Description

Overview:
Ever heard of attorney’s paying you? Elite information group has (85% of business from law firms). Elite is the #1 company in selling Professional Services Software to 33% of the top 1000 US law firms and 50% of the top 100 UK law firms but only 15% of Europe’s top 300. The company is trading at only EV/EPS 8x & 5x next years, EV/FCF 5.9x & 4.4x, EV/Growth flow (R&D+EPS)(EV/Growth flow is a shaky ratio to use in analysis because who knows what a co. will get out of R&D, but stood out nonetheless) 2.2x. Elite has a rock solid b-sheet with $3.15 in Cash and debt free (EV=$3.85, or $33.50mm). The company is spending $11mm in R&D this year 33% of EV. Elite’s revenues for first Half 2001 vs. 2002 have grown +18% with projected EPS growth of 32% from .50 to .67 yr./yr. (company is comfortable with .47-.52 EPS for 2002 and .62-.70 EPS for 2003). Switching costs are high: there is a learning curve and implementation takes 9-12 months.
Revenue visibility into Elite Information Group (ELTE)
Deferred revs: $17.9mm
Signed Customer backlog $30.3mm vs. $25.5mm as of 12/31/01
30% of business is recurring

What derailed the stock:
Last qtr disappointed EPS by increasing R&D spending by 52% yr./yr. while ramping sales force for new products and the company lowered growth projections from 15-20% this yr. to 12-14%. Most importantly: "During the quarter a contract dispute occurred with a significant customer where we felt it was prudent to reverse revenue earned on this engagement for the year and reserve against the collection of related accounts receivable. We remain in ongoing discussions with the customer regarding the resolution of this matter. This reversal had effect of reducing revenue for the second quarter by approximately $400,000 and lowering earnings per diluted share by approximately $0.03." July 2002 was obviously very rough on equity markets: ELTE shed 40% of the market cap ($30mm market value) on this news. WOW!!!

Competitive position:
Company has twice market share of next closest competitor (Australian Company Solution 6 product called CMS, who tried to buy ELTE). According to American Lawyer Tech Survey June 2001: Top US 100 law firms Elite had 51% market share, CMS (Solution 6) had 26%, other (PSFT, NIKU, LWSN, JDEC,EVLV, ORCL)18%, and custom 5%. Elite’s Law Manager addresses management issues: Calendar/Docketing, Records Management, Conflict management, Document Management, Time & Expense tracking, E-invoicing/auditing. Key customers: Johnson & Johnson, Pepsi, The Hartford, Bombardier Capital, Citigroup, MetLife. ELTE customer base has nearly doubled since 1997 from 470 to 800+ in 2001.

Elite plans to go after Accounting, Architects, IT Consultants, Management consultants, and Physical, engineering & Life Sciences verticals to diversify outside legal. The company also plans to take market-dominating product to South America, Asia, and more aggressively through Europe.

I have followed this industry and seen that some competitors do well for several reasons. 1) very strong in a particular niche (Carved moat, PSFT et al try to be all things to all customers. (from enterprise to small business: customers want someone who understands the specifics of their business), 2) high recurring revenues (due to high switching costs) which generates a ton of FCF= Strong B-sheet.

Valuation:
VIC member Paul212 astutely mentioned a similar situation in Jan ’02 about DLTK which management took private in Feb ’02. DLTK went private EV/Sales of .67x and EV/normalized EBIT of 9x, however DLTK was in more trouble than ELTE: revenues were declining, new product cycle that wasn;t gaining traction, and Father/Son team that owned 40% of company. Using depressed DLTK comps (which I would argue are very conservative for ELTE: due to growth (12-14%), #1 player, high R&D expense (understates normalized EPS), pipeline of new products, and expanding sales force) gets you a value of $9.40 (+35%). Using a NOPAT DCF: assuming 10% revenue growth (actual 12-14%), EBIT margin 8%(should get to 12%), tax rate of 37%, WACC 10.85% (Risk free 3%, Equity Risk Prem. 8.0%, Beta of .98) gets you a value of $12.30 (76%). I believe over the next 9-12 months, the company will get a more aggressive valuation in the range of $12-14 (15x operating ’03 EPS =growth rate plus cash $3.15)= $13.60 (+94.20%). EBIT 2002 should be approximately $6.1mm and 2003 $10mm with EV of $33.4mm currently (5.4x and 3.5x respectively).

Solutions 6 offered to buy Elite in early 2000 for $11 per share revenues were $52mm and losing money (.02) for the yr. FTC turned down the deal due to potential market dominance. Now company is nicely profitable and 50% bigger and growing (although valuations in 2000 were very different too).

CEO Comments from July Quarter
"We remain very optimistic about our business. Our booked backlog is strong and growing and our pipeline of prospective business is solid. But in a tough economy, firms tend to spend more on enhancing their existing technology investments than on acquiring new, big ticket systems. As long as this trend continues it will have the effect of decreasing new higher margin license revenues even while our services revenue remains strong. We have been and will continue to watch this trend very closely. Concurrently, we have pushed out our projections for our new Encompass document management product. The combined effect of all of this is to cause us to revise our revenue and earnings assumptions for 2002." (Revised:.47-.52 EPS and .62-.70 EPS, Wall Street consensus is .79 EPS for ’03).


Management
CEO, Chris Poole has worked @ Elite since 1995 starting as COO, then working up to President in 1998 and then Chairman/CEO in 1999. Prior to joining Elite, Chris Poole was the Executive Director/Director of Technology of Latham & Watkins (top 5 law firm worldwide). Alan Rich co-founded company and was President from 1982-1997 and is non-employee Chairman. Management is solid.

Top Holders: PAR Capital Management, Ironwood Capital, Nicholas Applegate, Tudor, Northern Trust, AXA, and Royce.

Catalyst

Catalysts:
Company is Re-purchasing equity 500, 000 shares.
Free Cash Flow should be $1 per share in 2003 (8-10x+ Cash=$11-14 Per share)
New Product sales to installed base.
Expanding into UK, Asia, and South America (under-penetrated market)
5.4x EV/EBIT ’02 and 3.5x EV/EBIT ‘03
New markets: Accounting, architects, IT consulting, Management Consulting, Marketing services.
Legal IT market less impacted than corporate America (still impacted but Legal IT market still growing @ high single digits this year).
Strong Stable Franchise: #1 player Law firms
High Recurring revs
Fundamentals: .47-.52 EPS 2002E (EV/EPS 8x).62-.70 EPS 2003E (EV/EPS 5x),CASH per share $3.15 per share (45% of EV), Deferred Revs: $2.15 per share, Sale Estimate: $77mm or $9.00 per share this yr, EV/Sales: .42x, EV/R&D=3x