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Epiq Systems (NASDAQ:EPIQ)

Q4 2013 Earnings Call

February 25, 2014 4:30 pm ET


Lew P. Schroeber - Vice President of Investor Relations/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


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

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


Good day, ladies and gentlemen, and welcome to the Epiq Systems, Inc. Fourth Quarter 2013 Conference Call. [Operator Instructions] As a reminder, today's conference is being recorded. I would now like to turn the call over to Lew Schroeber. Please go ahead, sir.

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 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 4.

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. Welcome to our year end call. You should all have a copy of the press release, which will provide you with a full set of financials. We're pleased to have you with us today. We'll follow our usual format. We'll divide the call into 3 parts. I'll start with the highlight of Q4 2013. I'll then provide you with our insight into 2014. I'll turn things over to Chris who will provide you with his remarks. And then we'll have Betsy join us for the Q&A session, and we're pleased to answer any questions that you may have today.

Let's begin with some general overall financial comments. We were very pleased with the quarter and the year on an overall basis. The quarter came in with operating revenue of $121 million. This was a 37% increase over prior year. And for the full year 2013, operating revenue was $439 million. This was up 27% versus 2012. I should point out that all of this growth was organic. We did not have any revenue, which came from strategic acquisitions last year.

Let's take a look at eDiscovery for a moment. This, of course, was the growth driver. It is, as you know, by far the largest part of our business, about 70% of the company now. eDiscovery had a very strong year. Once again, all growth was organic. $285 million for the year in revenue. This was up 45%. And the quarter was $84 million, which was up 55%. As we said to you in the Q3 call, we took the opportunity last year to step forward, take a position of global leadership in this market, and we'll talk with you further about how we plan to further solidify and cement that leadership as we go through 2014.

Let's step back for a moment and look at several other items that pertain to building shareholder value. Last year, in our share repurchase program, we acquired 1,800,000 shares at an average price of $12.94. In addition, we had the board approve a new share repurchase program, which authorizes up to $35 million in share repurchases going forward. In addition, we declared quarterly cash dividends, which amounted to $0.36 for the year. We paid that at the rate of $0.09 cash per quarter. We've been paying a dividend now since 2010. The current $0.36, with the price of the stock where it is, will equate to a yield of about 2.6%.

Next, we closed a new $400 million senior secured credit facility. This includes a $100 million revolving line of credit and a $300 million term loan, which amortizes at the rate of 1% per year. This new facility gives us some additional financial strength and flexibility, in particular as we look at any possible strategic opportunities that may arise going forward.

Looking at several other financial items. Our EBITDA for the year, non-adjusted GAAP EBITDA, $99.3 million, up 8%. Our non-GAAP EPS for the quarter was $0.26, which is right in line with our projection. For the full year, it was $0.98, which confirms what we talked about on the last conference call, and the $0.98 was in line with consensus.

Let's come back to eDiscovery for just a moment. We had growth throughout the eDiscovery business. ESI contributed some very attractive growth. The growth in Document Review was very significant. We had a terrific year in expanding the Document Review business.

For the full year, ESI represented approximately 58% of our revenue, within eDiscovery, and Doc Review was about 42%.

Our international business in eDiscovery did extremely well. We continue to expand. We expanded the operation in London and Hong Kong. We opened new facilities in Tokyo and Toronto and also a new data center in Shanghai. The international eDiscovery business had extremely strong growth. Operating revenue was up 90% for the year.

Now we're in a low bankruptcy cycle. I'm sure Chris will touch on this a little bit further. Our objective in a low cycle, when filings are really down, is to maintain our market leadership position, which we did. But revenue and profitability, understandably, did decline, as it's impacted by these low filings in the low part of the cycle. We expect exactly the same thing in 2014.

On the other hand, we keep the business strong. We maintain our market leadership. We follow carefully developments in that market. We do feel that we'll return sometime in the next year or 2 to increase filings to see a more robust bankruptcy cycle. We're not planning on that in 2014, but we think that, that most likely would happen in the '15, '16 period. We look at the possibility of rates rising. We look at the amount of leverage debt that's maturing. And so we do feel that in the not-too-distant future, Bankruptcy will gain some additional strength.

The Settlement business, which we also refer to as our class action mass tort business, it's doubled in the last 2 years. This was a $37 million business in 2011, a $74 million business in 2013. Last year, it increased 24% versus prior year. Settlement has done very well in the last couple of years. We have been retained in larger cases. We've strengthened the management team. We've expanded the sales team. We'll talk further about Settlement as we move forward.

We get some questions on our margins, so I'll make a couple of comments on there, just so we're very transparent on that topic. I've mentioned to you that the growth last year came from Document Review in eDiscovery and the class action mass tort business. You're aware that those are 2 of our lower-margin businesses. So when they lead the company in the way of growth, that naturally will have a tendency to bring the margin down.

Likewise, we're in a low bankruptcy cycle, as I said, so we're going to see Bankruptcy revenue and profits decline. Bankruptcy, as you know, is a very high-margin business. So when we're in a low cycle and those margins come down and then you look at where the growth is coming from, as I just indicated, that kind of a shift in product mix will have a tendency to bring down the margin, and that is the phenomenon that we experienced last year.

I should, however, point this out: A few years ago, when we had a down bankruptcy cycle, we were not able to mitigate that or offset that. Today, with eDiscovery by far our largest business, with Settlement being very strong, even though a high profitable business like Bankruptcy is in a low cycle, to a large extent, we're able to mitigate the effect of that. And that, of course, is good news.

Let me now talk about 2014 for just a few minutes, and then I'll turn things over to Chris. First of all, from a qualitative basis, how do we view 2014? Just very briefly, in summary form, as I mentioned, we continue to see a down cycle in bankruptcy. We expect the filings will continue to drop off as we go through most or perhaps all of 2014. I've talked about how strong the Settlement business has been. However, we do have a timing issue, which has come up in 2014. We've been retained in a very large matter, the interchange case. That's the case that involves major credit card companies, and we've previously referenced it. We had planned on some very significant revenue from that case starting early in 2014. However, after the court ruled on that, it was appealed. It is now going through appeal. That will delay the revenue, and this is a brand-new development. And so we would now expect very modest revenue from that case. And depending on the appeal, that revenue is delayed, most likely to 2015 or '16. Therefore, I would expect that Settlement would drop off slightly from where it was last year, but that's purely a function of timing.

Now, eDiscovery, 70% of the business. We seized the global leadership last year. We are further cementing that leadership now. We will solidify that position going to 2014. We will continue to invest in this business. We're in this on a long-term basis. This is the largest market in which we participate. It's a multibillion market. It is the fastest-growing market in which we participate. Market research shows it growing at about 16%. We expect to grow faster than the market. We continue to invest in technology, new facilities, expanding sales. Clearly, the international part of the business continues to grow and expand. So we're excited about eDiscovery. It's a growth driver, and it continues to do very well.

Now with all that said, let's quantify it, and here are the objectives I would provide you for 2014:

Overall operating revenue, I see at about $475 million. That's up from $439 million last year.

I would break that out as follows: eDiscovery should come in at about $340 million. That's up from $285 million. The Bankruptcy/Settlement segment at approximately $135 million, that's down from $154 million. So Bankruptcy/Settlement will come down about $19 million, eDiscovery will go up about $55 million and overall business, therefore -- overall basis will be up about $36 million for the company at $475 million.

Non-GAAP EBITDA, I see at about $106 million. That's an increase from last year's $99 million. Non-GAAP EPS, I would look at $1 even, and that's up from $0.98 last year. All of this will be primarily driven by very strong eDiscovery performance on a global basis, once again, as we take even firmer control of the global leadership that we now have in that business.

With that said, let me turn things over to Chris for his commentary.

Christopher E. Olofson

Good afternoon. Starting with eDiscovery, we were very pleased to have our best-ever year and our best-ever revenue quarter by a very wide margin. As Tom mentioned, the quarter grew 55% on a year-over-year comparison to $84.4 million. And in fact, another sequential increase versus Q3. Q3 at $75.6 million, growing to $84.4 million at the end of the year. All of this growth was organic. We had very significant client activity and unprecedented sustained volumes from both corporate clients and law firm clients from both new accounts and more long-standing relationships and from both North America and the Europe, Asia regions. We are now at sixth consecutive quarters of increased revenue.

Starting in Q2 of 2012, I'll just read them out in sequence in millions: $42.7 million, $50.9 million, $54.4 million, $54.8 million, $70.1 million, $75.6 million and now jumping up to $84.4 million.

The fourth quarter saw new all-time monthly and quarterly records in all of the major categories that we track. October and November were the 2 best months in the history of the eDiscovery business, and we saw new records for the whole business unit for the Europe, Asia region, which as Tom mentioned, experienced very rapid growth. For our U.S. ESI business, comprising pre-filter processing and hosting revenue and for our U.S. Document Review business. So we really checked every box for the quarter and for the year.

The revenue mix for the division continues to show growth from our U.S. Document Review business, which is accompanied by a lower margin. And through our increased Document Review, nevertheless, it has enabled us to attract more integrated projects from clients, where we provide the soup to nuts end-to-end capabilities for both of those services, packaged under a single delivery vehicle. We are also witnessing the continuing effects of long-established pricing trends for eDiscovery, and our results reflect the continuing investments we have made in our expansion, both in the United States and abroad.

Some of those growth highlights for the year include new geographies. We opened a full-service office in Tokyo. We opened a new facility in Toronto at the very end of the year. I'd like to mention that we have a very established, stable Canada client relationship that will jump-start the new in-country services. And we simply believe that with a facility in Toronto, we can gather more market share and accelerate growth in the region.

We opened a new data center in Shanghai. And when we look at our portfolio of data centers and locations, it really has become a very significant competitive advantage at the highest end of the market to support clients across multiple geographies, in particular the large multinational corporate client.

We also have had very significant expansion in London with a new Document Review center. We have expanded capacity very significantly in New York City, which is where we have the largest capacity of seats for Document Review.

We are also doing significantly increased business in audio review. This is emerging important trend in the business. It's part of the leadership we want to have in the industry. That as new trends establish prevalence, we want to be at the leading edge and offer clients the best capabilities.

For client engagements, both for the quarter and for the year, we saw very significant business in bank regulatory work, significant merger clearances, significant litigation. And many of those, in turn, experienced both scope expansion and time extension that were very favorable for us in the provision of services.

Late in the year, we announced a new proprietary product, Epiq Analytics. This is a web-based early case assessment tool that enables clients to make better strategy decisions early on for data minimization, for concept search and clustering and for visualizing how data is structured across the collection of data. So a continuing investment, not only in our product, but so too in talent towards the end of the year, as we have seen increased demand for services. As the business has grown, we have invested in increased talent across all of the functional areas: management, sales, operations, client services and technology.

So today, we are at the top of the global eDiscovery business, having started with an initial investment in late 2005. We are continuing to plan the future strategy in this marketplace, which remains highly fragmented and where we see a continuing attractive growth opportunity. So the quarter and the year for eDiscovery ended with new high watermarks in essentially every one of the categories that we track. January was a very solid start to the new year, and we are well underway now in 2014 for eDiscovery.

Turning to Bankruptcy and Settlement. Quarterly Bankruptcy and Settlement revenue grew just about 9% in the year-over-year comparison, from $33.7 million in the year-ago period to $36.6 million in Q4. Throughout the year, the segment did well in the context of the marketplace, but with particular consideration for conditions in Bankruptcy. Bankruptcy filings are at a low point since 2008, and that impacts all of Chapter 7, 11, 13 and AACER, which are either directly or indirectly fed by the supply of new matters coming into the system.

That said, within Corporate Restructuring, we had excellent market share throughout the year. We outpaced competitors by a material margin. And nevertheless, for those matters coming into the Chapter 11 space, we are seeing them move through the system faster and are often asset sales or prepacks that have a smaller opportunity for Epiq at this bottom end of the market.

In contrast, Settlement Administration had very solid organic growth of 24% for the year and benefited from exceptional signature matters in our backlog. Settlement Administration was the highlight of the segment. The business unit has developed some very nice momentum against its competitors. And market share for both Bankruptcy and Settlement remains strong, though as mentioned, market conditions are at a low point for bankruptcy.

So as an interesting contrast, where we have seen some high watermarks at the end of the year in eDiscovery, because of market conditions, we are seeing some low watermarks within Bankruptcy, in particular, even though the segment as a whole had just at a 9% growth, thanks to the very attractive growth in Settlement Administration.

That said, we do want to emphasize that this is part of the normal ebbing and flowing and cycle of the bankruptcy system. And as rates come back, as filings go up, we are extremely well positioned to benefit from that uptick. We will be investing in this market and protecting our #1 market position very carefully. And as the market evolves in due course, we believe our results will track accordingly.

We do think we have the very best bankruptcy franchise in the business, with comprehensive coverage across both consumer and business cases and all of Chapter 7, 11 and 13 and the best bench of industry experts for a leadership position.

These factors also, I think, validate and show the importance of the attractive diversification that we have in the company. So within the segment, there is both Bankruptcy and Settlement Administration, and then alongside that segment is another segment for eDiscovery. We believe not having all of the eggs in one basket is a very judicious way to run the business, but all of the eggs, nevertheless, continue to tell a very coherent story of managed technology in the global, legal profession.

On the strategic front, with our financing activity in 2013, the company is very well poised to act promptly to a favorable acquisition opportunity, provided it met both our qualitative and our quantitative criteria. While we have nothing specific to discuss today, we do point out we have a proactive posture, as always, for evaluating investment candidates.

So we're very, very pleased as how the year wrapped up across the business. Our new year is up and running. And with that, we would be pleased to take your questions.

Question-and-Answer Session


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

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

First, I guess just because you're just talking about it on the acquisition front. I guess, are you signaling that you're looking to be more aggressive or just that you see more attractive opportunities out there? Or just is it a comment on where the balance sheet and the financing sits at this point and your capability to do something?

Tom W. Olofson

Tim, we're interested if the right thing comes along. As Chris said, we don't have anything right now. Candidly, we're always pretty active in terms of looking for the right opportunity. But we're very, very selective, as I think you know. It has to be a very good strategic fit. It's got to meet the financial criteria. From a financial point of view, we certainly have the flexibility. If we do something, we would want it to be accretive. We would not do anything that would be losing money or a turnaround or that sort of a situation irrespective of how it might look strategically. So we're focused. We're selective. But we don't have anything on the horizon right now that we're very actively pursuing.

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

Okay. And as we think about next year, you gave us some guidance on the revenue and the overall EBITDA. I guess, what's implicit in that from an eDiscovery standpoint? Will we continue to see the margins trends decline in that business next year? Or are we at a point where they can start to stabilize?

Elizabeth M. Braham

Well, as we look at the components that will affect margins for next year for eDiscovery, we don't expect to see a shift between ESI and Document Review to the same order of magnitude that we saw in 2013. So we would continue to expect to see prices come down in 2014, more than likely, at rates similar to what we've seen in the 2012 and 2013 time frame. And then of course, we have our revenue expansion, which allows us to leverage our fixed expenses. And so as we think about margins overall for eDiscovery, we don't expect to see them making a significant shift in 2014 like we did in '13.

Tom W. Olofson

The other comment I'd make, Tim, is that, and I said it in my comments, we do continue to invest in the business. We feel pretty strongly about that. Naturally, we want to balance that. It's the old short-term, long-term balance, and that's an executive judgment call. But we really do feel good about taking a position of global leadership in 2013. I think we asserted ourselves, we stepped in, we seized the moment, so to speak, and we were able to surpass some major competitors relative to size and market share. So we do want to continue with the right kind of investments. So as I said, we really further solidify that leadership, take on more market share. And so I think that in 2014, you'll see somewhat of a continuation of investing as you did in 2013. Betsy, would that be from a financial point of view an appropriate way to summarize it?

Elizabeth M. Braham

Yes. And I would just add to that, Tom, the first half of the year, obviously, the company will have kind of the full impact of those expenses. So in 2013, they built gradually over the course of the year. In the first half of 2014, we have kind of the first full impact of all of those investments. And then it's really in the second half of 2014 where we will see any -- more profound way the revenue benefits that will come along with certain aspects of those investments.

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

Okay, great. And then just last question, I guess, for me is how do you -- in a business without much visibility -- and I think I know that it's an expanding industry. But I guess, given -- on top of the growth you've seen last year, what type of things, I guess, can you point to, to have confidence around eDiscovery continue to grow at -- off the higher levels at still a pretty fast pace here in terms of what you're guiding to next year? I mean, is it just the -- I guess, it's the backlog and the trends you see, but any color on that?

Tom W. Olofson

Well, a couple of things, Tim. And then, Chris, you might want to chime in on this as well. We see a continuation of very solid international growth. We're up and running in Toronto. That's brand new. We are excited about the prospects in Tokyo and Hong Kong. London continues to do extremely well. We're certainly looking for other international geographic possibilities. That business is doing very nicely on a global basis. Domestically, we continue to strengthen and expand the sales force. Doc Review, which had a great year last year, is continuing to do well. We really picked up the pace as the year went on last year in ESI. So net-net, we feel good about the pace of the business in eDiscovery. The $340 million number that I gave you as an objective for next year, that's about a 19%, not quite a 20% increase. It's up $55 million over the $285 million. I personally feel very good about that, and I just think we have some very good momentum going.

Elizabeth M. Braham

The other thing I would point out, Tim, is that -- to remind you that we do have a very consistent customer base that we retain from year-to-year. And so we do have some visibility into revenue in terms of our client base. That then gets augmented with new customers. And the variability, obviously, comes in from projects.


The next question comes from Peter Heckmann from Avondale.

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

I know the previous caller asked a similar question, but I missed the detail. Could you just quantify the investments made in the Electronic Discovery franchise? Can you quantify those on a dollar amount and an EPS level for '13? And then, as well, just affirm, I believe I heard you right, but I believe I heard you say that they're going to be flattish in '14. And then you'd start to see the leverage in '15. But can you clarify for me?

Elizabeth M. Braham

Yes. So as Tom pointed out in the last conference call, the 2013 impact for the investments for expansion and movement into new geographies was about $0.06. We would expect that impact to continue through 2014, especially as we fully ramped up those investments into our expense base. And then as we continue through 2014, we're beginning to -- we obviously, for the growth expansion piece, we saw benefits of that in 2013, and we'll continue to see that in 2014. But in particular, the new markets that we moved into and the investments for those new markets, we'll begin to see the revenue impact of those as we move throughout 2014. But obviously, much more so in the second half of the year versus the first half.

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

That's fair. And then as regard to your annual guidance, I see that you -- the board authorized a new share repurchase program. Are there any material level of repurchase implied in the guidance?

Elizabeth M. Braham

There is not.

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

Okay, okay. And so to the extent that you weren't able to find an acquisition that met your criteria, would it be fair to assume that you may be more active on the share repurchase program?

Elizabeth M. Braham

That is a possibility, yes, depending on the stock price.


At this time, I show no further questions. I would now like to turn the call back over to Epiq Systems for closing remarks.

Lew P. Schroeber

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


Ladies and gentlemen, that does conclude the conference for today. Again, thank you for your participation. You may all disconnect. Have a good day.

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