Table ofContents

** **

 

** **

**UNITED STATES**

**SECURITIES AND EXCHANGE COMMISSION**

**WASHINGTON, D. C. 20549**

 

**FORM 10-Q**

 

**(MarkOne)**

 

**x****                              QUARTERLYREPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACTOF 1934**

 

**For the quarterly period ended September 30, 2010**

 

**or**

 

**o****                                 TRANSITIONREPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACTOF 1934**

 

**For the transition period from                    to                      **

 

**Commission File Number 0-22081**

 

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**EPIQ SYSTEMS, INC.**

(Exact name of registrant as specified in its charter)

 

| **Missouri**                                                      | ** ** | **48-1056429**                          |
|-------------------------------------------------------------------|------------|-----------------------------------------|
| (State  or other jurisdiction of

incorporation  or organization) |       | (I.R.S.  Employer

Identification  No.) |
|                                                              |       |                                    |
| **501 Kansas Avenue, Kansas City, Kansas**                        | ** ** | **66105-1300**                          |
| (Address of principal executive offices)                          |       | (Zip Code)                              |

 

**913-621-9500**

(Registrant’s telephone number)

 

**None**

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

 

Indicateby check mark whether the registrant (1) has filed all reports required tobe filed by Section 13 or 15(d) of the Securities Exchange Act of1934 during the preceding 12 months (or for such shorter period that theregistrant was required to file such reports), and (2) has been subject tosuch filing requirements for the past 90 days.    Yes x  No o

 

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

 

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

 

| Large accelerated  filer  o          |   | Accelerated  filer  x         |
|------------------------------------------------|--------|-----------------------------------------|
|                                           |   |                                    |
| Non-accelerated  filer  o            |   | Smaller reporting  company  o |
| (Do not check if a smaller  reporting company) |   |                                    |

 

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

 

Indicatethe number of shares outstanding of each of the issuer’s classes of commonstock, as of the latest practicable date.

 

| **Class**                                | ** ** | **Outstanding at October 22, 2010** |
|------------------------------------------|------------|---------------------------------------------------------|
| Common  Stock, $0.01 par value per share |       | 36,695,591 shares                                       |

 

 

 

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Table ofContents

 

**EPIQ SYSTEMS, INC.**

**FORM 10-Q**

**QUARTER ENDED SEPTEMBER30, 2010**

 

**CONTENTS**

 
| ** **                               | ** **                                                                                                                                                                  | ** ** | **Page** |
|------------------------------------------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|----------|
|                                     |                                                                                                                                                                        |       |     |
| **PART I -  FINANCIAL INFORMATION** |
|                                     |                                                                                                                                                                        |       |     |
| Item 1.                                  | Financial Statements                                                                                                                                                        |       |     |
|                                     |                                                                                                                                                                        |       |     |
|                                     | Condensed  Consolidated Statements of Income –  Three and nine months ended  September 30, 2010 and 2009 (Unaudited)                                              |       | 2        |
|                                     |                                                                                                                                                                        |       |     |
|                                     | Condensed  Consolidated Balance Sheets –  September 30, 2010 and December 31, 2009 (Unaudited)                                                               |       | 3        |
|                                     |                                                                                                                                                                        |       |     |
|                                     | Condensed  Consolidated Statements of Changes in Stockholders’ Equity and Comprehensive  Income –  Nine months ended September 30, 2010 and 2009 (Unaudited) |       | 4        |
|                                     |                                                                                                                                                                        |       |     |
|                                     | Condensed  Consolidated Statements of Cash Flows –  Nine months ended September 30, 2010 and 2009 (Unaudited)                                                     |       | 5        |
|                                     |                                                                                                                                                                        |       |     |
|                                     | Notes to Condensed Consolidated Financial Statements  (Unaudited)                                                                                                           |       | 6        |
|                                     |                                                                                                                                                                        |       |     |
| Item 2.                                  | Management’s Discussion and  Analysis of Financial Condition and Results of Operations                                                                                 |       | 21       |
|                                     |                                                                                                                                                                        |       |     |
| Item 3.                                  | Quantitative  and Qualitative Disclosures about Market Risk                                                                                                                 |       | 33       |
|                                     |                                                                                                                                                                        |       |     |
| Item 4.                                  | Controls and  Procedures                                                                                                                                                    |       | 33       |
|                                     |                                                                                                                                                                        |       |     |
| **PART II  - OTHER INFORMATION**    |
|                                     |
| Item 1.                                  | Legal Proceedings                                                                                                                                                           |       | 34       |
|                                     |                                                                                                                                                                        |       |     |
| Item 1A.                                 | Risk Factors                                                                                                                                                                |       | 34       |
|                                     |                                                                                                                                                                        |       |     |
| Item 2.                                  | Unregistered  Sales of Equity Securities and Use of Proceeds                                                                                                                |       | 35       |
|                                     |                                                                                                                                                                        |       |     |
| Item 6.                                  | Exhibits                                                                                                                                                                    |       | 36       |
|                                     |                                                                                                                                                                        |       |     |
| Signatures                               |                                                                                                                                                                        |       | 37       |
|                                          |                                                                                                                                                                             |            |          |  |  |

 

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Table ofContents

 

**PART I - FINANCIAL INFORMATION**

 

**Item 1.  Financial Statements**

 

**EPIQ SYSTEMS, INC.**

**CONDENSED CONSOLIDATED STATEMENTS OF INCOME**

**(UNAUDITED)**

**(in thousands, except per share data)**

 
| ** **                                                                                                         | ** ** | **Three Months Ended  September 30,** | ** ** | **Nine months ended  September 30,** | ** ** |
|--------------------------------------------------------------------------------------------------------------------|------------|------------------------------------------------------|------------|-----------------------------------------------------|------------|
| ** **                                                                                                         | ** ** | **2010**                                             | ** ** | **2009**                                            | ** ** | **2010** | ** ** | **2009** | ** ** |
| **REVENUE:**                                                                                                       |       |                                                 |       |                                                |       |   |   |   |   |
| Case management services                                                                                           |       | $                                                    | 36,626     |                                                | $          | 33,356 |   | $ | 110,674 |   | $ | 103,702 |   |
| Case management bundled products and services                                                                      |       | 4,847                                                |       | 3,877                                               |       | 14,433 |   | 10,680 |   |
| Document management services                                                                                       |       | 10,526                                               |       | 13,874                                              |       | 32,042 |   | 46,477 |   |
| Operating revenue before reimbursed direct costs                                                                   |       | 51,999                                               |       | 51,107                                              |       | 157,149 |   | 160,859 |   |
| Operating revenue from reimbursed direct costs                                                                     |       | 6,288                                                |       | 6,702                                               |       | 22,442 |   | 23,968 |   |
| Total Revenue                                                                                                      |       | 58,287                                               |       | 57,809                                              |       | 179,591 |   | 184,827 |   |
|                                                                                                               |       |                                                 |       |                                                |       |   |   |   |   |
| **OPERATING EXPENSE:**                                                                                             |       |                                                 |       |                                                |       |   |   |   |   |
| Direct cost of services (exclusive of depreciation  and amortization shown separately below)                       |       | 16,455                                               |       | 17,966                                              |       | 48,207 |   | 57,359 |   |
| Direct cost of bundled  products and services (exclusive of depreciation and amortization shown  separately below) |       | 831                                                  |       | 916                                                 |       | 2,669 |   | 2,626 |   |
| Reimbursed direct costs                                                                                            |       | 6,126                                                |       | 6,660                                               |       | 21,959 |   | 23,742 |   |
| General and administrative                                                                                         |       | 20,068                                               |       | 18,197                                              |       | 64,181 |   | 60,348 |   |
| Depreciation and software and leasehold  amortization                                                              |       | 4,911                                                |       | 4,763                                               |       | 15,358 |   | 13,829 |   |
| Amortization of identifiable intangible assets                                                                     |       | 1,697                                                |       | 1,828                                               |       | 5,213 |   | 5,582 |   |
| Other operating expense                                                                                            |       | 281                                                  |       | 127                                                 |       | 350 |   | 611 |   |
| Total Operating Expense                                                                                            |       | 50,369                                               |       | 50,457                                              |       | 157,937 |   | 164,097 |   |
|                                                                                                               |       |                                                 |       |                                                |       |   |   |   |   |
| **INCOME FROM OPERATIONS**                                                                                         |       | 7,918                                                |       | 7,352                                               |       | 21,654 |   | 20,730 |   |
|                                                                                                               |       |                                                 |       |                                                |       |   |   |   |   |
| **INTEREST EXPENSE (INCOME):**                                                                                     |       |                                                 |       |                                                |       |   |   |   |   |
| Interest expense                                                                                                   |       | 408                                                  |       | 339                                                 |       | 1,132 |   | 1,077 |   |
| Interest income                                                                                                    |       | (7                                                   | )          | (56                                                 | )          | (29 | ) | (107 | ) |
| Net Interest Expense                                                                                               |       | 401                                                  |       | 283                                                 |       | 1,103 |   | 970 |   |
|                                                                                                               |       |                                                 |       |                                                |       |   |   |   |   |
| **INCOME BEFORE INCOME TAXES**                                                                                     |       | 7,517                                                |       | 7,069                                               |       | 20,551 |   | 19,760 |   |
|                                                                                                               |       |                                                 |       |                                                |       |   |   |   |   |
| **PROVISION FOR INCOME TAXES**                                                                                     |       | 2,979                                                |       | 2,200                                               |       | 9,763 |   | 8,727 |   |
|                                                                                                               |       |                                                 |       |                                                |       |   |   |   |   |
| **NET INCOME**                                                                                                     |       | $                                                    | 4,538      |                                                | $          | 4,869 |   | $ | 10,788 |   | $ | 11,033 |   |
|                                                                                                               |       |                                                 |       |                                                |       |   |   |   |   |
| **NET INCOME PER SHARE INFORMATION:**                                                                              |       |                                                 |       |                                                |       |   |   |   |   |
| Basic                                                                                                              |       | $                                                    | 0.12       |                                                | $          | 0.13 |   | $ | 0.29 |   | $ | 0.31 |   |
| Diluted                                                                                                            |       | $                                                    | 0.12       |                                                | $          | 0.12 |   | $ | 0.28 |   | $ | 0.28 |   |
| **WEIGHTED AVERAGE COMMON SHARES  OUTSTANDING:**                                                                   |       |                                                 |       |                                                |       |   |   |   |   |
| Basic                                                                                                              |       | 37,063                                               |       | 35,917                                              |       | 36,646 |   | 35,793 |   |
| Diluted                                                                                                            |       | 38,185                                               |       | 41,938                                              |       | 40,315 |   | 41,909 |   |
|                                                                                                               |       |                                                 |       |                                                |       |   |   |   |   |
| Cash dividends declared per common share                                                                           |       | $                                                    | 0.035      |                                                | —     |   | $ | 0.070 |   | — |   |

 

**See accompanying Notes to Condensed Consolidated Financial Statements.**

 

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**EPIQ SYSTEMS, INC.**

**CONDENSEDCONSOLIDATED BALANCE SHEETS (UNAUDITED)**

**(in thousands, except share data)**

 
| ** **                                                                                                                      | ** ** | **September 30, 2010** | ** ** | **December 31, 2009** | ** ** |
|---------------------------------------------------------------------------------------------------------------------------------|------------|----------------------------------|------------|---------------------------------|------------|
| ** **                                                                                                                      |       |                             |       |                            |       |
| **ASSETS**                                                                                                                      |       |                             |       |                            |       |
| **CURRENT  ASSETS:**                                                                                                            |       |                             |       |                            |       |
| Cash and cash equivalents                                                                                                       |       | $                                | 7,846      |                            | $          | 48,986 |   |
| Trade accounts receivable,  less allowance for doubtful accounts  of $4,151 and $2,928, respectively                            |       | 55,987                           |       | 43,471                          |       |
| Prepaid expenses                                                                                                                |       | 4,665                            |       | 4,867                           |       |
| Income taxes receivable                                                                                                         |       | 4,492                            |       | —                          |       |
| Other current assets                                                                                                            |       | 3,008                            |       | 2,341                           |       |
| Total Current Assets                                                                                                            |       | 75,998                           |       | 99,665                          |       |
|                                                                                                                            |       |                             |       |                            |       |
| **LONG-TERM ASSETS:**                                                                                                           |       |                             |       |                            |       |
| Property and equipment, net                                                                                                     |       | 41,838                           |       | 40,005                          |       |
| Internally developed  software costs, net                                                                                       |       | 16,500                           |       | 13,732                          |       |
| Goodwill                                                                                                                        |       | 264,206                          |       | 264,239                         |       |
| Other intangibles, net of  accumulated amortization of $54,396  and $49,188, respectively                                       |       | 14,302                           |       | 19,524                          |       |
| Other                                                                                                                           |       | 2,363                            |       | 776                             |       |
| Total Long-term Assets, net                                                                                                     |       | 339,209                          |       | 338,276                         |       |
| **Total  Assets**                                                                                                               |       | $                                | 415,207    |                            | $          | 437,941 |   |
|                                                                                                                            |       |                             |       |                            |       |
| **LIABILITIES  AND STOCKHOLDERS’ EQUITY**                                                                                  |       |                             |       |                            |       |
| **CURRENT LIABILITIES:**                                                                                                        |       |                             |       |                            |       |
| Accounts payable                                                                                                                |       | $                                | 10,959     |                            | $          | 8,260 |   |
| Accrued compensation                                                                                                            |       | 5,609                            |       | 4,429                           |       |
| Deposits                                                                                                                        |       | 2,050                            |       | 2,996                           |       |
| Deferred revenue                                                                                                                |       | 1,594                            |       | 760                             |       |
| Other accrued liabilities                                                                                                       |       | 4,551                            |       | 4,138                           |       |
| Current maturities of  long-term obligations                                                                                    |       | 2,943                            |       | 54,144                          |       |
| Total Current Liabilities                                                                                                       |       | 27,706                           |       | 74,727                          |       |
|                                                                                                                            |       |                             |       |                            |       |
| **LONG-TERM  LIABILITIES:**                                                                                                     |       |                             |       |                            |       |
| Deferred income taxes                                                                                                           |       | 24,442                           |       | 22,261                          |       |
| Other long-term liabilities                                                                                                     |       | 5,456                            |       | 9,901                           |       |
| Long-term obligations  (excluding current maturities)                                                                           |       | 19,928                           |       | 4,654                           |       |
| Total Long-term Liabilities                                                                                                     |       | 49,826                           |       | 36,816                          |       |
|                                                                                                                            |       |                             |       |                            |       |
| **COMMITMENTS AND CONTINGENCIES STOCKHOLDERS’ EQUITY:**                                                                    |       |                             |       |                            |       |
| Preferred stock - $1 par  value; 2,000,000 shares authorized;  none issued and outstanding                                      |       | —                           |       | —                          |       |
| Common stock - $0.01 par  value; 100,000,000 shares authorized;  issued and outstanding – 39,063,327 and 36,237,562 shares |       | 391                              |       | 362                             |       |
| Additional paid-in capital                                                                                                      |       | 281,479                          |       | 248,937                         |       |
| Accumulated other  comprehensive loss                                                                                           |       | (1,668                           | )          | (1,815                          | )          |
| Retained earnings                                                                                                               |       | 87,928                           |       | 79,772                          |       |
| Treasury stock, at cost –  2,372,486 and 56,473 shares                                                                     |       | (30,455                          | )          | (858                            | )          |
| Total Stockholders’ Equity                                                                                                 |       | 337,675                          |       | 326,398                         |       |
| **Total  Liabilities and Stockholders’ Equity**                                                                            |       | $                                | 415,207    |                            | $          | 437,941 |   |

 

**See accompanying Notes to CondensedConsolidated Financial Statements.**

 

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**EPIQ SYSTEMS, INC.**

**CONDENSEDCONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS’ EQUITY**

**AND COMPREHENSIVE INCOME(UNAUDITED)**

**(in thousands)**

 
| ** **                                                     | ** ** | **Common  Stock** | ** ** | **Treasury  Stock** | ** ** | **Common  Stock** | ** ** | **Additional  Paid-In  Capital** | ** ** | **Retained  Earnings** | ** ** | **Treasury  Stock** | ** ** | **AOCI (1)** | ** ** | **Total** | ** ** |
|----------------------------------------------------------------|------------|-------------------|------------|---------------------|------------|-------------------|------------|----------------------------------|------------|------------------------|------------|---------------------|------------|-------------------|------------|-----------|------------|
| Balance  at December 31, 2009                             |       | 36,238            |       | (56                 | )          | $                 | 362        |                             | $          | 248,937                |       | $                   | 79,772     |              | $          | (858      | )          | $ | (1,815 | ) | $ | 326,398 |   |
| Comprehensive  income:                                         |       |              |       |                |       |              |       |                             |       |                   |       |                |       |              |       |      |       |
| Net  income                                                    |       |              |       |                |       | —            |       | —                           |       | 10,788                 |       | —              |       | —            |       | 10,788    |       |
| Foreign  currency translation adjustment                       |       |              |       |                |       | —            |       | —                           |       | —                 |       | —              |       | 147               |       | 147       |       |
| Total  comprehensive income                                    |       |              |       |                |       | —            |       | —                           |       | 10,788                 |       | —              |       | 147               |       | 10,935    |       |
| Tax  deficiency from share-based compensation                  |       | —            |       | —              |       | —            |       | (335                             | )          | —                 |       | —              |       | —            |       | (335      | )          |
| Common  stock issued under share-based compensation plans      |       | 497               |       | 89                  |       | 5                 |       | (259                             | )          | —                 |       | 1,275               |       | —            |       | 1,021     |       |
| Common  stock repurchased under share-based compensation plans |       | —            |       | (76                 | )          | —            |       | —                           |       | —                 |       | (948                | )          | —            |       | (948      | )          |
| Share  repurchases (Note 9)                                    |       | —            |       | (2,329              | )          | —            |       | —                           |       | —                 |       | (29,924             | )          | —            |       | (29,924   | )          |
| Dividends  declared (Note 9)                                   |       |              |       |                |       | —            |       | —                           |       | (2,632                 | )          | —              |       | —            |       | (2,632    | )          |
| Conversion  of convertible notes                               |       | 2,328             |       | —              |       | 24                |       | 27,144                           |       | —                 |       | —              |       | —            |       | 27,168    |       |
| Share-based  compensation                                      |       | —            |       | —              |       | —            |       | 5,992                            |       | —                 |       | —              |       | —            |       | 5,992     |       |
| Balance  at September 30, 2010                            |       | 39,063            |       | (2,372              | )          | $                 | 391        |                             | $          | 281,479                |       | $                   | 87,928     |              | $          | (30,455   | )          | $ | (1,668 | ) | $ | 337,675 |   |

 

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

 
| ** **                                                     | ** ** | **Common  Stock** | ** ** | **Treasury  Stock** | ** ** | **Common  Stock** | ** ** | **Additional  Paid-In  Capital** | ** ** | **Retained  Earnings** | ** ** | **Treasury  Stock** | ** ** | **AOCI (1)** | ** ** | **Total** | ** ** |
|----------------------------------------------------------------|------------|-------------------|------------|---------------------|------------|-------------------|------------|----------------------------------|------------|------------------------|------------|---------------------|------------|-------------------|------------|-----------|------------|
| Balance  at December 31, 2008                             |       | 35,658            |       | —              |       | $                 | 357        |                             | $          | 237,644                |       | $                   | 65,177     |              | $          | —    |       | $ | (2,683 | ) | $ | 300,495 |   |
| Comprehensive  income:                                         |       |              |       |                |       |              |       |                             |       |                   |       |                |       |              |       |      |       |
| Net  income                                                    |       |              |       |                |       | —            |       | —                           |       | 11,033                 |       | —              |       | —            |       | 11,033    |       |
| Foreign  currency translation adjustment                       |       |              |       |                |       | —            |       | —                           |       | —                 |       | —              |       | 767               |       | 767       |       |
| Total  comprehensive income                                    |       |              |       |                |       | —            |       | —                           |       | 11,033                 |       | —              |       | 767               |       | 11,800    |       |
| Tax  benefit from share-based compensation                     |       | —            |       | —              |       | —            |       | 613                              |       | —                 |       | —              |       | —            |       | 613       |       |
| Common  stock issued under share-based compensation plans      |       | 577               |       | 35                  |       | 5                 |       | 2,188                            |       | —                 |       | 508                 |       | —            |       | 2,701     |       |
| Common  stock repurchased under share-based compensation plans |       | —            |       | (117                | )          | —            |       | —                           |       | —                 |       | (1,782              | )          | —            |       | (1,782    | )          |
| Conversion  of convertible notes                               |       | 3                 |       | —              |       | —            |       | 32                               |       | —                 |       | —              |       | —            |       | 32        |       |
| Share-based  compensation                                      |       | —            |       | —              |       | —            |       | 6,304                            |       | —                 |       | —              |       | —            |       | 6,304     |       |
| Balance  at September 30, 2009                            |       | 36,238            |       | (82                 | )          | $                 | 362        |                             | $          | 246,781                |       | $                   | 76,210     |              | $          | (1,274    | )          | $ | (1,916 | ) | $ | 320,163 |   |

 

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

 

**See accompanying Notes to CondensedConsolidated Financial Statements.**

 

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**EPIQ SYSTEMS, INC.**

**CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)**

**(In thousands)**

** **
| ** **                                                                         | ** ** | **Nine months ended September 30,** | ** ** |
|------------------------------------------------------------------------------------|------------|---------------------------------------------------------|------------|
| ** **                                                                         | ** ** | **2010**                                                | ** ** | **2009** | ** ** |
| **CASH FLOWS FROM OPERATING  ACTIVITIES:**                                         |       |                                                    |       |   |   |
| Net income                                                                         |       | $                                                       | 10,788     |   | $ | 11,033 |   |
| Adjustments to reconcile net income to net cash  provided by operating activities: |       |                                                    |       |   |   |
| Expense for deferred income taxes                                                  |       | 295                                                     |       | 3,248 |   |
| Depreciation and software amortization                                             |       | 15,358                                                  |       | 13,829 |   |
| Amortization of intangible assets                                                  |       | 5,213                                                   |       | 5,582 |   |
| Benefit related to embedded option                                                 |       | (738                                                    | )          | (1,208 | ) |
| Share-based compensation expense                                                   |       | 5,992                                                   |       | 6,304 |   |
| Provision for bad debts                                                            |       | 1,612                                                   |       | 1,154 |   |
| Other, net                                                                         |       | 191                                                     |       | 388 |   |
| Changes in operating assets and liabilities:                                       |       |                                                    |       |   |   |
| Trade accounts receivable                                                          |       | (13,955                                                 | )          | (4,765 | ) |
| Prepaid expenses and other assets                                                  |       | 1,023                                                   |       | 751 |   |
| Accounts payable and other liabilities                                             |       | (7,299                                                  | )          | (8,713 | ) |
| Excess tax benefit related to share-based  compensation                            |       | (18                                                     | )          | (435 | ) |
| Other                                                                              |       | 716                                                     |       | 367 |   |
| Net cash provided by operating activities                                          |       | 19,178                                                  |       | 27,535 |   |
|                                                                               |       |                                                    |       |   |   |
| **CASH FLOWS FROM INVESTING  ACTIVITIES:**                                         |       |                                                    |       |   |   |
| Purchase of property and equipment                                                 |       | (8,993                                                  | )          | (9,253 | ) |
| Internally developed software costs                                                |       | (6,464                                                  | )          | (5,710 | ) |
| Other investing activities, net                                                    |       | 8                                                       |       | 302 |   |
| Net cash used in investing activities                                              |       | (15,449                                                 | )          | (14,661 | ) |
|                                                                               |       |                                                    |       |   |   |
| **CASH FLOWS FROM FINANCING  ACTIVITIES:**                                         |       |                                                    |       |   |   |
| Proceeds from borrowings                                                           |       | 15,000                                                  |       | — |   |
| Payments under long-term obligations                                               |       | (27,222                                                 | )          | (5,040 | ) |
| Excess tax benefit related to share-based  compensation                            |       | 18                                                      |       | 435 |   |
| Debt issuance costs                                                                |       | (1,460                                                  | )          | — |   |
| Common stock repurchases (Note 9)                                                  |       | (30,872                                                 | )          | (1,782 | ) |
| Cash dividends paid (Note 9)                                                       |       | (1,348                                                  | )          | — |   |
| Proceeds from issuance of common stock under  share-based compensation plans       |       | 1,021                                                   |       | 2,701 |   |
| Net cash used in financing activities                                              |       | (44,863                                                 | )          | (3,686 | ) |
|                                                                               |       |                                                    |       |   |   |
| Effect of exchange rate changes on cash                                            |       | (6                                                      | )          | 66 |   |
|                                                                               |       |                                                    |       |   |   |
| **NET (DECREASE) INCREASE IN CASH  AND CASH EQUIVALENTS**                          |       | (41,140                                                 | )          | 9,254 |   |
| **CASH AND CASH EQUIVALENTS,  BEGINNING OF YEAR**                                  |       | 48,986                                                  |       | 19,006 |   |
| **CASH AND CASH EQUIVALENTS, END  OF PERIOD**                                      |       | $                                                       | 7,846      |   | $ | 28,260 |   |

 

**See accompanying Notes to Condensed Consolidated Financial Statements.**

 

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**EPIQ SYSTEMS, INC.**

**NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS**

**(UNAUDITED)**

 

**NOTE1:  SUMMARY OF SIGNIFICANT ACCOUNTINGPOLICIES AND NATURE OF OPERATIONS**

 

The accompanying Condensed Consolidated Financial Statements have beenprepared in accordance with accounting principles generally accepted in theUnited States of America, and with the rules and regulations for reportingon Form 10-Q for interim financial statements. Accordingly, the financialstatements do not include certain disclosures required for comprehensive annualfinancial statements.

 

The unaudited financial information reflects all adjustments, whichare, in the opinion of management, necessary to present fairly our results ofoperations, financial position, and cash flows for the periods presented. Theadjustments consist solely of normal recurring adjustments. These CondensedConsolidated Financial Statements should be read in conjunction with theConsolidated Financial Statements and related Notes included in the EpiqSystems, Inc. (“Epiq,” “we,” “us,” or “our”) Annual Report on Form 10-Kfor the year ended December 31, 2009, filed with the Securities andExchange Commission on March 1, 2010.

 

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

 

Theresults of operations for any quarter or a partial fiscal year period are notnecessarily indicative of the results to be expected for other periods or theentire year.

 

***Principles of Consolidation***

 

The Condensed Consolidated Financial Statements include the accounts ofEpiq and its wholly-owned subsidiaries. Intercompany transactions and balanceshave been eliminated in consolidation.

 

***Nature of Operations***

 

Weare a provider of integrated technology solutions for the legalprofession.  Our solutions streamline theadministration of bankruptcy, litigation, financial transactions and regulatorycompliance matters.  We offer innovativetechnology solutions for eDiscovery, document review, legal notification,claims administration and controlled disbursement of funds.  Our clients include law firms, corporatelegal departments, bankruptcy trustees, government agencies and otherprofessional advisors who require innovative technology, responsive service anddeep subject-matter expertise.

 

***Revenue Recognition***

 

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

 

Following is a descriptionof significant sources of revenue:

 

·                  Fees contingent upon the month-to-monthdelivery of case management services defined by client contracts, such asclaims processing, claims reconciliation, professional services, call centersupport, disbursement services, project management, collections and forensicservices, document review services, and conversion of data into an organized,searchable electronic database. The amount we earn varies based primarily onthe size and complexity of the engagement.

 

·                  Hosting fees based on the amount of datastored.

 

·                  Deposit-based fees, earned primarily based ona percentage of Chapter 7 total liquidated assets placed on deposit with adesignated financial institution by our trustee clients, to whom we provide, atno charge, software licenses, limited hardware and hardware maintenance, andpostcontract customer support services. The fees we earn are based

 

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on total liquidated assets placed on deposit by our trustee clients andmay vary based on fluctuations in short-term interest rates.

 

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

 

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

 

*Non-SoftwareArrangements*

 

Servicesrelated to eDiscovery and settlement administration are billed based on volume.For these contractual arrangements, we have identified each deliverable serviceelement.  Based on our evaluation of eachelement, we have determined that each element delivered has standalone value toour customers because we or other vendors sell such services separately fromany other services/deliverables.  We havealso obtained objective and reliable evidence of the fair value of each elementbased either on the price we charge when we sell an element on a standalonebasis or based on third-party evidence of fair value of such similarservices.  Lastly, our arrangements donot include general rights of return. Accordingly, each of the service elements in our multiple element caseand document management arrangements qualifies as a separate unit ofaccounting. We allocate revenue to the various units of accounting in ourarrangements based on the fair value of each unit of accounting, which isgenerally consistent with the stated prices in our arrangements. As we haveevidence of an arrangement, revenue for each separate unit of accounting isrecognized each period.  Revenue isrecognized as the services are rendered, our fee becomes fixed anddeterminable, and collectability is reasonably assured.  Payments received in advance of satisfactionof the related revenue recognition criteria are recognized as a customerdeposit until all revenue recognition criteria have been satisfied.

 

*SoftwareArrangements*

 

For our Chapter 7 bankruptcytrustee arrangements, we provide our trustee clients with a software license,hardware lease, hardware maintenance, and postcontract customer supportservices, all at no charge to the trustee. The trustees place their liquidated estate deposits with a financialinstitution with which we have an arrangement. We earn contingent monthly fees from the financial institutions based onthe dollar level of average monthly deposits held by the trustees with thatfinancial institution related to the software license, hardware lease, hardwaremaintenance, and postcontract customer support services. Since we have notestablished vendor specific objective evidence (“VSOE”) of the fair value ofthe software license, we do not recognize any revenue on delivery of thesoftware.  The software element isdeferred and included with the remaining undelivered elements, which arepostcontract customer support services. This revenue, when recognized, is included as a component of “Casemanagement services” revenue.  Revenuerelated to postcontract customer support is entirely contingent on theplacement of liquidated estate deposits by the trustee with the financialinstitution.  Accordingly, we recognizethis contingent usage based revenue as the fee becomes fixed or determinable atthe time actual usage occurs and collectibility is probable.  This occurs monthly as a result of thecomputation, billing and collection of monthly deposit fees contractuallyagreed to. At that time, we have also satisfied the other applicable revenuerecognition criteria since we have persuasive evidence that an arrangementexists, services have been rendered, the price is fixed and determinable, andcollectability is reasonably assured.

 

Wealso provide our trustee clients with certain hardware, such as desktopcomputers, monitors, and printers; and hardware maintenance.  We retain ownership of all hardware providedand we account for this hardware as a lease. As the hardware maintenance arrangement is an executory contract similarto an operating lease, we use guidance related to contingent rentals inoperating lease arrangements for hardware maintenance as well as for thehardware lease.  Since the payments underall of our arrangements are contingent upon the level of trustee deposits andthe delivery of upgrades and other services, and there remain importantuncertainties regarding the amount of unreimbursable costs yet to be incurredby us, we account for the hardware lease as an operating lease.  Therefore, all lease payments, based on theestimated fair value of hardware provided, were accounted for as contingentrentals; which requires that we recognize rental income when the changes in thefactor on which the contingent lease payment is based actually occur.  This occurs at the end of each period as weachieve our target when deposits are held at the financial institution as, atthat time, evidence of an arrangement exists, delivery has occurred, the amounthas become fixed and determinable, and collection is reasonably assured.  This revenue, which is less than ten percentof our total revenue for the three and nine months ended September 30,2010 and 2009, is included in the Condensed Consolidated Statements of Incomeas a component of “Case management services” revenue.

 

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*Reimbursements*

 

We have revenue related tothe reimbursement of certain costs, primarily postage. Reimbursed postage andother reimbursable direct costs are recorded gross in the CondensedConsolidated Statements of Income as “Operating revenue from reimbursed directcosts” and as “Reimbursed direct costs”, respectively.

 

***Goodwill***

 

Goodwillconsists of the excess of cost of acquired enterprises over the sum of theamounts assigned to identifiable assets acquired less liabilities assumed. Weassess goodwill for impairment on an annual basis at a reporting unit level. Areporting unit is a component of a segment that constitutes a business, forwhich discrete financial information is available, and for which the operatingresults are regularly reviewed by management. We have determined that ourreporting units are bankruptcy trustee management, corporate restructuring,eDiscovery, and settlement administration. Goodwill is assessed between annualtests if an event occurs or circumstances change that would more likely thannot reduce the fair value of a reporting unit below its carrying value. Theseevents or circumstances could include a significant change in the businessclimate, a change in strategic direction, legal factors, operating performanceindicators, a change in the competitive environment, the sale or disposition ofa significant portion of a reporting unit, or future economic factors such asunfavorable changes in our stock price and market capitalization or unfavorablechanges in the estimated future discounted cash flows of our reporting units.Our annual test is performed as of July 31 each year, and there have beenno events since the annual test to indicate that it is more likely than notthat the recorded goodwill balance had become impaired.

 

Application of the goodwill impairment testrequires judgment, including the identification of reporting units, assignmentof assets and liabilities to reporting units, assignment of goodwill toreporting units, and determination of the fair value of each reporting unit. Weconsidered both a market approach and an income approach in order to develop anestimate of the fair value of each reporting unit for purposes of our annual impairmenttest.  When evaluating the marketapproach, we determined that directly comparable publicly-traded companies didnot exist, primarily due to the unique business model characteristics andprojected growth of each reporting unit. Instead, we utilized a discountedprojected future cash flow analysis (income approach) to determine the fairvalue of each reporting unit. Potential impairment is indicated when thecarrying value of a reporting unit, including goodwill, exceeds its estimatedfair value. This analysis requires significant judgments, including estimationof future cash flows, which is dependent on internal forecasts, estimation ofthe long-term rate of growth for our business, estimation of the useful lifeover which cash flows will occur, and determination of our weighted averagecost of capital. Changes in these estimates and assumptions could materiallyaffect the determination of fair value and goodwill impairment for eachreporting unit. In addition, financial and credit market volatility directlyimpacts our fair value measurement through our weighted average cost ofcapital, used to determine our discount rate, and through our stock price, usedto determine our market capitalization. We may be required to recognizeimpairment of goodwill based on future economic factors such as unfavorablechanges in our stock price and market capitalization or unfavorable changes inthe estimated future discounted cash flows of our reporting units.

 

Ifwe determine that the estimated fair value of any reporting unit is less thanthe reporting unit’s carrying value, then we proceed to the second step of thegoodwill impairment analysis to measure the potential impairment charge. Animpairment loss is recognized for any excess of the carrying value of the reportingunit’s goodwill over the implied fair value. If goodwill on our condensed consolidatedbalance sheet becomes impaired during a future period, the resulting impairmentcharge could have a material impact on our results of operations and financialcondition.

 

Due to the current economic environment and theuncertainties regarding the impact that future economic impacts will have onour reporting units, there can be no assurances that our estimates andassumptions regarding the duration of the economic recession, or the period orstrength of recovery, made for purposes of our annual goodwill impairment test,will prove to be accurate predictions of the future. If our assumptionsregarding forecasted revenues or margins of certain of our reporting units arenot achieved, we may be required to record goodwill impairment losses in futureperiods. It is not possible at this time to determine if any such futureimpairment loss would occur, and if it does occur, whether such charge would bematerial.

 

Our recognized goodwill totaled $264.2 million asof September 30, 2010.  Goodwillallocated by reporting unit as of September 30, 2010 was:  eDiscovery $79.9 million, settlement administration$32.9 million, corporate restructuring $76.5 million, and trustee management$74.9 million. As of July 31, 2010, which is the date of our most recentimpairment test, the fair value of each of our reporting units wassubstantially in excess of the carrying value of the reporting unit, except forthe bankruptcy trustee management reporting unit, the fair value of thisreporting unit exceeded its carrying value by approximately 14%. The discountrate used in the income approach for the trustee management reporting unit,evaluated at July 31, 2010, was 12.3%. An increase to the discount rate of 1%would have lowered the fair value determined under the income approach for thisreporting unit by approximately $12.0 million, or 12%, which, with all othervariables remaining the same, would result in the fair value of this reportingunit exceeding its carrying value by 1%.

 

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**Recently Adopted AccountingPronouncements**

 

In January 2010, the FASBissued updated guidance that requires entities to disclose separately theamounts of significant transfers in and out of Level 1 and Level 2 fair valuemeasurements and describe the reasons for the transfers. In addition, theupdate requires entities to present separately information about purchases,sales, issuances, and settlements in the reconciliation for fair valuemeasurements using significant unobservable inputs (Level 3). The disclosuresrelated to Level 1 and Level 2 fair value measurements are effective for us in2010. The update required new disclosures only, and had no impact on ourconsolidated financial position, results of operations, or cash flows as wehave not had any transfers out of Level 1. The disclosures related to Level 3fair value measurements are effective for us in 2011. This update also onlyrequires new disclosures, and will have no impact on our consolidated financialposition, results of operations, or cash flows.

 

**Recently Issued AccountingPronouncements Not Yet Adopted**

 

In October 2009, theFASB issued new standards for revenue recognition with multiple deliverables.These new standards require entities to allocate revenue in an arrangementusing estimated selling prices of the delivered goods and services based on aselling price hierarchy. The amendments eliminate the residual method ofrevenue allocation and require revenue to be allocated using the relative sellingprice method. These new standards are effective for us beginning in the firstquarter of fiscal year 2011, however early adoption is permitted. We do notanticipate that the adoption of these standards will have a material impact onour consolidated financial statements.

 

In October 2009, theFASB issued new standards for the accounting for certain revenue arrangementsthat include software elements. These new standards amend the scope ofpre-existing software revenue guidance by removing from the guidancenon-software components of tangible products and certain software components oftangible products.  These new standardsare effective for us beginning in the first quarter of fiscal year 2011,however early adoption is permitted. We do not anticipate that the adoption ofthese standards will have a material impact on our consolidated financialstatements.

 

**NOTE2:   GOODWILL AND INTANGIBLE ASSETS**

 

The change in the carrying amount of goodwill forthe first nine months of 2010 was as follows (in thousands):

 
| ** **                            | ** ** | **eDiscovery** | ** ** | **Bankruptcy** | ** ** | **Settlement  Administration** | ** ** | **Total** | ** ** |
|---------------------------------------|------------|----------------|------------|----------------|------------|--------------------------------|------------|-----------|------------|
| Balance as of December 31, 2009  |       | $              | 79,954     |           | $          | 151,438                        |       | $         | 32,847     |   | $ | 264,239 |   |
| Foreign currency translation          |       | (33            | )          | —         |       | —                         |       | (33       | )          |
| Balance as of September 30, 2010 |       | $              | 79,921     |           | $          | 151,438                        |       | $         | 32,847     |   | $ | 264,206 |   |

 

Amortizingidentifiable intangible assets as of September 30, 2010 and December 31,2009 consisted of the following (in thousands):

 
| ** **             | ** ** | **September 30, 2010** | ** ** | **December 31, 2009** | ** ** |
|------------------------|------------|----------------------------------|------------|---------------------------------|------------|
| ** **             | ** ** | **Gross Carrying  Amount**  | ** ** | **Accumulated  Amortization**   | ** ** | **Gross Carrying  Amount** | ** ** | **Accumulated  Amortization** | ** ** |
| Customer relationships |       | $                                | 40,050     |                            | $          | 28,697 |   | $ | 40,057 |   | $ | 25,880 |   |
| Trade names            |       | 745                              |       | 745                             |       | 745 |   | 745 |   |
| Non-compete agreements |       | 27,903                           |       | 24,954                          |       | 27,910 |   | 22,563 |   |
|                   |       | $                                | 68,698     |                            | $          | 54,396 |   | $ | 68,712 |   | $ | 49,188 |   |

 

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Customer relationships and non-compete agreementscarry a weighted average remaining life of eight years and ten years,respectively. Aggregate amortization expense related to identifiable intangibleassets was $1.7 million and $1.8 million for the three months ended September 30,2010 and 2009, respectively, and $5.2 million and $5.6 million for the ninemonths ended September 30, 2010 and 2009, respectively. The followingtable outlines the estimated future amortization expense related to intangibleassets held at September 30, 2010:

 

**(in thousands)**

 
| **Year Ending December 31,**                     | ** ** | ** ** | ** ** |
|-----------------------------------------------------------------|------------|------------|------------|
| 2010 (excluding the nine  months ended September 30, 2010) |       | $          | 1,440      |   |
| 2011                                                            |       | 4,844      |       |
| 2012                                                            |       | 4,568      |       |
| 2013                                                            |       | 3,041      |       |
| 2014                                                            |       | 192        |       |
| 2015                                                            |       | 192        |       |
|                                                                 |            |            |            |  |

 

Consistentwith prior years, and as discussed in Note 1, we performed our annual goodwillimpairment test during the third quarter. No impairment of goodwill was identified as a result of the testingperformed.

 

**NOTE 3:   LONG-TERM OBLIGATIONS**

 

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

 
| ** **                                                            | ** ** | **September 30,** | ** ** | **December 31,** | ** ** |
|-----------------------------------------------------------------------|------------|------------------------|------------|-----------------------|------------|
| ** **                                                            | ** ** | **2010**               | ** ** | **2009**              | ** ** |
| Contingent convertible subordinated notes,  including embedded option |       | $                      | —     |                  | $          | 50,706 |   |
| Senior revolving loan                                                 |       | 15,000                 |       | —                |       |
| Capital leases                                                        |       | 7,381                  |       | 5,190                 |       |
| Deferred acquisition price                                            |       | 490                    |       | 2,902                 |       |
| Total long-term obligations, including current  portion               |       | 22,871                 |       | 58,798                |       |
| Current maturities of long-term obligations                           |       | (2,943                 | )          | (54,144               | )          |
| Long-term obligations                                                 |       | $                      | 19,928     |                  | $          | 4,654 |   |

 

***Credit Facility***

 

Inthe second quarter of 2010, we entered into an amended senior credit facility,with KeyBank National Association as administrative agent, and a syndicate ofbanks as lenders. The credit facility, which continues to provide for a seniorrevolving loan, increased the aggregate amount of funds available from $100.0million to $140.0 million, and extended the maturity date from July 2011to June 2014. During the term of the credit facility, we have the right,subject to compliance with the covenants, to increase the borrowings to amaximum of $200.0 million, an increase from the $175.0 million maximum in ourprevious facility.  The credit facility issecured by liens on our land and buildings and a significant portion of ourfurniture and equipment.

 

Borrowingsunder the senior revolving loan bear interest at various rates based on ourleverage ratio with two rate options at the discretion of management asfollows:  (1) for base rate advances,borrowings bear interest at prime rate plus 100 to 200 basis points; (2) forLIBOR rate advances, borrowings bear interest at LIBOR rate plus 225 to 325basis points. At September 30, 2010, borrowings of $15.0 million underthis facility had a weighted average interest rate of 3.20%. The average amountof borrowings under this facility in the third quarter of 2010 was $10.0million, at a weighted average interest rate of 3.31%.  The maximum amount outstanding during thethird quarter was $15.0 million. At September 30, 2010, the amountavailable for borrowings under the credit facility is reduced by $1.1 millionin outstanding letters of credit. No amounts were borrowed under the seniorrevolving loan as of December 31, 2009.

 

Thecredit facility contains financial covenants related to earnings beforeinterest, provision for income taxes, depreciation, amortization, and otheradjustments as defined in the agreement, and total debt.  In addition, the credit facility alsocontains financial covenants related to senior debt, fixed charges, and workingcapital.  As of September 30, 2010and December 31, 2009, we were in compliance with all financial covenants.

 

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***Contingent Convertible Subordinated Notes***

 

Onor about June 11, 2010, prior to the maturity date, $27.2 million ofcontingent convertible subordinated notes (“convertible notes”) were convertedinto 2.3 million shares of common stock at a conversion price of $11.67. On June 15,2010, the convertible notes matured, resulting in a cash payment of $22.8million, plus accrued interest. The original $50.0 million of convertible noteswere issued in June 2004 with a fixed 4% per annum interest rate and anoriginal maturity of June 15, 2007. The holders of the convertible notes had the right to extend thematurity date by up to three years.  In April 2007,the holders exercised this right and the maturity date of the convertible noteswas extended to June 15, 2010.

 

Theright to extend the maturity of the convertible notes was accounted for as anembedded option subject to bifurcation. The embedded option was initially valued at $1.2 million and theconvertible notes balance was reduced by the same amount.  In April 2007, the holders of theconvertible notes exercised their right to extend and we performed a finalvaluation to estimate the fair value of the embedded option as of theapproximate date of the extension.  Theestimated fair value of the embedded option at that date, included as acomponent of the convertible notes, was approximately $4.8 million. The $4.8million estimated fair value of the embedded option was amortized as a creditto “Interest expense” on the Condensed Consolidated Statements of Income overthe period to the extended maturity, which was June 15, 2010. The balanceof this embedded option was included as a component of “Current maturities oflong-term obligations” on the Condensed Consolidated Balance Sheet at December 31,2009, and was fully amortized at September 30, 2010.

 

Uponconversion of $27.2 million of the notes, we recognized a nominal gain relatedto the remaining unamortized embedded option value associated with theconverted notes in the nine months ended September 30, 2010. During thethird quarter of 2009, a nominal principal amount of the notes were convertedinto shares of common stock. As a result of this conversion, we recognized anominal gain in the third quarter of 2009 related to the unamortized embeddedoption value associated with the converted notes.  The above changes related to the carryingvalue of the convertible notes, the estimated fair value of the embeddedoption, the amortization of the fair value of the embedded option, andrecognition of nominal gain upon conversion did not affect our cash flow.

 

***Capital Leases***

 

Welease certain property and software under capital leases that expire duringvarious years through 2014.

 

**NOTE4:   NET INCOME PER SHARE**

 

Basicnet income per share is computed on the basis of weighted average outstandingcommon shares.  Diluted net income pershare is computed on the basis of basic weighted average outstanding commonshares adjusted for the dilutive effect of stock options and convertible debt,if dilutive. The numerator of the diluted net income per share calculation isincreased by the amount of interest expense, net of tax, related to outstandingconvertible debt, and the allocation of net income and dividends declared tononvested shares, if the net impact is dilutive.

 

Wehave determined that certain nonvested share awards (also referred to asrestricted stock awards) issued by the company are participating securitiesbecause they have non-forfeitable rights to dividends. Accordingly, basic netincome per share is calculated under the two-class method calculation. Indetermining the number of diluted shares outstanding, we are required todisclose the more dilutive earnings per share result between the treasury stockmethod calculation and the two-class method calculation as it relates toparticipating securities. For the three and nine months ended September 30,2010 and 2009, the two-class method calculation was more dilutive; therefore,diluted net income per share is presented following the two-class method.

 

Thecomputation of basic and diluted net income per share for the three and ninemonths ended September 30, 2010 and 2009 is as follows (in thousands,except per share data):

 

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| ** **                                               | ** ** | **Three months ended September 30, 2010** | ** ** | **Three months ended September 30, 2009** | ** ** |
|----------------------------------------------------------|------------|--------------------------------------------------------------------|------------|--------------------------------------------------------------------|------------|
| ** **                                               | ** ** | **Net Income  (Numerator)**                                   | ** ** | **Weighted  Average  Common  Shares  Outstanding  (Denominator)**  | ** ** | **Per Share  Amount** | ** ** | **Net Income  (Numerator)** | ** ** | **Weighted  Average  Common  Shares  Outstanding  (Denominator)** | ** ** | **Per Share  Amount** | ** ** |
|                                                     |       |                                                               |       |                                                               |       |   |   |   |   |   |   |   |   |
| Net income                                               |       | $                                                                  | 4,538      |                                                               |       |   |   |   | $ | 4,869 |   |   |   |   |   |
| Less: amounts allocated to nonvested shares (1)          |       | (12                                                                | )          |                                                               |       |   |   | (23 | ) |   |   |   |   |
|                                                     |       |                                                               |       |                                                               |       |   |   |   |   |   |   |   |   |
| **Basic net income available to  common stockholders**   |       | 4,526                                                              |       | 37,063                                                             |       | $ | 0.12 |   | 4,846 |   | 35,917 |   | $ | 0.13 |   |
|                                                     |       |                                                               |       |                                                               |       |   |   |   |   |   |   |   |   |
| Effect of dilutive securities:                           |       |                                                               |       |                                                               |       |   |   |   |   |   |   |   |   |
| Stock options                                            |       | —                                                             |       | 1,122                                                              |       |   |   | — |   | 1,738 |   |   |   |
| Convertible debt                                         |       | —                                                             |       | —                                                             |       |   |   | 305 |   | 4,283 |   |   |   |
| Add-back: amounts allocated to nonvested shares(1)       |       | 12                                                                 |       | —                                                             |       |   |   | 23 |   | — |   |   |   |
| Less: amounts re-allocated to nonvested shares           |       | (12                                                                | )          | —                                                             |       |   |   | (21 | ) | — |   |   |   |
|                                                     |       |                                                               |       |                                                               |       |   |   |   |   |   |   |   |   |
| **Diluted net income available to  common stockholders** |       | $                                                                  | 4,526      |                                                               | 38,185     |   | $ | 0.12 |   | $ | 5,153 |   | 41,938 |   | $ | 0.12 |   |

 

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(1)             Amountsallocated to holders of nonvested shares are calculated based upon a weightedaverage percentage of nonvested shares that are participating securities inrelation to total shares outstanding.

 
| ** **                                               | ** ** | **Nine months ended September 30, 2010** | ** ** | **Nine months ended September 30, 2009** | ** ** |
|----------------------------------------------------------|------------|-------------------------------------------------------------------|------------|-------------------------------------------------------------------|------------|
| ** **                                               | ** ** | **Net Income  (Numerator)**                                  | ** ** | **Weighted  Average  Common  Shares  Outstanding  (Denominator)** | ** ** | **Per Share  Amount** | ** ** | **Net Income  (Numerator)** | ** ** | **Weighted  Average  Common  Shares  Outstanding  (Denominator)** | ** ** | **Per Share  Amount** | ** ** |
|                                                     |       |                                                              |       |                                                              |       |   |   |   |   |   |   |   |   |
| Net income                                               |       | $                                                                 | 10,788     |                                                              |       |   |   |   | $ | 11,033 |   |   |   |   |   |
| Less: amounts allocated to nonvested shares (1)          |       | (34                                                               | )          |                                                              |       |   |   | (58 | ) |   |   |   |   |
|                                                     |       |                                                              |       |                                                              |       |   |   |   |   |   |   |   |   |
| **Basic net income available to  common stockholders**   |       | 10,754                                                            |       | 36,646                                                            |       | $ | 0.29 |   | 10,975 |   | 35,793 |   | $ | 0.31 |   |
|                                                     |       |                                                              |       |                                                              |       |   |   |   |   |   |   |   |   |
| Effect of dilutive securities:                           |       |                                                              |       |                                                              |       |   |   |   |   |   |   |   |   |
| Stock options                                            |       | —                                                            |       | 1,080                                                             |       |   |   | — |   | 1,831 |   |   |   |
| Convertible debt                                         |       | 537                                                               |       | 2,589                                                             |       |   |   | 904 |   | 4,285 |   |   |   |
| Add-back: amounts allocated to nonvested shares(1)       |       | 34                                                                |       | —                                                            |       |   |   | 58 |   | — |   |   |   |
| Less: amounts re-allocated to nonvested shares           |       | (34                                                               | )          | —                                                            |       |   |   | (56 | ) | — |   |   |   |
|                                                     |       |                                                              |       |                                                              |       |   |   |   |   |   |   |   |   |
| **Diluted net income available to  common stockholders** |       | $                                                                 | 11,291     |                                                              | 40,315     |   | $ | 0.28 |   | $ | 11,881 |   | 41,909 |   | $ | 0.28 |   |

 

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(1)             Amountsallocated to holders of nonvested shares are calculated based upon a weightedaverage percentage of nonvested shares that are participating securities inrelation to total shares outstanding.

 

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Forthe three months ended September 30, 2010 and 2009, weighted-averageoutstanding stock options totaling approximately 2.8 million and 1.9 millionwere antidilutive, and therefore not included in the computation of diluted netincome per share. For the nine months ended September 30, 2010 and 2009,weighted-average outstanding stock options totaling approximately 3.1 millionand 1.9 million were antidilutive, and therefore not included in thecomputation of diluted net income per share.

 

**NOTE5:   SHARE-BASED COMPENSATION**

 

The 2004 Equity Incentive Plan,as amended (the “2004 Plan”), limits the combined grant of options to acquireshares of common stock, stock appreciation rights, and restricted stock awardsunder the 2004 Plan to 7,500,000 shares. Any grant under the 2004 Plan that expires or terminates unexercised,becomes unexercisable, or is forfeited will generally be available for futuregrants. At September 30, 2010, there were approximately 885,000 shares ofcommon stock available for future equity-related grants under the 2004 Plan.

 

Duringthe nine months ended September 30, 2010, we granted 430,000 nonvestedshare awards at a weighted-average grant date price of $11.67 per share;230,000 of these awards vested six months after the date of grant, and 200,000of these awards vest 12 months after the date of grant upon achievement of aperformance condition for the calendar year ending December 31, 2010. Asof September 30, 2010 we have assessed the likelihood that the performancecondition will be met and have recorded the related expense based on theestimated outcome. We also granted 102,500 stock options during the nine monthsended September 30, 2010 with a weighted-average exercise price of $11.81per share, which vest over periods ranging from five to seven years.

 

Fromtime to time we have treasury stock from the repurchase of common stock.  We may use treasury stock to satisfy optionexercises. As of September 30, 2010 we held 2,372,486 shares of treasurystock, which is discussed in Note 9.

 

Theweighted-average grant date fair value of stock options granted during the ninemonths ended September 30, 2010 and 2009 was $4.68 per option and $8.00per option, respectively. The weighted-average assumptions used for thecalculation of these values, utilizing the Black-Scholes methodology, were asfollows:

 
| ** **                            | ** ** | **Nine months ended  September 30,** | ** ** |
|---------------------------------------|------------|-----------------------------------------------------|------------|
| ** **                            | ** ** | **2010**                                            | ** ** | **2009** | ** ** |
| Expected volatility (%)               |       | 37.0                                                |       | 47.0 |   |
| Risk-free interest rate (%)           |       | 2.67                                                |       | 2.73 |   |
| Dividend yield (%)                    |       | 0.63                                                |       | — |   |
| Expected life of stock option (years) |       | 6.5                                                 |       | 6.2 |   |

 

The following table presentstotal share-based compensation expense, which is a non-cash charge, included inthe Condensed Consolidated Statements of Income (in thousands):

 
| ** **                                         | ** ** | **Three Months Ended  September 30,** | ** ** | **Nine months ended  September 30,** | ** ** |
|----------------------------------------------------|------------|------------------------------------------------------|------------|-----------------------------------------------------|------------|
| ** **                                         | ** ** | **2010**                                             | ** ** | **2009**                                            | ** ** | **2010** | ** ** | **2009** | ** ** |
|                                               |       |                                                 |       |                                                |       |   |   |   |   |
| Direct cost of services                            |       | $                                                    | 101        |                                                | $          | 166 |   | $ | 266 |   | $ | 421 |   |
| General and administrative                         |       | 2,064                                                |       | 1,882                                               |       | 5,726 |   | 5,883 |   |
| Pre-tax share-based compensation expense           |       | 2,165                                                |       | 2,048                                               |       | 5,992 |   | 6,304 |   |
| Income tax benefit                                 |       | (694                                                 | )          | (480                                                | )          | (1,781 | ) | (1,452 | ) |
| Total share-based compensation expense, net of tax |       | $                                                    | 1,471      |                                                | $          | 1,568 |   | $ | 4,211 |   | $ | 4,852 |   |

 

Asof September 30, 2010, there was $6.4 million of unrecognized compensationcost, net of estimated forfeitures, related to nonvested share-based awards,which will be recognized over a weighted-average period of 2.3 years.

 

**NOTE 6:   SEGMENTREPORTING**

 

Wehave three reporting segments: eDiscovery, bankruptcy, and settlementadministration.  Our eDiscovery businessprovides collections and forensics, processing, search and review, and documentreview services to companies and the litigation departments of law firms.  Produced documents are made availableprimarily through a hosted environment, and our DocuMatrixTM software allows forefficient attorney review and data requests. Our bankruptcy business provides solutions that

 

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addressthe needs of trustees to administer bankruptcy proceedings and of debtorcorporations that file a plan of reorganization.  Our settlement administration businessprovides managed services including legal notification, claims administration,project administration and controlled disbursement.

 

Thesegment performance measure is based on earnings before interest, taxes,depreciation and amortization, other operating expense, and share-basedcompensation expense.  In management’sevaluation of performance, certain costs, such as compensation foradministrative staff and executive management, are not allocated by segmentand, accordingly, the following reporting segment results do not include suchunallocated costs.

 

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

 

Followingis a summary of segment information forthe three months ended September 30, 2010. The intersegmentrevenues in the three months ended September 30, 2010 related primarily tocall center and printing services performed by the settlement administrationsegment for the bankruptcy segment.

 
| ** **                                       | ** ** | **Three Months Ended September 30, 2010** | ** ** |
|--------------------------------------------------|------------|--------------------------------------------------------------------|------------|
| ** **                                       | ** ** | **eDiscovery**                                                     | ** ** | **Bankruptcy** | ** ** | **Settlement  Administration** | ** ** | **Eliminations** | ** ** | **Total** | ** ** |
| ** **                                       | ** ** | **(in thousands)**                                            | ** ** |
| Revenue:                                         |       |                                                               |       |   |   |   |   |   |   |   |   |
| Operating revenue before reimbursed direct costs |       | $                                                                  | 19,957     |   | $ | 21,993 |   | $ | 10,049 |   | $ | — |   | $ | 51,999 |   |
| Intersegment revenue                             |       | 11                                                                 |       | 1 |   | 433 |   | (445 | ) | — |   |
|                                             |       |                                                               |       |   |   |   |   |   |   |   |   |
| Operating revenue before reimbursed direct costs |       | 19,968                                                             |       | 21,994 |   | 10,482 |   | (445 | ) | 51,999 |   |
| Operating revenue from reimbursed direct costs   |       | 132                                                                |       | 2,076 |   | 4,080 |   | — |   | 6,288 |   |
| Total revenue                                    |       | 20,100                                                             |       | 24,070 |   | 14,562 |   | (445 | ) | 58,287 |   |
|                                             |       |                                                               |       |   |   |   |   |   |   |   |   |
| Direct costs, general and administrative costs   |       | 10,734                                                             |       | 11,447 |   | 13,077 |   | (445 | ) | 34,813 |   |
| Segment performance measure                      |       | $                                                                  | 9,366      |   | $ | 12,623 |   | $ | 1,485 |   | $ | — |   | $ | 23,474 |   |

 

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Followingis a summary of segment information forthe three months ended September 30, 2009. The intersegmentrevenues in the three months ended September 30, 2009 related primarily tocall center services performed by the settlement administration segment for thebankruptcy segment.

 

 
| ** **                                       | ** ** | **Three Months Ended September 30, 2009** | ** ** |
|--------------------------------------------------|------------|--------------------------------------------------------------------|------------|
| ** **                                       | ** ** | **eDiscovery**                                                     | ** ** | **Bankruptcy** | ** ** | **Settlement  Administration** | ** ** | **Eliminations** | ** ** | **Total** | ** ** |
| ** **                                       | ** ** | **(in thousands)**                                            | ** ** |
| Revenue:                                         |       |                                                               |       |   |   |   |   |   |   |   |   |
| Operating revenue before reimbursed direct costs |       | $                                                                  | 12,153     |   | $ | 25,384 |   | $ | 13,570 |   | $ | — |   | $ | 51,107 |   |
| Intersegment revenue                             |       | —                                                             |       | — |   | 467 |   | (467 | ) | — |   |
|                                             |       |                                                               |       |   |   |   |   |   |   |   |   |
| Operating revenue before reimbursed direct costs |       | 12,153                                                             |       | 25,384 |   | 14,037 |   | (467 | ) | 51,107 |   |
| Operating revenue from reimbursed direct costs   |       | 128                                                                |       | 3,063 |   | 3,511 |   | — |   | 6,702 |   |
| Total revenue                                    |       | 12,281                                                             |       | 28,447 |   | 17,548 |   | (467 | ) | 57,809 |   |
|                                             |       |                                                               |       |   |   |   |   |   |   |   |   |
| Direct costs, general and administrative costs   |       | 9,007                                                              |       | 14,634 |   | 12,998 |   | (467 | ) | 36,172 |   |
| Segment performance measure                      |       | $                                                                  | 3,274      |   | $ | 13,813 |   | $ | 4,550 |   | $ | — |   | $ | 21,637 |   |

 

Followingis a reconciliation of our segment performance measure to income before incometaxes (in thousands):

 
| ** **                                            | ** ** | **Three Months Ended September 30,** | ** ** |
|-------------------------------------------------------|------------|----------------------------------------------------------|------------|
| ** **                                            | ** ** | **2010**                                                 | ** ** | **2009** | ** ** |
|                                                  |       |                                                     |       |   |   |
| Segment performance measure                           |       | $                                                        | 23,474     |   | $ | 21,637 |   |
| Corporate and unallocated expenses                    |       | (6,502                                                   | )          | (5,519 | ) |
| Share-based compensation expense                      |       | (2,165                                                   | )          | (2,048 | ) |
| Depreciation and software and leasehold  amortization |       | (4,911                                                   | )          | (4,763 | ) |
| Amortization of intangible assets                     |       | (1,697                                                   | )          | (1,828 | ) |
| Other operating expense                               |       | (281                                                     | )          | (127 | ) |
| Interest expense, net                                 |       | (401                                                     | )          | (283 | ) |
| Income before income taxes                            |       | $                                                        | 7,517      |   | $ | 7,069 |   |

 

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Followingis a summary of segment information forthe nine months ended September 30, 2010. The intersegment revenuesin the nine months ended September 30, 2010 related primarily to callcenter and printing services performed by the settlement administration segmentfor the bankruptcy segment.

 
| ** **                                       | ** ** | **Nine months ended September 30, 2010** | ** ** |
|--------------------------------------------------|------------|-------------------------------------------------------------------|------------|
| ** **                                       | ** ** | **eDiscovery**                                                    | ** ** | **Bankruptcy** | ** ** | **Settlement  Administration** | ** ** | **Eliminations** | ** ** | **Total** | ** ** |
| ** **                                       | ** ** | **(in thousands)**                                           | ** ** |
| Revenue:                                         |       |                                                              |       |   |   |   |   |   |   |   |   |
| Operating revenue before reimbursed direct costs |       | $                                                                 | 56,539     |   | $ | 70,988 |   | $ | 29,622 |   | $ | — |   | $ | 157,149 |   |
| Intersegment revenue                             |       | 41                                                                |       | 1 |   | 1,302 |   | (1,344 | ) | — |   |
|                                             |       |                                                              |       |   |   |   |   |   |   |   |   |
| Operating revenue before reimbursed direct costs |       | 56,580                                                            |       | 70,989 |   | 30,924 |   | (1,344 | ) | 157,149 |   |
| Operating revenue from reimbursed direct costs   |       | 227                                                               |       | 7,076 |   | 15,139 |   | — |   | 22,442 |   |
| Total revenue                                    |       | 56,807                                                            |       | 78,065 |   | 46,063 |   | (1,344 | ) | 179,591 |   |
|                                             |       |                                                              |       |   |   |   |   |   |   |   |   |
| Direct costs, general and administrative costs   |       | 31,834                                                            |       | 38,548 |   | 40,864 |   | (1,344 | ) | 109,902 |   |
| Segment performance measure                      |       | $                                                                 | 24,973     |   | $ | 39,517 |   | $ | 5,199 |   | $ | — |   | $ | 69,689 |   |

 

Followingis a summary of segment information forthe nine months ended September 30, 2009. The intersegment revenuesin the nine months ended September 30, 2009 related primarily to callcenter services performed by the settlement administration segment for thebankruptcy segment.

 
| ** **                                       | ** ** | **Nine months ended September 30, 2009** | ** ** |
|--------------------------------------------------|------------|-------------------------------------------------------------------|------------|
| ** **                                       | ** ** | **eDiscovery**                                                    | ** ** | **Bankruptcy** | ** ** | **Settlement  Administration** | ** ** | **Eliminations** | ** ** | **Total** | ** ** |
| ** **                                       | ** ** | **(in thousands)**                                           | ** ** |
| Revenue:                                         |       |                                                              |       |   |   |   |   |   |   |   |   |
| Operating revenue before reimbursed direct costs |       | $                                                                 | 40,537     |   | $ | 66,790 |   | $ | 53,532 |   | $ | — |   | $ | 160,859 |   |
| Intersegment revenue                             |       | —                                                            |       | 1 |   | 1,587 |   | (1,588 | ) | — |   |
|                                             |       |                                                              |       |   |   |   |   |   |   |   |   |
| Operating revenue before reimbursed direct costs |       | 40,537                                                            |       | 66,791 |   | 55,119 |   | (1,588 | ) | 160,859 |   |
| Operating revenue from reimbursed direct costs   |       | 190                                                               |       | 7,782 |   | 15,996 |   | — |   | 23,968 |   |
| Total revenue                                    |       | 40,727                                                            |       | 74,573 |   | 71,115 |   | (1,588 | ) | 184,827 |   |
|                                             |       |                                                              |       |   |   |   |   |   |   |   |   |
| Direct costs, general and administrative costs   |       | 28,114                                                            |       | 39,838 |   | 54,565 |   | (1,588 | ) | 120,929 |   |
| Segment performance measure                      |       | $                                                                 | 12,613     |   | $ | 34,735 |   | $ | 16,550 |   | $ | — |   | $ | 63,898 |   |

 

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Followingis a reconciliation of our segment performance measure to income before incometaxes (in thousands):

 
| ** **                                            | ** ** | **Nine months ended September 30,** | ** ** |
|-------------------------------------------------------|------------|---------------------------------------------------------|------------|
| ** **                                            | ** ** | **2010**                                                | ** ** | **2009** | ** ** |
|                                                  |       |                                                    |       |   |   |
| Segment performance measure                           |       | $                                                       | 69,689     |   | $ | 63,898 |   |
| Corporate and unallocated expenses                    |       | (21,122                                                 | )          | (16,842 | ) |
| Share-based compensation expense                      |       | (5,992                                                  | )          | (6,304 | ) |
| Depreciation and software and leasehold  amortization |       | (15,358                                                 | )          | (13,829 | ) |
| Amortization of intangible assets                     |       | (5,213                                                  | )          | (5,582 | ) |
| Other operating expense                               |       | (350                                                    | )          | (611 | ) |
| Interest expense, net                                 |       | (1,103                                                  | )          | (970 | ) |
| Income before income taxes                            |       | $                                                       | 20,551     |   | $ | 19,760 |   |

 

Followingare total assets by segment (in thousands):

 
| ** **                | ** ** | **September 30,   2010** | ** ** | **December 31,  2009** | ** ** |
|---------------------------|------------|------------------------------------|------------|-----------------------------|------------|
| **Assets**                |       |                               |       |                        |       |
| eDiscovery                |       | $                                  | 146,286    |                        | $          | 133,515 |   |
| Bankruptcy                |       | 194,635                            |       | 187,484                     |       |
| Settlement Administration |       | 51,741                             |       | 54,213                      |       |
| Corporate and unallocated |       | 22,545                             |       | 62,729                      |       |
| Total consolidated assets |       | $                                  | 415,207    |                        | $          | 437,941 |   |

 

**NOTE7:    FAIR VALUES OF ASSETS ANDLIABILITIES**

 

Accountingstandards establish a three-level fair value hierarchy based upon theassumptions (inputs) used to price assets or liabilities. The hierarchyrequires us to maximize the use of observable inputs and minimize the use ofunobservable inputs. The three levels of inputs used to measure fair value arelisted below.

 

Level1 — Unadjusted quoted prices in active markets for identical assets orliabilities.

 

Level2 — Observable inputs other than those included in Level 1, such as quotedmarket prices for similar assets and liabilities in active markets or quotedprices for identical assets in inactive markets.

 

Level3 — Unobservable inputs reflecting our own assumptions and best estimate ofwhat inputs market participants would use in pricing an asset or liability.

 

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***Assets***

 

Thecarrying value and estimated fair value of our cash equivalents, which consistof short-term money market funds, are classified as Level 1 and are presentedin the following table at September 30, 2010 and December 31, 2009.As of September 30, 2010 and December 31, 2009, the carrying value ofour trade accounts receivable approximated fair value.

 
| ** **                                                          | ** ** | ** **              | ** ** | **Estimated Fair Value Measurements** | ** ** |
|---------------------------------------------------------------------|------------|-------------------------|------------|------------------------------------------------------|------------|
| **Items Measured at Fair Value on a** | ** ** | **Carrying**            | ** ** | **Quoted  Prices in  Active  Markets**          | ** ** | **Significant  Other  Observable  Inputs** | ** ** | **Significant  Unobservable  Inputs** | ** ** |
| **Recurring Basis**                                            | ** ** | **Value**               | ** ** | **(Level 1)**                                   | ** ** | **(Level 2)** | ** ** | **(Level 3)** | ** ** |
| ** **                                                          | ** ** | **(in thousands)** | ** ** |
| **September 30, 2010:**                                        |       |                    |       |                                                 |       |   |   |   |   |
| *Financial Assets:*                                                 |       |                    |       |                                                 |       |   |   |   |   |
| Money market funds                                                  |       | $                       | 54         |                                                 | $          | 54 |   | $ | — |   | $ | — |   |
|                                                                |       |                    |       |                                                 |       |   |   |   |   |
| **December 31, 2009:**                                         |       |                    |       |                                                 |       |   |   |   |   |
| *Financial Assets:*                                                 |       |                    |       |                                                 |       |   |   |   |   |
| Money market funds                                                  |       | $                       | 44,428     |                                                 | $          | 44,428 |   | $ | — |   | $ | — |   |

 

***Liabilities***

 

As of September 30,2010 and December 31, 2009, the carrying value of accounts payable,certain other liabilities, deferred acquisition price payments and capitalleases approximated fair value. The carrying value of the embedded optionrelated to our convertible notes approximated fair value at December 31,2009, and was fully amortized as of September 30, 2010. At September 30,2010, the amount outstanding under our credit facility was $15.0 million, whichapproximated fair value due to the borrowing rates currently available to thecompany for debt with similar terms.

 

AtSeptember 30, 2010 there was no convertible debt outstanding. As of December 31,2009, the carrying value of convertible debt was approximately $50.0 million.The fair value of the convertible debt was estimated at $59.9 million as of December 31,2009. This amount was estimated by taking the outstanding convertible debt,divided by the conversion price of $11.67 per share, to arrive at an estimatednumber of shares that would be issued assuming conversion of all of the notes.The estimated number of shares was then multiplied by the closing price of ourcommon stock on the last day of the respective reporting period to arrive at anestimate of the fair value of our convertible debt.

 

**NOTE8:    SUPPLEMENTAL CASH FLOW INFORMATION**

 

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

 
| ** **                                                                                                   | ** ** | **Nine months ended  September 30,** | ** ** |
|--------------------------------------------------------------------------------------------------------------|------------|-----------------------------------------------------|------------|
| ** **                                                                                                   | ** ** | **2010**                                            | ** ** | **2009** | ** ** |
|                                                                                                         |       |                                                |       |   |   |
| **Cash paid for:**                                                                                           |       |                                                |       |   |   |
| Interest                                                                                                     |       | $                                                   | 2,073      |   | $ | 2,051 |   |
| Income taxes paid, net                                                                                       |       | 18,093                                              |       | 7,138 |   |
| **Non-cash investing and  financing transactions:**                                                          |       |                                                |       |   |   |
| Property, equipment, and leasehold improvements  accrued in accounts payable and other long-term liabilities |       | 1,167                                               |       | 581 |   |
| Conversion of convertible notes into common stock                                                            |       | 27,168                                              |       | 32 |   |
| Capitalized lease obligations incurred                                                                       |       | 3,827                                               |       | — |   |
| Dividends declared but not yet paid                                                                          |       | 1,284                                               |       | — |   |
|                                                                                                              |            |                                                     |            |  |  |  |  |

 

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**NOTE 9:                STOCKHOLDERS’ EQUITY**

 

***Share Repurchase***

 

On June 23, 2010 our Board of Directorsauthorized $35.0 million for share repurchases (the “Share Repurchase Program”).Repurchases may be made pursuant to the Share Repurchase Program from time totime at prevailing market prices in the open market or in privately negotiatedpurchases, or both. The company may utilize one or more plans with its brokersor banks for pre-authorized purchases within defined limits pursuant to SEC Rule 10b5-1to effect all or a portion of the repurchases. During the nine months ended September 30,2010, we purchased 2,328,863 shares of common stock for approximately $29.9million, at an average cost of $12.84 per share.

 

Subsequent to quarter end the Board of Directorsapproved a new Share Repurchase Program authorizing up to $35.0 million inshare repurchases.

 

We also have a policy thatrequires shares to be repurchased by the company to satisfy tax withholdingobligations upon the vesting of restricted stock awards.

 

***Dividend***

 

On August 12, 2010, we paid our first cashdividend of $1.3 million, or $0.035 per share. On September 21, 2010 ourBoard of Directors declared a cash dividend of $0.035 per share, payable on November 18,2010 to shareholders of record at the close of business on October 28,2010. Dividends payable of approximately $1.3 million is included as acomponent of “Other accrued liabilities” in the Condensed Consolidated BalanceSheets at September 30, 2010.

 

**NOTE10:              LEGAL PROCEEDINGS**

 

**PurportedDerivative Shareholder Complaint**

 

OnJuly 29, 2008, the Alaska Electrical Pension Fund filed a putativeshareholder derivative action on behalf of Epiq Systems, Inc. in the U.S.District Court for the District of Kansas (the “Court”) (Civil Action No. 08-CV-2344CM/JPO), alleging, among other things, improper conduct by each of our currentdirectors and certain current and former executive officers and directorsregarding stock option grants. The company has stated consistently that theclaims made in the action are meritless.

 

Alsoas previously reported, on April 27, 2010, on the determination of thecompany’s Board of Directors, the company entered into a Stipulation ofSettlement (the “Settlement Agreement”) with plaintiff and defendants relatingto the settlement of this litigation and mutual release of claims, and thecompany and its insurance carrier agreed to pay plaintiff’s counsel’s fees andexpenses, which totaled $3.5 million. On June 22, 2010, the Court enteredan order which, among other things, preliminarily approved the SettlementAgreement and scheduled a final hearing. On August 25, 2010, the Court entered a final order, dated August 24,2010, finally approving the Settlement and dismissing with prejudice thelawsuit and all claims contained therein (the “Final Order”). During the thirdquarter of 2010, the settlement amount,which had been fully accrued for inprior periods, was paid by the company and the insurance company. On or about September 24,2010, the Final Order became final and non-appealable because no appeal wasfiled prior to such date.

 

**NOTE11:              INCOME TAXES**

 

Aspreviously disclosed, our 2003 — 2007 New York state income tax returns wereunder examination and in July 2010, we reached a final settlementagreement with the state, which included extending the settlement to includethe 2008 income tax return.  The companyalso filed New York City tax returns during the third quarter of 2010 for thecorresponding years reflecting the outcome of the state examination. Thecompany accrued for these uncertain tax positions in prior periods and, as aresult, the resolution of these matters did not have a material effect on theprovision for income taxes. Approximately $3.5 million of previously unrecognized tax benefits and$0.9 million of accrued interest related to these matters, were paid during thethird quarter of 2010. Had we been able to recognize the $3.5 million ofpreviously unrecognized tax benefits related to the settlement, the entire $3.5million would have affected our effective tax rate.

 

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DuringSeptember 2010, lapses in the statute of limitations for certain federaland state tax returns resulted in recognizing $0.6 million of unrecognized taxbenefits, all of which reduced tax expense. Although income tax returns for2007 and later are generally subject to exam, it is reasonably possible that wewill recognize approximately $0.4 million of previously unrecognized taxbenefits as a result of lapses in the statute of limitations within twelvemonths of our reporting date. If recognized, the $0.4 million of tax benefitswould affect the effective tax rate.

 

Accruedinterest expense related to unrecognized tax benefits, included as a componentof “Other long-term liabilities” on the accompanying Condensed ConsolidatedBalance Sheets, totaled $0.4 million and $0.9 million at September 30,2010 and September 30, 2009, respectively.

 

**NOTE12:   SUBSEQUENT EVENTS**

 

**Acquisitionof Jupiter eSources**

 

OnOctober 1, 2010, we completed the acquisition of Jupiter eSources LLC. Thepurchase price was comprised of $60.0 million of cash, $8.4 million of whichwas withheld for any claims for indemnification, and purchase priceadjustments. In addition, there is contingent consideration related to an earn-outopportunity based on future revenue growth. The potential undiscounted amountof all future payments that we could be required to make under the earn-outopportunity is between $0 and $20 million over a four year period. Thetransaction was funded from our credit facility. We are evaluating the purchaseprice allocation to the fair value of the assets acquired, and the liabilityfor the contingent consideration related to this acquisition.

 

Jupiterdevelops, supports and markets a proprietary software product, AACER®(Automated Access to Court Electronic Records), that assists creditorsincluding banks, mortgage processors, and their administrative servicesprofessionals to streamline processing of their portfolios of loans inbankruptcy cases. The AACER® product electronically monitors developments inall U.S. bankruptcy courts and applies sophisticated algorithms to classifydocket filings automatically in each case to facilitate the management of largebankruptcy claims operations. By implementing the AACER® solution, clientsachieve greater accuracy in faster timeframes, with a significant cost savingscompared to manual attorney review of each case in the portfolio.

 

**ShareRepurchase**

 

Subsequent to quarter end the Board of Directors approveda new Share Repurchase Program authorizing up to $35.0 million in sharerepurchases.

 

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**Item 2.    Management’s Discussion and Analysis of FinancialCondition and Results of Operations**

 

Thisdiscussion and analysis should be read in conjunction with the CondensedConsolidated Financial Statements and the accompanying Notes to the CondensedConsolidated Financial Statements included in this Form 10-Q.

 

**Overview**

 

Weare a provider of integrated technology solutions for the legalprofession.  Our solutions streamline theadministration of bankruptcy, litigation, financial transactions and regulatorycompliance matters.  We offer innovativetechnology solutions for eDiscovery, document review, legal notification,claims administration and controlled disbursement of funds.  Our clients include law firms, corporatelegal departments, bankruptcy trustees, government agencies and otherprofessional advisors who require innovative technology, responsive service anddeep subject-matter expertise.

 

Wehave three reporting segments: eDiscovery, bankruptcy, and settlementadministration.

 

***eDiscovery***

 

OureDiscovery business provides collections and forensics, processing, search andreview, and document review services to companies and the litigationdepartments of law firms.  OureDataMatrixTM software analyzes, filters, deduplicates and produces documentsfor review.  Produced documents are madeavailable primarily through a hosted environment, and our DocuMatrixTM softwareallows for efficient attorney review and data requests. Our customers aretypically large corporations that use our products and services cooperativelywith their legal counsel to manage the eDiscovery process for litigation andregulatory matters.

 

Thesubstantial amount of electronic documents and other data used by businesseshas changed the dynamics of how attorneys support discovery in complexlitigation matters. Due to the complexity of cases, the volume of data that aremaintained electronically, and the volume of documents that are produced in alltypes of litigation, law firms have become increasingly reliant on electronicevidence management systems to organize and manage the litigation discoveryprocess.

 

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

 

·                  Consulting, forensics and collection servicefees based on the number of hours services are provided.

 

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

 

·                  Hosting fees based on the amount of datastored.

 

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

 

In 2009 we opened newoffices in Brussels and Hong Kong, established global reach for our datacenters in the U.S., Europe and Asia, and expanded our offerings to includedata forensics and collections services, as well as document review services.In 2009 we also launched IQ ReviewTM, a revolutionary combination of newintelligent technology and expert services which incorporates newprioritization technology into DocuMatrixTM, our flagship document managementplatform. Increased case activity levels and an uptake of new service offeringslaunched in 2009 is expected to continue to contribute to revenue growth during2010.

 

***Bankruptcy***

 

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

 

·                  Chapter 7 is a liquidationbankruptcy for individuals or businesses that, as measured by the number of newcases filed in the twelve-month period ended June 30, 2010, accounted forapproximately 72% of all bankruptcy filings. In a Chapter

 

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

 

·                  Chapter 11 is areorganization model of bankruptcy for corporations that, as measured by thenumber of new cases filed in the twelve-month period ended June 30, 2010,accounted for approximately 1% of all bankruptcy filings.  Chapter 11 generally allows a company, oftenreferred to as the debtor-in-possession, to continue operating under a plan ofreorganization to restructure its business and to modify payment terms of bothsecured and unsecured obligations. Chapter 11 cases generally last several years.

 

·                  Chapter 13 is areorganization model of bankruptcy for individuals that, as measured by thenumber of new cases filed in the twelve-month period ended June 30, 2010,accounted for approximately 27% of all bankruptcy filings.  In a Chapter 13 case, debtors make periodiccash payments into a reorganization plan and a Chapter 13 bankruptcy trusteeuses these cash payments to make monthly distributions to creditors.  Chapter 13 cases typically last between threeand five years.

 

Asreported by the Administrative Office of the U.S. Courts, bankruptcy filingsfor the twelve-month period ended June 30, 2010 increased 20% versus thetwelve-month period ended June 30, 2009. During this period, Chapter 7 filings increased 25%, Chapter 11 filingsincreased 2%, and Chapter 13 filings increased 10%.

 

The application of Chapter 7 bankruptcy regulations has the practicaleffect of discouraging trustee customers from incurring direct administrativecosts for computer system expenses.  As aresult, we provide our Chapter 7 products and services to our trustee customersat no direct charge, and they maintain deposit accounts for bankruptcy casesunder their administration at a designated banking institution.  We have arrangements with various banks underwhich we provide the bankruptcy trustee case management software and relatedservices, and the bank provides the bankruptcy trustee with deposit-relatedbanking services.

 

Chapter11 bankruptcy engagements are generally long-term, multi-year assignments thatprovide revenue visibility into future periods. For the Chapter 7 trusteeservices component of the bankruptcy segment, the increase in filings isexpected to translate into growth in client deposit balances related to assetliquidations. Our trustee services deposit portfolio exceeded $2.0 billionduring the third quarter of 2010, while pricing continued at floor pricinglevels under our agreements due to the low short-term interest rateenvironment.

 

Thekey participants in a bankruptcy proceeding include the debtor-in-possession,the debtor’s legal counsel, the creditors, the creditors’ legal counsel, andthe bankruptcy judge. Chapter 7 and Chapter 13 cases also include aprofessional bankruptcy trustee, who is responsible for administering thebankruptcy case. The end-user customers of our bankruptcy business are debtorcorporations that file a plan of reorganization and professional bankruptcytrustees.  The Executive Office for United StatesTrustees, a division of the U.S. Department of Justice, appoints all bankruptcytrustees.  A United States Trustee isappointed in most federal court districts and generally has responsibility foroverseeing the integrity of the bankruptcy system.  The bankruptcy trustee’s primaryresponsibilities include liquidating the debtor’s assets or collecting fundsfrom the debtor, distributing the collected funds to creditors pursuant to theorders of the bankruptcy court and preparing regular status reports for theExecutive Office for United States Trustees and for the bankruptcy court.  Trustees manage an entire caseload ofbankruptcy cases simultaneously.

 

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

 

·                  Data hosting fees and volume-based fees.

 

·                  Case management professional service fees andother support service fees related to the administration of cases, includingdata conversion, claims processing, claims reconciliation, professionalservices, and disbursement services.

 

·                  Deposit-based fees, earned primarily on apercentage of Chapter 7 total liquidated assets placed on deposit with adesignated financial institution by our trustee clients, to whom we provide, atno charge, software licenses, limited hardware and hardware maintenance, andpostcontract customer support services. The fees we earn based on total liquidated assets placed on deposit byour trustee clients may vary based on fluctuations in short-term interestrates.

 

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

 

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

 

***Settlement Administration***

 

Oursettlement administration segment provides managed services, including legalnotification, claims administration, project administration and controlleddisbursement.

 

The customers of oursettlement administration segment are companies that require the administrationof a settlement, resolution of a class action matter, or administration of aproject.  We sell our services directlyto those customers and other interested parties, including legal counsel, whichoften provide access to these customers. During the three and nine months endedSeptember 30, 2009, approximately 7% and 15% respectively, of our consolidatedrevenue was derived from a large contract with IBM in support of the federalgovernment’s analog to digital conversion program. During the nine months endedSeptember 30, 2010, approximately 0.1% of our consolidated revenue wasderived from this contract. The contract began in the fourth quarter of 2007,and, as expected, concluded in the second half of 2009. There was no revenuederived from this contract during the three month period ended September 30,2010.

 

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

 

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

 

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

 

·                Reimbursement for costsincurred related to postage on mailing services.

 

Keyparticipants in this marketplace include law firms that specialize inrepresenting class action and mass tort plaintiffs and other law firms thatspecialize in representing defendants.  Class actionand mass tort refers to litigation in which class representatives bring alawsuit against a defendant company or other persons on behalf of a large groupof similarly affected persons. Mass tort refers to class action cases that areparticularly large or prominent. Class action and mass tort litigation isoften complex and the cases, including administration of any settlement, maylast several years.

 

**Results of Operations for the Three Months Ended September 30,2010 Compared with the Three Months Ended September 30, 2009**

 

**Consolidated Results**

 

***Revenue***

 

Totalrevenue was $58.3 million for the three months ended September 30, 2010,an increase of $0.5 million, or 1%, as compared to the prior year. A portion ofour total revenue consists of reimbursement for direct costs we incur, such aspostage related to document management services.  We reflect the operating revenue from thesereimbursed direct costs as a separate line item on our accompanying CondensedConsolidated Statements of Income. Revenue originating from reimbursed direct costs was $6.3 million, adecrease of $0.4 million, or 6%, from $6.7 million in the prior year. Althoughoperating revenue from reimbursed direct costs may fluctuate significantly fromquarter to quarter, these fluctuations have a minimal effect on our income fromoperations as we realize little or no margin from this revenue.

 

Operatingrevenue exclusive of revenue originating from reimbursed direct costs was $52.0million in the three months ended September 30, 2010, an increase of $0.9million, or 2%, as compared to the prior year. This increase was driven by a$7.8

 

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millionincrease in the eDiscovery segment; partially offset by a $3.5 million decreasein the settlement administration segment, and a $3.4 million decrease in thebankruptcy segment. Changes by segment are discussed below.

 

***Operating Expense***

 

Thedirect cost of services, exclusive of depreciation and amortization, was $16.5million for the three months ended September 30, 2010, a decrease of $1.5million, or 8%, as compared to $18.0 million in the prior year. This decreasewas primarily the result of a $0.8 million decrease in production supplies anda $0.7 million decrease in expense related to outside services. Changes bysegment are discussed below.

 

Thedirect cost of bundled products and services, exclusive of depreciation andamortization, was $0.8 million, a decrease of $0.1 million, or 9%, as comparedto the prior year. Changes by segment are discussed below.

 

Reimburseddirect costs decreased $0.6 million, or 8%, to $6.1 million for the threemonths ended September 30, 2010, compared with $6.7 million during the prioryear.  This decrease corresponds to theincrease in operating revenue from reimbursed direct costs.  Changes by segment are discussed below.

 

Generaland administrative costs increased $1.9 million, or 10%, to $20.1 million forthe three months ended September 30, 2010. This increase was due primarily to a$0.7 million increase in outside services; a $0.4 million increase incompensation expense, including share-based compensation; a $0.4 millionincrease in lease expense; a $0.3 million increase in bad debt expense; and a$0.2 million increase in travel expense. Changes by segment are discussedbelow.

 

Depreciationand software and leasehold amortization costs for the three months endedSeptember 30, 2010 were $4.9 million, an increase of $0.1 million, or 3%,compared to the prior year. This increase was primarily the result of increaseddepreciation on equipment related to investments in our business segments.

 

Amortizationof identifiable intangible assets for the three months ended September 30, 2010was $1.7 million, a decrease of $0.1 million, or 7%, compared to the prioryear. This decrease was the result of certain non-compete and customer contractintangible assets that were fully amortized in the prior year.

 

***Interest Expense, Net***

 

Werecognized interest expense of approximately $0.4 million for three monthsended September 30, 2010 and $0.3 million for the three months ended September30, 2009.

 

***Income Taxes***

 

Oureffective tax rate for the three months ended September 30, 2010 was 39.6%compared with 31.1% in the prior year. The increase was primarily attributableto recognizing $0.5 million of tax benefits associated with expiring income taxstatute of limitations during 2010 compared to $0.9 million during the sameperiod in 2009. State taxes and non-deductible equity compensation are theprimary reasons our tax rate is higher than the statutory federal rate of 35%.We have significant operations located in New York City that are subject tostate and local tax rates that are higher than the tax rates assessed by otherjurisdictions where we operate.

 

Congressis currently considering legislation that would extend the research anddevelopment credit for 2010 which would result in a favorable impact on our2010 effective tax rate.

 

***Net Income***

 

Ournet income was $4.5 million for the three months ended September 30, 2010compared to $4.9 million for the prior year, a decrease of $0.4 million, or 7%.The change from the prior year was primarily driven by growth in our eDiscoverysegment; which was offset by declines in our settlement administration segment,and declines in our bankruptcy segment.

 

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**Results of Operations by Segment**

 

The following segment discussion is presented on abasis consistent with our segment disclosure contained in Note 6 of our Notesto Condensed Consolidated Financial Statements.

 

***eDiscovery Segment***

 

eDiscoveryoperating revenue before reimbursed direct costs for the three months endedSeptember 30, 2010 was $20.0 million, an increase of $7.8 million, or 64%,compared to the prior year.  The changefrom the prior year is primarily related to higher case activity levels bothdomestically and internationally, and a growing contribution from new serviceofferings.

 

eDiscoverydirect and administrative costs, including reimbursed direct costs, were $10.7million for the three months ended September 30, 2010, an increase of $1.7million, or 19%, compared to the prior year. This change was a result of a net increase in direct and administrativecosts, which primarily were in support of expanded business services, comparedto the prior year.

 

***Bankruptcy Segment***

 

Bankruptcyoperating revenue before reimbursed direct costs for the three months endedSeptember 30, 2010 was $22.0 million, a decrease of $3.4 million, or 13%,compared to $25.4 million in the prior year. This decrease was primarilyattributable to a lower level of new Chapter 11 filings compared to the recordhigh filing levels of 2009, partially offset by an increase in bankruptcytrustee fees associated with higher deposit levels than the prior year.

 

Bankruptcydirect and administrative costs, including reimbursed direct costs, decreased$3.2 million, or 22%, to $11.4 million for the three months ended September 30,2010, compared to $14.6 million in the prior year. The decrease in these costswere the result of a $1.7 million decrease in outside services, a $1.0 milliondecrease in reimbursed direct costs, and a $0.5 million decrease in legalnotification costs associated with the decline in Chapter 11 printing andnotification revenues.

 

***Settlement Administration Segment***

 

Settlementadministration operating revenue before reimbursed direct costs was $10.0million in the three months ended September 30, 2010, a decrease of $3.5million, or 26%, compared to the prior year, primarily due to the conclusion ofthe major analog to digital conversion contract in the latter part of 2009.

 

Settlementadministration direct and administrative costs, including reimbursed directcosts, for the three months ended September 30, 2010 were $13.1 million, anincrease of $0.1 million, or 1%, compared to $13.0 million in the prior year,primarily due to expenses related to increased mailing revenue associated withreimbursed direct costs.

 

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**Results of Operations for the Nine Months Ended September 30,2010 Compared with the Nine Months Ended September 30, 2009**

 

**Consolidated Results**

 

***Revenue***

 

Totalrevenue was $179.6 million for the nine months ended September 30, 2010, adecrease of $5.2 million, or 3%, as compared to the prior year. A portion ofour total revenue consists of reimbursement for direct costs we incur, such aspostage related to document management services.  We reflect the operating revenue from thesereimbursed direct costs as a separate line item on our accompanying CondensedConsolidated Statements of Income. Revenue originating from reimbursed direct costs was $22.4 million, adecrease of $1.6 million, or 6%, from $24.0 million in the prior year. Althoughoperating revenue from reimbursed direct costs may fluctuate significantly fromquarter to quarter, these fluctuations have a minimal effect on our income fromoperations as we realize little or no margin from this revenue.

 

Operatingrevenue exclusive of revenue originating from reimbursed direct costs was$157.1 million in the nine months ended September 30, 2010, a decrease of $3.7million, or 2%, as compared to the prior year. The change from the prior yearwas driven by a $16.0 million increase in the eDiscovery segment and a $4.2million increase in the bankruptcy segment, offset by a $23.9 million decreasein the settlement administration segment. Changes by segment are discussedbelow.

 

***Operating Expense***

 

Thedirect cost of services, exclusive of depreciation and amortization, was $48.2million for the nine months ended September 30, 2010, a decrease of $9.2million, or 16%, as compared to $57.4 million in the prior year. Contributingto this decrease was a $5.8 million decrease in the expense related to outsideservices, primarily related to temporary help and mailing, a $2.9 milliondecrease in production supplies, and a $1.1 million decrease in legalnotification costs. These decreases were partially offset by a $0.5 millionincrease in building and equipment expense. Changes by segment are discussedbelow.

 

Thedirect cost of bundled products and services, exclusive of depreciation andamortization, increased $0.1 million, or 2%, to $2.7 million for the ninemonths ended September 30, 2010 as compared to the prior year. Changes bysegment are discussed below.

 

Reimburseddirect costs decreased $1.7 million, or 8%, to $22.0 million for the ninemonths ended September 30, 2010, compared with $23.7 million during the prioryear.  This decrease directly correspondsto the decrease in operating revenue from reimbursed direct costs.  Changes by segment are discussed below.

 

Generaland administrative costs increased $3.8 million, or 6%, to $64.2 million forthe nine months ended September 30, 2010. A litigation provision for ashareholder derivative action of $1.6 million was recorded for the nine monthsended September 30, 2010, travel expense increased $1.2 million, lease expenseincreased $0.8 million, and bad debt expense increased $0.5 million. Theseincreases were partially offset by a $0.7 million decrease in outside services.Changes by segment are discussed below.

 

Depreciationand software and leasehold amortization costs for the nine months endedSeptember 30, 2010 were $15.4 million, an increase of $1.6 million, or 11%,compared to the prior year. This increase was primarily the result of increaseddepreciation on equipment primarily related to investments in our business segments.

 

Amortizationof identifiable intangible assets for the nine months ended September 30, 2010was $5.2 million, a decrease of $0.4 million, or 7%, compared to the prioryear. This decrease was the result of certain non-compete and customer contractintangible assets that were fully amortized in the prior year.

 

Otheroperating expense for the nine months ended September 30, 2010 decreased byapproximately $0.3 million due to a decrease in acquisition-related expenses.

 

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***Interest Expense, Net***

 

Werecognized interest expense of approximately $1.1 million for both the ninemonths ended September 30, 2010 and 2009.

 

***Income Taxes***

 

Oureffective tax rate for the nine months ended September 30, 2010 was 47.5%compared with 44.2% in the prior year. The increase was primarily attributableto recognizing a lesser amount of tax benefits associated with expiring incometax statute of limitations during 2010 compared to the same period in 2009,partially offset by a decrease in non-deductible equity compensation in 2010.State taxes and non-deductible equity compensation are the primary reasons ourtax rate is higher than the statutory federal rate of 35%. We have significantoperations located in New York City that are subject to state and local taxrates that are higher than the tax rates assessed by other jurisdictions wherewe operate.

 

Congressis currently considering legislation that would extend the research anddevelopment credit for 2010 which would result in a favorable impact on our2010 effective tax rate.

 

***Net Income***

 

Ournet income was $10.8 million for the nine months ended September 30, 2010compared to $11.0 million for the prior year, a decrease of $0.2 million, or2%. The change from the prior year was the result of growth in our bankruptcyand eDiscovery segments, offset by net costs related to the litigationsettlement for a shareholder derivative action of approximately $1.6 million,and a decline in our settlement administration segment, due primarily to theconclusion of the analog to digital conversion contract in the latter part of2009.

 

**Results of Operations by Segment**

 

The following segment discussion is presented on abasis consistent with our segment disclosure contained in Note 6 of our Notesto Condensed Consolidated Financial Statements.

 

***eDiscovery Segment***

 

eDiscoveryoperating revenue before reimbursed direct costs for the nine months ended September30, 2010 was $56.5 million, an increase of $16.0 million, or 39%, compared tothe prior year.  The change from theprior year is primarily related to higher case activity levels bothdomestically and internationally, and a growing contribution from new serviceofferings.

 

eDiscoverydirect and administrative costs, including reimbursed direct costs, were $31.8million for the nine months ended September 30, 2010, an increase of $3.7million, or 13%, compared to the prior year. This change was a result of a net increase in direct and administrativecosts, which primarily were in support of expanded business services, comparedto the prior year.

 

***Bankruptcy Segment***

 

Bankruptcyoperating revenue before reimbursed direct costs for the nine months ended September30, 2010 was $71.0 million, an increase of $4.2 million, or 6%, compared to$66.8 million in the prior year. This increase was primarily attributable tothe high number of active corporate restructuring cases; as well as an increasein bankruptcy trustee fees, associated with higher average deposit balances.

 

Bankruptcydirect and administrative costs, including reimbursed direct costs, decreased$1.3 million, or 3%, to $38.5 million for the nine months ended September 30,2010, compared to $39.8 million in the prior year. The decreases in these costswere primarily related to a decrease of $2.1 million in outside services, $0.7million in reimbursed direct costs, $0.3 million in legal noticing, $0.3million related a decline in call center activity, and $0.2 million in legaland professional services.  Thesedecreases were partially offset by an increase of $1.7 million in compensationrelated expense and $0.6 million in technology costs related to the businessgrowth.

 

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***Settlement Administration Segment***

 

Settlementadministration operating revenue before reimbursed direct costs was $29.6million in the nine months ended September 30, 2010, a decrease of $23.9million, or 45%, compared to the prior year, primarily due to the expectedconclusion of the major analog to digital conversion contract in the latterpart of 2009.

 

Settlementadministration direct and administrative costs, including reimbursed directcosts, for the nine months ended September 30, 2010 were $40.9 million, adecrease of $13.7 million, or 25%, compared to $54.6 million in the prior year,primarily due to the direct and administrative costs associated with theconclusion of the major analog to digital conversion contract in the latterpart of 2009.

 

**Liquidity and Capital Resources**

 

***Cash flows from operating activities***

 

Duringthe nine months ended September 30, 2010, our operating activities provided netcash of $19.2 million. Contributing to net cash provided by operatingactivities was net income of $10.8 million and non-cash expenses, such asdepreciation and amortization and share-based compensation expense, of $27.9million. These items were partially offset by a $19.5 million net use of cashresulting from changes in operating assets and liabilities. The mostsignificant changes in operating assets and liabilities were a $9.2 milliondecrease in income taxes payable, primarily related to New York state incometax settlement payments, and the timing of estimated payments; and a $14.0million increase in trade accounts receivable. These changes were partiallyoffset by a $2.0 million increase in accounts payable, and a $1.0 milliondecrease in prepaid expenses and other assets. Trade accounts receivable willfluctuate from period to period depending on the timing of sales andcollections. Accounts payable will fluctuate from period to period depending ontiming of purchases and payments.

 

***Cash flows from investing activities***

 

Duringthe nine months ended September 30, 2010, we used cash of $9.0 million for thepurchase of property and equipment, including computer hardware, purchasedsoftware licenses primarily for our eDiscovery business, and purchased computerhardware primarily for our bankruptcy trustee business. Enhancements to ourexisting software and the development of new software is essential to ourcontinued growth, and, during the nine months ended September 30, 2010, we usedcash of $6.5 million to fund internal costs related to the development ofsoftware for which technological feasibility had been established. We believethat cash generated from operations will be adequate to fund our anticipatedproperty, equipment, and software spending over the next year.

 

***Cash flows from financing activities***

 

Duringthe nine months ended September 30, 2010, we used cash of $30.9 million for therepurchase of our common stock, including $29.9 million for the purchase ofshares under our Share Repurchase Program, and $1.0 million for the purchase ofshares required to satisfy tax withholding obligations upon the vesting ofrestricted stock awards. We also used cash of $22.8 million upon maturity ofour contingent convertible subordinated notes (“convertible notes”),approximately $4.4 million for the payment of long-term obligations, includingcapital lease payments, $1.5 million for debt issuance costs related to theamendment of our revolving credit facility, and $1.3 million for dividends on ourcommon shares. These uses of cash were partially offset by $15.0 million ofborrowings under our senior revolving loan and $1.0 million of net proceedsfrom stock issued in connection with the exercise of employee stock options. Wealso recognized a portion of the tax benefit related to the exercise of stockoptions as a financing source of cash.

 

***Recent financing activities***

 

ContingentConvertible Subordinated Notes:  On or about June 11, 2010, prior to thematurity date, $27.2 million of convertible notes were converted into 2.3million shares of common stock at a conversion price of $11.67. On June 15,2010, the remaining convertible notes matured, resulting in a cash payment of$22.8 million, plus accrued interest. The original $50.0 million of convertiblenotes were issued in June 2004 with a fixed 4% per annum interest rate and anoriginal maturity of June 15, 2007.  Theholders of the convertible notes had the right to extend the maturity date byup to three years.  In April 2007, theholders exercised this right and the maturity date of the convertible notes wasextended to June 15, 2010.

 

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Revolving Credit Agreement:  We amended our credit facility during thesecond quarter of 2010 to increase the aggregate amount of funds available from$100.0 million to $140.0 million and extending the maturity date to June 2014.During the term of the credit facility, we have the right, subject tocompliance with our covenants, to increase the borrowings to $200.0 million.The credit facility is secured by liens on our land and buildings and asignificant portion of our furniture and equipment.  Interest on the credit facility is generallybased on a spread, ranging between 225 and 325 basis points, over the LIBORrate.  As of September 30, 2010, we hadborrowed $15.0 million under the senior revolving loan. At December 31, 2009,we did not have any borrowings outstanding under our $100.0 million seniorrevolving loan. To determine the amount that we may borrow, the amountavailable under the revolving loan is reduced by $1.1 million in outstandingletters of credit.

 

Borrowingsunder the senior revolving loan bear interest at various rates based on ourleverage ratio with two rate options at the discretion of management asfollows:  (1) for base rate advances,borrowings bear interest at prime rate plus 100 to 200 basis points; (2) forLIBOR rate advances, borrowings bear interest at LIBOR rate plus 225 to 325basis points. At September 30, 2010, borrowings of $15.0 million under thisfacility had a weighted average interest rate of 3.20%. The average amount ofborrowings under this facility in the third quarter of 2010 was $10.0 million,at a weighted average interest rate of 3.31%. The maximum amount outstanding during the third quarter was $15.0million. At September 30, 2010, the amount available for borrowings under thecredit facility is reduced by $1.1 million in outstanding letters of credit. Noamounts were borrowed under the senior revolving loan as of December 31, 2009.

 

As of September 30, 2010, significant financial covenants, all asdefined within our credit facility agreement, include a leverage ratio not toexceed 3.00 to 1.00, a fixed charge coverage ratio of not less than 1.25 to1.00, and a current ratio of not less than 1.50 to 1.00.  As of September 30, 2010, we were incompliance with all financial covenants.

 

Otherrestrictive covenants contained in our credit facility include limitations onincurring additional indebtedness and completing acquisitions. We generallycannot incur indebtedness outside the credit facility, with the exceptions ofcapital leases, with a limit of $15.0 million, and subordinated debt, with alimit of $100.0 million of aggregate subordinated debt. Generally, foracquisitions we must be able to demonstrate that, on a pro forma basis, wewould be in compliance with our covenants during the four quarters prior to theacquisition, and bank permission must be obtained for acquisitions in whichcash consideration exceeds $80.0 million or total consideration exceeds $125.0million.

 

Subsequentto quarter end, in connection with the acquisition of Jupiter eSources LLC,discussed further in Note 12 to the Condensed Consolidated FinancialStatements, we borrowed $49.0 million under the revolving credit agreement tofund the acquisition.

 

Share Repurchase Program:  OnJune 23, 2010 our Board of Directors authorized $35.0 million for share repurchases(the “Share Repurchase Program”). We purchased a total of 2,328,863 shares ofcommon stock for approximately $29.9 million, at an average cost of $12.84 pershare. On August 27, 2010 we concluded share repurchases under this Program.

 

Subsequent to quarter end the Board of Directorsapproved a new Share Repurchase Program authorizing up to $35.0 million inshare repurchases.

 

Dividends:  On August12, 2010 we paid our first cash dividend of $1.3 million, or $0.035 pershare.  On September 21, 2010, our Boardof Directors declared a cash dividend of $0.035 per share, payable on November18, 2010 to shareholders of record on October 28, 2010. Dividends payable ofapproximately $1.3 million is included as a component of “Other accrued liabilities”on the Condensed Consolidated Balance Sheets at September 30, 2010.

 

Webelieve that funds generated from operations, plus our existing cash resourcesand amounts available under our credit facility, will be sufficient to meet ourcurrently anticipated working capital requirements, internal softwaredevelopment expenditures, property, equipment and third party softwareexpenditures, deferred acquisition price agreements, capital leases, interestpayments due on our outstanding borrowings, and other contractual obligations.

 

In addition, we believe wecould fund any future acquisitions, dividend payments, or common stockrepurchases with our internally available cash, cash generated from operations,our existing available debt capacity, or from the issuance of additionalsecurities.

 

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***Off-balanceSheet Arrangements***

 

We generally donot utilize off-balance sheet arrangements in our operations; however, we enterinto operating leases in the normal course of business.  Our operating lease obligations are disclosedbelow under “Contractual Obligations”.

 

ContractualObligations

 

Thefollowing table sets forth a summary of our contractual obligations andcommitments, excluding periodic interest payments for capital leaseobligations, as of September 30, 2010.

 
| ** **                                               | ** ** | **Payments Due  By Period** | ** ** |
|----------------------------------------------------------|------------|-----------------------------|------------|
| ** **                                               | ** ** | **(In Thousands)**          | ** ** |
| **Contractual  Obligation****(1)**                       | ** ** | **Total**                   | ** ** | **Remaining in  2010** | ** ** | **2011 – 2013** | ** ** | **2014 – 2015** | ** ** | **2016 &  Thereafter** | ** ** |
|                                                     |       |                        |       |   |   |   |   |   |   |   |   |
| Long-term obligations and future accretion **(2)**  |       | $                           | 15,490     |   | $ | 490 |   | $ | — |   | $ | 15,000 |   | $ | — |   |
| Interest payments **(3)**                                |       | 749                         |       | 76 |   | 642 |   | 31 |   | — |   |
| Employment agreements **(4)**                            |       | 339                         |       | 212 |   | 127 |   | — |   | — |   |
| Capital lease obligations                                |       | 7,381                       |       | 325 |   | 6,033 |   | 1,023 |   | — |   |
| Operating leases                                         |       | 32,142                      |       | 5,925 |   | 18,569 |   | 7,562 |   |   86 |   |
| Total                                                    |       | $                           | 56,101     |   | $ | 7,028 |   | $ | 25,371 |   | $ |  23,616 |   | $ | 86 |   |

 

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**(1)**               Approximately $2.4 millionof unrecognized tax benefits are not included in this contractual obligationstable due to the uncertainty related to the timing of any payments. Settlementof such amounts would require the utilization of working capital.

 

**(2)**               Includes principal paymentson our credit facility which matures in June 2014. A portion of the purchaseprice for acquisitions was paid in the form on non-interest bearing notes orbelow market rate notes, which were discounted using an appropriate imputedinterest rate. The discounts are accreted over the life of the note and eachperiod’s accretion is added to the principal of the respective note. The amountin the above contractual obligation table includes both the notes’ principal,as reflected on our September 30, 2010 condensed consolidated balance sheet,and all future accretion.

 

**(3)**               Represents payments on fixedinterest debt.

 

**(4)**               In conjunction withacquisitions, we have entered into employment agreements with certain keyemployees of the acquired companies.

 

**Critical Accounting Policies**

 

Inour Annual Report on Form 10-K for the year ended December 31, 2009, wedisclose accounting policies, referred to as critical accounting policies, thatrequire management to use significant judgment or that require significantestimates.  Management regularly reviewsthe selection and application of our critical accounting policies.  There have been no updates, other than thosestated below, to the critical accounting policies contained in our AnnualReport on Form 10-K for the year ended December 31, 2009.

 

***Goodwill***

 

Goodwillconsists of the excess of cost of acquired enterprises over the sum of theamounts assigned to identifiable assets acquired less liabilities assumed. Weassess goodwill for impairment on an annual basis at a reporting unit level. Areporting unit is a component of a segment that constitutes a business, forwhich discrete financial information is available, and for which the operatingresults are regularly reviewed by management. We have determined that ourreporting units are bankruptcy trustee management, corporate restructuring,eDiscovery, and settlement administration. Goodwill is assessed between annualtests if an event occurs or circumstances change that would more likely thannot reduce the fair value of a reporting unit below its carrying value. Theseevents or circumstances could include a significant change in the businessclimate, a change in strategic direction, legal factors, operating performanceindicators, a change in the competitive

 

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environment,the sale or disposition of a significant portion of a reporting unit, or futureeconomic factors such as unfavorable changes in our stock price and marketcapitalization or unfavorable changes in the estimated future discounted cashflows of our reporting units. Our annual test is performed as of July 31 eachyear, and there have been no events since the annual test to indicate that itis more likely than not that the recorded goodwill balance had become impaired.

 

Application of the goodwill impairment testrequires judgment, including the identification of reporting units, assignmentof assets and liabilities to reporting units, assignment of goodwill toreporting units, and determination of the fair value of each reporting unit. Weconsidered both a market approach and an income approach in order to develop anestimate of the fair value of each reporting unit for purposes of our annualimpairment test.  When evaluating themarket approach, we determined that directly comparable publicly-tradedcompanies did not exist, primarily due to the unique business modelcharacteristics and projected growth of each reporting unit. Instead, weutilized a discounted projected future cash flow analysis (income approach) todetermine the fair value of each reporting unit. Potential impairment isindicated when the carrying value of a reporting unit, including goodwill,exceeds its estimated fair value. This analysis requires significant judgments,including estimation of future cash flows, which is dependent on internalforecasts, estimation of the long-term rate of growth for our business,estimation of the useful life over which cash flows will occur, anddetermination of our weighted average cost of capital. Changes in theseestimates and assumptions could materially affect the determination of fairvalue and goodwill impairment for each reporting unit. In addition, financialand credit market volatility directly impacts our fair value measurementthrough our weighted average cost of capital, used to determine our discountrate, and through our stock price, used to determine our market capitalization.We may be required to recognize impairment of goodwill based on future economicfactors such as unfavorable changes in our stock price and marketcapitalization or unfavorable changes in the estimated future discounted cashflows of our reporting units.

 

Ifwe determine that the estimated fair value of any reporting unit is less thanthe reporting unit’s carrying value, then we proceed to the second step of thegoodwill impairment analysis to measure the potential impairment charge. Animpairment loss is recognized for any excess of the carrying value of thereporting unit’s goodwill over the implied fair value. If goodwill on ourcondensed consolidated balance sheet becomes impaired during a future period,the resulting impairment charge could have a material impact on our results ofoperations and financial condition.

 

Due to the current economic environment and theuncertainties regarding the impact that future economic impacts will have onour reporting units, there can be no assurances that our estimates andassumptions regarding the duration of the economic recession, or the period orstrength of recovery, made for purposes of our annual goodwill impairment test,will prove to be accurate predictions of the future. If our assumptionsregarding forecasted revenues or margins of certain of our reporting units arenot achieved, we may be required to record goodwill impairment losses in futureperiods. It is not possible at this time to determine if any such futureimpairment loss would occur, and if it does occur, whether such charge would bematerial.

 

Ourrecognized goodwill totaled $264.2 million as of September 30, 2010.  Goodwill allocated by reporting unit as ofSeptember 30, 2010 was:  eDiscovery $79.9million, settlement administration $32.9 million, corporate restructuring $76.5million, and trustee management $74.9 million. As of July 31, 2010, which isthe date of our most recent impairment test, the fair value of each of ourreporting units was substantially in excess of the carrying value of thereporting unit, except for the bankruptcy trustee management reporting unit,the fair value of this reporting unit exceeded its carrying value byapproximately 14%. The discount rate used in the income approach for thetrustee management reporting unit, evaluated at July 31, 2010, was 12.3%. Anincrease to the discount rate of 1% would have lowered the fair valuedetermined under the income approach for this reporting unit by approximately$12.0 million, or 12%, which, with all other variables remaining the same,would result in the fair value of this reporting unit exceeding its carryingvalue by 1%.

 

**Recently Adopted AccountingPronouncements**

 

In January 2010, the FASB issuedupdated guidance that requires entities to disclose separately the amounts ofsignificant transfers in and out of Level 1 and Level 2 fair value measurementsand describe the reasons for the transfers. In addition, the update requiresentities to present separately information about purchases, sales, issuances,and settlements in the reconciliation for fair value measurements usingsignificant unobservable inputs (Level 3). The disclosures related to Level 1and Level 2 fair value measurements are effective for us in 2010, and areincluded in Note 8. The update required new disclosures only, and had no impacton our consolidated financial position, results of operations, or cash flows.The disclosures related to Level 3 fair value measurements are effective for usin 2011. This update also only requires new disclosures, and will have noimpact on our consolidated financial position, results of operations, or cashflows.

 

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**Recently Issued AccountingPronouncements Not Yet Adopted**

 

In October 2009, theFASB issued new standards for revenue recognition with multiple deliverables.These new standards require entities to allocate revenue in an arrangementusing estimated selling prices of the delivered goods and services based on aselling price hierarchy. The amendments eliminate the residual method ofrevenue allocation and require revenue to be allocated using the relativeselling price method. These new standards are effective for us beginning in thefirst quarter of fiscal year 2011, however early adoption is permitted. We donot anticipate that the adoption of these standards will have a material impacton our consolidated financial statements.

 

In October 2009, theFASB issued new standards for the accounting for certain revenue arrangementsthat include software elements. These new standards amend the scope ofpre-existing software revenue guidance by removing from the guidancenon-software components of tangible products and certain software components oftangible products.  These new standardsare effective for us beginning in the first quarter of fiscal year 2011,however early adoption is permitted. We do not anticipate that the adoption ofthese standards will have a material impact on our consolidated financialstatements.

 

**Forward-Looking Statements**

 

Inthis report, in other filings with the SEC and in press releases and otherpublic 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 includestatements about our future business plans and strategies, and other statementsthat are not historical in nature.  Theseforward-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’sDiscussion and Analysis of Financial Condition and Results of Operations”section of this report.

 

Forward-lookingstatements may be identified by words or phrases such as “believe,” “expect,” “anticipate,”“should,” “planned,” “may,” “estimated,” “goal,” “objective” “seeks,” and “potential,”and variations of these words and similar expressions.  Section 27A of the Securities Act of1933, 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 involvefuture risks and uncertainties, listed below are a variety of factors thatcould cause actual results and experience to differ materially from theanticipated results or other expectations expressed in our forward-lookingstatements.  These factors include (1) anymaterial changes in our total number of client engagements and the volumeassociated with each engagement, (2) any material changes in our client’sdeposit portfolio or the services required or selected by our clients inengagements, (3) material changes in the number of bankruptcy filings,class action filings or mass tort actions each year, (4) risks associatedwith handling of confidential data and compliance with information privacylaws, (5) changes in or the effects of pricing structures andarrangements, (6) risks associated with the integration of acquisitionsinto our existing business operations, (7) risks associated withindebtedness, (8) risks associated with foreign currency fluctuations, (9) risksassociated with developing and providing software and internet-based technologysolutions to our clients, and (10) other risks detailed from time to timein our SEC filings, including our annual report on Form 10-K. In addition,there may be other factors not included in our SEC filings that may causeactual results to differ materially from any forward-looking statements. Weundertake no obligation to update publicly or revise any forward-lookingstatements contained herein to reflect future events or developments.

 

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**Item 3.   Quantitativeand Qualitative DisclosuresAbout Market Risk**

 

Theprincipal market risks to which we are exposed include interest rates under oursenior revolving credit facility, foreign exchange rates giving rise totranslation, and fluctuations in short-term interest rates on a portion of ourbankruptcy trustee revenue.

 

Intereston our senior revolving credit facility is generally based on a spread, not toexceed 325 basis points over the LIBOR rate. As of September 30, 2010, wehad borrowed $15.0 million under the senior revolving loan.

 

Weperformed a sensitivity analysis assuming a hypothetical 100 basis pointmovement in interest rates applied to the average daily borrowings of thesenior revolving loan. As of September 30, 2010, the analysis indicatedthat such a movement would not have a material effect on our consolidatedfinancial position, results of operations, or cash flows.

 

Wehave operations outside of the United States, therefore, a portion of ourrevenues and expenses are incurred in a currency other than U.S. dollars. We donot utilize hedge instruments to manage the exposures associated withfluctuating currency exchange rates.  Thecompany’s operating results are exposed to changes in exchange rates betweenthe U.S. dollar and the functional currency of the countries where we have operations.When the U.S. dollar weakens against foreign currencies, the dollar value ofrevenues and expenses denominated in foreign currencies increases. When theU.S. dollar strengthens, the opposite situation occurs.

 

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

 

**Item 4.           Controls and Procedures**

 

An evaluation was carried out by the Epiq Systems, Inc.’sChief Executive Officer and Chief Financial Officer of the effectiveness of thedesign and operations of the company’s disclosure controls and procedures asdefined in Exchange Act Rule 13a-15(e). Based on this evaluation, our management, including the CEO and CFO,concluded that our disclosure controls and procedures are effective.  Disclosure controls and procedures are designedto ensure that information required to be disclosed by the company in itsperiodic 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 informationrequired to be disclosed by the company in the reports that it files or submitsto the SEC is accumulated and communicated to company’s management, includingits principal executive and principal financial officers, or persons performingsimilar functions, as appropriate to allow timely decisions regarding requireddisclosure.

 

There have been no changes in our internal controlsover financial reporting during the quarter covered by this report that havematerially affected, or are reasonably likely to materially affect, ourinternal controls over financial reporting.

 

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**PART II - OTHER INFORMATION.**

 

**Item 1**.           **Legal Proceedings**

 

**PurportedDerivative Shareholder Complaint**

 

OnJuly 29, 2008, the Alaska Electrical Pension Fund filed a putativeshareholder derivative action on behalf of Epiq Systems, Inc. in the U.S.District Court for the District of Kansas (the “Court”) (Civil Action No. 08-CV-2344CM/JPO), alleging, among other things, improper conduct by each of our currentdirectors and certain current and former executive officers and directorsregarding stock option grants. The company has stated consistently that theclaims made in the action are meritless.

 

Alsoas previously reported, on April 27, 2010, on the determination of thecompany’s Board of Directors, the company entered into a Stipulation ofSettlement (the “Settlement Agreement”) with plaintiff and defendants relatingto the settlement of this litigation and mutual release of claims, and thecompany and its insurance carrier agreed to pay plaintiff’s counsel’s fees andexpenses, which totaled $3.5 million. On June 22, 2010, the Court enteredan order which, among other things, preliminarily approved the SettlementAgreement and scheduled a final hearing. On August 25, 2010, the Court entered a final order, dated August 24,2010, finally approving the Settlement and dismissing with prejudice thelawsuit and all claims contained therein (the “Final Order”). During the thirdquarter of 2010, the settlement amount, which had been fully accrued for inprior periods, was paid by the company and the insurance company. On or about September 24,2010, the Final Order became final and non-appealable because no appeal wasfiled prior to such date.

 

**Item 1A**.        **Risk Factors**

 

There have been no material changes in our Risk Factors from thosedisclosed in our Annual Report on Form 10-K for the year ended December 31,2009 other than those described below.

 

**Revenue in our segments can be driven from key business arrangementswith third parties including law firms, financial institutions, technologyconsultancies or other third parties where we serve the same ultimateconsumers. The modification of business terms, the projected conclusion, or terminationof any of those arrangements could cause uncertainty and adversely affect ourfuture revenue and earnings.**

 

Wehave various key arrangements in our businesses with law firms, technologyconsultancies and other third parties where we serve the same ultimateconsumers.  For example, as reported inour 2009 Annual Report on Form 10-K, we had an arrangement with IBM insupport of the federal government’s analog to digital conversion program whichrepresented 12% and 22% of our consolidated revenue in the years ended December 31,2009 and 2008, respectively. This specific arrangement concluded, as expected,in the second half of 2009. The modification of business terms, the intendedconclusion, or the unpredicted termination of key business arrangements couldcause uncertainty and adversely affect our future revenue or earnings.

 

**We may not pay cash dividends on our common stock in the future and ourcommon stock may not appreciate in value or even maintain the price at which itwas purchased.**

 

Althoughwe historically have not paid cash dividends on our common stock, we recentlystarted to pay cash dividends on our common stock in fiscal year 2010. There isno assurance that we will continue to pay cash dividends on our common stock inthe future. Certain provisions in our credit facility may restrict our abilityto pay dividends in the future.  Subjectto any financial covenants in current or future financing agreements thatdirectly or indirectly restrict the payment of dividends, the payment ofdividends is within the discretion of our board of directors and will dependupon our future earnings and cash flow from operations, our capitalrequirements, our financial condition and any other factors that the board ofdirectors may consider.  Unless wecontinue to pay cash dividends on our common stock in the future, the successof an investment in our common stock will depend entirely upon its futureappreciation.  Our common stock may notappreciate in value or even maintain the price at which it was purchased.

 

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

 

The following table presents the total number of shares purchasedduring the quarter ended September 30, 2010, the average price paid pershare, the number of shares that were purchased as part of a publicly announcedrepurchase program, and the maximum number (or approximate dollar value) of sharesthat may yet be purchased under a share repurchase program.

 

We have a share repurchaseprogram that authorizes us to purchase shares of common stock in order toincrease shareholder value. We also have a policy that requires shares to berepurchased by the company to satisfy tax withholding obligations upon thevesting of restricted stock awards.

 
| **Period**                                                    | ** ** | **Total Number of  Shares Purchased** | ** ** | **Average Price Paid per  Share(2)** | ** ** | **Total Number of  Shares Purchased as  Part of Publicly  Announced Plans or  Programs** | ** ** | **Maximum Number (or  Approximate Dollar  Value) of Shares that  May Yet Be Purchased  Under the Plans or  Programs(1)(2)** | ** ** |
|---------------------------------------------------------------|------------|------------------------------------------------------|------------|-----------------------------------------------------|------------|----------------------------------------------------------------------------------------------------------------------------------|------------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|
|                                                          |       |                                                 |       |                                                |       |                                                                                                                             |       |                                                                                                                                                                                    |       |
| July                                                          |       | 1,187,497                                            |       | $                                                   | 12.8885    |                                                                                                                             | 1,187,497  |                                                                                                                                                                                    | $          | 18,043,037 |   |
| August                                                        |       | 1,092,013                                            |       | $                                                   | 12.6081    |                                                                                                                             | 1,015,926  |                                                                                                                                                                                    | $          | 5,075,727 |   |
| September                                                     |       | —                                               |       | —                                              |       | —                                                                                                                           |       | $                                                                                                                                                                                       | —     |   |
|                                                          |       |                                                 |       |                                                |       |                                                                                                                             |       |                                                                                                                                                                                    |       |
| Total Activity for the Quarter Ended  September 30, 2010 |       | 2,279,510                                            |       | $                                                   | 12.8240    |                                                                                                                             | 2,203,423  |                                                                                                                                                                                    | $          | — |   |

 

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(1)   On June 23, 2010, our Board of Directors authorized $35.0million for share repurchases; we concluded this plan on August 27, 2010 witha remaining unused balance of $5,075,727.

 

(2)   Includes brokerage commissions paid by the Company.

 

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**Item 6**.         **Exhibits**

 
| 10.1   |   | Final  Judgment and Order of Dismissal with Prejudice dated August 24, 2010,  for approval of Stipulation of Settlement (Alaska Electrical Pension Fund v.  Tom W. Olofson, et al., Case No.: 08-CV-2344 CM/JPO) |
|--------|--------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |   |                                                                                                                                                                                                                  |
| 31.1   |   | Certifications  of Chief Executive Officer of the Company under Rule 13a-14(a), as  adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.                                                      |
|   |   |                                                                                                                                                                                                                  |
| 31.2   |   | Certifications  of Chief Financial Officer of the Company under Rule 13a-14(a), as  adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.                                                      |
|   |   |                                                                                                                                                                                                                  |
| 32.1   |   | Certifications  of CEO and CFO pursuant to 18 U.S.C. Section 1350.                                                                                                                                               |

 

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**SIGNATURES**

 

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

 
|                                          | **Epiq  Systems, Inc**.                         |
|-----------------------------------------------|------------------------------------------------------|
|                                          |                                                 |
| Date:    October 28, 2010 | /s/  Tom W. Olofson                                  |
|                                          | Tom  W. Olofson                                      |
|                                          | Chairman  of the Board                               |
|                                          | Chief  Executive Officer                             |
|                                          | Director                                             |
|                                          | (Principal  Executive Officer)                       |
|                                          |                                                 |
|                                          |                                                 |
| Date:    October 28, 2010 | /s/  Elizabeth M. Braham                             |
|                                          | Elizabeth  M. Braham                                 |
|                                          | Executive  Vice President, Chief Financial Officer   |
|                                          | (Principal  Financial & Accounting Officer) |

 

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