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EPIQ > SEC Filings for EPIQ > Form 10-Q on 1-May-2013All Recent SEC Filings

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Form 10-Q for EPIQ SYSTEMS INC


1-May-2013

Quarterly Report


Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations

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) failure to keep pare with technological changes and significant changes in the competitive environment, (6) risks associated with the 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 cyber attacks, 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, or failure to protect our intellectual property, (16) any material non-cash write-downs based on impairment of our goodwill, and (17) 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 provider of managed technology solutions for the legal profession. Our solutions streamline the administration of bankruptcy, litigation, financial transactions and regulatory compliance matters. We offer innovative technology solutions for eDiscovery, document review, legal notification, claims administration and controlled disbursement of funds. Our clients include leading law firms, corporate legal departments, bankruptcy trustees, government agencies, mortgage processors, and financial institutions.

In the first quarter of 2013, we reorganized our internal financial reporting structure. Under the new structure, we began reporting our financial performance based on the following two reportable segments: the Technology segment and the Bankruptcy and Settlement Administration segment. The composition of the segment previously called eDiscovery remains unchanged and is now referred to as the Technology segment. The former Bankruptcy segment and Settlement Administration segment were combined and are now reported as the Bankruptcy and Settlement Administration segment. Although our consolidated results of operation, financial position and cash flows will not be impacted we have updated the segment disclosures for prior periods to reflect our new internal reporting structure.


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Technology

Our Technology segment provides eDiscovery managed services and technology solutions comprised of consulting, collections and forensics, processing, search and review, production of documents and document review services to companies and the litigation departments of law firms. Our eDataMatrix® and third-party software analyzes, filters, deduplicates and produces documents for review. Documents are made available primarily through a hosted environment, and our DocuMatrix™ and third-party software 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, investigations, anti-trust filings and regulatory matters and data requests.

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

Following is a description of the significant sources of revenue in our Technology segment.

† Consulting, forensics, collection and project management service fees based on the number of hours that 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 or volume of data processed.

† Hosting fees based on the amount of data stored.

† Production of documents based on the number of documents

† 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.

Bankruptcy and Settlement Administration

Our Bankruptcy and Settlement Administration segment provides managed services and technology solutions that address the needs of our customers with respect to litigation, claims and project administration, compliance matters, controlled disbursements corporate restructuring bankruptcy and class action proceedings.

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 December 31, 2012 and 2011, there were approximately 1.22 million and 1.41 million new bankruptcy filings, respectively. Bankruptcy filings for the twelve-month period ended December 31, 2012 decreased 13% versus the twelve-month period ended December 31, 2011. During this period, Chapter 7 filings decreased 15%, Chapter 11 filings fell 10%, and Chapter 13 filings decreased 10%.

This segment 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 December 31, 2012, accounted for approximately 69% 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 December 31, 2012, accounted for less than 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 December 31, 2012, accounted for approximately 30% of all bankruptcy filings. In a Chapter 13 case, debtors make periodic cash payments into a reorganization plan and a Chapter 13 bankruptcy trustee


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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 $1.7 billion during the three months ended March 31, 2013, while pricing continued at floor pricing levels under our agreements due to the low short-term interest rate environment.

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.

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. 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.

Following is a description of the significant sources of revenue in our Bankruptcy and Settlement Administration segment.

† Data hosting fees and volume-based fees.

† Professional service fees and other support service fees contingent upon the month-to-month delivery of services such as data conversion, 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.

† Deposit-based and service fees. Deposit-based fees are earned on a percentage of Chapter 7 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 assets placed on deposit by our trustee clients may vary based on fluctuations in short-term interest rates and changes in service fees.

† Legal noticing services to parties of interest in bankruptcy, class action, and other administrative 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.


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

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

Results of Operations for the Three Months Ended March 31, 2013 Compared with the Three Months Ended March 31, 2012

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



                                        Three Months Ended March         $ Change
                                                   31,                  Increase /
Amounts in thousands                      2013             2012         (Decrease)    % Change
Operating revenue                    $      102,908    $      82,827   $     20,081          24 %
Reimbursable expenses                        20,682            5,645         15,037         266 %
Total Revenue                               123,590           88,472         35,118          40 %

Direct cost of operating revenue
(exclusive of depreciation and
amortization shown separately
below)                                       52,496           32,076         20,420          64 %
Reimbursed direct costs                      19,542            5,568         13,974         251 %
Selling, general and
administrative                               32,424           32,032            392           1 %
Depreciation and software and
leasehold amortization                        6,999            6,728            271           4 %
Amortization of identifiable
intangible assets                             4,966            6,769         (1,803 )       -27 %
Other operating expense (income)                 47             (171 )          218           N/M
Total Operating Expense                     116,474           83,002         33,472          40 %

Income From Operations                        7,116            5,470          1,646          30 %

Interest Expense (Income)
Interest expense                              1,839            2,726           (887 )       -33 %
Interest income                                  (4 )             (6 )            2           N/M
Net Interest Expense                          1,835            2,720           (885 )       -33 %

Income Before Income Taxes                    5,281            2,750          2,531          92 %

Provision for Income Taxes                    1,344              711            633          89 %

Net Income                           $        3,937    $       2,039   $      1,898          93 %

N/M - not meaningful


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Revenue

The increase in operating revenue for the three months ended March 31, 2013 as compared to the same period in the prior year was driven by a $5.9 million increase in the Technology segment and a $14.1 million increase in the Bankruptcy and Settlement Administration segment.

Total revenue includes reimbursed expenses, such as postage related to notification services. We reflect these reimbursed expenses as a separate line item on our accompanying Condensed Consolidated Statements of Income. Although reimbursable expenses may fluctuate significantly from quarter to quarter, these fluctuations have a minimal effect on our quarter to quarter income from operations as we realize little or no margin from this revenue.

Operating Expense

The increase in direct cost of operating revenue, exclusive of depreciation and amortization, was primarily the result of the increase in and mix of operating revenue and includes a $5.6 million increase in compensation related expense, a $7.5 million increase related to costs for legal notification and advertising services, and a $6.4 million increase in other production costs.

The increase in reimbursed direct costs for the three months ended March 31, 2013 as compared to the same period of 2012 corresponds to the increase in revenue from reimbursed expenses.

Selling, general and administrative expenses and depreciation and software and leasehold amortization expense were comparable to the prior period notwithstanding the increase in revenue.

Interest Expense, Net

The decrease in net interest expense was primarily due to a $0.6 million decrease in accreted interest expense related to acquisition-related liabilities for the three months ended March 31, 2013 as compared to the same period in the prior year.

Income Taxes

Our effective tax rate for the three months ended March 31, 2013 was 25.5% compared to 25.9% in the prior year. The 2013 reduction from statutory rates is primarily due to the enactment of the 2012 American Taxpayer Relief Act which extended the federal research credit for both 2012 and 2013. We have recognized approximately $0.4 million of tax benefit relating to the 2012 credits and a portion of our 2013 tax credits during this quarter. The 2012 reduction from statutory rates resulted from a tax benefit related to settling our New York investment tax credit claim, as previously reported.

We have been informed that our income tax returns for the years ended December 31, 2009, 2010 and 2011will be audited by the State of New York beginning in the third quarter of this year. The outcome of the tax exam cannot be predicted with certainty but we do not expect any adjustments to be material. If any issues are resolved in a manner not consistent with our expectations, we could be required to adjust our provision for income tax in the period such resolution occurs.


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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 March 31,        Increase /         %
Amounts in thousands                     2013               2012          (Decrease)      Change
Operating revenue
Technology                         $         54,787    $       48,848    $      5,939           12 %
Bankruptcy and Settlement
Administration                               48,121            33,979          14,142           42 %
Total operating revenue            $        102,908    $       82,827    $     20,081           24 %

Reimbursable expenses
Technology                         $            287    $          456    $       (169 )        -37 %
Bankruptcy and Settlement
Administration                               20,395             5,189          15,206          293 %
Total reimbursable expenses        $         20,682    $        5,645    $     15,037          266 %

Direct costs, selling, general
and administrative costs
Technology                         $         38,687    $       31,759    $      6,928           22 %
Bankruptcy and Settlement
Administration                               53,917            24,949          28,968          116 %
Intercompany eliminations                        (5 )             (48 )            43          -90 %
Total direct costs, selling,
general and administrative
costs                              $         92,599    $       56,660    $     35,939           63 %

Segment performance measure
Technology                         $         16,392    $       17,593    $     (1,201 )         -7 %
Bankruptcy and Settlement
Administration                               14,599            14,219             380            3 %
Total segment performance
measure                            $         30,991    $       31,812    $       (821 )         -3 %

Segment performance measure        $         30,991    $       31,812
Unallocated corporate expenses              (10,324 )         (11,162 )
Share-based compensation
expense                                      (1,539 )          (1,854 )
Depreciation and software and
leasehold amortization                       (6,999 )          (6,728 )
Amortization of intangible
assets                                       (4,966 )          (6,769 )
Other operating expense
(income)                                        (47 )             171
Income from operations                        7,116             5,470
Interest expense, net                        (1,835 )          (2,720 )
Income before income taxes         $          5,281    $        2,750


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Technology Segment

Operating revenue increased $5.9 million compared to the prior year period primarily as a result of an increase in document review engagements as compared to the first quarter of 2012.

Direct, selling, general and administrative costs increased primarily in support of revenue growth and related to a $4.3 million increase in compensation related expenses, a $1.0 million increase in outside service providers and a $1.1 million increase in technology-related costs, offset by a $0.9 million decrease in maintenance and repairs expense.

Bankruptcy and Settlement Administration Segment

Operating revenue increased $14.1 million as compared to the prior year, primarily due to a large active private anti-trust settlement engagement, which was principally complete in the first quarter of 2013, that increased legal notification and advertising services as compared to the prior year. This increase was partially offset by decreases in revenues resulting from the current cyclical downturn in bankruptcy filings.

Direct, selling, general and administrative costs increased primarily related to an increase in legal advertising costs of $7.5 million, an increase of $14.2 million in reimbursed direct costs, a $1.3 million increase in compensation expense, and an increase of $2.1 million in outside services, which were primarily related to the large active private anti-trust settlement engagement.

Liquidity and Capital Resources

Cash flows from operating activities

During the three months ended March 31, 2013, our operating activities used net cash of $5.3 million. Included in net cash used by operating activities was net income of $3.9 million, including $14.8 million of non-cash expenses, for a total of $18.7 million. Cash used by operating activities also included a $24.0 million net use of cash resulting from changes in operating assets and liabilities, primarily from a $15.1 million increase in trade accounts receivable due to revenue growth and a $13.2 million decrease in customer deposits, offset by a $5.4 million increase in accounts payable and other liabilities. Trade accounts receivable will fluctuate from period to period depending on the timing of sales and collections. Accounts payable will fluctuate from period to period depending on the timing of purchases and payments.

During the three months ended March 31, 2012, our operating activities provided net cash of $15.1 million. Contributing to net cash provided by operating activities were net income of $2.0 million and non-cash expenses, such as depreciation and amortization and share-based compensation expense, of $16.9 million, for a total of $18.9 million. These items were partially offset by a $4.5 million net use of cash resulting from changes in operating assets and liabilities, resulting primarily from a $5.1 million increase in accounts receivable, due to revenue growth, a $1.2 million decrease in prepaid expenses and other assets, and a $1.0 million reduction in accounts payable and other liabilities.

Cash flows from investing activities

During the three months ended March 31, 2013 and 2012, we used cash of $3.7 million and $2.6 million, respectively, for the purchase of property and . . .

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