Back to GetFilings.com



 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D. C. 20549

 

FORM 10-Q

 

Quarterly Report Under Section 13 or 15(d)
of the Securities Exchange Act of 1934

 

For the Quarterly Period Ended March 31, 2004

 

OR

 

Transition Report Pursuant to Section 13 or 15(d)

of the Securities Exchange Act of 1934

 

For the transition period from               to              

 

Commission File Number 0-22081

 


 

EPIQ SYSTEMS, INC.

(Exact name of registrant as specified in its charter)

 

Missouri

 

48-1056429

(State or other jurisdiction of
incorporation or organization)

 

(IRS Employer Identification Number)

 

 

 

 

 

 

501 Kansas Avenue, Kansas City, Kansas 66105-1300

(Address of principal executive office)

 

 

 

913-621-9500

(Registrant’s telephone number)

 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days  Yes  ý No  o

 

Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Act). Yes  ý No  o

 

The number of shares outstanding of registrant’s common stock at April 30, 2004:

 

Class

 

Outstanding

Common Stock, $.01 par value

 

17,830,861

 

 



 

EPIQ SYSTEMS, INC. AND SUBSIDIARIES

FORM 10-Q

QUARTER ENDED MARCH 31, 2004

 

CONTENTS

 

 

 

Page

 

 

 

PART I - FINANCIAL INFORMATION

 

 

 

 

Item 1.

Financial Statements

 

 

 

 

 

Condensed Consolidated Statements of Income –
Three months ended March 31, 2004 and 2003 (Unaudited)

1

 

 

 

 

Condensed Consolidated Balance Sheets –
March 31, 2004 and December 31, 2003 (Unaudited)

2

 

 

 

 

Condensed Consolidated Statements of Cash Flows –
Three months ended March 31, 2004 and 2003 (Unaudited)

3

 

 

 

 

Notes to Condensed Consolidated Financial Statements (Unaudited)

4

 

 

 

Item 2.

Management’s Discussion and Analysis of Financial Condition and Results of Operations

13

 

 

 

Item 3.

Quantitative and Qualitative Disclosures about Market Risk

20

 

 

 

Item 4.

Controls and Procedures

20

 

 

 

PART II - OTHER INFORMATION

 

 

 

 

Item 6.

Exhibits and Reports on Form 8-K

21

 

 

 

Signatures

22

 



 

PART I - FINANCIAL INFORMATION

 

ITEM 1.     Condensed Consolidated Financial Statements.

 

EPIQ SYSTEMS, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF INCOME

(In Thousands, Except Per Share Data)

(Unaudited)

 

 

 

Three Months Ended March 31,

 

 

 

2004

 

2003

 

 

 

 

 

 

 

REVENUE:

 

 

 

 

 

Case management

 

$

16,926

 

$

11,415

 

Document management

 

6,067

 

1,881

 

Operating revenue

 

22,993

 

13,296

 

Reimbursed expenses

 

3,019

 

779

 

Total Revenue

 

26,012

 

14,075

 

 

 

 

 

 

 

COSTS AND EXPENSES:

 

 

 

 

 

Direct costs

 

10,305

 

2,955

 

General and administrative

 

5,638

 

3,487

 

Depreciation and software amortization

 

1,381

 

1,118

 

Amortization of identifiable intangible assets

 

1,680

 

682

 

Acquisition related

 

2,181

 

1,485

 

Total Operating Expenses

 

21,185

 

9,727

 

 

 

 

 

 

 

INCOME FROM CONTINUING OPERATIONS

 

4,827

 

4,348

 

 

 

 

 

 

 

INTEREST INCOME (EXPENSE):

 

 

 

 

 

Interest income

 

34

 

113

 

Interest expense

 

(1,522

)

(43

)

Net Interest Income (Expense)

 

(1,488

)

70

 

 

 

 

 

 

 

INCOME FROM CONTINUING OPERATIONS BEFORE INCOME TAXES

 

3,339

 

4,418

 

 

 

 

 

 

 

PROVISION FOR INCOME TAXES

 

1,338

 

1,741

 

 

 

 

 

 

 

NET INCOME FROM CONTINUING OPERATIONS

 

2,001

 

2,677

 

 

 

 

 

 

 

DISCONTINUED OPERATIONS:

 

 

 

 

 

Loss from operations of discontinued infrastructure software  segment

 

(436

)

(602

)

Income tax benefit from operations of discontinued  infrastructure software segment

 

172

 

237

 

TOTAL DISCONTINUED OPERATIONS

 

(264

)

(365

)

 

 

 

 

 

 

NET INCOME

 

$

1,737

 

$

2,312

 

 

 

 

 

 

 

 

 

NET INCOME PER SHARE INFORMATION:

 

 

 

 

 

Income per share — Basic

 

 

 

 

 

Income from continuing operations

 

$

0.11

 

$

0.16

 

Loss from discontinued operations

 

(0.01

)

(0.03

)

Net income per share — Basic

 

$

0.10

 

$

0.13

 

 

 

 

 

 

 

Income per share — Diluted

 

 

 

 

 

Income from continuing operations

 

$

0.11

 

$

0.15

 

Loss from discontinued operations

 

(0.01

)

(0.02

)

Net income per share — Diluted

 

$

0.10

 

$

0.13

 

 

 

 

 

 

 

WEIGHTED AVERAGE COMMON SHARES OUTSTANDING:

 

 

 

 

 

Basic

 

17,813

 

17,250

 

Diluted

 

18,237

 

17,782

 

 

See accompanying notes to condensed consolidated financial statements.

 

1



 

EPIQ SYSTEMS, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED BALANCE SHEETS

(In Thousands)

(Unaudited)

 

 

 

March 31, 2004

 

December 31, 2003

 

ASSETS

 

 

 

 

 

CURRENT ASSETS:

 

 

 

 

 

Cash and cash equivalents

 

$

2,088

 

$

30,347

 

Accounts receivable, trade, less allowance for doubtful accounts  of $610 and $340, respectively

 

26,491

 

11,337

 

Prepaid expenses

 

3,536

 

1,023

 

Deferred income taxes

 

7,601

 

1,736

 

Other current assets

 

2,806

 

915

 

Current assets held for sale

 

1,233

 

1,304

 

Total Current Assets

 

43,755

 

46,662

 

 

 

 

 

 

 

LONG-TERM ASSETS:

 

 

 

 

 

Property and equipment, net

 

17,608

 

11,886

 

Software development costs, net

 

6,074

 

2,799

 

Goodwill

 

148,513

 

64,188

 

Other intangibles, net of accumulated amortization of $5,930 and  $4,250, respectively

 

30,144

 

16,325

 

Other

 

1,045

 

67

 

Total Long-term Assets

 

203,384

 

95,265

 

Total Assets

 

$

247,139

 

$

141,927

 

 

 

 

 

 

 

LIABILITIES AND STOCKHOLDERS’ EQUITY

 

 

 

 

 

CURRENT LIABILITES:

 

 

 

 

 

Accounts payable

 

$

4,836

 

$

1,998

 

Customer deposits

 

4,093

 

1,712

 

Other accrued expenses

 

1,389

 

1,943

 

Current maturities of long-term obligations

 

18,713

 

849

 

Current liabilities held for sale

 

997

 

1,137

 

Total Current Liabilities

 

30,028

 

7,639

 

 

 

 

 

 

 

LONG-TERM LIABILITIES:

 

 

 

 

 

Deferred income taxes

 

9,101

 

1,967

 

Long-term obligations (excluding current maturities)

 

76,668

 

3,066

 

Total Long-term Liabilities

 

85,769

 

5,033

 

 

 

 

 

 

 

STOCKHOLDERS’ EQUITY:

 

 

 

 

 

Preferred stock - $1 par value; 2,000,000 shares authorized;  none issued and outstanding

 

 

 

Common stock – $0.01 par value; 50,000,000 shares authorized;  issued and outstanding — 17,827,627 and 17,780,854  shares at March 31, 2004 and December 31, 2003, respectively

 

178

 

178

 

Additional paid-in capital

 

102,240

 

101,890

 

Retained earnings

 

28,924

 

27,187

 

Total Stockholders’ Equity

 

131,342

 

129,255

 

Total Liabilities and Stockholders’ Equity

 

$

247,139

 

$

141,927

 

 

See accompanying notes to condensed consolidated financial statements.

 

2



 

EPIQ SYSTEMS, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(In Thousands)

(Unaudited)

 

 

 

Three Months Ended March 31,

 

 

 

2004

 

2003

 

CASH FLOWS FROM OPERATING ACTIVITIES:

 

 

 

 

 

Net income

 

$

1,737

 

$

2,312

 

Adjustments to reconcile net income to net cash from operating activities:

 

 

 

 

 

Provision for deferred income taxes

 

227

 

188

 

Depreciation and software amortization

 

1,381

 

1,463

 

Loan fee amortization

 

615

 

 

Amortization of other intangible assets

 

1,680

 

719

 

Other

 

54

 

55

 

Changes in operating assets and liabilities, net of effects from  business acquisition:

 

 

 

 

 

Accounts receivable

 

203

 

(5,342

)

Prepaid expenses and other assets

 

(281

)

142

 

Accounts payable and accrued expenses

 

(449

)

1,693

 

Withholding and related liabilities assumed in the acquisition  of a business and subsequently paid

 

(7,973

)

 

Deferred revenue

 

4

 

(179

)

Income taxes, including tax benefit from exercise of stock options

 

194

 

273

 

Net cash provided by (used in) operating activities

 

(2,608

)

1,324

 

 

 

 

 

 

 

CASH FLOWS FROM INVESTING ACTIVITIES:

 

 

 

 

 

Purchase of property and equipment

 

(1,251

)

(1,372

)

Software development costs

 

(479

)

(589

)

Cash paid for acquisition of business, net of $2,765 cash acquired

 

(113,193

)

(43,263

)

Other

 

19

 

3

 

Net cash used in investing activities

 

(114,904

)

(45,221

)

 

 

 

 

 

 

CASH FLOWS FROM FINANCING ACTIVITIES:

 

 

 

 

 

Proceeds from long-term debt borrowings

 

92,000

 

 

Debt issuance costs

 

(2,473

)

 

Principal payments under long-term debt and capital lease obligations

 

(579

)

(25

)

Direct costs associated with stock offering

 

 

(114

)

Proceeds from exercise of stock options and warrants

 

287

 

85

 

Net cash provided by (used in) financing activities

 

89,235

 

(54

)

 

 

 

 

 

 

NET DECREASE IN CASH AND CASH EQUIVALENTS

 

(28,277

)

(43,951

)

CASH AND CASH EQUIVALENTS, BEGINNING OF PERIOD

 

30,347

 

59,827

 

Decrease in cash classified as held for sale

 

18

 

 

CASH AND CASH EQUIVALENTS, END OF PERIOD

 

$

2,088

 

$

15,876

 

 

 

 

 

 

 

SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION:

 

 

 

 

 

Interest paid

 

$

540

 

$

4

 

Income taxes paid

 

$

745

 

$

1,044

 

 

See accompanying notes to condensed consolidated financial statements.

 

3



 

EPIQ SYSTEMS, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

NOTE 1:   NATURE OF OPERATIONS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

 

Nature of Operations

 

EPIQ Systems is a national provider of integrated technology-based products and services for fiduciary management and claims administration applications used by attorneys, trustees, and corporations primarily engaged in bankruptcy, class action, mass tort, and other similarly complex legal proceedings.  Our solutions combine advanced technology with in-depth subject matter expertise to offer customers an efficient environment in which to comprehensively manage the complexities of case administration and document management.

 

Comprehensive Income

 

We do not have any components of other comprehensive income; therefore comprehensive income equals net income.

 

Stock-Based Compensation

 

We account for stock compensation awards under the intrinsic method of Accounting Principles Board Opinion No. 25, Accounting for Stock Issued to Employees, which requires compensation cost to be recognized based on the excess, if any, between the quoted market price at the date of grant and the amount an employee must pay to acquire stock. Options awarded under the Company’s plan are granted with an exercise price equal to the fair market value on the date of the grant. Had the compensation cost been determined based on the fair value at the grant dates based on the guidance provided by Statement of Financial Accounting Standard (“SFAS”) No. 123, Accounting for Stock-Based Compensation, our net income and net income per share for the three months ended March 31, 2004 and 2003 would have been adjusted to the following pro forma amounts (in thousands, except per share data):

 

 

 

 

 

Three Months Ended March 31,

 

 

 

 

 

2004

 

2003

 

 

 

 

 

 

 

 

 

Net income, as reported

 

 

 

$

1,737

 

$

2,312

 

Add:  stock-based employee compensation included in reported net earnings, net of tax

 

 

 

 

 

Deduct:  stock-based employee compensation expense determined under fair value based method, net of tax

 

 

 

(1,155

)

(578

)

Net income, pro forma

 

 

 

$

582

 

$

1,734

 

 

 

 

 

 

 

 

 

Net income per share – Basic

 

As reported

 

$

0.10

 

$

0.13

 

 

 

Pro forma

 

$

0.03

 

$

0.10

 

 

 

 

 

 

 

 

 

Net income per share – Diluted

 

As reported

 

$

0.10

 

$

0.13

 

 

 

Pro forma

 

$

0.03

 

$

0.10

 

 

Pro forma amounts presented here are based on actual earnings and consider only the effects of estimated fair values of stock options.

 

4



 

Recent Accounting Pronouncements

 

In December 2003 the FASB issued FAS No. 132 (Revised) (“FAS 132-R”), Employer’s Disclosure about Pensions and Other Post Retirement Benefits. FAS 132-R retains disclosure requirements of the original FAS 132 and requires additional disclosures relating to assets, obligations, cash flows, and net periodic benefit cost. FAS 132-R is effective for fiscal years ending after December 15, 2003, except that certain disclosures are effective for fiscal years ending after June 15, 2004.  Interim period disclosures are effective for interim periods beginning after December 15, 2003.  The adoption of the disclosure provisions of FAS 132-R did not have a material effect on our consolidated Financial Statements.

 

Reclassification

 

Certain reclassifications have been made to the prior periods’ condensed consolidated financial statements to conform with the current period’s condensed consolidated financial statement presentation.

 

NOTE 2:   INTERIM FINANCIAL STATEMENTS

 

The accompanying condensed consolidated financial statements have been prepared in accordance with the instructions to Form 10-Q of the Securities and Exchange Commission and in accordance with accounting principles generally accepted in the United States of America (“GAAP”) applicable to interim financial statements, and do not include all of the information and footnotes required by GAAP for complete financial statements.  The financial statements should be read in conjunction with our audited financial statements and accompanying notes, which are included in Form 10-K for the year ended December 31, 2003.

 

In the opinion of our management, the accompanying financial statements reflect all adjustments necessary (consisting solely of normal recurring adjustments) to present fairly our financial position as of March 31, 2004 and the results of operations and cash flows for the three months ended March 31, 2004 and 2003.

 

The results of operations for the period ended March 31, 2004 are not necessarily indicative of the results to be expected for the entire year.

 

NOTE 3:   NET INCOME PER SHARE

 

Basic net income per share from continuing operations is computed based on the weighted average number of common shares outstanding during each period.  Diluted net income per share from continuing operations is computed using the weighted average common shares and all potentially dilutive common share equivalents outstanding during the period.  The computation of net income per share from continuing operations for the three months ended March 31, 2004 and 2003 is as follows (in thousands, except per share data):

 

 

 

Three Months Ended March 31,

 

 

 

2004

 

2003

 

 

 

 

 

 

 

Net income from continuing operations

 

$

2,001

 

$

2,677

 

 

 

 

 

 

 

Weighted average common shares outstanding

 

17,813

 

17,250

 

Weighted average common share equivalents (stock options)

 

424

 

532

 

Weighted average diluted common shares outstanding

 

18,237

 

17,782

 

 

 

 

 

 

 

Net income per share from continuing operations:

 

 

 

 

 

Basic

 

$

0.11

 

$

0.16

 

Diluted

 

$

0.11

 

$

0.15

 

 

Options to purchase 324,000 and 91,000 shares of common stock for the three-month period ended March 31, 2004 and 2003, respectively, were antidilutive and therefore not included in the computation of diluted earnings per share.

 

5



 

NOTE 4:   GOODWILL AND INTANGIBLE ASSETS

 

Intangible assets at March 31, 2004 and December 31, 2003 consisted of the following (in thousands):

 

 

 

March 31, 2004

 

December 31, 2003

 

 

 

Gross Carrying
Amount

 

Accumulated
Amortization

 

Gross Carrying
Amount

 

Accumulated
Amortization

 

Amortized intangible assets:

 

 

 

 

 

 

 

 

 

Customer contracts

 

$

16,560

 

$

3,967

 

$

8,060

 

$

2,925

 

Trade names

 

1,634

 

181

 

60

 

45

 

Non-compete agreement

 

17,880

 

1,782

 

11,980

 

1,279

 

 

 

$

36,074

 

$

5,930

 

$

20,100

 

$

4,249

 

 

At March 31, 2004, intangible assets not subject to amortization, comprised solely of goodwill, had a carrying value of $148.5 million.  At December 31, 2003, intangible assets not subject to amortization consisted of goodwill and a trade name with a carrying values of $64.2 million and $0.5 million, respectively.

 

In conjunction with our January 30, 2004, acquisition of Poorman-Douglas, we reassessed our use of all trade names.  As a result of this reassessment, in February 2004 we commenced amortizing the BSI trade name on a straight-line basis over two years.

 

Aggregate amortization expense was $1.7 million and $0.7 million for the three-month periods ended March 31, 2004 and 2003, respectively.  Amortization expense related to intangible assets for 2004 and the following five years is estimated to be as follows (in thousands):

 

Year Ended
December 31,

 

 

 

2004

 

$

7,769

 

2005

 

5,906

 

2006

 

4,989

 

2007

 

3,029

 

2008

 

2,857

 

2009

 

1,775

 

 

 

 

 

 

 

$

26,325

 

 

The changes in the carrying amount of goodwill, with the prior period restated to conform to our current segment presentation, for the three-month period ended March 31, 2004, and year ended December 31, 2003 are as follows (in thousands):

 

 

 

Three Months Ended March 31, 2004

 

Year Ended December 31, 2003

 

 

 

Case
Management

 

Document
Management

 

Total

 

Case
Management

 

Document
Management

 

Total

 

Balance, beginning of period

 

$

43,716

 

$

20,472

 

$

64,188

 

$

17,449

 

$

 

$

17,449

 

Goodwill acquired during the period

 

63,244

 

21,081

 

84,325

 

26,267

 

20,472

 

46,739

 

Balance, end of period

 

$

106,960

 

$

41,553

 

$

148,513

 

$

43,716

 

$

20,472

 

$

64,188

 

 

6



 

NOTE 5:   BUSINESS ACQUISITION

 

On January 30, 2004, we acquired for cash 100% of the equity of P-D Holding Corp. and its wholly-owned subsidiary, Poorman-Douglas Corporation (collectively, “Poorman-Douglas”),  We believe this acquisition will provide complementary diversification to our existing legal services business, as Poorman-Douglas is a provider of technology-based products and services for class action, mass tort and bankruptcy case administration.  The total value of the transaction, including capitalized acquisition costs, was approximately $116.0 million.  Based on our preliminary valuation, the purchase price has been allocated as follows (in thousands):

 

Current assets

 

$

21,718

 

Deferred tax assets

 

6,175

 

Property and software

 

8,675

 

Trade names

 

1,100

 

Customer backlog

 

6,200

 

Customer relationships

 

2,300

 

Non-compete agreements

 

5,900

 

Goodwill

 

84,325

 

Current liabilities

 

(13,217

)

Deferred tax liabilities

 

(7,218

)

 

 

 

 

Total purchase price

 

$

115,958

 

 

All acquired identifiable intangible assets will be amortized on a straight-line basis as follows:  the trade names over two years, the customer backlog over three years, the customer relationships over twelve years, and the non-compete agreements over five years.  The excess purchase price of $84.3 million was allocated to goodwill and, in accordance with SFAS No. 142 “Goodwill and Other Intangible Assets,” is not being amortized but will be reviewed for impairment annually and between annual tests if events or changes in circumstances indicate that the asset might be impaired.  The purchase price in excess of the tax basis of the assets, primarily allocated to identifiable intangible assets and goodwill, is not expected to be deductible for tax purposes.

 

The acquisition was accounted for using the purchase method of accounting with the operating results included in the accompanying condensed consolidated financial statements from the date of acquisition.

 

7



 

On January 31, 2003, we acquired 100% of the membership interests of Bankruptcy Services LLC (“BSI”), a provider of technology-based case management, consulting and administrative services for Chapter 11 cases. The total value of the transaction, including capitalized transaction costs, was $67.0 million of which $45.5 million was paid in cash, $16.5 million (1,054,000 shares) was paid in EPIQ Systems, Inc. stock, $3.4 million was deferred in the form of a non-interest bearing note with a face value of $4.0 million discounted using an imputed interest rate of 5% per annum, $1.3 million represents assumed liabilities and $0.3 million was paid in acquisition costs.  The note is payable in five annual installments and is presented as deferred acquisition price on the balance sheet. The purchase price was allocated as follows (in thousands):

 

Current assets

 

$

2,616

 

Property and software

 

755

 

Trade names

 

474

 

Customer backlog

 

4,700

 

Non-compete agreements

 

11,730

 

Goodwill

 

46,739

 

 

 

 

 

Total purchase price

 

$

67,014

 

 

The software is being amortized over three years, the customer backlog over two years and the non-compete agreement over 10 years, all using the straight-line method.  Initially, the trade name was not amortized as it had an indefinite life.  In conjunction with our acquisition of Poorman-Douglas, we reassessed our use of all trade names.  Accordingly, in February 2004 we commenced amortizing the BSI trade name on a straight-line basis over two years.  The excess purchase price of $46.7 million was allocated to goodwill and, in accordance with SFAS No. 142, is not being amortized but will be reviewed for impairment annually and between annual tests if events or changes in circumstances indicate that the asset might be impaired.  The purchase price in excess of the tax basis of the assets, primarily allocated to identifiable intangible assets and goodwill, has been determined to be deductible for tax purposes.

 

The acquisition was accounted for using the purchase method of accounting with the operating results included in the accompanying condensed consolidated financial statements from the date of acquisition.

 

Unaudited pro forma operations assuming both purchase acquisitions were made at the beginning of the periods presented are shown below (in thousands, except per share data):

 

 

 

Three Months Ended March 31,

 

 

 

2004

 

2003

 

 

 

 

 

 

 

Revenue

 

$

32,695

 

$

29,660

 

 

 

 

 

 

 

Net income from continuing operations

 

$

1,809

 

$

1,917

 

Net income per share from continuing operations:

 

 

 

 

 

Basic

 

$

0.10

 

$

0.11

 

Diluted

 

$

0.10

 

$

0.11

 

 

The pro forma information is not necessarily indicative of what would have occurred had the acquisition been completed on that date nor is it necessarily indicative of future operations.

 

8



 

NOTE 6:   SEGMENT REPORTING

 

EPIQ Systems has two operating segments: (i) case management and (ii) document management.  Previously, the Company’s operating segments were (x) bankruptcy and related services and (y) infrastructure software.  Following our decision to sell the infrastructure software business and our January 2004 acquisition of Poorman-Douglas, resources are now allocated and performance assessed by case management and document management.  Case management solutions provide clients with integrated technology-based products and services for the automation of administrative tasks faced by our clients.  Document management solutions include proprietary technology and production services to ensure timely, accurate and complete execution of the documents handled by our clients.

 

Each segment’s performance is assessed based on segment revenues less costs directly attributable to each segment.  In management’s evaluation of performance, certain costs, such as shared services, administrative staff, and executive management, are not allocated by segment and, accordingly, the following operating segment results do not include such unallocated costs.  Assets reported within a segment are those assets used by the segment in its operations, and consist of property and equipment, software, identifiable intangible assets and goodwill.  All other assets are classified as unallocated.  Infrastructure software is held for sale and is presented as a discontinued operation.  Consistent with guidance provided by the Financial Accounting Standards Board, we have not presented segment information related to our discontinued operation.

 

Following is a summary of segment information, with the prior period restated to conform to our current segment presentation (in thousands):

 

 

 

Three Months Ended March 31, 2004

 

 

 

Case
Management

 

Document
Management

 

Unallocated

 

Consolidated

 

 

 

 

 

 

 

 

 

 

 

Revenue:

 

 

 

 

 

 

 

 

 

Operating revenue

 

$

16,926

 

$

6,067

 

$

 

$

22,993

 

Reimbursed expenses

 

104

 

2,915

 

 

3,019

 

Total revenue

 

17,030

 

8,982

 

 

26,012

 

 

 

 

 

 

 

 

 

 

 

Costs and expenses:

 

 

 

 

 

 

 

 

 

Direct and administrative costs and  depreciation and software amortization

 

5,568

 

6,771

 

4,985

 

17,324

 

Amortization of identifiable  intangible assets

 

1,109

 

571

 

 

1,680

 

Acquisition related

 

 

 

2,181

 

2,181

 

Total operating expenses

 

6,677

 

7,342

 

7,166

 

21,185

 

 

 

 

 

 

 

 

 

 

 

Operating income

 

$

10,353

 

$

1,640

 

$

(7,166

)

4,827

 

Interest expense, net

 

 

 

 

 

 

 

(1,488

)

 

 

 

 

 

 

 

 

 

 

Income from continuing operations  before income taxes

 

 

 

 

 

 

 

3,339

 

 

 

 

 

 

 

 

 

 

 

Provision for income taxes

 

 

 

 

 

 

 

1,338

 

 

 

 

 

 

 

 

 

 

 

Net income from continuing operations

 

 

 

 

 

 

 

$

2,001

 

 

 

 

 

 

 

 

 

 

 

Total assets

 

$

135,741

 

$

53,796

 

$

57,602

 

$

247,139

 

Provisions for depreciation and amortization

 

$

2,084

 

$

709

 

$

268

 

$

3,061

 

Capital expenditures

 

$

983

 

$

9

 

$

259

 

$

1,251

 

 

9



 

 

 

Three Months Ended March 31, 2003

 

 

 

Case
Management

 

Document
Management

 

Unallocated

 

Consolidated

 

 

 

 

 

 

 

 

 

 

 

Revenue:

 

 

 

 

 

 

 

 

 

Operating revenue

 

$

11,415

 

$

1,881

 

$

 

$

13,296

 

Reimbursed expenses

 

47

 

732

 

 

779

 

Total revenue

 

11,462

 

2,613

 

 

14,075

 

 

 

 

 

 

 

 

 

 

 

Costs and expenses:

 

 

 

 

 

 

 

 

 

Direct and administrative costs and  depreciation and software amortization

 

3,086

 

1,435

 

3,039

 

7,560

 

Amortization of identifiable  intangible assets

 

408

 

274

 

 

682

 

Acquisition related

 

 

 

1,485

 

1,485

 

Total operating expenses

 

3,494

 

1,709

 

4,524

 

9,727

 

 

 

 

 

 

 

 

 

 

 

Operating income

 

$

7,968

 

$

904

 

$

(4,524

)

4,348

 

Interest income, net

 

 

 

 

 

 

 

70

 

 

 

 

 

 

 

 

 

 

 

Income from continuing operations  before income taxes

 

 

 

 

 

 

 

4,418

 

 

 

 

 

 

 

 

 

 

 

Provision for income taxes

 

 

 

 

 

 

 

1,741

 

 

 

 

 

 

 

 

 

 

 

Net income from continuing operations

 

 

 

 

 

 

 

$

2,677

 

 

 

 

 

 

 

 

 

 

 

Total assets as of December 31, 2003

 

$

59,518

 

$

26,806

 

$

55,603

 

$

141,927

 

Provisions for depreciation and amortization

 

$

1,369

 

$

274

 

$

157

 

$

1,800

 

Capital expenditures

 

$

546

 

$

 

$

826

 

$

1,372

 

 

10



 

NOTE 7:   LONG-TERM OBLIGATIONS

 

In conjunction with our acquisition of Poorman-Douglas, we replaced our $25.0 million line of credit with a $100.0 million credit facility.  The credit facility consists of a $45.0 million senior term loan, with amortizing quarterly principal payments of $4.5 million beginning April 30, 2004, a $25.0 million senior revolving loan, and a $30.0 million subordinated term loan.  The senior term loan and revolver mature July 31, 2006, while the subordinated term loan matures December 31, 2006.  Interest on the credit facility is generally based on a spread over the LIBOR rate.  As of March 31, 2004, interest charged ranged from 4.6% to 5.6%.

 

As of March 31, 2004, our borrowings under the syndicated credit facility totaled $92.0 million, consisting of $45.0 million borrowed under the senior term loan, $17.0 million borrowed under the senior revolving loan, and $30.0 million borrowed under the subordinated term loan.

 

The syndicated credit facility is secured by liens on our real property and a significant portion of our personal property and contains financial covenants related to EBITDA (earnings before interest, provision for income taxes, depreciation and amortization), total debt and interest charges.  We were in compliance with all financial covenants as of March 31, 2004.

 

Our long-term obligations, including credit facility debt, deferred acquisition costs, and capitalized leases, mature as follows for each twelve month period ending March 31 (in thousands):

 

2005

 

$

18,713

 

2006

 

19,677

 

2007

 

56,508

 

2008

 

483

 

Total

 

$

95,381

 

 

NOTE 8:   OPERATING LEASES

 

We have non-cancelable operating leases for office space at various locations expiring at various times through 2015.  Each of the leases requires us to pay all executory costs (property taxes, maintenance and insurance).  Additionally, we have non-cancelable operating leases for office equipment and automobiles expiring through February 2007.

 

Future minimum lease payments during each of the twelve months ending March 31 are as follows (in thousands):

 

2005

 

$

2,517

 

2006

 

2,220

 

2007

 

2,029

 

2008

 

1,704

 

2009

 

1,489

 

Thereafter

 

9,244

 

Total minimum lease payments

 

$

19,203

 

 

Expense related to operating leases was approximately $0.7 million and $0.3 million for the three months ended March 31, 2004 and 2003, respectively.

 

11



 

NOTE 9:   DISCONTINUED OPERATIONS

 

The primary offering for our infrastructure software business is DataExpress®, a software product line that automates the exchange of data files between a company’s customers and their business partners.  During November 2003 (the “Measurement Date”), we determined that the infrastructure software segment was no longer aligned with our long-term strategic objectives.  Accordingly, we developed a plan to sell, within one year, the infrastructure software business.

 

The disposal of the infrastructure business represents a discontinued operation and is classified as held for sale.  Accordingly, assets and liabilities related to this segment have been reclassified in the accompanying Condensed Consolidated Balance Sheets as held for sale, and revenues, cost of sales, and operating expenses related to this segment have been reclassified in the accompanying Condensed Consolidated Statements of Income for all periods presented as “Discontinued Operations.”

 

Long-lived assets classified as held for sale are to be measured at the lower of their carrying amounts or fair value less cost to sell.  Accordingly, as of the Measurement Date, the Company performed an impairment analysis based on estimated proceeds from the sale less estimated selling costs.  Based on this analysis, the carrying amounts of the long-lived assets including property and equipment, goodwill and other intangible assets were impaired.  For the quarter ended December 31, 2003, we wrote down the carrying value of these assets and recorded a pre-tax impairment charge of approximately $7.6 million.  The tax benefit related to this impairment charge, also included in Discontinued Operations, was approximately $3.0 million.

 

On April 30, 2004, we sold our infrastructure software business to a private investor group with expertise in file transfer technology.  As consideration, we received $0.5 million in cash and a $1.1 million note receivable bearing 6.5% interest and due July 31, 2005.  The buyer also acquired certain assets and assumed certain liabilities related to our infrastructure business.

 

The following tables summarize financial information for Discontinued Operations (in thousands):

 

Balance sheets of discontinued operations:

 

 

 

March 31,
2004

 

December 31,
2003

 

ASSETS

 

 

 

 

 

CURRENT ASSETS:

 

 

 

 

 

Cash

 

$

696

 

$

714

 

Accounts receivable, trade, less allowance for  doubtful accounts of $13 and $16, respectively

 

218

 

258

 

Prepaid expenses

 

69

 

82

 

Property and equipment, net

 

24

 

24

 

Software development costs, net

 

226

 

226

 

Total Current Assets

 

1,233

 

1,304

 

 

 

 

 

 

 

LIABILITIES

 

 

 

 

 

CURRENT LIABILITIES:

 

 

 

 

 

Accounts payable and accrued expenses

 

188

 

173

 

Deferred revenue

 

809

 

964

 

Total Current Liabilities

 

997

 

1,137

 

 

 

 

 

 

 

NET ASSETS OF DISCONTINUED OPERATIONS

 

$

236

 

$

167

 

 

Net revenue and pre-tax loss from discontinued operations:

 

 

 

Three Months Ended March 31,

 

 

 

2004

 

2003

 

 

 

 

 

 

 

Net revenue from discontinued operations

 

$

380

 

$

560

 

 

 

 

 

 

 

Pre-tax loss from discontinued operations

 

$

(436

)

$

(602

)

 

12



 

ITEM 2.                             Management’s Discussion and Analysis of Financial Condition and Results of Operations.

 

Overview

 

EPIQ Systems provides an advanced offering of integrated technology-based products and services for fiduciary management and claims administration applications. Our solutions enable clients to optimize the administration of large and complex bankruptcy, class action, mass tort, and other similar legal proceedings. EPIQ Systems’ clients include corporations, attorneys, bankruptcy trustees and administrative professionals who require sophisticated case administration and document management capabilities, extensive subject matter expertise and a high service capacity. We provide clients a packaged offering of both proprietary technology and value-added services that comprehensively addresses their extensive business requirements.

 

We have two operating segments: case management and document management.

 

Case Management Segment

 

Our case management segment generates revenue primarily through the following integrated technology-based products and services.  Case management support for client engagements generally lasts several years and has a revenue profile that typically includes a recurring component.

 

                  An integrated solution of a proprietary technology platform and professional services that facilitates the administration of class action and mass tort proceedings and Chapter 11 bankruptcy restructurings.

 

                  TCMS®, an integrated solution, including a proprietary software product, computer hardware, and support services, installed in Chapter 7 bankruptcy trustee offices to facilitate the efficient management of asset liquidations, creditor distributions, and government reporting.

 

                  CasePower®, a proprietary software designed to enable Chapter 13 bankruptcy trustees to manage efficiently debtor payments, creditor distributions and government reporting.

 

                  Database processing, maintenance and management products and services.

 

                  Database conversions and software upgrades.

 

                  Professional and support services, including case management, claims processing, claims reconciliation, and customized programming and technology services.

 

                  Call center support.

 

Document Management Segment

 

Our document management segment generates revenue primarily through the following products and services.  Document management revenue is generally less recurring in nature due to the unpredictability of the frequency, timing and magnitude of the clients’ business requirements.

 

                  Legal noticing services.

 

                  Reimbursement for costs incurred related to postage on mailing services.

 

                  Media campaign and advertising management.

 

                  Document custody services.

 

13



 

Critical Accounting Policies

 

We consider our accounting policies related to revenue recognition, business combinations, goodwill, identifiable intangible assets, and software capitalization to be critical policies in understanding our historical and future performance.

 

Revenue recognition.  We have agreements with customers obligating us to deliver various products and services each month.  Case management fees paid are contingent upon the month-to-month delivery of the products and services defined by the contracts and are related primarily to the size and complexity of the ongoing engagement.  The formula-based fees earned each month become fixed and determinable on a monthly basis as a result of all contractually required products and services delivered by us during the month.  Document management revenues are recognized in the period the services are provided.  Significant sources of revenue include:

 

                  A monthly fee from financial institutions based on a percentage of total liquidated assets on deposit and on the number of trustees.

 

                  Fees for database conversions, database processing, maintenance and software upgrades.

 

                  Monthly revenue based on the number of cases in a database.

 

                  Fees based on the number of claims in a case.

 

                  Fees for services, including technology services, claims reconciliation, document printing, noticing, balloting, and other professional services.

 

Business combination accounting.  We have acquired a number of businesses during the last several years, and we may acquire additional businesses in the future.  Business combination accounting, often referred to as purchase accounting, requires us to determine the fair value of all assets acquired, including identifiable intangible assets, and liabilities assumed.  The cost of the acquisition is allocated to the assets acquired and liabilities assumed in amounts equal to the fair value of each asset and liability, and any remaining acquisition cost is classified as goodwill.  This allocation process requires extensive use of estimates and assumptions, including estimates of future cash flows to be generated by the acquired assets.  Identifiable intangible assets, such as customer lists and covenants not to compete, are amortized on a straightline basis over the intangible asset’s estimated useful life.  The estimated useful life of amortizable identifiable assets range from two to 14 years.  Accordingly, the acquisition cost allocation has had a significant impact on our current operating results and will have a significant impact on our future operating results.

 

Goodwill.  We assess goodwill, which is not subject to amortization, for impairment as of each July 31 and also at any other date when events or changes in circumstances indicate that the carrying value of these assets may exceed their fair value.  This assessment is performed at a reporting unit level.  A reporting unit is a component of a segment that constitutes a business, for which discrete financial information is available, and for which the operating results are regularly reviewed by segment management.

 

A change in events or circumstances, including a decision to hold an asset or group of assets for sale, a change in strategic direction, or a change in the competitive environment in which any reporting unit operates, could adversely affect the fair value of one or more reporting units.  During November 2003, we determined that our infrastructure software segment was no longer aligned with our long-term strategic objectives and we developed a plan to sell this segment within a year.  As a result, we recognized a pre-tax impairment charge of approximately $3.8 million related to goodwill.

 

The estimate of fair value is highly subjective and requires significant judgment.  If we determine that the fair value of any reporting unit is less than the reporting unit’s carrying value, then we will recognize an impairment charge.  If goodwill on our balance sheet becomes impaired during a future period, the resulting impairment charge could have a material impact on our results of operations and financial condition.  Our unimpaired, recognized goodwill totaled $148.5 million as of March 31, 2004.

 

Identifiable intangible assets.  Each period we evaluate whether events and circumstances warrant a revision to the remaining estimated useful life of each identifiable intangible asset.  If events and circumstances warrant a change to the estimate of an identifiable intangible asset’s remaining useful life, then the remaining carrying amount of the identifiable intangible asset would be amortized prospectively over that revised remaining useful life.  Furthermore, information developed during our

 

14



 

annual assessment, or other events and circumstances, may indicate that the fair value of one or more identifiable intangible assets is less than the identifiable intangible asset’s carrying value and would result in recognition of an impairment charge.  During November 2003, we determined that our infrastructure software segment was no longer aligned with our long-term strategic objectives and we developed a plan to sell this segment within a year.  As a result, we recognized a pre-tax impairment charge of approximately $0.9 million related to identifiable intangible assets.

 

A change in the estimate of the remaining life of one or more identifiable intangible assets or the impairment of one or more identifiable intangible assets could have a material impact on the Company’s results of operations and financial condition.  Our identifiable intangible assets’ carrying value, net of amortization, was $30.1 million as of March 31, 2004.

 

Internal software development costs.  Certain internal software development costs incurred in the creation of computer software products are capitalized once technological feasibility has been established.  Prior to the completion of detailed program design, development costs are expensed and shown as general and administrative expenses on the statements of income.  Determination that technological feasibility has been established requires management judgment, and that judgment affects the allocation between capitalization and current period expense recognition of costs incurred.  Capitalized internal software development costs are amortized based on the greater of:

 

                  the ratio of current revenue to current and estimated future revenue for each product, or

 

                  the straight-line amortization over the remaining estimated economic life of the product, not to exceed five years.

 

Management periodically reevaluates its previous estimated future revenue for each product and the remaining estimated economic life of the product.  Our forecast of estimated future revenue may affect the amount of amortization expense recognized during any period.  Including $3.2 million of software internally developed by Poorman-Douglas and acquired in our purchase of Poorman-Douglas, our capitalized internal software development costs, net of accumulated amortization, totaled $6.1 million as of March 31, 2004.

 

Results of Operations for the Three Months Ended March 31, 2004 Compared with the Three Months Ended March 31, 2003

 

Management Overview

During the three months ended March 31, 2003, our operations primarily consisted of products and services provided to the bankruptcy industry.  Through our recent acquisition of Poorman-Douglas, we expanded our product and service offerings to include class action, mass tort and other similar legal proceedings.

 

Our case management segment generates revenue primarily through integrated technology-based products and services for class action, mass tort and bankruptcy proceedings that support client engagements that generally last several years and has a revenue profile that typically includes a recurring component. Our document management segment generates revenue primarily through legal noticing services, reimbursement for costs incurred related to postage on mailing services, media campaign and advertising management and document custody services.  Document management revenue is generally less recurring in nature due to the unpredictability of the frequency, timing and magnitude of the clients’ business requirements.

 

The number of new bankruptcy filings each year may vary based on the level of consumer and business debt, the general economy, interest rate levels and other factors.  We believe the level of consumer and business debt is among the most important indicators of future bankruptcy filings.  The most recent available Federal Reserve Flow of Funds Accounts of the United States, dated March 4, 2004, reported increases in both consumer and business debt outstanding as compared with the same period of the prior year.

 

We have acquired a number of businesses during the past several years, and we may acquire additional businesses in the future.  In January 2003, we acquired BSI to expand our offerings to include an integrated solution of a proprietary technology platform and professional services for Chapter 11 restructurings. In January 2004, we acquired Poorman-Douglas and expanded our product and service offerings to include class action, mass tort, and other similar legal proceedings.

 

15



 

Consolidated Results

 

Revenue

Total revenue of $26.0 million for the three months ended March 31, 2004 represents an approximate 85% increase compared to $14.1 million of revenue for the same period in the prior year.  With our acquisition of Poorman-Douglas, revenue related to reimbursed expenses, such as postage pertaining to document management services, increased significantly.  We reflect the revenue from these reimbursed expenses as a separate line item on our Condensed Consolidated Statements of Income.  Although reimbursed revenues and expenses may fluctuate significantly from quarter to quarter, these fluctuations have a minimal effect on our operating income as we realize little or no margin from this revenue.  Revenue exclusive of reimbursed expenses, which we refer to as operating revenue, increased $9.7 million, or approximately 73%, to $23.0 million for the three months ended March 31, 2004 compared to $13.3 million for the same period in the prior year.  All revenue is directly related to a segment, and changes in revenue by segment are discussed below.

 

Costs and Expenses

Direct and administrative costs increased $9.5 million, or approximately 147%, to $15.9 million for the three months ended March 31, 2004 compared with $6.4 million for the same period in the prior year.  This increase primarily results from the inclusion of Poorman-Douglas’s direct and administrative expenses subsequent to the acquisition date and the inclusion of three months of BSI’s direct and administrative expenses for the three months ended March 31, 2004 compared to two months of BSI expenses for the three months ended March 31, 2003. As a result of the Poorman-Douglas acquisition, we realized a higher mix of document management revenue relative to case management revenue than during the same period in the prior year, which resulted in an increase in reimbursed expenses.  In addition, as a result of our growth, corporate administrative costs increased due to increased travel expense related to expanded locations, increased insurance coverage due to business expansion, and increased costs due to regulatory compliance.

 

Depreciation and software amortization increased $0.3 million, or approximately 24%, to $1.4 million for the three months ended March 31, 2004 compared with $1.1 million for the same period in the prior year.  This increase primarily relates to the additional depreciation and software amortization expense resulting from assets acquired through the Poorman-Douglas transaction.

 

Amortization of identifiable intangible assets increased $1.0 million, or approximately 146%, to $1.7 million for the three months ended March 31, 2004 compared with $0.7 million for the same period in the prior year.  All identifiable intangible assets are directly related to a segment, and changes in amortization of identifiable intangible assets by segment are discussed below.

 

Acquisition related expenses of $2.2 million for the three months ended March 31, 2004 and $1.5 million for the three months ended March 31, 2003, result from non-capitalizable expenses consisting of executive bonuses, legal, accounting and valuation services, and travel incurred in connection with potential and completed transactions.

 

Interest

We incurred net interest expense of $1.5 million for the three months ended March 31, 2004 compared with net interest income of $0.1 million for the three months ended March 31, 2003.  The increase in interest expense resulted primarily from borrowing $92.0 million to finance the acquisition of Poorman-Douglas.  Interest expense includes $0.6 million of acquisition related amortized loan fees.

 

Business Segments

 

Revenue

 

Case management operating revenue increased $5.5 million, or approximately 48%, to $16.9 million for the three months ended March 31, 2004 compared to $11.4 million for the three months ended March 31, 2003.  This increase primarily results from the inclusion of operating revenue related to the Poorman-Douglas acquisition subsequent to the acquisition date and the inclusion of three months of BSI operating revenue during the three months ended March 31, 2004 compared to two months of BSI operating revenue during the three months ended March 31, 2003.  Other factors that contributed to the increase in our case management operating revenue include an increase in fees related to bankruptcy trustee deposits and an increase in professional services, primarily related to Chapter 11 cases.

 

Document management operating revenue increased $4.2 million, or approximately 223%, to $6.1 million for the three months ended March 31, 2004 compared to $1.9 million for the three months ended March 31, 2003.  Document management

 

16



 

revenue for reimbursed expenses of $2.9 million increased 298% from the prior year quarter. The increase in total revenue for the document management segment was primarily the result of the acquisition of Poorman-Douglas subsequent to the acquisition date and the inclusion of three months of BSI operating revenue during the three months ended March 31, 2004 compared to two months of BSI operating revenue during the three months ended March 31, 2003.

 

Operating Expense

 

Case management direct and administrative expenses, including depreciation and software amortization, of $5.6 million increased $2.5 million, or approximately 81%, for the three months ended March 31, 2004 compared with $3.1 million for the same period in the prior year.  This increase primarily results from the inclusion of Poorman-Douglas’s direct and administrative expenses subsequent to the acquisition date and the inclusion of three months of BSI’s expenses during the three months ended March 31, 2004 compared to the inclusion of two months of BSI’s expenses for the three months ended March 31, 2003.

 

Document management direct and administrative expenses, including depreciation and software amortization, of $6.8 million increased $5.3 million, or approximately 379%, for the three months ended March 31, 2004 compared with $1.4 million for the same period in the prior year.  This increase primarily results from the inclusion of Poorman-Douglas’s expenses, including reimbursed expenses, subsequent to the acquisition date and the inclusion of three months of BSI’s expenses, including reimbursed expenses, for the three months ended March 31, 2004 compared to the inclusion of two months of BSI’s expenses, including reimbursed expenses, for the three months ended March 31, 2003.  Document management direct expenses include reimbursed expenses and other operating expenses which are more variable in nature than case management direct expenses.  Document management expenses will fluctuate from quarter to quarter based on document management business requirements delivered during each quarter.

 

Both the case management and document management segments have identifiable intangible assets.  Amortization of case management’s identifiable intangible assets increased $0.7 million, or approximately 172%, to $1.1 million for the three months ended March 31, 2004 compared with $0.4 million for the same period in the prior year.  Amortization of document management’s identifiable intangible assets increased $0.3 million, or approximately 108%, to $0.6 million for the three months ended March 31, 2004 compared with $0.3 million for the same period in the prior year.  For both segments, this increase primarily relates to the amortization expense related to the acquired intangible assets resulting from the Poorman-Douglas transaction and the February 2004 commencement of amortization related to the BSI trade name.  We also incurred three months of amortization expense related to the acquired intangible assets resulting from the BSI acquisition compared with only two months amortization expense related to the acquired intangible assets resulting from the BSI acquisition in the same period of the prior year.  Note 5 of the Notes to Condensed Consolidated Financial Statements section of this report provides a summary of the total identified intangible assets, the scheduled amortization expense and the scheduled amortization periods for the Poorman-Douglas and BSI acquisitions.

 

Liquidity and Capital Resources

 

Operating Activities

 

During the three months ended March 31, 2004, the primary sources of cash from operating activities were net income of $1.7 million and $4.0 million of adjustments for non-cash charges and credits, primarily depreciation and amortization.  These operating sources of cash were offset by an $8.3 million use of cash related to operating assets and liabilities, net of the effect of the initial acquisition of assets and assumption of liabilities related to the Poorman-Douglas transaction.  As a result, our operating activities had a net use of $2.6 million of cash for the three months ended March 31, 2004.

 

As noted above, changes in working capital as a direct result of assets acquired or liabilities assumed have been excluded from our Condensed Consolidated Statements of Cash Flows.  However, subsequent to the Poorman-Douglas acquisition, cash flows related to these acquired assets and assumed liabilities are reflected in our Condensed Consolidated Statements of Cash Flows.  For example, accounts payable and accrued expenses assumed as a part of the transaction are not reflected as a source of cash.  The subsequent payment of assumed accounts payable and accrued expenses are, however, reflected as an operating use of cash.

 

Our $8.3 million use of working capital primarily related to operating assets and liabilities assumed from Poorman-Douglas.  On acquisition of Poorman-Douglas, we assumed approximately $12.3 million of accounts payable and accrued expenses.  Of this amount, approximately $8.0 million were the direct result of acquisition-related transactions, primarily withholding taxes

 

17



 

resulting from the vesting of restricted Poorman-Douglas stock concurrent with the acquisition, that were due and payable shortly after the transaction closed.  The $12.3 million of accounts payable and accrued expenses assumed was not reflected as a source of cash, but the payment of the $8.0 million was reflected as a use of operating cash.

 

Investing Activities

 

Our most significant use of cash was the acquisition of Poorman-Douglas.  Net of $2.8 million cash acquired in the acquisition, we used cash of approximately $113.2 million related to this transaction.  During the three months ended March 31, 2004, we used approximately $1.3 million of cash to purchase property and equipment, primarily related to computer equipment used by our trustee clients at their various locations.  Enhancements to our existing software and development of new software is essential to our continued growth and, during the three months ended March 31, 2004, we used cash of approximately $0.5 million to fund internal costs related to development of computer software for which technological feasibility has been established.

 

Financing Activities

 

In addition to using approximately $28.3 million of available cash on hand, during the three months ended March 31, 2004 we also borrowed $92.0 million of cash.  Of these borrowings, approximately $2.5 million was used to pay fees related to the borrowing, and the remainder was used to partly finance our acquisition of Poorman-Douglas.

 

Our credit facility consists of a $45.0 million senior term loan, with amortizing quarterly principal payments of $4.5 million beginning April 30, 2004, a $25.0 million senior revolving loan, and a $30.0 million subordinated term loan.  The senior term loan and revolver mature July 31, 2006, while the subordinated term loan matures December 31, 2006.  As of March 31, 2004, we had aggregate outstanding borrowings under the syndicated credit facility of $92.0 million, consisting of all of the senior and subordinated term loans and $17.0 million of the senior revolving loan.  As of March 31, 2004, we had borrowing availability of $8.0 million under our senior revolving loan.

 

We believe that the funds generated from operations plus amounts available under our line of credit will be sufficient over the next year to finance currently anticipated working capital requirements, software and property and equipment expenditures, payments for contractual obligations, interest payments due on our credit facility borrowings, and the required quarterly principal payments of $4.5 million on our senior term loan.

 

During 2004, we may decide to issue equity, subordinated debt, or convertible subordinated debt to repay part or all of the borrowings under the credit facility.  Furthermore, we continue to explore acquisition opportunities.  Covenants contained in our new credit facility may limit our ability to consummate an acquisition.  If we make an additional acquisition or acquisitions, it may be necessary to raise additional capital through a restructuring of our credit facility, the issuance of equity, subordinated debt, or convertible subordinated debt, or some combination of the preceding.

 

18



 

Contractual Obligations

 

The following table sets forth a summary of our contractual obligations as of March 31, 2004 (in thousands):

 

Payments Due By Period

Contractual Obligation

 

Total

 

Less than
1 Year

 

1 – 3 Years

 

3 – 5 Years

 

More Than
5 Years

 

Long-term debt and future  accretion (1)

 

$

95,695

 

$

18,806

 

$

76,296

 

$

593

 

$

 

Employment agreements

 

6,540

 

1,822

 

3,618

 

1,100

 

 

Capital lease obligations

 

51

 

51

 

 

 

 

Operating leases

 

19,203

 

2,517

 

4,249

 

3,193

 

9,244

 

Total

 

$

121,489

 

$

23,196

 

$

84,163

 

$

4,886

 

$

9,244

 

 


(1)          A portion of the BSI purchase price was paid in the form of a non-interest bearing note, which was discounted using an imputed rate of 5% per annum.  The discount is being accreted over the life of the note.  The amount included in the contractual obligation table includes both the BSI note principal as reflected on our March 31, 2004 balance sheet as well as future accretion of the note discount.

 

Recent Accounting Pronouncements

 

In December 2003 the FASB issued FAS No. 132 (Revised) (“FAS 132-R”), Employer’s Disclosure about Pensions and Other Post Retirement Benefits. FAS 132-R retains disclosure requirements of the original FAS 132 and requires additional disclosures relating to assets, obligations, cash flows, and net periodic benefit cost. FAS 132-R is effective for fiscal years ending after December 15, 2003, except that certain disclosures are effective for fiscal years ending after June 15, 2004.  Interim period disclosures are effective for interim periods beginning after December 15, 2003.  The adoption of the disclosure provisions of FAS 132-R did not have a material effect on our consolidated Financial Statements.

 

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 statements about our future business plans and strategies, and other statements that are not historical in nature.  These forward-looking statements are based on our current expectations.  Many of these statements are found in the “Management’s Discussion and Analysis of Financial Conditions and Results of Operations” section of this report.

 

In this Quarterly Report on Form 10-Q, we make statements that plan for or anticipate the future.  These forward-looking statements include statements about our future business plans and strategies, and other statements that are not historical in nature. These forward-looking statements are based on our current expectations.

 

Forward-looking statements may be identified by words or phrases such as “believe,” “expect,” “anticipate,” “should,” “planned,” “may,” “estimated,” “goal,” “objective” and “potential.”  Section 27A of the Securities Act of 1933, as amended and Section 21E of the Securities Exchange Act of 1934, as amended, 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 the Company’s forward-looking statements.  These factors include, but are not limited to, (1) any material changes in the Company’s total number of bankruptcy trustees and bankruptcy, class action, and mass tort cases, (2) any material changes in the Company’s Chapter 7 deposits or the services required by our bankruptcy, class action, and mass tort cases,  (3) changes in the number of bankruptcy, class action, and mass tort filings each year, (4) changes to our Chapter 7 marketing arrangement and pricing arrangements (5) new bankruptcy, class action, or mass tort legislation, (6) risks associated with the integration of acquisitions into our existing business operations, including the Poorman-Douglas acquisition, and (7) other risks detailed from time to time in the Company’s filings with the SEC, including the “Risk Factors” discussed in our Annual Report on Form 10-K for the year ended December 31, 2003.  We do not undertake any obligation to update any forward-looking statements contained herein to reflect future events or developments.

 

19



 

ITEM 3.     Quantitative and Qualitative Disclosures About Market Risk.

 

Market risk refers to the risk that a change in the level of one or more market prices, interest rates, indices, volatilities, correlations or other market factors such as liquidity, will result in losses for a certain financial instrument or group of financial instruments.  During the three months ended March 31, 2004, our exposure to interest rate risk increased significantly.  Our primary interest risk relates to our borrowings under our syndicated credit facility.  Currently, interest on these borrowings is computed at a variable rate based on the LIBOR rate.  However, interest on our $30 million term loan will convert to a fixed rate effective August 1, 2004.  A 1% increase in the LIBOR rate would increase our annual interest expense by approximately $0.9 million.  We do not currently use any derivative financial instruments to modify this interest rate risk.

 

ITEM 4.     Controls and Procedures.

 

An evaluation was carried out by the Company’s Chief Executive Officer and Chief Financial Officer of the effectiveness of the design and operations of the Company’s disclosure controls and procedures (as defined in Exchange Act Rule 13a-15(e)).  Based upon that evaluation as of the end of the period covered by this report, the CEO and the CFO concluded that the Company’s disclosure controls and procedures are effective in timely alerting them to material information relating to the Company (including our consolidated subsidiaries) required to be included in the Company’s periodic filings with the SEC.  There have been no changes in the Company’s internal controls over financial reporting during the quarter ended March 31, 2004, that have materially affected, or are reasonably likely to materially affect, the Company’s internal controls over financial reporting.

 

During the first quarter of 2004, the Company acquired the Poorman-Douglas Corporation.  As part of its ongoing integration activities, the Company is continuing to incorporate its controls and procedures into this recently acquired business.

 

20



 

EPIQ SYSTEMS, INC.

MARCH 31, 2004 FORM 10-Q

 

PART II - OTHER INFORMATION

 

ITEM 6.     Exhibits and Reports on Form 8-K.

 

(a)                                  Exhibits.

 

31.1                           Certifications of Chief Executive Officer of the Company under Rule 13a-14(a), as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.

 

31.2                           Certifications of Chief Financial Officer of the Company under Rule 13a-14(a), as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.

 

32.1                           Certifications of CEO and CFO pursuant to 18 U.S.C. Section 1350.

 

(b)                                  Reports on Form 8-K.

 

1.               A report on Form 8-K on February 13, 2004, subsequently amended by a report on Form 8-K/A filed on April 13, 2004, reporting the acquisition of PD Holding Corp. and its wholly-owned subsidiary, the Poorman-Douglas Corporation and including historical financial statements of PD Holding Corp. and pro forma financial information for PD Holding Corp. and EPIQ Systems, Inc.

 

2.               A report on Form 8-K was filed on February 24, 2004, furnishing the Company’s earnings release for the fourth quarter ended and year ended December 31, 2003.

 

21



 

SIGNATURES
 

Pursuant to the requirements of the Securities Exchange Act of 1934, as amended, the registrant has caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.

 

 

EPIQ Systems, Inc.

 

 

 

 

Date:   May 7, 2004

/s/  Tom W. Olofson

 

 

 

Tom W. Olofson

 

 

Chairman of the Board

 

 

Chief Executive Officer

 

 

Director

 

 

(Principal Executive Officer)

 

 

 

 

 

 

 

Date:   May 7, 2004

/s/  Elizabeth M. Braham

 

 

 

Elizabeth M. Braham

 

 

Senior Vice President, Chief Financial Officer

 

 

(Principal Financial Officer)

 

 

 

 

 

 

 

Date:   May 7, 2004

/s/  Douglas W. Fleming

 

 

 

Douglas W. Fleming

 

 

Director of Finance

 

 

(Principal Accounting Officer)

 

 

22