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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

EPIQ Systems (EPIQ) Q1 2013 Earnings Call April 30, 2013 4:30 PM ET

Operator

Good day, ladies and gentlemen, and welcome to the Epiq Systems First Quarter 2013 Earnings Call. [Operator Instructions] As a reminder, this conference call is being recorded. I would now like to introduce your host for today's conference, Lew Schroeber. Please go ahead.

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 Vice -- 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 May 6.

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. Welcome to our call. We'll follow our usual format. I'll begin the call with some remarks relative to Q1 financial performance and some overall comments on the business. I'll then turn things over to Chris for his comments, and we'll then have Betsy join Chris and me for the Q&A session.

At the beginning of the call, I'll point out, as we mentioned in the press release, starting in Q1 of 2013, we have reorganized our financial reporting so that we will now report 2 segments. We'll have the Technology segment, which represents our eDiscovery business, and we have combined the former Bankruptcy and Settlement segments into a single segment for Bankruptcy and Settlement. And that is how you will note the internal financial reporting as we go through the year 2013.

Let's begin with operating revenue. We had a strong first quarter with a 24% increase in operating revenue. Revenue hit $102.9 million and that's the first time we've gone through the $100 million mark for a quarter. So we found that overall revenue was strong and actually came in slightly better than we originally anticipated.

Looking at GAAP earnings per share, that number came in at $0.11 versus $0.06 for the prior period. In terms of cash from operations, we used $5 million of cash in Q1 versus a year ago when we actually provided $15 million. This is a measurement, as I've reviewed with you previously, that you really need to look at a full annual basis to get an accurate measurement because you can have a variety of fluctuations quarter by quarter. So as is always the case with Epiq, we look forward to a strong year in terms of generating cash from operations for the full year 2013.

In the first quarter, we did have an increase late in the quarter from receivables and that resulted from some significant revenue growth. And then we also had one item, which was a planned reduction in a large customer deposit, and we actually referenced that toward the end of last year.

In terms of non-GAAP performance, non-GAAP EPS came in at $0.23, which was right in line with consensus, and that's where we expected it would be. Non-GAAP adjusted EBITDA came in at $22.4 million, which was basically the same as the year-ago period.

If we now turn briefly to the segments, and Chris will talk about these items in more detail momentarily, but let's start with the Technology segment, which represents our global eDiscovery business. We had a 12% increase in operating revenue, $54.8 million. I mentioned to you in the last call that we expected eDiscovery revenue would have a double-digit growth this year. We continue to feel that, that would be the case, and that for the full year, we'll have a nice double-digit revenue growth in eDiscovery. This was a very, very strong eDiscovery quarter revenue-wise and as I mentioned, Chris will talk with you about that in more detail.

The EBITDA for Technology was $16.4 million versus last year's $17.6 million. As we say in the press release, we did have higher document review sales in our product mix. We are gaining significant market share in document review. It's obviously a crucial business to us. It's one of the main reasons we completed the De Novo acquisition, to have a stronger business in document review.

We're also seeing a number of additional, what we call, integrated sales where you sell both document review and ESI in the same transaction. Normally, when that happens, the document review, part of it will represent 2/3 to 3/4 of the revenue with ESI being in the minority. You all recognize that document review carries a lower margin than ESI. We do look for strong performance as we move through the year in this part of our business.

As we referenced in the press release, we are also launching our Japanese business that will, of course, be headquartered in Tokyo. We have retained a very seasoned executive who ran the Japanese business for a major competitor for a number of years, and that we will invest in this business in both Q1 and Q2 so that we'll really get it off and running in the second half of 2013. We think it has significant potential. It's a large market, and that's why we're pursuing this course of action.

I should also point out that international sales generally have been strong. We had nice double-digit growth. We have seen very good performance internationally out of our London and Hong Kong offices and look forward to seeing that in the not-too-distant future in the new Tokyo office.

Many of you asked about the size of the international eDiscovery business. We don't break it out with real specificity for competitive purposes, but on an overall basis, you should view it as representing approximately 12% to 15% of our total global eDiscovery business.

Let's now look at the Bankruptcy/Settlement segment. Operating revenue for the segment was up 12%, $54.8 million -- let me just redo that for you. Revenue in Bankruptcy and Settlement came in at $48 million. So let me restate that correctly, $48 million, and that represented a nice 42% increase versus last year's $34 million.

The Bankruptcy portion of that segment was $20.9 million. This was off 14% and if you recall in our last conference call, I indicated that recognizing we're in a down bankruptcy cycle -- and I'll talk more about this in a minute then Chris will also reference it -- I indicated we probably see revenue off maybe 10% to 15% this year because of the cycle. So being off 14% was right in line with that.

The Settlement business had a terrific quarter, and we should take just a moment on that. They had $27.3 million in revenue for the Settlement unit. This represented a 180% increase versus prior year. We are seeing some very strong sales in the Settlement business. They are taking some nice market share away from our competition. We have continued to expand and solidify our sales capability.

If you recall last year, we did about $60 million in sales, and that was up versus the prior year of $37 million. This year, even though we went from $37 million to $60 million, last year, we expect another moderate increase and we'll exceed $60 million and we would look for this business to probably be somewhere in the mid-60s in terms of operating revenue.

We're getting some major matters, and that's very important. We referenced that in the press release, a very large antitrust matter that we had in the first quarter. But one of the significant developments in this business is that we're seeing more and more large matters and that, of course, has a very significant increase on the financial performance of the unit.

The Settlement business does have a lower margin. And so when it has these very significant increases, it will slightly lower the overall corporate margin. On the other hand, this is a very good business for us, very complementary to Corporate Restructuring, and we absolutely are dedicated seeing this business really further grow and make additional contributions to Epiq.

Looking at the Bankruptcy portion of the segment, we all recognize that we're in a down part of the bankruptcy cycle. Filings have slowed down. Filings are down versus prior year. Nevertheless, Corporate Restructuring is by far the largest part of our bankruptcy operation, I think you're all aware of that. We achieved some very nice market share in Q1 with Corporate Restructuring. You read about these matters in the paper. The filings are public. In fact, what we actually are retained on becomes public information.

And we had some nice retentions. In addition to that, we actually have some meaningful retentions that have not yet filed. And so as we look to the next couple of quarters, the balance of the year, we expect to further increase our market share, have some good filings, have some good retentions, I should say, even though filings are down.

I think one of the important things to reference, since we're now in the beginning of 2013, you've heard me say this before, but the amount of debt maturity in 2014 is very significant. If you look at the various tables that present this information, you will see that the debt that matured in 2012, 2013, pales in comparison with what will mature in 2014. We feel that as you look at that, as you also become aware that there are some recessionary indicators in the European economy, we certainly have some challenges in our economy. But net-net, we continue to feel that in the not-too-distant future, we see the potential for increased filings and entering another robust bankruptcy cycle. It's hard to predict that timing, but we think that it's perhaps not too far down the road.

So the last comment on the segment, the EBITDA was $14.6 million for the segment, which was a slight increase versus prior year. So those are some comments relative to the eDiscovery business and the Bankruptcy/Settlement segment as well. Let me touch on a few other topics, and then I'll turn things over to Chris.

In terms of looking at the full year 2013, I would simply reiterate the full year guidance that I have previously provided to you. I went through that some detail in the last call, so I'll reiterate that today.

When I look at overall financial performance for the business, I would say that we would achieve approximately 45% of our financial performance in the first half and about 55% in the second half. That usually is the way most years play out for us, with the second half being slightly stronger than the first half, and we see that kind of trend taking place in 2013.

We will pay our next $0.09 quarterly cash dividend on June 3 to record holders on May 1. And our dividend program is a solid one. It provides a good yield, and we're pleased that we've initiated that dividend program and continue to grow it over the last couple of years.

Our proxy will be put in the mail during the next 10 days. Our annual shareholders' meeting is scheduled for Thursday, June 13, 10 a.m. at the Westin Crown Center Hotel here in Kansas City. As always, we encourage as many shareholders as possible to attend that meeting. All of our directors and executive officers are normally in attendance for all of our shareholder meetings. So we look forward to taking that opportunity to further brief you and provide you with additional updates on the business.

With that general overview, I'd like to turn things over to Chris for his comments. And then when Chris concludes, Betsy, Chris and I have will be happy to take your questions.

Christopher E. Olofson

Good afternoon. Thank you for joining us. We're very happy to report our first $100 million-plus revenue quarter here at the beginning of 2013.

Starting with eDiscovery. Discovery had a very strong sales in the quarter. Revenue increased 12% versus the year-ago quarter and perhaps more importantly, reached an all-time revenue record for a standalone quarter, slightly ahead of the sequential quarter in Q4 of 2012, which itself was a record. We worked on a significant number of merger and acquisition-related assignments in the U.S. and did significant bank regulatory work internationally. The quarter represented an all-time revenue record for the whole business unit, for international and for U.S. document review. So we reached new high-water marks on several key metrics.

As Tom mentioned, EBITDA was $16.4 million versus $17.6 million for the year-ago quarter, and I'd like to walk through several of the factors that contributed to that year-over-year comparison. First, the revenue mix weighted much more heavily towards document review than before, and we know that document review has a lower margin than does processing and hosting, which together represents the ESI component of the business. With the full life cycle capability that Epiq offers today spanning collection, consulting, processing, hosting and document review, the number of integrated projects where we are working on both ESI and document review, that we have had under pursuit and that we have won, has increased. And therefore, document review as a percentage of total eDiscovery revenue has similarly increased.

So this is a trend that's been in the business for several quarters now. We see it in a more pronounced way in the current period result given the inventory of work on which we had assignments in Q1.

Also, the quarter continued the effect of the long-established pricing trends in the eDiscovery marketplace. That trend was sustained in Q1. Also, we incurred some start-up expense for our Asian expansion that Tom alluded to. Start-up activities in preparation for our Tokyo office that we announced initially on February 25 are well underway, and we expect to be in business by the early summer. This will be a full-service office with its own data center, will feature our proprietary technology and will have local capability for consulting, processing, hosting and document review. In addition, we are opening a data center in Shanghai to serve clients in China more effectively and to increase our profile in the competitive marketplace within the region.

I would like to point out that we think we have a strong track record for international expansion, having grown our London office from a small launch team into the leading practice in London, having grown our Hong Kong office very substantially since it initially opened a few years ago and we would have comparable objectives for our new presence in Tokyo.

Also for eDiscovery, you'll see that for the very first time, the rolling 4-quarter revenue trend exceeds $200 million, which is another milestone for the business, and we believe we continue to be among the top global eDiscovery franchises. We see continuing opportunity in a marketplace that remains highly fragmented where we have an opportunity for leadership with our unique combination of proprietary technology and awareness of third-party tools, and we point out the continuing expansion of the global nature of the business. In addition to the Japan opening, we have done work in 50 countries where we are not necessarily opening a full-service office but nevertheless, can shift in a mobile environment to perform in-country services essentially anywhere in the world.

On the Settlement Administration front, as Tom mentioned, Settlement had an outstanding start to the year, with revenue contribution from the largest private antitrust settlement in history on which we will retain a very favorable year-on-year comparison. And as usual, this is our business line that is most subject to quarterly volatility, so it is important to look at this business from an annualized perspective.

And realizing in 2012 that we had a tremendous nonrecurring work -- nonrecurring revenue from our work on the BP Deepwater Horizon case, which is now complete, the growth that we anticipate for Settlement Administration really will be a very strong result in 2013. We have a very strong competitive positioning, a very strong ability to win major cases as is evidenced by the big antitrust settlement retention, and we'll keep you posted as the year continues to unfold.

On the Bankruptcy front, yes, we remain at the low light of the bankruptcy cycle with fewer filings. However, of those filings that we have seen in the marketplace, Epiq has had very strong market share and very strong competitive performance for Corporate Restructuring engagements this far in the year. Bankruptcy was down versus the year-ago quarter as we anticipate. We are at the low end of the bankruptcy cycle. That situation will continue to influence the results of Bankruptcy over the course of the year and its 4 business lines, of which Corporate Restructuring is the largest, the 2 trustee businesses and AACER rounding it out.

Some of the very large cases that we were retained on during the peak period several years ago are simply winding down and not yet being replaced with cases of comparable size. But the market share, as I mentioned, has been quite strong, and Corporate Restructuring, in particular, has had a very busy start to the year with high activity in cases and strong performance in retention of those matters that have been available in the competitive marketplace. We do envision an uptick in the bankruptcy business, Tom alluded to this, as leveraged debt in the marketplace matures from 2014.

So I hope that provides some additional information about the various business lines that contributed to the quarterly results. And with that said, we would be happy to take your questions, and we'll ask the operator to introduce the question-and-answer period.

Question-and-Answer Session

Operator

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

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

First, on the eDiscovery business. Can you talk about the ESI revenue? Did -- was that up or was it just that the -- in other words, that the document review just grew faster? Or did you actually see some sort of weakness in that revenue stream?

Christopher E. Olofson

Well, as you know, we do not break out service-by-service, product-by-product, all of the various components of the eDiscovery franchise. We saw very high levels of activity in terms of units of data coming into the business throughout the quarter that would include work performed in ESI-related activities. When we match up all of the trends in the business, including the increased weighting towards document review, the continuing effect of the pricing trend in the industry, the revenue strength for the quarter really did come from document review and from international matters.

Elizabeth M. Braham

And I would just add to that, that in particular, the international growth was primarily from ESI and not document review. And so as Chris indicated, it is a combination of mix, pricing, international and U.S., the overall strength of the franchise, so we were pleased with.

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

I guess I just want to make sure from a competitive perspective or pricing or otherwise, is the ESI side more challenged or is it simply that the other part of the business grew faster?

Elizabeth M. Braham

Yes, what we clearly saw in the first quarter, Tim, was in 2012, as we brought De Novo into the business, one of our key strategic objectives was to sell more integrated deals. So as we went through the course of 2012, we saw that grow a little bit quarter-by-quarter. And we could see those shifts in our mix as we went through last year. So this is the natural evolution of what we were expecting and then as you know, the mix of the matter between ESI and document review is heavily weighted towards document review. As Chris also indicated in his comments, we did significant work on the ESI on the international front relative to bank regulatory matters. And on the U.S. front, we did significant work related to antitrust filings. And so while we saw a decline in the ESI work in 2012 on antitrust filings, we actually saw that ESI work tick back up in Q1 of this year.

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

Okay. And the pricing pressures, it's still mostly on the ESI side, or are you seeing it also on the document review side of the business?

Elizabeth M. Braham

We're seeing it on both sides, although I would say that I think ESI may be a little bit more so and in particular, probably on the presale terms side versus hosting.

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

Okay. And then can you help us get a sense for the magnitude of the investments? I guess it sounds more so in the first half of the year before you get started with Japan?

Elizabeth M. Braham

That would be true. So what we're anticipating on the investment for Japan is that we will incur expense and have an operating income loss in both the first and second quarter, which we anticipate moving towards probably a breakeven as we enter Q3 and hopefully profit as we go through Q4. But it is definitely investment mode for the first half of the year.

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

Is it meaningful enough that that's part of why you expect the second half of the year? Or is it -- it's just a small number we shouldn't worry about?

Elizabeth M. Braham

Well, when we look at the first half of this year, and the expense implication in the overall eDiscovery business, it will erode their margins a little bit and their profitability a little bit. When we get to the second half of the year, it will not contribute to a material level, but it won't be hurting us like it is the first half of the year.

Operator

Our next question comes from Peter Heckmann from Avondale Partners.

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

I had a question on eDiscovery margins. I understand the issues as regard to Tokyo and the mix, but would you expect eDiscovery margins for the year to be higher than the first quarter?

Elizabeth M. Braham

Yes. So as we are looking at the second half of the year in particular, we expect the margins to improve. So as we're -- as we have visibility into Q2, we still see a fairly heavy mix of document review in Q2, similar to what we had in Q1. And we still have the Japan investment without any revenue offset. So we do expect margins as we go through the course of the year to improve quarter by quarter.

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

Okay. And then you had a large contribution in the Settlement business last year in the second quarter, which appears to be a relatively difficult comp this year. I heard what you said in terms of raising your expectations for revenue for the full year a little bit for this segment. But in the second quarter, would you expect Settlement revenue to be up? Or because of that tough comp, would you expect to be down in the second quarter but then up for the year?

Elizabeth M. Braham

Okay. So we'll expect it to be down for the second quarter because as you indicated, it's an extremely difficult comp, and you really saw a Q1 in 2013 that was more comparable to Q2. But as we now are getting a little bit further into the year, I think our early guidance to you guys was that we thought that our Settlement Administration business might be flat to up slightly. I think we're now comfortable to say that our Settlement Administration business will be up double digit for 2013. And so as we look at the overall Bankruptcy and Settlement Administration segment, we have been predicting that bankruptcy will continue to be down this year. And as we look overall at the segment on a full year basis, we expect that it may be flat to up slightly being driven by Settlement Administration growth.

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

Okay. Great. And then just one line item question, you called out about $1 million of litigation expense in the quarter as an add back to EBITDA. Is that an unusual item, or anything that deserves further explanation?

Elizabeth M. Braham

Yes, it is a unusual item that was settled in the course of the first quarter, and we don't expect to have a recurring litigation expense related to that matter through the remainder of the year. So that is settled in full.

Operator

This concludes our Q&A session. I will turn it back to Chris Olofson for closing remarks.

Christopher E. Olofson

Thank you, all, very much for joining us this afternoon. Have a good evening.

Operator

Ladies and gentlemen, thanks for participating in today's program. This concludes the program. You may all disconnect.

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