Forward-Looking Statements

In this report, in other filings with the SEC and in press releases and other public statements by our officers throughout the year, Epiq Systems, Inc. makes or will make statements that plan for or anticipate the future. These forward-looking statements include , but are not limited to any projection or expectation of earnings, revenue or other financial items; the plans, strategies and objectives of management for future operations; factors that may affect our operating results; new products or services; the demand for our products and services; our ability to consummate acquisitions and successfully integrate them into our operations; future capital expenditures; effects of current or future economic conditions or performance; industry trends and other matters that do not relate strictly to historical facts or statements of assumptions underlying any of the foregoing. These forward-looking statements are based on our current expectations. In this Quarterly Report on Form 10-Q, we make statements that plan for or anticipate the future. Many of these statements are found in the "Management's Discussion and Analysis of Financial Condition and Results of Operations" section of this report.

Forward-looking statements may be identified by words or phrases such as "believe," "expect," "anticipate," "should," "planned," "may," "estimated," "goal," "objective" "seeks," and "potential" and variations of these words and similar expressions or negatives of these words. Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended (the "Exchange Act"), provide a "safe harbor" for forward-looking statements. Because forward-looking statements involve future risks and uncertainties, listed below are a variety of factors that could cause actual results and experience to differ materially from the anticipated results or other expectations expressed in our forward-looking statements. These factors include (1) any material changes in our total number of client engagements and the volume associated with each engagement, (2) any material changes in our clients' deposit portfolio or the services required or selected by our clients in engagements, (3) material changes in the number of bankruptcy filings, class action filings or mass tort actions each year, or changes in government legislation or court rules affecting these filings, (4) overall strength and stability of general economic conditions, both in the United States and in the global markets, (5) significant changes in the competitive environment,
(6) risks associated with handling of confidential data and compliance with information privacy laws, (7) changes in or the effects of pricing structures and arrangements, (8) risks associated with the integration of acquisitions into our existing business operations, (9) risks associated with indebtedness,
(10) risks associated with foreign currency fluctuations, (11) risks associated with developing and providing software and internet-based technology solutions to our clients, (12) risks associated with interruptions or delays in services at data centers, (13) risks of errors or failures of software or services, (14) risks associated with our international operations, (15) risks of litigation against us, and (16) other risks detailed from time to time in our SEC filings, including our most recent Annual Report on Form 10-K, Quarterly Reports on Form 10-Q and Current Reports on Form 8-K. In addition, there may be other factors not included in our SEC filings that may cause actual results to differ materially from any forward-looking statements. We undertake no obligation to update publicly or revise any forward-looking statements contained herein to reflect future events or developments, except as required by law.

This discussion and analysis should be read in conjunction with the Condensed Consolidated Financial Statements and the accompanying Notes to the Condensed Consolidated Financial Statements included in this Quarterly Report on Form 10-Q.

Overview

We are a leading global provider of technology-enabled solutions for electronic discovery, bankruptcy and class action administration. We offer full-service capabilities, which include eDiscovery for litigation, investigations, financial transactions, regulatory, compliance and other legal matters. Our innovative technology and services, combined with deep subject-matter expertise, provide reliable solutions for the professionals we serve.

We have three reporting segments: eDiscovery, bankruptcy, and settlement administration.

eDiscovery

Our eDiscovery segment provides collections and forensics, processing, search and review, and document review and staffing services to companies and the litigation departments of law firms. We process data which analyzes, filters, deduplicates and produces documents for review. Produced documents are made available primarily through a hosted environment, our proprietary software, DocuMatrix™, and third-party software which allows for efficient attorney review and data requests.

Our customers are typically large corporations that use our products and services cooperatively with their legal counsel to manage the eDiscovery process for litigation, financial transactions, investigations and regulatory matters.

The substantial number of electronic documents and amount of other electronic data has changed the dynamics of how attorneys support discovery in complex matters. Due to the complexity of cases, the volume of data that are maintained electronically, and the volume of documents that are produced in all types of discovery matters, law firms have become increasingly reliant on electronic evidence management systems to organize and manage the discovery process.

Following is a description of the significant sources of revenue in our eDiscovery business.

† Consulting, forensics and collection service fees based on the number of hours during which services are provided.

† Fees related to the conversion of data into an organized, searchable electronic database. The amount earned varies primarily on the number of documents.

† Hosting fees based on the amount of data stored.

† Document review fees based on the number of hours spent reviewing documents, the number of pages reviewed, or the amount of data reviewed.

Our primary offices are in New York, Phoenix, London and Hong Kong and we operate data centers in the United States, Europe and Asia. IQ Review™ is our combination of intelligent technology and expert services which incorporates new prioritization technology into DocuMatrix™, our flagship document management platform. Epiq Portal™ is a web-based platform that provides clients real-time visibility into discovery projects with connectors to both our proprietary products and to third party tools. Key benefits include cost-based reporting and budgeting tools, activity tracking, trend analysis and a project management console.

On December 28, 2011, we acquired De Novo Legal LLC ("De Novo") for approximately $86.6 million and $5.0 million is being held by us and deferred for eighteen months following the closing as security for potential indemnification claims. In addition to the net closing consideration, there is contingent consideration consisting of an earn-out based on future operating revenue growth. The potential undiscounted amount of all future payments that we could be required to make under the earn-out opportunity is between $0 and $29.1 million over a two-year period. The transaction was funded from our credit facility. See Note 11 of our Notes to Condensed Consolidated Financial Statements for further detail.

On April 4, 2011, we completed the acquisition of Encore Discovery Solutions ("Encore") for $104.3 million cash, $10.0 million of which was placed in escrow as security for potential indemnification claims. Encore provides market-proven products and services for electronic evidence processing, document review platforms, and professional services for project management, data collection and forensic consulting. With this transaction, we further strengthened our worldwide e-discovery franchise providing corporate legal departments and law firms with a broad range of capabilities to manage electronic information for discovery, investigations, compliance and related legal matters.

Both the De Novo and the Encore acquisitions further augment and accelerate growth opportunities for our global eDiscovery business. Each of these companies has strong customer bases that expand our market share. By continuing the availability of both businesses' products, services and technologies, we will continue to offer an industry leading combination of resources, experience and subject matter expertise.

Bankruptcy

Bankruptcy is an integral part of the United States' economy. As of the most recently reported data by the Administrative Office of the U.S. Courts for the twelve-month period ended March 31, 2012 and 2011, there were approximately 1.37 million and 1.57 million new bankruptcy filings, respectively. Bankruptcy filings for the twelve-month period ended March 31, 2012 decreased 13% versus the twelve-month period ended March 31, 2011. During this period, Chapter 7 filings decreased 14%, Chapter 11 filings fell 13%, and Chapter 13 filings decreased 10%.

Our bankruptcy business provides solutions that address the needs of Chapter 7, Chapter 11, and Chapter 13 bankruptcy trustees to administer bankruptcy proceedings and of debtor corporations that file a plan of reorganization.

† Chapter 7 is a liquidation bankruptcy for individuals or businesses that, as measured by the number of new cases filed in the twelve-month period ended March 31, 2012, accounted for approximately 70% of all bankruptcy filings. In a Chapter 7 case, the debtor's assets are liquidated and the resulting cash proceeds are used by the Chapter 7 bankruptcy trustee to pay creditors. Chapter 7 cases typically last several years.

† Chapter 11 is a reorganization model of bankruptcy for corporations that, as measured by the number of new cases filed in the twelve-month period ended March 31, 2012, accounted for approximately 1% of all bankruptcy filings. Chapter 11 generally allows a company, often referred to as the debtor-in-possession, to continue operating under a plan of reorganization to restructure its business and to modify payment terms of both secured and unsecured obligations. Chapter 11 cases generally last several years.

† Chapter 13 is a reorganization model of bankruptcy for individuals that, as measured by the number of new cases filed in the twelve-month period ended March 31, 2012, accounted for approximately 29% of all bankruptcy filings. In a Chapter 13 case, debtors make periodic cash payments into a reorganization plan and a Chapter 13 bankruptcy trustee uses these cash payments to make monthly distributions to creditors. Chapter 13 cases typically last between three and five years.

Chapter 11 bankruptcy engagements are generally long-term, multi-year assignments that provide revenue visibility into future periods. Our trustee services deposit portfolio averaged approximately $2.0 billion during the six months ended June 30, 2012, while pricing continued at floor pricing levels under our agreements due to the low short-term interest rate environment.

The application of Chapter 7 bankruptcy regulations has the practical effect of discouraging trustee customers from incurring direct administrative costs for computer system expenses. As a result, we provide our Chapter 7 products and services to our trustee customers at no direct charge, and they maintain deposit accounts for bankruptcy cases under their administration at a designated banking institution. We have arrangements with various banks under which we provide the bankruptcy trustee case management software and related services, and the bank provides the bankruptcy trustee with deposit-related banking services.

The key participants in a bankruptcy proceeding include the debtor-in-possession, the debtor's legal counsel, the creditors, the creditors' legal counsel, and the bankruptcy judge. Chapter 7 and Chapter 13 cases also include a professional bankruptcy trustee, who is responsible for administering the bankruptcy case. The end-user customers of our Chapter 7, Chapter 11, and Chapter 13 bankruptcy businesses are debtor corporations that file a plan of reorganization and professional bankruptcy trustees. The Executive Office for United States Trustees, a division of the United States Department of Justice, appoints all bankruptcy trustees. A United States Trustee is appointed in most federal court districts and generally has responsibility for overseeing the integrity of the bankruptcy system. The bankruptcy trustee's primary responsibilities include liquidating the debtor's assets or collecting funds from the debtor, distributing the collected funds to creditors pursuant to the orders of the bankruptcy court and preparing regular status reports for the Executive Office for United States Trustees and for the bankruptcy court. Trustees manage an entire caseload of bankruptcy cases simultaneously.

Our proprietary software product, AACER® (Automated Access to Court Electronic Records) ("AACER®"), assists creditors including banks, mortgage processors, and their administrative services professionals to streamline processing of their portfolios of loans in bankruptcy cases. AACER® electronically monitors developments in all United States bankruptcy courts and applies sophisticated algorithms to classify docket filings automatically in each case to facilitate the management of large bankruptcy claims operations. By implementing AACER®, clients achieve greater accuracy in faster timeframes, with a significant cost savings compared to manual attorney review of each case in the portfolio. Banking PortalTM, a centralized hub for processing online banking transactions across Epiq's family of Chapter 7 products, facilitates the rapid on boarding of new banks and provides ebanking capabilities.

Following is a description of the significant sources of revenue in our bankruptcy business.

† Data hosting fees and volume-based fees.

† Case management professional service fees and other support service fees related to the administration of cases, including data conversion, claims processing, claims reconciliation, professional services, and disbursement services.

† Deposit-based fees, earned primarily on a percentage of Chapter 7 total liquidated assets placed on deposit with a designated financial institution by our trustee clients, to whom we provide, at no charge, software licenses, limited hardware and hardware maintenance, and postcontract customer support services. The fees we earn based on total liquidated assets placed on deposit by our trustee clients may vary based on fluctuations in short-term interest rates.

† Legal noticing services to parties of interest in bankruptcy matters, including direct notification and media campaign and advertising management in which we coordinate notification, primarily through print media outlets, to potential parties of interest for a particular client engagement.

† Reimbursement for costs incurred, primarily related to postage on mailing services.

† Monitoring and noticing fees earned based on monthly or on-demand requests for information provided through AACER®.

Settlement Administration

Our settlement administration segment provides managed services, including legal notification, claims administration, project administration and controlled disbursement.

The customers of our settlement administration segment are companies that require the administration of a settlement, resolution of a class action matter, or administration of a project. We sell our services directly to these customers and other interested parties, including legal counsel, which often provide access to these customers.

Following is a description of the significant sources of revenue in our settlement administration business.

† Fees contingent upon the month-to-month delivery of case management services such as claims processing, claims reconciliation, project management, professional services, call center support, website development and administration, and controlled disbursements. The amount we earn varies primarily on the size and complexity of the engagement.

† Legal noticing services to parties of interest in class action matters, including media campaign and advertising management, in which we coordinate notification through various media outlets, such as print, radio and television, to potential parties of interest for a particular client engagement.

† Reimbursement for costs incurred related to postage on mailing services.

Key participants in this marketplace include law firms that specialize in representing class action and mass tort plaintiffs and other law firms that specialize in representing defendants. Class action refers to litigation in which class representatives bring a lawsuit against a defendant company or other persons on behalf of a large group of similarly affected persons. Mass tort refers to class action cases that are particularly large or prominent. Class action and mass tort litigation is often complex and the cases, including administration of any settlement, may last several years.

Results of Operations for the Three Months Ended June 30, 2012 Compared with the Three Months Ended June 30, 2011

The discussion that follows provides information which we believe is relevant to an understanding of our consolidated results of operations. Also see discussion of segment results in Results of Operations by Segment section below.

Consolidated Results



                                                                         $ Change
                                     Three Months Ended June 30,        Increase /
Amounts in thousands                    2012              2011          (Decrease)     % Change
Operating revenue before
reimbursed direct costs            $       89,837    $       68,691    $     21,146           31 %
Operating revenue from
reimbursed direct costs                     8,058             5,263           2,795           53 %
Total Revenue                              97,895            73,954          23,941           32 %

Direct cost of services
(exclusive of depreciation and
amortization shown separately
below)                                     40,254            22,072          18,182           82 %
Direct cost of bundled products
and services (exclusive of
depreciation and amortization
shown separately below)                       749               782             (33 )         -4 %
Reimbursed direct costs                     7,720             5,152           2,568           50 %
General and administrative                 28,232            27,078           1,154            4 %
Depreciation and software and
leasehold amortization                      6,523             5,806             717           12 %
Amortization of identifiable
intangible assets                           6,752             6,195             557            9 %
Fair value adjustment to
contingent consideration                   (5,471 )          (2,775 )        (2,696 )        N/M
Intangible asset impairment
expense                                     1,777                 -           1,777          N/M
Other operating (income)
expense                                       (54 )           3,427          (3,481 )       -102 %
Total Operating Expense                    86,482            67,737          18,745           28 %

Income From Operations                     11,413             6,217           5,196           84 %

Interest Expense (Income)
Interest expense                            2,713             1,757             956           54 %
Interest income                                (1 )             (11 )            10          N/M
Net Interest Expense                        2,712             1,746             966           55 %

Income Before Income Taxes                  8,701             4,471           4,230           95 %

Provision for Income Taxes                  3,544             1,698           1,846          N/M

Net Income                         $        5,157    $        2,773    $      2,384           86 %

Revenue

The increase in operating revenue exclusive of revenue originating from reimbursed direct costs was driven by a $4.0 million increase in the eDiscovery segment and a $17.2 million increase in the settlement administration segment from a large active engagement which was principally completed in the second quarter of 2012.

A portion of our total revenue consists of reimbursement for direct costs we incur, such as postage related to document management services. We reflect the operating revenue from these reimbursed direct costs as a separate line item on our accompanying Condensed Consolidated Statements of Income. Although operating revenue from reimbursed direct costs may fluctuate significantly from quarter to quarter, these fluctuations have a minimal effect on our income from operations as we realize little or no margin from this revenue.

Operating Expense

The increase in direct cost of services, exclusive of depreciation and amortization, was primarily the result of a $4.4 million increase in compensation related expense, primarily related to the De Novo acquisition, an $11.5 million increase related primarily to costs for legal notification and advertising services related to a large active engagement in the second quarter of 2012, a $0.9 million increase in software maintenance costs, and a $1.5 million increase related to outside services, offset by a $0.3 million decrease in general office expense and a $0.5 million decrease in third party material costs.

The decrease in direct cost of bundled products and services, exclusive of depreciation and amortization, was primarily related to a decrease in compensation expense.

The increase in reimbursed direct costs for the three months ended June 30, 2012 as compared to 2011 corresponds to the increase in operating revenue from reimbursed direct costs.

This increase in general and administrative costs was primarily due to an increase of $0.7 million in compensation and related expense which is primarily related to the De Novo acquisition, a $0.5 million increase in travel and related expense, a $0.7 million increase in legal expense during the three months ended June 30, 2012, and a $0.3 million increase in lease expense primarily related to the De Novo acquisition, offset by a $0.6 million decrease in maintenance service contracts and a $0.6 million decrease in professional services expense.

Depreciation and software and leasehold amortization costs increased primarily as a result of increased depreciation on equipment and software related to investments in our business segments and depreciation on the equipment acquired from the De Novo acquisition.

Amortization of identifiable intangible assets increased due the acquisition of intangible assets associated with the acquisition of De Novo in the fourth quarter of 2011.

The fair value adjustment to contingent consideration of $5.5 million of income during the three months ended June 30, 2012 resulted from a fair value adjustment to the contingent consideration related to the De Novo acquisition. The fair value adjustment to contingent consideration of $2.8 million of income during the three months ended June 30, 2011 resulted from a fair value adjustment to the contingent consideration related to the Jupiter eSources acquisition. See Notes 7 and 11 of our Notes to Condensed Consolidated Financial Statements for further detail.

Intangible asset impairment expense was $1.8 million for the three months ended June 30, 2012 related to an impairment of the AACER® trade name acquired as part of the Jupiter eSources acquisition in 2010. See Note 2 of our Notes to Condensed Consolidated Financial Statements for further detail.

Interest Expense, Net

The increase in net interest expense was primarily due to interest expense resulting from increased borrowings on our senior revolving loan to fund the Encore and De Novo acquisitions in April 2011 and December 2011, respectively, in addition to $0.6 million of accretion expense related to acquisition related obligations in connection with the De Novo acquisition.

Income Taxes

Our effective tax rate for the three months ended June 30, 2012 was 40.7% compared to 38.0% in the prior year. The year-over-year increased tax rate is primarily due to the change in expected mix of taxable income by jurisdictions.

Results of Operations by Segment

The following segment discussion is presented on a basis consistent with our segment disclosure contained in Note 6 of our Notes to Condensed Consolidated Financial Statements. The table below presents operating revenue, direct and administrative costs (including reimbursed costs) and segment performance measure for each of our reportable segments and a reconciliation of the segment performance measure to consolidated income before income taxes.

                                                                          $ Change
                                      Three Months Ended June 30,        Increase /
Amounts in thousands                     2012              2011          (Decrease)     % Change
Operating revenue before
reimbursed direct costs
eDiscovery                          $       42,711    $       38,717    $      3,994           10 %
Bankruptcy                                  21,466            21,532             (66 )
Settlement Administration                   25,660             8,442          17,218          204 %
Total operating revenue before
reimbursed direct costs             $       89,837    $       68,691    $     21,146           31 %

Operating revenue from
reimbursed direct costs
eDiscovery                          $          266    $          131    $        135          103 %
Bankruptcy                                   1,674             1,167             507           43 %
Settlement Administration                    6,118             3,965           2,153           54 %
Total operating revenue before
reimbursed direct costs             $        8,058    $        5,263    $      2,795           53 %

Direct costs, general and
administrative costs
eDiscovery                          $       27,059    $       22,555    $      4,504           20 %
Bankruptcy                                  12,696            11,273           1,423           13 %
Settlement Administration                   27,407            11,877          15,530          N/M
Intercompany eliminations                     (766 )            (373 )          (393 )        105 %
Total direct costs, general and
administrative costs                $       66,396    $       45,332    $     21,064           46 %

. . .