**UNITED STATESSECURITIES AND EXCHANGE COMMISSION**

**WASHINGTON, D. C.20549**

 

**FORM 10-Q**

 

**Quarterly Report Pursuant to Section 13 or 15(d)of the Securities Exchange Act of 1934**

 

**For the QuarterlyPeriod Ended September 30, 2003**

 

**OR**

 

**Transition Report Pursuant to Section 13 or 15(d)of the Securities Exchange Act of 1934**

 

**For the transitionperiod from                    to                    **

 

**Commission FileNumber 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 whetherthe registrant (1) has filed all reports required to be filed bySection 13 or 15(d) of the Securities Exchange Act of 1934 during thepreceding 12 months (or for such shorter period that the registrant was requiredto file such reports), and (2) has been subject to such filing requirements forthe past 90 days  Yes  ý  No  o

 

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

 

The number of sharesoutstanding of registrant’s common stock at October 31, 2003:

 

| **Class**                    |   | **Outstanding** |
|------------------------------|--------|-----------------|
| Common Stock, $.01 par value |   | 17,777,003      |

 

 

----

 

**EPIQ SYSTEMS, INC.AND SUBSIDIARIES**

**FORM 10-Q**

**QUARTER ENDEDSEPTEMBER 30, 2003**

 

**CONTENTS**

 
|                               | **Page**                                                                                                                              |
|------------------------------------|---------------------------------------------------------------------------------------------------------------------------------------|
|                               |                                                                                                                                  |
| **PART I - FINANCIAL INFORMATION** |                                                                                                                                  |
|                               |                                                                                                                                  |   |
| Item 1.                            | Financial Statements                                                                                                                  |   |
|                               |                                                                                                                                  |   |
|                               | Condensed Consolidated Statements of Income  –  Three months and nine months ended September 30, 2003 and 2002  (Unaudited) | 2 |
|                               |                                                                                                                                  |   |
|                               | Condensed Consolidated Balance Sheets –  September 30, 2003 (Unaudited) and December 31, 2002                          | 3 |
|                               |                                                                                                                                  |   |
|                               | Condensed Consolidated Statements of Cash  Flows –  Nine months ended September 30, 2003 and 2002 (Unaudited)               | 4 |
|                               |                                                                                                                                  |   |
|                               | Notes to Condensed Consolidated Financial  Statements (Unaudited)                                                                     | 5 |
|                               |                                                                                                                                  |   |
| Item 2.                            | Management’s Discussion and Analysis of  Financial Condition and Results of Operations                                           | 12 |
|                               |                                                                                                                                  |   |
| Item 3.                            | Quantitative and Qualitative Disclosures  About Market Risk                                                                           | 18 |
|                               |                                                                                                                                  |   |
| Item 4.                            | Controls and Procedures                                                                                                               | 18 |
|                               |                                                                                                                                  |   |
| **PART II - OTHER INFORMATION**    |                                                                                                                                  |
|                               |                                                                                                                                  |   |
| Item 6.                            | Exhibits and Reports on Form 8-K                                                                                                      | 19 |
|                               |                                                                                                                                  |   |
| Signatures                         | 20                                                                                                                                    |
|                                    |                                                                                                                                       |  |  |

 

1

----

 

**PART I - FINANCIAL INFORMATION**

 

**ITEM 1.****                             FinancialStatements**

 

##### **EPIQ SYSTEMS,INC. AND SUBSIDIARIES**

##### **CONDENSED CONSOLIDATEDSTATEMENTS OF INCOME**

**(In Thousands, ExceptPer Share Data)**

**(Unaudited)**

 
|                                            |   | **Three  months ended********September 30,** |   | **Nine  months ended********September 30,** |   |
|-------------------------------------------------|--------|---------------------------------------------------|--------|--------------------------------------------------|--------|
|                                            |   | **2003**                                          |   | **2002**                                         |   | **2003** |   | **2002** |   |
|                                            |   |                                              |   |                                             |   |   |   |   |   |
| **OPERATING REVENUES:**                         |   |                                              |   |                                             |   |   |   |   |   |
| Bankruptcy case management fees                 |   | $                                                 | 9,124  |                                             | $      | 6,031 |   | $ | 29,338 |   | $ | 20,756 |   |
| Bankruptcy professional services                |   | 9,251                                             |   | 3,171                                            |   | 20,196 |   | 5,576 |   |
| Infrastructure software                         |   | 535                                               |   | 500                                              |   | 1,573 |   | 1,442 |   |
| Total Operating Revenues                        |   | 18,910                                            |   | 9,702                                            |   | 51,107 |   | 27,774 |   |
|                                            |   |                                              |   |                                             |   |   |   |   |   |
| **COST OF SALES:**                              |   |                                              |   |                                             |   |   |   |   |   |
| Cost of products and services                   |   | 4,910                                             |   | 1,805                                            |   | 12,374 |   | 5,396 |   |
| Depreciation and amortization                   |   | 1,187                                             |   | 1,246                                            |   | 3,691 |   | 3,566 |   |
| Total Cost of Sales                             |   | 6,097                                             |   | 3,051                                            |   | 16,065 |   | 8,962 |   |
|                                            |   |                                              |   |                                             |   |   |   |   |   |
| **GROSS PROFIT**                                |   | 12,813                                            |   | 6,651                                            |   | 35,042 |   | 18,812 |   |
|                                            |   |                                              |   |                                             |   |   |   |   |   |
| **OPERATING EXPENSES:**                         |   |                                              |   |                                             |   |   |   |   |   |
| General and administrative                      |   | 5,106                                             |   | 2,753                                            |   | 13,843 |   | 8,633 |   |
| Depreciation                                    |   | 218                                               |   | 181                                              |   | 589 |   | 438 |   |
| Amortization – intangibles                 |   | 1,013                                             |   | 133                                              |   | 2,745 |   | 366 |   |
| Acquisition related                             |   | —                                            |   | 570                                              |   | 1,485 |   | 570 |   |
| Total Operating Expenses                        |   | 6,337                                             |   | 3,637                                            |   | 18,662 |   | 10,007 |   |
|                                            |   |                                              |   |                                             |   |   |   |   |   |
| **INCOME FROM OPERATIONS**                      |   | 6,476                                             |   | 3,014                                            |   | 16,380 |   | 8,805 |   |
|                                            |   |                                              |   |                                             |   |   |   |   |   |
| **INTEREST INCOME (EXPENSE):**                  |   |                                              |   |                                             |   |   |   |   |   |
| Interest income                                 |   | 49                                                |   | 146                                              |   | 219 |   | 396 |   |
| Interest expense                                |   | (52                                               | )      | (84                                              | )      | (149 | ) | (124 | ) |
| Net Interest Income (Expense)                   |   | (3                                                | )      | 62                                               |   | 70 |   | 272 |   |
|                                            |   |                                              |   |                                             |   |   |   |   |   |
| **INCOME BEFORE INCOME TAXES**                  |   | 6,473                                             |   | 3,076                                            |   | 16,450 |   | 9,077 |   |
|                                            |   |                                              |   |                                             |   |   |   |   |   |
| **PROVISION FOR INCOME TAXES**                  |   | 2,547                                             |   | 1,164                                            |   | 6,604 |   | 3,436 |   |
|                                            |   |                                              |   |                                             |   |   |   |   |   |
| **NET INCOME**                                  |   | $                                                 | 3,926  |                                             | $      | 1,912 |   | $ | 9,846 |   | $ | 5,641 |   |
|                                            |   |                                              |   |                                             |   |   |   |   |   |
| **NET INCOME PER SHARE INFORMATION:**           |   |                                              |   |                                             |   |   |   |   |   |
| Basic                                           |   | $                                                 | 0.22   |                                             | $      | 0.13 |   | $ | 0.56 |   | $ | 0.39 |   |
| Diluted                                         |   | $                                                 | 0.21   |                                             | $      | 0.13 |   | $ | 0.54 |   | $ | 0.38 |   |
|                                            |   |                                              |   |                                             |   |   |   |   |   |
| **WEIGHTED AVERAGE COMMON SHARES OUTSTANDING:** |   |                                              |   |                                             |   |   |   |   |   |
| Basic                                           |   | 17,756                                            |   | 14,500                                           |   | 17,566 |   | 14,452 |   |
| Diluted                                         |   | 18,391                                            |   | 15,002                                           |   | 18,262 |   | 14,975 |   |

 

**See accompanying notes to condensedconsolidated financial statements.**

 

2

----

 

**EPIQ SYSTEMS, INC.AND SUBSIDIARIES**

**CONDENSEDCONSOLIDATED BALANCE SHEETS**

**(In Thousands, Except Share Data)**

**(Unaudited)**

 
|                                                                                                                                                                                          |   | **September 30,********2003** |    | **December 31,  2002** |   |
|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|--------|------------------------------------|---------|-----------------------------|--------|
| **ASSETS:**                                                                                                                                                                                   |   |                               |    |                        |   |
| **Current Assets:**                                                                                                                                                                           |   |                               |    |                        |   |
| Cash and cash equivalents                                                                                                                                                                     |   | $                                  | 24,195  |                        | $      | 59,827 |   |
| Accounts receivable, trade, less allowance  for doubtful accounts of $394 and $31, respectively                                                                                               |   | 12,824                             |    | 5,647                       |   |
| Prepaid expenses and other                                                                                                                                                                    |   | 1,946                              |    | 962                         |   |
| Deferred income taxes                                                                                                                                                                         |   | 122                                |    | —                      |   |
| Total Current Assets                                                                                                                                                                          |   | 39,087                             |    | 66,436                      |   |
|                                                                                                                                                                                          |   |                               |    |                        |   |
| **Property and equipment, net**                                                                                                                                                               |   | 12,620                             |    | 11,886                      |   |
| **Software development costs, net**                                                                                                                                                           |   | 5,225                              |    | 4,336                       |   |
| **Goodwill**                                                                                                                                                                                  |   | 68,014                             |    | 21,275                      |   |
| **Other intangibles, net of accumulated  amortization of $3,796 and $1,051, respectively**                                                                                                    |   | 18,178                             |    | 4,019                       |   |
| **Other**                                                                                                                                                                                     |   | 67                                 |    | 85                          |   |
| **Total Assets**                                                                                                                                                                              |   | $                                  | 143,191 |                        | $      | 108,037 |   |
|                                                                                                                                                                                          |   |                               |    |                        |   |
| **LIABILITIES AND STOCKHOLDERS’ EQUITY:**                                                                                                                                                |   |                               |    |                        |   |
| **Current Liabilities:**                                                                                                                                                                      |   |                               |    |                        |   |
| Accounts payable                                                                                                                                                                              |   | $                                  | 2,323   |                        | $      | 1,076 |   |
| Accrued expenses                                                                                                                                                                              |   | 2,831                              |    | 663                         |   |
| Income taxes payable                                                                                                                                                                          |   | 127                                |    | 290                         |   |
| Deferred revenue                                                                                                                                                                              |   | 975                                |    | 868                         |   |
| Deferred income tax                                                                                                                                                                           |   | —                             |    | 106                         |   |
| Current portion of deferred acquisition  price                                                                                                                                                |   | 733                                |    | 241                         |   |
| Current maturities of long-term obligations                                                                                                                                                   |   | 89                                 |    | 97                          |   |
| Total Current Liabilities                                                                                                                                                                     |   | 7,078                              |    | 3,341                       |   |
|                                                                                                                                                                                          |   |                               |    |                        |   |
| **Deferred revenue**                                                                                                                                                                          |   | 36                                 |    | 52                          |   |
| **Long-term obligations (less current  portion)**                                                                                                                                             |   | —                             |    | 66                          |   |
| **Deferred acquisition price (less current  portion)**                                                                                                                                        |   | 3,066                              |    | 223                         |   |
| **Deferred income taxes**                                                                                                                                                                     |   | 2,761                              |    | 1,980                       |   |
| Total Liabilities                                                                                                                                                                             |   | 12,941                             |    | 5,662                       |   |
|                                                                                                                                                                                          |   |                               |    |                        |   |
| **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 - 17,763,499 and 16,538,287 shares  at September 30, 2003 and December 31, 2002, respectively |   | 178                                |    | 165                         |   |
| Additional paid-in capital                                                                                                                                                                    |   | 101,747                            |    | 83,730                      |   |
| Retained earnings                                                                                                                                                                             |   | 28,325                             |    | 18,480                      |   |
| Total Stockholders’ Equity                                                                                                                                                               |   | 130,250                            |    | 102,375                     |   |
| **Total Liabilities and Stockholders’ Equity**                                                                                                                                           |   | $                                  | 143,191 |                        | $      | 108,037 |   |

 

**See accompanying notes to condensedconsolidated financial statements.**

 

3

----

 

**EPIQ SYSTEMS, INC.AND SUBSIDIARIES**

##### **CONDENSED CONSOLIDATEDSTATEMENTS OF CASH FLOWS**

**(In Thousands)**

**(Unaudited)**

 
|                                                                                           |   | **Nine  Months Ended  September 30,** |   |
|------------------------------------------------------------------------------------------------|--------|--------------------------------------------|--------|
|                                                                                           |   | **2003**                                   |   | **2002** | ** ** |
| **Cash Flows From Operating Activities:**                                                      |   |                                       |   |   |   |
| Net income                                                                                     |   | $                                          | 9,846  |   | $ | 5,641 |   |
| **Adjustments to reconcile net income to net  cash from operating activities:**                |   |                                       |   |   |   |
| Provision for deferred income taxes                                                            |   | 553                                        |   | 695 |   |
| Depreciation and amortization                                                                  |   | 2,782                                      |   | 2,742 |   |
| Amortization of software development costs                                                     |   | 1,498                                      |   | 1,262 |   |
| Amortization of other intangible assets                                                        |   | 2,745                                      |   | 365 |   |
| Other, net                                                                                     |   | 186                                        |   | 152 |   |
| **Changes in operating assets and  liabilities, net of effects from****business acquisition:** |   |                                       |   |   |   |
| Accounts receivable                                                                            |   | (7,178                                     | )      | (2,668 | ) |
| Prepaid expenses and other assets                                                              |   | (905                                       | )      | (505 | ) |
| Accounts payable and accrued expenses                                                          |   | 2,165                                      |   | (344 | ) |
| Deferred revenue                                                                               |   | 91                                         |   | 105 |   |
| Income taxes, including tax benefit from  exercise of stock options                            |   | 546                                        |   | 730 |   |
| Net cash from operating activities                                                             |   | 12,329                                     |   | 8,175 |   |
|                                                                                           |   |                                       |   |   |   |
| **Cash Flows From Investing Activities:**                                                      |   |                                       |   |   |   |
| Purchases of property and equipment                                                            |   | (3,167                                     | )      | (4,302 | ) |
| Software development costs                                                                     |   | (2,046                                     | )      | (1,452 | ) |
| Cash paid for acquisition of business, net  of cash acquired                                   |   | (43,263                                    | )      | (852 | ) |
| Other, net                                                                                     |   | 18                                         |   | 264 |   |
| Net cash from investing activities                                                             |   | (48,458                                    | )      | (6,342 | ) |
|                                                                                           |   |                                       |   |   |   |
| **Cash Flows From Financing Activities:**                                                      |   |                                       |   |   |   |
| Principal payments under capital lease  obligations                                            |   | (73                                        | )      | (79 | ) |
| Principal payments on long-term debt                                                           |   | (250                                       | )      | (250 | ) |
| Direct costs associated with stock offering                                                    |   | (114                                       | )      | — |   |
| Proceeds from exercise of stock options and  warrants                                          |   | 934                                        |   | 357 |   |
| Net cash from financing activities                                                             |   | 497                                        |   | 28 |   |
|                                                                                           |   |                                       |   |   |   |
| **Net Increase (Decrease) in Cash and Cash Equivalents**                                       |   | (35,632                                    | )      | 1,861 |   |
| **Cash and Cash Equivalents, beginning of period**                                             |   | 59,827                                     |   | 25,306 |   |
| **Cash and Cash Equivalents, end of period**                                                   |   | $                                          | 24,195 |   | $ | 27,167 |   |
|                                                                                           |   |                                       |   |   |   |
| **Supplemental disclosures of cash flow information**:                                         |   |                                       |   |   |   |
| Interest paid                                                                                  |   | $                                          | 10     |   | $ | 88 |   |
| Income taxes paid                                                                              |   | $                                          | 5,760  |   | $ | 2,011 |   |

 

**See accompanying notes to condensedconsolidated financial statements.**

 

4

----

 

**EPIQ SYSTEMS, INC.AND SUBSIDIARIES**

**NOTES TO CONDENSEDCONSOLIDATED FINANCIAL STATEMENTS**

**(Unaudited)**

 

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

 

***Natureof Operations***

 

EPIQSystems, Inc. and subsidiaries (“EPIQ”, “EPIQ Systems”, “we”, “us”, “our”, orthe “Company”) is a national provider of technology-based solutions to lawfirms and attorneys who work in the federal bankruptcy system and to companiesthat have filed for bankruptcy reorganization. Our products provide a single environment in which customers administercases, automating various administrative tasks pertaining to bankruptcy claims,assets, financial records and other data associated with liquidations andreorganizations.  In addition to ourbankruptcy management business, our infrastructure software division developsfile transfer software used by companies in various industries.

 

***ComprehensiveIncome***

 

EPIQ Systems does not have any components ofother comprehensive income; therefore comprehensive income equals net income.

 

***Stock-BasedCompensation***

 

EPIQ Systems has adopted the disclosureprovisions of Statement of Financial Accounting Standards (SFAS) No. 148, *Accounting for Stock-Based Compensation-Transitionand Disclosure, an amendment of FASB Statement No. 123*. TheStatement requires prominent disclosures in both annual and interim financialstatements regarding the method of accounting for stock-based employeecompensation and the effect of the method used on reported results.  We account for stock compensation awardsusing the intrinsic method of Accounting Principles Board Opinion No. 25, *Accounting for Stock Issued to Employees,*whichrequires compensation cost to be recognized based on the excess between thequoted market price at the date of grant and the exercise price, which is theamount an employee must pay to acquire stock. Options awarded by EPIQ Systems are granted with an exercise price equalto the quoted market price as of the grant date.  The following pro forma information reflects the effect on netincome and net income per share for the three and nine months endedSeptember 30, 2003 and 2002 if we had recognized expense, calculated inaccordance with SFAS No. 123, *Accounting forStock-Based Compensation,*for options granted.

 
|                                                                                                           |            | **(In Thousands, Except Per Share Data)**    |      |
|----------------------------------------------------------------------------------------------------------------|-----------------|----------------------------------------------|-----------|
|                                                                                                           |            | **Three Months Ended****September 30,** |      | **Nine Months Ended****September 30,** |   |
|                                                                                                           |            | **2003**                                     |      | **2002** | ** ** | **2003** | ** ** | **2002** | ** ** |
| **Net income, as reported**                                                                                    |            | **$**                                        | **3,926** | ** ** | **$** | **1,912** | ** ** | **$** | **9,846** | ** ** | **$** | **5,641** | ** ** |
| Deduct: Total stock-based  employee compensation expense determined under fair value based method, net  of tax |            | (158                                         | )         | (437 | ) | (1,726 | ) | (830 | ) |
| Net income, pro forma                                                                                          |            | $                                            | 3,768     |   | $ | 1,475 |   | $ | 8,120 |   | $ | 4,811 |   |
|                                                                                                           |            | ** **                                   |      | ** ** |   | ** ** |   | ** ** |   | ** ** |
| **Net income per share – Basic**                                                                          | **As reported** | ** **                                   | **$**     | **0.22** | ** ** | **$** | **0.13** | ** ** | **$** | **0.56** | ** ** | **$** | **0.39** | ** ** |
|                                                                                                           | **Pro forma**   |                                         | **$**     | **0.21** | ** ** | **$** | **0.10** | ** ** | **$** | **0.46** | ** ** | **$** | **0.33** | ** ** |
|                                                                                                           |            | ** **                                   |      | ** ** |   | ** ** |   | ** ** |   | ** ** |
| **Net income per share – Diluted**                                                                        | **As reported** | ** **                                   | **$**     | **0.21** | ** ** | **$** | **0.13** | ** ** | **$** | **0.54** | ** ** | **$** | **0.38** | ** ** |
|                                                                                                           | **Pro forma**   |                                         | **$**     | **0.20** | ** ** | **$** | **0.10** | ** ** | **$** | **0.44** | ** ** | **$** | **0.32** | ** ** |

 

5

----

 

***Recent AccountingPronouncements***

 

In August 2001, theFinancial Accounting Standards Board (FASB) issued SFAS No. 143, *Accounting for Asset Retirement Obligations*.  SFAS No. 143 requires the recognition of aliability if a company has a legal or contractual financial obligation inconnection with the retirement of a tangible long-lived asset.  The Company’s adoption of this standard asof January 1, 2003 did not have a material effect on its financialposition, results of operations or cash flows.

 

In April 2002, the FASBissued SFAS No. 145, *Rescission of FASBStatements No. 4, 44, and 64, Amendment of FASB Statement No. 13, and TechnicalCorrections* principally to eliminate an inconsistency between therequired accounting for sale-leaseback transactions and the required accountingfor certain lease modifications that have economic effects that are similar tosale-leaseback transactions.  TheCompany’s adoption of this standard as of January 1, 2003 did not have amaterial effect on its financial position, results of operations or cash flows.

 

In June 2002, the FASBissued SFAS No. 146, *Accounting for CostsAssociated With Exit or Disposal Activities*, which is effective forany activity initiated after December 31, 2002.  This SFAS modifies the timing and measurement of the recognitionof costs associated with an exit or disposal activity and nullifies EITF IssueNo. 94-3, *Liability Recognition for CertainEmployee Termination Benefits and Other Costs to Exit an Activity (includingCertain Costs Incurred in a Restructuring)*.  The Company’s adoption of this standard asof January 1, 2003 did not have a material effect on its financialposition, results of operations or cash flows.

 

In April 2003, the FASBissued SFAS No. 149, *Amendment of Statement133 on Derivative Instruments and Hedging Activities*.  SFAS No. 149 amends and clarifies financialaccounting and reporting for derivative instruments, including certainderivative instruments embedded in other contracts and for hedging activitiesunder SFAS No. 133.  SFAS No. 149 iseffective for contracts entered into or modified after June 30, 2003.  The Company’s adoption of this standard asof July 1, 2003 did not have a material effect on its financial position,results of operations or cash flows.

 

In May 2003, theFASB issued SFAS No. 150, *Accounting forCertain Financial Instruments with Characteristics of both Liabilities andEquity*.  SFAS No. 150 revisesthe accounting for certain financial instruments that, under previous guidance,issuers could account for as equity. SFAS No. 150 requires that those instruments be classified asliabilities in statements of financial position.  SFAS No. 150 is effective for all financial instruments enteredinto or modified after May 31, 2003 and is otherwise effective at thebeginning of the first interim period beginning after June 15, 2003.  The Company’s adoption of this standard asof July 1, 2003 did not have a material effect on its financial position,results of operations or cash flows.

 

In November 2002, the FASB issuedInterpretation No. 45 (FIN 45), *Guarantor’sAccounting and Disclosure Requirements for Guarantees, Including IndirectGuarantees of Indebtedness of Others*.  FIN 45 elaborates on the existing disclosure requirementsfor most guarantees.  FIN 45requires that at the time a company issues certain guarantees, the company mustrecognize an initial liability for the fair value or market value of theobligations it assumes under that guarantee and must disclose that informationin its interim and annual financial statements.  The initial recognition and initial measurement provisions of FIN45 are applicable on a prospective basis to guarantees issued or modifiedafter December 31, 2002.  FIN 45’sdisclosure requirements are effective for financial statements of interim orannual periods ending after December 15, 2002 and are applicable to allguarantees issued by the guarantor subject to FIN 45’s scope, includingguarantees issued prior to the issuance of FIN 45.  The adoption of FIN 45 on January 1,2003 did not have a material effect on the Company’s financial position,results of operations or financial statement disclosure.

 

InJanuary 2003, the FASB issued Interpretation No. 46 (FIN 46), *Consolidation of Variable Interest Entities*.  FIN 46, which applies to all publicentities, clarifies the application of Accounting Research Bulletin No. 51, *Consolidated Financial Statements*, tocertain entities in which equity investors do not have the characteristics of acontrolling financial interest or do not have sufficient equity at risk for theentity to finance its activities without additional subordinated financialsupport from other parties.  Theeffective date of FIN 46 has been delayed until the first interim or annualperiod ending after December 15, 2003.  The Company is currently assessing the impact that adoption of thisstatement will have on its consolidated financial statements, but does notexpect the impact to be material.

 

6

----

 

**NOTE 2: INTERIM FINANCIAL STATEMENTS**

 

The accompanying financialstatements have been prepared in accordance with the instructions toForm 10-Q of the SEC and in accordance with accounting principlesgenerally accepted in the United States of America (“GAAP”) applicable tointerim financial statements, and do not include all of the information andfootnotes required by GAAP for complete financial statements.  In the opinion of management of the Company,all adjustments, consisting only of normal recurring adjustments, considerednecessary for a fair presentation have been included.  The financial statements should be read in conjunction with theCompany’s audited financial statements and accompanying notes, which areincluded in its Form 10-K for the year ended December 31, 2002.

 

The results of operations forthe period ended September 30, 2003 are not necessarily indicative of theresults to be expected for the entire year.

 

**NOTE 3: NET INCOME PER SHARE**

 

Basic net income pershare is computed based on the weighted average number of common sharesoutstanding during each period.  Dilutednet income per share is computed using the weighted average common shares andall potentially dilutive common share equivalents outstanding during theperiod.  The computation of earnings pershare for the three and nine months ended September 30, 2003 and 2002 isas follows:

 
|                                                       |   | **(In Thousands, Except Per Share Data)**    |       |
|------------------------------------------------------------|--------|----------------------------------------------|------------|
|                                                       |   | **Three Months Ended****September 30,** |       | **Nine Months Ended****September 30,** |   |
|                                                       |   | **2003**                                     |       | **2002** | ** ** | **2003** | ** ** | **2002** | ** ** |
|                                                       |   |                                         |       |   |   |   |   |   |   |
| **Net Income**                                             |   | **$**                                        | **3,926**  | ** ** | **$** | **1,912** | ** ** | **$** | **9,846** | ** ** | **$** | **5,641** | ** ** |
|                                                       |   |                                         |       |   |   |   |   |   |   |
| Weighted average common shares outstanding                 |   | 17,756                                       |       | 14,500 |   | 17,566 |   | 14,452 |   |
|                                                       |   |                                         |       |   |   |   |   |   |   |
| Weighted average common share equivalents  (stock options) |   | 635                                          |       | 502 |   | 696 |   | 523 |   |
| Weighted average diluted common shares  outstanding        |   | 18,391                                       |       | 15,002 |   | 18,262 |   | 14,975 |   |
|                                                       |   |                                         |       |   |   |   |   |   |   |
| **Net Income per  share:**                                 |   |                                         | ** ** |   | ** ** |   | ** ** |   | ** ** |
| **Basic**                                                  |   | **$**                                        | **0.22**   | ** ** | **$** | **0.13** | ** ** | **$** | **0.56** | ** ** | **$** | **0.39** | ** ** |
| **Diluted**                                                |   | **$**                                        | **0.21**   | ** ** | **$** | **0.13** | ** ** | **$** | **0.54** | ** ** | **$** | **0.38** | ** ** |

 

Options to purchase 103,000 and4,000 shares of common stock for the three and nine month periods endedSeptember 30, 2002, respectively were not included in the computation ofdiluted earnings per share because the exercise price exceeded the averagemarket price and inclusion of these shares in the computation would have had ananti-dilutive effect.  For both thethree-month period and the nine-month period ended September 30, 2003, theCompany had 55,000 options that were anti-dilutive and, therefore, were notincluded in the computation.

 

7

----

 

#### **NOTE 4:  GOODWILL AND INTANGIBLEASSETS**

 

Intangibleassets subject to amortization at September 30, 2003 and December 31,2002 consisted of the following:

 
|                         |   | **(In  Thousands)**          |   |
|------------------------------|--------|------------------------------|--------|
|                         |   | **September 30,  2003** |   | **December 31,  2002** |   |
|                         |   | **Gross  Carrying  Value**   |   | **Accumulated  Amortization** | ** ** | **Gross  Carrying  Value** | ** ** | **Accumulated  Amortization** | ** ** |
| Amortized intangible assets: |   |                         |   |   |   |   |   |   |   |
| Customer contracts           |   | $                            | 8,760  |   | $ | 2,508 |   | $ | 4,060 |   | $ | 656 |   |
| Trade names                  |   | 710                          |   | 270 |   | 710 |   | 206 |   |
| Non-compete agreements       |   | 12,030                       |   | 1,018 |   | 300 |   | 189 |   |
|                         |   | $                            | 21,500 |   | $ | 3,796 |   | $ | 5,070 |   | $ | 1,051 |   |

 

Aggregateamortization expense was $1,013,000 and $133,000 for the three month periodsended September 30, 2003 and 2002, respectively, and $2,745,000 and$366,000 for the nine month periods ended September 30, 2003 and 2002,respectively. Amortization expense related to intangible assets is estimated tobe $3,757,000 in 2003, $4,032,000 in 2004, $1,814,000 in 2005 and $1,618,000 in2006 and 2007.

 

Intangibleassets not subject to amortization had a total carrying value of $68,488,000and $21,275,000 at September 30, 2003 and December 31, 2002,respectively.  Components of intangibleassets not subject to amortization were goodwill, with an aggregate carryingvalue of $68,014,000 and $21,275,000 at September 30, 2003 andDecember 31, 2002, respectively, and a trade name, with a carrying valueof $474,000 and $0 at September 30, 2003 and December 31, 2002,respectively.

 

Thechanges in the carrying amount of goodwill for the nine months endedSeptember 30, 2003 and the year ended December 31, 2002 are asfollows:

 
|                                                   |   | **(In  Thousands)**                            |   |
|--------------------------------------------------------|--------|------------------------------------------------|--------|
|                                                   |   | **Nine  Months Ended September 30, 2003** |   | **Year Ended  December 31, 2002** |   |
|                                                   |   | **Bankruptcy  Segment**                        |   | **Infrastructure  Software  Segment** | ** ** | **Total** | ** ** | **Bankruptcy  Segment** | ** ** | **Infrastructure  Software  Segment** | ** ** | **Total** | ** ** |
|                                                   |   |                                           |   |   |   |   |   |   |   |   |   |   |   |
| Balance, beginning of period                           |   | $                                              | 17,449 |   | $ | 3,826 |   | $ | 21,275 |   | $ | 17,398 |   | $ | 3,826 |   | $ | 21,224 |   |
| Goodwill acquired during the period                    |   | 46,739                                         |   | — |   | 46,739 |   | 221 |   | — |   | 221 |   |
| Settlement of contingencies from previous  acquisition |   | —                                         |   | — |   | — |   | (170 | ) | — |   | (170 | ) |
| Balance, end of period                                 |   | $                                              | 64,188 |   | $ | 3,826 |   | $ | 68,014 |   | $ | 17,449 |   | $ | 3,826 |   | $ | 21,275 |   |

 

8

----

 

**NOTE 5: BUSINESS ACQUISITION**

 

On January 31, 2003,EPIQ acquired 100% of the membership interest of Bankruptcy Services LLC(“BSI”), a provider of technology-based case management, consulting, andadministrative services for Chapter 11 cases, for a purchase price of$67,014,000.  The results of BSI’soperations have been included in the consolidated results of operations sincethat date.  The purchase price includedthe following components:

 
| Cash                                               |   | $ | 45,500,000 |   |
|----------------------------------------------------|--------|---|------------|--------|
| Restricted stock (1,054,000 shares) of the Company |   | $ | 16,500,000 |   |
| Deferred acquisition price                         |   | $ | 3,445,000  |   |
| Assumed liabilities                                |   | $ | 1,250,000  |   |
| Acquisition cost                                   |   | $ | 319,000    |   |

 

The deferred acquisitionprice consists of a non-interest bearing note, payable in five annualinstallments, with a face value of $4,000,000 discounted using an imputed rateof 5% per annum.

 

The purchase price hasbeen allocated to tangible and identifiable intangible assets as follows:

 
| Net tangible assets    |   | $ | 3,030,000  |   |
|------------------------|--------|---|------------|--------|
| Software               |   | $ | 341,000    |   |
| Trade name             |   | $ | 474,000    |   |
| Customer backlog       |   | $ | 4,700,000  |   |
| Non-compete agreements |   | $ | 11,730,000 |   |

 

We are using thestraight-line method to amortize the software over three years, the customerbacklog over two years and the non-compete agreements over ten years.  The trade name has an indefinite life and,therefore, currently is not subject to amortization.  Goodwill of $46,739,000, which is deductible for tax purposes,was assigned to the bankruptcy segment.

 

Unaudited pro forma operationsassuming the purchase acquisition was made at the beginning of the yearpreceding the acquisition are shown below:

 
|                   |   | **(In Thousands, Except Per Share Data)**    |       |
|------------------------|--------|----------------------------------------------|------------|
|                   |   | **Three Months Ended****September 30,** |       | **Nine Months Ended****September 30,** |   |
|                   |   | **2003**                                     |       | **2002** | ** ** | **2003** | ** ** | **2002** | ** ** |
| **Operating Revenues** |   | **$**                                        | **18,910** | ** ** | **$** | **17,579** | ** ** | **$** | **53,085** | ** ** | **$** | **44,080** | ** ** |
| Net Income             |   | $                                            | 3,926      |   | $ | 3,454 |   | $ | 10,138 |   | $ | 8,833 |   |
| Net Income Per Share:  |   |                                         | ** ** |   | ** ** |   | ** ** |   | ** ** |
| **Basic**              |   | **$**                                        | **0.22**   | ** ** | **$** | **0.20** | ** ** | **$** | **0.57** | ** ** | **$** | **0.50** | ** ** |
| **Diluted**            |   | **$**                                        | **0.21**   | ** ** | **$** | **0.19** | ** ** | **$** | **0.55** | ** ** | **$** | **0.49** | ** ** |

 

The pro forma informationis not necessarily indicative of what would have occurred had the acquisitionbeen completed on that date nor is it necessarily indicative of futureoperations.

 

Pro forma data reflects thedifference in amortization expense between EPIQ and the acquired company aswell as other adjustments including income taxes and management compensation.

 

**NOTE6:  SEGMENT REPORTING**

 

EPIQ Systems has two operatingsegments to which it allocates resources and assesses performance: bankruptcyand related services and infrastructure software.  Gross profit, as reported in the Condensed ConsolidatedStatements of Income, is the financial measure used by the chief operatingdecision maker in assessing segment performance and deciding how to allocateresources.

 

Previously the Company hadthree operating segments to which it allocated resources and assessedperformance: Chapter 7 and related bankruptcy services, Chapter 13 services andinfrastructure software. The individual

 

9

----

 

bankruptcy segments werepreviously presented as a single aggregated reportable segment due to similaroperating and economic characteristics.

 

With the acquisition ofBankruptcy Services LLC, the bankruptcy operating model is now based onproviding comprehensive bankruptcy case management solutions supported by abankruptcy shared services organization. Our bankruptcy product and service offerings automate variousadministrative tasks pertaining to bankruptcy claims, assets, financial recordsand other data associated with liquidations and reorganizations, and assistcustomers in organizing and managing their databases of case information, inpreparing notices and mailings, and in fulfilling their variousresponsibilities.

 

The infrastructure softwaresegment develops file transfer software used by companies in variousindustries.

 

Information concerningoperations in these reportable segments of business is as follows:

 
|                                                                                                       |   | **(In  Thousands)**                         |   |
|------------------------------------------------------------------------------------------------------------|--------|---------------------------------------------|--------|
|                                                                                                       |   | **Three  Months Ended  September 30,** |   | **Nine  Months Ended  September 30,** |   |
|                                                                                                       |   | **2003**                                    |   | **2002** | ** ** | **2003** | ** ** | **2002** | ** ** |
| Operating revenues:                                                                                        |   |                                        |   |   |   |   |   |   |   |
| Bankruptcy and related services                                                                            |   | $                                           | 18,375 |   | $ | 9,202 |   | $ | 49,534 |   | $ | 26,332 |   |
| Infrastructure software                                                                                    |   | 535                                         |   | 500 |   | 1,573 |   | 1,442 |   |
| Total operating revenues                                                                                   |   | $                                           | 18,910 |   | $ | 9,702 |   | $ | 51,107 |   | $ | 27,774 |   |
|                                                                                                       |   |                                        |   |   |   |   |   |   |   |
| Cost of Sales:                                                                                             |   |                                        |   |   |   |   |   |   |   |
| Cost of products and services:                                                                             |   |                                        |   |   |   |   |   |   |   |
| Bankruptcy and related services                                                                            |   | $                                           | 4,667  |   | $ | 1,604 |   | $ | 11,743 |   | $ | 4,715 |   |
| Infrastructure software                                                                                    |   | 243                                         |   | 201 |   | 631 |   | 681 |   |
| Depreciation and amortization:                                                                             |   |                                        |   |   |   |   |   |   |   |
| Bankruptcy and related services                                                                            |   | 862                                         |   | 951 |   | 2,727 |   | 2,765 |   |
| Infrastructure software                                                                                    |   | 325                                         |   | 295 |   | 964 |   | 801 |   |
| Total cost of sales                                                                                        |   | 6,097                                       |   | 3,051 |   | 16,065 |   | 8,962 |   |
| Gross profit:                                                                                              |   |                                        |   |   |   |   |   |   |   |
| Bankruptcy and related services                                                                            |   | 12,846                                      |   | 6,647 |   | 35,064 |   | 18,852 |   |
| Infrastructure software                                                                                    |   | (33                                         | )      | 4 |   | (22 | ) | (40 | ) |
| Total gross profit                                                                                         |   | $                                           | 12,813 |   | $ | 6,651 |   | $ | 35,042 |   | $ | 18,812 |   |
|                                                                                                       |   |                                        |   |   |   |   |   |   |   |
| Reconciliation of reportable segments’  measure of profit to consolidated income before income taxes: |   |                                        |   |   |   |   |   |   |   |
| Gross profit identified to reportable  segments                                                            |   | $                                           | 12,813 |   | $ | 6,651 |   | $ | 35,042 |   | $ | 18,812 |   |
| Unallocated operating expenses                                                                             |   | (6,337                                      | )      | (3,637 | ) | (18,662 | ) | (10,007 | ) |
| Unallocated interest income (expense), net                                                                 |   | (3                                          | )      | 62 |   | 70 |   | 272 |   |
| Income before income taxes                                                                                 |   | $                                           | 6,473  |   | $ | 3,076 |   | $ | 16,450 |   | $ | 9,077 |   |

 
|                            |   | **September 30,  2003** |    | **December 31,  2002** |   |
|---------------------------------|--------|------------------------------|---------|-----------------------------|--------|
| Total Assets                    |   |                         |    |                        |   |
| Bankruptcy and related services |   | $                            | 100,342 |                        | $      | 31,184 |   |
| Infrastructure software         |   | 8,047                        |    | 8,174                       |   |
| Other and unallocated           |   | 34,802                       |    | 68,679                      |   |
| Total                           |   | $                            | 143,191 |                        | $      | 108,037 |   |

 

We havenot disclosed any additional information regarding net income by segment, asthe information is not reviewed by our chief operating decision maker, is notproduced internally, and its preparation is impracticable.

 

10

----

 

**NOTE7:  LINES OF CREDIT**

 

During the quarter endedJune 30, 2003, the Company entered into a new $25,000,000 revolving lineof credit, which matures on May 31, 2006. Any borrowings on the line of credit accrue interest at the Prime Rateas published in the *Wall Street Journal*or LIBOR plus 200 basis points, at the option of the Company.  The line of credit is unsecured.  However, the line contains certain financialcovenants pertaining to the maintenance of minimum earnings before interest,taxes, depreciation and amortization (“EBITDA”) and maximum total debt toEBITDA.  The $25,000,000 revolving lineof credit replaced two existing lines of credit that aggregated$15,000,000.  The Company was incompliance with all the financial covenants under the new line and the twoprior lines of credit for the periods ended September 30, 2003 andDecember 31, 2002.

 

There were no borrowingsoutstanding under the new line of credit or the two prior lines of credit as ofSeptember 30, 2003 or December 31, 2002.

 

11

----

 

**ITEM2.****                             Management’sDiscussion and Analysis of Financial Condition and Results of Operations**

 

**Recent Developments**

 

*Chapter 7 Marketing Arrangement*

 

EPIQ has an exclusive marketingarrangement in the Chapter 7 bankruptcy market with Bank of America.  Through this arrangement, we receiverevenues based on the level of customer deposits with Bank of America, thenumber of customers using our product, database conversions, software upgrades,and technology management and strategic consulting services.  During October 2003, EPIQ and Bank ofAmerica reached agreement that this exclusive marketing arrangement will becomea non-exclusive marketing arrangement effective April 1, 2004.  The non-exclusive marketing arrangement willextend through September 30, 2006, unless otherwise mutually agreed upon.

 

Bankruptcy case managementrevenues account for approximately 80% of the total revenue we receive fromBank of America, and this monthly recurring revenue is related to the level oftrustee deposits and the number of trustees. Throughout the three-year term of our agreement with Bank of America, wemaintain our current bankruptcy case management fee structure.  Bankruptcy professional services revenuesaccount for approximately 20% of the total revenue we receive from Bank of America.  Bankruptcy professional services revenuesare earned based on database conversions, software upgrades, and technologymanagement and strategic consulting services provided to Bank of America byEPIQ.  Through the end of the exclusivemarketing relationship, we will continue to provide professional services atlevels approximately commensurate with prior periods.  Although we anticipate that, following inception of thenon-exclusive marketing arrangement, aggregate professional services providedto Bank of America will decline compared with prior periods, our newarrangement provides us the opportunity to establish marketing relationshipswith other financial institutions.  Webelieve we will be successful in establishing such new relationships and thatrevenues from these financial institutions will largely or completely offsetthe anticipated decline in professional services revenues from Bank ofAmerica.  However, no assurance can beprovided that any revenues from new financial institutions with which weestablish relationships will be commensurate with the revenues received inprior periods from Bank of America.

 

### **Overview**

 

EPIQ Systems provides technology-based case management solutions toattorneys, law firms, trustees and debtor companies that administer cases inthe federal bankruptcy system. Customers implement our solutions to administerpersonal and corporate bankruptcy cases of all sizes and configurations.  EPIQ Systems’ products automate variousadministrative tasks pertaining to bankruptcy claims, assets, financial recordsand other data associated with liquidations and reorganizations.  The Company’s services assist customers inorganizing and managing their databases of case information, preparing noticesand mailings, and in fulfilling their additional responsibilities.  Customers implementing our bankruptcymanagement solution have a single environment in which to administer theircases.

 

Our infrastructure software division serves corporatecustomers that must frequently exchange data files with their business partnersor their own end-user customers. The *DataExpress®*product line automates the transmission of data files over the Internet orprivate networks in a secure environment.

 

12

----

 

***Bankruptcyand Related Services:***

 

EPIQ Systems’ bankruptcy casemanagement offerings include:

 

•                  *TCMS®*, a package of computer hardware,support services and a proprietary software product installed in a Chapter 7trustee’s office to manage asset liquidations, creditor distributions, andgovernment reporting.

 

•                  A proprietarytechnology platform that provides companies in Chapter 11 reorganization andtheir counsel with web-enabled access to case information.

 

•                  *CasePower®,*a proprietary software packageand related support services designed to enable Chapter 13 trustees to manageefficiently debtor payments, creditor distributions and government reporting.

 

We generate bankruptcy revenuesthrough a variety of arrangements. Significant sources of revenues include:

 

•                  A monthly feefrom banks, primarily Bank of America (see “Recent Developments” above), basedon a percentage of total liquidated assets on deposit and on the number oftrustees.

 

•                  Fees forservices, including technology services, marketing and strategic consultingservices, claims reconciliation, document printing, noticing, balloting andother professional services.

 

•                  Fees forconversions and software upgrades.

 

•                  For certaintrustees, monthly revenues based on the number of cases in their database.

 

•                  Fees based onthe number of claims in a case.

 

On January 31, 2003,we acquired 100% of the membership interests in Bankruptcy Services LLC(“BSI”). BSI provides technology-based case management, consulting andadministrative services for Chapter 11 cases. The results of BSI’s operations have been included in our consolidatedresults of operations since that date.

 

***Infrastructure Software Market:***

 

Our primary offering forthe infrastructure software market is *DataExpress®*,a software product line that automates the exchange of data files between ourcustomers and their business partners.  *DataExpress®* serves customers in a varietyof industries, including financial services, insurance and retail.  We license this product on a named-serverbasis, and we charge additional fees for annual software maintenance and forprofessional services provided on a time and materials basis.

 

**CriticalAccounting Policies**

 

We consider our accountingpolicies related to revenue recognition, business combination accounting,goodwill and intangible assets not subject to amortization, and softwarecapitalization to be critical policies in understanding our historical andfuture performance.

 

*Revenue recognition*. Third party revenue is recognized from both segments of our business:bankruptcy and related services, and infrastructure software.  Within the bankruptcy and related servicessegment, revenues are derived from bankruptcy case management fees andbankruptcy professional services.  Wehave agreements with each of our bankruptcy trustee or debtor in possessioncustomers obligating us to deliver software products and services eachmonth.  The fees paid are contingentupon the month-to-month delivery of the products and services and are based onformulas, as defined by the contracts, related to the number of trustees andcash balances in a trustee’s bank

 

13

----

 

account,the number of cases in a trustee’s portfolio or the number of claims in eachcase. The formula based fees earned each month become fixed and determinable ona monthly basis as a result of all contractually required products and servicesdelivered by us during the month. Professional services revenues are recognized in the period the servicesare provided.

 

For our infrastructure softwarebusiness, the Company recognizes revenues for software licensing followingdelivery and acceptance by the customer. Revenues are deferred for the fair value of professional services andmaintenance fees.  Deferred consulting revenueis recognized as services are provided and maintenance fees are collected andrecognized as revenue on a straight-line basis over the life of the maintenancecontract, which is typically one year. Revenues on multiple-elements are allocated based on the actual amountthe Company charges when that element is sold separately.

 

*Business combination**accounting. *Weacquired several businesses during the past three years, and we may acquireadditional businesses in the future. Business combination accounting, often referred to as purchaseaccounting, 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 tothe assets acquired and liabilities assumed in amounts equal to the fair valueof each asset and liability, and any remaining acquisition cost is classifiedas goodwill.  This allocation processrequires extensive use of estimates and assumptions, including estimates offuture cash flows to be generated by the acquired assets.  Certain identifiable intangible assets, suchas customer lists and covenants not to compete, are amortized over the asset’sestimated useful life.  Goodwill andcertain other identifiable intangible assets are not amortized.  Accordingly, the acquisition cost allocationhas a significant impact on our future operating results.

 

*Goodwill and intangible assets not subject to amortization.*  We assess goodwill and intangible assets notsubject to amortization for impairment as of each July 31 and also at anyother date when events or changes in circumstances indicate that the fair valueof these assets may exceed their carrying value.  This assessment is performed at a reporting unit level.  A reporting unit is a component of a segmentthat constitutes a business, for which discrete financial information isavailable, and for which the operating results are regularly reviewed bysegment management.  A change in eventsor circumstances, including a decision to hold an asset or group of assets forsale, a change in strategic direction, or a change in the competitiveenvironment in which any reporting unit operates, could adversely affect thefair value of one or more reporting units. The estimate of fair value is highly subjective and requires significantjudgment.  If we determine that the fairvalue of any reporting unit is less than the reporting unit’s carrying value,then we will recognize an impairment charge. Such an impairment charge could have a material impact on the Company’sresults of operations and financial condition. The Company’s recognized goodwill and intangible assets not subject toamortization totaled $68,488,000 as of September 30, 2003.

 

*Internal software development costs.*  Certain internal software development costsincurred in the creation of computer software products are capitalized oncetechnological feasibility has been established.  Prior to the completion of detailed program design, developmentcosts are expensed and shown as general and administrative expenses on thestatements of income.  Capitalized costsare amortized based on the greater of:

 

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

 

•                  thestraight-line amortization over the remaining estimated economic life of theproduct, not to exceed five years.

 

Management periodicallyreevaluates its previous estimated future revenue for each product and theremaining estimated economic life of the product.  The Company’s capitalized internal software development costs,net of accumulated amortization, totaled $5,225,000 as of September 30,2003.

 

14

----

 

### **Results of Operations**

 

### ***ThreeMonths Ended September 30, 2003 Compared With Three Months Ended September 30,2002***

 

**Revenues**

 

*Overview.* The Company’s revenues increased approximately 95%, from $9,702,000during the three months ended September 30, 2002 to $18,910,000 during thethree months ended September 30, 2003. This increase is almost entirely attributable to an increase in revenuesfrom our bankruptcy and related services segment.

 

*Bankruptcy and related services.* Revenues from the bankruptcy and relatedservices segment increased by $9,173,000, or approximately 100%, to $18,375,000for the quarter ended September 30, 2003 compared to $9,202,000 during thesame period of the prior year. Bankruptcy case management fees increased $3,093,000, or approximately51%, partly as a result of the acquisition of BSI and partly due to growth inthe value of bankruptcy estate deposits, which increased deposit fees receivedby the Company by approximately 33%. The increase in bankruptcy estate deposits resulted from a combinationof an increase in the number of trustees using our software and an increase inthe average level of deposits per trustee. Bankruptcy professional services revenue increased by $6,080,000, orapproximately 192%, primarily as a result of the acquisition of BSI.  As a result of increased revenues subsequentto the acquisition of BSI, fees from Bank of America for marketing andstrategic consulting and technology services accounted for approximately 11% ofbankruptcy and related services revenues compared to 24% in the same period ofthe prior year.  Based on currentprojects and agreed upon fees with Bank of America, we anticipate that revenuefrom Bank of America for bankruptcy professional services during the next twoquarters will be comparable to revenue earned in the same periods in the prioryear.  Thereafter, certain professionalservices provided to Bank of America will decline versus prior periods.  Although no assurances can be provided, weanticipate that as we establish marketing relationships with new financialinstitutions, revenues from these financial institutions will largely orcompletely offset the anticipated decline in professional services revenuesfrom Bank of America.  See “RecentDevelopments” above for additional discussion of our Chapter 7 MarketingArrangements.

 

**Costof Sales**

 

*Overview.* The Company’s cost of sales increased approximately 100%, from$3,051,000 during the three months ended September 30, 2002 to $6,097,000during the three months ended September 30, 2003.  This increase is almost entirelyattributable to an increase in revenues from our bankruptcy and relatedservices segment.

 

*Bankruptcy and related services. *Total cost of sales for the bankruptcy andrelated services segment increased 116% to $5,529,000, or approximately 30% ofbankruptcy and related services revenues, for the quarter ended September 30,2003 compared to $2,555,000, or approximately 28% of bankruptcy and relatedservices revenues, for the same period of the prior year.  The dollar increase is primarilyattributable to increased salary expense and increased expenses related tonoticing and printing services necessary to support the Chapter 11 casemanagement and professional services product lines.  As a result of our change in product mix, our cost of productsand services as a percent of revenue increased from approximately 17% of bankruptcyand related services revenue to approximately 25% of bankruptcy and relatedservices revenue.  However, our grossmargin remained stable as this increase in cost of products and services as apercent of revenue was largely offset by a decrease in depreciation andamortization expense as a percent of revenue.

 

**OperatingExpenses**

 

Operating expenses increased74% to $6,337,000 for the three months ended September 30, 2003 comparedto $3,637,000 during the same period in the prior year.  Operating expenses, as a percentage ofrevenues, were approximately 34% and 37% for the quarters endedSeptember 30, 2003 and 2002, respectively.  The largest component of operating expenses, general andadministrative expenses, increased 85% to $5,106,000 for the quarter endedSeptember 30, 2003 compared to $2,753,000 during the same period in theprior year.  General and administrativeexpenses, as a percent of revenues, were approximately 27% and 28% for thequarters ended September 30, 2003 and 2002, respectively.  The dollar increase in general andadministrative expenses was largely related to our acquisition of BSI,including increases in compensation expenses primarily related to BSI, travelexpense to support integration of the operations of BSI into our consolidatedoperations, and rent expense for the acquired New York office facility.  Amortization expense related to acquiredidentifiable intangible assets increased $880,000 compared with the same periodin the prior year primarily due to amortization of customer contracts andnon-compete agreements acquired as a part of the BSI transaction.

 

15

----

 

**EffectiveTax Rate**

 

The Company had an effectivetax rate of 39.3% for the quarter ended September 30, 2003 compared to37.8% for the third quarter of 2002 due primarily to higher tax rates in NewYork City and State, BSI’s local jurisdictions.

 

***Nine Months Ended September 30, 2003Compared With Nine Months Ended September 30, 2002***

 

### **Revenues**

 

*Overview.* The Company’s revenues increased approximately 84%, from $27,774,000during the nine months ended September 30, 2002 to $51,107,000 during thenine months ended September 30, 2003. This increase is almost entirely attributable to an increase in revenuesfrom our bankruptcy and related services segment.

 

*Bankruptcy and related services.* Revenues from the bankruptcy and relatedservices segment increased by $23,202,000, or approximately 88%, to $49,534,000for the nine months ended September 30, 2003 compared to $26,332,000 duringthe same period of the prior year. Bankruptcy case management fees increased $8,582,000, partly as a resultof the acquisition of BSI and partly due to growth in the value of bankruptcyestate deposits, which increased deposit fees received by the Company byapproximately 32%.  The increase inbankruptcy estate deposits resulted from a combination of an increase in thenumber of trustees using our software and an increase in the average level ofdeposits per trustee.  Bankruptcyprofessional services revenue increased by $14,620,000 primarily as a result ofthe acquisition of BSI.  As a result ofincreased revenues subsequent to the acquisition of BSI, fees from Bank ofAmerica for marketing and strategic consulting and technology servicesaccounted for approximately 7% of bankruptcy and related services revenuescompared to 12% in the same period of the prior year.  Based on current projects and agreed upon fees with Bank ofAmerica, we anticipate that revenue from Bank of America for bankruptcy professionalservices during the next two quarters will be comparable to revenue earned inthe same periods in the prior year. Thereafter, certain professional services provided to Bank of Americawill decline versus prior periods. Although no assurances can be provided, we anticipate that as weestablish marketing relationships with new financial institutions, revenuesfrom these financial institutions will largely or completely offset theanticipated decline in professional services revenues from Bank of America.  See “Recent Developments” above foradditional discussion of our Chapter 7 Marketing Arrangements.

 

### **Cost of Sales**

 

*Overview.* The Company’s cost of sales increased approximately 79%, from $8,962,000during the nine months ended September 30, 2002 to $16,065,000 during thenine months ended September 30, 2003. This increase is almost entirely attributable to an increase in revenuesfrom our bankruptcy and related services segment.

 

*Bankruptcy and related services*.  Total bankruptcy and related services costof sales increased 93% to $14,470,000, or 29% of bankruptcy and relatedservices revenues, for the nine-month period ended September 30, 2003compared to $7,480,000, or 28% of bankruptcy and related services revenues, forthe same period in the prior year.  Thedollar increase is primarily attributable to increased compensation expense andincreased expense related to noticing and printing services necessary tosupport our new Chapter 11 case management and professional services productlines.  As a result of our change inproduct mix, our cost of products and services as a percent of revenueincreased from approximately 18% of bankruptcy and related services revenue toapproximately 24% of bankruptcy and related services revenue.  However, our gross margin remained stable asthis increase in cost of sales as a percent of revenue was largely offset by adecrease in depreciation and amortization expense as a percent of revenue.

 

### **Operating Expenses**

 

Operating expenses increased86% to $18,662,000 for the nine-month period ended September 30, 2003compared to $10,007,000 for the same period in the prior year.  Operating expenses, as a percent ofoperating revenues, were 37% for the nine-month period ended September 30,2003 compared to 36% for the nine-month period ended September 30,2002.  The largest component ofoperating expenses, general and administrative expenses, increased 60% to$13,843,000 for the nine month period ended September 30, 2003 compared to$8,633,000 during the same period in the prior year.  General and administrative expenses, as a percent of revenues,were approximately 27% and 31% for the nine-month periods endedSeptember 30, 2003 and 2002, respectively.  The dollar increase in general and administrative expenses waslargely related to our acquisition of BSI, including increases in compensationexpense primarily related to BSI, travel expense to support integration of theoperations of BSI into our consolidated operations, and rent expense for theacquired New York office facility. Amortization expense related to acquired identifiable intangible assetsincreased $2,379,000 compared with the same period in the prior 

 

16

----

 

year primarily due toamortization of customer contracts and non-compete agreements acquired as apart of the BSI transaction. Acquisition related expenses, consisting of executive bonuses, legal,accounting and valuation services, and travel, increased $915,000, to $1,485,000for the nine-month period ended September 30, 2003, due to theinvestigation of potential and completed acquisitions.

 

**EffectiveTax Rate**

 

The Company had an effectivetax rate of 40.1% for the nine-month period ended September 30, 2003compared to 37.8% for the first nine months of 2002 due to higher tax rates inNew York City and State, BSI’s local jurisdictions.

 

**Liquidityand Capital Resources**

 

During the nine monthsended September 30, 2003, the Company generated $17,610,000 of cash andcash equivalents from earnings, after adjustment for non-cash items such asdepreciation and amortization.  However,during the nine months ended September 30, 2003 the Company’s cash andcash equivalents decreased by $35,632,000, from $59,827,000 at January 1,2003 to $24,195,000 at September 30, 2003.  The cash and cash equivalents generated during this period andthe $35,632,000 decrease in cash and cash equivalents since the beginning ofthe year were primarily used as follows:

 

•                  $43,263,000, netof cash acquired, was paid as partial consideration for the purchase of BSI;

 

•                  $5,918,000 wasused to finance additional net working capital, which increased primarily as aresult of the combined effect of additional accounts receivable which increasedas a result of increased sales, the acquisition of BSI, and the timing ofbilling and collections;

 

•                  $3,167,000 wasused to purchase property and equipment, primarily related to the installationof computer equipment at various trustee locations; and

 

•                  $2,046,000 wasused to fund internal costs related to development of computer software forwhich technological feasibility has been established.

 

The Company maintains a working capital lineof credit of $25,000,000, maturing on May 31, 2006.  No amounts were outstanding under this lineof credit at September 30, 2003.

 

The Company believes that the funds generatedfrom operations plus amounts available under its lines of credit will besufficient to finance the Company’s currently anticipated working capital andproperty and equipment expenditures for the foreseeable future.

 

**ContractualObligations and Commitments**

 

The Company’s contractualobligations, including commitments for future payments under non-cancelablelease arrangement and short and long-term debt arrangements, are summarizedbelow.

 

Payments Due By Year

(In Thousands)

 
|                          |   | **Total** |   | **Less than  1  Year** |   | **1-3 Years** |   | **4-5 Years** |   | **After 5  Years** |   |
|-------------------------------|--------|-----------|--------|------------------------|--------|---------------|--------|---------------|--------|--------------------|--------|
| Deferred acquisition price    |   | $         | 4,250  |                   | $      | 806           |   | $             | 2,259  |               | $      | 1,185 |   | $ | 0 |   |
| Capital leases                |   | 89        |   | 89                     |   | 0             |   | 0             |   | 0                  |   |
| Operating leases              |   | 7,379     |   | 1,053                  |   | 2,119         |   | 1,344         |   | 2,863              |   |
| Total contractual obligations |   | $         | 11,718 |                   | $      | 1,948         |   | $             | 4,378  |               | $      | 2,529 |   | $ | 2,863 |   |

 

17

----

 

***Forward-Looking Statements***

 

In this report, the Companymakes statements that plan for or anticipate the future.  These forward-looking statements includestatements about the Company’s future business plans and strategies, and otherstatements that are not historical in nature. These forward-looking statements are based on the Company’s currentexpectations.

 

Forward-looking statements maybe identified by words or phrases such as “believe,” “expect,” “anticipate,”“should,” “planned,” “may,” “estimated,” “goal,” “objective” and“potential.”  Section 27A of theSecurities Act of 1933, as amended and Section 21E of the SecuritiesExchange Act of 1934, as amended, provide a “safe harbor” for forward-lookingstatements. Because forward-looking statements involve future risks anduncertainties, listed below are a variety of factors that could cause actualresults and experience to differ materially from the anticipated results orother expectations expressed in the Company’s forward-looking statements.  These factors include, but are not limitedto, (1) any material changes in the Company’s total number of bankruptcytrustees and bankruptcy cases, (2) any material changes in the Company’sChapter 7 deposits, the services required by the Company’s Chapter 11 orChapter 13 cases, or the number of cases processed by the Company’s Chapter 13bankruptcy trustee customers, (3) changes in the number of bankruptcy filingseach year, (4) our reliance on and the recent changes to our marketingarrangement and pricing arrangements with Bank of America for Chapter 7revenues (5) changes in bankruptcy legislation, (6) risks associated with the integrationof acquisitions into the Company’s existing business operations, including theBSI acquisition and (7) other risks detailed from time to time in the Company’sfilings with the SEC, including the **“RiskFactors”** discussed in the Company’s Annual Report on Form 10-K forthe year ended December 31, 2002. The Company undertakes no obligations to update any forward-lookingstatements contained herein to reflect future events or developments.

 

**ITEM3:  Quantitative and QualitativeDisclosures About Market Risk**

 

Marketrisk refers to the risk that a change in the level of one or more marketprices, interest rates, indices, volatilities, correlations or other marketfactors such as liquidity, will result in losses for a certain financialinstrument or group of financial instruments. The Company is currently exposed to credit risk on credit extended tocustomers and interest risk on capital lease obligations and the line of creditborrowings, the deferred acquisition price note and cash equivalents.  The Company actively monitors these risksthrough a variety of control procedures involving senior management.  The Company does not currently use anyderivative financial instruments. Based on the controls in place, creditworthiness of the customer base and the relative size of these financialinstruments, the Company believes the risk associated with these instrumentswill not have a material adverse affect on its business, financial position,results of operations and cash flows.

 

**ITEM4.  Controls and Procedures**

 

Anevaluation was carried out by the Company’s Chief Executive Officer and ChiefFinancial Officer of the effectiveness of the design and operations of theCompany’s disclosure controls and procedures (as defined in Exchange Act Rule13a-15(e)).  Based upon that evaluationas of the end of the period covered by this report, the CEO and the CFOconcluded that the Company’s disclosure controls and procedures are effectivein timely alerting them to material information relating to the Company (includingour consolidated subsidiaries) required to be included in the Company’speriodic filings with the SEC.  Therehave not been any significant changes in the Company’s internal controls or inother factors that could significantly affect these controls subsequent to thedate of evaluation.

 

18

----

 

**PARTII - 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 Chief Executive Officer and Chief Financial Officer pursuant to 18 U.S.C.  Section 1350.                                            |

 

**(b)****                                  Reportson Form 8-K**

 

1.                                       A report on Form 8-K was filed onJuly 28, 2003, furnishing the Company’s earnings release for the secondquarter of 2003.

 

19

----

 

##### **SIGNATURES**

##### ** **

Pursuant to the requirements ofthe Securities Exchange Act of 1934, as amended, the registrant has caused thisreport to be signed on its behalf by the undersigned, thereunto dulyauthorized.

 
|                                                                                                                                            |   | **EPIQ Systems, Inc**.                                                                        |
|-------------------------------------------------------------------------------------------------------------------------------------------------|--------|-----------------------------------------------------------------------------------------------|
|                                                                                                                                            |   |                                                                                          |
|                                                                                                                                            |   |                                                                                          |
| Date:                    November 13,  2003 |   |                                                                                          | /s/  Tom W. Olofson |   |
|                                                                                                                                            |   | Tom W. Olofson                                                                                |
|                                                                                                                                            |   | Chairman of  the Board  Chief Executive Officer  Director  (Principal Executive Officer)      |
|                                                                                                                                            |   |                                                                                          |
|                                                                                                                                            |   |                                                                                          |
| Date:                    November 13,  2003 |   |                                                                                          | /s/  Elizabeth M. Braham |   |
|                                                                                                                                            |   | Elizabeth M.  Braham                                                                          |
|                                                                                                                                            |   | Senior Vice  President, Chief Financial Officer  (Principal Financial and Accounting Officer) |
|                                                                                                                                                 |        |                                                                                               |  |  |  |  |

 

20

----