** **

**UNITEDSTATESSECURITIES AND EXCHANGE COMMISSION**

**WASHINGTON,D. C. 20549**

 

**FORM 10-Q**

 

**Quarterly Report Under Section 13 or15(d)of the Securities Exchange Act of 1934**

 

**Forthe Quarterly Period Ended June 30, 2004**

 

**OR**

 

**Transition Report Pursuant to Section13 or 15(d)of the Securities Exchange Act of 1934**

 

**Forthe transition period from               to               **

 

**CommissionFile Number 0-22081**

 

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**EPIQSYSTEMS, INC.**

(Exact name of registrant as specified in itscharter)

 

| **Missouri**                                                    |   | **48-1056429**                       |
|-----------------------------------------------------------------|--------|--------------------------------------|
| (State or other jurisdiction of  incorporation or organization) |   | (IRS Employer Identification Number) |

 

**501Kansas Avenue, Kansas City, Kansas 66105-1300**

(Address of principal executive office)

 

**913-621-9500**

(Registrant’s telephone number)

 

Indicate by check mark whether the registrant (1) has filed all reportsrequired to be filed by Section 13 or 15(d) of the Securities Exchange Act of1934 during the preceding 12 months (or for such shorter period that theregistrant was required to file such reports), and (2) has been subject to suchfiling requirements for the past 90 days Yes  ý   No  o

 

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

 

The number of shares outstanding of registrant’s common stock at July20, 2004:

 

| **Class**                    |   | **Outstanding** |
|------------------------------|--------|-----------------|
| Common Stock, $.01 par value |   | 17,860,336      |

 

 

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**EPIQSYSTEMS, INC. AND SUBSIDIARIES**

**FORM10-Q**

**QUARTERENDED JUNE 30, 2004**

 

**CONTENTS**

 
| **PART I - FINANCIAL INFORMATION** |                                                                                                                      |
|------------------------------------|---------------------------------------------------------------------------------------------------------------------------|
|                               |                                                                                                                      |   |
| Item 1.                            | Financial Statements                                                                                                      |   |
|                               |                                                                                                                      |   |
|                               | Condensed  Consolidated Statements of Income –  Three months and six months ended June 30, 2004 and 2003 (Unaudited) | 1 |
|                               |                                                                                                                      |   |
|                               | Condensed  Consolidated Balance Sheets –  June 30, 2004 and December 31, 2003 (Unaudited)                            | 3 |
|                               |                                                                                                                      |   |
|                               | Condensed  Consolidated Statements of Cash Flows –  Six months ended June 30, 2004 and 2003 (Unaudited)              | 4 |
|                               |                                                                                                                      |   |
|                               | Notes  to Condensed Consolidated Financial Statements (Unaudited)                                                         | 5 |
|                               |                                                                                                                      |   |
| Item 2.                            | Management’s Discussion and Analysis of  Financial Condition and Results of Operations                               | 19 |
|                               |                                                                                                                      |   |
| Item 3.                            | Quantitative and Qualitative Disclosures  about Market Risk                                                               | 29 |
|                               |                                                                                                                      |   |
| Item 4.                            | Controls and Procedures                                                                                                   | 29 |
|                               |                                                                                                                      |   |
| **PART II - OTHER INFORMATION**    |                                                                                                                      |
|                               |                                                                                                                      |   |
| Item 4.                            | Submission of Matters to a Vote of Security  Holders                                                                      | 30 |
|                               |                                                                                                                      |   |
| Item 6.                            | Exhibits and Reports on Form 8-K                                                                                          | 30 |
|                               |                                                                                                                      |   |
| Signatures                         | 32                                                                                                                        |

 

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**PART I - FINANCIALINFORMATION**

 

**ITEM1.****                                                     FinancialStatements.**

 

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

##### **CONDENSEDCONSOLIDATED STATEMENTS OF INCOME**

**(InThousands, Except Per Share Data)**

**(Unaudited)**

** **
|                                                                                                                      |   | **Three  months ended  June 30,** |   | **Six months  ended  June 30,** |   |
|---------------------------------------------------------------------------------------------------------------------------|--------|-----------------------------------|--------|---------------------------------|--------|
|                                                                                                                      |   | **2004**                          |   | **2003**                        |   | **2004** |   | **2003** |   |
|                                                                                                                      |   |                              |   |                            |   |   |   |   |   |
| **REVENUE:**                                                                                                              |   |                              |   |                            |   |   |   |   |   |
| Case management                                                                                                           |   | $                                 | 17,372 |                            | $      | 12,347 |   | $ | 34,298 |   | $ | 23,762 |   |
| Document management                                                                                                       |   | 12,224                            |   | 3,392                           |   | 18,290 |   | 5,273 |   |
| Operating revenue                                                                                                         |   | 29,596                            |   | 15,739                          |   | 52,588 |   | 29,035 |   |
| Reimbursed expenses                                                                                                       |   | 5,312                             |   | 1,345                           |   | 8,332 |   | 2,124 |   |
| Total Revenue                                                                                                             |   | 34,908                            |   | 17,084                          |   | 60,920 |   | 31,159 |   |
|                                                                                                                      |   |                              |   |                            |   |   |   |   |   |
| **COSTS AND EXPENSES:**                                                                                                   |   |                              |   |                            |   |   |   |   |   |
| Direct costs                                                                                                              |   | 17,672                            |   | 4,113                           |   | 27,976 |   | 7,068 |   |
| General and administrative                                                                                                |   | 6,573                             |   | 4,289                           |   | 12,211 |   | 7,775 |   |
| Depreciation and software amortization                                                                                    |   | 1,578                             |   | 1,093                           |   | 2,959 |   | 2,211 |   |
| Amortization of identifiable intangible  assets                                                                           |   | 2,032                             |   | 976                             |   | 3,712 |   | 1,658 |   |
| Acquisition related                                                                                                       |   | —                            |   | —                          |   | 2,181 |   | 1,485 |   |
| Total Operating Expenses                                                                                                  |   | 27,855                            |   | 10,471                          |   | 49,039 |   | 20,197 |   |
|                                                                                                                      |   |                              |   |                            |   |   |   |   |   |
| **INCOME FROM OPERATIONS**                                                                                                |   | 7,053                             |   | 6,613                           |   | 11,881 |   | 10,962 |   |
|                                                                                                                      |   |                              |   |                            |   |   |   |   |   |
| **INTEREST INCOME (EXPENSE):**                                                                                            |   |                              |   |                            |   |   |   |   |   |
| Interest income                                                                                                           |   | 32                                |   | 57                              |   | 66 |   | 170 |   |
| Interest expense                                                                                                          |   | (2,007                            | )      | (54                             | )      | (3,529 | ) | (97 | ) |
| Net Interest Income (Expense)                                                                                             |   | (1,975                            | )      | 3                               |   | (3,463 | ) | 73 |   |
|                                                                                                                      |   |                              |   |                            |   |   |   |   |   |
| **INCOME FROM CONTINUING OPERATIONS BEFORE  INCOME TAXES**                                                                |   | 5,078                             |   | 6,616                           |   | 8,418 |   | 11,035 |   |
|                                                                                                                      |   |                              |   |                            |   |   |   |   |   |
| **PROVISION FOR INCOME TAXES**                                                                                            |   | 2,095                             |   | 2,741                           |   | 3,433 |   | 4,482 |   |
|                                                                                                                      |   |                              |   |                            |   |   |   |   |   |
| **NET INCOME FROM CONTINUING OPERATIONS**                                                                                 |   | 2,983                             |   | 3,875                           |   | 4,985 |   | 6,553 |   |
|                                                                                                                      |   |                              |   |                            |   |   |   |   |   |
| **DISCONTINUED  OPERATIONS:**                                                                                             |   |                              |   |                            |   |   |   |   |   |
| Income (loss) from operations  of discontinued  infrastructure  software segment (including  gain  on disposal of $1,626) |   | 1,667                             |   | (457                            | )      | 1,231 |   | (1,058 | ) |
| Income tax (expense) benefit  related to  discontinued  infrastructure software segment                                   |   | (659                              | )      | 190                             |   | (487 | ) | 425 |   |
| **TOTAL  DISCONTINUED OPERATIONS**                                                                                        |   | 1,008                             |   | (267                            | )      | 744 |   | (633 | ) |
|                                                                                                                      |   |                              |   |                            |   |   |   |   |   |
| **NET INCOME**                                                                                                            |   | $                                 | 3,991  |                            | $      | 3,608 |   | $ | 5,729 |   | $ | 5,920 |   |

 

**See accompanyingnotes to condensed consolidated financial statements.**

 

1

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|                                            |   | **Three  Months Ended  June 30,** |   | **Six Months  Ended  June 30,** |   |
|-------------------------------------------------|--------|-----------------------------------|--------|---------------------------------|--------|
|                                            |   | **2004**                          |   | **2003**                        |   | **2004** |   | **2003** |   |
| **NET INCOME PER SHARE INFORMATION:**           |   |                              |   |                            |   |   |   |   |   |
| Income  per share – Basic                  |   |                              |   |                            |   |   |   |   |   |
| Income from continuing  operations              |   | $                                 | 0.16   |                            | $      | 0.22 |   | $ | 0.28 |   | $ | 0.38 |   |
| Gain (loss) from discontinued  operations       |   | 0.06                              |   | (0.02                           | )      | 0.04 |   | (0.04 | ) |
| Net income per share – Basic               |   | $                                 | 0.22   |                            | $      | 0.20 |   | $ | 0.32 |   | $ | 0.34 |   |
|                                            |   |                              |   |                            |   |   |   |   |   |
| Income per share –  Diluted                |   |                              |   |                            |   |   |   |   |   |
| Income from continuing operations               |   | $                                 | 0.16   |                            | $      | 0.21 |   | $ | 0.27 |   | $ | 0.36 |   |
| Gain (loss) from discontinued  operations       |   | 0.06                              |   | (0.01                           | )      | 0.04 |   | (0.03 | ) |
| Net income per share – Diluted             |   | $                                 | 0.22   |                            | $      | 0.20 |   | $ | 0.31 |   | $ | 0.33 |   |
|                                            |   |                              |   |                            |   |   |   |   |   |
| **WEIGHTED AVERAGE COMMON SHARES OUTSTANDING:** |   |                              |   |                            |   |   |   |   |   |
| Basic                                           |   | 17,831                            |   | 17,687                          |   | 17,822 |   | 17,470 |   |
| Diluted                                         |   | 18,248                            |   | 18,204                          |   | 18,240 |   | 17,987 |   |

 

**See accompanyingnotes to condensed consolidated financial statements.**

 

2

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**EPIQ SYSTEMS, INC. AND SUBSIDIARIES**

**CONDENSED CONSOLIDATED BALANCE SHEETS**

**(In Thousands)**

**(Unaudited)**

 
|                                                                                                                                                                                   |   | **June 30, 2004** |    | **December 31, 2003** |   |
|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|--------|-------------------|---------|-----------------------|--------|
| **ASSETS**                                                                                                                                                                             |   |              |    |                  |   |
| **CURRENT ASSETS:**                                                                                                                                                                    |   |              |    |                  |   |
| Cash and cash equivalents                                                                                                                                                              |   | $                 | 14,231  |                  | $      | 30,347 |   |
| Accounts receivable, trade,  less allowance for doubtful accounts  of $603 and $340, respectively                                                                                      |   | 20,437            |    | 11,337                |   |
| Prepaid expenses                                                                                                                                                                       |   | 1,682             |    | 1,023                 |   |
| Deferred income taxes                                                                                                                                                                  |   | 5,965             |    | 1,736                 |   |
| Other current assets                                                                                                                                                                   |   | 3,172             |    | 915                   |   |
| Current assets held for sale                                                                                                                                                           |   | —            |    | 1,304                 |   |
| Total Current Assets                                                                                                                                                                   |   | 45,487            |    | 46,662                |   |
|                                                                                                                                                                                   |   |              |    |                  |   |
| **LONG-TERM  ASSETS:**                                                                                                                                                                 |   |              |    |                  |   |
| Property and equipment, net                                                                                                                                                            |   | 21,184            |    | 11,886                |   |
| Software development costs, net                                                                                                                                                        |   | 5,973             |    | 2,799                 |   |
| Goodwill                                                                                                                                                                               |   | 148,492           |    | 64,188                |   |
| Other intangibles, net of  accumulated amortization of $7,962 and  $4,250, respectively                                                                                                |   | 28,112            |    | 16,325                |   |
| Other                                                                                                                                                                                  |   | 2,305             |    | 67                    |   |
| Total Long-term Assets                                                                                                                                                                 |   | 206,066           |    | 95,265                |   |
| **Total Assets**                                                                                                                                                                       |   | $                 | 251,553 |                  | $      | 141,927 |   |
|                                                                                                                                                                                   |   |              |    |                  |   |
| **LIABILITIES AND  STOCKHOLDERS’ EQUITY**                                                                                                                                         |   |              |    |                  |   |
| **CURRENT  LIABILITES:**                                                                                                                                                               |   |              |    |                  |   |
| Accounts payable                                                                                                                                                                       |   | $                 | 5,321   |                  | $      | 1,998 |   |
| Customer deposits                                                                                                                                                                      |   | 2,913             |    | 1,712                 |   |
| Other accrued expenses                                                                                                                                                                 |   | 1,890             |    | 1,943                 |   |
| Current maturities of long-term  obligations                                                                                                                                           |   | 19,440            |    | 849                   |   |
| Current liabilities held for  sale                                                                                                                                                     |   | —            |    | 1,137                 |   |
| Total Current Liabilities                                                                                                                                                              |   | 29,564            |    | 7,639                 |   |
|                                                                                                                                                                                   |   |              |    |                  |   |
| **LONG-TERM  LIABILITIES:**                                                                                                                                                            |   |              |    |                  |   |
| Deferred income taxes                                                                                                                                                                  |   | 10,069            |    | 1,967                 |   |
| Long-term obligations  (excluding current maturities)                                                                                                                                  |   | 76,540            |    | 3,066                 |   |
| Total Long-term Liabilities                                                                                                                                                            |   | 86,609            |    | 5,033                 |   |
|                                                                                                                                                                                   |   |              |    |                  |   |
| **STOCKHOLDERS’  EQUITY:**                                                                                                                                                        |   |              |    |                  |   |
| Preferred stock - $1 par value;  2,000,000 shares authorized;  none issued and outstanding                                                                                             |   | —            |    | —                |   |
| Common stock - $0.01 par value;  50,000,000 shares authorized;  issued and outstanding – 17,834,180 and  17,780,854  shares at June 30, 2004  and December 31, 2003, respectively |   | 178               |    | 178                   |   |
| Additional paid-in capital                                                                                                                                                             |   | 102,287           |    | 101,890               |   |
| Retained earnings                                                                                                                                                                      |   | 32,915            |    | 27,187                |   |
| Total Stockholders’ Equity                                                                                                                                                        |   | 135,380           |    | 129,255               |   |
| **Total  Liabilities and Stockholders’ Equity**                                                                                                                                   |   | $                 | 251,553 |                  | $      | 141,927 |   |

** **

**See accompanyingnotes to condensed consolidated financial statements.**

 

3

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**EPIQSYSTEMS, INC. AND SUBSIDIARIES**

**CONDENSEDCONSOLIDATED STATEMENTS OF CASH FLOWS**

**(InThousands)**

**(Unaudited)**

 
|                                                                                                |   | **Six Months  Ended June 30,** |   |
|-----------------------------------------------------------------------------------------------------|--------|--------------------------------|--------|
|                                                                                                |   | **2004**                       |   | **2003** |   |
| **CASH FLOWS FROM OPERATING ACTIVITIES:**                                                           |   |                           |   |   |   |
| Net income                                                                                          |   | $                              | 5,729  |   | $ | 5,920 |   |
| Adjustments to reconcile net income to net  cash from operating activities:                         |   |                           |   |   |   |
| Provision for deferred income taxes                                                                 |   | 2,855                          |   | 463 |   |
| Depreciation and software amortization                                                              |   | 2,959                          |   | 2,875 |   |
| Loan fee amortization                                                                               |   | 1,493                          |   | — |   |
| Amortization of other intangible assets                                                             |   | 3,712                          |   | 1,732 |   |
| Gain on disposal of discontinued operations                                                         |   | (1,626                         | )      | — |   |
| Other                                                                                               |   | (176                           | )      | 114 |   |
| Changes in operating assets and  liabilities, net of effects from business acquisition:             |   |                           |   |   |   |
| Accounts receivable                                                                                 |   | 6,544                          |   | (5,125 | ) |
| Prepaid expenses and other assets                                                                   |   | 1,667                          |   | 297 |   |
| Accounts payable and accrued expenses                                                               |   | (1,488                         | )      | 1,160 |   |
| Withholding and related liabilities assumed  in the acquisition of a business and subsequently paid |   | (7,973                         | )      | — |   |
| Income taxes, including tax benefit from  exercise of stock options                                 |   | 1,297                          |   | (12 | ) |
| Other                                                                                               |   | 276                            |   | 6 |   |
| Net cash provided by operating activities                                                           |   | 15,269                         |   | 7,430 |   |
|                                                                                                |   |                           |   |   |   |
| **CASH FLOWS FROM INVESTING ACTIVITIES:**                                                           |   |                           |   |   |   |
| Purchase of property and equipment                                                                  |   | (3,236                         | )      | (2,313 | ) |
| Software development costs                                                                          |   | (869                           | )      | (1,318 | ) |
| Cash paid for acquisition of business, net  of $2,765 cash acquired                                 |   | (113,115                       | )      | (43,263 | ) |
| Proceeds from sale of discontinued  operations                                                      |   | 500                            |   | — |   |
| Payment received on note for sale of  discontinued operations                                       |   | 176                            |   | — |   |
| Other                                                                                               |   | —                         |   | 20 |   |
| Net cash used in investing activities                                                               |   | (116,544                       | )      | (46,874 | ) |
|                                                                                                |   |                           |   |   |   |
| **CASH FLOWS FROM FINANCING ACTIVITIES:**                                                           |   |                           |   |   |   |
| Proceeds from long-term debt borrowings                                                             |   | 145,500                        |   | — |   |
| Debt issuance costs                                                                                 |   | (5,088                         | )      | — |   |
| Principal payments under long-term debt and  capital lease obligations                              |   | (56,254                        | )      | (301 | ) |
| Direct costs associated with stock offering                                                         |   | —                         |   | (114 | ) |
| Proceeds from exercise of stock options                                                             |   | 287                            |   | 850 |   |
| Net cash provided by financing activities                                                           |   | 84,445                         |   | 435 |   |
|                                                                                                |   |                           |   |   |   |
| **NET DECREASE IN CASH AND CASH EQUIVALENTS**                                                       |   | (16,830                        | )      | (39,009 | ) |
| **CASH AND CASH EQUIVALENTS, BEGINNING OF PERIOD**                                                  |   | 30,347                         |   | 59,827 |   |
| Decrease in cash classified as held for  sale                                                       |   | 714                            |   | — |   |
| **CASH AND CASH EQUIVALENTS, END OF PERIOD**                                                        |   | $                              | 14,231 |   | $ | 20,818 |   |
|                                                                                                |   |                           |   |   |   |
| **SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION:**                                              |   |                           |   |   |   |
| Interest paid                                                                                       |   | $                              | 1,895  |   | $ | 8 |   |
| Income taxes paid (refunded)                                                                        |   | $                              | (573   | ) | $ | 3,605 |   |

 

**See accompanyingnotes to condensed consolidated financial statements.**

 

4

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**EPIQSYSTEMS, INC. AND SUBSIDIARIES**

**NOTESTO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS**

**(Unaudited)**

 

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

 

***Nature of Operations***

EPIQ Systems is a national provider of integrated technology-basedsolutions for fiduciary management and claims administration applications usedby attorneys, trustees, and corporations primarily engaged in bankruptcy, classaction, mass tort, and other similarly complex legal proceedings.  Our solutions combine advanced technologywith in-depth subject matter expertise to offer customers an efficientenvironment in which to comprehensively manage the complexities of caseadministration and document management.

 

***Comprehensive Income***

We do not haveany components of other comprehensive income; therefore comprehensive incomeequals net income.

 

***Stock-Based Compensation***

We account forstock compensation awards under the intrinsic method of Accounting PrinciplesBoard Opinion No. 25, *Accounting for Stock Issued to Employees,*whichrequires compensation cost to be recognized based on the excess, if any,between the quoted market price at the date of grant and the amount an employeemust pay to acquire stock. Options awarded under the Company’s plans aregranted with an exercise price equal to the fair market value on the date ofthe grant. Had the compensation cost been determined based on the fair value atthe grant dates based on the guidance provided by Statement of FinancialAccounting Standard (“SFAS”) No. 123, *Accounting for Stock-Based Compensation,*our net income and net income per share for the three and six months ended June30, 2004 and 2003 would have been adjusted to the following pro forma amounts(in thousands, except per share data):

 
|                                                                                                                 |        | **Three  Months Ended  June 30,** |   | **Six Months  Ended  June 30,** |   |
|----------------------------------------------------------------------------------------------------------------------|-------------|-----------------------------------|--------|---------------------------------|--------|
|                                                                                                                 |        | **2004**                          |   | **2003**                        |   | **2004** |   | **2003** |   |
| Net income, as reported                                                                                              |        | $                                 | 3,991  |                            | $      | 3,608 |   | $ | 5,729 |   | $ | 5,920 |   |
| Add:   stock-based employee compensation included in reported net earnings,  net of tax                         |        | —                            |   | —                          |   | — |   | — |   |
| Deduct:   Total stock-based employee compensation expense determined under fair  value based method, net of tax |        | (275                              | )      | (983                            | )      | (1,430 | ) | (1,576 | ) |
| Net income, pro forma                                                                                                |        | $                                 | 3,716  |                            | $      | 2,625 |   | $ | 4,299 |   | $ | 4,344 |   |
|                                                                                                                 |        |                              |   |                            |   |   |   |   |   |
| Net income per share – Basic                                                                                    | As reported |                              | $      | 0.22                            |   | $ | 0.20 |   | $ | 0.32 |   | $ | 0.34 |   |
|                                                                                                                 | Pro forma   |                              | $      | 0.21                            |   | $ | 0.15 |   | $ | 0.24 |   | $ | 0.25 |   |
|                                                                                                                 |        |                              |   |                            |   |   |   |   |   |
| Net income per share – Diluted                                                                                  | As reported |                              | $      | 0.22                            |   | $ | 0.20 |   | $ | 0.31 |   | $ | 0.33 |   |
|                                                                                                                 | Pro forma   |                              | $      | 0.20                            |   | $ | 0.14 |   | $ | 0.24 |   | $ | 0.24 |   |

 

Pro formaamounts presented here are based on actual earnings and consider only theeffects of estimated fair values of stock options.

 

5

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***Recent Accounting Pronouncements***

The EITF (Emerging Issues Task Force) reached a consensus regardingIssue No. 03-06, *Participating Securities and the Two-Class Method under FASB StatementNo. 128*.  The consensusclarified what is meant by a “participating security,” provided guidance onapplying the two-class method for computing EPS, and required affectedcompanies to retroactively restate EPS amounts presented.  The consensus is effective for reportingperiods beginning after March 31, 2004. Adoption of EITF Issue No. 03-06 did not have a material effect on ourconsolidated Financial Statements.

 

The EITF currently is addressing when the dilutive effect ofcontingently convertible debt instruments should be included in dilutedearnings per share.  The EITF’stentative conclusion is that contingently convertible debt instruments shouldbe included in diluted earnings per share computations regardless of whetherthe market price trigger has been met. Although we cannot predict the future effect that this conclusion willhave on our diluted earnings per share calculation, it will likely have adilutive affect.

 

***Reclassification***

Certainreclassifications have been made to the prior periods’ condensed consolidatedfinancial statements to conform with the current period’s condensedconsolidated financial statement presentation.

 

**NOTE 2:  INTERIM FINANCIAL STATEMENTS**

 

The accompanying condensed consolidated financial statements have beenprepared in accordance with the instructions to Form 10-Q of theSecurities and Exchange Commission 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.  The financial statements should be read inconjunction with our audited financial statements and accompanying notes, whichare included in Form 10-K for the year ended December 31, 2003.

 

In the opinion of our management, the accompanying financial statementsreflect all adjustments necessary (consisting solely of normal recurringadjustments) to present fairly our financial position as of June 30, 2004 andthe results of operations and cash flows for the three months and six monthsended June 30, 2004 and 2003.

 

The results of operations for the three month and six month periodsended June 30, 2004 are not necessarily indicative of the results to beexpected for the entire year.

 

6

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**NOTE 3:  NET INCOME PER SHARE**

 

Basic net income per share from continuing operations is computed basedon the weighted average number of common shares outstanding during eachperiod.  Diluted net income per sharefrom continuing operations is computed using the weighted average common sharesand all potentially dilutive common share equivalents outstanding during the period.  The computation of net income per share fromcontinuing operations for the three months and six months ended June 30, 2004and 2003 is as follows (in thousands, except per share data):

 
|                                                       |   | **Three  Months Ended  June 30,** |   | **Six Months  Ended  June 30,** |   |
|------------------------------------------------------------|--------|-----------------------------------|--------|---------------------------------|--------|
|                                                       |   | **2004**                          |   | **2003**                        |   | **2004** |   | **2003** |   |
|                                                       |   |                              |   |                            |   |   |   |   |   |
| Net income from continuing operations                      |   | $                                 | 2,983  |                            | $      | 3,875 |   | $ | 4,985 |   | $ | 6,553 |   |
|                                                       |   |                              |   |                            |   |   |   |   |   |
| Weighted average common shares outstanding                 |   | 17,831                            |   | 17,687                          |   | 17,822 |   | 17,470 |   |
| Weighted average common share equivalents  (stock options) |   | 417                               |   | 517                             |   | 418 |   | 517 |   |
| Weighted average diluted common shares  outstanding        |   | 18,248                            |   | 18,204                          |   | 18,240 |   | 17,987 |   |
| Net income per share from continuing  operations :         |   |                              |   |                            |   |   |   |   |   |
| Basic                                                      |   | $                                 | 0.16   |                            | $      | 0.22 |   | $ | 0.28 |   | $ | 0.38 |   |
| Diluted                                                    |   | $                                 | 0.16   |                            | $      | 0.21 |   | $ | 0.27 |   | $ | 0.36 |   |

 

#### **For the three month periods ended June 30, 2004 and2003, options to purchase 1,593,000 and 3,000 shares of common stock,respectively, were outstanding but were not included in the computation ofdiluted earnings per share because the exercise price was greater than theaverage market price of the common shares; therefore, the effect would beantidilutive.**

 

For the six month periods ended June 30, 2004and 2003, options to purchase 952,000 and 3,000 shares of common stock,respectively, were outstanding but were not included in the computation ofdiluted earnings per share because the exercise price was greater than theaverage market price of the common shares; therefore, the effect would beantidilutive.

 

7

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#### **NOTE 4:  GOODWILL AND INTANGIBLE ASSETS**

 

Intangible assets at June 30, 2004 andDecember 31, 2003 consisted of the following (in thousands):

 
|                          |   | **June 30,  2004**          |   | **December  31, 2003**        |   |
|-------------------------------|--------|-----------------------------|--------|-------------------------------|--------|
|                          |   | **Gross  Carrying  Amount** |   | **Accumulated  Amortization** |   | **Gross  Carrying  Amount** |   | **Accumulated  Amortization** |   |
| Amortizing intangible assets: |   |                        |   |                          |   |   |   |   |   |
| Customer contracts            |   | $                           | 16,560 |                          | $      | 5,196 |   | $ | 8,060 |   | $ | 2,926 |   |
| Trade names                   |   | 1,634                       |   | 383                           |   | 60 |   | 45 |   |
| Non-compete agreement         |   | 17,880                      |   | 2,383                         |   | 11,980 |   | 1,279 |   |
|                          |   | $                           | 36,074 |                          | $      | 7,962 |   | $ | 20,100 |   | $ | 4,250 |   |

 

At June 30, 2004, intangible assets notsubject to amortization, comprised solely of goodwill, had a carrying value of$148.4 million.  At December 31, 2003,intangible assets not subject to amortization consisted of goodwill and a tradename with carrying values of $64.2 million and $0.5 million, respectively.

 

In conjunction with our January 30, 2004,acquisition of Poorman-Douglas, we reassessed our use of all trade names.  As a result of this reassessment, in February2004 we commenced amortizing the BSI trade name on a straight-line basis overtwo years.

 

Aggregate amortization expenserelated to identifiable intangible assets was $2.0 million and $1.0 million forthe three month periods ended June 30, 2004 and 2003, respectively and was $3.7million and $1.7 million for the six month periods ended June 30, 2004 and2003, respectively.  Amortizationexpense related to intangible assets for the year ending December 31, 2004 andfor each of the following five years ending December 31 is estimated to be asfollows (in thousands):

 

| 2004   |   | $      | 7,767  |   |
|--------|--------|--------|--------|--------|
| 2005   |   | 5,904  |   |
| 2006   |   | 4,987  |   |
| 2007   |   | 3,027  |   |
| 2008   |   | 2,855  |   |
| 2009   |   | 1,773  |   |
|   |   |   |   |
|   |   | $      | 26,313 |   |

 

The changes in the carrying amount ofgoodwill, with the prior period conformed to our current segment presentation,for the six-month period ended June 30, 2004, and year ended December 31,2003 are as follows (in thousands):

 
|                                        |   | **Six Months  Ended June 30, 2004** |    | **Year Ended  December 31, 2003** |   |
|---------------------------------------------|--------|-------------------------------------|---------|-----------------------------------|--------|
|                                        |   | **Case  Management**                |    | **Document  Management**          |   | **Total** |   | **Case  Management** |   | **Document  Management** |   | **Total** |   |
|                                        |   |                                |    |                              |   |   |   |   |   |   |   |   |   |
| Balance, beginning of period                |   | $                                   | 43,716  |                              | $      | 20,472 |   | $ | 64,188 |   | $ | 17,449 |   | $ | — |   | $ | 17,449 |   |
| Goodwill acquired during the period         |   | 63,244                              |    | 21,081                            |   | 84,325 |   | 26,267 |   | 20,472 |   | 46,739 |   |
| Settlement of contingencies and adjustments |   | (16                                 | )       | (5                                | )      | (21 | ) | — |   | — |   | — |   |
| Balance, end of period                      |   | $                                   | 106,944 |                              | $      | 41,548 |   | $ | 148,492 |   | $ | 43,716 |   | $ | 20,472 |   | $ | 64,188 |   |

 

8

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### **NOTE 5: BUSINESS ACQUISITION**

 

On January 30, 2004, we acquired for cash100% of the equity of P-D Holding Corp. and its wholly-owned subsidiary,Poorman-Douglas Corporation (collectively, “Poorman-Douglas”),  We believe this acquisition provides complementarydiversification to our existing legal services business, as Poorman-Douglas isa provider of technology-based products and services for class action, masstort and bankruptcy case administration. The total value of the transaction, including capitalized acquisitioncosts, was approximately $115.9 million. Based on our preliminary valuation, the purchase price has beenallocated as follows (in thousands):

 

| Current assets           |   | $       | 21,718  |   |
|--------------------------|--------|---------|---------|--------|
| Deferred tax assets      |   | 6,175   |    |
| Property and software    |   | 8,612   |    |
| Trade names              |   | 1,100   |    |
| Customer backlog         |   | 6,200   |    |
| Customer relationships   |   | 2,300   |    |
| Non-compete agreements   |   | 5,900   |    |
| Goodwill                 |   | 84,304  |    |
| Current liabilities      |   | (13,236 | )       |
| Deferred tax liabilities |   | (7,193  | )       |
|                     |   |    |    |
| Total purchase price     |   | $       | 115,880 |   |

 

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

 

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

 

9

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On January 31, 2003, we acquired 100% of the membership interests ofBankruptcy Services LLC (“BSI”), a provider of technology-based casemanagement, consulting and administrative services for Chapter 11 cases. Thetotal value of the transaction, including capitalized transaction costs, was$67.0 million of which $45.5 million was paid in cash, $16.5 million (1,054,000shares) was paid in EPIQ Systems, Inc. stock, $3.4 million was deferred in theform of a non-interest bearing note with a face value of $4.0 milliondiscounted using an imputed interest rate of 5% per annum, $1.3 million ofliabilities were assumed, and $0.3 million was paid in acquisition costs.  The purchase price was allocated as follows(in thousands):

 

| Current assets         |   | $      | 2,616  |   |
|------------------------|--------|--------|--------|--------|
| Property and software  |   | 755    |   |
| Trade names            |   | 474    |   |
| Customer backlog       |   | 4,700  |   |
| Non-compete agreements |   | 11,730 |   |
| Goodwill               |   | 46,739 |   |
|                   |   |   |   |
| Total purchase price   |   | $      | 67,014 |   |

 

Customer backlog and the non-compete agreement are amortized using thestraight-line method over, respectively, two years and ten years.  Initially, the trade name was not amortizedas it had an indefinite life.  Inconjunction with our acquisition of Poorman-Douglas, we reassessed our use ofall trade names.  Accordingly, inFebruary 2004 we commenced amortizing the BSI trade name on a straight-line basisover two years.  The excess purchaseprice of $46.7 million was allocated to goodwill and, in accordance with SFASNo. 142, is not being amortized but will be reviewed for impairment annuallyand between annual tests if events or changes in circumstances indicate thatthe asset might be impaired.  Thepurchase price in excess of the tax basis of the assets, primarily allocated toidentifiable intangible assets and goodwill, has been determined to bedeductible for tax purposes.

 

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

 

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

 

|                  |   | **(In  Thousands, Except Per Share Data)** |   |
|-----------------------|--------|--------------------------------------------|--------|
|                  |   | **Three  Months Ended  June 30,**          |   | **Six Months  Ended  June 30,** |   |
|                  |   | **2004**                                   |   | **2003** |   | **2004** |   | **2003** |   |
| Revenue               |   | $                                          | 34,908 |   | $ | 31,687 |   | $ | 67,603 |   | $ | 61,347 |   |
| Net Income            |   | $                                          | 3,991  |   | $ | 3,233 |   | $ | 5,550 |   | $ | 4,721 |   |
| Net Income Per Share: |   |                                       |   |   |   |   |   |   |   |
| Basic                 |   | $                                          | 0.22   |   | $ | 0.18 |   | $ | 0.31 |   | $ | 0.27 |   |
| Diluted               |   | $                                          | 0.22   |   | $ | 0.18 |   | $ | 0.30 |   | $ | 0.26 |   |

 

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

 

10

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**NOTE 6: SEGMENT REPORTING**

 

EPIQ Systems has two operating segments: (i) case management and (ii)document management.  Previously, ouroperating segments were (x) bankruptcy and related services and (y)infrastructure software.  Following ourdecision to sell the infrastructure software business and our January 2004 acquisitionof Poorman-Douglas, resources are now allocated and performance assessed bycase management and document management. Case management solutions provide clients with integratedtechnology-based products and services for the automation of administrativetasks faced by our clients.  Documentmanagement solutions include proprietary technology and production services toensure timely, accurate and complete execution of the documents handled by ourclients.

 

Each segment’s performance is assessed based on segment revenues lesscosts directly attributable to each segment. In management’s evaluation of performance, certain costs, such as sharedservices, administrative staff, and executive management, are not allocated bysegment and, accordingly, the following operating segment results do notinclude such unallocated costs.  Assetsreported within a segment are those assets used by the segment in itsoperations, and consist of property and equipment, software, identifiableintangible assets and goodwill.  Allother assets are classified as unallocated. Infrastructure software, which was classified as held for sale during2003 and was sold during 2004, is presented as a discontinued operation.  Consistent with guidance provided by theFinancial Accounting Standards Board, we have not presented segment informationrelated to our discontinued operation.

 

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

 
|                                                                        |   | **Three Months  Ended June 30, 2004** |    |
|-----------------------------------------------------------------------------|--------|---------------------------------------|---------|
|                                                                        |   | **Case  Management**                  |    | **Document  Management** |   | **Unallocated** |   | **Consolidated** |   |
|                                                                        |   |                                  |    |   |   |   |   |   |   |
| Revenue:                                                                    |   |                                  |    |   |   |   |   |   |   |
| Operating revenue                                                           |   | $                                     | 17,372  |   | $ | 12,224 |   | $ | — |   | $ | 29,596 |   |
| Reimbursed expenses                                                         |   | 1,226                                 |    | 4,086 |   | — |   | 5,312 |   |
| Total revenue                                                               |   | 18,598                                |    | 16,310 |   | — |   | 34,908 |   |
|                                                                        |   |                                  |    |   |   |   |   |   |   |
| Costs and expenses:                                                         |   |                                  |    |   |   |   |   |   |   |
| Direct and administrative costs and  depreciation and software amortization |   | 6,919                                 |    | 12,986 |   | 5,918 |   | 25,823 |   |
| Amortization of identifiable intangible  assets                             |   | 1,381                                 |    | 651 |   | — |   | 2,032 |   |
| Total operating expenses                                                    |   | 8,300                                 |    | 13,637 |   | 5,918 |   | 27,855 |   |
|                                                                        |   |                                  |    |   |   |   |   |   |   |
| Operating income                                                            |   | $                                     | 10,298  |   | $ | 2,673 |   | $ | (5,918 | ) | 7,053 |   |
| Interest expense, net                                                       |   |                                  |    |   |   |   |   | (1,975 | ) |
|                                                                        |   |                                  |    |   |   |   |   |   |   |
| Income from continuing operations before  income taxes                      |   |                                  |    |   |   |   |   | 5,078 |   |
|                                                                        |   |                                  |    |   |   |   |   |   |   |
| Provision for income taxes                                                  |   |                                  |    |   |   |   |   | 2,095 |   |
|                                                                        |   |                                  |    |   |   |   |   |   |   |
| Net income from continuing operations                                       |   |                                  |    |   |   |   |   | $ | 2,983 |   |
|                                                                        |   |                                  |    |   |   |   |   |   |   |
| Total assets                                                                |   | $                                     | 135,708 |   | $ | 53,121 |   | $ | 62,724 |   | $ | 251,553 |   |
| Provisions for depreciation and amortization                                |   | $                                     | 2,410   |   | $ | 731 |   | $ | 469 |   | $ | 3,610 |   |
| Capital expenditures                                                        |   | $                                     | 2,063   |   | $ | — |   | $ | 2,636 |   | $ | 4,699 |   |

 

11

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|                                                                        |   | **Three  Months Ended June 30, 2003** |   |
|-----------------------------------------------------------------------------|--------|---------------------------------------|--------|
|                                                                        |   | **Case  Management**                  |   | **Document  Management** |   | **Unallocated** |   | **Consolidated** |   |
|                                                                        |   |                                  |   |   |   |   |   |   |   |
| Revenue:                                                                    |   |                                  |   |   |   |   |   |   |   |
| Operating revenue                                                           |   | $                                     | 12,347 |   | $ | 3,392 |   | $ | — |   | $ | 15,739 |   |
| Reimbursed expenses                                                         |   | 65                                    |   | 1,280 |   | — |   | 1,345 |   |
| Total revenue                                                               |   | 12,412                                |   | 4,672 |   | — |   | 17,084 |   |
|                                                                        |   |                                  |   |   |   |   |   |   |   |
| Costs and expenses:                                                         |   |                                  |   |   |   |   |   |   |   |
| Direct and administrative costs and  depreciation and software amortization |   | 3,299                                 |   | 2,313 |   | 3,883 |   | 9,495 |   |
| Amortization of identifiable intangible  assets                             |   | 565                                   |   | 411 |   | — |   | 976 |   |
| Total operating expenses                                                    |   | 3,864                                 |   | 2,724 |   | 3,883 |   | 10,471 |   |
|                                                                        |   |                                  |   |   |   |   |   |   |   |
| Operating income                                                            |   | $                                     | 8,548  |   | $ | 1,948 |   | $ | (3,883 | ) | 6,613 |   |
| Interest income, net                                                        |   |                                  |   |   |   |   |   | 3 |   |
|                                                                        |   |                                  |   |   |   |   |   |   |   |
| Income from continuing operations before  income taxes                      |   |                                  |   |   |   |   |   | 6,616 |   |
|                                                                        |   |                                  |   |   |   |   |   |   |   |
| Provision for income taxes                                                  |   |                                  |   |   |   |   |   | 2,741 |   |
|                                                                        |   |                                  |   |   |   |   |   |   |   |
| Net income from continuing operations                                       |   |                                  |   |   |   |   |   | $ | 3,875 |   |
|                                                                        |   |                                  |   |   |   |   |   |   |   |
| Total assets as of December 31, 2003                                        |   | $                                     | 59,518 |   | $ | 26,806 |   | $ | 55,603 |   | $ | 141,927 |   |
| Provisions for depreciation and  amortization                               |   | $                                     | 1,469  |   | $ | 411 |   | $ | 189 |   | $ | 2,069 |   |
| Capital expenditures                                                        |   | $                                     | 582    |   | $ | — |   | $ | 359 |   | $ | 941 |   |

 

12

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|                                                                        |   | **Six Months  Ended June 30, 2004** |    |
|-----------------------------------------------------------------------------|--------|-------------------------------------|---------|
|                                                                        |   | **Case  Management**                |    | **Document  Management** |   | **Unallocated** |   | **Consolidated** |   |
|                                                                        |   |                                |    |   |   |   |   |   |   |
| Revenue:                                                                    |   |                                |    |   |   |   |   |   |   |
| Operating revenue                                                           |   | $                                   | 34,298  |   | $ | 18,290 |   | $ | — |   | $ | 52,588 |   |
| Reimbursed expenses                                                         |   | 1,331                               |    | 7,001 |   | — |   | 8,332 |   |
| Total revenue                                                               |   | 35,629                              |    | 25,291 |   | — |   | 60,920 |   |
|                                                                        |   |                                |    |   |   |   |   |   |   |
| Costs and expenses:                                                         |   |                                |    |   |   |   |   |   |   |
| Direct and administrative costs and  depreciation and software amortization |   | 12,486                              |    | 19,758 |   | 10,902 |   | 43,146 |   |
| Amortization of identifiable intangible  assets                             |   | 2,490                               |    | 1,222 |   | — |   | 3,712 |   |
| Acquisition related                                                         |   | —                              |    | — |   | 2,181 |   | 2,181 |   |
| Total operating expenses                                                    |   | 14,976                              |    | 20,980 |   | 13,083 |   | 49,039 |   |
|                                                                        |   |                                |    |   |   |   |   |   |   |
| Operating income                                                            |   | $                                   | 20,653  |   | $ | 4,311 |   | $ | (13,083 | ) | 11,881 |   |
| Interest expense, net                                                       |   |                                |    |   |   |   |   | (3,463 | ) |
|                                                                        |   |                                |    |   |   |   |   |   |   |
| Income from continuing operations before  income taxes                      |   |                                |    |   |   |   |   | 8,418 |   |
|                                                                        |   |                                |    |   |   |   |   |   |   |
| Provision for income taxes                                                  |   |                                |    |   |   |   |   | 3,433 |   |
|                                                                        |   |                                |    |   |   |   |   |   |   |
| Net income from continuing operations                                       |   |                                |    |   |   |   |   | $ | 4,985 |   |
|                                                                        |   |                                |    |   |   |   |   |   |   |
| Total assets                                                                |   | $                                   | 135,708 |   | $ | 53,121 |   | $ | 62,724 |   | $ | 251,553 |   |
| Provisions for depreciation and  amortization                               |   | $                                   | 4,495   |   | $ | 1,440 |   | $ | 736 |   | $ | 6,671 |   |
| Capital expenditures                                                        |   | $                                   | 3,046   |   | $ | 9 |   | $ | 2,895 |   | $ | 5,950 |   |

 

13

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|                                                                        |   | **Six Months  Ended June 30, 2003** |   |
|-----------------------------------------------------------------------------|--------|-------------------------------------|--------|
|                                                                        |   | **Case  Management**                |   | **Document  Management** |   | **Unallocated** |   | **Consolidated** |   |
|                                                                        |   |                                |   |   |   |   |   |   |   |
| Revenue:                                                                    |   |                                |   |   |   |   |   |   |   |
| Operating revenue                                                           |   | $                                   | 23,762 |   | $ | 5,273 |   | $ | — |   | $ | 29,035 |   |
| Reimbursed expenses                                                         |   | 112                                 |   | 2,012 |   | — |   | 2,124 |   |
| Total revenue                                                               |   | 23,874                              |   | 7,285 |   | — |   | 31,159 |   |
|                                                                        |   |                                |   |   |   |   |   |   |   |
| Costs and expenses:                                                         |   |                                |   |   |   |   |   |   |   |
| Direct and administrative costs and  depreciation and software amortization |   | 6,410                               |   | 3,758 |   | 6,886 |   | 17,054 |   |
| Amortization of identifiable intangible  assets                             |   | 972                                 |   | 686 |   | — |   | 1,658 |   |
| Acquisition related                                                         |   | —                              |   | — |   | 1,485 |   | 1,485 |   |
| Total operating expenses                                                    |   | 7,382                               |   | 4,444 |   | 8,371 |   | 20,197 |   |
|                                                                        |   |                                |   |   |   |   |   |   |   |
| Operating income                                                            |   | $                                   | 16,492 |   | $ | 2,841 |   | $ | (8,371 | ) | 10,962 |   |
| Interest income, net                                                        |   |                                |   |   |   |   |   | 73 |   |
|                                                                        |   |                                |   |   |   |   |   |   |   |
| Income from continuing operations before  income taxes                      |   |                                |   |   |   |   |   | 11,035 |   |
|                                                                        |   |                                |   |   |   |   |   |   |   |
| Provision for income taxes                                                  |   |                                |   |   |   |   |   | 4,482 |   |
|                                                                        |   |                                |   |   |   |   |   |   |   |
| Net income from continuing operations                                       |   |                                |   |   |   |   |   | $ | 6,553 |   |
|                                                                        |   |                                |   |   |   |   |   |   |   |
| Total assets as of December 31, 2003                                        |   | $                                   | 59,518 |   | $ | 26,806 |   | $ | 55,603 |   | $ | 141,927 |   |
| Provisions for depreciation and  amortization                               |   | $                                   | 2,837  |   | $ | 686 |   | $ | 346 |   | $ | 3,869 |   |
| Capital expenditures                                                        |   | $                                   | 1,128  |   | $ | — |   | $ | 1,185 |   | $ | 2,313 |   |

 

14

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#### **NOTE 7:  LONG-TERM OBLIGATIONS**

 

In conjunction with our acquisition of Poorman-Douglas, we replaced our$25.0 million line of credit with a $100.0 million credit facility.  The credit facility consisted of a $45.0million senior term loan, with amortizing quarterly principal payments of $4.5million beginning April 30, 2004, a $25.0 million senior revolving loan, and a$30.0 million subordinated term loan. The senior term loan and revolver mature July 31, 2006.  The subordinated term loan, which had amaturity of December 31, 2006, was paid in full and terminated during ourquarter ended June 30, 2004.  Intereston the credit facility is generally based on a spread over the LIBOR rate.

 

As of June 30, 2004, our borrowings under the syndicated creditfacility totaled $40.1 million, consisting entirely of borrowings under thesenior term loan.  As of June 30, 2004,the interest rate charged on outstanding borrowings was approximately 4.8%.

 

The credit facility is secured by liens on our real property and asignificant portion of our personal property and contains financial covenantsrelated to EBITDA (earnings before interest, provision for income taxes,depreciation and amortization), total debt and interest charges.  We were in compliance with all financialcovenants as of June 30, 2004.

 

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

 

•                  bear interest ata fixed rate of 4%,

•                  are payablequarterly,

•                  under certaincircumstances are convertible into shares of EPIQ common stock at a price of$17.50 per share, and

•                  mature on June15, 2007, subject to extension of maturity to June 15, 2010 at the option ofthe noteholders, as described below.

 

Net proceeds of $47.4 million were used to repay and terminate oursubordinated term loan described above and to pay in full our revolving loanbalance.  The revolving loan was notterminated and, as of June 30, 2004, the full $25 million of the revolving loanremained available for our use.

 

The note holders’ right to convert the notes is contingent on themarket price of our common stock as follows:

 

•                  through January14, 2005, the shares are convertible only if the arithmetic average of theprice of our common stock equals or exceeds $19.25 on any ten consecutivetrading days or if the price of our common stock is less than $10.75 on anyfive consecutive trading days;

•                  after January14, 2005, the shares are convertible only if the arithmetic average of the priceof our common stock equals or exceeds $19.25 on any five consecutive tradingdays or if the price of our common stock is less than $10.75 on any fiveconsecutive trading days.

 

If the contingency were satisfied and all shares were converted, thenotes would convert into approximately 2,857,000 shares of our commonstock.  If we change our capitalstructure (for example, through a stock dividend or stock split) while thenotes are outstanding, the conversion price will be adjusted on a consistentbasis and, accordingly, the number of shares of common stock we would issue onconversion would be adjusted.

 

The holders of the notes have the right to extend the maturity of thecontingent convertible notes for a period not to exceed three years.  The right to extend the maturity of the noterepresents an embedded option.  Theembedded option has a current value of approximately $1.2 million.  On our balance sheet, our obligation relatedto the embedded option has been included as a component of the convertible notepayable.  The embedded option will berevalued as of the end of each period and the change in value included as acomponent of our operating earnings.

 

On June 30, 2004, we entered into a capitallease to finance the purchase of operating software.  The capital lease has been recorded as a long-term obligation inthe amount of $2.7 million, with $1.0 million classified as a currentobligation, and the purchased software, also in the amount of $2.7 million, is includedon the balance sheet as a component of property and equipment.  As this was a noncash investing andfinancing activity, these amounts are not included on our CondensedConsolidated Statement of Cash Flows.  Paymentson the capital lease will be included in our Condensed Consolidated Statementof Cash Flows during the period in which they are made.

 

15

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During July 2004, we entered into a newcredit facility with KeyBank National Association as administrative agent.  This facility consists of a$25.0 million senior term loan, with amortizing quarterly principal payments of$1.6 million beginning September 30, 2004, and a $50.0 million senior revolvingloan.  During the term of the loan wehave the right, subject to compliance with our covenants, to increase thesenior revolving loan to $75.0 million. The senior term loan and the senior revolving loan mature June 30,2008.  Interest on the credit facilityis generally based on a spread over the LIBOR rate.

 

This new credit facility is secured by liens on our real property and asignificant portion of our personal property and contains financial covenantsrelated to EBITDA, total debt, senior debt, fixed charges and working capital.

 

On inception of the new credit facility, we borrowed the $25.0 millionunder the senior term loan and $8.0 million of the revolving loan.  We used these proceeds plus available cashon hand to pay in full the borrowings outstanding under our prior creditfacility, and that credit facility was terminated.  As a result, as of July 20, 2004, the inception date of our newcredit facility, our borrowings included $50.0 million from the contingentconvertible subordinated notes, $25.0 million under the new credit facility’ssenior term loan, $8.0 million under the new credit facility’s senior revolvingloan, and approximately $5.9 million of obligations related to capitalizedleases and deferred acquisition price.

 

Our long-term obligations, including creditfacility debt outstanding as of June 30, 2004, convertible debt, deferredacquisition costs, and capitalized leases, mature as follows for each twelvemonth period ending June 30 (in thousands):

 

| 2005  |   | $      | 19,440 |   |
|-------|--------|--------|--------|--------|
| 2006  |   | 20,513 |   |
| 2007  |   | 55,536 |   |
| 2008  |   | 491    |   |
| Total |   | $      | 95,980 |   |

 

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#### **NOTE 8:  OPERATING LEASES**

 

We have non-cancelable operating leases for office space at severallocations expiring at various times through 2015.  Each of the leases requires us to pay all executory costs(property taxes, maintenance and insurance). Additionally, we have non-cancelable operating leases for officeequipment and automobiles expiring through December 2008.

 

Future minimum lease payments during each of the twelve months endingJune 30 are as follows (in thousands):

 

| 2005                         |   | $     | 2,724  |   |
|------------------------------|--------|-------|--------|--------|
| 2006                         |   | 2,497 |   |
| 2007                         |   | 2,335 |   |
| 2008                         |   | 1,931 |   |
| 2009                         |   | 1,694 |   |
| Thereafter                   |   | 8,847 |   |
| Total minimum lease payments |   | $     | 20,028 |   |

 

Expense related to operating leases was approximately $0.6 million and$0.3 million for the three months ended June 30, 2004 and 2003, respectively,and approximately $1.1 million and $0.6 million for the six months ended June30, 2004 and 2003, respectively.

 

**NOTE 9: DISCONTINUED OPERATIONS**

 

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

 

On April 30, 2004, we sold our infrastructure software business to aprivate investor group with expertise in file transfer technology.  As consideration, we received $0.5 millionin cash and a $1.1 million note receivable bearing 6.5% interest and withmonthly payments due through July 31, 2005. The buyer also acquired certain assets and assumed certain liabilitiesrelated to our infrastructure business. During the three and six months ended June 30, 2004, we recognized again related to this sale of approximately $1.0 million, net of tax.

 

The disposal of the infrastructure business represents a discontinuedoperation.  Accordingly, the assets andliabilities of this business segment have been reclassified in the accompanyingCondensed Consolidated Balance Sheets as held for sale.  Revenues, cost of sales, and operatingexpenses related to this segment, as well as the gain on sale of this segment,have been reclassified as “Discontinued Operations” in the accompanyingCondensed Consolidated Statements of Income for all periods presented.

 

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

 

**Condensed balance sheets of discontinuedoperations:**

 
|                                                                                             |   | **June 30,  2004** |   | **December  31,  2003** |   |
|--------------------------------------------------------------------------------------------------|--------|--------------------|--------|-------------------------|--------|
| **ASSETS**                                                                                       |   |               |   |                    |   |
| **CURRENT ASSETS**:                                                                              |   |               |   |                    |   |
| Cash                                                                                             |   | $                  | — |                    | $      | 714 |   |
| Accounts receivable, trade, less allowance  for doubtful accounts of $16 as of December 31, 2003 |   | —             |   | 258                     |   |
| Prepaid expenses                                                                                 |   | —             |   | 82                      |   |
| Property and equipment, net                                                                      |   | —             |   | 24                      |   |
| Software development costs, net                                                                  |   | —             |   | 226                     |   |
| Total Current Assets                                                                             |   | —             |   | 1,304                   |   |
|                                                                                             |   |               |   |                    |   |
| **LIABILITIES**                                                                                  |   |               |   |                    |   |
| **CURRENT LIABILITIES:**                                                                         |   |               |   |                    |   |
| Accounts payable and accrued expenses                                                            |   | —             |   | 173                     |   |
| Deferred revenue                                                                                 |   | —             |   | 964                     |   |
| Total Current Liabilities                                                                        |   | —             |   | 1,137                   |   |
|                                                                                             |   |               |   |                    |   |
| **NET ASSETS OF DISCONTINUED OPERATIONS**                                                        |   | $                  | — |                    | $      | 167 |   |

 

**Net revenue and pre-tax income (loss) fromdiscontinued operations:**

 
|                                                |   | **Three  Months Ended June 30,** |   |
|-----------------------------------------------------|--------|----------------------------------|--------|
|                                                |   | **2004**                         |   | **2003** |   |
|                                                |   |                             |   |   |   |
| Net revenue from discontinued operations            |   | $                                | 281    |   | $ | 478 |   |
|                                                |   |                             |   |   |   |
| Pre-tax income (loss) from discontinued  operations |   | $                                | 1,667  |   | $ | (457 | ) |

 

**Net revenue and pre-tax income (loss) fromdiscontinued operations:**

 
|                                                |   | **Six Months  Ended June 30,** |   |
|-----------------------------------------------------|--------|--------------------------------|--------|
|                                                |   | **2004**                       |   | **2003** |   |
|                                                |   |                           |   |   |   |
| Net revenue from discontinued operations            |   | $                              | 661    |   | $ | 1,038 |   |
|                                                |   |                           |   |   |   |
| Pre-tax income (loss) from discontinued  operations |   | $                              | 1,231  |   | $ | (1,058 | ) |

 

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### **ITEM 2.**                                                  Management’sDiscussion and Analysis of Financial Condition and Results of Operations.

### ** **

### **Overview**

 

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

 

We have two operating segments: case management and documentmanagement.

 

***Case Management Segment***

 

Our case management segment generates revenue primarily through thefollowing integrated technology-based solutions.  Case management support for client engagements generally lastsseveral years and has a revenue profile that typically includes a recurringcomponent.

 

•                  An integratedsolution of a proprietary technology platform and professional services thatfacilitates the administration of class action and mass tort proceedings andChapter 11 bankruptcy restructurings.

 

•                  *TCMS*®, an integrated solution, including aproprietary software product, computer hardware, and support services,installed in Chapter 7 bankruptcy trustee offices to facilitate the efficientmanagement of asset liquidations, creditor distributions, and governmentreporting.

 

•                  *CasePowe*r®, a proprietary softwaredesigned to enable Chapter 13 bankruptcy trustees to manage efficiently debtorpayments, creditor distributions and government reporting.

 

•                  Databaseprocessing, maintenance and management products and services.

 

•                  Databaseconversions and software upgrades.

 

•                  Professional andsupport services, including case management, claims processing, claimsreconciliation, and customized programming and technology services.

 

•                  Call centersupport.

 

***Document ManagementSegment***

 

Our document management segment generates revenue primarily through thefollowing technology-based solutions. Document management revenue is generally less recurring in nature due tothe unpredictability of the frequency, timing and magnitude of the clients’business requirements.

 

•                  Legal noticingservices.

 

•                  Reimbursementfor costs incurred related to postage on mailing services.

 

•                  Media campaignand advertising management.

 

•                  Document custodyservices.

 

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**Critical Accounting Policies**

 

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

 

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

 

•                  A monthly feefrom financial institutions based on a percentage of total liquidated assets ondeposit and on the number of trustees.

 

•                  Fees fordatabase conversions, database processing, maintenance and software upgrades.

 

•                  Monthly revenuebased on the number of cases in a database.

 

•                  Feesbased on the number of claims in a case.

 

•                  Fees forservices, including technology services, claims reconciliation, documentprinting, noticing, balloting, and other professional services.

 

***Business combinationaccounting.*** We have acquired a number of businesses during the last several years,and we may acquire additional businesses in the future.  Business combination accounting, oftenreferred to as purchase accounting, requires us to determine the fair value ofall assets acquired, including identifiable intangible assets, and liabilitiesassumed.  The cost of the acquisition isallocated to the assets acquired and liabilities assumed in amounts equal tothe fair value of each asset and liability, and any remaining acquisition costis classified as goodwill.  Thisallocation process requires extensive use of estimates and assumptions,including estimates of future cash flows to be generated by the acquiredassets.  Identifiable intangible assets,such as customer lists and covenants not to compete, are amortized on astraight-line basis over the intangible asset’s estimated useful life.  The estimated useful life of amortizableidentifiable assets range from two to 14 years.  Accordingly, the acquisition cost allocation has had asignificant impact on our current operating results and will have a significantimpact on our future operating results.

 

***Goodwill*.**  We assess goodwill, which is not subject toamortization, for impairment as of each July 31 and also at any other date whenevents or changes in circumstances indicate that the carrying value of theseassets may exceed their fair 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 events or circumstances, including a decision to hold anasset or group of assets for sale, a change in strategic direction, or a changein the competitive environment in which any reporting unit operates, couldadversely affect the fair value of one or more reporting units.  During November 2003, we determined that ourinfrastructure software segment was no longer aligned with our long-termstrategic objectives and we developed a plan to sell this segment within ayear.  As a result, we recognized a pre-taximpairment charge of approximately $3.8 million related to goodwill.

 

The estimate of fair value is highly subjective and requiressignificant judgment.  If we determinethat the fair value of any reporting unit is less than the reporting unit’scarrying value, then we will recognize an impairment charge.  If goodwill on our balance sheet becomesimpaired during a future period, the resulting impairment charge could have amaterial impact on our results of operations and financial condition.  Our unimpaired, recognized goodwill totaled$148.4 million as of June 30, 2004.

 

***Identifiableintangible assets. ***Eachperiod we evaluate whether events and circumstances warrant a revision to theremaining estimated useful life of each identifiable intangible asset.  If events and circumstances warrant a changeto the estimate of an identifiable intangible asset’s remaining useful life,then the remaining carrying amount of the identifiable intangible asset wouldbe amortized prospectively over that revised remaining useful life.  Furthermore, information developed duringour

 

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annual assessment, or other events and circumstances, may indicate thatthe fair value of one or more identifiable intangible assets is less than theidentifiable intangible asset’s carrying value and would result in recognitionof an impairment charge.  DuringNovember 2003, we determined that our infrastructure software segment was nolonger aligned with our long-term strategic objectives and we developed a planto sell this segment within a year.  Asa result, we recognized a pre-tax impairment charge of approximately $0.9million related to identifiable intangible assets.

 

A change in the estimate of the remaining life of one or moreidentifiable intangible assets or the impairment of one or more identifiableintangible assets could have a material impact on the Company’s results ofoperations and financial condition.  Ouridentifiable intangible assets’ carrying value, net of amortization, was $28.1million as of June 30, 2004.

 

***Internal softwaredevelopment costs***.  Certain internal software development costs incurred in thecreation of computer software products are capitalized once technologicalfeasibility has been established.  Priorto the completion of detailed program design, development costs are expensedand are reflected as operating expense on the statements of income.  Determination that technological feasibilityhas been established requires management judgment, and that judgment affectsthe allocation between capitalization and current period expense recognition ofcosts incurred.  Capitalized internalsoftware development costs are amortized based on the greater of:

 

•                  theratio of current revenue to current and estimated future revenue for eachproduct, or

 

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

 

Management periodically reevaluates its previous estimated futurerevenue for each product and the remaining estimated economic life of the product.  Our forecast of estimated future revenue mayaffect the amount of amortization expense recognized during any period.  Our capitalized internal softwaredevelopment costs, net of accumulated amortization, totaled $6.0 million as ofJune 30, 2004.

 

**Results of Operations**

 

### **Management Overview**

Our operations consist primarily of integrated technology-basedproducts and services for fiduciary management and claims administrationapplications. Our solutions enable clients to optimize the administration of largeand complex bankruptcy, class action, mass tort, and other similar legalproceedings.  We have two operatingsegments: case management and document management.

### ** **

Our case management segment generates revenue primarily throughintegrated technology-based products and services for class action, mass tortand bankruptcy proceedings that support client engagements that generally lastseveral years and has a revenue profile that typically includes a recurringcomponent. Our document management segment generates revenue primarily throughlegal noticing services, reimbursement for costs incurred related to postage onmailing services, media campaign and advertising management and documentcustody services.  Document managementrevenue is generally less recurring in nature due to the unpredictability ofthe frequency, timing and magnitude of the clients’ business requirements.

 

The number of new bankruptcy filings each year may vary based on thelevel of consumer and business debt, the general economy, interest rate levelsand other factors.  We believe the levelof consumer and business debt is among the most important indicators of futurebankruptcy filings.  The most recentavailable Federal Reserve *Flow of Funds Accounts of the United States*,dated June 10, 2004, reported increases in both consumer and business debtoutstanding as compared with the same period of the prior year.

 

We have acquired a number of businesses during the past several years,and we may acquire additional businesses in the future.  In January 2003, we acquired BSI to expandour offerings to include an integrated solution of a proprietary technologyplatform and professional services for Chapter 11 restructurings. In January2004, we acquired Poorman-Douglas and expanded our product and serviceofferings to include class action, mass tort, and other similar legalproceedings.

 

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**Resultsof Operations for the Six Months Ended June 30, 2004 Compared with the SixMonths Ended June 30, 2003**

 

**ConsolidatedResults**

 

### ***Revenue***

Total revenue of $60.9 million for the six months ended June 30, 2004represents an approximate 96% increase compared to $31.2 million of revenue forthe same period in the prior year.  Withour acquisition of Poorman-Douglas, revenue related to reimbursed expenses,such as postage pertaining to document management services, increasedsignificantly.  We reflect the revenuefrom these reimbursed expenses as a separate line item on our CondensedConsolidated Statements of Income.  Whilereimbursed revenues and expenses may fluctuate significantly from quarter toquarter, these fluctuations have a minimal effect on our operating income as werealize little or no margin from this revenue. Revenue exclusive of reimbursed expenses, which we refer to as operatingrevenue, increased $23.6 million, or approximately 81%, to $52.6 million forthe six months ended June 30, 2004 compared to $29.0 million for the sameperiod in the prior year.  All revenueis directly related to a segment and changes in revenue by segment arediscussed below.

 

### ***Costsand Expenses***

Direct costs, administrative costs, and depreciation and softwareamortization increased $26.0 million, or approximately 153%, to $43.1 millionfor the six months ended June 30, 2004 compared with $17.1 million for the sameperiod in the prior year.  This increaseprimarily results from the inclusion of Poorman-Douglas’ expenses subsequent tothe acquisition date and the inclusion of six months of BSI’s expenses for thesix months ended June 30, 2004 compared to five months of BSI expenses for thesix months ended June 30, 2003. As a result of the Poorman-Douglas acquisition,we realized a higher mix of document management revenue relative to casemanagement revenue than during the same period in the prior year, whichresulted in an increase in reimbursed expenses.  In addition, as a result of our growth, corporate administrativecosts increased due to increased travel expense related to additional locationsand increased insurance coverage due to business expansion.

 

Amortization of identifiable intangible assets increased $2.0 millionto $3.7 million for the six months ended June 30, 2004 compared with $1.7million for the same period in the prior year. All identifiable intangible assets are directly related to a segment andchanges in amortization of identifiable intangible assets by segment arediscussed below.

 

Acquisition related expenses of $2.2 million for the six months endedJune 30, 2004 and $1.5 million for the six months ended June 30, 2003, resultfrom non-capitalizable expenses consisting of executive bonuses, legal,accounting and valuation services, and travel incurred in connection withpotential and completed transactions.

 

***Interest***

We incurred net interest expense of $3.5 million for the six monthsended June 30, 2004 compared with net interest income of $0.1 million for thesix months ended June 30, 2003.  Theincrease in interest expense resulted primarily from borrowings to finance ouracquisition of Poorman-Douglas.  Interestexpense for the six months ended June 30, 2004 includes $1.5 million of loanfee amortization charges.

 

**Business Segments**

 

***Revenue***

 

Case management operating revenue increased $10.5 million, orapproximately 44%, to $34.3 million for the six months ended June 30, 2004compared to $23.8 million for the six months ended June 30, 2003.  This increase primarily results from theinclusion of operating revenue related to the Poorman-Douglas acquisitionsubsequent to the acquisition date. Other factors that contributed to the increase in our case managementoperating revenue include an increase in bankruptcy trustee based revenue andan increase in professional services related to Chapter 11 cases, partly offsetby a decrease in professional service fees from Bank of America.

 

Document management operating revenue increased $13.0 million, orapproximately 247%, to $18.3 million for the six months ended June 30, 2004compared to $5.3 million for the six months ended June 30, 2003.  Document management revenue for reimbursedexpenses of $7.0 million for the six months ended June 30, 2004 increased 248%compared with the same period in the prior year. The increase in total revenuefor the document management segment was primarily the result of the acquisitionof Poorman-Douglas subsequent to the acquisition date.  Exclusive of Poorman-Douglas revenues, ourdocument management operating revenue declined slightly due primarily to adecrease in bankruptcy noticing services. Document management revenues will fluctuate from quarter to quarterbased on document management business requirements delivered during eachquarter.

 

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***OperatingExpense***

 

Case management direct and administrative expenses, includingdepreciation and software amortization, of $12.5 million increased $6.1million, or approximately 95%, for the six months ended June 30, 2004 comparedwith $6.4 million for the same period in the prior year.  This increase primarily results from theinclusion of Poorman-Douglas’ expenses subsequent to the acquisition date.

 

Document management direct and administrative expenses, includingdepreciation and software amortization, increased $16.0 million to $19.8million for the six months ended June 30, 2004 compared with $3.8 million forthe same period in the prior year.  Thisincrease primarily results from the inclusion of Poorman-Douglas’ expenses,including reimbursed expenses, subsequent to the acquisition date.  Document management direct expenses includereimbursed expenses and other operating expenses which are more variable thancase management direct expenses. Exclusive of Poorman-Douglas’ expenses, our document management expensesdeclined slightly due primarily to a decrease in bankruptcy noticingservices.  Document management expenseswill fluctuate from quarter to quarter based on document management businessrequirements delivered during each quarter.

 

Both the case management and document management segments haveidentifiable intangible assets. Amortization of case management’s identifiable intangible assetsincreased $1.5 million to $2.5 million for the six months ended June 30, 2004compared with $1.0 million for the same period in the prior year.  Amortization of document management’sidentifiable intangible assets increased $0.5 million to $1.2 million for thesix months ended June 30, 2004 compared with $0.7 million for the same periodin the prior year.  For both segments,this increase primarily relates to the amortization expense related to the acquiredintangible assets resulting from the Poorman-Douglas transaction and theFebruary 2004 commencement of amortization related to the BSI trade name.  We also incurred six months of amortizationexpense related to the acquired intangible assets resulting from the BSIacquisition compared with only five months of such amortization expense duringthe same period of the prior year.  Note5 to the Condensed Consolidated Financial Statements section of this reportprovides a summary of the total identified intangible assets, the scheduledamortization expense and the scheduled amortization periods for thePoorman-Douglas and BSI acquisitions.

 

**Results of Operations for the Three MonthsEnded June 30, 2004 Compared with the Three Months Ended June 30, 2003**

 

### **Consolidated Results**

 

### ***Revenue***

Total revenue of $34.9 million for the three months ended June 30, 2004represents an approximate 104% increase compared to $17.1 million of revenuefor the same period in the prior year. With our acquisition of Poorman-Douglas, revenue related to reimbursedexpenses, such as postage pertaining to document management services, increasedsignificantly.  We reflect the revenuefrom these reimbursed expenses as a separate line item on our CondensedConsolidated Statements of Income. While reimbursed revenues and expenses may fluctuate significantly fromquarter to quarter, these fluctuations have a minimal effect on our operatingincome as we realize little or no margin from this revenue.  Revenue exclusive of reimbursed expenses, whichwe refer to as operating revenue, increased $13.9 million, or approximately88%, to $29.6 million for the three months ended June 30, 2004 compared to$15.7 million for the same period in the prior year.  All revenue is directly related to a segment and changes inrevenue by segment are discussed below.

 

### ***Costsand Expenses***

Direct and administrative costs increased $16.3 million, orapproximately 172%, to $25.8 million for the three months ended June 30, 2004compared with $9.5 million for the same period in the prior year.  This increase primarily results from theinclusion of Poorman-Douglas’ direct and administrative expenses subsequent tothe acquisition date.  As a result ofthe Poorman-Douglas acquisition, we realized a higher mix of document managementrevenue relative to case management revenue than during the same period in theprior year, which resulted in an increase in reimbursed expenses.  In addition, as a result of our growth,corporate administrative costs increased due to increased travel expenserelated to additional locations and increased insurance coverage due tobusiness expansion.

 

Amortization of identifiable intangible assets increased $1.0 millionto $2.0 million for the three months ended June 30, 2004 compared with $1.0million during the same period in the prior year.  All identifiable intangible assets are directly related to asegment and changes in amortization of identifiable intangible assets bysegment are discussed below.

 

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***Interest***

We incurred net interest expense of $2.0 million for the three monthsended June 30, 2004, an increase of $2.0 million compared with the three monthsended June 30, 2003.  The increase ininterest expense resulted primarily from borrowings to finance our acquisitionof Poorman-Douglas.  Interest expenseincludes $0.9 million of loan fee amortization charges.

 

**Business Segments**

 

***Revenue***

 

Case management operating revenue increased $5.1 million, orapproximately 41%, to $17.4 million for the three months ended June 30, 2004compared to $12.3 million for the three months ended June 30, 2003.  This increase primarily results from theinclusion of operating revenue related to the Poorman-Douglas acquisition subsequentto the acquisition date.  Exclusive ofPoorman-Douglas’ operating revenues, our case management revenues declinedslightly as we provided fewer professional services to Bank of America, partlyoffset by an increase in bankruptcy trustee based revenue.

 

Document management operating revenue increased $8.8 million, orapproximately 260%, to $12.2 million for the three months ended June 30, 2004compared to $3.4 million for the three months ended June 30, 2003.  Document management revenue for reimbursedexpenses of $4.1 million increased 219% from the prior year quarter. Theincrease in total revenue for the document management segment was primarily theresult of the acquisition of Poorman-Douglas subsequent to the acquisitiondate.  Exclusive of Poorman-Douglas’operating revenues, our document management operating revenue declined $0.6million primarily due to a decrease in bankruptcy noticing services.  Document management revenues will fluctuatefrom quarter to quarter based on document management business requirementsdelivered during each quarter.

 

***OperatingExpense***

 

Case management direct and administrative expenses, includingdepreciation and software amortization, of $6.9 million increased $3.6 million,or approximately 110%, for the three months ended June 30, 2004 compared with$3.3 million for the same period in the prior year.  This increase primarily results from the inclusion ofPoorman-Douglas’ expenses subsequent to the acquisition date.

 

Document management direct and administrative expenses, includingdepreciation and software amortization, of $13.0 million increased $10.7million, or approximately 461%, for the three months ended June 30, 2004compared with $2.3 million for the same period in the prior year.  This increase primarily results from theinclusion of Poorman-Douglas’ expenses, including reimbursed expenses,subsequent to the acquisition date. Exclusive of Poorman-Douglas’ expenses,these document management expenses declined $0.5 million primarily due to adecrease in bankruptcy noticing services. Document management direct expenses include reimbursed expenses andother operating expenses which are more variable in nature than case managementdirect expenses.  Document managementexpenses will fluctuate from quarter to quarter based on document managementbusiness requirements delivered during each quarter.

 

Both the case management and document management segments haveidentifiable intangible assets. Amortization of case management’s identifiable intangible assetsincreased $0.8 million to $1.4 million for the three months ended June 30, 2004compared with $0.6 million for the same period in the prior year.  Amortization of document management’sidentifiable intangible assets increased $0.2 million to $0.6 million for thethree months ended June 30, 2004 compared with $0.4 million for the same periodin the prior year.  For both segments,this increase primarily relates to the amortization expense related to theacquired intangible assets resulting from the Poorman-Douglas transaction andthe February 2004 commencement of amortization related to the BSI tradename.  Note 5 to the CondensedConsolidated Financial Statements section of this report provides a summary ofthe total identified intangible assets, the scheduled amortization expense andthe scheduled amortization periods for the Poorman-Douglas and BSIacquisitions.

 

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**Liquidityand Capital Resources**

 

***OperatingActivities***

 

During the six months ended June 30, 2004, our operating activitiesprovided net cash of $15.3 million.  Theprimary sources of cash from operating activities were net income of $5.7million and adjustments for non-cash charges and credits, primarilydepreciation and amortization, of $9.2 million.

 

Changes in operating assets and liabilities as a direct result ofassets acquired or liabilities assumed have been excluded from our CondensedConsolidated Statements of Cash Flows. However, subsequent to the Poorman-Douglas acquisition, cash flowsrelated to these acquired assets and assumed liabilities are reflected in ourCondensed Consolidated Statements of Cash Flows.  For example, accounts payable and accrued expenses assumed as apart of the transaction are not reflected as a source of cash.  The subsequent payment of assumed accountspayable and accrued expenses are, however, reflected as an operating use ofcash.

 

Changes in operating assets and liabilities generated net cash of $0.3million in cash.  The most significantsource of cash from changes in operating assets and liabilities was a reductionin accounts receivable, primarily as a result of the collection of certainlarge receivables related primarily to class action customers.  The timing of the receipt of class actionreceivables may be determined by status of the legal proceedings and, as aresult, significant balances may accumulate prior to payment.  The most significant use of cash related tochanges in operating assets and liabilities was our payment of approximately$8.0 million of liabilities assumed in our acquisition of Poorman-Douglas thatwere the direct result of acquisition-related transactions, primarilywithholding taxes resulting from the vesting of restricted Poorman-Douglasstock concurrent with the acquisition, and that were due and payable shortlyafter the transaction closed.

 

***InvestingActivities***

 

Our most significant investing use of cash was the acquisition ofPoorman-Douglas.  Net of $2.8 millioncash acquired in the acquisition, we used cash of approximately $113.1 millionrelated to this transaction.  During thesix months ended June 30, 2004, we used cash of approximately $3.2 million topurchase property and equipment, primarily related to computer equipment usedby our trustee clients, at their various locations.  Enhancements to our existing software and development of newsoftware is essential to our continued growth and, during the six months endedJune 30, 2004, we used cash of approximately $0.9 million to fund internalcosts related to development of computer software for which technologicalfeasibility has been established. During April 2004, we completed the sale of our discontinued operationfor cash and a note receivable payable in installments over 15 months.  During the six months ended June 30, 2004,we realized cash proceeds of $0.7 million related to this transaction.

 

***FinancingActivities***

 

In conjunction with our acquisition of Poorman-Douglas, we replaced our$25.0 million line of credit with a $100.0 million credit facility.  The credit facility consisted of a $45.0million senior term loan, with amortizing quarterly principal payments of $4.5million beginning April 30, 2004, a $25.0 million senior revolving loan, and a$30.0 million subordinated term loan. At inception of this facility, we borrowed approximately $92.0 millionthat, in combination with available cash on hand, was used to finance ouracquisition of Poorman-Douglas.  Duringour second quarter, we borrowed an additional $3.5 million under the revolvingloan facility for general operating purposes which we also repaid during thesecond quarter.

 

During June 2004, we issued $50.0 million of contingent convertiblesubordinated notes.  These contingentconvertible notes bear interest at a fixed rate of 4%, payable quarterly, undercertain circumstances are convertible into shares of EPIQ common stock at aprice of $17.50 per share, and mature on June 15, 2007, subject to extension ofmaturity to June 15, 2010 at the option of the noteholders.  Net proceeds of approximately $47.4 millionwere used to repay and terminate our subordinated term loan and to pay in fullour revolving loan.

 

Subsequent to June 30, 2004, we entered intoa new syndicated credit facility with KeyBank National Association asadministrative agent.  This facilityconsists of a $25.0 million senior term loan, with amortizingquarterly principal payments of $1.6 million beginning September 30, 2004 and a$50.0 million senior revolving loan. During the term of the loan we have the right, subject to compliancewith our covenants, to increase the senior revolving loan to $75 million.  The senior term loan and the seniorrevolving loan mature June 30, 2008.

 

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On inception of the new credit facility, we borrowed the $25.0 millionterm loan and $8.0 million of the revolving loan.  We used these proceeds to pay in full the borrowings outstandingunder our prior credit facility, and that credit facility was terminated.  In conjunction with the termination of ourprior credit facility, during our quarter ending September 30, 2004, weanticipate we will incur a non-cash charge of approximately $1.0 million towrite-off the unamortized portion that facility’s loan fees.

 

As of July 20, 2004, the inception date of our new syndicated creditfacility, our borrowings included $50.0 million from the subordinatedcontingent convertible debt, $25.0 million under the new credit facility’ssenior term loan, $8.0 million under the new credit facilities senior revolvingloan, and approximately $5.9 million of obligations related to capitalizedleases and deferred acquisition price.

 

We believethat the funds generated from operations plus amounts available under our newcredit facility’s senior revolving loan will be sufficient over the next yearto finance currently anticipated working capital requirements, software andproperty and equipment expenditures, payments for contractual obligations,interest payments due on our credit facility borrowings, and the requiredquarterly principal payments of $1.6 million on our senior term loan.

 

We continue toexplore acquisition opportunities and may use the availability under ourrevolving loan and cash on hand to finance a future acquisition.  If the acquisition price exceeds thecapacity of these sources of financing, we may decide to issue equity,restructure our credit facility, partly finance the acquisition with a notepayable, or some combination of the preceding. Covenants contained in our credit facility may limit our ability toconsummate an acquisition.

 

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***ContractualObligations***

 

The following table sets forth a summary of our contractual obligationsas of June 30, 2004.

 
|                                          |   | **Payments  Due By Period** |    |
|-----------------------------------------------|--------|-----------------------------|---------|
|                                          |   | **(In  Thousands)**         |    |
| **Contractual  Obligation**                   |   | **Total**                   |    | **Less than  1 Year** |   | **1 - 3  Years** |   | **3 - 5  Years** |   | **More Than  5 Years** |   |
| Long-term debt and future  accretion (1) |   | $                           | 93,545  |   | $ | 18,556 |   | $ | 74,396 |   | $ | 593 |   | $ | — |   |
| Employment agreements                         |   | 6,073                       |    | 1,752 |   | 3,551 |   | 770 |   | — |   |
| Capital lease obligations                     |   | 2,733                       |    | 960 |   | 1,773 |   | — |   | — |   |
| Operating leases                              |   | 20,028                      |    | 2,724 |   | 4,832 |   | 3,625 |   | 8,847 |   |
| Total                                         |   | $                           | 122,379 |   | $ | 23,992 |   | $ | 84,552 |   | $ | 4,988 |   | $ | 8,847 |   |

 

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(1)          A portion of the BSI purchase price was paidin the form of a non-interest bearing note, which was discounted using animputed rate of 5% per annum.  The discountis accreted over the life of the note and each period’s accretion is added tothe note’s principal.  The amountincluded in the contractual obligation table includes the note’s principal, asreflected on our June 30, 2004 balance sheet, plus all future accretion.

 

**Recent Accounting Pronouncements**

 

The EITF (Emerging Issues Task Force) reached a consensus regardingIssue No. 03-06, *Participating Securities and the Two-Class Method under FASB StatementNo. 128*.  The consensusclarified what is meant by a “participating security,” provided guidance onapplying the two-class method for computing EPS, and required affectedcompanies to retroactively restate EPS amounts presented.  The consensus is effective for reportingperiods beginning after March 31, 2004. Adoption of EITF Issue No. 03-06 did not have a material effect on ourconsolidated Financial Statements.

 

The EITF currently is addressing when the dilutive effect ofcontingently convertible debt instruments should be included in dilutedearnings per share.  The EITF’stentative conclusion is that contingently convertible debt instruments shouldbe included in diluted earnings per share computations regardless of whetherthe market price trigger has been met. Although we cannot predict the future effect that this conclusion willhave on our diluted earnings per share calculation, it will likely have adilutive affect.

 

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***Forward-LookingStatements***

 

In this report, in other filings with the SEC and in press releases andother public statements by our officers throughout the year, EPIQ Systems, Inc.makes or will make statements that plan for or anticipate the future.  These forward-looking statements include statementsabout our future business plans and strategies, and other statements that arenot historical in nature.  Theseforward-looking statements are based on our current expectations.  Many of these statements are found in the **“Management’sDiscussion and Analysis of Financial Conditions and Results of Operations”**section of this report.

 

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

 

Forward-looking statements may be identified by words or phrases suchas “believe,” “expect,” “anticipate,” “should,” “planned,” “may,” “estimated,”“goal,” “objective” and “potential.” Section 27A of the Securities Act of 1933, as amended and Section 21E ofthe Securities Exchange Act of 1934, as amended, provide a “safe harbor” forforward-looking statements. Because forward-looking statements involve futurerisks and uncertainties, listed below are a variety of factors that could causeactual results and experience to differ materially from the anticipated resultsor other expectations expressed in the Company’s forward-looking statements.  These factors include, but are not limitedto, (1) any material changes in our total number of bankruptcy trustees andcases, (2) any material changes in our Chapter 7 deposits, the servicesrequired by our Chapter 11, Chapter 13, class action or mass tort cases, or thenumber of cases processed by our Chapter 13 bankruptcy trustee customers, (3)material changes in the number of bankruptcy filings, class action filings ormass tort actions each year, (4) our reliance on and the previously-announcedchange in our marketing arrangement and pricing arrangements with Bank ofAmerica for Chapter 7 revenue, (5) future bankruptcy, class action, or masstort legislation, (6) risks associated with the integration of acquisitionsinto our existing business operations, (7) risks associated with thesignificant new indebtedness we have incurred in 2004, (8) a decline in thebusiness of Poorman-Douglas Corporation, and (9) other risks detailed from timeto time in our SEC filings, including our annual report on Form 10-K. Inaddition, there may be other factors not included in our SEC filings that maycause actual results to differ materially from any forward-looking statements.We undertake no obligations to update any forward-looking statements containedherein to reflect future events or developments.

 

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**ITEM 3.****                                                     Quantitativeand Qualitative Disclosures About Market Risk.**

 

Market risk refers to the risk that a changein the level of one or more market prices, interest rates, indices,volatilities, correlations or other market factors such as liquidity, willresult in losses for a certain financial instrument or group of financialinstruments.  During the six monthsended June 30, 2004, our exposure to interest rate risk increasedsignificantly.  We have a fixed, 4%interest rate on our $50.0 million subordinated contingent convertiblenotes.  Interest on borrowings underboth the syndicated credit facility in existence as of June 30, 2004 and ournew syndicated credit facility is computed at a variable rate based on theLIBOR rate.  A 1% increase in the LIBORrate would have increased our annual interest expense on variable rateborrowings outstanding as of June 30, 2004 by approximately $0.4 million.  We do not currently use any derivativefinancial instruments to modify our interest rate risks.

 

**ITEM 4.****                                                     Controlsand Procedures.**

 

An evaluation was carried out by the Company’s Chief Executive Officerand Chief Financial Officer of the effectiveness of the design and operationsof the Company’s disclosure controls and procedures (as defined in Exchange ActRule 13a-15(e)).  Based upon thatevaluation as of the end of the period covered by this report, the CEO and theCFO concluded that the Company’s disclosure controls and procedures areeffective in timely alerting them to material information relating to theCompany (including our consolidated subsidiaries) required to be included inthe Company’s periodic filings with the SEC. There have been no changes in the Company’s internal controls overfinancial reporting during the quarter ended June 30, 2004, that havematerially affected, or are reasonably likely to materially affect, theCompany’s internal controls over financial reporting.

 

During the first quarter of 2004, the Companyacquired the Poorman-Douglas Corporation. As part of its ongoing integration activities, the Company is continuingto incorporate its controls and procedures into this recently acquiredbusiness.

 

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**EPIQSYSTEMS, INC.**

**JUNE30, 2004 FORM 10-Q**

 

**PART II - OTHERINFORMATION**

 

### **ITEM 4:  Submissionof Matters to a Vote of Security Holders**

 

The AnnualMeeting of the Shareholders of the Company was held on June 2, 2004, at whichthe shareholders elected the directors named below, approved a proposal toadopt a new 2004 Equity Incentive Plan to replace the 1995 Stock Option Planprior to its scheduled expiration, and approved an amendment to the Company’sArticles of Incorporation as permitted by The General and Business Law ofMissouri to limit the personal liability of directors in certaincircumstances.  The results of thevoting at the Annual Meeting were as follows:

 
| **Election  of Directors** |   | **For**    |   | **Withhold  Authority** |   |
|----------------------------|--------|------------|--------|-------------------------|--------|
| Tom W. Olofson             |   | 15,399,847 |   | 300,168                 |   |
| Christopher E. Olofson     |   | 15,380,844 |   | 319,171                 |   |
| W. Bryan Satterlee         |   | 15,189,532 |   | 510,483                 |   |
| Edward M. Connolly, Jr.    |   | 15,189,332 |   | 510,683                 |   |
| James A. Byrnes            |   | 15,208,754 |   | 491,261                 |   |

 
| **Other  Matters**                   |   | **For**    |   | **Against** |   | **Abstain** |   | **Broker  Non-Votes** |   |
|--------------------------------------|--------|------------|--------|-------------|--------|-------------|--------|-----------------------|--------|
| Adopt the 2004 Equity Incentive Plan |   | 7,027,165  |   | 3,190,154   |   | 20,107      |   | 5,462,589             |   |
| Amend the Articles of Incorporation  |   | 15,508,074 |   | 160,588     |   | 31,353      |   | -0-                   |   |

 

No other matters were submitted to a vote of the shareholders at theAnnual Meeting.

 

**ITEM6**.                                                     **Exhibitsand Reports on Form 8-K.**

 

**(a)****                                  Exhibits.**

 

10.1                           Credit and SecurityAgreement dated as of July 20, 2004, among EPIQ Systems, Inc., the Lendersnamed therein, and KeyBank National Association, as Lead Arranger, Sole BookRunner and Administrative Agent.

 

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

 

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

 

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

 

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

 

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

 

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2.               A report on Form 8-K was filed on April 28,2004, furnishing the Company’s earnings release for the first quarter endedMarch 31, 2004.

 

3.               A report on Form 8-K was filed on June 14,2004, reporting the issuance of $50,000,000 principal amount of contingentconvertible subordinated notes.

 

4.               A report on Form 8-K was filed on June 21,2004, providing new segment reporting financial information.

 

5.               A report on Form 8-K/A on June 29, 2004, amendingreports previously filed on Form 8-K on February 13, 2004 and on Form 8-K onApril 13, 2004, reporting updated pro forma financial information for PDHolding Corp. and EPIQ Systems, Inc.

 

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##### **SIGNATURES**

##### ** **

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

 
|   |           | **EPIQ Systems, Inc**.                         |
|--------|----------------|------------------------------------------------|
|   |           |                                           |
| Date:  | August 6, 2004 | /s/  Tom W. Olofson                       |   |
|   |           | Tom W. Olofson                                 |
|   |           | Chairman of the Board                          |
|   |           | Chief Executive Officer                        |
|   |           | Director                                       |
|   |           | (Principal Executive Officer)                  |
|   |           |                                           |
|   |           |                                           |
| Date:  | August 6, 2004 | /s/  Elizabeth M. Braham                  |   |
|   |           | Elizabeth M. Braham                            |
|   |           | Senior Vice President, Chief Financial Officer |
|   |           | (Principal Financial Officer)                  |
|   |           |                                           |
|   |           |                                           |
| Date:  | August 6, 2004 | /s/  Douglas W. Fleming                   |   |
|   |           | Douglas W. Fleming                             |
|   |           | Director of Finance                            |
|   |           | (Principal Accounting Officer)                 |
|        |                |                                                |  |  |  |

 

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