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Table of Contents

 

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

 

FORM 10-Q

 

(Mark One)

 

x                QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

For the quarterly period ended March 31, 2012

 

or

 

o                   TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

For the transition period from                      to                   

 

Commission File Number 000-22081

 


 

EPIQ SYSTEMS, INC.

(Exact name of registrant as specified in its charter)

 

Missouri

 

48-1056429

(State or other jurisdiction of

incorporation or organization)

 

(I.R.S. Employer

Identification No.)

 

 

 

501 Kansas Avenue, Kansas City, Kansas

 

66105-1300

(Address of principal executive offices)

 

(Zip Code)

 

913-621-9500

(Registrant’s telephone number)

 

None

(Former name, former address and former fiscal year, if changed since last report)

 

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

 

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).  Yes x  No o

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company.  See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

 

Large accelerated filer  o

 

Accelerated filer  x

 

 

 

Non-accelerated filer  o

 

Smaller reporting company  o

(Do not check if a smaller reporting company)

 

 

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act).  Yes o  No x

 

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date.

 

Class

 

Outstanding at April 13, 2012

Common Stock, $0.01 par value per share

 

36,033,056 shares

 

 

 



Table of Contents

 

EPIQ SYSTEMS, INC.

FORM 10-Q

QUARTER ENDED MARCH 31, 2012

 

CONTENTS

 

 

 

Page

 

 

 

PART I - FINANCIAL INFORMATION

 

 

 

 

Item 1.

Financial Statements

 

 

 

 

 

Condensed Consolidated Statements of Income —

 

 

Three months ended March 31, 2012 and 2011 (Unaudited)

2

 

 

 

 

Condensed Consolidated Statements of Comprehensive Income —

 

 

Three months ended March 31, 2012 and 2011 (Unaudited)

3

 

 

 

 

Condensed Consolidated Balance Sheets —

 

 

March 31, 2012 and December 31, 2011 (Unaudited)

4

 

 

 

 

Condensed Consolidated Statements of Changes in Equity—

 

 

Three months ended March 31, 2012 and 2011 (Unaudited)

5

 

 

 

 

Condensed Consolidated Statements of Cash Flows —

 

 

Three months ended March 31, 2012 and 2011 (Unaudited)

6

 

 

 

 

Notes to Condensed Consolidated Financial Statements (Unaudited)

7

 

 

 

Item 2.

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

25

 

 

 

Item 3.

Quantitative and Qualitative Disclosures about Market Risk

34

 

 

 

Item 4.

Controls and Procedures

35

 

 

 

PART II - OTHER INFORMATION

 

 

 

 

Item 1.

Legal Proceedings

35

 

 

 

Item 1A.

Risk Factors

35

 

 

 

Item 2.

Unregistered Sales of Equity Securities and Use of Proceeds

36

 

 

 

Item 6.

Exhibits

36

 

 

 

Signatures

38

 



Table of Contents

 

PART I - FINANCIAL INFORMATION

Item 1.  Financial Statements

 

EPIQ SYSTEMS, INC.

CONDENSED CONSOLIDATED STATEMENTS OF INCOME

(UNAUDITED)

(in thousands, except per share data)

 

 

 

Three Months Ended
March 31,

 

 

 

2012

 

2011

 

REVENUE:

 

 

 

 

 

Case management services

 

$

73,721

 

$

41,883

 

Case management bundled products and services

 

3,263

 

4,415

 

Document management services

 

5,843

 

7,915

 

Operating revenue before reimbursed direct costs

 

82,827

 

54,213

 

Operating revenue from reimbursed direct costs

 

5,645

 

5,409

 

Total Revenue

 

88,472

 

59,622

 

 

 

 

 

 

 

OPERATING EXPENSE:

 

 

 

 

 

Direct cost of services (exclusive of depreciation and amortization shown separately below)

 

31,321

 

18,566

 

Direct cost of bundled products and services (exclusive of depreciation and amortization shown separately below)

 

755

 

831

 

Reimbursed direct costs

 

5,568

 

5,337

 

General and administrative expense

 

32,032

 

19,290

 

Depreciation and software and leasehold amortization

 

6,728

 

5,207

 

Amortization of identifiable intangible assets

 

6,769

 

3,766

 

Other operating (income) expense

 

(171

)

483

 

Total Operating Expense

 

83,002

 

53,480

 

 

 

 

 

 

 

INCOME FROM OPERATIONS

 

5,470

 

6,142

 

 

 

 

 

 

 

INTEREST EXPENSE (INCOME):

 

 

 

 

 

Interest expense

 

2,726

 

810

 

Interest income

 

(6

)

(5

)

Net Interest Expense

 

2,720

 

805

 

 

 

 

 

 

 

INCOME BEFORE INCOME TAXES

 

2,750

 

5,337

 

 

 

 

 

 

 

PROVISION FOR INCOME TAXES

 

711

 

2,255

 

 

 

 

 

 

 

NET INCOME

 

$

2,039

 

$

3,082

 

 

 

 

 

 

 

NET INCOME PER SHARE INFORMATION:

 

 

 

 

 

Basic

 

$

0.06

 

$

0.09

 

Diluted

 

$

0.06

 

$

0.08

 

WEIGHTED AVERAGE COMMON SHARES OUTSTANDING:

 

 

 

 

 

Basic

 

35,478

 

35,092

 

Diluted

 

36,447

 

36,487

 

 

 

 

 

 

 

Cash dividends declared per common share

 

$

0.05

 

$

0.07

 

 

See accompanying Notes to Condensed Consolidated Financial Statements.

 

2



Table of Contents

 

EPIQ SYSTEMS, INC.

CONDENSED CONSOLIDATED STATEMENTS OF COMREHENSIVE INCOME

(UNAUDITED)

(in thousands)

 

 

 

Three Months Ended
March 31,

 

 

 

2012

 

2011

 

Net income

 

$

2,039

 

$

3,082

 

Other comprehensive income:

 

 

 

 

 

Foreign currency translation adjustment

 

437

 

426

 

Comprehensive income

 

$

2,476

 

$

3,508

 

 

See accompanying Notes to Condensed Consolidated Financial Statements.

 

3



Table of Contents

 

EPIQ SYSTEMS, INC.

CONDENSED CONSOLIDATED BALANCE SHEETS (UNAUDITED)

(in thousands, except share data)

 

 

 

March 31, 2012

 

December 31, 2011

 

 

 

 

 

 

 

ASSETS

 

 

 

 

 

CURRENT ASSETS:

 

 

 

 

 

Cash and cash equivalents

 

$

6,674

 

$

2,838

 

Trade accounts receivable, less allowance for doubtful accounts of $4,647 and $4,514, respectively

 

94,056

 

89,619

 

Prepaid expenses

 

8,291

 

7,768

 

Other current assets

 

8,314

 

9,999

 

Total Current Assets

 

117,335

 

110,224

 

 

 

 

 

 

 

LONG-TERM ASSETS:

 

 

 

 

 

Property and equipment, net

 

43,607

 

46,773

 

Internally developed software costs, net

 

20,699

 

21,195

 

Goodwill

 

404,162

 

402,736

 

Other intangibles, net of accumulated amortization of $70,280 and $63,511, respectively

 

81,547

 

88,087

 

Other

 

8,497

 

9,649

 

Total Long-term Assets, net

 

558,512

 

568,440

 

Total Assets

 

$

675,847

 

$

678,664

 

 

 

 

 

 

 

LIABILITIES AND EQUITY

 

 

 

 

 

CURRENT LIABILITIES:

 

 

 

 

 

Current maturities of long-term obligations

 

$

24,301

 

$

15,484

 

Accounts payable

 

12,889

 

12,048

 

Accrued compensation

 

5,789

 

10,293

 

Deposits

 

3,768

 

1,972

 

Deferred revenue

 

3,843

 

3,214

 

Other accrued liabilities

 

8,938

 

6,979

 

Total Current Liabilities

 

59,528

 

49,990

 

 

 

 

 

 

 

LONG-TERM LIABILITIES:

 

 

 

 

 

Deferred income taxes

 

40,570

 

42,557

 

Other long-term liabilities

 

6,595

 

5,204

 

Long-term obligations (excluding current maturities)

 

235,787

 

247,994

 

Total Long-term Liabilities

 

282,952

 

295,755

 

 

 

 

 

 

 

COMMITMENTS AND CONTINGENCIES

 

 

 

 

 

EQUITY:

 

 

 

 

 

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

 

 

 

Common stock - $0.01 par value; 100,000,000 shares authorized; Issued and outstanding 2012 — 39,923,852 and 36,033,056 shares Issued and outstanding 2011 — 39,493,852 and 35,754,074 shares

 

399

 

395

 

Additional paid-in capital

 

288,460

 

286,869

 

Accumulated other comprehensive loss

 

(1,550

)

(1,987

)

Retained earnings

 

96,085

 

95,849

 

Treasury stock, at cost — 3,890,796 and 3,739,778 shares

 

(50,027

)

(48,207

)

Total Equity

 

333,367

 

332,919

 

Total Liabilities and Equity

 

$

675,847

 

$

678,664

 

 

See accompanying Notes to Condensed Consolidated Financial Statements.

 

4



Table of Contents

 

EPIQ SYSTEMS, INC.

CONDENSED CONSOLIDATED STATEMENTS OF CHANGES IN EQUITY

(UNAUDITED)

(in thousands)

 

 

 

Common
Stock

 

Treasury
Stock

 

Common
Stock

 

Additional
Paid-In
Capital

 

AOCI (1)

 

Retained
Earnings

 

Treasury
Stock

 

Total

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Balance at December 31, 2011

 

39,494

 

(3,740

)

$

395

 

$

286,869

 

$

(1,987

)

$

95,849

 

$

(48,207

)

$

332,919

 

Net income

 

 

 

 

 

 

2,039

 

 

2,039

 

Foreign currency translation adjustment

 

 

 

 

 

437

 

 

 

437

 

Tax benefit from share-based compensation

 

 

 

 

(251

)

 

 

 

(251

)

Common stock issued under share-based compensation plans

 

430

 

4

 

4

 

(12

)

 

 

48

 

40

 

Common stock repurchased under share-based compensation plans

 

 

(155

)

 

 

 

 

(1,868

)

(1,868

)

Dividends declared ($0.05 per share) (Note 9)

 

 

 

 

 

 

(1,803

)

 

(1,803

)

Share-based compensation

 

 

 

 

1,854

 

 

 

 

 

1,854

 

Balance at March 31, 2012

 

39,924

 

(3,891

)

$

399

 

$

288,460

 

$

(1,550

)

$

96,085

 

$

(50,027

)

$

333,367

 

 


(1)         AOCI Accumulated Other Comprehensive Income (Loss)

 

 

 

Common
Stock

 

Treasury
Stock

 

Common
Stock

 

Additional
Paid-In
Capital

 

AOCI (1)

 

Retained
Earnings

 

Treasury
Stock

 

Total

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Balance at December 31, 2010

 

39,063

 

(3,295

)

$

391

 

$

281,119

 

$

(1,971

)

$

91,069

 

$

(42,085

)

$

328,523

 

Net income

 

 

 

 

 

 

3,082

 

 

3,082

 

Foreign currency translation adjustment

 

 

 

 

 

426

 

 

 

426

 

Tax benefit from share-based compensation

 

 

 

 

78

 

 

 

 

78

 

Common stock issued under share-based compensation plans

 

431

 

15

 

4

 

(70

)

 

 

204

 

138

 

Common stock repurchased under share-based compensation plans

 

 

(66

)

 

 

 

 

(900

)

(900

)

Share repurchases (Note 9)

 

 

(745

)

 

 

 

 

 

(9,958

)

(9,958

)

Dividends declared ($0.07 per share) (Note 9)

 

 

 

 

 

 

(2,471

)

 

(2,471

)

Share-based compensation

 

 

 

 

1,837

 

 

 

 

 

1,837

 

Balance at March 31, 2011

 

39,494

 

(4,091

)

$

395

 

$

282,964

 

$

(1,545

)

$

91,680

 

$

(52,739

)

$

320,755

 

 


(1)         AOCI — Accumulated Other Comprehensive Income (Loss)

 

See accompanying Notes to Condensed Consolidated Financial Statements.

 

5



Table of Contents

 

EPIQ SYSTEMS, INC.

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)

(In thousands)

 

 

 

Three months ended March 31,

 

 

 

2012

 

2011

 

CASH FLOWS FROM OPERATING ACTIVITIES:

 

 

 

 

 

Net income

 

$

2,039

 

$

3,082

 

Adjustments to reconcile net income to net cash provided by operating activities:

 

 

 

 

 

Expense for deferred income taxes

 

858

 

2,028

 

Depreciation and software amortization

 

6,728

 

5,207

 

Amortization of intangible assets

 

6,769

 

3,766

 

Share-based compensation expense

 

1,854

 

1,837

 

Provision for bad debts

 

497

 

257

 

Accretion of discount

 

721

 

54

 

Other, net

 

145

 

78

 

Changes in operating assets and liabilities:

 

 

 

 

 

Trade accounts receivable

 

(5,147

)

1,903

 

Prepaid expenses and other assets

 

1,205

 

650

 

Accounts payable and other liabilities

 

(983

)

(7,566

)

Excess tax benefit related to share-based compensation

 

 

(178

)

Other

 

410

 

(365

)

Net cash provided by operating activities

 

15,096

 

10,753

 

 

 

 

 

 

 

CASH FLOWS FROM INVESTING ACTIVITIES:

 

 

 

 

 

Purchase of property and equipment

 

(2,639

)

(4,102

)

Internally developed software costs

 

(1,644

)

(1,703

)

Other investing activities, net

 

51

 

41

 

Net cash used in investing activities

 

(4,232

)

(5,764

)

 

 

 

 

 

 

CASH FLOWS FROM FINANCING ACTIVITIES:

 

 

 

 

 

Proceeds from revolver

 

16,000

 

17,000

 

Payments on revolver

 

(18,000

)

(11,000

)

Payments under long-term obligations

 

(1,517

)

(302

)

Excess tax benefit related to share-based compensation

 

 

178

 

Common stock repurchases (Note 9)

 

(1,868

)

(10,858

)

Cash dividends paid (Note 9)

 

(1,787

)

(1,239

)

Proceeds from issuance of common stock under share-based compensation plans

 

40

 

138

 

Net cash used in financing activities

 

(7,132

)

(6,083

)

 

 

 

 

 

 

Effect of exchange rate changes on cash

 

104

 

5

 

 

 

 

 

 

 

NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS

 

3,836

 

(1,089

)

CASH AND CASH EQUIVALENTS, BEGINNING OF YEAR

 

2,838

 

5,439

 

CASH AND CASH EQUIVALENTS, END OF PERIOD

 

$

6,674

 

$

4,350

 

 

See accompanying Notes to Condensed Consolidated Financial Statements.

 

6



Table of Contents

 

EPIQ SYSTEMS, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(UNAUDITED)

 

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

 

The accompanying Condensed Consolidated Financial Statements have been prepared in accordance with accounting principles generally accepted in the United States of America, and with the rules and regulations for reporting on Form 10-Q for interim financial statements. Accordingly, the financial statements do not include certain disclosures required for comprehensive annual financial statements.

 

The unaudited financial information reflects all adjustments, which are, in the opinion of management, necessary to present fairly our results of operations, financial position, and cash flows for the periods presented. The adjustments consist primarily of normal recurring adjustments. These Condensed Consolidated Financial Statements should be read in conjunction with the Consolidated Financial Statements and related Notes included in the Epiq Systems, Inc. (“Epiq,” “we,” “us,” or “our”) Annual Report on Form 10-K for the year ended December 31, 2011, filed with the Securities and Exchange Commission (“SEC”) on March 1, 2012.

 

In preparing these financial statements, we have evaluated events and transactions for potential recognition or disclosure through the date the financial statements were issued.

 

The results of operations for any quarter or a partial fiscal year period are not necessarily indicative of the results to be expected for other periods or the entire year.

 

Principles of Consolidation

 

The Condensed Consolidated Financial Statements include the accounts of Epiq and its wholly-owned subsidiaries. Intercompany transactions and balances have been eliminated in consolidation.

 

Nature of Operations

 

We are a leading global provider of technology-enabled solutions for electronic discovery, bankruptcy and class action administration.  We offer full-service capabilities, which include litigation, investigations, financial transactions, regulatory, compliance and other legal matters for eDiscovery.  Our innovative technology and services, combined with deep subject-matter expertise, provide reliable solutions for the professionals we serve.

 

Revenue Recognition

 

We have agreements with clients pursuant to which we deliver various services each month.

 

Following is a description of significant sources of revenue:

 

·                  Fees contingent upon the month-to-month delivery of case management services defined by client contracts, such as claims processing, claims reconciliation, professional services, call center support, disbursement services, project management, collections and forensic services, document review services, and conversion of data into an organized, searchable electronic database. The amount we earn varies based primarily on the size and complexity of the engagement, the number of hours services are provided and the number of documents or amount of data reviewed.

 

·                  Hosting fees based on the amount of data stored.

 

·                  Deposit-based fees, earned primarily based on a percentage of Chapter 7 total liquidated assets placed on deposit with a designated financial institution by our trustee clients, to whom we provide, at no charge, software licenses, limited hardware and hardware maintenance, and postcontract customer support services. The fees we earn are based on total liquidated assets placed on deposit by our trustee clients and may vary based on fluctuations in short-term interest rates.

 

7



Table of Contents

 

·                  Legal noticing services to parties of interest in bankruptcy and class action matters, including direct notification, media campaign, and advertising management in which we coordinate notification through various media outlets, such as print, radio and television, to potential parties of interest for a particular client engagement.

 

·                  Reimbursement for costs incurred, primarily related to postage on mailing services.

 

·                  Monitoring and noticing fees earned based on monthly or on-demand requests for information provided through our AACER® (Automated Access to Court Electronic Records) (“AACER®”) software product.

 

Non-Software Arrangements

 

Services related to eDiscovery and settlement administration are billed based on volume. For these contractual arrangements, we have identified each deliverable service element.  Based on our evaluation of each element, we have determined that each element delivered has standalone value to our customers because we or other vendors sell such services separately from any other services/deliverables.  We have also obtained objective and reliable evidence of the fair value of each element based either on the price we charge when we sell an element on a standalone basis or on third-party evidence of fair value of such similar services.  For elements where evidence cannot be established we have used the best estimate of sales price.  Lastly, our arrangements do not include general rights of return.  Accordingly, each of the service elements in our multiple element case and document management arrangements qualifies as a separate unit of accounting. We allocate revenue to the various units of accounting in our arrangements based on the fair value or best estimated selling price of each unit of accounting, which is generally consistent with the stated prices in our arrangements. In instances when revenue has been required to be deferred, we utilize the relative selling price method to calculate the revenue recognized.  As we have evidence of an arrangement, revenue for each separate unit of accounting is recognized each period.  Revenue is recognized as the services are rendered, our fee becomes fixed and determinable, and collectability is reasonably assured.  Payments received in advance of satisfaction of the related revenue recognition criteria are recognized as a customer deposit until all revenue recognition criteria have been satisfied.

 

Software Arrangements

 

For our Chapter 7 bankruptcy trustee arrangements, we provide our trustee clients with a software license, hardware lease, hardware maintenance, and postcontract customer support services, all at no charge to the trustee.  The trustees place their liquidated estate deposits with a financial institution with which we have an arrangement.  We earn contingent monthly fees from the financial institutions based on the dollar level of average monthly deposits held by the trustees with that financial institution related to the software license, hardware lease, hardware maintenance, and postcontract customer support services. Since we have not established vendor specific objective evidence of the fair value of the software license, we do not recognize any revenue on delivery of the software.  The software element is deferred and included with the remaining undelivered elements, which are postcontract customer support services.  This revenue, when recognized, is included as a component of “Case management services” revenue in the Condensed Consolidated Statements of Income.  Revenue related to postcontract customer support is entirely contingent on the placement of liquidated estate deposits by the trustee with the financial institution.  Accordingly, we recognize this contingent usage based revenue as the fee becomes fixed or determinable at the time actual usage occurs and collectability is probable.  This occurs monthly as a result of the computation, billing and collection of monthly deposit fees contractually agreed to. At that time, we have also satisfied the other applicable revenue recognition criteria since we have persuasive evidence that an arrangement exists, services have been rendered, the price is fixed and determinable, and collectability is reasonably assured.

 

We also provide our trustee clients with certain hardware, such as desktop computers, monitors, and printers as well as hardware maintenance.  We retain ownership of all hardware provided and we account for this hardware as a lease.  As the hardware maintenance arrangement is an executory contract similar to an operating lease, we use guidance related to contingent rentals in operating lease arrangements for hardware maintenance as well as for the hardware lease.  Since the payments under all of our arrangements are contingent upon the level of trustee deposits and the delivery of upgrades and other services, and there remain important uncertainties regarding the amount of unreimbursable costs yet to be incurred by us, we account for the hardware lease as an operating lease.  Therefore, all lease payments, based on the estimated fair value of hardware provided, were accounted for as contingent rentals; which requires that we recognize rental income when the changes in the factor on which the contingent lease payment is based actually occur.  This occurs at the end of each period as we achieve our target

 

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when deposits are held at the financial institution as, at that time, evidence of an arrangement exists, delivery has occurred, the amount has become fixed and determinable, and collection is reasonably assured.

 

This revenue, which was less than ten percent of our total revenue for the three months ended March 31, 2012 and 2011, is included in the Condensed Consolidated Statements of Income as a component of “Case management services” revenue.

 

Reimbursements

 

We have revenue related to the reimbursement of certain costs, primarily postage. Reimbursed postage and other reimbursable direct costs are recorded gross in the Condensed Consolidated Statements of Income as “Operating revenue from reimbursed direct costs” and as “Reimbursed direct costs”, respectively.

 

Goodwill

 

Goodwill consists of the excess of cost of acquired enterprises over the sum of the amounts assigned to identifiable assets acquired less liabilities assumed. We assess goodwill for impairment on an annual basis at a reporting unit level. A reporting unit is a component of a segment that constitutes a business, for which discrete financial information is available, and for which the operating results are regularly reviewed by management. We have identified our operating segments (eDiscovery, bankruptcy and settlement administration) as our reporting units for purposes of testing for goodwill impairment. Goodwill is assessed between annual tests if an event occurs or circumstances change that would more likely than not reduce the fair value of a reporting unit below its carrying value. These events or circumstances could include a significant change in the business climate, a change in strategic direction, legal factors, operating performance indicators, a change in the competitive environment, the sale or disposition of a significant portion of a reporting unit, or future economic factors such as unfavorable changes in our stock price and market capitalization or unfavorable changes in the estimated future discounted cash flows of our reporting units. Our annual test is performed as of July 31 each year, and there have been no events since our last annual test to indicate that it is more likely than not that the recorded goodwill balance had become impaired.

 

Application of the goodwill impairment test requires judgment, including the identification of reporting units, assignment of assets and liabilities to reporting units, assignment of goodwill to reporting units, and determination of the fair value of each reporting unit. We considered both a market approach and an income approach in order to develop an estimate of the fair value of each reporting unit for purposes of our annual impairment test.  When evaluating the market approach, we determined that directly comparable publicly-traded companies did not exist, primarily due to the unique business model characteristics and projected growth of each reporting unit. Instead, we utilized a discounted projected future cash flow analysis (income approach) to determine the fair value of each reporting unit. Potential impairment is indicated when the carrying value of a reporting unit, including goodwill, exceeds its estimated fair value. This analysis requires significant judgments, including estimation of future cash flows, which is dependent on internal forecasts, estimation of the long-term rate of growth for our business, estimation of the useful life over which cash flows will occur, and determination of our weighted average cost of capital. Changes in these estimates and assumptions could materially affect the determination of fair value and goodwill impairment for each reporting unit. In addition, financial and credit market volatility directly impacts our fair value measurement through our weighted average cost of capital, used to determine our discount rate, and through our stock price, used to determine our market capitalization. We may be required to recognize impairment of goodwill based on future economic factors such as unfavorable changes in our stock price and market capitalization or unfavorable changes in the estimated future discounted cash flows of our reporting units.

 

If we determine that the estimated fair value of any reporting unit is less than the reporting unit’s carrying value, then we proceed to the second step of the goodwill impairment analysis to measure the potential impairment charge. An impairment loss is recognized for any excess of the carrying value of the reporting unit’s goodwill over the implied fair value. If goodwill on our Condensed Consolidated Balance Sheet or Consolidated Balance Sheet becomes impaired during a future period, the resulting impairment charge could have a material impact on our results of operations and financial condition.

 

Due to the current economic environment and the uncertainties regarding the impact that future economic impacts will have on our reporting units, there can be no assurances that our estimates and assumptions regarding the duration of the economic recession, or the period or strength of recovery, made for purposes of our annual goodwill impairment test, will prove to be accurate predictions of the future. If our assumptions regarding forecasted revenues or margins of certain of our reporting units are not achieved, we may be required to record goodwill impairment losses in future periods. It is not possible at this

 

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time to determine if any such future impairment loss would occur, and if it does occur, whether such charge would be material.

 

Our recognized goodwill totaled $404.2 million as of March 31, 2012.  As of July 31, 2011, which is the date of our most recent impairment test, the fair value of each of our reporting units was substantially in excess of the carrying value of such reporting unit.

 

Recently Adopted Accounting Pronouncements

 

In June 2011, the Financial Accounting Standards Board (the “FASB”) issued a new standard related to comprehensive income.  This new standard requires companies to present comprehensive income in a single statement below net income or in a separate statement of comprehensive income immediately following the income statement.  In both options, companies must present the components of net income, total net income, the components of other comprehensive income, total other comprehensive income and total comprehensive income.  This new standard does not change which items are reported in other comprehensive income or the requirement to report reclassifications of items from other comprehensive income to net income.  The new standard eliminates the option to present comprehensive income on the statement of changes in shareholders’ equity.  This requirement was effective for us beginning with this Quarterly Report on Form 10-Q for the quarter ended March 31, 2012 and required retrospective application for all periods presented.  The adoption of this guidance did not have a material effect on our consolidated financial position, results of operations or cash flows.

 

In May 2011, the FASB issued new standards to provide guidance about fair value measurement and disclosure requirements.  These standards do not extend the use of fair value but rather provide guidance about how fair value should be determined where it is already required or permitted under generally accepted accounting principles.  A majority of the changes include clarifications of existing guidance and new disclosure requirements related to changes in valuation technique and related inputs that result from applying the standard.  We adopted this guidance and applied the new standard prospectively for interim and annual periods beginning January 1, 2012.  The adoption of this guidance did not have a material effect on our consolidated financial position, results of operations or cash flows.

 

Recently Issued Accounting Pronouncements Not Yet Adopted

 

In September 2011, the FASB issued guidance which amends the existing standards related to annual and interim goodwill impairment tests.  Current guidance requires companies to test goodwill for impairment, at least annually, using a two-step process. The updated guidance provides companies with the option to first assess qualitative factors to determine whether it is necessary to perform the two-step quantitative goodwill impairment test. Under this option, companies are no longer required to calculate the fair value of a reporting unit unless they determine, based on that qualitative assessment, that it is more likely than not that the reporting unit’s fair value is less than its carrying amount. The new guidance includes examples of the types of events and circumstances to consider in conducting the qualitative assessment.  The amendments will be effective for us beginning with our annual goodwill impairment test in 2012.  We do not expect this new guidance to have a material effect on our consolidated financial position, results of operations or cash flows.

 

NOTE 2:   GOODWILL AND INTANGIBLE ASSETS

 

The change in the carrying amount of goodwill for the first three months of 2012 was as follows:

 

 

 

eDiscovery

 

Bankruptcy

 

Settlement
Administration

 

Total

 

 

 

(in thousands)

 

Balance as of December 31, 2011

 

$

187,773

 

$

182,116

 

$

32,847

 

$

402,736

 

Purchase price adjustments

 

1,276

 

 

 

1,276

 

Foreign currency translation

 

150

 

 

 

150

 

Balance as of March 31, 2012

 

$

189,199

 

$

182,116

 

$

32,847

 

$

404,162

 

 

During the first quarter of 2012, we increased goodwill recorded in connection with our acquisition of De Novo Legal LLC (“De Novo”) by $1.3 million.  This adjustment is based on new information obtained since December 31, 2011, related to the results of an

 

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independent valuation of the fair value of De Novo’s property, plant and equipment.  See Note 11 of our Notes to Condensed Consolidated Financial Statements for further detail.

 

Identifiable intangible assets as of March 31, 2012 and December 31, 2011 consisted of the following:

 

 

 

March 31, 2012

 

December 31, 2011

 

 

 

Gross Carrying
Amount

 

Accumulated
Amortization

 

Gross Carrying
Amount

 

Accumulated
Amortization

 

 

 

(in thousands)

 

Amortizing intangible assets:

 

 

 

 

 

 

 

 

 

Customer relationships

 

$

124,512

 

$

56,704

 

$

124,283

 

$

50,813

 

Trade names

 

3,212

 

1,110

 

3,212

 

987

 

Non-compete agreements

 

18,947

 

12,466

 

18,947

 

11,711

 

Non-amortizing intangible assets:

 

 

 

 

 

 

 

 

 

Trade names

 

5,156

 

 

5,156

 

 

Total

 

$

151,827

 

$

70,280

 

$

151,598

 

$

63,511

 

 

During the first quarter of 2012, we increased our customer relationships intangible asset recorded in connection with our acquisition of De Novo by $0.2 million.  This adjustment is based on new information obtained since December 31, 2011, related to the results of an independent valuation of the fair value of De Novo’s property, plant and equipment which also impacted the valuation model used for customer relationships.  See Note 11 of our Notes to Condensed Consolidated Financial Statements for further detail.  Customer relationships, non-compete agreements and amortizing trade names carry a weighted average life of seven years, five years and five years, respectively. The AACER® trade name acquired in 2010 was determined to have an indefinite life and is therefore not being amortized.  It is tested annually for impairment and also reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of the asset might not be recoverable.  The annual testing date for this non-amortizing trade name is October 31 of each year.  Amortization expense related to identifiable intangible assets was $6.8 million and $3.8 million for the three months ended March 31, 2012 and 2011, respectively.  The following table outlines the estimated future amortization expense related to intangible assets at March 31, 2012:

 

(in thousands)

 

 

 

Year Ending December 31,

 

 

 

2012 (excluding the three months ended March 31, 2012)

 

$

19,748

 

2013

 

18,650

 

2014

 

12,154

 

2015

 

9,497

 

2016

 

6,630

 

2017 and thereafter

 

9,824

 

 

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NOTE 3:   LONG-TERM OBLIGATIONS

 

The following is a summary of long-term obligations outstanding (in thousands):

 

 

 

March 31,
2012

 

December 31,
2011

 

 

 

(in thousands)

 

Senior revolving loan

 

$

215,000

 

$

217,000

 

Capital leases

 

5,562

 

6,025

 

Notes payable

 

10,032

 

11,004

 

Acquisition-related liabilities

 

29,494

 

29,449

 

Total long-term obligations, including current portion

 

260,088

 

263,478

 

Current maturities of long-term obligations

 

 

 

 

 

Capital leases

 

(3,118

)

(3,213

)

Notes payable

 

(3,947

)

(3,924

)

Acquisition-related liabilities

 

(17,236

)

(8,347

)

Total current maturities of long-term obligations

 

(24,301

)

(15,484

)

Total Long-term obligations

 

$

235,787

 

$

247,994

 

 

Credit Facilities

 

On April 25, 2011, we entered into an amended senior credit facility, with KeyBank National Association as administrative agent, and a syndicate of banks as lenders.  The amended credit facility provides for a senior revolving loan with an aggregate amount of funds available of $325.0 million with a maturity date of December 2015. We have the right, subject to compliance with the covenants as set forth in the credit facility agreement, to increase the borrowings to a maximum of $375.0 million.  The credit facility is secured by liens on our land and buildings and substantially all of our personal property.

 

Borrowings under the senior revolving loan bear interest at various rates based on our leverage ratio with two rate options at the discretion of management as follows:  (1) for base rate advances, borrowings bear interest at prime rate plus 75 to 175 basis points; (2) for LIBOR rate advances, borrowings bear interest at LIBOR rate plus 175 to 275 basis points. At March 31, 2012, borrowings of $215.0 million under this facility had a weighted average interest rate of 2.82%. The average amount of borrowings under this facility in the first quarter of 2012 was $220.0 million, at a weighted average interest rate of 2.86%.  The maximum month-end amount outstanding during the first quarter of 2012 was $222.0 million. At March 31, 2012, the amount available for borrowings under the credit facility is reduced by the $215.0 million outstanding and $1.0 million in outstanding letters of credit.

 

The financial covenants contained in the credit facility include a total debt leverage ratio and a fixed charge coverage ratio (all as defined in our credit facility agreement).  The leverage ratio is not permitted to exceed 3.00 to 1.00 and the fixed charge coverage ratio is not permitted to be less than 1.25 to 1.00.  As of March 31, 2012 we were in compliance with all financial covenants.

 

Other restrictive covenants contained in our credit facility include limitations on incurring additional indebtedness and completing acquisitions.  We generally cannot incur indebtedness outside the credit facility, with the exception of capital leases, up to $15.0 million, and subordinated debt, up to $100 million.  In addition, for acquisitions we must be able to demonstrate that, on a pro forma basis, we would be in compliance with our covenants during the four quarters prior to the acquisition, and bank permission must be obtained for acquisitions in which cash consideration exceeds $125.0 million or total consideration exceeds $175.0 million.  The total consideration for all acquisitions consummated during the term of our credit facility may not exceed $300.0 million in the aggregate without lender permission.

 

Capital Leases

 

We lease certain property and software under capital leases that expire during various years through 2014.  As of March 31, 2012, our capital leases had a weighted-average interest rate of approximately 7.1%.

 

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Notes Payable

 

During the fourth quarter of 2011 we entered into a note payable related to a software license agreement that bears interest of approximately 2.2% and is payable quarterly through September 2014.

 

Acquisition-related Liabilities

 

In connection with the acquisitions of Jupiter eSources LLC (“Jupiter eSources”) on October 1, 2010, and De Novo on December 28, 2011, we incurred liabilities related to contingent consideration for earn-out opportunities based on future revenue growth. We estimated the fair value of the contingent consideration using probability assessments of projected revenue over the earn-out period, and applied an appropriate discount rate based upon the weighted average cost of capital.  This fair value is based on significant inputs not observable in the market.

 

Amounts recorded in connection with acquisition-related liabilities as of March 31, 2012 and December 31, 2012 are as follows:

 

 

 

March 31,
2012

 

December 31,
2011

 

 

 

(in thousands)

 

De Novo contingent consideration:

 

 

 

 

 

Current portion

 

$

8,836

 

$

 

Long-term portion

 

7,801

 

16,226

 

Total De Novo contingent consideration

 

16,637

 

16,226

 

De Novo deferred acquisition price

 

 

 

 

 

Long-term portion

 

4,457

 

4,870

 

Jupiter deferred acquisition price

 

 

 

 

 

Current portion

 

8,400

 

8,347

 

 

Jupiter eSources

 

The undiscounted amount of all potential future payments that we could be required to make under the Jupiter eSources earn-out opportunity was between $0 and $20 million over a four-year period following the date of acquisition.  During 2011, based on our probability assessments over the remainder of the earn-out period, we determined that it is not likely that any earn-out for Jupiter eSources will be achieved and based on this assessment, there is no liability recorded related to this earn-out opportunity as of March 31, 2012 and December 31, 2011.

 

In connection with the acquisition of Jupiter eSources, we withheld a portion of the purchase price for any claims for indemnification and purchase price adjustments.  This amount will be deferred until May 2012.  This holdback has been discounted using an appropriate imputed interest rate.

 

De Novo

 

The undiscounted amount of all potential future payments that we could be required to make under the De Novo earn-out opportunity is between $0 and $33.6 million over a two-year period following the date of acquisition.  A portion of the De Novo earn-out opportunity is contingent upon certain of the sellers remaining employees of Epiq.  The portion of the contingent consideration that is not tied to employment is considered to be part of the total consideration transferred for the purchase of De Novo and has been measured and recognized at fair value.  The $0.4 million change in fair value has been recognized as accretion expense and is included in “Interest expense” in the Condensed Consolidated Statement of Income for the three months ended March 31, 2012.  Subsequent fair value changes, measured quarterly, up to the ultimate amount paid, will be recognized in earnings. The portion of the contingent consideration that is tied to employment is recorded as compensation expense when incurred.  See Note 11 of our Notes to Condensed Consolidated Financial Statements for further detail.

 

In connection with the acquisition of De Novo, a portion of the purchase price is being held by us and deferred until July 2013 as security for potential indemnification claims.  This amount has been discounted using an appropriate imputed interest rate.

 

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NOTE 4:   NET INCOME PER SHARE

 

Basic net income per share is computed on the basis of weighted average outstanding common shares.  Diluted net income per share is computed on the basis of basic weighted average outstanding common shares adjusted for the dilutive effect of stock options, if dilutive. The numerator of the diluted net income per share calculation is increased by the allocation of net income and dividends declared to nonvested shares, if the net impact is dilutive.

 

We have determined that certain nonvested share awards (also referred to as restricted stock awards) issued by the company are participating securities because they have non-forfeitable rights to dividends. Accordingly, basic net income per share is calculated under the two-class method calculation. In determining the number of diluted shares outstanding, we are required to disclose the more dilutive earnings per share result between the treasury stock method calculation and the two-class method calculation. For the three-month period ended March 31, 2012, the two-class method calculation was more dilutive and for the three-month period ended March 31, 2011, the treasury stock method calculation was more dilutive.

 

The computation of basic and diluted net income per share for the three months ended March 31, 2012 is as follows:

 

 

 

Three months ended March 31, 2012

 

 

 

Net Income
(Numerator)

 

Weighted
Average
Common
Shares
Outstanding
(Denominator)

 

Per Share
Amount

 

 

 

(in thousands, except per share data)

 

 

 

 

 

 

 

 

 

Net income

 

$

2,039

 

 

 

 

 

Less: amounts allocated to nonvested shares

 

(6

)

 

 

 

 

 

 

 

 

 

 

 

 

Basic net income available to common stockholders

 

2,033

 

35,478

 

$

0.06

 

 

 

 

 

 

 

 

 

Effect of dilutive securities:

 

 

 

 

 

 

 

Stock options

 

 

969

 

 

 

Add back: amounts allocated to nonvested shares

 

6

 

 

 

 

Less: amounts re-allocated to nonvested shares

 

(6

)

 

 

 

Diluted net income available to common stockholders

 

$

2,033

 

36,447

 

$

0.06

 

 

The computation of basic and diluted net income per share for the three months ended March 31, 2011 is as follows:

 

 

 

Three months ended March 31, 2011

 

 

 

Net Income
(Numerator)

 

Weighted
Average
Common
Shares
Outstanding
(Denominator)

 

Per Share
Amount

 

 

 

(in thousands, except per share data)

 

 

 

 

 

 

 

 

 

Net income

 

$

3,082

 

 

 

 

 

Less: net income allocated to nonvested shares

 

(2

)

 

 

 

 

 

 

 

 

 

 

 

 

Basic net income available to common stockholders

 

3,080

 

35,092

 

$

0.09

 

 

 

 

 

 

 

 

 

Effect of dilutive securities:

 

 

 

 

 

 

 

Stock options

 

 

1,288

 

 

 

Nonvested shares

 

2

 

107

 

 

 

Diluted net income available to common stockholders

 

$

3,082

 

36,487

 

$

0.08

 

 

For the three months ended March 31, 2012 and 2011, weighted-average outstanding stock options totaling approximately 3.2 million and 2.0 million, respectively, were antidilutive, and therefore not included in the computation of diluted net income per share.

 

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NOTE 5:   SHARE-BASED COMPENSATION

 

Share-based compensation is measured at grant date, based on the fair value of the award, and is recognized on a straight-line basis over the requisite service period.  The following table presents total share-based compensation expense, which is a non-cash charge, included in the Condensed Consolidated Statements of Income:

 

 

 

Three Months Ended

 

 

 

March 31,
2012

 

March 31,
2011

 

 

 

(in thousands)

 

Direct costs of services

 

$

89

 

$

96

 

General and administrative

 

1,765

 

1,741

 

Pre-tax share-based compensation expense

 

1,854

 

1,837

 

Income tax benefit

 

(809

)

(796

)

Total share-based compensation expense, net of tax

 

$

1,045

 

$

1,041

 

 

The 2004 Equity Incentive Plan, as amended (the “2004 Plan”), limits the grant of options to acquire shares of common stock, stock appreciation rights, and restricted stock awards under the 2004 Plan to an aggregate of 7,500,000 shares.  Any grant under the 2004 Plan that expires or terminates unexercised, becomes unexercisable, or is forfeited will be available for future grants. At March 31, 2012, there were approximately 326,000 shares of common stock available for future equity-related grants under the 2004 Plan.

 

During the three months ended March 31, 2012, we granted 430,000 nonvested share awards at a weighted-average grant date price of $11.85 per share.  These awards vest 12 months after the date of grant upon achievement of a performance condition for the calendar year ending December 31, 2012. As of March 31, 2012 we have assessed the likelihood that the performance condition will be met and have recorded the related expense based on the estimated outcome. We also granted 60,000 stock options with a weighted-average exercise price of $11.85 per share, which vest 20% per year over five years.

 

We settle stock option exercises and nonvested share awards with newly issued common shares or treasury stock.

 

The fair value of each stock option grant was estimated at the date of grant using a Black-Scholes option pricing model. The following table presents the weighted-average assumptions used and the weighted-average fair value per option granted.

 

 

 

Three months ended
March 31,

 

 

 

2012

 

2011

 

Expected life of stock option (years)

 

6.6

 

6.6

 

Expected volatility

 

38

%

34

%

Risk-free interest rate

 

1.2

%

3.0

%

Dividend yield

 

1.5

%

1.1

%

Weighted average grant-date fair value

 

$

3.97

 

$

4.70

 

 

As of March 31, 2012 there was $8.5 million of unrecognized compensation cost, net of estimated forfeitures, related to nonvested share-based awards, which will be recognized over a weighted-average period of 2.1 years.

 

NOTE 6:   SEGMENT REPORTING

 

We have three reporting segments: eDiscovery, bankruptcy, and settlement administration.  Our eDiscovery business provides collections and forensics, processing, search and review, and document review and staffing services to companies and the litigation departments of law firms.  Produced documents are made available primarily through a hosted environment, and our DocuMatrix™ software allows for efficient attorney review and data requests.  Our bankruptcy business provides solutions that address the needs of trustees to administer bankruptcy proceedings and of debtor corporations that file a plan of reorganization and software to monitor bankruptcy cases for creditors.  Our settlement administration business provides managed services including legal notification, claims administration, project administration and controlled disbursement.

 

The segment performance measure is based on earnings before interest, taxes, depreciation and amortization, other operating expense, and share-based compensation expense.  In management’s evaluation of performance, certain costs, such as

 

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compensation for administrative staff and executive management, are not allocated by segment and, accordingly, the following reporting segment results do not include such unallocated costs.

 

Assets reported within a segment are those assets that can be identified to a segment and primarily consist of trade receivables, property, equipment and leasehold improvements, software, identifiable intangible assets and goodwill.  Cash, tax-related assets, and certain prepaid assets and other assets are not allocated to our segments.  Although we can and do identify long-lived assets such as property, equipment and leasehold improvements, software, and identifiable intangible assets to reporting segments, we do not allocate the related depreciation and amortization to the segment as management evaluates segment performance exclusive of these non-cash charges.

 

Following is a summary of segment information for the three months ended March 31, 2012. The intersegment revenues in the three months ended March 31, 2012 related primarily to call center and printing services performed by the settlement administration segment for the bankruptcy segment.

 

 

 

Three Months Ended March 31, 2012

 

 

 

eDiscovery

 

Bankruptcy

 

Settlement
Administration

 

Eliminations

 

Total

 

 

 

(in thousands)

 

Revenue:

 

 

 

 

 

 

 

 

 

 

 

Operating revenue before reimbursed direct costs

 

$

48,848

 

$

24,229

 

$

9,750

 

$

 

$

82,827

 

Intersegment revenue

 

48

 

 

1,497

 

(1,545

)

 

 

 

 

 

 

 

 

 

 

 

 

 

Operating revenue before reimbursed direct costs

 

48,896

 

24,229

 

11,247

 

(1,545

)

82,827

 

Operating revenue from reimbursed direct costs

 

456

 

1,477

 

3,712

 

 

5,645

 

Total revenue

 

49,352

 

25,706

 

14,959

 

(1,545

)

88,472

 

 

 

 

 

 

 

 

 

 

 

 

 

Direct costs, general and administrative costs

 

31,759

 

13,981

 

12,465

 

(1,545

)

56,660

 

Segment performance measure

 

$

17,593

 

$

11,725

 

$

2,494

 

$

 

$

31,812

 

 

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Following is a summary of segment information for the three months ended March 31, 2011. The intersegment revenues in the three months ended March 31, 2011 related primarily to call center services performed by the settlement administration segment for the bankruptcy segment.

 

 

 

Three Months Ended March 31, 2011

 

 

 

eDiscovery

 

Bankruptcy

 

Settlement
Administration

 

Eliminations

 

Total

 

 

 

(in thousands)

 

Revenue:

 

 

 

 

 

 

 

 

 

 

 

Operating revenue before reimbursed direct costs

 

$

20,971

 

$

22,774

 

$

10,468

 

$

 

$

54,213

 

Intersegment revenue

 

5

 

 

536

 

(541

)

 

 

 

 

 

 

 

 

 

 

 

 

 

Operating revenue before reimbursed direct costs

 

20,976

 

22,774

 

11,004

 

(541

)

54,213

 

Operating revenue from reimbursed direct costs

 

80

 

987

 

4,342

 

 

5,409

 

Total revenue

 

21,056

 

23,761

 

15,346

 

(541

)

59,622

 

 

 

 

 

 

 

 

 

 

 

 

 

Direct costs, general and administrative costs

 

11,225

 

11,262

 

14,038

 

(541

)

35,984

 

Segment performance measure

 

$

9,831

 

$

12,499

 

$

1,308

 

$

 

$

23,638

 

 

Following is a reconciliation of our segment performance measure to income before income taxes.

 

 

 

Three Months Ended March 31,

 

 

 

2012

 

2011

 

 

 

(in thousands)

 

Segment performance measure

 

$

31,812

 

$

23,638

 

Corporate and unallocated expenses

 

(11,162

)

(6,203

)

Share-based compensation expense

 

(1,854

)

(1,837

)

Depreciation and software and leasehold amortization

 

(6,728

)

(5,207

)

Amortization of intangible assets

 

(6,769

)

(3,766

)

Other operating expense

 

171

 

(483

)

Interest expense, net

 

(2,720

)

(805

)

Income before income taxes

 

$

2,750

 

$

5,337

 

 

Following are total assets by segment.

 

 

 

March 31,
2012

 

December 31,
2011

 

 

 

(in thousands)

 

Assets

 

 

 

 

 

eDiscovery

 

$

345,083

 

$

343,868

 

Bankruptcy

 

242,680

 

246,203

 

Settlement Administration

 

51,622

 

52,911

 

Corporate and unallocated

 

36,462

 

35,682

 

Total consolidated assets

 

$

675,847

 

$

678,664

 

 

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NOTE 7:  FAIR VALUES OF ASSETS AND LIABILITIES

 

Accounting standards establish a three-level fair value hierarchy based upon the assumptions (inputs) used to price assets or liabilities. The hierarchy requires us to maximize the use of observable inputs and minimize the use of unobservable inputs. The three levels of inputs used to measure fair value are listed below.

 

Level 1 — Unadjusted quoted prices in active markets for identical assets or liabilities.

 

Level 2 — Observable inputs other than those included in Level 1, such as quoted market prices for similar assets and liabilities in active markets or quoted prices for identical assets in inactive markets.

 

Level 3 — Unobservable inputs reflecting our own assumptions and best estimate of what inputs market participants would use in pricing an asset or liability.

 

Assets and Liabilities Measured at Fair Value on a Recurring Basis

 

The carrying value and estimated fair value of our cash equivalents, which consist of short-term money market funds, are classified as Level 1. There have been no transfers between Level 1 and Level 2 during the three months ended March 31, 2012.  Our Level 3 liability is valued using unobservable inputs to the valuation methodology that are significant to the measurement of the fair value of the contingent consideration.

 

For fair value measurements categorized within Level 3 of the fair value hierarchy, our accounting and finance management, who report to the chief financial officer, determine our valuation policies and procedures.  The development and determination of the unobservable inputs for Level 3 fair value measurements and fair value calculations are the responsibility of our accounting and finance management and are approved by the chief financial officer.  Fair value calculations are generally prepared by third-party valuation experts who rely on discussions with management in addition to the use of management’s assumptions and estimates as they related to the assets or liabilities in Level 3.  Such assumptions and estimates include such inputs as estimates of future cash flows, projected profit and loss information, discount rates, and assumptions as they relate to future pertinent events.  Through regular interaction with the third-party valuation experts, finance and accounting management determine that the valuation techniques used and inputs and outputs of the models reflect the requirements of accounting standards as they relate to fair valur measurements.  Changes in fair value measurements categorized within Level 3 of the fair value hierarchy are analyzed each period based on changes in estimates or assumptions and recorded as appropriate.

 

As of March 31, 2012 and December 31, 2011, our assets and liabilities that are measured and recorded at fair value on a recurring basis were as follows:

 

 

 

 

 

Estimated Fair Value Measurements

 

Items Measured at Fair Value on a

 

Carrying

 

Quoted
Prices in
Active
Markets

 

Significant
Other
Observable
Inputs

 

Significant
Unobservable
Inputs

 

Recurring Basis

 

Value

 

(Level 1)

 

(Level 2)

 

(Level 3)

 

 

 

(in thousands)

 

March 31, 2012:

 

 

 

 

 

 

 

 

 

Assets:

 

 

 

 

 

 

 

 

 

Money market funds

 

$

34

 

$

34

 

$

 

$

 

Liabilities:

 

 

 

 

 

 

 

 

 

Contingent consideration (1)

 

$

16,637

 

$

 

$

 

$

16,637

 

 

 

 

 

 

 

 

 

 

 

December 31, 2011:

 

 

 

 

 

 

 

 

 

Assets:

 

 

 

 

 

 

 

 

 

Money market funds

 

$

34

 

$

34

 

$

 

$

 

Liabilities:

 

 

 

 

 

 

 

 

 

Contingent consideration (1)

 

$

16,226

 

$

 

$

 

$

16,226

 

 


(1)                    The contingent consideration represents the estimated fair value of the additional potential earn-out opportunity payable in connection with our acquisition of De Novo that is contingent upon future operating revenue growth. We estimated the fair value using management’s estimate of projected revenue over the earn-out period as well as the probability of earn-out achievement and applied a discount rate to the projected earn-out payments that approximated the weighted average cost of capital.

 

A hypothetical 1% decrease in the discount rate used in calculating the fair value of the De Novo contingent consideration would have resulted in approximately a $0.2 million increase in the fair value of the contingent consideration and a hypothetical 1% increase related to our revenue assumptions as they relate to the De Novo contingent consideration would have resulted in approximately a $0.2 million increase in the fair value of the contingent consideration. 

 

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As of March 31, 2012 and December 31, 2011, the carrying value of our trade accounts receivable, accounts payable, certain other liabilities, deferred acquisition price payments and capital leases approximated fair value. The amount outstanding under our credit facility at March 31, 2012 and December 31, 2011 was $215.0 million and $217.0 million, respectively, which approximated fair value due to the borrowing rates currently available to us for debt with similar terms and is classified as Level 2.

 

 

 

Fair Value Measurements
Using

Significant Unobservable
Inputs

(Level 3)
(in thousands)

 

 

 

Contingent Consideration

 

 

 

 

 

Beginning balance December 31, 2011

 

$

16,226

 

Increase in fair value related to accretion

 

411

 

Ending balance March 31, 2012

 

$

16,637

 

 

NOTE 8:  SUPPLEMENTAL CASH FLOW INFORMATION

 

Supplemental cash flow information is as follows (in thousands):

 

 

 

Three months ended
March 31,

 

 

 

2012

 

2011

 

 

 

 

 

 

 

Cash paid for:

 

 

 

 

 

Interest

 

$

1,691

 

$

634

 

Income taxes paid, net

 

1,158

 

795

 

Non-cash investing and financing transactions:

 

 

 

 

 

Property, equipment, and leasehold improvements accrued in accounts payable and other long-term liabilities

 

913

 

2,110

 

Capitalized lease obligations incurred

 

 

196

 

Dividends declared but not yet paid

 

1,803

 

1,232

 

 

NOTE 9:                                                EQUITY

 

Share Repurchase

 

On October 26, 2010, our board of directors authorized $35.0 million for share repurchases (the “2010 Share Repurchase Program”). Repurchases may be made pursuant to the 2010 Share Repurchase Program from time to time at prevailing market prices in the open market or in privately negotiated purchases, or both. We may utilize one or more plans with our brokers or banks for pre-authorized purchases within defined limits pursuant to Rule 10b5-1 under the Securities Exchange Act of 1934, as amended, to effect all or a portion of the repurchases. During the three months ended March 31, 2011, we purchased 745,414 shares of common stock for approximately $10.0 million, at an average cost of $13.37 per share. There were no repurchases of shares under the 2010 Share Repurchase Program during the three months ended March 31, 2012.  As of March 31, 2012, $12.1 million remained available for share repurchases under the 2010 Share Repurchase Program.

 

We also have a policy that requires shares to be repurchased by us to satisfy employee tax withholding obligations upon the vesting of restricted stock awards.  During the three months ended March 31, 2012, we repurchased 154,768 shares for approximately $1.9 million and during the three months ended March 31, 2011, we repurchased 66,290 shares for approximately $0.9 million to satisfy employee tax withholding obligations upon the vesting of restricted stock awards.

 

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Dividend

 

On March 1, 2012, our board of directors declared a cash dividend of $0.05 per outstanding share of common stock, payable on May 18, 2012 to shareholders of record as of the close of business on April 16, 2012.  Dividends payable of approximately $1.8 million is included as a component of “Other accrued liabilities” in the Condensed Consolidated Balance Sheets at March 31, 2012.

 

NOTE 10:              LEGAL PROCEEDINGS

 

Employee Arbitration

 

Epiq and one of its subsidiaries are currently in arbitration before the American Arbitration Association in New York, New York, regarding claims alleging wrongful employment termination.  Arbitration proceedings were initiated in 2009 and were completed as of January 18, 2012.  In April 2012, the parties completed post-trial briefing to the arbitration panel, and we are awaiting a ruling. We believe that the employment claims are meritless and we have defended vigorously against them.  No settlement amounts associated with this matter have been accrued in the accompanying Condensed Consolidated Financial Statements due to the fact that any such amounts are not reasonably estimable by us at this time.

 

Purported Software License Complaint

 

On or about June 24, 2011, Epiq eDiscovery Solutions, Inc. (“EDS”), an indirect, wholly owned subsidiary of Epiq, filed a lawsuit against Sybase, Inc. (“Sybase”) and Does 1 to 50, et al. in the Superior Court of the State of California, Alameda County (the “Superior Court”), alleging breach of contract and requesting a declaratory judgment against Sybase.  EDS’s complaint against Sybase relates to a dispute that has arisen under a software license agreement between EDS and Sybase (the “Agreement”) and encompasses a request by EDS for the Superior Court to issue an order:  (a) declaring that EDS currently owes Sybase nothing under the Agreement, and (b) requiring Sybase to provide EDS with certain license keys to software licenses that EDS purchased from Sybase under the Agreement.  On or about July 29, 2011, Sybase filed an answer to the complaint and a cross-complaint, which Sybase subsequently amended, against EDS and Does 51-60 relating to that same dispute and Agreement, alleging that, among other things, EDS owes Sybase additional amounts under the Agreement totaling at least $7.0 million, plus interest and costs of the lawsuit.

 

We believe that Sybase’s amended cross-complaint has no merit and we will continue to defend against it vigorously.  No amounts associated with this matter have been accrued in the accompanying Condensed Consolidated Financial Statements. EDS filed the lawsuit in order to protect and defend its rights and to demonstrate that, at all relevant times, EDS acted in good faith and in accordance with the terms of the Agreement.

 

NOTE 11:  ACQUISITIONS

 

Encore Discovery Solutions

 

On April 4, 2011, we completed the acquisition of Encore Discovery Solutions (“Encore”) for approximately $104.3 million, $10.0 million of which was placed in escrow as security for potential indemnification claims.  Encore provides products and services for electronic evidence processing, document review platforms, and professional services for project management, data collection and forensic consulting. With this transaction, we further strengthen our worldwide eDiscovery franchise providing corporate legal departments and law firms with a broad range of capabilities to manage electronic information for discovery, investigations, compliance and related legal matters.  The transaction was funded from our credit facility.

 

The total purchase price transferred to effect the acquisition was as follows (in thousands):

 

 

 

(in thousands)

 

Cash paid at closing

 

$

103,385

 

Other consideration

 

844

 

Working capital adjustment

 

98

 

Total purchase price

 

$

104,327

 

 

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Transaction related costs, which were expensed during the period in which they were incurred, are reflected in “Other operating expense” in the Condensed Consolidated Statements of Income, and totaled $0.5 million for the quarter ended March 31, 2011, for this acquisition.

 

Total purchase consideration has been allocated to the tangible and identifiable intangible assets and to liabilities assumed based on their respective fair values on the acquisition date.  The purchase price allocations are summarized in the following table:

 

 

 

(in thousands)

 

Tangible assets and liabilities

 

 

 

Current assets, including cash acquired

 

$

20,044

 

Non-current assets

 

2,669

 

Current liabilities

 

(6,646

)

Non-current liabilities

 

(15,115

)

Intangible assets

 

32,578

 

Software

 

2,498

 

Goodwill

 

68,299

 

Net assets acquired

 

$

104,327

 

 

Included in the total liabilities assumed is a net deferred tax liability balance of $16.0 million, primarily comprised of the difference between the assigned values of the intangible assets acquired and the tax basis of those assets.

 

Based on the results of an independent valuation, we allocated approximately $32.6 million of the purchase price to acquired intangible assets, and $2.5 million of the purchase price to software. The following table summarizes the major classes of acquired intangible assets and software, as well as the respective weighted-average amortization periods:

 

 

 

Amount
(in thousands)

 

Weighted
Average
Amortization
Period
(Years)

 

Identifiable Intangible Assets

 

 

 

 

 

Trade name

 

$

1,617

 

5.0

 

Non-compete agreement

 

1,362

 

2.0

 

Customer relationships

 

29,599

 

7.0

 

Total identifiable intangible assets

 

$

32,578

 

 

 

 

 

 

 

 

 

Software internally developed

 

$

2,498

 

5.0

 

 

The Encore transaction was structured as a stock purchase and therefore, the goodwill and acquired intangible assets are not amortizable for tax purposes.

 

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The excess of purchase consideration over net assets assumed was recorded as goodwill, which represents the strategic value assigned to Encore, including the expected benefits from the synergies resulting from the transaction, as well as the knowledge and experience of the workforce in place.

 

De Novo Legal LLC

 

On December 28, 2011, we completed the acquisition of De Novo for approximately $86.6 million and $5.0 million is being held by us as security for potential indemnification claims.  De Novo has document review centers in key strategic locations in the United States and is among the largest providers of managed review and staffing services and also offers clients eDiscovery processing and hosted review.  This transaction augments our capacity for eDiscovery and document review services and broadens our eDiscovery customer base.  The transaction was funded from our credit facility.

 

The total purchase price transferred to effect the acquisition was as follows (in thousands):

 

 

 

(in thousands)

 

Cash paid at closing

 

$

67,866

 

Fair value of deferred cash consideration

 

4,417

 

Fair value of contingent consideration

 

16,226

 

Working capital adjustment

 

(1,861

)

Total purchase price

 

$

86,648

 

 

In connection with this acquisition $5.0 million of the purchase price is being held by us and deferred for 18 months following the closing date of the acquisition as security for any claims for indemnification.  During the first quarter 2012, we adjusted the purchase price to reflect a reduction to this deferred cash consideration related to an uncollected account receivable indemnified by the sellers.  This holdback has been discounted using an appropriate imputed interest rate.  At March 31, 2012 and December 31, 2011, $4.5 million and $4.9 million, respectively, were recorded in “Long-term obligations” on the Condensed Consolidated Balance Sheets related to this holdback.  Also during the first quarter of 2012, we finalized the calculation of the working capital adjustment to the purchase price as reflected in the table above.

 

As a result of an earn-out opportunity based on future revenue growth of our eDiscovery segment, we have recorded a liability related to potential contingent consideration. The undiscounted amount of all potential future payments that we could be required to make under the earn-out opportunity is between $0 and $33.6 million over a two-year period following the acquisition date. Approximately one-third of the De Novo earn-out opportunity is contingent upon certain of the sellers remaining employees of Epiq. The portion of the contingent consideration that is not tied to employment is considered to be part of the total consideration transferred for the purchase of De Novo and has been measured and recognized at a fair value of approximately $16.6 million and $16.2 million as of March 31, 2012 and December 31, 2011, respectively.  As of March 31, 2012, $8.8 million is included in “Current maturities of long-term obligations” and as of March 31, 2012 and December 31, 2012, $7.8 million and $16.2 million, respectively, is included in “Long-term obligations” on the Condensed Consolidated Balance Sheet.

 

The fair value of the contingent consideration was determined by a present value calculation of the potential payouts based on projected revenue. The $0.4 million change in fair value has been recognized as accretion expense and is included in “Interest expense” in the Condensed Consolidated Statement of Income for the three months ended March 31, 2012.  Subsequent fair value changes, measured quarterly, up to the potential ultimate amount paid, will be recognized in earnings. The portion of the contingent consideration that is tied to employment will be treated as compensation expense when incurred.  Based on management’s estimates of current projections for the earn-out periods, as of March 31, 2012, we have accrued $1.7 million of compensation expense related to the portion of the contingent consideration that is dependent upon continued employment of certain De Novo employees.  This amount is reflected in “General and administrative expense” on the Condensed Consolidated Statements of Income for the three months ended March 31, 2012.

 

Total purchase consideration has been allocated to the tangible and identifiable intangible assets and to liabilities assumed based on their respective fair values on the acquisition date.  The purchase price allocations are summarized in the following table:

 

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Table of Contents

 

 

 

(in thousands)

 

Tangible assets and liabilities

 

 

 

Current assets, including cash acquired

 

$

11,214

 

Non-current assets

 

2,738

 

Current liabilities

 

(2,361

)

Non-current liabilities

 

(500

)

Intangible assets

 

34,629

 

Goodwill

 

40,928

 

Net assets acquired

 

$

86,648

 

 

During the first quarter of 2012, based on new information obtained since December 31, 2011, related to the results of an independent valuation of the fair value of property, plant and equipment acquired in connection with the De Novo acquisition, we adjusted the preliminary purchase price allocation to reflect a $1.5 million reduction in property, plant and equipment along with a corresponding increase of $1.3 million to goodwill and a $0.2 million increase to the customer relationship intangible asset.

 

Based on the results of an independent valuation, we allocated approximately $34.4 million of the purchase price to acquired intangible assets. The following table summarizes the major classes of acquired intangible assets, as well as the respective weighted-average amortization periods:

 

 

 

Amount
(in thousands)

 

Weighted
Average
Amortization
Period
(Years)

 

Identifiable Intangible Assets

 

 

 

 

 

Trade name

 

$

850

 

5.0

 

Non-compete agreement

 

2,900

 

5.0

 

Customer relationships

 

30,879

 

8.0

 

Total identifiable intangible assets

 

$

34,629

 

 

 

 

The excess of purchase consideration over net assets assumed was recorded as goodwill, which represents the strategic value assigned to De Novo, including the expected benefits from the synergies resulting from the transaction, as well as the knowledge and experience of the workforce in place.  The goodwill and intangible assets related to this acquisition are deductible for tax purposes.

 

The Condensed Consolidated Financial Statements include the operating results of De Novo from the date of acquisition.

 

Pro Forma Financial Information

 

The following unaudited condensed pro forma financial information presents the results of operations as if the De Novo and Encore acquisitions had taken place on January 1, 2010 (in thousands).  These amounts were prepared in accordance with the acquisition method of accounting under existing standards and are not necessarily indicative of the results of operations that would have occurred if our acquisitions of De Novo and Encore had been completed on January 1, 2010, nor are they indicative of our future operating results. These unaudited pro forma amounts include an adjustment to reclassify acquisition expenses related to Encore and De Novo to the 2010 whereas they were actually incurred during the three months ended March 31, 2011.

 

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Table of Contents

 

 

 

Three Months Ended
March 31, 2011

 

Revenue

 

$

84,836

 

Net income

 

8,120

 

 

 

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Table of Contents

 

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

 

Forward-Looking Statements

 

In this report, in other filings with the SEC and in press releases and other public statements by our officers throughout the year, Epiq Systems, Inc. makes or will make statements that plan for or anticipate the future.  These forward-looking statements include , but are not limited to any projection or expectation of earnings, revenue or other financial items; the plans, strategies and objectives of management for future operations; factors that may affect our operating results; new products or services; the demand for our products and services; our ability to consummate acquisitions and successfully integrate them into our operations; future capital expenditures; effects of current or future economic conditions or performance; industry trends and other matters that do not relate strictly to historical facts or statements of assumptions underlying any of the foregoing.  These forward-looking statements are based on our current expectations.  In this Quarterly Report on Form 10-Q, we make statements that plan for or anticipate the future.  Many of these statements are found in the “Management’s Discussion and Analysis of Financial Condition and Results of Operations” section of this report.

 

Forward-looking statements may be identified by words or phrases such as “believe,” “expect,” “anticipate,” “should,” “planned,” “may,” “estimated,” “goal,” “objective” “seeks,” and “potential” and variations of these words and similar expressions or negatives of these words.  Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended (the “Exchange Act”), provide a “safe harbor” for forward-looking statements.  Because forward-looking statements involve future risks and uncertainties, listed below are a variety of factors that could cause actual results and experience to differ materially from the anticipated results or other expectations expressed in our forward-looking statements.  These factors include (1) any material changes in our total number of client engagements and the volume associated with each engagement, (2) any material changes in our clients’ deposit portfolio or the services required or selected by our clients in engagements, (3) material changes in the number of bankruptcy filings, class action filings or mass tort actions each year,  or changes in government legislation or court rules affecting these filings, (4) overall strength and stability of general economic conditions, both in the United States and in the global markets, (5) significant changes in the competitive environment, (6) risks associated with handling of confidential data and compliance with information privacy laws, (7) changes in or the effects of pricing structures and arrangements, (8) risks associated with the integration of acquisitions into our existing business operations, (9) risks associated with indebtedness, (10) risks associated with foreign currency fluctuations, (11) risks associated with developing and providing software and internet-based technology solutions to our clients, (12) risks associated with interruptions or delays in services at data centers, (13) risks of errors or failures of software or services, (14) risks associated with our international operations, (15) risks of litigation against us, and (16) other risks detailed from time to time in our SEC filings, including our most recent Annual Report on Form 10-K, Quarterly Reports on Form 10-Q and Current Reports on Form 8-K. In addition, there may be other factors not included in our SEC filings that may cause actual results to differ materially from any forward-looking statements. We undertake no obligation to update publicly or revise any forward-looking statements contained herein to reflect future events or developments, except as required by law.

 

This discussion and analysis should be read in conjunction with the Condensed Consolidated Financial Statements and the accompanying Notes to the Condensed Consolidated Financial Statements included in this Quarterly Report on Form 10-Q.

 

Overview

 

We are a leading global provider of technology-enabled solutions for electronic discovery, bankruptcy and class action administration.  We offer full-service capabilities, which include litigation, investigations, financial transactions, regulatory, compliance and other legal matters for eDiscovery.  Our innovative technology and services, combined with deep subject-matter expertise, provide reliable solutions for the professionals we serve.

 

We have three reporting segments: eDiscovery, bankruptcy, and settlement administration.

 

eDiscovery

 

Our eDiscovery segment provides collections and forensics, processing, search and review, and document review and staffing services to companies and the litigation departments of law firms.  We process data which analyzes, filters, deduplicates and produces documents for review.  Produced documents are made available primarily through a hosted environment, our proprietary software, DocuMatrix™, and third-party software which allows for efficient attorney review and data requests.

 

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Table of Contents

 

Our customers are typically large corporations that use our products and services cooperatively with their legal counsel to manage the eDiscovery process for litigation, financial transactions, investigations and regulatory matters.

 

The substantial number of electronic documents and amount of other electronic data has changed the dynamics of how attorneys support discovery in complex matters. Due to the complexity of cases, the volume of data that are maintained electronically, and the volume of documents that are produced in all types of discovery matters, law firms have become increasingly reliant on electronic evidence management systems to organize and manage the discovery process.

 

Following is a description of the significant sources of revenue in our eDiscovery business.

 

·                  Consulting, forensics and collection service fees based on the number of hours during which services are provided.

 

·                  Fees related to the conversion of data into an organized, searchable electronic database. The amount earned varies primarily on the number of documents.

 

·                  Hosting fees based on the amount of data stored.

 

·                  Document review fees based on the number of hours spent reviewing documents, the number of pages reviewed, or the amount of data reviewed.

 

Our primary offices are in New York, Phoenix, London and Hong Kong and we operate data centers in the United States, Europe and Asia. IQ Review™ is our revolutionary combination of new intelligent technology and expert services which incorporates new prioritization technology into DocuMatrix™, our flagship document management platform.  Epiq Portal™ is an industry-changing, web-based platform that provides clients unprecedented real-time visibility into discovery projects with connectors to both our proprietary products and to third party tools.  Key benefits include cost-based reporting and budgeting tools, activity tracking, trend analysis and a project management console.

 

On December 28, 2011, we acquired De Novo Legal LLC (“De Novo”) for approximately $86.6 million and $5.0 million is being held by us and deferred for eighteen months following the closing as security for potential indemnification claims.  In addition to the net closing consideration, there is contingent consideration consisting of an earn-out based on future operating revenue growth.  The potential undiscounted amount of all future payments that we could be required to make under the earn-out opportunity is between $0 and $33.6 million over a two-year period.  The transaction was funded from our credit facility. See Note 11 of our Notes to Condensed Consolidated Financial Statements for further detail.

 

On April 4, 2011, we completed the acquisition of Encore Discovery Solutions (“Encore”) for $104.3 million cash, $10.0 million of which was placed in escrow as security for potential indemnification claims.  Encore provides market-proven products and services for electronic evidence processing, document review platforms, and professional services for project management, data collection and forensic consulting. With this transaction, we further strengthened our worldwide e-discovery franchise providing corporate legal departments and law firms with a broad range of capabilities to manage electronic information for discovery, investigations, compliance and related legal matters.

 

Both the De Novo and the Encore acquisitions further augment and accelerate growth opportunities for our global eDiscovery business. Each of these companies has strong customer bases that expand our market share. By continuing the availability of both businesses’ products, services and technologies, we will continue to offer an industry leading combination of resources, experience and subject matter expertise.  Increased market share and case activity levels and an uptake of new service offerings contributed to revenue growth in 2011 and the first three months of 2012, which is expected to continue into the remainder of 2012.

 

Bankruptcy

 

Bankruptcy is an integral part of the United States’ economy.  As reported by the Administrative Office of the U.S. Courts for the fiscal years ended December 31, 2011 and 2010, there were approximately 1.41 million and 1.59 million new bankruptcy filings, respectively. Bankruptcy filings for the twelve-month period ended December 31, 2011 decreased 11% versus the twelve-month period ended December 31, 2010.  During this period, Chapter 7 filings decreased 13%, Chapter 11 filings fell 16%, and Chapter 13 filings decreased 7%.

 

Our bankruptcy business provides solutions that address the needs of Chapter 7, Chapter 11, and Chapter 13 bankruptcy trustees to administer bankruptcy proceedings and of debtor corporations that file a plan of reorganization.

 

·                  Chapter 7 is a liquidation bankruptcy for individuals or businesses that, as measured by the number of new cases filed in the twelve-month period ended December 31, 2011, accounted for approximately 70% of all bankruptcy filings.  In a

 

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Chapter 7 case, the debtor’s assets are liquidated and the resulting cash proceeds are used by the Chapter 7 bankruptcy trustee to pay creditors.  Chapter 7 cases typically last several years.

 

·                  Chapter 11 is a reorganization model of bankruptcy for corporations that, as measured by the number of new cases filed in the twelve-month period ended December 31, 2011, accounted for approximately 1% of all bankruptcy filings.  Chapter 11 generally allows a company, often referred to as the debtor-in-possession, to continue operating under a plan of reorganization to restructure its business and to modify payment terms of both secured and unsecured obligations.  Chapter 11 cases generally last several years.

 

·                  Chapter 13 is a reorganization model of bankruptcy for individuals that, as measured by the number of new cases filed in the twelve-month period ended December 31, 2011, accounted for approximately 29% of all bankruptcy filings.  In a Chapter 13 case, debtors make periodic cash payments into a reorganization plan and a Chapter 13 bankruptcy trustee uses these cash payments to make monthly distributions to creditors.  Chapter 13 cases typically last between three and five years.

 

Chapter 11 bankruptcy engagements are generally long-term, multi-year assignments that provide revenue visibility into future periods. Our trustee services deposit portfolio exceeded $2.0 billion during the three months ended March 31, 2012, while pricing continued at floor pricing levels under our agreements due to the low short-term interest rate environment.

 

The application of Chapter 7 bankruptcy regulations has the practical effect of discouraging trustee customers from incurring direct administrative costs for computer system expenses.  As a result, we provide our Chapter 7 products and services to our trustee customers at no direct charge, and they maintain deposit accounts for bankruptcy cases under their administration at a designated banking institution.  We have arrangements with various banks under which we provide the bankruptcy trustee case management software and related services, and the bank provides the bankruptcy trustee with deposit-related banking services.

 

The key participants in a bankruptcy proceeding include the debtor-in-possession, the debtor’s legal counsel, the creditors, the creditors’ legal counsel, and the bankruptcy judge.  Chapter 7 and Chapter 13 cases also include a professional bankruptcy trustee, who is responsible for administering the bankruptcy case. The end-user customers of our Chapter 7, Chapter 11, and Chapter 13 bankruptcy businesses are debtor corporations that file a plan of reorganization and professional bankruptcy trustees.  The Executive Office for United States Trustees, a division of the United States Department of Justice, appoints all bankruptcy trustees.  A United States Trustee is appointed in most federal court districts and generally has responsibility for overseeing the integrity of the bankruptcy system.  The bankruptcy trustee’s primary responsibilities include liquidating the debtor’s assets or collecting funds from the debtor, distributing the collected funds to creditors pursuant to the orders of the bankruptcy court and preparing regular status reports for the Executive Office for United States Trustees and for the bankruptcy court.  Trustees manage an entire caseload of bankruptcy cases simultaneously.

 

Our proprietary software product, AACER® (Automated Access to Court Electronic Records) (“AACER®”), assists creditors including banks, mortgage processors, and their administrative services professionals to streamline processing of their portfolios of loans in bankruptcy cases. AACER® electronically monitors developments in all United States bankruptcy courts and applies sophisticated algorithms to classify docket filings automatically in each case to facilitate the management of large bankruptcy claims operations. By implementing AACER®, clients achieve greater accuracy in faster timeframes, with a significant cost savings compared to manual attorney review of each case in the portfolio.  Banking PortalTM, a centralized hub for processing online banking transactions across Epiq’s family of Chapter 7 products, facilitates the rapid on boarding of new banks and provides ebanking capabilities.

 

Following is a description of the significant sources of revenue in our bankruptcy business.

 

·                  Data hosting fees and volume-based fees.

 

·                  Case management professional service fees and other support service fees related to the administration of cases, including data conversion, claims processing, claims reconciliation, professional services, and disbursement services.

 

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·                  Deposit-based fees, earned primarily on a percentage of Chapter 7 total liquidated assets placed on deposit with a designated financial institution by our trustee clients, to whom we provide, at no charge, software licenses, limited hardware and hardware maintenance, and postcontract customer support services.  The fees we earn based on total liquidated assets placed on deposit by our trustee clients may vary based on fluctuations in short-term interest rates.

 

·                  Legal noticing services to parties of interest in bankruptcy matters, including direct notification and media campaign and advertising management in which we coordinate notification, primarily through print media outlets, to potential parties of interest for a particular client engagement.

 

·                  Reimbursement for costs incurred, primarily related to postage on mailing services.

 

·                  Monitoring and noticing fees earned based on monthly or on-demand requests for information provided through AACER®.

 

Settlement Administration

 

Our settlement administration segment provides managed services, including legal notification, claims administration, project administration and controlled disbursement.

 

The customers of our settlement administration segment are companies that require the administration of a settlement, resolution of a class action matter, or administration of a project. We sell our services directly to these customers and other interested parties, including legal counsel, which often provide access to these customers.

 

Following is a description of the significant sources of revenue in our settlement administration business.

 

·                  Fees contingent upon the month-to-month delivery of case management services such as claims processing, claims reconciliation, project management, professional services, call center support, website development and administration, and controlled disbursements. The amount we earn varies primarily on the size and complexity of the engagement.

 

·                  Legal noticing services to parties of interest in class action matters including media campaign and advertising management, in which we coordinate notification through various media outlets, such as print, radio and television, to potential parties of interest for a particular client engagement.

 

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

 

Key participants in this marketplace include law firms that specialize in representing class action and mass tort plaintiffs and other law firms that specialize in representing defendants. Class action refers to litigation in which class representatives bring a lawsuit against a defendant company or other persons on behalf of a large group of similarly affected persons.  Mass tort refers to class action cases that are particularly large or prominent. Class action and mass tort litigation is often complex and the cases, including administration of any settlement, may last several years.

 

Results of Operations for the Three Months Ended March 31, 2012 Compared with the Three Months Ended March 31, 2011

 

Consolidated Results

 

Revenue

 

Total revenue was $88.5 million for the three months ended March 31, 2012, an increase of $28.9 million, or 48.4%, as compared to the prior year. A portion of our total revenue consists of reimbursement for direct costs we incur, such as postage related to document management services.  We reflect the operating revenue from these reimbursed direct costs as a separate line item on our accompanying Condensed Consolidated Statements of Income.  Revenue originating from reimbursed direct costs was $5.6 million, an increase of $0.2 million, or 4.4%, from the prior year. Although operating revenue from reimbursed direct costs may fluctuate significantly from quarter to quarter, these fluctuations have a minimal effect on our income from operations as we realize little or no margin from this revenue.

 

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Operating revenue exclusive of revenue originating from reimbursed direct costs was $82.8 million in the three months ended March 31, 2012, an increase of $28.6 million, or 52.8%, as compared to the prior year. This increase was driven by a $27.8 million increase in the eDiscovery segment, and a $1.5 million increase in the bankruptcy segment; partially offset by a $0.7 million decrease in the settlement administration segment. Changes by segment are discussed below.

 

Operating Expense

 

The direct cost of services, exclusive of depreciation and amortization, was $31.3 million for the three months ended March 31, 2012, an increase of $12.7 million, or 68.7%, as compared to the prior year. This increase was primarily the result of a $12.1 million increase in compensation related expense, primarily related to the Encore and De Novo acquisitions, a $1.2 million increase in third-party material costs, a $0.7 million increase in expense related to claims management under a services agreement, offset by a $0.4 million decrease in outside mailing services expense and a $0.4 million decrease in general office expenses.  Changes by segment are discussed below.

 

The direct cost of bundled products and services, exclusive of depreciation and amortization, was $0.8 million, which is consistent with the comparable prior year expense.  Changes by segment are discussed below.

 

Reimbursed direct costs increased $0.3 million, or 4.3%, to $5.6 million for the three months ended March 31, 2012, compared to the prior year.  This increase corresponds to the increase in operating revenue from reimbursed direct costs.  Changes by segment are discussed below.

 

General and administrative costs increased $12.7 million, or 66.1%, to $32.0 million for the three months ended March 31, 2012. This increase was primarily due to an increase of $8.5 million in compensation related expense which is primarily related to the Encore and De Novo acquisitions.  In addition to the increase in compensation expense, a $0.9 million increase in travel and related expense, an $0.8 million increase in maintenance service contracts related to office equipment, a $0.5 million increase in office and equipment lease expense, a $0.5 million increase in professional services expense, a $0.4 million increase in telephone expense and a $0.3 million increase in office supplies expense, all of which are primarily related to the Encore and De Novo acquisitions, also contributed to the increase in general and administrative costs in 2012. Changes by segment are discussed below.

 

Depreciation and software and leasehold amortization costs for the three months ended March 31, 2012 were $6.7 million, an increase of $1.5 million or 29.2%, compared to $5.2 million in the prior year.  This increase was primarily the result of increased depreciation on equipment and software related to investments in our business segments and depreciation on the equipment acquired from the Encore and De Novo acquisitions.

 

Amortization of identifiable intangible assets for the three months ended March 31, 2012 was $6.8 million, an increase of $3.0 million, or 79.7%, compared to the prior year. This increase is due the acquisition of intangible assets associated with the acquisitions of Encore and De Novo in the second and fourth quarters of 2011, respectively.

 

Interest Expense, Net

 

We recognized interest expense of approximately $2.7 million for three months ended March 31, 2012, an increase of $1.9 million, or 236.5%, compared to the prior year.  This increase was primarily due to interest expense resulting from increased borrowings on our senior revolving loan to fund the Encore and De Novo acquisitions in April 2011 and December 2011, respectively, in addition to $0.7 million of accretion expense related primarily to acquisition related obligations in connection with the De Novo acquisition.

 

Income Taxes

 

Our effective tax rate for the three months ended March 31, 2012 was 25.9% compared to 42.3% in the prior year.  The reduced tax rate is primarily due to effectively settling our investment and employee incentive credit claims with New York State.  In late January 2012, the settlement proceeds were received and as a result we recognized $0.5 million of unrecognized tax benefits, of which $0.3 million affected our effective tax rate as well as $0.1 million of interest income which also affected our tax rate. The settlement reduced our first quarter 2012 effective tax rate by approximately 15%.  Also contributing to our lower rate is an expectation of a greater proportion of our 2012 pre-tax income being generated in lower tax jurisdictions such as the United Kingdom and in states with lower tax rates compared to our historical operations.

 

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In January 2012, we were notified that our 2009 United States federal income tax return will be examined by the Internal Revenue Service.  At this time we cannot reasonably estimate the outcome of this audit, but we believe that an assessment, if any, will be immaterial.  On December 31, 2011, the federal research credit expired.  Although extending the credit beyond 2011 has been introduced into legislation, it has not been passed by Congress or signed into law.  If the credit is extended, this would decrease our effective tax rate in future tax periods.

 

Net Income

 

Our net income was $2.0 million for the three months ended March 31, 2012 compared to $3.1 million for the prior year, a decrease of $1.1 million, or 33.8%. The decline in net income compared to the prior year was due to increased expenses in the initial post-acquisition periods related to the Encore and De Novo acquisitions, including amortization expense related to acquired intangible assets and compensation expense related to potential future contingent consideration.  A portion of our acquired intangible asset amortization expense is calculated under an accelerated method, resulting in higher levels of amortization expense in the initial periods following acquisitions. See Note 2 to our Condensed Consolidated Financial Statements for further detail. In addition, increased interest expense related to financing the costs of the recent acquisitions also contributed to the decrease in net income.  These increased expenses are partially offset by organic and acquisition-related earnings growth in our eDiscovery segment, primarily from the acquisitions of Encore and De Novo.

 

Results of Operations by Segment

 

The following segment discussion is presented on a basis consistent with our segment disclosure contained in Note 6 of our Notes to Condensed Consolidated Financial Statements.

 

eDiscovery Segment

 

eDiscovery operating revenue before reimbursed direct costs for the three months ended March 31, 2012 was $48.8 million, an increase of $27.8 million, or 132.9%, compared to the prior year.  Operating revenue growth as compared to the prior year period resulted primarily from the impact of the Encore and De Novo acquisitions, as well as organic growth.

 

eDiscovery direct and administrative costs, including reimbursed direct costs, were $31.8 million for the three months ended March 31, 2012, an increase of $20.6 million, or 182.9%, compared to the prior year.  This increase was primarily a result of the Encore and De Novo acquisitions and was driven by an $18.7 million increase in compensation and related expenses, a $1.2 million increase in third-party material costs, and a $0.8 million increase in maintenance service contracts related to office equipment.

 

Bankruptcy Segment

 

Bankruptcy operating revenue before reimbursed direct costs for the three months ended March 31, 2012 was $24.2 million, an increase of $1.5 million, or 6.1%, compared to the prior year. This increase was primarily attributable to a higher level of activity from existing corporate restructuring matters.

 

Bankruptcy direct and administrative costs, including reimbursed direct costs, increased $2.7 million, or 24.1%, to $14.0 million for the three months ended March 31, 2012, compared to the prior year. The change in these costs was the result of a $0.7 million increase in compensation related expenses, a $0.6 million increase in expenses related to claims management under a new services agreement, a $0.3 million increase in outside services, a $0.4 million increase in reimbursed direct costs, and a $0.3 million increase in legal notification costs associated with the higher level of corporate restructuring activity related to Chapter 11 printing and notification revenues.

 

Settlement Administration Segment

 

Settlement administration operating revenue before reimbursed direct costs was $9.8 million in the three months ended March 31, 2012, a decrease of $0.7 million, or 6.9%, compared to the prior year, primarily due to lower printing and claims administration services as compared to the prior year.

 

Settlement administration direct and administrative costs, including reimbursed direct costs, for the three months ended March 31, 2012 were $12.5 million, a decrease of $1.5 million, or 11.2%, compared to the prior year.  This decrease is primarily

 

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related to a decrease in legal advertising costs of $0.8 million and a decrease of $0.6 million in reimbursed direct costs, partially offset by an increase of $0.3 million in outside services.

 

Liquidity and Capital Resources

 

Cash flows from operating activities

 

During the three months ended March 31, 2012, our operating activities provided net cash of $15.1 million. Contributing to net cash provided by operating activities were net income of $2.0 million and $16.9 million of non-cash expenses, such as depreciation, amortization and share-based compensation expense. These items were partially offset by a $4.5 million net use of cash resulting from changes in operating assets and liabilities, resulting primarily from a $5.1 million increase in accounts receivable, due to revenue growth, a $1.2 million decrease in prepaid expenses and other assets, and a $1.0 million reduction in accounts payable and other liabilities.  Trade accounts receivable will fluctuate from period to period depending on the timing of sales and collections. Accounts payable will fluctuate from period to period depending on timing of purchases and payments.

 

During the three months ended March 31, 2011, our operating activities provided net cash of $10.8 million. Contributing to net cash provided by operating activities for the three months ended March 31, 2011, were net income of $3.1 million and non-cash expenses, such as depreciation and amortization and share-based compensation expense, of $13.2 million. These items were partially offset by a $5.5 million net use of cash resulting from changes in operating assets and liabilities. The most significant changes in operating assets and liabilities were a $7.6 million decrease in accounts payable, and a $1.9 million decrease in trade accounts receivable.

 

Cash flows from investing activities

 

During the three months ended March 31, 2012 and 2011, we used cash of $2.6 million and $4.1 million, respectively, for the purchase of property and equipment, including computer hardware and purchased software licenses primarily for our eDiscovery business and purchased computer hardware primarily for our corporate network infrastructure. Enhancements to our existing software and the development of new software is essential to our continued growth, and, during the three months ended March 31, 2012 and 2011, we used cash of $1.6 million and $1.7 million, respectively, to fund internal costs related to the development of software. We believe that cash generated from operations will be adequate to fund our anticipated property, equipment, and software spending over the next year.

 

Cash flows from financing activities

 

During the three months ended March 31, 2012, we borrowed $16.0 million and repaid $18.0 million under our senior revolving loan for a net reduction of $2.0 million along with $1.5 million of principal payments related to other debt.  In addition, we paid $1.8 million in dividends and used $1.9 million to repurchase shares required to satisfy employee tax withholding obligations upon the vesting of restricted stock awards.  See Notes 3 and 9 to our Condensed Consolidated Financial Statements for further detail.

 

During the three months ended March 31, 2011, we borrowed $17.0 million under our senior revolving loan, and had net proceeds from stock issued in connection with the exercise of employee stock options of $0.1 million.  This cash provided by financing activities during the three months ended March 31, 2011, was offset by the use of cash of $11.0 million for payments on our senior revolving loan, $10.0 million for the purchase of shares under our 2010 Share Repurchase Program and $0.9 million for the purchase of shares required to satisfy employee tax withholding obligations upon the vesting of restricted stock awards (as discussed below).  In the first quarter of 2011 we also used cash of $0.3 million for the payment of long-term obligations, including capital lease payments, and $1.2 million for dividends paid on our common shares and we also recognized a portion of the tax benefit related to the exercise of stock options as a financing source of cash.

 

Recent financing activities

 

Revolving Credit Agreement:  On April 25, 2011, we entered into an amended senior credit facility, with KeyBank National Association as administrative agent, and a syndicate of banks as lenders.  The amended credit facility provides for a senior revolving loan with an aggregate amount of funds available of $325.0 million with a maturity date of December 2015. We have the right, subject to compliance with the covenants as set forth in the credit facility agreement, to increase the

 

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borrowings to a maximum of $375.0 million.  The credit facility is secured by liens on our land and buildings and substantially all of our personal property.

 

Borrowings under the senior revolving loan bear interest at various rates based on our leverage ratio with two rate options at the discretion of management as follows:  (1) for base rate advances, borrowings bear interest at prime rate plus 75 to 175 basis points; (2) for LIBOR rate advances, borrowings bear interest at LIBOR rate plus 175 to 275 basis points. At March 31, 2012, borrowings of $215.0 million under this facility had a weighted average interest rate of 2.82%. The average amount of borrowings under this facility in the first quarter of 2012 was $220.0 million, at a weighted average interest rate of 2.86%.  The maximum month-end amount outstanding during the first quarter of 2012 was $222.0 million. At March 31, 2012, the amount available for borrowings under the credit facility is reduced by the $215.0 million outstanding and $1.0 million in outstanding letters of credit.

 

The financial covenants contained in the credit facility include a total debt leverage ratio and a fixed charge coverage ratio (all as defined in our credit facility agreement).  The leverage ratio is not permitted to exceed 3.00 to 1.00 and the fixed charge coverage ratio is not permitted to be less than 1.25 to 1.00.  As of March 31, 2012 we were in compliance with all financial covenants.

 

Other restrictive covenants contained in our credit facility include limitations on incurring additional indebtedness and completing acquisitions.  We generally cannot incur indebtedness outside of the credit facility, with the exception of capital leases, up to $15.0 million, and subordinated debt, up to $100 million.  In addition, for acquisitions we must be able to demonstrate that, on a pro forma basis, we would be in compliance with our covenants during the four quarters prior to the acquisition, and bank permission must be obtained for acquisitions in which cash consideration exceeds $125.0 million or total consideration exceeds $175.0 million.  The total consideration for all acquisitions consummated during the term of our credit facility may not exceed $300.0 million in the aggregate without lender permission.

 

On April 4, 2011, we completed the acquisition of Encore for $99.3 million cash, which was funded from our credit facility.  On December 28, 2011, we completed the acquisition of De Novo for $67.9 million cash, which was also funded from our credit facility. See Note 11 of our Notes to Condensed Consolidated Financial Statements for further detail.

 

Share Repurchase Program:  In 2010 our board of directors authorized $35.0 million for share repurchases (the “2010 Share Repurchase Program”). Repurchases may be made pursuant to the 2010 Share Repurchase Program from time to time at prevailing market prices in the open market or in privately negotiated purchases, or both. We may utilize one or more plans with our brokers or banks for pre-authorized purchases within defined limits pursuant to Rule 10b5-1 under the Exchange Act of 1934 to effect all or a portion of the repurchases. During the three months ended March 31, 2011, we purchased 745,414 shares of common stock for approximately $10.0 million, at an average cost of $13.37 per share.  There were no repurchases of shares under the 2010 Share Repurchase Program during the three months ended March 31, 2012. As of March 31, 2012, $12.1 million remained available for share repurchases under the 2010 Share Repurchase Program.

 

We also have a policy that requires shares to be repurchased by the company to satisfy employee tax withholding obligations upon the vesting of restricted stock awards.  During the three months ended March 31, 2012, we repurchased 154,768 shares for approximately $1.9 million and during the three months ended March 31, 2011, we repurchased 66,290 shares for approximately $0.9 million to satisfy employee tax withholding obligations upon the vesting of restricted stock awards.

 

Dividend:  On March 1, 2012, our board of directors declared a cash dividend of $0.05 per outstanding share of common stock, payable on May 18, 2012 to shareholders of record as of the close of business on April 16, 2012.  Dividends payable of approximately $1.8 million is included as a component of “Other accrued liabilities” in the Condensed Consolidated Balance Sheet at March 31, 2012.

 

We believe that funds generated from operations, plus our existing cash resources and amounts available under our credit facility, will be sufficient to meet our currently anticipated working capital requirements, internal software development expenditures, property, equipment and third party software expenditures, deferred acquisition price agreements, capital leases, interest payments due on our outstanding borrowings, and other contractual obligations.

 

In addition, we believe we could fund any future acquisitions, dividend payments, or common stock repurchases with our internally available cash, cash generated from operations, our existing available debt capacity, or from the issuance of additional securities.

 

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Foreign Cash

 

As of March 31, 2012 and December 31, 2011, our foreign subsidiaries had $4.1 million and $2.4 million, respectively, in cash located in financial institutions located outside of the United States.  All of this cash represents undistributed earnings of our foreign subsidiaries which are indefinitely reinvested.  In the event of a distribution to the United States, those earnings could be subject to United States federal and state income taxes, net of foreign tax credits.

 

Off-balance Sheet Arrangements

 

We generally do not utilize off-balance sheet arrangements in our operations; however, we enter into operating leases in the normal course of business.  Our operating lease obligations are disclosed below under “Contractual Obligations”.

 

Contractual Obligations

 

There have been no significant developments with respect to our contractual obligations since December 31, 2011.

 

Critical Accounting Policies

 

In our Annual Report on Form 10-K for the year ended December 31, 2011 that was filed with the SEC on March 1, 2012, we disclose accounting policies, referred to as critical accounting policies, that require management to use significant judgment or that require significant estimates.  Management regularly reviews the selection and application of our critical accounting policies.  There have been no updates to the critical accounting policies contained in our Annual Report on Form 10-K for the year ended December 31, 2011.

 

Recently Adopted Accounting Pronouncements

 

In June 2011, the Financial Accounting Standards Board (the “FASB”) issued a new standard related to comprehensive income.  This new standard requires companies to present comprehensive income in a single statement below net income or in a separate statement of comprehensive income immediately following the income statement.  In both options, companies must present the components of net income, total net income, the components of other comprehensive income, total other comprehensive income and total comprehensive income.  This new standard does not change which items are reported in other comprehensive income or the requirement to report reclassifications of items from other comprehensive income to net income.  The new standard eliminates the option to present comprehensive income on the statement of changes in shareholders’ equity.  This requirement was effective for us beginning with this Quarterly Report on Form 10-Q for the quarter ended March 31, 2012 and required retrospective application for all periods presented.  The adoption of this guidance did not have a material effect on our consolidated financial position, results of operations or cash flows.

 

In May 2011, the FASB issued new standards to provide guidance about fair value measurement and disclosure requirements.  These standards do not extend the use of fair value but rather provide guidance about how fair value should be determined where it is already required or permitted under generally accepted accounting principles.  A majority of the changes include clarifications of existing guidance and new disclosure requirements related to changes in valuation technique and related inputs that result from applying the standard.  We adopted this guidance and applied the new standard prospectively for interim and annual periods beginning January 1, 2012.  The adoption of this guidance did not have a material effect on our consolidated financial position, results of operations or cash flows.

 

Recently Issued Accounting Pronouncements Not Yet Adopted

 

In September 2011, the FASB issued guidance which amends the existing standards related to annual and interim goodwill impairment tests.  Current guidance requires companies to test goodwill for impairment, at least annually, using a two-step process. The updated guidance provides companies with the option to first assess qualitative factors to determine whether it is necessary to perform the two-step quantitative goodwill impairment test. Under this option, companies are no longer required to calculate the fair value of a reporting unit unless they determine, based on that qualitative assessment, that it is more likely than not that the reporting unit’s fair value is less than its carrying amount. The new guidance includes examples of the types of events and circumstances to consider in conducting the qualitative assessment.   The amendments will be effective for us

 

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beginning with our annual goodwill impairment test in 2012.  We do not expect this new guidance to have a material effect on our consolidated financial position, results of operations or cash flows.

 

Item 3.   Quantitative and Qualitative Disclosures About Market Risk

 

The principal market risks to which we are exposed include interest rates under our senior revolving credit facility, foreign exchange rates giving rise to translation, and fluctuations in short-term interest rates on a portion of our bankruptcy trustee revenue.

 

Interest Rate Risk

 

Interest on our senior revolving credit facility is generally based on a spread, not to exceed 275 basis points over the LIBOR rate. As of March 31, 2012, we had borrowed $215.0 million under the senior revolving loan.

 

We performed a sensitivity analysis assuming a hypothetical 100 basis point movement in interest rates applied to the average daily borrowings of the senior revolving loan. As of March 31, 2012, the analysis indicated that such a movement would have increased our interest expense by approximately $0.5 million for the three months ended March 31, 2012.

 

In our Chapter 7 bankruptcy business we earn deposit-based fees.  These fees are earned primarily on a percentage of Chapter 7 total liquidated assets placed on deposit with a designated financial institution by our trustee clients.  The fees we earn based on total liquidated assets placed on deposit by our trustee clients may vary based on fluctuations in short-term interest rates.  Based on sensitivity analysis we performed for the three months ended March 31, 2012, a hypothetical 1% movement in interest rates would not have had a material effect on our consolidated financial position, results from operations or cash flows.

 

We currently do not hold any interest rate floor options or other derivatives.

 

Foreign Currency Risk

 

We have operations outside of the United States, therefore, a portion of our revenues and expenses are incurred in a currency other than United States Dollars. We do not utilize hedge instruments to manage the exposures associated with fluctuating currency exchange rates.  Our operating results are exposed to changes in exchange rates between the United States Dollar and the functional currency of the countries where we have operations. When the United States Dollar weakens against foreign currencies, the United States Dollar value of revenues and expenses denominated in foreign currencies increases. When the United States Dollar strengthens, the opposite situation occurs.

 

We performed a sensitivity analysis assuming a hypothetical 1% increase in foreign exchange rates applied to our historical first quarter 2012 results of operations.  For the three months ended March 31, 2012, the analysis indicated that such a movement would not have had a material effect on our total revenues, operating income or net income.

 

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Item 4.           Controls and Procedures

 

An evaluation was carried out by the Epiq Systems, Inc.’s Chief Executive Officer and Chief Financial Officer of the effectiveness of the design and operations of our disclosure controls and procedures as defined in Exchange Act Rule 13a-15(e).  Based on this evaluation, our management, including the CEO and CFO, concluded that our disclosure controls and procedures are effective.  Disclosure controls and procedures are designed to ensure that information required to be disclosed by us in the reports that we file or submit under the Exchange Act is recorded, processed, summarized and reported, within the time periods specified in the SEC’s rules and forms.  Disclosure controls and procedures include, without limitation, controls and procedures designed to ensure that information required to be disclosed by us in the reports that we file or submit under the Exchange Act is accumulated and communicated to our management, including our principal executive and principal financial officers, or persons performing similar functions, as appropriate to allow timely decisions regarding required disclosure.

 

During the second quarter of 2011 we initiated a company-wide implementation of SAP, which provides certain enhancements, efficiencies, and increased security features to the financial reporting process and surrounding internal controls.  As of the end of the first quarter of 2012, the majority of our business units were using the new system, with remaining business units planned to move to SAP by the end of 2012.  We reviewed affected internal controls as part of this implementation, and made changes where appropriate.  There have been no other changes in our internal control over financial reporting during the quarter covered by this report that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

 

PART II - OTHER INFORMATION.

 

Item 1.           Legal Proceedings

 

Employee Arbitration

 

Epiq Systems, Inc. and one of its subsidiaries are currently in arbitration before the American Arbitration Association in New York, New York, regarding claims alleging wrongful employment termination.  Arbitration proceedings were initiated in 2009 and were completed as of January 18, 2012.  In April 2012, the parties completed post-trial briefing to the arbitration panel, and we are awaiting a ruling. We believe that the employment claims are meritless and we have defended vigorously against them.  No settlement amounts associated with this matter have been accrued in the accompanying Condensed Consolidated Financial Statements due to the fact that any such amounts are not reasonably estimable by us at this time.

 

Purported Software License Complaint

 

On or about June 24, 2011, Epiq eDiscovery Solutions, Inc., an indirect, wholly owned subsidiary of Epiq Systems, Inc. (“EDS”), filed a lawsuit against Sybase, Inc. (“Sybase”) and Does 1 to 50, et al. in the Superior Court of the State of California, Alameda County (the “Superior Court”), alleging breach of contract and requesting a declaratory judgment against Sybase.  EDS’s complaint against Sybase relates to a dispute that arose under a software license agreement between EDS and Sybase (the “Agreement”) and encompasses a request by EDS for the Superior Court to issue an order:  (a) declaring that EDS currently owes Sybase nothing under the Agreement, and (b) requiring Sybase to provide EDS with certain license keys to software licenses that EDS purchased from Sybase under the Agreement.  On or about July 29, 2011, Sybase filed an answer to the complaint and a cross-complaint, which Sybase subsequently amended, against EDS and Does 51-60 relating to that same dispute and Agreement, alleging that, among other things, EDS owes Sybase additional amounts under the Agreement totaling at least $7.0 million, plus interest and costs of the lawsuit.

 

We believe that Sybase’s amended cross-complaint has no merit and we will continue to defend vigorously against it. No amounts associated with this matter have been accrued in the accompanying Condensed Consolidated Financial Statements. EDS filed the lawsuit in order to protect and defend its rights and to demonstrate that, at all relevant times, EDS acted in good faith and in accordance with the terms of the Agreement.

 

Item 1A.        Risk Factors

 

There have been no material changes in our Risk Factors from those disclosed in our Annual Report on Form 10-K for the year ended December 31, 2011 that was filed with the SEC on March 1, 2012.

 

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Item 2.           Unregistered Sales of Equity Securities and Use of Proceeds

 

The following table presents the total number of shares purchased during the quarter ended March 31, 2012, the average price paid per share, the number of shares that were purchased as part of a publicly announced repurchase program, and the maximum number (or approximate dollar value) of shares that may yet be purchased under a share repurchase program.

 

We have a share repurchase program that authorizes us to purchase shares of common stock in order to increase shareholder value. We also have a policy that requires shares to be repurchased by us to satisfy employee tax withholding obligations upon the vesting of restricted stock awards.

 

Period

 

Total Number of
Shares Purchased

 

Average Price Paid per
Share(2)

 

Total Number of
Shares Purchased as
Part of Publicly
Announced Plans or
Programs

 

Maximum Number (or
Approximate Dollar
Value) of Shares that
May Yet Be Purchased
Under the Plans or
Programs(1)(2)

 

 

 

 

 

 

 

 

 

 

 

February 1 — February 29

 

154,768

(3)

$

12.07

 

 

$

12,137,000

 

January 1 — January 31

 

 

 

 

$

12,137,000

 

March 1 — March 31

 

 

 

 

$

12,137,000

 

 

 

 

 

 

 

 

 

 

 

Total Activity for the Quarter Ended March 31, 2012

 

154,768

 

$

12.07

 

 

$

12,137,000

 

 


(1)   On October 26, 2010, we announced that our board of directors authorized $35.0 million for share repurchases.  This program has no stated expiration date.  We did not repurchase any shares under this program during the three months ended March 31, 2012.

 

(2)   Includes brokerage commissions paid by the company.

 

(3)   Represents shares that were repurchased by the company at an average price of $12.07 per share to satisfy employee tax withholding obligations upon the vesting of restricted stock awards in February 2012.

 

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Item 6.           Exhibits

 

12.1 

 

Computation of ratio of earnings to fixed charges.

 

 

 

31.1 

 

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

 

 

 

31.2  

 

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

 

 

 

32.1 

 

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

 

 

 

101.INS†

 

XBRL Instance Document.

 

 

 

101.SCH†

 

XBRL Taxonomy Extension Schema Document.

 

 

 

101.CAL†

 

XBRL Taxonomy Extension Calculation Linkbase Document.

 

 

 

101.DEF†

 

XBRL Taxonomy Definition Linkbase Document.

 

 

 

101.LAB†

 

XBRL Taxonomy Extension Label Linkbase Document.

 

 

 

101.PRE†

 

XBRL Taxonomy Extension Presentation Linkbase Document.

 


 

Attached as Exhibit 101 to this report are documents formatted in XBRL (Extensible Business Reporting Language). Users of this data are advised that, pursuant to Rule 406T of Regulation S-T, the interactive data file is deemed not filed or part of a registration statement or prospectus for purposes of Sections 11 or 12 of the Securities Act of 1933, as amended, is deemed not filed for purposes of Section 18 of the Securities Exchange Act of 1934, as amended, and is otherwise not subject to liability under these sections.

 

 

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SIGNATURES

 

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

 

 

 

Epiq Systems, Inc.