Epicor's Mid-Market Pitch Becomes Higher For (One) Scala Part One: Event Summary

Event Summary

While the market has for some time been buzzing about the (for many still miraculous) predatory comeback of SSA Global, another true mid-market incumbent vendor, Epicor Software Corporation (NASDAQ: EPIC), should be lauded too for its recent revival. Like SSA Global, and intriguingly in the same time frame, Epicor did not have much upbeat news for several years following on its progenitors' (i.e., erstwhile Platinum Corporation and Dataworks) merger in 1998 and subsequent name change from Platinum to Epicor in 1999. Nevertheless, in the past two years, Epicor has seemingly achieved a turnaround both in terms of its financial performance and of its strategy clarity. It has also for over two years reverted to its, this time possibly more selective, acquisition streak starting with the Clarus e-procurement acquisition at the end of 2002, and former ROI Systems and TDC Solutions acquisitions mid-2003 (for more information, see Epicor Picks Clarus' Bargain At The Software Flea Market and Epicor Conducts Its Own ROI Acquisition Rationale).

As highlighted in the above articles, it appears this time though that Epicor has learned some hard lessons from its cumbersome inception through mergers that had initially resulted in unrelated, diverse products, and all in the face of the overall weakness of the enterprise resource planning (ERP) market during 1999 and 2000. Thus, the Scala merger too seems to have much of a strategic merit as opposed to a knee-jerk, me too' impulse owing to the ongoing consolidation craze in the market. While customers want their enterprise applications providers to oblige them with new products and technologies, vendors in turn feel compelled to increase revenues and market share as to be able to justify funding of new product development.

To that end, Epicor pledges to continue to invest in its products and to grow both organically and through acquisitions, in order to assemble the right mix of back-office, front-office, and collaborative e-business functions, delivered under a single-point accountability (i.e., "one-stop shop" and "one throat to choke") approach that is overwhelmingly desired by its target market. While in the past Epicor would integrate with partner products for best-of-breed solutions to accommodate these requirements, it has lately been expanding the boundaries of traditional ERP by building fully integrated applications that are based on the same technology and toolsets, and possibly delivered all from a single vendor.

This is Part One of a five-part note.

Part Two will detail how Scala complements Epicor.

Part Three will discuss the market impact.

Part Four will present merger synergies and challenges.

Part Five will address more challenges and make user recommendations.

Epicor Acquires Scala

Accordingly, back at the end of 2003, Epicor and Scala Business Solutions (Euronext: A.SCALA), an Amsterdam, the Netherlands-based provider of collaborative enterprise software for mid-size enterprises and subsidiaries of global corporations, jointly announced that the expectation was justified that they would reach agreement on a merger. The proposed merger was effected by a public offer by Epicor for all the outstanding ordinary shares in the capital of Scala at an anticipated aggregate transaction value of approximately $87 million (USD)—the equivalent of Euro3.27 per ordinary share—, as of the closing price on November 13, 2003, consisting of a cash price of $ 41.7 million (USD) subject to adjustment, plus 4.1 million shares of Epicor's common stock. The offer was made up of a cash price of $1.823 (USD) per Scala share plus 0.1795 shares of Epicor's common stock.

The public offer only commenced following the completion of Epicor's due diligence investigation of Scala, the receipt of a fairness opinion by Scala, regulatory approvals, the filing of an S-4 registration with the Security and Exchange Commission (SEC) by Epicor, and other customary conditions including, among others, material adverse changes to Scala and management retention agreements. Initially, Epicor anticipated that it would begin the public offer for all outstanding ordinary shares of Scala and publish an offer memorandum in December 2003, and close the transaction in the first quarter of 2004. The combination was then also expected to be accretive to Epicor's Generally Accepted Accounting Practice (GAAP) earnings in the second quarter of 2004 and for the fiscal year 2004.

One of the requirements for delisting Scala's stock on the Dutch exchange was that at least 95 percent of the ordinary shares of Scala are offered. As said earlier, the anticipated transaction value of approximately $87 million (USD) was to be paid partly in cash and partly in Epicor common stock, with a 20 percent downwards protection for the shareholders of Scala. Any decrease in the value of the common stock of Epicor below a floor of $10.21 (USD) per share was to be compensated in cash by an adjustment in the offer price. The anticipated transaction price of approximately $87 million (USD) represented a premium of approximately 40 percent as of the closing price of Scala's shares on November 13, 2003, and a 59 percent premium on the basis of the 30-day share price average. The closing of the transaction, which was expected to occur in early 2004, was subject to certain conditions including, but not limited to, regulatory clearance and acceptance by Scala shareholders, whereas the Dutch regulator of the financial markets (Netherlands Authority for the Financial Markets) and Euronext had been informed of the intended bid. SG Cowen Securities Corporation was adviser to Epicor and Fortis Bank Corporate & Investment Banking was adviser to Scala, with respect to the transaction.

However, the acquisition closing process was delayed for one major reason, which was the ensued restatement of Scala's US GAAP financial figures by its auditor KPMG, so that it was not until mid-June that Epicor was able to declare its public offer to acquire all issued and outstanding ordinary shares in Scala unconditional. As of the tender closing date, approximately 21.7 million Scala shares have been tendered into the offer, and upon the delivery of these Scala shares, Epicor was to hold approximately 93.2 percent of the issued share capital of Scala. Epicor then conducted a subsequent tender period for holders of Scala shares who had not yet tendered their shares, which expired effective July 5. Following the completion of that subsequent tender period and the tendering of 1,096,048 shares in the period, corresponding with approximately 4.54 percent of all outstanding Scala shares, Epicor now holds a total of approximately 97.98 percent of all outstanding Scala shares. Consequently, Euronext Amsterdam N.V. then confirmed that the listing of the Scala shares on the official market of Euronext Amsterdam N.V. would terminate as of July 13, 2004, whereby July 12, 2004 was the last trading day of the Scala shares on the Euronext exchange.

What the Merger Creates

The merger by all accounts creates the largest independent global mid-market provider of collaborative ERP, customer relationship management (CRM), and supply chain management (SCM) applications based on Microsoft's .NET platform and Web services, with approximately $250 million (USD) annual revenue run rate, nearly 1,500 employees, and with over 20,000 customers. The combined company hopes to expand its global presence with worldwide coverage of sales, consulting, and support for mid-market and large multinationals as well as local enterprises, offering a broad suite of integrated solutions.

Both Epicor and Scala customers should now be served by a global entity with the reach and scale to more effectively support their operations, and will be well positioned for growth with local support in emerging markets, and in key markets where Scala traditionally performs well, such as Scandinavia, Russia, Central and Eastern Europe, and China. Scala's customer base is predominantly European , while Epicor's largest customer base predominantly in North America, Australia, and the UK. The resulting company's revenues will therefore be diversified across regions with approximately 52 percent of its revenue base in North America and 48 percent outside this region.

The combined company plans to further support and develop iScala products, while Scala's management was offered one board seat out of six on Epicor's board of directors. In the long term, the combined company's product offering would be developed using the functional synergies of all products, and the integration advantages of the .NET framework and Web services. Enlarged Epicor pledges to continue the unwavering commitment to developing and bringing to market software and services based on Microsoft technology, given its strong Microsoft partnership—as a globally managed independent software vendor (ISV) and Microsoft Global ERP Ecosystem partners—and has actively participated for many years in numerous Microsoft joint development programs and early adopter technology initiatives.

The merger may also bode well for Epicor's expanded presence in key growing verticals including financial services, consumer packaged goods (CPG), professional services, automotive, industrial machinery, light engineering, electronics, hospitality, pharmaceuticals, and nonprofit. Also, this might increase the vendor's scale and reach to support global multinational corporations with a worldwide infrastructure for sales, consulting, and support, and a strong partner channel—combining over 400 partners worldwide, with possible operating and infrastructure synergies in general and administrative (G&A), research and development (R&D), facilities, and technical support with a solid platform and infrastructure for future strategic and tactical acquisitions in a consolidating market.

Prior to the merger, Epicor had delivered its solutions to over 15,000 customers worldwide, whereby its manufacturing customer community includes over 6,500 customers, implemented in more than thirty-five countries. Epicor's broadening suite of integrated software solutions features CRM, financials, manufacturing, SCM, professional services automation (PSA), and collaborative commerce applications.

On the other hand, Scala's main trump is unrivaled localization capabilities for companies doing business in established or emerging markets, or even in some of the world's most difficult-to-get-to places. Scala has garnered the local know-how and expertise to deliver results for businesses almost anywhere in the world, from over twenty-five years working with international companies and their subsidiaries and divisions in many types of industries. Scala delivers software and services that support local currencies, accounting regulations, and legal requirements in more than thirty languages in over 140 countries.

Epicor Financials

Since the transaction closing, Epicor has reported two quarters of earnings, most recently the October 20 upbeat announcement of financial results for the third quarter ended September 30, 2004. For a protractedly languishing company until not that long ago (see figure 1), reporting facts like that the Q3 2004 revenues grew over 54 percent, year-over-year, whereby Q3 2004 license revenues grew over 64 percent, year-over-year, second quarter GAAP earning per share (EPS) grew over whopping 175 percent, year-over year, while the vendor added over 165 new customers to its base and it released over 50 product upgrades to market across its suite of solutions, and so on, should bear a great importance and vindication to the long-embattled but persistent management.

Figure 1

Total revenues for the quarter were $62.2 million (USD), up over 54 percent compared to $40.3 million (USD) for Q3 2003, whereby it included $17.5 million (USD) in total revenues from Epicor's recently acquired subsidiary Scala Business Solutions N.V., whose revenues have fully contributed for the first time to this quarterly report. Excluding the contribution from Scala, Epicor's total revenues grew 11 percent year-over-year. Software license revenue totaled $15.3 million (USD), a 64 percent increase compared to $9.4 million (USD) a year ago and including $4.7 million (USD) for the contribution from Scala (see figure 2). Excluding the contribution from Scala, Epicor's license revenues grew approximately 13 percent year-over-year.

Figure 2

Consulting and maintenance revenues for the third quarter were $45.9 million (USD) compared with $30.4 million (USD) in the third quarter of 2003, up over 50 percent. Included in consulting and maintenance revenues was $12.6 million (USD) from Scala's contribution. Excluding the contribution from Scala, Epicor's consulting and maintenance revenues grew approximately 10 percent year-over-year. GAAP net income for the third quarter was $6.3 million (USD), which compares with net income of $1.8 million (USD) in the prior year's period. For the quarter, adjusted earnings were $9.6 million (USD) compared with adjusted earnings of $4.7 million (USD) in the same period last year. Adjusted earnings exclude amortization of capitalized software development costs and acquired intangible assets, stock-based compensation expense and restructuring charges, and other.

Further, Epicor ended the quarter with cash and cash equivalents of $46.6 million (USD), up approximately 2 percent from the prior quarter, including significant cash expenditure for transaction costs, Sarbanes-Oxley costs, and severance costs following the reduction in force completed during the quarter as a result of consolidating the Epicor and Scala organizations.

For the fourth quarter 2004, the company raised its previously issued total revenues expectations from the range of $66 to $67 million to $67 million (USD) in total revenues, while for fiscal year 2004, the company raised its previously issued total revenue guidance of $220 million to $221 million (USD). Additionally, the company provided an initial outlook for fiscal year 2005, where it anticipates the revenues to be approximately $273 million (USD) The company has also completed extensive operational reviews of its Scala acquisition and put in place plans toward achieving its cost synergies and accretion goals, which was demonstrated in the last quarter.

This concludes Part One of a five-part note.

Part Two will detail how Scala complements Epicor.

Part Three will discuss the market impact.

Part Four will present merger synergies and challenges.

Part Five will address more challenges and make user recommendations.