Epiq Systems Inc. Q2 2008 Earnings Call Transcript

Transcripts

Epiq Systems Inc. (EPIQ) Q2 2008 Earnings Call July 22, 2008 4:30 PM ET

Executives

Lew Schroeber - IR
Tom Olofson - Chairman and CEO
Chris Olofson - President and COO
Betsy Braham - EVP and CFO

Analysts

Herb Buchbinder - Wachovia Securities
Tim Willi - Avondale Partners
Dan Perlin - Wachovia
Richard Shannon - Northland Securities
Scott Haugan - Tygh Capital

Operator

At this time, I would like to welcome everyone to the Epiq System second quarter earnings release conference call (Operator Instructions). Thank you.

It is now my pleasure to turn the floor over to your host, Lew Schroeber. Sir, you may begin your conference.

Lew Schroeber

Thank you. Good afternoon and welcome to Epiq Systems second quarter 2008 Earnings Call. 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 3:00 P.M. Central time and is available on our website at www.Epiqsystems.com. The webcast will be available on our website until next quarters’ call and a phone replay will be available through August 31st.

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 filed which are filed with the SEC and available on our website or on the SEC website. We strongly encourage you to review those risk factors.

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

Tom Olofson

Thank you, Lew. Welcome to our Q2 earnings conference call. We are pleased to have all of you in attendance today. We'll follow our normal format. I'll begin with a brief overview of our financial results for the quarter and year-to-date. Chris will then provide you with a narrative update talking about a number of operating and strategic topics. Betsy, Chris and I will then be happy to answer any questions that you may have.

We are very, very pleased to report a strong overall quarterly performance. We were very satisfied with the quarter. We thought performance was solid and steady throughout the quarter, and we are also pleased to say that we entered Q3 with some very strong momentum. We feel very good about our performance, as we enter and move through Q3.

Let's begin our Q2 review by starting with operating revenue. Operating revenue for the quarter was $56.9 million; this represented a 49% increase versus the year-ago quarter. On a year-to-date basis, operating revenue $1.8 million and this represents a 38% increase versus the prior period.

Looking at non-GAAP net income; for the quarter, $5.9 million, a 40% increase versus the past year. On a year-to-date basis, $11.3 million, a 47% increase. Looking at non-GAAP, net income on a per share basis for the quarter was $0.15. This compared with $0.12 a year ago, a 25% increase. Year-to-date $0.29, this compares with $0.23, a 26% increase. Our non-GAAP adjusted EBITDA was $14.3 million for the quarter. This was a 16% increase, $27.5 million on a year-to-date basis, and this was a 17% increase.

Cash provided by operating activities came in at $7.3 million, this was up 22%. On a year–to-date basis, $15.1, which represented a very slight increase versus the first half of the prior year.

A quick look at our balance sheet. Shareholders equity is now at $293 million. So we will go through the $300 million mark in the not too distant future on equity. Our balance sheet is very solid, we have plenty of liquidity. We have zero bank debt at the present time, so our line of credit is unused.

We do have the $50 million convertible in place and we have discussed that with you previously. That matures in June of 2010 and it would continue to be our expectation that sometime between now and then that $50 million would convert to equity.

Let's briefly look at our segment results. As you know from the call last quarter, we have three segments in 2008, Electronic Discovery, Bankruptcy, and Settlement Administration, which includes our Class Action business. We are very pleased the way we broadened the base of the company in recent years. We think this puts us in a position to really have stronger, more balanced performance, and we think it provides us with significantly increased potential for future growth.

Let's look at eDiscovery first: Operating revenue for the quarter was $16.3 million. This represents a 34% increase. EBITDA for the quarter was $8.1 million; this is a 25% increase. On a year–to-date basis, operating revenue was $29.5 million, this is up 32% and EBITDA was $14.5 million, this represents a 24% increase. We continued to be very pleased with our performance in eDiscovery. As you know this is a real growth driver for the business and Chris will talk with you in more detail about what is taking place in eDiscovery.

Looking now at Bankruptcy, one of the things I would do is refer you to page two of the press release. In the middle paragraph of page two in the press release we highlighted our Bankruptcy segment and we provided you with an executive summary there, which I think you will find very helpful in terms of the key things we look at in measuring our Bankruptcy performance. Chris will also in just a moment walk you through Bankruptcy in more detail.

But as we look at the numbers in terms of operating revenue, the revenue is down slightly for the quarter, $12.5 million versus $16 million. The EBITDA likewise is down slightly, $6.1 million versus $9.4 million. As Chris will point out, most of that is attributable to short-term interest rates and the effect they have on our current Chapter 7 pricing. When you look at the year-to-date performance operating revenue, $25.9 million is down slightly from $31 million and EBITDA is $16.9 million, down slightly from $18.5 million.

So, those are the Bankruptcy numbers. There are a lot of very positive and exciting things taking place in the Bankruptcy markets. We feel very good about their business moving forward and Chris will talk about that with you in more detail here momentarily.

Relative to the Settlements business, we reported an excellent quarter. Performance was very strong. We saw some very solid new client activity. We continue to build the sales marketing organization and the corresponding capabilities of that group. The major piece of business, which we have previously discussed with you, is right on target and had a very solid quarter.

When you look at the numbers for Settlement, starting with the quarter operating revenue, they showed a very sizable increase: $28.2 million versus $9.9 million. Likewise, EBITDA had a very important increase: $6.1 million versus $1.4 million. On a year-to-date basis, revenue at $45.5 million is up from $19.9 million and EBITDA at $6.8 million up from $3.0 million. So, we are very pleased that we can report to you such solid performance in the Settlements parts of the business.

As I mentioned, we feel very good about both the quarter and the first half. We think results have been very strong. And as I previously mentioned, we feel very good about the second half and we take some very strong momentum into Q3. What I would do at this point, as I did in the last call, I would simply reiterate our comfort level with the 2008 objectives that I previously covered with you. If you recall what we said in terms of our goal for 2008, non-GAAP EPS of between $0.60 and $0.64; non-GAAP EBITDA between$60 and $64 million; and operating revenue in the $185 million to $195 million range.

With that said I'll turn the call over to Chris.

Chris Olofson

Good afternoon. We were very pleased with the second quarter results companywide. I would like to walk through segment-by-segment some of the highlights. Beginning with eDiscovery; continued solid growth, a very strong quarter with revenue up 34%. During the quarter, we saw some important new client relationships, both on the corporate side and on the law firm side.

Earlier today a new industry league table came out: the Socha-Gelbmann Electronic Discovery Survey. Epiq Systems competes in two areas that are measured on the survey, eDiscovery processing and eDiscovery review. We were very pleased to achieve a top five ranking in both categories in which we compete.

We believe we are clearly established at this time as a top tier provider in the eDiscovery marketplace working at the very highest end of that market. We are also continuing to see steady international growth, and have a very successful practice up and running in London that is continuing to contribute both revenue and profitability.

Turning to Settlement Administration, it was an excellent result for the Settlement Administration this quarter. Throughout this segment we are on target for both our revenue and profit objectives for the year, On a year to date basis since January, we have experienced strong booking rates of new engagement under contract that have not yet been recognized as revenue.

As we have discussed on the previous call, in the Settlement Administration segment the lag time between assigned customer contract and revenue recognition can naturally be longer then in some of the other segments of the company, but these new contracts contribute to backlog and inventory, to work off in future periods favorably.

Historically, the Class Action business has not been our best performing segment, so we are particularly pleased this quarter to show the viability and the strength of this business. We continue to invest in the sales and marketing efforts characterized as a rejuvenating line of business and we are pleased with the quarter.

Turning to the Bankruptcy Segment, comprised of Chapter 7, 11 and 13, you will note a decline in revenue and profitability that we would like to share some background on, to help interpret, and to put in appropriate context.

For the Chapter 7 component of the Bankruptcy segment there are basic variables that contribute to results. Number one is short-term interest rates that relate to chapter 7 pricing, over which we do not have control. Second is fluctuations in aggregate trustee deposits that are related to the number of new cases trustees have received in previous periods and how they convert to assets. We do not control that factor. And number three, our market share, the number of customers that we have in our overall client portfolio, which we clearly are able to influence.

Of those three variables, Epiq does not control number one or number two. And these are the primary factors that resulted in a decline in the Bankruptcy segment. Aggregate trustee deposits declined modestly but we would like to point out they remained in the same range where they have been: $1.5 billion to $1.75 billion, albeit at the lower end of that range in this quarter.

Market share remains very strong and client retention remains very high. While it is true that Bankruptcy filings have increased for eight consecutive quarters, they nonetheless remain well below the peak levels of 2005. So, our interpretation is that Bankruptcy is ramping up for increased results in future periods.

It has worked out well that Epiq's total business is more diversified than it has been in earlier years. And that our three reporting segments can have a strong complimentary relationship.

On the corporate restructuring front, Epiq has the top market share for new engagements this year and we have experienced a near 150% increase in new client engagements versus the prior year. We are working with leading cases, including retail and airline engagements, and we expect filings will continue trending upwards. So, we feel good about the Bankruptcy segment going forward. And we hope that those observations help to interpret the current period results in a useful way.

Continued subprime fallout, we believe will contribute not only to the Bankruptcy segment but also to eDiscovery and Settlement Administration. Additional factors such as oil prices, tightening credit, and both consumer and corporate debt also suggest increased Bankruptcy filings looking ahead.

On the strategic acquisition front, we do not have any announcements today. As we have been, we continue to look proactively, entering selectively perhaps the most likely candidate, maybe in the eDiscovery space, whether a complimentary technology or service or way to broaden our capabilities in the overall eDiscovery lifecycle.

We are focused on healthy profitable targets that would contribute solidly to the company and as has been the case previously, we are not receptive to turnaround or trouble potential acquisition candidate. So, from a high level, we were very pleased with the Q2 results. We feel good. We have some wind in our back going into Q3.

I'll be happy to turn things back over to Tom, and then we'll take your questions in a moment.

Tom Olofson

Thanks, Chris. I think that gives you a good rundown on our summarizing the quarter for you. You can tell that we felt good about the performance, and I think that both Chris and I have indicated how strong we feel about the momentum we take into Q3. We feel very good about the quarter when looked into it, and we have covered with you the balance of the year and our comfort level in achieving our full year goals.

Now, we are happy to take any questions you have and Betsy, Chris and I, all three of us are here. So, I'll turn things back to the operator and we are ready to field any questions that you might be ready to ask.

Question-and-Answer Session

Operator

(Operator Instructions) There appears to be no questions at this time. I would like to turn the floor back over to Lew Schroeber.

Chris Olofson

This is Chris Olofson. We would be happy to address topics of interest. We believe it's possible that certain callers are preparing their questions. So, we'll take just another moment. We welcome your enquires, and operator we'll ask that we just hold the line for a moment and see who comes into queue.

Operator

Your first question comes from Herb Buchbinder from Wachovia Securities.

Herb Buchbinder - Wachovia Securities

Better just stay with Herb. Just a quick question. How far off were you in your budgets on the Chapter 7, 11, 13 Bankruptcy business that those declines looked a little more than I thought? But I mean, overall the numbers are just fine. But did that business surprise you, or was it close to what you were planning?

Betsy Braham

Hi, Herb, this is Betsy.

Herb Buchbinder - Wachovia Securities

Hi, Betsy.

Betsy Braham

Our Bankruptcy segment is on target with the projections. Keep in mind that we are able to do. While we can't control it, we do understand what is happening in the dynamics of the short-term interest rate environment and Bankruptcy filings, and had planned on Bankruptcy segment according to those specific variables, and knowing and looking towards what our expected market share with this. So as we look at that segment, we actually are on target with our expectations.

Herb Buchbinder - Wachovia Securities

Okay, and could you just give us the status report of where you are with these coupon processing for converting from analog to digital TV and if it’s likely that its going to be extended because a lot of people haven’t gotten their coupons in yet?

Betsy Braham

Yeah, the large project that we are managing within in our Settlement Administration business is on target with projections from a year-to-date perspective, both for revenue and for profit. As we look at the remainder of the year, we would expect to have continued activity for 2008, and essentially into 2009, although the 2009 access of that program is still being evaluated.

It is, at this point, much more tightly controlled and we have a better understanding of the program as we are midway through the year. But that project is again on target with our expectations for both revenue and for profit. And as we head into the second half of the year we expect continued activity.

Herb Buchbinder - Wachovia Securities

And go down of a swing of $0.50.

Chris Olofson

Herb, thanks very much we will proceed then to the next caller please operator. Operator, this is Chris Olofson. Could you chime in on the line please and ring through the next caller please.

Operator

The next question comes from Tim Willi from Avondale Partners. Your line is on live.

Chris Olofson

Thank you.

Tim Willi - Avondale Partners

Thanks, and good afternoon. Just a couple of questions, if I could. First one is sort of book-keeping question, it’s about the just going through the reconciliation of EPS to non GAAP EPS. If I take the number that you of the $5.881 million of non GAAP net income, if I reconcile with the share count that you have in your consolidated statement of income, it actually comes to around $0.14 a share. Do we make some kind of adjustment to share count in the non GAAP because of dilutive or anti dilutive impacts?

Betsy Braham

If you look at the share count for the non GAAP.

Tim Willi - Avondale Partners

Do you get that out of somewhere that I didn’t see it and we---

Betsy Braham

If you go -- if you look at the last page on the press release, you will see the diluted shares and how those are calculated. And so you will see what the shares are and then we do an adjustment to reflect the stock options, and then we will do adjustments to reflect the comfort of that share which are included. And those are in both GAAP and non-GAAP terms. And if you look at that, it is 41,510.

Tim Willi - Avondale Partners

41,510. Okay. So you got that labeled under the six months. I guess maybe we missed out there. I didn’t see that?

Betsy Braham

Right. We have a different share count for first quarter, for second quarter, and for year-to-date. And so you will have on this particular press release, you will see what the calculation is for the three months ended June 30^th, and for the six months ended. And if you were to look back at the press release for the first quarter, you would see the first quarter share count.

Tim Willi - Avondale Partners

Okay, I'll go offline with you on that one there. I don't want to take up any more time.

Betsy Braham

And if you have any further questions on that just let me know that…

Tim Willi - Avondale Partners

Yes.

Betsy Braham

We do provide in our press release the reconciliation of our share. So, the people can see exactly how we get from basic to diluted.

Tim Willi - Avondale Partners

Yeah, that's fine. I'll catch you offline on that one. The two other questions I had were, I apologize if I missed this in your comments, Tom or Chris, just any commentary you could offer around the direction or size of your eDiscovery backlog at the end of 2Q versus 1Q?

Chris Olofson

Well. We would certainly have consistency in our hosting clients that are the component that most people would look at in that type of question. Typically the processing or nonrecurring work that we received is completed very promptly either in the quarter in which it's received, or towards the end of the quarter very early into the next. So, we would characterize our visibility as consistent with prior periods, and that would focus really on the hosting side or the review side of the eDiscovery business.

Tim Willi - Avondale Partners

And if you think about the recurring revenue stream that's coming out of that portion of your business, and clients that you signed during Q2 or the ones that you feel that you are close to signing? Would it be, or do you feel like you are in a better position now than when we had this call in April, in terms of new potential business just starting to ramp up that will come on the hosting side?

Betsy Braham

Tim, we have had several retentions of clients in the second quarter of 2008 in our eDiscovery business, in both the US and the UK, that provide visibility into our revenue stream, which is incremental to what we knew in the first quarter. And again, that will come in the form of processing for nonrecurring revenue, and then enter the recurring hosted and review revenue stream for typically a much longer period of time.

Tim Willi - Avondale Partners

Okay. And then one last question on Chapter 7, in particular, we understand obviously that the impact that rates have on this revenue stream both pro and con. I just wondered if you could give any kind of color around what might have had more magnitude if we think about the year-over-year change in Chapter 7 revenues would it be balances or would it be interest rates that probably had the bigger impact.

Chris Olofson

Clearly the primary factor that contributed to the year-over-year comparison for Chapter 7 was short-term interest rate, as it related to pricing formulas. The second variable is fluctuation in deposits from current customers, but that is certainly the smaller variable.

Tim Willi - Avondale Partners

Okay, great. Thank you.

Operator

The next question comes from Dan Perlin from Wachovia.

Dan Perlin - Wachovia

Good afternoon. The major question I have, I was just trying to think about the Settlement Administration revenue? And then I guess to a lesser extent, really, the margins, but more specifically, the revenues in the back half of the year? Should we be thinking about this $28 million as a new jumping off point, given the size and backlog you guys talk about, or is that going to drop back to more the $16 to $18 million run rate level?

Betsy Braham

As we look at the second half of the year for Settlement Administration, it may be down slightly versus the first half of the year, but it will – it will not be materially different then the first half Dan.

Dan Perlin - Wachovia

So the first half of the year you guys did $45 million. You are saying it could be flat to slightly down from that absolute number?

Betsy Braham

Correct.

Dan Perlin - Wachovia

And it should be evenly distributed then it was in the first half.

Betsy Braham

Not necessarily, we may still see some variability between the quarters, depending on the launched contract and how that goes through the remainder of the year. We wouldn’t expect quite the variability as we saw in the first half of the year, and then, secondarily, we wouldn’t expect to see the variability in our cost structure in the second half of the year, so I think we would see a better balance between the revenue and the cost in the second half.

Dan Perlin - Wachovia

Okay, so we are through 22 days in July. So are you thinking the third quarter is going to be bigger or the December quarter?

Betsy Braham

At this point it is difficult for us to completely project how that program is going to ramp between the quarters, because it is tied to volume levels that are outside of our control.

Dan Perlin - Wachovia

Okay. And then to the extent that we keep rates, short-term rates, where they are or on average where they were this quarter, which looks like that might be realistic, is there any major adjustment that we need to be aware of as trusty assets role into the second half of the year, or should we keep a run rate above what we saw this quarter?

Betsy Braham

I think that if you stay fairly consistent with your run rate you will be okay.

Dan Perlin - Wachovia

Okay. And then on the eDiscovery margin, should we be thinking the back half of the year – margin degradation on a year-over-year basis, or margins sequentially holding steady at what we saw in first half on average?

Betsy Braham

Well, if you look at what’s happened with those margins, they have steadily come down not materially, just very slight decline, each quarter over – basically the last six quarters. I think that if you look at it quarter-over-quarter, you should probably expect to see the same level of the trend as you have seen over the last six quarters as we look into the reminder of the year.

Dan Perlin - Wachovia

Okay. And then, if I heard your comments correctly, we are going keep Bankruptcy roughly flat on our run rate. Do you think that back half of the year for Settlement is about similar to the first half, maybe slightly down, which would put you guys, if you just kind of held eDiscovery constant, well above your $195 million guidance. Is there anything we need to read into that or is there something rolling of the eDiscovery or how should I reconcile these two segments?

Betsy Braham

Now, that’s actually a good question and on the revenue side we would probably come in towards the higher end and we were just slightly higher than our guidance. I don’t think that will drive any change, however, in our EPS or EBITDA guidance, as we are looking at where we expect margins to come in for the remainder of the year. So, I think you are correct that you may see though a little bit higher revenue, but as our mix has shifted more heavily to our Settlement Administration segment, which have a lower margins than the other two segments, we would expect to see that kind of transition.

Dan Perlin - Wachovia

Got it, okay. Thank you very much.

Betsy Braham

Sure.

Operator

The next question comes from Richard Shannon.

Richard Shannon - Northland Securities

Hi, how are you?

Betsy Braham

Good afternoon, Richard.

Richard Shannon - Northland Securities

Hi, I guess I have a quick question on Electronic Discovery, I think. Maybe I’ll ask the question in a different way from another previous question. I guess, looking at really sustainable growth into the third quarter and farther, obviously you had one of the better quarters in terms of sequential growth in that business in about a year's time. To what extent do you see a 20% sequential growth to be a sustainable number, or even something gets into double digits?

Betsy Braham

All right. Well, you are absolutely correct. This quarter was the highest sequential quarter growth that we saw in all of 2007 and so far in 2008. We would not expect to necessarily see sequential quarter growth like that as we proceed through the remainder of the year. So, we would expect to continue to see nice year-over-year growth in that particular segment.

Richard Shannon - Northland Securities

Okay. Was the reason for the growth here, was it kind of broad based in terms of number of cases and number of customers, or whether one or a few number of very large cases that came in that really goosed the numbers here?

Betsy Braham

No. It was very broad based. It spans both our US business and our UK business, and it was across actually a wide variety of clients.

Richard Shannon - Northland Securities

Okay. And then, was the spread across both corporate and law firm or was it skewed towards one angle or the other?

Betsy Braham

Both.

Richard Shannon - Northland Securities

Both okay. Quick question on Chapter 11 business, I guess, when you look at that business in a corporate structure by itself, did that grow sequential in the second quarter?

Chris Olofson

We report Bankruptcy now on a consolidated segment basis. We would say that our retention on a year-to-date basis are very significant, almost 150% versus the year ago, and we do have the leading market share for new Chapter 11 retentions on a year-to-date basis, and I believe we would -- which provide information in that fashion.

Richard Shannon - Northland Securities

Okay. I guess, maybe asking question on Settlements, obviously the transition in the revenue stream in this business over the last couple of quarters have been quite nice, and we have done a lot of discussion about this one large contract that you have. Your commentary, in your opening statements talked a little bit about very nice engagements presumably outside of this large contract.

I guess I would love to hear kind of a qualitative comment to the extent which the improvement we are seeing in the revenues in this area is coming from this large contract, versus other engagements that you've seen come in the last couple of quarters. Would you say it's a majority, a large majority almost entirely? Can you give us some sense of how much the large contract is contributing here?

Betsy Braham

Well, clearly when you have a significant contract of this order of magnitude and you see the types of results that we are experiencing in 2008 you can apply a good portion of that to that contract. As Chris discussed in his comments, we are seeing very nice achievement in our new business retentions. Some of those have materialized into revenue during 2008. And some of those are yet to materialize into revenue and profits, and some will come through in 2008, and some will carry forward actually probably into 2009.

What we would say about that segment is that from a new business retention perspective, we are on target with the new business projections that we had established at the beginning of the year, and those are contributing in exactly the manner that we expected into this year.

Richard Shannon - Northland Securities

Okay, great. Thank you.

Operator

The next question comes from Scott Haugan from Tygh Capital.