**UNITED STATES**

**SECURITIES AND EXCHANGE COMMISSION**

**Washington,D. C. 20549**

**FORM 10-K**

**ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d)**

**OF THE SECURITIES EXCHANGE ACT OF 1934**

**For the fiscal year ended****December 31, 2006**

**Commission file number****0-22081**

**EPIQ SYSTEMS, INC.**

(Exact name of registrantas specified in its charter)

| **Missouri**                               |   | **48-1056429**                        |
|--------------------------------------------|--------|---------------------------------------|
| (State or other  jurisdiction of           |   | (I.R.S. Employer  Identification No.) |
| incorporation or  organization)            |   |                                  |
| **501 Kansas Avenue, Kansas City, Kansas** |   | **66105-1300**                        |
| (Address of  principal executive office)   |   | (Zip Code)                            |

 

Registrant’s telephonenumber, including area code **(913) 621-9500**

Securities registeredpursuant to Section 12(b) of the Act: **None**

Securities registeredpursuant to Section 12(g) of the Act: **Common Stock, $.01 par value**

Indicate by check mark if the registrant is awell-known seasoned issuer, as defined in Rule 405 of the Securities Act.  Yes o   No x

Indicate by check mark if the registrant is notrequired to file reports pursuant to Section 13 or Section 15(d) ofthe Act.  Yes o   No x

Indicate by check mark whether the registrant (1) hasfiled all reports required to be filed by Section 13 or 15(d) of theSecurities Exchange Act of 1934 during the preceding 12 months (or for suchshorter period that the registrant was required to file such reports), and (2) hasbeen subject to such filing requirements for the past 90 days.  Yes x   No o

Indicate by check mark if disclosure of delinquentfilers pursuant to Item 405 of Regulation S-K (229.405 of this chapter) is notcontained herein, and will not be contained, to the best of registrant’sknowledge, in definitive proxy or information statements incorporated byreference in Part III of this Form 10-K or any amendment tothis Form 10-K. x

Indicate by checkmark whether the registrant is a large accelerated filer, an accelerated filer,or a non-accelerated filer. See definition of “accelerated filer and largeaccelerated filer” in Rule 12b-2 of the Exchange Act.

| Large Accelerated Filer o |   | Accelerated Filer x |   | Non-Accelerated  Filer o |
|--------------------------------|--------|--------------------------|--------|-------------------------------|

 

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

The aggregate market value of voting common stock heldby non-affiliates of the registrant (based upon the last reported sale price onthe Nasdaq Global Market), as of the last business day of the registrant’s mostrecently completed second fiscal quarter (June 30, 2006) was approximately$283,000,000.

There were 19,496,271 shares of common stock of theregistrant outstanding as of February 16, 2007.

Documentsincorporated by reference:  Theinformation required by Part III of Form 10-K is incorporatedherein by reference to the registrant’s definitive Proxy Statement relating toits 2007 Annual Meeting of Shareholders, which will be filed with theCommission within 120 days after the end of the registrant’s fiscal year.

 

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**EPIQ SYSTEMS, INC. ANNUAL REPORT ON FORM 10-K TABLE OF CONTENTS**

| **PART I**   |
|-------------------|
| **ITEM 1.**       | **Business** | **1** |
| **ITEM  1A.**     | **Risk  Factors** | **6** |
| **ITEM 1B.**      | **Unresolved Staff Comments** | **13** |
| **ITEM  2.**      | **Properties** | **13** |
| **ITEM  3.**      | **Legal  Proceedings** | **13** |
| **ITEM 4.**       | **Submission of Matters to a Vote of Security Holders** | **13** |
| **PART II**  |
| **ITEM 5.**       | **Market for the Registrant’s Common Equity, Related  Stockholder Matters and Issuer Purchases of Equity Securities** | **14** |
| **ITEM  6.**      | **Selected  Financial Data** | **18** |
| **ITEM 7.**       | **Management’s Discussion and Analysis of Financial  Condition And Results of Operation** | **20** |
| **ITEM 7A.**      | **Quantitative and Qualitative Disclosures About Market  Risk** | **36** |
| **ITEM 8.**       | **Financial Statements and Supplementary Data** | **37** |
| **ITEM 9.**       | **Changes in and Disagreements with Accountants on  Accounting and Financial Disclosure** | **38** |
| **ITEM 9A.**      | **Controls and Procedures** | **38** |
| **ITEM  9B.**     | **Other  Information** | **42** |
| **PART III** |
| **ITEM 10.**      | **Directors and Executive Officers of the Registrant** | **42** |
| **ITEM 11.**      | **Executive Compensation** | **42** |
| **ITEM 12.**      | **Security Ownership of Certain Beneficial Owners and  Management and Related Shareholder Matters** | **42** |
| **ITEM 13.**      | **Certain Relationships and Related Transactions** | **42** |
| **ITEM 14.**      | **Principal Accounting Fees and Services** | **42** |
| **PART IV**  |
| **ITEM 15.**      | **Exhibits and Financial Statement Schedules** | **43** |

 

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**CAUTIONARYSTATEMENT CONCERNING FORWARD-LOOKING STATEMENTS**

In this report, in other filings with the SEC and inpress releases and other public statements by our officers throughout the year,Epiq Systems, Inc. makes or will make statements that plan for oranticipate the future. These forward-looking statements include statementsabout our future business plans and strategies, and other statements that arenot historical in nature. These forward-looking statements are based on ourcurrent expectations. Many of these statements are found in the **“Business”** and **“Management’s Discussionand Analysis of Financial Condition and Results of Operation”**sections of this report.

Forward-looking statements may be identified by wordsor phrases such as “believe,” “expect,” “anticipate,” “should,” “planned,” “may,”“estimated,” “potential,” “goal,” and “objective.”  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. In order tocomply with the terms of the safe harbor, and because forward-lookingstatements involve future risks and uncertainties, listed in Item 1A, **“Risk Factors,”**of this report are a variety of factors that could cause actualresults and experience to differ materially from the anticipated results orother expectations expressed in our forward-looking statements. We undertake noobligation to update any forward-looking statements contained herein or infuture communications to reflect future events or developments.

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**PART I**

**ITEM 1.**                BUSINESS

**General**

Epiq Systems, Inc. is a provider oftechnology-based solutions for the legal and fiduciary services industries. Ourproducts and services assist clients with the administration of complex legalproceedings, including electronic discovery, bankruptcy administration andclass action administration. Our clients include law firms, corporate legaldepartments, bankruptcy trustees, and other professional advisors who requiresophisticated case administration and document management capabilities,extensive subject matter expertise and a high service capacity. We provideclients with an integrated offering of proprietary technology and value-addedservices that comprehensively address their extensive business requirements.

We were incorporated in the State of Missouri on July 13,1988, and on July 15, 1988 acquired all of the assets of an unrelatedpredecessor corporation.

As a part of our strategic business plan, we have madeseveral acquisitions and one disposition over the past five years. During 2006,we acquired the net assets of Gazes LLC to supplement our ability to provideclaims preference services for corporate restructuring clients. During 2005, weacquired nMatrix, Inc. to enter the market for electronic discovery andHilsoft, Inc. to enhance our capabilities in legal notification services. During2004, we acquired Poorman-Douglas Corporation to enter the market for classaction and mass tort administrative services and we completed the dispositionof our infrastructure software business, which was held for sale as of December 31,2003. During 2003, we acquired Bankruptcy Services LLC (BSI) to enter themarket for corporate restructuring administrative services. During 2002, weacquired the Chapter 7 trustee business of CPT Group, Inc.

Our trademarks include TCMS®, CasePower®, CasePower 13TM,DocumatrixTM, and eDatamatrixTM.

Our principal executiveoffice is located at 501 Kansas Avenue, Kansas City, Kansas 66105. Thetelephone number at that address is (913) 621-9500, and our websiteaddress is www.epiqsystems.com. We make available free of charge through ourinternet website our annual report on Form 10-K, our quarterlyreports on Form 10-Q, our current reports on Form 8-K andamendments to those reports filed with or furnished to the SEC as soon asreasonably practicable after we electronically file those reports with orfurnish them to the SEC, as well as our code of ethics and other governancedocuments. The public may read and copy materials filed by us with the SEC atthe SEC’s Public Reference Room at 100 F Street, NE, Washington, DC 20549.The public may obtain information on the operation of the Public Reference Room bycalling the SEC at 1-800-SEC-0330. The SEC maintains aninternet site that contains reports, proxy and information statements and otherinformation regarding issuers that file electronically with the SEC athttp://www.sec.gov. The contents of these websites are not incorporated intothis report. Further, our references to the URLs for these websites areintended to be inactive textual references only.

**IndustryEnvironment**

Both our case management and our document managementsegments provide products and services primarily to the legal and fiduciary services industries. Substantiallyall of our revenues are generated from services provided within the UnitedStates, and substantially all of our assets are located within the UnitedStates. Segment information related to revenues from external customers, ameasure of profit or loss, and total assets is contained in note 15 of thenotes to consolidated financial statements. Our clients include leading law firms, corporate legal departments,bankruptcy trustees, and other professional advisors, who use our services forthe administration of legal proceedings, such as electronic discovery,bankruptcy administration and class action administration.

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Our case and document management segments provide ourclients with a broad range of technology and service offerings to meet theunique needs and requirements of each matter. For example, a particular classaction matter may require professional services, call center support and claimsprocessing from our case management segment and a uniquely developed mediacampaign to provide notice to a class of unknown claimants and document custodyservices from our document management segment, while another class actionmatter may only require claims processing services from our case managementsegment and a simple class mailing notification to a class of known claimantsfrom our document management segment. Not all cases have the same businessrequirements, and our expanded technology and service offerings allow clientsto procure services from our broad range of case management and documentmanagement solutions.

Our case management and document management technologyand service offerings provide solutions primarily for the electronic discovery,bankruptcy, and class action markets. These technology and service offeringscan cross the various markets and customers we serve.

Each segment provides adistinct group of services and solutions to our customers. Both are critical toour business as many of our customers require both case management and documentmanagement solutions. By offering both groups of services, we can providecustomers with end-to-end solutions. Our customers typically have a large amountof discrete information to organize and process. Case management solutionsconsist of services to facilitate the “back-office” administration of cases forthe electronic discovery, bankruptcy, and class action markets. Documentmanagement solutions consist primarily of notification for bankruptcy and classaction customers.

*ElectronicDiscovery*

The substantial increaseof electronic documents in the business community has changed the dynamics ofhow attorneys support discovery in complex litigation matters. According to the2006 Socha-Gelbmann Electronic Discovery Survey, the 2005 domestic commercialelectronic discovery revenues were estimated at $1.3 billion, an approximate56% increase from 2004. According to this same source, the market is expected tocontinue to grow at a substantial rate from 2006 to 2008, with expectedincreases of approximately 30% to 35% each year. Due to the increasingcomplexity of cases, the increasing volume of data that are maintainedelectronically, and the increasing volume of documents that are produced in alltypes of litigation, law firms are increasingly reliant on electronic evidencemanagement systems to organize and manage the litigation discovery process.

*Bankruptcy*

Bankruptcy is an integral part of the United States’economy. As reported by the Administrative Office of the U.S. Courts for thegovernment fiscal years ended September 30, 2004, 2005, and 2006, therewere approximately 1.62 million, 1.78 million, and 1.11 million newbankruptcy filings, respectively.

There are fivechapters of the U.S. Bankruptcy Code that serve different purposes and requirevarious types of services and information. Our products and services aredesigned for cases filed under the following three chapters:

·       Chapter7 is a liquidation bankruptcy for individuals or businesses that, as measuredby the number of new cases filed in 2006, accounted for approximately 75% ofall bankruptcy filings. In a Chapter 7 case, the debtor’s assets are liquidatedand the resulting cash proceeds are used by the Chapter 7 bankruptcy trustee topay creditors. Chapter 7 cases typically last several years.

·       Chapter11 is a reorganization model of bankruptcy for corporations that, as measuredby the number of new cases filed in fiscal 2006, accounted for approximately 1%of all bankruptcy filings. Chapter 11 generally allows a company, oftenreferred to as the debtor-in-possession, to continue 

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operating under a plan ofreorganization to restructure its business and to modify payment terms of bothsecured and unsecured obligations. Chapter 11 cases may last several years.

·       Chapter13 is a reorganization model of bankruptcy for individuals that, as measured bythe number of new cases filed in 2006, accounted for approximately 24% of allbankruptcy filings. In a Chapter 13 case, debtors make periodic cash paymentsinto a reorganization plan and a Chapter 13 bankruptcy trustee uses these cashpayments to make monthly distributions to creditors. Chapter 13 cases typicallylast between three and five years.

The participants in abankruptcy proceeding include the debtor, the debtor’s counsel, the creditors,and the bankruptcy judge. Chapter 7 and Chapter 13 cases also have aprofessional bankruptcy trustee, who is responsible for administering thebankruptcy case.

*Class Action*

Class action and masstort refer to litigation in which class representatives bring a lawsuit againsta defendant company or other persons on behalf of a large group of similarlyaffected persons (the class). Mass action or mass tort refers to class actioncases that are particularly large or prominent. The class action and mass tortmarketplace is significant, with estimated annual tort claim costs ofapproximately $260 billion in 2004, according to an update study issued in 2004by Towers Perrin. Administrative costs, which include costs, other than defensecosts, incurred by either the insurance company or self-insured entity in theadministration of claims, comprise approximately 20% of this total. 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 action and mass tortlitigation is often complex and the cases, including administration of anysettlement, may last several years.

**Products andServices**

*Case ManagementSegment*

Case managementsupport for client engagements may last several years and has a revenue profilethat typically includes a recurring component. Our technology platform enablesour case management segment to generate revenue through the efficient provisionof the following services:

·       Datahosting fees, volume-based fees, and professional services fees related to themanagement of large volumes of electronic data in support of a legal proceeding.

·       Proprietaryelectronic discovery software that sorts, cleanses, organizes and performssearches on large databases in support of a legal proceeding.

·       Volume-basedfees related to software and postcontract customer support to facilitate theefficient administration of Chapter 7 and Chapter 13 bankruptcy cases.

·       Professionaland other support services related to the administration of cases, includingdata conversion, claims processing, claims reconciliation, professionalconsulting services, and settlement administration.

·       Callcenter support to process and respond to telephone inquiries related tocreditor and class action claims.

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*Document ManagementSegment*

Document managementrevenue is generally non-recurring due to the nature of the frequency, timingand magnitude of the clients’ business requirements. Our document managementsegment generates revenue primarily through the following services.

·       Legalnoticing services to parties of interest in bankruptcy and class actionmatters, including media campaign and advertising management, in which wecoordinate notification through various media outlets, such as print, radio andtelevision, to potential parties of interest for a particular clientengagement, and

·       Reimbursement for costsincurred related to postage on mailing services.

**Customers**

Our clients for both case management and documentmanagement segments include law firms, corporate legal departments, bankruptcytrustees and other professional advisors. Frequently, law firms act as referralsources for our services, which are ultimately consumed and paid for by acorporate client involved in litigation requiring our electronic discoveryservices, a bankruptcy proceeding, a class action settlement or other complexlitigation. We rely extensively on our network of law firm and in-housecorporate counsel relationships and expend considerable resources to developand extend those relationships.

For electronic discovery, our customers are typicallylarge corporations that use our products and services cooperatively with theirlegal counsel or other professional advisors to manage the electronic discoveryprocess for complex litigation matters.

For our Chapter 7 and Chapter 13 bankruptcy trusteeproducts, our end-user customers are professional bankruptcy trustees. The Executive Office for UnitedStates Trustees, a division of the U.S. Department of Justice, appoints allbankruptcy trustees. A United States Trustee is appointed in most federal courtdistricts and generally has responsibility for overseeing the integrity of thebankruptcy system. The bankruptcy trustee’s primary responsibilities includeliquidating the debtor’s assets or collecting funds from the debtor,distributing the collected funds to creditors pursuant to the orders of thebankruptcy court and preparing regular status reports for the Executive Officefor United States Trustees and for the bankruptcy court. Trustees typicallymanage an entire caseload of bankruptcy cases simultaneously.

The application of Chapter 7 bankruptcy regulationshas the practical effect of discouraging trustee customers from incurringdirect administrative costs for computer system expenses. As a result, weprovide our Chapter 7 products and services to trustee customers at no directcharge, and our trustee customers agree to maintain deposit accounts forbankruptcy cases under their administration at a designated banking institution.We have marketing arrangements with various banks under which we provideChapter 7 trustee case management software and related services and the bankprovides the Chapter 7 bankruptcy trustee with deposit-related banking services.Under these Chapter 7 deposit relationships, we receive revenue based primarilyon the aggregate amount of trustee deposits maintained at the bank. Prior to April 1,2004, we had an exclusive marketing arrangement with Bank of America forChapter 7 trustee software and services. Since April 1, 2004, we haveestablished new deposit relationships with additional financial institutions. Duringthe year ended December 31, 2006, a substantial majority of our Chapter 7trustee clients’ deposits were maintained at Bank of America. See note 9 of thenotes to consolidated financial statements.

Our customers for classaction and corporate restructuring are primarily large corporations that areadministering the settlement or resolution of class action cases and debtorcorporations or businesses that file a plan of reorganization. We sell ourservices directly to those customers; however, our relationships with otherinterested parties, including legal counsel, often provide access to thesecustomers.

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**Sales and Marketing**

Our sales executivesmarket our case management and document management products and servicesdirectly to prospective customers and referral law firms through on-site salescalls and through longstanding relationships. We focus on attracting andretaining customers by providing superior integrated technology solutions andby providing exceptional customer service. Our client support specialists areresponsible for providing ongoing support services for existing customers. Additionally,we maintain a website that clients and potential clients may access to obtainadditional information related to solutions we offer, various clientrelationship associates attend industry trade shows, and we conduct direct mailcampaigns and advertise in trade journals.

**Competition**

There are a variety ofcompanies competing, primarily on the basis of quality of service, technologyinnovations, and price, for the finite number of available client engagementsthat become available each year. Competitors include BMC Group, Inc.,Bankruptcy Management Solutions, Inc., Kurtzman Carson Consultants LLC,Electronic Evidence Discovery, Inc., Fios, Inc., The Garden CityGroup Inc., Kroll Ontrack, Inc., Rust Consulting Inc., The Trumbull Group,Zantaz, Lexis Nexis Applied Discovery and others. Additionally, certain law firms,accounting firms, management consultant firms, turnaround specialists andcrisis management firms offer certain products and services that compete withours.

**GovernmentRegulation**

Our products and services are not directly regulatedby the government. However, our bankruptcy trustee and corporate restructuringcustomers are subject to significant regulation under the United StatesBankruptcy Code (the Bankruptcy Code), the Federal Rules of BankruptcyProcedure and local rules and procedures established by bankruptcy courts.Additionally, the Executive Office for United States Trustees, a division ofthe United States Department of Justice, oversees the federal bankruptcy systemand establishes administrative rules governing our clients’ activities. Furthermore,class action and mass tort cases, as well as electronic discovery requirementsrelated to litigation, are subject to various federal and state laws, as wellas rules and procedures established by the courts.

In February 2005, new federal class action andtort reform legislation was passed by Congress and signed into law by PresidentBush. The primary impact of the new federal legislation is to require thatcertain types of class action lawsuits be brought in federal court rather thanstate courts. Based on the report “The Impact of the Class Action FairnessAct of 2005, Second Interim Report to the Judicial Conference AdvisoryCommittee on Civil Rules,” issued by the Federal Judicial Center in September 2006,this legislation has resulted in an increase in filings in federal districtcourts and/or removals from state courts to federal courts. The slowerprocessing of class action lawsuits in federal courts could delay the ultimatesettlement of those cases, which could adversely affect the timing of serviceswe provide in those cases. Similar to this recent federal legislation, therehave been various efforts at the state level to modify and reform the laws andprocedures related to class action and mass tort. We cannot predict the effect,if any, that state legislative action would have on the number or size of classaction and mass tort lawsuits filed or on the claims administration process.

In April 2005, the Bankruptcy Abuse Preventionand Consumer Protection Act of 2005 was passed by Congress and signed into lawby President Bush. The intent of this legislation, which became effective October 2005,is to move certain individual bankruptcy filings from Chapter 7, whichliquidates most of the debtor’s assets and discharges most of the debtor’sliabilities, to Chapter 13 which does not liquidate the debtor’s assets butwhich requires a debtor to pay disposable income to their creditors. Thelegislation also affects Chapter 11 bankruptcy filings, in part by restrictingthe period of time in which a debtor has the exclusive right to file and obtainacceptance of a plan of reorganization, accelerating the time frame within 

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which a debtor must acceptor reject executory contracts and unexpired leases, and potentially increasingcertain priority claims. While the bankruptcy reform legislation had the effectof a significant increase in bankruptcy filings prior to the effective date ofthe law in fiscal 2005 and a corresponding significant drop in bankruptcyfilings in fiscal 2006, this fluctuation in the number of filings did notappear to have any meaningful impact on our bankruptcy management business orrevenues because (i) the fluctuation in filings appear to have beenprimarily in “no asset” Chapter 7 cases, and (ii) a slight shift ofChapter 7 cases to Chapter 13 cases, neither of which had a material impact onour bankruptcy revenues.

In April 2006, theUnited States Supreme Court approved certain amendments to the Federal Rules ofCivil Procedure (“FRCP”) regarding the discovery in litigation of certain “electronicallystored information” (“ESI”). These amendments became effective on December 1,2006. Among other things, the FRCP amendments (i) require early attentionby parties in litigation to meet and confer regarding discovery issues and todevelop a discovery plan that identifies and addresses the parties’ ESI, (ii) expandthe reach of federal court subpoenas to include ESI, (iii) allow forparties to object to production of ESI that is not reasonably accessible due tothe undue burden or cost associated with such retrieval, and (iv) providea “safe harbor” to parties unable to provide ESI lost or destroyed as a resultof the routine, good-faith operation of an electronic information system. Whilethese federal rules do not apply in state court proceedings, the civilprocedure rules of many states have been closely modeled on theseprovisions. As a result of this new legislation, the electronic discoverymarket may experience an increase in volume and demand. However, these federaland state rules will continue to evolve and be subject to interpretationby courts. Therefore, we cannot predict the effect, if any, that thislegislation will have on our business in future years.

**Employees**

Asof December 31, 2006, we employed approximately 500 full-time employees,none of whom is covered by a collective bargaining agreement. We believe therelationship with our employees is good.

**ITEM 1A.**        RISK FACTORS

*This report, other reports to be filed by us with the SEC, press releasesmade by us and other public statements by our officers, oral and written,contain or will contain forward-looking statements within the meaning ofSection 27A of the Securities Act of 1933, as amended and Section 21Eof the Securities Exchange Act of 1934, as amended, including those relating tothe possible or assumed future results of operations and financial condition. Becausethose statements are subject to a number of uncertainties and risks, actualresults may differ materially from those expressed or implied by theforward-looking statements. Listed below are risks associated with aninvestment in our securities that could cause actual results to differ fromthose expressed or implied. If any of the following risks occurs, our business,financial condition, results of operations and prospects could be materiallyadversely affected.*

**We compete with other third party providers primarilyon the basis of the technological features and capabilities of our products andservices, and we could lose existing customers and fail to attract new businessif we do not keep pace with technological changes.**

The markets for case and document management productsand services are competitive, continually evolving and subject to technologicalchange. We believe that the principal competitive factors in the markets weserve include the breadth and quality of system and software solutionofferings, the stability of the information systems provider, the features andcapabilities of the product and service offerings, and the potential for futureproduct and service enhancements. Our success depends upon our ability to keeppace with technological change and to introduce, on a timely and cost-effectivebasis, new and enhanced software solutions and services that satisfy changingclient requirements and achieve market acceptance.

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**We have a limited number of clients and referralsources.**

We rely on a limited number of referral sources thatsupport new business engagements.  Ourfuture financial performance will depend on our ability to retain existingcustomer accounts, to attract business from new customers, to maintain ourexisting referral relationships, and to develop new referral relationships.

**Security problems with, or product liability claimsarising from, our software products and errors or fraud related to our businessprocesses could cause increased expense for litigation, increased service costsor damage to our reputation.**

We have included security features in our productsthat are intended to protect the privacy and integrity of data, includingconfidential client or consumer data. Security for our products is criticalgiven the confidential nature of the information our software processes. Oursoftware products and the systems on which the products are used may not beimpervious to intentional break-ins (“hacking”) or other disruptive disclosuresor problems, whether as a result of inadvertent third party action, employeeaction, malfeasance, or other. Hacking or other disruptive problems couldresult in the diversion of our development resources, damage to our reputation,increased service costs or impaired market acceptance of our products, any ofwhich could result in higher expenses or lower revenues. Additionally, we couldbe exposed to potential liability claims related to the unauthorized access toor release of confidential client or consumer data. Defending such liabilityclaims could result in increased expenses for litigation and/or claimsettlement and a significant diversion of our management’s attention.

Furthermore, we administer claims and provideprofessional services for third parties. Errors or fraud related to theprocessing or payment of these claims or errors related to the delivery ofprofessional services could result in the diversion of management resources,damage to our reputation, increased servicecosts or impaired market acceptance of our services, any of which could resultin higher expenses and/or lower revenues. Additionally, such errors or fraudcould result in lawsuits alleging damages. Defending such claims could resultin increased expenses for litigation and/or claims settlement and a significantdiversion of our management’s attention.

**Interruptions or delays in service related tothird-party facilities could impair the delivery of our service and harm ourbusiness.**

We provide certain of our services through computerhardware that is located in third-party facilities. We do not control theoperation of these facilities, and they are subject to damage or interruptionfrom earthquakes, floods, fires, power loss, terrorist attacks,telecommunications failures and similar events. They are also subject tobreak-ins, sabotage, intentional acts of vandalism and similar misconduct. Theoccurrence of any of these events, a decision to close a facility withoutadequate notice, or other unanticipated problems at a facility could result ininterruptions in certain of our services. In addition, the failure by ourvendor to provide our required data communications capacity could result ininterruptions in our service. Any damage to, or failure of, our systems couldreduce our revenue, cause us to issue credits or pay penalties, cause customersto terminate their agreements with us and adversely affect our ability tosecure business in the future. Our business will be harmed if our customers andpotential customers believe our services are unreliable.

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**New releases of oursoftware products may have undetected errors, which could cause litigationclaims against us or damage to our reputation.**

We intend to continue to issue new releases of oursoftware products periodically. Complex software products, such as those weoffer, can contain undetected errors when first introduced or as new versionsare released. Any introduction of new products and future releases has a riskof undetected errors. These undetected errors may be discovered only after aproduct has been installed and used either in our internal processing or by ourcustomers. Likewise, the software products we acquire in business acquisitionshave a risk of undetected errors.

Errors may be found in oursoftware products in the future. Any undetected errors, as well as anydifficulties in installing and maintaining our new software and releases ordifficulties training customers and their staffs on the utilization of newproducts and releases, may result in a delay or loss of revenue, diversion of developmentresources, damage to our reputation, increased service costs, increased expensefor litigation or claims settlement, or impaired market acceptance of ourproducts.

**We rely onthird-party hardware and software, which could cause errors or failures of ourservice.**

We rely on hardwarepurchased or leased and software licensed from third parties in order to offercertain services. Any errors or defects in third-party hardware or softwarecould result in errors in our software products or a failure of our servicewhich could harm our business.

**Substantially allof our Chapter 7 revenues are collected through a single financial institution,and the termination of that marketing arrangement could cause uncertainty andadversely affect our future Chapter 7 revenue and earnings.**

The application ofChapter 7 bankruptcy regulations discourages Chapter 7 trustees from incurringdirect administrative costs for computer system expenses. As a result, weprovide our products and services to Chapter 7 trustee customers at no directcharge, and our Chapter 7 trustee customers agree to deposit the cash proceedsfrom liquidations of debtors’ assets with a designated financial institutionwith which we have a Chapter 7 marketing arrangement. We have arrangements withseveral financial institutions under which our Chapter 7 trustees deposit theChapter 7 liquidated assets at one of those financial institutions. Under thesearrangements:

·       welicense our proprietary software to the trustee and furnish hardware,conversion services, training and customer support, all at no cost to thetrustee;

·       thefinancial institution provides certain banking services to the joint trusteecustomers; and

·       wecollect from the financial institution monthly revenues based primarily upon apercentage of the total liquidated assets on deposit at that financialinstitution.

These bankruptcy deposit-based fees are the largestcomponent of our Chapter 7 revenues.

Previously, we promoted our Chapter 7 productexclusively through a marketing arrangement established with Bank of America inNovember 1993. Substantially all of our Chapter 7 revenues are collectedthrough this relationship. On April 1, 2004, this exclusive marketingarrangement became a non-exclusive arrangement. During February 2006, theparties extended the non-exclusive arrangement indefinitely. Either party may,with appropriate notice, wind down the arrangement over a period of threeyears, including the notice period. If either party were to give notice oftermination of this arrangement, we could experience uncertainty relating tothe transfer of Chapter 7 trustee deposits to other financial institutions, andwe could experience a decline in revenues and earnings as those deposits aretransferred during the wind-down period.

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Chapter 7 revenues fromBank of America comprised 38%, 3% and 3% of our total revenue recognized forthe years ended December 31, 2006, 2005, and 2004, respectively. As of December 31,2005 and 2004, we had recorded on our consolidated balance sheets $59.7 million,and $35.2 million, respectively, of deferred revenue related to our arrangementwith Bank of America. There was no deferred revenue related to our arrangementwith Bank of America as of December 31, 2006.

**Our pricing modelsfor Chapter 7 trustee clients have or are scheduled to have a component ofpricing tied to prevailing interest rates, and a significant decline ininterest rates would adversely affect our revenues and earnings.**

Underthe Chapter 7 marketing arrangements we have with each depository financialinstitution, certain fees we earn for deposits placed with those financialinstitution could have, within certain limits, variability based onfluctuations in short-term interest rates. A significant decline in short-terminterest rates would adversely affect our Chapter 7 revenues and earnings.

**We depend upon ourkey personnel and we may not be able to retain them or to attract, assimilateand retain highly qualified employees in the future.**

Our future success maydepend upon the continued service of our senior management and certain of ourkey technical personnel and our continuing ability to attract, assimilate andretain highly qualified technical, managerial, and sales and marketingpersonnel. We do not have employment agreements with our Chief ExecutiveOfficer, President, or Chief Financial Officer. We maintain key-man lifeinsurance policies on our Chief Executive Officer and our President. The lossof the services of any of these executives or other key personnel or theinability to hire or retain qualified personnel in the future could have amaterial adverse impact on our results of operations.

**The integration ofacquired businesses is time consuming, may distract our management from ourother operations, and can be expensive, all of which could reduce or eliminateour expected earnings.**

During the five years ended December 31, 2006, weacquired eight businesses at a combined cost of approximately $330 million incash and stock. We may consider additional opportunities to acquire othercompanies, assets or product lines that complement or expand our business. Ifwe are unsuccessful in integrating these companies or product lines with ourexisting operations, or if integration is more difficult than anticipated, wemay experience disruptions to our operations. A difficult or unsuccessfulintegration of an acquired business would likely have a material adverse effecton our results of operations.

Some of the risksthat may affect our ability to integrate or realize any anticipated benefitsfrom companies we acquire include those associated with:

·       unexpectedlosses of key employees or customers of the acquired business;

·       conformingstandards, processes, procedures and controls of the acquired business with ouroperations;

·       increasingthe scope, geographic diversity and complexity of our operations;

·       difficultiesin transferring processes and know-how;

·       difficultiesin the assimilation of acquired operations, technologies or products;

·       diversionof management’s attention from other business concerns;

·       adverseeffects on existing business relationships with customers; and

·       the challenges of operatinginternationally.

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**Our intellectualproperty is not protected through patents or formal copyright registration. Therefore,we do not have the full benefit of patent or copyright laws to prevent othersfrom replicating our software.**

Our intellectual propertyrights are not protected through patents or formal copyright registration. Wemay not be able to protect our trade secrets or prevent others from independentlydeveloping substantially equivalent proprietary information and techniques orfrom otherwise gaining access to our trade secrets. In addition, foreignintellectual property laws may not protect our intellectual property rights. Moreover,litigation may be necessary to enforce our intellectual property rights, toprotect our trade secrets, to determine the validity and scope of theproprietary rights of others or to defend against claims of infringements. Litigationof this nature could result in substantial expense for us and diversion ofmanagement and other resources, which could result in a loss of revenue andprofits.

**We may be sued bythird parties for alleged infringement of their proprietary rights.**

The software and internetindustries are characterized by the existence of a large number of patents,trademarks, and copyrights and by frequent litigation based on allegations ofinfringement or other violations of intellectual property rights. We havereceived in the past, and may receive in the future, communications from thirdparties claiming that we have infringed on the intellectual property rights ofothers. Our technologies may not be able to withstand any third-party claims orrights against their use. Any intellectual property claims, with or withoutmerit, could be time-consuming and expensive to resolve, could divertmanagement attention from executing our business plan, and could require us topay monetary damages or enter into royalty or licensing agreements. Inaddition, certain customer agreements require us to indemnify our customers forthird-party intellectual property infringement claims, which would increase thecost to us of an adverse ruling on such a claim. An adverse determination couldalso prevent us from offering our service to others.

**Compliance withchanging regulation of corporate governance and public disclosure may result inadditional expenses and diversion of management time and attention fromoperational activities to compliance activities.**

Compliance with changing laws, regulations andstandards relating to corporate governance and public disclosure, including theSarbanes-Oxley Act of 2002, new SEC regulations, and Nasdaq Global Marketrules, are time consuming and expensive. Since 2002, we have spent substantialamounts of management time and have incurred substantial legal and accountingexpense in complying with the Sarbanes-Oxley Act and regulatory initiativesresulting from that Act. Complying with these new laws and regulations alsocreates uncertainty for companies such as ours. These new or changed laws,regulations and standards are subject to varying interpretations, in many casesdue to their lack of specificity. As a result, their application in practicemay evolve over time as new guidance is provided by regulatory and governingbodies, which could result in continuing uncertainty regarding compliancematters and higher costs necessitated by ongoing revisions to disclosure andgovernance practices.

We are committed to maintaining high standards ofcorporate governance and public disclosure. As a result, our efforts to complywith evolving laws, regulations and standards have resulted in, and are likelyto continue to result in, increased general and administrative expenses and adiversion of management time and attention from revenue-generating activitiesto compliance activities. In particular, our efforts to comply with Section 404of the Sarbanes-Oxley Act of 2002 and the related regulations regarding ourrequired assessment of our internal controls over financial reporting and ourexternal auditors’ certification of that assessment have required thecommitment of significant financial and managerial resources. We expect theseefforts to require the continued commitment of significant resources.

SEC rules implementingSection 404 of Sarbanes-Oxley require disclosure of the remediation ofsignificant deficiencies or material weaknesses in internal controls overfinancial reporting and the 

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existence,at year-end, of material weaknesses related to our internal control overfinancial reporting. During 2006, we restated certain previously issuedconsolidated and condensed consolidated financial statements. Related to thisrestatement, we identified a material weakness, which was remediated prior to December 31,2006, related to our 2005 consolidated financial statements. If we havematerial weaknesses in our internal control over financial reporting or arestatement in the future, the price of our common stock could be adverselyaffected.

**Our quarterlyresults have fluctuated in the past and may fluctuate in the future. If theydo, our operating results may not meet the expectations of securities analystsor investors. This could cause fluctuations in the market price of our commonstock.**

Our quarterly results have fluctuated during the pastand may fluctuate in the future. Our quarterly revenues and operating resultsare increasingly difficult to forecast. It is possible that our futurequarterly results from operations from time to time will not meet theexpectations of securities analysts or investors. This could cause a materialdrop in the market price of our common stock.

Our business willcontinue to be affected by a number of factors, any one of which couldsubstantially affect our results of operations for a particular fiscal quarter.Specifically, our quarterly results from operations can vary due to:

·       the initiation ortermination of a large corporate restructuring, class action or electronicdiscovery engagement;

·       thetiming, size, cancellation or rescheduling of customer orders;

·       fluctuationsin bankruptcy trustees’ deposit balances;

·       unanticipatedexpenses related to software maintenance or customer service; and

·       unexpected legal orregulatory expenses.

**Our stock price maybe volatile even if our quarterly results do not fluctuate significantly.**

If our quarterlyresults fluctuate, the market price for our common stock may fluctuate as welland those fluctuations may be significant. Even if we report stable orincreased earnings, the market price of our common stock may be volatile. Thereare a number of factors, beyond earnings fluctuations, that can affect themarket price of our common stock, including the following:

·       adecrease in market demand for our stock;

·       downwardrevisions in securities analysts’ estimates;

·       announcementsof technological innovations or new products developed by us or ourcompetitors;

·       thedegree of customer acceptance of new products or enhancements offered by us;and

·       generalmarket conditions and other economic factors.

In addition, the stock market has experienced significantprice and volume fluctuations that have particularly affected the market pricesof stocks of technology companies and that have often been unrelated to theoperating performance of particular companies. The market price of our commonstock has been volatile and this is likely to continue.

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**We do not pay cashdividends on our common stock and our common stock may not appreciate in valueor even maintain the price at which it was purchased.**

We presently do not intendto pay any cash dividends on our common stock. In addition, certain terms of ourconvertible notes restrict our payment of dividends while the subordinatedconvertible debt is outstanding, and certain provisions in our credit agreementmay restrict our ability to pay dividends in the future. Subject to anyfinancial covenants in current or future financing agreements that directly orindirectly restrict the payment of dividends, the payment of dividends iswithin the discretion of our board of directors and will depend upon our futureearnings, if any, our capital requirements, our financial condition and anyother factors that the board of directors may consider. We currently intend toretain all earnings to reduce our debt and for use in the operation andexpansion of our business. As a result, the success of an investment in our commonstock will depend entirely upon its future appreciation. Our common stock maynot appreciate in value or even maintain the price at which it was purchased.

**The use of ourcommon stock to fund acquisitions or to refinance debt incurred for acquisitionscould dilute existing shares.**

We have used our common stock to partly fundacquisitions and to refinance debt. During June 2004, we issued $50million of convertible notes, which are convertible into approximately 2.9million shares of common stock, to refinance a portion of the purchase pricefor the January 2004 Poorman-Douglas acquisition. During November 2005,we issued approximately 1.2 million shares of common stock in connection withour nMatrix acquisition. We may consider issuing additional common shares andusing the proceeds to pay part or all of our indebtedness.

We may consider furtheropportunities to acquire companies, assets or product lines that complement orexpand our business. We expect that future acquisitions, if any, could providefor consideration to be paid in cash, shares of our common stock, or acombination of cash and shares. If the consideration for an acquisition is paidin common stock, existing shareholders’ investments could be diluted. Furthermore,we may decide to issue convertible debt or additional shares of common stockand use part or all of the proceeds to finance or refinance the costs of anypast or future acquisitions.

**In certaincircumstances, we may be obligated to pay one of our shareholders thedifference between $20.35 per share and any lower price at which thatshareholder sells up to 1,228,501 shares of our common stock, which couldadversely affect our liquidity or the market price of our common stock.**

We issued to the former owner of nMatrix 1.2 millionshares of our common stock as a part of the purchase price for the nMatrixbusiness. We are required to maintain an effective registration statement forthe resale of those shares by that shareholder until November 15, 2007. Ouragreement with that shareholder includes a limited price protection provision,which provides that if the shareholder sells any of those shares pursuant tothe registration statement at a per share price (before commissions and othertransaction expenses) lower than $20.35, we will pay that selling shareholderan amount in cash equal to the number of shares sold by the shareholdermultiplied by the difference between the $20.35 minus the sale price. Thelimited price protection will terminate permanently upon the earlier oftermination of our obligation to maintain the effectiveness of the registrationstatement or, during the period of the effectiveness of the registrationstatement, after any 15 trading days (which need not be consecutive tradingdays) on which both of the following conditions are satisfied:  (1) the shareholder may lawfully sellshares under the registration statement, and (2) the closing price for ourcommon stock has been equal to or greater than $20.35 per share. Payments underthis provision would adversely affect our liquidity.

As a result of theimminent expiration of either the limited price protection, the shareholder maychoose to sell all or substantially all the shares of our common stock thenheld by that shareholder subject to these agreements. Those sales couldadversely affect the market price of our common stock at that time.

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**Our articles ofincorporation and Missouri law contain provisions that could be used by us todiscourage or prevent a takeover of our company.**

Some provisions of our articles of incorporation couldmake it more difficult for a third party to acquire control of our company,even if the change of control would be beneficial to certain shareholders. Forexample, our articles of incorporation include “blank check” preferred stockprovisions, which permit our board of directors to issue one or more series ofpreferred stock without shareholder approval. In conjunction with the issuanceof a series of preferred stock, the board is authorized to fix the rights ofthat series, including voting rights, liquidation preferences, conversionrights and redemption privileges. The board could issue a series of preferredstock to a friendly investor and use one or more of these features of thepreferred stock to discourage or prevent a takeover of the company. Additionally,our articles of incorporation do not permit cumulative voting in the electionof directors. Cumulative voting, if available, would enable minorityshareholders to elect one or more representatives to the board in certaincircumstances, which could be used by third parties to facilitate a takeover ofour company that was opposed by our board or management.

In addition, the Generaland Business Corporation Law of Missouri, under which we are incorporated,provides that any merger involving the company must be approved by the holdersof not less than two-thirds of the outstanding shares of capital stock entitledto vote on the merger. Presently, our only outstanding voting securities areour shares of common stock. Accordingly, shareholders with voting power over aslittle as one-third of our outstanding common stock could block a mergerproposal, even if that merger proposal were supported by our board of directorsor shareholders holding a majority of our then outstanding shares of commonstock.

**ITEM 1B.**       UNRESOLVEDSTAFF COMMENTS

None.

**ITEM 2.**                PROPERTIES

Our corporate headquartersare located in a 49,000-square-foot facility in Kansas City, Kansas.This owned property serves as collateral under our credit facility. We alsohave significant corporate offices in New York City and in metropolitanPortland, Oregon, and maintain smaller offices in Chicago, Miami, Washington,D.C., Los Angeles, Philadelphia and London.

**ITEM 3.**                LEGALPROCEEDINGS

We occasionally becomeinvolved in litigation arising in the normal course of business. There is nocurrently pending or, to the knowledge of management, threatened materiallitigation against us.

**ITEM 4.**                SUBMISSIONOF MATTERS TO A VOTE OF SECURITY HOLDERS

No matters were submitted in the fourth quarter of2006 to a vote of security holders.

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**PART II**

**ITEM5.**                MARKET FOR THEREGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OFEQUITY SECURITIES

**Market Information**

Ourcommon stock is traded under the symbol “EPIQ” on the Nasdaq Global Market. Thefollowing table shows the reported high and low sales prices for the commonstock for the calendar quarters of 2006 and 2005 as reported by Nasdaq:

| ** **     | ** ** | **2006** | ** ** | **2005** | ** ** |
|----------------|------------|----------|------------|----------|------------|
| ** **     | ** ** | **High** | ** ** | **Low**  | ** ** | **High** | ** ** | **Low** | ** ** |
| First Quarter  |       | $        | 23.40      |     | $          | 18.05 |   | $ | 15.00 |   | $ | 12.05 |   |
| Second Quarter |       | 19.13    |       | 14.82    |       | 16.97 |   | 12.90 |   |
| Third Quarter  |       | 17.13    |       | 14.52    |       | 22.22 |   | 16.13 |   |
| Fourth Quarter |       | 17.60    |       | 14.31    |       | 22.44 |   | 17.21 |   |
|                |            |          |            |          |            |  |  |  |  |  |  |  |  |

 

**Holders**

As of February 21,2007, there were approximately 100 owners of record of our common stock andapproximately 5,800 beneficial owners of our common stock.

**Dividends**

At this time, we intend toretain our earnings to reduce our debt and for use in the operation andexpansion of our business. Accordingly, we do not expect to declare or pay anycash dividends in the foreseeable future. Under the terms of our subordinatedconvertible debt agreement, we are restricted from payment of dividends whilethe subordinated convertible debt is outstanding. Thereafter, the payment ofdividends is within the discretion of our board of directors and will depend uponvarious factors, including future earnings, capital requirements, financialcondition, the terms of our credit agreement, and other factors deemed relevantby the board of directors. Various financial covenants in our credit agreementmay have the effect of limiting the ability of our board of directors todeclare and pay cash dividends on our common stock. There is no restriction onthe ability of our subsidiaries to transfer funds to Epiq in the form of cashdividends, loans or advances.

**Equity Compensation Plan Information**

Thefollowing table sets forth as of December 31, 2006 (a) the number ofsecurities to be issued upon exercise of outstanding options, warrants andrights, (b) the weighted average exercise price of outstanding options,warrants and rights and (c) the number of securities remaining availablefor future issuance under equity compensation plans (excluding securitiesreflected in column (a)).

| *** ***                                                    | *** *** | ***(a)***                                                                                                                                                              | *** *** | ***(b)***                                                                                                   | *** *** | ***(c)***                                                                                                                                                                                                    | *** *** |
|-----------------------------------------------------------------|--------------|------------------------------------------------------------------------------------------------------------------------------------------------------------------------|--------------|-------------------------------------------------------------------------------------------------------------|--------------|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|--------------|
| **Plan Category**                                          | ** **   | **Number of securities to  be issued upon exercise  of outstanding options,     warrants and rights** | ** **   | **Weighted-average  exercise price of  outstanding options,  warrants and rights** | ** **   | **Number of securities  remaining available for  future issuance under  equity compensation  plans (excluding  securities reflected in  column (a))** | ** **   |
| **Equity compensation plans  approved by security holders**     |         |                                                                                                                                                                   | 4,633,000    |                                                                                                        |         |                                                                                                                                                                                                         | $            | 14.30 |   |   |   | 2,204,000 |   |   |
| **Equity  compensation plans not approved by security holders** |         |                                                                                                                                                                   | 690,000      |                                                                                                        |         |                                                                                                                                                                                                         | $            | 17.89 |   |   |   | — |   |   |
| **Total**                                                       |         |                                                                                                                                                                   | 5,323,000    |                                                                                                        |         |                                                                                                                                                                                                         | $            | 14.76 |   |   |   | 2,204,000 |   |   |

 

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As of December 31, 2006, equity compensationplans approved by security holders consist of our 1995 Stock Option Plan andour 2004 Equity Incentive Plan, both as amended. Securities remaining availablefor future issuance under equity compensation plans approved by security holdersconsist solely of shares available under the 2004 Equity Incentive Plan. Securitiesremaining available for future issuance under our 2004 Equity Incentive Planmay be issued, in any combination, as incentive stock options, non-qualifiedstock options, stock appreciation rights or restricted stock.

As of December 31, 2006, equity compensationplans not approved by security shareholders consist of stock options issued inconjunction with (i) our acquisitions of BSI, Poorman-Douglas, andnMatrix, and (ii) the recruitment of two new executive officers in 2006. The stock options issued to key employees ofBSI, Poorman-Douglas, and nMatrix were inducement stock options issued inconjunction with the execution of employment agreements with each of those keyemployees to become employees of our newly acquired subsidiaries. Similarly,the stock options granted to two new executive officers that we recruited in2006 as part of a national search efforts were inducement stock options issuedin conjunction with the negotiation of their employment letters. In accordancewith the Nasdaq corporate governance rules, shareholder approval of each ofthese inducement stock option grants was not required.

The stock options grantedunder equity compensation plans not approved by security holders were grantedat option exercise prices equal to fair market value of the common stock on thedate of grant, are non-qualified options, are exercisable for up to 10 yearsfrom the date of grant, and otherwise have terms substantially identical to thematerial terms of the 1995 Stock Option Plan and the 2004 Equity Incentive Plan.Additional information related to the equity compensation plans not approved bysecurity holders is contained in note 12 of the notes to consolidated financial statements.

**Recent Sales ofUnregistered Securities**

None.

**Purchases of EquitySecurities by the Issuer and Affiliated Purchasers**

None.

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**Performance Graph**

*The following Performance Graphs and relatedinformation shall not be deemed “soliciting material” or to be “filed” with theSecurities and Exchange Commission, nor shall such information be incorporatedby reference into any future filing under the Securities Act of 1933 orSecurities Exchange Act of 1934, each as amended, except to the extent that wespecifically incorporate it by reference into such a filing.*

The following graphs show the total shareholder returnof an investment of $100 in cash for (i) Epiq’s common stock, (ii) the NasdaqStock Market Computer and Data Processing Services Index (the “Nasdaq ComputerIndex”), and (iii) the Standard & Poor’s 500 Index (the “S&P 500Index”) for our last five fiscal years (December 31, 2001 through December 31,2006) and for the period beginning on the date of our initial public offeringthrough the end of the last fiscal year (February 4, 1997 through December 31,2006).  All values assume reinvestment ofthe full amount of any dividends.  TheNasdaq Computer Index and the S&P 500 Index are calculated by Standard& Poor’s Institutional Market Services.

The five-year graphassumes that $100.00 was invested in our common stock on December 31, 2001, atthe price of $19.35 per share, the closing sales price on that date.  The second graph assumes that $100.00 wasinvested in our common stock on February 4, 1997, the date of our initialpublic offering, at the price of $1.39 per share, the closing sales price onthat date (after giving effect to the stock splits and stock dividends paid byEpiq).  The closing sales prices were usedfor each index on December 31, 2001 or February 4, 1997, as applicable, and alldividends were reinvested.  No cashdividends have been declared on our common stock.  Shareholder returns over the indicated periodshould not be considered indicative of future shareholder returns.

**Five-Year PerformanceGraphCOMPARISON OF CUMULATIVE TOTAL RETURNAMONG EPIQ SYSTEMS, INC.,S&P 500 INDEX AND NASDAQ COMPUTER & DATA PROCESSING**

 

ASSUMES $100 INVESTED ONDEC. 31, 2001ASSUMES DIVIDEND REINVESTEDFISCAL YEAR ENDING DEC. 31, 2006

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**Performance GraphSince Initial Public OfferingCOMPARISON OF CUMULATIVE TOTAL RETURNAMONG EPIQ SYSTEMS, INC.,S&P 500 INDEX AND NASDAQ COMPUTER & DATA PROCESSING**

ASSUMES $100INVESTED ON FEB. 4, 1997ASSUMES DIVIDEND REINVESTEDFISCAL YEAR ENDING DEC. 31, 2006

 

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**ITEM 6.**                SELECTEDFINANCIAL DATA

Thefollowing table presents selected historical financial data for the years endedDecember 31, 2006, 2005, 2004, 2003, and 2002.

| ** **                                        | ** ** | **Years Ended December 31,**                        | ** ** |
|---------------------------------------------------|------------|--------------------------------------------------------------------|------------|
| ** **                                        | ** ** | **2006**                                                           | ** ** | **2005** | ** ** | **2004** | ** ** | **2003** | ** ** | **2002** | ** ** |
| ** **                                        | ** ** | **(In Thousands, Except Per Share Data)** | ** ** |
| INCOME  STATEMENT DATA:                           |       |                                                               |       |   |   |   |   |   |   |   |   |
| Total revenue from continuing operations          |       | $                                                                  | 224,170    |   | $ | 106,330 |   | $ | 98,368 |   | $ | 59,780 |   | $ | 36,256 |   |
| Income (loss) from continuing operations          |       | 35,131                                                             |       | (3,842 | ) | (7,290 | ) | 9,595 |   | 9,766 |   |
| Income (loss) from discontinued operations        |       | —                                                             |       | — |   | 667 |   | (5,818 | ) | (1,533 | ) |
| Net income (loss)                                 |       | 35,131                                                             |       | (3,842 | ) | (6,623 | ) | 3,777 |   | 8,233 |   |
| Income  (loss) per share—Diluted             |       |                                                               |       |   |   |   |   |   |   |   |   |
| from continuing operations                        |       | $                                                                  | 1.58       |   | $ | (0.21 | ) | $ | (0.41 | ) | $ | 0.53 |   | $ | 0.64 |   |
| from discontinued operations                      |       | $                                                                  | —     |   | $ | — |   | $ | 0.04 |   | $ | (0.32 | ) | $ | (0.10 | ) |
| Net income (loss) per  share—Diluted         |       | $                                                                  | 1.58       |   | $ | (0.21 | ) | $ | (0.37 | ) | $ | 0.21 |   | $ | 0.54 |   |
| BALANCE SHEET DATA:                               |       |                                                               |       |   |   |   |   |   |   |   |   |
| Working capital related to continuing  operations |       | $                                                                  | (45,864    | ) | $ | (25,090 | ) | $ | 22,979 |   | $ | 39,023 |   | $ | 63,503 |   |
| Total assets                                      |       | 382,220                                                            |       | 418,471 |   | 244,317 |   | 143,186 |   | 108,037 |   |
| Long-term debt                                    |       | 83,873                                                             |       | 145,906 |   | 74,499 |   | 3,066 |   | 289 |   |
| Stockholders’  equity                        |       | 184,179                                                            |       | 140,468 |   | 118,550 |   | 124,325 |   | 102,375 |   |

 

During July 2002, we acquired the Chapter 7trustee business of CPT Group, Inc. The acquisition was accounted forusing the purchase method of accounting with the operating results of CPT Groupincluded in our statements of operations since the date of acquisition.

During November 2002, wecompleted a private placement of 2,000,000 shares of common stock and receivednet proceeds of $28.1 million.

During January 2003, weacquired the member interests of BSI. The acquisition was accounted for usingthe purchase method of accounting with the operating results of BSI included inour statements of operations since the date of acquisition.

In October 2003 we enteredinto a three-year arrangement related to our Chapter 7 bankruptcy trusteebusiness that included various elements which had previously been provided on astandalone basis. As a result, for the final quarter of 2003 and for the yearsended December 31, 2005 and 2004 we deferred substantially all of ourChapter 7 bankruptcy trustee revenue. The $59.7 million of revenuedeferred during these periods related to this arrangement was recognized duringthe year ended December 31, 2006. The effect of this was to:  (i) reduce revenue recognized for theyears ended December 31, 2005, 2004 and 2003 with a corresponding increasein revenue recognized for the year ended December 31, 2006; (ii) substantiallydecrease net income for the year ended December 31, 2003 and increase ournet loss for the years ended December 31, 2005 and 2004, with acorresponding increase in net income for the year ended December 31, 2006;and (iii) substantially decrease our working capital as of December 31,2005.

During November 2003, thedecision was made to dispose of our infrastructure software business and thebusiness was sold in April 2004. Accordingly, all revenues, cost of sales,operating expenses, assets and liabilities related to infrastructure softwarehave been reclassified as discontinued operations for all periods presented. Seenote 14 of the notes to consolidated financial statements.

During January 2004, weacquired the equity of P-D Holding Corp. and its wholly-owned operatingsubsidiary, Poorman-Douglas Company (Poorman-Douglas). The acquisition wasaccounted for using the 

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purchasemethod of accounting with the operating results of Poorman-Douglas included inour statement of operations since the date of acquisition. See note 13 of thenotes to consolidated financial statements.

During October 2005, weacquired the equity of Hilsoft, Inc. (Hilsoft). The acquisition wasaccounted for using the purchase method of accounting with the operatingresults of Hilsoft included in our statement of operations since the date ofacquisition. See note 13 of the notes to consolidated financial statements.

During November 2005, weacquired the equity of nMatrix, Inc. and nMatrix Australia Pty. Ltd. (collectively,nMatrix). The acquisition was accounted for using the purchase method ofaccounting with the operating results of nMatrix included in our statement ofoperations since the date of acquisition. See note 13 of the notes toconsolidated financial statements.

On January 1, 2006, we adopted SFAS No. 123R,*Share-Based Payment*. We elected to adoptSFAS No. 123R using the modified version of prospective application. Usingthis method, we recognized compensation costs related to share-basedcompensation beginning January 1, 2006. Compensation costs related toshare-based compensation for periods ended on or before December 31, 2005are reflected on a pro forma basis. See note 12 of the notes to theconsolidated financial statements. As a result of our adoption of SFAS No. 123R,during the year ended December 31, 2006 we recognized approximately $5.4 millionof expense related to share options issued prior to but unvested as of January 1,2006 as well as expense related to share options issued subsequent to January 1,2006.

During May 2006, weacquired the net assets of Gazes LLC and placed these assets in a newly formedsubsidiary, Epiq Advisory Services. The acquisition was accounted for using thepurchase method of accounting with the operating results of Epiq AdvisoryServices included in our statement of operations since the date of acquisition.See note 13 of the notes to consolidated financial statements.

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**ITEM 7.**                MANAGEMENT’SDISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATION

This discussion andanalysis should be read in conjunction with the consolidated financialstatements and the accompanying notes to the consolidated financial statementsincluded in this Form 10-K.

**Management’sOverview**

Epiq is a provider of technology-based solutions forthe legal and fiduciary services industries. Our products and services assistclients with the administration of complex legal proceedings, includingelectronic litigation discovery, bankruptcy administration and class actionadministration. We have two operating segments: case management and documentmanagement.

Our case management segment generates revenueprimarily through integrated technology-based products and services thatsupport client engagements for electronic discovery, class action and masstort, and bankruptcy proceedings that can last several years and has a revenueprofile that typically includes a recurring component. Our document managementsegment generates revenue primarily through legal noticing services,reimbursement for costs incurred related to postage on mailing services, mediacampaign and advertising management and document custody services. Documentmanagement revenue is generally less recurring due to the unpredictable natureof the frequency, timing, and magnitude of the clients’ business requirements.

The number of new bankruptcy filings each year mayvary based on the level of consumer and business debt, the general economy,interest rate levels and other factors. For the government fiscal years ended September 30,2004, 2005, and 2006, the Administrative Office of the U.S. Courts reported approximately1.62 million, 1.78 million, and 1.11 million new bankruptcyfilings, respectively. We believe an important indicator of futurebankruptcy filings is the level of consumer and business debt outstanding. Themost recent available Federal Reserve *Flow of Funds Accounts ofthe United States*, dated December 7, 2006, reported increasesin both consumer and business debt outstanding as compared with the same periodof the prior year.

For our Chapter 7 bankruptcy services, our end-usercustomers are professional bankruptcy trustees. The application of Chapter 7 bankruptcy regulations has thepractical effect of discouraging trustee customers from incurring directadministrative costs for computer system expenses. As a result, we provide ourChapter 7 services to trustee customers at no direct charge, and our trusteecustomers maintain deposit accounts for bankruptcy cases under theiradministration at a designated banking institution. We have marketingarrangements with various banks under which we provide Chapter 7 bankruptcytrustee case management software and related services and the bank provides theChapter 7 bankruptcy trustee with deposit-related banking services. Our mostsignificant marketing arrangement is with our primary depository institution,Bank of America. Under this arrangement, we primarily receive revenue based onthe aggregate amount of trustee deposits and the number of Chapter 7 trusteeswhich we refer to collectively as volume-based fees. These volume-based feescompensate us for the software license, hardware and postcontract customersupport services that we provide to the Chapter 7 bankruptcy trustees.

Prior to October 2003, our primary depositoryinstitution engaged us to provide the trustees with software upgrades in thefirst and second quarter of each year. These software upgrades were documentedin arrangements which were separate from our volume-based fee arrangement. Oncethe upgrade was delivered to the trustees and we had provided satisfactoryevidence of the delivery, we would invoice the primary depository institutionfor the agreed upon amount and recognize revenue related to the softwareupgrade.

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In October 2003, we entered into a newarrangement (the 2003 Arrangement) with the primary depository institution. Asa part of the 2003 Arrangement, we agreed to continue to perform each of ourfirst and second quarter software upgrades through the term of the arrangement,and the primary depository institution agreed to compensate us for theseupgrades on terms similar to our historical terms when we delivered theupgrades on a standalone basis. As the 2003 Arrangement included volume-basedpricing related to our software license, hardware and postcontract customersupport services, as well as pricing related to software upgrades and specialprojects, the 2003 Arrangement was considered a bundled arrangement. As the2003 Arrangement involved the delivery of software, we accounted for thisarrangement pursuant to Statement of Position 97-2, *SoftwareRevenue Recognition* (SOP 97-2). For bundled arrangements, SOP97-2 requires that for separate elements of the arrangement, such assoftware upgrades, we must be able to establish vendor specific objectiveevidence (VSOE) of fair value. VSOE is established based on the price chargedwhen the same element is sold on a standalone basis. Although we historicallysold software upgrades on a standalone basis, each software upgrade isconsidered a separate product and, therefore, we determined that the price ofprior software upgrades cannot be used to establish the price of futuresoftware upgrades. As the primary financial institution was our only payee forsoftware upgrades during the period of the 2003 Arrangement, we were unable toestablish VSOE for the software upgrades. Under SOP 97-2, if VSOE cannotbe established for software upgrades, then consideration received under the2003 Arrangement, except for consideration related to the provision of hardwareand hardware maintenance, must be deferred until all software upgrades havebeen delivered. Under the terms of the 2003 Arrangement, the final softwareupgrade was delivered in the second quarter of 2006. Although, during theperiod of the 2003 Arrangement, we continued to invoice, and the primaryfinancial institution continued to pay, our volume-based fees related tosoftware licenses and postcontract customer support as well as our semi-annualsoftware upgrades, we did not recognize these amounts as revenue. Instead,these amounts were recorded as deferred revenue liability through the firstquarter of 2006. Substantially all deferred revenue was recognized during thesecond quarter of 2006 when the final upgrade was delivered. The remainingamount of deferred revenue was recognized during the third quarter of 2006 whenthe 2003 Arrangement terminated. Throughout the period of the 2003 Arrangement,we continued to recognize revenue related to the hardware and hardwaremaintenance we provided to Chapter 7 trustees as this revenue is accounted forpursuant to Statement of Financial Accounting Standards No. 13 (SFAS 13), *Accounting for Leases*. This revenue is a relatively minorcomponent of the 2003 Arrangement.

During February 2006, we entered into a newarrangement with our primary depository institution, which became effective October 1,2006. As specified software upgrades and special projects are not contained inthis contract, this arrangement does not require the deferral of revenue. As aresult, the revenue is recognized as explained under “Critical AccountingPolicies—Revenue recognition—Software Arrangements” below.

We have acquired a numberof businesses during the past several years. In January 2004, we acquiredPoorman-Douglas and expanded our product and service offerings to include classaction, mass tort, and other similar legal proceedings. In October 2005,we acquired Hilsoft to enhance our ability to provide specialized mediaplacement services related to class action, mass tort and bankruptcy noticing. InNovember 2005, we acquired nMatrix to expand our product and serviceofferings to include electronic discovery. In May 2006, we acquired EpiqAdvisory Services to expand our capabilities in claims preference services.

**Critical AccountingPolicies**

Weconsider our accounting policies related to revenue recognition, share-basedcompensation, business combinations, goodwill, and identifiable intangibleassets to be critical policies in understanding our historical and futureperformance.

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***Revenuerecognition.*****  **We haveagreements with clients pursuant to which we deliver various case managementand document management services each month.

Significant sources ofrevenue include:

·       Feescontingent upon the month-to-month delivery of case management services definedby client contracts, such as claims processing, claims reconciliation,professional services, call center support, and conversion of data into anorganized, searchable electronic database. The amount we earn varies basedprimarily on the size and complexity of the engagement;

·       Hostingfees based on the amount of data stored;

·       Deposit-basedfees from financial institutions, primarily based on a percentage of totalliquidated assets placed on deposit at that financial institution by ourbankruptcy trustee clients, to whom we provide, at no charge, softwarelicenses, limited hardware and hardware maintenance, and postcontract customersupport (PCS) services,

·       Legalnoticing services to parties of interest in bankruptcy and class action matters,including media campaign and advertising management, in which we coordinatenotification through various media outlets, such as print, radio andtelevision, to potential parties of interest for a particular clientengagement, and

·       Reimbursementfor costs incurred related to postage on mailing services.

*Non-SoftwareArrangements*

Case and documentmanagement services related to electronic discovery, corporate restructuring,and class action revenue, which are billed based on volume, are evaluated pursuantto Emerging Issues Task Force (EITF) 00-21, *RevenueArrangements with Multiple Deliverables*. For each of thesecontractual arrangements, we have identified the following deliverables and/orservices:

·       ElectronicDiscovery

**·****      **Dataprocessing

**·****      **Hosting

·       CorporateRestructuring

**·****      **Consulting

**·****      **Claimsmanagement

**·****      **Printingand reproduction

**·****      **Mailingand noticing

**·****      **Documentmanagement

·       Class Action

**·****      **Consulting

**·****      **Noticecampaigns

**·****      **Toll freecustomer support

**·****      **Web sitedesign/hosting

**·****      **Claimsadministration

**·****      **Distribution

Based on our evaluation of each element, we havedetermined that each element delivered has standalone value to our customersbecause we or other vendors sell such services separately from any otherservices/deliverables. We have also obtained objective and reliable evidence ofthe fair value of each 

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element based either onthe price we charge when we sell an element on a standalone basis or based onthird-party evidence of fair value of such services. Lastly, our arrangementsdo not include general rights of return. Accordingly, each of the serviceelements in our multiple element case and document management arrangementsqualifies as a separate unit of accounting under EITF 00-21. We allocaterevenue to the various units of accounting in our arrangements based on thefair value of each unit of accounting, which is generally consistent with thestated prices in our arrangements. As we have evidence of an arrangement,revenue for each separate unit of accounting is recognized each period inaccordance with Staff Accounting Bulletin Topic 13, *RevenueRecognition* (SAB Topic 13). As the services are rendered, our feebecomes fixed and determinable, and collectibility is reasonably assured. Paymentsreceived in advance of satisfaction of the related revenue recognition criteriaare recognized as a customer deposit until all revenue recognition criteriahave been satisfied.

*Software Arrangements*

Forour Chapter 7 bankruptcy trustee arrangements, we provide our trustee clientswith a software license, hardware lease, hardware maintenance, and postcontractcustomer support (PCS) services, all at no charge to the trustee. The trusteesplace their liquidated estate deposits with a financial institution with whichwe have an arrangement. We earn contingent monthly fees from the financialinstitutions based on the dollar level of average monthly deposits placed bythe trustees with that financial institution, from the financial institutionrelated to the software license, hardware lease, hardware maintenance, and PCSservices. We account for the software license and PCS elements in accordancewith Statement of Position 97-2, *Software RevenueRecognition* (SOP 97-2). Since we have not established vendorspecific objective evidence (VSOE) of the fair value of the software license,we do not recognize any revenue on delivery of the software. The softwareelement is deferred and included with the remaining undelivered element, whichis PCS. This revenue, when recognized, is included as a component of casemanagement services revenue. Revenue related to PCS is entirely contingent onthe placement of liquidated estate deposits by the trustee with the financialinstitution. Accordingly, except for the arrangement described in the followingparagraph, we recognize this contingent usage based revenue consistent with theguidance provided by the American Institute of Certified Public Accountants’Technical Practice Aid (TPA) 5100.76, *Fair Value inMultiple-Element Arrangements That Include Contingent Usage-Based Fees andSoftware Revenue Recognition* as the fee becomes fixed ordeterminable at the time actual usage occurs and collectibility is probable. Thisoccurs monthly as a result of the computation, billing and collection ofmonthly deposit fees contractually agreed to. At that time, we have alsosatisfied the other revenue recognition criteria contained in SOP 97-2,since we have persuasive evidence that an arrangement exists, services havebeen rendered, the price is fixed and determinable, and collectibility is reasonablyassured.

EffectiveOctober 1, 2003, we entered into an arrangement with our primarydepository financial institution under which we delivered two specifiedupgrades annually with the last specified upgrade occurring in the secondquarter of 2006. This arrangement included specific pricing for each softwareupgrade and certain special projects in addition to the contingentdeposit-based pricing related to the software license, hardware, hardwaremaintenance, and PCS to each trustee client. Therefore, the software upgrades and special projects are part of abundled arrangement. Each software upgrade is considered a separate anddiscrete product and, as we do not sell each software upgrade on a standalonebasis, we were unable to establish VSOE of the fair value of the softwareupgrades. As a result, the licensed software, software upgrade, specialprojects and PCS are a combined unit of accounting. Revenue for this combinedunit of accounting, when recognized, is included as a component of casemanagement services revenue. Since we did not have VSOE of the fairvalue of each separate upgrade, we deferred recognition of substantially allrevenue under this arrangement until the final upgrade was delivered. Theongoing costs related to this arrangement were recognized as expense whenincurred. On delivery of the final upgrade during the second quarter of 2006,the only remaining undelivered element was PCS services. In accordance with SOP97-2, on delivery of the final software upgrade, we recognized revenuepreviously deferred on a proportionate basis over the three year term of thecontract. As the contract terminated 

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September 30, 2006, during 2006 we recognizedapproximately $59.7 million of revenue which had been deferred as of December 31,2005.

We also provide our trustee clients with certainhardware, such as desktop computers, monitors, and printers, and hardwaremaintenance. We retain ownership of all hardware provided and, based onguidance provided in EITF 01-8, *Determining Whether anArrangement Contains a Lease*, we account for this hardware as alease. 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 under all of our arrangements are contingentupon the level of trustee deposits and the delivery of upgrades and otherservices, there remain important uncertainties regarding the amount ofunreimbursable costs yet to be incurred by us, we account for the hardwarelease as an operating lease in accordance with SFAS 13, *Accountingfor Leases*. Therefore, all lease payments, based on the estimatedfair value of hardware provided, were accounted for as contingent rentals underEITF Issue No. 98-9, *Accounting for ContingentRent* and SAB Topic 13, which requires that we recognize rentalincome when the changes in the factor on which the contingent lease payment isbased actually occur. This occurs at the end of each period as we achieved ourtarget when deposits are held at the depository financial institution as, atthat time, evidence of an arrangement exists, delivery has occurred, the amounthas become fixed and determinable, and collection is reasonably assured. Thisrevenue, which is less than ten percent of our total revenue, is included as acomponent of case management services revenue.

*Reimbursements*

Ourcase and document management businesses both have revenue related to thereimbursement of certain costs, primarily postage. Consistent with guidanceprovided by EITF No. 01-14, *Income StatementCharacterization of Reimbursements Received for “Out-of-Pocket” ExpensesIncurred*, reimbursed postage and other reimbursable direct costs arerecorded gross in the consolidatedstatement of operations as “Operating revenue from reimbursed directcosts” and as “Reimbursed direct costs”.

***Share-based compensation.******  ***Effective January 1,2006, we began accounting for share-based compensation under SFAS No. 123R,*Share-Based Payment*(SFAS 123R). SFAS No. 123Rrequires a public entity to measure the cost of employee services received inexchange for an award of equity instruments based on the grant-date fair valueof the award and to recognize that cost over the period during which anemployee is required to provide service in exchange for the award. As a result of our adoption of SFAS No. 123R,during the year ended December 31, 2006 we recognized expense related toshare options issued prior to but unvested as of January 1, 2006 as wellas expense related to share options issued subsequent to January 1, 2006. Forshare options issued prior to but unvested as of January 1, 2006,compensation expense was based on the fair value of those share options ascalculated using the Black-Scholes option valuation model at the date the shareoptions were issued. Key assumptions for the Black-Scholes option valuationmodel include expected volatility, expected term of share options granted, theexpected risk-free interest rate, and the expected dividend rate. For shareoptions issued during the year ended December 31, 2006, the share optionswere also valued using the Black-Scholes option valuation models and with keyassumptions related to expected volatility, expected term of share optionsgranted, the expected risk-free interest rate, and the expected dividend rate. Weestimate our expected volatility based on implied volatilities from tradedshare options on our stock and on our stock’s historical volatility. We haveestimated the expected term of our share options based on the historicalexercise pattern of groups of employees that have similar historical exercisebehavior. The expected risk-free interest rate is based on the U.S. Treasuryyield curve in effect at the time of the grant. Historically, we have not paiddividends and we do not anticipate paying dividends in the foreseeable future;accordingly, our expected dividend rate is zero. We recognize thisexpense on a straight-line basis over the requisite service period of the lastseparately vesting portion of the award. Due to the numerous assumptionsinvolved in calculating share-based compensation expense, the expenserecognized in our consolidated financial statements may differ significantlyfrom the value realized by employees on exercise of the share-based instruments.In accordance with the methodology prescribed by SFAS 123R, we do not adjustour recognized 

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compensationexpense to reflect these differences. Recognition of share-based compensationexpense had, and will likely continue to have, a material affect on our directcosts and general and administrative line items within our consolidatedstatements of operations and also may have a material affect on our deferredincome taxes and additional paid-in capital line items within our consolidatedbalance sheets. Adoption of SFAS No. 123R affects the classificationwithin our consolidated statement of cash flows of certain tax benefits ascertain tax benefits formerly classified as an operating cash flow are nowclassified as a financing cash flow. To date, the only share-based compensationwe have issued is share options.

***Business combination accounting.****  *We have acquired a number ofbusinesses during the last several years, and we may acquire additionalbusinesses in the future. Business combination accounting, often referred to aspurchase accounting, requires us to determine the fair value of all assetsacquired, including identifiable intangible assets, and liabilities assumed. Thecost of the acquisition is allocated to the assets acquired and liabilitiesassumed in amounts equal to the fair value of each asset and liability, and anyremaining acquisition cost is classified as goodwill. This allocation processrequires extensive use of estimates and assumptions, including estimates offuture cash flows to be generated by the acquired assets. Certain identifiableintangible assets, such as customer lists and covenants not to compete, areamortized on a straight-line basis over the intangible asset’s estimated usefullife. The estimated useful life of amortizable identifiable intangible assetsranges from one to fourteen years. Goodwill is not amortized. Accordingly, theacquisition cost allocation has had, and will continue to have, a significantimpact on our current operating results.

***Goodwill.******  ***We assessgoodwill, which is not subject to amortization, for impairment as of each July 31and also at any other date when events or changes in circumstances indicatethat the carrying value of these assets may exceed their fair value. Thisassessment is performed at a reporting unit level. A reporting unit is acomponent of a segment that constitutes a business, for which discretefinancial information is available, and for which the operating results areregularly reviewed by management. We develop an estimate of the fair value ofeach reporting unit, using both a market approach and an income approach. If potential for impairment exists, the fairvalue of the reporting unit is subsequently measured against the fair value ofits underlying assets and liabilities, excluding goodwill, to estimate animplied fair value of the reporting unit’s goodwill. For each reportingunit, the fair value estimate for our 2006 annual assessment was consistentwith the fair value estimate for our 2005 annual assessment.

Achange in events or circumstances, including a decision to hold an asset orgroup of assets for sale, a change in strategic direction, or a change in thecompetitive environment could adversely affect the fair value of one or more reportingunits.

Theestimate of fair value is highly subjective and requires significant judgment. Ifwe determine that the fair value of any reporting unit is less than thereporting unit’s carrying value, then we will recognize an impairment charge. Ifgoodwill on our consolidated balance sheet becomes impaired during a futureperiod, the resulting impairment charge could have a material impact on ourresults of operations and financial condition. Our recognized goodwill totaled$260.6 million as of December 31, 2006.

***Identifiable intangible assets.******  ***Each period we evaluatewhether events and circumstances warrant a revision to the remaining estimateduseful life of each identifiable intangible asset. If events and circumstanceswarrant a change to the estimate of an identifiable intangible asset’sremaining useful life, then the remaining carrying amount of the identifiableintangible asset would be amortized prospectively over that revised remaininguseful life. Furthermore, information developed during our annual assessment,or other events and circumstances, may indicate that the carrying value of oneor more identifiable intangible assets is not recoverable and its fair value isless than the identifiable intangible asset’s carrying value and would resultin recognition of an impairment charge.

Achange in the estimate of the remaining life of one or more identifiableintangible assets or the impairment of one or more identifiable intangibleassets could have a material impact on our results of operations and financialcondition. Our identifiable intangible assets’ carrying value, net ofamortization, was $43.8 million as of December 31, 2006.

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**Results ofOperations for the Year Ended December 31, 2006 Compared with the YearEnded December 31, 2005**

To enhance comparabilityof the results for the year ended December 31, 2006 to the prior year, weseparately identify the operating results of recently acquired entities,nMatrix, Hilsoft, and Epiq Advisory Services (collectively, the recentlyacquired entities), which were not included in our operating results for all ora substantial portion of the prior year.

***Revenue***

Total revenue fromoperations of $224.2 million for the year ended December 31, 2006represents an approximate $117.9 million, or 111%, increase compared with$106.3 million of revenue for the prior year. Total revenue includesoperating revenue from reimbursed direct costs, which are presented as aseparate line item captioned “Operating revenue from reimbursed direct costs”on our consolidated statement of operations. While operating revenuefrom reimbursed direct costs may fluctuate significantly from period to period,these fluctuations have a minimal effect on our income (loss) from operationsas we realize little or no margin from this revenue. Operating revenue beforereimbursed direct costs, also presented as a separate line item on our consolidatedstatement of operations, increased $117.0 million, or approximately142%, to $199.7 million for the year ended December 31, 2006 comparedwith $82.7 million for the same period in the prior year. This increase isprimarily the result of an approximate $109.4 million increase in casemanagement revenue combined with an approximate $7.6 million increase indocument management revenue. All revenue is directly related to a segment andchanges in revenue by segment are discussed below.

***Operating Expenses***

Direct cost of services increased approximately $18.1 million,or 60% to $48.3 million for the year ended December 31, 2006 comparedwith $30.2 million for the prior year. This increase is primarilyattributable to an approximate $16.0 million increase in direct costs ofservices related to our recently acquired entities. Changes by segment arediscussed below.

Direct cost of bundled software license, softwareupgrade and postcontract customer support services increased approximately $0.1 million,or approximately 3%, to $3.9 million for the year ended December 31,2006 compared with $3.8 million for the prior year primarily as a resultof increased compensation costs. Changes by segment are discussed below.

Reimbursed direct costs increased approximately $0.8 million,or approximately 3%, to $24.6 million for the year ended December 31,2006 compared with $23.8 million for the prior year. This increasedirectly corresponds to the increase in operating revenue from reimburseddirect costs.

General and administrative expenses increased $23.0 million,or approximately 74%, to $54.1 million for the year ended December 31,2006 compared with $31.1 million for the prior year. Approximately $12.7 millionof this increase is attributable to our recently acquired entities. Theremainder of the increase is primarily attributable to the combination of a$6.7 million increase in compensation expense, primarily related to therecognition of share-based compensation expense resulting from the adoption ofSFAS 123R, and increases in administrative expenses to support the expansion ofour business, including an approximate $2.1 million increase in travel andpromotional expense. Changes by segment are discussed below.

Depreciation and software and leasehold amortizationexpenses increased $2.8 million, or approximately 39%, to $10.1 millionfor the year ended December 31, 2006 compared with $7.3 million forthe prior year, primarily as a result of an approximate $2.2 millionincrease related to our recently acquired entities. The remainder of theincrease is primarily the result of a $0.7 million increase in internally 

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developed softwareamortization due to our continued investment in software development. Changesby segment are discussed below.

Amortization of intangibles increased approximately72% to $11.6 million for the year ended December 31, 2006 comparedwith $6.8 million for the prior year, primarily related to an increase inidentifiable intangible assets related to our recently acquired entities. Allexpense related to amortization of identifiable intangible assets is directlyrelated to a segment and changes in identifiable intangible amortizationexpense by segment are discussed below.

Acquisition relatedexpenses of $0.3 million for the year ended December 31, 2006 resultfrom non-capitalized expenses for bonuses, legal, accounting and valuationservices, and travel incurred in connection with potential and completedtransactions compared to $3.0 million for the prior year.

***Interest Expense***

Interest expense increased$6.7 million, to $13.5 million for the year ended December 31,2006 compared with $6.8 million of interest expense for the prior year. Thisincrease primarily relates to an approximate $6.2 million increase ininterest expense related to our credit facility, primarily as a result of anincrease in borrowings to finance our November 2005 electronic discoveryacquisition.

***Effective Tax Rate***

Our effective tax rate torecord tax expense was 39.4% for the year ended December 31, 2006 comparedwith an effective rate to record the tax benefit related to our net loss of38.4% for the prior year. The change in our 2006 effective tax rate compared tothe prior year’s benefit is primarily the result of the effect of nondeductibleexpenses on pre-tax income in 2006 versus a pre-tax loss in 2005. Our tax rateis higher than the statutory federal rate of 35% primarily due to state taxes. Severalof our subsidiaries operate in New York City and are subject to state and localtax rates which are higher than the tax rates assessed by other jurisdictionswhere we operate.  Deferred revenuerecognized during 2006 was related primarily to lower tax rate jurisdictionsleading to a lower effective tax rate than what we expect in the future.

***Net Income (Loss)***

We had net income of $35.1 millionfor the year ended December 31, 2006 compared with a net loss of $3.8 millionfor the prior year. This change is primarily the result of an $85.9 millionincrease in revenue from case management bundled software license, softwareupgrade and postcontract customer support services, partly offset by $22.8 millionin tax expense for the year ended December 31, 2006 compared with a taxbenefit of $2.4 million for the prior year, a $7.7 million increasein depreciation and software and intangible asset amortization expenses, a $6.7 millionincrease in interest expense, and a $5.4 million increase in share-basedcompensation expense. The increase in case management bundled revenue, as morefully explained under the “Case Management Segment” caption below, primarilyrelated to the recognition during 2006 of revenue which was deferred beginningin October 2003. The change in tax expense is largely the result therecognition of income during 2006 compared with a loss during the prior year. Theincrease in depreciation and software and intangible asset amortization expenseis largely attributable to the depreciation and amortization of assets acquiredby acquisition during 2005 and 2006, primarily assets related to our electronicdiscovery acquisition. The increase in interest expense is primarily the resultof additional bank debt incurred to finance these acquisitions. The increase inshare-based compensation expense resulted from the adoption as of January 1,2006, of the SFAS 123R, which resulted in recognition of expense related toissued and unvested stock options.

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**Business Segments**

The following managementdiscussion and analysis is presented on a basis consistent with our segmentdisclosure contained in note 15 of our notes to consolidated financialstatements.

***Case Management Segment***

Case management operating revenue before reimburseddirect costs increased approximately $109.4 million to $164.2 millionfor the year ended December 31, 2006 compared with $54.8 million forthe prior year. Our recently acquired entities accounted for approximately$29.8 million of the increase. The remainder of the increase is primarilyattributable to an $85.9 million increase in revenue from case managementbundled software license, software upgrades and postcontract customer supportservices. This increase primarily relates to a bundled arrangement which began October 1,2003 and ended September 30, 2006. As of December 31, 2005, we haddeferred recognition of $59.7 million in revenue pending delivery of afinal specified software upgrade under the contract provisions. As a result ofthis final delivery, we recognized the $59.7 million of previouslydeferred revenue during 2006. Additionally, we recognized, through the end ofthe arrangement, revenue for bundled software license, software upgrades andpostcontract customer support services delivered during 2006. We alsorecognized revenue related to software licenses and postcontract customersupport services delivered under a new arrangement, which commenced October 1,2006. These increases in revenue were partly offset by an approximate $4.8 milliondecline in professional fees, primarily as a result of fewer class actionclient retentions.

Case management direct costs, general andadministrative expenses, and depreciation and software amortization increased $22.3 million,or approximately 68%, to $54.9 million for the year ended December 31,2006 compared with $32.6 million for the same period in the prior year. Ourrecently acquired entities accounted for approximately $19.5 million ofthe increase. The remainder of this increase is primarily attributable to anapproximate $2.0 million increase in outside service costs. Our casemanagement cost structure is relatively stable and generally does not fluctuatematerially with changes in operating revenues.

Amortization of casemanagement’s identifiable intangible assets increased to $9.7 million forthe year ended December 31, 2006 compared with $5.0 million for theprior year. This increase is primarily attributable to the amortization relatedto the identifiable intangible assets acquired in the nMatrix acquisition. Note4 of the notes to the consolidated financial statements provides a summary ofthe total identified intangible assets and the scheduled amortization expenserelated to these identified intangible assets over the next five years.

***Document Management Segment***

Document management operating revenue beforereimbursed direct costs increased approximately $7.6 million, orapproximately 27%, to $35.5 million for the year ended December 31,2006 compared with $27.9 million for the prior year. This increase isprimarily attributable to an increase in operating revenue before reimburseddirect costs related to recently acquired entities, partly offset by a declinein noticing services primarily as a result of fewer class action clientretentions combined with a decrease in our bankruptcy noticing requirements. Documentmanagement revenues, including revenue related to media campaigns and services,can fluctuate materially from period to period based on clients’ businessrequirements.

Document management direct costs, general andadministrative expenses, and depreciation and software amortization increased$11.5 million, or 32%, to $48.1 million for the year ended December 31,2005 compared with $36.6 million for the prior year. This increaseprimarily results from an approximate $12.1 million increase in costsrelated to recently acquired entities, partly offset by an approximate $0.5decrease in compensation expense related to reduced staffing. Our documentmanagement cost structure 

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is more variable than casemanagement and will fluctuate based on document management businessrequirements delivered.

Amortization of documentmanagement’s identifiable intangible assets increased to $2.0 million forthe year ended December 31, 2006 compared with $1.7 million for theprior year. This increase is primarily attributable to amortization related tointangible assets acquired in the Hilsoft acquisition. Note 4 of the notes tothe consolidated financial statements provides a summary of the totalidentified intangible assets and the scheduled amortization expense related tothese identified intangible assets over the next five years.

**Results ofOperations for the Year Ended December 31, 2005 Compared with the YearEnded December 31, 2004**

**ConsolidatedResults**

***Revenue***

Total revenue fromoperations of $106.3 million for the year ended December 31, 2005represents an approximate $7.9 million, or 8%, increase compared with$98.4 million of revenue for the prior year. Total revenue includesoperating revenue from reimbursed direct costs, which are presented as aseparate line item captioned “Operating revenue from reimbursed direct costs”on our consolidated statement of operations. While operating revenuefrom reimbursed direct costs may fluctuate significantly from period to period,these fluctuations have a minimal effect on our income (loss) from operationsas we realize little or no margin from this revenue. Operating revenue beforereimbursed direct costs, also presented as a separate line item on our consolidatedstatement of operations, increased $4.7 million, or approximately6%, to $82.7 million for the year ended December 31, 2005 comparedwith $78.0 million for the same period in the prior year. All revenue isdirectly related to a segment and changes in revenue by segment are discussedbelow.

***Operating Expenses***

Direct cost of services decreased approximately $7.2 million,or 19% to $30.2 million for the year ended December 31, 2005 comparedwith $37.4 million for the prior year. Excluding our subsidiaries acquiredduring 2005, direct costs of services decreased $8.1 million, orapproximately 22%, compared with the prior year. This decrease is primarily theresult of a decrease in cost of advertising. Changes by segment are discussedbelow.

Direct cost of bundled software license, softwareupgrade and postcontract customer support services increased approximately $1.0 millionto $3.8 million for the year ended December 31, 2005 compared with$2.8 million for the prior year primarily as a result of increasedcompensation costs. Changes by segment are discussed below.

Reimbursed direct costs increased approximately 18% to$23.8 million for the year ended December 31, 2005 compared with$20.1 million for the prior year. This increase directly corresponds tothe increase in operating revenue from reimbursed direct costs.

General and administrative expenses increased $5.2 million,or approximately 20%, to $31.1 million for the year ended December 31,2005 compared with $25.9 million for the prior year. Excluding oursubsidiaries acquired during 2005, general and administrative expensesincreased $4.4 million, or approximately 17%, compared with the prior year.This increase primarily results from the increase in the scope and complexityof our business, and is primarily the result of increases in compensation andrelated expenses, travel, and professional services. Changes by segment arediscussed below.

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Depreciation and software and leasehold amortizationexpenses increased $0.8 million, or approximately 12%, to $7.3 millionfor the year ended December 31, 2005 compared with $6.5 million forthe prior year. Excluding our subsidiaries acquired during 2005, depreciationand software and leasehold amortization expenses increased $0.5 million,or approximately 8%, compared with the prior year primarily as a result ofincreased software amortization. Changes by segment are discussed below.

Amortization of identifiable intangible assetsdecreased $1.0 million to $6.8 million for the year ended December 31,2005 compared with $7.8 million for the prior year. All expense related toamortization of identifiable intangible assets is directly related to a segmentand changes in identifiable intangible amortization expense by segment arediscussed below.

Acquisition relatedexpenses of $3.0 million for the year ended December 31, 2005 and$2.2 million for the prior year result from non-capitalized expenses forbonuses, legal, accounting and valuation services, and travel incurred inconnection with potential and completed transactions.

***Interest Expense***

Interest expenseincreased $0.5 million, to $6.8 million for the year ended December 31,2005 compared with $6.3 million of interest expense for the prior year. Thisincrease related to various components:

·       Variableinterest expense related to our credit facilities and fixed interest expenserelated to our convertible debt increased $0.7 million to $4.5 millionduring the year ended December 31, 2005 compared to $3.8 million forthe prior year primarily as a result of an increase in our variable interestrate, partly offset by a decrease in weighted average borrowings outstandingduring the year.

·       Amortizationof loan fees related to our credit facilities and our convertible debt offeringdecreased $1.0 million to $1.1 million during the year ended December 31,2005 compared to $2.1 million for the prior year. This decrease isprimarily a result of amortization related to a short-term subordinatedborrowing under the credit facility used to finance the acquisition ofPoorman-Douglas in January 2004. All fees related to this subordinatedborrowing were amortized during 2004.

·       Our convertible debtfacility includes a provision allowing the convertible debt holders to extendthe debt maturity from three years to six years. Under SFAS 133, *Accounting for Derivative Instruments and Hedging Activities*,this provision is accounted for as an embedded option. At inception, theembedded option was valued at $1.2 million and the convertible debtbalance was reduced by the same amount. The convertible debt accretesapproximately $0.1 million each quarter such that, at the end of threeyears, the convertible debt balance will total $50.0 million. The embeddedoption must be revalued at each period end based on the probability weighteddiscounted cash flows related to the additional 4% interest rate payments whichwould be made if the convertible debt maturity is extended an additional threeyears. While the changes in fair value of the embedded option and carryingvalue of the convertible debt do not affect our current cash flow, theaggregate of these changes in value is accounted for as a current income orexpense item and is included on our accompanying consolidated statement of operations as a component of interestexpense. During the year ended December 31, 2005, we recognized expenserelated to the convertible debt accretion and change in value of the embeddedoption of $1.0 million, compared with $0.3 million of such expense inthe prior year. If the embedded option is eventually exercised, the valueassigned to the embedded option will be amortized to income as a reduction toour 4% convertible debt interest expense over the periods payments are made. Ifthe option is not exercised by some or all convertible debt holders, anyremaining related value assigned to the embedded option will be recognized as again during that period.

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***Debt Extinguishment***

During 2004, we replacedthe senior portion of the credit facility used to finance the Poorman-Douglastransaction with our KeyBank credit facility. As a result, during the yearended December 31, 2004, we recognized a $1.0 million charge for thewrite-off of loan fees related to the terminated credit facility. We did notrecognize any debt extinguishment expense during 2005.

***Effective Tax Rate***

Our effective tax rate torecord the tax benefit related to our loss from continuing operations increasedfrom 37.2% for the year ended December 31, 2004 to 38.4% for the yearended December 31, 2005. The change in our 2005 effective tax benefit ratecompared to the prior year is primarily the result of discrete events,including characterization of the loss from disposal of our discontinuedoperations from a business loss to a non-business loss and an increase in ourresearch and expenditure credit. Our tax benefit rate is higher than thestatutory federal rate of 34% primarily due to state taxes. Our corporaterestructuring and electronic discovery businesses operate primarily in New YorkCity and are subject to state and local tax rates which are higher than the taxrates assessed by other jurisdictions where we operate.

***Net Loss***

Our net loss decreased toa $3.8 million net loss for the year ended December 31, 2005 compared witha $6.6 million net loss for the prior year. This decrease in our net loss wasprimarily the result of an $8.0 million increase in revenue, primarilyresulting from the inclusion of revenue from our electronic discovery businessacquired during November 2005, and a $2.6 million decrease in directcosts, primarily resulting from a decrease in media campaign and advertisingdirect costs. This decrease in our net loss was partly offset by a $5.2 millionincrease in our general and administrative expenses, a $1.9 million decrease inour tax benefit primarily resulting from the reduced pre-tax loss, and a $0.7million decrease of income from operations of our discontinued infrastructuresegment compared with 2004.

**Business Segments**

The following managementdiscussion and analysis is presented on a basis consistent with our segmentdisclosure contained in note 15 of our notes to consolidated financialstatements.

***Case Management Segment***

Case management operating revenue before reimburseddirect costs increased approximately 32% to $54.8 million for the year ended December 31,2005 compared with $41.5 million for the prior year. Our electronic discoverybusiness, which was acquired on November 15, 2005, accounted forapproximately $3.7 million of the increase in operating revenue beforereimbursed direct costs. The remainder of the increase is primarilyattributable to a $5.7 million increase in class action operating revenuesbefore reimbursed direct costs resulting from the timing of several large casesand a $2.8 million increase resulting from a net increase in bankruptcyprofessional services.

Case management direct costs, general andadministrative expenses, and depreciation and software amortization increased$3.5 million, or approximately 12%, to $32.6 million for the year ended December 31,2005 compared with $29.1 million for the same period in the prior year. Ourelectronic discovery business, which was acquired on November 15, 2005,accounted for approximately $1.4 million of the increase. Exclusive ofelectronic discovery, direct and administrative expenses, includingdepreciation and software amortization, increased by $2.1 million, orapproximately 7%. This increase is primarily attributable to an increase inreimbursed expenses and expenses related to the expansion of our 

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bankruptcy serviceofferings. Our case management cost structure is relatively stable andgenerally does not fluctuate materially with changes in operating revenues.

Amortization of casemanagement’s identifiable intangible assets decreased $0.2 million to $5.0 millionfor the year ended December 31, 2005 compared with $5.2 million for theprior year. This decrease is primarily attributable to certain intangibleassets acquired in the BSI acquisition that became fully amortized during 2005,largely offset by an increase in amortization related to intangible assetsacquired in the nMatrix acquisition. Note 4 of the notes to the consolidatedfinancial statements provides a summary of the total identified intangibleassets and the scheduled amortization expense related to these identifiedintangible assets over the next five years.

***Document Management Segment***

Document management operating revenue before reimburseddirect costs decreased approximately $8.6 million, or approximately 24%, to$27.9 million for the year ended December 31, 2005 compared with $36.5million for the prior year. This decrease is primarily attributable to adecline in media campaign and advertising services. Our media campaign andadvertising services are primarily connected with class action and bankruptcycustomers for whom we provide case administration services. Media campaign andadvertising services vary significantly depending on the characteristics of thecase. Generally, cases in which the specific identity of members of theplaintiff class is unknown will require significantly more media campaign andadvertising services than cases in which the specific identity of the membersof the plaintiff class is known. During 2004, we had several large cases inwhich the specific identity of the members of the plaintiff class was unknownand, therefore, required extensive media campaign and advertising services. During2005, the identities of the members of the plaintiff class on our large caseswere known and, therefore, did not require extensive media campaign andadvertising services. Document management operating revenue from reimburseddirect costs of $20.5 million for the year ended December 31, 2005increased approximately 15% compared with the same period in the prior year. Operatingrevenue from reimbursed direct costs has little or no margin and, accordingly,this increase in operating revenue from reimbursed direct costs did not have amaterial effect on our income from operations. Document management revenues,including revenues related to media campaign and services, can fluctuatematerially from period to period based on clients’ business requirements.

Document management direct costs, general andadministrative expenses, and depreciation and software amortization decreased$4.0 million, or 10%, to $36.6 million for the year ended December 31,2005 compared with $40.6 million for the prior year. This decrease primarilyresults from a decrease in cost of media campaign and advertising, related tothe decline in media campaign and advertising service revenue discussed above,partly offset by an increase in reimbursed expenses, the inclusion of Hilsoftoperating expenses, and an increase in expenses paid to third parties forproduction services. Our document management cost structure is more variablethan case management and will fluctuate based on document management businessrequirements delivered.

Amortization of document management’s identifiableintangible assets decreased $0.8 million to $1.7 million for the yearended December 31, 2005 compared with $2.5 million for the prior year. Thisdecrease is primarily attributable to certain intangible assets acquired in theBSI acquisition that became fully amortized during 2005, partly offset by anincrease in amortization related to intangible assets acquired in the Hilsoftacquisition. Note 4 of the notes to the consolidated financial statementsprovides a summary of the total identified intangible assets and the scheduledamortization expense related to these identified intangible assets over thenext five years.

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**Liquidity and CapitalResources**

***OperatingActivities***

Duringthe year ended December 31, 2006, our operating activities provided netcash of $34.4 million. The primary sources of cash from operating activitieswas net income of $35.1 million, adjusted for $48.8 million of non-cashcharges and credits, primarily deferred tax expense of $20.0 million,share-based compensation of $5.4 million, and depreciation and amortizationexpense of $21.7 million. These sources of cash were partly offset by a $49.5million net use of cash resulting from changes in operating assets andliabilities. The most significant change in operating assets and liabilitieswas a $59.2 million decrease in deferred revenue, primarily as a result ofrecognition of previously deferred amounts related to a three year arrangementthat ended September 30, 2006. This use of cash was partly offset by a$5.0 million decrease in income taxes refundable, primarily as a result of thereceipt of refunds due to us, a $3.1 million increase in accounts payable andother liabilities, primarily as a result of the recognition of lease expense inexcess of cash lease payments and normal fluctuations, and a $2.3 milliondecrease in trade accounts receivable. Trade accounts receivable will fluctuatefrom period to period depending on the timing of collections.

Changes in operating assets and liabilities as adirect result of assets acquired or liabilities assumed have been excluded fromour consolidated statements of cash flows. However, subsequent to acquisition,cash flows related to these acquired assets and assumed liabilities arereflected in our consolidated statements of cash flows. For example, accountsreceivable and accounts payable acquired or assumed as a part of thetransaction are not reflected, respectively, as a use or source of cash. However,the subsequent collection or payment, respectively, of accounts receivable andaccounts payable acquired or assumed as a part of the transaction are reflectedas an operating source or use of cash, respectively.

***InvestingActivities***

During the year ended December 31, 2006, we usedcash of approximately $6.4 million to purchase property and equipment. Ourproperty and equipment purchases consisted primarily of computer-relatedhardware to support our electronic discovery and bankruptcy businesses. Enhancementsto our existing software and development of new software is essential to our continuedgrowth and we used cash of approximately $4.6 million to fund internal costsrelated to development of software for which technological feasibility has beenestablished. We also used approximately $3.6 million of cash to partly fund anacquisition. We believe that cash generated from operations will be adequate tofund our anticipated property, equipment and software spending over the nextyear.

***FinancingActivities***

Duringthe year ended December 31, 2006, we paid approximately $10.0 million as aprincipal reduction on our senior term loan, we paid $4.7 million as aprincipal reduction on deferred acquisition debt, we paid $1.0 million due oncapital leases, and we repaid, net of borrowings, $15.0 million of our seniorrevolving loan. This financing use of cash was partly offset by $2.6 million ofnet proceeds from stock issued in connection with the exercise of employeeshare options. As a result of the adoption of SFAS 123R, we also classify aportion of the tax benefit, referred to as excess tax benefit, that we realizeon exercise of employee share options as a financing cash flow. The effect ofthis accounting change was to recognize $0.2 million of excess tax benefit as afinancing cash flow rather than as an operating cash flow.

Asof December 31, 2006, our borrowings consisted of $52.2 million from thecontingent convertible subordinated notes (including the fair value of theembedded option), $15.0 million under our senior term loan, $78.0 million underour senior revolving loan, and approximately $9.2 million of obligationsrelated to capitalized leases and deferred acquisition price. Our convertibledebt of $50.0 million matures on June 15, 2007. The convertible notes willrequire the use of cash at their scheduled maturity in June 2007 if 

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the note holders do not extend the maturity of thenotes, at their option, and do not convert the notes into shares of our commonstock. If the maturity of the notes is extended or if they are converted intoshares of our common stock prior to the scheduled maturity of those notes, thenthere will be no cash requirements associated with those convertible notes,other than the regular payment of interest on the outstanding notes. Weanticipate continuing to pay interest on the notes from cash flow from operations,and we anticipate paying the principal of any maturing notes from the sourcesdiscussed below.

Asof December 31,2006, significant financial covenants, all as defined within our creditfacility agreement, include a leverage ratio not to exceed 3.95 to 1.00, asenior leverage ratio not to exceed 2.75 to 1.00, a fixed charge coverage ratioof not less than 1.25 to 1.00, and a current ratio of not less than 1.50 to1.00. As of December 31, 2006, we were in compliance with all covenants inour credit facility, including all financial covenants.

Wemay pursue acquisitions in the future. Covenants contained in our creditfacility and in our convertible notes may limit our ability to consummate anacquisition. Pursuant to the terms of our credit facility, we generally cannotincur indebtedness outside the credit facility with the exception of capitalleases and additional subordinated debt, with a limit of $100.0 million ofaggregate subordinated debt. Furthermore, for any acquisition we must be ableto demonstrate that, on a pro forma basis, we would be in compliance with ourcovenants during the four quarters prior to the acquisition and we must obtainbank permission for any acquisition for which cash consideration exceeds $65.0million or total consideration exceeds $125.0 million.

We believe that the funds generated from operationsplus our existing cash resources and amounts available under our seniorrevolving loan facility will be sufficient over the next 12 months, and for theforeseeable future thereafter, to finance currently anticipated working capitalrequirements, software expenditures, property and equipment expenditures,common share price protection payments, if any, related to common shares issuedin conjunction with the acquisition of our electronic discovery business,principal payments due under the credit facility, deferred acquisition priceagreements and capital leases, interest payments due on our outstandingborrowings, and payments for other contractual obligations. As noted above, ifthe holders of our outstanding convertible notes do not either (i) extendthe maturity of those notes, at the option of the note holders, or (ii) convertthe notes into shares of our common stock in accordance with the terms of thenotes, those notes, in the outstanding principal amount of $50.0 million, willmature on June 15, 2007. If those notes mature at that time, our cash flowfrom operations from the date of this report through that maturity date is notanticipated to be sufficient to pay those notes (after the uses of anticipatedcash flow from operations to meet our other normal uses of cash describedabove). Management believes we couldincrease liquidity to fund payment of these notes through arestructuring our credit facility, through the disposition of non-strategicassets, or through the issuance of debt or equity securities.

**Off-balance SheetArrangements**

Although we generally do not utilize off-balance sheetarrangements in our operations, we enter into operating leases in the normalcourse of business. Our operating lease obligations are disclosed below under “ContractualObligations” and also in note 6 of the notes to consolidated financialstatements. As discussed more fully in note 13 of the notes to consolidatedfinancial statements, we guaranteed the price for approximately 1.2 millionshares of our common stock issued in connection with the acquisition ofnMatrix.

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**Contractual Obligations**

The following table sets forth a summary of ourcontractual obligations and commitments, excluding periodic interest payments,as of December 31, 2006.

| ** **                                    | ** ** | **Payments Due By Period** | ** ** |
|-----------------------------------------------|------------|-------------------------------------------|------------|
| **Contractual Obligation**               | ** ** | ** **                                | ** ** | **Total** | ** ** | **Less than  1 Year** | ** ** | **1-3 Years** | ** ** | **3-5 Years** | ** ** | **More Than  5 Years** | ** ** |
| ** **                                    | ** ** | **(In Thousands)**                   | ** ** |
| Long-term obligations and future accretion(1) |       | $                                         | 152,513    |   |   | $ | 68,393 |   |   |   | $ | 82,120 |   |   |   | $ | 2,000 |   |   |   | $ | — |   |   |
| Employment agreements(2)                      |       | 8,763                                     |       |   | 3,097 |   |   |   | 3,821 |   |   |   | 1,845 |   |   |   | — |   |   |
| Capital lease obligations                     |       | 178                                       |       |   | 48 |   |   |   | 65 |   |   |   | 65 |   |   |   | — |   |   |
| Operating leases                              |       | 42,893                                    |       |   | 5,947 |   |   |   | 11,299 |   |   |   | 10,020 |   |   |   | 15,627 |   |   |
| Total                                         |       | $                                         | 204,347    |   |   | $ | 77,485 |   |   |   | $ | 97,305 |   |   |   | $ | 13,930 |   |   |   | $ | 15,627 |   |   |
|                                               |            |                                           |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

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(1)          Aportion of the BSI, Hilsoft, and Epiq Advisory Services purchase prices werepaid in the form of non-interest bearing notes or below market rate notes,which were discounted using an imputed rate of 5%, 8%, and 8%, respectively,per annum. The discounts are accreted over the life of the note and each period’saccretion is added to the principal of the respective note. The amount in theabove contractual obligation table includes both the notes’ principal, as reflectedon our December 31, 2006 consolidated balance sheet, and all futureaccretion. If certain revenue objectives are satisfied, we will make additionalpayments, not to exceed $3.0 million, over the next five years to the formerowners of Hilsoft. Such payments, if any, are not included in the abovecontractual obligation table. As of December 31, 2006, we had not made oraccrued any additional payments. Convertible debt is included at stated valueof the principal redemption and excludes adjustments related to the embeddedoption, which will not be paid in cash. Any conversion to our common stock ofpart or all of the convertible debt will reduce our cash obligation related tothe convertible debt.

(2)          Inconjunction with acquisitions, we have entered into employment agreements withcertain key employees of the acquired companies.

**Recent AccountingPronouncements**

In February 2007, theFinancial Accounting Standards Board (FASB) issued Statement of FinancialAccounting Standards No. 159, *The Fair Value Option forFinancial Assets and Financial Liabilities—Including an amendment of FASBStatement No. 115* (SFAS 159). SFAS 159 permits the measurementof specified financial instruments and warranty and insurance contracts at fairvalue on a contract-by-contract basis, with changes in fair value recognized inearnings each reporting period. We do not anticipate that adoption of thisstatement will have a material impact on our consolidated financial statements.

In September 2006,the FASB issued Statement of Financial Accounting Standards No. 157, *Fair Value Measurements*, (SFAS 157). SFAS 157 defines fairvalue, establishes a framework for measuring fair value in generally acceptedaccounting principles and expands disclosures about fair value measurements. FAS157 is effective for financial statements issued for fiscal years beginningafter November 15, 2007 and interim periods within those fiscal years. Managementis still evaluating the impact, if any, that the adoption of SFAS 157 will haveon our financial position, results of operations, or cash flows.

In June 2006,the FASB issued FASB Interpretation No. 48, (FIN 48) *Accountingfor Uncertainty in Income Taxes,* an interpretation of SFAS 109, *Accounting for Income Taxes*. FIN 48 prescribes acomprehensive model for how companies should recognize, measure, present, anddisclose in their financial statements uncertain tax positions taken orexpected to be taken on a tax return. Under FIN 48, tax positions shallinitially be recognized in the financial statements when it is more likely thannot the position will be sustained upon examination by the tax authorities. Suchtax positions shall initially and subsequently be measured as the largestamount of tax benefit that is greater than 50% likely of being realized uponultimate settlement with the tax authority assuming full knowledge of theposition and all relevant facts. FIN 48 also revises disclosure requirements toinclude an annual tabular rollforward of 

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unrecognized tax benefits. The provisions of thisinterpretation are effective for fiscal years beginning after December 15,2005. We will be required to apply the provisions of FIN 48 to all taxpositions upon initial adoption with any cumulative effect adjustment to berecognized as an adjustment to retained earnings. We are currently evaluatingwhat effect the adoption of FIN 48 will have on our consolidated financialstatements.

In October 2006,the FASB issued Staff Position No. FAS 123(R)-5, *Amendment of FASB StaffPosition 123(R)-1*(FSP 123(R)-5). FSP 123(R)-5,which amends FSP 123(R)-1, addresses instruments originally issued asemployee compensation and later modified solely to reflect an equityrestructuring that occurs when the holders are no longer employees. In thatsituation, no change in the recognition or measurement (due to change inclassification) of those instruments will result if (i) there is noincrease in the fair value of the award, or an antidilution provision is notadded to the terms of the award in contemplation of an equity restructuring;and (ii) all holders of the same class of equity instruments are treatedin the same manner. The guidance in FSP 123(R)-5 is to be applied in thefirst reporting period beginning after October 15, 2006. We do notanticipate that adoption of this statement will have a material impact on ourconsolidated financial statements.

In October 2006,the FASB issued Staff Position No. FAS 123(R)-6, *Technical Corrections of FASB Statement No. 123(R) *(FSP123(R)-6). FSP 123(R)-6 was issued to make several technicalcorrections to SFAS 123(R). These include exemption for non-public entitiesfrom disclosing the aggregate intrinsic value of outstanding fully vested shareoptions, revision to the computation of the minimum compensation cost that mustbe recognized, indication that at the date the illustrative awards were nolonger probable of vesting, any previously recognized compensation cost shouldhave been reversed, and changes to the definition of short-term inducement toexclude an offer to settle an award. The guidance in FSP 123(R)-6 iseffective in the first reporting period beginning after October 20, 2006.Early application is permitted in periods for which financial statements havenot yet been issued. We do not anticipate that adoption of this statement willhave a material impact on our consolidated financial statements.

In September 2006, the SEC issued StaffAccounting Bulletin (SAB) No. 108, “*Considering the Effects ofPrior Year Misstatements when Quantifying Misstatements in Current YearFinancial Statements*,” which provides interpretive guidanceregarding the consideration given to prior year misstatements when determiningmateriality in current year financial statements. SAB No. 108 is effectivefor fiscal years ending after November 15, 2006. The impact of thisadoption was not material to our consolidated financial statements.

**ITEM 7A.**        QUANTITATIVEAND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

Marketrisk refers to the risk that a change in the level of one or more marketprices, interest rates, indices, volatilities, correlations or other marketfactors, such as liquidity, will result in losses for a certain financialinstrument or group of financial instruments. Our convertible debt and creditfacility borrowings create market risks for us. We do not actively manage thesemarket risks.

During2004, we issued $50.0 million of convertible notes with a 4% fixed interestrate. While we do not have cash flow risk related to this instrument, theinstrument does contain an embedded option related to the right of securityholders to extend the maturity of the convertible notes which creates anearnings risk. A 10% increase in our stock value would result in a $0.9 millionincrease in the fair value of the embedded option and a corresponding decreasein pre-tax earnings. A 10% decrease in our stock value would result in a $1.0million decrease in the fair value of the embedded option and a correspondingincrease in pre-tax earnings. The estimated changes in fair value werecalculated using a pricing model that incorporates assumptions regarding futurevolatility, interest rates and credit risk.

At December 31,2006, we have borrowings outstanding under a credit facility. Interest onborrowings under our credit facility is computed at a variable rate based onthe LIBOR rate and the prime rate and results in a market risk related tointerest rates. A 1% increase or decrease in the LIBOR rate and the prime ratewould increase or decrease, respectively, our annual pre-tax interest expenseon variable rate borrowings outstanding as of December 31, 2006 byapproximately $0.9 million.

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**ITEM 8.**                FINANCIALSTATEMENTS AND SUPPLEMENTARY DATA

Our consolidated financialstatements appear following Item 15 of this Report.

**Supplementary Data—QuarterlyFinancial Information**

The following table sets forth the quarterly financialdata for the quarters of the years ended December 31, 2006 and 2005 (inthousands, except per share data):

| ** **                                   | ** ** | **Quarters**    | ** ** |
|----------------------------------------------|------------|-----------------|------------|
| ** **                                   | ** ** | **1**st         | ** ** | **2**nd | ** ** | **3**rd | ** ** | **4**th | ** ** |
| ** **                                   | ** ** | **(Unaudited)** | ** ** |
| **Year ended December 31,  2006**       |       |            |       |   |   |   |   |   |   |
| Total revenue                                |       | $               | 38,218     |   | $ | 100,496 |   | $ | 39,032 |   | $ | 46,424 |   |
| Gross profit(1)                              |       | 15,538          |       | 80,616 |   | 23,365 |   | 21,053 |   |
| Net income (loss)                            |       | (1,749          | )          | 36,292 |   | 2,681 |   | (2,093 | ) |
| Net income (loss)  per share—Basic(2)   |       | $               | (0.09      | ) | $ | 1.87 |   | $ | 0.14 |   | $ | (0.11 | ) |
| Net income (loss)  per share—Diluted(2) |       | $               | (0.09      | ) | $ | 1.59 |   | $ | 0.13 |   | $ | (0.11 | ) |
| **Year  ended December 31, 2005**       |       |            |       |   |   |   |   |   |   |
| Total revenue                                |       | $               | 24,644     |   | $ | 25,352 |   | $ | 26,294 |   | $ | 30,040 |   |
| Gross profit(1)                              |       | 9,714           |       | 10,592 |   | 10,349 |   | 12,891 |   |
| Net income (loss)                            |       | (2,128          | )          | 1,836 |   | 495 |   | (4,045 | ) |
| Net income (loss)  per share—Basic(2)   |       | $               | (0.12      | ) | $ | 0.10 |   | $ | 0.03 |   | $ | (0.22 | ) |
| Net income (loss) per  share—Diluted(2) |       | $               | (0.12      | ) | $ | 0.10 |   | $ | 0.03 |   | $ | (0.22 | ) |

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(1)          Gross profit iscalculated as total revenue less direct costs of services, reimbursed directcosts, and the      portion of depreciation and softwareamortization attributable to direct costs of services.

(2)          The sum of the quartersmay not equal the total of the respective year’s net income (loss) per sharedue to changes in the weighted average shares outstanding throughout the year.

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**ITEM 9.**                CHANGESIN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE

None.

**ITEM 9A.**        CONTROLSAND PROCEDURES

**ConclusionRegarding the Effectiveness of Disclosure Controls and Procedures**

Under the supervision andwith the participation of our management, including our principal executiveofficer and principal financial officer, we conducted an evaluation of theeffectiveness of the design and operation of our disclosure controls andprocedures, as defined in Rules 13a-15(e) and 15d-15(e) ofthe Securities Exchange Act of 1934. Based on their evaluation as of December 31,2006, the end of the period covered by this Annual Report on Form 10-K,our principal executive officer and principal financial officer concluded thatour disclosure controls and procedures were effective at a reasonable assurancelevel to ensure that the information required to be disclosed in reports filedor submitted under the Securities Exchange Act of 1934, including this AnnualReport, were recorded, processed, summarized and reported within the timeperiods specified in the SEC’s rules and forms, and was accumulated andcommunicated to management, including our principal executive officer andprincipal financial officer, as appropriate to allow timely decisions regardingrequired disclosure.

**Management’s Reporton Internal Control Over Financial Reporting**

Our management isresponsible for establishing and maintaining adequate internal control overfinancial reporting. Our internal control over financial reporting is designedto provide reasonable assurance regarding the reliability of financialreporting and the preparation of financial statements for external purposes inaccordance with generally accepted accounting principles and includes thosepolicies and procedures that:

·       Pertainto the maintenance of records that in reasonable detail accurately and fairlyreflect the transactions and dispositions of the assets of the company;

·       Providereasonable assurance that the transactions are recorded as necessary to permitpreparation of financial statements in accordance with generally acceptedaccounting principles, and that receipts and expenditures of the company arebeing made only in accordance with authorizations of management and directorsof the company; and

·       Providereasonable assurance regarding prevention or timely detection of unauthorizedacquisition, use or disposition of the company’s assets that could have amaterial effect on the financial statements.

All internal control systems, no matter how well designed,have inherent limitations. Therefore, even those systems determined to beeffective can provide only reasonable assurance with respect to financialstatement preparation and presentation. Because of its inherent limitations,internal control over financial reporting may not prevent or detectmisstatements. Projections of any evaluation of effectiveness to future periodsare subject to the risk that controls may become inadequate because of changesin conditions or that the degree of compliance with the policies or proceduresmay deteriorate.

In connection with the filing of our Annual Report on Form 10-K,our management assessed the effectiveness of our internal control overfinancial reporting as of December 31, 2006. In making this assessment,our management used the criteria set forth by Committee of SponsoringOrganizations of the Treadway Commission in *Internal Control—IntegratedFramework*. Based on our assessment using those criteria, managementbelieves that, as of December 31, 2006, our internal control overfinancial reporting is effective based on those criteria.

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Our management’sassessment of the effectiveness of our internal control over financialreporting as of December 31, 2006 has been audited by Deloitte &Touche LLP, an independent registered public accounting firm, as stated intheir report which appears beginning on page 40.

**Changes in InternalControl Over Financial Reporting**

Changes in ourinternal control over financial reporting during the fourth quarter ended December 31,2006 that have materially affected, or are reasonably likely to materiallyaffect, our internal control over financial reporting, are as follows:

·       Weimplemented new controls related to contracts or other arrangements that arewithin the scope of SOP 97-2 to provide a written analysis of theappropriate accounting for these contracts or other arrangements and to reviewour conclusions with qualified internal accounting personnel or third partyaccounting experts; and

·       Wehave provided our accounting staff with additional training related togenerally accepted accounting principles and financial statement reportingmatters.

As a result of the above actions, management believesthe material weakness in the Company’s internal control over financialreporting with respect to maintaining adequate controls related to the specificevaluation of vendor specific objective evidence of fair value for specifiedsoftware upgrades provided within a bundled arrangement as required by  SOP 97-2 and as discussed in priorfilings was remediated in the fourth quarter ended December 31, 2006.

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**REPORTOF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM**

**To theBoard of Directors and Stockholders ofEpiq Systems, Inc.Kansas City, Kansas**

We have audited management’s assessment, included inthe accompanying Management’s Report on Internal Control Over FinancialReporting, that Epiq Systems, Inc. and subsidiaries (the “Company”)maintained effective internal control over financial reporting as of December 31,2006, based on criteria established in *Internal Control—IntegratedFramework* issued by the Committee of Sponsoring Organizations of theTreadway Commission. The Company’s management is responsible for maintainingeffective internal control over financial reporting and for its assessment ofthe effectiveness of internal control over financial reporting. Ourresponsibility is to express an opinion on management’s assessment and anopinion on the effectiveness of the Company’s internal control over financialreporting based on our audit.

We conducted our audit in accordance with thestandards of the Public Company Accounting Oversight Board (United States). Thosestandards require that we plan and perform the audit to obtain reasonableassurance about whether effective internal control over financial reporting wasmaintained in all material respects. Our audit included obtaining anunderstanding of internal control over financial reporting, evaluatingmanagement’s assessment, testing and evaluating the design and operatingeffectiveness of internal control, and performing such other procedures as weconsidered necessary in the circumstances. We believe that our audit provides areasonable basis for our opinions.

A company’s internal control over financial reportingis a process designed by, or under the supervision of, the company’s principalexecutive and principal financial officers, or persons performing similarfunctions, and effected by the company’s board of directors, management, andother personnel to provide reasonable assurance regarding the reliability offinancial reporting and the preparation of financial statements for externalpurposes in accordance with generally accepted accounting principles. A company’sinternal control over financial reporting includes those policies andprocedures that (1) pertain to the maintenance of records that, in reasonabledetail, accurately and fairly reflect the transactions and dispositions of theassets of the company; (2) provide reasonable assurance that transactionsare recorded as necessary to permit preparation of financial statements inaccordance with generally accepted accounting principles, and that receipts andexpenditures of the company are being made only in accordance withauthorizations of management and directors of the company; and (3) providereasonable assurance regarding prevention or timely detection of unauthorizedacquisition, use, or disposition of the company’s assets that could have amaterial effect on the financial statements.

Because of the inherent limitations of internalcontrol over financial reporting, including the possibility of collusion orimproper management override of controls, material misstatements due to erroror fraud may not be prevented or detected on a timely basis. Also, projectionsof any evaluation of the effectiveness of the internal control over financialreporting to future periods are subject to the risk that the controls maybecome inadequate because of changes in conditions, or that the degree ofcompliance with the policies or procedures may deteriorate.

In our opinion, management’s assessment that theCompany maintained effective internal control over financial reporting as of December 31,2006, is fairly stated, in all material respects, based on the criteriaestablished in *Internal Control—Integrated Framework*issued by the Committee of Sponsoring Organizations of the Treadway Commission.Also in our opinion, the Company maintained, in all material respects,effective internal control over financial reporting as of December 31,2006, based on the criteria 

40

----

established in *Internal Control—Integrated Framework* issued by theCommittee of Sponsoring Organizations of the Treadway Commission.

We have also audited, inaccordance with the standards of the Public Company Accounting Oversight Board(United States), the consolidated financial statements and financial statementschedule as of and for the year ended December 31, 2006, of the Companyand our report dated March 6, 2007 expressed an unqualified opinion onthose financial statements and financial statement schedule and included anexplanatory paragraph regarding the change in accounting for stock-basedcompensation upon adoption of Statement of Financial Accounting Standards No. 123(R),“*Share-Based Payment*.”

/s/ DELOITTE &TOUCHE LLPKansas City, MissouriMarch 6, 2007

41

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**ITEM 9B.**       OTHERINFORMATION

None.

**PART III**

**ITEM 10.**         DIRECTORSAND EXECUTIVE OFFICERS OF THE REGISTRANT

Incorporated by referenceto our Proxy Statement for our 2007 Annual Meeting of Shareholders to be filedwith the Securities and Exchange Commission within 120 days after the close ofthe year ended December 31, 2006.

**ITEM 11.**         EXECUTIVECOMPENSATION

Incorporated by referenceto our Proxy Statement for our 2007 Annual Meeting of Shareholders to be filedwith the Securities and Exchange Commission within 120 days after the close ofthe year ended December 31, 2006.

**ITEM 12.**         SECURITYOWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED SHAREHOLDERMATTERS

Incorporated by referenceto our Proxy Statement for our 2007 Annual Meeting of Shareholders to be filedwith the Securities and Exchange Commission within 120 days after the close ofthe year ended December 31, 2006.

**ITEM 13.**         CERTAINRELATIONSHIPS AND RELATED TRANSACTIONS

Incorporated by referenceto our Proxy Statement for our 2007 Annual Meeting of Shareholders to be filedwith the Securities and Exchange Commission within 120 days after the close ofthe year ended December 31, 2006.

**ITEM 14.**         PRINCIPALACCOUNTING FEES AND SERVICES

Incorporated by reference to our Proxy Statement forour 2007 Annual Meeting of Shareholders to be filed with the Securities andExchange Commission within 120 days after the close of the year ended December 31,2006.

42

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**PART IV**

**ITEM 15.**         EXHIBITSAND FINANCIAL STATEMENT SCHEDULES

**(a) The following documents are filed as a part ofthis report:**

**(1)****          FinancialStatements.**The following consolidated financial statements, contained on pages F-1through F-31 of this report, are filed as part of this report under Item8 “Financial Statements and Supplementary Data.”

Report of Independent Registered Public AccountingFirm

Consolidated Balance Sheets—December 31, 2006 and2005

Consolidated Statements of Operations—Years Ended December 31,2006, 2005 and 2004

Consolidated Statements of Changes in Stockholders’Equity—Years Ended December 31, 2006, 2005 and 2004

Consolidated Statements of Cash Flows—Years Ended December 31,2006, 2005 and 2004

Notes to Consolidated Financial Statements

**(2)****          FinancialStatement Schedules.**Epiq Systems, Inc. and subsidiaries for each ofthe years in the three-year period ended December 31, 2006.

Schedule   II—Valuationand qualifying accounts

**(3)****          Exhibits.**Exhibits are listed on the Exhibit Index at the end of this report.

43

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**SIGNATURES**

In accordance with Section 13or 15(d) of the Exchange Act, the registrant has duly caused this reportto be signed on its behalf by the undersigned, thereunto duly authorized.

| Dated:  March 9,  2007 | EPIQ SYSTEMS, INC. |
|----------------------------------|--------------------|
|                             | By:                | /s/  Tom W.  Olofson |
|                             |               | Tom W. Olofson |
|                             |               | Chairman of the Board, Chief Executive |
|                             |               | Officer and Director |

 

In accordance with the Exchange Act this report hasbeen signed below by the following persons on behalf of the registrant and inthe capacities indicated on the dates indicated.
|                                        | **Signature** | ** **                                          | ** ** | ** **          | **Name and Title** | ** ** | ** ** | ** ** | **Date** | ** ** |
|----------------------------------------|---------------|-----------------------------------------------------|------------|---------------------|--------------------|------------|------------|------------|----------|------------|
| ** **                             |          |                                                |       |                |
| /s/ Tom  W. Olofson               |          | Tom W. Olofson                                      |       | March 9,  2007 |
|                                   |          | Chairman of the Board,  Chief Executive Officer and |       |                |
|                                   |          | Director (Principal Executive  Officer)             |       |                |
| ** **                             |          |                                                |       |                |
| /s/ Christopher  E. Olofson       |          | Christopher E. Olofson                              |       | March 9,  2007 |
|                                   |          | President, Chief  Operating Officer and Director    |       |                |
| ** **                             |          |                                                |       |                |
| /s/ Elizabeth  M. Braham          |          | Elizabeth M. Braham                                 |       | March 9,  2007 |
|                                   |          | Executive Vice  President, Chief Financial Officer  |       |                |
| ** **                             |          | (Principal Financial  Officer)                      |       |                |
| ** **                             |          |                                                |       |                |
| /s/ Douglas  W. Fleming           |          | Douglas W. Fleming                                  |       | March 9,  2007 |
|                                   |          | Director of Finance,  Chief Accounting Officer      |       |                |
|                                   |          | (Principal Accounting  Officer)                     |       |                |
|                                   |          |                                                |       |                |
| /s/ W.  Bryan Satterlee           |          | W. Bryan Satterlee                                  |       | March 9,  2007 |
|                                   |          | Director                                            |       |                |
|                                   |          |                                                |       |                |
|                                   |          |                                                |       |                |
| /s/ Edward  M. Connolly, Jr. |          | Edward M.  Connolly, Jr.                       |       | March 9,  2007 |
|                                   |          | Director                                            |       |                |
|                                   |          |                                                |       |                |
| /s/ James  A. Byrnes              |          | James A. Byrnes                                     |       | March 9,  2007 |
|                                   |          | Director                                            |       |                |
|                                   |          |                                                |       |                |
| /s/ Joel  Pelofsky                |          | Joel Pelofsky                                       |       | March 9,  2007 |
|                                   |          | Director                                            |       |                |

 

44

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**REPORTOF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM**

To the Board of Directorsand Stockholders of Epiq Systems, Inc.**Kansas City, Kansas

We have audited the accompanying consolidated balancesheets of Epiq Systems, Inc. and subsidiaries (the “Company”) as of December 31,2006 and 2005, and the related consolidated statements of operations, changesin stockholders’ equity, and cash flows for each of the three years in theperiod ended December 31, 2006. Our audits also included the financialstatement schedule listed in the Index at Item 15(a)(2). These financialstatements and financial statement schedule are the responsibility of theCompany’s management. Our responsibility is to express an opinion on thesefinancial statements and financial statement schedule based on our audits.

We conducted our audits in accordance with thestandards of the Public Company Accounting Oversight Board (United States). Thosestandards require that we plan and perform the audit to obtain reasonableassurance about whether the financial statements are free of materialmisstatement. An audit includes examining, on a test basis, evidence supportingthe amounts and disclosures in the financial statements. An audit also includesassessing the accounting principles used and significant estimates made bymanagement, as well as evaluating the overall financial statement presentation.We believe that our audits provide a reasonable basis for our opinion.

In our opinion, such consolidated financial statementspresent fairly, in all material respects, the financial position of EpiqSystems, Inc. and subsidiaries as of December 31, 2006 and 2005, andthe results of its operations and its cash flows for each of the three years inthe period ended December 31, 2006, in conformity with accountingprinciples generally accepted in the United States of America. Also, in ouropinion, such financial statement schedule, when considered in relation to thebasic consolidated financial statements taken as a whole, present fairly in allmaterial respects the information set forth therein.

As discussed in Note 1 to the consolidatedfinancial statements, the Company changed its method of accounting forstock-based compensation upon adoption of Statement of Financial AccountingStandards No. 123(R), “*Share-Based Payment*.”

We have also audited, inaccordance with the standards of the Public Company Accounting Oversight Board(United States), the effectiveness of the Company’s internal control overfinancial reporting as of December 31, 2006, based on the criteriaestablished in *Internal**Control—IntegratedFramework* issued by the Committee of Sponsoring Organizations of theTreadway Commission and our report dated March 6, 2007, expressed anunqualified opinion on management’s assessment of the effectiveness of theCompany’s internal control over financial reporting and an unqualified opinionon the effectiveness of the Company’s internal control over financialreporting.

/s/ DELOITTE & TOUCHE LLPKansas City, MissouriMarch 6, 2007

F-1

----

**EPIQ SYSTEMS, INC. CONSOLIDATED BALANCE SHEETS (In Thousands, Except Share and Per Share Data)**
|                                                                                                                                                                 | ** ** | **As of December 31,** | ** ** |
|-----------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|---------------------------------------|------------|
| ** **                                                                                                                                                      | ** ** | **2006**                              | ** ** | **2005** | ** ** |
| **ASSETS**                                                                                                                                                      | ** ** | ** **                            | ** ** | ** ** | ** ** |
| **CURRENT ASSETS:**                                                                                                                                             | ** ** | ** **                            | ** ** | ** ** | ** ** |
| Cash and cash equivalents                                                                                                                                       |       | $                                     | 5,274      |   | $ | 13,563 |   |
| Trade accounts receivable, less allowance for doubtful accounts  of  $1,684 and $3,481, respectively                                             |       | 33,066                                |       | 33,504 |   |
| Prepaid expenses                                                                                                                                                |       | 2,537                                 |       | 2,818 |   |
| Income taxes refundable                                                                                                                                         |       | 332                                   |       | 4,643 |   |
| Deferred income taxes                                                                                                                                           |       | 1,313                                 |       | 25,579 |   |
| Other current assets                                                                                                                                            |       | 740                                   |       | 85 |   |
| Total Current Assets                                                                                                                                            |       | 43,262                                |       | 80,192 |   |
| **LONG-TERM ASSETS:**                                                                                                                                           | ** ** | ** **                            | ** ** | ** ** | ** ** |
| Property, equipment and leasehold improvements, net                                                                                                             |       | 23,153                                |       | 23,751 |   |
| Software development costs, net                                                                                                                                 |       | 9,611                                 |       | 8,848 |   |
| Goodwill                                                                                                                                                        |       | 260,609                               |       | 249,427 |   |
| Other intangibles, net of accumulated amortization of $25,387  and  $13,758, respectively                                                   |       | 43,840                                |       | 53,399 |   |
| Other                                                                                                                                                           |       | 1,745                                 |       | 2,854 |   |
| Total Long-term Assets, net                                                                                                                                     |       | 338,958                               |       | 338,279 |   |
| **Total  Assets**                                                                                                                                               |       | $                                     | 382,220    |   | $ | 418,471 |   |
| **LIABILITIES AND STOCKHOLDERS’ EQUITY**                                                                                                                   | ** ** | ** **                            | ** ** | ** ** | ** ** |
| **CURRENT LIABILITIES:**                                                                                                                                        | ** ** | ** **                            | ** ** | ** ** | ** ** |
| Accounts payable                                                                                                                                                |       | $                                     | 7,930      |   | $ | 7,954 |   |
| Other accrued expenses                                                                                                                                          |       | 9,635                                 |       | 9,462 |   |
| Deferred revenue                                                                                                                                                |       | 1,073                                 |       | 60,224 |   |
| Current maturities of long-term obligations                                                                                                                     |       | 70,488                                |       | 27,642 |   |
| Total Current Liabilities                                                                                                                                       |       | 89,126                                |       | 105,282 |   |
| **LONG-TERM LIABILITIES:**                                                                                                                                      | ** ** | ** **                            | ** ** | ** ** | ** ** |
| Deferred income taxes                                                                                                                                           |       | 23,307                                |       | 26,815 |   |
| Other long-term liabilities                                                                                                                                     |       | 1,735                                 |       | — |   |
| Long-term obligations (excluding current maturities)                                                                                                            |       | 83,873                                |       | 145,906 |   |
| Total Long-term Liabilities                                                                                                                                     |       | 108,915                               |       | 172,721 |   |
| **STOCKHOLDERS’ EQUITY:**                                                                                                                                  | ** ** | ** **                            | ** ** | ** ** | ** ** |
| Preferred stock—$1 par value; 2,000,000 shares authorized;  none  issued and outstanding                                               |       | —                                |       | — |   |
| Common stock—$0.01 par value; 50,000,000 shares authorized;  issued  and outstanding—19,478,839 and 19,253,466  shares at 2006 and 2005, respectively |       | 195                                   |       | 193 |   |
| Additional paid-in capital                                                                                                                                      |       | 137,044                               |       | 128,484 |   |
| Accumulated other comprehensive income                                                                                                                          |       | 18                                    |       | — |   |
| Retained earnings                                                                                                                                               |       | 46,922                                |       | 11,791 |   |
| Total Stockholders’ Equity                                                                                                                                 |       | 184,179                               |       | 140,468 |   |
| **Total  Liabilities and Stockholders’ Equity**                                                                                                            |       | $                                     | 382,220    |   | $ | 418,471 |   |

 

See accompanying notes to consolidated financial statements.

F-2

----

**EPIQ SYSTEMS, INC. CONSOLIDATED STATEMENTS OF OPERATIONS (In Thousands, Except Per Share Data)**
|                                                                                                                                                                               | ** ** | **Years Ended December 31,** | ** ** |
|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|---------------------------------------------|------------|
| ** **                                                                                                                                                                    | ** ** | **2006**                                    | ** ** | **2005** | ** ** | **2004** | ** ** |
| **REVENUE:**                                                                                                                                                                  | ** ** | ** **                                  | ** ** | ** ** | ** ** | ** ** | ** ** |
| Case management services                                                                                                                                                      |       | $                                           | 76,534     |   | $ | 53,042 |   | $ | 41,275 |   |
| Case management bundled  software license, software  upgrade  and postcontract customer support services                                                                      |       | 87,716                                      |       | 1,771 |   | 199 |   |
| Document management services                                                                                                                                                  |       | 35,472                                      |       | 27,874 |   | 36,549 |   |
| Operating revenue before  reimbursed direct costs                                                                                                                             |       | 199,722                                     |       | 82,687 |   | 78,023 |   |
| Operating revenue from  reimbursed direct costs                                                                                                                               |       | 24,448                                      |       | 23,643 |   | 20,345 |   |
| Total Revenue                                                                                                                                                                 |       | 224,170                                     |       | 106,330 |   | 98,368 |   |
| **OPERATING EXPENSES:**                                                                                                                                                       | ** ** | ** **                                  | ** ** | ** ** | ** ** | ** ** | ** ** |
| Direct cost of services  (exclusive of depreciation and  amortization  shown separately below)                                                                                |       | 48,345                                      |       | 30,225 |   | 37,411 |   |
| Direct cost of bundled  software license, software upgrade  and  postcontract customer support services (exclusive  of depreciation and amortization shown  separately below) |       | 3,921                                       |       | 3,809 |   | 2,849 |   |
| Reimbursed direct costs                                                                                                                                                       |       | 24,583                                      |       | 23,756 |   | 20,124 |   |
| General and administrative                                                                                                                                                    |       | 54,071                                      |       | 31,072 |   | 25,886 |   |
| Depreciation and software and  leasehold amortization                                                                                                                         |       | 10,113                                      |       | 7,288 |   | 6,527 |   |
| Amortization of intangibles                                                                                                                                                   |       | 11,629                                      |       | 6,751 |   | 7,767 |   |
| Acquisition related                                                                                                                                                           |       | 283                                         |       | 2,984 |   | 2,197 |   |
| Total Operating Expenses                                                                                                                                                      |       | 152,945                                     |       | 105,885 |   | 102,761 |   |
| **INCOME (LOSS) FROM OPERATIONS**                                                                                                                                             |       | 71,225                                      |       | 445 |   | (4,393 | ) |
| **EXPENSES (INCOME) RELATED TO FINANCING:**                                                                                                                                   | ** ** | ** **                                  | ** ** | ** ** | ** ** | ** ** | ** ** |
| Interest expense                                                                                                                                                              |       | 13,468                                      |       | 6,809 |   | 6,343 |   |
| Interest income                                                                                                                                                               |       | (208                                        | )          | (122 | ) | (128 | ) |
| Debt extinguishment                                                                                                                                                           |       | —                                      |       | — |   | 995 |   |
| Net Expenses (Income) Related  to Financing                                                                                                                                   |       | 13,260                                      |       | 6,687 |   | 7,210 |   |
| **INCOME (LOSS) FROM CONTINUING  OPERATIONS BEFORE INCOME TAXES**                                                                                                             |       | 57,965                                      |       | (6,242 | ) | (11,603 | ) |
| **PROVISION (BENEFIT) FOR INCOME  TAXES**                                                                                                                                     |       | 22,834                                      |       | (2,400 | ) | (4,313 | ) |
| **INCOME (LOSS) FROM CONTINUING  OPERATIONS**                                                                                                                                 |       | 35,131                                      |       | (3,842 | ) | (7,290 | ) |
| **DISCONTINUED OPERATIONS:**                                                                                                                                                  | ** ** | ** **                                  | ** ** | ** ** | ** ** | ** ** | ** ** |
| Income from operations of  discontinued infrastructure  segment  (including gain on disposal of $1,616 during  the year ended December 31, 2004)                         |       | —                                      |       | — |   | 1,104 |   |
| Income tax expense from  operations of discontinued  infrastructure  segment                                                                                                  |       | —                                      |       | — |   | (437 | ) |
| **TOTAL DISCONTINUED OPERATIONS**                                                                                                                                             |       | —                                      |       | — |   | 667 |   |
| **NET INCOME (LOSS)**                                                                                                                                                         |       | $                                           | 35,131     |   | $ | (3,842 | ) | $ | (6,623 | ) |

 

F-3

----

**EPIQ SYSTEMS, INC. CONSOLIDATED STATEMENTS OF OPERATIONS (Continued) (In Thousands, Except Per Share Data)**
|                                                 | ** ** | **Years Ended December 31,** | ** ** |
|-------------------------------------------------|------------|---------------------------------------------|------------|
| ** **                                      | ** ** | **2006**                                    | ** ** | **2005** | ** ** | **2004** | ** ** |
| **NET INCOME (LOSS) PER SHARE INFORMATION:**    |       |                                        |       |   |   |   |   |
| Income (loss) per share—Basic              |       |                                        |       |   |   |   |   |
| Income (loss) from continuing  operations       |       | $                                           | 1.81       |   | $ | (0.21 | ) | $ | (0.41 | ) |
| Income from discontinued  operations            |       | —                                      |       | — |   | 0.04 |   |
| Net income (loss) per share—Basic          |       | $                                           | 1.81       |   | $ | (0.21 | ) | $ | (0.37 | ) |
| Income (loss) per share—Diluted            |       |                                        |       |   |   |   |   |
| Income (loss) from continuing  operations       |       | $                                           | 1.58       |   | $ | (0.21 | ) | $ | (0.41 | ) |
| Income from  discontinued operations            |       | —                                      |       | — |   | 0.04 |   |
| Net income (loss) per  share—Diluted       |       | $                                           | 1.58       |   | $ | (0.21 | ) | $ | (0.37 | ) |
| **WEIGHTED AVERAGE COMMON SHARES OUTSTANDING:** |       |                                        |       |   |   |   |   |
| Basic                                           |       | 19,399                                      |       | 18,092 |   | 17,848 |   |
| Diluted                                         |       | 23,048                                      |       | 18,092 |   | 17,848 |   |

 

See accompanying notes to consolidated financial statements.

F-4

----

**EPIQ SYSTEMS, INC. CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS’ EQUITY (In Thousands)**
|                                              | ** ** | **As of December 31,** | ** ** |
|----------------------------------------------|------------|---------------------------------------|------------|
| ** **                                   | ** ** | **2006**                              | ** ** | **2005** | ** ** | **2004** | ** ** |
| PREFERRED SHARES (2,000 authorized)          |       | —                                |       | — |   | — |   |
| COMMON SHARES (50,000 authorized):           |       |                                  |       |   |   |   |   |
| Shares, beginning of year                    |       | 19,253                                |       | 17,884 |   | 17,781 |   |
| Shares issued upon exercise of  options      |       | 226                                   |       | 140 |   | 103 |   |
| Shares issued in acquisition  of business    |       | —                                |       | 1,229 |   | — |   |
| Shares, end of year                          |       | 19,479                                |       | 19,253 |   | 17,884 |   |
| COMMON STOCK—PAR VALUE $0.01 PER SHARE: |       |                                  |       |   |   |   |   |
| Balance, beginning of year                   |       | $                                     | 193        |   | $ | 179 |   | $ | 178 |   |
| Proceeds from exercise of  options           |       | 2                                     |       | 2 |   | 1 |   |
| Shares issued in acquisition  of business    |       | —                                |       | 12 |   | — |   |
| Balance, end of year                         |       | 195                                   |       | 193 |   | 179 |   |
| ADDITIONAL PAID-IN CAPITAL:                  |       |                                  |       |   |   |   |   |
| Balance, beginning of year                   |       | 128,484                               |       | 102,738 |   | 101,891 |   |
| Proceeds from exercise of  options           |       | 2,627                                 |       | 1,029 |   | 595 |   |
| Share-based income tax benefit               |       | 576                                   |       | 496 |   | 252 |   |
| Share-based compensation  expense            |       | 5,357                                 |       | — |   | — |   |
| Shares issued in acquisition  of business    |       | —                                |       | 24,221 |   | — |   |
| Balance, end of year                         |       | 137,044                               |       | 128,484 |   | 102,738 |   |
| ACCUMULATED OTHER  COMPREHENSIVE  INCOME:    |       |                                  |       |   |   |   |   |
| Balance, beginning of year                   |       | —                                |       | — |   | — |   |
| Foreign currency translation  adjustment     |       | 18                                    |       | — |   | — |   |
| Balance, end of year                         |       | 18                                    |       | — |   | — |   |
| RETAINED EARNINGS:                           |       |                                  |       |   |   |   |   |
| Balance, beginning of year                   |       | 11,791                                |       | 15,633 |   | 22,256 |   |
| Net income (loss)                            |       | 35,131                                |       | (3,842 | ) | (6,623 | ) |
| Balance, end of year                         |       | 46,922                                |       | 11,791 |   | 15,633 |   |
| TOTAL STOCKHOLDERS’ EQUITY              |       | $                                     | 184,179    |   | $ | 140,468 |   | $ | 118,550 |   |

 

See accompanying notes to consolidated financial statements.

F-5

----

**EPIQ SYSTEMS, INC.CONSOLIDATED STATEMENTS OF CASH FLOWS(In Thousands)**
|                                                                                                                                  | ** ** | **Years Ended December 31,** | ** ** |
|----------------------------------------------------------------------------------------------------------------------------------|------------|---------------------------------------------|------------|
| ** **                                                                                                                       | ** ** | **2006**                                    | ** ** | **2005** | ** ** | **2004** | ** ** |
| **CASH FLOWS FROM OPERATING  ACTIVITIES:**                                                                                       |       |                                        |       |   |   |   |   |
| Net  income (loss)                                                                                                               |       | $                                           | 35,131     |   | $ | (3,842 | ) | $ | (6,623 | ) |
| Adjustments to reconcile net  income (loss) to net cash from operating activities:                                               |       |                                        |       |   |   |   |   |
| Expense  (benefit) for deferred income taxes                                                                                     |       | 19,995                                      |       | (9,864 | ) | (2,491 | ) |
| Depreciation  and software amortization                                                                                          |       | 10,113                                      |       | 7,288 |   | 6,527 |   |
| Loan  fee amortization and debt extinguishment                                                                                   |       | 1,445                                       |       | 1,147 |   | 3,115 |   |
| Change  in valuation of embedded option and  convertible debt                                                                    |       | 844                                         |       | 1,034 |   | 292 |   |
| Amortization  of intangible assets                                                                                               |       | 11,629                                      |       | 6,751 |   | 7,767 |   |
| Share-based  compensation expense                                                                                                |       | 5,357                                       |       | — |   | — |   |
| Gain  on sale of discontinued operation                                                                                          |       | —                                      |       | — |   | (1,616 | ) |
| Other,  net                                                                                                                      |       | (558                                        | )          | 1,015 |   | 370 |   |
| Changes in operating assets and  liabilities, net of effects  from business acquisitions:                                        |       |                                        |       |   |   |   |   |
| Trade  accounts receivable                                                                                                       |       | 2,255                                       |       | (3,141 | ) | 7,951 |   |
| Prepaid  expenses and other assets                                                                                               |       | (430                                        | )          | (330 | ) | 1,187 |   |
| Accounts  payable and other liabilities                                                                                          |       | 3,067                                       |       | 3,126 |   | (10,779 | ) |
| Deferred  revenue                                                                                                                |       | (59,151                                     | )          | 24,742 |   | 27,069 |   |
| Excess  tax benefit related to share-based compensation                                                                          |       | (234                                        | )          | — |   | — |   |
| Income  taxes, including tax benefit of $576, $496  and $252 of tax  benefit related to share-based  compensation,  respectively |       | 4,973                                       |       | (688 | ) | (1,180 | ) |
| Net  cash provided by operating activities                                                                                       |       | 34,436                                      |       | 27,238 |   | 31,589 |   |
| **CASH FLOWS FROM INVESTING  ACTIVITIES:**                                                                                       |       |                                        |       |   |   |   |   |
| Purchase  of property and equipment                                                                                              |       | (6,431                                      | )          | (4,555 | ) | (5,424 | ) |
| Software  development costs                                                                                                      |       | (4,563                                      | )          | (2,269 | ) | (1,670 | ) |
| Cash  paid for acquisition of businesses, net of cash acquired                                                                   |       | (3,586                                      | )          | (110,533 | ) | (113,111 | ) |
| Proceeds  from sale of infrastructure business                                                                                   |       | —                                      |       | 489 |   | 1,111 |   |
| Purchase  of short-term investments                                                                                              |       | —                                      |       | 6,000 |   | — |   |
| Sale  of short-term investments                                                                                                  |       | —                                      |       | (6,000 | ) | — |   |
| Other  investing activities, net                                                                                                 |       | (71                                         | )          | 38 |   | 65 |   |
| Net  cash used in investing activities                                                                                           |       | (14,651                                     | )          | (116,830 | ) | (119,029 | ) |
| **CASH FLOWS FROM FINANCING  ACTIVITIES:**                                                                                       |       |                                        |       |   |   |   |   |
| Proceeds  from long-term debt borrowings                                                                                         |       | 14,000                                      |       | 106,841 |   | 193,500 |   |
| Debt  issuance costs                                                                                                             |       | (281                                        | )          | (938 | ) | (5,931 | ) |
| Payments  under long-term debt and capital  lease  obligations                                                                   |       | (44,656                                     | )          | (17,109 | ) | (118,455 | ) |
| Excess  tax benefit related to share-based compensation                                                                          |       | 234                                         |       | — |   | — |   |
| Proceeds  from exercise of stock options                                                                                         |       | 2,629                                       |       | 1,031 |   | 595 |   |
| Net  cash (used in) provided by financing activities                                                                             |       | (28,074                                     | )          | 89,825 |   | 69,709 |   |
| **NET INCREASE (DECREASE) IN CASH AND****CASH EQUIVALENTS**                                                  |       | (8,289                                      | )          | 233 |   | (17,731 | ) |
| **CASH AND  CASH EQUIVALENTS, BEGINNING OF YEAR**                                                                                |       | 13,563                                      |       | 13,330 |   | 30,347 |   |
| Increase  in cash classified as held for sale                                                                                    |       | —                                      |       | — |   | 714 |   |
| **CASH AND CASH EQUIVALENTS,  END OF YEAR**                                                                                      |       | $                                           | 5,274      |   | $ | 13,563 |   | $ | 13,330 |   |

 

See accompanying notes to consolidated financial statements.

F-6

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**EPIQSYSTEMS, INC.**

**NOTESTO CONSOLIDATED FINANCIAL STATEMENTS**

**DECEMBER31, 2006, 2005 AND 2004**

**NOTE 1: NATURE OF OPERATIONS AND SUMMARY OFSIGNIFICANT ACCOUNTING POLICIES**

***Principles ofConsolidation***

The consolidated financialstatements include the accounts of Epiq Systems, Inc. (“Epiq”) and itswholly-owned subsidiaries. All significant intercompany transactions andbalances have been eliminated in consolidation.

***Nature ofOperations***

Epiq is a provider oftechnology-based solutions for the legal and fiduciary services industries. Ourproducts and services assist clients with the administration of complex legalproceedings, including electronic discovery, bankruptcy administration andclass action administration. Our clients include law firms, corporate legaldepartments, bankruptcy trustees, and other professional advisors who requiresophisticated case administration and document management capabilities,extensive subject matter expertise and a high service capacity. We provideclients with an integrated offering of proprietary technology and value-addedservices that comprehensively address their extensive business requirements.

***Cash and CashEquivalents***

Cash and cash equivalentsinclude cash on hand and in banks and all liquid investments with original maturitiesof three months or less at the time of purchase.

***SoftwareDevelopment Costs***

Certain internal softwaredevelopment costs incurred in the creation of computer software products arecapitalized once technological feasibility has been established. Capitalizedcosts are amortized based on the ratio of current revenue to current andestimated future revenue for each product with minimum annual amortizationequal to the straight-line amortization over the remaining estimated economiclife of the product.

***Goodwill andIdentifiable Intangible Assets***

Goodwill is not amortizedbut is assigned to a reporting unit and tested for impairment at least annuallyand between annual tests if events or changes in circumstances have indicatedthat the assets might be impaired. Generally, fair value represents discountedprojected future cash flows and potential impairment is indicated when thecarrying value of a reporting unit, including goodwill, exceeds its estimatedfair value. If potential for impairment exists, the fair value of the reportingunit is subsequently measured against the fair value of its underlying assetsand liabilities, excluding goodwill, to estimate an implied fair value of thereporting unit’s goodwill. An impairment loss is recognized for any excess ofthe carrying value of the reporting unit’s goodwill over the implied fair value.Our annual impairment test, performed as of July 2006 and using adiscounted cash flow analysis to determine the fair value of each reportingunit, indicated that there were no impairments.

Identifiable intangibleassets, resulting from various business acquisitions, consist primarily ofcustomer relationships, trade names and agreements not to compete. Customerrelationships, trade names and agreements not to compete are being amortized ona straight-line basis over their estimated economic benefit period, generallyfrom one to 14 years. Identifiable intangible assets are reviewed forimpairment 

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wheneverevents or changes in circumstances have indicated that the carrying amount ofthese assets might not be recoverable.

***Impairment ofLong-lived Assets***

Long-lived assets arereviewed for impairment, using our best estimates of operating cash flows basedon reasonable and supportable assumptions and projections, whenever events orchanges in circumstances indicate that the carrying amount of the assets mightnot be recoverable.

***Deferred Loan Fees***

Incremental, third partycosts related to establishing credit facilities and issuing convertible debtare capitalized and amortized based on the amortization schedule of the relateddebt. The unamortized costs are included as a component of other long-termassets on our consolidated balance sheets. Amortization costs are included as acomponent of interest expense on our consolidated statements of operations. Unamortizedcosts related to debt extinguished prior to maturity due to refinancing wereexpensed and comprise debt extinguishment on our consolidated statements ofoperations.

***Share-BasedCompensation***

On January 1, 2006,we adopted Statement of Financial Accounting Standards No. 123 (revised2004) (SFAS No. 123R), *Share-Based Payment*.SFAS No. 123R established standards for the accounting for transactions inwhich an entity exchanges its equity instruments for goods and services or incursliabilities in exchange for goods or services that are based on the fair valueof the entity’s equity instruments or that may be settled by the issuance ofthose equity instruments. SFAS No. 123R requires a public entity tomeasure the cost of employee services received in exchange for an award ofequity instruments based on the grant-date fair value of the award and torecognize that cost over the period during which an employee is required toprovide service in exchange for the award.

We elected to adopt SFAS No. 123Rusing the modified version of prospective application. Under the modifiedversion of prospective application, we have recognized compensation costsrelated to share-based compensation beginning January 1, 2006. Werecognize this expense on a straight-line basis over the requisite serviceperiod of the last separately vesting portion of the award. Prior to 2006, weaccounted for stock-based compensation awards under the intrinsic method ofAccounting Principles Board Opinion No. 25, *Accountingfor Stock Issued to Employees,*which required compensation cost tobe recognized based on the excess, if any, between the quoted market price atthe date of grant and the amount an employee must pay to acquire stock. Compensationcosts related to share-based compensation for periods ended on or before December 31,2005 are reflected on a pro forma basis in note 12 of these consolidatedfinancial statements.

***Income Taxes***

A liability or asset isrecognized for the deferred tax consequences of temporary differences betweenthe tax basis of assets or liabilities and their reported amounts in thefinancial statements. Deferred tax assets and liabilities are measured usingenacted tax rates expected to apply to taxable income in the years in whichthose temporary differences are expected to be recovered or settled. Avaluation allowance is provided when, in the opinion of management, it is morelikely than not that some portion or all of a deferred tax asset will not berealized.

***Revenue Recognition***

We have agreements withclients pursuant to which we deliver various case management and documentmanagement services each month.

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Significantsources of revenue include:

·       Feescontingent upon the month-to-month delivery of case management services definedby client contracts, such as claims processing, claims reconciliation,professional services, call center support, and conversion of data into anorganized, searchable electronic database. The amount we earn varies basedprimarily on the size and complexity of the engagement;

·       Hostingfees based on the amount of data stored;

·       Deposit-basedfees from financial institutions, primarily based on a percentage of totalliquidated assets placed on deposit at that financial institution by ourbankruptcy trustee clients, to whom we provide, at no charge, softwarelicenses, limited hardware and hardware maintenance, and postcontract customersupport (PCS) services,

·       Legalnoticing services to parties of interest in bankruptcy and class actionmatters, including media campaign and advertising management, in which wecoordinate notification through various media outlets, such as print, radio andtelevision, to potential parties of interest for a particular clientengagement, and

·       Reimbursement for costsincurred related to postage on mailing services.

*Non-Software Arrangements*

Caseand document management services related to electronic discovery, corporaterestructuring, and class action revenue, which are billed based on volume, areevaluated pursuant to Emerging Issues Task Force (EITF) 00-21, *Revenue Arrangements with Multiple Deliverables*. For each ofthese contractual arrangements, we have identified the following deliverablesand/or services:

·       ElectronicDiscovery

**·****     **Dataprocessing

**·****     **Hosting

·       CorporateRestructuring

**·****     **Consulting

**·****     ** Claims management

**·****     **Printingand reproduction

**·****     **Mailingand noticing

**·****     **Documentmanagement

·       Class Action

**·****     **Consulting

**·****     **Noticecampaigns

**·****     **Toll freecustomer support

**·****     **Web sitedesign/hosting

**·****     **Claimsadministration

**·****     **Distribution

Based on our evaluation ofeach element, we have determined that each element delivered has standalonevalue to our customers because we or other vendors sell such servicesseparately from any other 

F-9

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services/deliverables.We have also obtained objective and reliable evidence of the fair value of eachelement based either on the price we charge when we sell an element on astandalone basis or based on third-party evidence of fair value of suchservices. Lastly, our arrangements do not include general rights of return. Accordingly,each of the service elements in our multiple element case and documentmanagement arrangements qualifies as a separate unit of accounting under EITF 00-21.We allocate revenue to the various units of accounting in our arrangementsbased on the fair value of each unit of accounting, which is generallyconsistent with the stated prices in our arrangements. As we have evidence ofan arrangement, revenue for each separate unit of accounting is recognized eachperiod in accordance with Staff Accounting Bulletin Topic 13, *Revenue Recognition* (SAB Topic 13). As the services arerendered, our fee becomes fixed and determinable, and collectibility isreasonably assured. Payments received in advance of satisfaction of the relatedrevenue recognition criteria are recognized as a customer deposit until allrevenue recognition criteria have been satisfied.

*Software Arrangements*

For our Chapter 7bankruptcy trustee arrangements, we provide our trustee clients with a softwarelicense, hardware lease, hardware maintenance, and postcontract customersupport (PCS) services, all at no charge to the trustee. The trustees placetheir liquidated estate deposits with a financial institution with which wehave an arrangement. We earn contingent monthly fees from the financialinstitutions based on the dollar level of average monthly deposits placed bythe trustees with that financial institution, from the financial institutionrelated to the software license, hardware lease, hardware maintenance, and PCSservices. We account for the software license and PCS elements in accordancewith Statement of Position 97-2, *Software RevenueRecognition* (SOP 97-2). Since we have not established vendorspecific objective evidence (VSOE) of the fair value of the software license,we do not recognize any revenue on delivery of the software. The softwareelement is deferred and included with the remaining undelivered element, whichis PCS. This revenue, when recognized, is included as a component of casemanagement services revenue. Revenue related to PCS is entirely contingent onthe placement of liquidated estate deposits by the trustee with the financialinstitution. Accordingly, except for the arrangement described in the followingparagraph, we recognize this contingent usage based revenue consistent with theguidance provided by the American Institute of Certified Public Accountants’Technical Practice Aid (TPA) 5100.76, *Fair Value inMultiple-Element Arrangements That Include Contingent Usage-Based Fees andSoftware Revenue Recognition* as the fee becomes fixed ordeterminable at the time actual usage occurs and collectibility is probable. Thisoccurs monthly as a result of the computation, billing and collection ofmonthly deposit fees contractually agreed to. At that time, we have alsosatisfied the other revenue recognition criteria contained in SOP 97-2,since we have persuasive evidence that an arrangement exists, services havebeen rendered, the price is fixed and determinable, and collectibility isreasonably assured.

Effective October 1,2003, we entered into an arrangement with our primary depository financialinstitution under which we delivered two specified upgrades annually with thelast specified upgrade occurring in the second quarter of 2006. Thisarrangement included specific pricing for each software upgrade and certainspecial projects in addition to the contingent deposit-based pricing related tothe software license, hardware, hardware maintenance, and PCS to each trusteeclient. Therefore, the softwareupgrades and special projects are part of a bundled arrangement. Each softwareupgrade is considered a separate and discrete product and, as we do not selleach software upgrade on a standalone basis, we were unable to establish VSOEof the fair value of the software upgrades. As a result, the licensed software,software upgrade, special projects and PCS are a combined unit of accounting. Revenuefor this combined unit of accounting, when recognized, is included as acomponent of case management services revenue. Since we did not haveVSOE of the fair value of each separate upgrade, we deferred recognition ofsubstantially all revenue under this arrangement until the final upgrade wasdelivered. The ongoing costs related to this arrangement were recognized asexpense when incurred. On delivery of the final upgrade during the secondquarter of 2006, the only remaining undelivered element was PCS services. In 

F-10

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accordancewith SOP 97-2, on delivery of the final software upgrade, we recognizedrevenue previously deferred on a proportionate basis over the three year termof the contract. As the contract terminated September 30, 2006, during2006 we recognized approximately $59.7 million of revenue which had beendeferred as of December 31, 2005.

We also provide ourtrustee clients with certain hardware, such as desktop computers, monitors, andprinters, and hardware maintenance. We retain ownership of all hardwareprovided and, based on guidance provided in EITF 01-8, *Determining Whether an Arrangement Contains a Lease*, weaccount for this hardware as a lease. As the hardware maintenance arrangementis an executory contract similar to an operating lease, we use guidance relatedto contingent rentals in operating lease arrangements for hardware maintenanceas well as for the hardware lease. Since the payments under all of ourarrangements are contingent upon the level of trustee deposits and the deliveryof upgrades and other services, there remain important uncertainties regardingthe amount of unreimbursable costs yet to be incurred by us, we account for thehardware lease as an operating lease in accordance with SFAS 13, *Accounting for Leases*. Therefore, all lease payments, basedon the estimated fair value of hardware provided, were accounted for ascontingent rentals under EITF Issue No. 98-9, *Accountingfor Contingent Rent* and SAB Topic 13, which requires that werecognize rental income when the changes in the factor on which the contingentlease payment is based actually occur. This occurs at the end of each period aswe achieved our target when deposits are held at the depository financialinstitution as, at that time, evidence of an arrangement exists, delivery hasoccurred, the amount has become fixed and determinable, and collection isreasonably assured. This revenue, which is less than ten percent of our totalrevenue, is included as a component of case management services revenue.

*Reimbursements*

Our case and documentmanagement businesses both have revenue related to the reimbursement of certaincosts, primarily postage. Consistent with guidance provided by EITF No. 01-14,*Income Statement Characterization of ReimbursementsReceived for “Out-of-Pocket” Expenses Incurred*, reimbursed postageand other reimbursable direct costs are recorded gross in the consolidated statement of operations as“Operating revenue from reimbursed direct costs” and as “Reimbursed directcosts”.

***Costs Related toContract Acquisition, Origination, and Set-up***

SAB Topic 13 providesguidance that contract acquisition, origination, and set-up costs may beexpensed as incurred or capitalized and amortized in accordance with FASBTechnical Bulletin No. 90-1, *“Accounting for SeparatelyPriced Extended Warranty and Product Maintenance Contracts”* orStatement of Financial Accounting Standards No. 91, *“Accountingfor Nonrefundable Fees and Costs Associated with Originating or Acquiring Loansand Initial Direct costs of Leases.” *Wehave elected to expense these costs as incurred.

***Derivative Financial Instrument***

The holders of our contingently convertible subordinatednotes have the right to extend the maturity of these notes for a period not toexceed three years. Under SFAS No. 133, *Accountingfor Derivative Instruments and Hedging Activities*, the right toextend the maturity of the notes represents an embedded option and is accountedfor as a derivative financial instrument. The fair value of our obligationrelated to the embedded option has been included as a component of ourlong-term obligations on our accompanying consolidated balance sheets. Changesin the fair value of the embedded option are recorded each period as acomponent of interest expense on our accompanying consolidated statements ofoperations. Changes in the fair value of the embedded option do not affect ourcash flows and, accordingly, are reflected as an adjustment to reconcile netincome (loss) to net cash from operating activities on our accompanyingconsolidated statements of cash flows.

F-11

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***Comprehensive Income (Loss)***

Statement of FinancialAccounting Standards No. 130, *Reporting ComprehensiveIncome*, establishes requirements for reporting and display ofcomprehensive income and its components. Our accumulated other comprehensiveincome, which is not material to our financial position, results of operations,or cash flows, is included as a separate component of shareholders’ equity onour consolidated balance sheets  Therewere no reclassification adjustments from accumulated other comprehensiveincome to net income (loss) during the years ended December 31, 2006, 2005and 2004.

***Depreciation and Software and Leasehold Amortization***

The caption “Depreciationand software and leasehold amortization” in the accompanying consolidatedstatements of operations includes direct costs of approximately $6.7 million,$5.0 million, and $4.5 million of for the years ended December 31, 2006,2005 and 2004, respectively.

***Income (Loss) Per Share***

Basic net income (loss)per share is computed by dividing net income (loss) available to commonshareholders by the weighted average number of common shares outstanding forthe period. Diluted net income (loss) per share is computed by dividing netincome (loss) available to common shareholders, increased by the amount ofinterest expense, net of tax, related to outstanding convertible debt, by theweighted average number of outstanding common shares and incremental sharesthat may be issued in future periods relating to outstanding share options andconvertible debt, if dilutive. When calculating incremental shares related tooutstanding share options, we apply the treasury stock method. The treasurystock method assumes that proceeds, consisting of the amount the employee mustpay on exercise, compensation cost attributed to future services and not yetrecognized, and excess tax benefits that would be credited to additionalpaid-in capital on exercise of the share options, are used to repurchaseoutstanding shares at the average market price for the period.

***Segment Information***

In determining ourreportable segments, we consider how we organize our business internally formaking operating decisions and assessing business performance. Substantiallyall our revenues are derived from sources within the United States of Americaand substantially all of our long-lived assets are located in the United Statesof America.

***Use of Estimates***

The preparation offinancial statements in conformity with accounting principles generallyaccepted in the United States of America requires management to make estimatesand assumptions that affect the reported amounts of assets and liabilities anddisclosure of contingent assets and liabilities at the date of the financialstatements. Estimates also affect the reported amounts of revenues and expensesduring the periods reported. Actual results could differ from those estimates.

***Recent Accounting Pronouncements***

In February 2007,the Financial Accounting Standards Board (FASB) issued Statement ofFinancial Accounting Standards No. 159, *The FairValue Option for Financial Assets and Financial Liabilities**—Including an amendment ofFASB Statement No. 115** *(SFAS 159). SFAS 159 permits themeasurement of specified financial instruments and warranty and insurancecontracts at fair value on a contract-by-contract basis, with changes in fairvalue recognized in earnings each reporting period. We do not anticipate thatadoption of this statement will have a material impact on our consolidatedfinancial statements.

F-12

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In September 2006, the FASB issued Statement ofFinancial Accounting Standards No. 157, *Fair ValueMeasurements*, (SFAS 157). SFAS 157 defines fair value, establishes aframework for measuring fair value in generally accepted accounting principlesand expands disclosures about fair value measurements. FAS 157 is effective forfinancial statements issued for fiscal years beginning after November 15,2007 and interim periods within those fiscal years. Management is stillevaluating the impact, if any, that the adoption of SFAS 157 will have on ourfinancial position, results of operations, or cash flows.

In June 2006, the FASB issued FASB InterpretationNo. 48, (FIN 48) *Accounting for Uncertaintyin Income Taxes,* an interpretation of SFAS 109, *Accountingfor Income Taxes*. FIN 48 prescribes a comprehensive model for howcompanies should recognize, measure, present, and disclose in their financialstatements uncertain tax positions taken or expected to be taken on a taxreturn. Under FIN 48, tax positions shall initially be recognized in thefinancial statements when it is more likely than not the position will besustained upon examination by the tax authorities. Such tax positions shallinitially and subsequently be measured as the largest amount of tax benefitthat is greater than 50% likely of being realized upon ultimate settlement withthe tax authority assuming full knowledge of the position and all relevantfacts. FIN 48 also revises disclosure requirements to include an annual tabularrollforward of unrecognized tax benefits. The provisions of this interpretationare effective for fiscal years beginning after December 15, 2005. We willbe required to apply the provisions of FIN 48 to all tax positions upon initialadoption with any cumulative effect adjustment to be recognized as anadjustment to retained earnings. We are currently evaluating what effect theadoption of FIN 48 will have on our consolidated financial statements.

In October 2006, the FASB issued Staff Position No. FAS123(R)-5, *Amendment of FASB Staff Position 123(R)-1*(FSP 123(R)-5).FSP 123(R)-5, which amends FSP 123(R)-1, addresses instrumentsoriginally issued as employee compensation and later modified solely to reflectan equity restructuring that occurs when the holders are no longer employees.In that situation, no change in the recognition or measurement (due to changein classification) of those instruments will result if (i) there is noincrease in the fair value of the award, or an antidilution provision is notadded to the terms of the award in contemplation of an equity restructuring;and (ii) all holders of the same class of equity instruments are treatedin the same manner. The guidance in FSP 123(R)-5 is to be applied in thefirst reporting period beginning after October 15, 2006. We do notanticipate that adoption of this statement will have a material impact on ourconsolidated financial statements.

In October 2006, the FASB issued Staff Position No. FAS123(R)-6, *Technical Corrections of FASB Statement No. 123(R) *(FSP123(R)-6). FSP 123(R)-6 was issued to make several technicalcorrections to SFAS 123(R). These include exemption for non-public entitiesfrom disclosing the aggregate intrinsic value of outstanding fully vested shareoptions, revision to the computation of the minimum compensation cost that mustbe recognized, indication that at the date the illustrative awards were nolonger probable of vesting, any previously recognized compensation cost shouldhave been reversed, and changes to the definition of short-term inducement toexclude an offer to settle an award. The guidance in FSP 123(R)-6 iseffective in the first reporting period beginning after October 20, 2006.Early application is permitted in periods for which financial statements havenot yet been issued. We do not anticipate that adoption of this statement willhave a material impact on our consolidated financial statements.

In September 2006,the SEC issued Staff Accounting Bulletin (SAB) No. 108, “*Considering the Effects of Prior Year Misstatements when QuantifyingMisstatements in Current Year Financial Statements*,” which providesinterpretive guidance regarding the consideration given to prior yearmisstatements when determining materiality in current year financial statements.SAB No. 108 is effective for fiscal years ending after November 15,2006. The impact of this adoption was not material to our consolidatedfinancial statements.

F-13

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**NOTE 2: PROPERTY,EQUIPMENT AND LEASEHOLD IMPROVEMENTS**

Property,equipment and leasehold improvements are stated at cost and depreciated oramortized on a straight-line basis over the estimated useful life of each assetor, for leasehold improvements, the lesser of the lease term or useful life. Theclassification of property, equipment and leasehold improvements and theirestimated useful lives is as follows (in thousands):

| ** **                                           | ** ** | **December 31,** | ** ** | **Estimated** | ** ** |
|------------------------------------------------------|------------|-----------------------|------------|---------------|------------|
| ** **                                           | ** ** | **2006**              | ** ** | **2005**      | ** ** | **Useful Life** | ** ** |
| Land                                                 |       | $                     | 192        |          | $          | 192 |   |   |   |
| Building and  building and leasehold improvements    |       | 9,283                 |       | 8,947         |       | 5–30 years |   |
| Furniture and  fixtures                              |       | 2,261                 |       | 2,061         |       | 5–10 years |   |
| Computer and  office equipment                       |       | 26,424                |       | 23,044        |       | 2–5 years |   |
| Transportation  equipment                            |       | 6,396                 |       | 6,396         |       | 3–5 years |   |
| Mailroom  equipment                                  |       | 1,015                 |       | 858           |       | 3–5 years |   |
| Construction in  progress                            |       | 525                   |       | —        |       |   |   |
|                                                 |       | 46,096                |       | 41,498        |       |   |   |
| Accumulated depreciation and amortization            |       | (22,943               | )          | (17,747       | )          |   |   |
| Property,  equipment and leasehold improvements, net |       | $                     | 23,153     |          | $          | 23,751 |   |   |   |

 

Computer and officeequipment includes property acquired under capital leases. As of December 31,2006 and 2005, assets acquired under capital lease had a historical cost basisof $3.0 million and $2.9 million, respectively, and accumulated amortization of$2.4 million and $1.4 million, respectively.

**NOTE 3: SOFTWAREDEVELOPMENT COSTS**

Thefollowing is a summary of software development costs capitalized (inthousands):

| ** **                              | ** ** | **Year Ended December 31,** | ** ** |
|-----------------------------------------|------------|--------------------------------------------|------------|
| ** **                              | ** ** | **2006**                                   | ** ** | **2005** | ** ** |
| Amounts  capitalized, beginning of year |       | $                                          | 16,976     |   | $ | 11,838 |   |
| Development costs  capitalized          |       | 4,563                                      |       | 2,269 |   |
| Dispositions                            |       | (257                                       | )          | — |   |
| Acquisitions                            |       | —                                     |       | 2,869 |   |
| Amounts  capitalized, end of year       |       | 21,282                                     |       | 16,976 |   |
| Accumulated amortization, end of year   |       | (11,671                                    | )          | (8,128 | ) |
| Software development  costs, net        |       | $                                          | 9,611      |   | $ | 8,848 |   |

 

Included in the above arecapitalized software development costs for unreleased products of $2.0 millionand $1.0 million at December 31, 2006 and 2005, respectively. During theyears ended December 31, 2006, 2005 and 2004, we recognized amortizationexpense related to capitalized software development costs of $3.7 million, $2.1million, and $1.8 million, respectively.

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**NOTE 4: GOODWILLAND INTANGIBLE ASSETS**

Changesin the carrying amounts of goodwill by segment are as follows (in thousands):
|                                                      | ** ** | **Year Ended December 31, 2006** | ** ** | **Year Ended December 31, 2005** | ** ** |
|------------------------------------------------------|------------|------------------------------------------------------|------------|------------------------------------------------------|------------|
| ** **                                           | ** ** | **Case  Management**                                 | ** ** | **Document  Management**                             | ** ** | **Total** | ** ** | **Case  Management** | ** ** | **Document  Management** | ** ** | **Total** | ** ** |
| Balance,  beginning of period                        |       |                                                 | $          | 200,936                                              |       |   |   | $ | 48,491 |   |   | $ | 249,427 |   |   | $ | 106,371 |   |   |   | $ | 41,357 |   |   | $ | 147,728 |   |
| Goodwill acquired  during the period and adjustments |       |                                                 | 11,116     |                                                 |       |   | 66 |   |   | 11,182 |   |   | 94,565 |   |   |   | 7,134 |   |   | 101,699 |   |
| Balance, end of period                               |       |                                                 | $          | 212,052                                              |       |   |   | $ | 48,557 |   |   | $ | 260,609 |   |   | $ | 200,936 |   |   |   | $ | 48,491 |   |   | $ | 249,427 |   |

 

Otherintangible assets as of December 31, 2006 and 2005 consisted of thefollowing (in thousands):

| ** **                                 | ** ** | **December 31,** | ** ** | **Estimated** | ** ** |
|--------------------------------------------|------------|-----------------------|------------|---------------|------------|
| ** **                                 | ** ** | **2006**              | ** ** | **2005**      | ** ** | **Useful Life** | ** ** |
| Amortized  Identifiable Intangible Assets: |       |                  |       |          |       |   |   |
| Customer relationships                     |       | $                     | 39,287     |          | $          | 37,313 |   | 2–14 years |   |
| Accumulated amortization                   |       | (12,779               | )          | (6,170        | )          |   |   |
| Customer relationships, net                |       | 26,508                |       | 31,143        |       |   |   |
| Trade names                                |       | 2,414                 |       | 2,319         |       | 1–2 years |   |
| Accumulated amortization                   |       | (2,301                | )          | (1,578        | )          |   |   |
| Trade names, net                           |       | 113                   |       | 741           |       |   |   |
| Non-compete agreements                     |       | 27,526                |       | 27,525        |       | 5–10 years |   |
| Accumulated amortization                   |       | (10,307               | )          | (6,010        | )          |   |   |
| Non-compete agreements, net                |       | 17,219                |       | 21,515        |       |   |   |
| Total amortized  intangible assets, net    |       | $                     | 43,840     |          | $          | 53,399 |   |   |   |

 

Theweighted average life for identifiable intangibles acquired during 2006 are asfollows:

| Customer  relationships |   | 2.0 years |   |
|-------------------------|--------|-----------|--------|

 

Amortizationexpense for each year in the three year period ended December 31, 2006 andestimated amortization expense for each of the next five years is as follows(in thousands):

| ** **                                                         | ** ** | **For the Year Ending  December 31,** | ** ** |
|--------------------------------------------------------------------|------------|-----------------------------------------------------------|------------|
| Aggregate  amortization expense included in continuing operations: |       |                                                      |       |   |   |
| 2004                                                               |       |                                                      | $          | 7,767 |   |   |
| 2005                                                               |       |                                                      | 6,751      |   |   |
| 2006                                                               |       |                                                      | 11,629     |   |   |
| Estimated  amortization expense:                                   |       |                                                      |       |   |   |
| 2007                                                               |       |                                                      | 9,531      |   |   |
| 2008                                                               |       |                                                      | 8,361      |   |   |
| 2009                                                               |       |                                                      | 6,829      |   |   |
| 2010                                                               |       |                                                      | 6,439      |   |   |
| 2011                                                               |       |                                                      | 4,706      |   |   |
|                                                                    |            |                                                           |            |  |  |  |

 

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**NOTE 5: LONG-TERMOBLIGATIONS**

Thefollowing is a summary of indebtedness outstanding (in thousands):

| ** **                                                | ** ** | **Year Ended December 31,** | ** ** |
|-----------------------------------------------------------|------------|--------------------------------------------|------------|
| ** **                                                | ** ** | **2006**                                   | ** ** | **2005** | ** ** |
| Senior term loan                                          |       | $                                          | 15,000     |   | $ | 25,000 |   |
| Senior revolving  loan                                    |       | 78,028                                     |       | 93,028 |   |
| Convertible  subordinated debt, including embedded option |       | 52,170                                     |       | 51,326 |   |
| Capital leases                                            |       | 179                                        |       | 972 |   |
| Deferred  acquisition price                               |       | 8,984                                      |       | 3,222 |   |
| Total long-term  obligations                              |       | $                                          | 154,361    |   | $ | 173,548 |   |

 

***Credit Facilities***

As of December 31, 2005, we had a creditfacility, with KeyBank NationalAssociation as administrative agent, which consisted of a $25.0 millionsenior term loan with an August 2006 maturity and a $100.0 million seniorrevolving loan with a November 2008 maturity. During 2006, we repaid $10.0million of the senior term loan and, in June 2006, our credit facility wasamended to extend the maturity of the outstanding senior term loan balance to June 30,2007. The senior term loan does not have any required amortizing payments. Duringthe term of the loan we have the right, subject to compliance with ourcovenants, to increase the senior revolving loan to $175.0 million.

The credit facility issecured by liens on our real property and a significant portion of our personalproperty and contains financial covenants related to earnings before interest,provision for income taxes, depreciation and amortization (“EBITDA”), totaldebt, senior debt, fixed charges and working capital. As of December 31,2006, our borrowings under the credit facility totaled $93.0 million,consisting of $15.0 million borrowed under the senior term loan and $78.0million borrowed under the senior revolving loan. Interest on the creditfacility is generally based on a spread, which as of December 31, 2006 was300 basis points, over the LIBOR rate. As of December 31, 2006, theinterest rate charged on outstanding borrowings under the credit facilityranged from 8.4% to 8.6%.

***Convertible Subordinated Debt***

During June 2004,we issued $50.0 million of contingent convertible subordinated notes. Netproceeds of $47.4 million were used to repay and terminate an outstandingsubordinated term loan and to pay in full our then outstanding revolving loanbalance. The contingency for the notes has been satisfied and the notes may, atthe option of the holders, be converted into shares of our common stock at anytime. These convertible subordinated notes:

·       bearinterest at a fixed rate of 4%, payable quarterly;

·       areconvertible into shares of our common stock at a price of $17.50 per share; and

·       matureon June 15, 2007, subject to extension of maturity to June 15, 2010at the option of the note holders.

If all shares were converted, the notes would convertinto approximately 2.9 million shares of our common stock. If we change ourcapital structure (for example, through a stock dividend or stock split) whilethe notes are outstanding, the conversion price will be adjusted on aconsistent basis and, accordingly, the number of shares of common stock wewould issue on conversion would be adjusted.

The holders of the noteshave the right to extend the maturity of the notes for a period not to exceedthree years. Under SFAS No. 133, *Accounting for DerivativeInstruments and Hedging Activities*, the right to extend the maturityof the notes represents an embedded option subject to bifurcation. The embedded

F-16

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optionwas initially valued at $1.2 million and the convertible debt balance wasreduced by the same amount. The convertible debt is accreted approximately $0.1million each quarter such that, at the end of three years, the convertible debtbalance will total $50.0 million. On our accompanying consolidated statementsof operations, this accretion is a component of interest expense. The embeddedoption must be revalued at each period end based on the probability weighteddiscounted cash flows related to the additional 4% interest rate payments thatwill be made if the convertible debt maturity is extended an additional threeyears. Under this methodology, the embedded option had a fair value andcarrying value at December 31, 2006 and 2005 of approximately $2.4 millionand $1.9 million, respectively. On our accompanying consolidated balancesheets, our obligation related to the embedded option has been included as acomponent of the convertible note payable. The increase in the fair value ofthe embedded option is included as a component of interest expense on ouraccompanying consolidated statements of operations. The changes in carryingvalue of the convertible debt and fair value of the embedded option do notaffect our cash flow and, if the embedded option is exercised, the valueassigned to the embedded option will be amortized as a reduction to our 4%convertible debt interest expense over the periods payments are made. If theoption is not exercised by some or all convertible debt holders, any remainingrelated value assigned to the embedded option will be recognized as a gainduring that period.

***Covenant Compliance***

Our credit facilitycontains financial covenants related to earnings before interest, provision forincome taxes, depreciation, amortization and other adjustments as defined inthe agreements (EBITDA) and total debt. In addition, our credit facility alsocontains financial covenants related to senior debt, fixed charges, and workingcapital. As of December 31, 2006, we were in compliance with all financialcovenants.

***Deferred Acquisition Price***

We have made threeacquisitions, Bankruptcy Services, Hilsoft, and Epiq Advisory Services, forwhich a portion of the purchase price was deferred. These deferred payments,which are either non-interest bearing or have a below market interest rate,have been discounted at imputed interest rates (Bankruptcy Services at 5%,Hilsoft and Epiq Advisory Services at 8%). As of December 31, 2006 and2005, the discounted value of the remaining note payments was approximately$9.0 million and $3.2 million, respectively, of which approximately $3.3million and $1.7 million, respectively, was classified as a current liabilityin the consolidated balance sheets.

***Scheduled Principal Payments***

Our long-termobligations, including credit facility debt outstanding as of December 31,2006, convertible debt (including embedded option), deferred acquisition costs,and capitalized leases, mature as follows for years ending December 31 (inthousands):

| 2007  |   | $      | 70,488  |   |
|-------|--------|--------|---------|--------|
| 2008  |   | 80,557 |    |
| 2009  |   | 1,440  |    |
| 2010  |   | 1,396  |    |
| 2011  |   | 480    |    |
| Total |   | $      | 154,361 |   |

 

**NOTE 6: OPERATINGLEASES**

We have non-cancelable operating leases for officespace at various locations expiring at various times through 2015. Each of theleases requires us to pay all executory costs (property taxes, maintenance andinsurance). Certain of our lease agreements provide for scheduled rentincreases during the lease term. 

F-17

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Rent expense is recognizedon a straight-line basis over the lease term. Also, landlord provided tenantimprovement allowances are recorded as a liability and amortized as a reductionto rent expense. Additionally, we have non-cancelable operating leases foroffice equipment and automobiles expiring through 2010.

Futureminimum lease payments during the years ending December 31 are as follows(in thousands):

| 2007                          |   | $      | 5,947  |   |
|-------------------------------|--------|--------|--------|--------|
| 2008                          |   | 5,889  |   |
| 2009                          |   | 5,410  |   |
| 2010                          |   | 5,179  |   |
| 2011                          |   | 4,841  |   |
| Thereafter                    |   | 15,627 |   |
| Total minimum lease  payments |   | $      | 42,893 |   |

 

Expense related tooperating leases was approximately $5.6 million, $2.9 million, and $2.5 millionfor the years ended December 31, 2006, 2005 and 2004, respectively.

**NOTE 7: STOCKHOLDERS’EQUITY**

On November 15, 2005, we issued approximately 1.2million shares of restricted common stock, valued at approximately $24.2million, as a part of the transaction to purchase nMatrix. Under the terms of aregistration rights agreement executed concurrent with the acquisitionagreement, we have agreed to prepare and file with the SEC a registrationstatement, and to use our best efforts to cause the registration statement tobecome effective as soon as reasonably practicable thereafter, to enable theresale of these shares on a delayed or continuous basis under Rule 415 ofthe Securities Act of 1933, as amended.

At this time we intend toretain our earnings to reduce our debt and for use in the operation andexpansion of our business and, accordingly, do not expect to declare or pay anycash dividends during the foreseeable future. Under the terms of our convertiblesubordinated debt agreement, we are restricted from payment of dividends whilethe convertible subordinated debt is outstanding. Thereafter, the payment ofdividends is within the discretion of our board of directors and will dependupon various factors, including future earnings, capital requirements,financial condition, the terms of our credit agreement, the terms of ourconvertible notes, and other factors deemed relevant by the board of directors.There is no restriction on the ability of our subsidiaries to transfer funds toEpiq in the form of cash dividends, loans or advances.

**NOTE 8: EMPLOYEEBENEFIT PLANS**

***Stock Purchase Plan***

We have an employee stockpurchase plan that provides an opportunity for employees to purchase shares ofour common stock through payroll deduction. The purchase prices for allemployee participants are based on the closing bid price on the last businessday of the month.

***Defined Contribution Plan***

We have a definedcontribution 401(k) plan that covers substantially all employees. We match60% of the first 10% of employee contributions and also have the option ofmaking discretionary contributions. Our plan contributions were approximately$1.1 million, $0.8 million, and $0.8 million for the years ended December 31,2006, 2005, and 2004, respectively.

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**NOTE 9: FINANCIALINSTRUMENTS AND CONCENTRATIONS**

***Fair Value of Financial Instruments***

Estimates of fair values are subjective in nature andinvolve uncertainties and matters of significant judgment and therefore cannotbe determined with precision. Changes in assumptions could affect theestimates.

As of December 31,2006, the carrying value of cash, cash equivalents, trade receivables, andaccounts payable approximate fair value. Borrowings under our credit facilityare repriced frequently at market rates and approximate fair value. Notesrelated to the BSI, Hilsoft, and Epiq Advisory Services deferred acquisitionprice, with a combined carrying value of $9.0 million as of December 31,2006, are either non-interest bearing or bear interest at a below market rateand are discounted at an imputed interest rate of 5% and 8%, and 8%,respectively. We also have fixed rate convertible notes which, as of December 31,2006, had a carrying value of $52.2 million. The aggregate carrying value ofthese deferred acquisition price and convertible notes approximates fair valueas of December 31, 2006. The fair value was calculated using a pricingmodel that incorporates assumptions regarding future volatility, interest ratesand credit risk.

***SignificantCustomer and Concentration of Credit Risk***

On April 1, 2004, our exclusive nationalmarketing arrangement with Bank of America became a non-exclusive arrangementwith pricing established through September 30, 2006. During February 2006,the parties agreed to extend the arrangement indefinitely. Either party may,with appropriate notice, wind down the agreement over a period of three years. Wecurrently promote our Chapter 7 *TCMS*®software related products and services through marketing arrangements withvarious financial institutions. Bank of America has been, and continues to be,a significant partner for these marketing arrangements. Revenues recognized byus from Bank of America, all related to our case management segment, wereapproximately 38%, 3% and 3% of our total revenues for the years ended December 31,2006, 2005 and 2004, respectively. Additionally, Bank of America representedapproximately 13% of our accounts receivable balance as of both December 31,2006 and 2005.

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**NOTE 10: INCOMETAXES**

Thefollowing table presents the income from operations before income taxes and theprovision for (benefit from) income taxes (in thousands):

| ** **                                                          | ** ** | **Years Ended December 31,** | ** ** |
|---------------------------------------------------------------------|------------|---------------------------------------------|------------|
| ** **                                                          | ** ** | **2006**                                    | ** ** | **2005** | ** ** | **2004** | ** ** |
| Income (loss) from continuing operations before  income taxes       |       | $                                           | 57,965     |   | $ | (6,242 | ) | $ | (11,603 | ) |
| Provision  (benefit) for income taxes from continuing operations:   |       |                                        |       |   |   |   |   |
| Currently payable  (receivable) income taxes                        |       |                                        |       |   |   |   |   |
| Federal                                                             |       | $                                           | 2,261      |   | $ | 6,996 |   | $ | (16 | ) |
| State                                                               |       | 491                                         |       | 468 |   | 83 |   |
| Foreign                                                             |       | 87                                          |       | — |   | — |   |
| Total                                                               |       | 2,839                                       |       | 7,464 |   | 67 |   |
| Deferred income  taxes                                              |       |                                        |       |   |   |   |   |
| Federal                                                             |       | 17,289                                      |       | (8,560 | ) | (2,962 | ) |
| State                                                               |       | 2,725                                       |       | (1,304 | ) | (1,418 | ) |
| Foreign                                                             |       | (19                                         | )          | — |   | — |   |
| Total                                                               |       | 19,995                                      |       | (9,864 | ) | (4,380 | ) |
| Provision (benefit) for income taxes from continuing  operations    |       | 22,834                                      |       | (2,400 | ) | (4,313 | ) |
| Provision  (benefit) for income taxes from discontinued operations: |       |                                        |       |   |   |   |   |
| Current income taxes                                                |       | —                                      |       | — |   | (1,452 | ) |
| Deferred income taxes                                               |       | —                                      |       | — |   | 1,889 |   |
| Provision for  income taxes from discontinued operations            |       | —                                      |       | — |   | 437 |   |
| Consolidated  income tax provision (benefit)                        |       | $                                           | 22,834     |   | $ | (2,400 | ) | $ | (3,876 | ) |

 

Areconciliation of the provision (benefit) for income taxes from continuingoperations at the statutory rate of 35% for the year ended December 31,2006 and 34% for the years ended December 31, 2005 and 2004 to theprovision (benefit) for income taxes from continuing operations at oureffective rate is shown below (in thousands):

| ** **                                                       | ** ** | **Years Ended December 31,** | ** ** |
|------------------------------------------------------------------|------------|---------------------------------------------|------------|
| ** **                                                       | ** ** | **2006**                                    | ** ** | **2005** | ** ** | **2004** | ** ** |
| Computed at the  statutory rate                                  |       | $                                           | 20,288     |   | $ | (2,122 | ) | $ | (3,945 | ) |
| Change in taxes  resulting from:                                 |       |                                        |       |   |   |   |   |
| State income taxes, net of federal tax effect                    |       | 2,090                                       |       | (274 | ) | (514 | ) |
| Research and development credits                                 |       | (300                                        | )          | (196 | ) | (99 | ) |
| Permanent differences                                            |       | 683                                         |       | 299 |   | 239 |   |
| Other                                                            |       | 73                                          |       | (107 | ) | 6 |   |
| Provision (benefit) for  income taxes from continuing operations |       | $                                           | 22,834     |   | $ | (2,400 | ) | $ | (4,313 | ) |

 

Taxes related to acquisitions of $0.5 million wererecorded as an increase to goodwill for the year ended December 31, 2006. Forthe years ended December 31, 2005 and 2004, taxes related to acquisitionsof $0.3 million and $0.5 million, respectively, were recorded as a reduction togoodwill.

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Thetax effects of temporary differences that give rise to significant portions ofdeferred tax assets and deferred tax liabilities on the accompanyingconsolidated balance sheets are as follows (in thousands):

| ** **                                             | ** ** | **December 31,** | ** ** |
|--------------------------------------------------------|------------|-----------------------|------------|
| ** **                                             | ** ** | **2006**              | ** ** | **2005** | ** ** |
| Deferred tax assets:                                   |       |                  |       |   |   |
| Deferred revenue                                       |       | $                     | —     |   | $ | 23,601 |   |
| Allowance for doubtful  accounts                       |       | 778                   |       | 1,567 |   |
| Share-based compensation                               |       | 2,054                 |       | — |   |
| Convertible debt                                       |       | 900                   |       | 567 |   |
| Intangible assets                                      |       | 718                   |       | 532 |   |
| Accrued liabilities                                    |       | 710                   |       | 906 |   |
| Foreign loss:                                          |       |                  |       |   |   |
| Carryforwards                                          |       | 228                   |       | — |   |
| Valuation allowance                                    |       | (228                  | )          | — |   |
| State net operating loss  carryforwards                |       | 1,209                 |       | 572 |   |
| Total deferred tax  assets                             |       | 6,369                 |       | 27,745 |   |
| Deferred tax  liabilities:                             |       |                  |       |   |   |
| Prepaid expenses                                       |       | 561                   |       | 868 |   |
| Intangible assets                                      |       | 21,905                |       | 22,958 |   |
| Property and equipment  and software development costs |       | 5,815                 |       | 4,873 |   |
| Other                                                  |       | 82                    |       | 282 |   |
| Total deferred tax  liabilities                        |       | 28,363                |       | 28,981 |   |
| Net deferred tax asset (liability)                     |       | $                     | (21,994    | ) | $ | (1,236 | ) |

 

As of December 31,2006, we have aggregate state operating loss carryforwards of $16.6 million. Thesecarryforwards expire as follows:  $6.8million in 2019, $2.7 million in 2025, and $7.1 million in 2026. Managementbelieves that it is more likely than not that we will be able to utilize thesecarryforwards and, therefore, no valuation allowance is necessary.

As of December 31,2006, we have an operating loss carryforward in the United Kingdom of $1.2million, resulting in recognition of a $0.2 million deferred tax asset. During2006, we established a valuation allowance for the full amount of the foreignloss carryforward deferred tax asset. Although this net operating losscarryforward does not expire, management believes a valuation allowance isappropriate until such time as reasonable evidence exists that this foreignoperation will generate profits.

Theabove net deferred tax asset (liability) is presented on the consolidatedbalance sheets as follows (in thousands):

| ** **                               | ** ** | **December 31,** | ** ** |
|------------------------------------------|------------|-----------------------|------------|
| ** **                               | ** ** | **2006**              | ** ** | **2005** | ** ** |
| Current deferred income  tax asset       |       | $                     | 1,313      |   | $ | 25,579 |   |
| Long-term deferred  income tax liability |       | (23,307               | )          | (26,815 | ) |
|                                     |       | $                     | (21,994    | ) | $ | (1,236 | ) |

 

**NOTE 11: NET INCOME (LOSS) PER SHARE**

Basicnet income (loss) per share is computed by dividing net income (loss) availableto common shareholders by the weighted average number of common sharesoutstanding for the period. Diluted net income (loss) per share is computed bydividing net income (loss) available to common shareholders, increased by theamount of interest expense, net of tax, related to outstanding convertibledebt, by the weighted average number of outstanding common shares andincremental shares that may be issued in future periods relating to outstandingstock options and convertible debt, if dilutive. When calculating incrementalshares related to outstanding stock options, we apply the treasury stock method.The treasury stock method assumes that proceeds, consisting of the amount theemployee must pay on exercise, compensation cost attributed to future servicesand not yet recognized, and excess tax benefits that would 

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be credited to additional paid-in capital on exerciseof the options, are used to repurchase outstanding shares at the average marketprice for the period. The treasury stock method is applied only to share grantsfor which the effect is dilutive (in thousands, except per share data).
|                                                            | ** ** | **Year Ended December 31,** | ** ** |
|------------------------------------------------------------|------------|--------------------------------------------|------------|
| ** **                                                 | ** ** | **2006**                                   | ** ** | **2005** | ** ** | **2004** | ** ** |
| ** **                                                 | ** ** | **Net  Income**                            | ** ** | **Weighted  Average  Shares  Outstanding** | ** ** | **Per  Share  Amount** | ** ** | **Net  Loss** | ** ** | **Weighted  Average  Shares  Outstanding** | ** ** | **Per  Share  Amount** | ** ** | **Net  Loss** | ** ** | **Weighted  Average  Shares  Outstanding** | ** ** | **Per  Share  Amount** | ** ** |
| Basic income (loss) per share from continuing operations   |       | $                                          | 35,131     |   |   | 19,399 |   |   |   | $ | 1.81 |   |   | $ | (3,842 | ) |   | 18,092 |   |   |   | $ | (0.21 | ) |   | $ | (7,290 | ) |   | 17,848 |   |   |   | $ | (0.41 | ) |   |
| Effect of dilutive  securities:                            |       |                                       |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Stock options                                              |       |                                       |       |   | 792 |   |   |   |   |   |   |   |   |   | — |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Convertible debt                                           |       | 1,209                                      |       |   | 2,857 |   |   |   |   |   |   |   |   |   | — |   |   |   |   |   |   |   |   |   | — |   |   |   |   |   |   |
| Diluted income (loss) per share from continuing operations |       | $                                          | 36,340     |   |   | 23,048 |   |   |   | $ | 1.58 |   |   | $ | (3,842 | ) |   | 18,092 |   |   |   | $ | (0.21 | ) |   | $ | (7,290 | ) |   | 17,848 |   |   |   | $ | (0.41 | ) |   |

 

For the year ended December 31,2006, weighted-average outstanding stock options totaling approximately 1.8million shares of common stock were antidilutive and, therefore, not includedin the computation of diluted earnings per share. For the years ended December 31,2005 and 2004, we did not assume conversion of the convertible debt or exerciseof any share-based options as the effect would be anti-dilutive.

**NOTE 12: STOCK OPTIONS**

On January 1, 2006,we adopted SFAS No. 123R, *Share-Based Payment*.SFAS No. 123R establishes standards for the accounting for transactions inwhich an entity exchanges its equity instruments for goods and services orincurs liabilities in exchange for goods or services that are based on the fairvalue of the entity’s equity instruments or that may be settled by the issuanceof those equity instruments. SFAS No. 123R requires a public entity tomeasure the cost of employee services received in exchange for an award ofequity instruments based on the grant-date fair value of the award and torecognize that cost over the period during which an employee is required toprovide service in exchange for the award.

We elected to adopt SFASNo. 123R using the modified version of prospective application. Using thismethod, we have recognized compensation costs related to share-basedcompensation beginning with the quarter ended March 31, 2006. Compensationcosts related to share-based compensation for periods ended on or beforeDecember 31, 2005 are reflected on a pro forma basis in this note to ourconsolidated financial statements. We have elected as the transition method forpurposes of calculating the pool of excess tax benefits available to absorb taxdeficiencies recognized based on a recalculation of the pool that would havebeen available had we adopted SFAS 123 for recognition purposes for all awardsissue from the date (February 1997) of our initial grant of share-basedoptions.

During February 2005our compensation committee approved acceleration of the vesting ofapproximately 0.5 million unvested share options, with a weighted-averageexercise price of $14.28 per share, for certain employees, including anexecutive officer and non-employee directors. Unvested share options topurchase approximately 1.2 million shares, with a weighted-average exerciseprice of approximately $15.26 per share, were not accelerated as the employees holdingthe unvested share options did not meet the criteria established by ourcompensation committee. The decision to accelerate the vesting of these shareoptions and eliminate future compensation expense was based primarily on areview of our long-term incentive programs considering the effect on ourfinancial statements of the then pending change in accounting rules forshare-based compensation. This action, which had an immaterial effect on ourfinancial statements for the year ended December 31, 2005, reduced theamount of expense we would have recognized under SFAS 123R by approximately$2.2 million (approximately $0.8 million, $0.7 million, $0.5 million and $0.2million for the years ending December 31, 2006, 2007, 2008, and 2009,respectively).

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During June 2004, our 2004 Equity Incentive Planwas approved by our shareholders and replaced our 1995 Stock Option Plan, asamended (the “1995 Plan”). During June 2006, an amendment to the 2004Equity Incentive Plan was approved by our shareholders. The 2004 EquityIncentive Plan as amended (the “2004 Plan”) limits the combined grant ofoptions to acquire shares of common stock, stock appreciation rights, andrestricted stock under the 2004 Plan to 5,000,000 shares. Any grant under the2004 Plan that expires or terminates unexercised, becomes unexercisable or isforfeited will be available for further grants unless, in the case of optionsgranted, related stock appreciation rights are exercised. At December 31,2006, there were approximately 2,204,000 equity instruments available forfuture grants under the 2004 Plan. Although various forms of equity instrumentsmay be issued, to date we have issued only incentive share options andnonqualified share options under this Plan. These share options, which have acontractual term of 10 years, are issued with an exercise price equal to thegrant date closing market price of our common stock. The vesting periods rangefrom immediate to 5 years. Share options which vest over 5 years generally vesteither 20% per year on the first five anniversaries of the grant date, or 25%per year on the second through fifth anniversaries of the grant date. Sharesvesting over a shorter period will generally vest 100% as of the designatedvesting date. We issue new shares to satisfy share option exercises. We do notanticipate that we will repurchase shares on the open market during 2007 forthe purpose of satisfying share option exercises.

During October 2006, inducement stock optionswere granted, outside the 2004 Plan, related to the hiring of key employees toacquire up to 200,000 shares of common stock. The options were granted at anoption exercise price equal to fair market value of the common stock on thedate of grant, were non-qualified options, were exercisable for up to 10 yearsfrom the date of grant and vest 25% on the second anniversary of the grant dateand continue to vest 25% per year on each anniversary of the grant date untilfully vested.

During November 2005, as part of the nMatrixacquisition, inducement stock options were granted, outside the 2004 Plan, tokey employees to acquire up to 370,000 shares of common stock. The options weregranted at an option exercise price equal to fair market value of the commonstock on the date of grant, were non-qualified options, were exercisable for upto 10 years from the date of grant and vest 25% on the second anniversary ofthe grant date and continue to vest 25% per year on each anniversary of thegrant date until fully vested.

During the year ended December 31, 2004, as partof the Poorman-Douglas acquisition, inducement stock options were granted,outside the 1995 Plan and 2004 Plan, to two key executives to acquire up to300,000 shares of common stock. The options were granted at an option exerciseprice equal to fair market value of the common stock on the date of grant, werenon-qualified options, were exercisable for up to 10 years from the date ofgrant and vested 20% on the first anniversary of the grant date and continue tovest 20% per year on each anniversary of the grant date until fully vested. During2004, one of the executives transitioned from full-time employee status to aconsulting role and his option to purchase 100,000 shares of common stock wasterminated. During 2006, the other employee left and the unvested portion ofhis option to purchase common stock was terminated.

As a result of our adoption of SFAS No. 123R,during the year ended December 31, 2006 we recognized expense related toshare options issued prior to but unvested as of January 1, 2006 as wellas expense related to share options issued subsequent to January 1, 2006. Forshare options issued prior to but unvested as of January 1, 2006,compensation expense was based on the fair value of those share options ascalculated using the Black-Scholes option valuation model at the date the shareoptions were issued. Key assumptions for the Black-Scholes option valuationmodel include expected volatility, expected term of share options granted, theexpected risk-free interest rate, and the expected dividend rate. For shareoptions issued during the year ended December 31, 2006, the share optionswere also valued using the Black-Scholes option valuation models and with keyassumptions related to expected volatility, expected term of share optionsgranted, the expected risk-free interest rate, and the expected dividend 

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rate. We estimate ourexpected volatility based on implied volatilities from traded share options onour stock and on our stock’s historical volatility. We have estimated theexpected term of our share options based on the historical exercise pattern ofgroups of employees that have similar historical exercise behavior. Theexpected risk-free interest rate is based on the U.S. Treasury yield curve ineffect at the time of the grant. Historically, we have not paid dividends andwe do not anticipate paying dividends in the foreseeable future; accordingly,our expected dividend rate is zero.

Thefollowing table summarizes information about stock options outstanding as of December 31,2006 (in thousands, except life and price data):

|                                         | ** ** | **Options Outstanding** | ** ** | **Options Exercisable** | ** ** |
|-----------------------------------------|------------|------------------------------|------------|------------------------------|------------|
| **Range of  Exercise Prices** | ** ** | ** **                   | ** ** | **Number  Outstanding**      | ** ** | **Weighted-  Average  Remaining  Contractual Life** | ** ** | **Weighted-  Average  Exercise  Price** | ** ** | **Number  Exercisable** | ** ** | **Weighted-  Average  Exercise  Price** | ** ** |
| $1.56 to $12.20                         |       |                         | 1,376      |                         |       |   | 6.12 years |   |   |   | $ | 9.89 |   |   |   | 1,273 |   |   |   | $ | 9.71 |   |   |
| $12.21 to $15.09                        |       |                         | 1,112      |                         |       |   | 7.73 years |   |   |   | 14.43 |   |   |   | 680 |   |   |   | 14.39 |   |   |
| $15.10 to $16.05                        |       |                         | 1,124      |                         |       |   | 8.56 years |   |   |   | 15.76 |   |   |   | 869 |   |   |   | 15.77 |   |   |
| $16.06 to $18.96                        |       |                         | 1,091      |                         |       |   | 6.36 years |   |   |   | 17.45 |   |   |   | 746 |   |   |   | 17.06 |   |   |
| $18.97 and over                         |       |                         | 620        |                         |       |   | 8.91 years |   |   |   | 19.61 |   |   |   | 185 |   |   |   | 19.04 |   |   |
|                                    |       |                         | 5,323      |                         |       |   | 7.35 years |   |   |   | 14.76 |   |   |   | 3,753 |   |   |   | 13.88 |   |   |
|                                         |            |                              |            |                              |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

Followingis a summary of key assumptions we used to value share options granted duringthe three years ended December 31, 2006.

|                          | ** ** | **2006**       | ** ** | **2005**       | ** ** | **2004**      | ** ** |
|--------------------------|------------|----------------|------------|----------------|------------|---------------|------------|
| Expected term  (years)   |       | 5.0–6.0   |       | 5.0–5.3   |       | 5.3–5.4  |       |
| Expected  volatility     |       | 30%–38%   |       | 40%            |       | 30%–48%  |       |
| Risk-free  interest rate |       | 4.3%–5.0% |       | 4.0%–4.3% |       | 2.9–3.9% |       |
| Dividend yield           |       | 0%             |       | 0%             |       | 0%            |       |

 

Compensation expense for year ended December 31,2006 was adjusted for share options we estimate will be forfeited prior tovesting. We use historical information to estimate employee termination and theresulting option forfeiture rate.

Asummary of option activity during the year ended December 31, 2006 ispresented below (shares and aggregate intrinsic value in thousands):

|                                                     | ** ** | **Shares** | ** ** | **Weighted  Average  Exercise  Price** | ** ** | **Weighted  Average  Remaining  Contractual  Term** | ** ** | **Aggregate  Intrinsic  Value** | ** ** |
|-----------------------------------------------------|------------|------------|------------|----------------------------------------|------------|-----------------------------------------------------|------------|---------------------------------|------------|
| Outstanding,  beginning of period                   |       |       | 4,769      |                                   |       |                                                | $          | 14.49                           |       |   |   |   |   |   |   |   |   |   |
| Granted                                             |       |       | 1,033      |                                   |       |                                                | 16.10      |                            |       |   |   |   |   |   |   |   |   |
| Exercised                                           |       |       | (225       | )                                      |       |                                                | 11.67      |                            |       |   |   |   |   |   |   |   |   |
| Forfeited                                           |       |       | (254       | )                                      |       |                                                | 17.78      |                            |       |   |   |   |   |   |   |   |   |
| Outstanding, end  of period                         |       |       | 5,323      |                                   |       |                                                | 14.76      |                            |       |   | 7.35 |   |   |   | $ | 14,113 |   |   |
| Options vested  and expected to vest, end of period |       |       | 4,983      |                                   |       |                                                | 14.61      |                            |       |   | 7.24 |   |   |   | $ | 13,738 |   |   |
| Options exercisable, end  of period                 |       |       | 3,753      |                                   |       |                                                | 13.88      |                            |       |   | 6.77 |   |   |   | $ | 12,230 |   |   |

 

F-24

----

The aggregate intrinsic value was calculated using thedifference between the December 31, 2006 market price and the grant pricefor only those awards that have a grant price that is less than the December 31,2006 market price. The weighted average grant-date fair value of share optionsgranted during the years ended December 31, 2006, 2005 and 2004 were$6.53, $6.46 and $7.04, respectively. The total intrinsic value of shareoptions exercised during the year ended December 31, 2006, 2006 was $1.5million. During the year ended December 31, 2006, we received cash forpayment of the grant price of exercised share options of approximately $2.6million and we anticipate we will realize a tax benefit related to theseexercised share options of approximately $0.6 million. The cash received forpayment of the grant price is included as a component of cash flow fromfinancing activities. The tax benefit related to the option exercise price inexcess of the option fair value at grant date is separately disclosed as acomponent of cash flow from financing activities on the consolidated statementof cash flows; the remainder of the tax benefit is included as a component ofcash flow from operating activities.

During the year ended December 31, 2006, werecognized share-based compensation expense, which is a non-cash charge, ofapproximately $5.4 million, of which $0.6 million is included under the caption“Direct costs of services” and $4.8 million is included under the caption “Generaland administrative” on the accompanying consolidated statements of operations. Duringthe year ended December 31, 2006, we recognized a net tax benefit ofapproximately $2.1 million related to aggregate share-based compensationexpense recognized during the same period. As a result, income before incometaxes was reduced by approximately $5.4 million, net income was reduced byapproximately $3.3 million, net income per share—basic was reduced byapproximately $0.17 per share, and net income per share—diluted was reduced byapproximately $0.14 per share. As of December 31, 2006, there was $8.0million of total unrecognized compensation cost related to nonvestedshare-based compensation arrangements, which will be recognized over aweighted-average period of 3.7 years.

Priorto adoption of SFAS 123R, we accounted for stock-based compensation awardsunder the intrinsic method of Accounting Principles Board Opinion No. 25, *Accounting for Stock Issued to Employees,*which requiredcompensation cost to be recognized based on the excess, if any, between thequoted market price at the date of grant and the amount an employee must pay toacquire stock. Share options awarded under our share option plans are grantedwith an exercise price equal to the fair market value on the date of the grant.As a result, our consolidated statements of operations do not include expenserelated to share-based compensation for the years ended December 31, 2005and 2004. Had the compensation cost been determined based on the fair value atthe grant dates based on the guidance provided by Statement of FinancialAccounting Standard (SFAS) No. 123, *Accounting for Stock-BasedCompensation,* our net loss and net loss per share for the yearsended December 31, 2005 and 2004 would have been adjusted to the followingpro forma amounts (in thousands, except per share data):
|                                                                                                                                | ** ** | ** **  | ** ** | **Years Ended  December 31,** | ** ** |
|--------------------------------------------------------------------------------------------------------------------------------|------------|-------------|------------|-----------------------------------------|------------|
| ** **                                                                                                                     | ** ** | ** **  | ** ** | **2005**                                | ** ** | **2004** | ** ** |
| Net loss, as reported                                                                                                          |       |        |       | $                                       | (3,842     | ) | $ | (6,623 | ) |
| Add: stock-based  employee compensation included in reported net earnings, net of tax                                          |       |        |       | —                                  |       | — |   |
| Deduct: Total  stock-based employee compensation expense determined under fair value based  method for all options, net of tax |       |        |       | (6,605                                  | )          | (2,975 | ) |
| Net loss, pro forma                                                                                                            |       |        |       | $                                       | (10,447    | ) | $ | (9,598 | ) |
| Net loss per share—Basic                                                                                                  |       | As reported |       | $                                       | (0.21      | ) | $ | (0.37 | ) |
|                                                                                                                           |       | Pro forma   |       | $                                       | (0.58      | ) | $ | (0.54 | ) |
| Net loss per share—Diluted                                                                                                |       | As reported |       | $                                       | (0.21      | ) | $ | (0.37 | ) |
|                                                                                                                           |       | Pro forma   |       | $                                       | (0.58      | ) | $ | (0.54 | ) |

 

F-25

----

Pro forma amountspresented above are based on actual earnings and consider only the effects ofestimated fair values of stock options. For the years ended December 31,2005 and 2004, our diluted loss per share calculation did not assume exerciseof options or conversion of the convertible notes as the effects wereantidilutive. The convertible notes, if converted, would result in issuance of2,857,000 shares of our common stock.

**NOTE 13: BUSINESSACQUISITIONS**

***Epiq AdvisoryServices, Inc.***

On May 16, 2006, our wholly-owned subsidiary,Epiq Advisory Services Inc., acquired the claims preference business of GazesLLC in an asset acquisition. The total value of the transaction was $13.8million, consisting of $3.0 million of cash paid on closing, $10.2 million ofdeferred payments, and $0.6 million of capitalized transaction costs. Ifcertain income targets are satisfied, we may be required to make additionalpayments, which would be recorded as compensation expense, to the seller. Thepreliminary allocation of the purchase price is as follows:  less than $0.1 million to net assets,approximately $2.4 million to customer contracts, amortizable on astraight-line basis over two years, and approximately $11.4 million to goodwill.The purchase price in excess of the tax basis of the assets is expected to bedeductible for tax purposes. This acquisition further expands our casemanagement service offerings.

The acquisition wasaccounted for using the purchase method of accounting with the operatingresults included in the accompanying condensed consolidated financialstatements from the date of acquisition. The operating results of Epiq AdvisoryServices are included within our case management segment.

***nMatrix***

On November 15,2005, Epiq, acting through a wholly-owned subsidiary, acquired all the issuedand outstanding shares of capital stock of nMatrix, Inc., nMatrixAustralia Ptd. Ltd., and nMatrix Ltd. (collectively, “nMatrix”) forapproximately $126.2 million, including capitalized acquisition costs. Thisacquisition provides complementary diversification to our existing legalservices business as nMatrix provides electronic litigation discovery servicesto law firms and in-house counsel. nMatrix is included within our casemanagement segment. The purchase price consisted of cash of $100.0 million andapproximately 1.2 million shares of our common stock. The fair value of ourcommon stock issued, calculated based upon the five-day average of the closingprice of the common stock two days before and two days after the acquisitionwas agreed to and publicly announced, was approximately $24.2 million. Inconjunction with the acquisition, we entered into an agreement with the sellingshareholder to register the shares of common stock issued as a part of theacquisition consideration. Within this agreement, we guaranteed the commonstock price of $20.35 per share, valued as the average closing price of ourcommon stock for the 40 consecutive trading days ending on the date fourtrading days prior to the closing date. This guarantee terminates as of theclose of business on the date that is after any 15 trading days on which theselling shareholder may lawfully sell shares under a registration statement andthe last sale price for our common stock has been equal to or greater than the$20.35. Based on our December 31, 2006 closing price of $16.97 per share,as of December 31, 2006 the guarantee amount would be approximately $4.2million. A liability will not be recorded for this guarantee until thecontingency is resolved. If a payment is made under this guarantee, we willreduce the equity proceeds recorded as a part of the acquisition transaction. Basedon our valuation, the purchase price has been allocated as follows (inthousands):

F-26

----

 

| Accounts receivable    |   | $       | 12,735  |   |
|------------------------|--------|---------|---------|--------|
| Other current assets   |   | 2,926   |    |
| Property and software  |   | 7,236   |    |
| Trade names            |   | 569     |    |
| Customer relationships |   | 24,614  |    |
| Non-compete agreements |   | 6,676   |    |
| Current liabilities    |   | (6,199  | )       |
| Deferred tax liability |   | (16,333 | )       |
| Goodwill               |   | 94,364  |    |
| Total purchase price   |   | $       | 126,588 |   |

 

Trade names, customerrelationships, and the non-compete agreements are amortized using thestraight-line method over one year, eight years, and five years, respectively. Theexcess purchase price of $94.4 million was allocated to goodwill and is notamortized but will be reviewed for impairment annually and between annual testsif events or changes in circumstances indicate that the asset might be impaired.The purchase price in excess of the tax basis of the assets, primarilyallocated to identifiable intangible assets and goodwill, is not expected to bedeductible for tax purposes. Of our common shares issued as consideration,approximately 246,000 are held in escrow. On submission of properly approvedindemnification claims, the escrow trustee will liquidate sufficient shares topay the indemnification claim. As of December 31, 2006, we have notsubmitted any claims related to this escrow. The escrow arrangement terminates May 14,2007, at which time any of our common shares that have not been liquidated topay claims will be distributed to the seller.

The acquisition wasaccounted for using the purchase method of accounting with the operatingresults included in the accompanying consolidated financial statements from thedate of acquisition.

***Hilsoft, Inc.***

On October 20,2005, we acquired for cash all the issued and outstanding shares of capitalstock of Hilsoft Inc. This acquisition provides complementary diversificationto our existing class action business as Hilsoft is a specialty provider of legal notification services, primarily for classaction engagements. The total value of the transaction, includingcapitalized transaction costs, was $9.3 million. If certain revenue objectivesare satisfied, we may be required to make additional payments of up to $3.0million to the former owners of Hilsoft. Hilsoft is included within ourdocument management segment. Based on our valuation, the purchase price hasbeen allocated as follows (in thousands):

| Tangible assets        |   | $      | 438    |   |
|------------------------|--------|--------|--------|--------|
| Trade name             |   | 271    |   |
| Customer backlog       |   | 323    |   |
| Non-compete agreements |   | 2,680  |   |
| Current liabilities    |   | (271   | )      |
| Deferred taxes, net    |   | (1,448 | )      |
| Goodwill               |   | 7,300  |   |
| Total purchase price   |   | $      | 9,293  |   |

 

Customer backlog and thetrade name are amortized using the straight-line method over two years. Thenon-compete agreements are amortized using the straight-line method over fiveyears. The excess purchase price of $7.3 million was allocated to goodwill andis not amortized but will be reviewed for impairment annually and betweenannual tests if events or changes in circumstances indicate that the assetmight be impaired. The purchase price in excess of the tax basis of the assets,primarily allocated to identifiable intangible assets and goodwill, is notexpected to be deductible for tax purposes.

The acquisition wasaccounted for using the purchase method of accounting with the operatingresults included in the accompanying consolidated financial statements from thedate of acquisition.

F-27

----

***P-D Holding Corp.***

On January 30,2004, we acquired for cash 100% of the equity of P-D Holding Corp. and itswholly-owned subsidiary, Poorman-Douglas Corporation (collectively, “Poorman-Douglas”).This acquisition allowed for expansion into class action and mass tort case anddocument management administration. The total value of the transaction,including capitalized acquisition costs, was approximately $115.7 million. Basedon our valuation, the purchase price has been allocated as follows (inthousands):

| Current assets           |   | $       | 21,986  |   |
|--------------------------|--------|---------|---------|--------|
| Deferred tax assets      |   | 6,044   |    |
| Property and software    |   | 8,391   |    |
| Trade names              |   | 1,100   |    |
| Customer backlog         |   | 6,200   |    |
| Customer relationships   |   | 2,300   |    |
| Non-compete agreements   |   | 5,900   |    |
| Goodwill                 |   | 83,141  |    |
| Current liabilities      |   | (12,920 | )       |
| Deferred tax liabilities |   | (6,476  | )       |
| Total purchase price     |   | $       | 115,666 |   |

 

All acquired identifiableintangible assets are amortized on a straight-line basis as follows:  the trade names over two years, the customerbacklog over three years, the customer relationships over twelve years, and thenon-compete agreements over five years. The excess purchase price of $83.1million was allocated to goodwill and is not amortized but will be reviewed forimpairment annually and between annual tests if events or changes incircumstances indicate that the asset might be impaired. The purchase price inexcess of the tax basis of the assets, primarily allocated to identifiableintangible assets and goodwill, is not expected to be deductible for taxpurposes.

The acquisition wasaccounted for using the purchase method of accounting with the operatingresults included in the accompanying consolidated financial statements from thedate of acquisition.

***Pro FormaInformation***

Unauditedpro forma operations, assuming each purchase acquisition was made at thebeginning of the year preceding the acquisition such that the pro-forma resultsof operations for the acquired company were included for the full year in boththat preceding period and in the subsequent year, are shown below (inthousands, except per share data):

| ** **                                  | ** ** | **For the Years Ended December 31,** | ** ** |
|---------------------------------------------|------------|---------------------------------------------------------------|------------|
| ** **                                  | ** ** | **2006**                                                      | ** ** | **2005** | ** ** | **2004** | ** ** |
| Total revenues                              |       | $                                                             | 225,382    |   | $ | 138,635 |   | $ | 119,875 |   |
| Income (loss) from  continuing operations   |       | $                                                             | 35,033     |   | $ | (3,498 | ) | $ | (12,424 | ) |
| Discontinued operations                     |       | —                                                        |       | — |   | 667 |   |
| Net income (loss)                           |       | $                                                             | 35,033     |   | $ | (3,498 | ) | $ | (11,757 | ) |
| Net income (loss) per share:                |       |                                                          |       |   |   |   |   |
| Net income (loss) per share—Basic      |       |                                                          |       |   |   |   |   |
| Income (loss) from  continuing operations   |       | $                                                             | 1.81       |   | $ | (0.18 | ) | $ | (0.70 | ) |
| Income from discontinued  operations        |       | —                                                        |       | — |   | 0.04 |   |
| Net income (loss) per  share—Basic     |       | $                                                             | 1.81       |   | $ | (0.18 | ) | $ | (0.66 | ) |
| Income (loss) per share—Diluted        |       |                                                          |       |   |   |   |   |
| Income (loss) from  continuing operations   |       | $                                                             | 1.57       |   | $ | (0.18 | ) | $ | (0.70 | ) |
| Income (loss) from  discontinued operations |       | —                                                        |       | — |   | 0.04 |   |
| Net income (loss) per share—Diluted    |       | $                                                             | 1.57       |   | $ | (0.18 | ) | $ | (0.66 | ) |

 

 

F-28

----

Pro forma data reflectsthe difference in amortization expense between Epiq and the acquired companiesas well as other adjustments, including income taxes and managementcompensation. The pro forma information is not necessarily indicative of whatwould have occurred if the acquisition had been completed on that date nor isit necessarily indicative of future operating results.

**NOTE 14: DISCONTINUEDOPERATIONS**

During November 2003, we determined that theinfrastructure software business was no longer aligned with our long-termstrategic objectives. Accordingly, we developed a plan to sell, within oneyear, our infrastructure software business. At the time, we determined thatthis business should be classified as a discontinued operation and that therelated long-lived assets should be measured at the lower of their carryingamounts or fair value less cost to sell.

On April 30, 2004, wesold our infrastructure software business to a private company with expertisein file transfer technology for consideration consisting of cash and a notereceivable. During the year ended December 31, 2004, we recognized $0.7million of revenue from discontinued operations, and we realized pre-tax incomefrom discontinued operations, including a gain on the sale of our discontinuedoperation, of approximately $1.1 million.

**NOTE 15: SEGMENTREPORTING**

We are organized into operating segments based on thenature of services provided. Case management solutions provide clients withintegrated technology-based products and services for the automation of variousadministrative tasks. Document management solutions include proprietarytechnology and production services to ensure timely, accurate and completeexecution of the many documents associated with multi-faceted legal cases andcommunications applications.

Performance is assessed for our case management anddocument management operating segments. Each segment’s performance is assessedbased on segment revenues less costs directly attributable to that segment. Inmanagement’s evaluation of performance, certain costs, such as shared services,administrative staff, and executive management, are not allocated by segmentand, accordingly, the following operating segment results do not include thoseunallocated costs. Assets reported within a segment are those assets used bythe segment in its operations and consist of property and equipment, software,identifiable intangible assets and goodwill. All other assets are classified asunallocated.

F-29

----

Informationconcerning operations of our reportable segments is as follows (in thousands):

| ** **                                                                                                | ** ** | **Year Ended December 31, 2006** | ** ** |
|-----------------------------------------------------------------------------------------------------------|------------|---------------------------------------|------------|
| ** **                                                                                                | ** ** | **Case  Management**                  | ** ** | **Document  Management** | ** ** | **Unallocated** | ** ** | **Consolidated** | ** ** |
| Revenue:                                                                                                  |       |                                  |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Operating revenue before  reimbursed direct costs                                                         |       |                                  | $          | 164,250 |   |   |   | $ | 35,472 |   |   |   | $ | — |   |   |   | $ | 199,722 |   |   |
| Operating revenue from  reimbursed direct costs                                                           |       |                                  | 3,050      |   |   |   | 21,398 |   |   |   | — |   |   |   | 24,448 |   |   |
| Total revenue                                                                                             |       |                                  | 167,300    |   |   |   | 56,870 |   |   |   | — |   |   |   | 224,170 |   |   |
| Costs and expenses:                                                                                       |       |                                  |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Direct costs, general  and administrative costs and depreciation and software and leasehold  amortization |       |                                  | 54,880     |   |   |   | 48,108 |   |   |   | 38,045 |   |   |   | 141,033 |   |   |
| Amortization of  identifiable intangible assets                                                           |       |                                  | 9,657      |   |   |   | 1,972 |   |   |   | — |   |   |   | 11,629 |   |   |
| Acquisition related                                                                                       |       |                                  | —     |   |   |   | — |   |   |   | 283 |   |   |   | 283 |   |   |
| Total operating expenses                                                                                  |       |                                  | 64,537     |   |   |   | 50,080 |   |   |   | 38,328 |   |   |   | 152,945 |   |   |
| Operating income                                                                                          |       |                                  | $          | 102,763 |   |   |   | $ | 6,790 |   |   |   | $ | (38,328 | ) |   |   | 71,225 |   |   |
| Net expenses related to  financing                                                                        |       |                                  |       |   |   |   |   |   |   |   |   |   |   |   | (13,260 | ) |   |
| Income from continuing  operations before income taxes                                                    |       |                                  |       |   |   |   |   |   |   |   |   |   |   |   | 57,965 |   |   |
| Provision for income tax  expense                                                                         |       |                                  |       |   |   |   |   |   |   |   |   |   |   |   | 22,834 |   |   |
| Net income from  continuing operations                                                                    |       |                                  |       |   |   |   |   |   |   |   |   |   |   |   | $ | 35,131 |   |   |
| Total assets                                                                                              |       |                                  | $          | 265,687 |   |   |   | $ | 57,516 |   |   |   | $ | 59,017 |   |   |   | $ | 382,220 |   |   |
| Provisions for  depreciation and amortization                                                             |       |                                  | $          | 16,873 |   |   |   | $ | 2,336 |   |   |   | $ | 2,533 |   |   |   | $ | 21,742 |   |   |
| Capital expenditures,  including capital leases                                                           |       |                                  | $          | 9,586 |   |   |   | $ | 203 |   |   |   | $ | 1,363 |   |   |   | $ | 11,152 |   |   |

 

| ** **                                                                                                | ** ** | **Year Ended December 31, 2005** | ** ** |
|-----------------------------------------------------------------------------------------------------------|------------|---------------------------------------|------------|
| ** **                                                                                                | ** ** | **Case  Management**                  | ** ** | **Document  Management** | ** ** | **Unallocated** | ** ** | **Consolidated** | ** ** |
| Revenue:                                                                                                  |       |                                  |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Operating revenue before  reimbursed direct costs                                                         |       |                                  | $          | 54,813 |   |   |   | $ | 27,874 |   |   |   | $ | — |   |   |   | $ | 82,687 |   |   |
| Operating revenue from  reimbursed direct costs                                                           |       |                                  | 3,138      |   |   |   | 20,505 |   |   |   | — |   |   |   | 23,643 |   |   |
| Total revenue                                                                                             |       |                                  | 57,951     |   |   |   | 48,379 |   |   |   | — |   |   |   | 106,330 |   |   |
| Costs and expenses:                                                                                       |       |                                  |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Direct costs, general  and administrative costs and depreciation and software and leasehold  amortization |       |                                  | 32,580     |   |   |   | 36,581 |   |   |   | 26,989 |   |   |   | 96,150 |   |   |
| Amortization of  identifiable intangible assets                                                           |       |                                  | 5,027      |   |   |   | 1,724 |   |   |   | — |   |   |   | 6,751 |   |   |
| Acquisition related                                                                                       |       |                                  | —     |   |   |   | — |   |   |   | 2,984 |   |   |   | 2,984 |   |   |
| Total operating expenses                                                                                  |       |                                  | 37,607     |   |   |   | 38,305 |   |   |   | 29,973 |   |   |   | 105,885 |   |   |
| Operating income                                                                                          |       |                                  | $          | 20,344 |   |   |   | $ | 10,074 |   |   |   | $ | (29,973 | ) |   |   | 445 |   |   |
| Net expenses related to  financing                                                                        |       |                                  |       |   |   |   |   |   |   |   |   |   |   |   | (6,687 | ) |   |
| Loss from continuing  operations before income taxes                                                      |       |                                  |       |   |   |   |   |   |   |   |   |   |   |   | (6,242 | ) |   |
| Provision for income tax  benefit                                                                         |       |                                  |       |   |   |   |   |   |   |   |   |   |   |   | (2,400 | ) |   |
| Net loss from continuing  operations                                                                      |       |                                  |       |   |   |   |   |   |   |   |   |   |   |   | $ | (3,842 | ) |   |
| Total assets                                                                                              |       |                                  | $          | 260,831 |   |   |   | $ | 59,581 |   |   |   | $ | 98,059 |   |   |   | $ | 418,471 |   |   |
| Provisions for  depreciation and amortization                                                             |       |                                  | $          | 9,681 |   |   |   | $ | 2,155 |   |   |   | $ | 2,203 |   |   |   | $ | 14,039 |   |   |
| Capital expenditures                                                                                      |       |                                  | $          | 4,961 |   |   |   | $ | 38 |   |   |   | $ | 1,825 |   |   |   | $ | 6,824 |   |   |

 

F-30

----

| ** **                                                                                               | ** ** | **Year Ended December 31, 2004** | ** ** |
|----------------------------------------------------------------------------------------------------------|------------|---------------------------------------|------------|
| ** **                                                                                               | ** ** | **Case  Management**                  | ** ** | **Document  Management** | ** ** | **Unallocated** | ** ** | **Consolidated** | ** ** |
| Revenue:                                                                                                 |       |                                  |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Operating revenue before reimbursed direct costs                                                         |       |                                  | $          | 41,474 |   |   |   | $ | 36,549 |   |   |   | $ | — |   |   |   | $ | 78,023 |   |   |
| Operating revenue from reimbursed direct costs                                                           |       |                                  | 2,465      |   |   |   | 17,880 |   |   |   | — |   |   |   | 20,345 |   |   |
| Total revenue                                                                                            |       |                                  | 43,939     |   |   |   | 54,429 |   |   |   | — |   |   |   | 98,368 |   |   |
| Costs and expenses:                                                                                      |       |                                  |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Direct costs, general and administrative costs and  depreciation and software and leasehold amortization |       |                                  | 29,107     |   |   |   | 40,604 |   |   |   | 23,086 |   |   |   | 92,797 |   |   |
| Amortization of identifiable intangible assets                                                           |       |                                  | 5,243      |   |   |   | 2,524 |   |   |   | — |   |   |   | 7,767 |   |   |
| Acquisition related                                                                                      |       |                                  | —     |   |   |   | — |   |   |   | 2,197 |   |   |   | 2,197 |   |   |
| Total operating expenses                                                                                 |       |                                  | 34,350     |   |   |   | 43,128 |   |   |   | 25,283 |   |   |   | 102,761 |   |   |
| Operating loss                                                                                           |       |                                  | $          | 9,589 |   |   |   | $ | 11,301 |   |   |   | $ | (25,283 | ) |   |   | (4,393 | ) |   |
| Net expenses  related to financing                                                                       |       |                                  |       |   |   |   |   |   |   |   |   |   |   |   | (7,210 | ) |   |
| Loss from  continuing operations before income taxes                                                     |       |                                  |       |   |   |   |   |   |   |   |   |   |   |   | (11,603 | ) |   |
| Provision for  income tax benefit                                                                        |       |                                  |       |   |   |   |   |   |   |   |   |   |   |   | (4,313 | ) |   |
| Net loss from continuing  operations                                                                     |       |                                  |       |   |   |   |   |   |   |   |   |   |   |   | $ | (7,290 | ) |   |
| Provisions for  depreciation and amortization                                                            |       |                                  | $          | 9,505 |   |   |   | $ | 2,998 |   |   |   | $ | 1,791 |   |   |   | $ | 14,294 |   |   |
| Capital expenditures,  including capital leases                                                          |       |                                  | $          | 5,326 |   |   |   | $ | 36 |   |   |   | $ | 4,465 |   |   |   | $ | 9,827 |   |   |

 

**NOTE 16: SUPPLEMENTALCASH FLOW INFORMATION**

Supplementalcash flow information is as follows (in thousands):

| ** **                                         | ** ** | **Year Ended December 31,** | ** ** |
|----------------------------------------------------|------------|--------------------------------------------|------------|
| ** **                                         | ** ** | **2006**                                   | ** ** | **2005** | ** ** | **2004** | ** ** |
| Cash paid (received)  for:                         |       |                                       |       |   |   |   |   |
| Interest                                           |       | $                                          | 10,708     |   | $ | 3,376 |   | $ | 3,877 |   |
| Income taxes paid (refunded), net                  |       | (2,328                                     | )          | 8,499 |   | (207 | ) |
| Non-cash investing and  financing transactions:    |       |                                       |       |   |   |   |   |
| Capitalized lease obligations incurred             |       | 158                                        |       | — |   | 2,733 |   |
| Issuance of common shares in purchase transactions |       | —                                     |       | 24,233 |   | — |   |
| Obligation  incurred in purchase transactions      |       | 10,173                                     |       | 463 |   | — |   |
|                                                    |            |                                            |            |  |  |  |  |  |  |  |

 

*     *     *

F-31

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**EPIQ SYSTEMS, INC.SCHEDULE IIVALUATION AND QUALIFYING ACCOUNTS(in thousands)**
|                                             | ** ** | ** ** | ** ** | **Additions**                                | ** ** | ** **                                    | ** ** | ** **                           | ** ** |
|---------------------------------------------|------------|------------|------------|----------------------------------------------|------------|-----------------------------------------------|------------|--------------------------------------|------------|
| **Description**                             | ** ** | ** ** | ** ** | **Balance at  beginning of  year** | ** ** | **Charged to  costs and  expenses** | ** ** | **Charged to  other  accounts** | ** ** | **Deductions  from  reserves** | ** ** | **Balance at  end of  year** | ** ** |
| Allowance for doubtful  receivables         |       |       |       |                                         |       |                                          |       |                                 |       |   |   |   |   |   |   |   |   |   |   |   |   |
| For the year ended  December 31, 2006  |       |       | $          | 3,481                                        |       |                                          |       | $                                    | 458        |   |   |   | $ | — |   |   |   | $ | (2,255 | ) |   |   | $ | 1,684 |   |   |
| For the year ended  December 31, 2005  |       |       | $          | 1,069                                        |       |                                          |       | $                                    | 1,119      |   |   |   | $ | 2,008 | (1) |   |   | $ | (715 | ) |   |   | $ | 3,481 |   |   |
| For the year ended  December 31,  2004 |       |       | $          | 340                                          |       |                                          |       | $                                    | 1,099      |   |   |   | $ | — |   |   |   | $ | (370 | ) |   |   | $ | 1,069 |   |   |
|                                             |            |            |            |                                              |            |                                               |            |                                      |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

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(1)          Consists primarily of allowance related toacquired receivables.
|                                             | ** ** | ** ** | ** ** | **Additions**                                | ** ** | ** **                                    | ** ** | ** **                           | ** ** |
|---------------------------------------------|------------|------------|------------|----------------------------------------------|------------|-----------------------------------------------|------------|--------------------------------------|------------|
| **Description**                             | ** ** | ** ** | ** ** | **Balance at  beginning of  year** | ** ** | **Charged to  costs and  expenses** | ** ** | **Charged to  other  accounts** | ** ** | **Deductions  from  reserves** | ** ** | **Balance at  end of  year** | ** ** |
| Deferred tax valuation  allowance           |       |       |       |                                         |       |                                          |       |                                 |       |   |   |   |   |   |   |   |   |   |   |   |   |
| For the year ended  December 31, 2006  |       |       | $          | —                                       |       |                                          |       | $                                    | 228        |   |   |   | $ | — |   |   |   | $ | — |   |   |   | $ | 228 |   |   |
| For the year ended  December 31, 2005  |       |       | $          | —                                       |       |                                          |       | $                                    | —     |   |   |   | $ | — |   |   |   | $ | — |   |   |   | $ | — |   |   |
| For the year ended  December 31,  2004 |       |       | $          | —                                       |       |                                          |       | $                                    | —     |   |   |   | $ | — |   |   |   | $ | — |   |   |   | $ | — |   |   |
|                                             |            |            |            |                                              |            |                                               |            |                                      |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

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**EXHIBIT INDEX**

The following exhibits are filedwith this Form 10-K or are incorporated herein by reference:

|        | **Exhibit   Number** | ** ** | ** ** | **Description**                                                                                                                                                                                                                                                                                                                                                                                                                                         |
|--------|----------------------|------------|------------|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   | 3.1                  |       |       | Articles  of Incorporation, as amended through June 2, 2004. Previously filed as  an exhibit to the annual report on Form 10-K for the year ended  December 31, 2005, filed with the Securities and Exchange Commission on  March 8, 2006.                                                                                                                                                                                          |
|   | 3.2                  |       |       | Bylaws,  as amended and restated. Incorporated by reference and previously filed as an  exhibit to the quarterly report on Form 10-Q for the quarter ended  March 31, 2001, filed with the Securities and Exchange Commission on  May 11, 2001.                                                                                                                                                                                          |
|   | 4.1                  |       |       | Reference  is made to exhibits 3.1 and 3.2.                                                                                                                                                                                                                                                                                                                                                                                                             |
|   | 4.2                  |       |       | Securities  Purchase Agreement dated as of June 10, 2004, among Epiq  Systems, Inc. and the Buyers listed on Exhibit A thereto.  Incorporated by reference and previously filed as an exhibit to the current  report on Form 8-K filed with the Securities and Exchange  Commission on June 14, 2004.                                                                                                                          |
|   | 4.3                  |       |       | Amendment No. 1 to  Securities Purchase Agreement among Epiq Systems, Inc. and the Holders,  dated as of December 15, 2005. Incorporated by reference and previously  filed as an exhibit to the current report on Form 8-K filed with  the Securities and Exchange Commission on December 21, 2005.                                                                                                                           |
|   | 4.4                  |       |       | Registration  Rights Agreement dated as of June 10, 2004, among Epiq  Systems, Inc. and the Buyers listed on the Schedule of Buyers attached  thereto. Incorporated by reference and previously filed as an exhibit to the  current report on Form 8-K filed with the Securities and Exchange  Commission on June 14, 2004.                                                                                                         |
|   | 4.5                  |       |       | Form of  Contingent Convertible Subordinated Note, as amended. Previously filed as an  exhibit to the annual report on Form 10-K for the year ended  December 31, 2005, filed with the Securities and Exchange Commission on  March 8, 2006.                                                                                                                                                                                        |
|   | 10.1                 |       |       | 1995  Stock Option Plan, as amended. Incorporated by reference and previously filed  as an exhibit to the registration statement on Form SB-2 filed  with the Securities and Exchange Commission (File No. 333-51525)  on May 1, 1998.                                                                                                                                                                                                   |
|   | 10.2                 |       |       | 2004  Equity Incentive Plan, as amended. Incorporated by reference and previously  filed as an appendix to the Definitive Proxy Statement filed with the  Securities and Exchange Commission on April 28, 2006.                                                                                                                                                                                                                                    |
|   | 10.3                 |       |       | Agreement and Plan of  Merger among P-D Holding Corp., Epiq  Systems, Inc., PD Merger Corp., and Endeavour Capital Fund III,  L.P., in its capacity as Shareholders’ Representative, dated as of  January 30, 2004. Incorporated by  reference and previously filed as an exhibit to the current report on  Form 8-K filed with the Securities and Exchange Commission on  February 13, 2004.                                  |
|   | 10.4                 |       |       | Agreement Related to  Merger Agreement among Epiq  Systems, Inc., P-D  Holding Corp., certain shareholders of P-D Holding Corp. and Endeavour Capital Fund III, L.P., in its  capacity as Shareholders’ Representative, dated as of January 30, 2004. Incorporated by reference and previously filed  as an exhibit to the current report on Form 8-K filed with the  Securities and Exchange Commission on February 13, 2004. |
|   | 10.5                 |       |       | Stock Purchase Agreement between Epiq Systems Acquisition, Inc.  and Ajuta International Pty. Ltd., as trustee of Hypatia Trust, dated as of November 15, 2005. Incorporated by reference and previously filed  as an exhibit to the current report on Form 8-K filed with the  Securities and Exchange Commission on November 21, 2005.                                                                                            |
|   | 10.6                 |       |       | Amended and Restated  Credit and Security Agreement dated November 15, 2005, among Epiq  Systems, Inc., the Lenders named therein, and KeyBank, National  Association, as Lead Arranger, Sole Book Runner, and Administrative Agent. Incorporated by reference and previously filed  as an exhibit to the current report on Form 8-K filed with the  Securities and Exchange Commission on November 21, 2005.                       |
|   | 10.7                 |       |       | Registration Rights  Agreement between Epiq Systems, Inc. and Ajuta International Pty. Ltd.,                                                                                                                                                                                                                                                                                                                                                       |

----

 

|        |   |   |   | as trustee of Hypatia  Trust, dated as of November 15, 2005. Incorporated by reference and previously filed as an exhibit to the  current report on Form 8-K filed with the Securities and Exchange  Commission on November 21, 2005.                                                                                                                                                                                                                            |
|--------|--------|--------|--------|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   | 10.8   |   |   | Form of  Nonqualified Stock Option Agreement under 2004 Equity Incentive Plan. Previously filed as an exhibit to the annual  report on Form 10-K for the year ended December 31, 2005,  filed with the Securities and Exchange Commission on March 8, 2006.                                                                                                                                                                                                 |
|   | 10.9   |   |   | Escrow Agreement among  Epiq Systems, Inc., Ajuta International Pty. Ltd., as trustee of Hypatia  Trust, and Wells Fargo Bank, N.A. dated as of November 15, 2005. Incorporated  by reference and previously filed as an exhibit to the Registration Statement  No. 333-133296 on Form S-3/A filed with the Securities  and Exchange Commission on June 14, 2006.                                                                                      |
|   | 10.10  |   |   | Employment arrangement  between Epiq Systems, Inc. and Lorenzo Mendizabal dated as of May 20,  2005, as amended October 19 , 2005.*                                                                                                                                                                                                                                                                                                                         |
|   | 10.11  |   |   | Third Amendment  Agreement dated as of June 26, 2006, amending the Amended and Restated  Credit and Security Agreement dated as of November 15, 2005, among Epiq  Systems, Inc., the Lenders named therein, and KeyBank, National  Association, as Administrative Agent. Incorporated  by reference and previously filed as an exhibit to the current report on  Form 8-K filed with the Securities and Exchange Commission on  June 27, 2006.         |
|   | 10.12  |   |   | Employment Offer Letter  to William Carter dated September 18, 2006. Incorporated by reference and previously filed as an exhibit to the  current report on Form 8-K filed with the Securities and Exchange  Commission on October 6, 2006.                                                                                                                                                                                                                      |
|   | 10.13  |   |   | Letter Agreement dated  February 7, 2006, between Epiq Systems, Inc. and Bank of America,  N.A. (redacted—request for confidential treatment pending with the  Commission).*                                                                                                                                                                                                                                                                                     |
|   | 10.14  |   |   | Fourth Amendment  Agreement dated as of September 29, 2006, amending the Amended and  Restated Credit and Security Agreement dated as of November 15, 2005,  among Epiq Systems, Inc., the Lenders named therein, and KeyBank,  National Association, as Administrative Agent. Incorporated by reference and previously filed as an exhibit to the  current report on Form 8-K filed with the Securities and Exchange  Commission on October 12, 2006. |
|   | 10.15  |   |   | Employment Offer Letter  to Timothy Corcoran dated September 18, 2006. Incorporated by reference and previously filed as an exhibit to the  current report on Form 8-K filed with the Securities and Exchange  Commission on October 20, 2006.                                                                                                                                                                                                                   |
|   | 10.16  |   |   | Fifth Amendment  Agreement dated as of December 14, 2006, amending the Amended and  Restated Credit and Security Agreement dated as of November 15, 2005,  among Epiq Systems, Inc., the Lenders named therein, and KeyBank,  National Association, as Administrative Agent. Incorporated by reference and previously filed as an exhibit to the  current report on Form 8-K filed with the Securities and Exchange  Commission on December 19, 2006.  |
|   | 12.1   |   |   | Statement regarding  computation of earnings to fixed charges.*                                                                                                                                                                                                                                                                                                                                                                                                                 |
|   | 21.1   |   |   | List of Subsidiaries.*                                                                                                                                                                                                                                                                                                                                                                                                                                                          |
|   | 23.1   |   |   | Consent  of Deloitte & Touche LLP, Independent Registered Public Accounting  Firm.*                                                                                                                                                                                                                                                                                                                                                                                    |
|   | 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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*                    Filedherewith.

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