Epiq Systems' (EPIQ) CEO Tom Olofson on Q2 2014 Results - Earnings Call Transcript

Jul.31.14 | About: EPIQ Systems, (EPIQ)

Epiq Systems (NASDAQ:EPIQ)

Q2 2014 Earnings Call

July 31, 2014 4:30 pm ET

Executives

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

Tom W. Olofson - Chairman and Chief Executive Officer

Brad D. Scott - President and Chief Operating Officer

Paul Liljegren -

Analysts

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

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

Operator

Good day, ladies and gentlemen, and welcome to the Epiq Systems' Second Quarter 2014 Earnings Conference Call. [Operator Instructions] As a reminder, this conference is being recorded. I would now like to introduce your host for today's conference, Mr. Lew Schroeber. Sir, you may now 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, Brad Scott; and Executive Vice President and Chief Financial Officer, KJ Tjon.

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 August 7.

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-Q and the quarterly reports on Form 10-K -- our annual report on 10-Q -- quarterly reports on Form 10-Q (sic) [ 10-K ], 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 Q2 conference call. We are pleased to have all of you join us today. We'll follow our usual format. You should all have a copy of the press release, which will give you a full set of financial statements. We won't go through those in detail today, but we will provide some highlights for you. I'll start the call and make some general remarks about the company on an overall basis, our current status. I'll then highlight the key operating performance items for Q2 and YTD. I'll also provide you our thoughts relative to the balance of the year and speak to our objectives for the full year.

So let me begin by saying that we're very pleased to have Brad Scott and KJ Tjon with us on the call, both members of our executive committee. Brad, of course, now in the President and Chief Operating Officer position; KJ in the Executive VP and Chief Financial Officer job. Brad will make a few comments today. KJ will participate in the Q&A. KJ will also be on all of the analyst calls following this conference call. And then next week, KJ and I will participate in the Needham Conference in New York City.

As I indicated last month in the annual shareholders meeting, we are placing a real focus on the topics of profitability and margins as we move through the balance of the year, so that we really focus on those areas, and performance there will complement the very strong double-digit revenue growth that we've been achieving. Financial planning and analysis will be an area we spend a good bit of our time. And as we prepare for 2015 and the budgeting and the profit planning process, we'll focus on those areas in a very intense fashion.

While KJ is new, under her direction, we have recently reorganized our Finance and Accounting department, and we think that will be very helpful relative to emphasizing the topics I just highlighted: margins, profitability, cash flow, et cetera. We're also in the process of bolstering, under Brad's direction, our technology area. We have recently hired a new VP for IT. We've hired a VP for Products. They will be joining us shortly to bolster that part of our management operation. And when they join, we will put out a press release and advise you accordingly. We're also in the process of recruiting a new Chief Technology Officer, and are using one of the national search firms in that respect, so we'll be designating a CTO sometime over the next couple of months. And we're doing these things, once again, as we strengthen the company. We're looking throughout the business, now that we're a $0.5 billion global company, which is significantly different than we were just a few years ago. We're really beefing up, strengthening management throughout the business so that we can maximize our performance as we look out the next couple of years.

Now a few general comments relative to some performance items. Operating revenue for the quarter was $115.5 million. This was up 10% on a YTD basis. Revenues $232 million, up 11%. And we're pleased with that revenue growth, considering that we're still in a down bankruptcy cycle, and we'll speak further about that on this call. In addition, we have some timing issues on some major class-action business, and we'll also address that with you.

In terms of our overall revenue, 68% was in the eDiscovery segment and 32% was in the Bankruptcy/Settlement area.

Relative to adjusted EPS, we achieved consensus, came in at $0.21. This is right in line with our objective. We have talked about that in our last conference call. We're exactly where we thought we'd be at the half: $0.19 in Q1, $0.21 in Q2, $0.40 for the half. In terms of our adjusted EBITDA, for the quarter it was $24.7 million, up from $23.4 million; YTD, $48 million versus $46 million. This came in slightly above consensus. Revenue, by the way, was also very slightly above consensus.

We had a very solid quarter for cash from operating activities. We generated $19.6 million of cash from operations for the quarter, which was, by far, our best quarter of the year. We've also declared our regular quarterly dividend of $0.09 cash per quarter. The next dividend will be paid on September 9 to shareholders of record as of the close of business on August 1.

Couple of brief comments in the segments, and then Brad will make some additional comments. In particular, he'll speak to the eDiscovery business. But in the eDiscovery business, the operating revenue was $78.5 million. This was up 12%. On a YTD basis, $160 million, up 28%. The adjusted EBITDA for the quarter was $20.5 million, which was down just slightly from $21.8 million. And YTD, the EBITDA, $42.8 million, up from $38.2 million. On an overall company basis, eDiscovery accounted for 60% of EBITDA for the quarter and Bankruptcy/Settlement was 40%.

A couple of other brief comments on eDiscovery, and then Brad will supplement with his remarks. We did have increases in both ESI and Doc Review from a revenue point of view. The split was 54% ESI, 46% Doc Review. That's been running generally about 60-40, so it was a little bit different in the quarter, 54-46. And that mix does account for a slight change in the margin, with Doc Review being higher. A lot of that is simply timing related, just depending on the different matters we're working on.

The international revenue was up 19%. Our international business continues to be very strong. The International business accounted for about 19% of the segment. We have very strong margins internationally. I feel that the growth internationally will be very attractive as we move forward. We're really building that part of the business.

A quick look at Bankruptcy/Settlement. The operating revenue for the combined segment, $36.9 million, up from $34.9 million. YTD, $72 million, down from $83 million. And I'll talk about why the quarter was up here in just a second. The EBITDA for the quarter, $13.9 million, and that was up from $10.9 million. And then, YTD, $25.9 million, about the same as last year, $25.5 million. The large Chapter 11 case served us very well in the quarter, and that certainly made a nice contribution to the profitability and the increase in the EBITDA.

If we look at Bankruptcy all by itself, revenue in the quarter was $23.9 million, up from $20.8 million. Settlement was $13 million, down from $14.1 million, but we'll talk about those timing issues.

We've previously announced that we've been named claims administrator for the Energy Future Holdings Corp. It's the largest Chapter 11 filing in a number of years. It had about $36 billion in assets, and we were very pleased to be retained in that case. And it is making a nice contribution to the performance of restructuring and the overall Bankruptcy business in total.

As I mentioned, we continue to be in a down bankruptcy cycle. Filings, on an overall basis, decreased 12% for the first 6 months of the year. Commercial filings were actually down 22%. Commercial filings can be either Chapter 11 or Chapter 7, as you know. We do feel that, in the not-too-distant future, we may very well see an uptick in the bankruptcy cycle. It's always hard to predict the exact timing, but as you see in the press, there's more and more written on the topic of interest rates and the subject of when interest rates -- it's really not a matter of if, it's really when interest rates will begin to tick up. And when that process starts, it clearly will have a direct impact on initiating the beginning of another bankruptcy cycle. So we'll watch for that very carefully.

The Settlement operating revenues are down from last year, but that's relative. That's due to the Interchange case. Interchange, a very, very large antitrust matter involving several of the major credit card companies. We've spoken with you about it in the past. We did have some revenue from that case last year, but we have a timing issue right now. The case is on appeal, and we originally thought we would have revenue from it this year. But due to the timing involved, we're not. And so that timing issue did have a direct impact on Settlement revenue in the current period. We're very pleased, though, with what's happening in Settlement, generally, and as you know, we refer to Settlement as the Class Action/Mass Tort business as well. We are receiving many additional large retentions. We had a meeting the other day and looked at the $1-million-plus retentions that we have recently been called in on, and that has really picked up in volume versus where it was over the last couple of years. So we have some very good things in the pipeline. We have a number of large matters in which we've recently been retained. And we feel very good about the Settlement business.

And likewise, in Bankruptcy, while we're in a down cycle, we are clearly in good shape with our market share and the business, everything considered, is doing quite well, considering the cycle. And of course, I referenced the importance of the major 11 retention that we recently were brought in on.

I'll conclude my comments by simply reiterating our objectives for the year. So I'm confirming with you today that we leave those objectives in place as I previously discussed them with you. Accordingly, we do see Q3 as a stronger quarter than Q2, meaning that each quarter is ramping up as we go through the year. And then, we see Q4 very significantly ramping up over Q3, and we see Q4 as our strongest quarter of the year, ending the year on a very strong note with that quarter. And so that's how we look at the balance of the year. We leave those objectives in place, and we'll see each quarter ramp up as we go through the full course of 2014.

With that said, let me call upon Brad, who will provide you with his remarks and give you a little more insight into the eDiscovery business, in particular. When Brad concludes, he'll turn it back over to me. We'll then move into the Q&A session. And KJ, Brad and I will be happy to answer any questions. We also have Paul Liljegren, our Senior VP of Finance, with us as well. And we'll now turn it over to Brad to have him give you his comments.

Brad D. Scott

Thank you, Tom. In the Technology segment, Tom mentioned that we're experiencing continued growth in our international business. And I'll note that we continue to make investments in infrastructure and overall capabilities throughout the various regions. In June, we had a record month in Asia and expect continued growth throughout the year in that particular region. We're also pleased with the immediate positive reaction of clients to the addition of ESI to our Canadian operations. And our London office, which supports European operations, continues to grow there.

In the domestic market, in particular, we have experienced a higher mix of lower-margin Document Review business, which has negatively impacted margins. And generally, we are seeing price pressures in the domestic market. And note that, as Tom has covered the Bankruptcy and Settlement Administration segment results well, relating to product and service mix, while the Settlement Administration business has -- is experiencing lower revenues, it is benefiting from a higher mix of higher-margin business, again positively impacting margins there. Tom?

Tom W. Olofson

On that last comment, I'd like to come back to that before we go to Q&A. I think it's very important. The Settlement margin, while the revenue is down for the timing issue, the quality of business is very good. And therefore, the margin in Settlement has improved. And we're pleased with that progress in the margin. And so in that whole Bankruptcy/Settlement segment, with the 11 case on the Bankruptcy side, with some high-quality business on the Settlement side, we had some good margins there. And as Brad indicated, and we've talked with you about this before, we did have a higher mix of Doc Review in the quarter in eDiscovery. That does bring the margin down slightly, and that's going to vary from quarter-to-quarter. But it is important for us to note that both ESI and Doc Review are clearly growing. And as Brad indicated, we're especially pleased with the growth we're seeing in the international markets.

Okay, with everything, at that point, covered in terms of our presentation, I'll turn things over to the operator. We'll take whatever questions you have, and we're pleased to answer those questions at the present time.

Question-and-Answer Session

Operator

[Operator Instructions] And our first question comes from the line of Tim McHugh from William Blair.

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

Yes. I guess, first, Bankruptcy revenue ticking up. I guess, how sustainable is that? I know that Energy Future probably will continue for a long time, but is the run rate you saw it jump up to here a sustainable level, or is there some sort of kind of initial project activity that spiked that up?

Tom W. Olofson

We clearly always have some upfront revenue in the major 11 cases. And while there clearly will be some ongoing recurring revenue from our new large Chapter 11 matter, we do get a spike upfront. So I think that you should look at that revenue as not being sustainable on a quarter-after-quarter basis, but rather a nice spike in the initial quarter. And then, the ongoing revenue will be at a lower level, but we will have some spikes in the future when they do major noticing items and so on and so forth.

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

Okay, great. And then, I guess, I get the shift towards Document Review and then also the international expansion. But I guess, it's still somewhat surprising to see the EBITDA down year-over-year in the eDiscovery business. Can you help us quantify, I guess, how much some of those factors are having? And what drove the decrease year-over-year in the EBITDA, I guess?

Tom W. Olofson

Yes. I think there's a couple of factors, and then Paul may want to chime in because he knows these numbers very well. If we have a quarter in which, for whatever reason, there is a higher level of growth in that quarter at Doc Review, and therefore, the mix tilts a little more to Doc Review, that will bring the margin down a bit. In addition to that, as we go forward, we have taken some steps to reduce some costs and increase some efficiencies. And that will be very helpful in the eDiscovery business moving forward. That's part of our program of -- I'm simply looking at various cost efficiencies, productivities in that business so that we can counteract any pricing pressures and that sort of thing. And that's what I mentioned in my upfront comments and talked about in the shareholders meeting as we zero in on -- in a more focused way on margins and profitability. Paul, do you want to add some specificity to that?

Paul Liljegren

Sure. Tim, I think, as you look at our year-over-year comps, certainly, the investments we made in the business during last year and early this year have been reflected in the second quarter this year. The mix increase, the Doc Review being slightly higher is a factor as well. The cost reduction that Tom mentioned that we took during the second quarter should reflect over the balance of year. So we tend to think in terms of going forward. From where we are, we certainly expect revenue growth as we move through the year sequentially. And then, the focus on pricing and margin management is really a function of price management and cost management and leveraging from our cost base that exists today. So I think, that's how we look at it.

Tom W. Olofson

Yes. And as Paul indicated and I said in my comments, Tim, we do look for both ESI and Doc Review revenue domestically to increase as we go through Q3 and Q4 versus where they were in Q2. And we clearly look for a continuation of some nice increases internationally in Q3 and Q4. So as the revenue ramps up a bit further, and we also look at what I'll call some of the focus on efficiency, we think that has a favorable impact on our bottom line results.

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

And I guess, just to -- I guess, you're touching on it there, but to get to the second half numbers, you're talking about a pretty significant increase versus what we've seen year-to-date. I guess, how big are those cost savings? I mean, how much of an add is that supposed to give us?

Paul Liljegren

Yes. We, Tom -- Tim, we haven't quantified those specifically. It's really a combination of all the things we're doing, along with mix management and really, just keep with leveraging the investments we made late last year and early this year is really the bigger factor -- and along with revenue growth going forward, are the bigger factors.

Tom W. Olofson

Yes. And the impacts you get from the incremental revenue, especially above the point where we currently are, can be very significant. And in particular, ESI revenue, as it grows from the current level, will be very favorable in terms of its impact on the bottom line. So it's not one factor, Tim. It's a combination of the 3 or 4 things we've talked about, but we feel very good about our eDiscovery business going forward. And as Brad said, in some of the new offices, we're doing very, very well. I think Brad referenced Hong Kong is really, really now ramping up nicely. We just took some steps to further bolster sales in Tokyo. Toronto is off to a good start. Brad and I actually were both in London last week. London is doing extremely well. We're getting more business on the continent. Obviously, the business in London is not all from the U.K. And -- so -- I mean, we feel very positive about going forward for all those various factors.

Operator

Our next question comes from the line of Peter Heckmann from Avondale Partners.

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

I wanted to go a little bit deeper again into the margin issue. And I guess, based on where the revenue's coming from at this point, we would expect the majority of the revenue -- or the sequential margin improvement to come from leveraging the investments made in the data center and the international offices, as well as potentially a stabilization of the mix. But were there other actions taken in either Settlement or Bankruptcy that we should expect to see some margin improvement there, or will that have to wait for higher revenues?

Tom W. Olofson

Well, there's been a general improvement in Class Action/Mass Tort margins. And that pertains to the quality of the mix. And even though we have the timing issue, Pete, on the one very major matter, and I should emphasize to everybody that the original expectation this year was that we'd have revenue from that very significant item, and then it was placed on hold. But we have had some other very attractive business, and the margins are better in Settlement. And as we move forward, we want to focus on keeping stronger margins in Settlement than what we have historically had. In Bankruptcy, clearly, whenever you engage with a major Chapter 11 matter, that will always have a positive impact on the margins. But to a large extent, as you know, for the business generally, we will look forward to the beginning of the next cycle when we actually see the decline in cases stop and level out. We then watch interest rates carefully as they begin to tick up. We would feel that cases will then begin to pick up throughout all of the different parts of Bankruptcy. When that happens, there's a favorable impact on 13, 7 and AACER, as well as 11. And we think that's a little ways in the future, but perhaps not that far away. But the margins are holding up nicely, considering we're in a down cycle. And then, I think we've talked quite a bit here about margins in eDiscovery. And the key there will be the investments are paying off, the cost reductions will pay off. And as we further ramp up the revenues in Q3 and Q4, that will also have a positive impact.

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

Okay, okay. And then I was encouraged to see the strong operating cash flow in the period with a sequential reduction in receivables. It looks to me like DSOs are still just above 100. I know, structurally, it's going to be difficult to get DSOs down materially, but do you think you can get DSOs down to kind of a $90 -- 90-day range and pull some additional cash flow out of working capital?

Paul Liljegren

Yes. This is Paul. I think we absolutely do. I think we made a modest improvement during the quarter. We made a more dramatic improvement year-over-year. So I think we're at a point where we've developed some momentum. We have more reductions to achieve and we think those are achievable. It'll take some time, but we think they're achievable and sustainable, yes.

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

All right. Great, great. And then, it is -- just last question and I'll get back in the queue. At this point, does the company intend to open any additional international offices, or are we going to stay with what we have today? Do you feel like the footprint is built out sufficiently today that you can take a break from additional office build-outs?

Brad D. Scott

Yes. We continue to think that we can open yet an additional office in Europe. We feel that our London office supports the European operation well, but we do think -- and we're looking at potentially opening yet another office in Europe. And we're -- always have our eye open to Asia as well. We have Shanghai, Tokyo and Hong Kong, and we think that there could be an additional opening there in that Asian market.

Tom W. Olofson

Yes. The key, Pete is, as you know, we have some very significant opportunities in both Europe and Asia. We've really taken a position of competitive leadership. We've significantly enhanced our market share. We've moved past a couple of our major competitors, especially in the European market. So we're building up our sales and business development activities. We will look very carefully in terms of opening new offices just from the cost point of view. On the other hand, where we really think we have very, very significant opportunities and can ramp up sales in a large market area, then, as Brad indicated, we'll look at that very carefully, because there's no question in our mind that the opportunities, internationally, in eDiscovery are very, very attractive and we really do want to enhance our position of leadership in that geographic area.

Operator

This concludes the question-and-answer session of our call. I would now like to turn the call over to Mr. Olofson for closing remarks.

Tom W. Olofson

Thank you, all, very much for joining us today. For the analysts on the line, KJ is going to host some analyst calls following this call. And so we look forward to spending some time with the analysts going to -- and answer additional questions, talk about topics that come up in those calls. But for those of you on this call, we appreciate your interest and your attention. And on that note, we will close off the call. Thank you.

Operator

Ladies and gentlemen, thank you for attending today's conference. This does conclude today's program. You may all disconnect. Everyone, have a fabulous evening.

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