quarter.

And looking at the year-over-year first quarter changes in adjusted EBITDA, current quarter service revenue growth was offset by the increases in salaries and wages associated with our investment in recruiting and training of billable consultant headcount in the absence of $535,000 in royalty revenue generated from the process-related contracts. 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 is posted on the Investor Relations section of our website at www.edgewater.com.

As we highlighted during our full year 2011 earnings call, we want to continue to inform investors that we have been able to leverage the development work we performed under Fullscope's process-related contracts and our developing proprietary software modules based upon the Dynamics AX platform. We have incurred and we anticipate that we will continue to incur product development-related expenses. Examples of such development efforts released by the company include the Chemical Accelerator and FDA Toolkit and the recently announced Process Industries 2 solution for chemical, food, and life sciences companies. Releases related to these products can be found on our website.

Moving on to some final operating metrics, cash and cash equivalents totaled $8.8 million as of March 31 compared to $10.3 million at the end of 2011. As of March 31, our cash and cash equivalents now represent $0.76 per diluted share. We are reporting cash outflows from operations of $1.1 million during the first quarter of 2012. This compares to cash outflows from operations of $1.3 million during the first quarter of 2011. We have historically reported net cash outflows from operations during the first quarter of a given fiscal year. This in connection with recurring payments associated with the company’s prior year performance-based bonus programs, premiums associated with the renewal of annual insurance programs, and estimated state income tax liabilities.

Accounts receivable balances including unbilled AR total $22.6 million at the end of the quarter and our DSO metric related to billed AR was approximately 68 days. This compared to 65 days at the end of the first quarter of 2011.

A final comment updating our stock repurchase authorization. In March 2012, the company’s Board of Directors authorized a written trading plan under Rule 10b5-1 of the Securities Exchange Act in order to facilitate the repurchase of the company’s common stock pursuant to the company’s existing stock repurchase authorization.

During the first quarter, the company repurchased a total of 69,000 shares of common stock at an aggregate purchase price of $260,000. As of March 31, we have just over $4.3 million remaining on our stock repurchase authorization, which expires in September of 2012.

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

Shirley Singleton – Chairman, President and Chief Executive Officer

Thanks, Tim. All-in-all, we believe we had a really good quarter. As Tim mentioned, we made a strategic decision to higher ahead of the strong pipeline. Resources in ERP and EPM are really hard to find, and with our growing presence in these areas, we have made a strategic decision to be aggressive in securing some new staff and that does include some ramp up training in bringing our net new staff. We anticipate that Q2 service revenue will be slightly up sequentially, but strongly up year-over-year.

With that (Marie), we would love to take some questions.

Question-and-Answer Session

Operator

(Operator Instructions) 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.

Timothy Oakes

Hi, Lee.

Lee Jagoda – CJS Securities

Shirley, can you quantify the impact of the hiring in Q1 in anticipation of the demand versus I guess what you normally do just hire people when you have the contracts already signed?

Shirley Singleton

Sure, Tim do we have?

Timothy Oakes

Yeah, I mean, you could – Lee I'd have to answer on a global basis meeting, I can't really stratify the increase of 18 as it relates to ongoing work or hiring in advance of demand and putting people on training – internal training programs and whatnot. But if I just isolate on the 18 heads assuming a flat annual salary and low NIMs on fringe. You are probably looking at a number, that’s over $600,000.

Lee Jagoda – CJS Securities

That’s for the full 18 or not for the piece that's being hired?

Timothy Oakes

Yeah, I don’t have stratified information on the head count as to who related to what. I cannot look at it right now on a global number of the 18 heads.

Lee Jagoda – CJS Securities

I guess asking the question is slightly differently as we look into Q2, how many of those 18 or any future hires will be sort of underutilized based on waiting for the work to be signed?

Shirley Singleton

I can’t give you a definitive answer on that, because what happens in our business is people keep coming up and down on projects. Our hope is that we could roll these people right into billable assignments. It does depend upon timing of jobs closing.

Lee Jagoda – CJS Securities

Okay. And just yeah a couple more to what extent is both your Q2 revenue guidance as well as your view of double-digit service revenue for the full year predicated on some of these larger potential deals closing versus just your regular deal flow?

Shirley Singleton

I think my opinion on giving guidance about double-digit annual growth and the guidance we have given for Q2 is based on just our regular pattern of closing business. What caused me to change in terms of hiring a head, because you've known me for a long time, Lee, and I typically don’t do this is when I look at things in the pipeline that are historically maybe a $200,000 first-time gig and there is multiple instances of $2 million as part of our first-time gig. If I just play the statistics game and part of this is statistics is that we are going to hit on some of those. And I don’t want to be there without the resources, and with the resources being scarce, that’s causing me to make this move. I would have liked to have seen more lift in profit. The easiest thing I could have done was giving more profit to the shareholders and not hired, but that would not be looking at the business over the long-term in building a deep depth powerful business. It’s to me it's a marathon, it's not a spread. So, if I was going for the profit, I would have not hired the people and I would have been (indiscernible) down on some of these things that are in the pipeline. When they close the function of the customers signing on the dotted line, I wish I was a fear here like look out and say when they are going to sign it.

The other artifact that I will give you some more color, Lee, because I know the investors probably have a lot of questions in this area is if you think that, that's on the EPM side, that I am talking about that these large deals are there. And why have they grown in such depth and I took a peak into that? And historically, we sold planning separately and budgeting separately and consolidation services separately and strategic finance separately.

And if you look back in our earnings call, we talked about that we – I want to say this is more than a year ago that we are one of the few guys out there that have all four products under oracle EPM that we possess all of them, which was very unique. The rise in the proposal sizes are because customers are looking at bundling all of the products up in one as one sale and that is very different than what we have seen in the past. So, that's one piece.

Second piece I'll give you is on the ERP business. You know – the investors know that we actually are 2012 AX competency center as viewed by Microsoft. The reason why I feel like I can make that statement is because we built a lot of the process code and that was part of that process contract that finished in June 2011. Microsoft is not selling AX 2009 going forward. They are only going to sell 2012. So, you have resources out there that maybe 2009 competent, i.e., they know ERP, they know the functions within AX, but they may not know in 2012 version of set packages.

Having us built part of that package for Microsoft, we are one of the few 2012 competency centers. So, as we grow ERP, we are recruiting in – it's pretty high odds, we are going to be able to secure 2009 competent people, but not 2012, and that's where the training comes in. Does that help, Lee?

Lee Jagoda – CJS Securities

Yeah, that's very helpful. And Tim just one more question and I'll back in queue. Do you have – have you repurchased any shares post the end of the quarter and so can you give us some sense for the magnitude?

Timothy Oakes

Yeah, obviously we have with the 25 program in place, which allows us to repurchase during normal blackout period. So far in Q2 to-date, we've repurchased just about 20,000 shares and aggregate purchase value of about 78,000.

Lee Jagoda – CJS Securities

Great, thanks very much.

Operator

Thank you. (Operator Instructions) Our next question comes from Nick Halen from Sidoti & Company. Your line is open.

Nick Halen – Sidoti & Company

Good morning, guys.

Shirley Singleton

Hi, Nick.

Timothy Oakes

Hi, Nick.

Nick Halen – Sidoti & Company

So, the first question I had is I know you touch on briefly about the low utilization and the increase in the consultants and everything like that. I know what you said it's tough to tell, but I guess just looking at the full year of 2012, I mean, do you guys still expect by year end to have a utilization rate in the high 70s, I mean is that still so feasible in your mind.

Shirley Singleton

Yeah, that's always our goal. I can't predict utilization. We don't put guidance on utilization, but absolutely.

Nick Halen – Sidoti & Company

Okay.

Shirley Singleton

Not the goal, yeah.

Timothy Oakes

We would leverage the growth mix to drive utilization.

Nick Halen – Sidoti & Company

Okay. Also I guess do you keep track of what percentage of your customers who I guess by your EPM and ERP software, what percentage of those customers are also purchasing maintenance on that software and do you see an opportunity for that to expand?

Shirley Singleton

There is a higher repeat factor of maintenance services on ERP. There is a growing service that people are asking for in EPM and it's a (various) two question. We alluded to some of this in the last earnings call that we were going to start push some of the support because that the resources, there is not a lot of resources out there especially in all four product in EPM that they are continues updates needed in terms of their budgeting and planning each year, the CFO who is going to do a new budget and they may not have those resources to go in and help them make the changes that are needed. So, there is a growing movement and support for EPM.

Nick Halen – Sidoti & Company

Great, thanks guys.

Shirley Singleton

You're welcome.

Operator

Thank you. I show no further questions. I would like to turn the conference back to Ms. Shirley Singleton for closing remarks.

Shirley Singleton – Chairman, President and Chief Executive Officer

Okay. So, we have a lot of activities coming up guys. We are on a mini road show next week in the Midwest. We are at the B. Riley Conference on May 23 that would be in California. We have our Annual Shareholder Meeting on June 6 here in the Wakefield area in Massachusetts. We are hosting the Closing Bell Ceremony for NASDAQ in New York on Tuesday, June 19 and our Q2 earnings call will be August 1. So, we have got a full play and we look forward to speaking with you again. With that (Marie), I am all set.

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 140-4537-3406 and using access code 68572001. This concludes our conference for today. Thank you all for participating and have a nice day. All participants may now disconnect.

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