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| EPIQ > SEC Filings for EPIQ > Form 10-Q on 29-Apr-2009 | All Recent SEC Filings |
29-Apr-2009
Quarterly Report
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 Form 10-Q.
Overview
We are a provider of integrated technology solutions for the legal profession. Our solutions streamline the administration of bankruptcy, litigation, financial transactions and regulatory compliance matters. We offer innovative technology solutions for electronic discovery, document review, legal notification, claims administration and controlled disbursement of funds. Our clients include law firms, corporate legal departments, bankruptcy trustees and other professional advisors who require innovative technology, responsive service and deep subject-matter expertise.
We have three reporting segments: electronic discovery, bankruptcy, and settlement administration.
Electronic Discovery
Our electronic discovery business provides collections and forensics, processing, and search and review services to companies and the litigation departments of law firms. Our eDataMatrix™ software analyzes, filters, deduplicates and produces documents for review. Produced documents are made available primarily through a hosted environment, and our DocuMatrix™ software allows for efficient attorney review and data requests.
Our customers are typically large corporations that use our products and services cooperatively with their legal counsel to manage the electronic discovery process for complex litigation matters.
The substantial increase of electronic documents by businesses has changed the dynamics of how attorneys support discovery in complex litigation matters. According to the 2008 Socha-Gelbmann Electronic Discovery Survey, 2007 domestic commercial electronic discovery revenues were estimated at $2.8 billion, an approximate 43% increase from 2006. According to this same source, the market is expected to continue to grow at year over year annual rates of 20% in 2009 and 15% for 2010. 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 litigation, we anticipate that law firms will become increasingly reliant on electronic evidence management systems to organize and manage the litigation discovery process.
Following is a description of the significant sources of revenue in our electronic discovery business.
† Fees related to the conversion of data into an organized, searchable electronic database. The amount we earn varies primarily on the size (number of documents) and complexity of the engagement.
† Hosting fees based on the amount of data stored.
Bankruptcy
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 fiscal year ended September 30, 2008, accounted for approximately 65% of all bankruptcy filings. In a 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 fiscal year ended September 30, 2008, 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 fiscal year ended September 30, 2008, accounted for approximately 34% 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.
The end-user customers of our bankruptcy business are debtor corporations that file a plan of reorganization and professional bankruptcy trustees. The Executive Office for United States Trustees, a division of the U.S. 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.
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 consulting services, and settlement administration.
† 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. Interest rate fluctuations are somewhat mitigated by pricing arrangements with each financial institution that set ceilings and floors on the fees that those financial institutions pay us.
† 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.
Settlement Administration
Our settlement administration segment provides managed services, including legal notification, claims administration, project administration and controlled disbursement.
Class action and mass tort refer 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. The class action and mass tort marketplace is significant, with estimated annual tort claim costs of approximately $250 billion in 2007, according to a study issued in 2008 by Towers Perrin. Administrative costs, which include costs, other than defense costs, incurred by either the insurance company or self-insured entity in the administration of claims, comprise approximately 24% of this total.
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 and mass tort litigation is often complex and the cases, including administration of any settlement, may last several years.
The customers of our settlement administration segment are companies that are administering the settlement or resolution of class action cases or are administering projects. We sell our services directly to those customers and other interested parties, including legal counsel, which often provide access to these customers.
Following is a description of 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, 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.
Results of Operations for the Three Months Ended March 31, 2009 Compared with the Three Months Ended March 31, 2008
Consolidated Results
Revenue
Total revenue was $60.8 million for the three months ended March 31, 2009, an increase of $11.8 million, or 24%, 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. Operating revenue from reimbursed direct costs was $8.2 million, an increase of $3.1 million, or 61%, from $5.1 million in the period 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.
Operating revenue exclusive of operating revenue from reimbursed direct costs, which we refer to as operating revenue before reimbursed direct costs, was $52.6 million in the three months ended March 31, 2009, an increase of $8.7 million, or 20%, as compared to the prior year. The increase consists of a $3.9 million increase in the settlement administration segment, a $4.0 million increase in the bankruptcy segment, and a $0.8 million increase in the electronic discovery segment. Changes by segment are discussed below.
Operating Expense
The direct cost of services, exclusive of depreciation and amortization, was $19.7 million for the three months ended March 31, 2009, an increase of $0.9 million, or 4%, as compared to $18.8 million in the prior year. Contributing to this increase was a $1.3 million increase in compensation related expense; a $1.5 million increase in production supplies; a $0.8 million increase in the cost of outside services, primarily related to temporary help and mailing; and a $0.3 million increase in software maintenance costs related to client service capabilities. These increases were partially offset by a $3.1 million decrease in legal noticing costs. Changes by segment are discussed below.
The direct cost of bundled products and services, exclusive of depreciation and amortization, was $0.9 million for the three months ended March 31, 2009, a decrease of $0.1 million, or 10%, compared to the prior year. Changes by segment are discussed below.
Reimbursed direct costs increased $2.9 million, or 57%, to $8.0 million for the three months ended March 31, 2009, compared with $5.1 million during the prior year. This increase directly corresponds to the increase in operating revenue from reimbursed direct costs. Changes by segment are discussed below.
General and administrative costs increased $3.2 million, or 21%, to $18.3 million for the three months ended March 31, 2009. Contributing to this increase was a $2.3 million increase in compensation, commission and benefits expense, primarily resulting from expanded staffing to meet client demands, and a $1.0 million increase in share-based compensation expense. The increase in share-based compensation expense was due to nonvested share awards granted in February 2009, for which expense will be recognized over a six-month vesting period. Changes by segment are discussed below.
Depreciation and software and leasehold amortization costs for the three months ended March 31, 2009 were $4.5 million, an increase of $0.8 million, or 22%, compared to the prior year. This increase was primarily the result of increased software amortization expense and increased hardware depreciation related to investments in our business segments.
Amortization of identifiable intangible assets for the three months ended March 31, 2009 was $1.9 million, a decrease of $0.3 million, or 15%, compared to the prior year. This decrease was the result of certain non-compete and customer contract intangible assets that are fully amortized in the current quarter, partly offset by an increase in non-compete amortization resulting from our 2008 acquisition of an electronic discovery business in the United Kingdom.
Other operating expense of $0.5 million for the three months ended March 31, 2009 primarily consists of expenses related to potential acquisitions. For the three months ended March 31, 2008, we had other operating income of $2.4 million which represented a gain we recognized related to interest rate floor options purchased during 2007.
Interest Expense
We recognized interest expense of $0.4 million for the three months ended March 31, 2009 compared with $0.5 million for the same period in the prior year. The $0.1 million decrease in interest expense resulted from a decrease in loan fee amortization.
Effective Tax Rate
Our effective tax rate for the three months ended March 31, 2009 was 51.0% compared with an effective rate of 47.6% for the prior year. The increase compared to the prior period is primarily due to non-deductible equity compensation granted in the first quarter of 2009. State taxes and non-deductible equity compensation are the primary reasons our tax rate is higher than the statutory federal rate of 35%. We have significant operations located in New York City that are subject to state and local tax rates that are higher than the tax rates assessed by other jurisdictions where we operate.
It is reasonably possible that we will recognize approximately $1.0 million of previously unrecognized tax benefits as a result of anticipated lapses in the statute of limitations during 2009 within twelve months of our reporting date. If recognized, the $1.0 million of tax benefits would affect the effective tax rate in 2009.
Net Income
Our net income was $3.3 million for the three months ended March 31, 2009 compared to $2.7 million for the prior year, an increase of $0.6 million, or 23%. Growth in our bankruptcy segment, resulting primarily from an increase in corporate restructuring engagements, as well as growth in our settlement administration segment, contributed to the increase in net income. The increase was offset in part by increased expenses in the electronic discovery segment in support of the growth and expansion of the business, a decline in other operating income due to the gain on the interest rate floor options recognized in the prior year quarter, as well as an increase in our 2009 effective tax rate, resulting in higher tax expense.
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.
Electronic Discovery Segment
Electronic discovery operating revenue from external customers before reimbursed direct costs increased $0.8 million, or 6%, to $14.0 million for the three months ended March 31, 2009, compared to $13.2 million in the prior year. This increase is primarily attributable to additional projects from existing clients, as well as the expansion of our client base which resulted in an increase in processing revenue.
Electronic discovery direct and administrative expenses increased $2.2 million, or 31%, to $9.1 million for the three months ended March 31, 2009, compared with $6.9 million in the prior year. This increase is primarily a result of a $1.4 million increase in compensation, commission and benefits expense resulting from expanded staffing to generate and support the continued growth and expansion of our business; a $0.3 million increase in software maintenance costs related to client
service capabilities; a $0.2 million increase in building and equipment lease expense, primarily related to data center expansion; and a $0.1 million increase in travel expense.
Bankruptcy Segment
Bankruptcy operating revenue from external customers before reimbursed direct costs for the three months ended March 31, 2009 was $17.3 million, an increase of $3.9 million, or 30%, compared to $13.4 million in the prior year. This increase is primarily attributable to an increase in corporate restructuring engagements. Partially offsetting this increase was a decline in bankruptcy trustee fees, due to lower interest rates in the first three months of 2009 compared to the same 2008 period. Revenue from our Chapter 7 trustee business is expected to continue to be lower than comparable prior periods if short-term interest rates do not increase from current levels.
Bankruptcy direct and administrative expenses increased $3.5 million, or 51%, to $10.4 million for the three months ended March 31, 2009, compared to $6.9 million in prior year. The increase is primarily attributable to a $1.1 million increase in compensation costs, due to additional staffing in support of new client retentions; a $1.0 million increase in outside services expense, resulting from several large noticing engagements; a $0.7 million increase in reimbursed direct costs, which directly corresponds to the increase in operating revenue from reimbursed direct costs; and a $0.5 million increase in intercompany expense related to call center services performed by the settlement administration segment for the bankruptcy segment. The intercompany expense is eliminated in consolidation.
Settlement Administration Segment
Settlement administration operating revenue from external customers before reimbursed direct costs was $21.2 million in the three months ended March 31, 2009, an increase of $3.9 million, or 23%, compared to the prior year. This increase was due to a $2.0 million increase in revenue primarily related to a large contract, and a $5.7 million increase in professional services revenue related to several clients. These increases were partially offset by a $3.7 million decrease in legal notification revenue.
Settlement administration direct and administrative expenses, including reimbursed direct costs, for the three months ended March 31, 2009 were $21.6 million, an increase of $0.8 million, or 4%, compared to $20.8 million in the prior year. The increase in expense is the result of an increase in call center, outside services, and mailing supplies costs of $1.3 million, which supported the large contract referenced above; and a $2.4 million increase in reimbursable expenses. These increases were partially offset by a decrease of $3.1 million in the cost of legal noticing which is directly related to the decrease in legal notification revenue.
Liquidity and Capital Resources
Operating Activities
During the three months ended March 31, 2009, our operating activities provided net cash of $2.5 million. Contributing to net cash provided by operating activities was net income of $3.3 million and increased non-cash expenses, such as depreciation and amortization and share-based compensation expense, of $7.9 million. These items were partially offset by an $8.8 million net use of cash resulting from changes in operating assets and liabilities. The most significant change in operating assets and liabilities was a $14.0 million increase in trade accounts receivable, related to a large matter in settlement administration and several large matters in the bankruptcy segment. Trade accounts receivable will fluctuate from period to period depending on the timing of sales and collections. Partially offsetting the increase in accounts receivable was an increase in accounts payable and other liabilities of $5.1 million. Accounts payable will fluctuate from period to period depending on timing of purchases and payments.
Investing Activities
During the three months ended March 31, 2009, we used cash of $4.7 million for the purchase of property and equipment, including computer hardware, purchased software licenses, and purchased computer hardware. Enhancements to our existing software and the development of new software is essential to client retention and continued growth, and during the three months ended March 31, 2009, we used cash of $2.3 million to fund internal costs related to the development of software for which technological feasibility had been established. We anticipate that cash generated from operations will be adequate to fund our anticipated property, equipment, and software spending for the foreseeable future.
Financing Activities
During the three months ended March 31, 2009, we used cash to pay approximately $0.9 million for capital lease payments. This financing use of cash was partially offset by $0.6 million of net proceeds from stock issued in connection with the exercise of employee stock options. We also recognized a portion of the tax benefit related to the exercise of stock options as a financing source of cash.
As of March 31, 2009, our borrowings consisted of $51.9 million (including the fair value of the embedded option) from the contingent convertible subordinated notes, which bears interest at 4% per annum based on the $50.0 million principal amount, and approximately $8.0 million of obligations related to capital leases and deferred acquisition price payments. During 2007, the term of our contingent convertible subordinated notes was extended to June 2010. The notes will require the use of $50.0 million of cash at the extended maturity date if the note holders do not convert the notes into shares of our common stock. The holders of the contingent convertible subordinated notes have the right to convert at a price of approximately $11.67 per share. If any or all notes are converted into shares of our common stock prior to the scheduled maturity of those notes, then there will be no cash requirements associated with those converted notes, other than the regular payment of interest earned prior to the conversion date.
As of March 31, 2009 we did not have any borrowings outstanding under our $100.0 million senior revolving loan. During the term of the credit facility, we have the right, subject to compliance with our covenants, to increase the senior revolving loan to $175.0 million. Interest on the credit facility is generally based on a spread, not to exceed 325 basis points over the LIBOR rate. As of March 31, 2009, significant financial covenants, all as defined within our credit facility agreement, include a leverage ratio not to exceed 3.00 to 1.00, a fixed charge coverage ratio of not less than 1.25 to 1.00, and a current ratio of not less than 1.50 to 1.00. As of March 31, 2009, we were in compliance with all financial covenants.
Covenants contained in our credit facility and in our contingent convertible subordinated notes include limitations on acquisitions, should we pursue acquisitions in the future. Pursuant to the terms of our credit facility, we generally cannot incur indebtedness outside the credit facility, with the exceptions of capital leases and subordinated debt, with a limit of $100.0 million of aggregate subordinated debt. Furthermore, for any acquisition 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 an acquisition for which cash consideration exceeds $80.0 million or total consideration exceeds $125.0 million.
We believe that funds generated from operations, plus our existing cash resources and amounts available under our credit facility, will be sufficient over the next 12 months, and for the foreseeable future thereafter, to finance currently anticipated working capital requirements, internal software development expenditures, property, equipment and third party software expenditures, deferred acquisition price agreements and capital leases, interest payments due on our outstanding borrowings, and payments for other contractual obligations.
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 in Note 6 of the Notes to Consolidated Financial Statements contained in our Annual Report on Form 10-K for the year ended December 31, 2008.
Critical Accounting Policies
In our Annual Report on Form 10-K for the year ended December 31, 2008, 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, 2008.
Recently Adopted Accounting Pronouncements
In December 2007, the Financial Accounting Standards Board ("FASB") issued SFAS No. 141 (revised 2007), Business Combinations ("SFAS 141(R)"). SFAS 141(R) establishes guidelines for the recognition and measurement of assets, liabilities and equity in business combinations. The provisions of SFAS 141 (R) were effective for us as of January 1, 2009. Due to the adoption of SFAS 141(R) we now expense, as incurred, acquisition-related costs for potential and completed acquisitions. Acquisition-related costs expensed in the first quarter of 2009 were approximately $0.5 million. These costs are included in "Other operating expense (income)" in our Condensed Consolidated Statements of Income. SFAS 141(R) also amends SFAS No. 109, Accounting for Income Taxes, and now requires the recognition of changes in an acquirer's income tax valuation allowance on deferred taxes and acquired tax contingencies associated with acquisitions that closed prior to the effective date of SFAS 141(R) to apply the provisions of SFAS 141(R). The provisions of SFAS 141(R) will primarily apply to all future acquisitions.
In December 2007, the FASB issued SFAS No. 160, Noncontrolling Interest in Consolidated Financial Statements ("SFAS 160"). SFAS 160 changes the way in which noncontrolling interests in subsidiaries are measured and classified on the balance sheet. The provisions of SFAS 160 were effective for us as of January 1, 2009. The adoption of SFAS 160 had no impact on our consolidated financial position or results of operations.
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