EPIQ Systems, Inc. Q4 2008 Earnings Call Transcript

| About: EPIQ Systems, (EPIQ)
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EPIQ Systems, Inc. (NASDAQ:EPIQ) Q4 2008 Earnings Call February 24, 2009 4:30 PM ET


Lew Schroeber – Vice President, Investor Relations

Tom Olofson – Chairman and Chief Executive Officer

Chris Olofson – President and Chief Operating Officer

Betsy Braham – Executive Vice President, Chief Financial Officer and Secretary


Tim Willi – Avondale Partners

Richard Shannon – Northland Securities


Welcome to the EPIQ Systems fourth quarter 2008 earnings results conference call. This call is being recorded. At this time, for opening remarks and introductions, I would like to turn the call over to Lew Schroeber. Mr. Schroeber, please go ahead.

Lew 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 web site at www.epiqsystems.com. The web cast will be available on our Web site until next quarter’s call, and a phone replay will be available through March 24th.

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 10K and the quarterly reports on Form 10Q which are filed with the SEC and available on our Web site or the SEC’s Web site. 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 Olofson

Thank you Lou. Good afternoon and welcome to our year-end conference call. We are pleased to have you join us. You should all have access to the press release and/or the web presentation and they will provide you with detailed financial information. We will follow the normal format on the call today. I will begin and provide some financial highlights. Chris will then talk about a variety of operational and strategic matters and also talk with you about performance in the various segments. I will then come back and review with you our 2009 management objectives and then Betsy, Chris and I are happy to take any questions you may have at that time.

We are very pleased with a strong Q4 and with a very solid full-year 2008. We achieved our objectives and I will begin the review by talking first about operating revenue. For Q4 operating revenue came in at $55.2 million. That represented a 41% increase versus the year-ago quarter. For the full year operating revenue was $207.9 million, a 37% increase versus the prior year.

We were very pleased with that strong revenue performance and in particular the fourth quarter was very, very solid. If we now switch to non-GAAP net income for Q4, $6.4 million a 25% increase and for the year $23.5 million, a 36% increase. Converting that to non-GAAP earnings per share, $0.16 for the quarter and $0.60 for the year and I am pleased to say we achieved our objectives for EPS for both the quarter and the year.

Looking next at adjusted EBITDA $15.7 million for the quarter up 27%; $57.8 million for the year up 17%.

Next, I’d like to look at some balance sheet items and liquidity. I think we all agree especially in these times that a strong balance sheet, good solid liquidity, plenty of access to cash are really important considerations and I am pleased to say that EPIQ is in really, really good condition in all of these areas.

On the balance sheet we have exceeded for the first time $300 million in shareholder’s equity. We have zero bank debt at the present time. We do have an unused, fully available $100 million line of credit. As you know from prior discussions we have a $50 million convertible in place. That is very straight forward. 4% coupon matures in June 2010. The stock trades well above the strike price and as we have said before it is our expectation some time between now and June 2010 that will simply be converted to equity and that would remove the $50 million debenture from the books and replace it with $50 million of equity.

We had $19 million in the checkbook at the end of the year. So we are very pleased with the balance sheet.

One other item we always discuss with you is cash from operations. In Q4 we generated $16.1 million cash from operating activities. This was up 27% versus the year-ago quarter. For the full year we had $34.2 million cash from operating activities. If I recap the fourth quarter it would say the following; Operating revenue up 41%. Non-GAAP net income up 25%. Adjusted EBITDA up 27%. Cash from operations up 27%.

We were pleased with that performance and happy that we were able to achieve our objectives and have a very, very strong Q4 and move into 2009 with some very significant momentum.

Segment performance. Let’s take a quick look at that and Chris will talk about the segments in more detail in just a moment. As you know we have three segments; bankruptcy, e-discovery and the class action settlement administration.

We’ll start with bankruptcy. Q4 operating revenue $20.8 million. This was up 44% versus the year-ago quarter. For the full year, $60 million of revenue which was identical to the prior year. In terms of the non-GAAP EBITDA for the bankruptcy segment $10.5 million for the quarter which was a 28% increase versus the year-ago quarter and $34 million for the full year which was down very, very slightly versus $35 million for the prior year. So you can see from bankruptcy there was a real surge in activity in Q4. Chris will talk with you in more detail about this.

I would make just a couple of comments. Our corporate restructuring Chapter 11 business is very, very strong. We expect that to continue throughout the year. In the trustee area our Chapter 13 business while it is a smaller part of the business is doing very, very well. They have been right on plan very steadily. The number of Chapter 13 cases has grown very nicely and Chris will talk to you in detail about Chapter 7. Certainly one of the highlights is our deposit portfolio has been growing and we are very pleased with where that is as of the end of the year.

Let’s look now at e-discovery. For the quarter $13.5 million in operating revenue which was about flat with the year-ago quarter at $13.7 million. Revenue was $58.1 million for the full year and that was an 18% increase versus the prior year. In terms of non-GAAP EBITDA $5.2 million for the quarter down slightly from $6.6 million. The full year $26.3 million which was up from $24.4 million.

I am pleased to say that we are off to a very good start in Q1. The month of January for e-discovery was a very strong month, better than any of the months in Q4 and Chris will talk with you in more detail about e-discovery as we look through the year 2009.

Looking now at the class action settlement administration business, very strong results for the quarter and the year. Operating revenue for the quarter $20.9 million which was a very significant increase versus $11.1 million in the year-ago quarter and for the full year operating revenue of $89.9 million once again a very significant increase versus $42.3 million.

The EBITDA numbers likewise were very attractive for the quarter $6.4 million versus $1.6 million a year ago. For the full year $19.9 million EBITDA versus $18.8 million once again a very sizeable percentage increase. So the class action settlement business did very nicely both for the quarter and for the full year.

You are aware we have had a very successful major contract that involved the analog to digital TV conversion. You have also read in the press, it has had plenty of publicity that the deadline date for that change has now been moved from February 17 to June 12. We will continue with this contract accordingly through the middle of the year and we are also building some very nice traditional class action business in that particular segment. Once again Chris will touch on some additional details there.

I think I would conclude my overall comments by saying we were very pleased with the strength of the performance and we clearly concluded the year with a very, very solid Q4 and as I mentioned we are going into 2009 with some attractive momentum.

With that said I will turn the meeting over to Chris and then I’ll come back before Q&A and talk about our objectives for 2009.

Chris Olofson

Good afternoon. We are very pleased with the financial results for the year. We are very pleased to be among that small percentage of companies that had a very successful 2008.

I’d like to start with some comments about the bankruptcy segment. Bankruptcy is a very strong environment. It has been and we expect that trend to continue throughout 2009 and beyond.

For the 12-month period ending September 30, 2008 more than one million new bankruptcy cases were filed, up more than 30% versus the year-ago period. Here in 2009 on a year-to-date basis just over six weeks into the New Year, there have been 36 public company filings across Chapter 7 and Chapter 11 compared to 16 at the same time in 2008, so more than double compared to 11 during the same time period in 2007, more than triple.

The combined pre-petition assets for those public company filings is in excess of $66 billion. That would compare to the 2008 figure of $10 billion and the 2007 figure a very small fraction $690 million. The source of those statistics is Bankruptcy Week, February 23 issue.

In corporate restructuring we at EPIQ are experiencing a very significant increase in business volume. Chapter 11 filings nationally are up 49% for the year ended September 30 compared to year prior. We have been and are continuing to be retained on major high profile matters. We have opened an auxiliary corporate restructuring office in Hartford, CT that is now fully up and running making a very positive contribution to the business. We are continuing to expand our professional staff and our case management capacity very steadily to meet increasing client demand. We have a very full pipeline of prospective engagements and our network of referral sources around the country is indicating to us continued escalating activity including very high profile, very large filings over the coming several weeks, months and quarters.

A selection of some of our recent cases to give you a flavor would include the Tribune Company, KB Toys, Lyondell Chemical at the time of filings the thirteenth largest Chapter 11 filing in history, Flying J, Nortel Networks, Smurfit-Stone Container, Apex Silver Mines, Muzak Holdings, Midway Games, Young Broadcasting and Philadelphia Newspapers. We have a very robust, busy corporate restructuring business and we believe that momentum will continue into the foreseeable future.

Turning to the trustee services side of the bankruptcy business, we would like to point out and are very pleased that the company achieved its overall corporate objective despite Chapter 7 pricing being at floor levels during the latter part of the year and that is because price formulas reference short-term interest rates, over which we have no control. The three variables that shape the financial outcome of Chapter 7 trustee engagements include interest rates, market hare and deposits per client.

For the time period that I referenced, the year ended September 30, 2008, Chapter 7 filings nationally were up 40% versus prior year. Here at EPIQ our revenue generating deposit portfolio ended the year with excellent balances, the highest balances of the past two years. We were very pleased with our year-end position in revenue generating deposit balances.

We would like to take a moment to touch upon a research update that came out from Standard and Poor’s the other day about our primary competitor in Trustee Services, VMS of Irvine, California. Typically during our investor calls we focus exclusively on news about EPIQ. In this instance we want to offer some clarifying remarks to avoid any potential confusion that may occur by investors who read the research update and the downgrade of our competitor in California.

One, the public news about the competitor references declining trustee balances. We would like to reiterate that EPIQ’s overall revenue generating deposit portfolio is in excellent condition, has been rising and ended the year at the high watermark for the previous two years.

The research update references the substantial interest burden and highly leveraged position of the competitor. We would like to contrast that to much, much, much lighter interest expense burden on EPIQ. We would like to point out that EPIQ does not have bank debt and point out the debt outstanding for the competitor referenced in the update of over $900 million.

So we simply take a moment on that to hopefully avoid any potential confusion between the two situations. Bankruptcy filings continue to increase. That suggests to us further assets which can translate into deposit generating revenue. We feel very good about the trustee space and are very pleased to have a market leading position in the trustee space.

I referenced several moments ago how short-term interest rates relate to Chapter 7 pricing and how because of those rates our pricing was at floor levels during the latter part of 2008. A short-term interest rate increase will translate automatically to incremental revenue and profitability for EPIQ Systems whenever that may happen in the future. So any increase in short-term interest rates would have a top line, bottom line direct contribution at EPIQ Systems.

Bankruptcy generally for EPIQ is long-term, multi-year relationship and engagement with an attractive, recurring revenue dimension particularly at the large and complex end of the spectrum where we our focus and have built our reputation. So the cases we are bringing on now we expect many of them will be long-term, multi-year engagements. EPIQ is the market leader across Chapter 7, 11, 13 with a unique market presence and stands poised to benefit from increased activity across the Federal bankruptcy system.

Let me turn to the e-discovery business. We were pleased to show year-over-year growth in e-discovery unlike some of our other competitors even at the high end of the market that shrank on an absolute basis. In Q4 there were some interesting dimensions to the e-discovery business. However, as Tom pointed out January started the New Year on a very positive note for e-discovery with a noticeable up tick in new client engagements versus the latter months of 2008 and in fact January was stronger than any October, November or December.

During the end of 2008, we believe like many market participants we at EPIQ witnessed clients working hard to delay new matters into the new budget year and we also witnessed existing clients working carefully to move older cases out of our hosting environment more so than we would typically expect.

Additionally, we saw some weaker competitors some of whom are shrinking, having layoffs and experiencing other prices put out very low ball prices which created an effect in the marketplace at the end of 2008. We at EPIQ see ourselves as a premium level, top tier provider in the e-discovery space and we see strong opportunity in 2009.

We have just opened new e-discovery offices in Brussels and Hong Kong. Brussels to focus on regulatory compliance work for the EU; Hong Kong as the hub of a new agent presence and working with the largest global corporations and law firms we now offer a true worldwide reach for e-discovery with major centers in New York, Washington D.C., London, Brussels, Hong Kong and Los Angeles.

We have also worked to broaden our solution offering in e-discovery and will be opening this spring a document review business to complement the proprietary processing and proprietary review platform that we have today. In the new document review business we will offer clients a service where in addition to providing the processing and review platform, qualified attorneys can actually perform a first-pass review itself at a very strong value proposition for the client and an incremental business opportunity for EPIQ Systems.

In addition, we have hired new collection and forensics experts to broaden that dimension of the business so that now with in-house resources we can assist clients with field data collection and forensic analysis.

As mentioned earlier in 2008 EPIQ Systems is classified a top five provider in e-discovery both for processing and for review. 2009 is off to a good start qualitatively and strategically. Two new office openings. A new review business coming together. New collection and forensics experts joining the business, status as a top five provider and quantitatively January has seen a nice up tick, better than any month in the fourth quarter, and we are expecting double digit growth from e-discovery as our objective in 2009.

In the settlement administration area we had an excellent 2008 highlighted by the analog to digital TV case that Tom mentioned. There is continuing business on that particular matter into 2009 and as we have mentioned in earlier calls we have spent a good bit of investment in 2008 increasing and building out the sales force for settlement administration, pursuing new business opportunities in 2009 and beyond and again many of the settlement administration engagements are multi-year, long-term matters with a recurring or visible revenue dimension.

So when we step back and we look at the totality of 2008 we had a strong end to the year clearly highlighted by a very busy bankruptcy department. We are seeing a very steady influx of major new matters into 2009 and believe there are significant new opportunities both on the restructuring side and the trustee services side that give us strong momentum in 2009.

I will turn things back over to Tom now for some further remarks and then we would be happy to take your questions.

Tom Olofson

I think my first comment would be we look to the 2009, 2010 and 2011 three year period very optimistically. We think we have some extremely attractive growth opportunities. We will pursue those in a very focused way so we look for some significant performance in that 2009, 2010 and 2011 period.

Focusing on 2009 specifically, I will give you our management objectives and I will give you a range as we have historically done. I will do that for non-GAAP EPS, adjusted EBITDA and operating revenue.

First, for non-GAAP EPS the range for the year is $0.66 to $0.74. The range for adjusted EBITDA for the year $66-74 million. The range of operating revenue $210-220 million.

Those are our management objectives for 2009. We look forward to a very successful overall performance in this New Year. We are off to a very good start in Q1. At this point we are very pleased to take your questions.

So let’s begin the Q&A session.

Question-and-Answer Session


(Operator Instructions) The first question comes from the line of Tim Willi – Avondale Partners.

Tim Willi – Avondale Partners

First, around e-discovery, Chris or Tom could you talk about the margin structure in Q4? I think it is probably lower than we would have expected. Is there any way to delineate the margins in Q4 between the soft revenue, pricing and then discretionary investment just so we can think about how that margin will look as we move through 2009 and hopefully revenue growth begins to pick back up?

Betsy Braham

Relative to our e-discovery margins the cost structure for that business is fairly fixed. So when we saw a deferral of revenues from the fourth quarter to the first quarter it naturally lowered the margin for that particular quarter. We would expect as we go into the first quarter of 2009 to see that margin level go back up to be more consistent with where we were in the second and third quarter.

Tim Willi – Avondale Partners

So it was purely just a function of the revenue growth rate? No discretionary expenses or anything like that which took it down temporarily?

Betsy Braham

That’s correct.

Tim Willi – Avondale Partners

I apologize if I missed some of the opening comments where you may have talked about this, but could you just talk a little bit about the success you are seeing as you have tried to brand EPIQ as one brand and cross-sell amongst the various disciplines between e-discovery, bankruptcy, and class action? Just any stories or pieces of evidence it is working and that you are seeing it resonate with customers?

Chris Olofson

Yes there are a variety of matters that we have been engaged where we are working both in an e-discovery capacity and a bankruptcy capacity or an e-discovery capacity and a settlement administration capacity. We believe that by offering clients that complete spectrum of services under a single relationship we can establish a competitive differentiation and offer a better value than can individual category competitors whose solutions would be more narrowly defined.

We have always believed, and I think this is the case, that is going to be a slow and steady building of that cross-selling opportunity. It is not something we are seeing any other competitor do so it is a novel concept in front of different types of customers but it is achieving traction and we are enjoying the benefits of being able to displace a competitor with a broader solution set.

Tim Willi – Avondale Partners

Settlement claim, can you give us some color around if we get beyond the analog to digital contribution just sort of give us some characteristics maybe around growth rates of the remaining parts of the business to help us again think about as that government contract begins to dissipate what the underlying or remaining part of the business looks like in terms of growth rates?

Betsy Braham

The settlement administration segment margins in 2008 were really consistent with where they were in 2007. We don’t look for the margin level of that business to change significantly as we look into 2009. We have stabilized the margins within that particular segment.

As Tom and Chris both indicated that program continues into 2009. So we will continue to participate at least half way through the year and potentially there will be some revenue that filters into the second half of the year also. It will be at a lower level, obviously than a full year program we had in 2008 but it will continue to contribute to the business. We will see the overall settlement administration segment go down in 2009 versus 2008 and that is included in the projections and the objectives we have established for the company that Tom communicated to you earlier.

Chris Olofson

Qualitatively what I might share with investors is the diversification strategy that EPIQ has pursued since 2003; expanding into corporate restructuring, in settlement administration, into e-discovery, into international. Each year those factors will combine in a slightly different way than the year before. Because we try to focus at the very highest end of our markets when there is a very large case like this such as the analog to digital TV conversion it is typically not replaced immediately in succession with another case of similar size in the same segment. So settlement administration will fit into the overall company financial complexion in 2009 in a different way than it may have in 2008 and we probably expect to see the more highlighted cases coming from the bankruptcy segment in this particular fiscal year.

Betsy Braham

That is a very good point that Chris has made in that if you look at our business from 2006, 2007 and 2008 every year it has been a different large case within a different segment that has contributed to a component of the growth and to that point it is typically not in the same segment year-over-year.


The next question comes from Richard Shannon – Northland Securities.

Richard Shannon – Northland Securities

My first question is on the overall guidance for the year. If I did my calculations correctly the implied revenue growth rate is about 3% year-over-year. I’d like to get your sense qualitatively or perhaps quantitatively on your assumptions of revenues for each of the three segments. I think you mentioned something about e-discovery but I would love to get your sense of the other ones as to how you get your revenue guidance for the year.

Betsy Braham

The e-discovery and bankruptcy revenues go up versus the prior year and settlement and administration revenue to go down versus the prior year.

Richard Shannon – Northland Securities

Perhaps could you comment on what you might see organically, removing obviously the large contract for the digital TV transition, how much is that depressing your organic growth rate for the year?

Chris Olofson

I think one thing to observe is that was a very large revenue case in the segment of the company that has the lowest margin. So as we look for a relatively higher contribution from a different segment those different segments, bankruptcy or e-discovery, are accompanied by higher margins. So when you look at the objectives that we have set forth for 2009 the type of revenue may be lower than what we saw on an absolute basis but coming from bankruptcy or e-discovery it is accompanied by a higher profit margin and there are simply not engagements of that revenue size in the marketplace at all times that are like the NTIA matter or the analog to digital conversion case.

Tom Olofson

Keep in mind also that what is really always important to us is our growth in terms of profitability and cash flow and the NTIA contract was a very successful contract and it has gone very nicely. But if you go to the web presentation where the segments are broken out it is a very, very easy computation to make. I have the arithmetic in front of me here. Bankruptcy had a 57% EBITDA margin. E-discovery had a 45% and it would have been higher if the fourth quarter had not been a little bit soft but we have addressed that. So you have one at 57% and one at 45% while you have settlement at 22%. So we had some nice dollars that came in from that contract but it took a lot more revenue to get the profit and the cash. So the reason just to get right to the heart of the matter and I think we have touched on it pretty well for you here, the reason that the management objective on revenue is a lower percentage than either EBITDA or EPS simply ties to what I’ve just said about the NTIA revenue.

Richard Shannon – Northland Securities

Maybe a quick question or two on Chapter 11. Obviously you don’t split out your bankruptcy business between Chapter 11 and Chapter 7 but given the fact that Chapter 7 revenues came down in the fourth quarter it looks like your Chapter 11 margins increased somewhat but it also looks like you had a fair amount of increase in document management services which I think I would attribute to that group. I guess there are probably a lot of people out there wondering to what extent you could see leverage in that Chapter 11 business as you go throughout 2009? Is that something we can see, I don’t want to put words in your mouth, but substantial or modest amount or how can we think about the leverage in Chapter 11 specifically as we go throughout this year?

Betsy Braham

We would expect to see the margins for the Chapter 11 business improve in 2009 compared to 2008 because we are able to leverage our cost structure. We clearly have to invest to be able to support the volume levels that are increasing for that business but as we have indicated I think in prior calls we will see the margin for the Chapter 11 business increase during 2009.

Chris Olofson

The way I would look at the bankruptcy segment in a nutshell, Chapter 11 has very strong momentum of multi-year engagements that are just starting up and that will continue for the foreseeable future. Chapter 7 or the trustee services side of the business ended the year with very, very strong deposit balance which is an indication of the core health of the business and the revenue had an offsetting effect from pricing formulas that referenced short-term interest rates and as I said earlier an increase in those rates will precipitate a contribution automatically at the revenue and profit line. So that is how we would encapsulate the whole bankruptcy picture.

Betsy Braham

Overall I don’t think you should expect to see a significant margin change in the bankruptcy business during 2009. You saw a level of consistency between 2007 and 2008 which I believe will move forward into 2009 because you have variables in one area of the business where the margins will potentially come down versus the prior year and other components of that segment where they will go up.

Richard Shannon – Northland Securities

Again, on Chapter 11 you said that fourth quarter was your best retention quarter ever I think was your wording. How was first quarter ramping up so far? It seems like from the data I have been able to collect it looks like the pace of business in the first quarter could exceed even that of the fourth quarter.

Chris Olofson

Yes, the first quarter isn’t over yet of course but we are off to a very busy start. I was in that office yesterday myself. It is an extremely busy business environment and a very steady influx right now of new client matters.


The final question is a follow-up question from Tim Willi – Avondale Partners.

Tim Willi – Avondale Partners

Just two follow-up’s related to guidance. Could you maybe just as you think about high and low end of the range maybe just give us sort of what the things are that get you to high versus low and vice versa just again for investors and us to think about as the year progresses? Is it related to whether a Chapter 11 case may truly be an 11 but instead go into 7 like is happening with retailers or are there other dynamics? What has to fall in line to get the high end versus low end I guess?

Betsy Braham

There are quite a few variables obviously that we look at when we look at our objectives for the year. From the interest rate environment for Chapter 7 to new client engagements across all of our businesses, just how many Chapter 11 retentions will there be and to what size. As Chris indicated in his comments earlier, the retentions have started out this year to be significantly larger retentions than what we were seeing in the fourth quarter. So when we look at all of those variables across each of the businesses it creates the type of range that we have and obviously as we go through the year we have more visibility to each of those variables and how that is impacting what the potential results will be for each of the segments.

Tim Willi – Avondale Partners

Betsy, on your reconciliation to the non-GAAP EPS number of $0.16, there are a handful of pennies there that look like they might be tied to some kind of charge associated with an asset sale or some other kind of expense. Could you clarify that?

Betsy Braham

We sold a very small component of one of our businesses in the fourth quarter which is immaterial in the overall businesses that EPIQ resides in.

Tim Willi – Avondale Partners

Was that all the $0.03 then?

Betsy Braham

It was not all the $0.03. That was a combination of acquisition related expense and disposal of long [inaudible] assets that were netted against one another.


There are no further questions. That does conclude our question-and-answer session.

Lew Schroeber

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


Again this does conclude today’s call. We thank you for your participation and ask that you have a wonderful day.

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