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EPIQ Systems (NASDAQ:EPIQ)

Q4 2012 Earnings Call

March 04, 2013 4:30 pm ET

Executives

Lew P. Schroeber - Vice President of Investor Relations and Finance

Tom W. Olofson - Chairman and Chief Executive Officer

Christopher E. Olofson - President, Chief Operating Officer and Director

Elizabeth M. Braham - Chief Financial Officer, Principal Accounting Officer, Executive Vice President, Corporate Secretary and Treasurer

Analysts

Timothy McHugh - William Blair & Company L.L.C., Research Division

Peter J. Heckmann - Avondale Partners, LLC, Research Division

Vincent A. Colicchio - Noble Financial Group, Inc., Research Division

Operator

Good day, ladies and gentlemen, and thank you for your patience, you've joined the Epiq Systems' Fourth Quarter 2012 Conference Call [Operator Instructions] As a reminder, this conference may be recorded. I would now like to turn the call over to your host, Mr. Lew Schroeber. Sir, you may begin.

Lew P. Schroeber

Thank you, and welcome, everyone. With me today to lead the discussion and address your questions are Epiq Systems Chairman and Chief Executive Officer, Tom Olofson; President and Chief Operating Officer, Chris Olofson; and Executive Vice President and Chief Financial Officer, Betsy Braham.

Our earnings release was today at 3 p.m. Central Time and is available on our website at epiqsystems.com. The webcast replay of this earnings call will be available on our website until next quarter's call, and a phone replay will be available through March 18.

As always, we discuss our financial objectives and make forward-looking statements during this call. We remind you that forward-looking statements involve a number of risks and uncertainties that could cause actual results to differ materially from those indicated. These risks are included in our earnings release and also in our annual report on Form 10-K and the quarterly reports on Form 10-Q, which are filed with the SEC and available on our website or the SEC's website. We strongly encourage you to review these risk factors.

It is now my pleasure to turn the call over to Epiq Systems' Chairman and CEO, Tom Olofson.

Tom W. Olofson

Thank you, Lew. Good afternoon. Thank you for joining us. We'll follow our usual format for the conference call. I will begin and highlight the financial performance. I'll turn things over to Chris for his remarks. I'll then come back and talk about 2013. Betsy will then join Chris and me, and we'll take your questions in the Q&A session.

So let's begin with highlights from Q4 and the full year. For the year, operating revenue came in at $344,750,000. That represented a 32% increase versus prior year. We had a strong fourth quarter, $88,221,000, and that was a 29% increase versus prior year.

Net income, and I'll give you the GAAP net income per share, as we say in the press release, this is adjusted for a noncash acquisition-related fair value adjustment and we explained that to you in the narrative. That particular adjustment does not impact our non-GAAP performance. But net income per share, $0.61 for the year versus $0.33 last year, $0.11 for the quarter versus $0.05 last year.

Non-GAAP adjusted EBITDA came in at $92,333,000 for the year. That was up 13%, and it was up 5% at $23,685,000 for the quarter.

Now our non-GAAP net income per share, $0.96 for the year, which was in line with the guidance that I provided you at our last call, and this showed a 10% increase versus $0.87 last year.

I might add that this represents the fifth consecutive year, if you go back to 2007, in which we've had consistent double-digit growth in the non-GAAP EPS. And over that 5-year period, we've actually averaged 14% per year. For the quarter, $0.26, this represented our best quarter of the year. It was actually a record quarter, but we finished the year on a very strong note with the $0.26.

We always talk about cash from operations. We had a very strong year, $73,735,000. And that was up 45% versus the prior year. This gives us very good cash strength, flexibility. And as you know, we always place a special priority on the cash that we generate in the business.

A couple of selected balance sheet items. Over the course of the year, our indebtedness decreased from $264 million down to $212 million. Our equity increased $333 million, up to $343 million. We also had one favorable development relative to our GAAP tax rate. This does not affect our non-GAAP numbers, but the GAAP tax rate, 36.7% for the year. And this actually came down from 42% the year before. And if you have a question on that, Betsy will be happy to give you any additional detail. But we're always looking to see how we can improve that tax rate.

In looking at the segments, first of all, how the revenue was broken out for the course of the year. We finished the full year with eDiscovery comprising 57% of our revenue. In the fourth quarter, it was actually 62%. It is the largest business we have. It is the growth engine, as you know. And I would tell you that the 62% that we had in the fourth quarter, that's probably about the ratio of eDiscovery revenue we'll have for the full year of 2013.

So I would put eDiscovery revenue of 2013 right there in the low 60% range. For the full year, we had Bankruptcy revenue at 26% and Class Action Settlement at 17%.

Several other comments relative to the segments, and Chris will talk more about the segments here, momentarily, but a couple of interesting things. Let's look at eDiscovery first. $197 million in revenue for the full year, which was up 48%. We felt we had a good solid year in eDiscovery. The non-GAAP adjusted EBITDA for the year was up 31%. In the fourth quarter, revenue was $54.5 million, up 49%. EBITDA was up 34% for the quarter. The $54.5 million was our best quarter of the year, and we did conclude the year, therefore, on a very strong note. And as we told you we would do, we had good solid sequential growth in the second half of the year. Q3 was up from Q2, and then Q4 was up from Q3. So we felt that was a solid finish to the year and actually a good solid overall year for eDiscovery.

Bankruptcy, Chris will talk more about the cycle. You're all aware that we're in a down bankruptcy cycle. Naturally, filings are down quarter-to-quarter. We expect that to continue for a while longer. Interest rates are also at record lows, close to 0%. We think those stay that way for a while.

But in the not-too-distant future, we see a return to more robust bankruptcy filings. It's a little difficult to pinpoint that timing, but we're fully prepared for that. We're maintaining good solid market share and when that market returns, we'll be ready to fully capitalize on it.

For the full year, we did $88.3 million in revenue. Actually, even in a down cycle, it was only off 4%. And in the fourth quarter, $21.3 million, it was off 10%.

In the Settlement Class Action business, this is one where we typically really look at it on a full year basis. As you know, it's subject to some fluctuations from quarter-to-quarter. And if we look at the full year, which is a good way to examine those result, we had a very, very strong year. Revenue came in at $59.5 million for the year, it's up 64%. It was really a very, very good year, up from $36 million the year before. And with a 64% revenue increase, we had an 83% EBITDA increase. And so we were able to improve the margins.

The last comment I would make would be in regard to the dividend program. The dividend program has been well received by our investors. We had a very strong year in 2012. We actually increased the dividend twice during the year. You may recall, we paid $0.05 per quarter earlier in the year. We took it up to $0.065, we took it up again to $0.09. And we then had a special dividend in addition to the 4 quarterly dividends. And that special dividend was paid at the very end of the year, that was also in the $0.09 rate. We just declared a dividend on February 28, and that next dividend will be paid June 3 to shareholders of record on May 1.

So we continue with what we think is a strong dividend program. Right now, we have a yield of about 2.9%. All in all, I think we had a good solid year.

I'd like to call upon Chris to provide you his commentary, and then Chris will turn it back to me, I will speak to the year 2013, and then we'll take your questions.

Christopher E. Olofson

Good afternoon, everybody. Thank you for joining us. I'd like to walk through the segments one by one, starting with eDiscovery. eDiscovery continued to build strength late in the year, and it finished with a new record for quarterly revenue at $54.5 million, nearly a 50% increase versus the year-ago quarter. International engagements showed significant results in Q4, in both the U.K. and in Asia, including achievement of record revenue months.

For the full year, eDiscovery in 2012 also reached a new record level of revenue at $197 million, an increase of just less than 50% versus approximately $133 million in the year prior. That, as Tom mentioned, made eDiscovery the largest segment, representing approximately 57% of total company revenue for the year. eDiscovery gained momentum as the year unfolded and showed a nice Q2, Q3, Q4 chain of sequential growth, with $42.7 million, $50.9 million and $54.5 million in each quarter, respectively.

We anticipate that eDiscovery will continue to be the growth driver for the company in 2013. Early on here in the new year, our largest eDiscovery engagements are coming from the M&A space, particularly on second request work here in the United States and continuing strength in the international division, with a number of assignments related to the banking sector and regulatory investigation.

Both of our eDiscovery strategic acquisitions from 2012 are substantially integrated. This enabled us to close the year, checking that assignment off and entering 2013 with new strengths in the marketplace. We continue to be among the top tier of global eDiscovery franchises. We continue to plan our strategy in a marketplace that remains highly fragmented and where we see continuing growth opportunity.

Epiq has a unique strength in the combination of both our proprietary technology tools and having the leading distribution status for a variety of third-party tools. And we are witnessing the continuing expansion of the global nature of our business, having done assignments now in approximately 50 countries.

As we announced on February 25, we are opening a full-service office for eDiscovery and document review in Tokyo, with an anticipated opening in very early spring of this year. We have welcomed a very seasoned General Manager with significant in-country eDiscovery expertise, who will launch that office for us. We see a significant market opportunity in Japan, and we have a good track record for growing the International business first in the United Kingdom and subsequently, Hong Kong.

This will add to some very important competitive differentiation that we have in the marketplace, particularly since all of our international locations are full-service offices with project management, data centers, IT, document review and not simply sales offices.

Turning to the Bankruptcy segment. We are at a low point in the bankruptcy cycle right now, with fewer filings. The Bankruptcy segment and all of its component revenue lines has experienced and will continue to experience these effects of lower bankruptcy filings and macroeconomic conditions throughout 2013.

That said, in the context of the marketplace, our bankruptcy franchise remains very strong and in fact, ended the year on a stronger note that we anticipated at the beginning of the year. Q4 Bankruptcy revenue is essentially comparable compared to the sequential quarter of it down versus the year-ago quarter, but this really reflects market conditions and lower filing levels.

In Corporate Restructuring, some of the 2008 and 2009 cases from the peak of the filing period are beginning to wind down or not yet being replaced. Those Corporate Restructuring matters that are filing presently are moving through the system faster and are often asset sales or prepacks that represent a smaller revenue opportunity for Epiq.

Nevertheless, Corporate Restructuring had a very strong start to the year, with high activity in cases from our current inventory and of those new matters in the marketplace that have filed in 2013. We have held very strong market share. We do envision uptick in bankruptcy filings as leveraged debt in the marketplace matures.

In Settlement Administration, this business showed excellent revenue growth versus 2011, coming in at just $60 million approximately. This was the best year ever since we concluded the mega TV converter case several years ago in 2009. We were retained on signature cases, including BP Deepwater Horizon, on which our assignment has completed and the Payment Card Interchange matter, the largest private antitrust settlement in history, which is ramping up.

As usual, this is the segment that is subject to the most quarterly volatility of all of our businesses. So as Tom mentioned, we believe it's most appropriate to look at it from an annualized perspective.

So some parting comments and then Tom will step back in and talk about our objectives for 2013. The fourth quarter was the strongest of the year and set a new record for quarterly earnings results. For the full year, results were in line with the objectives set forth in the Q3 conference call. We had a very nice -- a strong finish to the year, with record quarter for eDiscovery and the startup of the largest private antitrust case in history in Settlement Administration. 2012 was another year of double-digit non-GAAP EPS growth. And as we have started in 2013, with lending a bit of color to eDiscovery, our largest engagements are coming from the M&A space, domestically, particularly on second requests and in international bank regulatory work.

At this point, I'd like to turn the call back over to Tom.

Tom W. Olofson

Okay, thank you, Chris. Let's touch on 2013, and then we'll take your questions. First, if I look at the segments in 2013, at the revenue level, I would provide the following commentary: We anticipate that eDiscovery will have a very strong year. As Chris indicated, we're having nice growth domestically, we're having some very, very strong growth internationally, which we think is excellent. So when I look at the overall eDiscovery business in '13, I would look for between 15% and 20% growth in revenue.

In terms of the Bankruptcy business, as Chris and I have both commented, we're naturally in a low cycle, and this is a cyclical business. When we're in a low cycle, even though we're doing a very nice job on market share, and we're bringing in some good cases, there's only so much to work with. So I would say that for the full year, assuming we stay in that cycle, rate stay at 0, I would look at Bankruptcy revenue to decline in the 10% to 15% range. And I think everything considered that, that represents a good solid performance considering the market conditions in that particular sector.

In the Class Action Settlement business, the good news is that we moved right up to $60 million last year from $36 million the year before. And this was good solid, what I call traditional Class Action Settlement business. Chris mentioned, we had a really strong year, if you go way back to the 2009 period or thereabouts. But that was the NTI business, which was really a one-off kind of an arrangement. The business we're getting now, including the very large cases, are really, again what I refer to as the traditional bread-and-butter Class Action type business.

So even though we moved up to $60 million last year, I expect that we will increase just a bit further this year. And so I would look for a 5% to a 10% increase in revenue in Class Action over and above the $60 million we hit last year. And recognizing the year before was $36 million, I think that is a very nice accomplishment. So I would size up the 3 segments that way: eDiscovery, up 15% to 20%; Class Action, up 5% to 10%; Bankruptcy, down 10% to 15%.

Now looking at operating revenue, adjusted EBITDA and non-GAAP EPS for the full year 2013 and giving you a range at this point in time. Let's start with revenue. Last year, $345 million. The range I would give you in '13 is $365 million to $380 million. Adjusted EBITDA last year, $92 million. I would give you a '13 range of $98 million to $102 million. Non-GAAP EPS last year, $0.96, I would give you a range in 2013 of $1.03 to $1.06.

Now talking a little bit further about the early part of 2013, recognizing that we're moving through the first quarter. In Q1, a couple of interesting things are going on. We will have strong revenue in Q1. I think the entire company in Q1 will be up in the range of 15% to 20%. However, we have an interesting change in this quarter relative to product mix. We have some heavier Class Action Settlement business, heavier document review business. They carry lower margins, and that will have an impact on the margin and the profitability for Q1.

The really good news in Q1 is that in eDiscovery, in the month of February, we had a record month for closed business. Now I'd like to see that trend continue in the month of March, hopefully, it does. But in February, it was really very, very strong. The very best month we ever had in terms closed business for eDiscovery. We recognize a good bit of that business will not materialize into recognized revenue until we get into Q2 or perhaps even later.

So when you put all those dynamics together, the strong revenue overall, the product mix change and very strong eDiscovery closings, but probably the revenue not recognized until Q2, we had $0.26 in Q4 on non-GAAP EPS, I would see that come down a few pennies. It's not uncommon for us to have Q1 lower than the prior Q4. We've had that happen a number of times before. I would say probably something -- it might be in -- even in the $0.23 range, it's a little bit early to tell. But I would give you that kind of guidance trying to be as thorough with you as I can at this point.

So if Q1 comes in at $0.23-ish or thereabouts, with very strong top line revenue and very strong closings in eDiscovery, that naturally will lead to the stronger margins and strong revenue as we go into Q2 and move on from there.

So I'm comfortable with the full year numbers I've given you. I think we're going to have a good solid year, especially considering on a corporate wide basis that we still have a low cycle in bankruptcy, both Class Action and eDiscovery are going to do very, very nicely. And I wanted to give you as much detail on that as I could, including the very beginning of the year and then the full year. So hopefully, that helps you put things in good perspective.

With all that said, we'll have Betsy join us. Chris, Betsy and I are happy to take your questions. At this time, I'll ask the operator to move into the Q&A session.

Question-and-Answer Session

Operator

[Operator Instructions] Our first question comes from Tim McHugh of William Blair & Company.

Timothy McHugh - William Blair & Company L.L.C., Research Division

First I wanted to follow-up on a few of the comments about eDiscovery. How big is the international portion of the business now? And I guess, how much was that up for 2012?

Christopher E. Olofson

So international has been showing significant strength late in the year and very early this year. We generally do not break out the specific percentage of the whole within the segment. But suffice it to say, it's becoming an increasing important part of the segment. We believe that the new opening in Tokyo will add to that, and we see a particularly strong opportunity in the Japan market.

Elizabeth M. Braham

And I would just add to that, that the international growth exceeded our plans, but we don't specifically disclose our international revenue.

Timothy McHugh - William Blair & Company L.L.C., Research Division

Okay. I guess, the comment about second request, is that a change -- I know last year that was kind of a source of pain relative to -- for most of the year relative to at least the year-ago comparisons? Have you seen a change in the market? Or is it just kind of 1 or 2 projects?

Elizabeth M. Braham

No, we have seen a change in the market. So in 2011, we had record second request works that we did. In 2012, we saw our second request work decline quite significantly from the prior year. And as Chris indicated, as we go into the first quarter this year, we do see it picking back up significantly.

Timothy McHugh - William Blair & Company L.L.C., Research Division

And I guess on the margins, the comment about the mix shift towards marked document review in Q1, do you need to see that mix shift -- are you basically assuming that you shift back to kind of a normal balance across the rest of the year for -- to achieve the profit margins you're talking about?

Elizabeth M. Braham

That's right, Tim. So in Q1, what we're seeing is an unusual mix of both a combination of Settlement Administration and document review mix compared to what our norm is of our overall total product mix within the Epiq family. And so we do see that pulling down the overall first quarter margin, both for the eDiscovery segment and for the company as a whole.

Timothy McHugh - William Blair & Company L.L.C., Research Division

And have you seen any shift in terms of proprietary, that your technology sales versus the third-party tools that you guys sell, in terms of the client demand, or the mix of revenue for you guys?

Elizabeth M. Braham

No, I think that we are fairly consistent as we wound up 2012 and are going into 2013 with a mix that has been consistent since the acquisition of Encore.

Operator

Our next question comes from Peter Heckmann of Avondale Partners.

Peter J. Heckmann - Avondale Partners, LLC, Research Division

As regards -- as we look to the year, thanks for giving us a little bit more insight into the first quarter. I guess, this year is a little bit more of a challenge from a modeling standpoint in that we have a very difficult comparison in the second quarter in Settlement, but what appears to be relatively easier comparison in eDiscovery. The one big case that you have, the merchant antitrust, can you talk a little bit about how we might expect that to roll through the year? And if what quarters would we expect them to have the biggest effect.

Christopher E. Olofson

We see that the card interchange matter will have a significant contribution earlier in the year. But then in particular, in 2014, as we look at the different phases of the matter and how we see the calendarization of revenue, we see a concentration in the very early portion of 2013, then a quieter period, and then a significant contribution in 2014.

Elizabeth M. Braham

So we'll see a heavier first half of the year in 2013 than second half.

Peter J. Heckmann - Avondale Partners, LLC, Research Division

Okay, okay. And then, as regards, within the Bankruptcy segment. Last quarter, you had talked about an exciting new engagement with a, I think you said a -- was it a sovereign government? No details at the time, but are you at liberty to give any additional details at this point? And does your Bankruptcy guidance for 2013 anticipate that relationship ramping up?

Christopher E. Olofson

We are not in a position to identify the matter specifically. We are certainly able to say it's going very well, and our engagement has been quite successful. And we have anticipated that engagements contribution within the objectives set for 2013.

Peter J. Heckmann - Avondale Partners, LLC, Research Division

Okay, okay. And your GAAP tax rate, a little bit lower than expected. It appears that you used 40% for non-GAAP. What would you expect for GAAP tax rate in 2013? Can we see it below 40% again?

Elizabeth M. Braham

At this time, we're projecting a 40% tax rate. There's one component of the 2012 tax rate that won't be recurring, which was the benefit that came from effectively settling the state income tax audit claim. But we will get benefit in 2013 from the construction project of our corporate headquarters in Kansas City, as well as the R&D tax credit was approved at the beginning of this year. And so that'll have the practical effect of having the benefit for both 2012 and 2013 this year. So we do expect it to not be any higher than 40%, and at this point, we're projecting a 40% tax rate.

Peter J. Heckmann - Avondale Partners, LLC, Research Division

Okay. And then just lastly, as regard to your EPS guidance, what does that imply in terms of share repurchase?

Elizabeth M. Braham

At this point, we don't have any share repurchase factored into our objectives. That doesn't mean that we wouldn't necessarily pursue it. But because we have debt, the practical effect of a share repurchase on our non-GAAP EPS is minimal.

Tom W. Olofson

Yes, Pete, I think that the way we look at that -- it's a really good question. The dividend program, we support in a very robust way, our investors have received it well. While we don't have anything currently to say strategically, you're aware that we're always proactively looking for a really, really attractive strategic opportunity that, that fits well strategically and contributes in an accretive way financially. But I think with all that said, recognizing that we probably borrowed the money to do it, I'm not sure we'll be real active with share repurchase. It's authorized. We could do it. We don't have a plan to do it right now.

Operator

Our next question comes from Vincent Colicchio of Noble Financial.

Vincent A. Colicchio - Noble Financial Group, Inc., Research Division

Tom, if my calculations are correct, it looks like electronic discovery margins declined sequentially, despite higher revenue. What was behind that?

Elizabeth M. Braham

So the margins for eDiscovery, as we continue to look at the document review business becoming stronger, the document review business has a lower margin than the traditional ESI business. It's the same dynamic that we're seeing in Q1. However, in Q1, we're seeing it to a greater degree than we did in Q4.

Tom W. Olofson

It's important, Vince, that we really aggressively pursue document review. It's a key part of the business. It offers us a lot of advantages to do that. So we really geared up to have a very robust program in that area. But as Betsy and Chris had pointed out, the margins are lower there. So if document review becomes a large part of eDiscovery, which it is, naturally, the margin will come down somewhat. But the other side of the coin is that it's part of the business that we really do want to pursue aggressively and really be a leader internationally in document review. But those are the dynamics.

Elizabeth M. Braham

Yes. And keep in mind that third quarter of 2012 was our largest eDiscovery margin quarter at 38.9% in Q4. It came down, but it was still higher than Q1 and slightly below Q2. So we do see variances in those margins from quarter-to-quarter.

Vincent A. Colicchio - Noble Financial Group, Inc., Research Division

Okay. And your G&A cost picked up quite a bit in the 4Q. Will that elevated level continue into the 1Q?

Elizabeth M. Braham

We wouldn't expect to see the G&A expenses vary significantly. Again, it was lower than it was in the first quarter, and we do see some variation of our G&A expenses from quarter-to-quarter also. And we would expect our overall 2012 average to be a consistent average for 2013.

Vincent A. Colicchio - Noble Financial Group, Inc., Research Division

And just 1 more question, on Electronic Discovery, in terms of the competitive landscape, any meaningful changes in the quarter?

Elizabeth M. Braham

No. No significant changes in the quarter.

Operator

At this time, I'd like to turn the call back over to Chris Olofson for any closing remarks.

Christopher E. Olofson

Thank you, all, for joining us. We hope you have a nice afternoon.

Operator

And thank you, ladies and gentlemen, for your participation. That does conclude your program. You may disconnect your lines at this time. Have a great day.

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