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EPIQ > SEC Filings for EPIQ > Form 10-Q on 31-Jul-2013All Recent SEC Filings

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Form 10-Q for EPIQ SYSTEMS INC


31-Jul-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 pace 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 provide integrated technology solutions for the legal profession. Our solutions are designed to streamline the administration of bankruptcy, litigation, investigations, financial transactions and regulatory compliance matters. We offer innovative managed 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 allow 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, Washington D.C., Dallas, London, Hong Kong and Tokyo, which we opened for business during the second quarter of 2013. We operate data centers in the United States, Europe and Asia. During the second quarter of 2013 we opened a new data center in Shanghai.

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 March 31, 2013 and 2012, there were approximately 1.17 million and 1.37 million new bankruptcy filings, respectively. Bankruptcy filings for the twelve-month period ended March 31, 2013 decreased 14% versus the twelve-month period ended March 31, 2012. During this period, Chapter 7 filings decreased 16%, Chapter 11 filings fell 13%, 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 bankruptcy engagements are generally long-term, multi-year assignments that provide revenue visibility into future periods.

† 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.

Our trustee services deposit portfolio averaged approximately $1.7 billion during the six months ended June 30, 2013 as compared to $2.0 billion for the six months ended June 30, 2012, and our interest-based deposit fees continued at floor pricing levels under our agreements due to the low short-term interest rates 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 earned 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 assessed on such deposits.

† 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.

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

† Reimbursed expenses, primarily related to postage on mailing services and other pass-through expenses.


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Results of Operations for the Three Months Ended June 30, 2013 Compared with the Three Months Ended June 30, 2012

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

Consolidated Results



                                                                              $ Change
                                          Three Months Ended June 30,        Increase /
Amounts in thousands                        2013               2012          (Decrease)     % Change
Operating revenue                      $       104,976    $       89,837    $     15,139          17 %
Reimbursable expenses                            8,396             8,058             338           4 %
Total Revenue                                  113,372            97,895          15,477          16 %

Direct cost of operating revenue
(exclusive of depreciation and
amortization shown separately
below)                                          49,528            41,003           8,525          21 %
Reimbursed direct costs                          8,072             7,720             352           5 %
Selling, general and administrative             36,935            28,232           8,703          31 %
Depreciation and software and
leasehold amortization                           7,391             6,523             868          13 %
Amortization of identifiable
intangible assets                                4,736             6,752          (2,016 )       -30 %
Fair value adjustment to contingent
consideration                                        -            (5,471 )         5,471         n/m
Intangible asset impairment expense                  -             1,777          (1,777 )       n/m
Other operating expense (income)                    49               (54 )           103         n/m
Total Operating Expense                        106,711            86,482          20,229          23 %

Income From Operations                           6,661            11,413          (4,752 )       -42 %

Interest Expense (Income)
Interest expense                                 2,004             2,713            (709 )       -26 %
Interest income                                     (8 )              (1 )            (7 )       n/m
Net Interest Expense                             1,996             2,712            (716 )       -26 %

Income Before Income Taxes                       4,665             8,701          (4,036 )       -46 %

Provision for Income Taxes                       1,823             3,544          (1,721 )       -49 %

Net Income                             $         2,842    $        5,157    $     (2,315 )       -45 %

n/m - not meaningful


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Revenue

The increase in operating revenue for the three months ended June 30, 2013 as compared to the same period in the prior year was driven by a $27.4 million increase in the Technology segment offset by a $12.3 million decrease 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 $8.5 million increase in direct cost of operating revenue, exclusive of depreciation and amortization, was primarily the result of the increase in and the mix of operating revenue and includes a $17.2 million increase in direct compensation-related costs primarily in support of the revenue growth in our eDiscovery document review services. Also contributing to the increase was a $2.3 million increase in outside services also related to our revenue growth, These increases were partially offset by an $11.0 million decrease in costs for legal notification and advertising services related to a large engagement which was active during the second quarter of 2012.

The increase in reimbursed direct costs for the three months ended June 30, 2013 as compared to the same period of 2012 corresponds to the increase in revenue from reimbursed expenses.

Selling, general and administrative expenses increased $8.7 million primarily as a result of a $5.8 million increase in compensation-related expense, an increase of $1.4 million increase in office-related expenses such as lease expense, maintenance, utilities and supplies, and a $0.8 million increase in outside professional services.

Depreciation and software and leasehold amortization costs increased $0.9 million as a result of increased depreciation on equipment and software related to investments in our business segments.

Amortization of intangible assets decreased related to certain of our intangible assets being amortized on an accelerated amortization method which decreases expense over the estimated useful lives of the intangible assets.

Operating expenses for the three months ended June 30, 2012, included income of $5.5 million related to a fair value adjustment to contingent consideration related to our acquisition of De Novo in 2011. Also included in the three months ended June 30, 2012 was intangible asset impairment expense of $1.8 million related to an impairment of the AACER® trade name acquired as part of the Jupiter eSources acquisition in 2010.

Interest Expense, Net

The decrease in net interest expense was primarily due to a $0.7 million decrease in accreted interest expense related to acquisition-related liabilities for the three months ended June 30, 2013 as compared to the same period in the prior year.

Income Taxes

Our effective tax rate for the three months ended June 30, 2013 was 39.1% compared to 40.7% in the prior year.


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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 June 30,        Increase /        %
Amounts in thousands                        2013               2012          (Decrease)      Change
Operating revenue
Technology                             $        70,126    $       42,711    $     27,415          64 %
Bankruptcy and Settlement
Administration                                  34,850            47,126         (12,276 )       -26 %
Total operating revenue                $       104,976    $       89,837    $     15,139          17 %

Reimbursable expenses
Technology                             $           535    $          266    $        269         101 %
Bankruptcy and Settlement
Administration                                   7,861             7,792              69           1 %
Total reimbursable expenses            $         8,396    $        8,058    $        338           4 %

Direct costs, selling, general and
administrative costs
Technology                             $        48,979    $       27,059    $     21,920          81 %
Bankruptcy and Settlement
Administration                                  31,788            39,441          (7,653 )       -19 %
Intercompany eliminations                          (78 )            (104 )            26         n/m
Total direct costs, selling,
general and administrative costs       $        80,689    $       66,396    $     14,293          22 %

Segment performance measure
Technology                             $        21,760    $       16,022    $      5,738          36 %
Bankruptcy and Settlement
Administration                                  10,923            15,477          (4,554 )       -29 %
Total segment performance measure      $        32,683    $       31,499    $      1,184           4 %

Segment performance measure            $        32,683    $       31,499    $      1,184           4 %
Unallocated corporate expenses                 (11,021 )          (9,010 )        (2,011 )        22 %
Share-based compensation expense                (2,825 )          (1,549 )        (1,276 )        82 %
Depreciation and software and
leasehold amortization                          (7,391 )          (6,523 )          (868 )        13 %
Amortization of intangible assets               (4,736 )          (6,752 )         2,016         -30 %
Fair value adjustment to contingent
consideration                                        -             5,471          (5,471 )       n/m
Intangible asset impairment expense                  -            (1,777 )         1,777         n/m
Other operating expense (income)                   (49 )              54            (103 )       n/m
Income from operations                           6,661            11,413          (4,752 )       -42 %
Interest expense, net                           (1,996 )          (2,712 )           716         -26 %
Income before income taxes             $         4,665    $        8,701    $     (4,036 )       -46 %

n/m - not meaningful


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Technology Segment

Operating revenue increased $27.4 million compared to the prior year period primarily as a result of an increase in eDiscovery engagements as compared to the second quarter of 2012. We expect continued strength in our global eDiscovery franchise as we progress through the remainder of 2013.

Direct, selling, general and administrative costs increased primarily in support of revenue growth and included a $16.2 million increase in direct compensation-related expenses primarily in support of our eDiscovery document review services, a $1.2 million increase related to other eDiscovery production costs, a $1.1 million increase in technology-related expenses and a $1.2 million increase in eDiscovery office related expenses.

Bankruptcy and Settlement Administration Segment

Operating revenue decreased $12.3 million as compared to the prior year. Operating revenue for the three months ended June 30, 2012 included revenues from a large settlement administration engagement which increased legal notification and advertising services for that period. Also contributing to the decrease in the second quarter of 2013 is a decrease in revenues resulting from the current cyclical downturn in bankruptcy filings. We expect the current cyclical downturn in bankruptcy filings to continue through the remainder of 2013. Settlement administration continues to be dependent on the timing and size of contracts awarded.

Direct, selling, general and administrative costs decreased $7.7 million compared to the prior year. This decrease is primarily related to a decrease of $11.0 million in legal notification costs related to the large prior year engagement discussed above. This decrease was partially offset by an increase of $1.2 million in compensation-related expenses, and a $1.7 million increase in outside services and other production costs.

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