UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D. C. 20549
FORM 10-Q/A
Amendment No. 1
Quarterly Report Under Section 13 or 15(d)
of the Securities Exchange Act of 1934
x For the Quarterly Period Ended September 30, 2006
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 0-22081
EPIQ SYSTEMS, INC.
(Exact name of registrant as specified in its charter)
Missouri |
| 48-1056429 |
(State or other jurisdiction of |
| (IRS Employer Identification Number) |
incorporation or organization) |
|
|
501 Kansas Avenue, Kansas City, Kansas 66105-1300
(Address of principal executive office)
913-621-9500
(Registrant’s telephone number)
Indicate by check mark whether the registrant (1) has filed all 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 is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act.
Large Accelerated Filer o Accelerated Filer x Non-Accelerated Filer o
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act).
Yes o No x
The number of shares outstanding of registrant’s common stock at November 1, 2006:
Class |
| Outstanding |
|
Common Stock, $.01 par value |
| 19,475,194 |
|
EPIQ SYSTEMS, INC.
FORM 10-Q/A
QUARTER ENDED SEPTEMBER 30, 2006
CONTENTS
Explanatory Note
Epiq Systems, Inc. is filing this Amendment No. 1 to its Quarterly Report on Form 10-Q for the three and nine months ended September 30, 2006 (Form 10-Q/A) to restate our previously issued financial statements initially filed with the Securities and Exchange Commission (SEC) on November 14, 2006, as discussed in note 10 to the condensed consolidated financial statements.
This Form 10-Q/A amends and restates Items 1, 2 and 4 of Part I and Item 3 of Part II of the original filing to reflect the effects of this restatement. The remaining Items contained in this Form 10-Q/A consist of all other Items contained in the original Form 10-Q for the three and nine months ended September 30, 2006. These remaining Items are not amended by this filing. Except for the foregoing amended information, this 10-Q/A continues to describe conditions as of the date of the original filing, and the Company has not updated the disclosures contained herein to reflect events that occurred at a later date. In addition, pursuant to the rules of the SEC, Exhibits 31.1, 31.2, 32.1, and 32.2 of the original filing have been amended to contain currently dated certifications from our Chief Executive Officer and Chief Financial Officer. The updated certifications are attached to this Form 10-Q/A as Exhibits 31.1, 31.2, 32.1, and 32.2.
PART I - FINANCIAL INFORMATION
ITEM 1. Condensed Consolidated Financial Statements.
EPIQ SYSTEMS, INC.
CONDENSED CONSOLIDATED STATEMENTS OF INCOME
(In Thousands, Except Per Share Data)
(Unaudited)
|
| Three months ended |
| Nine months ended |
| ||||||||
|
| 2006 |
| 2005 |
| 2006 |
| 2005 |
| ||||
|
| (As Restated, |
| (As Restated, |
| (As Restated, |
| (As Restated, |
| ||||
REVENUE: |
|
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|
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| ||||
Case management services |
| $ | 16,980 |
| $ | 12,197 |
| $ | 54,064 |
| $ | 38,132 |
|
Case management bundled software license, software upgrade and postcontract customer support services |
| 12,818 |
| 550 |
| 80,511 |
| 1,146 |
| ||||
Document management services |
| 4,591 |
| 7,373 |
| 26,495 |
| 19,895 |
| ||||
Operating revenue before reimbursed direct costs |
| 34,389 |
| 20,120 |
| 161,070 |
| 59,173 |
| ||||
Operating revenue from reimbursed direct costs |
| 4,643 |
| 6,174 |
| 16,676 |
| 17,118 |
| ||||
Total Revenue |
| 39,032 |
| 26,294 |
| 177,746 |
| 76,291 |
| ||||
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|
|
|
|
| ||||
COSTS AND EXPENSES: |
|
|
|
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| ||||
Direct costs of services (exclusive of depreciation and amortization shown separately below) |
| 8,299 |
| 7,599 |
| 33,427 |
| 21,941 |
| ||||
Direct costs of bundled software license, software upgrade and postcontract customer support services (exclusive of depreciation and amortization shown separately below) |
| 961 |
| 977 |
| 2,976 |
| 2,837 |
| ||||
Reimbursed direct costs |
| 4,685 |
| 6,199 |
| 16,852 |
| 17,296 |
| ||||
General and administrative |
| 12,411 |
| 7,035 |
| 36,469 |
| 23,071 |
| ||||
Depreciation and software and leasehold amortization |
| 2,633 |
| 1,732 |
| 7,424 |
| 5,281 |
| ||||
Amortization of identifiable intangible assets |
| 3,027 |
| 1,442 |
| 8,672 |
| 4,492 |
| ||||
Acquisition related |
| — |
| 114 |
| 250 |
| 114 |
| ||||
Total Operating Expenses |
| 32,016 |
| 25,098 |
| 106,070 |
| 75,032 |
| ||||
|
|
|
|
|
|
|
|
|
| ||||
INCOME FROM OPERATIONS |
| 7,016 |
| 1,196 |
| 71,676 |
| 1,259 |
| ||||
|
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|
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|
|
|
|
|
| ||||
INTEREST EXPENSE (INCOME): |
|
|
|
|
|
|
|
|
| ||||
Interest income |
| (23 | ) | (28 | ) | (111 | ) | (106 | ) | ||||
Interest expense |
| 2,523 |
| 1,623 |
| 9,215 |
| 4,309 |
| ||||
Net Interest Expense |
| 2,500 |
| 1,595 |
| 9,104 |
| 4,203 |
| ||||
|
|
|
|
|
|
|
|
|
| ||||
INCOME (LOSS) FROM OPERATIONS BEFORE INCOME TAXES |
| 4,516 |
| (399 | ) | 62,572 |
| (2,944 | ) | ||||
|
|
|
|
|
|
|
|
|
| ||||
INCOME TAX PROVISION (BENEFIT) |
| 1,835 |
| (894 | ) | 25,348 |
| (3,147 | ) | ||||
|
|
|
|
|
|
|
|
|
| ||||
NET INCOME |
| $ | 2,681 |
| $ | 495 |
| $ | 37,224 |
| $ | 203 |
|
1
EPIQ SYSTEMS, INC.
CONDENSED CONSOLIDATED STATEMENTS OF INCOME
(In Thousands, Except Per Share Data)
(Unaudited)
(Continued)
|
| Three months ended |
| Nine months ended |
| ||||||||
|
| 2006 |
| 2005 |
| 2006 |
| 2005 |
| ||||
|
| (As Restated, |
| (As Restated, |
| (As Restated, |
| (As Restated, |
| ||||
|
|
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| ||||
NET INCOME PER SHARE INFORMATION: |
|
|
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|
|
|
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| ||||
Basic |
| $ | 0.14 |
| $ | 0.03 |
| $ | 1.92 |
| $ | 0.01 |
|
Diluted |
| $ | 0.13 |
| $ | 0.03 |
| $ | 1.65 |
| $ | 0.01 |
|
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| ||||
WEIGHTED AVERAGE COMMON SHARES OUTSTANDING: |
|
|
|
|
|
|
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| ||||
Basic |
| 19,442 |
| 17,942 |
| 19,372 |
| 17,911 |
| ||||
Diluted |
| 22,911 |
| 18,861 |
| 23,065 |
| 18,402 |
|
See accompanying notes to condensed consolidated financial statements.
2
EPIQ SYSTEMS, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(In Thousands, Except Share Data)
(Unaudited)
|
| September 30, 2006 |
| December 31, 2005 |
| ||
ASSETS |
|
|
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|
| ||
CURRENT ASSETS: |
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| ||
Cash and cash equivalents |
| $ | 4,026 |
| $ | 13,563 |
|
Trade accounts receivable, less allowance for doubtful accounts of $1,739 and $3,481, respectively |
| 32,634 |
| 33,504 |
| ||
Prepaid expenses |
| 2,249 |
| 2,818 |
| ||
Income taxes refundable |
| 705 |
| 4,643 |
| ||
Deferred income taxes |
| 1,725 |
| 25,579 |
| ||
Other current assets |
| 578 |
| 85 |
| ||
Total Current Assets |
| 41,917 |
| 80,192 |
| ||
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| ||
LONG-TERM ASSETS: |
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| ||
Property, equipment and leasehold improvements, net |
| 23,186 |
| 23,751 |
| ||
Software development costs, net |
| 9,343 |
| 8,848 |
| ||
Goodwill |
| 260,834 |
| 249,427 |
| ||
Identifiable intangible assets, net of accumulated amortization of $22,430 and $13,758, respectively |
| 46,797 |
| 53,399 |
| ||
Other |
| 1,962 |
| 2,854 |
| ||
Total Long-term Assets, net |
| 342,122 |
| 338,279 |
| ||
Total Assets |
| $ | 384,039 |
| $ | 418,471 |
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LIABILITIES AND STOCKHOLDERS’ EQUITY |
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CURRENT LIABILITIES: |
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Accounts payable |
| $ | 5,053 |
| $ | 7,954 |
|
Customer deposits |
| 2,322 |
| 2,196 |
| ||
Accrued compensation |
| 1,907 |
| 3,944 |
| ||
Other accrued expenses |
| 3,760 |
| 3,322 |
| ||
Deferred revenue |
| 826 |
| 60,224 |
| ||
Current maturities of long-term obligations |
| 72,000 |
| 27,642 |
| ||
Total Current Liabilities |
| 85,868 |
| 105,282 |
| ||
|
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LONG-TERM LIABILITIES: |
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Long-term obligations (excluding current maturities) |
| 88,206 |
| 145,906 |
| ||
Deferred income taxes |
| 26,077 |
| 26,815 |
| ||
Other long-term liabilities |
| 1,454 |
| — |
| ||
Total Long-term Liabilities |
| 115,737 |
| 172,721 |
| ||
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COMMITMENTS AND CONTINGENCIES |
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STOCKHOLDERS’ EQUITY: |
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Common stock - $0.01 par value; 50,000,000 shares authorized; issued and |
| 194 |
| 193 |
| ||
Additional paid-in capital |
| 133,224 |
| 128,484 |
| ||
Retained earnings |
| 49,015 |
| 11,791 |
| ||
Accumulated other comprehensive income, net |
| 1 |
| — |
| ||
Total Stockholders’ Equity |
| 182,434 |
| 140,468 |
| ||
Total Liabilities and Stockholders’ Equity |
| $ | 384,039 |
| $ | 418,471 |
|
See accompanying notes to condensed consolidated financial statements.
3
EPIQ SYSTEMS, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(In Thousands)
(Unaudited)
|
| Nine Months Ended September 30, |
| ||||
|
| 2006 |
| 2005 |
| ||
|
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| ||
CASH FLOWS FROM OPERATING ACTIVITIES: |
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| ||
Net income |
| $ | 37,224 |
| $ | 203 |
|
Adjustments to reconcile net income to net cash from operating activities: |
|
|
|
|
| ||
Share-based compensation expense |
| 1,671 |
| — |
| ||
Provision (benefit) for deferred income taxes |
| 22,761 |
| (7,428 | ) | ||
Depreciation and software and leasehold amortization |
| 7,424 |
| 5,281 |
| ||
Loan fee amortization |
| 1,077 |
| 833 |
| ||
Amortization of identifiable intangible assets |
| 8,672 |
| 4,492 |
| ||
Other |
| (839 | ) | 1,735 |
| ||
Changes in operating assets and liabilities, net of effects from business acquisition: |
|
|
|
|
| ||
Trade accounts receivable |
| 2,632 |
| (8,632 | ) | ||
Prepaid expenses and other assets |
| 28 |
| (1,374 | ) | ||
Accounts payable and other liabilities |
| (1,878 | ) | 968 |
| ||
Deferred revenue |
| (59,398 | ) | 19,724 |
| ||
Excess tax benefit related to share-based compensation |
| (154 | ) | — |
| ||
Income taxes (including $469 and $415 of tax benefit related to share-based compensation, respectively) |
| 4,355 |
| (2,065 | ) | ||
Net cash provided by operating activities |
| 23,575 |
| 13,737 |
| ||
|
|
|
|
|
| ||
CASH FLOWS FROM INVESTING ACTIVITIES: |
|
|
|
|
| ||
Purchase of property and equipment |
| (5,182 | ) | (3,035 | ) | ||
Software development costs |
| (3,275 | ) | (1,480 | ) | ||
Cash paid for acquisition of business |
| (3,586 | ) | (650 | ) | ||
Purchase of short-term investments |
| — |
| (6,000 | ) | ||
Sale of short-term investments |
| — |
| 6,000 |
| ||
Other |
| (45 | ) | 502 |
| ||
Net cash used in investing activities |
| (12,088 | ) | (4,663 | ) | ||
|
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CASH FLOWS FROM FINANCING ACTIVITIES: |
|
|
|
|
| ||
Proceeds from long-term debt borrowings |
| 3,000 |
| 6,000 |
| ||
Principal payments under long-term debt obligations |
| (26,643 | ) | (16,104 | ) | ||
Excess tax benefit related to share-based compensation |
| 154 |
| — |
| ||
Proceeds from exercise of share options |
| 2,602 |
| 903 |
| ||
Other |
| (137 | ) | — |
| ||
Net cash used in financing activities |
| (21,024 | ) | (9,201 | ) | ||
|
|
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|
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NET DECREASE IN CASH AND CASH EQUIVALENTS |
| (9,537 | ) | (127 | ) | ||
CASH AND CASH EQUIVALENTS, BEGINNING OF YEAR |
| 13,563 |
| 13,330 |
| ||
CASH AND CASH EQUIVALENTS, END OF PERIOD |
| $ | 4,026 |
| $ | 13,203 |
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SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION: |
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Interest paid |
| $ | 7,730 |
| $ | 2,649 |
|
Income taxes (received) paid, net |
| $ | (1,758 | ) | $ | 6,339 |
|
4
SUPPLEMENTAL DISCLOSURES OF NON-CASH INVESTING AND FINANCING ACTIVITIES:
We had property and equipment purchases accrued in accounts payable of approximately $0.4 million as of September 30, 2006.
During the nine months ended September 30, 2006, we incurred an obligation in a business acquisition, classified as a component of both current maturities of long-term obligations and long-term obligations, of approximately $10.2 million.
See accompanying notes to condensed consolidated financial statements.
5
EPIQ SYSTEMS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
NOTE 1: NATURE OF OPERATIONS AND SUMMARY OF RECENTLY ADOPTED ACCOUNTING POLICIES
Principles of Consolidation
The condensed consolidated financial statements include the accounts of Epiq Systems, Inc. (Epiq) and its wholly-owned subsidiaries. All significant intercompany transactions and balances have been eliminated in consolidation.
Nature of Operations
Epiq is a national provider of technology-based solutions for the legal and fiduciary services industries. Our solutions assist clients with the administration of complex legal proceedings, including electronic discovery, bankruptcy administration and class action administration. Our clients include leading law firms, corporate legal departments, bankruptcy trustees, and other professional advisors who require sophisticated case administration and document management capabilities, extensive subject matter expertise and a high service capacity. We provide clients with an integrated offering of both proprietary technology and value-added services that comprehensively address their case and document management business requirements.
Comprehensive Income
Statement of Financial Accounting Standards No. 130, Reporting Comprehensive Income, establishes requirements for reporting and display of comprehensive income and its components. Our total comprehensive income, which includes net income and foreign currency translation adjustments, was as follows (in thousands):
|
| Three months ended |
| Nine months ended |
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|
| 2006 |
| 2005 |
| 2006 |
| 2005 |
| ||||
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Net income |
| $ | 2,681 |
| $ | 495 |
| $ | 37,224 |
| $ | 203 |
|
Foreign currency translation adjustment, net |
| 2 |
| — |
| 1 |
| — |
| ||||
Total comprehensive income |
| $ | 2,683 |
| $ | 495 |
| $ | 37,225 |
| $ | 203 |
|
Revenue Recognition
We have agreements with clients pursuant to which we deliver various case management and document management services each month.
Significant sources of revenue include:
· 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, 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;
· Hosting fees based on the amount of data stored;
· Deposit-based fees from financial institutions, primarily based on a percentage of total liquidated assets placed on deposit at that financial institution by our bankruptcy trustee clients, to whom we provide, at no charge, software licenses, limited hardware and hardware maintenance, and postcontract customer support (PCS) services;
· Legal noticing services to parties of interest in bankruptcy and 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; and
· Reimbursement for costs incurred, primarily related to postage on mailing services.
6
Non-Software Arrangements
Case and document management services related to electronic discovery, corporate restructuring, and class action revenue, which are billed based on volume, are evaluated pursuant to Emerging Issues Task Force (EITF) 00-21, Revenue Arrangements with Multiple Deliverables. For each of these contractual arrangements, we have identified the following deliverables and/or services:
· Electronic Discovery
· Data processing
· Hosting
· Corporate Restructuring
· Consulting
· Claims management
· Printing and reproduction
· Mailing and noticing
· Document management
· Class Action
· Consulting
· Notice campaigns
· Toll free customer support
· Web site design/hosting
· Claims administration
· Distribution
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 based on third-party evidence of fair value of such services. 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 under EITF 00-21. We allocate revenue to the various units of accounting in our arrangements based on the fair value of each unit of accounting, which is generally consistent with the stated prices in our arrangements. As we have evidence of an arrangement, revenue for each separate unit of accounting is recognized each period in accordance with Staff Accounting Bulletin Topic 13, Revenue Recognition (SAB Topic 13). As the services are rendered, our fee becomes fixed and determinable, and collectibility 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 PCS 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. The financial institution pays us a monthly fee contingent on the dollar level of average monthly deposits placed by the trustees with that financial institution.
For Chapter 7 related arrangements with financial institutions, we earn contingent monthly fees from the financial institution related to the software license, hardware lease, hardware maintenance, and PCS services. We account for the software license and PCS service elements in accordance with Statement of Position 97-2, Software Revenue Recognition (SOP 97-2). Since we have not established vendor specific objective evidence (VSOE) 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 element, which is PCS services. This revenue, when recognized, is included on our condensed consolidated statements of operations as a component of “Case management bundled software license, software upgrade and postcontract customer support services” revenue. Revenue related to PCS services 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 consistent with the guidance provided by the American Institute of Certified Public Accountants’ Technical Practice Aid (TPA) 5100.76, Fair Value in Multiple-Element Arrangements That Include Contingent Usage-Based Fees and Software Revenue Recognition as the fee becomes fixed or determinable at the time actual usage occurs and collectibility 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 revenue recognition criteria contained in SOP 97-2, since we have persuasive
7
evidence that an arrangement exists, services have been rendered, the price is fixed and determinable, and collectibility is reasonably assured.
We also provide our trustees with certain hardware, such as desktop computers, monitors, and printers, and hardware maintenance. We retain ownership of all hardware provided and, based on guidance provided in EITF 01-8, Determining Whether an Arrangement Contains a Lease, 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 all of 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 in accordance with SFAS 13, Accounting for Leases. Therefore, all lease payments, based on the estimated fair value of hardware provided, were accounted for as contingent rentals under EITF Issue No. 98-9, Accounting for Contingent Rent and SAB Topic 13, which requires that we recognize rental income when the changes in the factor on which the contingent lease payment is based actually occur. This occurred at the end of each period as we achieve our target when deposits are held at the depository 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 is less than ten percent of our total revenue, is included in our condensed consolidated statements of operations as a component of “Case management services” revenue.
Effective October 1, 2003, we entered into an arrangement with our primary depository financial institution under which we delivered two specified upgrades annually with the last specified upgrade occurring in the second quarter of 2006. This arrangement included specific pricing for each software upgrade and certain special projects in addition to the contingent deposit-based pricing related to the software license, hardware, hardware maintenance, and PCS to each trustee client. Therefore, the software upgrades and special projects are part of a bundled arrangement. Each software upgrade is considered a separate and discrete product and, as we do not sell each software upgrade on a standalone basis, we were unable to establish VSOE of the fair value of the software upgrades. As a result, the licensed software, software upgrade, special projects and PCS are a combined unit of accounting. Revenue for this combined unit of accounting, when recognized, is included as a component of case management services revenue. Since we did not have VSOE of the fair value of each separate upgrade, we deferred recognition of substantially all revenue under this arrangement until the final upgrade was delivered. The ongoing costs related to this arrangement were recognized as expense when incurred. On delivery of the final upgrade during the second quarter of 2006, the only remaining undelivered element was PCS services. In accordance with SOP 97-2, on delivery of the final software upgrade, we recognized revenue previously deferred on a proportionate basis over the three year term of the contract. As the contract commenced October 1, 2003 and terminated September 30, 2006, we recognized approximately $60.1 million of net deferred revenue during the second quarter of 2006 and we recognized approximately $6.0 million of deferred revenue related to this arrangement during the third quarter of 2006.
Reimbursements
Our case and document management businesses both have revenue related to the reimbursement of certain costs, primarily postage. Consistent with guidance provided by EITF No. 01-14, Income Statement Characterization of Reimbursements Received for “Out-of-Pocket” Expenses Incurred, reimbursed postage and other reimbursable direct costs are recorded gross as revenue from reimbursed direct costs and as reimbursed direct costs.
Share-based Compensation
On January 1, 2006, we adopted Statement of Financial Accounting Standards No. 123 (revised 2004) (SFAS No. 123R), Share-Based Payment. SFAS No. 123R established standards for the accounting for transactions in which an entity exchanges its equity instruments for goods and services or incurs liabilities in exchange for goods or services that are based on the fair value of the entity’s equity instruments or that may be settled by the issuance of those equity instruments. SFAS No. 123R requires a public entity to measure the cost of employee services received in exchange for an award of equity instruments based on the grant-date fair value of the award and to recognize that cost over the period during which an employee is required to provide service in exchange for the award.
We elected to adopt SFAS No. 123R using the modified version of prospective application. Under the modified version of prospective application, we have recognized compensation costs related to share-based compensation beginning with the quarter ended March 31, 2006. We recognize this expense on a straight-line basis over the requisite service period of the last separately vesting portion of the award. Prior to 2006, we accounted for stock-based compensation awards under the intrinsic method of Accounting Principles Board Opinion No. 25, Accounting for Stock Issued to Employees, which required compensation cost to be recognized based on the excess, if any, between the quoted market price at the date of grant and the amount an employee must pay to acquire stock. Compensation costs related to share-based compensation for periods ended
8
on or before December 31, 2005 are reflected on a pro forma basis in note 6 of these condensed consolidated financial statements.
Recent Accounting Pronouncements
In September 2006, the Financial Accounting Standards Board (FASB) issued Statement of Financial Accounting Standards No. 157, Fair Value Measurements (SFAS 157). SFAS 157 defines fair value, establishes a framework for measuring fair value in generally accepted accounting principles, and expands disclosures about fair value measurements. SFAS 157 is effective for financial statements issued for fiscal years beginning after November 15, 2007, and interim periods within those fiscal years. We do not anticipate that adoption of this statement will have a material impact on our consolidated financial statements.
In June 2006, the FASB issued Interpretation No. 48, Accounting for Uncertainty in Income Taxes (FIN 48). FIN 48 applies to tax positions accounted for under Statement of Financial Accounting Standard No. 109, Accounting for Income Taxes. A tax position includes a current or future reduction in taxable income reported or expected to be reported on a tax return, the decision not to report a transaction in a tax return, and an assertion that a company is not subject to taxation. FIN 48 requires that a tax position be recognized only if it is more-likely-than-not to be sustained based solely on its technical merits as of the reporting date. A recognized tax benefit is measured based on the largest benefit that is more than 50 percent likely to be realized. FIN 48 is effective for an entity’s first fiscal year that begins after December 15, 2006. At adoption, any necessary adjustment to our financial statements will be recorded directly to the beginning balance of retained earnings in the period of adoption and reported as a change in accounting principle. At this time, we are unable to predict the impact, if any, that adoption of FIN 48 will have on our consolidated financial statements.
In June 2006, the EITF reached a consensus regarding EITF 05-1, Accounting for the Conversion of an Instrument That Becomes Convertible Upon the Issuer’s Exercise of a Call Option. EITF 05-1 pertains only to debt instruments that become convertible at the time the issuer calls the debt, but are not convertible before the call is exercised. Conversions of these instruments triggered by the call option would be accounted for as debt conversions and recognized as debt extinguishments if the debt instrument did not contain a substantive conversion feature at issuance. EITF 05-1 will be effective for conversions that occur as a result of the issuer’s exercise of a call option in the interim or annual period beginning after September 28, 2006. We do not anticipate that adoption of this statement will have a material impact on our consolidated financial statements.
In February 2006, the FASB issued Statement of Financial Accounting Standard No. 155, Accounting for Certain Hybrid Financial Instruments—an amendment of FASB Statements No. 133 and 140 (SFAS 155). SFAS 155 allows an entity to make an irrevocable election to measure a financial instrument with an embedded derivative, referred to as a hybrid financial instrument, at fair value in its entirety rather than bifurcating and separately valuing the embedded derivative instrument. SFAS 155 is effective for all financial instruments acquired, issued, or subject to a remeasurement (new basis) event occurring after the beginning of an entity’s first fiscal year that begins after September 15, 2006. We do not anticipate that adoption of this statement will have a material impact on our consolidated financial statements.
NOTE 2: INTERIM FINANCIAL STATEMENTS
The accompanying condensed consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America (GAAP) and with the rules and regulations for reporting on Form 10-Q for interim financial statements. Accordingly, they do not include certain information and disclosures required for comprehensive annual financial statements. The interim financial statements have not been audited. The financial statements should be read in conjunction with our audited financial statements and accompanying notes, which are included in our Form 10-K/A for the year ended December 31, 2005.
In the opinion of our management, the accompanying condensed consolidated financial statements reflect all adjustments necessary (consisting solely of normal recurring adjustments) to present fairly our financial position as of September 30, 2006, the results of operations for the three and nine month periods ended September 30, 2006 and 2005, and cash flows for the nine month periods ended September 30, 2006 and 2005.
The results of operations for the three and nine month periods ended September 30, 2006 are not necessarily indicative of the results to be expected for the entire year.
9
NOTE 3: GOODWILL AND INTANGIBLE ASSETS
Amortizing identifiable intangible assets at September 30, 2006 and December 31, 2005 consisted of the following (in thousands):
|
| September 30, 2006 |
| December 31, 2005 |
| ||||||||
|
| Gross Carrying |
| Accumulated |
| Gross Carrying |
| Accumulated |
| ||||
Customer contracts |
| $ | 39,287 |
| $ | 11,010 |
| $ | 37,313 |
| $ | 6,170 |
|
Trade names |
| 2,414 |
| 2,196 |
| 2,319 |
| 1,578 |
| ||||
Non-compete agreements |
| 27,526 |
| 9,224 |
| 27,525 |
| 6,010 |
| ||||
|
| $ | 69,227 |
| $ | 22,430 |
| $ | 67,157 |
| $ | 13,758 |
|
Aggregate amortization expense related to identifiable intangible assets was $3.0 million and $1.4 million for the three month periods ended September 30, 2006 and 2005, respectively and was $8.7 million and $4.5 million for the nine month periods ended September 30, 2006 and 2005, respectively. Amortization expense related to identifiable intangible assets for 2006 and the following five years is estimated as follows (in thousands):
Year Ending |
| Estimated |
| |
2006 |
| $ | 11,620 |
|
2007 |
| 9,531 |
| |
2008 |
| 8,361 |
| |
2009 |
| 6,829 |
| |
2010 |
| 6,439 |
| |
2011 |
| 4,706 |
| |
|
|
|
| |
|
| $ | 47,486 |
|
Changes in the carrying amounts of goodwill by segment are as follows (in thousands):
|
| Nine Month Period Ended September 30, 2006 |
| Year Ended December 31, 2005 |
| ||||||||||||||
|
| Case |
| Document |
| Total |
| Case |
| Document |
| Total |
| ||||||
|
|
|
|
|
|
|
|
|
|
|
|
|
| ||||||
Balance, beginning of period |
| $ | 200,936 |
| $ | 48,491 |
| $ | 249,427 |
| $ | 106,371 |
| $ | 41,357 |
| $ | 147,728 |
|
Goodwill acquired during the period and adjustments |
| 11,430 |
| (23 | ) | 11,407 |
| 94,565 |
| 7,134 |
| 101,699 |
| ||||||
Balance, end of period |
| $ | 212,366 |
| $ | 48,468 |
| $ | 260,834 |
| $ | 200,936 |
| $ | 48,491 |
| $ | 249,427 |
|
We assess goodwill for impairment as of each July 31 and also at any other date when events or changes in circumstances indicate that the carrying value of these assets may exceed their fair value. We did not recognize any impairment loss during the three and nine month periods ended September 30, 2006 and 2005.
10
NOTE 4: BUSINESS ACQUISITIONS
Epiq Advisory Services, Inc.
On May 16, 2006, our wholly-owned subsidiary, Epiq Advisory Services Inc., in an asset acquisition, acquired the claims preference business of Gazes LLC. The total value of the transaction was $13.8 million, consisting of $3.0 million of cash paid on closing, $10.2 million of deferred payments, and $0.6 million of capitalized transaction costs. If certain income targets are satisfied, we may be required to make additional payments, which would be recorded as compensation expense, to the seller. The preliminary allocation of the purchase price is as follows: less than $0.1 million to tangible net assets, approximately $2.4 million to customer contracts, amortizable on a straight-line basis over two years, and approximately $11.4 million to goodwill. The purchase price in excess of the tax basis of the assets is expected to be deductible for tax purposes. This acquisition further expands our case management service offerings.
The acquisition was accounted for using the purchase method of accounting with the operating results included in the accompanying condensed consolidated financial statements from the date of acquisition. The operating results of Epiq Advisory Services are included within our case management segment.
nMatrix
On November 15, 2005, Epiq, acting through a wholly-owned subsidiary, acquired all the issued and outstanding shares of capital stock of nMatrix, Inc., nMatrix Australia Pty. Ltd., and nMatrix Ltd. (collectively, nMatrix) for approximately $126.3 million, including capitalized acquisition costs. The electronic discovery services of nMatrix further expands the service offerings of our legal services business. The purchase price consisted of cash of $100.0 million and approximately 1.2 million shares of our common stock. The fair value of our common stock issued, calculated based upon the five-day average of the closing price of the common stock two days before and two days after the acquisition was consummated, was approximately $24.2 million. In conjunction with the acquisition, we entered into an agreement with the selling shareholder to register the shares of common stock issued as a part of the acquisition consideration. Within this agreement, we guaranteed the common stock price of $20.35 per share, valued as the average closing price of our common stock for the 40 consecutive trading days ending on the date four trading days prior to the closing date. This guarantee terminates as of the close of business on the date that is after any 15 trading days on which the selling shareholder may lawfully sell shares under a registration statement and the last sale price for our common stock has been equal to or greater than the $20.35. Based on our September 30, 2006 closing price of $14.71 per share, as of September 30, 2006 the guarantee amount would be approximately $6.9 million. A liability will not be recorded for this guarantee until the contingency is resolved. If a payment is made under this guarantee, we will reduce the equity proceeds recorded as a part of the acquisition transaction. Based on our valuation, the purchase price has been allocated as follows (in thousands):
Accounts receivable |
| $ | 12,615 |
|
Other current assets |
| 2,926 |
| |
Property and software |
| 7,236 |
| |
Trade names |
| 569 |
| |
Customer relationships |
| 24,614 |
| |
Non-compete agreements |
| 6,676 |
| |
Current liabilities |
| (6,197 | ) | |
Deferred tax liability |
| (16,807 | ) | |
Goodwill |
| 94,664 |
| |
|
|
|
| |
Total purchase price |
| $ | 126,296 |
|
Trade names, customer relationships, and the non-compete agreements are amortized using the straight-line method over one year, eight years, and five years, respectively. The excess purchase price of $94.7 million was allocated to goodwill and is not amortized but will be reviewed for impairment annually and between annual reviews if events or changes in circumstances indicate that the asset might be impaired. The purchase price in excess of the tax basis of the assets, primarily allocated to identifiable intangible assets and goodwill, is not expected to be deductible for tax purposes. Of our 1.2 million common shares issued as consideration, approximately 246,000 are held in escrow. On submission of properly approved indemnification claims, the escrow agent will sell sufficient shares to pay the indemnification claim. As of September 30, 2006, we have not submitted any claims related to this escrow. This escrow arrangement terminates May 14, 2007, at which time any of our common shares that have not been sold to pay claims will be distributed to the seller. Also, $4.0 million of the cash consideration was initially placed in a separate escrow pending collection of certain pre-acquisition receivables.
11
Each month, a portion of this escrow is released to the seller based on the prior month’s collection of these pre-acquisition receivables. As of September 30, 2006, approximately $0.3 million remained in this escrow account. This escrow arrangement terminates following the payment for collections made through September 2006 of these pre-acquisition receivables, at which time any amount that remains in escrow will be distributed to Epiq.
The acquisition was accounted for using the purchase method of accounting with the operating results included in the accompanying condensed consolidated financial statements from the date of acquisition. The operating results of nMatrix are included within our case management segment.
Hilsoft, Inc.
On October 20, 2005, we acquired for cash all the issued and outstanding shares of capital stock of Hilsoft, Inc. The specialty legal notification services of Hilsoft further expand our document management capabilities. The total value of the transaction, including capitalized transaction costs, was $9.3 million. If certain revenue objectives are satisfied, we will be required to make additional payments of up to $3.0 million.
The acquisition was accounted for using the purchase method of accounting with the operating results included in the accompanying condensed consolidated financial statements from the date of acquisition. The operating results are included within our document management segment.
Pro Forma Results
Pro forma results of operations assuming the above acquisitions were made at the beginning of 2005 are shown below (in thousands, except per share data):
|
| Three months ended |
| Nine months ended |
| |||||
|
| 2005 |
| 2006 |
| 2005 |
| |||
|
|
|
|
|
|
|
| |||
Total revenue |
| $ | 36,312 |
| $ | 178,958 |
| $ | 103,328 |
|
|
|
|
|
|
|
|
| |||
Net income (loss) |
| $ | 573 |
| $ | 37,126 |
| $ | (168 | ) |
Net income (loss) per share |
|
|
|
|
|
|
| |||
Basic |
| $ | 0.03 |
| $ | 1.92 |
| $ | (0.01 | ) |
Diluted |
| $ | 0.03 |
| $ | 1.65 |
| $ | (0.01 | ) |
Pro forma adjustments include estimated amortization expense, interest expense, management compensation and income taxes. The pro forma information is not necessarily indicative of what would have occurred if the acquisitions had been completed on that date nor is it necessarily indicative of future operating results.
12
NOTE 5: INDEBTEDNESS
The following is a summary of indebtedness outstanding (in thousands):
| September 30, |
| December 31, |
| |||
|
| 2006 |
| 2005 |
| ||
Senior term loan |
| $ | 15,000 |
| $ | 25,000 |
|
Senior revolving loan |
| 82,028 |
| 93,028 |
| ||
Contingent convertible subordinated debt, including embedded option |
| 51,049 |
| 51,326 |
| ||
Capital leases |
| 31 |
| 972 |
| ||
Deferred acquisition price |
| 12,098 |
| 3,222 |
| ||
Total indebtedness |
| $ | 160,206 |
| $ | 173,548 |
|
Credit Facilities
We have a credit facility with KeyBank National Association as administrative agent. At inception, this facility consisted of a $25.0 million senior term loan, maturing in August 2006, and a $100.0 million senior revolving loan, maturing in November 2008. During 2006, we repaid $10.0 million of the senior term loan and, in June 2006, our credit facility was amended to extend the maturity of the outstanding senior term loan balance to June 30, 2007. The senior term loan does not have any required amortizing payments. During the term of the loan we have the right, subject to compliance with our covenants, to increase the senior revolving loan to $175.0 million.
The credit facility is secured by liens on our real property and a significant portion of our personal property. As of September 30, 2006, our borrowings under the credit facility totaled $97.0 million, consisting of $15.0 million under the senior term loan and $82.0 million under the senior revolving loan. Interest on the credit facility is generally based on a spread over the LIBOR rate. Effective April 16, 2007, the calculation of the interest rate for the senior term loan will be adjusted to increase the spread over the LIBOR rate by 2%. As of September 30, 2006, the interest rate charged on outstanding borrowings ranged from 8.3% to 9.5%.
Contingent Convertible Subordinated Debt
During June 2004, we issued $50.0 million of contingent convertible subordinated notes. Net proceeds of $47.4 million were used to repay and terminate an outstanding subordinated term loan and to pay in full our then outstanding revolving loan balance. The contingency has been satisfied, and the notes may, at the option of the holders, be converted into shares of our common stock at any time. These convertible subordinated notes:
· bear interest at a fixed rate of 4% per annum, payable quarterly;
· are convertible into shares of our common stock at a price of $17.50 per share; and
· mature on June 15, 2007, subject to extension of maturity to June 15, 2010 at the option of the note holders.
If all notes were converted, the notes would convert into approximately 2.9 million shares of our common stock. If we change our capital structure (for example, through a stock dividend or stock split) while the notes are outstanding, the conversion price will be adjusted on a consistent basis and, accordingly, the number of shares of common stock we would issue on conversion would be adjusted.
The holders of the notes have the right to extend the maturity of the notes for a period not to exceed three years. Under SFAS No. 133, Accounting for Derivative Instruments and Hedging Activities, the right to extend the maturity of the notes represents an embedded option subject to bifurcation. The embedded option was initially valued at $1.2 million and the convertible debt balance was reduced by the same amount. The convertible debt is accreted approximately $0.1 million each quarter such that, at the end of three years, the convertible debt balance will total $50.0 million. On our accompanying condensed consolidated statements of income, this accretion is a component of interest expense. The embedded option must be revalued at each period end based on the probability weighted discounted cash flows related to the additional 4% interest rate payments that will be made if the convertible debt maturity is extended an additional three years. Under this methodology, the embedded option has a current value of approximately $1.4 million. On our accompanying condensed consolidated balance sheets, our obligation related to the embedded option has been included as a component of the convertible note payable. For the three and nine month periods ended September 30, 2006, the value of the embedded option decreased by approximately $0.8 million and $0.6 million, respectively, and these decreases have been included as a
13
component of interest expense on our accompanying condensed consolidated statements of income. The changes in carrying value of the convertible debt and fair value of the embedded option do not affect our cash flow and, if the embedded option is exercised, the value assigned to the embedded option will be amortized as a reduction to our 4% convertible debt interest expense over the periods payments are made. If the option is not exercised by some or all convertible debt holders, any remaining related value assigned to the embedded option will be recognized as a gain during that period.
Covenant Compliance
Both our credit facility and subordinated debt contain financial covenants related to earnings before interest, provision for income taxes, depreciation, amortization and other adjustments as defined in the agreements (EBITDA) and total debt. In addition, our credit facility also contains financial covenants related to senior debt, fixed charges, and working capital. As a result of the restatement, which resulted in the deferral of a substantial portion of revenue related to the 2003 Arrangement as described in note 10, we were not in compliance with these financial covenants through March 31, 2006. As a result of recognition of the deferred revenue during the second and third quarters of 2006; we are in compliance with all financial covenants as of June 30 and September 30, 2006. The deferral of revenue through March 31, 2006, and the recognition of the deferred revenue during the second and third quarter of 2006, were not anticipated by us or the banks at the time we established the current financial covenants in the credit facility. On December 14, 2006, we obtained a waiver regarding this event of noncompliance from our credit facility syndicate. Accordingly, we have classified this debt as current or long-term based on the debt’s original scheduled maturity. As a result, as of September 30, 2006 and December 31, 2005, debt obligations of $82.0 million and $144.4 million, respectively, which were classified as current prior to obtaining a waiver regarding the event of non-compliance are classified as long-term in the accompanying condensed consolidated balance sheets.
Deferred Acquisition Price
We have made three acquisitions, Bankruptcy Services, Hilsoft, and Epiq Advisory Services, for which a portion of the purchase price was deferred. These deferred payments, which are either non-interest bearing or have a below market interest rate, have been discounted at imputed interest rates (Bankruptcy Services at 5% and Hilsoft and Epiq Advisory Services at 8%). At September 30, 2006, the discounted value of the remaining note payments was approximately $12.1 million of which approximately $5.9 million was classified as a current liability.
Scheduled Principal Payments
Our long-term obligations, including credit facility debt, convertible debt (including embedded option), deferred acquisition costs, and capitalized leases, mature as follows for each twelve-month period ending September 30 (in thousands):
2007 |
| $ | 72,000 |
|
2008 |
| 2,952 |
| |
2009 |
| 83,435 |
| |
2010 |
| 1,360 |
| |
2011 |
| 459 |
| |
Total |
| $ | 160,206 |
|
14
NOTE 6: SHARE-BASED COMPENSATION
During the quarter ended March 31, 2006, we adopted SFAS No. 123R, Share-Based Payment. SFAS No. 123R establishes standards for the accounting for transactions in which an entity exchanges its equity instruments for goods and services or incurs liabilities in exchange for goods or services that are based on the fair value of the entity’s equity instruments or that may be settled by the issuance of those equity instruments. SFAS No. 123R requires a public entity to measure the cost of employee services received in exchange for an award of equity instruments based on the grant-date fair value of the award and to recognize that cost over the period during which an employee is required to provide service in exchange for the award.
We elected to adopt SFAS No. 123R using the modified version of prospective application. Using this method, we have recognized compensation costs related to share-based compensation beginning with the quarter ended March 31, 2006. Compensation costs related to share-based compensation for periods ended on or before December 31, 2005 are reflected on a pro forma basis in this note to our condensed consolidated financial statements. We have not made an election as to the transition method we will use for purposes of calculating the pool of excess tax benefits available to absorb tax deficiencies recognized subsequent to the adoption of SFAS No. 123R.
As disclosed in our February 18, 2005 filing on Form 8-K, during February 2005 our compensation committee approved acceleration of the vesting of approximately 0.5 million unvested share options, with a weighted-average exercise price of $14.28 per share, for certain employees, including an executive officer and non-employee directors. Unvested share options to purchase approximately 1.2 million shares, with a weighted-average exercise price of approximately $15.26 per share, were not accelerated as the employees holding the unvested share options did not meet the criteria established by our compensation committee. The decision to accelerate the vesting of these share options and eliminate future compensation expense was based primarily on a review of our long-term incentive programs considering the effect on our financial statements of the then pending change in accounting rules for share-based compensation. This action, which had an immaterial effect on our financial statements for the year ended December 31, 2005, reduced the amount of expense we would have recognized under SFAS 123R by approximately $2.2 million (approximately $0.2 million and $0.6 million during the three months and nine month periods ended September 30, 2006, respectively, and approximately $0.8 million, $0.7 million, $0.5 million and $0.2 million for the years ending December 31, 2006, 2007, 2008, and 2009, respectively).
Our 2004 Equity Incentive Plan (the Plan), which is shareholder approved, permits us to grant up to 5 million equity-based instruments. Although various forms of equity instruments may be issued, to date we have issued only incentive share options and nonqualified share options under this Plan. These share options, which have a contractual term of 10 years, are issued with an exercise price equal to the grant date closing market price of our common stock. The vesting periods range from immediate to 5 years. Share options which vest over 5 years generally vest either 20% per year on the first five anniversaries of the grant date, or 25% per year on the second through fifth anniversaries of the grant date. Shares vesting over a shorter period will generally vest 100% as of the designated vesting date. We issue new shares to satisfy share option exercises. We do not anticipate that we will repurchase shares on the open market during 2006 for the purpose of satisfying share option exercises.
As a result of our adoption of SFAS No. 123R, during the three and nine month periods ended September 30, 2006 we recognized expense related to share options issued prior to but unvested as of January 1, 2006 as well as expense related to share options issued subsequent to January 1, 2006. For share options issued prior to but unvested as of January 1, 2006, compensation expense was based on the fair value of those share options as calculated using the Black-Scholes option valuation model at the date the share options were issued. Key assumptions for the Black-Scholes option valuation model include expected volatility, expected term of share options granted, the expected risk-free interest rate, and the expected dividend rate. The assumptions used in those fair value calculations have been disclosed in our Annual Reports on Form 10-K previously filed with the SEC. For share options issued during the nine month period ended September 30, 2006, the share options were also valued using the Black-Scholes option valuation models and with key assumptions related to expected volatility, expected term of share options granted, the expected risk-free interest rate, and the expected dividend rate. We estimate our expected volatility based on implied volatilities from traded share options on our stock and on our stock’s historical volatility. We have estimated the expected term of our share options based on the historical exercise pattern of groups of employees that have similar historical exercise behavior. The expected risk-free interest rate is based on the U.S. Treasury yield curve in effect at the time of the grant. Historically, we have not paid dividends and we do not anticipate paying dividends in the foreseeable future; accordingly, our expected dividend rate is zero.
15
Following is a summary of key assumptions we used to value share options granted during the nine months ended September 30, 2006.
Expected term (years) |
| 5.0 |
Expected volatility |
| 30.0% - 38.0% |
Weighted average expected volatility |
| 37.1% |
Risk-free interest rate |
| 4.3% - 5.0% |
Dividend yield |
| 0% |
Compensation expense for the three and nine month periods ended September 30, 2006 was adjusted for share options we estimate will be forfeited prior to vesting. We use historical information to estimate employee termination and the resulting option forfeiture rate.
A summary of option activity during the three months ended September 30, 2006 is presented below (shares and aggregate intrinsic value in thousands):
| Shares |
| Weighted |
| Weighted |
| Aggregate |
| |||
|
|
|
|
|
|
|
|
|
| ||
Outstanding, beginning of period |
| 4,809 |
| $ | 14.77 |
|
|
|
|
| |
Granted |
| 10 |
| 15.47 |
|
|
|
|
| ||
Exercised |
| (78 | ) | 12.45 |
|
|
|
|
| ||
Forfeited |
| (57 | ) | 18.00 |
|
|
|
|
| ||
Outstanding, end of period |
| 4,684 |
| 14.77 |
| 7.29 |
| $ | 7,106 |
| |
|
|
|
|
|
|
|
|
|
| ||
Options exercisable, end of period |
| 3,272 |
| 13.62 |
| 6.75 |
| $ | 6,703 |
| |
The aggregate intrinsic value was calculated using the difference between the September 30, 2006 market price and the grant price for only those awards that have a grant price that is less than the September 30, 2006 market price. The weighted average grant-date fair value of share options granted during the three months ended September 30, 2006 and 2005 were $5.52 and $7.23, respectively. No share options were granted during the three months ended September 30, 2005. The total intrinsic value of share options exercised during the three months ended September 30, 2006 was $0.2 million. During the three months ended September 30, 2006, we received cash for payment of the grant price of exercised share options of approximately $1.0 million and we anticipate we will realize a tax benefit related to these exercised share options of less than $0.1 million. The cash received for payment of the grant price is included as a component of cash flow from financing activities on the condensed consolidated statement of cash flows.
During the three months ended September 30, 2006, we recognized share-based compensation expense, which is a non-cash charge, of approximately $0.6 million, of which $0.2 million is included under the caption “Direct costs of services” and $0.4 million is included under the caption “General and administrative” on the accompanying condensed consolidated statements of income. During the three months ended September 30, 2006, we recognized a net tax benefit of approximately $0.2 million related to aggregate share-based compensation expense recognized during the same period. As a result, income before income taxes was reduced by approximately $0.6 million, net income was reduced by approximately $0.4 million, net income per share – basic was reduced by approximately $0.02 per share, and net income per share – diluted was reduced by approximately $0.02 per share.
16
A summary of option activity during the nine months ended September 30, 2006 is presented below (shares and aggregate intrinsic value in thousands):
| Shares |
| Weighted |
| Weighted |
| Aggregate |
| |||
|
|
|
|
|
|
|
|
|
| ||
Outstanding, beginning of period |
| 4,769 |
| $ | 14.49 |
|
|
|
|
| |
Granted |
| 237 |
| 18.53 |
|
|
|
|
| ||
Exercised |
| (221 | ) | 11.74 |
|
|
|
|
| ||
Forfeited |
| (101 | ) | 17.06 |
|
|
|
|
| ||
Outstanding, end of period |
| 4,684 |
| 14.77 |
| 7.29 |
| $ | 7,106 |
| |
|
|
|
|
|
|
|
|
|
| ||
Options exercisable, end of period |
| 3,272 |
| 13.62 |
| 6.75 |
| $ | 6,703 |
| |
The aggregate intrinsic value was calculated using the difference between the September 30, 2006 market price and the grant price for only those awards that have a grant price that is less than the September 30, 2006 market price. The weighted average grant-date fair value of share options granted during the nine months ended September 30, 2006 and 2005 were $7.42 and $5.30, respectively. The total intrinsic value of share options exercised during the nine months ended September 30, 2006 was $1.5 million. During the nine months ended September 30, 2006, we received cash for payment of the grant price of exercised share options of approximately $2.6 million and we anticipate we will realize a tax benefit related to these exercised share options of approximately $0.5 million. The cash received for payment of the grant price is included as a component of cash flow from financing activities. The tax benefit related to the option exercise price in excess of the option fair value at grant date is separately disclosed as a component of cash flow from financing activities on the condensed consolidated statement of cash flows; the remainder of the tax benefit is included as a component of cash flow from operating activities.
During the nine months ended September 30, 2006, we recognized share-based compensation expense, which is a non-cash charge, of approximately $1.7 million, of which $0.4 million is included under the caption “Direct costs of services” and $1.3 million is included under the caption “General and administrative” on the accompanying condensed consolidated statements of income. During the nine months ended September 30, 2006, we recognized a net tax benefit of approximately $0.6 million related to aggregate share-based compensation expense recognized during the same period. As a result, income before income taxes was reduced by approximately $1.7 million, net income was reduced by approximately $1.1 million, net income per share – basic was reduced by approximately $0.06 per share, and net income per share – diluted was reduced by approximately $0.05 per share. As of September 30, 2006, there was $7.1 million of total unrecognized compensation cost related to nonvested share-based compensation arrangements, which will be recognized over a weighted-average period of 2.2 years.
17
Prior to adoption of SFAS 123R, we accounted for stock-based compensation awards under the intrinsic method of Accounting Principles Board Opinion No. 25, Accounting for Stock Issued to Employees, which required compensation cost to be recognized based on the excess, if any, between the quoted market price at the date of grant and the amount an employee must pay to acquire stock. Share options awarded under our share option plans are granted with an exercise price equal to the fair market value on the date of the grant. As a result, our condensed consolidated statements of income do not include expense related to share-based compensation for the three and nine month periods ended September 30, 2005. Had the compensation cost been determined based on the fair value at the grant dates based on the guidance provided by Statement of Financial Accounting Standard (SFAS) No. 123, Accounting for Stock-Based Compensation, our net income and net income per share for the three month and nine month periods ended September 30, 2005 would have been adjusted to the following pro forma amounts (in thousands, except per share data):
|
|
| Three Months Ended |
| Nine Months Ended |
| |||
|
|
|
|
|
|
|
| ||
Net income, as reported |
|
|
| $ | 495 |
| $ | 203 |
|
Add: stock-based employee compensation Included in reported net earnings, net of tax |
|
|
| — |
| — |
| ||
Deduct: stock-based employee compensation expense determined under the fair value method, net of tax |
|
|
| (216 | ) | (5,482 | ) | ||
Net income (loss), pro forma |
|
|
| $ | 279 |
| $ | (5,279 | ) |
|
|
|
|
|
|
|
| ||
Net income (loss) per share – Basic |
| As reported |
| $ | 0.03 |
| $ | 0.01 |
|
|
| Pro forma |
| $ | 0.02 |
| $ | (0.29 | ) |
|
|
|
|
|
|
|
| ||
Net income (loss) per share – Diluted |
| As reported |
| $ | 0.03 |
| $ | 0.01 |
|
|
| Pro forma |
| $ | 0.01 |
| $ | (0.29 | ) |
Pro forma amounts presented here are based on actual earnings and consider only the effects of estimated fair values of share options. For the three and nine month period ended September 30, 2005, we did not assume conversion of the convertible notes as the effect was antidilutive. For the three and nine month periods ended September 30, 2005, we did not assume exercise of share options as the effect was antidilutive.
18
NOTE 7: NET INCOME PER SHARE
Basic net income per share is computed by dividing net income available to common shareholders by the weighted average number of common shares outstanding for the period. Diluted net income per share is computed by dividing net income available to common shareholders, increased by the amount of interest expense, net of tax, related to outstanding convertible debt, by the weighted average number of outstanding common shares and incremental shares that may be issued in future periods relating to outstanding share options and convertible debt, if dilutive. When calculating incremental shares related to outstanding share options, we apply the treasury stock method. The treasury stock method assumes that proceeds, consisting of the amount the employee must pay on exercise, compensation cost attributed to future services and not yet recognized, and excess tax benefits that would be credited to additional paid-in capital on exercise of the share options, are used to repurchase outstanding shares at the average market price for the period.
The computations of basic and diluted net income per share are as follows (in thousands, except per share data):
| Three Months Ended September 30, |
| |||||||||||||||
|
| 2006 |
| 2005 |
| ||||||||||||
|
|
|
| Weighted |
|
|
|
|
| Weighted |
|
|
| ||||
|
|
|
|
|
|
|
|
|
|
|
|
|
| ||||
Basic net income per share |
| $ | 2,681 |
| 19,442 |
| $ | 0.14 |
| $ | 495 |
| 17,942 |
| $ | 0.03 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| ||||
Effect of dilutive securities: |
|
|
|
|
|
|
|
|
|
|
|
|
| ||||
Share options |
|
|
| 612 |
|
|
|
|
| 919 |
|
|
| ||||
Convertible debt |
| 305 |
| 2,857 |
|
|
| — |
| — |
|
|
| ||||
|
|
|
|
|
|
|
|
|
|
|
|
|
| ||||
Diluted net income per share |
| $ | 2,986 |
| 22,911 |
| $ | 0.13 |
| $ | 495 |
| 18,861 |
| $ | 0.03 |
|
For the three month periods ended September 30, 2006 and 2005, weighted-average outstanding share options totaling approximately 2.8 million and 0.1 million shares of common stock, respectively, were antidilutive and therefore not included in the computation of diluted earnings per share. For the three months ended September 30, 2005, we did not assume conversion of the convertible notes as the effect was antidilutive.
| Nine Months Ended September 30, |
| |||||||||||||||
|
| 2006 |
| 2005 |
| ||||||||||||
|
|
|
| Weighted |
|
|
|
|
| Weighted |
|
|
| ||||
|
|
|
|
|
|
|
|
|
|
|
|
|
| ||||
Basic net income per share |
| $ | 37,224 |
| 19,372 |
| $ | 1.92 |
| $ | 203 |
| 17,911 |
| $ | 0.01 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| ||||
Effect of dilutive securities: |
|
|
|
|
|
|
|
|
|
|
|
|
| ||||
Share options |
|
|
| 836 |
|
|
|
|
| 491 |
|
|
| ||||
Convertible debt |
| 904 |
| 2,857 |
|
|
| — |
| — |
|
|
| ||||
|
|
|
|
|
|
|
|
|
|
|
|
|
| ||||
Diluted net income per share |
| $ | 38,128 |
| 23,065 |
| $ | 1.65 |
| $ | 203 |
| 18,402 |
| $ | 0.01 |
|
For the nine month periods ended September 30, 2006 and 2005, weighted-average outstanding share options totaling approximately 1.6 million and 1.5 million shares of common stock, respectively, were antidilutive and therefore not included in the computation of diluted earnings per share. For the nine months ended September 30, 2005, we did not assume conversion of the convertible notes as the effect was antidilutive.
19
NOTE 8: OPERATING LEASES
We have non-cancelable operating leases for office space at various locations expiring at various times through 2015. Each of the leases requires us to pay all executory costs (property taxes, maintenance and insurance). Additionally, we have non-cancelable operating leases for office equipment and automobiles expiring through 2010.
Future minimum lease payments during each of the twelve months ending September 30 are as follows (in thousands):
2007 |
| $ | 5,356 |
|
2008 |
| 4,754 |
| |
2009 |
| 4,319 |
| |
2010 |
| 4,194 |
| |
2011 |
| 3,771 |
| |
Thereafter |
| 12,868 |
| |
Total minimum lease payments |
| $ | 35,262 |
|
Rent expense related to operating leases was approximately $1.5 million and $0.7 million for the three month periods ended September 30, 2006 and 2005, respectively, and approximately $4.0 million and $2.1 million for the nine month periods ended September 30, 2006 and 2005, respectively.
NOTE 9: SEGMENT REPORTING
We have two operating segments: (i) case management and (ii) document management. Case management solutions include proprietary technology and integrated services to address the administrative business requirements of a case. Document management solutions include proprietary technology and production services to ensure timely, accurate and complete execution of documents related to a case.
Each segment’s performance is assessed based on segment revenues less costs directly attributable to each segment. In the evaluation of performance, certain costs, such as shared services, administrative staff, and executive management, are not allocated by segment and, accordingly, the following operating segment results do not include such unallocated costs. Assets reported within a segment are those assets used by the segment in its operations and consist of property, equipment and leasehold improvements, software, identifiable intangible assets and goodwill. All other assets are classified as unallocated.
20
Following is a summary of segment information (in thousands):
|
| Three Months Ended September 30, 2006 |
| ||||||||||
|
| Case |
| Document |
|
|
|
|
| ||||
|
| Management |
| Management |
| Unallocated |
| Consolidated |
| ||||
Revenue: |
|
|
|
|
|
|
|
|
| ||||
Operating revenue before reimbursed direct costs |
| $ | 29,798 |
| $ | 4,591 |
| $ | — |
| $ | 34,389 |
|
Operating revenue from reimbursed direct costs |
| 813 |
| 3,830 |
| — |
| 4,643 |
| ||||
Total revenue |
| 30,611 |
| 8,421 |
| — |
| 39,032 |
| ||||
|
|
|
|
|
|
|
|
|
| ||||
Costs and expenses: |
|
|
|
|
|
|
|
|
| ||||
Direct costs, general and administrative costs and depreciation and software and leasehold amortization |
| 12,800 |
| 7,353 |
| 8,836 |
| 28,989 |
| ||||
Amortization of identifiable intangible assets |
| 2,542 |
| 485 |
| — |
| 3,027 |
| ||||
Total operating expenses |
| 15,342 |
| 7,838 |
| 8,836 |
| 32,016 |
| ||||
Income from operations |
| $ | 15,269 |
| $ | 583 |
| $ | (8,836 | ) | 7,016 |
| |
Interest expense, net |
|
|
|
|
|
|
| 2,500 |
| ||||
Income from operations before income taxes |
|
|
|
|
|
|
| 4,516 |
| ||||
Provision for income taxes |
|
|
|
|
|
|
| 1,835 |
| ||||
|
|
|
|
|
|
|
|
|
| ||||
Net income |
|
|
|
|
|
|
| $ | 2,681 |
| |||
|
|
|
|
|
|
|
|
|
| ||||
Provision for depreciation and software and leasehold amortization |
| $ | 4,380 |
| $ | 574 |
| $ | 706 |
| $ | 5,660 |
|
21
|
| Three Months Ended September 30, 2005 |
| ||||||||||
|
| Case |
| Document |
|
|
|
|
| ||||
|
| Management |
| Management |
| Unallocated |
| Consolidated |
| ||||
|
|
|
|
|
|
|
|
|
| ||||
Revenue: |
|
|
|
|
|
|
|
|
| ||||
Operating revenue before reimbursed direct costs |
| $ | 12,747 |
| $ | 7,373 |
| $ | — |
| $ | 20,120 |
|
Operating revenue from reimbursed direct costs |
| 622 |
| 5,552 |
| — |
| 6,174 |
| ||||
Total revenue |
| 13,369 |
| 12,925 |
| — |
| 26,294 |
| ||||
|
|
|
|
|
|
|
|
|
| ||||
Costs and expenses: |
|
|
|
|
|
|
|
|
| ||||
Direct costs, general and administrative costs and depreciation and software and leasehold amortization |
| 7,613 |
| 9,692 |
| 6,237 |
| 23,542 |
| ||||
Amortization of identifiable intangible assets |
| 1,069 |
| 373 |
| — |
| 1,442 |
| ||||
Acquisition related |
| — |
| — |
| 114 |
| 114 |
| ||||
Total operating expenses |
| 8,682 |
| 10,065 |
| 6,351 |
| 25,098 |
| ||||
Income from operations |
| $ | 4,687 |
| $ | 2,860 |
| $ | (6,351 | ) | 1,196 |
| |
Interest expense, net |
|
|
|
|
|
|
| 1,595 |
| ||||
Loss from operations before income taxes |
|
|
|
|
|
|
| (399 | ) | ||||
Benefit for income taxes |
|
|
|
|
|
|
| (894 | ) | ||||
|
|
|
|
|
|
|
|
|
| ||||
Net income |
|
|
|
|
|
|
| $ | 495 |
| |||
|
|
|
|
|
|
|
|
|
| ||||
Provision for depreciation and software and leasehold amortization |
| $ | 2,168 |
| $ | 464 |
| $ | 542 |
| $ | 3,174 |
|
22
|
| Nine Months Ended September 30, 2006 |
| ||||||||||
|
| Case |
| Document |
|
|
|
|
| ||||
|
| Management |
| Management |
| Unallocated |
| Consolidated |
| ||||
|
|
|
|
|
|
|
|
|
| ||||
Revenue: |
|
|
|
|
|
|
|
|
| ||||
Operating revenue before reimbursed direct costs |
| $ | 134,575 |
| $ | 26,495 |
| $ | — |
| $ | 161,070 |
|
Operating revenue from reimbursed direct costs |
| 2,327 |
| 14,349 |
| — |
| 16,676 |
| ||||
Total revenue |
| 136,902 |
| 40,844 |
| — |
| 177,746 |
| ||||
|
|
|
|
|
|
|
|
|
| ||||
Costs and expenses: |
|
|
|
|
|
|
|
|
| ||||
Direct costs, general and administrative costs and depreciation and software and leasehold amortization |
| 37,652 |
| 34,050 |
| 25,446 |
| 97,148 |
| ||||
Amortization of identifiable intangible assets |
| 7,185 |
| 1,487 |
| — |
| 8,672 |
| ||||
Acquisition related |
| — |
| — |
| 250 |
| 250 |
| ||||
Total operating expenses |
| 44,837 |
| 35,537 |
| 25,696 |
| 106,070 |
| ||||
Income from operations |
| $ | 92,065 |
| $ | 5,307 |
| $ | (25,696 | ) | 71,676 |
| |
Interest expense, net |
|
|
|
|
|
|
| 9,104 |
| ||||
Income from operations before income taxes |
|
|
|
|
|
|
| 62,572 |
| ||||
Provision for income taxes |
|
|
|
|
|
|
| 25,348 |
| ||||
|
|
|
|
|
|
|
|
|
| ||||
Net income |
|
|
|
|
|
|
| $ | 37,224 |
| |||
|
|
|
|
|
|
|
|
|
| ||||
Provision for depreciation and software and leasehold amortization |
| $ | 12,471 |
| $ | 1,755 |
| $ | 1,870 |
| $ | 16,096 |
|
23
|
| Nine Months Ended September 30, 2005 |
| ||||||||||
|
| Case |
| Document |
|
|
|
|
| ||||
|
| Management |
| Management |
| Unallocated |
| Consolidated |
| ||||
|
|
|
|
|
|
|
|
|
| ||||
Revenue: |
|
|
|
|
|
|
|
|
| ||||
Operating revenue before reimbursed direct costs |
| $ | 39,278 |
| $ | 19,895 |
| $ | — |
| $ | 59,173 |
|
Operating revenue from reimbursed direct costs |
| 2,266 |
| 14,852 |
| — |
| 17,118 |
| ||||
Total revenue |
| 41,544 |
| 34,747 |
| — |
| 76,291 |
| ||||
|
|
|
|
|
|
|
|
|
| ||||
Costs and expenses: |
|
|
|
|
|
|
|
|
| ||||
Direct costs, general and administrative costs and depreciation and software and leasehold amortization |
| 23,436 |
| 26,355 |
| 20,635 |
| 70,426 |
| ||||
Amortization of identifiable intangible assets |
| 3,280 |
| 1,212 |
| — |
| 4,492 |
| ||||
Acquisition related |
| — |
| — |
| 114 |
| 114 |
| ||||
Total operating expenses |
| 26,716 |
| 27,567 |
| 20,749 |
| 75,032 |
| ||||
Income from operations |
| $ | 14,828 |
| $ | 7,180 |
| $ | (20,749 | ) | 1,259 |
| |
Interest expense, net |
|
|
|
|
|
|
| 4,203 |
| ||||
Loss from operations before income taxes |
|
|
|
|
|
|
| (2,944 | ) | ||||
Benefit for income taxes |
|
|
|
|
|
|
| (3,147 | ) | ||||
|
|
|
|
|
|
|
|
|
| ||||
Net income |
|
|
|
|
|
|
| $ | 203 |
| |||
|
|
|
|
|
|
|
|
|
| ||||
Provision for depreciation and software and leasehold amortization |
| $ | 6,557 |
| $ | 1,553 |
| $ | 1,663 |
| $ | 9,773 |
|
24
NOTE 10: RESTATEMENT OF PREVIOUSLY ISSUED FINANCIAL STATEMENTS
Subsequent to issuance on November 14, 2006 of our quarterly report on Form 10-Q for the three and nine months ended September 30, 2006, based on a comment received from the Securities and Exchange Commission (SEC), management determined that direct cost of services should have been disaggregated into two components: “Direct cost of services” and “Direct cost of bundled software license, software upgrade and post contract customer support services”. Additionally, management determined that a portion of revenue included under the “Case management services” should have been included as a component of “Case management bundled software license, software upgrade and postcontract customer support services”.
A summary of the significant effects of the restatement is as follows (in thousands, except per share data):
Condensed Consolidated Statements of Income
| For the Three Months Ended |
| |||||||||
|
| September 30, 2006 |
| September 30, 2005 |
| ||||||
|
| As |
| As Restated |
| As Previously |
| As Restated |
| ||
|
|
|
|
|
|
|
|
|
| ||
Case management services |
| $ | 22,353 |
| $ | 16,980 |
|
|
|
|
|
Case management bundled software license, software upgrade and postcontract customer support services |
| 7,445 |
| 12,818 |
|
|
|
|
| ||
Direct costs of services (exclusive of depreciation and amortization) |
| 9,260 |
| 8,299 |
| 8,576 |
| 7,599 |
| ||
Direct costs of bundled software license, software upgrade and postcontract customer support services (exclusive of depreciation and amortization) |
| — |
| 961 |
| — |
| 977 |
| ||
Condensed Consolidated Statements of Income
| For the Nine Months Ended |
| |||||||||
|
| September 30, 2006 |
| September 30, 2005 |
| ||||||
|
| As |
| As Restated |
| As Previously |
| As Restated |
| ||
|
|
|
|
|
|
|
|
|
| ||
Case management services |
| $ | 65,653 |
| $ | 54,064 |
|
|
|
|
|
Case management bundled software license, software upgrade and postcontract customer support services |
| 68,922 |
| 80,511 |
|
|
|
|
| ||
Direct costs of services (exclusive of depreciation and amortization) |
| 36,403 |
| 33,427 |
| 24,778 |
| 21,941 |
| ||
Direct costs of bundled software license, software upgrade and postcontract customer support services (exclusive of depreciation and amortization) |
| — |
| 2,976 |
| — |
| 2,837 |
| ||
25
ITEM 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations.
Overview
Business Solutions
Epiq Systems, Inc. is a provider of technology-based solutions for the legal and fiduciary services industries. Our two operating segments, case management and document management, assist clients with the administration of complex legal proceedings, including electronic discovery, bankruptcy administration and class action administration. Our clients include leading law firms, corporations, bankruptcy trustees, and other professional advisors who require sophisticated case administration and document management capabilities, extensive subject matter expertise and a high service capacity.
Our case and document management segments provide our clients with a broad range of technology and service offerings to meet the unique needs and requirements of each client matter. For example, a particular class action matter may require professional services, call center support, claims processing and settlement processing from our case management segment and a uniquely developed media campaign to provide notice to a class of unknown claimants and document custody services from our document management segment, while another class action matter may only require claims processing services from our case management segment and a simple mailing notification to a class of known claimants from our document management segment. Not all cases have the same business requirements, and our expanded technology and service offerings allow clients to procure services from our broad range of case management and document management solutions.
Our case management and document management technology and service offerings provide solutions primarily for the bankruptcy, class action and mass tort, and electronic discovery markets. These technology and service offerings can cross the various markets and clients we serve. For example, our legal notification expert may develop a document management notice program for either a bankruptcy matter or a class action matter. Our proprietary search technology solution, which may be used for an electronic discovery, class action, or bankruptcy matter, supports a unique set of case management and document management requirements.
Marketplace Information
The substantial increase of electronic documents in the business community has changed the dynamics of how attorneys support discovery in complex litigation matters. According to the 2005 Socha-Gelbmann Electronic Discovery Survey, 2004 domestic commercial electronic discovery revenues were estimated at $832 million, an approximate 94% increase from 2003. According to this same source, the market is expected to continue to grow 50% to 60% each year from 2005 to 2007. Due to the increasing complexity of cases, the increasing volume of data that are maintained electronically, and the increasing volume of documents that are produced in all types of litigation, law firms are increasingly reliant on electronic evidence management systems to organize and manage the litigation discovery process.
The number of new bankruptcy filings each year may vary based on the level of consumer and business debt, the general economy, interest rate levels and other factors. We believe the level of consumer and business debt are important indicators of future bankruptcy filings. The most recent available Federal Reserve Flow of Funds Accounts of the United States, dated September 19, 2006, reported increases in both consumer and business debt outstanding as compared with the same period of the prior year. The increase in consumer debt was the result of a significant increase in home mortgage debt, partly offset by a slight decline in consumer credit debt.
The class action and mass tort marketplace is significant, with estimated annual tort claim costs in excess of $250 billion according to an update study issued in 2004 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 20% of this total.
We have acquired a number of businesses during the past several years. In January 2003, we acquired Bankruptcy Services, which expanded our offerings to include an integrated solution of a proprietary technology platform and professional services for Chapter 11 corporate restructurings. In January 2004, we acquired Poorman-Douglas and expanded our offerings to include class action, mass tort, and other similar legal proceedings. In October 2005, we acquired Hilsoft, enhancing our expert legal notification. In November 2005, we acquired nMatrix which expanded our service offerings to include electronic
26
discovery and in August 2005 and May 2006, we acquired Novare and Epiq Advisory Services, respectively, to further expand our bankruptcy case management service offerings.
Case Management Segment
Case management support for client engagements may last several years and has a revenue profile that typically includes a recurring component. Our case management segment generates revenue primarily through the following services.
· Professional and support services, including case management, claims processing, specialty bankruptcy consulting, claims administration, and customized programming and technology services.
· Data hosting fees, volume-based fees, and professional services fees related to the management of large volumes of electronic data in support of a legal proceeding.
· Proprietary electronic discovery software to sort, cleanse, organize and perform searches on large databases in support of a legal proceeding.
· Software installed in bankruptcy trustee offices and provided over the internet that facilitates the administration of Chapter 7 and Chapter 13 bankruptcy cases.
· Database maintenance and processing, such as for creditor and class action claims, and conversion of that data into an organized, searchable, electronic database that we maintain on our servers and use, with our client, to manage the particular case.
· Call center support to process and respond to telephone inquiries related to creditor and class action claims.
Document Management Segment
Document management revenue is generally non-recurring due to the unpredictable nature of the frequency, timing and magnitude of the clients’ business requirements. Our document management segment generates revenue primarily through the following services.
· Legal noticing services to parties of interest in bankruptcy and 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.
Critical Accounting Policies
We consider our accounting policies related to revenue recognition, share-based compensation, business combinations, goodwill, and identifiable intangible assets to be critical policies in understanding our historical and future performance.
Revenue recognition. We have agreements with clients pursuant to which we deliver various case management and document management services each month.
Significant sources of revenue include:
· 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, 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;
· Hosting fees based on the amount of data stored;
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· Deposit-based fees from financial institutions, primarily based on a percentage of total liquidated assets placed on deposit at that financial institution by our bankruptcy trustee clients, to whom we provide, at no charge, software licenses, limited hardware and hardware maintenance, and postcontract customer support (PCS) services;
· Legal noticing services to parties of interest in bankruptcy and 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; and
· Reimbursement for costs incurred related to postage on mailing services.
Non-Software Arrangements
Case and document management services related to electronic discovery, corporate restructuring, and class action revenue, which are billed based on volume, are evaluated pursuant to Emerging Issues Task Force (EITF) 00-21, Revenue Arrangements with Multiple Deliverables. For each of these contractual arrangements, we have identified the following deliverables and/or services:
· Electronic Discovery
· Data processing
· Hosting
· Corporate Restructuring
· Consulting
· Claims management
· Printing and reproduction
· Mailing and noticing
· Document management
· Class Action
· Consulting
· Notice campaigns
· Toll free customer support
· Web site design/hosting
· Claims administration
· Distribution
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 based on third-party evidence of fair value of such services. 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 under EITF 00-21. We allocate revenue to the various units of accounting in our arrangements based on the fair value of each unit of accounting, which is generally consistent with the stated prices in our arrangements. As we have evidence of an arrangement, revenue for each separate unit of accounting is recognized each period in accordance with Staff Accounting Bulletin Topic 13, Revenue Recognition (SAB Topic 13). As the services are rendered, our fee becomes fixed and determinable, and collectibility 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 PCS 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. The financial institution pays us a monthly fee contingent on the dollar level of average monthly deposits placed by the trustees with that financial institution.
For Chapter 7 related arrangements with financial institutions, we earn contingent monthly fees from the financial institution related to the software license, hardware lease, hardware maintenance, and PCS services. We account for the software license and PCS service elements in accordance with Statement of Position 97-2, Software Revenue Recognition (SOP 97-2). Since we have not established vendor specific objective evidence (VSOE) 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
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undelivered element, which is PCS services. This revenue, when recognized, is included on our condensed consolidated statements of operations as a component of “Case management bundled software license, software upgrade and postcontract customer support services” revenue. Revenue related to PCS services 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 consistent with the guidance provided by the American Institute of Certified Public Accountants’ Technical Practice Aid (TPA) 5100.76, Fair Value in Multiple-Element Arrangements That Include Contingent Usage-Based Fees and Software Revenue Recognition as the fee becomes fixed or determinable at the time actual usage occurs and collectibility 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 revenue recognition criteria contained in SOP 97-2, since we have persuasive evidence that an arrangement exists, services have been rendered, the price is fixed and determinable, and collectibility is reasonably assured.
We also provide our trustees with certain hardware, such as desktop computers, monitors, and printers, and hardware maintenance. We retain ownership of all hardware provided and, based on guidance provided in EITF 01-8, Determining Whether an Arrangement Contains a Lease, 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 all of 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 in accordance with SFAS 13, Accounting for Leases. Therefore, all lease payments, based on the estimated fair value of hardware provided, were accounted for as contingent rentals under EITF Issue No. 98-9, Accounting for Contingent Rent and SAB Topic 13, which requires that we recognize rental income when the changes in the factor on which the contingent lease payment is based actually occur. This occurred at the end of each period as we achieve our target when deposits are held at the depository 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 is less than ten percent of our total revenue, is included in our condensed consolidated statements of operations as a component of “Case management services” revenue.
Effective October 1, 2003, we entered into an arrangement with our primary depository financial institution under which we delivered two specified upgrades annually with the last specified upgrade occurring in the second quarter of 2006. This arrangement included specific pricing for each software upgrade and certain special projects in addition to the contingent deposit-based pricing related to the software license, hardware, hardware maintenance, and PCS to each trustee client. Therefore, the software upgrades and special projects are part of a bundled arrangement. Each software upgrade is considered a separate and discrete product and, as we do not sell each software upgrade on a standalone basis, we were unable to establish VSOE of the fair value of the software upgrades. As a result, the licensed software, software upgrade, special projects and PCS are a combined unit of accounting. Revenue for this combined unit of accounting, when recognized, is included as a component of case management services revenue. Since we did not have VSOE of the fair value of each separate upgrade, we deferred recognition of substantially all revenue under this arrangement until the final upgrade was delivered. The ongoing costs related to this arrangement were recognized as expense when incurred. On delivery of the final upgrade during the second quarter of 2006, the only remaining undelivered element was PCS services. In accordance with SOP 97-2, on delivery of the final software upgrade, we recognized revenue previously deferred on a proportionate basis over the three year term of the contract. As the contract commenced October 1, 2003 and terminated September 30, 2006, we recognized approximately $60.1 million of net deferred revenue during the second quarter of 2006 and we recognized approximately $6.0 million of deferred revenue related to this arrangement during the third quarter of 2006.
Reimbursements
Our case and document management businesses both have revenue related to the reimbursement of certain costs, primarily postage. Consistent with guidance provided by EITF No. 01-14, Income Statement Characterization of Reimbursements Received for “Out-of-Pocket” Expenses Incurred, reimbursed postage and other reimbursable direct costs are recorded gross as revenue from reimbursed direct costs and as reimbursed direct costs.
Share-based compensation. Effective January 1, 2006, we began accounting for share-based compensation under SFAS No. 123R. SFAS No. 123R requires a public entity to measure the cost of employee services received in exchange for an award of equity instruments based on the grant-date fair value of the award and to recognize that cost over the period during which an employee is required to provide service in exchange for the award. We recognize this expense on a straight-line basis over the requisite service period of the last separately vesting portion of the award. Recognition of share-based compensation expense had, and will likely continue to have, a material affect on our direct costs and general and administrative line items within our condensed consolidated statements of income and also may have a material affect on our deferred income taxes
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and additional paid-in capital line items within our condensed consolidated balance sheets. Adoption of SFAS No. 123R affects the classification within our condensed consolidated statement of cash flows of certain tax benefits as certain tax benefits formerly classified as an operating cash flow are now classified as a financing cash flow. To date, the only share-based compensation we have issued is share options.
Determining the fair value of a share option grant at the date of the award requires the use of estimates related to expected volatility, expected term of share options granted, expected risk-free interest rate, and the expected dividend rate. We estimate our expected volatility based on implied volatilities from traded options on our stock and on our stock’s historical volatility. We have estimated the expected term of our share options based on the historical exercise pattern of groups of employees that have similar historical exercise behavior. The expected risk-free interest rate is based on the U.S. Treasury yield curve in effect at the time of the grant. Historically, we have not paid dividends and we do not anticipate paying dividends in the foreseeable future; accordingly, our expected dividend rate is zero. The estimate of fair value at grant date is not revised based on subsequent experience. Net share-based compensation expense recognized is also affected by our estimate of the number of stock option grants that will be forfeited prior to vesting and the tax benefit that will be realized if the stock option grants are exercised. We use historical information to estimate employee termination and the resulting option forfeiture rate. These factors are revised based on subsequent experience, and such revised estimates may have a material impact on our expense recognition and adjustments to additional paid-in capital in future periods.
Business combination accounting. We have acquired a number of businesses during the last several years, and we may acquire additional businesses in the future. Business combination accounting, often referred to as purchase accounting, requires us to determine the fair value of all assets acquired, including identifiable intangible assets, and liabilities assumed. The cost of the acquisition is allocated to the assets acquired and liabilities assumed in amounts equal to the fair value of each asset and liability, and any remaining acquisition cost is classified as goodwill. This allocation process requires extensive use of estimates and assumptions, including estimates of future cash flows to be generated by the acquired assets. Certain identifiable intangible assets, such as customer lists and covenants not to compete, are amortized on a straight-line basis over the intangible asset’s estimated useful life. The estimated useful lives of amortizable identifiable intangible assets range from 1 to 14 years. Goodwill is not amortized. Accordingly, the acquisition cost allocation has had, and will continue to have, a significant impact on our current operating results.
Goodwill. We assess goodwill, which is not subject to amortization, for impairment as of each July 31 and also at any other date when events or changes in circumstances indicate that the carrying value of these assets may exceed their fair value. This assessment is performed 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 develop an estimate of the fair value of each reporting unit, using both a market approach and an income approach.
A change in events or circumstances, including a decision to hold an asset or group of assets for sale, a change in strategic direction, or a change in the competitive environment, could adversely affect the fair value of one or more reporting units. The estimate of fair value is highly subjective and requires significant judgment. If we determine that the fair value of any reporting unit is less than the reporting unit’s carrying value, then we will recognize an impairment charge. If goodwill on our 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. Our goodwill totaled $260.8 million as of September 30, 2006.
Identifiable intangible assets. Each period we evaluate whether events and circumstances warrant a revision to the remaining estimated useful life of each identifiable intangible asset. If events and circumstances warrant a change to the estimate of an identifiable intangible asset’s remaining useful life, then the remaining carrying amount of the identifiable intangible asset would be amortized prospectively over that revised remaining useful life. Furthermore, information developed during our annual assessment, or other events and circumstances, may indicate that the carrying value of one or more identifiable intangible assets is not recoverable and its fair value is less than the identifiable intangible asset’s carrying value and would result in recognition of an impairment charge.
A change in the estimate of the remaining life of one or more identifiable intangible assets or the impairment of one or more identifiable intangible assets could have a material impact on our results of operations and financial condition. Our identifiable intangible assets’ carrying value, net of amortization, was $46.8 million as of September 30, 2006.
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Results of Operations for the Three Months Ended September 30, 2006 Compared with the Three Months Ended September 30, 2005
To enhance comparability to prior periods, throughout our management discussion and analysis we separately identify the operating results of the recently acquired entities, nMatrix, Hilsoft, Epiq Advisory Services (collectively, the recently acquired entities), which were not included in our operating results for the same period in the prior year.
Certain amounts related to our results for the three months ended September 30, 2005 have been restated (see note 10 to the condensed consolidated financial statements). As applicable, all references below are to the restated amounts.
Consolidated Results
Revenue
Total revenue of $39.0 million for the three months ended September 30, 2006 represents an increase of $12.7 million, or approximately 48%, compared to $26.3 million of revenue during the same period in the prior year. A significant part 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. Although reimbursed operating revenue and expenses may fluctuate significantly from quarter to quarter, these fluctuations have a minimal effect on our operating income as we realize little or no margin from this revenue. Operating revenue exclusive of revenue from reimbursed direct costs, which we refer to as operating revenue before reimbursed direct costs, increased approximately $14.3 million, or approximately 71%, to $34.4 million for the three months ended September 30, 2006 compared to $20.1 million for the same period in the prior year. Exclusive of the results of recently acquired entities, operating revenue before reimbursed direct costs increased approximately $6.0 million, or approximately 30%, to approximately $26.1 million for the three months ended September 30, 2006 compared to approximately $20.1 million for the same period in the prior year primarily as a result of an approximate $9.2 million increase in case management revenue combined with a $3.2 million decrease in document management revenue. Operating revenue exclusive of revenue from reimbursed direct costs may fluctuate considerably from period to period based on clients’ business requirements. All revenue is directly related to a segment, and changes in revenue by segment are discussed below.
Costs and Expenses
Direct cost of services, exclusive of depreciation and amortization, increased approximately $0.7 million, or approximately 9%, to $8.3 million for the three months ended September 30, 2006 compared with $7.6 million during the same period in the prior year. Exclusive of direct costs related to recently acquired entities, direct costs decreased approximately $1.2 million, or approximately 15%, to approximately $6.4 million for the three months ended September 30, 2006 compared with approximately $7.6 million for the same period in the prior year. This decrease is primarily attributable to a $0.9 million decrease in outside services as lower class action sales reduced the need for such services. Changes in segment costs are discussed, by segment, below.
Direct cost of bundled software license, software upgrade and postcontract customer support services, exclusive of depreciation and amortization, was approximately $1.0 million for both the three months ended September 30, 2006 and for the same period in the prior year. Changes in our segment cost structure are discussed below.
Reimbursed direct costs decreased approximately $1.5 million, or approximately 24%, to $4.7 million for the three months ended September 30, 2006 compared with $6.2 million during the same period in the prior year. Exclusive of reimbursed direct costs related to recently acquired entities, direct costs decreased approximately $1.7 million, or approximately 27%, to approximately $4.5 million for the three months ended September 30, 2006, compared with approximately $6.2 million for the same period in the prior year. This decrease is directly attributable to the decrease in operating revenue from reimbursed direct costs.
General and administrative costs increased approximately $5.4 million, or approximately 76%, to $12.4 million for the three months ended September 30, 2006 compared to $7.0 million for the same period in the prior year. Exclusive of general and administrative costs related to recently acquired entities, these costs increased $2.3 million, or approximately 32%, to approximately $9.3 million for the three months ended September 30, 2006 compared with approximately $7.0 million for the same period in the prior year. This increase is primarily attributable to an increase in administrative expenses to support the expansion of our business, including a $1.0 million increase in travel and promotional expense and a $0.8 million increase in professional fees. In addition, we also recognized share-based expense of $0.4 million resulting from adoption of SFAS 123R. Changes in segment costs are discussed, by segment, below.
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Depreciation and software and leasehold amortization costs increased approximately $0.9 million, or approximately 52%, to $2.6 million for the three months ended September 30, 2006 compared with $1.7 million during the same period in the prior year. Exclusive of depreciation and software and leasehold amortization costs related to recently acquired entities, these costs increased $0.3 million to approximately $2.0 million for the three months ended September 30, 2006 compared with approximately $1.7 million for the same period in the prior year. Changes in segment costs are discussed, by segment, below.
Amortization of identifiable intangible assets, compared with the same period in the prior year, increased $1.6 million to $3.0 million for the three months ended September 30, 2006. All identifiable intangible assets are directly related to a segment, and changes in amortization of identifiable intangible assets by segment are discussed below.
We did not recognize any acquisition related expense during the three months ended September 30, 2006. During the three months ended September 30, 2005, we recognized acquisition related expense of $0.1 million resulting from incremental third party expenses incurred in connection with potential transactions that were not completed.
Interest Expense
We incurred interest expense of $2.5 million for the three months ended September 30, 2006 compared with interest expense of $1.6 million during the same period in the prior year. The increase in interest expense during the three months ended September 30, 2006 compared with the same period in the prior year resulted primarily from a $1.8 million increase in interest expense related to increased borrowings under our credit facility in support of the acquisition of our electronic discovery business in November 2005. Also contributing to the increase in interest expense was an increase of $0.3 million in loan fee amortization and accretion expense. These increases were partly offset by a $1.2 million decrease in interest expense related to the change in value of the embedded option related to the outstanding convertible debt.
Effective Tax Rate
Our effective tax rate to record the tax expense related to our net income was 40.6% for the three months ended September 30, 2006 compared with a 224% effective tax benefit rate to record the tax benefit related to our pre-tax loss for the three months ended September 30, 2005. The effective tax rate for the three months ended September 30, 2005 was unusually high as the estimated aggregate annual expenses not deductible for tax purposes were significant in relation to income. The 2006 tax rate is higher than the statutory federal rate of 35% primarily due to state taxes. 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.
Net Income
During the three months ended September 30, 2006, we had net income of $2.7 million compared with net income of $0.5 million for the same period in the prior year. This change is attributable to a combination of factors. As a result of our 2003 Arrangement discussed above, during the three months ended September 30, 2006, we recognized $6.0 million of previously deferred revenue; during the same period in the prior year, we had deferred $5.7 million of revenue related to the 2003 Arrangement. This increase was partly offset by a decline in class action revenue as a result of fewer new client retentions, a $2.7 million increase in our tax expense, a $1.6 million increase in intangible amortization as a result of our recent acquisitions, a $0.9 million increase in interest expense primarily resulting from the increase in average borrowings outstanding under our credit facility as a result of our acquisition of our electronic discovery business in November 2005, and a $0.6 million increase in recognized share-based compensation expense as a result of the adoption of SFAS 123R.
Business Segments
The following management discussion and analysis is presented on a basis consistent with our segment disclosure contained in note 9 of our notes to the condensed consolidated financial statements.
Case Management Segment
Case management operating revenue before reimbursed direct costs increased $17.1 million, or approximately 134%, to $29.8 million for the three months ended September 30, 2006 compared to $12.7 million during the same period in the prior year. During the three months ended September 30, 2006, operating revenue before reimbursed direct costs from recently acquired entities totaled $7.8 million. The remainder of the increase is primarily due to an increase in bankruptcy operating revenue. As a result of our 2003 Arrangement discussed above, during the three months ended September 30, 2006, we recognized $6.0 million of previously deferred revenue; during the same period in the prior year, we had deferred $5.7 million of revenue related to the 2003 Arrangement. This increase was partly offset by an approximate $2.3 million decrease in class action case management revenue.
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Case management direct and administrative expenses, including depreciation and software and leasehold amortization, of $12.8 million increased $5.2 million, or approximately 68%, for the three months ended September 30, 2006 compared with $7.6 million during the same period in the prior year. During the three months ended September 30, 2006, direct and administrative expenses, including depreciation and software and leasehold amortization, from recently acquired entities totaled $5.2 million. Exclusive of these recently acquired businesses, our direct and administrative expenses, including depreciation and software and leasehold amortization, totaled approximately $7.6 million for both the three months ended September 30, 2006 and 2005.
Amortization of case management’s identifiable intangible assets increased to $2.5 million for the three months ended September 30, 2006 compared with $1.1 million for the same period in the prior year. This increase is primarily the result of amortization of additional identifiable intangible assets, resulting primarily from the acquisition in November 2005 of our electronic discovery business.
Document Management Segment
Document management operating revenue before reimbursed direct costs decreased $2.8 million, or approximately 38%, to $4.6 million for the three months ended September 30, 2006 compared to $7.4 million during the same period in the prior year. For the three months ended September 30, 2006, operating revenue before reimbursed direct costs from recently acquired entities totaled $0.4 million. Exclusive of this recently acquired business, operating revenue before reimbursed direct costs decreased $3.2 million. This decrease primarily relates to noticing activity resulting from fewer client retentions in our class action business. Additionally, even large notices are completed in a short time frame and, therefore, this revenue tends to be volatile. During the three months ended September 30, 2005 we had several large corporate restructuring and class action noticing activities, while during the three months ended September 30, 2006 our client’s did not have any large notice requirements. Document management revenues can fluctuate considerably from period to period based on clients’ business requirements.
Document management direct and administrative expenses, including depreciation and software and leasehold amortization, of $7.4 million decreased $2.3 million, or approximately 24%, for the three months ended September 30, 2006 compared with $9.7 million for the same period in the prior year. For the three months ended September 30, 2006, such expenses included $0.6 million of direct and administrative expenses, including depreciation and software and leasehold amortization, related to recently acquired entities. Exclusive of this recently acquired business, direct and administrative expenses, including depreciation and software and leasehold amortization, decreased $2.9 million, or 30%, primarily as a result of a decreases in reimbursable direct costs and outside services, both of which are primarily attributable to the decrease in operating revenue. Document management expenses can fluctuate from quarter to quarter based on document management business requirements delivered during each quarter.
Amortization of document management’s identifiable intangible assets increased to $0.5 million for the three months ended September 30, 2006 compared with $0.4 million for the same period in the prior year. This increase is primarily the result of amortization of other intangible assets, resulting from the acquisition of our legal notification business.
Results of Operations for the Nine Months Ended September 30, 2006 Compared with the Nine Months Ended September 30, 2005
To enhance comparability to prior periods, throughout our management discussion and analysis we separately identify the operating results of the recently acquired entities, nMatrix, Hilsoft, Epiq Advisory Services (collectively, the recently acquired entities), which were not included in our operating results for the same period in the prior year.
Certain amounts related to our results for the nine months ended September 30, 2005 have been restated (see note 10 to the condensed consolidated financial statements). As applicable, all references below are to the restated amounts.
Consolidated Results
Revenue
Total revenue of $177.7 million for the nine months ended September 30, 2006 increased approximately 133% compared with $76.3 million of total revenue for the same period in the prior year. A significant part 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. Although reimbursed operating revenue and the related direct costs may fluctuate significantly from period to period,
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these fluctuations have a minimal effect on our operating income as we realize little or no margin from this revenue. Revenue exclusive of reimbursed direct costs, which we refer to as operating revenue before reimbursed direct costs, increased approximately $101.9 million, or approximately 172%, to $161.1 million for the nine months ended September 30, 2006 compared to $59.2 million for the same period in the prior year. Exclusive of the results of recently acquired entities, operating revenue before reimbursed direct costs increased approximately $68.3 million, or approximately 115%, to approximately $127.5 million for the nine months ended September 30, 2006 compared to approximately $59.2 million for the same period in the prior year. This increase is primarily as a result of an approximate $71.1 million increase in case management revenue partly offset by a $2.8 million decrease in document management revenue. Operating revenue exclusive of revenue from reimbursed direct costs may fluctuate considerably from period to period based on clients’ business requirements. All revenue is directly related to a segment, and changes in revenue by segment are discussed below.
Costs and Expenses
Direct cost of services, exclusive of depreciation and amortization, increased $11.5 million, or approximately 52%, to $33.4 million for the nine months ended September 30, 2006 compared with $21.9 million for the same period in the prior year. Exclusive of direct costs related to recently acquired entities, direct cost of services decreased $0.3 million, or approximately 2%, to $21.6 million for the nine months ended September 30, 2006 compared with $21.9 million for the same period in the prior year. This decrease is primarily attributable to a $0.9 million decrease in outside service costs, partly offset by a $0.4 million increase in share-based compensation expense resulting from adoption of SFAS 123R. Changes in segment costs are discussed, by segment, below.
Direct cost of bundled software license, software upgrade and postcontract customer support services, exclusive of depreciation and amortization, increased to $3.0 million for nine months ended September 30, 2006 compared with $2.8 million for the same period in the prior year primarily as a result of increased compensation costs. Changes in our segment cost structure are discussed below.
Reimbursed direct costs decreased approximately $0.4 million, or approximately 3%, to $16.9 million for the nine months ended September 30, 2006 compared with $17.3 million during the same period in the prior year. Exclusive of direct costs related to recently acquired entities, direct costs decreased approximately $1.2 million, or approximately 7%, to approximately $16.1 million for the nine months ended September 30, 2006 compared with approximately $17.3 million for the same period in the prior year. This decrease is directly attributable to the decrease in operating revenue from reimbursed direct costs.
General and administrative costs increased approximately $13.4 million, or approximately 58%, to $36.5 million for the nine months ended September 30, 2006 compared with $23.1 million for the same period in the prior year. Exclusive of general and administrative costs related to recently acquired entities, these costs increased approximately $4.0 million, or approximately 17%, to $27.1 million for the nine months ended September 30, 2006 compared with $23.1 million for the same period in the prior year. This increase is primarily attributable to an increase in administrative expenses to support the expansion of our business, including a $1.8 million increase in travel and promotional expense related to the expansion of our business and a $1.9 million increase in compensation expense, primarily related to the recognition of share-based expense resulting from adoption of SFAS 123R. Changes in segment costs are discussed, by segment, below.
Depreciation and software and leasehold amortization costs increased approximately $2.1 million, or approximately 41%, to $7.4 million for the nine months ended September 30, 2006 compared with $5.3 million for the same period in the prior year. Exclusive of depreciation and software and leasehold amortization costs related to recently acquired entities, these costs increased approximately $0.4 million, or approximately 8%, to $5.7 million for the nine months ended September 30, 2006 compared with $5.3 million for the same period in the prior year. Changes in segment costs are discussed, by segment, below.
Amortization of identifiable intangible assets, compared with the same period in the prior year, increased $4.2 million to $8.7 million for the nine months ended September 30, 2006 compared with $4.5 million for the same period in the prior year. All identifiable intangible assets are directly related to a segment, and changes in amortization of identifiable intangible assets by segment are discussed below.
Acquisition related expenses were $0.3 million for the nine months ended September 30, 2006 compared with $0.1 million for the same period in the prior year. These expenses result from non-capitalized expenses incurred in connection with completed transactions and from incremental third party expenses incurred in connection with potential transactions which were not completed.
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Interest Expense
We incurred interest expense of $9.2 million for the nine months ended September 30, 2006 compared with interest expense of $4.3 million for the same period in the prior year. This increase primarily is the result of a $5.4 million increase in interest expense related to our credit facility, primarily resulting from the increase in average borrowings outstanding under our credit facility as a result of our acquisition of our electronic discovery business in November 2005. Also contributing to the increase in interest expense was an increase of $0.5 million in loan fee amortization and accretion expense. These increases were partly offset by a $1.0 million decrease in interest expense related to the change in value of the embedded option related to the outstanding convertible debt.
Effective Tax Rate
Our effective tax rate to record the tax expense related to our net income was 40.5% for the nine months ended September 30, 2006 compared with a 107% effective tax benefit rate to record the tax benefit related to our pre-tax loss for the nine months ended September 30, 2005. The effective tax rate for the nine months ended September 30, 2005 was unusually high as the estimated aggregate annual expenses not deductible for tax purposes were significant in relation to income. The 2006 tax rate is higher than the statutory federal rate of 35% primarily due to state taxes. We have significant operations located in New York City that are subject to state and local tax rates which are higher than the tax rates assessed by other jurisdictions where we operate.
Net Income
Net income increased approximately $37.0 million to $37.2 million for the nine months ended September 30, 2006 compared with $0.2 million for the same period in the prior year. This change is attributable to a combination of factors. As a result of our 2003 Arrangement discussed above, during the nine months ended September 30, 2006, we recognized $59.7 million of previously deferred revenue; during the same period in the prior year, we had deferred $18.8 million of revenue related to the 2003 Arrangement. This increase was partly offset by a decline in class action revenue as a result of fewer new client retentions, a $28.5 million increase in our tax expense, a $4.9 million increase in interest expense primarily resulting from the increase in average borrowings outstanding under our credit facility as a result of our acquisition of our electronic discovery business in November 2005, a $4.2 million increase in intangible amortization as a result of our recent acquisitions, and a $1.7 million increase in recognized share-based compensation expense as a result of the adoption of SFAS 123R.
Business Segments
The following management discussion and analysis is presented on a basis consistent with our segment disclosure contained in note 9 of our notes to the condensed consolidated financial statements.
Case Management Segment
Case management operating revenue before reimbursed direct costs increased $95.3 million, or approximately 243%, to $134.6 million for the nine months ended September 30, 2006 compared to $39.3 million for the same period in the prior year. During the nine months ended September 30, 2006, operating revenue before reimbursed direct costs from recently acquired entities totaled $24.3 million. Exclusive of the recently acquired entities revenues, operating revenue before reimbursed direct costs increased by $71.1 million compared to the same period in the prior year. This increase is primarily due to an increase in bankruptcy operating revenue. As a result of our 2003 Arrangement discussed above, during the nine months ended September 30, 2006, we recognized $59.7 million of previously deferred revenue; during the same period in the prior year, we had deferred $18.8 million of revenue related to the 2003 Arrangement. This increase was partly offset by an approximate $9.0 million decrease in class action case management revenue.
Case management direct and administrative expenses, including depreciation and software and leasehold amortization, increased approximately 61% to $37.7 million for the nine months ended September 30, 2006 compared with $23.4 million for the same period in the prior year. During the nine months ended September 30, 2006, direct and administrative expenses, including depreciation and software and leasehold amortization, from recently acquired entities totaled $14.7 million. Exclusive of these recently acquired entities expenses, our direct and administrative expenses, including depreciation and software leasehold amortization, decreased by approximately $0.4 million. This decrease in direct and administrative expenses, including depreciation and software and leasehold amortization, is primarily attributable to a $0.9 million decrease in class action outside services expenses.
Amortization of case management’s identifiable intangible assets increased to $7.2 million for the nine months ended September 30, 2006 compared with $3.3 million for the same period in the prior year. This increase is primarily the result of amortization of additional other intangible assets, resulting primarily from the acquisition of our electronic discovery business.
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Document Management Segment
Document management operating revenue before reimbursed direct costs increased $6.6 million, or approximately 33%, to $26.5 million for the nine months ended September 30, 2006 compared to $19.9 million for the same period in the prior year. For the nine months ended September 30, 2006, operating revenue before reimbursed direct costs from recently acquired entities totaled $9.4 million. Exclusive of these recently acquired entities revenues, operating revenue before reimbursed direct costs decreased $2.8 million. This decrease is primarily attributable to fewer client retentions in our class action business. Document management revenue can fluctuate from period to period based on clients’ business requirements.
Document management direct and administrative expenses, including depreciation and software and leasehold amortization, of $34.1 million increased $7.7 million, or approximately 29%, for the nine months ended September 30, 2006 compared to $26.4 million for the same period in the prior year. This increase is primarily attributable to the inclusion of $9.0 million of direct and administrative expenses, including depreciation and software and leasehold amortization, related to recently acquired entities. Exclusive of these recently acquired entities expenses, direct and administrative expenses, including depreciation and software and leasehold amortization, decreased $1.3 million primarily from decreases in reimbursable direct costs and outside services. Outside service costs will vary depending on the nature and complexity of services provided. Document management expenses will fluctuate from period to period based on document management business requirements delivered during each period.
Amortization of document management’s identifiable intangible assets increased to $1.5 million, for the nine months ended September 30, 2006 compared to $1.2 million for the same period in the prior year. This increase is primarily the result of amortization of additional other intangible assets, resulting from the acquisition of our acquired legal notification business.
Liquidity and Capital Resources
Operating Activities
During the nine months ended September 30, 2006, the primary source of cash from operating activities was net income of $37.2 million, adjusted for $40.8 million of non-cash charges and credits, primarily depreciation and amortization. Changes in net operating assets, primarily as a result of a decrease in deferred revenue, partly offset by decreases in trade accounts receivable and income taxes refundable, resulted in a $54.4 million use of cash. Deferred revenue decreased by approximately $59.4 million, primarily as a result of recognition of previously deferred amounts on delivery in the second quarter 2006 of our final software upgrade under our 2003 Arrangement. Trade accounts receivable, which will fluctuate from period to period depending on the timing of collections, decreased primarily as a result of increased collections related to our electronic discovery business. Income taxes refundable decreased primarily as a result of the receipt of refunds due to us. As a result, our operating activities generated net cash of $23.6 million for the nine months ended September 30, 2006.
Investing Activities
During the nine months ended September 30, 2006, we used cash of approximately $5.2 million to purchase property and equipment. Our property and equipment purchases consisted primarily of computer related hardware to support our electronic discovery and bankruptcy businesses. Enhancements to our existing software and development of new software is essential to our continued growth and we used cash of approximately $3.3 million to fund internal costs related to development of software for which technological feasibility has been established. We also used approximately $3.6 million of cash to partly fund an acquisition. We believe that cash generated from operations will be adequate to fund our anticipated property, equipment and software spending over the next year.
Financing Activities
During the nine months ended September 30, 2006, we paid approximately $10.0 million as a principal reduction on our senior term loan, $1.7 million as a principal reduction on deferred acquisition debt, and $0.9 million due on capital leases, and we repaid, net of borrowings, $14.0 million of our senior revolving loan. This financing use of cash was partly offset by $2.6 million of net proceeds from stock issued in connection with the exercise of employee share options. As a result of adoption of SFAS 123R, we also classify a portion of the tax benefit, referred to as excess tax benefit, that we realize on exercise of employee share options as a financing cash flow. The effect of this accounting change was to recognize $0.2 million of excess tax benefit as a financing cash flow rather than as an operating cash flow.
As of September 30, 2006, our borrowings consisted of $51.0 million from the contingent convertible subordinated notes (including the fair value of the embedded option), $15.0 million under our senior term loan, $82.0 million under our senior revolving loan, and approximately $12.1 million of obligations related to capitalized leases and deferred acquisition price. Our convertible debt of $50.0 million matures on June 15, 2007. The convertible notes will require the use of cash at their
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scheduled maturity in June 2007 if the note holders do not extend the maturity of the notes, at their option, and do not convert the notes into shares of our common stock. If the maturity of the notes is extended or if they 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 convertible notes, other than the regular payment of interest on the outstanding notes. We anticipate continuing to pay interest on the notes from cash flow from operations, and we anticipate paying the principal of any maturing notes from the sources discussed below.
As of September 30, 2006, significant financial covenants, all as defined within our credit facility agreement, include a leverage ratio not to exceed 3.50 to 1.00, a senior leverage ratio not to exceed 2.50 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 September 30, 2006, we were in compliance with all covenants in our credit facility, including all financial covenants. However, as a result of the restatement that resulted in the deferral of a substantial portion of revenue related to our primary Chapter 7 depository institution, we were not in compliance with these financial covenants through March 31, 2006. The deferral of revenue through March 31, 2006, and the recognition of the deferred revenue during the second and third quarter of 2006, were not anticipated by us or the banks at the time we established the current financial covenants in the credit facility. On December 14, 2006, we obtained a waiver regarding this event of noncompliance from our credit facility syndicate. Accordingly, we have classified this debt as current or long-term based on the debt’s original scheduled maturity.
We may pursue acquisitions in the future. Covenants contained in our credit facility and in our convertible notes may limit our ability to consummate an acquisition. Pursuant to the terms of our credit facility, we generally cannot incur indebtedness outside the credit facility with the exception of capital leases and additional 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 we must obtain bank permission for any acquisition for which cash consideration exceeds $65.0 million or total consideration exceeds $125.0 million.
We believe that the funds generated from operations plus our existing cash resources and amounts available under our senior revolving loan facility will be sufficient over the next 12 months to finance currently anticipated working capital requirements, software expenditures, property and equipment expenditures, common share price protection payments, if any, related to common shares issued in conjunction with the acquisition of our electronic discovery business, principal payments due under the credit facility, deferred acquisition price agreements and capital leases, interest payments due on our outstanding borrowings, and payments for other contractual obligations. As noted above, if the holders of our outstanding convertible notes do not either (i) extend the maturity of those notes, at the option of the note holders, or (ii) convert the notes into shares of our common stock in accordance with the terms of the notes, those notes, in the outstanding principal amount of $50.0 million, will mature on June 15, 2007. If those notes mature at that time, our cash flow from operations from the date of this report through that maturity date is not anticipated to be sufficient to pay those notes (after the uses of anticipated cash flow from operations to meet our other normal uses of cash described above). We could increase liquidity through a restructuring our credit facility, through the disposition of non-strategic assets, or through the issuance of debt or equity securities.
Off-balance Sheet Arrangements
As a part of the purchase price consideration to acquire nMatrix, we issued 1.2 million shares of our common stock to the seller. As explained in note 4 to the condensed consolidated financial statements, under certain circumstances we may be required to pay the difference between $20.35 per share and the price at which the seller sells the shares. Payments, if any, made under this arrangement will result in cash outflows. Based on our September 30, 2006 closing price of $14.71 per share, as of September 30, 2006, the guarantee amount was approximately $6.9 million. As discussed under the caption “Liquidity and Capital Resources – Financing Activities” above, we believe cash generated from operations plus amounts available under our senior revolving loan facility will provide adequate liquidity to make any required payments under this arrangement. The shares subject to this arrangement are currently unregistered; however, we anticipate these shares will be registered and available for sale in the future.
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Contractual Obligations
The following table sets forth a summary of our contractual obligations and commitments, excluding periodic interest payments, for each twelve month period ending September 30 (in thousands):
|
| Payments Due By Period |
| |||||||||||||
Contractual Obligation |
| Total |
| Less than |
| 1 – 3 Years |
| 3 – 5 Years |
| More Than |
| |||||
|
|
|
|
|
|
|
|
|
|
|
| |||||
Long-term debt and future accretion (1) |
| $ | 159,513 |
| $ | 70,892 |
| $ | 86,621 |
| $ | 2,000 |
| $ | — |
|
Employment agreements (2) |
| 9,216 |
| 3,397 |
| 4,206 |
| 1,613 |
| — |
| |||||
Capital lease obligations |
| 31 |
| 31 |
| — |
| — |
| — |
| |||||
Operating leases |
| 35,262 |
| 5,356 |
| 9,073 |
| 7,965 |
| 12,868 |
| |||||
Total |
| $ | 204,022 |
| $ | 79,676 |
| $ | 99,900 |
| $ | 11,578 |
| $ | 12,868 |
|
(1) A portion of the purchase price of certain acquisitions were in the form of notes on which the interest rate was below our incremental borrowing rate, and which were discounted using our estimated incremental borrowing rate. The discounts are accreted over the life of the note and each period’s accretion is added to the principal of the respective note. The amount in the above contractual obligations table includes both the notes’ principal, as reflected on our September 30, 2006 condensed consolidated balance sheet, and all future accretion. If certain financial objectives are satisfied, we will make additional payments over the next five years related to our acquisition of Hilsoft and Epiq Advisory Services. Such payments, if any, are not included in the above contractual obligation table. To date, no such payments have been made or accrued. Convertible debt is included at the stated value of the principal redemption and excludes adjustments related to the embedded option, which will not be paid in cash. Any conversion to our common stock of part or all of the convertible debt will reduce our cash obligation related to the convertible debt.
(2) In conjunction with acquisitions, we have entered into employment agreements with certain key employees of the acquired companies.
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Recent Accounting Pronouncements
In September 2006, the Financial Accounting Standards Board (FASB) issued Statement of Financial Accounting Standards No. 157, Fair Value Measurements (SFAS 157). SFAS 157 defines fair value, establishes a framework for measuring fair value in generally accepted accounting principles, and expands disclosures about fair value measurements. SFAS 157 is effective for financial statements issued for fiscal years beginning after November 15, 2007, and interim periods within those fiscal years. We do not anticipate that adoption of this statement will have a material impact on our consolidated financial statements.
In June 2006, FASB issued Interpretation No. 48, Accounting for Uncertainty in Income Taxes (FIN 48). FIN 48 applies to tax positions accounted for under Statement of Financial Accounting Standard No. 109, Accounting for Income Taxes. A tax position includes a current or future reduction in taxable income reported or expected to be reported on a tax return, the decision not to report a transaction in a tax return, and an assertion that a company is not subject to taxation. FIN 48 requires that a tax position be recognized only if it is more-likely-than-not to be sustained based solely on its technical merits as of the reporting date. A recognized tax benefit is measured based on the largest benefit that is more than 50 percent likely to be realized. FIN 48 is effective for an entity’s first fiscal year that begins after December 15, 2006. At adoption, any necessary adjustment to our financial statements will be recorded directly to the beginning balance of retained earnings in the period of adoption and reported as a change in accounting principle. At this time, we are unable to predict the impact, if any, that adoption of FIN 48 will have on our consolidated financial statements.
In June 2006, the EITF reached a consensus regarding EITF 05-1, Accounting for the Conversion of an Instrument That Becomes Convertible Upon the Issuer’s Exercise of a Call Option. EITF 05-1 pertains only to debt instruments that become convertible at the time the issuer calls the debt, but are not convertible before the call is exercised. Conversions of these instruments triggered by the call option would be accounted for as debt conversions and recognized as debt extinguishments if the debt instrument did not contain a substantive conversion feature at issuance. EITF 05-1 will be effective for conversions that occur as a result of the issuer’s exercise of a call option in the interim or annual period beginning after September 28, 2006. We do not anticipate that adoption of this statement will have a material impact on our consolidated financial statements.
In February 2006, the FASB issued Statement of Financial Accounting Standard No. 155, Accounting for Certain Hybrid Financial Instruments—an amendment of FASB Statements No. 133 and 140 (SFAS 155). SFAS 155 allows an entity to make an irrevocable election to measure a financial instrument with an embedded derivative, referred to as a hybrid financial instrument, at fair value in its entirety rather than bifurcating and separately valuing the embedded derivative instrument. SFAS 155 is effective for all financial instruments acquired, issued, or subject to a remeasurement (new basis) event occurring after the beginning of an entity’s first fiscal year that begins after September 15, 2006. We do not anticipate that adoption of this statement will have a material impact on our consolidated financial statements.
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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 statements about our future business plans and strategies, and other statements that are not historical in nature. 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” and “potential.” Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended, 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) risks associated with the application of complex accounting rules to unique transactions, including the risk that good faith application of those rules and audits of those results may be later reversed by new interpretations of those rules or new views regarding the application of those rules, (2) any material changes in our total number of client engagements and the volume associated with each engagement, including the results for 2006 to date in our class action client engagements, (3) any material changes in our Chapter 7 deposit portfolio, the services required or selected by our electronic discovery, Chapter 11, Chapter 13, class action or mass tort engagements, or the number of cases processed by our Chapter 13 bankruptcy trustee clients, (4) material changes in the number of bankruptcy filings, class action filings or mass tort actions each year, (5) our reliance on our marketing and pricing arrangements with Bank of America and other depository banks (6) risks associated with the integration of acquisitions into our existing business operations, (7) risks associated without indebtedness, and (8) other risks detailed from time to time in our SEC filings, including our annual report on Form 10-K/A. 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 obligations to update any forward-looking statements contained herein to reflect future events or developments.
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ITEM 3. Quantitative and Qualitative Disclosures About Market Risk.
Market risk refers to the risk that a change in the level of one or more market prices, interest rates, indices, volatilities, correlations or other market factors, such as liquidity, will result in losses for a certain financial instrument or group of financial instruments. Our exposure to market risk has not changed significantly since December 31, 2005.
ITEM 4. Controls and Procedures.
Disclosure Controls and Procedures
An evaluation was carried out by the Epiq Systems, Inc.’s (the Company’s) Chief Executive Officer and Chief Financial Officer of the effectiveness of the design and operations of the Company’s disclosure controls and procedures as defined in Exchange Act Rule 13a-15(e). Disclosure controls and procedures are designed to ensure that information required to be disclosed by the Company in its periodic filings with the SEC 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 the Company in the reports that it files or submits to the SEC is accumulated and communicated to Company’s management, including its principal executive and principal financial officers, or persons performing similar functions, as appropriate to allow timely decisions regarding required disclosure.
During fiscal year 2006, management identified an accounting error in its consolidated financial statements related to determination of the appropriate accounting treatment for certain complex aspects of revenue recognition, specifically the evaluation of vendor specific objective evidence of fair value for specified software upgrades provided within a bundled arrangement as required by Statement of Position 97-2 (SOP 97-2), Software Revenue Recognition. On November 14, 2006, our audit committee determined that our previously issued financial statements for the fiscal years ended December 31, 2005, 2004 and 2003, included in our Annual Report on Form 10-K for the fiscal year ended December 31, 2005, for the quarterly information included in our Annual Report on Form 10-K for the fiscal year ended December 31, 2005, and for the quarterly information included in our Quarterly Report on Form 10-Q for the quarters ended March 31, 2006 and June 30, 2006, should be restated. The restatement is further discussed in note 10 to the accompanying condensed consolidated financial statements. Public Company Accounting Oversight Board’s Auditing Standard No. 2, An Audit of Internal Control over Financial Reporting Performed in Conjunction with an Audit of Financial Statements, provides that a restatement of previously issued financial statements is a strong indicator of the existence of a material weakness in the design or operation of internal control over financial reporting. Management of the company, under the direction of our CEO and CFO, has reevaluated the effectiveness of our disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) as of September 30, 2006. Based upon this evaluation, management has concluded that the control deficiency surrounding management’s oversight of the determination of the appropriate accounting treatment for certain complex aspects of revenue recognition, specifically the evaluation of vendor specific objective evidence of fair value for specified software upgrades provided within a bundled arrangement as required by SOP 97-2 represented a material weakness in internal control over financial reporting. Our management, including our CEO and CFO, concluded that our disclosure controls and procedures were not effective as of September 30, 2006.
Changes in Internal Control Over Financial Reporting
There have been no changes in our internal controls over financial reporting during the quarter ended September 30, 2006, that have materially affected, or are reasonably likely to materially affect, our internal controls over financial reporting.
After identifying the material weakness subsequent to the original issuance of our Annual Report on Form 10-K for the fiscal year ended December 31, 2005, management initiated changes to remediate the material weakness described above. We believe that, prior to December 31, 2006, we completed our remediation of the aforementioned material weakness in our internal control over financial reporting. The completed remediation measures include the implementation of appropriate controls related to contracts or other arrangements that are within the scope of SOP 97-2 to provide a written analysis of the appropriate accounting for these contracts or other arrangement and the review of our conclusions with qualified internal accounting personnel or third party accounting experts. In addition, we have provided our accounting staff with additional training related to generally accepted accounting principles and financial statement reporting matters.
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There have been no material changes from the risk factors disclosed under the heading “Risk Factors” in Item 1A of our Annual Report on Form 10-K/A for the year ended December 31, 2005.
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. |
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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. |
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32.1 | Certifications of CEO and CFO pursuant to 18 U.S.C. Section 1350. |
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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. | |||||
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Date: | February 8, 2007 | /s/ Tom W. Olofson |
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| Tom W. Olofson | |||
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| Chairman of the Board | |||
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| Chief Executive Officer | |||
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| Director | |||
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| (Principal Executive Officer) | |||
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Date: | February 8, 2007 | /s/ Elizabeth M. Braham |
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| Elizabeth M. Braham | |||
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| Executive Vice President, Chief Financial Officer | |||
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| (Principal Financial Officer) | |||
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Date: | February 8, 2007 | /s/ Douglas W. Fleming |
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| Douglas W. Fleming | |||
| �� | Director of Finance | |||
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| (Principal Accounting Officer) | |||
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