The following discussion of our financial condition and results of operations should be read together with the financial statements and related notes that are included elsewhere in this Quarterly Report. This discussion may contain forward-looking statements based upon current expectations that involve risks and uncertainties. Our actual results may differ materially from those anticipated in these forward-looking statements as a result of various factors, including those set forth in this Quarterly Report under "Risk Factors," in our Annual Report on Form 10-K for the year ended December 31, 2007 under "Risk Factors" and in other parts of this Quarterly Report.

Overview

We develop and provide the leading software solutions for digital investigations, including EnCase® Enterprise, a network-enabled product primarily for large corporations and government agencies, and EnCase® Forensic, a desktop-based product primarily for law enforcement agencies. We were incorporated and commenced operations in 1997. From 1997 through 2002, we generated a substantial portion of our revenues from the sale of our EnCase ® Forensic products and related services. We have experienced increases in our revenue as a result of the release of our EnCase® Enterprise products in late 2002, which expanded our customer base into corporate enterprises and federal government agencies. In addition, the releases of our EnCase® eDiscovery solution in late 2005 and EnCase ® Information Assurance solution in late 2006 have increased our average transaction size. We anticipate that sales of our EnCase®Enterprise products and related services, in particular our EnCase® eDiscovery and EnCase® Information Assurance solutions, will comprise a substantial portion of our future revenues.

Factors Affecting Our Results of Operations

There are a number of trends that may affect our business and our industry. Some of these trends or other factors include:

• Legislative and regulatory developments. Our digital investigation solutions allow law enforcement agencies, government organizations and corporations to conduct investigations within the legal and regulatory framework. Historically, the implementation of new laws and regulations surrounding digital investigations has helped create demand for our products. Future changes in applicable laws or regulations could enhance or detract from the desirability of our products.

• Information technology budgets. Deployment of our solutions may require a substantial capital expenditure by our customers. Budgets for information technology-related capital expenditures at corporations and all levels of government organizations are typically cyclical in nature, with generally higher budgets in times of improving economic conditions and lower budgets in times of economic slowdowns.

• Law enforcement agency budgets. We sell our EnCase®Forensic products and training services primarily to law enforcement agencies. Because of the limited nature of law enforcement budgets, funds are typically initially allocated toward solving issues perceived to be the most pressing. Sales of our products could be impacted by changes in the budgets of law enforcement agencies or in the relative priority assigned to digital law enforcement investigations.

• Prevalence and impact of hacking incidents and spread of malicious software. The increasing sophistication of hacking attacks on government and private networks and the global spread of malicious software, such as viruses, worms and rootkits, have increased the focus of corporations and large government organizations on digital investigations and other aspects of network security. This has, in turn, increased demand for our products. Future changes in the number and severity of such attacks or the spread of malicious software could have an effect on the demand for our products.

• Seasonality in revenues. We experience seasonality in our revenues, with the third and fourth quarters typically having the highest revenues for the year. We believe that this seasonality results primarily from our customers' budgeting cycles. The federal government budget year ends in the third calendar quarter of the year and a majority of corporate budget years end in the fourth calendar quarter of the year. In addition, our customers also tend to make software purchases near the end of a particular quarter, which tends to make our revenues for a particular period unpredictable for a significant portion of that period. We expect that this seasonality within particular years and unpredictability within particular quarterly periods will continue for the foreseeable future.

• Amount of commercial litigation. Because commercial litigation often involves eDiscovery, an increase in commercial litigation could increase demand for our products and services, while a decrease in commercial litigation could decrease demand.

Critical Accounting Policies and Estimates

In preparing our financial statements, we make estimates, assumptions and judgments that can have a significant impact on our net revenue, operating income or loss and net income or loss, as well as on the value of certain assets and liabilities on our balance sheet. We believe that the estimates, assumptions and judgments involved in the accounting policies described in "Management's Discussion and Analysis of Financial Condition and Results of Operations" in Item 7 of our Annual Report on Form 10-K for the year ended December 31, 2007 have the greatest potential impact on our financial statements, so we consider them to be our critical accounting policies and estimates. There have no significant changes in those critical accounting policies and estimates during the nine months ended September 30, 2008.

Results of Operations

The following table sets forth selected statements of operations data for each
of the periods indicated expressed as a percentage of total revenues:



                                                    Three Months Ended         Nine Months Ended
                                                      September 30,              September 30,
                                                   2007           2008         2007          2008
Revenues:
Product revenue                                      57.3 %         54.1 %       56.7 %       51.4 %
Services and maintenance revenue                     42.7           45.9         43.3         48.6

Total revenues                                      100.0          100.0        100.0        100.0

Cost of revenues:
Cost of product revenue                               3.2            3.5          3.6          3.3
Cost of services and maintenance revenue             22.6           24.3         24.5         25.9

Total cost of revenues                               25.8           27.8         28.1         29.2

Gross profit                                         74.2           72.2         71.9         70.8

Operating expenses:
Selling and marketing                                38.8           43.0         43.6         44.5
Research and development                             11.3           14.1         11.6         14.3
General and administrative                           18.2           20.1         18.2         19.8
Depreciation and amortization                         4.5            4.4          4.3          4.6

Total operating expenses                             72.8           81.6         77.7         83.2

Operating income (loss)                               1.4           (9.4 )       (5.8 )      (12.4 )
Other income and expense:
Interest income                                       1.8            0.8          1.9          1.0
Interest expense                                     (0.1 )         (0.1 )       (0.1 )       (0.1 )
Other income, net                                     0.0            0.2          0.2          0.1

Income (loss) before income taxes                     3.1           (8.5 )       (3.8 )      (11.4 )
Income tax provision                                  4.9            7.3          1.8          2.1

Net loss                                             (1.8 )%       (15.8 )%      (5.6 )%     (13.5 )%

The following table sets forth share-based compensation expense recorded in each of the respective periods (in thousands):

                                                        Three Months Ended        Nine Months Ended
                                                          September 30,             September 30,
                                                       2007          2008          2007        2008
Non-cash Share Based Compensation Data (1):
Cost of product revenue                              $     13    $          6   $       59    $    30
Cost of services and maintenance revenue                  205             423          536      1,327
Selling and marketing                                     272             715          935      2,149
Research and development                                  137             339          390      1,062
General and administrative                                363             921          970      2,164

Total non-cash share based compensation              $    990    $      2,404   $    2,890    $ 6,732

(1) Non-cash share-based compensation relates to stock options and nonvested share awards granted to employees measured under the fair value method. See Notes 4 and 5 to the condensed consolidated financial statements.

Comparison of Results of Operations for the Three and Nine Months Ended
September 30, 2007 and 2008

Revenues



                                                   Three Months Ended                 Nine Months Ended
                                                      September 30,                     September 30,
                                                      Increase/                         Increase/
(Dollars in millions)                         2007    (decrease)       2008     2007    (decrease)       2008
Product revenues:
Encase® Enterprise (1)                       $  8.3           (2 %)   $  8.1   $ 23.2           (2 %)   $ 22.6
Encase® Forensic (2)                            3.0           25 %       3.7      7.7           24 %       9.6
Other                                           0.3          101 %       0.7      1.1           72 %       1.9

Total product revenues                         11.6            8 %      12.5     32.0            7 %      34.1

Services and maintenance revenues:
Professional services                           2.6           21 %       3.2      8.3           32 %      11.0
Training                                        2.2           12 %       2.4      6.3           18 %       7.4
Maintenance and other                           3.9           29 %       5.0      9.8           41 %      13.8

Total services and maintenance revenues         8.7           23 %      10.6     24.4           32 %      32.2

Total revenues                               $ 20.3           14 %    $ 23.1   $ 56.4           18 %    $ 66.3

(1) Includes perpetual licenses related to our eDiscovery and Information Assurance add-on products.

(2) Includes revenues related to our Premium License Support Program.

We generate product revenue principally from sales of our EnCase ® Enterprise and EnCase® Forensic products. A substantial portion of the EnCase® Enterprise and EnCase® Forensic license agreements we enter into include perpetual license terms. In conjunction with our EnCase® Forensic software, we also sell our Premium License Support Program product, which is sold on a subscription basis for a term of one or three years. In addition, we sell our Neutrino® mobile forensic device, EnCase® Bit9 Analyzer and certain other forensic hardware which we include in "Other" product revenue. The first two quarters of each fiscal year are typically our period of lowest product sales due to the seasonal budgetary cycles of our customers. The third quarter is typically the strongest sales quarter to our federal government customers. Typically, sales to our corporate customers are highest in the fourth quarter.

Product revenues increased by $0.9 million (8%) in the third quarter of 2008 over the 2007 quarter, with that growth driven primarily by increases in Encase® Forensic licenses and subscriptions and EnCase ® Bit9 Analyzer revenues, partially offset by slightly lower Enterprise license sales. Total sales revenues from our EnCase® Enterprise products decreased 2%

quarter over quarter, with lower sales of the basic EnCase® Enterprise platform outpacing new leasing revenues; module revenues were essentially flat. During third quarter 2008, we sold 19 products that run on the EnCase® Enterprise platform: 11 EnCase ® eDiscovery, four EnCase® Data Audit & Policy Enforcement, and four Information Assurance. Included in the 11 sales of EnCase ® eDiscovery in the third quarter were five deals sold on a Pay-Per-Use basis, which should begin to generate revenue in fourth quarter 2008. Forensic revenues increased due to increased government sales. The increase in Other product revenues reflects new efforts to sell certain third-party products (principally Bit9 Analyzer) integrated with our software platforms.

For the nine months ended September 30, 2008, product revenues increased by $2.1 million (7%) compared to the comparable 2007 period, with that growth also driven primarily by increased Encase® Forensic licenses and subscriptions, due to increased government sales offsetting lower commercial sales and an increase in the amortization of deferred governmental revenues as the expected life of the current version of that product approaches an end. Total sales revenues from our EnCase ® Enterprise products decreased 2% year over year due to lower sales of the basic EnCase® Enterprise platform, partially offset by increased add-on module sales, including the Data Audit & Policy Enforcement module. During the first three quarters of 2008 and 2007, we sold 53 and 61, respectively EnCase® eDiscovery, Information Assurance, AIRS and Data Audit & Policy Enforcement add-on modules. The increase in Other product revenues reflects new efforts to sell certain third-party products (principally Bit9 Analyzer) integrated with our software platforms.

Services and maintenance revenues increased $1.9 million (23%) in the third quarter of 2008, with our maintenance and professional services segments producing revenue increases of $1.1 million and $0.6 million, respectively, over the comparable 2007 quarter. The continuing growth in maintenance revenues is the result of an on-going overall increase in our installed product base along with maintenance renewals by customers desiring continuing maintenance support on our products. The professional services revenue growth has been driven by eDiscovery services engagements. eDiscovery services accounted for approximately 71% of professional services billings, with implementation and forensic engagements accounting for approximately 13% and 10%, respectively. The number of professional services personnel has increased from approximately 56 at September 30, 2007 to 65 at September 30, 2008. Training services revenue increased $0.2 million in third quarter 2008 as the number of customers we train has increased as compared to the 2007 quarter, due to growth in our installed product base and the greater availability of our training courses.

Services and maintenance revenues increased $7.8 million (32%) in the nine months ended September 30, 2008, with our maintenance and professional services segments producing revenue increases of $4.0 million and $2.7 million, respectively, over the comparable 2007 period. The continuing growth in maintenance revenues is the result of the on-going overall increase in our installed product base and high annual renewal rate. The professional services revenue growth has been driven by larger eDiscovery services engagements and increased demand for our services. Training services revenue increased $1.1 million in the first three quarters of 2008 as the number of customers we train has increased due both to growth in our installed product base and the greater availability of our training courses.

Cost of Revenues



                                                 Three Months Ended                  Nine Months Ended
                                                   September 30,                       September 30,
                                                     Increase/
(Dollars in millions)                      2007      (decrease)      2008       2007      Increase      2008
Cost of product revenues                  $  0.7             24 %   $  0.8     $  2.0            8 %   $  2.2

Cost of services and maintenance
revenues:
Professional services                        2.8             28 %      3.5        8.3           32 %     10.9
Training                                     1.3             11 %      1.4        4.1           10 %      4.5
Maintenance and other                        0.5             26 %      0.7        1.4           23 %      1.7

Total cost of services and maintenance
revenues                                     4.6             23 %      5.6       13.8           24 %     17.1

Total cost of revenues                    $  5.3             23 %   $  6.4     $ 15.8           22 %   $ 19.3

Share-based compensation included
above:
Cost of product revenues                  $   -                     $   -      $  0.1                  $   -

Cost of services and maintenance
revenues                                  $  0.2                    $  0.4     $  0.5                  $  1.3

Gross Margin Percentage
Products                                    94.4 %                    93.5 %     93.6 %                  93.5 %

Services and maintenance                    47.1 %                    47.0 %     43.5 %                  46.8 %

Overall                                     74.2 %                    72.2 %     71.9 %                  70.8 %

Cost of software product revenue consists principally of the cost of producing and distributing our software, including the cost of compact discs, packaging, shipping, customs duties, royalties on third-party products integrated into our software and, to a lesser extent, compensation and related overhead expenses. While these costs are primarily variable with respect to sales volumes, they remain very low in relation to the revenues generated. Our gross margins can be affected by product mix, as our EnCase ® Enterprise products are generally higher margin products than our EnCase® Forensic product, which is, in turn, higher margin than our hardware products.

The costs of professional services and training revenue are largely comprised of employee compensation, including share-based compensation, costs and related overhead expenses, travel and facilities costs. The cost of maintenance revenue consists primarily of commissions paid to our third party service provider for contract renewals and includes employee compensation cost for customer technical support.

The cost of product revenues increased 24% in third quarter 2008, on an overall increase in product revenues of 8%, over the 2007 quarter primarily due to royalties payable on sales of third-party software, which began in 2008, partially offset by generally lower costs otherwise. As a result, the product gross margin decreased slightly from 94.4% in third quarter 2007 to 93.5% in the 2008 quarter.

Total cost of services and maintenance revenue increased $1.0 million, or 23%, in third quarter 2008, on an overall increase in services and maintenance revenue of $1.9 million (also 23%) over third quarter 2007. Since September 30, 2007, we increased our team of professional services consulting personnel, which contributed to increased total services and maintenance compensation expense of $1.0 million (including a $0.2 million increase in share-based compensation) and employee benefit costs. In addition, travel expense related to consulting and training increased $0.1 million due to increased activity and bad debt expense increased $0.1 million, while facilities and consulting costs both decreased $0.1 million. Overall, the services and maintenance gross margin decreased slightly to 47.0% in third quarter 2008 compared to 47.1% in the 2007 quarter. Individually, the gross margins of our segments changed from third quarter 2007 to third quarter 2008 as follows: professional services segment, from (4.9%) to (10.7%), training segment, from 39.3% to 40.0%; maintenance segment, from 86.6% to 87.0%.

The cost of product revenues in the first nine months of 2008 increased 8%, on a 7% increase in product revenues, over the 2007 period primarily due to royalties payable on sales of third-party software, which began in 2008, partially offset by generally lower costs otherwise. Product gross margin was essentially flat at approximately 93.5% during the first nine months of both 2007 and 2008.

For the first nine months of 2008, total cost of services and maintenance revenue increased $3.3 million, or 24%, on an overall increase in services and maintenance revenue of $7.8 million (32%) over the 2007 period, with the majority of the increase ($2.6 million) in the professional services division. As noted for the third quarter, increased professional services staffing has contributed to increased total services and maintenance compensation expense of $2.6 million (including a $0.8 million increase in share-based compensation) and related employee benefit and recruiting costs. In addition, travel and entertainment expense related to consulting and training increased $0.3 million due to increased activity and bad debt expense increased $0.3 million. Overall, the services and maintenance gross margin improved to 46.8% in the first nine months of 2008 compared to 43.5% in the 2007 period. Individually, the gross margins of our segments increased from the first nine months of 2007 to 2008 as follows: professional services segment, from 0.0% to 0.2%, training segment, from 34.6% to 39.2%; maintenance segment, from 85.9% to 87.7%.

Selling and Marketing



                                                    Three Months Ended                 Nine Months Ended
                                                      September 30,                      September 30,
(Dollars in millions)                          2007      Increase      2008       2007      Increase      2008
Selling and marketing expenses                $  7.9           27 %   $  9.9     $ 24.6           20 %   $ 29.5

As a percentage of revenue 38.8 % 43.0 % 43.6 % 44.5 %

Share-based compensation included above $ 0.3 $ 0.7 $ 0.9 $ 2.1

Selling and marketing expenses consist primarily of base and incentive (sales commissions and share-based) compensation and related overhead expenses for employees engaged in selling and marketing. Selling and marketing

expenses also include expenses relating to advertising, brand building, marketing and trade show events (net of amounts received from sponsors and participants), product management and travel and entertainment.

Although we expense our sales commissions at the time the related sale is invoiced to the client, revenues from our EnCase® Enterprise term licenses, EnCase ® Forensic product, Premium License Support Program, Neutrino®, the Annual Training Passport, consulting, maintenance and implementation are recognized over the relevant performance or license period. Accordingly, we generally experience a delay between increased selling and marketing expenses and the recognition of a portion of the corresponding revenue. The number of sales and marketing personnel that we employ was approximately 140 and 160 at September 30, 2007 and 2008, respectively.

Selling and marketing expenses in third quarter 2008 increased $2.1 million (27%) over 2007, of which $1.6 million consisted of compensation costs largely due to increased staffing and higher commissions and share-based compensation. Higher costs were also incurred for marketing events and public relations ($0.1 million), eMarketing ($0.1 million) and recruiting ($0.1 million).

Year to date, selling and marketing expenses increased $4.9 million (20%) in 2008 over 2007, with the majority of that total attributable to higher compensation ($3.5 million) costs, including a $1.2 million increase in share-based compensation, and commission ($1.2 million) costs. Higher costs were also incurred for marketing events and public relations ($0.5 million), eMarketing ($0.4 million) and recruiting ($0.2 million).

Research and Development



                                                    Three Months Ended                 Nine Months Ended
                                                      September 30,                      September 30,
(Dollars in millions)                          2007      Increase      2008       2007      Increase      2008
Research and development expenses             $  2.3           42 %   $  3.3     $  6.5           45 %   $  9.5

As a percentage of revenue 11.3 % 14.1 % 11.6 % 14.3 %

Share-based compensation included above $ 0.1 $ 0.3 $ 0.4 $ 1.1

Research and development expenses consist primarily of compensation, including share-based compensation, and related overhead expenses for research and development personnel, including quality assurance and testing. In order to develop new product offerings, continue developing existing products and improve quality assurance, we increased the number of research and development personnel that we employ from 55 at September 30, 2007 to 75 at September 30, 2008.

Research and development expenses increased $1.0 million, or 42%, in the third quarter of 2008 over the 2007 quarter. The higher expenses were driven by increases of $0.8 million in compensation costs (including $0.2 million in share-based compensation) due to increased staffing and $0.2 million in benefits, recruiting and other employee-related costs.

For the nine months ended September 30, 2008, research and development expenses increased $3.0 million over the first nine months of 2007, with compensation-related costs (including share-based compensation) accounting for $2.2 million of that increase, and benefits, recruiting and other employee-related costs accounting for the majority of the balance.

General and Administrative



                                                    Three Months Ended                 Nine Months Ended
                                                      September 30,                      September 30,
(Dollars in millions)                          2007      Increase      2008       2007      Increase      2008
General and administrative expenses           $  3.7           27 %   $  4.7     $ 10.3           28 %   $ 13.1

As a percentage of revenue 18.2 % 20.1 % 18.2 % 19.8 %

. . .