**UNITED STATESSECURITIES AND EXCHANGE COMMISSION**

**Washington,D. C. 20549**

**FORM 10-K**

**ANNUAL REPORT PURSUANT TO SECTION 13 OR15(d)OF THE SECURITIES EXCHANGE ACT OF 1934**

**Forthe fiscal year ended December 31, 2005**

**Commissionfile number 0-22081**

**EPIQ SYSTEMS, INC.**

(Exact name of registrantas specified in its charter)

| **M****issouri**                            |   | **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 ifthe registrant is a well-known seasoned issuer, as defined in Rule 405 ofthe Securities Act. Yes oNo x

Indicate by check mark ifthe registrant is not required to file reports pursuant to Section 13 or Section 15(d) ofthe Act. Yes o No x

Indicate by check markwhether the registrant (1) has filed all reports required to be filed by Section 13or 15(d) of the Securities Exchange Act of 1934 during the preceding 12months (or for such shorter period that the registrant was required to filesuch reports), and (2) has been subject to such filing requirements forthe past 90 days. Yes x  No o

Indicate by check mark ifdisclosure of delinquent filers pursuant to Item 405 of Regulation S-K (229.405of this chapter) is not contained herein, and will not be contained, to thebest of registrant’s knowledge, in definitive proxy or information statementsincorporated by reference in Part III of this Form 10-K or anyamendment to this Form 10-K. x

Indicateby check mark whether the registrant is a large accelerated filer, anaccelerated filer, or a non-accelerated filer. See definition of “acceleratedfiler and large accelerated filer” in Rule 12b-2 of the ExchangeAct.

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

 

Indicate by check markwhether the registrant is a shell company (as defined in Rule 12b-2of the Act). Yes oNo x

The aggregate market valueof voting common stock held by non-affiliates of the registrant (based upon thelast reported sale price on the Nasdaq National Market), as of the lastbusiness day of the registrant’s most recently completed second fiscal quarter(June 30, 2005) was approximately $293,000,000.

There were 19,264,871shares of common stock of the registrant outstanding as of February 22,2006.

Documents incorporated byreference:  The information required by Part IIIof Form 10-K is incorporated herein by reference to the registrant’sdefinitive Proxy Statement relating to its 2006 Annual Meeting of Shareholders,which will be filed with the Commission within 120 days after the end of theregistrant’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** | ** ** | **15** |
| **ITEM 2.**       | ** ** | **Properties** | ** ** | **15** |
| **ITEM  3.**      | ** ** | **Legal  Proceedings** | ** ** | **15** |
| **ITEM 4.**       | ** ** | **Submission of Matters to a Vote of Security Holders** | ** ** | **15** |
| **PART II**  |
| **ITEM 5.**       | ** ** | **Market for the Registrant’s Common Equity, Related  Stockholder Matters and Issuer Purchases of Equity Securities** | ** ** | **16** |
| **ITEM  6.**      | ** ** | **Selected  Financial Data** | ** ** | **18** |
| **ITEM 7.**       | ** ** | **Management’s Discussion and Analysis of Financial  Condition And Results of Operation** | ** ** | **19** |
| **ITEM 7A.**      | ** ** | **Quantitative and Qualitative Disclosures About Market  Risk** | ** ** | **30** |
| **ITEM 8.**       | ** ** | **Financial Statements and Supplementary Data** | ** ** | **31** |
| **ITEM 9.**       | ** ** | **Changes in and Disagreements with Accountants on  Accounting and Financial Disclosure** | ** ** | **32** |
| **ITEM 9A.**      | ** ** | **Controls and Procedures** | ** ** | **32** |
| **ITEM  9B.**     | ** ** | **Other  Information** | ** ** | **36** |
| **PART III** |
| **ITEM 10.**      | ** ** | **Directors and Executive Officers of the Registrant** | ** ** | **36** |
| **ITEM 11.**      | ** ** | **Executive Compensation** | ** ** | **36** |
| **ITEM 12.**      | ** ** | **Security Ownership of Certain Beneficial Owners and  Management and Related Stockholder Matters** | ** ** | **36** |
| **ITEM 13.**      | ** ** | **Certain Relationships and Related Transactions** | ** ** | **36** |
| **ITEM 14.**      | ** ** | **Principal Accounting Fees and Services** | ** ** | **36** |
| **PART IV**  |
| **ITEM 15.**      | ** ** | **Exhibits and Financial Statement Schedules** | ** ** | **36** |

 

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**CAUTIONARY STATEMENT CONCERNING FORWARD-LOOKINGSTATEMENTS**

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 Operations”**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 is a provider of technology-basedsolutions for the legal and fiduciary services industries. Our products andservices assist clients with the administration of complex legal proceedings,including electronic litigation discovery, bankruptcy administration and classaction administration. Our clients include leading 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 both proprietary technology andvalue-added services that comprehensively address their extensive businessrequirements.

We have acquired several companies as part of ourstrategic business plan. During 2005, we acquired nMatrix, Inc. to enterthe market for electronic litigation discovery, Hilsoft, Inc. to enhanceour capabilities in legal notification services, and Novare, Inc. tosupplement our professional services for corporate restructuring clientengagements. During 2004, we acquired Poorman-Douglas Corporation to enter themarket for class action and mass tort administrative services. During 2003, weacquired Bankruptcy Services LLC (BSI) to enter the market for corporaterestructuring bankruptcy reorganization administrative services.

In November 2003, we determined that ourinfrastructure software business, which operated in the automated data exchangesoftware market, was no longer aligned with our long-term strategic objectives.On April 30, 2004, we completed the sale of this business.

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, including the name, Electronic Processing, Inc. Ourshareholders approved an amendment to our Articles of Incorporation on June 7,2000 to change our name from Electronic Processing, Inc. to EPIQ Systems, Inc.

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. The public may read and copy any materials filed by uswith the SEC at the SEC’s Public Reference Room at 100 F Street, NE,Washington, DC 20549. The public may obtain information on the operation of thePublic Reference Room by calling the SEC at 1-800-SEC-0330.The SEC maintains an internet site that contains reports, proxy and informationstatements and other information regarding issuers that file electronicallywith the SEC at http://www.sec.gov. The contents of these websites are notincorporated into this report. Further, our references to the URLs for thesewebsites are intended to be inactive textual references only.

**Industry Environment**

Both our case managementsegment and our document management segment provide products and servicesprimarily to the legaland fiduciary services industries. Segment information related torevenues from external customers, a measure of profit or loss, and total assetsis contained in Note 15 of the Notes to Consolidated Financial Statements. Our clients include leading law firms,corporate legal departments, bankruptcy trustees, case administrators and otherprofessional advisors, who use our products and services for the administrationof legal proceedings such as electronic litigation discovery, bankruptcy administrationand class action administration.

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*ElectronicLitigation Discovery*

The substantial increaseof electronic documents in the business community has changed the dynamics ofhow attorney’s support discovery in complex litigation matters. According to the2005 Socha-Gelbmann Electronic Discovery Survey, the 2004 domestic commercialelectronic discovery revenues were estimated at $832 million, an approximate94% increase from 2003. According to this same source, the market is expectedto continue to grow at a substantial rate from 2005 to 2007, with expectedincreases of 50% to 60% each year. Due to the increasing complexity of cases,the increasing volume of data that are maintained electronically, and theincreasing volume of documents (both paper and electronic) that are produced inall types of litigation, law firms are increasingly reliant on electronicevidence management systems to organize and manage the litigation discoveryprocess.

*Bankruptcy*

Bankruptcy is an integral part of the United States’economy, and bankruptcy filings have remained near record levels for the pastseveral years. As reported by the Administrative Office of the U.S. Courts forthe government fiscal years ended September 30, 2003, 2004, and 2005,there were approximately 1.66 million, 1.62 million, and 1.78 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 2005, accounted for approximately 75% ofall bankruptcy filings. In a Chapter 7 case, the debtor’s assets areliquidated and the resulting cash proceeds are used by the Chapter 7 bankruptcytrustee to pay 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 2005, accounted for approximately 1%of all bankruptcy filings. Chapter 11 generally allows a company to continueoperating under a plan of reorganization to restructure its business and tomodify payment terms of both secured and unsecured obligations. Chapter 11cases may last several years.

·       Chapter13 is a reorganization model of bankruptcy for individuals that, as measured bythe number of new cases filed in 2005, accounted for approximately 24% of allbankruptcy filings. In a Chapter 13 case, debtors make periodic cashpayments into a reorganization plan and a Chapter 13 bankruptcy trustee usesthese cash payments to make monthly distributions to creditors. Chapter 13cases typically last 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. For Chapter 7 and 13 bankruptcy products and services, ourcustomers are professional bankruptcy trustees. For Chapter 11 bankruptcyproducts and services, our customers are the debtor companies that file a planof reorganization, often referred to as a debtor-in-possession.

*Class Action*

Class action and mass tort litigation have becomea discrete component within the United States’ economy. Class action andmass tort refer to litigation in which class representatives bring a lawsuitagainst a defendant company or other persons on behalf of a large group ofsimilarly affected persons (the class). Mass action or mass tort refers toclass action cases that are particularly large or prominent.

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The class action and masstort marketplace is significant, with estimated annual tort claim costs inexcess of $250 billion according to an update study issued in 2004 by TowersPerrin. Administrative costs, which include costs, other than defense costs,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 complicated and the cases, including administration of anysettlement, may last several years.

**Products andServices**

*Case Management Segment*

Casemanagement support for client engagements generally lasts several years and hasa revenue profile that typically includes a recurring component. Our casemanagement segment generates revenue primarily through the following integratedtechnology-based products and services.

·       Anintegrated solution of a proprietary technology platform and relatedprofessional services that facilitates case administration of class action,mass tort and corporate restructuring client engagements.

·       Professionaland support services, including case management, claims processing, specialtybankruptcy consulting, claims reconciliation, and customized programming andtechnology services.

·       Datahosting fees, volume based fees, and professional services fees related to themanagement of large volumes of electronic documents in support of a legalproceeding.

·       Proprietaryelectronic discovery software that sorts, cleanses, organizes and performssearches on large volumes of electronic documents in support of a legalproceeding.

·       Softwareinstalled in bankruptcy trustee offices and provided over the internet thatfacilitates the administration of Chapter 7 and Chapter 13 bankruptcy cases.

·       Databaseconversions, maintenance and processing.

·       Call center support.

*Document Management Segment*

Documentmanagement revenue is generally non-recurring due to the unpredictable natureof the frequency, timing and magnitude of the clients’ business requirements. Ourdocument management segment generates revenue primarily through the followingservices.

·       Legalnoticing services to parties of interest in bankruptcy and class actionmatters.

·       Reimbursementfor costs incurred related to postage on mailing services.

·       Mediacampaign and advertising management.

·       Document custody services.

**Customers**

Our clients include lawfirms, corporate legal departments, bankruptcy trustees and other professionaladvisors. Frequently, law firms act as referral sources for our products andservices, which are ultimately consumed and paid for by a corporate clientinvolved in a bankruptcy proceeding, class action settlement or other complexlitigation. While a corporate client may sometimes be involved in only a singleengagement with us, our relationship with the law firm is longer and normallyspans multiple client engagements. Accordingly, we rely extensively on ournetwork of law firm relationships and expend considerable resources to developand extend those relationships.

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*Electronic Litigation Discovery*

For electronic litigationdiscovery, our customers are typically large corporations that use our productsand services cooperatively with their legal counsel or other professionaladvisors to manage the electronic litigation discovery process.

*Bankruptcy*

For our Chapter 7 andChapter 13 bankruptcy trustee products, our end-user customers are professionalbankruptcy trustees. TheExecutive Office for United States Trustees, a division of the U.S. Departmentof Justice, appoints all bankruptcy trustees. A United States Trustee isappointed in most federal court districts and generally has responsibility foroverseeing the integrity of the bankruptcy system. The bankruptcy trustee’sprimary responsibilities include liquidating the debtor’s assets(Chapter 7) or collecting funds from the debtor (Chapter 13),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 Chapter7 bankruptcy regulations has the practical effect of discouraging trusteecustomers from incurring direct administrative costs for computer systemexpenses. As a result, we provide our Chapter 7 products and services totrustee customers at no direct charge, and our trustee customers agree tomaintain deposit accounts for bankruptcy cases under their administration at adesignated banking institution. We have marketing arrangements with variousbanks under which we provide Chapter 7 trustee case management softwareand related services and the bank provides the Chapter 7 bankruptcy trusteewith deposit-related banking services. Under these Chapter 7 depositrelationships, we receive revenues based on factors such as the aggregateamount of trustee deposits maintained at the bank, the number of customersusing our product, software upgrades, and ancillary professional services.Prior to April 1, 2004, we had an exclusive marketing arrangement withBank of America for Chapter 7 trustee products and services. Effective April 1,2004, this relationship became a non-exclusive marketing arrangement. During February 2006, the partiesagreed to extend the arrangement indefinitely. Either party may, withappropriate notice, wind down the arrangement over a period, including thenotice period, of three years. Since April 1, 2004, we haveestablished new deposit relationships with additional financial institutions. Duringthe year ended December 31, 2005, approximately 21% of our consolidatedrevenues were from our marketing relationship with Bank of America (see Note 9of the Notes to Consolidated Financial Statements) and a substantial majorityof our Chapter 7 deposits were maintained at Bank of America.

Our customers forcorporate restructuring bankruptcy solutions are debtor corporations orbusinesses that file a plan of reorganization. Law firms representing thesecompanies are a key conduit through which both we and our competitors gainaccess to the debtor companies prior to their filing for bankruptcy. Debtor’scounsel often uses our services and products directly on behalf of theirclient, and we have developed relationships with the bankruptcy departments atvarious law firms.

*Class Action*

Our customers for classaction and mass tort solutions are primarily large corporations that areadministering the settlement or resolution of class action or mass tort cases. Wesell our services directly to those customers; however, our relationships withother interested parties, including plaintiff and defense law firms, oftenprovide access to these customers.

**Sales and Marketing**

Our sales departmentmarkets our case management and document management products and servicesdirectly to prospective customers and referral law firms through on-site salescalls. We focus on attracting and retaining customers by providing integratedtechnology solutions with leading edge features 

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and byproviding exceptional customer service. Our account executives, case managersand relationship managers are responsible for providing ongoing supportservices for existing customers. Various relationship managers, case managersand sales representatives attend industry trade shows. We also conduct directmail campaigns 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., Electronic Evidence Discovery, Inc.,Fios, Inc., The Garden City Group Inc., Kroll Ontrack, Inc., RustConsulting Inc., The Trumbull Group, Zantaz, Lexis Nexis Applied Discovery andothers. Additionally, certain law firms, accounting firms, managementconsultant firms, turnaround specialists and crisis management firms offercertain products and services that compete with ours.

**Government Regulation**

Our products and services are not directly regulatedby the government. Our bankruptcy trustee customers and corporate restructuringdebtor customers are, however, subject to significant regulation under theUnited States Bankruptcy Code, the Federal Rules of Bankruptcy Procedureand local rules and procedures established by bankruptcy courts. The ExecutiveOffice for United States Trustees, a division of the United States Departmentof Justice, oversees the bankruptcy industry and establishes administrative rules governingour clients’ activities. Our class action and mass tort cases are subject tovarious federal and state laws as well as rules and procedures establishedby the courts.

In February 2005, new federal class action andtort reform legislation was passed and signed by President Bush. The primaryimpact of the new federal legislation is to require that certain types of classaction lawsuits be brought in federal court rather than state courts. Webelieve the new federal legislation will likely result in fewer class actionlawsuits in state courts. The slower processing of class action lawsuits infederal courts could delay the ultimate settlement of those cases, which couldadversely affect the timing of services we provide in those cases. Similar tothis recent federal legislation, there have been various efforts at the statelevel to modify and reform the laws and procedures related to class action andmass tort. We cannot predict the effect, if any, that state legislative actionwould have on the number or size of class action and mass tort lawsuits filedor on the claims administration process.

In April 2005, theBankruptcy Abuse Prevention and Consumer Protection Act of 2005 was passed andsigned by President Bush. The intent of this legislation, which becameeffective October 2005, is to move certain individual bankruptcy filingsfrom Chapter 7, which liquidates most of the debtor’s assets and dischargesmost of the debtor’s liabilities, to Chapter 13 which does not liquidate thedebtor’s assets but which requires a debtor to pay disposable income to theircreditors. The legislation also affects Chapter 11 bankruptcy filings, in partby placing more strict limits on the period of time in which the debtor has anexclusive right to propose a reorganization plan, accelerating the time framein which a debtor must determine whether to reject a lease or other executorycontract, and potentially increasing certain priority claims. The legislationappears to have had the effect of increasing bankruptcy filings prior to theeffective date of the legislation. It is unclear what impact, if any, the legislationwill have on bankruptcy filings after the legislation’s October 2005effective date. As a result, we cannot predict the effect, if any, that thislegislation will have on our business.

**Employees**

As of December 31, 2005, weemployed approximately 500 full-time employees, none of whom is covered by acollective bargaining agreement. We believe the relationship with our employeesis good.

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**ITEM 1A.   RISK FACTORS**

*This report, other reports to befiled by us with the SEC, press releases made by us and other public statementsby our officers, oral and written, contain or will contain forward-lookingstatements within the meaning of Section 27A of the Securities Actof 1933, as amended and Section 21E of the Securities Exchange Act of1934, as amended, including those relating to the possible or assumed futureresults of operations and financial condition. Because those statements aresubject to a number of uncertainties and risks, actual results may differmaterially from those expressed or implied by the forward-looking statements. Listedbelow are risks associated with an investment in our securities that couldcause actual results to differ from those expressed or implied.*

**Asignificant reduction in the amount of Chapter 7 liquidated asset proceeds ondeposit by our Chapter 7 bankruptcy trustee customers or in the number ofpending bankruptcy cases would cause our revenues and earnings to drop significantly.**

Our bankruptcy depositbased fees are highly dependent on the amount of liquidated asset proceedsdeposited by Chapter 7 bankruptcy trustees and the number of bankruptcy filingsin the United States. Consumer and business debt combined with economicfluctuations in the United States affect the number of bankruptcy filings andthe dollar volume flowing through the federal bankruptcy system. A significantreduction in Chapter 7 liquidated asset proceeds on deposit by our bankruptcytrustee customers with our Chapter 7 depository banks would likely have amaterial adverse effect on our results of operations.

**Substantiallyall of our Chapter 7 revenues are collected through a single financialinstitution, and the termination of that marketing arrangement could causeuncertainty and adversely 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.

Previously, we promotedour Chapter 7 product exclusively through a marketing arrangement established withBank of America in November 1993. Substantially all of our Chapter 7revenues are collected through this relationship. On April 1, 2004, thisexclusive marketing arrangement became a non-exclusive arrangement. During February 2006,the parties agreed to extend the non-exclusive arrangement indefinitely. Eitherparty may, with appropriate notice, wind down the arrangement over a period ofthree years, including the notice period. If either party were to give noticeof termination 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 weretransferred during the wind-down period.

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**Wehave established new arrangements with additional financial institutions, andchanges in or terminations of those marketing arrangements could causeuncertainty and adversely affect our future Chapter 7 revenue and earnings.**

We also have marketingarrangements with several other financial institutions under which our Chapter7 trustees may deposit the Chapter 7 liquidated assets. Additionally, we may seek to establish additional Chapter 7 depositorybank relationships in the future. Changes in the terms of one or more of thosemarketing arrangements or the termination of any of those marketingarrangements could create uncertainty with current and prospective trusteecustomers or operational difficulties for trustees, which could adverselyaffect our relationships with those joint customers and our Chapter 7 revenuesand earnings.

**Someof our pricing models for Chapter 7 trustee clients have or are scheduled tohave a component of pricing tied to prevailing interest rates, and asignificant decline in interest rates would adversely affect our revenues andearnings.**

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.

**If afinancial institution with which we have a marketing arrangement for Chapter 7products and services is perceived negatively by current or prospective trusteeclients, our case management revenue and earnings could be adversely affected.**

The Chapter 7 depositorybanks, with which we have joint marketing arrangements, provide banking productsand services directly to our trustee clients. If the financial institutionprovides ineffective banking products or services to the joint customers or haserrors or omissions in its processing, we could experience collateral damage toour reputation. We cannot control the quality of products and services providedby the Chapter 7 depository banks to the joint customers. Additionally, if adepository bank arrangement is discontinued, it could disrupt the effectivedelivery of banking services to trustees. If the migration to a successordepository bank is not completed smoothly or if we were unable to move thetrustee customer’s deposits to a different banking arrangement prior to theexpiration, we could lose trustee customers, which could adversely affect ourcase management revenues and our results of operations.

**Bankruptcyreform legislation could alter the market for our products and services, whichcould cause a reduction in our revenues and earnings.**

In April 2005, theBankruptcy Abuse Prevention and Consumer Protection Act of 2005 was passed andsigned by President Bush. The intent of this legislation, which becameeffective October 2005, is to move certain individual bankruptcy filingsfrom Chapter 7, which liquidates most of the debtor’s assets and dischargesmost of the debtor’s liabilities, to Chapter 13 bankruptcy filings, which donot liquidate the debtor’s assets but which requires a debtor to pay disposableincome to their creditors. The legislation also affects corporate restructuringbankruptcy filings, in part by placing more strict limits on the period of timein which the debtor has an exclusive right to propose a reorganization plan,accelerating the time frame in which a debtor must determine whether to rejecta lease, and potentially increasing certain priority claims. The legislationappears to have had the effect of increasing bankruptcy filings prior to theeffective date of the legislation. It is unclear what impact, if any, thelegislation will have on bankruptcy filings after the legislation’s October 2005effective date. As a result, we cannot predict the effect, if any, that thislegislation will have on our business.

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**Tortreform legislation could reduce the number and scope of class action and massaction cases, thus reducing our business prospects in the class action market.**

In February 2005, newfederal class action and tort reform legislation was passed and signed byPresident Bush. The primary impact of the new federal legislation is to requirethat certain types of class action lawsuits be brought in federal court ratherthan state courts. We believe the new federal legislation will likely result infewer class action lawsuits in state courts, which are generally perceived asfaster and more plaintiff-friendly than federal courts. The slower processingof class action lawsuits in federal courts could delay the ultimate settlementof those cases, which could adversely affect the timing of services we providein those cases. Likewise, the new federal legislation could have the effect oflowering the overall number of class action cases, whether filed in federal orstate courts. Similar to this recent federal experience, there have beenvarious efforts at the state level to modify and reform the laws and proceduresrelated to class action and mass tort. The goal of certain state tort reformproposals has been to reduce the number and scope of class action and massaction cases. While we cannot predict whether any tort reform legislation willpass at the state levels or the substance of any future changes, anylegislative efforts that are successful in reducing the number or scope ofclass action or mass action cases would likely have an adverse effect on ourresults of operations.

**Wehave a limited number of bankruptcy trustee clients and a limited number ofsignificant referral sources for corporate restructuring and class action andmass tort engagements. The loss of even a limited number of our trusteecustomers or referral sources could result in a loss of revenue and earnings.**

There is a limited numberof Chapter 7 and Chapter 13 bankruptcy trustees to whom we can market ourbankruptcy products and services. Additionally, we rely heavily on a limitednumber of corporate restructuring and class action referral sources to earn newbusiness engagements. Our future financial performance will depend on ourability to maintain existing trustee customer accounts, to attract businessfrom trustees that are currently using a competitor’s software product, tomaintain our existing referral relationships, and to develop new referralrelationships. The loss of even a limited number of trustee customers or areduction in referral sources could result in a material loss of revenue andearnings.

**Weencounter competition for our products and services from other third partyproviders and we could lose existing customers and fail to attract newbusiness.**

The markets for case anddocument management products and services are competitive, continually evolvingand subject to technological change. We believe that the principal competitivefactors in the markets we serve include the breadth and quality of system andsoftware solution offerings, the stability of the information systems provider,the features and capabilities of the product and service offerings, and thepotential for enhancements. Our success will depend 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.

**Thefluctuations in quarterly projects for clients have affected and may affect inthe future the timing of our quarterly revenues and earnings and are likely toaffect our future quarterly results.**

The initiation ortermination of a large corporate restructuring, class action or mass tortengagement can directly affect our revenues and earnings for a particularquarter, and the levels of services, particularly services related to documentmanagement required for an ongoing corporate restructuring or class actionengagement can fluctuate quarter to quarter during the time that the debtor isin Chapter 11 corporate restructuring or the class action lawsuit is active.

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**Ourquarterly results have fluctuated in the past and may fluctuate in the future. Ifthey do, our operating results may not meet the expectations of securitiesanalysts or investors. This could cause fluctuations in the market price of ourcommon stock.**

Our quarterly results have fluctuated during the lastyear and may fluctuate in the future. As a result, our quarterly revenues andoperating results are increasingly difficult to forecast. It is possible thatour future quarterly results from operations from time to time will not meetthe expectations of securities analysts or investors. This could cause amaterial drop 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:

·       fluctuationsin bankruptcy trustees’ deposit balances or caseloads;

·       unanticipatedexpenses related to software maintenance or customer service;

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

·       the timing and marketacceptance of new software versions or support services.

**Ourstock price may be volatile even if our quarterly results do not fluctuatesignificantly.**

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;

·       generalmarket conditions and other economic factors; and

·       actualor perceived improvements in the national economy and the correspondingassumption that our bankruptcy business will decline as the economy improves.

In addition, the stockmarket has experienced significant price and volume fluctuations that haveparticularly affected the market prices of stocks of technology companies andthat have often been unrelated to the operating performance of particularcompanies. The market price of our common stock has been volatile and this islikely to continue.

**Ifcorporate restructuring cases on which we are retained convert to Chapter 7, wemay not be paid for the products and services we have provided.**

In corporate restructuringengagements we provide services directly to the debtor and we are paid directlyby the debtor. If a debtor’s corporate restructuring case converts to Chapter 7liquidation, we might not be paid for products and services previously providedand we would most likely lose all future revenue from the case. We have hadcorporate restructuring cases convert to Chapter 7 cases in the past. Theconversion of a major corporate restructuring case to Chapter 7 could have amaterial adverse effect on our results of operations.

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**Ifthe bankruptcy court reduces or eliminates our fees in major corporaterestructuring cases, our results of operations could be impaired.**

In corporate restructuringcases, the bankruptcy court may reduce or eliminate fees paid foradministrative services such as those we provide. If the court reduced oreliminated fees due to us in a major corporate restructuring case, our resultsof operations could be materially affected.

**If weare unable to develop new technologies, we could lose existing customers andfail to attract new business.**

We regularlyundertake new projects and initiatives in order to meet the changing needs ofour customers. In doing so, we invest substantial resources with no assuranceof the ultimate success of the project or initiative. We believe our futuresuccess will depend, in part, upon our ability to:

·       enhanceour existing products;

·       designand introduce new solutions that address the increasingly sophisticated andvaried needs of our current and prospective customers;

·       maintainour technology skills; and

·       respondto technological advances and emerging industry standards on a timely andcost-effective basis.

We may not be able toincorporate future technological advances into our business, and futureadvances in technology may not be beneficial to or compatible with our business.In addition, keeping abreast of technological advances in our business mayrequire substantial expenditures and lead-time. We may not be successful inusing new technologies, adapting our solutions to emerging industry standards,or developing, introducing and marketing new products or enhancements. Furthermore,we may experience difficulties that could delay or prevent the successfuldevelopment, introduction or marketing of these products. If we incur increasedcosts or are unable, for technical or other reasons, to develop and introducenew products or enhancements in a timely manner in response to changing marketconditions or customer requirements, we could lose existing customers and failto attract new business.

**Newreleases of our software products may have undetected errors, which could causelitigation claims 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 by our customers. Likewise, the softwareproducts we acquire in business acquisitions have 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 ofdevelopment resources, damage to our reputation, increased service costs,increased expense for litigation and impaired market acceptance of ourproducts.

**Securityproblems with, or product liability claims arising from, our software productsand business processes could cause increased expense for litigation, increasedservice costs and damage to our reputation.**

We have included security features in our productsthat are intended to protect the privacy and integrity of data. Security forour products is critical given the highly confidential nature of theinformation 

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our software processes. Oursoftware products and the servers on which the products are used may not beimpervious to intentional break-ins (“hacking”) or other disruptive problemscaused by the internet or by other users. Hacking or other disruptive problemscould result in the diversion of development resources, damage to ourreputation, increased service costs or impaired market acceptance of ourproducts, any of which could result in higher expenses or lower revenues. Additionally,we could be exposed to potential liability related to hacking or otherdisruptive problems. Defending these liability claims could result in increasedexpenses for litigation and a significant diversion of our management’sattention.

Furthermore, we administerclaims for third parties. Errors or fraud related to the processing or paymentof these claims could result in the diversion of management resources, damageto our reputation, increased service costsor impaired market acceptance of our services, any of which could result inhigher expenses and/or lower revenues. Additionally, such errors or fraudrelated to the processing or payment of claims could result in lawsuitsalleging damages. Defending such claims could result in increased expenses forlitigation and a significant diversion of our management’s attention.

**Interruptionsor delays in service from our third-party Web hosting facility could impair thedelivery of our service and harm our business.**

We provide certain of ourservices through computer hardware that is currently located in a third-partyWeb hosting facility operated by a third party vendor. We do not control theoperation of this facility, and it is subject to damage or interruption fromearthquakes, floods, fires, power loss, terrorist attacks, telecommunicationsfailures and similar events. It is also subject to break-ins, sabotage,intentional acts of vandalism and similar misconduct. The occurrence of anatural disaster, a decision to close the facility without adequate notice orother unanticipated problems at the facility could result in lengthyinterruptions in our service. In addition, the failure by our vendor to provideour required data communications capacity could result in interruptions in ourservice. Any damage to, or failure of, our systems could result ininterruptions in our service. Interruptions in our service may reduce ourrevenue, cause us to issue credits or pay penalties, cause customers toterminate their agreements with us and adversely affect our ability to securebusiness in the future. Our business will be harmed if our customers andpotential customers believe our service is unreliable.

**Ifour security measures are breached and unauthorized access is obtained to acustomer’s data, our service may be perceived as not being secure, customersmay curtail or stop using our service and we may incur significant liabilities.**

Our service involves thestorage and transmission of customers’ proprietary information, and securitybreaches could expose us to a risk of loss of this information, litigation andpossible liability. If our security measures are breached as a result ofthird-party action, employee error, malfeasance or otherwise and, as a result,someone obtains unauthorized access to one of our customers’ data, ourreputation will be damaged, our business may suffer and we could incursignificant liability. Because techniques used to obtain unauthorized access orto sabotage systems change frequently and generally are not recognized untillaunched against a target, we may be unable to anticipate these techniques orto implement adequate preventative measures. If an actual or perceived breach ofour security occurs, the market perception of the effectiveness of our securitymeasures could be harmed and we could lose sales and customers.

**Wemay be sued by third parties for alleged infringement of their proprietaryrights.**

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. 

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Anyintellectual property claims, with or without merit, could be time-consumingand expensive to resolve, could divert management attention from executing ourbusiness plan, and could require us to pay monetary damages or enter intoroyalty or licensing agreements. In addition, certain customer agreementsrequire us to indemnify our customers for third-party intellectual propertyinfringement claims, which would increase the cost to us of an adverse rulingon such a claim. An adverse determination could also prevent us from offeringour service to others.

**We rely on third-party hardware and software that maybe difficult to replace or which could cause errors or failures of our service.**

We rely on hardwarepurchased or leased and software licensed from third parties in order to offercertain services. This hardware and software may not continue to be availableon commercially reasonable terms, or at all. Any loss of the right to use anyof this hardware or software could result in delays in the provisioning of ourservice until equivalent technology is either developed by us or, if available,is identified, obtained and integrated, which could harm our business. Anyerrors or defects in third-party hardware or software could result in errors ora failure of our service which could harm our business.

**Ourintellectual property is not protected through patents or formal copyrightregistration. Therefore, we do not have the full benefit of patent or copyrightlaws to prevent others from 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 fromindependently developing substantially equivalent proprietary information andtechniques or from otherwise gaining access to our trade secrets. In addition,foreign intellectual property laws may not protect our intellectual propertyrights. Moreover, litigation may be necessary to enforce our intellectualproperty rights, to protect our trade secrets, to determine the validity andscope of the proprietary rights of others or to defend against claims ofinfringements. Litigation of this nature could result in substantial expensefor us and diversion of management and other resources, which could result in aloss of revenue and profits.

**Ourfailure to develop and maintain products and services that assist our customersin complying with significant government regulation could result in decreaseddemand for our products and services.**

Our products and servicesare not directly regulated by the government. Our bankruptcy customers are,however, subject to significant regulation, including the United StatesBankruptcy Code, the Federal Rules of Bankruptcy Procedure and localrules and procedures established by bankruptcy courts. The ExecutiveOffice for United States Trustees, a division of the United States Departmentof Justice, oversees bankruptcy trustees and establishes administrativerules governing trustees’ activities. Additionally, the process of administeringthe settlement of class action or mass tort cases is subject to courtsupervision and review by opposing plaintiffs’ and defendants’ counsel. Thesuccess of our business has been, and will continue to be, partly dependent onour ability to develop and maintain products and provide services that allowclients to perform their duties within applicable regulatory and judicialrules and procedures and that allow corporate restructuring debtors tomake filings and send required notices on a timely and accurate basis. Futureregulation and court practices or procedures may limit or eliminate the abilityof clients to utilize the types of products and services that we currentlyprovide. Our failure to adapt our products and services to changes in theBankruptcy Code and applicable legislative and judicial rules andprocedures could cause us to lose existing customers or fail to attract newcustomers.

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**Theintegration of acquired businesses is time consuming, may distract ourmanagement from our other operations, and can be expensive, all of which couldreduce or eliminate our expected earnings.**

In November 2005, we acquired nMatrix forapproximately $126 million in cash and stock. In January 2004, we acquiredPoorman-Douglas for approximately $116 million in cash. In addition to theseacquisitions, during the five years ended December 31, 2005, we acquiredfive other businesses at a combined cost of approximately $90 million. We mayconsider additional opportunities to acquire other companies, assets or productlines that complement or expand our business. If we are unsuccessful inintegrating these companies or product lines with our existing operations, orif integration is more difficult than anticipated, we may experiencedisruptions to our operations. A difficult or unsuccessful integration of anacquired business would likely have a material adverse effect on our results ofoperations.

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 company;

·       conformingthe acquired company’s standards, processes, procedures and controls 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 after the nMatrix acquisition.

**Ourbusiness and results of operations may be adversely affected if we are unableto manage our growth effectively.**

Certain businesses we haveacquired, including most recently the nMatrix business, have experiencedsubstantial growth immediately prior to the time we acquired the business. Thesuccess of those types of acquisitions is dependent upon a number of factors,including the ability to hire, train and retain an adequate number ofexperienced managers and employees for those rapidly growing businesses, theestablishment of policies, procedures and internal controls to allow us tomonitor the growth of those businesses, and other factors that are beyond ourcontrol. Expansion internationally will increase demands on management anddivert their attention, which could have an adverse impact on our business andfinancial results. The challenges of managing the growth of an acquiredbusiness may distract our management from their normal duties associated withour historical core businesses.

**Wehave non-U.S. operations which are subject to certain inherent risks.**

As a result of our recentacquisition of nMatrix, we now maintain small offices in the United Kingdom andAustralia. We anticipate that we will seek to expand our currently limitedglobal operations and may enter new global markets. Our foreign business istransacted in the local functional currency, but we do not currently have anymaterial exposure to foreign currency transaction gains or losses. All otherbusiness transactions are in U.S. dollars. To date, we have not entered intoany derivative financial instruments to manage our foreign currency risk. Ourcurrent and proposed international activities are subject to certain inherentrisks, including specific country economic conditions, exchange rate fluctuation,changes in regulatory requirements, reduced protection of intellectual propertyrights, potential adverse tax consequences, different or additional productfunctionality requirements, and cultural differences.

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**Theuse of our common stock to fund acquisitions or to refinance debt incurred foracquisitions could dilute existing shares.**

We have used our common stock to refinance debtincurred for several prior acquisitions. 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 and incurredapproximately $101 million of bank indebtedness in connection with our nMatrixacquisition. We may consider issuing additional common shares and using theproceeds to pay part or all of this additional 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.

**Wedepend upon our key personnel and we may not be able to retain them or toattract, assimilate and retain highly qualified employees in the future.**

Our future success willdepend in significant part upon the continued service of our senior managementand certain of our key technical personnel and our continuing ability toattract, assimilate and retain highly qualified technical, managerial, andsales and marketing personnel. We do not have employment agreements with our ChiefExecutive Officer, President, or Chief Financial Officer. We do have employmentagreements with our Chief Executive Officer—Poorman-Douglas Corporation, ourPresident—Bankruptcy Services LLC., and key executives of nMatrix. We maintainkey-man life insurance policies on our Chief Executive Officer and ourPresident. The loss of the services of any of these executives or other keypersonnel or the inability to hire or retain qualified personnel in the futurecould have a material adverse impact on our results of operations.

**We donot pay cash dividends on our common stock and our common stock may notappreciate in value or even maintain the price at which you purchased yourshares.**

We presently do not intendto pay any cash dividends on our common stock. Subject to any financialcovenants in current or future financing agreements that directly or indirectlyrestrict the payment of dividends, the payment of dividends is within thediscretion of our board of directors and will depend upon our future earnings,if any, our capital requirements, our financial condition and any other factorsthat the board of directors may consider. In addition, certain terms of ourconvertible notes and certain provisions in our credit agreement may restrictour ability to pay dividends in the future. We currently intend to retain allearnings to reduce our debt and for use in the operation and expansion of ourbusiness. As a result, the success of your investment in our common stock willdepend entirely upon its future appreciation. Our common stock may notappreciate in value or even maintain the price at which you purchased yourshares.

**Ourarticles of incorporation contain a provision that could be used by us, withoutshareholder approval, to discourage or prevent a takeover of our company.**

Some provisions of ourarticles of incorporation could make it more difficult for a third party toacquire control of our company, even if the change of control would bebeneficial to certain shareholders. In the event of a change in control of ourcompany, vesting of previously issued equity awards could be automaticallyaccelerated.

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**Compliancewith changing regulation of corporate governance and public disclosure mayresult in additional expenses.**

Compliance with changing laws, regulations andstandards relating to corporate governance and public disclosure, including theSarbanes-Oxley Act of 2002, new SEC regulations, and Nasdaq National 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 withSection 404 of the Sarbanes-Oxley Act of 2002 and the related regulationsregarding our required assessment of our internal controls over financialreporting and our external auditors’ certification of that assessment haverequired the commitment of significant financial and managerial resources. Weexpect these efforts to require the continued commitment of significantresources.

SECrules implementing Section 404 of Sarbanes-Oxley require disclosureof the remediation of significant deficiencies or material weaknesses ininternal controls over financial reporting and the existence, at year-end, ofmaterial weaknesses related to our internal control over financial reporting.If we are required to make any of these types of disclosures in the future, thesedisclosures could adversely affect the price of our common stock.

**ITEM 1B.**   UNRESOLVED STAFF COMMENTS

None.

**ITEM 2.**   PROPERTIES

Our corporateoffices are located in a 49,000-square-foot facility in KansasCity, Kansas. This owned property serves as collateral under our creditfacility. Significant leased properties include:

·       approximately 16,000 squarefeet of office space in New York, New York, through August, 2013;

·       approximately 23,000 squarefeet of office space in New York, New York through January 2006 (as of February 2006,we have relocated to a new leased location with approximately 42,000 squarefeet of office space in New York, New York through April 2015); and

·       approximately 88,000 squarefeet of office and document processing space in Beaverton, Oregon, throughSeptember, 2015.

**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 submittedin the fourth quarter of 2005 to a vote of security holders.

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**PART II**

**ITEM 5.**                MARKETFOR THE REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUERPURCHASES OF EQUITY SECURITIES

**Market Information**

Ourcommon stock is traded under the symbol “EPIQ” on the Nasdaq National Market. Thefollowing table shows the reported high and low sales prices for the commonstock for the calendar quarters of 2005 and 2004 as reported by Nasdaq:

| ** **     | ** ** | **2005** | ** ** | **2004** | ** ** |
|----------------|------------|----------|------------|----------|------------|
| ** **     | ** ** | **High** | ** ** | **Low**  | ** ** | **High** | ** ** | **Low** | ** ** |
| First Quarter  |       | $        | 15.00      |     | $          | 12.05 |   | $ | 20.90 |   | $ | 15.50 |   |
| Second Quarter |       | 16.97    |       | 12.90    |       | 17.80 |   | 13.24 |   |
| Third Quarter  |       | 22.22    |       | 16.13    |       | 16.65 |   | 12.63 |   |
| Fourth Quarter |       | 22.44    |       | 17.21    |       | 17.03 |   | 13.81 |   |
|                |            |          |            |          |            |  |  |  |  |  |  |  |  |

 

**Holders**

As of February 17,2006, there were approximately 100 owners of record of our common stock andapproximately 4,200 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. The payment of dividends is withinthe discretion of our board of directors and will depend upon various factors,including future earnings, capital requirements, financial condition, the termsof our credit agreement, the terms of our convertible notes, and other factorsdeemed relevant by the board of directors. Various financial covenants in ourcredit agreement and our outstanding convertible notes may have the effect oflimiting the ability of our board of directors to declare and pay cashdividends on our common stock. There is no restriction on the ability of oursubsidiaries to transfer funds to EPIQ in the form of cash dividends, loans oradvances.

**EquityCompensation Plan Information**

Thefollowing table sets forth as of December 31, 2005 (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**     |       |       | 4,119,000  |                                                                                                                                                 |       |                                                                                                        | $          | 13.77 |   |   |   | 986,000 |   |   |
| **Equity compensation plans not approved by  security holders** |       |       | 650,000    |                                                                                                                                                 |       |                                                                                                        | $          | 19.03 |   |   |   | 0 |   |   |
| **Total**                                                       |       |       | 4,769,000  |                                                                                                                                                 |       |                                                                                                        | $          | 14.49 |   |   |   | 986,000 |   |   |
|                                                                 |            |            |            |                                                                                                                                                      |            |                                                                                                             |            |  |  |  |  |  |  |  |  |  |

 

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As of December 31, 2005, equity compensationplans approved by security holders consist of our 1995 Stock Option Plan andour 2004 Equity Incentive Plan. Securities remaining available for futureissuance under equity compensation plans approved by security holders consistsolely 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, 2005, equity compensationplans not approved by security shareholders consist solely of stock optionsissued in conjunction with our acquisitions of BSI, Poorman-Douglas, andnMatrix. The stockoptions issued to key employees of BSI, Poorman-Douglas, and nMatrix wereinducement stock options issued in conjunction with the execution of employmentagreements with each of those key employees to become employees of our newlyacquired subsidiaries. In accordance with the Nasdaq corporate governancerules, shareholder approval of these inducement stock option grants was notrequired.

The stock options grantedunder equity compensation plans not approved by security holders were grantedat an option exercise price equal to fair market value of the common stock onthe date of grant, are non-qualified options, are exercisable for up to 10years from the date of grant, and otherwise have terms substantially identicalto the material terms of the 1995 Stock Option Plan and the 2004 EquityIncentive Plan. Stock options granted in conjunction with the acquisition ofBSI vested 20% on January 31, 2003, the grant date thereof, and continueto vest 20% per year on each anniversary of the grant date until fully vestedon January 31, 2007. Stock options granted in conjunction with theacquisition of Poorman-Douglas vest 20% per year, with the initial vestinghaving occurred January 31, 2005, over five years. Stock options grantedin conjunction with the acquisition of nMatrix vest 25% per year, with theinitial vesting to occur November 15, 2007, over five years.

**RecentSales of Unregistered Securities**

On November 15, 2005,we issued 1,228,501 shares of restricted common stock to the sole owner ofnMatrix as payment of a portion of the nMatrix purchase price. We issued thecommon stock in reliance on the exemption from registration in Section 4(2) ofthe Securities Act of 1933, as amended.

**Purchasesof Equity Securities by the Issuer and Affiliated Purchasers**

None.

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**ITEM6.**                SELECTED FINANCIALDATA

| ** **                                             | ** ** | **Years Ended December 31,**                        | ** ** |
|--------------------------------------------------------|------------|--------------------------------------------------------------------|------------|
| ** **                                             | ** ** | **2005**                                                           | ** ** | **2004** | ** ** | **2003** | ** ** | **2002** | ** ** | **2001** | ** ** |
| ** **                                             | ** ** | **(In Thousands, Except Per Share Data)** | ** ** |
| INCOME  STATEMENT DATA:                                |       |                                                               |       |   |   |   |   |   |   |   |   |
| Revenues from continuing operations                    |       | $                                                                  | 130,796    |   | $ | 125,420 |   | $ | 67,936 |   | $ | 36,256 |   | $ | 28,149 |   |
| Income from continuing operations                      |       | 10,948                                                             |       | 9,063 |   | 14,525 |   | 9,766 |   | 6,253 |   |
| Income (loss) from discontinued operations             |       | —                                                             |       | 667 |   | (5,818 | ) | (1,533 | ) | (1,311 | ) |
| Net income                                             |       | 10,948                                                             |       | 9,730 |   | 8,707 |   | 8,233 |   | 4,942 |   |
| Income  (loss) per share—Diluted                  |       |                                                               |       |   |   |   |   |   |   |   |   |
| from continuing operations                             |       | $                                                                  | 0.56       |   | $ | 0.49 |   | $ | 0.80 |   | $ | 0.64 |   | $ | 0.44 |   |
| from discontinued operations                           |       | $                                                                  | —     |   | $ | 0.03 |   | $ | (0.32 | ) | $ | (0.10 | ) | $ | (0.09 | ) |
| Net income per share—Diluted                      |       | $                                                                  | 0.56       |   | $ | 0.52 |   | $ | 0.48 |   | $ | 0.54 |   | $ | 0.35 |   |
| BALANCE SHEET DATA:                                    |       |                                                               |       |   |   |   |   |   |   |   |   |
| Working capital related to continuing  operations |       | $                                                                  | 10,983     |   | $ | 22,979 |   | $ | 38,856 |   | $ | 63,503 |   | $ | 27,286 |   |
| Total assets                                           |       | 394,870                                                            |       | 240,088 |   | 141,927 |   | 108,037 |   | 70,648 |   |
| Long-term debt                                         |       | 145,906                                                            |       | 74,499 |   | 3,066 |   | 289 |   | 594 |   |
| Stockholders’  equity                             |       | 176,541                                                            |       | 139,883 |   | 129,255 |   | 102,375 |   | 65,144 |   |

 

DuringJune 2001, we completed a follow-on offering of 1,537,500 shares of commonstock and received net proceeds of $22.7 million.

DuringOctober 2001, we acquired certain assets from ROC Technologies. Theacquisition was accounted for using the purchase method of accounting with theoperating results of ROC Technologies included in our statements of incomesince the date of acquisition.

During July 2002, weacquired the Chapter 7 trustee business of CPT Group, Inc. The acquisitionwas accounted for using the purchase method of accounting with the operatingresults of CPT Group included in our statements of income since the date ofacquisition.

DuringNovember 2002, we completed a private placement of 2,000,000 shares ofcommon stock and received net proceeds of $28.1 million.

DuringJanuary 2003, we acquired the member interests of BSI. The acquisition wasaccounted for using the purchase method of accounting with the operatingresults of BSI included in our statements of income since the date ofacquisition. See Note 13 of the Notes to Consolidated Financial Statements.

DuringNovember 2003, the decision was made to dispose of our infrastructuresoftware business and the business was sold in April 2004. Accordingly,all revenues, cost of sales, operating expenses, assets and liabilities relatedto infrastructure software have been reclassified as discontinued operationsfor all periods presented. See Note 14 of the Notes to Consolidated FinancialStatements.

DuringJanuary 2004, we acquired the equity of P-D Holding Corp. and itswholly-owned operating subsidiary, Poorman-Douglas Company (Poorman-Douglas). Theacquisition was accounted for using the purchase method of accounting with theoperating results of Poorman-Douglas included in our statement of income sincethe date of acquisition. See Note 13 of the Notes to Consolidated FinancialStatements.

DuringOctober 2005, we acquired the equity of Hilsoft, Inc. (Hilsoft). Theacquisition was accounted for using the purchase method of accounting with theoperating results of Hilsoft included in our statement of income since the dateof acquisition. See Note 13 of the Notes to Consolidated Financial Statements.

DuringNovember 2005, we acquired the equity of nMatrix, Inc. and nMatrixAustralia Pty. Ltd. (collectively, nMatrix). The acquisition was accounted forusing the purchase method of accounting with the operating results of nMatrixincluded in our statement of income since the date of acquisition. See Note 13of the Notes to Consolidated Financial Statements.

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

**Management’s Overview**

We are 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 litigation discovery, class actionand mass tort, and bankruptcy proceedings that can last several years and has arevenue profile that typically includes a recurring component. Our documentmanagement segment 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 may varybased on the level of consumer and business debt, the general economy, interestrate levels and other factors. For the government fiscal years ended September 30,2003, 2004, and 2005, the Administrative Office of the U.S. Courts reported approximately 1.66 million,1.62 million, and 1.78 million new bankruptcy filings, respectively. Webelieve an important indicator of future bankruptcy filings is the level ofconsumer and business debt outstanding. The most recent available FederalReserve *Flow of Funds Accounts of the United States*,dated December 8, 2005, reported increases in both consumer and businessdebt outstanding as compared with the same period of the prior year.

During 2003, we determined that our infrastructuresoftware segment was no longer aligned with our long-term strategic objectivesand we developed a plan to sell this segment within a year. Accordingly, ourinfrastructure software results for 2004 and 2003, including our gain ondisposition of the infrastructure software business, are included entirelywithin the discontinued operations section of our income statement.

We have acquired a number of businesses during thepast several years. In January 2003, we acquired BSI to expand ourofferings to include an integrated solution of a proprietary technologyplatform and professional services for corporate restructurings. In January 2004,we acquired Poorman-Douglas and expanded our product and service offerings toinclude class action, 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 litigation discovery.

In conjunction with ouracquisition of nMatrix, we had notable changes to our capital structure. Aspartial purchase price consideration, we issued approximately 1.2 millionshares of our common stock. To provide us with increased financial flexibility,we also restructured our credit facility. Our amended credit facility nowconsists of a $25 million senior term loan, due September 2006, and a $100million senior revolving loan, due November 2008. During the term of theloan we have the right, subject to compliance with our covenants, to increasethe senior revolving loan to $175 million.

**Critical Accounting Policies**

We consider our accounting policies related to revenuerecognition, business combinations, goodwill, and identifiable intangibleassets to be critical policies in understanding our historical and futureperformance.

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*Revenue recognition.*   Wehave agreements with customers obligating us to deliver various products andservices each month. Case management fees earned are contingent upon themonth-to-month delivery of the products and services defined by the contractsand are related primarily to the size and complexity of the ongoing engagement.The formula-based fees earned each month become fixed and determinable on amonthly basis as a result of our completion of all contractually requiredperformance obligations related to products delivered and services rendered byus during the month. Our case management business also provides hosting access;revenue related to hosting access is recognized over the period that service isprovided. Document management revenues are recognized in the period theservices are provided. Payments received in advance of satisfaction of therelated revenue recognition criteria are recognized as a deferred revenueliability until all revenue recognition criteria have been satisfied. Significantsources of revenue include:

·       amonthly fee from financial institutions based on a percentage of totalliquidated assets on deposit and on the number of trustees;

·       feesfor database conversions, database hosting, processing, storage, maintenanceand software upgrades;

·       monthlyrevenue based on the number of cases in a database;

·       feesbased on the number of claims in a case;

·       feesfor media placement; and

·       feesfor services, including technology services, claims reconciliation, documentprinting, noticing, balloting, voting tabulation and other professionalservices.

*Businesscombination accounting.**  *We have acquired a number of businesses during thelast several years, and we may acquire additional businesses in the future. Businesscombination accounting, often referred to as purchase accounting, requires usto determine the fair value of all assets acquired, including identifiableintangible assets, and liabilities assumed. The cost of the acquisition isallocated to the assets acquired and liabilities assumed in amounts equal tothe fair value of each asset and liability, and any remaining acquisition costis classified as goodwill. This allocation process requires extensive use ofestimates and assumptions, including estimates of future cash flows to begenerated by the acquired assets. Certain identifiable intangible assets, suchas customer lists and covenants not to compete, are amortized on astraight-line basis over the intangible asset’s estimated useful life. Theestimated useful life of amortizable identifiable intangible assets range fromone to 14 years. Goodwill and certain other identifiable intangible assets arenot amortized. Accordingly, the acquisition cost allocation has had, and willcontinue to have, a significant impact on our current operating results.

*Goodwill.**  *We assess goodwill, which is notsubject to amortization, for impairment as of each July 31 and also at anyother date when events or changes in circumstances indicate that the carryingvalue of these assets may exceed their fair value. This assessment is performedat a reporting unit level. A reporting unit is a component of a segment thatconstitutes a business, for which discrete financial information is available,and for which the operating results are regularly reviewed by management.

A change in events or circumstances, including adecision to hold an asset or group of assets for sale, a change in strategicdirection, or a change in the competitive environment could adversely affectthe fair value of one or more reporting units. During November 2003, we determined thatour infrastructure software segment was no longer aligned with our long-termstrategic objectives and we developed a plan to sell this segment within a year.As a result, we recognized a pre-tax impairment charge of approximately $3.8 millionrelated to goodwill during the year ended December 31, 2003.

The estimate of fair value is highly subjective andrequires significant judgment. If we determine that the fair value of anyreporting unit is less than the reporting unit’s carrying value, then we willrecognize an 

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impairment charge. Ifgoodwill on our balance sheet becomes impaired during a future period, theresulting impairment charge could have a material impact on our results ofoperations and financial condition. Our unimpaired, recognized goodwill totaled$249.4 million as of December 31, 2005.

*Identifiableintangible assets.**  *Eachperiod we evaluate whether events and circumstances warrant a revision to theremaining estimated useful life of each identifiable intangible asset. Ifevents and circumstances warrant a change to the estimate of an identifiableintangible asset’s remaining useful life, then the remaining carrying amount ofthe identifiable intangible asset would be amortized prospectively over thatrevised remaining useful life. Furthermore, information developed during ourannual assessment, or other events and circumstances, may indicate that thecarrying value of one or more identifiable intangible assets is not recoverableand its fair value is less than the identifiable intangible asset’s carryingvalue and would result in recognition of an impairment charge. During November 2003,we determined that our infrastructure software segment was no longer alignedwith our long-term strategic objectives and we developed a plan to sell thissegment within a year. As a result, we recognized a pre-tax impairment chargeof approximately $0.9 million related to identifiable intangible assets duringthe year ended December 31, 2003.

A change in the estimateof the remaining life of one or more identifiable intangible assets or theimpairment of one or more identifiable intangible assets could have a materialimpact on our results of operations and financial condition. Our identifiableintangible assets’ carrying value, net of amortization, was $53.4 million as ofDecember 31, 2005.

**Resultsof Operations for the Year Ended December 31, 2005 Compared with the YearEnded December 31, 2004**

**Consolidated Results**

***Revenue***

Total revenue of $130.8million for the year ended December 31, 2005 represents an approximate 4%increase compared with $125.4 million of revenue for the prior year. Totalrevenue includes revenue from reimbursed expenses, which are presented as aseparate line item on our Consolidated Statements of Income. While revenuesfrom reimbursed expenses may fluctuate significantly from period to period,these fluctuations have a minimal effect on our operating income as we realizelittle or no margin from this revenue. Revenue exclusive of revenue related toreimbursed expenses, which we refer to as operating revenue, increased $2.1million, or approximately 2%, to $107.2 million for the year ended December 31,2005 compared with $105.1 million for the same period in the prior year. Allrevenue is directly related to a segment and changes in revenue by segment arediscussed below.

***Operating Expenses***

Direct costs, general and administrative expenses, anddepreciation and software amortization increased $3.4 million, or approximately4%, to $96.2 million for the year ended December 31, 2005 compared with$92.8 million for the prior year. Changes in direct costs, general and administrativeexpenses, and depreciation and software amortization are directly related to asegment and are discussed below.

Corporate administrative costs not attributable tosegment operations increased by $3.9 million, or 17%, to $27.0 million for theyear ended December 31, 2005 compared with $23.1 million for the prioryear. This increase primarily results from the increase in the scope andcomplexity of our business, and is primarily the result of increases incompensation and related expenses, travel, professional services and softwareamortization expense.

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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 identifiable intangibleassets are directly related to a segment and changes in amortization ofidentifiable intangible assets by segment are discussed below.

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

***Expenses Related to Financing***

Net expensesrelated to financing decreased $0.5 million, to $6.7 million for the year endedDecember 31, 2005 compared with $7.2 million of net expenses related tofinancing for the prior year. This decrease related to various financingcomponents.

·       Variableinterest expense related to our credit facilities and fixed interest expenserelated to our convertible debt increased $0.7 million to $4.5 million duringthe year ended December 31, 2005 compared to $3.8 million for the prioryear primarily as a result of an increase in our variable interest rate, partlyoffset by a decrease in weighted average borrowings outstanding during theyear.

·       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 is primarily aresult of amortization related to a short-term subordinated borrowing under thecredit facility used to finance the acquisition of Poorman-Douglas in January 2004.All fees related to this subordinated borrowing were amortized during 2004.

·       During2004, we replaced the senior portion of the credit facility used to finance thePoorman-Douglas transaction with our KeyBank credit facility. As a result,during the year ended December 31, 2004, we recognized a $1.0 millioncharge for the write-off of loan fees related to the terminated creditfacility.

·       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 debt balance wasreduced by the same amount. The convertible debt accretes approximately $0.1million each quarter such that, at the end of three years, the convertible debtbalance will total $50.0 million. The embedded option must be revalued at eachperiod end based on the probability weighted discounted cash flows related tothe additional 4% interest rate payments which would be made if the convertibledebt maturity is extended an additional three years. While the changes in fairvalue of the embedded option and carrying value of the convertible debt do notaffect our current cash flow, the aggregate of these changes in value isaccounted for as a current income or expense item and is included on ouraccompanying Consolidated Statements of Income 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 in the prioryear. If the embedded option is eventually exercised, the value assigned to theembedded option will be amortized to income 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.

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***Effective Tax Rate***

Our effective tax raterelated to income from continuing operations decreased from 41.3% for the yearended December 31, 2004 to 39.9% for the year ended December 31,2005. The decrease in our 2005 effective tax rate compared to the prior year isthe result of discrete events, and we anticipate that our future tax rate willincrease. Our tax rate is higher than the statutory federal rate of 35%primarily due to state taxes. Two of our subsidiaries, BSI and the recentlyacquired nMatrix, operate primarily in New York City and are subject to stateand local New York tax rates, which are higher than the tax rates assessed byother jurisdictions where we operate.

**Business Segments**

***Revenue***

Case management operating revenue increased $10.8million, or approximately 16%, to $79.3 million for the year endedDecember 31, 2005 compared with $68.5 million for the year endedDecember 31, 2004. nMatrix, which was acquired on November 15, 2005,accounted for approximately $3.7 million of the increase in operating revenue.Operating revenue exclusive of nMatrix increased $7.1 million, or approximately10%. This increase is primarily attributable to an increase in class actionoperating revenues resulting from the timing of several large cases and the expansionof our corporate restructuring professional service offerings, partly offset bya decrease in our trustee professional services.

During February 2006, weentered into a new pricing arrangement with our primary Chapter 7 depositoryfinancial institution. This new pricing arrangement will be effective beginningOctober 2006. Chapter 7 depository fees are included entirely within ourcase management segment. Under this arrangement, the fees we earn for depositsplaced with this financial institution could have, within certain limits,variability based on fluctuations in short-term interest rates. Based on theterms of the pricing arrangement and the current interest rate environment, wedo not anticipate that this new pricing arrangement will have a material impacton our 2006 revenues or earnings.

Document managementoperating revenue decreased $8.8 million, or approximately 24%, to $27.9million for the year ended December 31, 2005 compared with $36.5 millionfor the prior year. This decrease is primarily attributable to a decline inadvertising services. Our advertising services are primarily connected withclass action and bankruptcy customers for whom we provide case administrationservices. Advertising services provided varies significantly depending on thecharacteristics of the case. Hilsoft, which we acquired in October 2005,provides advertising services independent of case management. As a result, webelieve that the level of advertising services will increase in future periodsfrom the level of advertising services provided during the year ended December 31,2005. Document management revenue for reimbursed expenses of $20.5 million forthe year ended December 31, 2005 increased approximately 15% compared withthe same period in the prior year. Revenue for reimbursed expenses have littleor no margin and, accordingly, this increase in revenue for reimbursed expensesdid not have a material effect on our income from operations. Documentmanagement revenues, including revenues related to advertising services, canfluctuate materially from period to period based on clients’ businessrequirements.

***Operating Expenses***

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. nMatrix,which was acquired on November 15, 2005, accounted for approximately $1.4million of the increase in direct costs, general and administrative expenses,and depreciation and software amortization. Exclusive of nMatrix, direct andadministrative expenses, including depreciation and software amortization,increased by $2.1 million, or approximately 7%. This increase is primarilyattributable to an increase in reimbursed expenses 

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and expenses related tothe expansion of our bankruptcy service offerings. Our case management coststructure is relatively stable and generally does not fluctuate materially withchanges in operating revenues.

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 advertising, related to the decline inadvertising service revenue discussed above, partly offset by an increase inreimbursed expenses, the inclusion of Hilsoft operating expenses, and anincrease in expenses paid to third parties for production services. Ourdocument management cost structure is more variable than case management andwill fluctuate based on document management business requirements delivered.

Both the case managementand document management segments have identifiable intangible assets. Amortizationof case management’s identifiable intangible assets decreased $0.2 million to$5.0 million for the year ended December 31, 2005 compared with $5.2million for the prior year. This decrease is primarily attributable to certainintangible assets acquired in the BSI acquisition that became fully amortizedduring 2005, largely offset by an increase in amortization related tointangible assets acquired in the nMatrix acquisition. Amortization of documentmanagement’s identifiable intangible assets decreased $0.8 million to $1.7million for the year ended December 31, 2005 compared with $2.5 millionfor the prior year. This decrease is primarily attributable to certainintangible assets acquired in the BSI acquisition that became fully amortizedduring 2005, partly offset by an increase in amortization related to intangibleassets acquired in the Hilsoft acquisition. Note 4 of the Notes to theConsolidated Financial Statements provides a summary of the total identifiedintangible assets, the scheduled amortization expense and the scheduledamortization periods for intangible assets acquired through the nMatrix,Hilsoft, Poorman-Douglas and BSI acquisitions.

**Resultsof Operations for the Year Ended December 31, 2004 Compared with the YearEnded December 31, 2003**

**Consolidated Results**

***Revenue***

Total revenue of $125.4million for the year ended December 31, 2004 represents an approximate 85%increase compared with $67.9 million of revenue for the same period in theprior year. With our acquisition of Poorman-Douglas in January 2004,revenue related to reimbursed expenses, such as postage pertaining to documentmanagement services, increased significantly. We reflect the revenue from thesereimbursed expenses as a separate line item on our Consolidated Statements ofIncome. While revenues from reimbursed expenses may fluctuate significantlyfrom period to period, these fluctuations have a minimal effect on ouroperating income as we realize little or no margin from this revenue. Revenueexclusive of revenue related to reimbursed expenses, which we refer to asoperating revenue, increased $42.7 million, or approximately 68%, to $105.1million for the year ended December 31, 2004 compared with $62.4 millionfor the same period in the prior year. All revenue is directly related to asegment and changes in revenue by segment are discussed below.

***Operating Expenses***

Direct costs, general and administrative expenses, anddepreciation and software amortization increased $54.9 million, orapproximately 145%, to $92.8 million for the year ended December 31, 2004compared with $37.9 million for the same period in the prior year. Thisincrease primarily results from the inclusion of Poorman-Douglas’ expenses subsequentto the acquisition date. As a result of the Poorman-Douglas acquisition, werealized a higher ratio of document management revenue relative to casemanagement revenue than during the same period in the prior year, whichresulted in an increase in 

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reimbursed expenses. Inaddition, corporate administrative costs not attributable to segment operationsincreased primarily due to significant increased expenses related to compliancewith regulations and standards imposed by Section 404 of the Sarbanes-OxleyAct of 2002, increased amortization expense primarily resulting from ouracquisition of additional operating software licenses, increased travel expenseprimarily related to additional locations, and increased insurance coverage dueto business expansion.

Amortization of identifiable intangible assetsincreased $4.2 million to $7.8 million for the year ended December 31,2004 compared with $3.6 million for the same period in the prior year. Allidentifiable intangible assets are directly related to a segment and changes inamortization of identifiable intangible assets by segment are discussed below.

Acquisition relatedexpenses of $2.2 million for the year ended December 31, 2004 and $1.8million for the year ended December 31, 2003 result from non-capitalizedexpenses for executive bonuses, legal, accounting and valuation services, andtravel incurred in connection with potential and completed transactions.

***Expenses Related to Financing***

Expenses related tofinancing totaled $7.2 million during the year ended December 31, 2004compared with $0.1 million of interest income during the same period in theprior year. This increase related to various financing components. During theyear ended December 31, 2004, we recognized a $1.0 million charge for thewrite-off of loan fees related to a credit facility we terminated. Variableinterest expense related to our credit facilities, fixed interest expenserelated to our convertible debt, and interest accreted on debt with no statedinterest rate totaled $3.8 million during the year ended December 31, 2004.Amortization of loan fees related to our credit facilities and related to ourconvertible debt offering totaled $2.1 million during the year ended December 31,2004. Our convertible debt facility includes a provision allowing theconvertible debt holders to extend the debt maturity from three years to sixyears. Under SFAS 133, *Accounting for DerivativeInstruments and Hedging Activities*, this provision is accounted foras an embedded option. At inception, the embedded option was valued at $1.2million and the convertible debt balance was reduced by the same amount. Theconvertible debt accretes approximately $0.1 million each quarter such that, atthe end of three years, the convertible debt balance will total $50.0 million. Theembedded option must be revalued at each period end based on the probabilityweighted discounted cash flows related to the additional 4% interest ratepayments which would be made if the convertible debt maturity is extended anadditional three years. While the changes in fair value of the embedded optionand carrying value of the convertible debt do not affect our current cash flow,the aggregate of these changes in value, totaling $0.3 million of expense forthe year ended December 31, 2004, is accounted for as a current income orexpense item and is included on our accompanying Consolidated Statements ofIncome as a component of interest expense. If the embedded option is eventuallyexercised, the value assigned to the embedded option will be amortized toincome as a reduction to our 4% convertible debt interest expense over theperiods payments are made. If the option is not exercised by some or allconvertible debt holders, any remaining related value assigned to the embeddedoption will be recognized as a gain during that period.

***Effective Tax Rate***

Our effective tax raterelated to income from continuing operations increased slightly from 41.2% forthe year ended December 31, 2003 to 41.3% for the year ended December 31,2004. Our tax rate is higher than the statutory federal rate of 35% primarilydue to state taxes. Our corporate restructuring subsidiary, BSI, operatesprimarily in New York City and is subject to state and local New York taxrates, which are higher than the tax rates assessed by other jurisdictionswhere we operate.

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***Discontinued Operations***

Our infrastructuresoftware results are included entirely within the discontinued operationssection of our income statement. Pre-tax income from discontinued operations of$1.1 million for the year ended December 31, 2004 resulted primarily fromour gain on sale of the business, partly offset by operating losses through thedate of sale, which was April 30, 2004. Pre-tax loss from discontinuedoperations of $9.6 million for the year ended December 31, 2003 wasprimarily the result of a $7.6 million impairment charge to reduce goodwill,other intangible assets, software and other long-lived assets to theirestimated fair value.

**Business Segments**

***Revenue***

Case management operating revenue increased $18.8million, or approximately 38%, to $68.5 million for the year ended December 31,2004 compared with $49.7 million for the year ended December 31, 2003. Thisincrease is a result of the inclusion of operating revenue related to thePoorman-Douglas acquisition subsequent to the acquisition date. Exclusive ofPoorman-Douglas operating revenue, operating revenue declined by $3.5 milliondue primarily to a decrease in non-recurring bankruptcy case managementprofessional service revenue, partly offset by an increase in bankruptcydeposit based revenue.

Document managementoperating revenue increased $23.8 million, or approximately 187%, to $36.5million for the year ended December 31, 2004 compared with $12.7 millionfor the year ended December 31, 2003. Document management revenue forreimbursed expenses of $17.9 million for the year ended December 31, 2004increased approximately 243% compared with the same period in the prior year.The increases in both operating revenue and reimbursed revenue for the documentmanagement segment were primarily the result of the acquisition ofPoorman-Douglas. Exclusive of Poorman-Douglas revenue, our document managementoperating revenue declined $3.4 million due primarily to a decrease inbankruptcy noticing services. Document management revenues can fluctuatematerially from period to period based on clients’ business requirements.

***Operating Expenses***

Case management direct costs, general andadministrative expenses, and depreciation and software amortization increased$16.0 million, or approximately 122%, to $29.1 million for the year ended December 31,2004 compared with $13.1 million for the same period in the prior year. Thisincrease primarily results from the inclusion of Poorman-Douglas’ expensessubsequent to the acquisition date. Exclusive of Poorman-Douglas expenses, casemanagement’s direct and administrative expenses, including depreciation andsoftware amortization, increased $0.9 million due primarily to increases inoperating software amortization and wage related expense. Our case managementcost structure is relatively stable and generally does not fluctuate materiallywith changes in operating revenues.

Document management direct costs, general andadministrative expenses, and depreciation and software amortization increased$30.9 million to $40.6 million for the year ended December 31, 2004compared with $9.7 million for the prior year. This increase primarily resultsfrom the inclusion of Poorman-Douglas’ expenses, including reimbursed expenses,subsequent to the acquisition date. Exclusive of Poorman-Douglas’ expenses, ourdocument management expenses declined $2.4 million due primarily to a declinein postage and print expense related to a decrease in noticing services. Ourdocument management cost structure is more variable than case management andwill fluctuate based on document management business requirements delivered.

Both the case managementand document management segments have identifiable intangible assets. Amortizationof case management’s identifiable intangible assets increased $3.1 million to$5.2 million for 

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the yearended December 31, 2004 compared with $2.1 million for the prior year. Amortizationof document management’s identifiable intangible assets increased $1.0 millionto $2.5 million for the year ended December 31, 2004 compared with $1.5million for the prior year. For both segments, this increase is due primarilyto the amortization expense related to the acquired intangible assets resultingfrom the Poorman-Douglas transaction and the February 2004 commencement ofamortization related to the BSI trade name.

**Liquidity and Capital Resources**

***Operating Activities***

During the year ended December 31, 2005, ouroperating activities provided net cash of $27.2 million. The primary sources ofcash from operating activities were net income of $10.9 million and adjustmentsfor non-cash charges and credits, primarily depreciation and amortization, of$17.0 million.

Changes in operatingassets and liabilities as a direct result of assets acquired or liabilitiesassumed have been excluded from our Consolidated Statements of Cash Flows. However,subsequent to acquisition, cash flows related to these acquired assets andassumed liabilities are reflected in our Consolidated Statements of Cash Flows.For example, accounts receivable and accounts payable acquired or assumed as apart of the transaction are not reflected, respectively, as a use or source ofcash. However, the subsequent collection or payment, respectively, of accountsreceivable and accounts payable acquired or assumed as a part of thetransaction are reflected as an operating source or use of cash, respectively.

***Investing Activities***

Our most significant useof cash for investing activities was to expand our business through acquisitions.Total cash used in 2005 to acquire businesses, net of $0.9 million cashacquired in the acquisitions, was approximately $110.5 million. During the yearended December 31, 2005, we used cash of approximately $4.6 million topurchase property and equipment. Enhancements to our existing software anddevelopment of new software is essential to our continued growth and, duringthe year ended December 31, 2005, we used cash of approximately $2.3million to fund internal costs related to development of software for whichtechnological feasibility has been established. We believe the nature ofnMatrix’s operations will cause our property, equipment and software spendingto increase during 2006 compared with 2005. We anticipate that cash generatedfrom operations will be adequate to fund our anticipated property, equipmentand software spending in 2006.

***Financing Activities***

In conjunction with our acquisition of nMatrix, duringNovember 2005 we amended our credit facility. Based on the terms of ouramended credit facility, we increased our senior term loan borrowings from$17.2 million to $25.0 million. The amended credit facility eliminated therequirement for quarterly amortizing payments on the senior term loan, butshortened the maturity of the senior term loan from June 2008 to August 2006.The amended credit facility also increased our senior revolving loan from $75.0million to $100.0 million. The maturity of the senior revolving loan wasextended from June 2008 to November 2008. During the term of theloan, we have the right, subject to compliance with our covenants, to increasethe senior revolving loan to $175.0 million.

During November 2005, under the amended creditfacility we borrowed an additional $7.8 million under the senior term loan and$93.0 million under the senior revolving loan to finance the cash portion ofour acquisition of nMatrix.

As of December 31, 2005, our borrowings consistedof $51.3 million from the contingent convertible subordinated notes (includingthe fair value of the embedded option), $25.0 million under the credit 

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facility’s senior termloan, $93.0 million under the credit facility’s senior revolving loan, andapproximately $4.2 million of obligations related to capitalized leases anddeferred acquisition price.

We believe that the funds generated from operationsplus amounts available under our credit facility’s senior revolving loan ($7.0million at December 31, 2005) will be sufficient over the next year tofinance currently anticipated working capital requirements, software expenditures,property and equipment expenditures, payments for contractual obligations, andinterest payments due on our outstanding borrowings. The $25.0 million termloan under our credit facility matures in August 2006. In addition tocurrent sources of liquidity discussed above, we may also consider an equityoffering of our common shares to generate additional cash for payment of thisterm loan at maturity.

Subject to compliance with certain covenants under theamended credit facility, we have the right to increase the senior revolvingloan to $175.0 million. We believe that funds generated from operationscombined with the flexibility to increase our borrowings under our creditfacility provide the liquidity to satisfy our foreseeable operational cash requirements.

We may pursue acquisitionsin the future. If the acquisition price exceeds our then available cash andunused borrowing capacity, we may decide to issue equity, restructure ourcredit facility, partly finance the acquisition with a note payable, or somecombination of the preceding. Covenants contained in our credit facility maylimit our ability to consummate an acquisition.

**Off-balance Sheet Arrangements**

Although we generally donot utilize off-balance sheet arrangements in our operations, we enter intooperating leases in the normal course of business. Our operating leaseobligations are disclosed below under “Contractual Obligations” and also inNote 6 of the Notes to Consolidated Financial Statements.

**Contractual Obligations**

Thefollowing table sets forth a summary of our contractual obligations andcommitments, excluding periodic interest payments, as of December 31,2005.

| ** **                              | ** ** | **Payments Due By Period (In Thousands)** | ** ** |
|-----------------------------------------|------------|---------------------------------------------------------------|------------|
| ** **                              | ** ** | **Total**                                                     | ** ** | **Less than  1 Year** | ** ** | **1 - 3 Years** | ** ** | **3 - 5 Years** | ** ** | **More Than  5 Years** | ** ** |
| **Contractual Obligation**         | ** ** | ** **                                                    | ** ** | ** ** | ** ** |
| Long-term debt  and future accretion(1) |       | $                                                             | 172,389    |   |   | $ | 27,654 |   |   | $ | 144,735 |   |   | $ | — |   |   |   | $ | — |   |   |
| Employment  agreements(2)               |       | 10,812                                                        |       |   | 4,943 |   |   | 4,345 |   |   | 1,524 |   |   |   | — |   |   |
| Capital lease  obligations              |       | 972                                                           |       |   | 950 |   |   | 22 |   |   | — |   |   |   | — |   |   |
| Operating leases                        |       | 19,201                                                        |       |   | 3,019 |   |   | 4,941 |   |   | 3,581 |   |   |   | 7,660 |   |   |
| Total                                   |       | $                                                             | 203,374    |   |   | $ | 36,566 |   |   | $ | 154,043 |   |   | $ | 5,105 |   |   |   | $ | 7,660 |   |   |
|                                         |            |                                                               |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

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(1)          A portion of the BSI andHilsoft purchase price were paid in the form of a non-interest bearing notes,which were discounted using an imputed rate of 5% and 8%, respectively, perannum. 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, asreflected on our December 31, 2005 Consolidated Balance Sheet, and allfuture accretion. If certain revenue objectives are satisfied, we will makeadditional payments, not to exceed $3.0 million, over the next five years tothe former owners of Hilsoft. Such payments, if any, are not included in theabove contractual obligation table. Convertible debt is included at statedvalue of the principal redemption and excludes adjustments related to theembedded option, which will not be paid in cash. Any conversion to our commonstock of part or all of the convertible debt will reduce our cash obligationrelated to the convertible debt.

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

**Recent Accounting Pronouncements**

In September 2005,the Emerging Issues Task Force (EITF) issued EITF 05-07, *Accounting for Modifications to Conversion Options Embedded in DebtInstruments and Related Issues.*EITF 05-07 requires that, whena modification of a convertible debt instrument results in a change in the fairvalue of an embedded conversion option, the change in fair value of theembedded conversion option be included in the analysis of whether there hasbeen a substantial change in the terms of the convertible debt instrument forpurposes of determining whether the debt has been extinguishment. EITF 05-07also requires subsequent recognition of interest expense for any change in thefair value of the embedded conversion option resulting from a modification of aconvertible debt instrument. EITF 05-07 is effective beginning in thefirst interim or annual reporting period beginning after December 15, 2005.We do not anticipate that the adoption of EITF 05-07 will have a materialimpact on our consolidated financial statements.

In May 2005,the Financial Accounting Standards Board (FASB) issued Statement of FinancialAccounting Standards (SFAS) No. 154, *Accounting Changes andError Corrections, a replacement of APB Opinion No. 20 and FASB Statement No. 3*.SFAS No. 154 requires retrospective application for reporting a change inaccounting principle unless such application is impracticable or unlesstransition requirements specific to a newly adopted accounting principlerequire otherwise. SFAS No. 154 also requires the reporting of acorrection of an error by restating previously issued financial statements. SFASNo. 154 is effective for accounting changes and corrections of errors madein fiscal years beginning after December 15, 2005.

In December 2004, the FASB issued SFAS No. 123(revised 2004) (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. SFAS No. 123R is effective forEPIQ beginning January 1, 2006. Accordingly, we will adopt SFAS No. 123R,likely using the modified version of prospective application, beginning withour quarter ending March 31, 2006. Under the modified version ofprospective application, compensation costs related to share-based compensationwill be recognized in our financial statements for all periods beginning after December 31,2005. For comparative periods ended on or before December 31, 2005, whichare presented in our 2006 and subsequent financial statements, share-basedcompensation costs will continue to be excluded from our consolidatedstatements of income, but we will disclose these share-based compensation costson a pro forma basis in a note to the consolidated financial statements. DuringFebruary 2005, our compensation committee approved acceleration of thevesting of certain unvested options for employees, including an executiveofficer, and non-employee directors. The decision to accelerate the vesting ofthese options and eliminate future compensation expense was based primarily ona review of our long-term incentive programs considering the effect on ourfinancial statements of changes in accounting rules that we must adopt in2006. This action, which had an immaterial effect on our financial statementsfor the year ended December 31, 2005, will reduce the impact of adoptionof SFAS No. 123R on our future consolidated financial statements. Adoptionof SFAS No. 123R will materially increase our recognized compensationexpense and will have a material impact on our consolidated income statementand balance sheet. We are working with independent valuation experts todocument and validate key valuation variables, such as forfeiture rate,expected term, segmentation of employee population, expected term suboptimalexercise price, and expected volatility. Until this work is completed, 

29

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we are unable to estimatethe impact of adoption of this statement on our consolidated financialstatements. However, if subsequent to December 31, 2005 no new awards wereissued and no existing awards were forfeited, we estimate that adoption of SFASNo. 123R would decrease our net income for the year ending December 31,2006 by approximately $1.4 million. We do not anticipate that adoption of SFAS No. 123Rwill have a material impact on our consolidated statement of cash flows.

In August 2005, the FASB issued FASB StaffPosition (FSP) No. FAS 123(R)-1, *Classification andMeasurement of Freestanding Financial Instruments Originally Issued in Exchangefor Employee Services under FASB Statement No. 123(R)*, to deferthe requirement of SFAS No. 123R that a freestanding financial instrumentoriginally subject to SFAS No. 123R becomes subject to the recognition andmeasurement requirements of other applicable generally accepted accountingprinciples when the rights conveyed by the instrument to the holder are nolonger dependent on the holder being an employee of the entity. The guidance inthis FSP is effective upon initial adoption of SFAS No. 123R. We do notanticipate that adoption of FSP No. FAS 123(R)-1 will have amaterial impact on our consolidated financial statements.

In October 2005, the FASB issued FSP No. FAS123(R)-2, *Practical Accommodation to the Applicationof Grant Date as Defined in FASB Statement No. 123(R).*This FSPstates that, in determining the grant date of an award subject to SFAS No. 123R,a mutual understanding of the key terms and conditions of an award to anindividual employee shall be presumed to exist at the date the award isapproved in accordance with the relevant corporate governance requirements ifboth of the following conditions are met: a) the award is a unilateral grant and, therefore, the recipient doesnot have the ability to negotiate the key terms and conditions of the awardwith the employer; and b) the key terms and conditions of the award areexpected to be communicated to an individual recipient within a relativelyshort time period from the date of approval. The guidance in this FSP iseffective upon initial adoption of SFAS No. 123R. We do not anticipatethat adoption of FSP No. FAS 123(R)-2 will have a material impact onour consolidated financial statements.

In November 2005, theFASB issued FSP No. FAS 123(R)-3, *TransitionElection Related to Accounting for the Tax Effects of Share-Based PaymentAwards.*This FSP provides a simplified method for calculating thepool of excess tax benefits available to absorb tax deficiencies recognizedsubsequent to the adoption of SFAS No. 123R. We have until December 31,2006, to determine whether to make a one-time election to adopt the transitionmethod described in this FSP. At this time, management is uncertain whether wewill make the election to adopt the transition method described in this FSP andwe are unable to estimate the impact, if any, on our consolidated financialstatements if we elect to use the transition method described in this FSP.

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

Market risk refers to the risk that a change in thelevel of one or more market prices, interest rates, indices, volatilities,correlations or other market factors, such as liquidity, will result in lossesfor a certain financial instrument or group of financial instruments. Ourconvertible debt and credit facility borrowings create market risks for us. Wedo not actively manage these market risks.

During 2004, we issued $50.0 million of convertiblenotes with a 4% fixed interest rate. While we do not have cash flow riskrelated to this instrument, the instrument does contain an embedded optionrelated to the right of security holders to extend the maturity of theconvertible notes which creates an earnings risk. A 10% increase in our stockvalue would result in a $0.2 million increase in the fair value of the embeddedoption and a corresponding decrease in pre-tax earnings. A 10% decrease in ourstock value would result in a $0.2 million decrease in the fair value of theembedded option and a corresponding increase in pre-tax earnings. The estimatedchanges in fair value were calculated using a pricing model that incorporatesassumptions regarding future volatility, interest rates and credit risk.

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At December 31, 2005,we have borrowings outstanding under a credit facility. Interest on borrowingsunder our credit facility is computed at a variable rate based on the LIBORrate and the prime rate and results in a market risk related to interest rates.A 1% increase or decrease in the LIBOR rate and the prime rate would increaseor decrease, respectively, our annual pre-tax interest expense on variable rateborrowings outstanding as of December 31, 2005 by approximately $1.2million.

**ITEM 8.**   FINANCIALSTATEMENTS AND SUPPLEMENTARY DATA

Our Consolidated FinancialStatements appear following Item 15 of this Report.

**SupplementaryData - Quarterly Financial Information**

Thefollowing table sets forth quarterly unaudited financial data for the quartersof the years ended December 31, 2005 and 2004 (in thousands, except pershare data):

| ** **                                     | ** ** | **Quarters** | ** ** |
|------------------------------------------------|------------|--------------|------------|
| ** **                                     | ** ** | **1**st      | ** ** | **2**nd | ** ** | **3**rd | ** ** | **4**th | ** ** |
| **Year ended December 31,  2005**         |       |         |       |   |   |   |   |   |   |
| Revenues from  continuing operations           |       | $            | 31,461     |   | $ | 31,635 |   | $ | 32,016 |   | $ | 35,684 |   |
| Net income                                     |       | 3,250        |       | 2,904 |   | 3,087 |   | 1,707 |   |
| Net income per  share—Diluted(1)          |       | $            | 0.17       |   | $ | 0.15 |   | $ | 0.16 |   | $ | 0.09 |   |
| **Year  ended December 31, 2004**         |       |         |       |   |   |   |   |   |   |
| Revenues from  continuing operations           |       | $            | 26,012     |   | $ | 34,908 |   | $ | 35,694 |   | $ | 28,806 |   |
| Income from  continuing operations             |       | 2,001        |       | 2,983 |   | 2,161 |   | 1,918 |   |
| Income (loss)  from discontinued operations(2) |       | (264         | )          | 1,008 |   | (77 | ) | — |   |
| Net income                                     |       | 1,737        |       | 3,991 |   | 2,084 |   | 1,918 |   |
| Net income per  share—Diluted(1)          |       | $            | 0.10       |   | $ | 0.22 |   | $ | 0.11 |   | $ | 0.10 |   |

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(1)          The sum of the quartersmay not equal the total of the respective year’s net income per share on adiluted basis due to changes in the weighted average shares outstandingthroughout the year.

(2)          Discontinued operationsrelates entirely to the sale of our infrastructure business. See Note 14 of theNotes to Consolidated Financial Statements.

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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 31,2005, the end of the period covered by this Annual Report on 10-K, ourprincipal executive officer and principal financial officer concluded that ourdisclosure 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’sReport on Internal Control Over Financial Reporting**

(a)   Our management is responsible for establishing and maintainingadequate internal control over financial reporting. Our internal control overfinancial reporting is designed to provide reasonable assurance regarding thereliability of financial reporting and the preparation of financial statementsfor external purposes in accordance with generally accepted accountingprinciples and includes those policies 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.

Our management assessed the effectiveness of ourinternal control over financial reporting as of December 31, 2005. Inmaking this assessment, our management used the criteria set forth by Committeeof Sponsoring Organizations of the Treadway Commission (COSO) in *Internal Control—Integrated Framework.*

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Based on ourassessment, management believes that, as of December 31, 2005, EPIQ’sinternal control over financial reporting is effective based on those criteria.

(b)   Ourmanagement’s assessment of the effectiveness of our internal control overfinancial reporting as of December 31, 2005 has been audited by Deloitte &Touche LLP, an independent registered public accounting firm, as stated intheir report which appears on page 34.

Management hasexcluded Hilsoft, Inc., nMatrix, Inc., nMatrix Australia Pty. Ltd.,and nMatrix Ltd. from our assessment of internal control over financialreporting as of December 31, 2005 because we completed the acquisition ofthese entities during 2005. Hilsoft, Inc., nMatrix, Inc., nMatrixAustralia Pty. Ltd., and nMatrix Ltd. are wholly-owned subsidiaries all ofwhich were acquired during the fourth quarter of the year ended December 31,2005 and whose financialstatements, exclusive of goodwill, certain identifiable intangible assets,consisting of customer relationships, covenants not to compete, and tradenames, and intercompany amounts (all of which are subject to corporate levelcontrols), constitute 10% and 6% of net and total assets, respectively, 3% ofrevenues and 8% of net income of the consolidated financial statement amountsas of and for the year ended December 31, 2005. Our conclusion inthis Annual Report on Form 10-K regarding the effectiveness of ourinternal control over financial reporting as of December 31, 2005 does notinclude the internal control over financial reporting of Hilsoft, Inc.,nMatrix, Inc., nMatrix Australia Pty. Ltd., and nMatrix Ltd.

(c)   There havebeen no changes in our internal controls over financial reporting during ourfourth quarter that have materially affected, or are reasonably likely tomaterially affect, our internal control over financial reporting.

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**REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTINGFIRM**

To the Board of Directorsand ShareholdersEPIQ Systems, Inc.Kansas City, Kansas

We have audited management’s assessment, included assection (a) in the accompanying Management’s Report on Internal ControlOver Financial Reporting appearing under Item 9A of this Annual Report on Form 10-K,that EPIQ Systems, Inc. and subsidiaries (the “Company”) maintainedeffective internal control over financial reporting as of December 31,2005, based on criteria established in*Internal Control—Integrated Framework*issued by the Committee of Sponsoring Organizations of the Treadway Commission(COSO). As described in Management’s Report on Internal Control OverFinancial Reporting, management excluded from their assessment the internalcontrol over financial reporting at Hilsoft, Inc., nMatrix, Inc.,nMatrix Australia Pty. Ltd., and nMatrix Ltd., all of which were acquiredduring the fourth quarter of the year ended December 31, 2005, and whosefinancial statements, exclusive of goodwill, certain identifiable assets,consisting of customer relationships, covenants not to compete, and tradenames, and intercompany amounts (all of which are subject to corporate levelcontrols), constitute 10% and 6% of net and total assets, respectively, 3% ofrevenues and 8% of net income of the consolidated financial statement amountsas of and for the year ended December 31, 2005. Accordingly, our audit didnot include the internal control over financial reporting at Hilsoft, Inc.,nMatrix, Inc., nMatrix Australia Pty. Ltd., and nMatrix Ltd. The Company’smanagement is responsible for maintaining effective internal control overfinancial reporting and for its assessment of the effectiveness of internalcontrol over financial reporting. Our responsibility is to express an opinionon management’s assessment and an opinion on the effectiveness of the Company’sinternal control over financial reporting based on our audit.

We conducted our audit in accordance with thestandards of the Public Company Accounting Oversight Board (United States).Those standards 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 

34

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effectiveness to futureperiods are subject to the risk that the controls may become inadequate becauseof changes in conditions, or that the degree of compliance with the policies orprocedures may deteriorate.

In our opinion, management’s assessment that theCompany maintained effective internal control over financial reporting as of December 31,2005, is fairly stated, in all material respects, based on criteria established in*Internal Control—Integrated Framework*issuedby the COSO. Also in our opinion, the Company maintained, in allmaterial respects, effective internal control over financial reporting as of December 31,2005, based on criteria established in*Internal Control—Integrated Framework*issuedby the COSO.

We have also audited, inaccordance with the standards of the Public Company Accounting Oversight Board(United States), the consolidated financial statements and consolidatedfinancial statement schedule as of and for the year ended December 31,2005 of the Company and our report dated March 7, 2006 expressed anunqualified opinion on those consolidated financial statements and theconsolidated financial statement schedule.

DELOITTE &TOUCHE LLPKansas City, MissouriMarch 7, 2006

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**ITEM 9B.**   OTHER INFORMATION

None.

**PART III**

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

Incorporated by referenceto our Proxy Statement for our 2006 Annual Meeting of Shareholders to be filedwith the Securities and Exchange Commission within 120 days after the close ofthe year ended December 31, 2005.

**ITEM 11.**   EXECUTIVECOMPENSATION

Incorporated by referenceto our Proxy Statement for our 2006 Annual Meeting of Shareholders to be filedwith the Securities and Exchange Commission within 120 days after the close ofthe year ended December 31, 2005.

**ITEM12.**   SECURITYOWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED SHAREHOLDERMATTERS

Incorporated by referenceto our Proxy Statement for our 2006 Annual Meeting of Shareholders to be filedwith the Securities and Exchange Commission within 120 days after the close ofthe year ended December 31, 2005.

**ITEM 13.**   CERTAINRELATIONSHIPS AND RELATED TRANSACTIONS

Incorporated by referenceto our Proxy Statement for our 2006 Annual Meeting of Shareholders to be filedwith the Securities and Exchange Commission within 120 days after the close ofthe year ended December 31, 2005.

**ITEM 14.**   PRINCIPALACCOUNTING FEES AND SERVICES

Incorporated by referenceto our Proxy Statement for our 2006 Annual Meeting of Shareholders to be filedwith the Securities and Exchange Commission within 120 days after the close ofthe year ended December 31, 2005.

**PART IV**

**ITEM 15.**   EXHIBITSAND FINANCIAL STATEMENT SCHEDULES

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

**(1)****          FinancialStatements.****  **Thefollowing consolidated financial statements, contained on pages F-1through F-29 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, 2005 and2004

Consolidated Statements of Income—Years Ended December 31,2005, 2004 and 2003

Consolidated Statements of Changes in Stockholders’Equity—Years Ended December 31, 2005, 2004 and 2003

Consolidated Statements of Cash Flows—Years Ended December 31,2005, 2004 and 2003

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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, 2005.

Schedule II—Valuation and qualifying accounts

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

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**SIGNATURES**

Inaccordance with Section 13 or 15(d) of the Exchange Act, theregistrant has duly caused this report to be signed on its behalf by theundersigned, thereunto duly authorized.

| Dated: March 8, 2006 |   | EPIQ SYSTEMS, INC. |
|---------------------------|--------|--------------------|
|                      |   | By:                | /s/ TOM W. OLOFSON |
|                      |   |               | Tom W. Olofson |
|                      |   |               | *Chairman of the Board, Chief Executive  Officer and Director* |

 

Inaccordance with the Exchange Act this report has been signed below by thefollowing persons on behalf of the registrant and in the capacities indicatedon the dates indicated.

|                                                   | **Signature** | ** **                                                                                  | ** ** |                     | **Name and Title** | ** ** | ** ** |  | **Date** | ** ** |
|---------------------------------------------------|---------------|---------------------------------------------------------------------------------------------|------------|---------------------|--------------------|------------|------------|--|----------|------------|
| /s/   TOM W. OLOFSON               |          | Tom W. Olofson                                                                              |       | March 8,  2006 |
|                                              |          | Chairman of the Board, Chief  Executive Officer and Director  (Principal Executive Officer) |       |                |
| /s/   CHRISTOPHER E. OLOFSON       |          | Christopher E.  Olofson                                                                     |       | March 8,  2006 |
|                                              |          | President, Chief  Operating Officer and Director                                            |       |                |
| /s/   ELIZABETH M. BRAHAM          |          | Elizabeth M.  Braham                                                                        |       | March 8,  2006 |
|                                              |          | Executive Vice  President,  Chief Financial Officer (Principal Financial Officer)           |       |                |
| /s/   DOUGLAS W. FLEMING           |          | Douglas W.  Fleming                                                                         |       | March 8,  2006 |
|                                              |          | Director of Finance,  Chief Accounting Officer (Principal Accounting Officer)               |       |                |
| /s/   W. BRYAN SATTERLEE           |          | W. Bryan  Satterlee                                                                         |       | March 8,  2006 |
|                                              |          | Director                                                                                    |       |                |
| /s/   EDWARD M. CONNOLLY, JR. |          | Edward M.  Connolly, Jr.                                                               |       | March 8,  2006 |
|                                              |          | Director                                                                                    |       |                |
| /s/   JAMES A. BYRNES              |          | James A. Byrnes                                                                             |       | March 8,  2006 |
|                                              |          | Director                                                                                    |       |                |
| /s/   JOEL PELOFSKY                |          | Joel Pelofsky                                                                               |       | March 8,  2006 |
|                                              |          | Director                                                                                    |       |                |

 

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**REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTINGFIRM**

To the Board of Directors and ShareholdersEPIQ Systems, Inc.**Kansas City, Kansas

We have audited the accompanying consolidated balancesheets of EPIQ Systems, Inc. andsubsidiaries (the “Company”) as of December 31, 2005 and 2004, and therelated consolidated statements of income, changes in stockholders’ equity, andcash flows for each of the three years in the period ended December 31,2005. Our audits also included the schedule of valuation and qualifyingaccounts listed in the Index at Item 15(a)(2). These consolidated 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 reasonable assuranceabout whether the financial statements are free of material misstatement. Anaudit includes examining, on a test basis, evidence supporting the amounts anddisclosures in the financial statements. An audit also includes assessing theaccounting principles used and significant estimates made by management, aswell as evaluating the overall financial statement presentation. We believethat 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 EPIQ Systems, Inc. andsubsidiaries as of December 31, 2005 and 2004, and the results of theiroperations and their cash flows for each of the three years in the period endedDecember 31, 2005, in conformity with accounting principles generallyaccepted in the United States of America. Also, in our opinion, such financialstatement schedule, when considered in relation to the basic consolidatedfinancial statements taken as a whole, present fairly in all material respectsthe information set forth therein.

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, 2005, based on the criteriaestablished in *Internal Control—IntegratedFramework* issued by the Committee of Sponsoring Organizations of theTreadway Commission and our report dated March 7, 2006 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.

*DELOITTE &TOUCHE LLP*

Kansas City, MissouriMarch 7, 2006

F-1

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**EPIQ SYSTEMS, INC.CONSOLIDATED BALANCE SHEETS(In Thousands, Except Share and Per Share Data)**

| ** **                                                                                                                                                           | ** ** | **As of December 31,** | ** ** |
|----------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|---------------------------------------|------------|
| ** **                                                                                                                                                           | ** ** | **2005**                              | ** ** | **2004** | ** ** |
| **ASSETS**                                                                                                                                                           |       |                                  |       |   |   |
| **CURRENT  ASSETS:**                                                                                                                                                 |       |                                  |       |   |   |
| Cash and cash equivalents                                                                                                                                            |       | $                                     | 13,563     |   | $ | 13,330 |   |
| Trade accounts receivable, less  allowance for doubtful accounts of $3,481 and  $1,069, respectively                                                            |       | 33,504                                |       | 18,690 |   |
| Prepaid expenses                                                                                                                                                     |       | 2,818                                 |       | 2,052 |   |
| Income taxes refundable                                                                                                                                              |       | 4,643                                 |       | 3,477 |   |
| Deferred income taxes                                                                                                                                                |       | 1,978                                 |       | 754 |   |
| Other current assets                                                                                                                                                 |       | 85                                    |       | 736 |   |
| Total Current Assets                                                                                                                                                 |       | 56,591                                |       | 39,039 |   |
| **LONG-TERM ASSETS:**                                                                                                                                                |       |                                  |       |   |   |
| Property, equipment and  leasehold improvements, net                                                                                                                 |       | 23,751                                |       | 20,431 |   |
| Software development costs, net                                                                                                                                      |       | 8,848                                 |       | 5,838 |   |
| Goodwill                                                                                                                                                             |       | 249,427                               |       | 147,728 |   |
| Other intangibles, net of  accumulated amortization of $13,758 and $11,707,  respectively                                                                       |       | 53,399                                |       | 24,057 |   |
| Other                                                                                                                                                                |       | 2,854                                 |       | 2,995 |   |
| Total Long-term Assets, net                                                                                                                                          |       | 338,279                               |       | 201,049 |   |
| **Total Assets**                                                                                                                                                     |       | $                                     | 394,870    |   | $ | 240,088 |   |
| **LIABILITIES AND STOCKHOLDERS’  EQUITY**                                                                                                                       |       |                                  |       |   |   |
| **CURRENT  LIABILITIES:**                                                                                                                                            |       |                                  |       |   |   |
| Accounts payable                                                                                                                                                     |       | $                                     | 7,954      |   | $ | 4,263 |   |
| Customer deposits                                                                                                                                                    |       | 2,196                                 |       | 2,375 |   |
| Accrued compensation                                                                                                                                                 |       | 3,944                                 |       | 873 |   |
| Other accrued expenses                                                                                                                                               |       | 3,872                                 |       | 899 |   |
| Current maturities of long-term  obligations                                                                                                                         |       | 27,642                                |       | 7,650 |   |
| Total Current Liabilities                                                                                                                                            |       | 45,608                                |       | 16,060 |   |
| **LONG-TERM LIABILITIES:**                                                                                                                                           |       |                                  |       |   |   |
| Deferred income taxes                                                                                                                                                |       | 26,815                                |       | 9,696 |   |
| Long-term obligations  (excluding current maturities)                                                                                                                |       | 145,906                               |       | 74,499 |   |
| Total Long-term Liabilities                                                                                                                                          |       | 172,721                               |       | 84,195 |   |
| **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—19,253,466 and 17,883,917 shares at 2005  and 2004, respectively |       | 193                                   |       | 179 |   |
| Additional paid-in capital                                                                                                                                           |       | 128,484                               |       | 102,738 |   |
| Retained earnings                                                                                                                                                    |       | 47,864                                |       | 36,916 |   |
| Total Stockholders’ Equity                                                                                                                                      |       | 176,541                               |       | 139,833 |   |
| **Total  Liabilities and Stockholders’ Equity**                                                                                                                 |       | $                                     | 394,870    |   | $ | 240,088 |   |

 

See accompanying notes to consolidated financial statements.

F-2

----

**EPIQ SYSTEMS, INC.CONSOLIDATED STATEMENTS OF INCOME(In Thousands, Except Per Share Data)**

| ** **                                                                                                                                                             | ** ** | **Years Ended December 31,** | ** ** |
|------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|---------------------------------------------|------------|
| ** **                                                                                                                                                             | ** ** | **2005**                                    | ** ** | **2004** | ** ** | **2003** | ** ** |
| **REVENUE:**                                                                                                                                                           |       |                                        |       |   |   |   |   |
| Case management                                                                                                                                                        |       | $                                           | 79,279     |   | $ | 68,526 |   | $ | 49,688 |   |
| Document management                                                                                                                                                    |       | 27,874                                      |       | 36,549 |   | 12,730 |   |
| Operating revenue                                                                                                                                                      |       | 107,153                                     |       | 105,075 |   | 62,418 |   |
| Reimbursed expenses                                                                                                                                                    |       | 23,643                                      |       | 20,345 |   | 5,518 |   |
| Total Revenue                                                                                                                                                          |       | 130,796                                     |       | 125,420 |   | 67,936 |   |
| **OPERATING EXPENSES:**                                                                                                                                                |       |                                        |       |   |   |   |   |
| Direct costs                                                                                                                                                           |       | 57,790                                      |       | 60,384 |   | 16,490 |   |
| General and administrative                                                                                                                                             |       | 31,072                                      |       | 25,886 |   | 16,868 |   |
| Depreciation and software  amortization                                                                                                                                |       | 7,288                                       |       | 6,527 |   | 4,568 |   |
| Amortization of intangibles                                                                                                                                            |       | 6,751                                       |       | 7,767 |   | 3,610 |   |
| Acquisition related                                                                                                                                                    |       | 2,984                                       |       | 2,197 |   | 1,793 |   |
| Total Operating Expenses                                                                                                                                               |       | 105,885                                     |       | 102,761 |   | 43,329 |   |
| **INCOME FROM OPERATIONS**                                                                                                                                             |       | 24,911                                      |       | 22,659 |   | 24,607 |   |
| **EXPENSES (INCOME) RELATED TO FINANCING:**                                                                                                                            |       |                                        |       |   |   |   |   |
| Interest expense                                                                                                                                                       |       | 6,809                                       |       | 6,343 |   | 201 |   |
| Interest income                                                                                                                                                        |       | (122                                        | )          | (128 | ) | (284 | ) |
| Debt extinguishment                                                                                                                                                    |       | —                                      |       | 995 |   | — |   |
| Net Expenses (Income) Related  to Financing                                                                                                                            |       | 6,687                                       |       | 7,210 |   | (83 | ) |
| **INCOME FROM CONTINUING  OPERATIONS BEFORE INCOME TAXES**                                                                                                             |       | 18,224                                      |       | 15,449 |   | 24,690 |   |
| **PROVISION FOR INCOME TAXES**                                                                                                                                         |       | 7,276                                       |       | 6,386 |   | 10,165 |   |
| **INCOME FROM CONTINUING  OPERATIONS**                                                                                                                                 |       | 10,948                                      |       | 9,063 |   | 14,525 |   |
| **DISCONTINUED  OPERATIONS:**                                                                                                                                          |       |                                        |       |   |   |   |   |
| Income (loss) from operations  of discontinued infrastructure segment (including gain on  disposal of  $1,616 during the year  ended December 31, 2004) |       | —                                      |       | 1,104 |   | (9,562 | ) |
| Income tax (expense) benefit  from operations of discontinued infrastructure segment                                                                              |       | —                                      |       | (437 | ) | 3,744 |   |
| **TOTAL DISCONTINUED  OPERATIONS**                                                                                                                                     |       | —                                      |       | 667 |   | (5,818 | ) |
| **NET INCOME**                                                                                                                                                         |       | $                                           | 10,948     |   | $ | 9,730 |   | $ | 8,707 |   |
| **NET INCOME PER SHARE INFORMATION:**                                                                                                                                  |       |                                        |       |   |   |   |   |
| Income per share—Basic                                                                                                                                            |       |                                        |       |   |   |   |   |
| Income from continuing  operations                                                                                                                                     |       | $                                           | 0.61       |   | $ | 0.51 |   | $ | 0.82 |   |
| Income (loss) from discontinued  operations                                                                                                                            |       | —                                      |       | 0.04 |   | (0.33 | ) |
| Net income per share—Basic                                                                                                                                        |       | $                                           | 0.61       |   | $ | 0.55 |   | $ | 0.49 |   |
| Income per share—Diluted                                                                                                                                          |       |                                        |       |   |   |   |   |
| Income from continuing  operations                                                                                                                                     |       | $                                           | 0.56       |   | $ | 0.49 |   | $ | 0.80 |   |
| Income (loss) from discontinued  operations                                                                                                                            |       | —                                      |       | 0.03 |   | (0.32 | ) |
| Net income per share—Diluted                                                                                                                                      |       | $                                           | 0.56       |   | $ | 0.52 |   | $ | 0.48 |   |
| **WEIGHTED AVERAGE COMMON SHARESOUTSTANDING:**                                                                                                                         |       |                                        |       |   |   |   |   |
| Basic                                                                                                                                                                  |       | 18,092                                      |       | 17,848 |   | 17,619 |   |
| Diluted                                                                                                                                                                |       | 21,551                                      |       | 19,828 |   | 18,104 |   |

 

See accompanying notes to consolidated financial statements.

F-3

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**EPIQ SYSTEMS, INC.CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS’ EQUITY(In Thousands)**

| ** **                                                         | ** ** | **As of December 31,** | ** ** |
|--------------------------------------------------------------------|------------|---------------------------------------|------------|
| ** **                                                         | ** ** | **2005**                              | ** ** | **2004** | ** ** | **2003** | ** ** |
| PREFERRED SHARES (2,000 authorized)                                |       | —                                |       | — |   | — |   |
| COMMON SHARES (50,000 authorized):                                 |       |                                  |       |   |   |   |   |
| Shares, beginning of year                                          |       | 17,884                                |       | 17,781 |   | 16,538 |   |
| Shares issued upon exercise of  options                            |       | 140                                   |       | 103 |   | 189 |   |
| Shares issued in acquisition  of business                          |       | 1,229                                 |       | — |   | 1,054 |   |
| Shares, end of year                                                |       | 19,253                                |       | 17,884 |   | 17,781 |   |
| COMMON STOCK—PAR VALUE $0.01 PER SHARE:                       |       |                                  |       |   |   |   |   |
| Balance, beginning of year                                         |       | $                                     | 179        |   | $ | 178 |   | $ | 165 |   |
| Proceeds from exercise of  options                                 |       | 2                                     |       | 1 |   | 2 |   |
| Shares issued in acquisition  of business                          |       | 12                                    |       | — |   | 11 |   |
| Balance, end of year                                               |       | 193                                   |       | 179 |   | 178 |   |
| ADDITIONAL PAID-IN CAPITAL:                                        |       |                                  |       |   |   |   |   |
| Balance, beginning of year                                         |       | 102,738                               |       | 101,891 |   | 83,731 |   |
| Proceeds from exercise of  options                                 |       | 1,029                                 |       | 595 |   | 1,039 |   |
| Tax benefit from exercise of  options                              |       | 496                                   |       | 252 |   | 746 |   |
| Net proceeds from (expenses  for)  private placement of stock |       | —                                |       | — |   | (114 | ) |
| Shares issued in acquisition  of business                          |       | 24,221                                |       | — |   | 16,489 |   |
| Balance, end of year                                               |       | 128,484                               |       | 102,738 |   | 101,891 |   |
| RETAINED EARNINGS:                                                 |       |                                  |       |   |   |   |   |
| Balance, beginning of year                                         |       | 36,916                                |       | 27,186 |   | 18,479 |   |
| Net income                                                         |       | 10,948                                |       | 9,730 |   | 8,707 |   |
| Balance, end of year                                               |       | 47,864                                |       | 36,916 |   | 27,186 |   |
| TOTAL STOCKHOLDERS’ EQUITY                                    |       | $                                     | 176,541    |   | $ | 139,833 |   | $ | 129,255 |   |

**Seeaccompanying notes to consolidated financial statements.**

F-4

----

**EPIQ SYSTEMS, INC.CONSOLIDATED STATEMENTS OF CASH FLOWS(In Thousands)**

| ** **                                                                                      | ** ** | **Years Ended December 31,** | ** ** |
|-------------------------------------------------------------------------------------------------|------------|-----------------------------------|------------|
| ** **                                                                                      | ** ** | **2005**                          | ** ** | **2004** | ** ** | **2003** | ** ** |
| **CASH FLOWS FROM OPERATING  ACTIVITIES:**                                                      |       |                              |       |   |   |   |   |
| Net  income                                                                                     |       | $                                 | 10,948     |   | $ | 9,730 |   | $ | 8,707 |   |
| Adjustments to reconcile net  income to net cash from operating activities:                     |       |                              |       |   |   |   |   |
| Provision  (benefit) for deferred income taxes                                                  |       | (188                              | )          | 8,208 |   | (1,855 | ) |
| Depreciation  and software amortization                                                         |       | 7,288                             |       | 6,527 |   | 5,796 |   |
| Loan  fee amortization and debt extinguishment                                                  |       | 1,147                             |       | 3,115 |   | — |   |
| Change  in valuation of embedded option and  convertible debt                              |       | 1,034                             |       | 292 |   | — |   |
| Amortization  of intangible assets                                                              |       | 6,751                             |       | 7,767 |   | 3,745 |   |
| Asset  impairment charges                                                                       |       | —                            |       | — |   | 7,615 |   |
| Gain  on sale of discontinued operation                                                         |       | —                            |       | (1,616 | ) | — |   |
| Other,  net                                                                                     |       | 1,015                             |       | 370 |   | 234 |   |
| Changes in operating assets  and liabilities, net of effects  from  business acquisitions: |       |                              |       |   |   |   |   |
| Trade  accounts receivable                                                                      |       | (3,141                            | )          | 7,951 |   | (5,948 | ) |
| Prepaid  expenses and other assets                                                              |       | (330                              | )          | 1,187 |   | (981 | ) |
| Accounts  payable and other liabilities                                                         |       | 3,402                             |       | (10,762 | ) | 2,607 |   |
| Income  taxes, including tax benefit from exercise  of stock options                       |       | (688                              | )          | (1,180 | ) | 731 |   |
| Net  cash provided by operating activities                                                      |       | 27,238                            |       | 31,589 |   | 20,651 |   |
| **CASH FLOWS FROM INVESTING  ACTIVITIES:**                                                      |       |                              |       |   |   |   |   |
| Purchase  of property and equipment                                                             |       | (4,555                            | )          | (5,424 | ) | (3,772 | ) |
| Software  development costs                                                                     |       | (2,269                            | )          | (1,670 | ) | (2,753 | ) |
| Cash  paid for acquisition of businesses, net of cash acquired                                  |       | (110,533                          | )          | (113,111 | ) | (43,263 | ) |
| 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                                                                |       | 38                                |       | 65 |   | (209 | ) |
| Net  cash used in investing activities                                                          |       | (116,830                          | )          | (119,029 | ) | (49,997 | ) |
| **CASH FLOWS FROM FINANCING  ACTIVITIES:**                                                      |       |                              |       |   |   |   |   |
| Proceeds  from long-term debt borrowings                                                        |       | 106,841                           |       | 193,500 |   | — |   |
| Debt  issuance costs                                                                            |       | (938                              | )          | (5,931 | ) | — |   |
| Payments  under long-term debt and capital  lease  obligations                             |       | (17,109                           | )          | (118,455 | ) | (347 | ) |
| Expenses  for stock issuance                                                                    |       | —                            |       | — |   | (114 | ) |
| Proceeds  from exercise of stock options                                                        |       | 1,031                             |       | 595 |   | 1,041 |   |
| Net  cash provided by financing activities                                                      |       | 89,825                            |       | 69,709 |   | 580 |   |
| **NET  INCREASE (DECREASE) IN CASH AND  CASH  EQUIVALENTS**                                |       | 233                               |       | (17,731 | ) | (28,766 | ) |
| **CASH AND  CASH EQUIVALENTS, BEGINNING OF YEAR**                                               |       | 13,330                            |       | 30,347 |   | 59,827 |   |
| (Increase)  decrease in cash classified as held for sale                                        |       | —                            |       | 714 |   | (714 | ) |
| **CASH AND CASH EQUIVALENTS,  END OF YEAR**                                                     |       | $                                 | 13,563     |   | $ | 13,330 |   | $ | 30,347 |   |

 

See accompanying notesto consolidated financial statements.

F-5

----

**EPIQ SYSTEMS, INC.NOTES TO CONSOLIDATED FINANCIAL STATEMENTSDECEMBER 31, 2005, 2004 AND 2003**

**NOTE 1:**             NATUREOF OPERATIONS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

***Principles of Consolidation***

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 of Operations***

EPIQ is a nationalprovider of technology-based solutions for the legal and fiduciary servicesindustries. Our products and services assist clients with the administration ofcomplex legal proceedings, including electronic litigation discovery,bankruptcy administration and class action administration. Our clients includeleading law firms, corporate legal departments, bankruptcy trustees, and otherprofessional advisors who require sophisticated case administration anddocument management capabilities, extensive subject matter expertise and a highservice capacity. We provide clients with an integrated offering of bothproprietary technology and value-added services that comprehensively addresstheir extensive business requirements.

***Cash and Cash Equivalents***

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

***Software Development 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 and Identifiable Intangible Assets***

Goodwill is not amortized but is assigned to areporting unit and tested for impairment at least annually and between annualtests if events or changes in circumstances have indicated that the assetsmight be impaired. Our annual impairment test, performed in July 2005 andusing a discounted cash flow analysis to determine the fair value of eachreporting unit, 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 intangibles assets are reviewed forimpairment whenever events or changes in circumstances have indicated that thecarrying amount of these assets might not be recoverable.

F-6

----

**NOTE 1:**             NATURE OF OPERATIONSAND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)

***Impairment of Long-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 Income. Unamortizedcosts related to debt extinguished prior to maturity due to refinancing wereexpensed and comprise debt extinguishment on our Consolidated Statements ofIncome.

***Stock-Based Compensation***

Stockcompensation awards are accounted for under the intrinsic method of AccountingPrinciples Board Opinion No. 25, *Accounting for StockIssued to Employees*. Opinion No. 25 requires compensation costto be recognized based on the excess, if any, between the quoted market priceat the date of grant and the amount an employee must pay to acquire stock. Stockoptions awarded by us are granted with an exercise price equal to the fairmarket value on the date of the grant. As required by Statement of FinancialAccounting Standard (“SFAS”) No. 148, *Accountingfor Stock-Based Compensation—Transition and Disclosure, an amendment of FASBStatement No. 123*,following is a reconciliation of reported net income and net income per shareto pro forma net income and pro forma net income per share had thecompensation cost been determined based on the fair value at the grant datesusing SFAS No. 123, *Accounting for Stock-BasedCompensation*, for the years ended December 31, 2005, 2004 and2003 (in thousands, except per share data):

| ** **                                                                                                                     | ** **  | **Years Ended December 31,** | ** ** |
|--------------------------------------------------------------------------------------------------------------------------------|-------------|---------------------------------------------|------------|
| ** **                                                                                                                     | ** **  | **2005**                                    | ** ** | **2004** | ** ** | **2003** | ** ** |
| Net income, as  reported                                                                                                       |        | $                                           | 10,948     |   | $ | 9,730 |   | $ | 8,707 |   |
| 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 | ) | (2,195 | ) |
| Net income, pro  forma                                                                                                         |        | $                                           | 4,343      |   | $ | 6,755 |   | $ | 6,512 |   |
| Net income per share—Basic                                                                                                | As reported |                                        | $          | 0.61 |   | $ | 0.55 |   | $ | 0.49 |   |
|                                                                                                                           | Pro forma   |                                        | $          | 0.24 |   | $ | 0.38 |   | $ | 0.37 |   |
| Net income per share—Diluted                                                                                              | As reported |                                        | $          | 0.56 |   | $ | 0.52 |   | $ | 0.48 |   |
|                                                                                                                           | Pro forma   |                                        | $          | 0.23 |   | $ | 0.34 |   | $ | 0.36 |   |

 

Pro forma amounts presented above are based on actualearnings and consider only the effects of estimated fair values of stockoptions. For the year ended December 31, 2005, we did not assumeconversion of the convertible notes as the effect was antidilutive. Theconvertible notes, if converted, would result in issuance of 2,857,000 sharesof our common stock.

F-7

----

**NOTE 1:**             NATURE OF OPERATIONSAND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)

The fair value of stockoptions is estimated using the Black-Scholes option-pricing model with thefollowing key assumptions:

| ** **              | ** ** | **2005**     | ** ** | **2004**     | ** ** | **2003**     |
|-------------------------|------------|--------------|------------|--------------|------------|--------------|
| Expected life (years)   |       | 5.0  - 5.3   |       | 5.3  - 5.4   |       | 5.5  - 6.2   |
| Expected volatility     |       | 40%          |       | 30%  - 48%   |       | 50%  - 55%   |
| Risk-free interest rate |       | 4.0%  - 4.3% |       | 2.9%  - 3.9% |       | 2.2%  - 3.1% |
| Dividend yield          |       | 0%           |       | 0%           |       | 0%           |

 

***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 with customers obligating us todeliver various products and services each month. Case management fees earnedare contingent upon the month-to-month delivery of the products and servicesdefined by the contracts and are related primarily to the size and complexityof the ongoing engagement. The formula-based fees earned each month becomefixed and determinable and are recognized as revenue on a monthly basis as aresult of our completion of all contractually required performance obligationsrelated to products delivered and services rendered by us during the month. Ourcase management business also provides hosting access; revenue related tohosting access is recognized over the period that service is provided. Documentmanagement revenues become fixed and determinable and are recognized in theperiod the services are provided. For both case management and documentmanagement, payments received in advance of satisfaction of the related revenuerecognition criteria are recognized as a deferred revenue liability until allrevenue recognition criteria have been satisfied. Revenue or deferred revenueis recognized only if collectibility is reasonably assured.

We receive expensereimbursements, primarily for postage, from customers. Based on guidanceprovided by the Financial Accounting Standard’s Board’s (the “FASB”) EmergingIssues Task Force (the “EITF”), reimbursements received are reported as revenueon an accrual basis. The expense related to the reimbursement is recorded as acomponent of direct costs on our accompanying Consolidated Statements ofIncome.

***Derivative Financial Instrument***

The holders of ourcontingently convertible subordinated notes have the right to extend thematurity of these notes for a period not to exceed three years. Under SFAS No. 133,*Accounting for Derivative Instruments and HedgingActivities*, the right to extend the maturity of the notes representsan embedded option and is accounted for as a derivative financial instrument. Thefair value of our obligation related to the embedded option has been includedas a component of our long-term obligations on our accompanying ConsolidatedBalance Sheets. Changes in the fair value of the embedded option are recordedeach period as a component of interest expense on our accompanying ConsolidatedStatements of Income. Changes in the fair value of the embedded option do notaffect our cash flows and, accordingly, 

F-8

----

**NOTE 1:**             NATURE OF OPERATIONSAND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)

arereflected as an adjustment to reconcile net income to net cash from operatingactivities on our accompanying Consolidated Statements of Cash Flows.

***Comprehensive Income***

We do not have anycomponents of other comprehensive income; therefore comprehensive income equalsnet income for each of the three years ended December 31, 2005, 2004 and2003.

***Income Per Share***

Basic net income per shareis computed by dividing net income available to common shareholders by theweighted average number of common shares outstanding for the period. Dilutednet income per share is computed by dividing net income available to commonshareholders, increased by the amount of interest expense, net of tax, relatedto outstanding convertible debt by the weighted average number of outstandingcommon shares and shares that may be issued in future periods relating tooutstanding stock options and convertible debt, if dilutive.

***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 September 2005,the EITF issued EITF 05-07, *Accounting forModifications to Conversion Options Embedded in Debt Instruments and Related Issues.*EITF 05-07 requires that, when a modification of a convertibledebt instrument results in a change in the fair value of an embedded conversionoption, the change in fair value of the embedded conversion option be includedin the analysis of whether there has been a substantial change in the terms ofthe convertible debt instrument for purposes of determining whether the debthas been extinguished. EITF 05-07 also requires subsequent recognition ofinterest expense for any change in the fair value of the embedded conversionoption resulting from a modification of a convertible debt instrument. EITF 05-07is effective beginning in the first interim or annual reporting periodbeginning after December 15, 2005. We do not anticipate that the adoptionof EITF 05-07 will have a material impact on our consolidated financialstatements.

In May 2005,the FASB issued SFAS No. 154, *Accounting Changes andError Corrections, a replacement of APB Opinion No. 20 and FASB Statement No. 3*.SFAS No. 154 requires retrospective application for reporting a change inaccounting principle unless such application is impracticable or unlesstransition requirements specific to a newly adopted accounting principlerequire otherwise. SFAS No. 154 also requires the reporting of a correctionof an error by restating previously issued financial statements. 

F-9

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**NOTE 1:**             NATURE OF OPERATIONSAND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)

SFAS No. 154 is effective for accounting changes andcorrections of errors made in fiscal years beginning after December 15,2005.

In December 2004, the FASB issued SFAS No. 123(revised 2004) (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. SFAS No. 123R is effective forEPIQ beginning January 1, 2006. Accordingly, we will adopt SFAS No. 123R,likely using the modified version of prospective application, beginning withour quarter ending March 31, 2006. Under the modified version ofprospective application, compensation costs related to share-based compensationwill be recognized in our financial statements for all periods beginning after December 31,2005. For comparative periods ended on or before December 31, 2005, whichare presented in our 2006 and subsequent financial statements, share-basedcompensation costs will continue to be excluded from our consolidatedstatements of income, but we will disclose these share-based compensation costson a pro forma basis in a note to the consolidated financial statements. DuringFebruary 2005, our compensation committee approved acceleration of thevesting of certain unvested options for employees, including an executiveofficer, and non-employee directors. The decision to accelerate the vesting ofthese options and eliminate future compensation expense was based primarily ona review of our long-term incentive programs considering the effect on ourfinancial statements of changes in accounting rules that we must adopt in2006. This action, which had an immaterial effect on our financial statementsfor the year ended December 31, 2005, will reduce the impact of adoptionof SFAS No. 123R on our future consolidated financial statements. Adoptionof SFAS No. 123R will materially increase our recognized compensationexpense and will have a material impact on our consolidated income statementand balance sheet. We are working with independent valuation experts todocument and validate key valuation variables, such as forfeiture rate,expected term, segmentation of employee population, expected term suboptimalexercise price, and expected volatility. Until this work is completed, we areunable to estimate the impact of adoption of this statement on our consolidatedfinancial statements. However, if subsequent to December 31, 2005 no newawards were issued and no existing awards were forfeited, we estimate thatadoption of SFAS No. 123R would decrease our net income for the yearending December 31, 2006 by approximately $1.4 million. We do notanticipate that adoption of SFAS No. 123R will have a material impact onour consolidated statement of cash flows.

In August 2005, the FASB issued FASB StaffPosition (FSP) No. FAS 123(R)-1, *Classification andMeasurement of Freestanding Financial Instruments Originally Issued in Exchangefor Employee Services under FASB Statement No. 123(R)*, to deferthe requirement of SFAS No. 123R that a freestanding financial instrumentoriginally subject to SFAS No. 123R becomes subject to the recognition andmeasurement requirements of other applicable generally accepted accountingprinciples when the rights conveyed by the instrument to the holder are nolonger dependent on the holder being an employee of the entity. The guidance inthis FSP is effective upon initial adoption of SFAS No. 123R. We do notanticipate that adoption of FSP No. FAS 123(R)-1 will have amaterial impact on our consolidated financial statements.

In October 2005, the FASB issued FSP No. FAS123(R)-2, *Practical Accommodation to the Applicationof Grant Date as Defined in FASB Statement No. 123(R).*This FSPstates that, in determining the grant date of an award subject to SFAS No. 123R,a mutual understanding of the key terms and conditions of an award to anindividual employee shall be presumed to exist at the date the award isapproved in 

F-10

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**NOTE 1:**             NATURE OF OPERATIONSAND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)

accordance with therelevant corporate governance requirements if both of the following conditionsare met:  a) the award is a unilateralgrant and, therefore, the recipient does not have the ability to negotiate thekey terms and conditions of the award with the employer; and b) the key termsand conditions of the award are expected to be communicated to an individualrecipient within a relatively short time period from the date of approval. Theguidance in this FSP is effective upon initial adoption of SFAS No. 123R. Wedo not anticipate that adoption of FSP No. FAS 123(R)-2 will have amaterial impact on our consolidated financial statements.

In November 2005, theFASB issued FSP No. FAS 123(R)-3, *TransitionElection Related to Accounting for the Tax Effects of Share-Based Payment Awards.*This FSP provides a simplified method for calculating the pool ofexcess tax benefits available to absorb tax deficiencies recognized subsequentto the adoption of SFAS No. 123R. We have until December 31, 2006, todetermine whether to make a one-time election to adopt the transition methoddescribed in this FSP. At this time, management is uncertain whether we willmake the election to adopt the transition method described in this FSP and weare unable to estimate the impact, if any, on our consolidated financialstatements if we elect to use the transition method described in this FSP.

**NOTE 2:**             PROPERTYAND EQUIPMENT

Property,equipment and leasehold improvements are stated at cost and depreciated oramortized on a straight-line basis over the estimated useful life of eachasset. The classification of property, equipment and leasehold improvements andtheir estimated useful lives is as follows (in thousands):

| ** **                                           | ** ** | **December 31,** | ** ** | **Estimated** | ** ** |
|------------------------------------------------------|------------|-----------------------|------------|---------------|------------|
| ** **                                           | ** ** | **2005**              | ** ** | **2004**      | ** ** | **Useful Life** | ** ** |
| Land                                                 |       | $                     | 192        |          | $          | 192 |   |   |   |
| Building and building  and leasehold improvements    |       | 8,947                 |       | 8,912         |       | 5 - 30 years |   |
| Furniture and  fixtures                              |       | 2,061                 |       | 2,035         |       | 5 - 10 years |   |
| Computer and  office equipment                       |       | 23,044                |       | 17,379        |       | 2 - 5 years |   |
| Mailroom  equipment                                  |       | 858                   |       | 832           |       | 3 - 5 years |   |
| Transportation  equipment                            |       | 6,396                 |       | 4,855         |       | 3 - 5 years |   |
|                                                 |       | 41,498                |       | 34,205        |       |   |   |
| Less accumulated depreciationand amortization        |       | (17,747               | )          | (13,774       | )          |   |   |
| Property, equipment and  leasehold improvements, net |       | $                     | 23,751     |          | $          | 20,431 |   |   |   |

 

Computer and officeequipment includes property acquired under capital leases. As ofDecember 31, 2005 and 2004, assets acquired under capital lease had ahistorical cost basis of $2.9 million and $2.7 million, respectively, andaccumulated amortization of $1.4 million and $0.5 million, respectively. Amortizationexpense related to these assets has been included as a component of“Depreciation and software amortization” in the accompanying ConsolidatedStatements of Income.

F-11

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**NOTE 3:**             SOFTWAREDEVELOPMENT COSTS

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

| ** **                              | ** ** | **Year Ended December 31,** | ** ** |
|-----------------------------------------|------------|--------------------------------------------|------------|
| ** **                              | ** ** | **2005**                                   | ** ** | **2004** | ** ** |
| Amounts  capitalized, beginning of year |       | $                                          | 11,838     |   | $ | 7,212 |   |
| Development costs  capitalized          |       | 2,269                                      |       | 1,670 |   |
| Acquisitions                            |       | 2,869                                      |       | 2,956 |   |
| Amounts  capitalized, end of year       |       | 16,976                                     |       | 11,838 |   |
| Accumulated amortization, end of year   |       | (8,128                                     | )          | (6,000 | ) |
| Software development  costs, net        |       | $                                          | 8,848      |   | $ | 5,838 |   |

 

Included in the above arecapitalized software development costs for unreleased products of $1.0 millionand $1.3 million at December 31, 2005 and 2004, respectively. During theyears ended December 31, 2005, 2004 and 2003, we recognized amortizationexpense related to capitalized software development costs of $2.1 million, $1.8million, and $1.9 million, respectively.

**NOTE 4:**             GOODWILLAND INTANGIBLE ASSETS

Changesin the carrying amounts of goodwill by segment are as follows (in thousands):

| ** **                           | ** ** | **Year Ended December 31, 2005** | ** ** | **Year Ended December 31, 2004** | ** ** |
|--------------------------------------|------------|------------------------------------------------------|------------|------------------------------------------------------|------------|
| ** **                           | ** ** | **Case  Management**                                 | ** ** | **Document  Management**                             | ** ** | **Total** | ** ** | **Case  Management** | ** ** | **Document  Management** | ** ** | **Total** | ** ** |
| Balance,  beginning of period        |       |                                                 | $          | 106,371                                              |       |   |   | $ | 41,357 |   |   | $ | 147,728 |   |   | $ | 43,716 |   |   |   | $ | 20,472 |   |   | $ | 64,188 |   |
| Goodwill acquired  during the period |       |                                                 | 94,565     |                                                 |       |   | 7,134 |   |   | 101,699 |   |   | 62,655 |   |   |   | 20,885 |   |   | 83,540 |   |
| Balance, end of period               |       |                                                 | $          | 200,936                                              |       |   |   | $ | 48,491 |   |   | $ | 249,427 |   |   | $ | 106,371 |   |   |   | $ | 41,357 |   |   | $ | 147,728 |   |

 

Otherintangible assets as of December 31, 2005 and 2004 consisted of thefollowing (in thousands):

| ** **                                 | ** ** | **December 31,** | ** ** | **Estimated** | ** ** |
|--------------------------------------------|------------|-----------------------|------------|---------------|------------|
| ** **                                 | ** ** | **2005**              | ** ** | **2004**      | ** ** | **Useful Life** | ** ** |
| Amortized Identifiable  Intangible Assets: |       |                  |       |          |       |   |   |
| Customer relationships                     |       | $                     | 37,313     |          | $          | 16,560 |   | 2 - 14 years |   |
| Accumulated amortization                   |       | (6,170                | )          | (7,656        | )          |   |   |
| Customer relationships, net                |       | 31,143                |       | 8,904         |       |   |   |
| Trade names                                |       | 2,319                 |       | 1,574         |       | 1 - 2 years |   |
| Accumulated amortization                   |       | (1,578                | )          | (721          | )          |   |   |
| Trade names, net                           |       | 741                   |       | 853           |       |   |   |
| Non-compete agreements                     |       | 27,525                |       | 17,630        |       | 5 - 10 years |   |
| Accumulated amortization                   |       | (6,010                | )          | (3,330        | )          |   |   |
| Non-compete agreements, net                |       | 21,515                |       | 14,300        |       |   |   |
| Total amortized  intangible assets, net    |       | $                     | 53,399     |          | $          | 24,057 |   |   |   |

 

F-12

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**NOTE 4:    GOODWILL AND INTANGIBLE ASSETS (Continued)**

The weighted average lifefor identifiable intangibles acquired during 2005 are as follows:

| Customer relationships       |   | 7.9 years |
|------------------------------|--------|-----------|
| Trade names                  |   | 1.4 years |
| Non-compete agreements       |   | 5.0 years |
| All identifiable intangibles |   | 7.0 years |

 

Amortizationexpense for each year in the three year period ended December 31, 2005 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: |       |                                                      |       |   |   |
| 2003                                                               |       |                                                      | $          | 3,610 |   |   |
| 2004                                                               |       |                                                      | 7,767      |   |   |
| 2005                                                               |       |                                                      | 6,751      |   |   |
| Estimated amortization expense:                                    |       |                                                      |       |   |   |
| 2006                                                               |       |                                                      | 10,853     |   |   |
| 2007                                                               |       |                                                      | 8,384      |   |   |
| 2008                                                               |       |                                                      | 7,964      |   |   |
| 2009                                                               |       |                                                      | 6,882      |   |   |
| 2010                                                               |       |                                                      | 6,492      |   |   |
|                                                                    |            |                                                           |            |  |  |  |

 

During November 2003(the “Measurement Date”), a decision was made to dispose of our infrastructuresoftware business. In accordance with SFAS No. 144, *Accountingfor the Impairment or Disposal of Long-Lived Assets,*long-livedassets classified as held for sale were measured at the lower of their carryingamounts or fair value less cost to sell. Accordingly, as of the MeasurementDate, we performed an impairment analysis based on estimated proceeds from thesale less selling costs. Based on this analysis, the carrying amount ofgoodwill and identified intangible assets related to the infrastructuresoftware segment, with an aggregate balance of $4.8 million as of January 1,2003, was entirely impaired. The related impairment charge is included as acomponent of discontinued operations on our Consolidated Statements of Incomefor the year ended December 31, 2003.

**NOTE 5:**             INDEBTEDNESS

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

| ** **                                                | ** ** | **Year Ended December 31,** | ** ** |
|-----------------------------------------------------------|------------|--------------------------------------------|------------|
| ** **                                                | ** ** | **2005**                                   | ** ** | **2004** | ** ** |
| Senior term loan                                          |       | $                                          | 25,000     |   | $ | 21,875 |   |
| Senior revolving  loan                                    |       | 93,028                                     |       | 5,000 |   |
| Convertible  subordinated debt, including embedded option |       | 51,326                                     |       | 50,292 |   |
| Capital leases                                            |       | 972                                        |       | 1,773 |   |
| Deferred  acquisition price                               |       | 3,222                                      |       | 3,209 |   |
| Total indebtedness                                        |       | $                                          | 173,548    |   | $ | 82,149 |   |

 

F-13

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**NOTE 5:**   INDEBTEDNESS (Continued)

***Credit Facilities***

As of December 31,2004, we had a credit facility, withKeyBank National Association as administrative agent, which consisted ofa $25.0 million senior term loan, with amortizing quarterly principal paymentsof $1.6 million, and a $50.0 million senior revolving loan.

In conjunction with ouracquisition of the nMatrix companies, during November 2005 we amended ourcredit facility. Based on the terms of our amended credit facility, weincreased our senior term loan borrowings from $17.2 million to $25.0 million. Theamended credit facility eliminated the requirement for quarterly amortizingpayments on the senior term loan, but also shortened the maturity of the seniorterm loan from June 2008 to August 2006. The amended credit facilityalso increased our senior revolving loan from $75.0 million to $100.0 million. Thematurity of the senior revolving loan was extended from June 2008 to November 2008.During the term of the loan, we have the right, subject to compliance with ourcovenants, to increase the senior revolving loan to $175.0 million.

During November 2005,under the amended credit facility we borrowed an additional $7.8 million underthe senior term loan and $93.0 million under the senior revolving loan tofinance the cash portion of our acquisition of nMatrix.

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. We were in compliancewith all financial covenants as of December 31, 2005. As calculated at December 31,2005, additional availability under this facility was approximately $7.0million. As of December 31, 2005, our borrowings under the new creditfacility totaled $118.0 million, consisting of $25.0 million borrowed under thesenior term loan and $93.0 million borrowed under the senior revolving loan. Intereston the credit facility is generally based on a spread, which as of December 31,2005 was 300 basis points, over the LIBOR rate. As of December 31, 2005,the interest rate charged on outstanding borrowings under the credit facilityranged from 7.4% to 7.6%.

***ConvertibleSubordinated Debt***

DuringJune 2004, we issued $50.0 million of contingent convertible subordinatednotes. Net proceeds of $47.4 million were used to repay and terminate anoutstanding subordinated term loan and to pay in full our then outstandingrevolving loan balance. The contingency has been satisfied and the notes may,at the option of the holders, be converted into shares of our common stock atany time. 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

·       mature on June 15,2007, subject to extension of maturity to June 15, 2010 at the option ofthe 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 a consistentbasis and, accordingly, the number of shares of common stock we would issue onconversion would be adjusted.

The holders of the notes have the right to extend thematurity of the notes for a period not to exceed three years. Under SFAS No. 133,*Accounting for Derivative Instruments and HedgingActivities*, the right to extend the maturity of the notes representsan embedded option subject to bifurcation. The embedded option was initiallyvalued at $1.2 million and the convertible debt balance was reduced by the sameamount. The convertible debt is accreted approximately $0.1 million eachquarter such that, at the end of 

F-14

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**NOTE 5:**   INDEBTEDNESS (Continued)

three years, theconvertible debt balance will total $50.0 million. On our accompanyingConsolidated Statements of Income, this accretion is a component of interestexpense. The embedded option must be revalued at each period end based on theprobability weighted discounted cash flows related to the additional 4%interest rate payments that will be made if the convertible debt maturity isextended an additional three years. Under this methodology, the embedded optionhas a current value of approximately $1.9 million. On our accompanyingConsolidated Balance Sheets, our obligation related to the embedded option hasbeen included as a component of the convertible note payable. During the yearended December 31, 2005, the value of the embedded option increased byapproximately $0.6 million and this increase is included as a component ofinterest expense on our accompanying Consolidated Statements of Income for theyear ended December 31, 2005. The changes in carrying value of theconvertible debt and fair value of the embedded option do not affect our cashflow and, if the embedded option is exercised, the value assigned to theembedded option will be amortized as a reduction to our 4% convertible debtinterest expense over the periods payments are made. If the option is notexercised by some or all convertible debt holders, any remaining related valueassigned to the embedded option will be recognized as a gain during thatperiod.

The notes evidencing thecontingent subordinated convertible debt contains financial covenants relatedto EBITDA, total debt, and senior debt. We were in compliance with allfinancial covenants as of December 31, 2005.

***Capital Lease***

At December 31, 2005,our debt obligation related to capital leases, classified as a currentliability, was approximately $1.0 million.

***Deferred Acquisition Price***

On January 31, 2003, we acquired 100% of themembership interests of Bankruptcy Services LLC (“BSI”), a provider oftechnology-based case management, consulting and administrative services forcorporate restructurings,. A portion of the purchase price, $4.0 million, wasdeferred. This deferred purchase price, which is payable in five annualinstallments through January 2008, was discounted using an imputedinterest rate of 5% per annum. At December 31, 2005, the discounted valueof the remaining note payments was approximately $2.8 million of whichapproximately $1.7 million was classified as a current liability.

On October 20, 2005,we acquired 100% of the equity of Hilsoft, Inc. (“Hilsoft”), a specialtyprovider of legal notification services, primarily for class action engagements.A portion of the purchase price, $0.5 million, was deferred. This deferredpayment, which is non-interest bearing and is payable on October 20, 2007,was discounted using an imputed interest rate of 8% per annum. At December 31,2005, the discounted value of this deferred payment was approximately $0.4million and is classified entirely as a noncurrent liability.

F-15

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**NOTE 5:**   INDEBTEDNESS (Continued)

***Scheduled Principal Payments***

Ourlong-term obligations, including credit facility debt outstanding as of December 31,2005, convertible debt (including embedded option), deferred acquisition costs,and capitalized leases, mature as follows for years ending December 31 (inthousands):

| 2006  |   | $      | 27,642  |   |
|-------|--------|--------|---------|--------|
| 2007  |   | 52,342 |    |
| 2008  |   | 93,564 |    |
| Total |   | $      | 173,548 |   |

 

**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). Additionally, we have non-cancelable operating leases for officeequipment and automobiles expiring through 2009.

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

| 2006                          |   | $     | 3,019  |   |
|-------------------------------|--------|-------|--------|--------|
| 2007                          |   | 2,670 |   |
| 2008                          |   | 2,271 |   |
| 2009                          |   | 1,995 |   |
| 2010                          |   | 1,586 |   |
| Thereafter                    |   | 7,660 |   |
| Total minimum lease  payments |   | $     | 19,201 |   |

 

Expense related to operating leases was approximately$2.6 million, $2.5 million, and $1.0 million for the years ended December 31,2005, 2004 and 2003, respectively.

Subsequent to year-end, weentered into a lease for new office space for our electronic litigationdiscovery operations. This lease extends through 2015 and has total minimumlease of approximately $17.9 million.

**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.

On January 31, 2003, we issued approximately 1.1million shares of restricted common stock, valued at approximately $16.5million, as a part of the transaction to purchase the membership interests ofBSI. Half of the restricted shares could not be sold, transferred or encumberedfor a period of one year from the date of issue, and the other half of therestricted shares could not be sold, transferred or encumbered for a period oftwo years from the date of issue. All shares of our common stock issued inconnection with the BSI acquisition are now unrestricted.

F-16

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**NOTE 7:**   STOCKHOLDERS’ EQUITY(Continued)

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. The payment of dividends iswithin the discretion of our board of directors and will depend upon variousfactors, including future earnings, capital requirements, financial condition,the terms of our credit agreement, the terms of our convertible notes, andother factors deemed relevant by the board of directors. There is norestriction on the ability of our subsidiaries to transfer funds to EPIQ in theform of cash dividends, loans or advances.

**NOTE8:**   EMPLOYEE BENEFITPLANS

***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.

***DefinedContribution Plan***

We have definedcontribution 401(k) plans covering substantially all employees. For EPIQand BSI employees, we match 60% of the first 10% of employee contributions andalso have the option of making discretionary contributions. For Poorman-Douglasemployees, the percent match is based on years of service. After three years ofservice, we match 100% of the first 6% of employee contributions. Ourcontributions under both plans were approximately $0.8 million, $0.8 million,and $0.4 million for the years ended December 31, 2005, 2004, and 2003,respectively.

**NOTE9:**   FINANCIALINSTRUMENTS AND CONCENTRATIONS

***Fair Value ofFinancial Instruments***

Estimates of fair valuesare subjective in nature and involve uncertainties and matters of significantjudgment and therefore cannot be determined with precision. Changes inassumptions could affect the estimates.

As of December 31,2005, the carrying value of cash, cash equivalents, and trade receivablesapproximate fair value. Borrowings under our credit facility are repricedfrequently at market rates and approximate fair value. Our notes related to theBSI and Hilsoft deferred acquisition price are discounted at an imputedinterest rate of 5% and 8%, respectively, and their combined carrying value of$3.2 million approximates fair value as of December 31, 2005. As of December 31,2005, our convertible notes, which have a fixed interest rate of 4%, have acarrying value of $51.3 million and a fair value of $50.3 million. The fairvalue was calculated using a pricing model that incorporates assumptionsregarding future volatility, interest rates and credit risk.

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

On April 1, 2004, ourexclusive national marketing arrangement with Bank of America became anon-exclusive arrangement with pricing established through September 30,2006. During February 2006, the parties agreed to extend the arrangementindefinitely. Either party may, with appropriate notice, wind down theagreement over a period, including the notice period, of three years. Wecurrently promote our Chapter 7 *TCMS*âsoftware 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 21%, 24% and 51% of our total revenues for the years ended December 31,2005, 2004 and 2003, respectively. Additionally, Bank of America representedapproximately 

F-17

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**NOTE 9:**   FINANCIAL INSTRUMENTS ANDCONCENTRATIONS (Continued)

13% and12% of our accounts receivable balance as of December 31, 2005 and 2004,respectively. In addition, a customer related to our newly acquired electroniclitigation discovery business represented approximately 13% of our accountsreceivable balance as of December 31, 2005.

**NOTE 10:**   INCOME TAXES

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

| ** **                                                          | ** ** | **Years Ended December 31,** | ** ** |
|---------------------------------------------------------------------|------------|---------------------------------------------|------------|
| ** **                                                          | ** ** | **2005**                                    | ** ** | **2004** | ** ** | **2003** | ** ** |
| Income from  continuing operations before income taxes              |       | $                                           | 18,224     |   | $ | 15,449 |   | $ | 24,690 |   |
| Provision for income  taxes from continuing operations:             |       |                                        |       |   |   |   |   |
| Currently payable  (receivable) income taxes                        |       |                                        |       |   |   |   |   |
| Federal                                                             |       | $                                           | 6,996      |   | $ | (16 | ) | $ | 7,245 |   |
| State                                                               |       | 468                                         |       | 83 |   | 2,886 |   |
| Total                                                               |       | 7,464                                       |       | 67 |   | 10,131 |   |
| Deferred income  taxes                                              |       |                                        |       |   |   |   |   |
| Federal                                                             |       | (597                                        | )          | 5,843 |   | 28 |   |
| State                                                               |       | 409                                         |       | 476 |   | 6 |   |
| Total                                                               |       | (188                                        | )          | 6,319 |   | 34 |   |
| Provision for  income taxes from continuing operations              |       | 7,276                                       |       | 6,386 |   | 10,165 |   |
| Provision (benefit) for  income taxes from discontinued operations: |       |                                        |       |   |   |   |   |
| Current income taxes                                                |       | —                                      |       | (1,452 | ) | (1,855 | ) |
| Deferred income taxes                                               |       | —                                      |       | 1,889 |   | (1,889 | ) |
| Provisions  (benefit) for income taxes from discontinued operations |       | —                                      |       | 437 |   | (3,744 | ) |
| Consolidated income tax  provision                                  |       | $                                           | 7,276      |   | $ | 6,823 |   | $ | 6,421 |   |

 

Areconciliation of the provision for income taxes from continuing operations atthe statutory rate of 35% to the provision for income taxes from continuingoperations at our effective rate is shown below (in thousands):

| ** **                                             | ** ** | **Years Ended December 31,** | ** ** |
|--------------------------------------------------------|------------|---------------------------------------------|------------|
| ** **                                             | ** ** | **2005**                                    | ** ** | **2004** | ** ** | **2003** | ** ** |
| Computed at the  statutory rate                        |       | $                                           | 6,378      |   | $ | 5,407 |   | $ | 8,641 |   |
| Change in taxes  resulting from:                       |       |                                        |       |   |   |   |   |
| State income taxes, net of federal tax effect          |       | 840                                         |       | 717 |   | 1,372 |   |
| Other                                                  |       | 58                                          |       | 262 |   | 152 |   |
| Provision for income  taxes from continuing operations |       | $                                           | 7,276      |   | $ | 6,386 |   | $ | 10,165 |   |

 

Tax benefits related toacquisitions of $0.3 million and $0.5 million were recorded as a reduction togoodwill for the years ended December 31, 2005 and 2004, respectively.

F-18

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**NOTE 10:**   INCOME TAXES(Continued)

The tax effects oftemporary differences that give rise to significant portions of deferred taxassets and deferred tax liabilities on the accompanying Consolidated BalanceSheets are as follows (in thousands):

| ** **                                             | ** ** | **December 31,** | ** ** |
|--------------------------------------------------------|------------|-----------------------|------------|
| ** **                                             | ** ** | **2005**              | ** ** | **2004** | ** ** |
| Deferred tax assets:                                   |       |                  |       |   |   |
| Allowance for doubtful accounts                        |       | $                     | 1,567      |   | $ | 467 |   |
| Convertible debt                                       |       | 567                   |       | 115 |   |
| Intangible assets                                      |       | 532                   |       | 127 |   |
| Accrued liabilities                                    |       | 906                   |       | — |   |
| State net operating loss carryforwards                 |       | 572                   |       | 781 |   |
| Total deferred tax assets                              |       | 4,144                 |       | 1,490 |   |
| Deferred tax  liabilities:                             |       |                  |       |   |   |
| Prepaid expenses                                       |       | 868                   |       | 494 |   |
| Intangible assets                                      |       | 22,958                |       | 6,396 |   |
| Property and equipment and software development  costs |       | 4,873                 |       | 3,542 |   |
| Other                                                  |       | 282                   |       | — |   |
| Total deferred tax liabilities                         |       | 28,981                |       | 10,432 |   |
| Net deferred tax  liability                            |       | $                     | (24,837    | ) | $ | (8,942 | ) |

 

As of December 31, 2005, we have aggregate stateoperating loss carryforwards, primarily related to our acquisitions ofPoorman-Douglas and nMatrix, of $9.9 million. These carryforwards expire asfollows:  $7.5 million in 2019 and $2.4million in 2025. Management believes that it is more likely than not that wewill be able to utilize these carryforwards and, therefore, no valuationallowance is necessary.

Theabove net deferred tax liability is presented on the Consolidated BalanceSheets as follows (in thousands):

| ** **                                 | ** ** | **December 31,** | ** ** |
|--------------------------------------------|------------|-----------------------|------------|
| ** **                                 | ** ** | **2005**              | ** ** | **2004** | ** ** |
| Current deferred  income tax assets        |       | $                     | 1,978      |   | $ | 754 |   |
| Long-term  deferred income tax liabilities |       | (26,815               | )          | (9,696 | ) |
|                                       |       | $                     | (24,837    | ) | $ | (8,942 | ) |

 

F-19

----

**NOTE 11:**   NET INCOME PER SHARE

Thedetails of the calculation of basic and diluted net income per share fromcontinuing operations are as follows (in thousands, except per share data):

| ** **                                                   | ** ** | **Year Ended December 31,** | ** ** |                                       |
|--------------------------------------------------------------|------------|--------------------------------------------|------------|--------------------------------------------|
| ** **                                                   | ** ** | **2005**                                   | ** ** | **2004**                                   | ** ** | **2003** | ** ** |   |
| ** **                                                   | ** ** | **Net  Income**                            | ** ** | **Weighted  Average  Shares  Outstanding** | ** ** | **Per  Share  Amount** | ** ** | **Net  Income** | ** ** | **Weighted  Average  Shares  Outstanding** | ** ** | **Per  Share  Amount** | ** ** | **Net  Income** | ** ** | **Weighted  Average  Shares  Outstanding** | ** ** | **Per  Share  Amount** | ** ** |   |
| Basic income per share from continuing operations            |       | $                                          | 10,948     |                                       |   | 18,092 |   |   |   | $ | 0.61 |   |   |   | $ | 9,063 |   |   |   | 17,848 |   |   |   | $ | 0.51 |   |   | $ | 14,525 |   |   | 17,619 |   |   |   | $ | 0.82 |   |   |
| Effect of dilutive  securities:                              |       |                                       |       |                                       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Stock options                                                |       |                                       |       |                                       | 602 |   |   |   |   |   |   |   |   |   |   |   | 411 |   |   |   |   |   |   |   |   |   | 485 |   |   |   |   |   |   |
| Convertible debt                                             |       | $                                          | 1,178      |                                       |   | 2,857 |   |   |   |   |   |   |   | $ | 647 |   |   |   | 1,569 |   |   |   |   |   |   |   |   |   | — |   |   |   |   |   |   |
|  

Diluted income per  share from continuing operations |       | $                                          | 12,126     |                                       |   | 21,551 |   |   |   | $ | 0.56 |   |   |   | $ | 9,710 |   |   |   | 19,828 |   |   |   | $ | 0.49 |   |   | $ | 14,525 |   |   | 18,104 |   |   |   | $ | 0.80 |   |   |

 

For the years endedDecember 31, 2005, 2004, and 2003, weighted-average outstanding stockoptions totaling approximately 1.3 million, 1.5 million and 0.1 million sharesof common stock, respectively, were antidilutive and therefore not included inthe computation of diluted earnings per share.

**NOTE 12:**   STOCKOPTIONS

During June 2004, our 2004 Equity Incentive Plan(the “2004 Plan”) was approved by our shareholders and replaced our 1995 StockOption Plan, as amended (the “1995 Plan”). The 2004 Plan limits the combinedgrant of options to acquire shares of common stock, stock appreciation rights,and restricted stock to 3,000,000 shares. Any grant under the 2004 Plan thatexpires or terminates unexercised, becomes unexercisable or is forfeited willbe available for further grants unless, in the case of options granted, relatedstock appreciation rights are exercised. At December 31, 2005, there wereapproximately 986,000 options available for future grants under the 2004 Plan. Underthe 2004 Plan, the option price may not be less than 100% of the fair marketvalue of the common stock on the date of grant for a non-qualified stock optionor an incentive stock option (“ISO”). In the case of an ISO granted to anemployee owning more than 10% of the voting stock of EPIQ, the option price maynot be less than 110% of the fair market value of the common stock on the dateof grant.

The Compensation Committee of the Board of Directorsadministers the 2004 Plan and has discretion to determine the term of anoption, which may not be exercised more than 10 years after the date of grant. Inthe case of an ISO granted to an employee owning more than 10% of the votingstock of EPIQ, the term may not exceed five years from the date of grant. Optionsmay not be transferred by an optionee except by will or the laws of descent anddistribution or to a family member by gift or qualified domestic relationsorder and are exercisable during the lifetime of an optionee only by theoptionee or the optionee’s guardian or legal representatives. Assuming theoption is otherwise still exercisable, options must be exercised within oneyear after termination of employment due to death or disability and withinthree months of any other termination of employment.

The Board of Directors may require in its discretionthat any option granted becomes exercisable only in installments or after someminimum period of time, or both. The vesting schedule for outstanding optionsranges from immediate to five years.

F-20

----

**NOTE12:**   STOCK OPTIONS (Continued)

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 vested 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 February 2005, our compensation committeeapproved acceleration of the vesting of certain unvested options for employees,including an executive officer, and non-employee directors. The decision toaccelerate the vesting of these options and eliminate future compensationexpense was based primarily on a review of our long-term incentive programsconsidering the effect on our financial statements of changes in accounting rules thatwe must adopt in 2006. This action, which had an immaterial effect on ourfinancial statements for the year ended December 31, 2005, will reduce theimpact of adoption of SFAS No. 123R on our future consolidated financialstatements.

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 key executives to acquire up to 300,000shares of common stock. The options were granted at an option exercise priceequal 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. Duringthe year, one of the executives transitioned from full-time employee status toa consulting role and his option to purchase 100,000 shares of common stock wasterminated.

During the year ended December 31, 2003, as partof the BSI acquisition, inducement stock options were granted, outside the 1995Plan and 2004 Plan, to a key executive to acquire up to 100,000 shares ofcommon stock. The option was granted at an option exercise price equal to fairmarket value of the common stock on the date of grant, were non-qualifiedoptions, were exercisable for up to ten years from the date of grant and vested20% on the grant date and continues to vest 20% per year on each anniversary ofthe grant date until fully vested. During the year ended December 31,2003, the vested portion of the option was exercised to purchase 20,000 sharesof common stock.

Following is a summary of our stock optionsoutstanding as of each year ended December 31 (in thousands, except pricedata):

| ** **                                                      | ** ** | **2005**   | ** ** | **2004**                                | ** ** | **2003**   | ** ** |
|-----------------------------------------------------------------|------------|------------|------------|-----------------------------------------|------------|------------|------------|
| ** **                                                      | ** ** | **Shares** | ** ** | **Weighted-  Average  Exercise  Price** | ** ** | **Shares** | ** ** | **Weighted-  Average  Exercise  Price** | ** ** | **Shares** | ** ** | **Weighted-  Average  Exercise  Price** | ** ** |
| Outstanding, beginning of year                                  |       | 3,230      |       |                                    | $          | 13.65      |       |   | 2,192 |   |   | $ | 12.38 |   |   | 1,744 |   |   | $ | 6.87 |   |   |
| Granted                                                         |       | 1,750      |       |                                    | 15.43      |       |       | 1,370 |   |   | 15.48 |   |   | 727 |   |   | 16.42 |   |   |
| Forfeited                                                       |       | (70        | )          |                                    | 14.08      |       |       | (232 | ) |   | 15.83 |   |   | (87 | ) |   | 10.08 |   |   |
| Exercised                                                       |       | (141       | )          |                                    | 7.25       |       |       | (100 | ) |   | 5.75 |   |   | (192 | ) |   | 5.36 |   |   |
| Outstanding, end  of year                                       |       | 4,769      |       |                                    | 14.49      |       |       | 3,230 |   |   | 13.65 |   |   | 2,192 |   |   | 12.38 |   |   |
| Options exercisable, end of year                                |       | 3,323      |       |                                    |       |       |       | 1,783 |   |   |   |   |   | 1,225 |   |   |   |   |   |
| Weighted-average fair  value of options granted during the year |       | $          | 6.46       |                                    |       |       |       |   | $ | 7.04 |   |   |   |   |   | $ | 8.34 |   |   |   |   |   |
|                                                                 |            |            |            |                                         |            |            |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

F-21

----

**NOTE 12:**   STOCK OPTIONS(Continued)

The following table summarizes information about stockoptions outstanding as of December 31, 2005 (in thousands, except life andprice 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 $11.99  |                                    |                         | 597        |                         |       |   | 4.18 years |   |   |   | $ | 6.48 |   |   |   | 597 |   |   |   | $ | 6.48 |   |   |
| $12.00 to $13.99 |                                    |                         | 1,221      |                         |       |   | 8.77 years |   |   |   | 12.45 |   |   |   | 1,009 |   |   |   | 12.37 |   |   |
| $14.00 to $15.99 |                                    |                         | 1,141      |                         |       |   | 8.32 years |   |   |   | 15.18 |   |   |   | 836 |   |   |   | 15.34 |   |   |
| $16.00 to $17.99 |                                    |                         | 761        |                         |       |   | 7.33 years |   |   |   | 16.61 |   |   |   | 566 |   |   |   | 16.62 |   |   |
| $18.00 and over  |                                    |                         | 1,049      |                         |       |   | 9.19 years |   |   |   | 19.11 |   |   |   | 315 |   |   |   | 18.66 |   |   |
|             |                                    |                         | 4,769      |                         |       |   | 7.95 years |   |   |   | 14.49 |   |   |   | 3,323 |   |   |   | 13.38 |   |   |
|                  |                                         |                              |            |                              |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

**NOTE 13:**   BUSINESSACQUISITIONS

***nMatrix***

On November 15, 2005, EPIQ, acting through awholly-owned subsidiary, acquired all the issued and outstanding shares ofcapital stock of nMatrix, Inc., nMatrix Australia Ptd. Ltd., and nMatrixLtd. (collectively, “nMatrix”) for approximately $126.2 million, includingcapitalized acquisition costs. We believe this acquisition providescomplementary diversification to our existing legal services business asnMatrix provides electronic litigation discovery services to law firms andin-house counsel. 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. nMatrix,which will be included within our case management segment, will be operatedfrom its current locations in New York, the United Kingdom, and Australia. Basedon our preliminary valuation, the purchase price has been allocated as follows(in thousands):

| Accounts receivable    |   | $       | 11,844  |   |
|------------------------|--------|---------|---------|--------|
| Other current assets   |   | 2,926   |    |
| Property and software  |   | 7,323   |    |
| Trade names            |   | 474     |    |
| Customer relationships |   | 25,040  |    |
| Non-compete agreements |   | 6,675   |    |
| Current liabilities    |   | (6,426  | )       |
| Deferred tax liability |   | (16,301 | )       |
| Goodwill               |   | 94,602  |    |
| Total purchase price   |   | $       | 126,157 |   |

 

Trade names, customer relationships, and thenon-compete agreements are amortized using the straight-line method over oneyear, eight years, and five years, respectively. The excess purchase price of$94.6 million was allocated to goodwill and is not amortized but will bereviewed for impairment annually and between annual tests if events or changesin circumstances indicate that the asset might be impaired. The purchase pricein excess of the tax basis of the assets, primarily allocated to identifiableintangible assets and goodwill, is not expected to be deductible for taxpurposes. Of our common shares issued as consideration, approximately 246,000are held in escrow. On submission of properly approved indemnification claims,the escrow trustee will liquidate sufficient shares to pay the indemnificationclaim. As of December 31, 2005, we have not submitted any claims relatedto this escrow. The escrow 

F-22

----

**NOTE 13:**   BUSINESS ACQUISITIONS (Continued)

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. Also, $4.0 million of the cashconsideration is held in escrow pending collection of certain pre-acquisitionreceivables. Each month, a portion of the escrow is released to the sellerbased on the prior month’s collection of these pre-acquisition receivables. Asof December 31, 2005, $2.6 million remained in this escrow account. Thisescrow arrangement terminates following the payment for collections made duringSeptember 2006 of these pre-acquisition receivables, at which time anyamount that remains in escrow will be distributed to us.

The acquisition was accounted for using the purchasemethod of accounting with the operating results included in the accompanyingconsolidated financial statements from the date of acquisition.

***Hilsoft, Inc.***

On October 20, 2005, we acquired for cash all theissued and outstanding shares of capital stock of Hilsoft Inc. We believe thisacquisition provides complementary diversification to our existing class actionbusiness as Hilsoft is a specialtyprovider of legal notification services, primarily for class action engagements.The total value of the transaction, including capitalized transactioncosts, was $9.3 million. If certain revenue objectives are satisfied, we may berequired to make additional payments of up to $3.0 million to the former ownersof Hilsoft. Hilsoft, which will be included entirely within our documentmanagement segment, will be operated from its current location in Pennsylvania.Based on our preliminary valuation, the purchase price has been allocated asfollows (in thousands):

| Tangible assets         |   | $      | 418    |   |
|-------------------------|--------|--------|--------|--------|
| Trade name              |   | 271    |   |
| Customer backlog        |   | 323    |   |
| Non-compete  agreements |   | 2,680  |   |
| Current  liabilities    |   | (291   | )      |
| Deferred taxes,  net    |   | (1,341 | )      |
| Goodwill                |   | 7,233  |   |
| Total purchase price    |   | $      | 9,293  |   |

 

Customer backlog and the trade name are amortizedusing the straight-line method over two years. The non-compete agreements areamortized using the straight-line method over five years. The excess purchaseprice of $7.2 million was allocated to goodwill and is not amortized but willbe reviewed for impairment annually and between annual tests if events orchanges in circumstances indicate that the asset might be impaired. Thepurchase price in excess of the tax basis of the assets, primarily allocated toidentifiable intangible assets and goodwill, is not expected to be deductiblefor tax purposes.

The acquisition was accounted for using the purchasemethod of accounting with the operating results included in the accompanyingconsolidated financial statements from the date of acquisition.

F-23

----

**NOTE 13:**   BUSINESS ACQUISITIONS (Continued)

***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”).We believe this acquisition provides complementary diversification to ourexisting legal services business as Poorman-Douglas is a provider oftechnology-based products and services for class action, mass tort andbankruptcy case administration. The total value of the transaction, includingcapitalized acquisition costs, was approximately $115.7 million. Based on ourvaluation, the purchase price has been allocated as follows (in thousands):

| 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 identifiable intangible assets areamortized on a straight-line basis as follows: the trade names over two years, the customer backlog over three years,the customer relationships over twelve years, and the non-compete agreementsover five years. The excess purchase price of $83.1 million was allocated togoodwill and is not amortized but will be reviewed for impairment annually andbetween annual tests if events or changes in circumstances indicate that theasset might be impaired. The purchase price in excess of the tax basis of theassets, primarily allocated to identifiable intangible assets and goodwill, isnot expected to be deductible for tax purposes. The acquisition was accountedfor using the purchase method of accounting with the operating results includedin the accompanying consolidated financial statements from the date ofacquisition.

***Bankruptcy Services LLC***

On January 31, 2003, we acquired 100% of themembership interests of Bankruptcy Services LLC (“BSI”), a provider oftechnology-based case management, consulting and administrative services forcorporate restructuring cases. The total value of the transaction, includingcapitalized transaction costs, was $67.0 million of which $45.5 million waspaid in cash, $16.5 million (approximately 1.1 million shares) was paid in ourcommon stock, $3.4 million was deferred in the form of a non-interest bearingnote with a face value of $4.0 million discounted using an imputed interestrate of 5% per annum, $1.3 million of liabilities were assumed, and $0.3million was paid in acquisition costs. The purchase price was allocated asfollows (in thousands):

| Current assets          |   | $      | 2,616  |   |
|-------------------------|--------|--------|--------|--------|
| Property and  software  |   | 755    |   |
| Trade names             |   | 474    |   |
| Customer backlog        |   | 4,700  |   |
| Non-compete  agreements |   | 11,730 |   |
| Goodwill                |   | 46,739 |   |
| Total purchase price    |   | $      | 67,014 |   |

 

F-24

----

**NOTE 13:**   BUSINESS ACQUISITIONS (Continued)

Customer backlog and the non-compete agreements areamortized using the straight-line method over, respectively, two years and tenyears. Initially, the trade name was not amortized as it had an indefinite life.In conjunction with our acquisition of Poorman-Douglas we reassessed our use ofall trade names. Accordingly, in February 2004 we commenced amortizing theBSI trade name on a straight-line basis over two years. The excess purchaseprice of $46.7 million was allocated to goodwill and is not amortized but willbe reviewed for impairment annually and between annual tests if events orchanges in circumstances indicate that the asset might be impaired. Thepurchase price in excess of the tax basis of the assets, primarily allocated toidentifiable intangible assets and goodwill, has been determined to bedeductible for tax purposes.

The acquisition was accounted for using the purchasemethod of accounting with the operating results included in the accompanyingconsolidated financial statements from the date of acquisition.

***Pro Forma Information***

Unaudited pro forma operations, assuming each purchaseacquisition was made at the beginning of the year preceding the acquisition,are shown below (in thousands, except per share data):

| ** **                         | ** ** | **For the Years Ended December 31,** | ** ** |
|------------------------------------|------------|---------------------------------------------------------------|------------|
| ** **                         | ** ** | **2005**                                                      | ** ** | **2004** | ** ** | **2003** | ** ** |
| Total revenues                     |       | $                                                             | 158,084    |   | $ | 146,927 |   | $ | 133,532 |   |
| Income from continuing  operations |       | $                                                             | 10,668     |   | $ | 3,929 |   | $ | 15,438 |   |
| Discontinued operations            |       | —                                                        |       | 667 |   | (5,818 | ) |
| Net income                         |       | $                                                             | 10,668     |   | $ | 4,596 |   | $ | 9,620 |   |
| Net income per share:              |       |                                                          |       |   |   |   |   |
| Income per share—Basic        |       |                                                          |       |   |   |   |   |
| Income from continuing  operations |       | $                                                             | 0.59       |   | $ | 0.22 |   | $ | 0.88 |   |
| Loss from discontinued operations  |       | —                                                        |       | 0.04 |   | (0.33 | ) |
| Net income per share—Basic    |       | $                                                             | 0.59       |   | $ | 0.26 |   | $ | 0.55 |   |
| Income per share—Diluted      |       |                                                          |       |   |   |   |   |
| Income from continuing  operations |       | $                                                             | 0.52       |   | $ | 0.20 |   | $ | 0.85 |   |
| Loss from discontinued  operations |       | —                                                        |       | 0.03 |   | (0.32 | ) |
| Net income per share—Diluted  |       | $                                                             | 0.52       |   | $ | 0.23 |   | $ | 0.53 |   |

 

Pro forma data reflects the difference in amortizationexpense between EPIQ and the acquired companies as well as other adjustments,including income taxes and management compensation. The pro forma informationis not necessarily indicative of what would have occurred if the acquisitionhad been completed on that date nor is it necessarily indicative of futureoperating results.

F-25

----

**NOTE 14:**   DISCONTINUED OPERATIONS

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. Our estimated proceeds from the saleof our infrastructure software business, net of estimated selling costs, wasless than the carrying amount of this business. As a result, for the year endedDecember 31, 2003, we reduced the carrying value of these assets,consisting of property and equipment, goodwill and other intangible assets, andrecorded a pre-tax impairment charge, included in Discontinued Operations inthe accompanying Consolidated Statements of Income, of approximately $7.6million. The tax benefit related to this impairment charge, also included inDiscontinued Operations in the accompanying Consolidated Statements of Income,was approximately $3.0 million.

On April 30, 2004, we sold our infrastructuresoftware business to a private company with expertise in file transfertechnology for consideration consisting of cash and a note receivable. As of December 31,2005, we had collected all amounts due related to the note receivable. Duringthe year ended December 31, 2004, we recognized a gain related to thissale, included in discontinued operations in the accompanying ConsolidatedStatements of Income, of approximately $1.0 million, net of tax.

As of December 31,2004 and 2005, we did not hold any assets or liabilities related to thisdiscontinued business. Revenues, cost of sales, and operating expenses relatedto this discontinued business have been classified as “Discontinued Operations”in the accompanying Consolidated Statements of Income for all periods presented.Following is summary financial information for discontinued operations (inthousands):

**Netrevenue and pre-tax income (loss) from discontinued operations:**

| ** **                                          | ** ** | **Years Ended December 31,** | ** ** |
|-----------------------------------------------------|------------|---------------------------------------------|------------|
| ** **                                          | ** ** | **2005**                                    | ** ** | **2004** | ** ** | **2003** | ** ** |
| Net revenue from  discontinued operations           |       |                                        | $          | — |   |   | $ | 661 |   | $ | 1,988 |   |
| Pre-tax income  (loss) from discontinued operations |       |                                        | $          | — |   |   | $ | 1,104 |   | $ | (9,562 | ) |

 

**NOTE 15:**   SEGMENTREPORTING

During the quarter ended March 31, 2004, wechanged the structure of our operating segments as a result of changes in ourbusiness operations. These changes included our decision, during November 2003,to hold for sale our infrastructure business and our acquisition, in January 2004,of Poorman-Douglas, a provider oftechnology-based products and services for class action, mass tort andbankruptcy case administration.

With these changes, performance is now assessed forour case management and document management operating segments. Case managementsolutions provide clients with integrated technology-based products andservices for the automation of various administrative tasks. Documentmanagement solutions include proprietary technology and production services toensure timely, accurate and complete execution of the many documents associatedwith multi-faceted legal cases and communications applications.

Each segment’s performance is assessed based onsegment 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 

F-26

----

**NOTE 15:**   SEGMENT REPORTING (Continued)

segment are those assetsused by the segment in its operations and consist of property and equipment,software, identifiable intangible assets and goodwill. All other assets areclassified as unallocated.

Information concerningoperations of our reportable segments is as follows (in thousands):

| ** **                                                                  | ** ** | **Year Ended December 31, 2005** | ** ** |
|-----------------------------------------------------------------------------|------------|------------------------------------------------------|------------|
| ** **                                                                  | ** ** | **Case**                                             | ** ** | **Document** | ** ** | ** ** | ** ** | ** ** | ** ** |
| ** **                                                                  | ** ** | **Management**                                       | ** ** | **Management** | ** ** | **Unallocated** | ** ** | **Consolidated** | ** ** |
| Revenue:                                                                    |       |                                                 |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Operating revenue                                                           |       |                                                 | $          | 79,279 |   |   |   | $ | 27,874 |   |   |   | $ | — |   |   |   | $ | 107,153 |   |   |
| Reimbursed expenses                                                         |       |                                                 | 3,138      |   |   |   | 20,505 |   |   |   | — |   |   |   | 23,643 |   |   |
| Total revenue                                                               |       |                                                 | 82,417     |   |   |   | 48,379 |   |   |   | — |   |   |   | 130,796 |   |   |
| Costs and  expenses:                                                        |       |                                                 |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Direct and administrative costs and depreciation and  software 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                                                            |       |                                                 | $          | 44,810 |   |   |   | $ | 10,074 |   |   |   | $ | (29,973 | ) |   |   | 24,911 |   |   |
| Net expenses  related to financing                                          |       |                                                 |       |   |   |   |   |   |   |   |   |   |   |   | (6,687 | ) |   |
| Income from  continuing operations before income taxes                      |       |                                                 |       |   |   |   |   |   |   |   |   |   |   |   | 18,224 |   |   |
| Provision for  income taxes                                                 |       |                                                 |       |   |   |   |   |   |   |   |   |   |   |   | 7,276 |   |   |
| Net income from  continuing operations                                      |       |                                                 |       |   |   |   |   |   |   |   |   |   |   |   | $ | 10,948 |   |   |
| Total assets                                                                |       |                                                 | $          | 260,831 |   |   |   | $ | 59,581 |   |   |   | $ | 74,458 |   |   |   | $ | 394,870 |   |   |
| Provisions for  depreciation and amortization                               |       |                                                 | $          | 9,681 |   |   |   | $ | 2,155 |   |   |   | $ | 2,203 |   |   |   | $ | 14,039 |   |   |
| Capital expenditures                                                        |       |                                                 | $          | 4,961 |   |   |   | $ | 38 |   |   |   | $ | 1,825 |   |   |   | $ | 6,824 |   |   |

 

F-27

----

**NOTE 15:**   SEGMENT REPORTING (Continued)

| ** **                                                                  | ** ** | **Year Ended December 31, 2004** | ** ** |
|-----------------------------------------------------------------------------|------------|------------------------------------------------------|------------|
| ** **                                                                  | ** ** | **Case**                                             | ** ** | **Document** | ** ** | ** ** | ** ** | ** ** | ** ** |
| ** **                                                                  | ** ** | **Management**                                       | ** ** | **Management** | ** ** | **Unallocated** | ** ** | **Consolidated** | ** ** |
| Revenue:                                                                    |       |                                                 |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Operating revenue                                                           |       |                                                 | $          | 68,526 |   |   |   | $ | 36,549 |   |   |   | $ | — |   |   |   | $ | 105,075 |   |   |
| Reimbursed expenses                                                         |       |                                                 | 2,465      |   |   |   | 17,880 |   |   |   | — |   |   |   | 20,345 |   |   |
| Total revenue                                                               |       |                                                 | 70,991     |   |   |   | 54,429 |   |   |   | — |   |   |   | 125,420 |   |   |
| Costs and  expenses:                                                        |       |                                                 |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Direct and administrative costs and depreciation and  software 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 income                                                            |       |                                                 | $          | 36,641 |   |   |   | $ | 11,301 |   |   |   | $ | (25,283 | ) |   |   | 22,659 |   |   |
| Net expenses  related to financing                                          |       |                                                 |       |   |   |   |   |   |   |   |   |   |   |   | (7,210 | ) |   |
| Income from  continuing operations before income taxes                      |       |                                                 |       |   |   |   |   |   |   |   |   |   |   |   | 15,449 |   |   |
| Provision for  income taxes                                                 |       |                                                 |       |   |   |   |   |   |   |   |   |   |   |   | 6,386 |   |   |
| Net income from  continuing operations                                      |       |                                                 |       |   |   |   |   |   |   |   |   |   |   |   | $ | 9,063 |   |   |
| Total assets                                                                |       |                                                 | $          | 131,233 |   |   |   | $ | 51,264 |   |   |   | $ | 57,591 |   |   |   | $ | 240,088 |   |   |
| Provisions for  depreciation and amortization                               |       |                                                 | $          | 9,505 |   |   |   | $ | 2,998 |   |   |   | $ | 1,791 |   |   |   | $ | 14,294 |   |   |
| Capital expenditures,  including capital leases                             |       |                                                 | $          | 5,326 |   |   |   | $ | 36 |   |   |   | $ | 4,464 |   |   |   | $ | 9,826 |   |   |

 

| ** **                                                                  | ** ** | **Year Ended December 31, 2003** | ** ** |
|-----------------------------------------------------------------------------|------------|------------------------------------------------------|------------|
| ** **                                                                  | ** ** | **Case**                                             | ** ** | **Document** | ** ** | ** ** | ** ** | ** ** | ** ** |
| ** **                                                                  | ** ** | **Management**                                       | ** ** | **Management** | ** ** | **Unallocated** | ** ** | **Consolidated** | ** ** |
| Revenue:                                                                    |       |                                                 |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Operating revenue                                                           |       |                                                 | $          | 49,688 |   |   |   | $ | 12,730 |   |   |   | $ | — |   |   |   | $ | 62,418 |   |   |
| Reimbursed expenses                                                         |       |                                                 | 311        |   |   |   | 5,207 |   |   |   | — |   |   |   | 5,518 |   |   |
| Total revenue                                                               |       |                                                 | 49,999     |   |   |   | 17,937 |   |   |   | — |   |   |   | 67,936 |   |   |
| Costs and  expenses:                                                        |       |                                                 |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Direct and administrative costs and depreciation and  software amortization |       |                                                 | 13,118     |   |   |   | 9,658 |   |   |   | 15,150 |   |   |   | 37,926 |   |   |
| Amortization of identifiable intangible assets                              |       |                                                 | 2,102      |   |   |   | 1,508 |   |   |   | — |   |   |   | 3,610 |   |   |
| Acquisition related                                                         |       |                                                 | —     |   |   |   | — |   |   |   | 1,793 |   |   |   | 1,793 |   |   |
| Total operating expenses                                                    |       |                                                 | 15,220     |   |   |   | 11,166 |   |   |   | 16,943 |   |   |   | 43,329 |   |   |
| Operating income                                                            |       |                                                 | $          | 34,779 |   |   |   | $ | 6,771 |   |   |   | $ | (16,943 | ) |   |   | 24,607 |   |   |
| Net income  related to financing                                            |       |                                                 |       |   |   |   |   |   |   |   |   |   |   |   | 83 |   |   |
| Income from  continuing operations before income taxes                      |       |                                                 |       |   |   |   |   |   |   |   |   |   |   |   | 24,690 |   |   |
| Provision for  income taxes                                                 |       |                                                 |       |   |   |   |   |   |   |   |   |   |   |   | 10,165 |   |   |
| Net income from  continuing operations                                      |       |                                                 |       |   |   |   |   |   |   |   |   |   |   |   | $ | 14,525 |   |   |
| Total assets                                                                |       |                                                 | $          | 59,518 |   |   |   | $ | 26,806 |   |   |   | $ | 55,603 |   |   |   | $ | 141,927 |   |   |
| Provisions for  depreciation and amortization                               |       |                                                 | $          | 5,881 |   |   |   | $ | 1,516 |   |   |   | $ | 781 |   |   |   | $ | 8,178 |   |   |
| Capital expenditures                                                        |       |                                                 | $          | 3,609 |   |   |   | $ | — |   |   |   | $ | 2,916 |   |   |   | $ | 6,525 |   |   |

 

F-28

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**NOTE 16:**   SUPPLEMENTALCASH FLOW INFORMATION

Supplementalcash flow information is as follows (in thousands):

| ** **                                         | ** ** | **Year Ended December 31,** | ** ** |
|----------------------------------------------------|------------|--------------------------------------------|------------|
| ** **                                         | ** ** | **2005**                                   | ** ** | **2004** | ** ** | **2003** | ** ** |
| Cash paid (received)  for:                         |       |                                       |       |   |   |   |   |
| Interest                                           |       | $                                          | 3,376      |   | $ | 3,877 |   | $ | 53 |   |
| Income taxes                                       |       | 8,499                                      |       | (207 | ) | 7,518 |   |
| Non-cash investing and  financing transactions:    |       |                                       |       |   |   |   |   |
| Capitalized lease obligations incurred             |       | —                                     |       | 2,733 |   | — |   |
| Issuance of common shares in purchase transactions |       | 24,233                                     |       | — |   | 16,500 |   |
| Obligation  incurred in purchase transactions      |       | 463                                        |       | — |   | 3,445 |   |
|                                                    |            |                                            |            |  |  |  |  |  |  |  |

 

F-29

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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 from  continuing operations | ** ** |       | ** ** | ** **                                   |       |                                          | ** ** | ** **                           |       |   | ** ** | ** ** |   |   | ** ** | ** ** |   |   |   |   |   |
| 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 |   |   |
| For  the year ended  December 31,  2003                     |       |       | 5          | ** **                                   |       |                                          | 347        | ** **                           |       |   | **—** | ** ** |   |   | (12 | ) |   |   | 340 |   |   |
|                                                                       |            |            |            |                                              |            |                                               |            |                                      |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

----

(1)          Consistsprimarily of allowance related to acquired receivables.

 

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**EXHIBITINDEX**

The following exhibits are filed with this Form 10-Kor are incorporated herein by reference:

| Exhibit Number | ** ** | ** **                                                                                                                                                                                                                                                                                                                                                                                                                          | ** ** | **Description** |
|---------------------|------------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-----------------|
| 3.1                 |       | Articles  of Incorporation, as amended through June 2, 2004.*                                                                                                                                                                                                                                                                                                                                                                  |
| 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.*                                                                                                                                                                                                                                                                                                                                                                |
| 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. Incorporated by reference and previously filed as an  exhibit to the Definitive Proxy Statement filed with the Securities and  Exchange Commission on April 28, 2004.                                                                                                                                                                                                                             |
| 10.3                |       | Securities  Purchase Agreement dated as of November 7, 2002, among EPIQ  Systems, Inc. and the Purchasers named therein. 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 15, 2002.                                                                                                              |
| 10.4                |       | Membership  Interest Purchase Agreement dated as of January 31, 2003, among Jay D.  Chazanoff, Stephen R. Simms, Ron L. Jacobs, Kathleen Gerber, Bankruptcy  Services LLC, EPIQ Systems Acquisition, Inc. and EPIQ Systems, Inc.  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 10, 2003. |
| 10.5                |       | Employment  Agreement dated as of January 31, 2003, among Bankruptcy Services LLC,  EPIQ Systems, Inc. and Ron Jacobs. 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 10, 2003.                                                                                                            |
| 10.6                |       | Employment  Agreement dated as of January 31, 2003, among Bankruptcy Services LLC,  EPIQ Systems, Inc. and Kathleen Gerber. 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 10, 2003.                                                                                                            |
| 10.7                |       | Stock  Option Agreement among EPIQ Systems, Inc., Bankruptcy Services LLC and  Ron Jacobs dated as of January 31, 2003. 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 10, 2003.                                                                                                                |

----

 

| 10.8  |   | 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.                                  |
|-------|--------|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 10.9  |   | 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. |
| 10.10 |   | Employment and  Non-Competition Agreement between Poorman-Douglas Corporation and Jeffrey B.  Baker 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.                                                                                                                              |
| 10.11 |   | Stock Option Agreement  between EPIQ Systems, Inc. and  Jeffrey B. Baker 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.                                                                                                                                                     |
| 10.12 |   | 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.                                                                                            |
| 10.13 |   | 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.                       |
| 10.14 |   | 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.                                                                                                  |
| 10.15 |   | Form of  Nonqualified Stock Option Agreement under 2004 Equity Incentive Plan.*                                                                                                                                                                                                                                                                                                                                                                    |
| 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  Accountants.*                                                                                                                                                                                                                                                                                                                                                                |
| 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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