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, 2005

 

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		(IRS Employer Identification Number)
incorporation or organization)
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 20, 2005:

 

Class		Outstanding
Common Stock, $.01 par value		17,895,654

 

 

EPIQ SYSTEMS, INC. AND SUBSIDIARIES

FORM 10-Q

QUARTER ENDED MARCH 31, 2005

 

CONTENTS

 

		Page
PART I - FINANCIAL INFORMATION
Item 1.	Condensed Consolidated Financial Statements
	Condensed Consolidated Statements of Income –
	Three months ended March 31, 2005 and 2004 (Unaudited)	1
	Condensed Consolidated Balance Sheets –
	March 31, 2005 and December 31, 2004 (Unaudited)	2
	Condensed Consolidated Statements of Cash Flows –
	Three months ended March 31, 2005 and 2004 (Unaudited)	3
	Notes to Condensed Consolidated Financial Statements (Unaudited)	4
Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	14
Item 3.	Quantitative and Qualitative Disclosures about Market Risk	21
Item 4.	Controls and Procedures	21
PART II - OTHER INFORMATION
Item 5.	Other Information	22
Item 6.	Exhibits	27
Signatures		28

 

 

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,
		2005			2004
REVENUE:
Case management		$	19,885		$	16,926
Document management		6,081			6,067
Operating revenue		25,966			22,993
Reimbursed expenses		5,495			3,019
Total Revenue		31,461			26,012
COSTS AND EXPENSES:
Direct costs		13,736			10,305
General and administrative		7,992			5,638
Depreciation and software amortization		1,774			1,381
Amortization of identifiable intangible assets		1,623			1,680
Acquisition related		—			2,181
Total Operating Expenses		25,125			21,185
INCOME FROM OPERATIONS		6,336			4,827
EXPENSES RELATED TO FINANCING:
Interest income		39			34
Interest expense		(801		)	(1,522		)
Net Expenses Related To Financing		(762		)	(1,488		)
INCOME FROM CONTINUING OPERATIONS BEFORE INCOME TAXES		5,574			3,339
PROVISION FOR INCOME TAXES		2,324			1,338
NET INCOME FROM CONTINUING OPERATIONS		3,250			2,001
DISCONTINUED OPERATIONS:
Loss from operations of discontinued infrastructure software  segment		—			(436		)
Income tax benefit from operations of discontinued infrastructure software segment		—			172
TOTAL DISCONTINUED OPERATIONS		—			(264		)
NET INCOME		$	3,250		$	1,737
NET INCOME PER SHARE INFORMATION:
Income per share – Basic
Income from continuing operations		$	0.18		$	0.11
Loss from discontinued operations		—			(0.01		)
Net income per share – Basic		$	0.18		$	0.10
Income per share – Diluted
Income from continuing operations		$	0.17		$	0.11
Loss from discontinued operations		—			(0.01		)
Net income per share – Diluted		$	0.17		$	0.10
WEIGHTED AVERAGE COMMON SHARES OUTSTANDING:
Basic		17,887			17,813
Diluted		21,112			18,237

 

See accompanying notes to condensed consolidated financial statements.

 

1

 

EPIQ SYSTEMS, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED BALANCE SHEETS

(In Thousands)

(Unaudited)

 

		March 31, 2005			December 31, 2004
ASSETS
CURRENT ASSETS:
Cash and cash equivalents		$	8,507		$	13,330
Short-term investments		3,850			—
Trade accounts receivable, less allowance for doubtful accounts of $1,345 and $1,069, respectively		24,644			18,690
Prepaid expenses		2,540			2,052
Income taxes refundable		1,460			3,477
Deferred income taxes		608			754
Other current assets		268			736
Total Current Assets		41,877			39,039
LONG-TERM ASSETS:
Property and equipment, net		19,512			20,431
Software development costs, net		5,805			5,838
Goodwill		147,728			147,728
Other intangibles, net of accumulated amortization of $8,630 and  $11,707, respectively		22,434			24,057
Other		3,226			2,995
Total Long-term Assets, net		198,705			201,049
Total Assets		$	240,582		$	240,088
LIABILITIES AND STOCKHOLDERS’ EQUITY
CURRENT LIABILITIES:
Accounts payable		$	3,350		$	4,263
Customer deposits		2,320			2,375
Accrued compensation		1,018			873
Other accrued expenses		1,263			899
Current maturities of long-term obligations		8,698			7,650
Total Current Liabilities		16,649			16,060
LONG-TERM LIABILITIES:
Deferred income taxes		9,793			9,696
Long-term obligations (excluding current maturities)		70,990			74,499
Total Long-term Liabilities		80,783			84,195
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 – 17,892,233 and 17,883,917  shares at March 31, 2005 and December 31, 2004, respectively		179			179
Additional paid-in capital		102,805			102,738
Retained earnings		40,166			36,916
Total Stockholders’ Equity		143,150			139,833
Total Liabilities and Stockholders’ Equity		$	240,582		$	240,088

 

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,
		2005			2004
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income		$	3,250		$	1,737
Adjustments to reconcile net income to net cash from operating activities:
Provision for deferred income taxes		243			227
Depreciation and software amortization		1,774			1,381
Loan fee amortization		284			615
Amortization of other intangible assets		1,623			1,680
Other		(57		)	54
Changes in operating assets and liabilities, net of effects from business acquisition:
Trade accounts receivable		(6,230		)	203
Prepaid expenses and other assets		(757		)	(281		)
Accounts payable and accrued expenses		(458		)	(449		)
Withholding and related liabilities assumed in the acquisition of a business and subsequently paid		—			(7,973		)
Deferred revenue		—			4
Income taxes, including tax benefit from exercise of stock options		2,035			194
Net cash provided by (used in) operating activities		1,707			(2,608		)
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchase of property and equipment		(404		)	(1,251		)
Software development costs		(437		)	(479		)
Cash paid for acquisition of business, net of cash acquired		—			(113,193		)
Purchase of short-term investments		(4,000		)	—
Sale of short-term investments		2,150			—
Other		(1,767		)	19
Net cash used in investing activities		(4,458		)	(114,904		)
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from long-term debt borrowings		5,000			92,000
Debt issuance costs		—			(2,473		)
Principal payments under long-term debt obligations		(7,118		)	(579		)
Proceeds from exercise of stock options and warrants		46			287
Net cash provided by (used in) financing activities		(2,072		)	89,235
NET DECREASE IN CASH AND CASH EQUIVALENTS		(4,823		)	(28,277		)
CASH AND CASH EQUIVALENTS, BEGINNING OF PERIOD		13,330			30,347
Decrease in cash classified as held for sale		—			18
CASH AND CASH EQUIVALENTS, END OF PERIOD		$	8,507		$	2,088
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION:
Interest paid		$	834		$	540
Income taxes paid		$	46		$	745

 

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, Inc. 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.

 

Short-term Investments

 

Short-term investments consist of auction rate securities issued by various governmental agencies throughout the United States.  These investments are classified as available for sale securities and are recorded at fair value.  The securities are long-term instruments; however, the interest rates are reset approximately every week, at which time we can sell the securities.  Due to this short time period between the reset dates of the interest rates, there are no unrealized gains or losses associated with these securities.

 

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-based 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 our option plans 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, 2005 and 2004 would have been adjusted to the following pro forma amounts (in thousands, except per share data):

 

 

Pro forma amounts presented here are based on actual earnings and consider only the effects of estimated fair values of stock options.  For the three months ended March 31, 2005, we did not assume conversion of the convertible notes as the effect was antidilutive.

 

4

 

Recent Accounting Pronouncements

 

In December 2004, the Financial Accounting Standards Board (FASB) issued Statement of Financial Accounting Standards (SFAS) No. 153, Exchanges of Nonmonetary Assets, an amendment of APB Opinion No. 29.  SFAS 153 expanded the scope of APB Opinion No. 29 to require that the nonmonetary exchange of similar productive assets should be measured based on the fair value of the assets exchanged.  We are required to adopt the provisions of SFAS 153 for our quarter ending September 30, 2005.  We do not anticipate that adoption of this statement will have a material impact on our consolidated financial statements.

 

In December 2004, the FASB issued SFAS No. 123 (revised 2004) (SFAS 123R), Share-Based Payment.  SFAS 123R establishes standards for the accounting for transactions in which an entity exchanges its equity instruments for goods and services or incurs liabilities in exchange for goods or services that are based on the fair value of the entity’s equity instruments or that may be settled by the issuance of those equity instruments.  SFAS 123R requires a public entity to measure the cost of employee services received in exchange for an award of equity instruments based on the grant-date fair value of the award and to recognize that cost over the period during which an employee is required to provide service in exchange for the award.  SFAS 123R is effective for fiscal years beginning after June 15, 2005.  Accordingly, we will adopt SFAS 123R, likely using the modified version of prospective application, beginning with our quarter ending March 31, 2006.  Under the modified version of prospective application, compensation costs related to share-based compensation will be recognized in our financial statements for all periods beginning after December 31, 2005.  For comparative periods ending on or before December 31, 2005 which are presented in our 2006 and subsequent financial statements, share-based compensation costs will continue to be excluded from the financial statements but we will disclose these share-based compensation costs on a pro forma basis in a note to the financial statements.  Adoption of SFAS 123R will materially increase our recognized compensation expense and will have a material impact on our consolidated income statement and balance sheet.  We are unable to estimate the impact of adoption of this statement on our consolidated financial statements as the impact will depend, in part, on future stock awards and stock option awards made prior to the adoption date, whether any such awards granted are qualified or non-qualified, the vesting period of those awards, and forfeitures related to both existing awards and new awards.  Subsequent to December 31, 2004, our Compensation Committee approved acceleration of the vesting of certain unvested options for employees, including an executive officer, and non-employee directors.  The decision to accelerate the vesting of these options and eliminate future compensation expense was based primarily on a review of our long-term incentive programs considering the effect on our financial statements of changes in accounting rules that we must adopt in the future.  This action, which had an immaterial affect on our financial statements for the three months ended March 31, 2005, will reduce the impact of adoption of SFAS 123R on our consolidated financial statements. If, subsequent to March 31, 2005, no new awards were issued and no existing awards were forfeited, we estimate that adoption of SFAS 123R would increase our pre-tax compensation expense for the year ending December 31, 2006 by approximately $1.0 million.  We do not anticipate that adoption of SFAS 123R will have a material impact on our consolidated statement of cash flows.

 

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 the information and notes 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 our Form 10-K for the year ended December 31, 2004.

 

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, 2005 and the results of operations and cash flows for the three months ended March 31, 2005 and 2004.

 

The results of operations for the period ended March 31, 2005 are not necessarily indicative of the results to be expected for the entire year.

 

5

 

NOTE 3:   NET INCOME PER SHARE

 

Basic net income per share is computed by dividing net income available to common shareholders by the weighted average number of common shares outstanding for the period.  Diluted net income per share is computed by dividing net income available to common shareholders, increased by the amount of interest expense, net of tax, related to outstanding convertible debt, by the weighted average number of outstanding common shares and shares that may be issued in future periods relating to outstanding stock options and convertible debt, if dilutive.

 

The computation of basic and diluted net income per share from continuing operations are as follows (in thousands, except per share data):

 

 

Options to purchase approximately 2,823,000 and 324,000 shares of common stock for the three-month periods ended March 31, 2005 and 2004, respectively, were antidilutive and therefore not included in the computation of diluted net income per share from continuing operations.

 

6

 

NOTE 4:   GOODWILL AND INTANGIBLE ASSETS

 

Amortizing identifiable intangible assets at March 31, 2005 and December 31, 2004 consisted of the following (in thousands):

 

		March 31, 2005						December 31, 2004
		Gross Carrying Amount			Accumulated Amortization			Gross Carrying Amount			Accumulated Amortization
Customer contracts		$	11,860		$	3,794		$	16,560		$	7,656
Trade names		1,574			918			1,574			721
Non-compete agreements		17,630			3,918			17,630			3,330
		$	31,064		$	8,630		$	35,764		$	11,707

 

During the three months ended March 31, 2005, $4.7 million of identifiable intangible assets related to Bankruptcy Services LLC (“BSI”) customer contracts became fully amortized.  Accordingly, we wrote off both the identifiable intangible assets and the related accumulated amortization.

 

Aggregate amortization expense related to identifiable intangible assets was $1.6 million and $1.7 million for the three-month periods ended March 31, 2005 and 2004, respectively.  Amortization expense related to identifiable intangible assets for 2005 and the following five years is estimated as follows (in thousands):

 

 

At both March 31, 2005 and December 31, 2004, intangible assets not subject to amortization, consisting solely of goodwill, had a carrying value of $147.7 million.

 

7

 

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 provides 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 $115.9 million.  Based on our valuation, the purchase price has been allocated as follows (in thousands):

 

 

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 $83.5 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.

 

Unaudited pro forma results of operations assuming the purchase acquisition was made at the beginning of 2004 are shown below (in thousands, except per share data):

 

		Three Months Ended March 31, 2004
Revenue		$	32,695
Net income from continuing operations		$	1,809
Net income per share from continuing operations:
Basic		$	0.10
Diluted		$	0.10

 

The pro forma financial 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

 

We have two operating segments: (i) case management and (ii) document management.  Case management solutions provide clients with integrated technology-based products and services for the automation of administrative tasks to address their business requirements.  Document management solutions include proprietary technology and production services to ensure timely, accurate and complete execution of documents related to a case.

 

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 was held for sale and is presented as a discontinued operation.  Consistent with guidance provided related to SFAS No. 131, we have not presented segment information related to our discontinued operation.

 

During the current year, we determined that certain revenues from reimbursed expenses and certain expenses, including reimbursed expenses, related to our Poorman-Douglas subsidiary acquired in January 2004 had not been recorded in the correct segment.  These classification errors did not affect our Consolidated Statements of Income, Balance Sheets, Statements of Cash Flows, or Statement of Changes in Stockholders’ Equity for any period previously reported.  Additionally, these errors do not affect historical or future net cash flows or compliance with any debt covenants.  However, the classification errors did affect our previously reported segment information disclosed in our 2004 quarterly reports filed on Form 10-Q and on our annual report filed on Form 10-K for the year ended December 31, 2004.  We will not amend our previously filed 2004 quarterly reports filed on Form 10-Q or our 2004 annual report filed on Form 10-K, but will restate our comparative 2004 quarterly segment information to correct these classification errors prospectively in our 2005 quarterly reports filed on Form 10-Q and our 2005 annual report filed on Form 10-K.  See Item 5 contained in Part II of this quarterly report on Form 10-Q for additional information regarding this restatement.

 

Following is a summary of segment information (in thousands):

 

		Three Months Ended March 31, 2005
		Case Management			Document Management			Unallocated			Consolidated
Revenue:
Operating revenue		$	19,885		$	6,081		$	—		$	25,966
Reimbursed expenses		896			4,599			—			5,495
Total revenue		20,781			10,680			—			31,461
Costs and expenses:
Direct and administrative costs and depreciation and software amortization		8,094			8,144			7,264			23,502
Amortization of identifiable intangible assets		1,157			466			—			1,623
Acquisition related		—			—			—			—
Total operating expenses		9,251			8,610			7,264			25,125
Operating income		$	11,530		$	2,070		$	(7,264	)	6,336
Interest expense, net											762
Income from continuing operations before income taxes											5,574
Provision for income taxes											2,324
Net income from continuing operations											$	3,250
Total assets		$	129,917		$	50,807		$	59,858		$	240,582
Provisions for depreciation and amortization		$	2,244		$	592		$	561		$	3,397

 

9

 

		Three Months Ended March 31, 2004
		(as restated)
		Case Management			Document Management			Unallocated			Consolidated
Revenue:
Operating revenue		$	16,926		$	6,067		$	—		$	22,993
Reimbursed expenses		655			2,364			—			3,019
Total revenue		17,581			8,431			—			26,012
Costs and expenses:
Direct and administrative costs and depreciation and software amortization		6,053			6,161			5,110			17,324
Amortization of identifiable intangible assets		1,109			571			—			1,680
Acquisition related		—			—			2,181			2,181
Total operating expenses		7,162			6,732			7,291			21,185
Operating income		$	10,419		$	1,699		$	(7,291	)	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

 

10

 

NOTE 7:   LONG-TERM OBLIGATIONS

 

The following is a summary of indebtedness outstanding (in thousands):

 

		March 31, 2005			December 31, 2004
Senior term loan		$	20,313		$	21,875
Senior revolving loan		5,000			5,000
Contingent convertible subordinated debt, including embedded option		49,913			50,292
Capital leases		1,772			1,773
Deferred acquisition price		2,690			3,209
Total indebtedness		$	79,688		$	82,149

 

Credit Facilities

We have a credit facility with KeyBank National Association as administrative agent.  This facility consists of a $25.0 million senior term loan, with amortizing quarterly principal payments of $1.6 million, and a $50.0 million senior revolving loan.  Both the senior term loan and the senior revolving loan mature June 30, 2008.  During the term of the loan we have the right, subject to compliance with our covenants, to increase the senior revolving loan to $75.0 million.

 

The credit facility is secured by liens on our real property and a significant portion of our personal property and contains financial covenants related to earnings before interest, provision for income taxes, depreciation and amortization (“EBITDA”), total debt, senior debt, fixed charges and working capital.  We were in compliance with all financial covenants as of March 31, 2005.  As calculated at March 31, 2005, additional availability under the senior revolving loan was approximately $31.0 million.  As of March 31, 2005, our borrowings under the credit facility totaled $25.3 million, consisting of $20.3 million borrowed under the senior term loan and $5.0 million borrowed under the senior revolving loan.  Interest on the credit facility is generally based on a spread over the LIBOR rate.  As of March 31, 2005, the interest rate charged on outstanding borrowings ranged from 5.6% to 6.5%.

 

Contingent Convertible Subordinated Debt

During June 2004, we issued $50.0 million of contingent convertible subordinated notes.  These contingent convertible subordinated notes:

 

•      bear interest at a fixed rate of 4%, payable quarterly;

•      under certain circumstances are convertible into shares of our common stock at a price of $17.50 per share; and

•      mature on June 15, 2007, subject to extension of maturity to June 15, 2010 at the option of the note holders.

 

The note holders’ right to convert the notes is contingent on the market price of our common stock.  The shares are convertible only if the weighted average of the price of our common stock equals or exceeds $19.25 on any five consecutive trading days or if the weighted average price of our common stock is less than $10.75 on any five consecutive trading days.

 

The contingency has not been satisfied and, accordingly, the notes are not currently convertible.  If the contingency were satisfied and all shares were converted, the notes would convert into approximately 2,857,000 shares of our common stock.  If we change our capital structure (for example, through a stock dividend or stock split) while the notes are outstanding, the conversion price will be adjusted on a consistent basis and, accordingly, the number of shares of common stock we would issue on conversion would be adjusted.

 

The Emerging Issues Task Force (EITF) reached a consensus regarding Issue No. 04-08, The Effect of Contingently Convertible Debt on EPS, that the dilutive effect of contingently convertible debt instruments should be included in the diluted earnings per share calculations in all periods, regardless of whether the contingency is met, unless the effect of such inclusion would be antidilutive.  This consensus was effective for reporting periods ending on or after December 15, 2004.  Accordingly, the shares issuable on conversion have been included in our diluted shares calculation for the three months ended March 31, 2005.

 

11

 

The note holders have the right to extend the maturity of the contingent convertible subordinated notes for a period not to exceed three years.  Under SFAS No. 133, Accounting for Derivative Instruments and Hedging Activities, the right to extend the maturity of the notes represents an embedded option subject to bifurcation.  The embedded option was initially valued at $1.2 million and the convertible debt balance was reduced by the same amount.  The convertible debt is accreted approximately $0.1 million each quarter such that, at the end of three years, the convertible debt balance will total $50.0 million.  On our accompanying Condensed Consolidated Statements of Income, this accretion is a component of interest expense.  The embedded option must be revalued at each period end based on the probability weighted discounted cash flows related to the additional 4% interest rate payments that will be made if the convertible debt maturity is extended an additional three years.  Under this methodology, the embedded option has a current value of approximately $0.8 million.  On our accompanying Condensed Consolidated Balance Sheet, our obligation related to the embedded option has been included as a component of the convertible note payable.  During the three months ended March 31, 2005, the value of the embedded option decreased by approximately $0.5 million and this decrease is included as a reduction of interest expense on our accompanying Condensed Consolidated Statements of Income for the three months ended March 31, 2005.  The changes in carrying value of the convertible debt and fair value of the embedded option do not affect our cash flow and, if the embedded option is exercised, the value assigned to the embedded option will be amortized as a reduction to our 4% convertible debt interest expense over the periods payments are made.  If the option is not exercised by some or all note holders, any remaining related value assigned to the embedded option will be recognized as a gain during that period.

 

The notes evidencing the contingent convertible subordinated debt contains financial covenants related to EBITDA, total debt, and senior debt.  We were in compliance with all financial covenants as of March 31, 2005.

 

Capital Lease

On June 30, 2004, we entered into a capital lease to finance the purchase of operating software.  At inception of the capital lease, we recorded this transaction as a debt obligation in the amount of $2.7 million and as purchased software, also in the amount of $2.7 million, included on the balance sheet as a component of property and equipment.  As this was a non-cash investing and financing activity, these initial amounts were not included on our Condensed Consolidated Statement of Cash Flows.  Subsequent payments on the capital lease are included in our statement of cash flows during the period in which they are made.  As of March 31, 2005, our debt obligation related to this capital lease was approximately $1.8 million, of which approximately $0.9 million was classified as a current liability.

 

Deferred Acquisition Price

On January 31, 2003, we acquired 100% of the membership interests of BSI, a provider of technology-based case management, consulting and administrative services for Chapter 11 restructurings, for a purchase price of $67.0 million.  A portion of the purchase price was deferred which consists of a $4.0 million non-interest bearing note, payable in five annual installments, discounted using an imputed interest rate of 5% per annum.  At March 31, 2005, the discounted value of the remaining note payments was approximately $2.7 million of which approximately $1.6 million was classified as a current liability.

 

Scheduled Principal Payments

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

 

2006		$	8,698
2007		7,729
2008		56,699
2009		6,562
Total		$	79,688

 

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NOTE 8:   DISCONTINUED OPERATIONS

 

The primary offering of our former infrastructure software business was 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.

 

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 disposal of the infrastructure business represents a discontinued operation.  Accordingly, for the three months ended March 31, 2004, revenues, cost of sales, and operating expenses related to this segment have been presented on the accompanying Condensed Consolidated Statements of Income under the caption “Discontinued Operations.”

 

The following table summarizes financial information for discontinued operations (in thousands):

 

Net revenue and pre-tax loss from discontinued operations:

 

		Three Months Ended March 31,
		2005			2004
Net revenue from discontinued operations		$	—		$	380
Pre-tax loss from discontinued operations		$	—		$	(436	)

 

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

 

Overview

 

We provide 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.  Our 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 with an integrated offering of both proprietary technology and value-added services that comprehensively address their extensive business requirements.

 

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

 

Case Management Segment

 

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

 

•      An integrated solution of a proprietary technology platform and related professional services that facilitates case administration of class action, mass tort and Chapter 11 client engagements.

 

•      Comprehensive support for the balloting and voting activities that accompany Chapter 11 bankruptcy restructurings.

 

•      TCMS®, an integrated solution comprised of 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®, proprietary software designed to enable Chapter 13 bankruptcy trustees to manage efficiently debtor payments, creditor distributions and government reporting.

 

•      Database conversions, maintenance and processing.

 

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

 

•      Call center support.

 

Document Management Segment

 

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

 

•      Legal noticing services to parties of interest in bankruptcy and class action and mass tort matters.

 

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

 

•      Media campaign and advertising management.

 

•      Document custody services.

 

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Critical Accounting Policies

 

We consider our accounting policies related to revenue recognition, business combinations, goodwill, and identifiable intangible assets 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 our completion of all contractually required performance obligations related to products delivered and services rendered 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; and

 

•      fees for services, including technology services, claims reconciliation, document printing, noticing, balloting, voting tabulation and other professional services; and

 

•      reimbursement for costs incurred related to postage on mailing 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.  Certain identifiable intangible assets, such as customer lists and covenants not to compete, are amortized on a straight-line basis over the intangible asset’s estimated useful life.  The estimated useful life of amortizable identifiable intangible assets range from two to 14 years.  Goodwill and certain other identifiable intangible assets are not amortized.  Accordingly, the acquisition cost allocation has had, and will continue to have, a significant impact on our current 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 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 could adversely affect the fair value of one or more reporting units.  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 goodwill totaled $147.7 million as of March 31, 2005 and $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 annual assessment, or other events and circumstances, may indicate that the carrying value of one or more identifiable intangible assets is not recoverable and its fair value is less than the identifiable intangible asset’s carrying value and would result in recognition of an impairment charge.

 

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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 our results of operations and financial condition.  Our identifiable intangible assets’ carrying value, net of amortization, was $22.4 million as of March 31, 2005 and $30.1 million as of March 31, 2004.

 

Results of Operations for the Three Months Ended March 31, 2005 Compared with the Three Months Ended March 31, 2004

 

Management Overview

 

Our operations consist primarily 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.  We have two operating segments: case management and document management.

 

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 due to the unpredictable nature 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 10, 2005, reported increases in both consumer and business debt outstanding as compared with the same period of the prior year.

 

In February 2005, new federal class action and tort reform legislation was passed and signed by President Bush.  The primary impact of the new federal legislation is to require that certain types of class action lawsuits be brought in federal court rather than state courts.  We believe the new federal legislation will likely result in fewer class action lawsuits in state courts.  The slower processing of class action lawsuits in federal courts could delay the ultimate settlement of those cases, which could adversely affect the timing of services we provide in those cases.  Similar to this recent federal experience, there have been various efforts at the state level to modify and reform the laws and procedures related to class action and mass tort.  We cannot predict the effect, if any, that state legislative action would have on the number or size of class action and mass tort lawsuits filed, or on the claims administration process.

 

In April 2005, new federal bankruptcy legislation was passed and signed by President Bush.  The intent of this legislation, which is effective October 2005, is to move certain individual bankruptcy filings from Chapter 7, which liquidates most of the assets of the debtor and discharges most of the debtor’s liabilities, to Chapter 13, which does not liquidate the debtor’s assets but which requires partial repayment of the debtor’s liabilities.  We believe it is unlikely that this legislation will have a material impact on our business.

 

We have acquired a number of businesses during the past several years.  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.

 

Consolidated Results

 

Revenue

Total revenue of $31.5 million for the three months ended March 31, 2005 represents an approximate 21% increase compared to $26.0 million of revenue for the same period in the prior year.  A significant part of our total revenue consists of reimbursement for certain expenses we incur, such as postage related to document management services.  We reflect the revenue from these reimbursed expenses as a separate line item on our accompanying Condensed Consolidated Statements of Income.  Although reimbursed revenue 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

 

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reimbursed expenses, which we refer to as operating revenue, increased $3.0 million, or approximately 13%, to $26.0 million for the three months ended March 31, 2005 compared to $23.0 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, including depreciation and software amortization, increased $6.2 million, or approximately 36%, to $23.5 million for the three months ended March 31, 2005 compared with $17.3 million for the same period in the prior year.

 

Direct and administrative costs, including depreciation and software amortization, not allocated to a segment increased $2.2 million, or 42%, to $7.3 million for the three months ended March 31, 2005 compared with $5.1 million for the three months ended March 31, 2004.  Unallocated direct and administrative costs, including depreciation and software amortization, increased due to a combination of factors, including the inclusion of three months of Poorman-Douglas’s operating expenses during the three months ended March 31, 2005 compared to two months of Poorman-Douglas’s unallocated expenses included in the three months ended March 31, 2004, an increase in estimated expense related to annual bonuses, increased professional fees, increased bad debt charges, and an increase in operating software amortization expense.

 

Amortization of identifiable intangible assets decreased $0.1 million to $1.6 million for the three months ended March 31, 2005 compared with $1.7 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.

 

During the three months ended March 31, 2005, we did not have any acquisition related expenses.  Acquisition related expenses of $2.2 million for the three months ended March 31, 2004, resulted 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 $0.8 million for the three months ended March 31, 2005 compared with net interest expense of $1.5 million for the three months ended March 31, 2004.  The decrease in interest expense resulted primarily from a decrease in the value of the embedded option related to the outstanding convertible debt, which resulted in a credit to interest expense, combined with a decrease in amortized loan fee expenses.

 

Effective Tax Rate

Our effective tax rate related to income from continuing operations increased from 40.1% for the three months ended March 31, 2004 to 41.7% for the three months ended March 31, 2005.  Our tax rate is higher than the statutory federal rate of 35% primarily due to state taxes, including taxes related to our New York operations which are subject to relatively high state and local New York tax rates, which have a combined 17.88% tax rate.

 

Business Segments

 

Revenue

Case management operating revenue increased $3.0 million, or approximately 17%, to $19.9 million for the three months ended March 31, 2005 compared to $16.9 million for the three months ended March 31, 2004.  This increase primarily results from the inclusion of three months of Poorman-Douglas’s operating revenue during the three months ended March 31, 2005 compared to two months of Poorman-Douglas’s operating revenue during the three months ended March 31, 2004.  The remainder of the increase in our case management operating revenue is primarily attributable to an increase in class action operating revenues, partly offset by a decrease in bankruptcy professional fees.

 

Document management operating revenue was approximately $6.1 million for both the three months ended March 31, 2005 and the three months ended March 31, 2004.  Poorman-Douglas, for which we recorded three months of revenue during the three months ended March 31, 2005 compared with two months revenue recorded for the three months ended March 31, 2004, had only a small increase in operating revenue primarily due to a decline in class action advertising-related revenue and bankruptcy noticing and related professional services.

 

Operating Expense

Case management direct and administrative expenses, including depreciation and software amortization, of $8.1 million increased $2.0 million, or approximately 34%, for the three months ended March 31, 2005 compared with $6.1 million for the same period in the prior year.  This increase primarily results from the inclusion of three months of Poorman-Douglas’s

 

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expenses during the three months ended March 31, 2005 compared to the inclusion of two months of Poorman-Douglas’s expenses for the three months ended March 31, 2004, as well as increased reimbursed costs and additional costs, primarily temporary labor and outside services, to support the increase in class action operating revenues.  We also had an increase in amortization costs related to operating system software.

 

Document management direct and administrative expenses, including depreciation and software amortization, of $8.1 million increased $1.9 million, or approximately 32%, for the three months ended March 31, 2005 compared with $6.2 million for the same period in the prior year.  This increase primarily results from the inclusion of three months of Poorman-Douglas’s expenses, including reimbursed expenses, for the three months ended March 31, 2005 compared to the inclusion of two months of Poorman-Douglas’s expenses, including reimbursed expenses, for the three months ended March 31, 2004.  Other document management expenses declined slightly, primarily due to decreased costs related to advertising-related revenue and decreased print costs related to the decrease in document management noticing and related professional fees.  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 $0.1 million to $1.2 million for the three months ended March 31, 2005 compared with $1.1 million for the same period in the prior year.  This increase is primarily the result of amortization of intangible assets resulting from Poorman-Douglas for three months for the three month period ended March 31, 2005 compared with only two months of amortization for these intangible assets during the three month period ended March 31, 2004.  Amortization of document management’s identifiable intangible assets decreased $0.1 million to $0.5 million for the three months ended March 31, 2005 compared with $0.6 million for the same period in the prior year.  This decrease is primarily attributable to the fact that certain document management intangible assets related to prior acquisitions became fully amortized during the three months ended March 31, 2005.  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 acquisition.

 

Liquidity and Capital Resources

 

Operating Activities

During the three months ended March 31, 2005, the primary sources of cash from operating activities were net income of $3.3 million and $3.9 million of adjustments for non-cash charges and credits, primarily depreciation and amortization.  These operating sources of cash were largely offset by a $6.2 million use of cash related to an increase in trade accounts receivable.  Trade accounts receivable increased primarily as the result of the timing of collections.  As a result, our operating activities generated net cash of $1.7 million for the three months ended March 31, 2005.

 

Investing Activities

During the three months ended March 31, 2005, we used approximately $1.9 million of net cash to acquire short-term investments, $0.4 million of cash to purchase property and equipment, and $0.4 million of cash to fund internal costs related to development of computer software for which technological feasibility has been established.

 

Financing Activities

During the three months ended March 31, 2005, we paid approximately $1.6 million related to our senior term loan and $0.6 million related to the BSI deferred acquisition price.  We also had $5.0 million of both borrowings and repayments related to our senior revolving loan.

 

As of March 31, 2005, our borrowings consisted of $49.9 million from the contingent convertible subordinated notes (including the fair value of the embedded option), $20.3 million under our senior term loan, $5.0 million under our senior revolving loan, and approximately $4.5 million of obligations related to capitalized leases and deferred acquisition price.

 

We believe that the funds generated from operations plus amounts available under our senior revolving loan will be sufficient over the next year to finance currently anticipated working capital requirements, software expenditures, property and equipment expenditures, payments for contractual obligations, interest payments due on our credit facility borrowings, and the required quarterly principal payments of $1.6 million on our senior term loan.

 

We may pursue an acquisition in the future and we may use the availability under our revolving loan and cash on hand to finance a future acquisition.  If the acquisition price exceeds the capacity of these sources of financing, we may decide to

 

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issue equity, restructure our credit facility, partly finance the acquisition with a note payable, or some combination of the preceding.  Covenants contained in our credit facility may limit our ability to consummate an acquisition.

 

Recent Accounting Pronouncements

 

In December 2004, the Financial Accounting Standards Board (FASB) issued Statement of Financial Accounting Standards (SFAS) No. 153, Exchanges of Nonmonetary Assets, an amendment of APB Opinion No. 29.  SFAS 153 expanded the scope of APB Opinion No. 29 to require that the nonmonetary exchange of similar productive assets should be measured based on the fair value of the assets exchanged.  We are required to adopt the provisions of SFAS 153 for our quarter ending September 30, 2005.  We do not anticipate that adoption of this statement will have a material impact on our consolidated financial statements.

 

In December 2004, the FASB issued SFAS No. 123 (revised 2004) (“SFAS 123R”), Share-Based Payment.  SFAS 123R establishes standards for the accounting for transactions in which an entity exchanges its equity instruments for goods and services or incurs liabilities in exchange for goods or services that are based on the fair value of the entity’s equity instruments or that may be settled by the issuance of those equity instruments.  SFAS 123R requires a public entity to measure the cost of employee services received in exchange for an award of equity instruments based on the grant-date fair value of the award and to recognize that cost over the period during which an employee is required to provide service in exchange for the award.  SFAS 123R is effective for fiscal years beginning after June 15, 2005.  Accordingly, we will adopt SFAS 123R, likely using the modified version of prospective application, beginning with our quarter ending March 31, 2006.  Under the modified version of prospective application, compensation costs related to share-based compensation will be recognized in our financial statements for all periods beginning after December 31, 2005.  For comparative periods ending on or before December 31, 2005 which are presented in our 2006 and subsequent financial statements, share-based compensation costs will continue to be excluded from the financial statements but we will disclose these share-based compensation costs on a pro forma basis in a note to the financial statements.  Adoption of SFAS 123R will materially increase our recognized compensation expense and will have a material impact on our consolidated income statement and balance sheet.  We are unable to estimate the impact of adoption of this statement on our consolidated financial statements as the impact will depend, in part, on stock awards and stock option awards made prior to the adoption date, whether awards granted were qualified or non-qualified, the vesting period of those awards, and forfeitures related to both existing awards and new awards.  Subsequent to December 31, 2004, our Compensation Committee approved acceleration of the vesting of certain unvested options for employees, including an executive officer and non-employee directors.  The decision to accelerate the vesting of these options and eliminate future compensation expense was based primarily on a review of our long-term incentive programs considering the effect on our financial statements of changes in accounting rules that we must adopt in the future.  This action, which had an immaterial affect on our financial statements for the three months ended March 31, 2005, will reduce the impact of adoption of SFAS 123R on our consolidated financial statements. If, subsequent to March 31, 2005, no new awards were issued and no existing awards were forfeited, we estimate that adoption of SFAS 123R would increase our pre-tax compensation expense for the year ending December 31, 2006 by approximately $1.0 million.  We do not anticipate that adoption of SFAS 123R will have a material impact on our consolidated statement of cash flows.

 

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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.  In this Quarterly Report on Form 10-Q, we make statements that plan for or anticipate the future.  Many of these statements are found in the “Management’s Discussion and Analysis of Financial Condition and Results of Operations” section of this report.

 

Forward-looking statements may be identified by words or phrases such as “believe,” “expect,” “anticipate,” “should,” “planned,” “may,” “estimated,” “goal,” “objective” 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 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 Chapter 7 deposit portfolio, the services required or selected by our Chapter 11, Chapter 13, class action or mass tort engagements, or the number of cases processed by our Chapter 13 bankruptcy trustee clients, (3) material changes in the number of bankruptcy filings, class action filings or mass tort actions each year, (4) our reliance on and future changes in our marketing arrangement and pricing arrangements with Bank of America for Chapter 7 revenue, (5) the marketing and pricing arrangements with other Chapter 7 depository banks,  (6) the impact of recently enacted tort reform and bankruptcy reform legislation on the volume and timing of disposition of client engagements, (7) risks associated with the integration of acquisitions into our existing business operations, (8) risks associated with our indebtedness, and (9) other risks detailed from time to time in our SEC filings, including our annual report on Form 10-K for the year ended December 31, 2004.  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 obligations to update any forward-looking statements contained herein to reflect future events or developments.

 

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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.  Our exposure to market risk has not changed significantly since December 31, 2004.

 

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, 2005, that have materially affected, or are reasonably likely to materially affect, the Company’s internal controls over financial reporting.

 

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PART II - OTHER INFORMATION

 

ITEM 5.                  Other Information.

 

During the current year we determined that certain revenues from reimbursed expenses and certain expenses, including reimbursed expenses, related to our Poorman-Douglas subsidiary acquired in January 2004 had not been recorded in the correct segment.

 

These classification errors did not affect our Consolidated Statements of Income, Balance Sheets, Statements of Cash Flows, or Statement of Changes in Stockholders’ Equity for any period previously reported.  Additionally, these errors do not affect historical or future net cash flows or compliance with any debt covenants.  However, the classification errors did affect our previously reported segment information disclosed in our 2004 quarterly reports filed on Form 10-Q and on our annual report filed on Form 10-K for the year ended December 31, 2004.  We will not amend our previously filed 2004 quarterly reports filed on Form 10-Q or our 2004 annual report filed on Form 10-K, but will restate our comparative 2004 quarterly segment information to correct these classification errors prospectively in our 2005 quarterly reports filed on Form 10-Q and our 2005 annual report filed on Form 10-K.  Following is a summary of the effects of the corrections to the segment disclosures for each of the 2004 quarters and for the fiscal year ended December 31, 2004.

 

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		Three Months Ended March 31, 2004
		(as previously reported)
		Case			Document
		Management			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

 

		Three Months Ended March 31, 2004
		(as restated)
		Case			Document
		Management			Management			Unallocated			Consolidated
Revenue:
Operating revenue		$	16,926		$	6,067		$	—		$	22,993
Reimbursed expenses		655			2,364			—			3,019
Total revenue		17,581			8,431			—			26,012
Costs and expenses:
Direct and administrative costs and depreciation and software amortization		6,053			6,161			5,110			17,324
Amortization of identifiable intangible assets		1,109			571			—			1,680
Acquisition related		—			—			2,181			2,181
Total operating expenses		7,162			6,732			7,291			21,185
Operating income		$	10,419		$	1,699		$	(7,291	)	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

 

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