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EPIQ > SEC Filings for EPIQ > Form 10-Q on 30-Apr-2014All Recent SEC Filings

Show all filings for EPIQ SYSTEMS INC

Form 10-Q for EPIQ SYSTEMS INC


30-Apr-2014

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 this "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

Epiq is a leading global provider of integrated technology solutions for the legal profession. We combine proprietary software, deep subject matter expertise, highly responsive customer service delivery and a global infrastructure to assist our customers with the technology requirements for their most important and complex matters. We offer these capabilities across a variety of practice areas including bankruptcy, litigation, class action, antitrust, investigations and regulatory compliance.

Our two reportable segments are our Technology segment and our Bankruptcy and Settlement Administration segment.

Our Technology segment ("Technology") 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 law firms.

Our Bankruptcy and Settlement Administration segment ("Bankruptcy and Settlement Administration") 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.


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Investing in proprietary software development maximizes our competitiveness in the marketplace and distinguishes us from our competitors. Beyond our proprietary software we also incorporate various licensed third-party software products in our solution set allowing us to expand our solutions.

Because we deliver most of our software in a hosted environment and because of the high volume of client data that we manage, network infrastructure is an essential component of our technology strategy. A single large client engagement may entail over 100 million documents or 100 terabytes of information and may include complex structured data (i.e., databases) and unstructured data (e.g., email archives). We operate eDiscovery data centers in the United States, Canada, United Kingdom, Hong Kong, Shanghai and Japan that provide reliable, secure access to our software environments and to customer databases. Information security is of paramount importance in any managed technology business, and Epiq incorporates best practices designed to protect sensitive customer data.

Our software and IT capabilities include significant in-house fulfillment capabilities. Our office locations in New York, Kansas City and Portland have internal abilities for high-speed printing and mailing, call center operations, and disbursement and tax records preparation. The combination of software, IT and fulfillment resources enables Epiq to act as a single-source solution for even the largest, most complex matters in the markets where we compete.

We work in niche, specialty areas which require deep subject matter expertise - such as litigation, bankruptcy, M&A, mass tort, investigations and class action -which have distinctive practices and requirements. Technology alone is insufficient to bring about a successful outcome on a sophisticated client matter; it is often the application of the technology and the expertise of our staff that create the most value for our client. We have a worldwide team of executives, client services specialists and technical consultants on whom clients rely for expert advice - whether delivered at the client's site or from one of our office locations. Our team includes former practicing litigators, bankruptcy attorneys, plaintiff's counsel, defense counsel, eDiscovery counsel and other professionals who are leaders in their areas of expertise. While we do not offer clients legal advice (because we are not a law firm), we draw heavily from our subject matter expertise in the legal profession to assist clients in achieving the best outcome on each project on which we are retained.

Our clients include top tier law firms, the in-house legal departments of major corporations, trustees, specialty fiduciaries and other professionals. Among corporate clients, we have substantial relationships with large, multinational companies in a variety of industries, including financial services, pharmaceuticals, insurance, technology and others. Among law firms, we work extensively with Am Law 100 firms in the U.S., Magic Circle firms in the U.K. and leading boutique or specialty law firms in all geographies. The global nature of our business continues to grow. With full-service offices (i.e., locations having a data center, on-site technical staff, on-site project management capabilities and local consulting capacities) around the world, Epiq offers a geographic reach to support client relationships wherever we are needed.

Our financial results are primarily driven by the following facts, among others:

          the number, size and complexity of customer engagements attained;



          the number of documents or volume of data we processed, hosted or
reviewed;



          the number of hours professional services are provided;



          the deposit-based fees we earn are dependent upon the balance of
assets placed with our designated financial institutions by bankruptcy trustees;
and

the geographic locations of our clients or locations where services are rendered.

Our financial results for first quarter 2014 reflect the impact of strategic investments directed at the global expansion of the eDiscovery franchise as well as a continued higher mix of eDiscovery document review services compared to the prior year period which have a lower margin than the company's overall margin which impacted income from operations.

During 2013 and the first three months of 2014, we are continuing to expand our eDiscovery services internationally. We added eDiscovery offices and data centers in Tokyo, Shanghai and Toronto in 2013. Document review services and international growth were the primary contributors to Technology segment operating revenue growth in the first quarter of 2014 as compared to the same period in 2013, with growth occurring in both electronically stored information ("ESI") and document review services. Global ESI solutions continued as the primary service offering, representing approximately 55% of the total 2014 first quarter Technology segment operating revenue, while global document review services increased during the year to now represent approximately 45% of the total 2014 first quarter Technology segment operating revenue.

Lower bankruptcy filings due to the current cyclical downturn in bankruptcy cases, in general, and lower trustee deposit balances specifically related to our Chapter 7 services, resulted in decreases in operating revenues related to our bankruptcy service


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offerings. Our bankruptcy services continue to maintain market leadership during this period of declining bankruptcy filings. We expect the current cyclical downturn in bankruptcy filings to continue throughout 2014.

Operating revenues related to our settlement administration services for the quarter ended March 31, 2014 decreased as compared to the prior year period due to activity related to a large private anti-trust settlement administration engagement in the prior year period.

Results of Operations for the Three Months Ended March 31, 2014 Compared with the Three Months Ended March 31, 2013

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 March 31,        Increase /
Amounts in thousands                   2014               2013           (Decrease)     % Change
Operating revenue                 $       116,220    $       102,908    $     13,312           13 %
Reimbursable expenses                       7,051             20,682         (13,631 )        -66 %
Total Revenue                             123,271            123,590            (319 )          0 %

Direct cost of operating
revenue (exclusive of
depreciation and amortization
shown separately below)                    57,635             52,496           5,139           10 %
Reimbursed direct costs                     6,803             19,542         (12,739 )        -65 %
Selling, general and
administrative                             44,176             32,424          11,752           36 %
Depreciation and software and
leasehold amortization                      8,700              6,999           1,701           24 %
Amortization of identifiable
intangible assets                           3,120              4,966          (1,846 )        -37 %
Fair value adjustment to
contingent consideration                    1,142                  -           1,142          n/m
Other operating expense                        69                 47              22           47 %
Total Operating Expense                   121,645            116,474           5,171            4 %

Income From Operations                      1,626              7,116          (5,490 )        -77 %

Interest Expense (Income)
Interest expense                            4,877              1,839           3,038          165 %
Interest income                                (4 )               (4 )             -          n/m
Net Interest Expense                        4,873              1,835           3,038          166 %

Income (Loss) Before Income
Taxes                                      (3,247 )            5,281          (8,528 )       -161 %

Provision (Benefit) for Income
Taxes                                        (949 )            1,344          (2,293 )       -171 %

Net Income (Loss)                 $        (2,298 )  $         3,937    $     (6,235 )       -158 %

n/m - not meaningful


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Revenue

The increase in operating revenue for the three months ended March 31, 2014 as compared to the same period in the prior year was driven by a $26.4 million increase in the Technology segment, offset by a $13.1 million decrease in operating revenues for 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 $5.1 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 $15.5 million increase in direct compensation-related costs primarily in support of the continued revenue growth in our Technology segment. This increase was partially offset by an $8.8 million decrease in costs for legal notification and advertising services as compared to the three months ended March 31, 2013, which included costs related to a large private anti-trust settlement engagement.

The decline in reimbursed direct costs for the three months ended March 31, 2014 as compared to the same period of 2013 corresponds to the decline in revenue from reimbursed expenses.

Selling, general and administrative expenses increased $11.8 million and included an increase of $6.1 million in compensation-related expense which includes $2.6 million in post-employment benefits related to an executive resignation agreement and a $2.0 million increase in share-based compensation expense. The increase in selling, general and administrative expenses also includes an increase of $1.5 million in outside professional services, an increase of $2.1 million in office-related expenses such as lease expense, maintenance, utilities and supplies and an increase of $0.7 million in travel related expense.

Depreciation and software and leasehold amortization costs increased $1.7 million as a result of increased depreciation on equipment and software related to segment investments.

Amortization of intangible assets decreased $1.8 million related to certain of our intangible assets being amortized on an accelerated amortization method which are at lower amortization stages of the estimated useful lives of the intangible assets.

Operating expenses for the three months ended March 31, 2014, included a fair value adjustment to contingent consideration of $1.1 million related to our acquisition of De Novo in 2011. No fair value adjustment to contingent consideration is included in operating expenses for the three months ended March 31, 2013. See Note 3 to the Condensed Consolidated Financial Statements for further discussion of the contingent consideration.

Interest Expense, Net

The increase in net interest expense was primarily due an increased principal amount of debt outstanding during the first quarter 2014 as compared to the prior year period and also due to the higher rate of interest for our term loan under the Credit Agreement as compared to the interest rate under the prior credit agreement. Interest expense for the three months ended March 31, 2014 also includes $0.8 million related to fees incurred in conjunction with the amendment to our Credit Agreement. See Note 3 to the Condensed Consolidated Financial Statements for further discussion of the Credit Agreement.

Income Taxes

Our effective tax rate for the three months ended March 31, 2014 was 29.2% compared to 25.9% for the comparable prior year period. The reduced 2013 rate reflected a discrete benefit related to the enactment of the 2012 American Taxpayer Relief Act which extended the federal research credit for both 2013 and 2012. We recognized approximately $0.4 million of tax benefit relating to the 2012 credits and a portion of our 2013 tax credits during the first quarter of 2013. While legislation has been introduced to retroactively reinstate the credit to the beginning of 2014, the federal research credit has not yet been extended past 2013 and our 2014 effective tax rate does not reflect any research credit benefit. Our effective tax rate is lower than the U.S. statutory rate because we earned income in international jurisdictions with lower tax rates and our income from


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these jurisdictions increased during the three months ended March 31, 2014 as compared to the three months ended March 31, 2013.

On March 31, 2014, New York State passed comprehensive corporate income tax reform with most changes effective for years 2015 and beyond. We have substantial business presence within the state, but we do not expect the new law to have a material impact on our overall expected future tax expense. Because a change in tax law is accounted for in the period of enactment, our results for the three months ended March 31, 2014 reflect the impact of this state law change, however, the impact was not material.

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.

                                      Three Months Ended          $ Change
                                           March 31,             Increase /         %
Amounts in thousands                  2014           2013        (Decrease)      Change
Operating revenue
Technology                         $    81,169    $   54,787    $     26,382           48 %
Bankruptcy and Settlement
Administration                          35,051        48,121         (13,070 )        -27 %
Total operating revenue            $   116,220    $  102,908    $     13,312           13 %

Reimbursable expenses
Technology                         $     1,107    $      287    $        820          286 %
Bankruptcy and Settlement
Administration                           5,944        20,395         (14,451 )        -71 %
Total reimbursable expenses        $     7,051    $   20,682    $    (13,631 )        -66 %

Direct costs, selling, general
and administrative costs
Technology                         $    60,158    $   38,687    $     21,471           55 %
Bankruptcy and Settlement
Administration                          29,044        53,917         (24,873 )        -46 %
Intercompany eliminations                 (180 )          (5 )          (175 )        n/m
Total direct costs, selling,
general and administrative
costs                              $    89,022    $   92,599    $     (3,577 )         -4 %

Segment performance measure
Technology                         $    22,298    $   16,392    $      5,906           36 %
Bankruptcy and Settlement
Administration                          11,951        14,599          (2,648 )        -18 %
Total segment performance
measure                            $    34,249    $   30,991    $      3,258           11 %

Segment performance measure        $    34,249    $   30,991    $      3,258           11 %
Unallocated corporate expenses         (16,053 )     (10,324 )        (5,729 )         55 %
Share-based compensation
expense                                 (3,539 )      (1,539 )        (2,000 )        130 %
Depreciation and software and
leasehold amortization                  (8,700 )      (6,999 )        (1,701 )         24 %
Amortization of intangible
assets                                  (3,120 )      (4,966 )         1,846          -37 %
Fair value adjustment to
contingent consideration                (1,142 )           -          (1,142 )        n/m
Other operating expense                    (69 )         (47 )           (22 )         47 %
Income from operations                   1,626         7,116          (5,490 )        -77 %
Interest expense, net                   (4,873 )      (1,835 )        (3,038 )        166 %
Income (loss) before income
taxes                              $    (3,247 )  $    5,281    $     (8,528 )       -161 %

n/m - not meaningful


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Technology Segment

Operating revenue increased $26.4 million during the three months ended March 31, 2014 as compared to the prior year period primarily as a result of an increase in eDiscovery engagements as compared to the first quarter of 2013, and was solely related to organic growth. We expect to continue to grow our global leadership position throughout the remainder of 2014. Our eDiscovery businesses in Europe and Asia showed continued combined growth with a 40% increase in operating revenue over the prior year first quarter.

Direct, selling, general and administrative costs increased primarily in support of revenue growth and included a $15.0 million increase in direct compensation-related expenses primarily in support of our eDiscovery document review services, a $2.2 million increase in information technology-related costs, a $0.9 million increase in other production costs and a $1.5 million increase in office related expenses related to the expansion of our document review centers capacity.

The Technology segment's financial results for the three months ended March 31, 2014 reflect the impact of strategic investments primarily in support of global expansion and revenue growth of the eDiscovery franchise as well as a higher mix of eDiscovery document review services compared to the prior year which have lower operating margins than the Company's overall margin.

Bankruptcy and Settlement Administration Segment

Operating revenue decreased $13.1 million as compared to the prior year, primarily due to a large private anti-trust engagement in the prior year period which was principally completed in the first quarter of 2013 that increased legal notification and advertising services for that period. Also impacting the first quarter of 2014 was the continued current cyclical downturn in bankruptcy filings. We expect the current cyclical downturn in bankruptcy filings to continue through the remainder of 2014. Settlement administration continues to be dependent on the timing and size of contracts awarded.

Direct, selling, general and administrative costs decreased $24.9 million primarily related to a $11.0 million decrease in direct cost of services and a $13.4 million decrease in reimbursed direct costs both which are related to the large private anti-trust engagement which was active during the first quarter of 2013.

Liquidity and Capital Resources

Cash flows from operating activities

During the three months ended March 31, 2014, our operating activities used net cash of $0.8 million. Included in net cash used by operating activities was a net loss of $2.3 million which included $17.5 million of non-cash expenses for a total contribution to cash flows of $15.2 million related to net income adjusted to exclude non-cash expenses. Cash used by operating activities also included a $16.0 million net use of cash resulting from changes in operating assets and liabilities, primarily from an $11.2 million decrease in accounts payable and other liabilities, a decrease in income taxes payable of $3.8 million and an increase of $1.8 million in prepaid expenses and other assets. These uses of cash were partially offset by a $3.1 million decrease in trade accounts receivable. Trade accounts receivable will fluctuate from period to period depending on the period to period change in revenue and the timing of revenue 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, 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 non-cash expenses of $14.8 million, for a total contribution to cash flows of $18.7 million related to net income adjusted to exclude non-cash expenses. 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 also included the use of cash for customer deposits primarily related to the fourth quarter 2012 receipt of a $14.3 million customer deposit for a large settlement administration engagement and the first quarter 2013 expenditures for that matter. These uses of cash were offset by a $6.4 million increase in accounts payable and other liabilities.


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