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| EPIQ > SEC Filings for EPIQ > Form 10-Q on 29-Oct-2009 | All Recent SEC Filings |
29-Oct-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, government agencies 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 impacts of current economic conditions for the electronic discovery market have resulted in customers delaying new litigation or starting-up activities related to new signed projects due to budgetary constraints, as well as pricing pressures in the industry, as discussed in more detail below. According to the 2009 Socha-Gelbmann Electronic Discovery Survey, the amount of money spent on electronic discovery services and software appears to have dropped by about 9% from 2007 to 2008.
The substantial increase of electronic documents by businesses has changed the dynamics of how attorneys support discovery in complex litigation 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 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.
In the first half of 2009, we opened new offices in Brussels and Hong Kong, established global reach for our data centers in the U.S., Europe and Asia, and expanded our offerings to include data forensics and collections services and document review services. We expect industry pricing pressures, as well as a slower pace in the start-up of litigation matters, both of which can be attributed to the current economic climate, to continue for the remainder of 2009.
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 twelve-month period ended June 30, 2009, accounted for approximately 70% 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 twelve-month period ended June 30, 2009, 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 June 30, 2009, 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.
As reported by the Administrative Office of the U.S. Courts, bankruptcy filings for the twelve-month period ended June 30, 2009 increased 35% versus the twelve-month period ended June 30, 2008. During this period, Chapter 7 filings increased 47%, Chapter 11 filings increased 91%, and Chapter 13 filings increased 12%. The quarter ended June 30, 2009 represented the highest quarterly filing period since the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 was enacted.
Chapter 11 bankruptcy engagements are generally long-term, multi-year assignments that provide revenue visibility into future periods. For the Chapter 7 trustee services component of the bankruptcy segment, the increase in filings is expected to translate into growth in client deposit balances related to asset liquidations and pricing is generally not expected to change for the remainder of 2009.
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 disbursement services.
† 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 of funds.
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.
A large Settlement Administration contract with IBM in support of the federal government's analog to digital television conversion program, which was launched in the fourth quarter of 2007 and contributed 22% of our consolidated revenue during the year ended December 31, 2008, and 15% of our consolidated revenue during the nine month period ended September 30, 2009, was substantially completed during the second quarter of 2009.
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 September 30, 2009 Compared with the Three Months Ended September 30, 2008
Consolidated Results
Revenue
Total revenue was $57.8 million for the three months ended September 30, 2009, a decrease of $1.1 million, or 2%, 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 $6.7 million, a decrease of $0.3 million, or 5%, from $7.0 million in 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.
Operating revenue before reimbursed direct costs, was $51.1 million in the three months ended September 30, 2009, a decrease of $0.7 million, as compared to the prior year. This decrease was driven by a $9.9 million decrease in the settlement administration segment, and a $3.0 million decrease in the electronic discovery segment. These decreases were partially offset by a $12.2 million increase in the bankruptcy segment. Changes by segment are discussed below.
Operating Expense
The direct cost of services, exclusive of depreciation and amortization, was $18.0 million for the three months ended September 30, 2009, a decrease of $1.5 million, or 8%, as compared to $19.5 million in the prior year. Contributing to this decrease was a $2.5 million decrease in the expense related to outside services, primarily related to temporary help and mailing, and a $0.4 million decrease in legal noticing costs. These decreases were partially offset by a $1.4 million increase in compensation related expense, due primarily to increases in the bankruptcy segment resulting from an increase in corporate restructuring engagements. Changes by segment are discussed below.
The direct cost of bundled products and services, exclusive of depreciation and amortization, remained flat at $0.9 million for the three months ended September 30, 2009 and 2008. Changes by segment are discussed below.
Reimbursed direct costs decreased $0.3 million, or 5%, to $6.7 million for the three months ended September 30, 2009, compared with $7.0 million during the prior year. This decrease directly corresponds to the decrease in operating revenue from reimbursed direct costs. Changes by segment are discussed below.
General and administrative costs increased $0.3 million, or 2%, to $18.2 million for the three months ended September 30, 2009. Contributing to this increase was a $1.1 million increase in share-based compensation expense, for nonvested share awards granted in February 2009, and a $0.3 million increase in utility expense. These increases were partially offset by a $0.6 million decrease in professional fees, and a $0.4 million decrease in compensation related expense. Changes by segment are discussed below.
Depreciation and software and leasehold amortization costs for the three months ended September 30, 2009 were $4.8 million, an increase of $0.5 million, or 11%, 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 September 30, 2009 was $1.8 million, a decrease of $0.4 million, or 20%, compared to the prior year. This decrease was the result of certain non-compete and customer contract intangible assets that were fully amortized in the first quarter of 2009.
Other operating expense for the three months ended September 30, 2009 increased by approximately $0.1 million due to acquisition-related expenses.
Interest Expense, Net
We recognized interest expense of approximately $0.3 million and $0.4 million for the three months ended September 30, 2009 and 2008, respectively.
Effective Tax Rate
Our effective tax rate for the three months ended September 30, 2009 was 31.1% compared with an effective tax rate of 40.2% for the prior year. The decrease compared to the prior year was primarily related to recognizing approximately $0.8 million of previously unrecognized tax benefits as a result of lapses in the 2005 Federal statute of limitations and $0.2 million of both research credits and benefits related to the domestic production activities deduction, partially offset by non-deductible equity compensation expense in 2009 for which a comparable expense did not exist in the prior year.
Although income tax returns for 2006 and later are generally subject to exam, it is reasonably possible that we will recognize approximately $0.7 million of previously unrecognized tax benefits as a result of anticipated lapses in the statute of limitations within twelve months of our reporting date. If recognized, the $0.7 million of tax benefits would affect the effective tax rate.
Net Income
Our net income was $4.9 million for the three months ended September 30, 2009 compared to $4.0 million for the prior year, an increase of $0.9 million, or 22%. The change from the prior year is primarily related to growth in our bankruptcy segment, which was the result of an increase in corporate restructuring retentions, and approximately $1.0 million of tax benefits, which
were partially offset by a decline in our settlement administration segment, due primarily to the wind down of the analog to digital conversion contract; a decline in our electronic discovery segment, driven by lower revenues related to the current economic climate and lower pricing, and increased expenses related to expansion of service offerings and geographic expansion in this segment; and an increase in share based compensation 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 before reimbursed direct costs for the three months ended September 30, 2009 was $12.2 million, a decrease of $3.0 million, or 20%, compared to the prior year. The change from the prior year is primarily related to industry pricing pressures, the impact of which was an approximate 20% decline in the average price of services, as well as a slower pace in the start-up of litigation matters, both of which can be attributed to the current economic climate.
Electronic discovery direct and administrative costs, including reimbursed direct costs, were $9.0 million for the three months ended September 30, 2009, an increase of $0.6 million, or 7%, compared to the prior year. This increase was a result of a $0.6 million increase in the direct cost of services, primarily due to expenses related to the expansion of service offerings and geographic expansion.
Bankruptcy Segment
Bankruptcy operating revenue before reimbursed direct costs for the three months ended September 30, 2009 was $25.4 million, an increase of $12.2 million, or 93%, compared to $13.2 million in the prior year. This increase was primarily attributable to an increase in corporate restructuring engagements resulting from an increase in Chapter 11 bankruptcy filings. Partially offsetting this increase was a slight decline in bankruptcy trustee fees, as an increase in average deposit balances was more than offset by lower pricing compared to the prior year period.
Bankruptcy direct and administrative costs, including reimbursed direct costs, increased $7.2 million, or 97%, to $14.6 million for the three months ended September 30, 2009, compared to $7.4 million in the prior year. The increases in these costs were directly related to the increase in corporate restructuring engagements. Expense related to outside services increased $2.3 million, compensation related expense increased $1.7 million, expense related to call center services increased $0.5 million, and legal notification costs increased $0.5 million. Also contributing to the increase in costs was a $2.1 million increase in reimbursed direct costs, which directly corresponds to the increase in operating revenue from reimbursed direct costs.
Settlement Administration Segment
Settlement administration operating revenue before reimbursed direct costs was $13.6 million in the three months ended September 30, 2009, a decrease of $9.9 million, or 42%, compared to the prior year. This decrease was primarily related to a decline of $7.2 million related to the analog to digital conversion contract, which was substantially completed during the second quarter of 2009. Also contributing to the decrease was a $1.0 million decrease in legal notification revenue and a $1.1 million decrease in mailing revenue, due to declines from the prior year related to several other large cases; and a $0.5 million decrease in transaction processing revenue.
Settlement administration direct and administrative costs, including reimbursed direct costs, for the three months ended September 30, 2009 were $13.0 million, a decrease of $9.9 million, or 43%, compared to $22.9 million in the prior year. Contributing to the decrease in expense was a $5.4 million decrease in costs that supported the analog to digital conversion contract in the prior year; a $1.5 million decrease in reimbursed direct costs, which corresponds to the decrease in operating revenue from reimbursed direct costs; a $1.2 million decrease in expense related to outside services and professional fees; a $1.0 million decrease in expense related to legal noticing; and a $0.8 million decrease in compensation related expense.
Results of Operations for the Nine Months ended September 30, 2009 Compared with the Nine Months ended September 30, 2008
Consolidated Results
Revenue
Total revenue was $184.8 million for the nine months ended September 30, 2009, an increase of $12.1 million, or 7%, 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 $24.0 million, an increase of $3.9 million, or 19%, from $20.1 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 before reimbursed direct costs was $160.9 million in the nine months ended September 30, 2009, an increase of $8.2 million, or 5%, as compared to the prior year. The increase consists of a $27.8 million increase in the bankruptcy segment, partially offset by a $15.5 million decrease in the settlement administration segment, and a $4.1 million decrease in the electronic discovery segment. Changes by segment are discussed below.
Operating Expense
The direct cost of services, exclusive of depreciation and amortization, was $57.4 million for the nine months ended September 30, 2009, a decrease of $5.4 million, or 9%, as compared to $62.8 million in the prior year. Contributing to this decrease was a $5.6 million decrease in legal noticing costs, and a $5.6 million decrease in outside services, primarily related to temporary help and mailing in the prior year period. These decreases were partially offset by an increase of $3.7 million in compensation related expense, a $1.0 million increase in production supplies, a $0.7 million increase in software maintenance costs, and a $0.5 million increase in equipment expense. Changes by segment are discussed below.
The direct cost of bundled products and services, exclusive of depreciation and amortization, was $2.6 million for the nine months ended September 30, 2009, compared with $2.8 million for the nine months ended September 30, 2008. Changes by segment are discussed below.
Reimbursed direct costs increased $3.7 million, or 19%, to $23.7 million for the nine months ended September 30, 2009, compared with $20.0 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 $9.2 million, or 18%, to $60.3 million for the nine months ended September 30, 2009. Contributing to this increase was a $4.6 million increase in compensation related expense, a $4.2 million increase in share-based compensation expense for nonvested share awards granted in February 2009, a $0.7 million increase in expense related to outside services, a $0.7 million increase in utility expense, a $0.2 million increase in lease expense, and a $0.2 million increase in bad debt expense. These increases were partially offset by a $0.8 million decrease in travel and entertainment expense and a $0.6 million decrease in professional fees. Changes by segment are discussed below.
Depreciation and software and leasehold amortization costs for the nine months ended September 30, 2009 were $13.8 million, an increase of $2.0 million, or 17%, 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 nine months ended September 30, 2009 was $5.6 million, a decrease of $1.3 million, or 19%, compared to the prior year. This decrease was the result of certain non-compete and customer contract intangible assets that were fully amortized in the current year; partly offset by an increase in non-compete amortization resulting from our acquisition of an electronic discovery business in the United Kingdom in the second quarter of 2008.
Other operating expense of $0.6 million for the nine months ended September 30, 2009 primarily consisted of expense related to potential acquisitions. For the nine months ended September 30, 2008, we had other operating income of $1.5 million which consisted of a gain of $2.4 million that we recognized related to interest rate floor options purchased during 2007, partially offset by acquisition-related expenses of $0.9 million.
Interest Expense, Net
We recognized interest expense of $1.1 million for the nine months ended September 30, 2009 compared with $1.3 million for the same period in the prior year. The $0.2 million decrease in interest expense primarily resulted from a decrease in loan fee amortization.
Effective Tax Rate
Our effective tax rate for the nine months ended September 30, 2009 was 44.2% compared with an effective rate of 44.6% for the prior year. The decrease compared to the prior year was primarily related to recognizing approximately $1.0 million of previously unrecognized tax benefits and $0.2 million of both research credits and benefits related to the domestic production activities deduction, partially offset by non-deductible equity compensation in 2009 for which a comparable expense did not exist in the prior year. State taxes and non-deductible equity compensation were the primary reasons our tax rate was 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.
Although our income tax returns for 2006 and later are generally subject to exam, it is reasonably possible that we will recognize approximately $0.7 million of previously unrecognized tax benefits as a result of anticipated lapses in the statute of limitations within twelve months of our reporting date. If recognized, the $0.7 million of tax benefits would affect the effective tax rate.
Net Income
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